Paying income tax in the USA

This question is inspired by this thread, which mentions wait-staff having to declare tips to the IRS.

I’m also reminded of various sitcom plots, where the characters struggle to fill in huge, legalese-filled tax forms.

Does everyone in the USA have to complete a tax return? As far as I know, in the UK only self-employed people have to complete tax returns, and most of them hire an accountant to do it for them. For everyone else, income tax is deducted from their monthly / weekly wages by their employer.

If the average Joe does have to complete an annual tax return, how does he know how much money to keep in his savings, in order to pay his taxes at the end of the year?

This is how it usually works in the U.S. as well. Many people fill out a simplified “E-Z” tax form that isn’t as complicated as sitcoms make it out to be; it’s basically one page long.

The complications come in if you have a lot of deductions to make (e.g. school tuition, mortgage payments, etc.) or if you have non-employer income like capital gains or dividend income.

Not everyone in the U.S. must file income tax returns. Some are exempt if their income is below a certain level. I’m not sure what the amount is.

Even if no tax is owed, some do still file because of the child tax credits which sometimes amounts to about 5k per kid. This can net the filer a nice sum of money.

Taxes are deducted by the employer. For the self employed, I believe they must make quarterly payments or estimate what the tax will be and pay that amount.

Yes, everyone (i.e. the vast majority with some exceoptions) has to fill one out for state and federal taxes. An estimate of income taxes is deducted from each paycheck, so the annual filing only includes a true-up payment from/to the average Joe.

Mortgage payments and private tuition are tax-deductible? We don’t have any tax-deductible expenses for individuals, only for businesses…

Mortgage interest is deductible. Tuition is deductible up to a certain amount for people earning under a certain amount in that year.

Yeah, lots of things are deductible, including some types of incidental expenses associate with your work, or with seeking work if you are unemployed, and I can testify that, yes, it really can get quite complicated, even for individuals with quite low income. There is a “standard deduction” you can take as an alternative to laboriously working out all the different deductions you might be entitled to, but for may people this would mean that they would lose out.

As others have mentioned, there are also tax credits you are eligible for in some circumstances (particularly if your income is low), and the criteria for eligibility can be quite arcane. So, even if you take the standard deduction, matters can still get quite complicated. (It is possible to wind up with the IRS giving you back more money than you paid in taxes that year. It happened to me once in a year when I was mostly unemployed.) Large numbers of quite ordinary people in the US employ a tax accountant to prepare their returns, to ensure that they are neither over- nor under-paying.

People in regular employment usually do have taxes withheld from their pay, but very often the amount withheld over the year does not equal the amount they actually turn out to owe, which sometimes means having to pay a small amount extra, but also quite often results in a refund.

Oops. Poor phrasing on my part.

As stated above, the vast majority of individuals/families must file income tax returns.

Every year in January, folks receive little forms from their employer, bank, stock broker–in short anyone who has provided them a significant amount of income for the past year. Tips do count as income, and for a long time these had to be self-reported (guess how well that worked); nowadays, I believe the January forms include an estmated tip value based on earned wages.

The rate of tax on each income source varies (e.g. capital gains–like profit from stock sales or interest on bank account–are taxed at lower rates than income, and that rate can vary depending on how long you held the underlying asset). Moreover, the rate on earned income is set according to tax margins–e.g. you pay X% on the first $50,000 you earn, Y% on the next $50,000, etc.

There are also ways to reduce the “taxable income” value you use for the calculation–these are tax deductions. For example, if you paid interest on a mortgage, the total amount of interest you paid can be deducted from the total taxable income you use to calculate your tax payment. Significant deductions like mortgage interest are also mailed in January for use in tax preparation; other deductions–like qualifying charitable donations–are usually kept by the taxpayer him/herself thru the use of receipts. You can probably guess there’s a lot of opportunity for creative hanky-panky here, which is why sitcom plots often get a lot of humor out of characters who face an IRS audit.

I would say tax forms are definitely lengthy–personally I set aside a few hours to finishing my own, and I use Turbo Tax SW to do it. But IMO they are not necessarily complex in the sense that they are difficult to understand unless math in general scares you off, and nowadays if you use SW to complete the form the math is pretty much invisible. With more atypical situations (especially if, say, you are self-employed) the problem is more with skating legal interpretations and estimating values–e.g. how much of my home value can I deduct as a business expense if I have a home office for my business?

And if you’re worried, you can hire someone to do it for you. Besides private tax professionals, there are also chains of tax/financial prep companies where you can bring in your paperwork and have them figure out your taxes. I think federal and state filing for a married couple with not too complicated of a situation costs around $100 or so.

I first went to one of these tax prep firms when I owed state tax in three different states that year. I figured a small fee was totally worth the peace of mind.

If you’re making enough money to live in a place without roommates, get to work and feed yourself, you probably have to file.
There are a bunch of reasons someone making less than the below numbers would want to file, too.
The numbers below are the income you need to make before filing is mandatory.

