Where Do Our Taxes Go?

woman calculating her paycheck taxes

Every time you receive a paycheck, I am sure you see a nice portion of it being taken by the federal & state governments. If you do not have that money withheld on a paycheck you really notice when tax time comes, and you owe a good amount of money to the IRS.  

We all know we must pay taxes and if you don’t there can be trouble with the IRS, but the big question is why we pay these taxes and where do these taxes go? 

In this article, we will start by explaining exactly what income taxes are. I will then give you a little history of how our tax system was put in place and finally we will discuss where the money is being spent. Hopefully, with this information, it does not hurt so bad when you see that portion taken from your paycheck.

 

What Is Income Tax?

Income tax is a direct tax that a government levies on the income of its citizens. Paying a portion of income to the government is mandatory for anybody who meets minimum income amounts.

2020 tax filing requirements for most people

  • Single filing status: $12,400 if under age 65.
  • Married filing jointly: $24,800 if both spouses under age 65.
  • Married filing separately — $5 for all ages.
  • Head of household: $18,650 if under age 65.
  • Qualifying widow/widower with dependent child: $24,800 if under age 65.

Even though the United States was founded to avoid paying high taxes to England taxes have crept into our system over many years. In 1862 Abraham Lincoln signed into law the nation’s first-ever income tax on personal income to pay for the Union war effort. At this point, the Bureau of Internal Revenue was established. This was repealed 10 years later. 

Congress once again tried in 1894 but this tax was ruled unconstitutional. Then in 1909, the 16th amendment to the Constitution was ratified allowing the federal government to tax individual personal income.  Congress used the power granted by the constitution and the 16th amendment and made laws requiring all individuals to pay taxes. They have delegated the IRS the responsibility of administering tax laws known as the Internal Revenue Code. 

Income tax is the primary source of cash flow for the federal government. Income taxes include three separate categories: individual, payroll, and corporate income tax. 

In 2020 individual and payroll tax revenue accounted for 85% of the government’s revenue. The US has a progressive tax system which means you are taxed a certain percentage based on your income. It is progressive because the more money you make the higher percentage of tax you must pay. The tax brackets are laid out below as seen directly on the IRS website. 

  • 35%, for incomes over $209,425 ($418,850 for married couples filing jointly)
  • 32% for incomes over $164,925 ($329,850 for married couples filing jointly)
  • 24% for incomes over $86,375 ($172,750 for married couples filing jointly)
  • 22% for incomes over $40,525 ($81,050 for married couples filing jointly)
  • 12% for incomes over $9,950 ($19,900 for married couples filing jointly)
  • The lowest rate is 10% for incomes of single individuals with incomes of $9,950 or less ($19,900 for married couples filing jointly).

Where Does Tax Money Go?

A lot of people are of the opinion that the government mismanages and overspends our tax dollars. I will not be addressing this in this article. I will get more into the basics of where and how the money is spent. 

As much as it hurts to lose that chunk of the paycheck a lot of our tax money pays for things very necessary such as the roads we drive on, making sure our infrastructure is maintained, and giving citizens access to services they need to survive. They fund many government programs such as Social Security, Medicaid & Medicare, and the military. 

The money also goes towards benefits for veterans and federal retires, education, transportation, international affairs, and science and medical research.

Government spending by the US can be divided into 3 different categories: mandatory spending, discretionary spending, and interest on the federal debt. Every year a budget is submitted and approved by the president and the Senate and the House. Mandatory spending accounts for the majority of where the money goes followed by discretionary funding. 

Unfortunately, currently, there is a gap between government spending and government revenue. This means they are spending more money than they have coming in through taxes creating a deficit. This deficit creates the national debt on which interest must be paid.

 

Mandatory Spending

Mandatory government spending is all the spending that does not take place through appropriations, legislation. Mandatory spending includes entitlement programs such as social security, Medicare, and other programs required by law. It also includes smaller programs such as food stamps, housing assistance, earned income tax credits, and temporary assistance for needy families.  

These are all permanent programs that the government cannot set the amount they wish to spend. They can only set eligibility rules for who qualifies for these programs. The only way they can manipulate mandatory spending is by changing these eligibility rules. They may make changes to exclude or include more people or offer more or less generous benefits to those eligible, but they cannot do direct budget cuts.  

Mandatory spending continues to grow every year. Congress has a hard time making cuts to these entitlement programs because making these cuts guarantees voter opposition. Also, with the aging of America and the advancement in medicine prolonging life the costs of Medicare and social security are constantly on the rise. 

Expectations have been set that with these two programs alone spending will almost double in the next ten years. In 2021 mandatory spending was estimated to be $2.966 trillion.

Mandatory Spending Categories and Amounts
Mandatory Spending (billions of dollars) 2020 2021
Social Security 1,091 1,142
Medicare 862 810
Medicaid 466 537
Income Security Programs 1,132 499
Federal Civilian and Military Retirement 173 179
Veteran’s Programs 122 132

Source: https://www.cbo.gov/about/products/budget-economic-data#3

 

Discretionary Spending

Discretionary spending is spending that is subject to the appropriations process, whereby Congress sets a new funding level each fiscal year for programs covered in appropriations bills. There are twelve separate appropriation bills that are supposed to be pushed through Congress and be signed by the President annually. 

