Join Jane Barratt for an in-depth discussion in this video Tax and your hard-earned dollars, part of Managing Your Personal Finances.
- There is so much anxiety wrapped up in our relationship to money. We all work so hard to get it, and it's so easy to spend it. And every day we're barraged with messages about what we should be doing, which for many people just makes you feel bad. But it doesn't have to be that way. In this video, I'm going to share a practical perspective on tax time as well as ways to keep more of your hard-earned money. The first thing to consider is that tax shouldn't be a surprise. It happens every year and it certainly shouldn't bring an unpleasant surprise where you have to write a big check.
As an aside, you should know that the tax rates on wages are generally higher than tax rates on investments. So if you're in a high tax bracket your earnings from actual labor can be taxed at over 30 percent. On the other hand, your earnings on Apple stock can be taxed as low as 15. The U.S. tax system definitely looks more favorably on money earned through investments. My goal as an investment adviser is to get people out of the day-to-day money in money out cycle and start thinking of themselves as investors.
The sooner that happens, the sooner benefits like tax advantages can start to pay off for you. So let's start with how to reduce taxes. Again, with the goal of saving money not to spend but to start investing or to contribute to existing investments. There's three ways to reduce taxes. First are the income reductions. You can lower the income that tax is assessed on a number of ways. Contributions to IRAs and interest on student loans can generally be used to reduce your income, subject to earning limits.
Employer-based Flex Spending Accounts for expenses such as transit, parking, education, and child care can sometimes be used to reduce your taxable income. These lower your taxable income, thereby lowering the amount of earnings that you're taxed on. Second, use credits to reduce your taxes. Make sure you check if you can get the Earned Income Credit on your tax return. The Earned Income Tax Credit, sometimes called EITC, is a tax credit to help you keep more of what you've earned.
To qualify, you must meet certain requirements and file a tax return, even if you don't owe any tax or you're not required to file. An estimated 25 percent of people who qualify for the EITC do not apply for it, and you can get it credited even if you missed it for the last three years. Make sure you check. There's also credits available for education, child care, and for savings. They're geared to people earning under 50,000 per year, but check to see if you qualify for these.
Last are deductions. These are things you can claim to lower your taxable income. It isn't a dollar for dollar benefit, but it reduces your tax by essentially showing you have less income to tax. Here's a list of things that can be used as deductions. Interest on mortgages, property taxes, state and local taxes, charitable donations, and some medical expenses. If you add up these deductions, see if they're greater than the standard deductions. If they are greater, you should itemize your deductions in your tax return.
It will save you money. Also, be aware of other miscellaneous deductions. If they amount to over two percent of your adjusted gross income, you can claim them too. These include tuition, dependent care, tools for work, magazine subscriptions, fees you pay to get your taxes prepared, and expenses incurred looking for a job. Confused? Absolutely, this is confusing. If you qualify for a lot of the deductions and credits I've just talked about, it may be a good idea to get some help.
There's a lot of tax preparation services online that are good and cheap. Many have free tools to help guide you through some of the process and file some, if not all, your tax return for free. Take advantage of them, but if things look super complicated get a professional to help and get a quote upfront before you begin. Your goal should be to make sure the cost of the professional is less than the extra money you'll get back. Tax is an inevitable part of life. If you're just starting out on your working life, now's a good time to form good habits.
And if you've been doing it for many years and dread it, there's no time like the present to look at it with fresh eyes.
- Maximizing your earning potential
- Planning for future earnings
- Budgeting and spending
- Understanding your credit score