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EPISODE 6 - LISTENER REQUEST: WHAT IS INCOME TAX AND HOW DOES IT WORK?

podcast taxes Aug 22, 2019

Do you know why taxes are coming out of your check every pay period?  How do they calculate it?  What is it used for?  Join Tiffany as she answers these questions and more!  This episode was a listener request!  To submit a question: join our Facebook group or fill out the form on the website and it could be featured on a future episode!
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Transcription

Welcome to Money Talk with Tiff, a podcast where we discuss everything money – from tips and tricks to current events. Follow me on my journey to become debt-free, and meet other cool people along the way. I'm your host, Tiffany Grant, now let's talk money.

Introduction

"Death and taxes in life are certain; knowing how to pay only your fair share is third."

– Yvette D. Best

Alright, so in this episode, I wanted to talk about income taxes. I had someone ask me the question: "How does income taxes work? When they take it out of my check, how do they figure how much to take?" You know, pretty much how it all works on the backend, so I just wanted to touch on that a little bit today.

Just a little background about me, I used to be in the Payroll department. That was one of my many roles in HR, and as a part of Payroll, I had to pay income taxes – both for the employee and the employer. So, I guess I'll just start there.

How Income Taxes Work

So, when you fill up the W-4 for an employer, you put how many exemptions you would want for your income taxes, and I highly recommend using the worksheet that's available on the form to give you a good baseline of what you should put as your exemptions.

Refunds

Many people default to zero or one and then end up paying too much (in taxes) throughout the year, therefore making their check shorter and then getting a big refund once a year. That's not the way to go.

It's better to make sure that you withhold the right amount through the year with your paychecks, and then that way, you don't get a refund, or your refund is minimal. Because if you think about it, when you get a big tax refund, it's because you pay too much in income taxes, and therefore, you're giving the government a free loan – basically – because they're not paying you any interest on that. They're just holding it for you until you file your taxes the following year, and then they're paying it back to you. So, it's not like you're getting free money or anything.

W-4 and Worksheets

So, once you go ahead and fill out a W-4, you give it to your HR department, they put it in the payroll system. Once that goes into the payroll system, there are some calculations on the backend that typically the payroll software does for the company or the payroll person, and that calculates how much taxes should come out of each and every check – the more exemptions you put on the W-4 form, the fewer taxes that will be taken out.

So, as a single mom with two kids, I claimed about nine exemptions, I believe, because with the new tax laws, I did have to change it, and that's another reason I recommend using the worksheet because it stays up-to-date with the tax laws. So, mine is about nine exemptions. So, my taxes – I pay very minimally through the year, and then I don't really get a huge refund. Once that happens, and the money is coming out of your check (every paycheck), that's not all the employer is sending to the government. They actually have to match what you're getting taking out dollar-for-dollar, and then that goes to the government.

For instance, let's say I get $200 taken out of my paycheck in federal taxes. Well, on the backend, the payroll department is taking that money, multiplying it by two, and they're sending $400 just for you (just for that paycheck) to the federal government.

How they are used

Income taxes are used to pay for pretty much all the government benefits that we have – social security, Medicaid, Medicare, food stamps, all of that stuff – all that comes from income taxes.

So, it's very important we have enough workers to have those income taxes coming out. You know, just to roll this into like current events, that's what the big fuss is about – we don't have enough workers in here in the U.S to fulfill that need, and that's why you keep hearing "Oh! Social security is going to run out, Medicare is going to run out," and things like that. This is because they need more workers to take the taxes out of those checks in order to pay those benefits to the people that are currently receiving them.

Understanding Exemptions

So, that's just a little bit about how income taxes work, and how they're important to the government operating; and to make sure of your attention when you're filling out your W-4 form, that you do out the right amount in a mix of exemptions.

"Today, it takes more brains and effort to make out the income-tax form than it does to make the income."

– Alfred E. Neuman

Another point is you can change your exemptions at any time throughout the year. For instance, if you're really nerdy and you want to go ahead and pay a lot, so you want zero or one exemption for half the year, and for the second half of the year, you want to bump that up, so that way you even out (mind you, you have to do the maths for all of these). So, you have no refund, and you don't owe – that's the ideal scenario. But like I said, that would take a lot of maths and a lot of consideration, and you will probably need a tax professional for that.

It is important to note that you can change it at any time. Don't think that once you're hired, and you fill out the W-4 form, and you don't look at it again, if you get married, you have children, all of those things, make sure you change your W-4 exemptions, if applicable because it can make a huge difference in your paychecks.

Conclusion

Anyway, I hope that answers the listener's question about how income taxes work and what they're used for. Feel free to reach out and let me know if you have any other questions.

Thank you for listening to the Money Talk with Tiff Podcast. For free resources and materials, head over to moneytalkwitht.com, and while you're there, why not sign up for our newsletter, so you'll never miss an episode. Talk to you soon…

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