What You Need to Know About Personal Income Taxes
Last updated 3/8/2019 at 1:02pm
As Benjamin Franklin once said, in this world nothing can be said to be certain, except death and taxes. Taxes impact nearly every aspect of your financial life, from your overall financial and investment strategy to how you choose to save for your most important goals, such as a dream vacation, retirement or your child's education. Understanding tax concepts and tax planning strategies-and opportunities that may reduce your tax bill-will help you make the most of the money you've worked so hard to earn.
In order to plan for your tax obligations and take advantage of common tax strategies, you need to know what forms you will need, how different types of income are taxed and how your federal taxes are calculated.
Common Tax Forms
W-4 Form. This is the form your employer uses to determine what percentage of your pay will be deducted for taxes. Filling out your W-4 form correctly helps ensure you don't underpay or overpay your taxes during the year.
W-2 Form. Your W-2 statement provides a breakdown of your earnings and the amount of taxes withheld from your paycheck for the year. If contributions to your retirement plan and health savings account were deducted from your paycheck, you will see this on your W-2, as well.
Form 1099-INT. If you received any interest income, it will be reported on this form.
Form 1099-DIV. If you received any dividend income, it will be reported on this form.
Form 1040. This is the official form used to file your individual income tax return each year.
How Income Is Taxed
Your taxable income includes more than just the money you earn at work. Taxable income can be divided into ordinary income and capital gains. Ordinary income includes the compensation you receive from your job, as well as interest income. Capital gains include money you make on selling an asset, such as stock or real estate, as well as investment property. If you lose money selling an asset, you incur a capital loss.
It is important to distinguish between ordinary income and capital gains or losses because these two types of income are treated differently for tax purposes.
For capital gains, your tax will rate will depend on how long you held the asset. If the holding period was longer than one year, your capital gain or loss is considered long-term and is subject to a lower tax rate. If you have capital losses you can offset them against gains or against a maximum of $3,000 of ordinary income. If you still have capital losses left over, you can carry them forward to the next tax year.
How Your Taxes Are Calculated
Important components of your tax calculation include:
Gross Income. This includes all your income from all sources.
Adjustments to Income. These are deductions that reduce your gross income, such as traditional IRA contributions, student loan interest payments and contributions to a health savings account.
Standard or Itemized Deductions. These are deductions, such as medical expenses, mortgage interest and charitable gifts that reduce your taxable income.
Credits. These are credits that reduce your tax liability, such as child tax credits and education credits.
Tax Planning Strategies
There are a number of tax-deferred accounts that you may be able to use to set aside money for specific needs and to potentially reduce your liability. These include flexible spending accounts, health savings accounts, commuter accounts or commuter benefits programs, education savings accounts, employer-sponsored retirement plans and individual retirement accounts.
Another strategy that may help to reduce your tax liability is to maximize your contributions to your company retirement plan and/or your IRA(s).
With your permission, a Financial Advisor can work with your tax advisor to help ensure that your tax strategy aligns with your overall wealth management strategy and is tailored to your individual goals.
Article by Morgan Stanley and provided courtesy of Morgan Stanley Financial Advisor.
Susan S. Craig is a Financial Advisor in Tampa Office of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). She can be reached by email at email@example.com or by telephone 813-227-2182. Her website is: http://www.morganstanleyFA.com/Susan.Craig
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