Spending Your Money – How Income Taxes Really Work

Most people are often unaware of how income taxes really work. They know that the government uses these taxes to spend on public utilities and programs that would benefit its citizens, but many claim ignorance when it comes down to how income taxes are processed. Income taxes, although the bane of most citizens’ existence, should be understood about how this affects most law-abiding residents of the country.

When delving into how income taxes really work, many assume that the process starts with the filing of income tax forms. This is not the case; the process actually starts when a person is officially hired by a company. During this period, both the employer and the prospective employee agree on the latter’s current wages, and sign an agreement to that effect.

Once the person is hired, he has to fill out his tax forms, especially the W-4 form, which lists down his salary information, and number of children or dependents. This is then given to the employer, so that he would know how much he would need to take away from his employee’s paycheck for the income tax.

Now that a set amount for the employee’s salary has been made, the income tax he would need to provide for can now be deducted. Starting with his gross income, which includes his current income, interest and other wage benefits, adjustments are then subtracted. This may include retirement plans taken, alimony, and self-employment taxes. The difference is now termed as the adjustment gross income.

From here, the adjustment gross income is further subtracted by any personal expenses and exemptions made, and by either standard or itemized deductions. Standard deductions are a set amount by the Internal Revenue Service, while itemized deductions include charity contributions, medical and dental expenses, home mortgage interests, and any state and local taxes incurred. The resulting amount is now the employee’s taxable income.

The main gist of how income taxes really work falls under the next process. If the overall taxable income is less than $100,000, the IRS tax tables should be used to check for the amount that the employee would need to pay based on his income bracket. If it is more than $100,000, then the employee should instead check the IRS tax rate schedules. The taxable income in these charts will indicate the person’s gross tax liability. From this gross tax liability, credits such as expenses for child care should be subtracted further. The result would be the net tax, which is the amount of money that would be required by the employee to pay.

Every time wage salary pay checks are given to its employees, the company also computes for these net taxes of all its workers, and then deposits the money in the federal reserve bank. The government uses the money deposited here for their budget.

These processes explain how income taxes really work; now that it has the money acquired form these income taxes, the government is now able to plan their budget and determine government spending based on the amount its citizens have provided for.