Taxes are fraught with confusion and frustration. If the IRS decided to publish a book of frequently asked questions, it would rival the 4 million words of the U.S. tax code itself. We've assembled the 10 most common questions that every American asks about taxes, including, Why do we even pay taxes in the first place? Where does our tax money go? And what happens if we don't pay them? (Hint: bad things.)
If you can't find an answer to your tax questions here, just scrawl them across the top of your 1040 in red ink and ALL CAPS. We're sure the IRS — or the FBI — will get right back to you.
This is a fair question, and it's one that every American citizen should be able to answer. The whole point of taxes is to raise money to help pay for programs and services authorized by state and federal governments. Here are some examples of what your federal and state income taxes help to provide.
Federal taxes help pay for:
- National defense – Securing America and protecting its interests overseas
- Social Security – Providing a secure safety net for older Americans
- Medicare, Medicaid and CHIP (Medicaid for children) – Ensuring access to quality health care for low-income families, children and the disabled
- Science and medical research – Finding cures and funding innovation
- Education – Making college more affordable through Pell grants
- Regulation – Keeping the water and air clean, and products and services safe
State taxes help pay for:
- Public schools – Providing free, quality education from grades K-12
- Public colleges and universities – Subsidizing the education of in-state residents to promote employment and economic development
- Infrastructure – Building and maintaining highways, roads and bridges
- Medicaid and CHIP – States also cover a portion of health care costs for lower-income families
- Public safety – Both state and local governments hire police and firefighters, and operate prisons
In short, taxes are the price we pay for living in a society that looks after the elderly and less fortunate and takes an active role in educating and protecting its citizens. If you feel that state or federal governments are spending tax money unwisely, write your representatives and support candidates who share your values.
If you work for someone else — let's call it "the man" — then taxes are withheld from each of your paychecks. When you file your tax return in April, you have a chance to claim deductions and credits that lower your total taxable income. If you lower it far enough, Uncle Sam will owe you some of the money that was withheld during the year. That's called a refund!
One way to get a bigger refund is to withhold more money from each paycheck. Talk to your human resources representative and ask to lower the number of exemptions on your W-4 form. Keep in mind, though, that you could probably do smarter things with that money than lend it to the IRS. It won't return with any interest. Consider investing the extra income or using it to pay down debts.
The other way to get a bigger refund is to claim more deductions and credits on your tax return. Every taxpayer is entitled to a standard deduction, but you might be able to trim even more from your taxable income by itemizing your deductions. Keep track of deductible items like mortgage interest, charitable contributions, unreimbursed job expenses, expenses related to a home business, and student loan interest.
If you have a lot of investments, own rental property or operate your own small business, consider hiring a professional tax preparer. They can help you identify potential losses and expenses that may result in a bigger refund.
If you miss the April 15 due date (established by the IRS for filing and paying any taxes due to the federal government), the world isn't going to end, but you might be charged some late fees.
The IRS charges two different kinds of late fees: failure-to-file and failure-to-pay penalties. The failure-to-file penalty is much higher than the failure-to-pay penalty — 5 percent of unpaid taxes per month versus 0.5 of 1 percent per month — so the best advice is to file on time even if you can't pay your full tax bill [source: IRS].
Yes, the IRS lets everyone apply for an automatic six-month filing extension, but read the fine print. An extension gives you six more months to prepare and file your tax return, but it does not excuse you from paying your taxes on time. When you file for the extension, you are asked to pay an estimation of your outstanding tax bill. If you don't cover at least 90 percent of your taxes due by April 15, the failure-to-pay penalty still applies.
If you are self-employed, paid in cash, have no home or car loans, no bank accounts, and have never filed or paid income taxes in the past, then it's possible to stay under the IRS's radar. On average, only 2 percent of non-filers get caught [source: Beam]. But if you receive a regular paycheck from an employer, have a mortgage and keep your savings in a bank rather than in garbage bags buried in the backyard, then the IRS will likely catch up with you and the penalties will be stiff.
The trouble starts when IRS computers notice that there are wages, loans and bank accounts associated with your Social Security number but no tax return. After mailing a series of increasingly sternly worded letters, the IRS will file a substitute for return, its own approximation of what you owe. Based on those calculations, the IRS will start applying failure-to-file and failure-to-pay penalties for each month you are late. Both penalties can go as high as 25 percent of your unpaid tax bill [source: IRS].
There is a subculture of tax protesters that employ constitutional objections — the IRS calls them frivolous tax arguments — to justify not paying taxes. The courts have routinely rejected these arguments as tax fraud or tax evasion. The extra penalty for tax fraud is 75 percent of taxes owed, and tax evasion can land you in prison [source: IRS]. Just ask Al Capone.
