Taxes: The basics

Every year, Americans prepare for Tax Day — the day when all U.S. workers are expected to have submitted their annual income tax forms. Despite all the clichés about how the period leading up to Tax Day is stressful, this process does not have to be complicated or make you nervous.

By understanding why taxes are important, how to stay on top of your taxes, and the steps for filing, you can avoid the stress of tax season.

What are taxes?

Taxes are mandatory payments made to local, state, and federal governments to pay for government-funded public works and services, such as public transportation and education.

Personal income taxes will be the focus here, but it is good to know about the three main types of U.S. taxes.

• Income tax: This is a tax that both individuals and businesses are required to pay on their earnings. Depending on where you live, you may have to pay income tax to your local or state governments, as well as to the U.S. federal government. All taxpayers are required to file an income tax return every year to make sure they are meeting their tax obligations.
• Sales tax: This is a tax that consumers pay when they purchase goods or services from a retailer. The retailer then submits these taxes to the appropriate tax authority (local, state, or federal).
• Property tax: This is a tax paid by real estate owners. The amount of this tax is usually based on the value of the property, including the land on which it is located. In addition to the federal government, most states and many local municipalities require their residents to pay a personal income tax.

What should I know about my personal income taxes?

Although personal income tax laws are always subject to change and vary by state and even local municipality, certain things are used to determine how much you owe in taxes. Look at four pieces of key information that you should know.

• Filing status: Your filing status is important. It determines your tax rate and whether you are eligible for certain tax deductions or other tax breaks. Your status is based mainly on your marital status and whether you financially support other family or dependents.
• Taxable income: Your taxable income is the amount of your earnings that is subject to taxes in a given year. This is also referred to as adjusted gross income.
• Tax bracket: Tax brackets are the ranges of income used by the IRS to determine the percentage at which a given portion of your income is taxed. Tax brackets use filing status and taxable income to determine the rate at which you will be taxed and how much in taxes you owe.
• Deductions and credits: Deductions and credits are both ways to reduce the overall amount you will owe in taxes, but they work differently. Deductions reduce your taxable income (the amount being taxed), while credits reduce the amount you owe in taxes (your tax bill).

What documents and forms do I need to file my taxes?

To file your taxes, you will need to collect personal documents and information, as well as the appropriate tax forms for your specific situation.

Personal documents

You will need proof of all income earned, as well as proof to support any deductions or credits you plan to take. The following are just examples of some personal documents you will need.

• Social Security or Tax ID number for you and anyone else you are claiming on your taxes
• Proof of all income, including income from unemployment, Social Security, earned interest, and investment gains
• Proof of interest you’ve paid on your mortgage via a form from the company holding your mortgage
• Proof of student loan interest paid
• Proof of charitable contributions via forms or receipts from the organizations you donated to

Tax forms

Choosing the right forms to use when filing your return can be confusing. Here are some examples of key tax forms. However, we suggest that you consult with a qualified tax professional or the IRS to be sure of which forms you will need to file.

• Form W-2: This form details how much money you have earned in a given year, as well as all the taxes you have paid on those earnings. This comes from employers and must be sent to you by January 31 each year.
• Form 1099: This form details how much money you have earned in a given year, other than the salary paid to you by your employer. You should receive this form from clients if you worked as a contractor. It must be sent to you by January 31 each year.
• Form 1040: This is the form used by U.S. taxpayers to file their annual income tax return. If your return is more complicated, however, the IRS may require you to fill out additional forms.

To determine your total income, you should refer to the amounts indicated on your W-2 or your 1099 forms. If you receive these forms from multiple employers, you will need to add these amounts together to determine your total income.

What’s my filing status?

Although determining your filing status may seem straightforward, it is important to understand the meaning behind each status to make sure you select the one that is best for you.

• Single: This means that you were not married as of the end of the year for which you are filing taxes.
• Married filing jointly: This means that you were married at the end of the year for which you are filing taxes and that you and your spouse are filing a joint return that combines your financial information.
• Married filing separately: This means that you were married as of the last day of the tax year but have chosen to file a separate return from your spouse.
• Head of household: This means that you are not married, that you maintain the cost of a household, and that you support children, parents, or other relatives.
• Qualifying widow(er): Generally, this means that your spouse is deceased, and you have a dependent child. You may retain the benefits of the married filing jointly status for up to two years after the death of your spouse.

