How Income Taxes Work
Paying taxes is on everyone’s mind, rarely in a good way. Knowing some pithy facts about our tax system and how you fit in may not make you feel any better. But, it could even help you plan.
- The IRS receives over 140 million individual tax returns and collects over $950 billion in taxes.
- The biggest tax deductions are those for taxes paid to state and local governments. Next biggest are for interest, especially on home mortgages.
- The average tax refund is almost $3,000, $2,953 to be exact. In all, over $325 billion in tax refunds are paid out.
- Want to aim really high and try to crack the $10 million mark? More than 11,000 individual tax returns reported adjusted gross income above $10 million.
- As a percentage of adjusted gross income, people earning $100,000 to $200,000 pay an average federal tax rate of only 12%. Those earning $200,000 to $500,000 pay 19.6%. Don’t confuse marginal rates with average rates. The former is what you pay on your very last dollar.
The income tax process is fairly straight forward. The tax process starts with income & usually most income which is received is taxable. Income from work, interest, pensions, and investments as well as other sources are included in a taxpayer’s gross income. The income from all these sources are added together to arrive at the taxpayer’s gross income.
What is not considered as income?
Gifts, worker’s compensation benefits, child support payments, inheritances, cash rebate from a dealer or manufacture or inheritances?
Adjustments are subtracted from gross income. They might include retirement plan contribution, alimony, half of self-employment & moving expenses, among other items. This results to adjusted gross income.
Deductions are subtracted from adjusted gross income. Tax payers have two choices regarding deductions: The standard or itemized deductions, whichever is greater. The standard deductions vary based on filing status:
|Filing status||Married filing jointly||Married filing separately||Single filers||Head of household|
|Standard deduction amounts||
Itemized deductions could include state and local taxes, certain unreimbursed job expenses, charitable contributions, interest on a home mortgage & the cost of having your taxes prepared, among other things.
The personal exemption is subtracted once the deductions have been subtracted. For the tax year 2017, personal exemption amount is $4,050 regardless of filing status. The result here is taxable income which leads to gross tax liability.
The IRS reports that about 40% of the taxpayers use tax preparation software. Source: IRS, 2017
But, it’s not over yet.
The tax credits are subtracted from gross tax liability. Tax payers might receive credits from variety of items, including energy-saving improvements. This results to the taxpayers Net Tax.
Understanding tax process is one thing and the work is another. Remember this material is not intended as tax or legal advice. Please do consult a tax professional for information regarding your individual situation.