Taxes 101, (a simple explanation of a complex system)

It is that time a year again, tax time is upon us. There are hundreds of strategies and approaches people deploy. Some people like getting a big refund as a kind of savings bonus, others want to break even because they do not want the government borrowing their money all year long. Remember it could have been invested for you all year making you money. Here we lay out a very simple way that one can think about taxes to develop an effective strategy. This is a taxes 101 that I wish someone had taught me a long time ago. Again, our education system never talks about this stuff and it is so important to us personally and for our country. It is important to pay our fair share and no more. Someone has to pay for defense, roads, food inspection, research, bio-defense, infrastructure, social security, etc. But we should take advantage of the deductions and credits available if we are playing by the rules. In general, there are various tax brackets that you fall into depending on your income level. In general, the more money one makes, the more they pay in taxes as a percentage of income. Some call this a progressive tax structure. Even though one may make a certain amount that puts them in a specific bracket, you will want to deploy strategies to have deductions so it appears you are in a lower bracket. This way you pay less in taxes. Here are the brackets in general for married filing jointly: 12% rate …….. $19,051 to $77,400 22% rate ……. $77,401 to $165,000 24% rate ……. $165,001 to $315,000 Remember it is a tiered system where you pay the percentage of tax on that block of your income. In other words, if you are in the 22% bracket, you pay the 22% on the amount you made over the $77k mark. The first $77k is taxed at the 12% rate. I am not going to list the other brackets because the vast majority of tax payers fall into these brackets. The trick from this point is to qualify for deductions, that from a tax calculation perspective lower your gross income on paper. What are the most popular deductions: A. Mortgage interest B. Real estate taxes D. State and local taxes E. Moving money into an IRA These popular deductions reduce tax collection by about $1 Trillion each year. So let’s say you made $80k last year, but were able to use the deductions above to look like you made $75k; Boom, you just lowered from the 22% tax rate down to 12%! As a saver and investor, a huge way to take advantage of this system is to pay into an Individual Retirement Account. That money is also pulled off your gross income in terms of taxes. Just remember a Roth IRA is taxed now  in order to gain that back tax free as income in retirement. I try to increase these IRA investments to lower my tax burden now and later. The next category of deductions are called tax credits. This is an amount of money taken directly off what you owe. Here are the most popular tax credits one should look into: A. Earned income credit, depends on income level and number of children, usually for low to moderate incomes B. Child and Dependent care credit C. American opportunity credit, for certain education expenses D. Lifetime learning credit This is just meant as a taxes 101 explanation so that you understand the big picture structure. The tax code is thousands of pages long, therefore has become very complicated with many loopholes and provisions that individuals and corporations use to pay less in taxes. Major changes for 2018…
  • The standard deduction increased from $13k to $24k. In many cases this will make sense instead of wasting a bunch of time with itemization.
  • Child tax credit has been raised from $1,000 to $2,000.
  • Mortgage interest deduction is capped at $750k for loans taken out after December 15, 2017.
  • Retirement savings contributions raised to $18,500.
See a tax specialist with specific questions, this is meant as an overview and primer for how the system works. I am no tax expert, just trying to make sense of a complicated system and pay my fair share, but no more!  

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