What is tax law? It's one of the most complex areas of the law. That doesn't mean you can't figure out the basics on your own, but more complicated areas of tax law often require an accountant or a tax attorney.
From paying your taxes to minimizing tax liability on your estate, here are the fundamentals of tax law:
Paying your taxes as an individual
To file and pay your federal income taxes as an individual:
Figure out your tax filing status. Filing statuses include single, married, head of household, etc.
Count your dependents and exemptions. You can claim exemptions for yourself and your dependents. Exemptions are essentially like tax deductions because they lower your taxable income.
Report your income for the year. For most people, this is as simple as looking over your W-2s.
Claim any deductions and tax credits for which you're eligible. A tax credit, such as the child and dependent care credit, reduces the amount of tax you owe. A tax deduction, such as the student loan interest deduction, reduces your taxable income.
File your tax return and make a payment. You can obtain and submit the forms you need on the IRS' website. You have several options for payment, including online payment with a credit card, debit card or bank account. You can also send a check or money order via mail. If you file and the IRS determines you have overpaid, you'll receive a refund.
There are also a few special considerations to be aware of:
Tax-exempt status. Most Americans must file and pay federal income tax every year, but some individuals are exempt. In other words, they don't have to pay income taxes. Exempt individuals include people with certain disabilities, those with very low incomes, children, and others.
Child support tax requirements. Child support payments aren't considered taxable income, at least on the federal level. However, they also aren't tax-deductible for the person making the payments.
Immigration tax requirements. Whether or not an immigrant needs to pay taxes depends on their status. Green card holders are considered "tax residents" and must pay, but not all visa holders fall into this category.
Paying your taxes as a business
To file and pay business taxes:
Gather your records. You'll need all your records of your expenses and earnings.
Select and complete the correct form. Sole proprietors and partnerships will file using a Schedule C attachment to their personal income tax return. Corporations file a separate tax return using Form 1120.
File by the deadline. If you use a Schedule C, your deadline is usually the same as your individual return: April 15. For Form 1120, the deadline is usually March 15 for most corporations.
As with individuals, some businesses are exempt from paying taxes. An exempt organization qualifies for 501(c)(3) status if its purpose is charitable, religious, scientific, educational, etc.
Non-payment and tax evasion
Tax evasion is a criminal offense in which illegal tactics are used to avoid paying taxes. That may be underreporting income, exaggerating deductions, or hiding money from the IRS. Tax evasion can result in hefty fines, prison time, or both.
Many people who get into trouble with the IRS, however, are not guilty of tax evasion. They simply don't have the money to pay or accidentally miscalculated their liability. The IRS can nonetheless impose penalties, including:
- Tax liens (give the IRS claim to your real or personal property in relation to other creditors)
- Wage garnishments
- Interest and penalty fees
- Taking your Social Security
- Seizing your property or bank account
- Jail time (typically reserved for people who hide large amounts of money from the government and show a pattern of willful wrongdoing)
When you start a job, you fill out a W-4 form to tell the government how much to take out of your checks. Your W-2 then indicates how much you earned. After you take out any exemptions and deductions, you'll get your taxable income.
The taxes you pay on that figure will depend on how much your earn and your filing status. For example, if you made less than $9,225 in 2015, you'd pay a tax rate of 10 percent.
Businesses also pay taxes on their earnings in the form of a business income tax. If you are the sole owner of your business, in a partnership, or a member of an LLC not treated as a corporation, you'll file your business earnings as part of your individual return. Corporations and LLCs treated as corporations file separately.
Employer and employee taxes
Both employers and employees pay payroll taxes, which are typically calculated as a percentage of the employee's income. Employees pay these taxes in the form of withholdings from their paychecks. Employers also pay taxes based on the employee's earnings.
Specifically, employers and employees must pay FICA tax (Federal Insurance Contributions Act) to fund the Social Security and Medicare programs. Both employers and employees must pay:
- A 6.2% Social Security tax
- A 1.45% Medicare tax
As of 2013, employees making more than $200,000 must also pay the Additional Medicare Tax of 0.9 percent as added by the Affordable Care Act. Finally, employers must pay, out of their own funds, a federal unemployment tax (FUTA) based on the employee's earnings.
FUTA helps fund payments of unemployment benefits to workers who've lost their jobs. Most employers must pay both FUTA and state unemployment taxes.
Aside from the mortgage payment, property taxes are typically the second-largest expense homeowners face. Property taxes pay for important local government services, such as schools, road construction and maintenance, salaries of municipal employees, public parks, and police.
Each year, your city, county, and state charge a tax on each piece of real estate in their limits. In most places, property taxes are assessed and collected at the county level on an ad valorem basis, meaning "according to value."
The county applies a certain tax percentage to the real estate's assessed value. Property taxes can also take the following forms:
Direct assessments. Direct assessments and bonds are flat fees assigned to real property after a vote to fund services not sufficiently covered by ad valorem property taxes. Street landscaping and public transportation projects are commonly funded by direct assessments, for example.
Special assessments. Special assessments guarantee long-term funding for the schools, parks, and emergency services that directly benefit new developments. Built by developers of new subdivisions, these services are often located within the new subdivision but are available to everyone in the area.
Estate planning and taxes often go hand in hand. Estate planning means making arrangements for the disposition of current and anticipated assets upon death. Estate plans reduce the financial burden on the estate from taxes and other expenses, and minimize uncertainty about how the court will distribute assets.
Estate planners, typically accountants or attorneys, can structure the disposition of an estate to completely avoid estate taxes. They usually do so with trusts, gifts, life insurance, and other legal and financial tools.
The federal estate tax is a tax on your right to pass on property at death. To calculate your taxable estate, the tax adds the value of everything you own. This figure is known as your "gross estate" and includes real estate, cash, securities, and insurance.
After taking out deductions from your gross estate, you have your taxable estate. For 2015, you do not have to file an estate tax return if your taxable estate falls below $5,430,000. The top estate tax rate is now 40 percent.
In addition to the federal estate tax, some states charge their own estate and inheritance taxes. Inheritance taxes are state taxes that people who inherit property or money from a decedent's estate pay. They differ from estate taxes, which are taken from the estate itself, not its beneficiaries.
The gift tax is a tax on the transfer of property to another individual while the donor, or giver, receives nothing in return. If a gift exceeds the annual exclusion for that year, the giver is responsible for paying the tax. For 2015, the annual exclusion is $14,000 to each donee (recipient).
Federal and state governments levy many other taxes as well, including:
Capital gains tax. Tax on the sale of securities and property. The max net capital gain rate is currently 20 percent.
Sales tax. Taxes imposed at the city, county, and state level on the purchase of goods. Not all states have sales taxes, such as Montana and Oregon.
Excise tax. Taxes on certain activities, such as wagering, or the purchase of specific products, such as gasoline.
More complex aspects of the tax code are beyond the scope of this guide. However, you now have a solid enough understanding of tax law to make an informed decision on hiring an accountant or tax attorney to walk you through the process.