An Excerpt from “Bank Magic: Financial Literacy for Young People, the Upcoming Book on Teaching Children About Money

A discussion about taxes can get complicated because there are different details and deductions and other things that go into it. But here’s a simple way of understanding taxes.

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The main message here, if you make $10 then $3 of that has to go to pay taxes to the government.

Now let’s dig deeper. The best thing to remember about taxes is that once you make over $6,300 or $10,000 for the year, you have to start paying taxes on the money you make.

There may be three different places where the taxes you pay go.

#1 is the IRS or the federal government in Washington DC.

#2 is the state you live and work in. Although many states don’t have a tax on your income.

#3 in very, very rare situations is to the city that you live and work in.

Now, it’s also worth noting that when it comes to paying federal taxes to the IRS, the more money you make the more of a percentage of income has to be paid in taxes. This is called a progressive tax.

Here’s how it works, let’s say you make $15,000 for the year. In this situation, your federal or IRS tax rate may be 10% of your income. That would make your tax bill $1,500 ($15,000 x 10%) for the year.

On the other hand if you make $150,000 per year your tax rate may be 28% and your tax bill will be $42,000 ($150,000 x 28%) for the year.

There are different details involved in how to figure out how much you should pay in taxes for the year based on the amount of income you make, but here is a more detailed summary of how our federal progressive tax system works. hhh

Again, there are many more details that go into how much has to be paid in taxes. But you have time to worry about that later for the most part.

Now when it comes to paying taxes most people that work for a company have the taxes taken out of their paycheck. That process makes paying taxes pretty ease. Here’s what the form looks like when you first start a job and want to have your federal taxes taken out of your paycheck (Your state and city would have their own separate form to fill out if necessary).ppp

The most important box here is box #5. Why? Because that box determines how much tax is taken out of your paycheck every pay period. As a general rule of thumb, the smaller the number in box #5 the more taxes are taken out. If you put 0 (the number zero) here, the most possible taxes will be taken out of your paycheck.

If at the end of the year it turns out that you paid more taxes then you were supposed to, the government will give you back the money as a refund. On the other hand, if you didn’t pay enough in taxes during the year the government wants you to pay the remainder of what you owe.

So how do you know how much you made for the year and how much you paid in taxes for the year? By getting this W2 form from every job you worked at for the year.rrr

Each company has to give you a copy of this form by January 31 of every year. Again, the information on it provides a summary of what happened the prior year from January 1 to December 31. You use this W2 and a number of other pieces of information to prepare your tax return from late January until mid-April. Usually April 15.

So what are the number in the different boxes? Here’s a quick summary:

Box #1 – How much you made that is taxable for the year.

Box #2- How much you paid to the IRS for the year.

Box #17- How much you paid in taxes to the state you work and live in.

Box #19- How much you paid in taxes to the city you live and work in.

Obviously there are more boxes here but we just wanted to highlight the ones you would pay attention to the most.

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Alimony Payments Are Tax Deductible

Here’s how the IRS describes what is tax deductible when it comes to divorce or separation:

Amounts paid under divorce or separate maintenance decrees or written separation agreements entered into between you and your spouse or former spouse are considered alimony for federal tax purposes if:

  • You and your spouse or former spouse do not file a joint return with each other
  • You pay in cash (including checks or money orders)
  • The payment is received by (or on behalf of) your spouse or former spouse
  • The divorce or separate maintenance decree or written separation agreement does not say the payment is not alimony
  • If legally separated under a decree of divorce or separate maintenance, you and your former spouse are not members of the same household when you make the payment
  • You have no liability to make the payment (in cash or property) after the death of your spouse or former spouse, and
  • Your payment is not treated as child support or a property settlement

So as you can see, for taxpayers that are going through a divorce and have to pay alimony there is a silver lining. The payments are tax deductible.

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