Bring up the subject of income taxes and many people's eyes glaze over. While no one likes to think about income taxes, they're a significant expense. Thus, you should come to grips with some basics about taxes:
- Realize that you do have some control over how much you pay in taxes. While you do have to file and pay income taxes every year, how much you pay depends on the tax strategies utilized. For instance, contributing to your company's 401(k) plan will reduce your current-year income taxes.
- Understand basic tax concepts. You don't have to become a tax expert, but you should have a basic understanding of tax law so you recognize when you need assistance. Before completing a major transaction, like buying or selling your home or selling securities, review the tax ramifications. For instance, you might want to wait to sell your home until you've lived there at least two years so some gains are tax free.
- Don't make decisions solely for tax reasons. While you want to minimize the payment of income taxes, that's only one factor in most financial decisions. You should first make sure the transaction is economically beneficial and then decide how to minimize the tax effects. For instance, perhaps you're considering selling a stock with gains. If you hold the stock for another month, that gain will be subject to lower, long-term capital gains tax rates. However, during that time, the stock's value could go down. You need to decide whether the benefit of lower tax rates offsets the risk that the stock's value could go down.
- Keep good tax records. During the year, keep any records with possible tax ramifications. That way, when it comes time to file your income tax return, all your tax records will be located in one place and you won't forget a tax deduction. Good records also help in the event of an IRS audit.
What Do Taxes Pay For?
In a series of lessons about taxes that teachers can use, the IRS answers the question: "Why pay taxes?"
One lesson explains: "Taxes provide revenue for federal, local, and state governments to fund essential services — defense, highways, police, a justice system — that benefit all citizens, who could not provide such services very effectively for themselves."
Some other services that are funded by taxes include air traffic controllers, scientific research, national defense, schools, parks and bank regulation."
— Understanding Taxes, an IRS site