Thursday, February 12, 2015

Adultification III: Taxes and Deductions

I've figured it out a little more.

Last year, when I filed for the first time (to my understanding I hadn't been required to file previously because I'd been a full time student and made less than some threshold amount of money--though because I didn't think about it, I would essentially have been giving free money away to the government, sadly), I got every cent of income tax back, both from the federal government and my state government.

What that led to was my mistaken understanding that the standard deduction was a maximum value on the amount of money you would automatically get back in taxes from the government. Say you make $10,000 in one year, and your standard deduction is $3,000. State and federal taxes add up to about 30% altogether, so because the deduction is higher than the amount of income tax that was deducted from your W-2, you get all of it back.

That was incorrect, and I learned how it actually works, this time around.

When the online preparation software I was using didn't automatically tabulate my full amount of income tax as the refund I was supposed to be getting, I was confused and concerned that because I'd initially said I wanted to itemize deductions, that I'd messed up the software and it wasn't giving me the right numbers. It was in the process of actually going through the previewable 1040 that the software provided for me, that I understood how it was all being calculated.

Now I know that neither the 'standard deduction' nor the 'student loan interest rate deduction' are gratis cash-back maximum allowances. Instead, they are subtracted from your gross income, and then taxes are calculated based on that new number (the AGI, or Adjusted Gross Income). The difference between these taxes and the taxes you actually paid is refunded to you.
Chances are I'm still somewhat ignorant, but at least there's been progress. :)
So the reason I got all my income tax back last year wasn't because the standard deduction was higher than my income tax -- it was because the standard deduction was higher than my gross income! That meant that my AGI, the taxable income I earned, went to $0, and hence I owed no income tax.

Yeah, I didn't make a lot of money last year. That's mainly because I didn't start working until August, so I accrued a little less than a half year's wages altogether.

So if you have student loan interest to pay, just understand: it's not the case that you get every dollar of it that you pay, back. That was what I mistakenly thought for a while (something seemed off). But it will reduce the amount of your income that gets taxed, leading to a larger refund. So if you can afford to pay your loan interest, go ahead. But it's not free money you're getting back; you are still paying money, net-wise.

Hope this was helpful or entertaining, depending on where you fall on the spectrum of understanding taxes.

~ Rak Chazak

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