Understanding Taxes
Not sure how income tax works?
The following section explains basic tax terminology, concepts and procedures currently being used by the IRS.
Deductible Taxes
- State, local and foreign income taxes
- State, local and foreign real estate taxes
- State, and local personal property taxes, and
- State and local general sales taxes
The first key to understanding taxes is to understand what deductible taxes are. State and local income taxes withheld from your wages during the year appear on your Form W-2. You can elect to deduct state and local general sales taxes instead of state and local income taxes, but you cannot deduct both. If you elect to deduct state and local general sales taxes, you can use either your actual expenses or the optional sales tax tables. The following amounts are also deductible:
- Any estimated taxes you paid to state or local governments during the year, and
- Any prior year’s state or local income tax you paid during the year.
Generally, you can take either a deduction or a tax credit for foreign income taxes imposed on you by a foreign country or a United States possession. As an employee, you can deduct mandatory contributions to state benefit funds that provide protection against loss of wages.
Deductible real estate taxes are generally any state, local, or foreign taxes on real property levied for the general public welfare. They need to be charged uniformly against all real property in the jurisdiction at a like rate. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. However, you can increase the cost basis of your property by the amount of the assessment. Local benefits taxes are deductible if they are for maintenance or repair, or interest charges related to those benefits.
If a portion of your monthly mortgage payment goes into an escrow account, and periodically the lender pays your real estate taxes out of the account to the local government, do not deduct the amount paid into the escrow account. Only deduct the amount actually paid out of the escrow account during the year to the taxing authority.
Deductible personal property taxes are those based only on the value of personal property such as a boat or car. The taxes need to be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year.
Some taxes and fees you cannot deduct on Schedule A include federal income taxes, social security taxes, transfer taxes (or stamp taxes) on the sale of property, homeowner’s association fees, estate and inheritance taxes, and service charges for water, sewer, etc.
Estimated Taxes
Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income is not enough.
How to Figure Estimated Tax
To figure your estimated tax, you need to figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
When figuring your estimated tax for the current year, it may be helpful to use your income, deductions, and credits for prior year as a starting point. Use your prior year’s federal tax return as a guide. You can use the worksheet in Form 1040-ES to figure your estimated tax.
Payroll Taxes and Federal Income Tax
If you aren’t sure how income tax works, Gross Pay is the amount the employee earns.
Net pay, or take-home pay, is the amount the employee receives after deductions. Deductions will include Social Security taxes, Medicare taxes, and other amounts. Read More
Exemptions
To fully understand your taxes, you need to know that there are two types of exemptions, personal exemptions and dependency exemptions. Each exemption reduces the income that is subject to tax by the exemption amount. The exemption amount changes every year. In 2009, the exemption amount is $3,650. Read More
Understanding Tax Credits
There are two tax credits taxpayers may claim for themselves or their dependents, for higher education: the American Opportunity Credit (previously known as the Hope Credit) Read More
Dependents
A dependent may be either a “Qualifying Child” or a “Qualifying Relative.”
Qualifying child must meet the following requirements: The child must be younger than you. A child cannot be your qualifying child if he or she files a joint return, unless the return was filed only as a claim for refund. Read More
Interest Income
Interest income is the charge for the use of borrowed money. In most cases you will earn interest if you let others use your money. Your money earns interest when it is deposited in accounts in banks, savings and loans or credit unions, used to buy certificates of deposit or bonds, lent to another person or business. Read More
Refund, Amount Due, and Record Keeping
- Taxpayers receive refunds when their total tax payments are greater than the total tax. Refunds can be received by check in the mail or by direct deposit. The IRS will keep any refunds if you owe back taxes and apply it toward your balance.
- Taxpayers must pay an amount due when the total tax is greater than their total tax payments. Payments can be made by check, money order, credit card, or direct debit (electronic filers only).
- It is important for taxpayers to keep good records in order to prepare their tax returns and support items on their tax returns.
- Electronic Tax Return Preparation and Transmission Preparation means the completion of all the forms and schedules needed to compute and report the tax.
- Understand that Tax Returns can be prepared manually or electronically.
Self-Employment Income/Self-Employment Tax
A business is a continuous, regular activity that has income or profit as its primary purpose. Independent contractors are self-employed. Self-employed workers control the methods and means of performing services for others. Read More
Tax Return Transmission
When it comes to understanding your taxes, transmitting your taxes is the sending of the tax return to the taxing authority. You can transmit your taxes the following ways: Read More
The Five IRS Recognized Filing Statuses
- Single
- Married Filing a Joint Return
- Married Filing a Separate Return
- Head of Household
- Qualifying Widow(er) with Dependent Child