Discretionary spending can be broken down into 2 categories: defense and non-defense. Defense spending includes the Department of Defense, the State Department, and Homeland Security. Defense spending represents more than half of all discretionary spending. 

Nondefense spending includes education, Veterans Assistance, and Housing and Urban Development. Historically most government spending was discretionary. In the 1960s two-thirds of total government spending was discretionary. Over time with the increases discussed above on mandatory spending, this has changed. Discretionary spending is projected to be about 32 percent of the budget. This decrease is expected to continue in the following decade.

Discretionary Spending Categories and Amounts
Discretionary Spending (billions of dollars) 2020 2021
Defense 757 752
Nondefense 1,139 668

Source: https://www.cbo.gov/about/products/budget-economic-data#3

 

Net Interest

The interest on the national debt is how much the federal government must pay on the outstanding public debt each year. Interest on the debt is currently exceptionally low but is projected to increase. With these increases, interest costs have become the fastest-growing program in the federal budget. 

Even with the low rates, the federal government is projected to spend just over $300 billion on net interest payments in the fiscal year 2021. This is more than it will spend on food stamps and Social Security Disability combined.

Fiscal Year Interest on the Debt (in billions) Percent of Budget
2018 $325 7.9%
2019 $375 8.4%
2020 $376 7.8%
2021 $378 7.8%

 

In conclusion, taxes taken every year are necessary for all the programs out there and supporting our infrastructure. Also, there is an intricate system set up for the decision-making into where the money is spent. Decisions are not made by one person. Each year the budget is submitted by the president outlining plans for mandatory and discretionary payment. 

This is just the beginning of the process.  From there they must still be voted on and approved by Congress. To get through Congress there are also a lot of changes made before it gets final approval. To keep the government running the budget must be approved by September 30th. Many years September 30th comes, and the President and Congress can not come to an agreement. At this point, there are either temporary measures approved, or the government shuts down. 

This is not a perfect system, and it may seem that some things need to be drastically changed with the system in the near future with the projections on necessary spending and the national debt but as you see a lot of the things that we really take for granted are made available because of the tax money taxpayers contribute. Without this funding, many things that everybody in our population depends on would not be available and many programs that people need to live would no longer exist. 

Hopefully, with this knowledge, it may not hurt so much each time you see that pay stub with that chunk of taxes removed.

 

Do You Have to Report Gambling Winnings?

men gambling at a casino

One of the biggest issues I come across with my clients is unreported income. A major form of income that is left off tax filings is gambling winnings. Be it purposefully or just sometimes people forget and do not receive the form from the casino reporting this income. It can turn into major tax debts. 

While there are still ways to fix it after the fact to possibly reduce the debt the IRS is saying that you owe or even sometimes eliminate it, with the correct knowledge and tax planning throughout the year you can save yourself a lot of money and avoid getting yourself on the radar of the IRS

If you have won a large sum, it is always smart to contact a true tax professional. A CPA or an enrolled agent would be the person with the knowledge and education to advise you. Today I am going to provide you with a lot of knowledge that can help you if you have winnings from gambling.

 

When Are Gambling Winnings Considered Income?

It is always great to win big on a scratch ticket or pick the right horse at the races, but you always must make sure to report all winnings on your tax return. Whether you win $5 or $5000 you are required to report this as income.

Even if you win a non-cash prize like a car or a truck you are required to report its fair market value as income. Now the IRS is not chasing anybody down for not reporting a $5 win but if not reported it is still considered tax evasion.

 

How Does the IRS Know About Your Winnings?

When gambling with actual business and winnings are at least $600 and the payout is at least 300 times the amount of your wager you will receive an IRS form W-2G. For slots or bingo, the amount is $1200, for Keno $1500 and $5000 from poker tournaments. These forms are sometimes given to you right on the spot or mailed out to you by January 31st of the following year. This income needs to be added on a tax return under “other income” Schedule 1 on your Form 1040.  

This W-2G is also sent to the IRS so they will be aware of the income. If this income is left off it is very rarely missed and typically the IRS will do your return through audit or examination a few years later. At this point, you are subject to penalties for nonpayment and underreporting of income as well as interest backdated to the original filing deadline. So, it is especially important that all gambling winnings are reported on your tax return yearly.

Another reason why it’s so important to make sure you file correctly is that typically when a W2G form is submitted by the payer, they withhold a standard 24% for taxes. Filing the amount withheld on line 25c on your tax return will make sure that you get credit for these taxes already being paid. If you have not received this form and have no withholdings you are still required to file, the income. 

Unfortunately, the excuse of not receiving the form in the mail will not work because all income received throughout the year must be reported.  On large winnings, the 24% withheld typically covers the taxes owed. The marginal tax rate on high-income earners is 37% so even though you had withholdings you need to set aside funds and expect to owe once taxes are filed.

