Episode 32: I SMELL refund (Income Tax Part 3)

GRANT: Yes!! April 15th is behind us, Mak. Now dad should feel a bit better, and life will get back to normal.

MAK: Yeah!! And, I heard we’re getting a refund.

GRANT: What do you mean “we”? Does dad give you part of the refund???

MAK: No, it was just an expression. You know dad does the calculation and deals with the budget for the house.

GRANT: I’m sure he’ll probably save or invest it like normal.

MAK: Yeah, you’re probably right.

GRANT: Ok, I feel better that I’m not missing out. Was it a refund that was “big enough”?

MAK: What do you mean “big enough”?

GRANT: Is it “big enough” to make him do the happy dance in his robe?

MAK: Oh Lord, I hope not, but it’s possible.

GRANT: I’ll try to stay in my room!! Ok, all the taxes should be paid around the country. We know the more you make the more you pay.

MAK: That sounds like what we learnt..

GRANT: Well, I’ve been thinking… We did a calculation for income that gets taxed.

MAK: Ok… and we know it includes salary, dividends, interest and some capital pains. So?

GRANT: I thought I heard dad say you get some deductions too?

MAK: You mean subtractions from income to reduce the amount of tax you pay?

GRANT: Yeah, exactly. If there are deductions, maybe some people won’t pay very much.

MAK: Makes sense to me. But, do you think it’s possible that after you do the calculation you wouldn’t have to pay anything for the entire year?

GRANT: I guess it’s possible. But, I don’t know.

MAK: Why don’t we find out a little more.

GRANT: Agree.

MAK/GRANT: DAD!!! We have some tax questions!!

DAD: Hey guys, what’s up? Where are you?? I can’t see you.

MAK: That’s because you’re face down. What are you doing on the floor?

GRANT: And, why are you laying on your stomach with your legs bent and the soles of your shoes toward the ceiling?

DAD: I’m practicing. How’s my form?

MAK: Practicing for what?

GRANT: What form are you supposed to be in? You look like you’re about ready to give the floor a hug!

DAD: Well, I’m supposed to be in the shape of an “X”. Can you tell?

MAK: I guess. Why is the ceiling fan on “high”? Can I turn it down.

GRANT: Is there a reason you’re wearing a backpack? Are you ok?

DAD: Of course I’m ok. Don’t I look ok?

MAK: Do you really want an answer to that Einstein?

GRANT: Nice one Mak! We can’t see your face. So, how would we know?

DAD: Ok, I’m practicing to jump out of a plane? Isn’t that sooo cool.

GRANT: Oh, oh, it’s my turn. Why do you want to jump out of plane Einstein?

MAK: High five. Nice one G!

DAD: I get it, you don’t think it’s smart to jump out of a perfectly good airplane.

MAK: Why do you? Didn’t you break your thumb last time you did it, maybe 25 years ago?

GRANT: Seriously dad, do you think it’s safe?

DAD: Ok, let’s forget about that thumb incident. But don’t you think it’s a little like investing? Risk and reward?

MAK: I’m not sure. I don’t see the “reward” part? Seems like a lot of risk though. Aren’t you a little old?

DAD: The reward is the feeling you get when you freefall. It’s really an awesome thrill. By the way, the oldest guy to parachute was 101, so no I’m not too old.

GRANT: Ok, you love the feeling of the falling sensation, which makes most people sick. Now it’s super clear. Who even thought of the idea to parachute anyway?

MAK: I know this. He was a Frenchman in 1797. He loved going up in balloons. On one of the trips, he jumped out from 3,000 feet. He had a parachute attached to a bucket he sat in.

GRANT: I guess he wanted to eat some wine and cheese on the way down.

DAD: You know the French. That’s really interesting Mak. I didn’t know that.

GRANT: I was just watching a video of a guy that did a jump from 25,000 feet without a parachute and he was caught in a net. He only had a GPS device to make sure he could find the net.

MAK: Wow, that’s crazy. Most airplanes fly around 35,000 feet in the air. And, get this. I saw a video last week of a guy that jumped from 135,000 feet.

DAD: Seriously? That’s way up there.

MAK: Yeah, it was the highest jump ever made. It was some guy from Google. He landed safely without any problems.

GRANT: So he was 100,000 feet higher than a plane. Isn’t that outer space? Did he wear an astronaut outfit with that big bubble helmet thingy?

MAK: Yep. And, It was on the edge of the “stratosphere”, he went over 800 miles per hour coming down, and he did freefall for 4 and ½ minutes.

