Michigan Retirement & Financial Services Group, LLC

1. If you get a big refund each year, you’re having too much withheld from your paycheck.

In effect, you’re giving the government an interest-free loan.

2. If you have too little withheld, you may be charged an underpayment penalty.

You must pay 90% of what you owe for the tax year by the end of that year or an amount equal to 100% of your tax liability for the previous tax year, whichever is smaller.

3. Not every dollar of your taxable income is taxed at the same rate.

That’s because portions of your earned income fall into different brackets, which are assigned different tax rates. Generally speaking, the first dollar you make will be taxed at a lower rate than your last dollar. Your marginal tax rate is the tax bracket at which the highest (or last) portion of your income is taxed.

4. Your combined tax bracket determines how much tax you’ll owe on income from investments such as CDs and money market funds.

Your combined bracket is the sum of your top (or marginal) federal tax rate and your top state income tax rate. It may be less if you itemize deductions since you will be able to deduct your state income tax on your federal return.

5. If you file your return by April 15, but don’t pay the tax you owe, you may receive a late payment penalty.

The same goes if you file for an extension. An extension only allows you to file your return after the due date. But full payment is still required by April 15. If you make a partial payment by then, you may be charged interest on the amount outstanding.

6. You can reduce your chances of being audited.

One of the best ways is to fill out your return completely, correctly, and on time every year.

7. You should pay estimated taxes if you’re self-employed; expect hefty investment income or profits from a property sale; or if you don’t have enough taxes withheld to cover the taxes you’ll owe on non-wage-related income.

Retirees should also consider paying them if they haven’t opted for voluntary withholding on their pension or IRA payments. Estimated taxes are due four times a year (April 15, June 15, Sept. 15, and Jan. 15).

8. Your adjusted gross income (AGI) is your total income minus certain “above the line” deductions such as deductible IRA contributions, alimony payments, or health savings account contributions.

Your AGI primarily determines whether or not you’re eligible for tax breaks. Almost every break, be it a deduction, exemption, or a credit, has its own AGI limit.

9. Your taxable income is your AGI minus exemptions and deductions.

The less your taxable income, the less in taxes you’ll owe. That’s why it’s in your best interest to take advantage of tax breaks where you can.

10. A credit is better than a deduction.

Understanding tax fundamentals can save you money.

If that opportunity lacks appeal or your finances are just too complicated to handle on your own, there are plenty of tax professionals who can do the work for you.

No matter which route you choose, however, you should understand tax basics for two reasons: You are legally responsible for your tax return; and being tax-savvy throughout the year can save you a great deal of money over time.

In this lesson we’ll go over some tax essentials, including:

- How much you should withhold;

- What those oft-heard but rarely defined phrases on your 1040 mean;

- What tax records you should keep;

- How you can avoid an audit; and

- Some good tax-planning strategies.

Unless we note otherwise, we’re talking primarily about federal taxes. State and local governments impose a variety of income, sales, and property taxes that are too complex and varied to address here.

Not every dollar of your income is taxed at the same rate.

When folks ask that question, they’re really asking for your marginal tax rate.

That’s because portions of your income fall into different brackets, which are assigned tax rates that increase on a graduated scale. Generally speaking, the first dollar you make will be taxed at a lower rate than the last dollar you make.

Your taxable income is not the salary your boss told you you’d make when you got your job, but the amount of income left over after you’ve made your pre-tax contributions to your 401(k) and after you’ve subtracted the tax breaks to which you’re entitled.

The income ranges that define tax brackets are adjusted for inflation, change yearly and differ depending on your filing status (e.g., single or married filing jointly).

Tax rates can change as well.

Here’s an example of how income is taxed: Say you are single and report $80,000 in taxable income for the 2008 tax year (filing in 2009). In accordance with the income ranges defining federal tax brackets for single filers in 2008, the first $8,025 of your income is taxed at 10%; dollars $8,026 through $32,550 are taxed at 15%; dollars $32,551 through $78,850 are taxed at 25%; and dollars $78,851 through $80,000 are taxed at 28%.

When people ask you what your tax bracket is, they’re really asking for your marginal tax rate. That is, the percent at which the highest portion of your income is taxed. In the example above, if you report $80,000 of taxable income for 2008, your marginal tax rate is 28% - the rate at which the last dollar of that $80,000 is taxed.

Your marginal rate is the rate you use to calculate the value of a deduction. For example, if your marginal rate is 28%, a $100 deduction reduces your taxable income by $28 (100 x 0.28).

Your effective rate, meanwhile, is the overall percentage of your taxable income that was actually paid in income taxes at the end of the day. And that rate will be lower than your marginal rate because much of your income will be taxed at rates lower than your top rate.

