Money Lesson 18 - Taxes: 5 Basic Ideas

Fill up tax forms can be very scary and complicated. Sometime you hope to use your favorite tax software to help you but it doesn’t make things easier. In fact, if you get to understand what taxes are all about, you won’t feel that hard when preparing your tax forms.

Five Aspects of the Tax System

Everyone is subject to taxation. The amount of taxes you need to pay is based on your income, the higher your income the more taxes you need to pay. As the tax payer, you must pay taxes through out the year on pay-as-you-go system. The more income you earn the more taxes need to be paid but the tax rate is not proportional, instead it get progressively increase; But you can reduce your taxes by taking the advantages of various tax benefits. In fact, you actually can take control of you tax situation. Below are the basic five aspects of tax system:

1. All is Subject to Income Tax

First of all, everyone which include individual, company or institute, either profit or non-profit organization is subject to the income tax. Although some organizations which meet some tax exemptions criteria are exempted from tax, they need to report and file their income as well. The bottom line is all people and organization must report their income and calculated their tax. For organization to be exempted from tax, they need to fulfill a certain criteria but this tax-exempt status could be revoked any time if the organization fails to meet the required criteria.

2. Taxed On Your Income

All the monies you earn either through working or investing are subject to tax. Your income may include wages, interest, dividends, profits on your investments, pensions you receive, and so forth, all these are taxable.

3. You must pay your taxes throughout the year

You must pay your tax as you go throughout the year. For most working individuals, their taxes are normally auto-deducted from their paycheck and sent directly to the federal government by the company. At the end of the year, the government tax department will compile the exact tax you need pay based on your income reported. If you pay more that what you should pay for, the government will refund the balance to you, this is call tax refund. Else, if you paid less than the amount of tax you should pay for, then you have a balance due. If you have a balance due, your must pay it by April 15th of the following year, or the government will charge you interest on the balance due.

4. Tax system is progressive

In US and most countries, the tax system is progressive. This means that the more income you earn the higher tax rate will be. People who earn less will have lower tax rate. Your exact tax rate will be determined by your total money you made throughout the year.

One way to reduce your tax rate is to reduce your total income. You can do this by contributing your money to retirement account, such as 401(k) or IRA plan. There are tax benefits which you can use to reduce your tax rate. The goal of tax planning is to choose which tax benefits make the most sense for you.

5. The income tax system is voluntary

You are free to arrange your financial affairs in such a way to take advantage of any tax benefits to minimize your taxes.

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