7 Answers to Frequently Asked Income Tax Questions
Money Girl answers 7 common questions about paying income tax that will help you comply with the law, minimize what you owe, understand tax deductions and credits, pay household workers or nannies properly, and avoid trouble if you can’t pay Uncle Sam on time.
Taxes are one of the most confusing aspects of personal finances. The IRS regulations are complicated, and many tax rules change from year to year. Even if you have a relatively simple financial situation or use a good tax software program such as Turbo Tax, taxes can still trip you up. Â
In this episode, I’ll cover answers to seven common questions about income tax. They’ll help you comply with the law, minimize what you owe, understand tax deductions and credits, pay household workers or nannies properly, and avoid trouble if you can’t pay Uncle Sam on time. Â
7 Answers to Frequently Asked Income Tax Questions
- Who must pay income tax?Â
- When should you itemize income tax deductions?
- Who can claim the home mortgage interest tax deduction?Â
- If my raise puts me in a higher tax bracket will I get less pay?Â
- What’s the difference between tax deductions and credits?Â
- Do I have to pay taxes for a household worker or nanny?Â
- What if I can’t afford to pay my taxes?
Here are the answers to some common income tax conundrums.
Question 1:Â Who must pay income tax?
Michelle B. from Orlando, Florida, says, “Hi, Laura. I’m a longtime podcast listener and have purchased your books on Audible. I’ve got a burning question and think you’re the perfect person to trust to answer it correctly. Is it true that filing an income tax return is optional or not required if you don’t have any taxable income?”
Thanks for your kind words, Michelle! It’s true that not everyone must file an income tax return. The requirements depend on how much you earn, your filing status, and age.
For 2018, if you’re a single taxpayer, you must pay taxes if your gross income exceeds the standard deduction, which is $12,000. If you’re married and file jointly, the limit is double that, or $24,000. If you’re over age 65, these income thresholds go up slightly.
Gross income is all income you receive that isn’t exempt from tax. It typically includes wages, retirement benefits, and investments. It includes all sources of income, including any earnings you might have from outside of the U.S.
These income limits apply when no one can claim you as a dependent. Note that if you are claimed as a dependent on someone else’s tax return, you may be required to file taxes, even if you earn less than the thresholds I mentioned. And if you’re the parent or guardian of a dependent who is required to file but isn’t able to do so on their own (such as an adult child), you must file an income tax return on his or her behalf.
The IRS specifies more situations when you must file taxes. These include having net self-employment income of at least $400 and receiving distributions from a tax-favored account, such as an IRA or HSA.
Even if you don’t owe tax, filing a return is the only way to get money back from the government that it owes you.
Even in years when you’re not required to file a tax return, you might want to. That’s because filing could allow you to qualify for refundable tax credits or to receive a refund for federal taxes withheld from your paycheck. Even if you don’t owe tax, filing a return is the only way to get money back that the government owes you.
If you’re not sure if you must file a return be sure to ask a professional tax preparer or accountant. You can also use a tool at IRS.gov, the Do I Need to File a Tax Return? Calculator, to learn more.
Question 2: When should you itemize income tax deductions?
Money Girl listener Megan S. wants to know if she should itemize deductions and how to make it easier. Megan, thanks for sending in your questions.
Deductions are important because they reduce your taxable income and therefore the amount of tax you owe. Every year you’re allowed to choose between claiming a standard deduction or itemizing deductions.
I previously mentioned that for 2018 the standard deduction is $12,000 for singles and $24,000 joint filers. When your total itemized deductions exceed the standard for your tax filing status, you’ll come out ahead by itemizing.
The trick is to understand which expenses are deductible and to keep track of them carefully throughout the year. Then you can compare the actual value of your deductions to the standard deduction and choose the method that cuts your taxes the most.