 

Gambling and Tax Deductions

Another benefit of filing can be the possible use of deductions reducing your taxable income. Some people are just incredibly lucky, and they gamble once and win big. For others, it can be a hobby or for some, it is their actual business. A lot of the time when this is a hobby or a business there a lot of losses and money spent before you get that big win. These losses are considered expenses and help reduce the taxable income which would reduce the amount owed. There are some catches with this though. 

Unless you are a professional gambler and actually operating as a business then it may not benefit you to use expenses. Since the 2017 tax changes the standard deduction per person has basically doubled so it typically does not make sense to itemize deductions on a Schedule A anymore because if you do you lose the standard deduction. The standard deduction is $12,200 for single filers, $18,800 for those who qualify as head of household, and $24,400 for those who are married and file joint returns in 2021.

Also, when itemizing your losses, they cannot be more than the actual gambling winnings and be carried over towards other income. So, unless you have won more than the $12,200 standard and have more than $12,200 in losses it would not make sense to lose the standard deduction.

Now if you are a professional gambler and operating as a business it would benefit you to write off expenses. You can write off these expenses on a Schedule C without having to itemize. The net income after these losses is what will become taxable. Doing it like this can help you reduce the net income but remember net income for the self-employed will be subject to not only federal taxes but also self-employment taxes as well. 

Use caution when you can operate as a business, or your gambling is just a hobby. A professional gambler only qualifies as a business if your primary purpose is to make a profit and you are continually and regularly involved in it. If the gambling is inconsistent or sporadic then it is considered a hobby.

 

Keep Good Records

With gambling winnings, it is especially important to keep particularly good records.  The IRS recommends keeping a diary or similar record of all your gambling activities. Gambling income is highly auditable. The IRS receives the W-2G as well, so they are always looking for people who fail to report the income on their tax filings. They also scrutinize people that are claiming losses on a Schedule A or C. 

Also, when people are utilizing the Schedule C the IRS is always looking for supposed “business activities” that are really hobbies. With all of this said it is especially important to be prepared for an audit. Your records should include specific dates and types of wagers, names, and addresses of the locations of each casino or racetrack that you visited, witnesses or people with you at the time and the amounts won and lost. 

Also keep items of proof of winnings and losses such as wagering tickets, canceled checks, credit records, bank withdrawals, and statements of winnings or payslips. With some of these situations when winnings are high, and things seem to be done intentionally to avoid paying taxes there can be charges of tax evasion which can be criminal charges

Remember even if the amounts do not meet the thresholds of being reported by a casino or if it is just betting where cash is received this income can still be tracked through audits. This would be the same type of situation as someone mowing a lawn for cash income. There is a general expectation that this income is reported.

 

The IRS Does Go After Violators

Just last month a Connecticut business owner, Guy Smith was sentenced to 14 months of imprisonment for not reporting gambling winnings. He provided his tax preparer with income and expenses for his business for his filings but failed to provide reports of the income from the poker tournaments he was winning. Smith is a professional poker player and has participated in poker tournaments in Connecticut and throughout the US. Smith had failed to report over $1 million in gambling winnings. The judge also ordered that pay $821,415 in federal income tax owed with the penalties and interest.

 

Be Safe Rather Than Sorry

In conclusion, you need to know each year what information to turn over to your tax professional for filing purposes. Making them aware of all income either reported or not reported and allowing them to make the determination of what should go onto the tax return. It can cause you a lot of money if any of this income is missed on a filing and caught by the IRS. Doing it correctly the first time is the cheapest way to pay back your tax obligations. 

I know there are all the stories of most people getting away with it. At this point, everything with the IRS is automated through ACS. This is the Automated Collection System so most likely especially with reported income being left off of a return it will be flagged by the IRS. When this happens as I had mentioned earlier it isn’t always just the IRS’ way or the highway there a lot of things, they can still be done to limit your exposure to the tax debt. At this point contact either an enrolled agent or CPA to make sure things are done correctly and worst case, you don’t overpay the IRS from this point on.

 

States That Have No Income Tax

partial map of the United States

The deadline for the federal income tax may have already been pushed back until May 17, but some taxpayers might be luckier than others. In nine U.S. states, individuals do not have to file a state tax return, as they (the states) don’t oblige taxpayers to pay tax on personal income. This means that each taxpaying resident of these states sees less money coming out of their monthly paycheck. Also, when the tax season comes, they are only called to submit a federal return. 

