US is one of the those countries that have a high ratio of tax revenue to GDP and certain Government policies are set to reduce the tax burden on people even further. Yet there are some areas of the US tax system that still need improvement. The income tax system is very complex, and thus the incentives of work, saving and creating new businesses may be harmed due to the high taxes. Further, the revenue from income tax is more than that generated from consumption of goods, which is a not a healthy trend in the long run.
Basic Elements Of Tax System
To build a greater understanding of the US tax system, it is important to know about the basic elements. Once you are able to get a grasp of this system, you will be able to negotiate effectively.
W4 Form:
You fill this form as soon as you start a job. This is the form where you list your “withholding allowance information”. This information is an estimate of how much you are going to owe at the end of year in terms of tax, based on your predicted income, deductions and exemptions. On the basis of this information, your employer deducts a certain amount each month from your paycheck as your withholding.
W2 Form:
At the end of each tax year (in January), your employer sends you the W2 form that reports exactly how much you made and how much was withheld for the purpose of income tax.
These two forms; W4 and W2, contain almost all the information that you would need to fill up your tax returns. It will not include the information regarding return from investments, deductions, and tax breaks that do not apply to everyone etc.
Exemptions: The amount that you can subtract from your taxable income for things like getting married, having children or for just being alive (thus having more dependents).
Deductions:
These are personal expenses that you are allowed to subtract from your income. You are allowed to take your deductions in two ways. First is the standard deduction which is a set amount that the Govt. allows you to take just for paying your taxes. The other kind of deduction is the itemized deduction where you have to document all the other deductions that you qualify for. You can choose the kind of deduction that you are going to take. Thus, you have the option of figuring out which kind of deduction would give you more benefits.
Taxable Income:
Taxable income means your Adjusted Gross Income (AGI) minus your deductions, exemptions and tax credits. This figure is used for calculating your taxes. AGI is your earned and unearned income from all taxable accounts. Add up the following to arrive at your AGI: Income, taxable pensions, retirement plan benefits, capital gains from investments, rental income. From this sum, now subtract IRA, SEP or other valid donations and alimony payments.
Tax Saving Strategies
Some tax-saving strategies are -
• Always make optimal use of the exemptions and deductions. If you are confused, get professional help.
• Reduce your withheld amount by asking your employer to withhold only the exact amount of money. If you pay the Govt. more taxes than what you owe, you will get the amount adjusted but the Govt. is not going to pay you interest for that amount.
• There are certain tax credits that you can avail. These include child tax credit; child and dependents care credit, disabled or elderly credit, lifetime learning credit, Hope scholarship credit, adoption credit.
• Use a retirement account. If you save in a retirement account, you not only secure your future, but save taxes at present.
Once, you are familiar with these basics of the US tax system, you will be able to appreciate and benefit from the various tax credits and deductions. It will help you save unnecessary taxes, encourage planned savings and reduce confusion regarding the system.