Stressed out about paying your income taxes?
Our tax system in the United States is quite complex. It’s very helpful to work with a qualified income tax professional, such as an accountant. An accountant can help you prepare your tax return and help you understand your tax liability. It’s also important to know and understand some of the key tax terms.
Explore these personal finance insights that focus on how to navigate income tax.
Important Tax Terms
Here’s a brief overview of some important tax terms to help you navigate your taxes:
Federal income tax
Whether or not you must file a federal return depends upon your age and income. However, most people who earn income must file a federal return and pay federal income taxes. In order to receive a tax refund, you must file a federal tax return.
State income tax
Most states impose state income tax on its residents. But some states, such as Florida, have no state income tax. If your state has an income tax, you must pay tax on your earnings in addition to paying your federal income tax. Your state return is separate from your federal tax return.
If you are employed, your employer withholds a certain amount of each paycheck in order to pay your income tax liability. You can adjust your withholding during the year using Form W-4. You should avoid withholding too much or too little from each paycheck.
A deduction lowers your income tax liability. For example, if you earned $60,000 and receive a $10,000 deduction, you are only taxed on $50,000. Deductions are a great way to reduce your overall tax liability.
A credit is an offset directly against the tax you owe. So, for example, if your tax liability is $10,000, a $2,000 tax credit means you only owe $8,000. A credit is more beneficial than a deduction, so take advantage of all of the tax credits you can.
Itemized vs. standard deduction
You choose whether you take the standard deduction or itemize your deductions each year. Starting in 2018, the standard deduction was increased significantly. Unless you have a lot of deductions to itemize, you should take the standard deduction. If the amount of your deductions is greater than the standard deduction, it makes sense to itemize. Common itemized deductions include state and local property or income tax, mortgage interest, and charitable contributions.
The IRS determines your tax bracket based on a percentage of your income. There are seven tax brackets. Your bracket depends upon your taxable income, and also what type of return you file: single, married filing jointly, married filing separately or head of household. You can find your tax bracket each year on the IRS’ website.
If employed, your employer provides you with a form W-2 each year which you need to file your taxes. It shows how much you earned and how much money was withheld during the year.
If you are an independent contractor or earned miscellaneous income, you will receive a form 1099 from any entity that paid you over $600 in one calendar year. Don’t forget to include 1099 income in calculating your overall tax liability.
Know how to navigate your income taxes
Now that you better understand these key tax terms, you should have a greater understanding of your own taxes. Even if you work with an accountant or tax preparer, the more armed you are with knowledge, the better you can control your tax liability. If you’re looking for someone to help you with your taxes, it’s easy to find a qualified accountant in your area.