 

The 9 States With No Income Tax 

In the following states, residents do not pay tax on their earnings. You will notice that we have added New Hampshire to the list, although it taxes investment earnings. This is because New Hampshire does not charge any tax on earned wages. Something similar applies to Tennessee, which has no state income tax on earned income AND no longer taxes investment earnings as of this year

  1. Texas – The Texas constitution has forbidden personal income tax, but the state does have higher sales and property taxes than other states to make up the difference. 
  2. Washington – Washington is probably the only state that has never levied personal income tax on its residents. It does, however, have a particularly high average sales tax rate (around 9%) while businesses have to pay occupation and business tax. They are not subject to income tax, though. The fuel costs here are also quite higher than in other states. 
  3. Alaska – The businesses and individuals in Alaska have been free of state income tax for many decades. However, the state is also sales-tax-free and makes up these funds through other types of taxes, such as from estate, gift, and severance. In addition, Alaska distributes extra funds to its citizens annually via the Alaska Permanent Fund Corporation.
  4. Nevada – Nevada earns a huge income every year from gambling taxes and fees and, of course, tourism. Perhaps, that’s why it does not charge personal income tax. On the flip side, it makes up the deficit with a higher sales tax that climbs to 8% in some jurisdictions.  
  5. Florida – Florida has stopped charging state income tax since 1855. Nevertheless, its property taxes are higher than in the majority of other U.S states. Also, its businesses are obliged to pay corporate income tax while its individuals are subject to sales tax. 
  6. Wyoming – Living in Wyoming saves you from both personal income and retirement income taxes. Income tax is also not imposed on corporations. The state makes money by taxing businesses producing natural resources (i.e., coal) and property taxes. 
  7. South Dakota – South Dakota is considered a haven for retirees and has not been having state income since 1943. It is one of the most tax-friendly states in the country that makes up the difference with things like laundromat license fees and taxes on cigarettes and alcohol. South Dakota funds country and city improvement projects via personal and local property taxes. It also has one of the lowest sales tax rates nationwide and close-to-the-national-average property tax rates. 
  8. New Hampshire – The state of New Hampshire does not have personal income tax except for a 5% tax imposed on investment income of more than $2,400 per person. New Hampshire is, however, high in excise and alcohol taxes and is among the top states with the highest property taxes. College costs are also relatively high here. 
  9. Tennessee – Residents of Tennessee are not called to pay taxes on personal wages. To make up the difference, the state has high sales, beer, and excise taxes. 

As for the remaining states in the United States, 32 states (plus Washington, D.C.) charge a progressive income tax where lower earners pay a lower percentage of their income than higher earners do. Another nine (9) states have a flat income tax that taxes all taxpayers at the same rate irrespective of how much they earn. 

It should be noted that according to a United Van Lines National Migration study conducted in 2020, the Coronavirus situation seems to have accelerated decisions to move from states like New Jersey (known for charging a high income tax) to no-income tax states like Florida and South Dakota. 

However, is relocating to a tax-friendlier state a wise move? Are there any significant trade-offs that should be taken into account? Here are some factors to bear in mind before taking the step.

 

The Migration to No-Income-Tax States

A report published by the American Legislative Exchange Council demonstrates that in the past 10 years or so, the nine states that impose no personal income tax have outperformed their counterparts with the highest taxes on personal income, on in-state migration, employment growth, and GDP growth. 

Similarly, the same nine states witnessed a population growth that was 109% faster than in other states with high income tax. Simultaneously, there were many more available jobs in the nine states than the other ones (130% faster job growth). There was even a 51% rise in local and state tax revenues in the same nine states. 

Aside from that, living in a state that charges no income tax is a significant advantage for high-income households. Instead of being forced to pay high taxes, which is the case in many states, the states with zero personal income tax do not tax these individuals’ earnings at all. This, in turn, enables them (the taxpayers) to save more of their money, which is a major reason why wealthy people choose to relocate or live in a state without a state income tax. 

However, all income classes are benefited from not having to pay state income taxes since they can pocket more of their hard-earned dollars during tax season and save for school tuition, retirement, and more. It is also worth noting that having no income tax is also an appealing and effective way to redistribute wealth, with low-income households reaping the most benefits from it. 

Another point of consideration is the new tax laws that limit the itemized deductions for local and state taxes (the cap is $10.000). This falls heavily on the people living in states with high personal income rates, such as California and New York, who can no longer deduct the full sum of their sales and property taxes (if they were not taking the $12,700 standard deduction for married couples filing jointly or the $6,350 deduction for individuals). Clearly, a low-tax environment comes with major advantages in this respect. 

 

The Other Side of the Coin

States with no income tax need to find other alternatives to make up for the state’s revenue loss from charging no income tax. In their attempt, they usually end up imposing higher excise, property, or sales taxes. So, people living in these states may be called to pay more tax for things like alcohol, tobacco, fuel, clothes, groceries, and other goods. This is the case in Nevada. 

According to a Washington-based think tank, the Tax Foundation, Tennessee was nearly on top of the list of the states with the highest sales tax rate across the country (9.53%). Another report dealing with state gas tax rates has evidenced that Washington’s gasoline tax rate is among the highest in the USA as of 2019 (49.5 cents/gallon). The Energy Information Administration reports that this is the 3rd highest gas tax in the country, behind California and Pennsylvania. 

Besides, Alaska, Texas, Florida, and New Hampshire appear to be the most reliant of all states on property taxes (accounting for 51.8% and 67.6% of their revenue, respectively). What is more, the sales taxes in Nevada and Texas are above average, while Alaska and Wyoming have hefty taxes on oil drilling and coal mining operations. So, they use their natural resources to make up for the lost income tax revenue. 

