According to government statistics, over 55 million people prepared their taxes themselves in 2019. Are you one of them? Need a refresher? Just read through this guide really quick to get a good handle on basic tax terms so you can, at the very least, make your way to the free tax filing websites to get started.
Earning income means you fall into a tax bracket
You pay taxes on your income, right? Yes. And, how much you owe depends on how much you earned. Those who earn more pay taxes at higher rates. But how do you get from here to there with a good understanding of how to ensure you’re not paying more than you need to? It’s helpful to get a good handle on some very general tax terms that apply to everybody.
Let’s start with earned income, which applies to independent contractors and salaried employees alike. Earned income is anything you earn. Duh, right? Okay, it’s income from any source that you have to work for, including a 9 to 5 job or side hustles. Income from investments doesn’t count as you’re not technically working to earn them. (But, you still have to pay taxes on that kind of income.)
Depending on your earned income amount, you’ll fall into a tax bracket, which is basically a group that the IRS uses to assign you a tax rate. Under current tax rates, those who file as single and earn $9,950 or less per year fall into the 12% tax bracket; they’ll owe 12% on their taxable income. However, these change slightly every year, so it’s important to check tax brackets before you file each year.
What about deductions and withholding?
What about earning income from a side hustle or freelance job? You’ll need to know about deductions, which help you lower your overall tax liability (which is the total amount of money you have to pay taxes on). Generally, deductions are expenses that you incur throughout the year that you had to pay out-of-pocket that you’ll subtract from your gross income.
And what about withholding? You know, why do you earn $4,000 a month but only receive a portion of that? The government is withholding a part of it for Social Security and Medicare if you’re a salaried employee (not just a contractor).
To be more specific, they’ll withhold 7.65% (6.2% for Social Security plus 1.45% for Medicare). They’ll also withhold state taxes if those apply, plus federal income tax (depending on how much you earn and how you file your taxes). Independent contractors have to factor in their withholding, and you can read more about that headache here.
These are the basic, basic tax terms that you need to familiarize yourself with when filing your taxes for the first time.
Salaried employees get a W-2 form to file their 1040
Depending on your employment status and whether or not you make investments, own property, or pay back your student loans, you’ll have to file a few different tax forms each year around mid-April (April 15th in 2021).
The majority of the population that has a salaried 9 to 5 job will receive a W-2 at the end of each tax year. This form will show you how much was withheld from you for things like Social Security and Medicare. You use this form and the numbers on it to file your taxes (there are convenient little boxes with numbers that’ll correspond with the instructions on your 1040).
Speaking of the 1040 form, it’s what you use to file your taxes every year, whether you’re an employee or a self-employed individual, or even a limited liability company. Depending on your employment and financial status, you might have to file Schedule forms as well, which go along with your 1040. For example, Schedule 2 is a form used if you owe self-employment tax while Schedule 3 is a form used to claim education credits.
You to all that cash money that the government owes you back.
Freelance tax forms
Freelance tax forms look a little different before filing. Whereas salaried employees fill out a W-4 for tax withholding and receive a W-2 at the end of each year with their reported earnings, freelancers fill out a W-9 and receive a 1099 form at the end of each year with their reported earnings from each client.
Independent contractors use a W-9 form to send to a client before (or sometimes after) completing work for them. This is for accounting purposes on their end. If you eventually switch back to being a salaried employee, you’ll fill out a W-4 form for tax reporting and receive a W-2 at the end of each year that tells you how much the company paid you and how much of that went to federal or state taxes.
Then, at the end of each tax year, you’ll receive a 1099 form as a “receipt” of sorts from anybody you worked with; they’re letting you know the total amount of income they paid you, which is also the amount of income they reported to the IRS.
Why do they do this? Well, they paid you out of their pocket for a service, and they have to deduct that payment on their own taxes. By submitting this information to the IRS, they’re able to prove that they paid you (while simultaneously letting the government know that you earned some form of independent cash).
More tax terms to know
We’ve just thrown a lot at you. Take a deep breath and let it all sink in. If your brain’s still having trouble processing what you’ve just learned, it might be easier to digest in video form.
We’ve created a course for beginners like you, and we’ve made it as exciting as taxes can possibly be. Head over to Tackling Income Taxes for bite-sized lessons that’ll help you navigate the insanely boring, dense world of taxes.