Introduction
One of the most common questions asked by taxpayers is how much they need to make in order to be required to pay taxes. The answer to this question is not always straightforward as there are various factors that can impact your tax liability. This article aims to provide a comprehensive guide to understanding the different components that affect how much you need to make to pay taxes.
The Basics of Taxable Income
When it comes to calculating your tax liability, the first thing to understand is what taxable income is. Taxable income is your gross income minus all the deductions and exemptions you are entitled to under the law. There are different categories of taxable income including earned income (wages and salaries), investment income (interest, dividends, capital gains), and self-employment income.
If you are a single filer under the age of 65, you are required to file a tax return if your gross income is at least $12,400 for the 2020 tax year. If you are married and filing jointly, the threshold is $24,800. If you are self-employed, the threshold is $400 of net self-employment income.
If you meet these minimum income requirements, you are required to file a tax return and will receive forms, such as Form W-2, Form 1099-INT or Form 1099-DIV, that you must use to report your income and deductions.
What is the Standard Deduction and How It Affects Your Taxes?
The standard deduction is a fixed dollar amount that reduces your taxable income. The amount of the standard deduction depends on your filing status, age, and vision status. For 2020, the standard deduction for single taxpayers is $12,400, for married filing jointly taxpayers is $24,800, for head of household is $18,650.
By taking the standard deduction, you can lower your tax liability without having to itemize your deductions. This means that if you have fewer deductions than the standard deduction amount, it is better to take the standard deduction.
To calculate your taxable income after the standard deduction is applied, simply subtract your standard deduction from your gross income. For example, if you are a single taxpayer with a gross income of $30,000, your taxable income after the standard deduction would be $17,600 ($30,000 – $12,400).
Understanding Tax Brackets
The federal government uses a progressive tax system, meaning that the more you make, the higher your tax rate. Tax brackets are levels of income at which different tax rates apply. In the US, there are seven tax brackets ranging from 10% to 37% based on your income level.
If you fall under a high income tax bracket, it does not necessarily mean that you will pay a higher tax rate on your entire income. For example, if you are a single filer with a taxable income of $40,000, your tax rate would be 22%. However, only the income above $9,875 is taxed at that rate. The first $9,875 is taxed at a lower rate of 10%, and income between $9,876 and $40,000 is taxed at 12%.
To calculate your tax liability based on your income bracket, you will need to use the tax tables provided by the IRS or consult with a tax professional.
Tax Credits and Deductions
Both tax credits and deductions can help lower your tax liability. A tax credit is a dollar-for-dollar reduction in your tax bill. For example, if you have a $1,000 tax liability and a $500 tax credit, your tax bill would be reduced to $500 ($1,000 – $500).
A tax deduction, on the other hand, reduces your taxable income. For example, if you have a $1,000 deduction and a taxable income of $40,000, your taxable income would be reduced to $39,000.
There are many tax credits and deductions available, including the Earned Income Tax Credit, Child Tax Credit, and American Opportunity Tax Credit. Deductions include things like charitable contributions, mortgage interest deductions, and medical expense deductions. It is important to research and understand which credits and deductions you are eligible for to ensure that you are taking full advantage of all available options to reduce your tax bill.
Self-Employment Taxes
If you are self-employed, you are responsible for paying both the employer and employee portion of Social Security and Medicare taxes, which is known as self-employment taxes. If your net self-employment income is more than $400, you are required to pay self-employment taxes.
The self-employment tax rate is currently 15.3%, which is divided into a Social Security portion of 12.4% and a Medicare portion of 2.9%. However, you can deduct half of your self-employment taxes as an adjustment to income on your tax return.
To calculate your self-employment tax liability, use Schedule SE.
Investment Taxes
Investment income is usually taxed at a different rate than earned income. If you earn income from investments such as stocks, bonds, mutual funds or real estate investments, you will be subject to capital gains taxes.
Capital gains taxes are divided into short-term gains and long-term gains. Short-term gains are taxed at ordinary income tax rates, while long-term gains (gains on investments held for over a year) are taxed at lower rates, ranging from 0% to 20% depending on your income level.
To report investment income on your tax return, you will need to receive Form 1099-DIV or Form 1099-B. Make sure you report all taxable transactions and pay the appropriate taxes on your investment income.
State Income Taxes
Most states require residents to pay state income taxes in addition to federal income taxes. State income taxes vary depending on the state’s tax laws. A few states do not have state income tax at all, such as Nevada, Texas and Washington
If you are required to pay state income tax, you will need to know the state’s tax laws and tax rates to calculate your total tax liability. You will also need to file a state tax return if you meet the state’s minimum income requirements.
Conclusion
Calculating your tax liability can be a complicated process, which is why it is important to understand the different components that make up your tax bill. By understanding taxable income, the standard deduction, tax brackets, tax credits and deductions, and state income taxes, you can better estimate your tax liability.
If you still have questions or need help calculating your taxes, it is recommended to seek advice from a tax professional. By investing time to educate yourself about the tax system, you can ensure that you are taking full advantage of all tax-saving opportunities and avoiding unnecessary tax expenses.
