What are Income Taxes? - Napkin Finance

Income Taxes

Pay the Piper

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Income Tax

Personal income tax is money the government collects from people based on how much they earned or received during the year.

Who pays

You may have to pay income tax if you received money from sources such as:

How paid

Every taxpayer is (or should be) making periodic tax payments throughout the year. How you make these depends on how you earn income:

Source How paid
W-2 employment Employer withholds and sends taxes to the government on your behalf
Self-employment You make quarterly payments to the IRS based on what you expect to earn that year
Lottery or gambling winnings The payer withholds some money for taxes (if you’ve won more than a certain amount)
Investments and retirement income  You can opt to have taxes withheld or make estimated payments

When you file your tax return each spring (usually by April 15), you’re really just settling up with the government. If you paid too much during the year, you’ll get a refund. If you paid too little, you owe Uncle Sam.

“Next to being shot at and missed, nothing is really quite as satisfying  as an income tax refund.“

—F. J. Raymond

How much

The federal income tax is “progressive,” meaning the more you make, the more you pay (in theory). The IRS sets different tax rates for different income ranges. These rates and ranges change frequently (and are different for single versus married people), but here’s an example:

Income range Tax rate
$0 to $9,700 10%
$9,701 to $39,475 12%
$39,476 to $84,200 22%

Let’s say you earned $50,000 last year. That would put you in the 22% tax bracket. However, the IRS doesn’t tax your entire income at that rate. Instead, it taxes each chunk of your income in its own bracket (this is called a “marginal tax rate” system). Here’s how it works:
Income Tax
So, you would only pay 22% on that last $10,524 in income. (And in real life, you would probably be eligible for various credits and deductions that would reduce what you owe.)

Whom you pay

You’re probably most familiar with the IRS, which is the federal government’s tax collection arm. However, depending on where you live, you might also owe state and/or local income taxes.

In fact, depending on where you live and work, and how you work, you could owe taxes in multiple states or localities. This often becomes an issue for athletes who play in many different cities and those who spend part of the year traveling to and working in certain states.

Tips

Doing your income taxes can be a good chance to check in on your finances in general. If you end up receiving a refund, consider using the extra cash to:

  • Invest for your future whether in a retirement account, 529, or other account
  • Put toward your emergency fund
  • Pay down debt

No one likes having to cut a large check to the government. So, if you find out you’ll need to pay more at tax time, consider:

  • Checking and adjusting your allowances to try to avoid another big tax bill next year
  • Adjusting your budget to make sure you have enough cash handy to pay your bill
Conclusion

People pay income taxes based on how much they earn each year. Many types of earnings, including salary and investment income, trigger an income tax. The federal government collects this tax as do many state and local governments. Although you file one tax return each spring, you’re likely paying taxes all year.

Fun facts
  • One astronaut on the Apollo 13 mission, Jack Swigert, hadn’t filed his taxes before liftoff and had to radio Mission Control from space to ask about an extension.
  • President Franklin D. Roosevelt once proposed a 100% top tax rate, believing that no American should net more than $25,000 per year after paying taxes.
  • Even though we’re grumpy about it, Americans are some of the least taxed citizens in the developed world.
Key takeaways
  • Income tax is levied on people who earned money during the year from a job, investments, unemployment, and other sources.
  • The federal government—plus some state and local governments—collect these taxes to help fund public services.
  • Income taxes are paid throughout the year, either by you, your employer, or the organization that represents the source of your income.
  • When you file your tax return, you’ll get a refund if you paid too much during the year or a tax bill if you paid too little.
“Mo Money, Mo Taxes,” — The Notorious I.R.S.

References

https://turbotax.intuit.com/tax-tips/general/how-are-federal-taxes-spent/L6kinGuUt
https://www.cbpp.org/research/federal-budget/policy-basics-where-do-our-federal-tax-dollars-go
https://www.investopedia.com/financial-edge/0210/7-states-with-no-income-tax.aspx#citation-3
https://www.moneycrashers.com/facts-us-federal-income-taxes-history/
https://turbotax.intuit.com/tax-tips/irs-tax-return/does-everyone-need-to-file-an-income-tax-return/L7pluHkoW
https://taxfoundation.org/2020-tax-brackets/
https://www.irs.gov/newsroom/tax-quotes
https://www.cbsnews.com/news/how-would-you-feel-about-a-94-tax-rate/
https://www.space.com/25513-taxes-in-space-nasa-astronauts.html
https://www.investopedia.com/terms/i/incometax.asp
https://turbotax.intuit.com/tax-tips/general/what-are-income-taxes/L5PKSEZTs
https://www.daveramsey.com/blog/what-are-income-taxes
https://www.taxpolicycenter.org/briefing-book/how-do-federal-income-tax-rates-work
https://www.urban.org/policy-centers/cross-center-initiatives/state-and-local-finance-initiative/projects/state-and-local-backgrounders/individual-income-taxes
https://money.howstuffworks.com/personal-finance/personal-income-taxes/income-tax.htm
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