Let’s also not forget that the public services in every state (i.e., education, healthcare, law enforcement agencies, and infrastructure) are primarily financed by taxes (property, income, and sales taxes). So, the less taxes they receive from their taxpayers, the lower funding these initiatives have. In fact, the United States Census Bureau has shown that the state which spends the least on education in the Midwest is South Dakota. When the national average school spending per pupil is $12,612, South Dakota spends $10,073. Other states like Texas, Tennessee, Nevada, and Florida also spend below the national average. 

When it comes to the living expenses in the nine states with no income tax, they tend to be higher than the national average in some of these states, including Alaska, Washington, Florida, South Dakota, Nevada, and New Hampshire. They were all among the 24 U.S. states with the highest living cost in 2020

 

Balancing the Pros and Cons

It becomes apparent that the final choice is yours, and it is only a matter of perspective and what trade-offs you are willing to compromise with. You may, for example, have to come to terms with a lower-paying job for more affordable real estate. The final decision also depends on your income level, filing status, and the kind of life you see for yourself and your loved ones in the future. 

If you are ready to start a new life in another state, like one of the nine offering no income tax, feel free to contact us for effective debt relief solutions to help solve your federal or state income tax debt. That way, you can start fresh again and get rid of the hurdles that affect your financial bottom line. 

 

Do You Pay Taxes On… ?

woman cashing her stimulus check at the bank

Here, you will find the most commonly asked questions about paying taxes.

Do You Pay Taxes on Unemployment?

In the years before the Covid-19 pandemic, almost all types of unemployment compensation were taxable. In general, the IRS considers unemployment compensation as income, so it taxes it accordingly.

Passed in March 2021, the ARP (American Rescue Plan) now has a provision according to which unemployment compensation is tax-free up to $10,200 (in 2020). If you have already filed your 2021 tax return will have to file an amended return so that you recover (1) the extra $300-$600 a week you got under the CARES Act or (2) any taxes paid on your state unemployment payments. The hows and whens of this action are yet to be announced by the IRS. Also, the $300 weekly federal supplement is extended through September 2021.

At this point, though, do note that the unemployment benefits you will receive in 2021 remain taxable with next year’s return, unless a new measure is enacted in the future, providing tax relief. This is why we advise to withhold tax upfront, just to stay on the safe side. You may also use this IRS tool to help determine whether your unemployment compensation is taxable based on the income you have received.

Your 3 Options:

  1. You have the right to have federal income tax withheld from your unemployment compensation benefits, although you can’t decide on the amount you wish to be withheld. To do so, use the Voluntary Withholding Request (Form W-4V). Note that there is a flat rate of 10% for withholding federal income tax from unemployment benefits.
  2. If you do not elect to have taxes withheld from your unemployment benefits, you might be required to make quarterly estimated tax payments directly to the IRS. So, instead of having 10% withheld from your monthly unemployment checks, you pay once every three months while receiving unemployment benefits.
  3. Or you could have both – withholding from your unemployment benefits and making quarterly payments. This is a good choice if your refundable tax credits you are eligible for and the withheld taxes will be 100% of the total taxes you paid last year or below 90% of what you will owe. It is also a recommended option if you owe more than $1,000 after accounting for all the taxes withheld from your income sources.

As you can understand, this is a complicated situation that could easily get you facing government penalties if a mistake is made. For that reason, it is best to consult with a tax professional.

 

Do You Pay Taxes on Stimulus Checks?

According to the tax code, any income is taxable, irrespective of where you got it from, unless it is specifically excluded or exempted. When it comes to stimulus checks, one would expect them to be taxable, since there is no specific exclusion or exemption for them. However, the current law does not consider stimulus checks as income. Hence, you don’t need to pay taxes on the stimulus check money. In fact, the law views a stimulus payment as an advance payment of a tax credit (so, non-taxable income).

Here are some details. When you file Form 10400 (your 2020 federal income tax return), you will come across the Recovery Rebate Credit line (check the 2nd page). Make sure you do not disregard this line, especially if you had a dramatic change of circumstances in 2020. Some examples are as follows:

  • You are a recent college graduate.
  • You had a baby in 2020.
  • You experienced a major reduction in your income in 2020.
  • You are married and either you or your spouse does not have an SSN (Social Security Number).
  • You did not file a 2019 or 2018 tax return.
  • You did not receive any (or full) 1st or 2nd-round stimulus check.

If you meet the qualifying criteria of the stimulus check, you could save quite a lot of money with this credit.

Now, when it comes to calculating the credit amount and your stimulus check, the procedure is the same. Nevertheless, stimulus round 1 and 2 used the information from your 2019 or 2018 tax return while the tax credit is based on your 2020 tax return details. So, a change in your circumstances from 2019 to 2020 or failure to file a 2019 or 2018 return may as well lead to a difference between the sum of the credit amount and your stimulus checks. All in all, if your stimulus payments were higher than the credit allowed, you don’t need to pay anything (you keep the difference), whereas if the credit is higher than the total sum of your stimulus payments, you may receive a refund since your tax bill will be lower (in 2020).

