Tax Jargon for Millennials.

This is a beginner blog post for people who don’t know anything or know very little about the tax system.

I have recently started working in the USA, and I knew nothing about taxes. I did not know when to pay them, or how to pay them. My time for reckoning came when I came across a video on youtube about how I could save on taxes if I registered as an LLC. Although I am not that well versed, from my research, yet to help you figure out if and why you should register as an LLC, I will help you understand, as best as I have understood, the Tax Jargon for the USA.

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Image by The New York Public Library from uplash.

Components of taxes.

Federal Taxes

Federal taxes are taxes you owe the federal government. This is also collected by the IRS. The federal tax rate is the same throughout the country, and you must pay it every year. The rate of tax varies from year to year. The current tax code can be found here.

State Taxes

Apart from federal taxes, most states require you to pay an additional state income tax. This state tax depends on the state you live in and earn your income in. If you work and reside in different states things get a little complicated and extra research is due.

Tax Slabs

Tax slabs are how income tax is calculated. You can think of it as steps, and you divide your money and put them on each step. Each step is associated with a percentage.

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Fig 1: Simplified Tax slab. Image by the author.

Deductions and Credits

Deductions.

A tax deduction is an amount you can reduce from your total annual income, so you pay Income tax only on the reduced total Income. An example would be the interest on your mortgage. If you earn 200,000 $ annually but pay 10,000 $ annually on the interest for your house mortgage, Then you can apply for tax deductions, and subtract 10,000$ from the 200,000$ income. Now you pay taxes only on 190,000$ rather than the full 200,000$.

Credits.

Tax credits are reductions you can make in the amount of tax you pay. This is an extremely powerful tool. Think about the following situation:

Filing for taxes

Filing taxes refers to filling out the correct forms required by the IRA and your state, to pay the taxes that you owe. Most employers will deduct pay to account for taxes, this way you have been paying taxes throughout the year instead of in one lump sum at the end. Even though you may have only one source of income (ex. Wages), and your employer has withheld taxes from your paycheck, and paid them to the IRA, you may still want to look into filing taxes. These can be either because you have earned extra income, or you think you are eligible to tax deductions and credits. There are 3 major ways you can file your taxes.

  1. The second method is to hire a tax professional, either a certified personal accountant or a licensed member from the IRA.
    The Pros of this method are:- you get personalized attention and solutions to help you save. This method is also particularly helpful if you have a complicated tax situation.
    The Cons of this method are:- It’s the most expensive approach. You also have to do research on your accountant to find a well-qualified accountant.
  2. The third method is to use tax software. These are a good in-between method, that has some qualities of both previously mentioned methods.
    The Pros of this method are:- It’s cheaper than hiring a professional and easier than learning the tax code. It’s fast and efficient.
    The Cons of this method are:- It’s not very personalized and is a more generic approach. If your tax situation is complicated, this might not be the best option for you.

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I love anything that makes me think. Check out my github here: https://github.com/akash-shastri. Get in touch with me on LinkedIn at https://www.linkedin.com/in

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