A Guide to Paying Your First Taxes (Part One)

The tax-paying process often gets a bad rap in the media as complicated, difficult, and overly stressful. Those descriptions can certainly be true at times, but if you approach tax-paying with certain knowledge and the right mindset, you can handle it with relative ease.

Unfortunately, a lot information about taxes is convoluted and difficult to find. That is where this guide comes in. Although it is not a substitute for professional tax assistance—or better, the kinds of free tax preparation software that I’ll be discussing in a future post—this guide will attempt to cover the most important concepts for young people to understand to pay their taxes properly. (If you have any questions about a term discussed here, or one omitted, please add it in the comments section!)

Here is a list of common tax questions, and answers that are relevant to young people:

When do I need to pay taxes?

Taxes are typically due on April 15^th for the previous year’s income. You have to file taxes any time that you have earned income, whether it be from a minimum-wage job, a business that you have started, or just work around the neighborhood, such as shoveling snow for people. Typically people consider this threshold to be around a few hundred dollars’ worth of income. Of course, depending on some other factors discussed below, you might not actually owe money to the government, but you are supposed to file taxes. In fact, you might even be owed money by the government—what is called a tax refund. Unless you file your taxes, you won’t know if that is the case.

What is tax-filing status, and how can I determine mine?

In the United States, the tax code applies differently to people depending on their filing status. Typically, this status refers to whether you are single or married, and also whether someone else covers your expenses. Most teens and young adults are considered dependents under the tax code, meaning that someone else covers roughly half or more of their living expenses.

If you are unsure of your tax status, this free tax preparation software can prompt you with a few questions to determine your appropriate status. Also, this page has a pretty good description of what the different statuses mean and how they can impact your tax return.

How much do I owe on my income tax?

Your exact amount owed requires calculating a few different figures, but the US’s tax brackets can help provide a pretty good estimate of your tax bill. For the year 2012 (meaning the taxes due in April of 2013), here are the tax brackets:

In the United States, tax brackets show what is called your marginal tax rate. Someone who is a single payer and makes $25,000 in taxable income would not just pay 15% of her income. Instead, she would pay 10% on her first $8,700, and then 15% on the dollars between 8,701 and 25,000. In other words, while her average tax rate would certainly be higher than that of someone who only earns $8,700, she would not be overly penalized for jumping up to the next bracket. Going from $8,700 to $8,800, for instance, would not make her worse off by increasing her total taxes owed; she would only owe the 15% rate on the dollars between 8,701 and 8,800.

To calculate an estimate of your taxes, compute the amount of tax that you’ll owe on each segment of your income (for most young people, this probably means the bottom bracket or the bottom two). Of course, this calculation does not consider things like deductions, which are discussed below.

What is a deduction, and how can I claim one?

A deduction is a legitimate expense or write-off that allows you to legally reduce your tax burden. In general, there are two main kinds of deductions: above-the-line deductions and below-the-line deductions.

An above-the-line deduction reduces the taxable amount of income that the IRS considers you to have earned. For example, if you have put money into a Traditional IRA—a form of tax-advantaged retirement account—for the year, that amount of money would not factor into your taxable income. Another example has to do with being self-employed—say, as a coach in some activity, or as a private tutor: When you are self-employed, many of your legitimate business expenses can be subtracted as a deduction from the money you brought in, meaning that your taxable income is lower. (If you make $500 annually from a website but spend $50 on marketing the site, you would owe taxes on $450 for the site.)

A below-the-line deduction can also decrease your amount of taxable income, but the difference is in terms of whether you can take some of these deductions with other ones. In other words, above-the-line deductions can often be used in conjunction with one another without a problem, but you usually have to pick and choose between below-the-line deductions. (NOTE: I’m not 100% clear on this difference, so if you are still confused at the end of the article, you might want to read this Wikipedia entry on the differences between the two.)

For most young people, the largest below-the-line deduction is what is known as the standard deduction, which is a flat amount of money that you can subtract from your taxable income. The exact amount depends on your filing status, but for dependents the amount was roughly $950 in 2011; it is larger for people who are no longer dependents. If you earned $7,000 in income for the year 2011 but took the standard deduction, you would only owe taxes on $6,050 of it.

The alternative is to the standard deduction is what is known as itemizing your deductions. Instead of taking a flat amount of money out of your taxable income, this method requires you to calculate specific deductions for things such as charitable donations and to figure out exactly how much you would save on taxes by claiming those deductions. Tax software can make this calculation fairly simple, but for most young people, the standard deduction will likely be greater because their donations and other categories aren’t yet large enough.

Click here to download an entirely FREE tax preparation software from H&R Block--no hidden charges, trial periods, or surprise fees! Not sure if you're going to file taxes? Download it anyway, and just check it out!

Check back next week to read Part Two!

Image above is from here.