You should also be aware of what’s known as your combined tax bracket. That’s the sum of your federal tax bracket and your state tax bracket, minus the amount of state taxes you can deduct from your federal return.

For example, if your top federal rate is 28% and your state tax rate is 5%, your combined rate is 33% if you take the standard deduction on your federal return.

But if you itemize deductions on your return, your combined rate is likely to be less since you may deduct the state income tax you pay on your federal return, unless you’re subject to the alternative minimum tax.

Your combined tax rate determines how much tax you’ll owe on income from your investments. If your combined bracket is 33%, then 33%of your investment income will go to the federal and state governments. Put another way, you’ll be able to keep 67% of your investment income.

If you’re like most people, you probably pay Uncle Sam throughout the year by having your employer withhold tax from your paychecks.

Your employer, using tables supplied by the government, determines how much of your paycheck should be withheld based on information you provide.

Surprised? That’s because you’ve probably forgotten about that Form W-4 you filled out, something most people do when they start a new job.

If you’re a wage or salaried employee, your employer picks up half of this tax burden.

That limit rises to $97,500 for the 2007 tax year from $94,200 for the 2006 tax year.

There are no earned income limits on Medicare taxes - so even if your salary is well above the cap for Social Security tax, you will still owe Medicare tax on your total earned income.

If you’re a wage or salaried employee, you pay only half the FICA bill (6.2% for Social Security plus 1.45% for Medicare), and the tax is automatically withheld.

Your employer contributes the other half.

For most people that means 7.65% of their paycheck is withheld and their company pays another 7.65% on their behalf.

If you’re self-employed, however, you’re expected to cough up both the employee and the employer share of FICA. You are, however, permitted to deduct half of this self-employment tax as a business expense.

If you’re self-employed, anticipate having a lot of investment income, are selling property in a given tax year, or don’t have enough taxes withheld from your paycheck to cover an influx of non-wage related income (e.g., alimony or rental income), there’s a good chance you will need to pay estimated taxes.

They’re due four times a year (April 15, June 15, Sept. 15 and Jan. 15) and are filed using IRS Form 1040-ES.

If you’re a retiree, you might also consider paying estimated taxes if you make unexpected lump-sum withdrawals from your nest egg during the year or if your IRA custodian does not withhold tax on your regular withdrawals, says enrolled agent Tony Bardi.

On April 15, you have to file an annual return (Form 1040) for the previous year, and make your first estimated payment for the current year.

Figuring estimated payments can be tricky, so keep IRS Publication 505, “Tax Withholding and Estimated Tax,” handy, and consult with a tax professional.

If, after taking all your deductions, exemptions, and credits, you don’t think you will owe any more than $1,000 on April 15 on top of what you’ve already paid in taxes for the year, then you’re not required to pay estimated taxes, Bardi says.

As such, if you’re expecting a substantial income boost from the sale of stock or property, you may be able to avoid the complication of estimated taxes by increasing the withholdings on your W-4.

That should allow you to offset the remaining tax you’ll owe at the end of the year. Likewise, if you’re a shareholder in an S Corporation from which you receive a salary and distributions, then you can boost your withholding to counterbalance any taxes you’ll owe on the distributions.

Even if you balk at how much you pay the federal government, at least try to minimize your aggravation by doing all you can to avoid paying penalty and interest charges

Figuring out the payments - which are due four times a year - can be tricky.

There are plenty of circumstances in which such charges apply. Here are a few common ones:

Underpayment

Most of us look to April 15 as the day we must pay our taxes. Actually, it’s the day we need to finish paying our taxes.

Indeed, the Internal Revenue Service will charge you a penalty if you haven’t paid 90% of what you owe for the tax year or an amount equal to 100% of your tax liability for the prior year, whichever is smaller.

In other words, if you owed a total of $25,000 in taxes last year, and will owe $35,000 this year, you’re in the clear as long as you have paid at least $25,000 by Dec. 31.

Late payments

There are three other key ways you’ll get hit with extra charges if you don’t give the IRS its fair share by the appropriate date:

If you file your taxes on time, but don’t pay the full amount you owe, you may be charged:

- Interest on the unpaid tax from the due date of the return through the date of payment; and

- A late payment penalty.

If you file your taxes late and owe money, you may be charged:

- Interest on the unpaid tax from the due date of the return through the payment date;

- A late payment penalty and;

- A late filing penalty.

If you file for an extension but don’t pay the tax you owe by April 15, you will avoid the late filing penalty. But you still may be charged:

- Interest on the unpaid tax from April 15 through the payment date; and

- A late payment penalty.