All income is presumed to be taxable. However, U.S. tax laws provide that income is taxed in a variety of ways. Here's how different types of income are taxed in the U.S., and how to take advantage of these differences in your tax planning.
Form W-2 is the annual "Wage and Tax Statement" that reports your taxable income earned from an employer to you and to the Internal Revenue Service (IRS). The form also includes taxes withheld from your pay, as well as Social Security and Medicare payments made on your behalf by both you and your employer. Box 1 on the W-2 reports your total taxable wages or salary, and Box 2 reports how much your employer withheld from your paychecks for federal income taxes.
When you file your tax return, you'll start with your gross income and take several deductions to get your adjusted gross income (AGI). Then, you'll subtract other deductions to arrive at your taxable income, which is what the IRS uses to determine how much you owe for the year before credits. If you qualify for tax credits, you'll apply them directly to your tax liability, reducing it dollar for dollar to get your final tax bill for the year.
Your adjusted gross income (AGI) is the key element in determining your taxes. It's the starting number for calculations, and your tax rate and various tax credits and deductions depend on it. Credits and deductions that can help reduce your taxable income include contributions you made to a traditional IRA, health savings account, or flexible spending account, gifts to charity and cash donations, and child tax and earned income credit can help you reduce your tax bill.
You almost certainly won't have to pay income tax on your Social Security benefits if they are your only source of income. That means your Social Security income probably isn't taxable if you never got around to investing in a 401(k), if you don't rent out a property for profit, or if you've given up working entirely. However, if you have other sources of income in addition to your Social Security benefits, the taxable portion will be either 50% or 85% of your benefits.
In 2021, there are several types of non-taxable income including needs-based public assistance, including supplemental security income, disability benefits for which your employer paid the insurance premiums, workers’ compensation payments, employer-provided health insurance, life insurance death benefits—but not proceeds when a policy is cashed in, child support, alimony, as well as inheritances and gifts under a certain amount.
Adjusted gross income (AGI) is a tax term for your gross income minus tax deductions that are allowable whether or not you itemize deductions when you file your tax return. It is the determiner for many of the deductions and credits you will receive, as well as any taxes you will owe when you file your tax return.
Payroll taxes are amounts of pay withheld from an employee’s paycheck during the payroll process, and employers must usually match these amounts. Some payroll taxes are also known as “FICA taxes.” FICA stands for the “Federal Insurance Contributions Act,” and includes Social Security and Medicare taxes.
Form W-4 provides your employer with your filing status, and optionally, the number of dependents you have, and the tax credits and deductions that you intend to claim when you file your return. The information you include determines how much your employer withholds from your paycheck. Previously called the “Employee’s Withholding Allowance Certificate,” Form W-4 is now called the "Employee's Withholding Certificate" and was redesigned to reflect that you can no longer claim personal or dependency exemptions.
Backup withholding is a type of federal tax withholding on income that otherwise typically doesn't require tax withholding. Although some types of income usually don't have taxes withheld, some situations may require that payers withhold a portion of their payments to you. Backup withholding only applies to certain types of 1099 or gambling income in specific circumstances.
Other income is added together and entered on line 8 of the 2021 Schedule 1 instead. Then the total additional incomes from Schedule 1 are transferred to line 8 on the 2021 Form 1040. Other income includes earnings other than wages or income from self-employment, retirement income, or investments, foreign income, and canceled debts.
Schedule C on Form 1040 is a tax document that must be filed by people who are self-employed. It is a calculation worksheet known as the "Profit or Loss From Business" statement. This is where self-employed income from the year is entered and tallied, and any allowable business expenses are deducted.
A tax swap typically means selling a stock or security that’s underperforming and claiming a capital loss on the transaction. You can carry this loss over and subtract it from your taxable capital gains income if you then purchase a similar, better-performing security, and proceed to sell that to realize a capital gain.
Ad valorem taxes are taxes that are levied as a percentage of the assessed value of a piece of property. Examples of values that could be used to determine an ad valorem tax include the price of a product for a sales tax, or the assessed value of a home for a property tax. Ad valorem is Latin for “according to value,” and this kind of tax is used quite often at the state and local level in the U.S.
A taxable event is an event or transaction that triggers a tax consequence. A taxable event often results in taxes owed, but some taxable events can also reduce your tax bill. Payment of wages, dividends, or interest, and the creation of capital gains are all common examples of taxable events. Some changes in tax filing status—such as from single to head of household, single to married filing jointly, or adding a dependent child—are also considered taxable events.
The net investment income tax is a 3.8% surtax on a portion of your modified adjusted gross income (MAGI) over certain thresholds. It is generally paid by high earners with significant investment income. The net investment income tax can still apply to your finances even if you manage to avoid paying significant income taxes on your investment income through the use of deductions, credits, and other tax perks.
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