Things I’ve learned while doing my taxes
I’ve been working on my taxes the last couple of days (I do them on multiple websites to find the best deal). Since this is the first year that I have really made enough to have to pay any significant taxes, I have been trying to reduce that amount as much as possible. Here are a few things that I have learned: (1) Higher tax brackets only apply to the money you earn above that level. Thus, assume the tax bracket for $0-$10,000 is 10% and the tax bracket for $10,000-$20,000 is 20%. If you earn $15,000, you pay 10% on the first $10,000 and 20% on the next $5,000. This means that a tax break on the lowest tax brackets (as the House Republicans are suggesting) will lower EVERYONE’s taxes, not just the lowest earners - as the Republicans are implying. (2) People who don’t make very much don’t pay income taxes. With the deductions and credits out there, the people on the low end of the tax bracket don’t pay taxes. For example, because of my education expenses and moving expenses, I will get all of my federal taxes back this year. I made well above the poverty line for the year. This means that reducing the percentage paid in the lowest tax brackets (as suggested by the Republicans) does not actually help those who make the least. Since I am getting all of my taxes back, anything I paid this year (whether it was 10% or 5% or 20%) is coming back to me. Thus, I don’t care if my tax burden is reduced from 10% to 5%. 10% of $0 is the same as 5% of $0. (3) Tax credits are different from deductions. I often heard these two terms used and did not really know the difference. A deduction allows you to reduce your income so that the amount that is taxed is lowered. That is, if you made $20,000 and have a $5,000 deduction, you only pay taxes on the $15,000. There are also two types of deductions. Everyone can take a general deductions (which is around $5,000) or they can choose to itemize. Itemized deductions are deductions like moving expenses, mileage on your car for business, etc. Unless you have more than the general deduction in itemized deductions, you should take the general deduction. There are also “over the line” deductions which you can take in addition to the general deduction. Student loan interest is an example of an over the line deduction. Besides deductions, there are also tax credits. Tax credits apply after the tax has been calculated. The credit directly reduces the amount you have to pay on taxes. Thus, if you earned $20,000 and got $5,000 in deductions, you would pay tax on $15,000. Assume that this means you owe $2,000. If you got a credit for $1,000, you would only owe $1,000 in taxes. If you had $2,000 in credit, you would owe nothing. There are two types of credits. Refundable and non-refundable. A non-refundable tax credit means that once your tax burden reaches $0, you don’t get any money back. With a refundable tax credit, you get the money back, even if you don’t owe anything. Thus, if you owe $2,000 and have a $3,000 non-refundable tax credit, you owe $0 in taxes. If the credit is refundable, you get the $1,000 difference back as a check. Therefore, the most favorable plan for a person who makes very little is a refundable tax credit. Even if they pay no taxes, they get the difference back. Obama has proposed a $500 refundable tax credit for the stimulus package. Not sure if this is applying to 2008 taxes or 2009 taxes. Getting this money to the poorest people is the best tax break for a stimulus, because they will go out and actually spend the money. (Note: all figures and statistics and percentages are completely made up).
