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What are taxes and how do they work?
Taxes are the fees everyone in the world pays to their government in one way or another to pay for the goods and services provided by the government like law enforcement, health care, the military, and others. Taxes are normally collected in a few different ways that include things like income taxes, property taxes, sales taxes, and etc. Luckily, governments also allow for tax deductions which save people money on the taxes they owe!
What are tax deductions?
Although the government collects taxes from the people in order to pay for the different services that the government provides, sometimes the government gives you a break on how much taxes that you have to pay based on your situation. When people or businesses take advantage of these tax breaks this is called a “tax deduction” because said tax breaks allow you to “deduct” or subtract a certain amount of money that an individual or business owes to the government for the year that the tax deduction is taken.
You typically need the services of a CPA or tax processing software like TurboTax or H&R Block in order to find all of the tax deductions that you have access to. Tax deductions can come from things like payment on loan interest, business expenses, and more.
What is the difference between standard and itemized tax deductions?
For most people, there are two different ways that you can use tax deductions. Those are the standard deduction and the itemized deduction. The standard deduction is a type of deduction where the government sets a specific amount of money that you are allowed to deduct from your taxable income for the year.
Itemized deductions are deductions that you can take from multiple sources like healthcare costs, including medical bills, dental bills, and prescription drugs, property taxes, mortgage interest, home office, and other job-related expenses, retirement account contributions, and etc. Unfortunately, you can only take one or the other when it comes to standard or itemized deductions, so if the standard deduction is higher than all of your itemized tax deductions combined then you have to take the standard deduction.
So for example, for the year 2021, the standard deduction is $12,550 for singles filers and married-filing-separately, $25,100 for joint filers, and $18,800 for the head of household. So if you earn $100,000 for the year and you’re single or married-filing-separately you can take the standard deduction of $12,550. This lowers your total taxable income for the year to $87,500 for the year.
Since you took the standard deduction you now pay taxes on only $87,450 of your income which would put you in the 22% income tax bracket. If you took the same example for joint filers earning a total of $100,000 you could take the standard deduction of $25,100 and only pay taxes on $74,900 of your income. This would put also put you in the 22% income tax bracket for 2021.
Like I already mentioned, itemized deductions come from tax-deductible expenses like healthcare costs, property taxes, mortgage interest, retirement account contributions, and etc. If you’re self-employed you get access to a wider range of itemized tax deductions than the average person. Businesses like Amazon, Nike, FedEx, and others are famous for using so many of their business expenses as itemized tax deductions that they sometimes get a large tax refund instead of paying into taxes.
Disclaimer: I am not any sort of investment or financial professional giving any sort of legal advice. I’m just some guy trying to teach other people about how they might navigate the financial world.