Federal Income Tax
The thing you complain about every April. Even when you end up with a refund, you end up thinking “I did all this paperwork to get my own money back?”
Essentially, the federal government levies a tax on your earnings. Most states also have income taxes (though the federal one is generally a lot bigger). If you receive a standard paycheck, the taxes are collected as you go. Your company (or their payroll processor, acting on their behalf) takes an estimated amount of income tax out of your pay and sends it to the government.
Then, after the year is completed, you run the numbers and see if you paid the right amount of tax, based on the amount of earnings you had and what deductions you racked up over the year.
The paperwork you file related to this process is called your tax return.
If too much of your paycheck went to the government during the year, you get a refund. The government sends you a check for the extra (or directly deposits it in your account, if you prefer). If you didn't pay enough out of your paycheck during the year, then you have to make up the difference. You'll need to send some money to the the Treasury Department.
Some fun facts: the first income taxes in the U.S. were passed to pay for the Civil War, and initially only affected really rich people. The Supreme Court eventually ruled federal income taxes unconstitutional, so regular people actively pushed for and voted for a constitutional amendment in order to purposely, explicitly allow the government in Washington to be able to tax income.
That was the 16th amendment, if you’re counting. So, thank great-great grandpa (great-great grandma couldn’t vote at that point) every time you fill out a W-4.
Related or Semi-related Video
Finance: What are the Types of Income Ta...65 Views
finance a la shmoop. what are the types of income tax? well there are many types of
tacks. here are some nice ones .and here are some others. and here are more .wait never
mind. okay. so there really are only two flavours of income tax in America.
ordinary income tax. yep that. and investment tax. in the u.s.
we tax people at different rates on the money they actively learn, like from [scientists work in a lab]
working at a job. versus money they passively earn like from gains on
investment or inheritance from dead grandparents. well in the interest of not
making you want to vomit or fall asleep we have simplified a ton of things for
the sake of clarity here. the overarching theme in income taxes is that the
government has taken the position that the wealthy or successful or high
earners should be taxed at a higher rate than people who earn less money. and
since the actual numbers change with seemingly every presidential cycle, we're
going to just simplify them here. but if you earned 100 grand last year you'd be
taxed at different rates on the different levels of money you earned.
like you're going to be taxed a percentage on a certain amount of that
hundred grand and then you'll be taxed a different percentage on the rest of it.
so this system is called quote progressive unquote. it's kind of a
political term because the people who voted for it thought it was great. well
on the first $10,000 of earning you might pay zero tax. like you know say
you're a starving artist and the government which doesn't want to tax you [equation]
so you can keep painting more paintings or whatever you did during that ten
grand. from $10,001 to 25 grand you might pay 10% on that piece of it. so that's
ten percent on that next fifteen thousand bucks of earnings or $1,500.
then from twenty-five thousand one to sixty thousand dollars you might pay 20%
so that's a 20% rate on that 35 grand spread right there yeah 60 minus 25 35
in California anyway. so 7 grand in taxes there know how much it more expensive
those later dollars are. then on the sixty thousand one dollars to a hundred
thou you might pay 30 percent or 30 percent tax on that 40 grand oh you'd
have paid 12 grand on that last 40 grand in taxes oh you only keep
28 grand after earning 40. well the total amount you would have paid then is one
less day fifteen hundred plus seven grand plus well grant go a hair over 20
grand. your average tax on that ordinary income [equation]
in for your federal tax would have been twenty point five percent. well things
get way more complex from here many states have a state tax in addition to
the income tax. Wyoming Florida in Texas for example have no state tax. they pay
their state bills from sales taxes and mineral / oil / energy taxes on
corporations, who drill them. California has the highest taxes on ordinary income
and investment income actually. topping out at thirteen point three percent for
the wealthiest earners there. yeah it's a mess doin your taxes and there's a
reason H&R Block is so profitable. well a lot of things beyond your paycheck get
taxed at ordinary income rates as well like rent you collect from renting out
your guest house and short term investment gains like if you paid ten [one woman collects money from the other]
bucks for a share of stock held it less than a year and then flipped it for
fifteen bucks that year well then you'd be taxed as if that $5 a share gain was
ordinary income. okay so thus far we've been covering flavor number one ordinary
income tax. time for the second flavor investments gain taxes but when you
invest in a stock or land or gold or rare coins or art and you hold it for a
year or longer you receive what's called long-term gain tax treatment. that's
cheaper than ordinary income tax taxes oddly long-term gains have historically
been roughly half of ordinary rates well the system is designed to reduce
volatility in the market in which assets are bought and sold by giving a benefit
to investors who hold things longer they tend to marry them rather than have lots
of no one-night stands with their stocks. it's better for everybody. [man frowns at stock drooling next to him in bed]
long-term rates have hovered around 20 percent per year and change so if you
invested a hundred grand into a stock and held it five years and it turned
into 250 grand and then you sold it you'd show a gain of a hundred and fifty
K. well that 150 K is your realized gain. you realized it when you got the cash
wired into your brokerage account so you can tax 20% on the gain
150k and well 150 k times 20 is 30 grand.
so from your original investment which turned into a 250 K pre-tax you'd keep
after-tax 250 K minus that 30 grand tax or 220 grand and note that many
states tax gains on income as well the above is just an example based on
federal rates. well the gist in this video is to be able to distinguish
between ordinary income from sources like your part-time job at the Wendy's
drive-through window or the money you make shoveling old man mather's driveway [man works drive through window]
or that by weekly paycheck you get for selling your soul to Geico. yeah an
investment income which gets long-term gains treatment like flipping an IPO
that gets ordinary income tax treatment because you owned the stock for only a
day or so. that's ordinary income. or a great long-term investment over five
years in a soft drink company that ends up being acquired for big bucks by
Coca-Cola./ or an angel funding round investing in two kids in garage who end
up making a car that actually flies without killing people upon landing.it's
be pretty cool so yeah two totally different flavors and both can leave a [kids smile as their car flies]
bad taste in your mouth.