Highlights of today’s show:
- Why taxes are so frustrating and confusing
- Is it wise to get a big tax refund?
- Explaining the tax system
- The difference between a deduction and a credit
- Tax software vs. Accountants. Who should you go with?
The only thing certain in life is death and taxes. We chuckle every time we hear this because it is true. Taxes aren’t something that you or I like to discuss, mostly because taxes are money going out instead of coming in. But with that being said, taxes are a major component of our finances and we often make decisions based on the tax implications.
With that being said, there are a lot of myths that we believe when it comes to our taxes. Today we break down four of them.
Tax Myth #1-It’s good to get a tax refund
This might be a little overstated. I’d rather you get $2,000 back in a refund than owe $2,000. But a tax refund is simply the IRS giving you back your money; it’s not a reward in the tax code or anything like that. Instead of getting a refund, adjust your W-4 and have less money taken out each paycheck. You won’t get a nice refund each April instead you’ll get that money sooner each and every month.
Tax Myth #2-All your income is taxed at the same rate
We can get the whole tax bracket thing mixed up. The tax brackets are marginal tax rates, meaning that each dollar is taxed differently. For example, for those of us who are married, the first $17,850 of taxable income you earned in 2013 is taxed at 10%, no matter if your total income is $20,000, $200,000, or $2 million. As you make more, your higher earnings are taxed higher, but just that income in the bracket, not all of it. If you make more money and get into a higher tax bracket, don’t worry about it. That tax rate just applies to those specific dollars. You can find out what tax bracket you are in for 2013 by visiting Forbes.com.
Tax Myth #3 A tax deduction is the same as a tax credit
Often a deduction and a credit get used interchangeably but they are vastly different. A tax credit is a reduction in your taxes due. So for example, if your taxes due at the end of the year are $2,000 but you have a $500 credit of some kind, the credit takes your total taxes owed down to $1,5000.
A tax deduction is a reduction in taxable income. If you have a $500 tax deduction and your total income was $50,000 for the year, your total taxable income is $49,500 ($50,000 less the $500 tax deduction.) If you are in a 15% tax bracket then your deduction saves you $75 in taxes ($500 times 15%).
Therefore a credit is not the same as a deduction. In almost every case a credit is worth more than a deduction. Truthfully I want both on my taxes, but if I can have only one I’d rather have a credit.
Tax myth #4 I don’t need to hire someone to do my taxes for me, I’ll instead use software
This isn’t really a myth as much as a service announcement. I don’t care what you use to file your income taxes. But tax software can only get you every deduction and credit if it knows that you earned it. If you don’t tell the software you earned the credit or deduction it won’t give it to you. However a trained professional will know the tax code and will know to ask whether you qualify or not. I personally use the software but I also know a lot about the tax code. If your taxes are pretty basic then you are probably fine using the software. But if yours are complicated and you are claiming a lot of deductions or you own a business, hiring someone might be the right way to go.
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