DAD: Maybe I should rethink things a bit. Please don’t tell mom, you know how she gets?

GRANT: Yeah, she gets a little nervous about you trying to do something where you could kill yourself. Got it.

DAD: Thanks. Hey, I think I heard you asking about something a bit safer, but just as scary. Taxes.

GRANT: Absolutely. We had a question. We know there are different levels of tax rates, but I remember you talking about deductions you get.

DAD: Good question. We talked about how you calculate your income, but I never mentioned the deductions. It’s an important part for sure.

MAK: So, what can you deduct? Is there a deduction for all the chocolate we eat?

GRANT: How about video games? I’m sure there’s a deduction for that.

DAD: No there aren’t deductions for those. Sorry. you do have a choice. The first is a “standard deduction”, which is a set amount anyone can take. Or, there is a more complicated one.

GRANT: Is the standard deduction the one most people take?

DAD: Absolutely, 90% of people use it because it is easier and usually bigger. We get a break on money earned without tax to pay for the basics like food, clothing and housing.

MAK: So, how much is it? Sounds like it should be different for a single person and a family?

DAD: It is. Families need more money to live, so their deduction is bigger. A single person gets around $12,500 and a family gets approximately $25,000 but it usually changes over time.

MAK: That sounds like a lot. So what’s the other, more complicated method you can use?

DAD: It’s called the “itemized deduction”?

GRANT: Did you say “oversized” deductions?

DAD: That would be great to have “oversized” deductions. But, It’s actually “Itemized”. You must list each “item” you can deduct. Mom itemizes the food you want on a grocery list…

MAK: Like “Chocolate”!!! Sorry, I got distracted. Since we know the tax code explains the rules for doing your taxes, what stuff is on the list?

DAD: One deduction is for money spent on a necessity, which you had to spend. And, there are a couple others which encourage you to spend your money in a particular way.

GRANT: I think video games are a “necessity”. It should be on there, but what’s this “necessity”?

DAD: It’s medical and dental. If you spent a lot of money for it, you might be able to deduct it. Just like you’re broken arm, mom’s surgery or when I got my tooth fixed!!

MAK: That’s good to know. But you can choose between this way and the standard deduction, right?

GRANT: Shouldn’t you always choose the bigger deduction? The standard deduction is large, but if this was larger, I’d choose this way, right?

MAK: Excellent G. Sounds right to me. What about the other deductions the government wants you to spend money on?

DAD: Nice job guys. I’m glad you get it. The government wants you to do two things 1) give money to charities and 2) buy a house.

GRANT: So, grandma got a deduction for giving money to the food pantry to feed those in need?

DAD: Yes, if her total itemized deductions were bigger than her standard deduction.

MAK: So, it can be any charity. I get it. Can it be the animal adoption place in town? Or, can we give to the Red Cross to help those with the Coronavirus?

DAD: Yep, a charity has to fill out an application with the government and get an identification number. If the charity has that, you’re good to go. Just ask them.

MAK: That’s super cool. So, we could help dolphins, get kids glasses who need them or support a yoga charity?

DAD: Absolutely, as long as they have their identification number.

GRANT: That’s cool. And, what about that deduction we can get for our house?

DAD: Well, you only get a deduction on the interest we pay to the bank for the mortgage on our house.

MAK: Did you say “baggage” in our house? What? That’s weird. What’s that?

GRANT: It’s “mortgage” Mak. Dad, isn’t that the loan used to buy the house?

DAD: Sure is. If you don’t have $300,000 to buy a house, the bank can loan you the money, but they charge you interest for it. We’ve spoken about it before. This is how the bank makes their money.

MAK: I remember. The bank gets deposits we put in savings accounts. They pay us a low rate of interest like 1% to use those deposits.

GRANT: That’s right, and they lend the money to other people at a higher rate, like 5%. So the difference between 5% and 1% is their income.

MAK: So, why does the government give you the option to take the interest on your mortgage as a deduction?

DAD: The more houses that are built, the more people work, the more taxes the government collects. And, the more money the bank makes on interest, the more taxes they pay too.

GRANT: So, it helps things grow. Dad, you’ve said the government isn’t that smart.

MAK: Yeah dad, but this sounds like the government is smarter than you give them credit for?

DAD: Ok, you got me there. Can’t argue with that one.

GRANT: So, with all these deductions, does everyone pay income tax?

