The transition to adulthood is sometimes hard to detect, but one sign you’ve arrived is if you know a handful of things about income taxes. Here are six things that tax pros say every adult should understand.
1. How tax brackets work
There are seven federal tax brackets, ranging from 10% to 39.6% this filing season. The country’s progressive tax system means that people with higher taxable incomes are subject to higher tax rates, and people with lower taxable incomes are subject to lower tax rates. Basically, the government divides taxable income into chunks — brackets — and each chunk is taxed at the corresponding rate.
But the bracket you fall into isn’t what you pay on your entire income.
“Even if you’re in the 35% tax bracket, your effective tax rate may be 27%,” says Barbara Weltman, author of “J.K. Lasser’s 1001 Deductions & Tax Breaks 2018.”
2. How a W-4 works
IRS Form W-4 lets you tell your employer how much tax to withhold from your paycheck, and how you fill it out can be a big deal, warns Joshua Hanover, an enrolled agent and senior manager at accounting firm Marks Paneth in Boca Raton, Florida. Withhold too little and you might owe when you file your tax return in April. Withhold too much and you might get a refund — but live on less of your paycheck in the meantime.
“Many people minimize their withholding in an effort to bulk up their take-home pay without regard to it catching up with them at the end,” Hanover says. “Most people in this situation learn from it and correct it going forward.”
3. The difference between a deduction and a credit
A tax deduction is a dollar amount you can subtract from your taxable income. The lower your taxable income, the lower your tax bill.
Tax credits are even better, Weltman says. They are dollar-for-dollar reductions in your actual tax bill. Some credits are even refundable, which means that if you owe $250 in taxes but qualify for a $1,000 credit, you could get a check for $750. (Most tax credits, however, aren’t refundable.)
4. Why similar people have different tax lives
“Taxes vary from person to person based on a number of things — whether they itemize [or] take the standard deduction, if they have any credits — there’s so many things that are in there, but it’s amazing how many people compare theirs to someone else’s and say, ‘Oh, well they got that much more back and they make about the same amount of money,’” says Matt Leonard, a certified public accountant in Concord, North Carolina. “You may have marked your withholdings differently, you may have different credits, you may have different things that you’ve done that they didn’t do.”
5. The value of filing on time
Many people blow off filing their tax returns by the April deadline because they can’t pay the bill, Leonard says. That’s a big mistake: There’s a late-filing penalty of 5% per month, up to 25% of your unpaid taxes. “You should file your return, even if you can’t pay your tax bill,” he warns. Plus, the IRS offers payment plans. Adults should also know that getting an extension gives them more time to file — but not more time to pay. And you can get only one extension per year, Leonard says.
6. When to hire a pro
“Being adults means recognizing when we’re out of our element and seeking the assistance of professionals,” Hanover says. “The same way I can change a capacitor on my pool pump and help my children build an electromagnet, but I wouldn’t redo the wiring throughout my home. … I’d call an electrician.”
However, hiring a pro isn’t an excuse to remain ignorant. “You may go to someone and they just do it, and you don’t even know what they did,” Leonard adds. “That’s sad, but that’s probably more likely than not.”