Benjamin Franklin said it a couple of hundred years ago, and it’s still true today: the two inevitabilities in life are death and taxes. While it might be possible to live without paying taxes, it would involve a lifestyle a little more off-the-grid than most of us would find practical.
But just because taxes are pretty much inseparable from life, it doesn’t mean that you can’t make some smart choices to avoid paying Uncle Sam more than his due share. In fact, taxes are kind of a bad news/good news proposition. The bad news is that you’re likely going to be paying taxes for most of your earning life. But the good news is that if you’re paying taxes, it means you made money! The important thing is to make sure you aren’t paying more than required.
Why Pay Taxes?
It’s important to understand why taxes are necessary. The taxes you pay are used by local, state, or the federal government to cover the costs of things like roads and other basic infrastructure, to pay for public safety personnel and equipment, to provide other basic social and educational services, and, in the case of the federal government, to provide for national concerns like defense, programs like Social Security and Medicare, and other efforts that benefit the entire population.
There are several different types of taxes: property taxes, sales taxes, state and federal income taxes, and others. But in this article we’re focusing on the federal income taxes that you report every year when you file your return by April 15. The US income tax system is a progressive system, which means that the more you earn, the higher percentage of income you will pay in taxes. According to the tax tables used by the Internal Revenue Service, once you reach a minimum threshold of annual income (for 2023, $12,950 for single individuals, $25,900 for married couples), you pay tax equal to 10% of income above that level. And the percentage rates go up as your income increases, reaching a maximum level of 37% for individuals earning $578,125 or more ($693,750 for married couples). This means that as your income rises, different segments are taxed at different rates. Some states also impose an income tax at a rate in addition to that paid on your federal tax return.
How Does It Work?
The vast majority of individuals pay taxes through funds withheld from their paychecks by their employer. Most employers are required to hold back from the wages earned by employees an amount sufficient to cover their estimated income tax liability. You may remember that when you were hired, you had to fill out a Form W-4 (withholding form); this form indicates how much of your pay will be withheld for taxes. Generally, single persons should have more withheld than married persons with children, because the more people in your household, the higher your personal exemptions—an amount of money exempted from taxes on your federal tax return. Every three months, your employer is responsible for remitting to the government the amount withheld from employee wages. These amounts are then credited to you as taxes paid when you file your return.
Self-employed persons who have no employees are also responsible for paying a quarterly estimate of their tax liability. The due dates for these payments are:
- April 15
- June 15
- September 15
- January 15 of the following year.
When you file your tax return, the amount of estimated tax payments is reported on your form as taxes you paid. The form collects your income information, along with any exemptions and other deductions you qualify for. Your return compares how much you paid with the amount you owe—after exemptions and deductions—according to the tax tables. If you paid more than you needed to, you’ll receive a tax refund of the overpaid amount. If you underpaid, you’ll have to send with your return a payment of the amount you still owe.
Getting a Tax Refund?
Most people who work for an employer prefer to have slightly more than necessary withheld from their wages so that they get a tax refund every year. And it is a nice feeling to get a check from Uncle Sam. But it might surprise you to know that getting a refund has some downsides, too. For one thing, if you receive a refund, it means that you have provided the federal government with an interest-free loan, which doesn’t benefit you financially. Another major downside is that getting a refund means you have reduced the amount of money available to you from your paycheck; you could have been enjoying the use of that extra money, rather than Uncle Sam!
On the more positive side, however, your tax refund can provide you with additional funds for important financial purposes such as paying off excess debt, putting more money toward saving or investing, or other actions that will increase your net worth and help you build wealth. A good rule of thumb is to have enough withheld to provide a small refund of perhaps a couple hundred dollars. For most individuals, this is better than risking underpayment, which can make you liable not only for the amount of taxes still owed, but also extra penalties imposed by the IRS for under-withholding. Keep track of your tax refund from year to year, and work with the payroll department of your employer to make adjustments in your withholding, as needed. Typically, you’ll do this by submitting a revised W4.
Need More Time?
Some years, because of moving, changing jobs, or other major life events, you may not have time to prepare the information and file your return by the standard deadline (April 15, unless that day falls on a legal holiday or a weekend). In that case, you can file a request for an automatic extension, which gives you until October 15 to prepare and file your return (actually, for 2023, the extension due date is October 16). It’s important to remember, however, that this is not an extension of time to pay your taxes; they are still due on April 15. Rather, this is an extension of time to file your return. You will still need to estimate and pay any taxes due by the April 15 deadline.