What’s my taxable income?

Although the specific numbers used by the IRS to determine your taxable income are subject to change from year to year, there are steps you can use to estimate your taxable income.

1. Determine your total income. Total income is all the money you made in a given year, including money from work, interest earned, investment gains, and even retirement income.
2. Apply deduction(s) to your total income. In the U.S., taxpayers may choose either to add up all their individual deductions (known as itemizing), or take the standard deduction for that year, which is based on filing status.

Remember, taxable income is important to know because it is the amount that will be subject to tax by the IRS.

Keep in mind that your taxable income combined with your filing status is what determines your tax bracket.

What’s my tax bracket?

Tax brackets are established by the IRS each year to determine the percentage at which a given portion of your income is taxed. Although these ranges are subject to change each year, the important thing to note is that as your taxable income increases, so may the percentage rate at which your income will be taxed.

Remember, your tax bracket is aligned with your taxable income, not your total income. Be sure to subtract your standard or itemized deductions before determining your tax bracket.

What can I do to legally reduce my taxes?

Taxpayers routinely have too much income tax withheld. Out of the 126 million tax returns processed by the IRS through April 2015, almost three-quarters resulted in an average refund of $2,711.

To get the most bang for your tax bucks, look at the legal tax reduction strategies below.

• Be thorough and honest with the deductions you apply. Determine whether you would save more money using your standard deduction or through itemizing. Deductions include charitable contributions, mortgage interest, some state and local taxes, and others as applicable to your situation.
• Include eligible retirement savings. In some cases, contributions to certain retirement accounts, like a 401(k) or standard IRA, may be made on a pre-tax basis. This allows you to not only save for retirement but also to reduce your taxable income for the year. Money invested also grows tax-deferred until used for retirement.
• Be strategic about when you get paid. Accelerating or delaying income into a particular year, allows you to better match income and expenses and potentially lower your tax bill.
• Don’t withhold too much. Ensure that you do not have too much withheld for taxes during the year. This doesn’t reduce your taxes but puts more money in your pocket each payday. Be sure not to be under-withheld as you may have a big tax bill come tax time.
• Make it work for you. If you have business income from a non-employer source, you may consider combining business travel with a vacation and deducting the unreimbursed business expenses. Or, if you work at home as a self-employed individual, you may take a home office deduction.

5 ways to avoid tax scams

Your best weapon to combat tax scams is your own common sense. If you are in doubt, contact the IRS or your state taxing authority to confirm.

• Use caution on the phone: The IRS will never call you or email you or contact you via social media to collect money. Their first contact will always be via a letter. Don’t give any information to anyone contacting you via these other methods and certainly don’t send them any money.
• File early: File early so hackers will have a more difficult time filing a phony return and claiming a refund in your name.
• Beware of phishing: Phishing is a scam where a thief pretends to be a legitimate company and tries to collect your personal information, usually through email. Be careful about sharing any personal information with someone who contacts you via email. Always take steps to verify identity before communicating via email.
• Protect your computer: Make sure your computer is protected by anti-virus software to make it tougher for hackers to access your personal information.
• Be wary of phony charities: A growing number of tax scams are related to phony organizations soliciting help for victims of hurricanes and other natural disasters.

Next steps

• Research your personal tax situation. Since taxes are based on individual or family circumstances, it’s important to take the time to research exactly what you will need to file your taxes correctly and efficiently. Consider visiting the IRS website or engaging the services of a CPA or another tax professional.
• Document your income and expenses. Don’t wait until tax season to get organized. Be sure to keep good records of all income and expenses, both personal and, if applicable, for your business.
• Follow the news. The issue of taxes is constantly being debated, with changes in policy occurring at the local, state, and federal levels. Make sure you pay attention to any changes in policy that impact you.

The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.

This information is for educational purposes only. Please consult a tax expert or the IRS for help in figuring out your taxes.

Article written by EVERFI