DAD: Well, I’ve read the average family paid about $9,000 in income tax last year. Some people don’t pay any, others more and still others pay a lot? That’s the progressive tax system.

MAK: If you don’t pay any, Is that because your income was less than your deductions?

DAD: Yep, that’s one reason.

GRANT: So, how many people don’t pay income taxes? It can’t be very big, right? Because the government collects trillions of dollars.

DAD: If you don’t have enough income, no tax. But the government also gives you free money, called “credits” for certain things. Taxpayers can get an extra $2,000 cash for each kid.

GRANT: I have NEVER seen one cent from that $2,000 credit?

MAK: Dad, I don’t remember getting a check either.

DAD: Wow, where’s the love? I need that to pay bills, like your broken arm. I don’t think that will EVER get old!!

GRANT: Ha ha, funny! So, you really get money just given to you because of us?

DAD: Yep, it helps to pay for things around here, and that disease you both have?

MAK: What’s that?

GRANT: Here it comes, I can feel it.

DAD: It’s called Hunger!! You both like to eat every day, right?

GRANT: Funny dad.

MAK: So, you may not pay anything because you don’t make enough or you get credits. What percent don’t pay any income tax?

DAD: It changes each year. When things are good, more people pay, and when things are bad, it’s less. I’ve seen it go between 40 and 50% of all Americans don’t pay income tax.

GRANT: WOW, that’s a ton!!!

MAK: So, who pays most of it? Is that the people that make a lot of money each year?

DAD: Yep. The more you earn, the more you pay. If you earned enough to be in the top 1% of people in the US, which is over $500k, your group would pay about 40% of all income tax.

GRANT: That’s really interesting. So, out of 100 people, on average, one person would earn over $500k and pay 40% of the income taxes.

DAD: You got it.

MAK: But, that doesn’t mean those with low income don’t pay taxes, they just don’t pay income tax.

DAD: Correct. They still pay payroll tax, sales tax and others for sure. Now, if you add the next 9% of the highest earners, they pay another 30%.

GRANT: So, if my math is correct, the top 10% earners, which is the 1% and next 9%, they pay 70% of the income tax?

DAD: Yep. You got it. I bet their taxes are complicated, huh? They probably have companies, investments, wages and more.

MAK: Can you get more time if you have complicated taxes?

DAD: Sure can. The government will give you 6 extra months. But, they want their taxes on April 15. You’ll have to estimate the amount. If you don’t pay enough, there may be penalties and interest.

GRANT: Ok, I think I’m about done, can we take a break from taxes for now? My head is spinning.

DAD: Sure thing, Mak, is that good with you??

MAK: Yep. I’m done too. See you later alligator!!!

GRANT/MAK/DAD: Thanks for being here. Bye!!!

Ben’s 2 Cents

After we went through some information on how to calculate the basics of your income, we also have to think about the deductions that are allowed. These deductions reduce our taxable income. Taxable income is the amount that we use to determine how many levels we pay at each tax rate. We want this as low as possible, so we don’t go into the higher tax levels. Any tax program will easily do the calculation.

The standard deduction changed pretty significantly in 2018 due to legislation. For a single person it went from $6,350 to $12,000. That’s huge, but other items were taken away. Now, the standard deduction is utilized more than itemized deductions. However, understanding the major itemized deduction categories, can help manage your taxes. Dental and Medical is one, mortgage interest and charitable contributions are the biggest ones. It’s the government’s way of saying what’s important or incentivizing you to spend your money in a particular way. Planning when to consolidate these potential deductions, when possible, is one strategy to help manage your taxes.

The average American pays approximately $9,000 in income tax. So, that means some people pay more and others pay less. That’s part of the Progressive tax system. Approximately 40 to 50% of Americans don’t pay income tax. That doesn’t mean they don’t pay other taxes, but they don’t pay income tax. We’ll learn more about this later.

The largest portion of income tax payers are the top 10% of earners, which make sense in a progressive tax system. They earn more, and therefore, in this system they pay more. In total, it’s estimated they pay approximately 70% of all income tax. As we continue, we’ll see where all the money goes.

I find taxes absolutely fascinating. Who pays what, where did taxes come from, how do you reduce your burden, where does the money go and more. Almost anyone will agree it’s not a perfect system, but that doesn’t mean you shouldn’t understand it.

Thanks for being here. Please subscribe, rate and comment on the podcast. We’d love to have your input. Make sure to tell your friends and family. Until next time… BYE!!!