If you worry about taxes, then take comfort in the fact that you’re not alone. Taxes can be confusing, even for adults, and there’s so much we don’t know about them. But the good news is, you can always learn the income tax basics.
Now that the time of year is coming up when financial matters start to come into focus, we’re finding ourselves submerged under never-ending numbers, deductions, and taxable income. But don’t worry because it’s not that hard to understand.
For starters, ‘income tax’ is just a kind of tax imposed by the government on the earnings generated by companies and people within their area of authority. As a taxpayer, you’re required by the law to file a return of income taxes each year to establish your tax obligations. With this tax, governments fund public services, pay their obligations, and fulfill their duties to the citizens.
If you need to know more, you’re in the right place because this article is about to discuss all you need to know about income tax. So, let’s begin!
- Penalties and Audits
To file your tax returns, you need to make sure you’re complying with the appropriate tax laws. Because if you don’t, there might be grave consequences to face. This means penalties like substantial understatement penalties, fines, or even audits by tax authorities.
To prevent this, make sure you maintain accurate records, report all your income, and have all the documents to back up your claims. The key is to stay organized and thorough, as it’ll reduce the risk of any mistakes.
If you want the substantial understatement penalty explained, you need to know that it’s a kind of penalty placed if your tax return understates your tax obligation drastically. While we won’t go into specifics, you should understand that this penalty may have serious financial consequences. To avoid this, consult with a tax professional or become familiar with the tax laws in your jurisdiction.
- Federal Income Tax
You might not know this, but not everyone who makes money over the course of the year is required to file a federal income tax return. The amount you earned – and where you got that income from – the status of your filing, and even your age – all influence whether or not you’re required to file. For most of us, the quick hack of the formula is as follows: find your standard deduction and add it up by your personal exemption.
But there’s more you might not know. Even if you don’t fit the federal income tax filing criteria, you can still reap the benefits of tax breaks and credits. A tax credit is a tax break that allows some taxpayers to deduct the amount of the credit from the entire sum owed to the state. It could also be a credit given in recognition of previously paid taxes or a type of state “discount” applied in certain circumstances.
Also, if you’re still enrolled in school, you might be able to use the AOC to cover qualified expenses such as tuition and fees. Workers with low to moderate income can benefit from the earned income tax credit. Contrary to popular belief, having children is not required, but it does boost the benefit.
- State and Local Income Tax
Although most states in the US impose a personal income tax, there are still eight of them that don’t. These states are Florida, Alaska, South Dakota, Nevada, Washington, Tennessee, Texas, and Wyoming. A bonus state is New Hampshire, which also doesn’t charge a state income tax on its residents, but they still need to pay 5% on interests earned and dividends. But luckily, by 2024, this tax will be phased out thanks to a bill passed in 2018.
But don’t forget that just because a state doesn’t impose income taxes doesn’t necessarily mean it’s less expensive to live there. Keep in mind, however, that living in a state without income taxes may not always be less expensive. This is given that states usually compensate for lost revenue through other taxes or cut services. Additionally, other factors such as medical services, expenses for living, and job opportunities influence how affordable it is to live in a state.
- Tax Rate and Brackets
The amount of income tax you owe can vary depending on your total income and where you live. In several places, something known as “progressive tax systems” is used in which people fall into different tax brackets. These brackets categorize your income and assign a tax rate for every range.
In broad terms, the higher your income, the higher your rate of taxation. As a result, if you make a lot of money, you’ll most likely pay more in the way of taxes. But if you have a low income, your total income tax will be of a lower percentage. It’s always good to know the tax rates and brackets that apply to your situation so you know how much money you owe.
Also, if your tax bracket changes, not all your income is charged within that bracket. Only the portion within the bracket is taxed at the higher rate. So, if you fall within the 25% tax range, only the amount that put you there will be taxed at 25%.
- International Tax
If you do business overseas or own property in different countries, don’t be fooled. You’re not safe from income taxes. International tax rules will come back to haunt you. These rules tell you how your income will be taxed, and honestly, it can get kind of confusing.
But there’s no need to worry because that’s why tax treaties between countries exist. They set up rules to prevent double taxation, which is when two countries tax the same amount of income.
Understanding income tax basics can be stressful, but when you’re armed with basic income tax knowledge, you can easily navigate the complex web of regulations. After reading this, you have learned the fundamentals of income tax, from taxable income to tax brackets, deductions, and credits. Always keep in mind the importance of maintaining accurate records, filing on time, and sticking to tax laws. Planning ahead of time and seeking expert guidance can help you optimize your tax situation.