How do wages and tax work in the US?
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I think another thing the other posters haven't hit on yet is that Americans pay income taxes in two forms: one to the Federal/National government and then one to the state/locality government in which they live^1^.
Your taxes are "progressive" where each level is increasingly higher rates. So for example,^2^ let's say you make $50,000 dollars a year and you're filling as a single adult. The first 10 grand don't get taxed, so you don't owe any money yet. The next ten grand are taxed at 10% so you owe the government 10,000*.10=1,000. Then the next 10 thousand dollars are taxed at 15%, so you owe the 1000 from before plus an additional 1500 for a total so far of 2500. We continue this pattern until you have no more income to report.
BUT then! You also have credits where you tell the government that you can take X dollars of income off your total income because you did something they liked, such as gift to a tax deductible charity, had a kid, bought an EV, whatever.
So the goal with Americans is to go around collecting credits to lower their income to be the next level lower and collect a bigger refund. The government makes money holding the refund and collecting interest off it.
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yes there are states without income tax, but let's not dwell on that. The states that have income tax work just like the federal ones, except different rate thresholds, credits, etc.
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all the following numbers are made up, this is not legal or tax advice, never believe anything you read on the Internet.
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I'm aware, I was simply translating for our colleague across the pond.
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Oh, I thought maybe it was a Canadian thing.
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It's a racket. The government does receive enough information to automatically calculate taxes for 90% of us, but Intuit and HR Block lobbied congress to keep it complicated and not allow automatic filing.
My paycheck has deductions for tax, healthcare insurance, and 401k (superannuation) so net around 50% of gross like everyone else, and we don't generally have to pay more at year end.
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It’s not that complicated. You’re taxed on income and some things you can deduct to reduce your taxable income amount.
The irs provides worksheets to help with the math.
The irs will audit people at random to make sure it’s accurate.
A scummy third party intentionally keeps things confusing to help convince people to use their services to do the math for them.
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A return is what you file. The money you get back for overpayment is a refund.
Sorry, pet peeve of mine that comes up every tax season.
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Canadians also use "cheque", but I've got a foot in both countries. Consider me your Bri'ish/'murican translator.
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A typical employee would have taxes taken out of every paycheck. Employers calculate that assuming they are your only source of income and you have nothing interesting going on tax wise, which is correct for 90% of people. Employees can ask for their income tax withholding to be changed and employers will do so no questions asked [1]. At the end of the year, you're employer will give you a form W2 that says how much they payed you, how much they paid in taxes on your behalf, how much they payed into your tax deductible account on your behalf, etc. Basically everything about your job that is tax relevant. A copy of this W2 form is sent to the IRS.
If you have investment accounts, work as an independent contractor, or various other forms of income, you will generally be given a form 1099. Again, a copy of this will be sent to the IRS. Income tax is not automatically withheld from these, so if you get a lot of income through them, you may owe taxes at the end of the year.
You may also qualify for tax deductions that lower your effective income for the purposes of computing your income tax. For instance, the interest on you mortgage, charitable donations, etc. However if you choose not to claim these, you can instead claim a deduction of about $14,000; which is more than most people would be able to deduct anyway, so there often isn't a point of keeping track of these.
There are a couple of less common situations that you may need to deal with
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You can deduct significantly more than the standard deduction, so actually need to keep track of all of your possible deductions.
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You are self employed. In this case, you need to keep track of your business expenses, as those are deductible. You also do not have anyone taking out your income tax for you, so you are responsible for making sure you have enough saved come tax time (these tend to be the people who have problems). You are also supposed to pay taxes quarterly.
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You have a significant amount of income that is not from a single W2 employer. This can be multiple W2 jobs, 1099 jobs, investment income, proceeds from criminal activity, etc.
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You make a significant amount of money from unreported cash tips. (In practice, you can underreport this and no one will know).
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You choose to deduct your state's sales tax instead of your states income tax; and do so by actually tracking how much you pay in sales tax instead of estimating it based on your income.
Having said all of that. For 99% of taxpayers, the IRS knows exactly how much you owe; because all of your income was reported to them, as was your only significant deductions, and nothing else matters because you just take the standard deduction for the rest. The IRS could send you a bill/refund based on this and let the remaining 1% file if the IRS gets it wrong. However, that would collapse the tax preparation industry, so companies like TurboTax have lobbied against it for years.
What actually happens instead is you go to TurboTax, upload all of the forms that were sent to the IRS, and let them file taxes on your behalf. This service was "free" until they were sued for false advertising on account of charging money.
[0] At least for income tax. There's a few other taxes on payroll that you cannot change.
[1] Assuming you asked in the form of a properly filled out W4.
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It's really frustrating how many things are bad because some assholes are making money off of it. Saint Luigi, please bless up in these trying times.
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It is indeed called a refund by the IRS and all
tax professionals. The person(s) attempting to correct your use of “refund” are wrong, but they were probably trying to make the point that giving a lot of extra money to the government interest-free is not a smart financial idea. -
To also explain a part of the American tax system... people who are super excited to get a ton of money back on their taxes via refunds are complete idiots.
That's a direct function of paying too much withholding and not calibrating against their relevant deductions. Some of these people also feel that their tax burden has gone up if their refund is smaller from one year to the next, which may or may not be accurate.