If you make a modest income and try your best to file an honest reckoning of your income and expenses, there is very little chance that you will attract the attention of an IRS auditor. According to 2011 numbers, households making less than $200,000 had a one in 98 chance of being audited. The odds were significantly higher for the very wealthy. If you made more than $1 million in 2011, you had a one in eight chance of a friendly follow-up from the IRS [source: Kane].
- Forgetting income – If you are a salaried employee or a self-employed contractor, the IRS receives records of your wages for the year. If your numbers don't match up with the IRS's numbers, that's a red flag.
- "Business" expenses – Don't claim vehicle mileage as a business expense unless you use the car exclusively for business. The same advice goes for a home office. And don't try to write off lavish dinners as entertainment expenses unless you can prove that the main purpose of the meal was to discuss business with clients.
- Huge charitable contributions – If you claim tens of thousands of dollars in charitable contributions but only make a modest income, the IRS will get curious.
The first thing to recognize is that the so-called "marriage penalty" no longer exists. Before 2001, the standard deduction for a married couple filing jointly was less than twice the amount of a single taxpayer. Today joint filers can claim exactly twice as much as single or separate filers, so that's not an issue. Here's what to consider instead [source: Vient]:
Advantages of filing jointly:
- Double deduction – The double-sized standard deduction is reason enough to file jointly, particularly in single-earner households.
- Certain tax credits – Only married couples filing jointly (not separately) can qualify for the earned income tax credit, the American opportunity tax credit, the lifetime learning credits, the child and dependent care credit, and deductions for adoption expenses.
- Higher limits – You don't have to file jointly to claim the child tax credit, but the $1,000 credit begins to phase out at $110,000 for joint filers and only $55,000 for separate filers.
Advantages of filing separately:
- Medical bills — The IRS allows you to deduct medical expenses in excess of 10 percent of your income. If your spouse makes a lot more money than you, then his or her income can make it difficult to deduct your medical bills.
- No liability — By filing jointly, both husband and wife are legally liable for mistakes or misinformation on the tax return. If one spouse has complicated taxes related to a business, it might be smart to let the other half off the hook.
You don't have to file an income tax return if you make less than the minimum income requirement for the tax year. For 2013, that was $10,000 for single filers and $20,000 for married filing jointly, but only $3,900 for married filing separately. The minimum filing levels are slightly higher if you or your spouse is 65 or older [source: IRS]. If you are claimed as a dependent on someone else's tax return, then your minimum filing requirement is $6,100 [source: TurboTax]. The levels go up every year with inflation, so make sure to check the current figures.
But even if you don't have to file a tax return, there are times when you should anyway. If your employer withheld taxes from your paychecks, you might be entitled to some of that money back. Plus, it's good practice for when you're working full time and have more income to declare.
Thanks to the baffling logic of the IRS, this question is surprisingly difficult to answer. (To experience the confusion for yourself, go to IRS Publication 501 and click on the link for Exemptions for Dependents.)
Here's the short answer: a dependent is anyone who lives with you — other than your spouse — for whom you provide more than half of their financial support. Children are the most common dependents, but elderly parents and other relatives can qualify, and even unemployed friends crashing on your couch.
The IRS has two different sets of requirements for claiming dependents: qualifying child and qualifying relative.
Requirements for qualifying child:
- U.S. citizen or legal alien
- Younger than you and younger than 19 (or 24 if full-time student)
- A blood relative: son, daughter, niece, brother, etc. or adopted/foster child
- Lived with you for at least half the year
- You provide more than half of the child's financial support
Requirements for qualifying relative
- U.S. citizen or legal alien
- Not your qualifying child
- Either be related to you or live with you for the whole year (unemployed friend clause)
- Can't earn more than $3,900
- You must provide more than half of the "relative's" financial support
Some additional rules: Two people cannot claim the same dependent on two different tax returns, and you cannot claim someone as a dependent if that person is married and filing jointly with his or her spouse.
Ooh, this is a good one, because it's the source of a lot of confusion. The U.S. income tax code is called progressive, because the tax rates increase as income increases. In 2013, for example, income up to $8,925 was taxed at 10 percent. Income between $8,926 and $36,250 was taxed at 15 percent. And income between $36,251 and $87,850 was taxed at 25 percent. Someone who earned $50,000 is said to be in the "25 percent tax bracket." Seems easy enough, right?
