Nobody forgets the first time, whether it was at their high school job at the ice cream parlor or their first job out of college, that they eagerly tore open a paycheck, already planning a shopping spree… only to find that someone had stolen a huge chunk of their money! (If you haven’t felt this sinking feeling yet, prepare yourself.)
Yup, that big missing chunk went to taxes. But don’t think you’re not getting anything for it! Here are a few examples of what your taxes get you: the clean water running out of your tap, the police keeping your neighborhood safe and the garbage that gets picked up on your curbside.
We’re sure you have an opinion on whether you’re over or underpaying the government, but that’s a topic for another time. Today, we’re going to explain to you the ins and outs of taxes so you can fully understand how they affect your finances.
Taxes in a Nutshell
Taxes are compulsory contributions to the state you live in, and to the federal government, levied by the government to pay for things that we as a society need but can’t pay for individually. That includes everything from the roads you drive on to law enforcement to the salary of the President of the United States.
These taxes aren’t optional, and trying to hide or outrun them never really ends well. (Don’t believe us? Just Google “celebrity tax evasion.”) Plus, 96% of Americans believe it’s your civic duty to pay taxes, so the best thing to do is get a basic understanding of taxes so that you can pay them accurately and
on time, with minimum stress and pain—financial or emotional.
Why Understanding Taxes Is Important
Understanding taxes will save you when filing. Collectively, Americans overpay the government by $945 million every year. That’s about $400 per household. If you understand how taxes work, you can avoid giving too much to Uncle Sam.
Understanding taxes will also save you at work. At your job, understanding how taxes work can help you save hundreds on transportation costs or childcare by having your costs of getting to work or having your children take care of taken out of your paycheck pre-tax. But more on that below.
Understanding taxes will also help you budget better. You’ll be able to more accurately plan your monthly and yearly spending if you understand how much you’ll be paying. No one likes financial surprises (unless it’s a giant windfall).
How Taxes Work
When you pay taxes, the money goes to the coffers of the local, state and federal governments. That money is then pooled and allocated to various services and projects, ranging from regulatory agencies that ensure your medicines are safe and that your roads aren’t filled with potholes.
The tax system is complicated, but many of the regulations are there to incentivize you to save and spend wisely. For example, if you take money out of your 401(k) for anything besides retirement (not good!), the government will punish you by levying a tax penalty on top of ordinary taxes. But if you decide to donate a lot to charity, the government will reward you by lowering your tax bill.