Reform under the Tax Cuts and Jobs Act of 2017 significantly increased the standard deduction from 2017 to 2018 and changed or eliminated some popular deductions. So, if you itemized in the past, you may find that claiming the standard deduction save you more now. Â
Here are some of the most common and valuable deductions you should track:
- State and local taxes, including real estate taxes, up to $10,000
- Home mortgage interest and points paid on up to $750,000 of debt to buy, build, or improve a primary or secondary residence
- Medical and dental expenses that exceed 7.5% of adjusted gross income (goes up to 10% in later years)
- Charitable donations up to 60% of adjusted gross income
But what if you don’t have enough deductions to make itemizing pay off? Don’t worry, there are some deductions you can take even if you claim the standard deduction. For 2018, they include:Â
- Educator expenses up to $250Â
- Health Savings Account contributions up to a maximum of $6,900 when you have a high-deductible health planÂ
- Self-employment expenses, such as one-half the self-employment tax; contributions to a SEP, SIMPLE, or qualified retirement plan; and health insurance paymentsÂ
- Alimony you paid
- Traditional IRA contributions up to a maximum of $6,000 (or $7,000 if you’re age 50 or older)Â
- Student loan interest up to $2,500 (if you meet certain income limits)
Megan, I recommend using a program such as Quicken or Mint to categorize these expenses throughout the year. Then you can simply run a report at tax time. For mortgage interest, your lender will send you Form 1098 for any year that your interest exceeds $600.
Question 3: Who can claim the home mortgage interest tax deduction?
And speaking of the home mortgage interest tax deduction, that’s a surprisingly complicated tax benefit. And, yes, the rules for claiming it recently changed with tax reform.
Here’s a voicemail question from Cassie B. who says: “My parents pay the mortgage and property taxes on my home, but my name is on it the title. I pay rent to my parents in order to reimburse them for paying the mortgage. So, can I claim the mortgage interest deduction on my taxes or is that only available to my parents since they’re officially paying the mortgage?”
Thanks so much for your question. (And by the way, if you want to leave your money question, just call (302) 364-0308.)
The interest you pay on a mortgage, a home equity line of credit (HELOC), or a home equity loan for your primary residence or second home can only be deducted from your income when these two conditions are met:
- You must file taxes on Form 1040opens PDF file and itemize deductions on Schedule Aopens PDF file .
- You must have a secured debt on a qualified home in which you have an ownership interest.
Be aware that the total amount of home debt that you (and a spouse if you file taxes jointly) can base this deduction on changed from $1 million to $750,000, for loans closed starting in 2018.
So, if you have an older loan, you can still deduct interest based on $1 million worth of debt, or $500,000 if you’re married and file taxes separately. But if you have a newer loan, the limit is now $750,000, or $375,000 if married filing separately.
I frequently get questions, like Cassie’s, about who is entitled to claim the deduction. The answer is that you can only claim the mortgage interest deduction for interest that you actually paid.
Since her parents make the mortgage payments, they are the only ones allowed to claim the interest deduction, in any year that they itemize. And if they don’t itemize, no one can claim the deduction.
The bottom line is that you need some form of written proof stating your ownership and the amount of mortgage interest you paid during the year in order to qualify for the deduction.
Another question comes up when you co-own a property and pay half of the mortgage. In that case, each person would be eligible to deduct 50% of the interest. Even if your name isn’t listed on a Form 1098, if you have an ownership interest in a primary or secondary residence and paid mortgage interest, you can deduct the portion you paid.
If you’re like the caller and own a home, but are not listed on the mortgage, one tip is to make payments directly to the lender, instead of paying rent. When you reimburse someone else’s mortgage debt so they can make the loan payment, you can never claim the interest deduction.
So, if the caller’s parents allowed her to pay the lender directly, she could claim the mortgage interest deduction. Another option is for the caller and her parents to create a written contract that spells out her ownership interest. In that case, I would still recommend that she make payments directly to the lender for a clear paper trail.
Another situation is paying someone else’s mortgage out of the goodness of your heart because they’re unemployed or facing foreclosure. Again, if you don’t have an ownership interest in the property, you’re not entitled to claim the interest deduction.
The bottom line is that you need some form of written proof stating your ownership and the amount of mortgage interest you paid during the year in order to qualify for the deduction. If you have a more complicated situation, be sure to speak with an accountant or a legal professional who specializes in real estate.
Question 4:Â If my raise puts me in a higher tax bracket, will I get less pay?
When you get bumped into a higher tax bracket, pat yourself on the back! The U.S. tax system is progressive, which means that not all your income is necessarily taxed at the same rate.
A tax bracket is a range of income that’s taxed at a certain rate. Each bracket gets assigned a progressively higher rate, which means only a portion of your income is taxed at the highest rate.
There are seven tax brackets for 2018: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. If you’re in the 24% tax bracket, your entire income is not subject to 24% tax—that’s just the highest rate that’s applied to your top range of income.
Let’s say you’re a single taxpayer who made $80,000 in 2017. That amount of income put you in the 22% tax bracket. But for 2018, you got a raise and made $83,000.
