Income Taxes
Taxes are complex, but I’ll try to simplify them a bit. It’s always best to consult with your tax preparer.
At the beginning of every year you must pay taxes on all income earned in the previous year. Payroll, dividends, capital gains, business income, etc.
You must pay federal taxes to the IRS.
And then state taxes separately, with the exception of a few states that don’t have income taxes: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming. If you live in those states you don’t have to worry about paying state income taxes just federal income taxes.
The federal taxes have tax brackets which dictate what percentage of your income you must pay. The brackets change all the time so just do a search for “tax brackets YEAR” and you should see some information for the year you want. For example here is the 2020 tax brakets. Whatever bracket you fall under at the end of the previous year that’s how much you’ll be taxed.
States have their own brackets too. You can do a search for “YOUR STATE tax brackets YEAR”. Here is an example of California’s 2020 Tax Bracket.
Then there is a standard deduction, the simpler one, or you can also do what is called itemized deductions. You get to pick which technique to use, some might be more advantageous depending on your situation. Basically it’s income that you won’t be taxed on. Think of it as income that will get a free pass. Do note, that like the brackets the standard deduction may change each year, to see what the current standard deduction is just search for “YEAR standard deduction”.
So after you deduct the standard or itemized deductions, you’re left on what tax bracket you’ll be taxed on.
Brackets and standard deductions differ if you’re married or single.
You can further decrease your taxable income bracket by contributing some of your money into a IRA or 401k.
For example if in the year 2020 you were single and your income was $100k and you take the standard deduction you’re down to about $88K taxable income, which puts you at the 24% tax bracket according to the 2020 brackets. The 22% tax bracket cut-off is at about $85K, so to pay 22% income tax rather than 24% income tax you can contribute about $3K to your retirement plan which would effectively drop you to $85K taxable income bracket which is in the 22%. (Numbers will change based on year, but this gives a rough idea).
In a nutshell your taxable income = gross income - retirement contributions - standard deduction. It is your taxable income that you use to figure out what bracket you fall in.
But wait, there’s more. Now you can start looking at ways to get credited for other things like expenses, education, losses, and many other things.