Taxes—The Good, the Bad and the Smart

Key Takeaways

  • You can’t get away from taxes, but people who are well-informed pay less.
  • The majority of Americans pay not one but three taxes on their salary—federal, state and payroll.
  • There are a myriad of deductions, exemptions and strategies you can use to lessen your tax bite and accumulate wealth from Day One of your working years.
  • When investing, always look for tax-deductible, tax-deferred and tax-free options.

Journalist Andy Rooney said, “Nothing in fine print is good news.” You know what? All the tax code is in fine print. So, what’s the bad news? For starters, we have not one but three taxes on our salary: federal, state and payroll taxes.

  1. State taxes. Seven states don’t assess income taxes on their residents—the rest have graduated schedules ranging from just zero percent all the way up to California’s whopping 13.3 percent.
  1. Payroll taxes. These are a straight 7.65 percent taken out of our salary to pay for Social Security and Medicare.
  1. Federal income taxes. These are withheld on a graduated schedule, starting at zero percent and going all the way up to 39.6 percent for very-high-income earners.

When you add all three taxes, it can be a hefty chunk out of your paycheck. Fortunately, there are a variety of deductions, tax credits and exemptions you can use to lessen your tax bite.

Common deductions include contributions to your IRA or 401(k) plan, your cafeteria plan and your health savings account (HSA), and there’s an adjustment for interest you pay on your student loans, among others.

Tax credits include the earned income and the dependent care credits, HOPE Scholarships, and learning tax credits, plus many more.

Exemptions. On our tax returns, we get deductions for ourselves and our dependents. The more dependents you can legally claim, the lower your tax bill.

Smart tax moves for young adults

  1. Prioritize where you invest by looking for tax-deductible, then tax-deferred and then tax-free opportunities.
  1. Plan wisely every single tax year to make sure you take full advantage of everything that applies to you in the tax code. Otherwise, you’ll get a surprise the following April 15. If you use tax prep software, beware. The software is only as good as your financial skills and wisdom. If you’re facing anything complicated, consider hiring a tax professional. Even with a tax professional’s fee, if he or she helps you save $2,000 of taxes each year and that money earns 7 percent tax-deferred over 40 years, then it will grow to about $400,000. That’s a tremendous amount of tax savings! The bad news is taxes are always with us. The good news is taxes are lower for the well-informed.

Until next time, enjoy. Gary

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