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Fundamentals
of Income Taxes
Federal Income
Taxes - A simple concept with very complicated details.
Our federal income tax system was implemented in 1913 simply as a way
for the government to collect revenue. Since then, the laws have been
expanded and revised dozens, if not hundreds of times. If history is any
guide, you can expect the tax laws to continue to change and probably
get even more complex.
While you probably
do not want to spend the time and effort to become an income tax expert,
by understanding some of the basics you can make better financial decisions
and remove some of the anxiety surrounding this financial fact of life.
Everyone's tax situation can be different and this article covers only
some of the basics. If your situation is complicated or if you feel that
you need an expert to help with your taxes, do not hesitate to use the
services of a professional.
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Fundamentals
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Related
articles
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The very,
very basics
- You add
up your income. Most types of income (wages, interest, dividends,
and capital gains) are included.
- Perhaps,
you then make certain adjustments. These adjustments are usually
for certain IRA contributions and business expenses.
- You then
subtract either a standard deduction (set by the government) or
the total of your itemized deductions (state and local taxes,
charitable contributions, mortgage interest). You also get a reduction
for personal exemptions you claim.
- This leaves
you with your taxable income.
- You then
apply a series of tax rates to certain levels of taxable income.
Higher income gets taxed at higher rates.
- You then
compare your calculated tax with the taxes that have been withheld
from your paychecks (and additional estimated tax payments you
may have made).
- The difference
is what you owe when you file your return on April 15th or what
you will receive as a refund.
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The
Basics of Income Taxes
Tax
Implications of Financial Decisions
Develop
an Income Tax Strategy
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A
few more details
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| Income
subject to tax - Most of the income you receive by working or
by investing is taxable. Along with the items mentioned above, distributions
from retirement plans (unless rolled into an IRA), lottery winnings,
rental income, alimony and business income are taxable. However, interest
from municipal bonds is usually not taxable. Dividends and long term
capital gains (from investments held for more than a year) are taxed
at a lower rate than other income. |
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| Adjustments
- If you are not eligible to participate in a company sponsored retirement
plan or if your adjusted gross income is below a certain level, contributions
to a regular IRA are deductible. The current limit on IRA contributions
is $5,000. You may also be eligible to make adjustments for certain
educational and business expenses. |
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| Deductions
- You are allowed to reduce your income subject to tax for certain
types of expenses, including state and local income taxes, charitable
contributions, mortgage interest and medical expenses in some cases.
If you do not have these expenses or if your level of these expenses
is low, the law provides a standard deduction. For 2011, the standard
deduction for individuals is $5,800 and $11,600 for married couples
filing joint returns. The personal exemption amount for 2011 is $3,700. |
Tax
Implications of Home Ownership |
| Tax
rates - Our tax system has progressive marginal tax rates. That
means that income at lower levels is taxed at lower rates and income
at higher levels is taxed at higher rates. There are also different
rates for those that file individual returns and those married couples
filing joint returns. |
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2011
Single Return Rate Schedule
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2011
Married Filing Jointly Rate Schedule
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Taxable
income levels
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Tax
rate
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Taxable
income levels
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Tax
rate
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0
to $8,500
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10%
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0
to $17,000
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10%
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$8,501
to $34,500
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15%
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$17,001
to $69,000
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15%
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$34,501
to $83,600
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25%
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$69,001
to $139,350
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25%
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$83,601
to $174,400
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28%
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$139,351
to $212,300
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28%
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$174,401
to $379,150
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33%
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$212,301
to $379,150
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33%
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Over
$379,150
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35%
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Over
$379,150
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35%
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Dividends and
long term capital gains (for investments held for more than a year)
also get preferential treatment. For taxpayers in the 10% and 15%
brackets, qualifying dividends and long term capital gains (assets
held for more than a year) will be taxed at 0%. For those in higher
tax brackets, the special tax rate is 15%. These preferential rates
are scheduled to expire at the end of 2012.
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| Filing
your returns - You must file your income tax return by April 15th
each year. There are some rules that enable you to get an extension
of time, but most people file by the due date. Getting an extension
does not allow you to delay paying any taxes you may owe. For most
people, the taxes that are withheld from their paychecks cover what
they owe or come very close. If you have a relatively large amount
of investment or other income, you may want to consider making estimated
payments throughout the year to avoid owing any penalties or interest. |
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Being tax sensitive,
not tax foolish
No one wants to pay any more tax than what they are legally required to
pay. The expenses of owning a home can provide itemized deductions and
contributions to your company retirement plan or IRA can also reduce your
taxes. But be sure to not let the idea of saving taxes cause you to make
financial mistakes.
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