Taxes: These Basics are for Everyone




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Jun 01, 2021

By Hayley Norton, CPA Manager at Terry Lockridge & Dunn

Hayley NortonUnderstanding how our tax system works can be tricky for anyone. Whether you are an adult who never paid much attention to the taxes being withheld from your paycheck or a child who just got his or her first job, understanding the basics can help refine and define questions you may have.

Many schools do not teach these tax lessons. This results in many people entering life with a pretty incomplete picture of how taxes work unless someone else takes the time to explain these tax concepts. Here are some pointers to help you or someone you know navigate through this tax maze.

Taxes are mandatory!

While we can have a debate about how much each person should pay, there is no debating that local, state, and federal governments need tax revenue to run the country. These funds are used to build roads, support education, help those who need financial assistance, pay interest on our national debt, and defend the country.

There are many types of taxes

When you think of taxes, most think of the income tax, which is a tax on business and personal income you earn from performing a job. But there are also other types of taxes. Here are some of the most common types:

  • Payroll taxes. While income taxes can be used to pay for pretty much anything the government needs money for, payroll taxes are earmarked to pay for Social Security and Medicare benefits.
  • Property taxes. These are taxes levied on property you own. The most common example of this is the property tax on a home or vacation property.
  • Sales tax. These are taxes placed on goods and services you purchase. While most of this tax is applied at the state and local levels, there are also federal sales taxes on items like gasoline.
  • Capital gains taxes. If you sell an investment or an asset for a profit, you may owe capital gains taxes. The most common example of this is when you sell stock for a gain. Capital gains taxes could also come into play with other assets, such as a rental property you sell for a profit.
  • Estate taxes. This tax is applied to assets in your estate after you pass away.

Not all income is subject to tax

Most, but not all, of your income is subject to tax.

  • While your paycheck is subject to tax, interest earned from certain municipal bonds is not. The government often excludes things like benefits from the tax man.
  • Capital gains taxes have exclusions for gains on the sale of your home and donated stock.
  • Estate taxes have an exclusion, so only estates in excess of the exclusion are taxed.

By having someone in the know can be helpful in navigating through these rules.

The progressive nature of income tax

When it comes to income taxes, the government gets to take the first bite. The question is how BIG of a bite the government gets to take. We have a progressive tax rate system. For example, if you are considered single for tax purposes in 2021, the first $9,950 of taxable money you earn gets taxed at 10%. The next $30,575 you earn gets taxed at 12%. The next $45,850 gets taxed at 22%. Money you earn above this point will get taxed at either 24%, 32%, 35% or 37%.

Understanding the progressive nature of our tax system is a key concept in managing the size of the bite the government takes. That is why tax planning is so important!

Deductions can decrease the government's tax bite

The progressive tax system is complex because it is manipulated in a big way by our elected officials. This is typically done through credits, deductions and phaseouts of tax benefits. For example, there is a fairly complex deduction for families with children, and the earned income tax credit is an added tax cut for those in the lower end of the progressive income tax base. There are also credits and deductions for businesses, homeowners, education and many other types of taxpayers.

As you can imagine, the U.S. tax system is very complex with many nuances. Please seek help if you have further questions or are facing a complicated taxable transaction. Please reach out to Hayley at hnorton@tld-inc.com to discuss your specific tax circumstances. You may also reach any of our accountants in Cedar Rapids at 319-364-2945, or in Iowa City at 319-339-4884.



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