When we say someone is in the "25 percent tax bracket," it sounds like all 50,000 of their dollars are taxed at 25 percent, which would be $12,500 in taxes. But that's not true. Only the money greater than $36,250 is taxed at 25 percent. The rest is taxed at 15 percent and 10 percent according to the dollar amounts we just listed [source: Fidelity]. The real tax owed by a single filer on $50,000 is $8,428.75. That's a tax rate of 16.8 percent. (The real rate would be considerably lower after deductions and exemptions.)
"Tax bracket" is a meaningless term. The correct word is marginal tax rate. That's the tax rate charged to the last dollar you earn in a tax year — 25 percent in our example above. The real rate that you pay the IRS — 16.8 percent in our example — is called the average or effective tax rate. The average rate is always lower than the marginal rate, unless you make $8,925 or less, in which case they are equal.
Another great question that deserves a closer look. In 2011, billionaire investor Warren Buffett wrote an op-ed piece in The New York Times titled "Stop Coddling the Super-Rich" in which he claimed to pay an effective income tax rate of 17.4 percent, while other people in his office paid 36 percent.
How is that possible? Buffett, like many other extremely wealthy people, makes most of his money through investment income, not regular employment income. Back in 2011, all investment income was taxed at a flat 15 percent. In 2014, it's as high as 20 percent for people earning more than $400,000. Regular income, on the other hand, is taxed at 25 percent as soon as it exceeds $36,250, and the rates only go up from there [source: Fidelity].
Regular working folks also pay payroll taxes on each paycheck to contribute to the Social Security and Medicare/Medicaid trust funds. There are no such taxes on investment income.
In the end, people who make money from money (investors) pay lower effective tax rates than folks who make money from a job. That said, to pay an effective tax rate of 36 percent requires an extremely generous salary likely in the millions of dollars — hardly "regular folks." Middle-class earners are more likely to have effective tax rates of less than 10 percent after standard deductions and personal exemptions [source: CBPP].
For lots more Tax Day lists and helpful tips, check out the related HowStuffWorks articles on the next page.
The IRS or Internal Revenue Service handles taxes. Learn about the history of the IRS and how it enforces taxes.
Author's Note: 10 Most Common Tax Questions
Taxes are a blessing in disguise. Yes, we all cringe when we see the minus signs on our paycheck or watch with horror as the TurboTax "federal tax due" ticker goes up and up and up. But paying taxes forces me to care about what federal and state governments are doing with my hard-earned money. It makes me pay attention to budget debates and vote for candidates whose priorities align most closely with mine. In short, paying taxes makes me a more active participant in this thing called a democracy. Thank you, IRS. (Yuck, did I really just say that?)
- Beam, Christopher. "Taxes, Schmaxes: What happens if I don't file my tax return?" Slate. April 14, 2009. (March 14, 2014) http://www.slate.com/articles/news_and_politics/explainer/2009/04/taxes_schmaxes.html
- Center on Budget and Policy Priorities. "Policy Basics: Marginal and Average Tax Rates." April 15, 2013. (March 14, 2014) http://www.cbpp.org/cms/index.cfm?fa=view&id=3764
- Fidelity. " A Taxpayer's Guide to 2013." (March 14, 2014) https://www.fidelity.com/viewpoints/personal-finance/taxpayers-guide
- IRS. "2013 Filing Requirements." (March 14, 2014) http://www.irs.gov/publications/p554/ch01.html
- IRS. "Failure to File or Pay Penalties: Eight Facts." April 17, 2012. (March 14, 2014) http://www.irs.gov/uac/Failure-to-File-or-Pay-Penalties:-Eight-Facts
- Kane, Libby. "What are the Chances the IRS Will Audit You?" LearnVest. Jan. 6, 2012. (March 14, 2014) http://www.learnvest.com/knowledge-center/what-are-the-chances-the-irs-will-audit-you-469/
- TurboTax. "Does everyone need to file an income tax return?" (March 14, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/Does-Everyone-Need-to-File-an-Income-Tax-Return-/INF14399.html
- TurboTax. "2013 Tax Rate Schedules." (March 14, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/2013-Federal-Tax-Rate-Schedules/INF12044.html
- Vient, Samantha. "11 Common Questions About Taxes, Answered." Forbes. March 19, 2013. (March 14, 2014) http://www.forbes.com/sites/learnvest/2013/03/19/11-common-questions-about-taxes-answered/3/
- Wicker, Alden. "How to Avoid Getting Audited." LearnVest. Jan. 29, 2013. (March 14, 2014) http://www.learnvest.com/knowledge-center/how-to-avoid-getting-audited/