Understanding Personal Taxes
Governments need money to function effectively and develop the country. Capital projects such as building schools and hospitals, erecting bridges, constructing roads, need money to execute. The government imposes a tax on its citizens and businesses to raise money to complete capital projects, maintain a functioning system, and pay its workers. Taxing is the primary way for the government to raise the financial resources to pay for these social and civic needs.
Though there are different forms of taxes, every person is subject to personal taxation. Also, known as income tax, personal tax is a tax imposed on individuals based on their income. However, a certain measure of caution is needed here. While two individuals may earn the same amount, they may pay different tax rates. This is because the amount of taxes you pay is based on your taxable income, not your total income.
If you are an employee, your personal tax is taken out of your paychecks in a process called withholding, which empowers employers to deduct and send the money to the government on the employee’s behalf. If you are self-employed or an entrepreneur, you are expected to pay estimated taxes on your incomes four times a year since you are not subject to withholding. Self-employed people usually take an educated guess based on previous tax deductions, as to how much tax will be due on their income earned each quarter and send that amount to the IRS. As your taxable income increases, the rate of tax increases when it exceeds certain amounts, called tax brackets.
There are different types of personal income which are taxable by the government. These are wages and salaries, dividends, interest, and taxable capital gains.
How To File Your Income Taxes
Filing for your income taxes can be confusing, taking you in maze-like directions. To get a grip of your tax figures, here are the necessary steps to file your income taxes.
1. Start by adding up your gross income
This includes salary or wages, interest accrued from an investment, pensions and annuities. If you are an employee, you can have your employer send you a W-2 form which essentially shows how much you earned and how much income tax has been withheld by your employer.
2. Subtract any adjustments
Next, you subtract your expenses. This includes expenses you have made in the form of alimony, self-employment estimated taxes paid, retirement deposits, interest paid on loans, medical fees, charitable contributions, and state or local taxes from the previous year.
3. Subtract personal exemptions
If your country’s internal revenue service allows for deductions, then you can subtract this to get your net taxes.
4. Look up your taxable income range
This is where most people get confused and incorrectly file their taxes. Some countries use a marginal or progressive tax rate system, which implies the more you earn, the higher your tax rate. To determine precisely how much you owe, check your applicable taxable income on the tax table. Then find the number that matches your filing status (single, married filing jointly, married filing separately, head of household etc.), the number in your category or bracket is your gross tax liability. If you have any credits, you can subtract from this figure. The final number is your net tax. If it’s a positive number, you owe money to the IRS. If it’s negative, you’re getting a refund.
Tax Brakets
Tax brackets are categorizations which the revenue service uses to tax you. This categorization is based on your income. If your income falls within a specific category, you pay whatever percentage of your income in taxes that is designated to that category. Countries with progressive tax systems use tax brackets. Contrary to misinformation, how tax brackets work is quite simple to understand. The most important thing that those looking to file their taxes this year need to understand is that tax brackets enable you to assess what the impact of your income will be on your refund or tax burden. To get a clearer picture of how tax brackets work, check here.
How To Reduce Your Taxable Income
There are various ways through which taxpayers reduce their taxable personal income. These are through credit and deductions.
Tax Credits
This is a specific amount of money that is deducted from the amount of tax you owe – not from the amount of income you earn. A tax credit reduces your income tax by giving you a refund from your withholding or estimates. The amount of the tax credit is the same whatever amount of tax you owe.
Tax credits may be refundable or non-refundable. If you qualify for refundable tax credits, the government will pay you what you are eligible for, whether you owe tax or not. If you qualify for non-refundable tax credits, the government will deduct this amount from the tax that you owe.
Tax Deduction
Tax deductions are deductions that reduce a person’s tax by lowering their taxable income. These are expenses which the taxpayer incurs during the year and applies against them or subtracts from their gross income. Examples of tax deductions are childcare expenses, RRSP contributions, and professional dues.
Understand The Plan
The key to understanding your taxes is knowing what part of your income is taxable and which tax bracket your income places you. This enables you to plan your taxes in an efficient manner which reduces your tax liability and ensures prompt payment. It is legitimate to arrange their financial affairs in such a way as to take advantage of these tax breaks.