You realize that the cut-off between the 22% bracket and the next highest, 24% tax bracket is $82,500. So, should you worry about getting bumped from the 22% bracket into the 24% bracket? Absolutely not!
You should be thrilled to get a raise because your income won’t be taxed any differently—except for the amount that falls within the top 24% tax bracket, which is $500. Again, $500 is the only amount that will be taxed at 24%, the top rate for your bracket.
No matter your tax bracket, getting a raise always means that you take home more money. Use the IRS Tax Rate Schedules to find out your bracket and calculate how much tax you may owe based on your income. Depending on where you live you may also have to pay state income tax.
Question 5: What’s the difference between tax deductions and credits?
Both tax deductions and credits reduce the amount of tax you must pay or increase your tax refund. Deductions reduce the amount of income you pay taxes on, which in turn reduces your tax.
A tax deduction is an amount that the IRS allows you to subtract from your taxable income. When you reduce your taxable income, you lower your tax liability. For example, if your taxable income is $40,000 and you’re eligible to claim $10,000 in allowable tax deductions, then you only have to pay tax on $30,000—not $40,000. That makes a huge difference!
Tax credits are a dollar-for-dollar reduction in the amount of tax you owe, which can be more valuable than a deduction. For example, if you owe $1,000 in taxes, getting a $600 tax credit means you’d save that full amount and only owe $400.
Question 6:Â Do I have to pay taxes for a household worker or nanny?
Several folks in my Dominate Your Dollars Facebook Group brought up the topic of paying a nanny or other household worker correctly. This is an interesting question because many people don’t realize that they are actually an employer and must provide a formal payroll with multiple taxes deducted and filed, just like a business.
“Nannygate” is a popular term for problems in the early 90s that caused two of President Bill Clinton’s choices for Attorney General to go down the drain. It was discovered that both nominees had broken federal law by employing undocumented workers and failing to pay taxes.
So, what do the less rich and famous need to know? It’s critical to understand that if you hire workers to care for your children or to do housework that they are generally considered your employees. But note that if you’re a business owner or self-employed, you can’t just put a nanny on your company’s payroll. You must pay him or her separately.
An employee is someone whose work you control. It doesn’t matter if you control the work full- or part-time, if you found them through an agency, or if you pay by the hour, day, or job. As an employer, it’s against the law to pay a nanny in cash and avoid paying taxes—even if your nanny prefers receiving cash and being “off the books.”
The only household workers who are not your employees are those who control how they work or who are self-employed. However, if an agency provides a worker and also controls how their work is done, the agency is the employer, not you. Therefore, in the vast majority of cases, you can’t consider a household worker a contractor and issue a Form 1099opens PDF file .
If you employ a nanny, babysitter, or household worker and pay him or her more than $1,000 per quarter, or $2,100 a year, you’re generally responsible for reporting their income on Form W-2opens PDF file .
You must withhold income, Social Security, and Medicare taxes—and pay overtime for hours worked over 40 per week. And depending on where you live, there may be benefits you must legally provide, such as paid sick time and workers’ compensation insurance.
Not only is it illegal to skip paying tax for household workers, but it’s unfair to them. By not paying tax, you’re costing him or her their future Social Security and Medicare benefits.
Yes, paying a nanny properly by calculating and withholding taxes, issuing annual tax forms, maintaining the right records, and understanding employment law is confusing and time-consuming (especially if you don’t have experience running a business).
So, I recommend using a payroll service or accountant to handle the details for you. Check out services such as HomePay and SurePayroll to take the stress out of being a household employer. Prices range from about $40 to $70 a month.
After all, you hire a household worker to save time, not to spend hours each week processing paychecks and trying to stay compliant. You can also check out IRS Publication 926,opens PDF file Household Employer’s Tax Guideopens PDF file to learn more.
Question 7: What if I can’t afford to pay my taxes?
If you can’t pay Uncle Sam, you must still file tax a return. Failing to file on time results in late fees and penalties. Then can make arrangements to pay what you owe.
But always pay what you can, even if it’s less than the full amount owed. That will help minimize interest and fees.
The IRS offers a variety of payment options including short- and long-term payment plans, depending on how much you owe. But remember you’ll still owe interest, and possibly penalties, even if you enter into a payment agreement.
You might also qualify for an offer in compromise, which is a settlement to pay less than the full amount you owe. The IRS may also agree to temporarily delay collection until your financial situation improves.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
