It’s Tax Season again, everyone’s favorite time of year, and we’re sure you’ve already planned the vacation, new closet, bill, and/or savings you’ll be putting your tax return towards. Our hope here at ColorFull is that you don’t owe anything to the government! So, the accountant(s) on our team have put together some basics on taxes that every working adult should be familiar with.
Individual Taxes 101
- Exemption(s) (or Allowances) – These are reasons to pay less tax (or more), expressed as a number. You can change this on your W-4 , usually one of the many documents you fill out when you start working. You can change it at any time though – just hit up your HR department.
- Exemptions are tricky, the more you have, the more you have, the more money that reaches your paycheck every two weeks ( or whenever you get paid), but too many and BAM- you owe the government money 🙁
- Too little exemptions, and you are giving the government a loan – with no benefit to you ..i.e interest
- The sweet spot is finding the right number exemptions so the government is not getting an interest free loan but also not asking for your coins later.
2. Tax Deduction(s) – These reduce the income amount that your taxes are based on. Most are found on Schedule 1, but there are also specific ones like the Standard Deduction and Itemized Deductions.
- The Standard Deduction – A reduction from your Adjusted Gross Income AGI) based on your filing status (i.e. if you are married or have children/dependents; amounts vary, and change every year).
- Itemized Deduction(s) -This one is a doozy, so we’ll keep it simple. This is a collection of different taxes and costs you’ve paid for over the past year (e.g. state taxes, retail sales tax, medical expenses, mortgage interest, and real estate taxes if you own property, etc.). Found on Schedule A,
- You get a choice between doing the strenuous work of figuring out this number, or just taking the standard deduction (which is based on filing status)
- If you are between the ages of 24-30, you don’t typically own houses or pay enough state tax to do the work of itemizing (unless you own a business, but we’ll save that for a different class), so it’s probably best to stick with the standard deduction.
- Filing Status – Your relationship status for the year as far as the government is concerned. You get a few options: Single (if you are unmarried with no dependents), Married Filing Jointly, Head of Household (if you are not married but have dependents), or Married Filing Separately.
- The government loves itself some marriage and gives lots of tax breaks for married couples (it has the most tax advantages if you needed a push to jump the broom).
- Our advice – Never file separately if you are married; the government takes away most of your tax breaks – you get even less of them than if you were unmarried.
- Adjusted Gross Income (AGI) – Your income before making the choice of taking the standard deduction, or itemizing your deductions, but after factoring in deductions from the new schedule, called “Schedule 1”.
- Taxable Income – The income number that’s equal to the amount of tax you owe the federal and state government, which is based on factoring in what you paid them already, of course.
- This is also basically your AGI minus your chosen deduction (either the standard deduction or your total of itemized deductions)
- Tax Credit – This item reduces the amount of tax you owe, on a dollar for dollar basis. Example, if you owed $5,000 in taxes for the year based on your income (before factoring in how much tax was paid), a tax credit of $500 would change that amount to $4,500.
- There are lots of credit for all kinds of things, but we will save it for another class
These are likely the most common terms you’ll hear concerning your taxes, so be on the lookout. Hopefully, you don’t hear the term “phased out” too often, but I’m sure you don’t need help figuring that one out.
Now that you have some context, here’s what really matters. More fun facts.
In case you’ve been in a coma or hiding in a bomb shelter since November 2017 (not completely inadvisable), the Trump Administration changed the federal tax system a bit. Here are some of the biggest changes affecting you as a young working adult (in our opinion):
- Tax rates were effectively lowered between $9,500 and $200,000 of taxable income (the bottom 99% of the country).
- The standard deduction effectively DOUBLED since 2017 (for single filers, it went from about $6,300 to $12,000).
- Exemptions are gone (these were around $4,000 for self and dependents) but the child care tax credit doubled from $1,000 to $2,000 (each), and there was an added credit for non-child dependents of $500 each.
- If you by chance did, in fact, go the Itemized Deduction route…
- Now, you get a maximum of $10,000 as a deduction for state taxes (boooo..).
- More of your medical expense are deductible – the threshold lowered from 10% to 7.5% of your adjusted gross income, so it’s easier to qualify. (Yay!)
- In 2019, the tax penalty for not having health insurance will be ELIMINATED.
There’s a ton of other changes like lower business income tax, deductions for pass-through entities, and a lower maximum individual income tax rate just to name a few. If you haven’t yet seen the new tax form, or any tax return form, check out the IRS website. Keep in mind that taxes change slightly every year. There are adjustments to rates and deductions based on economic inflation, and be on the lookout for additions, subtractions, and even new tax credits!
I think I just heard the class bell. We’ll call it there, for now, more about taxes coming soon. Feel free to send us your tax questions in the meantime, we’ll do our best to get back before it’s filing time… Don’t forget the April 15 deadline!