Sunday, June 19, 2011

Only Death and Taxes

Even though tax season has already passed this year, I thought it would still be helpful to give a little insight into taxes in the U.S.  Most college students don't file their own taxes since their parents still claim them as dependents and just file for them.  However, after graduating and getting a job, it is essential to know how to file your taxes on your own, and it is good to know where all the money withheld from your paychecks go.

When you get a job, you usually have to fill out a W4 form which asks how many exceptions you have from withholding.  Withholding is the government's estimation of how much in taxes you will have to pay by the end of the year.  You can opt out of withholding if you make less than $5450 a year and you weren't taxed the year before.  Otherwise, there are certain conditions that allow you to claim exceptions.  The higher the number of exceptions, the less money will be withheld from your paycheck.

Then, come April, tax forms are due and you have to file your taxes which report all the income you've earned during the year.  You will be able to find out if you still owe more taxes or if you get a tax refund (meaning that too much was withheld from your paycheck all year).  Generally, people rejoice in a tax refund, but I would feel sad since this means I essentially gave the government a free loan for the past few months.  But this is just me being pessimistic about taxes.

The U.S. uses a progressive tax system which means that as you earn more income, the marginal income you get may be taxed at a higher rate.  A very common misconception is that all your money is taxed at whatever bracket you fall into.  For example, if you make between $0 and $8500, you would be in the 10% tax bracket and anything from $8500 to $34,500 would be in the 15% rate.  It continues up to 35% in the U.S.  But if you make $10,000 a year, a lot of people think they would get taxed $1500 ($10,000 * 15%) when technically, you should be taxed $1075 ($8500 * 10% + $1500 * 15%). Your first $8500 will always be taxed at 10%, your next $26,000 ($34,500 - $8500) will be taxed at 15%, and so on and so forth.  Of course, your actual tax rate is supposed to be much lower because of all the exceptions and deductions available to you, but we will talk more about those next time.

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