Decoding Taxes: 10 Essential Tax Concepts for Beginners

Howdy ladies & lady lads 👋🏼

Welcome back to Monarch!

Bailey here, coming @ you SO EXCITED for today’s article!!

Now, you might be thinking, "Excited? About taxes?!"

AND YES, I AM EXCITED ABOUT TAXES.

See, unfortunately “adulting” did not come with an instruction manual (especially when it comes to the dreaded T-word).

And to be vulnerable dudes, I’ve reached my breaking point here.

Taxes have been the monster under my back-and-hip-support bed for tooooo long.

I am now completely determined to make taxes my b*tch 💜

And today, I'm inviting YOU to join me on this magical (and profitable 👀) learning journey!!!

Enough chit chat - let’s dive into our first lesson in taxes: decoding 10 critical tax categories to jump start our tax knowledge. 🧠

Today’s Monarch Menu:

• 10 critical tax terms/categories to understand, structured:

  • Definition

  • Layman’s terms

  • Example

• Lil ol’ quiz question

1. Adjusted Gross Income (AGI): Your Key to Tax Savings

• Definition: AGI is your taxable income minus specific deductions (like retirement savings contributions or student loan interest).

• Layman's terms: It's the income number used to figure out your taxes after you've made certain legal deductions.

• Example: Let's say you earn $60,000 and contribute $5,000 to your retirement account. Your AGI would now be $55,000.

2. Itemized Deductions vs. Standard Deduction: The Two Roads to Tax Savings

When it's time to shrink your taxable income, you have two routes: the standard deduction or itemized deductions.

• Definition: Standard deduction offers a one-size-fits-all reduction. It’s a fixed amount deduction that reduces your taxable income without the need for detailed record-keeping.
  
  The 2022 standard deduction was $12,950 for single filers (🚶🏼), $25,900 for joint filers (👭) or $19,400 for heads of household (🏠).
  
  For 2023’s tax year, #s will rise to $13,850 (🚶🏼), $27,700 (👭), and $20,800, respectively (🏠).
  

• Definition: Itemized deductions allow you to reduce your taxable income with specific expenses, like mortgage interest and charitable donations
  
  One example of an eligible itemized deduction expense is the ✨simplified home office deduction✨. You can expense $5 per square foot of your home office, up to 300 square feet (that’s up to $1,500!)
  

• Layman's terms: Think of it as a choice between keeping every receipt and totaling them up, or just taking a one-size-fits-all deduction.

• Example: If your eligible itemized expenses (medical bills, donations, etc.) total up to $9,000 and the standard deduction you’re eligible for is $12,000, you'd be better off taking the standard deduction!

3. Above-the-Line Deductions: The First Line of Defense

• Definition: Deductions that are subtracted from your total income to reduce your AGI.
  
  Nice note: above-the-line deductions are available to everyone, regardless of whether you itemize your deductions or take the standard deduction.
  

• Layman's terms: These are deductions you can take, no matter what other deductions you’re looking into. They come off the top, before you even get to AGI.

• Example: You spend $1,000 on classroom supplies as a teacher. This could be an above-the-line deduction, reducing your AGI.

Other popular examples include student loan interest, HSA contributions, and tuition fees. Seizing these deductions is a surefire way to slice down your tax bill. 🤠

4. Capital Gains: Cashing In Smartly

Investment gains aren't just about the high of watching your stocks soar; they also come with tax considerations. Investing in assets like stocks, real estate, or bonds can lead to capital gains. 📈

• Definition: The income you earn when you sell an asset like stocks, real estate, or bonds for more than you paid for it.

• Layman's terms: Capital gains kick in when you sell an asset, like stocks or real estate, for more than you initially spent.

• Example: You bought a stock for $100 and sold it for $150. Your capital gain is $50.

Short vs. Long-term capital gains: If you held the asset for one year or less, it's considered a short-term capital gain and taxed at your ordinary income tax rate. However, if you held the asset for more than one year, it's classified as a long-term capital gain and taxed at lower capital gains rates (which can be as low as 0% for certain taxpayers!)

