Put together your net income for the year. If you had some big expenses, like a car or a home, be sure to include them.
Now subtract the following things:
– income tax – insurance – social security – phone
That is your net pay. How much of that do you get to keep?
If you want to understand and control your finances and keep track of your money, the first thing to do is to open a personal tax account. You can do it with TurboTax or H&R Block or one of the other tax software programs listed on their web sites. You can also do it as a spreadsheet or as a word processing document. The idea, as I’ve been describing it, is to put together all of your income from all sources.
In the process, you may discover some unpleasant things about how much money you owe to various government agencies. You will then have a chance to decide whether you want to pay those amounts voluntarily, or whether you want to propose a different arrangement under which perhaps you would feel comfortable paying less.
What we call gross income is all the money you earn, before any money is taken off for taxes and other deductions. Your net income, though, is what’s left over, after you pay all your taxes and deduct all your expenses.
If you are self-employed or have a sole proprietorship, you must pay taxes on your profits even if you don’t take all of them as income. You need to keep track of what your net income is. That means keeping records of what you’ve earned and what you’ve paid out to yourself.
This sounds like more trouble than it’s worth, but it’s not that hard. When you get income, just subtract the appropriate expenses from it. If you’re not sure whether an expense is legitimate, ask yourself whether it could be considered a cost of doing business. If so, treat it as an expense.
When people talk about their income, they usually mean gross income before taxes. That’s not what your tax return will show. Your net income is the number that matters to you, and it is found on Line 37 of Form 1040: Adjusted Gross Income (AGI).
So why do we so seldom hear about AGI? Why does your paycheck stub show your gross pay and not your net pay? And why do we call the money we put into our IRAs and 401(k)s and Roth IRAs “contributions,” as if it didn’t count until we took it out again?
If you have children, you can usually reduce your tax bill by putting them on your tax return. Each child reduces your taxable income by $4,000. The first two reduce it by $4,000 each, the third by $3,650, the fourth by $3,500.
The most straightforward way to do this is to claim them as dependents. But you can also claim each one as a “qualifying child”—that lowers your effective tax rate—or as a “qualifying relative”—that gets you extra benefits.
If your children are older than 17 at the end of the year and they don’t provide more than half their own support, then they are independent. If they are younger than 17 at the end of the year, then they are dependents.
If you want to claim either of them as a qualifying child or qualifying relative, then you use form 8812. You complete that form for each child and attach it to your 1040 tax return as an add-on. You can also put all of them on your return as dependents and let the IRS figure out which category they belong in—but if you do that you’re giving up control over how much benefit each one gets.
The government will match your contributions to tax-free accounts to a degree that varies with the account. The Roth IRA is especially free with the money; it will match you dollar for dollar, up to $5,500. Money in a 401(k) plan works less hard for you; it will match you only up to $1,000, and only if you are under 50.
If you are thinking of contributing more than $5,500 to an IRA or $1,000 to a 401(k), then great news: the government will support your decision by matching your contribution with free money. If you are thinking of contributing less than $5,500 to an IRA or $1,000 to a 401(k) , then also great news: you can use the money saved in taxes to buy something even better than whatever it is these accounts would give you.