Ep.35 - Adulting101 - How to Be Smart About Taxes as a Millennial? (3 Minute Read)
Read Time: 3 Minutes
I know our tax system is changing very soon. What I am about to say holds true, even after the tax change.
Unfortunately, we have a messy and complicated tax code in this country. It is very confusing. This short article aims to help you understand how it works, how much to expect to take home after taxes, and how not to be screwed if you have multiple jobs.
HOW DOES OUR TAX SYSTEM WORK?
We have what is called a progressive tax system, which simply means the richer you are, the higher percentage you pay in taxes. Let's use the 2017 federal tax system below to explain. As a single person, you can see in the tiered system, your top tier (effective rate) gradually climbs up from 10% to 15% to 25% and 28%, as you make more than $9,326, $37,950, or $91,900.
I am gonna stop there, because 90% of American households make less than $175k/yr.
RULE OF THUMB ON TAKE-HOME PAY: 1/3 GOES TO TAXES AND DEDUCTIONS
Aside from federal taxes, you also pay state taxes (except certain states), FICA tax (7.65%, or 15.3% if you are self-employed), and all sorts of deductions (401k, health insurance, commuter pass, FSA).
Everyone's scenario is different, but there is a rule to this madness. For the middle 50% of American households, which make between $50k to $175k, about 1/3 (somewhere between 30% and 35%) is taken out of every paycheck. In other words, you should expect your take-home pay to be 65% to 70% of your before-tax pay. For example, if you make $60k/yr, you should expect to bring home $39k/yr to $42/yr.
This rule of thumb is true for single folks as well as married people.
HAVE MORE THAN ONE JOB? DECREASE YOUR w-4 EXEMPTIONS ON YOUR SECOND JOB
What is a W-4 form, you ask? It's this form you fill out before you start every job! When you fill out a W-4 form on your second job, my advice is to only enter 1 for A, and fill in 0 for the rest. This leads up to a total of 1 in H.
What does it all mean? It means, the government will take out more taxes out of your pay every period. But why should you do this? The reason is, if you don't do this, you will face a huge tax bill during tax return.
Here's an example. Let's say you have a main job that pays $50k/yr, but you also have a side hustle that pays an extra $10k/yr. Your total income is $60k. With the rule of thumb, you should expect to pay 1/3 in taxes and deductions. If you don't purposely decrease your exemptions on your second job, your $10k/yr will be taxed artificially low (much lower than 1/3), because the accounting system assumes you only have one job and your total income is only $10k/yr. You know your total income is $60k, not $10k. As a result, you need to make sure the additional $10k is taxed at the same level as the $50k, so you won't face a surprise bill during tax return.
ARE YOU A NEW COLLEGE GRAD? YOU GET A BREAK FOR THE FIRST YEAR
If you have a job right after college, say between June and December of the same year, you get a tax break.
You get a tax break, because you will only be making money for at most 6 months of the year, but your taxes are taken out, as if you have worked the entire 12 months. For example, if you make $50k/yr, you will see around 1/3 taken out every pay period. But at the end of the year, you will at most make $25k, because graduation typically occurs in June. Even though your salary is $50k/yr, you actually only have made at most $25k, hence you will receive a tax refund the following year.
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