One of the most significant financial obligations you will have as a working adult is paying taxes. Knowing how taxes operate puts you in charge of your finances, regardless of whether you're starting your first job or taking up a side gig. Understanding the fundamentals can help you succeed and prevent surprises when it comes to filing, deductions, and refunds.
Knowing the Fundamentals of Taxation
The portion of your income that is allocated to the federal government, as well as frequently state or local governments, is known as income tax. Roads, schools, emergency services, and healthcare initiatives are all funded by these levies. A progressive tax system is one in which your tax rate increases as your income does.
Does Everyone Have to File Taxes?
Your age, income, and filing status all affect whether you must file taxes. You probably have to file if you work for a living, are self-employed, or receive compensation. Filing may not be necessary for students or part-time employees, but it may still result in a refund if taxes were deducted from their paychecks. Additionally, filing contributes to the establishment of a financial history that may be helpful in the future for financial aid or loans.
How to Submit Your Tax Return
It may seem overwhelming to file taxes for the first time, but it's easier if you break it down
- W-2 Form: This document, if you are an employee, details your earnings and the amount of taxes deducted.
- The 1099 form is used for gig, contract, or freelance work.
- The 1040 Form is the primary tax form used by individuals to determine their tax obligations and potential refunds.
You can work with a professional, file by mail, or use tax software. Here's how to choose the right tax advisor for you. You might be eligible to submit your federal taxes for free under the IRS Free submit Program if your income is below a specific threshold.
Typical Tax Credits and Deductions
When filing your taxes, you have two options for reducing your taxable income: the standard deduction or itemizing your deductions. Choosing the right method depends on which provides the greater tax benefit.
A standard deduction is a fixed rate based on your filing status, while itemized deductions are an alternative to the standard deduction. If you have permitting tax deductions such as mortgage interest, charitable donations, state income taxes, or real estate taxes, and the total of these deductions is above the standard deduction, you will benefit from taking the itemized deduction. The IRS permits you to take the higher deduction whether it be the standard or itemized deduction.
In addition to the standard deduction or itemized deduction, the IRS permits other tax deductions and credits that it’s important to be aware of. In general, a tax deduction will decrease the amount of taxable income, resulting in a lower taxable income base for which your tax liability will be calculated on. A tax credit is a dollar-for-dollar reduction of your tax liability. Tax credits are classified as either refundable or non-refundable. If your credit amount is more than your tax bill, a refundable credit will increase the refund due to you. However, non-refundable credits will only reduce your tax liability to zero but will not result in a refund.
Common deductions include:
- Student Loan Interest Deduction: The IRS permits taxpayers to deduct the interest paid on student loan debt.
- IRA Deduction: Making deductible contributions to a traditional IRA may reduce taxable income. To contribute to a traditional IRA, the taxpayer must have earned income. Other factors such as whether the taxpayer and or spouse are active participants in an employer sponsored plan should be considered. These factors will determine the modified adjusted gross income (MAGI) phaseouts that will apply when determining whether the contribution is deductible for the year the contribution is made.
Common Credits include:
- Education Credits: Assist in paying for tuition and other educational costs. The Lifetime Learning Credit (LLC) and American Opportunity Credit are common education credits (AOTC). American Opportunity Credit is partially refundable, where the lifetime learning credit is nonrefundable. Income phaseouts based on adjusted gross income, type of enrollment, and qualifying expenses are several of the requirements that must be met to qualify for these education credits.
- Child and dependent care credit: This credit assists in paying for childcare costs. To qualify for the childcare and dependent credit, there are requirements that must be met based on filing status, earned income requirement, and incurring expenses for what the IRS deems qualifying persons. This credit is non-refundable and any unused credit each year is lost, meaning the excess cannot carried into to the preceding tax year.
- Child Tax Credit: The IRS permits a tax credit for taxpayers who have qualifying children. The child tax credit has both non-refundable and refundable components to the credit.
For more on education-related tax savings, visit Federal Student Aid’s tax benefits page or the Consumer Financial Protection Bureau's guide to filing your taxes
Making the Most of Your Refund
Here are some pointers:
- To lower the chance of fraud and expedite your return, file early.
- Verify your data and forms one more time to prevent errors.
- Don't pass up credits and deductions for which you are eligible.
These four tips can help reduce stress around tax time.
What Happens If You Don't File Your Tax Return?
Taxes do not disappear if they are ignored. If you are in arrears and fail to pay or file:
- The IRS has the authority to impose fines and interest.
- It is possible for your bank accounts or salary to be garnished.
- Your property may be subject to a tax lien.
If you can’t pay in full, the IRS offers payment plans to help manage what you owe.
Remember, understanding taxes helps you take control of your financial future. Planning ahead, taking advantage of available deductions, and filing accurately can all have a significant impact. For resources, advice, and tools to help you, visit the Central Bank Learning Center.
For more information on available tax deductions and credits, including eligibility and guidelines, please visit IRS.gov.