 

Do You Pay Taxes on Stocks?

Briefly answered, if you made money, you pay taxes, based on what you paid for the stocks (the cost basis) and what you profited or made. Of course, you will need to report any income you earned from selling stocks, bonds, or other investments in 2020 on Schedule D of your tax return. This also includes interest or dividends you have earned (if any). In this case, you need to use a 1099-INT or 1099-DIV form. If you made a loss from selling stocks, you could get a write off up to $3,000 of these losses. You can ask your broker for a 1099-B form so you can fill in Schedule D on your tax return. Things change, though, if you have bought securities and kept them to yourself throughout 2020 as you won’t be called to pay any taxes.

To estimate how much you will owe in taxes on your stock gains, you will have to determine the tax bracket you are in. For the majority of investors, the rate is quite low and most of them are in the 22% bracket.

Don’t forget the 3.8% surtax on net investment income (i.e., royalties, annuities, passive rents, gains, dividends, taxable interest, etc.) that applies to:

  • Joint filers with more than $250,000 (modified adjusted gross incomes).
  • Single filers with over $200,000 (modified adjusted gross income).

Finally, short-term capital gains are taxes like your paycheck (as ordinary income) while long-term ones have a lower tax rate. For example, a married couple filing jointly with taxable income below $80,000 that has sold stock they owned for at least 12 months will not be asked to pay anything in long-term capital gains. If their income is between $80,000 – $496,000, they will pay 15% and 20% if it is higher.

 

Do You Pay Taxes on Social Security?

Yes, Social Security Income is taxable, in most cases at least (on a federal level), especially if you have a 401(K) or other sources of retirement income. However, your income level determines whether or not you will need to pay taxes on your Social Security benefits. If you go by solely with your Social Security checks, then chances are you won’t pay any taxes on the benefits you receive. Nevertheless, it is paramount to consult with a tax professional or financial advisor because state laws vary when it comes to taxing Social Security.

How to know if your Social Security Income is taxable? Check if your combined income (50% of your Social Security benefits + non-taxable interest + adjusted gross income) is above or below a certain threshold the IRS calls the base amount. The limit for a qualifying widower or widow with a dependent offspring, head of household, or single filer is $25,000. For joint filers, it is $32,000. So, if your combined income is over that limit, you will pay some tax. Married individuals filing separately will most likely pay taxes on their Social Security benefits.

According to the Social Security Administration, the following applies when calculating Social Security Income taxes in 2020:

  • Single filers whose combined income is between $25,000- $34,000 need to pay up to 50% of their Social Security benefits in income taxes.
  • Single filers whose combined income is over $34,000 will pay up to 85% of their Social Security benefits in taxes.
  • Married couples filing jointly with combined income between $32,000 – $44,000 will have to pay taxes on up to 50% of their Social Security income.
  • Married couples filing jointly with combined income over $44,000 will pay up to 85% of their Social Security benefits in taxes.
  • Individual taxpayers with a total income below $24,000 pay no taxes on their Social Security benefits.

You may use this IRS worksheet to calculate your Social Security tax liability. And, don’t forget that some states also require that you pay state income taxes, with 13 of them collecting taxes on Social Security income (at least some of it). Others, offer exemptions or deductions based on your income or age. Nevertheless, in 37 states, you won’t pay any taxes on your Social Security.

 

Do You Pay Taxes on an Inheritance?

In general, beneficiaries do not need to pay income tax on inheritance, be it property or money. It doesn’t matter if you are a designated beneficiary or receive the inheritance under the terms of a trust or will. It is not considered taxable income. Things change if the money is withdrawn from a 401(K) or IRA plan, which are regarded as tax-deferred until money is withdrawn from them. So, if you withdraw money from such an (inherited) account, you have to report it as ordinary income and the due tax will be determined by your state and federal annual income tax returns.

That being said, you can withdraw from an inherited retirement account over several years if you change it into an “inherited IRA” account. If you are a surviving spouse that inherits a retirement account, you can change it into a retirement account of your own to defer the tax.

Roth retirement plans are usually non taxable income as they are treated like any other inherited property. In general, you won’t need to pay income tax on money you take from an inherited Roth account if the account was opened and funded at least five years earlier. Also, if the deceased created and contributed to the particular Roth account you have inherited.

As for inherited property, you will pay taxes on any income produced by it.

For inherited bank accounts, you also pay no taxes on the money in the account, unless they start generating interest for you. Your taxable income, in this case, is the interest payments.

Finally, life insurance policy proceeds and appreciated inherited property may also be taxable income if you pay in installments over several years (in the first case) or the property you have inherited appreciated in value (in the second case).

Take into account that six states apply inheritance tax on an inherited property (Pennsylvania, New Jersey, Nebraska, Maryland, Kentucky, and Iowa) on top of your income tax. The exact sum depends on how closely related you were with the deceased one.

 

Do You Pay Taxes on Life Insurance?

