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Taxes

2 min read

questions

  • What are allowances on a W-4?
  • Do you have to enter standard deduction manually on tax software?

key concepts

  • Types
    • Federal income taxes
    • State income taxes
    • Payroll taxes: the Federal Insurance Contributions Act (FICA) tax pays for
      • Social Security (FICA Old Age, Survivor, Disability Insurance [OSADI])
      • Medicare (FICA health insurance [HI])
    • Sales taxes
    • Property taxes
  • Tax systems
    • Flat tax: everyone pays the same tax rate
    • Regressive tax: low-income earners pay a larger proportion
      • e.g. Sales tax on food at a grocery store
    • Progressive tax: high-income earners pay more
  • Gross income
    • Exclusions
      • Loan proceeds
      • Gifts and inheritances
      • Scholarships
      • Capital gain on sale of primary residence
      • Life insurance death benefits
      • Fringe benefits through employment
      • Qualifying distributions from Roth IRAs
      • Social Security benefits (some or all)
      • Municipal bond interest
      • Alimony received
  • Deductions: expenses allowed by Congress to offset gross income
    • Result in adjusted gross income (AGI)
      • FOR AGI: used to calculate AGI
      • FROM AGI: itemized deductions, subtracted from AGI
        • Common deductions
          • State and local taxes
          • Out-of-pocket medical expenses that are more than 8.5% of taxpayer’s AGI
          • Interest paid on mortgage debt for primary home
          • Donations to charities
    • Many only allowed if income is below certain amount
    • Standard deduction: amount set by Congress that increases yearly based on inflation
      • Claim the higher of standard vs. itemized
  • Taxable income
  • Tax bracket
  • Marginal tax rate: rate of change in tax resulting from change in income or deduction
    • Let NT = new tax liability, OT = old tax liability, NI = new income, OI = old income
  • Long-term capital gains: from selling assets owned for more than 1 year for a profit
    • Income has different tax rates
  • Short-term capital gains: taxed as ordinary income
  • Effective tax rates: average tax someone pays on entire income
  • Tax credit: dollar-for-dollar reduction in an assessed tax liability
    • Refundable
    • Nonrefundable: can reduce tax to zero but cannot be negative
  • Negative effective tax rates: when tax credits exceed an individual’s total tax

notes

  • Purpose
    • Build infrastructure
    • Provide social welfare
    • Pay for national defense
    • Provide public services
    • Encourage economic activity
  • Why taxes?
    • Primary source of federal receipts
      • Can have
        • Federal deficit
        • Federal surplus
    • Politicians often debate who pays, not the amount
  • IRS penalties can be up to 25% of tax owed

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