Federal Income Tax Introduction

Here are some helpful links to the basics on our federal income tax system and it’s history…

Students: This is the building blocks of “income tax 101” for the CFP curriculum. Buckle up as it gets much more detailed from here!

Individuals: You might be curious on how our tax system works and affects your own life. Or maybe you are considering doing your own taxes? (FYI - I teach taxes but I still pay a CPA to do mine…)

Advisors/Professionals: Understanding taxes is VITALLY important to providing good financial planning advice to clients.

Overall Federal Tax System Basics (macro level)

• Investopedia Article: Brief History of Federal Taxes

• Where do Federal Tax revenues come from?

• Where do Federal Tax dollars go?

• Videos below are from VOX (liberal media) and PRAGER U (conservative media) showing alternative viewpoints on our tax system. I would say that both have valid facts but there are some misrepresentations (on both sides). I’m not trying to convince you of a certain viewpoint - but hopefully once you understand how the system works you can come to your own opinions!

Federal Income tax at the individual level

• IRS FORM 1040 - the individual income tax form! Even if you aren’t a CPA/tax-preparer, understanding this form is immensely helpful!

• Understanding the basics of taxation: A PROGRESSIVE system with BRACKETS (videos below showing both political viewpoints on our tax system).

• Why tax income? Why a progressive tax? Why the tax code with different tax “breaks”? Three reasons:

  • 1) The government needs to raise money - they do this partially through an individual income tax.

  • 2) The government wants to encourage certain behaviors that are beneficial for the future (economically) - IE having children, saving for your retirement, investing in a business, getting a college degree (all of these have associated tax breaks - they are also all good for the future economy)

  • 3) The government decides to redistribute wealth to provide relief to those at the bottom end to keep more individuals/families out of poverty and have a basic standard of living.

• 2018 Congressional Budget Office (CBO.GOV) Report on “Distribution of Household Income”

• 1913-2013 Individual Income Tax Bracket/Rate Chart - shows history of former tax brackets (keep in mind inflation when you are thinking about brackets from 50+ years ago)

• Basic Formula:

  Gross income (not counting “exclusions” to gross income)

  Subtract “Adjustments” (also known as above-the-line deductions)

  Equals “Adjusted Gross Income” or “AGI” (important # for many things such as IRA contribution thresholds, tax credits/deductions, loan eligibility, needs based aid, stimulus checks, etc…)

  Subtract EITHER a “standard deduction” or “itemized deductions” (typically the larger of the two, more info later)

  Equals your “taxable income”

  Apply against your tax brackets for your filing status. This provides you with your “tax liability” (but we aren’t done yet)

  Finally, subtract any CREDITS you are eligible to receive (reduces your tax liability dollar for dollar)

  That is it! If you had any current year tax withholding (paycheck) or prepaid any tax estimates that amount would count towards your amount owed and you’d either end up with a refund or owe!

MoneyCoach has some great financial Youtube videos - 3 part series on the basics of the federal income tax system and how it applies to an individual