What is Income Tax?


Howdy Wall Street Willy. I heard my parents talk about Income Tax. But what is income tax anyway?

Well, income tax is tax that you pay on the money that you earn.

Well, does everyone pay the same amount of income tax?

No, they don’t because there are different tax brackets. Which means that the higher your income, the higher it’s the income tax.

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Ah. But what happens if you earn really, really little money? Do you still have to pay income tax?

No. Everyone gets a standard deduction, which is currently $12,000. Which means that if you earn less than $12,000 you do not have to pay any income tax.

Hurray! But do I pay income tax on my allowance?

No, you do not pay any income tax on your allowance because it’s usually below $12,000.

But is it better to earn less purposely and then qualify for a lower tax bracket?

No, the higher tax rate only applies to the incrementally higher income, not all of the income. So don’t try to earn less just so that you could qualify for a lower tax bracket.

Oh, okay. I’ll definitely do that because I love money.

Anyway, are there any different types of income tax or is there just one?

Well, there are two different kinds of income tax. The 1st one is federal income tax that you pay till your country, and the second is state income tax that you pay to your state.

Well, is the state income tax rate the same for all the states?

No, some states don’t have any income tax, like Texas. And some states have more income tax or less income tax than other states.

Yay! I can’t wait till I go back to Texas cause then I won’t have to pay any state income tax!

Does the income tax rate keep changing, or is it the same for, well, forever?

No, the income tax rate does keep changing. It can change from the course of one year to another year. But the highest income tax rate ever by the federal government was 94% in 1944.

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Whoa, that’s a lot of income tax!! I would not want to have to pay income tax back then! Anyway, when do we even have to pay income tax?

Well, income tax is withheld, or deducted, from your paycheck every time you get a paycheck.

Okay. Well, what happens if I end up paying extra income tax? Do I pay less income tax next year, or do I get the money back?

Yes, you do get your money back as a refund.

Well, what happens if I don’t pay my income tax or don’t pay all of it?

Then you will be charged interest and a penalty, which means you will end up paying more income tax than you needed to, since you did not pay it in full.

I will not pay less income tax than I’m supposed to – I don’t want to pay any extra money.

Well, how does the government know how much I earn, and how much tax I have to pay?

Well, you tell them by filing your income tax return by the April 15th of every year. But that’s a topic for another time…

Thank you very much for telling me about income tax, Wall Street Willy.

You’re welcome, Sooper Cooper. Remember, finance is you friend!

Podcast: What is Income Tax?

Income Tax
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