5. Dependent: Who Can You Claim on Your Taxes?

Claiming a dependent on your tax return can lead to some valuable tax benefits. The IRS has specific guidelines involving age, relationship, and financial dependency to qualify someone as a dependent. Knowing these rules can open doors to credits like the Child Tax Credit, putting extra money back in your pocket.

• Definition: An individual, often a child or relative, who relies on you for financial support and meets IRS criteria.

• Layman's terms: Someone you financially support, and can thereby claim for tax benefits.

• Example: Your 19-year-old college-going son who still lives at home and doesn't have a job can likely be claimed as a dependent.

6. Tax Credits: Golden Ticket(s) to Lower Taxes

Tax credits are powerful tools for reducing your tax liability dollar-for-dollar.

*Unlike deductions that reduce your taxable income, tax credits directly reduce the amount of tax you owe.

Common tax credits include the Child Tax Credit, which provides a credit for each qualifying child, and the Earned Income Tax Credit (EITC), are designed to assist low to moderate-income individuals and families.

• Definition: A direct reduction in the amount of taxes you owe.

• Layman's terms: It's like a gift card against your tax bill 🎁

• Example: A $2,000 Child Tax Credit would directly reduce your tax bill by $2,000.

• Another example: Qualified electric vehicle owners are eligible for a tax credit of up to $7,500 due to the Inflation Reduction Act of 2022 (s/o Tesla)

7. Filing Status: Discover Your Tax Persona

Choosing the correct filing status is very important, as it can greatly affect your tax liability (ie: what you owe).

• Definition: Your filing status determines your tax rates, eligibility for certain deductions and credits, and the tax brackets that apply to you.

  
  There are 5 filing statuses: Single, Head of Household, Married Filing Jointly, Married Filing Separately, and Qualifying Widow(er) with Dependent Child.
  

• Layman's terms: It's like your relationship status, but for taxes.

• Example: If you're married and your spouse has no income, filing jointly usually gives you a tax advantage.
  
  Another Example: Filing as Head of Household often results in lower tax rates and a higher standard deduction compared to filing as Single.

8. Estimated Tax Payments: Staying Ahead of the Game

For individuals who don't have taxes withheld from their income, estimated tax payments are a way to stay on top of their tax obligations AND keep you in the IRS's good graces.

• Definition: Quarterly tax payments made based on your expected annual income.

• Layman's terms: If no one's taking taxes out of your paychecks, you pay them yourself, four times a year.

• Example: If you're a freelancer earning around $40,000 a year, you'd send the IRS a check every quarter based on your expected yearly tax bill.

9. Charitable Contributions: A Win-Win Situation

Donating to a good cause doesn't just warm your heart; it can also lighten your tax burden ✨

• Definition: Donations made to qualifying charitable organizations that can reduce your taxable income.

• Layman's terms: Giving money to an eligible good cause = getting a tax break.

• Example: Donating $500 to a qualified charity could reduce your taxable income by $500.

10. Nontaxable Income: Go Away IRS!

Not all money you earn is up for grabs by the tax woman 🕵🏼

• Definition: Certain types of income that are not subject to federal income tax, like some Social Security benefits and life insurance proceeds.

• Layman's terms: Money you earn that the IRS can't touch.

• Example: Gifts you receive on your birthday are generally considered nontaxable income.

Conclusion: Your Roadmap to Tax Mastery

If you’re reading this sentence, then you made it all the way through this goliath of an Intro-to-taxes article.

And I am SO PROUD OF YOU! HYFR!!!

I know it’s a lot to digest - as a reward, you should order a pizza and digest that with a group of friends too! 🤪🍕

Ok my brain is becoming mush, I need to go watch the Michigan game to reset my vibes (Saturday morning tax sesh ✅)

Onward and upward, Monarch friends!

(and also Go Blue 〽️)

Bailey

Sources:

1. Forbes: Tax Terms to know when filing taxes

2. Bank of America: Better Money Habits, understanding tax terms

3. Prospect Tax: 10 important tax terms you should know

4. Chime: tax terms glossary

5. Nerd Wallet: Standard deduction 2022-2023

6. Turbo Tax: Tax tips for employees who work at home

7. Tesla: Incentives