Chapter 17: Uncle Sam's Money

Nathan Arizona, Sr: “All right, boy, I guess you got a reward coming. Twenty-five thousand dollars. Or, if you need home furnishings, I can give you a line of credit at any of my stores. In fact, that's the way I'd rather handle it. Tax reasons.”

– Raising Arizona (1987)‌

This book is not a tax guide, for which you should thank me. But taxes are a big deal when it comes to your financial life, so I’m going to go over a few practical considerations and important concepts.

Practical Tax Stuff

‌Here are some non-optional things to know about income taxes.‌


In the beginning there was the deadline: April 15th of every year. [41] Burn this date into your memory. Missing the deadline means hassles and penalties. If you are self-employed there are also quarterly dates (June 15th, September 15th, January 15th, in addition to April 15th) because you may need to make quarterly tax payments. And just because there is a deadline does not mean you should wait until the last minute. File early.

What do you file?

‌You file separate income tax returns with the federal government (the Internal Revenue Service or IRS) and each state you lived or earned money in during the previous year. For example, if you lived in one state and worked in another, you will need to file two state tax returns. [42] A tax return takes the income you earned and grinds it through a series of formulas to figure how much tax you owe. If more tax was withheld from your pay (or you paid more in quarterly payments) than you owe, you receive a tax refund. If not, you have to make up the difference.

Do you have to file?

‌Probably. You should file a return if you worked and your employer took federal or state income taxes out of your paycheck since you might get money back. You have to file once you earn more than a certain amount (which varies depending on whether you’re single or married, or have kids). There are also other circumstances under which you must file, including if you made more than $400 from self-employment.

How to file?

In most cases, you’ll want to file your taxes electronically. First, figure out whether you can file for free with the IRS and check out the filing options on your state website(s). The programs recommended by the IRS are versions of commercial programs. If you don’t qualify for free filing, you’ll be charged a fee based on how complicated your return is.

There is no single best program, but TurboTax, H&R Block, and TaxAct are all relatively user-friendly. They may try to lure you into paying extra for more expensive versions or sell you other services. Often you can get even complex returns done without upgrading.‌

If you sign up with Credit Karma—the free credit score website—you can file your taxes for free even if your income is higher and your situation more complicated. The downside is that you agree to be bombarded with financial offers.

On-line programs save your tax return information on their servers (somewhere in the cloud). They’re expected to have similar security as banks to protect your information. As an alternative, you can buy the software from some of the companies. When you do, completing your return is similar to the online versions but the information is stored on your own computer.

What if you want help? Depending on your situation you may be able to have your taxes prepared for free by volunteer preparers as part of the IRS’s VITA/TCE program. Otherwise, you need to go to a professional: this should be a certified public accountant (CPA) licensed in your state or an Enrolled Agent certified by the IRS. You should expect to pay in the $175-$350 range unless you have a complicated situation.

If you are due a refund be prepared to provide one or more bank account numbers to have the money deposited directly: it’s faster and more secure than a check.

When do I get my refund?

‌Your federal refund usually comes in less than three weeks after you file if you selected direct deposit. You can check your refund status at the IRS’s website.‌

Do not take the bait if you’re offered “instant” refunds or tax refund loans by your tax preparer or software. Even if loans are marketed as “zero interest,” you’ll probably be paying a high effective rate through tax preparation charges or other fees. See the chapter on debt if you need emergency money.

Important Tax Concepts

‌Here are some common tax concepts that often cause confusion.

Tax Rates

‌Sometimes, believe it or not, people worry about making too much money. Specifically, they’re concerned about “moving into a higher tax bracket.” The implication is that this somehow leaves them less well off. Not.

Tax brackets use marginal tax rates. A marginal tax rate is the tax rate you have to pay on the next dollar you earn. Below is a picture of the federal income tax brackets for a single individual in 2020. (Most years, tax brackets go up slightly for inflation.)

Notice that nobody pays tax on the first $12,400 they make. Everybody pays 10% tax on the next $9,875. After that, the next $30,250 is taxed at 12%. And so on. Somebody making $60,000 has a marginal tax rate of 22% because that is the rate an additional dollar of income would be taxed at. [43]​‌

Not to be confused with marginal tax rates is the average tax rate, sometimes also called the effective tax rate. This takes the total taxes owed divided by income. The person making $60,000 pays tax of $12,400 x 0% + $9,875 x 10% + $30,250 x 12% + $7,475 x 22%, which comes out to total tax of $6,262 or an average/effective tax rate of 10.4%.

The takeaway: you may pay a higher marginal tax rate if you make more and move into a higher tax bracket, but you are still better off. [44]​‌

Types of Income

‌The type of income you earn affects your tax rate. This becomes important as your net worth grows and you start earning investment income.

Ordinary income is income taxed at (so-called ordinary) tax rates such as those shown above for a single filer. It includes income from work and other sources such pensions, interest, rental income, and gambling winnings.

Some investment income is taxed at lower rates. Many stock dividends and long-term capital gains are taxed at a top rate of 15% for most people (20% if you’re rich).

Deductions vs. Credits

‌A common confusion is between tax deductions and tax credits. In general, credits are better than deductions.‌

Tax deductions reduce the income used to calculate how much tax you owe. If your marginal tax rate is 15%, a one-dollar tax deduction saves you 15 cents in taxes. Contributions to 401(k) plans, IRAs, and HSAs are deductible, as is interest paid on student loans, up to certain limits. On top of these, you generally choose either a standard deduction that is a fixed amount, or you elect to itemize deductions. You choose the option that reduces your income (and hence your tax bill) the most.

Tax credits reduce your tax bill directly. A one-dollar tax credit reduces your tax bill by one dollar, regardless of your tax rate. Some tax credits are refundable, meaning that even if you don’t owe any tax, you will receive a refund for the amount of the credit. The Earned Income Tax Credit or EITC is one of the most significant refundable credits for people with low to middle incomes who work, especially if they have children.

Tax Planning

‌It's complicated. But it can put real money in your pocket. Instead of tinkering with your portfolio to eke out questionable gains spend some time understanding taxes.‌


‌Government and Regulatory Agencies




Tax documentation and publications

Verify whether your tax preparer is an Enrolled Agent (does not include CPAs)

Last updated