The Confusion of US Taxes

Taxes here in the United States are such an interesting and confusing topic. For many of us, employers take taxes out of our paychecks making the process of paying our taxes about as simple as it gets. But, when you start a job, you have to tell your employer much they should withhold from your paycheck for taxes with one of the most confusing forms I have ever seen. Most people in this situation receive a healthy tax return. As long as they don’t end up owing the IRS, they often don’t consider taxes any further. However, self-employed people or those that run their own businesses on the side have much more complicated tax situations. They have to do quarterly estimates of their tax obligations, making payments as they go. And Lord help you if you fall behind on your taxes. The IRS is one of the most powerful government entities in terms of its ability to ruin your life. They can garnish wages directly from your paycheck without having to take you to court. It’s downright scary.

I have heard at various time that truth or knowledge is the opponent of fear. So, to combat the fear of the IRS and our complicated tax system, let’s shine more light on taxes. Disclosure: I am not a tax professional. If you need specific tax advice, please reach out to a tax professional.

Taxes in General

The US tax system works on a progressive percentage system. This means you will pay a varying percentage of your taxable income based on how much taxable income you have. From the IRS website:

Tax Percentage	Single Income Above ($)	Married Filing Jointly Income Above ($)
37	539,900	647,850
35	215,950	431,900
32	170,050	340,100
24	89,075	178,150
22	41,775	93,550
12	10,275	20,550
10	Below $10,275	Below $20,550

So, the more you make, the more you pay, but also the more you make, the higher rate of taxes you pay. To make it even more complicated, the US tax system uses marginal tax rates. What?!? Basically, this means that different portions of a person’s income are taxed at different rates. Using the numbers above for a single filer, the first $10,275 you make are taxed at 10%. Income you make above $10, 275 but less than $41,775 will be taxed at 12%, and so on and so forth. So, if you file Single and make $100,000 that year, your tax rate breaks down like this: 10% on $10,275, 12% on $31,550 (between $10,275 and $41,775), 22% on $47,300 (between $41,775 and $89,075), and 24% on $10,925 (above $89,075). Simple, right!

All of this is calculated based on your Adjusted Gross Income (AGI), which is not the same as the number you might see on your paycheck. Your AGI considers non-taxable expenses that are allowed as deductions. Again, just to keep things simple. This is also only considering federal income tax, not state taxes, Medicare taxes or any of the others.

IRS Tool

If you work for an employer, they have the responsibility to take your taxes out of your paychecks. However, you have to tell them how much they are supposed to withhold from your taxes based on your family situation. This is done via IRS Form W-4. From the IRS:

“Complete Form W-4 so that your employer can withhold the correct federal income tax from your pay. Consider completing a new Form W-4 each year and when your personal or financial situation changes.”

This might be one of the most confusing forms I’ve ever had to fill out. It has, however, been updated in recent years from the previous “Deductions” method to a monetary-based method, which makes more sense. But, the IRS recently created a very helpful tool on their website which helps you fill this form out as best you can. It walks you through 5 steps of filling out information, then spits out your results. It considers income from all the jobs you might have, deductions you might qualify for, tax credits and adjustments. I recommend using this tool early in the year to fill out a W-4 for that year. Your income and tax situation can change every year (or even throughout the year), so it’s a good idea to redo this form every year. I also like to use this tool a second time later in the year (around July or August) to make sure I am still on track to pay the correct amount in taxes. It is a very good tool, and I cannot encourage you enough to use it.

https://apps.irs.gov/app/tax-withholding-estimator

More Complicated Tax Situations

Many people find themselves with more complicated tax situations. Some may not even realize it. For example, simply owning your own business makes taxes much more complicated. Now you have to estimate your quarterly taxes and pay throughout the year. There are also many deductions available to people who own businesses that may not apply to those who do not. Many people who work for an employer will end up taking the Standard Deduction when they do their taxes. But business owners may have enough qualifying deductions to justify not taking the Standard Deduction.

When you get into these more complicated tax situations, I highly encourage you to seek the help of a tax professional. There are various software packages that can help you with this as well, but it’s hard to beat a real person. A good tax professional will not only make sure you pay as little as legally possible in taxes but will also help you understand why you are paying what you are. They will also keep you on track with any extra things you need to do (like quarterly tax estimates). US taxes are complicated, to say the least, and getting them wrong can have long-lasting consequences. So have someone on your side to get it right.

Tax Returns

The final thing I want to touch on is the concept of tax returns. I think many people misunderstand what a ‘tax return’ really is. They look at it as some gift from the government that arrives in April (or around April at least). It’s not. Throughout the year, you pay into your tax obligation to the federal government. You get a tax return when you have overpaid on your taxes. It is essentially like putting money into an account to cover your taxes, then getting any left over when the year is over. The problem is that any money you receive as a tax return is money you could have received throughout the year to use in your budget. The government was nice enough (LOL) to hold onto it for you while paying you a generous 0% interest. That money could be used to make you more money, to pay off debts, or anything else you might use money for. So, receiving a big tax return is not the cause for celebration that many people believe. Ideally, you would get no tax return, but would not owe taxes either. This is where the IRS Withholding Estimator tool is so useful. It can help you dial in your withholdings so that you are keeping as much money as possible in each paycheck without having to owe any federal taxes come April.

I hope this was helpful. As it is tax time again, I hear a lot of questions and complaints as well as incorrect statements about taxes. Hopefully, this helps clear up some of that. If you still have tax questions, please reach out to a tax professional. If you don’t know one, I can recommend a couple to you. Just ask 😊.