Income taxes can be confusing, but knowledge is power. This beginner’s guide covers the basics of what you need to know.
The following is a guest post from my bloggy friend Megan Isola. Interested in having a guest post on my website? Click here for my guest post submission form.
Demystifying Income Taxes: A Beginner’s Guide to Filing, Deductions, and Building Financial Literacy
Welcome to our beginner’s guide to understanding taxes. If filing your taxes confuses or overwhelms you, don’t worry, you’re not the only one. However, a basic knowledge of taxes and how they work is essential to building financial literacy and improving your financial health. In this guide, we’ll discuss some different types of taxes. Additionally, you’ll learn how to file and some lucrative tax deductions and credits to apply to your tax filing. Whether this is your first year filing or you want to improve your understanding of taxes, you’ll be better able to navigate the world of taxes after reading our guide. Let’s get started!
Types of taxes
When it comes to taxes, you probably aren’t surprised to learn there are many different types. Some may pertain to you, and others may not be relevant to your specific economic situation. However, it is good to be aware of the different types when improving your understanding of the world of taxes, especially those that may apply to you.
- Income Taxes are taxes on an individual or business’s income. Income tax includes any form of revenue, such as salaries, wages, dividends, and more. This tax is a percentage of your earned income and may vary based on your tax bracket and current laws and regulations. It’s important to note that any loans you take out, such as hard money loans, are not taxable income. In addition, monetary gifts you receive under $17,000 are not taxable income, nor is any money you receive from a will.
- Capital Gains Taxes may apply if you sell any capital assets like stocks, bonds, and real estate. The government taxes profits you make between your purchase and selling price (capital gains). For individuals, the percentage taken varies depending on your holding period, your income, and current tax laws.
- Sales Taxes apply to the sale of goods and services. A tax percentage, typically a percentage of the purchase price depending on local regulations, gets added when you purchase an item. For example, the state of Oregon does not have sales taxes.
- Property Taxes are taxes on property owned, including land, commercial buildings, and housing. Expect to pay your property taxes on an annual basis. The amount you pay depends on the value of your property and will depend on regulations set by your local government.
The 101 on filing
You’ve probably never met anyone who looks forward to tax season, except maybe tax accountants. Luckily for you, there are a couple of ways to make filing easier. Tax season typically begins in January and is due on April 15. These dates, however, are subject to change, as we saw during the pandemic.
To prepare for filing your taxes, gather relevant documents, such as your W2 or 1099s, depending on your type of employment. After you have your records together, choose how you will file them. You can file electronically using software like Turbotax or H&R Block. However, if your financial circumstances are complex, we recommend working with a tax professional. A tax professional has access to practice management software and complex tax operating systems which can help you owe less and get a better tax refund.
Whether you work with a tax accountant or file your taxes yourself, you may need to complete additional forms like a 1040, 1040A, or 1040EZ. You or your accountant will then calculate your tax liability based on your taxable income, current tax rate, and any credits or deductions you’re entitled to. After this is complete, you’re ready to file with the IRS. You must pay any taxes you owe within a certain period, but you can use your federal or state return (if you get one) on your owed amount. If you cannot pay the owed amount within the due period, you may open a payment plan and make payments monthly.
Tax deductions and credits
Tax deductions and credits help reduce your tax liability. Tax deductions reduce your taxable income, which in turn, reduces the amount you owe. Deductions are dollar-for-dollar reductions to your taxable income, meaning every dollar you deduct is a dollar you save.
Tax credits are slightly different because they are a dollar-for-dollar reduction in the taxes owed, rather than reducing your taxable income. Tax credits are more valuable because it directly reduces the amount you owe to the IRS.
Here are a few examples of commonly used tax deductions and credits:
- Child tax credit: This credit is available to you if you have dependent children under 17 years old. This credit is worth up to $2,000 per child, with a portion being refundable. If you owe less than $2,000 to the IRS, the remaining amount gets applied to your tax refund.
- Lifetime learning credit: If you spent any income on tuition, claiming 20% of the first $10,000 you paid within the last tax year is a great way to save on taxes, and there is no limit to the number of years you can utilize this credit. However, you are not reimbursed the remaining amount in your taxable income.
- Student loan deduction: If you or a family member took on debt to pay for school in the form of a student loan, you’re eligible to deduct $2,500 from your taxable income because of your interest payments. International student’s taxes may be different, so contact a tax professional to get an accurate understanding of your tax situation.
- Charitable donations deduction: If you made any donations to charity within the last year, the world and the IRS thank you. On your return, your generous donations allow you to deduct 60% of your adjusted gross income.
- 401K Contributions deduction: Hopefully, you’re contributing to your 401K, and if you are, the government rewards you for it. The IRS does not consider contributions to your 401K plan as taxable income. Reducing your taxable income reduces the amount you owe after filing.
There are many more deductions and credits, so it benefits you to work with a tax professional to ensure you’re getting the most out of your filing.
Ready to file?
Taxes are a complex topic, but a basic understanding of how they work will help you navigate tax season more confidently. Remember, if this is your first year filing or you have a complex financial situation, working with a tax professional is a worthwhile investment. Additionally, remember to start organizing your financial records so you have a clear picture of your tax situation and can make any applicable deductions or credits. Following the guidelines above gives you a jumpstart to understanding and managing your taxes effectively. So when tax season comes around, it’ll hurt a little less.
About the Author – Megan Isola
Megan Isola holds a Bachelor of Science in Hospitality and a minor in Business Marketing from Cal State University Chico. She enjoys going to concerts, trying new restaurants, and hanging out with friends.