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This is part of a series of posts on 10 Important Financial Lessons To Learn While You’re Young. A new lesson will go up every Friday. And if finances bore you, don’t worry…I’ll keep posting non-finance things on Mondays!
Everybody’s got to pay taxes (well, everybody is subject to paying taxes, some people owe $0) and if you’re lucky enough to have a job right out of college you need to know what you’re doing in this department. This doesn’t just mean learn how to use TurboTax and actually file your taxes once a year. It means learn about them, as well as learn how to file your taxes.
Taxes can be fairly complicated but this is the gist of it: everyone who earns an income is subject to paying a portion of that income to the government. Taxes are collected periodically throughout the year (usually deducted from each paycheck, or due quarterly if you’re self-employed). At the end of the year you file a tax return; if you’ve overpaid your taxes you get a refund, if you haven’t paid enough you must pay your balance by April 15th (actually, for 2011 taxes it’s April 17th because of some holidays…but usually it’s the 15th!).
Here are a few important things you should know about taxes:
- Income: All income is subject to taxes, not just your regular paycheck. This includes any interest earned from a bank, any capital gains from an investment account, any money earned from freelancing or selling textbooks, etc. Any income, and all income.
- Deductions: Deductions reduce the amount of your income that is subject to taxes. You can itemize your deductions and claim deductions for things like charitable donations, interest paid on student loans, and medical expenses. This means if you make $10,000 and spend $1,000 on qualified medical expenses, your taxable income would only be $9,000. Or you can take the standard deduction ($5,800 for singles, $11,600 for married couples in 2011). For young adults the standard deduction is usually a higher amount (and therefore better!) Learn more!
- Tax brackets: The more you earn, the more you pay. Know what the income tax brackets are for 2011 and which one you fall under based on how much money you make. (Just FYI, tax brackets are changing for 2012 taxes, so re-learn this piece next year too!) Learn more!
- Exemptions: Exemptions also reduce your amount of taxable income; each personal exemption is equivalent to a $3,650 deduction. You can claim one personal exemption for yourself, one for your spouse, and one for each qualified dependent (usually children).
- Filing status: Before you file taxes you have to know your filing status (Single, Married Filing Jointly, etc.) Your filing status determines a couple of things like your standard deduction, what credits you are eligible for, etc.
- Credits: Once you figure out how much you owe in taxes, credits can reduce that amount by a set dollar amount. They are actual money you might be able to get back on your return for certain things like having a child, contributing to a retirement account, or going back to school (unlike exemptions and deductions which just reduce the amount of your income you pay taxes on).
- Tax forms: There are tons of different tax forms but here are a few important ones: (Learn more!)
- 1040: These are the forms you use to file your taxes. There are a bunch of types of 1040 forms but Form 1040 is the standard form and Form 1040-EZ is a simpler version that you can use if you are Single or Married Filing Jointly and don’t have any dependents (most young adults can use this form).
- W-4: These are forms you fill out for your employer so that they know the proper amount of taxes to withhold from your paychecks.
- W-2: These forms give you tax info for your regular income and are sent to you by your employer each year.
- 1099: These forms give you tax info for other types of money you made (interest, dividends or capital gains, distributions from retirement accounts, etc.) They usually come from financial institutions.
- 1098: These forms give you tax info for possibly deductible expenses you paid throughout the year such as tuition, student loan interest. etc.
So your homework for this weekend is to get started learning about taxes! Read through the list above and if you come across something you’re unsure about, educate yourself. That’s what the internet is for! Besides funny cat videos. 🙂
How about you, do you already know all of this stuff? What do you think is important that isn’t on this list? (I mean, I know this isn’t totally comprehensive, it’s just some important basics.)
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