In most cases, life insurance on non-taxable income. There are exceptions to the rule, though, which are illustrated right below (each case has a taxable and non-taxable side, if certain conditions are met):

  • Your beneficiary gets a lump sum payout.
  • Your beneficiary receives a gain in cash value (applies to cash value life insurances).
  • You make a partial withdrawal from the cash value (applies to permanent insurance).
  • You receive annual cash dividends.
  • You turn in your permanent life insurance policy for a most cost-effective term life insurance policy.
  • You accelerate your death benefit because you become terminally or chronically ill.

Life insurance is usually taxable when three individuals are involved (the owner buys life insurance for another family member and then names another member as the beneficiary). Also, when your estate exceeds the threshold of the relevant estate tax, you sell a life insurance policy, or profit from turning in your cash value policy.

As for life insurance premiums, they are considered personal expenses so they are NOT deducted when calculating your taxable income.

 

Do I Have To File Taxes?

older couple filing taxes

Filing taxes can be burdensome, especially considering the complexity of filing a tax return. With tax laws changing almost overnight sometimes, it goes without saying that taxpayers often find themselves midst a tax storm that they do not know how to handle. 

Questions like ‘Do I need to file taxes if I collect Social Security?” “What about the case when I get Disability benefits?” “Do I file a tax return if I am retired?” are very common. Hopefully, this guide will help you figure some basics out and answer commonly asked questions about filing taxes. 

 

Do I Have To File Taxes If I Collect Social Security?

In general, individuals must file taxes if (1) they are unmarried, (2) their gross income is at least $14,050 or (3) are below 65 years of age. However, those that live exclusively on Social Security benefits have no gross income, which means that they do not have to file a federal income tax return. Also, you do not need to include your Social Security benefits in your gross income if your only source of income is your Social Security benefits. 

Things change if you earn additional, not tax-exempt income. In this case, you need to determine whether your annual gross income exceeds the $14,050 threshold. Beginning in 2018, tax exemptions are no longer considered part of your taxable income. So, you must use only your standard deduction. For the 2020 tax year, your Social Security benefits are regarded as gross income if:

  • You are married and file a separate tax return with your spouse. In this case, 85% of your Social Security benefits are regarded as gross income, which means that you may need to file a tax return. 
  • You are married filing jointly, and the sum of 50% of your Social Security plus any tax-exempt interest and other income is higher than $32,000. 
  • Half your Social Security plus other income is higher than $25,000, irrespective of your filing status. 

Note: For senior citizens (over 65 years of age) collecting Social Security benefits, the law is more gentle and flexible as it enables them to reduce the tax amount they must pay on their taxable income. As long as their income is not high (not including Social Security funds), they can lower their tax bill on a dollar-for-dollar basis using a special tax credit called Credit for the elderly or disabled (aka Schedule R).

 

Do I Have To File Taxes If I Did Not Work? 

In general, unemployment checks from the state are taxable. So, it depends on the collected unemployment. The current tax law wants individuals collecting or earning at least $8,000 to file taxes. Another important aspect to consider before answering this question is whether tax was withheld on the unemployment check payment or not. 

It should be noted that unemployment benefits are not free money. In fact, you need to take proper measures today to avoid unwanted surprises in the future when you receive your tax bills the following year. This is because unemployment money is taxable income. So, although you don’t need to pay Medicare or Social Security taxes, you will need to pay state and federal taxes in some jurisdictions while receiving unemployment benefits. 

Of course, some states, such as Virginia, Pennsylvania, Oregon, New Jersey, Montana, or California, waive this particular type of income. This means that if you live in any of these states, your unemployment benefits are tax-free. On the other hand, seven states (so far) do not impose any state income taxes. These include Washington, Texas, South Dakota, Nevada, Florida, and Alaska. 

Tip: The best course of action is to have taxes withheld from your unemployment benefits check, especially if you have earned income this year. The same applies to when you expect to be employed or hired again shortly, which will put you in a higher tax bracket. This, in turn, may make you ineligible for as many credits to offset your earnings. 

How to request the withholding:

  • Fill out form W-4V either online or via the benefits portal (depends on your state).  The Labor Department mentions that you can withhold a flat federal tax rate of 10% of the paid benefits from every payment. 
  • Request a W-4V from your state’s unemployment office if you are already collecting unemployment and then change your withholding. 
  • Take the money out of your checking account, and put it in a little envelope, or put it in a savings account. 

A key factor to bear in mind is your earned income tax credit (EITC) if you are currently unemployed and are worried about how this kind of money will affect your taxes. Depending on your income and whether you have any dependents (and how many), the EITC can provide you  between $538 and $6,660 in tax credits. Those eligible for it can use the tax credit to offset the amount they owe on their tax bill. The 2020 EITC income limit is $15,820 for single individuals or married couples with no children and $21,710 for married couples that file jointly. 

 

Do I Have To File Taxes If I’m Retired?

