13 Tax Lessons, Part 1

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Interested to know what Bankrate thinks are thirteen basic tax lessons every taxpayer should know? Over the next two days I’ll be writing briefly about each one and how nearly all of them have been covered, almost ad infinitum, on one personal finance blog or another out there. Be it as it may, they are still very important lessons worth reading because if you can pick up these lessons now then you’ll be set up for next year.

1. Overwithholding = Interest Free Loan
If you’re constantly getting several thousand dollars back on your tax returns, you’re surrendering money you don’t need to. Each exemption on your W-4 shelters the same amount, $3300 for 2006 taxes, that’s why they recommend 1 exemption for you and each of your dependants. If you know that you’ll be contributing money to your 401(k) and that your taxable income will be lower then you should claim more exemptions to offset that amount. Every dollar you don’t get refunded is one that can earn interest in a bank account, like at Emigrant Direct.

2. Underwithholding is bad
On the flip side, owing a lot of taxes at the end of the year could, at best, just put you in a financial bind and at worst, mean penalties and interest.

3. Income differentiation
The IRS has different rules based on our income, which comes in many flavors. Gross income refers to everything you’ve earned this year. Your adjusted gross income (AGI) is your gross income minus those items, listed on the bottom of your 1040, that you can from your gross income. The AGI is important because that will determine what tax breaks you’re eligible for. Then from your AGI you subtract the deductions (standard and itemized) and get to your taxable income.

via Yahoo Finance.

{ 6 comments, please add your thoughts now! }

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6 Responses to “13 Tax Lessons, Part 1”

  1. Miller says:

    The $3300 per exemption you mention. Is that $3300 in deductions for calculating AGI or total tax to be paid?

  2. jim says:

    On your W-4 (Employee’s Withholding Allowance Certificate) you specify how many allowances you are claiming. The instructions tell you to enter 1 if no one else can claim you as a dependent, 1 if you’re single with one job (or married but with one income), blah blah. Each one of those allowances is what I meant when I wrote exemption. For each of those, Bankrate says the withholding excludes $3300 from your income.

    Ie. if you have a salary of $50,000 and claim two allowances, then the amount of taxes withheld would be the same if if your salary were stated at $50,000 – $6,600 = $43,400 but you claimed zero allowances.

  3. questions says:

    I think most of your posts are informative and well thought out, but this one doesn’t make much sense. The Yahoo Finance ( article you link to already mentions all of the points in brief and, in the case of number 3, is easier to understand.

    If you plan to personally expand on numbers 4 – 13, that’s great. But if you’ll just be reducing an already easy to read article into a few (sometimes confusing) blog entries, you might want to just have an introductory paragraph and a link and call it good.

  4. Kay Bell says:

    Glad you found my article (that Yahoo licenses from helpful. Unfortunately, Yahoo didn’t pick up the tag line from Bankrate which lists my personal tax blog, Don’t Mess With Taxes ( I haven’t got around to blogging this article (Bankrate version) yet, but there are other tax tips, info and links there if you’re interested.

  5. Weekly Roundup – 03/10/06

    Weekly roundup time… Here are some of my favorite posts of the past week from the MoneyBlogNetwork and beyond…

  6. Matt says:

    I was under the impression that, legally speaking, it was far better to overwithhold than underwithhold. (In my case, the overwhelming majority of my $8000 refund this year was because of Schedule C losses…which I had no way of predicting precisely in advance, and indeed had the client I spent all that “lost” money wooing actually signed the contract I put in front of them, my Schedule C would have showed a profit. Paying the additional tax required, had that happened, would not have been in any way a hardship for me, but my understanding of the law was that I would still be in a significant amount of hot water for claiming W4 exemptions to which I was not legally entitled, even if I didn’t claim them on my 1040 and was able to make up any underwithheld tax obligations by the time I filed.)

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