Taxes for Personal Finances: 4 Major Areas to Understand

by MSE Staff | Published 15 Feb 2022 

As the 2021 tax filing deadline rapidly approaches, individuals and families alike are starting to think about their taxes. In this blog post, we will explore four major areas of taxes for personal finances: tax liability, taxable income, tax credits, and tax deductions. Each of these concepts is important to understand in order to make the most of your short-term and long-term financial planning. Keep in mind that this information is specific to individuals living in the United States; other countries may have different rules and regulations when it comes to taxation.

Tax Liability:

Your tax liability is the amount of money you actually owe in taxes for a given year. It's calculated by taking your taxable income and subtracting any applicable credits or deductions. If this number ends up being less than zero, then you will receive a refund from the IRS instead of paying more in taxes.

Taxable Income:

This is the amount of income that is subject to taxation. It's calculated by adding up all of your taxable sources of income and then subtracting any applicable exemptions or deductions.

Tax Credits:

Tax credits are a dollar-for-dollar reduction in your tax liability, and they can be claimed for a variety of reasons such as having children under the age of 18 or paying someone to take care of them while you're at work. There are three types: refundable, non-refundable, and partially refundable credits which we'll discuss below.

Refundable Credits - If your tax liability is less than $0 because these credits exceed your taxable income, then some portion (or all) will be paid to you as a refund.

Non-Refundable Credits - These credits can only be used to reduce your tax liability down to $0; any excess amount is not refunded to you.

Partially Refundable Credits - If your tax liability is less than $0 before because a portion of these credits exceeds your taxable income, that portion may be refunded up to a specified amount of the remaining credit.

Tax Deductions:

Tax deductions are expenses that you can subtract from your taxable income in order to lower your tax bill. There are two types of deductions: standard and itemized.

Standard Deduction - This is a fixed amount that everyone gets by default without having to provide any additional documentation or information about their finances/spending habits.

Itemized Deductions - These are expenses you have incurred over the course of the year which may be deducted from taxable income if they meet certain criteria. These expenses include things like mortgage interest payments or charitable donations, among others. Sometimes the total amount of itemized deductions doesn't exceed the standard deduction. It's important to hire a tax preparer you can trust to avoid overpaying taxes.

Final Thoughts

In sum, it's important to understand these four major concepts of taxes in order to make the most informed financial decisions for your future. Consult with a tax preparer if you have any questions about how these concepts apply to your unique situation; they can help you save money and avoid penalties from the IRS. Thanks for reading!