In short, yes. Your retirement taxes are determined by how much retirement income you draw every year and the sources of your retirement income. And, the kind of money you need to live on is directly related to your taxes. This may sound a paradox, but, in reality, the government never collects taxes on your Social Security money during your working years. The logic is that it simply holds onto it for you. Let’s look into an example to make things a bit clearer:

Suppose you get paid $5,000 every month as an employee. Your employer withholds the 6.2% Social Security tax rate (so, around $310) from your pay every month while contributing that 6.2% on your behalf to the federal government. They pay no tax on that sum, though. Then, when you turn 62 or older, the government gives back the money that went toward Social Security when you file a Social Security retirement benefits claim. Until that moment, nobody has paid taxes for that money.

So, will you owe taxes on your Social Security benefits in the end, and how much? According to the Social Security Administration, one in every four retirees will be called to pay income taxes on their Social Security benefits. For more details, check out the table below: 

Combined* Income Individual Return Married, Separate Return Married, Joint Return
$0-$24,999 No tax
$25,000-$34,000 Up to 50% of Social Security may be taxable
> $34,000 Up to 85% of Social Security may be taxable
$0-$31,999 No tax
$32,000-$44,000 Up to 50% of Social Security may be taxable
> $44,000 Up to 85% of Social Security may be taxable
$0+ Up to 85% of Social Security may be taxable

 

* This refers to half of your Social Security benefits, your nontaxable income, and your adjusted gross interest income, which is your total income minus income adjustments. Adjustments to gross income can be contributions to self-employment retirement plans, alimony paid, student loan interest deduction, and more.

Tip: To avoid paying taxes when you are a retiree, take note of the income you receive. If it is low enough, you won’t get taxed for it. Check the tax bracket into which your taxable income falls after calculating your earned and unearned taxable income. This will help determine whether you will need to pay income taxes or not. Your retirement tax bracket determines the exact way your taxable income is determined when you are in your working/productive years. As soon as you add up your taxable income sources, subtract your itemized or standard deduction, and apply any tax credits you may qualify for. Then form 1040SR or 1040

Below is a table showing the standard deduction for taxpayers over 65 years of age for the 2020 tax year. 

Filing Status Standard Deduction Senior Bonus Total Deduction
Head of household $18,650 $1,650 $20,300
Married filing jointly  $24,800 $1,300 per senior spouse $26,100 
Married filing separately $12,400 $1,300 $13,700
Single $12,400 $1,650 $14,050

 

 

Do I Have To File Taxes If I Collect Disability? 

Again, it depends on the income you receive and whether your spouse also gets an income (or not). If you are single and your Social Security Disability benefits are your sole income source, you don’t need to file taxes. For total incomes that exceed $25,000, it is paramount (and required by law) to file a federal tax return as an individual. The same applies to joint filers if their total combined income is more than $32,000. 

However, note that you will NOT be asked to pay taxes on the entire sum you receive from Social Security Disability if you fall within any of the brackets mentioned above. You usually need to file a federal tax return in the following situations:

    • You earn between $25,000-$34,000 as an individual – You might pay income tax on 50% of the sum you received from the Social Security Administration. 
    • You earn >$34,000 as an individual – You will probably need to pay taxes up to 85% of your SSD (Social Security Disability) benefits. 
    • You file jointly with your spouse and have a combined income between $32,000-$44,000 – You might have to pay taxes on 50% of your SSD benefits. The sum goes up to 85% of your SSD benefits if your income is over $44,000 (always referring to your combined sum). 
  • You also have a pension.
  • You collect short-term disability that is being provided by your employer. 

In general, though, if you have paid for your own disability policy, you won’t need to file a tax return. 

 

Do I Have To File Taxes On A Summer Job?

The majority of taxpayers are allowed to earn a specific amount of income every year without having to file a federal tax return or pay taxes. But, if you are obliged by law to file a tax return, it is critical that you have your earned income reported by your summer employer on a W-2

Full-time students may not need to file a return if they work for just a couple of months in the summertime. Nevertheless, if you qualify for a tax refund for taxes withheld from your paychecks, it is advised to file a return so you can claim that refund. Take note that if you show as a dependent on your parents’ tax return, though, you will have to file a tax return if you received more than $1,100 of unearned income (i.e., dividends and other non-employment income), irrespective of other earnings you may have. The same applies if your total earnings are higher than the standard deduction set for dependents.

 

Do I Have To File Taxes If I’m Married But Don’t Work?

You can choose to file separately or jointly on your income tax returns, with the first option being the most beneficial for you, most of the time, at least. This is because the IRS provides larger standard deductions to joint filers every year, which enables them to deduct more money from their income than those filing separately. For example, married couples filing jointly receive a $24,800 deduction while those filing separately only receive a standard deduction of $12,400. 

Plus, you are eligible for more tax credits, such as the Earned Income Tax Credit and the Child and Dependent Care Tax Credit. On top of that, joint filers earn a larger amount of income due to the higher income threshold for specific deductions and taxes while they may also qualify for certain tax breaks. 

There are, of course, some rare cases when filing separately is more preferred than filing jointly. You can contact us and give us the details of your case. Our tax relief professionals will then suggest the filing status that gives you the biggest tax savings