Marriage Status Age Minimum Income Requirement
Single Under 65 (and not blind) $5,800 earned (or $950 unearned)
65 or older OR blind $7,250 earned (or $2,400 unearned)
65 or older AND blind $8,700 earned (or $3,850 unearned)
Married Under 65 (and not blind) $5,800 earned (or $950 unearned)
65 or older OR blind $6,950 earned (or $2,100 unearned)
65 or older AND blind $8,100 earned (or $3,250 unearned)

Basically everyone who is making a living has to file. There are filing thresholds, but you run against them rather quickly. A stay at home mom who made $100 mowing lawns over the summer but kept house for the rest of the year probably doesn’t need to file. For an ordinary Joe Timeclock, the process is pretty simple and involves no math beyond high school (possibly not beyond middle school). If you have complex transactions, like if your mom died and nobody wanted her 2002 Dodge Caravan and so you and your sister decided to donate it to her church to use to transport kids to the retreat center, then you might have to do research and/or consult with a tax expert or attorney to determine who is allowed to count that as a tax deduction (her estate? you? sis?), and what its value is for tax purposes (you can’t just say that it’s worth $50,000). Business tax returns can get complex, but complex in a sense that there are a lot of rules and a lot of apparently gray areas that might need expert assistance, and the math may end up with a lot of add this add that multiply by %33.2 subtract something divide by 24.9 and add the result to the total of column D and multiply by 0.22, but it’s still basically high school algebra or less (no calculus, no trig, no linear algebra, no differential equations)

It’s pretty much impossible to do your business income tax properly without hiring help, unless you are a tax professional running his own business.
You might be able to avoid breaking the law, but you’ll miss tax breaks eventually if you DIY.

Thanks for the info, everyone. Phew, I feel lucky that I don’t have to deal with this sort of thing. Even my rebates are sorted out by my employer – because I’ve been off work the past few months due to illness, I’ve been getting some tax back each month through my employer.

On the other hand, we have to pay a heck of a lot more tax than you guys.

Deductions and credits are what the US tax system is all about. People over here tend to assume that everything is deductible. In fact, if we denied all deductions and credits*, our tax revenue would more than double. That’s the real problem with our system. Those people who fill out EZ forms every year often have no idea what they’re missing out on. Every year, I get at least one new client because the IRS sent them a letter saying “You qualified for EIC/ACTC last year. Here’s a check for the $3,500 in refunds you forgot to claim.”

  • This is not denying business expenses or deduction for basis in capital gains. Just things like itemized deductions, child credits, charitable contributions, etc. and the equivalents in corporations.

It should also be noted that most states and some cities have income taxes as well, which are calculated and paid separately. The forms themselves tend to be pretty similar (e.g., “Fill in the number from box 42 of your Federal return here:”) but it is an additional paperwork burden. It is very much possible (but I doubt common) to have a taxpayer that gets a refund from his/her Federal taxes and owes more to the state/local government (or vice versa).

The math involved is just simple arithmetic, and generally not that much of it, but figuring out such things as what counts and what doesn’t count as income, and which deductions, exemptions and tax credits you are entitled to under the sometimes ambiguous rules can be quite daunting, especially the first time you try to do it for yourself.

Of course, nobody anywhere enjoys paying taxes, but I do wonder if some of the higher-than-normal hostility to taxation (and, thereby, government in general) in the United States is a result of the fact that the process of paying your income tax every year is made into such a stressful and anxiety-inducing process.

Come to that, even retail sales tax is collected in such a way (calculated and added on at the till) as to make its collection more conspicuous and slightly less convenient than the way it is done with retail VAT in Europe (including the tax in the displayed price).

As another example of the piles of tax benefits that I navigate currently, consider all of the credits/deductions/exemptions for higher education. There are three types of tax credits and one type of deduction which you can get when you pay tuition. Each has different rules, and (I think…) if multiple apply to you, you pick which gives the biggest benefit.

Then there’s a deduction for student loan interest. Work-related education expenses can be deducted as a business expense in some situations. There are two types of college savings plans that provide tax benefits – put money in your kid’s college fund, and you don’t pay tax on some amount of that income.

Then, some types of scholarships are taxable income (anything beyond tuition and certain expenses). So if you get a scholarship that covers room and board, or a stipend of any sort, you’ll pay income taxes (but not social security/medicare taxes… depending on whether you’re “employed” as a student). Any amount that covers textbooks and fees is not taxable. But you can’t deduct textbooks and fees under other circumstances.

My situation for the last couple years has been complex enough that I can’t entirely rely on the free tax prep software. Last year I tried several until I found one that included a way to put in my “taxable scholarship income”, AND was able to give me all of the tax credits that I expect. I’ve also had trouble using free/cheap tax prep software to deal with years where I had to juggle multiple state tax returns. One year I lived/worked in state A, moved to state B for a job in state C, got refunds from A and C but had to pay the “difference” between B and C to state B…

But I have had a few years where I pretty much just enter a W2 and fill out some questionnaires, and the whole process takes maybe 30 minutes.

Yes, one major issue that makes the American system so much more complicated is that your employer has no way of knowing what your total tax burden is. It depends on so many details of your personal life: Whether you’re married, how many children you have (and their ages), whether you own a house, whether you gave money to charity, and it just goes on and on.