How Taxes ACTUALLY Work
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When you walk into your first job, you get your first paycheck and you see all of these numbers taken out. When it comes time to file your taxes, you are very confused. But we're going to go over some of the most common mistakes so that when you file, you do it correctly. And we are going to go step by step to make sure that you have the necessary tools to feel confident when you are filing. This message is brought to you by Apple Card.

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What's up, rich friends? Welcome back to another episode of Net Worth and Chill. I'm your host, Vivian Tu, aka your rich BFF and your favorite Wall Street girly. Today, we are going to cover the sexiest, hottest, most fun topic ever, taxes. Oh yeah, baby. Okay, so listen, maybe not the sexiest, and it's probably not how people would normally describe their taxes, but

Tax season is here, and I know a lot of you are probably thinking, how do I even do my taxes? How do I legally pay as little as possible? We're going to go over some of the most common mistakes, how you can best file, and ways to make sure you are taking full advantage of the tax code to pay less to Uncle Sam while still playing 100%

by the rules because we do not want beef with the US government. And just a friendly reminder, tax day is April 15th, which means all of your taxes are due that day. So before we get into anything else, make sure that you are ready to file by that date or you're ready to fill out your extension request. That all said, do not worry. I'm going to walk you through it all.

all, this is how taxes actually work. So if you watched my Trump economic policies podcast or listened to it, you'll have already heard this metaphor, this analogy, but a lot of people still don't understand how taxes actually work. So today I'm going to break it down. I'm going to share this again, just because I think that this is the easiest way to understand that taxes are

So first and foremost, let's go ahead and completely forget that we get paid in dollars. We're going to pretend like we get paid in pizza. Hilariously enough, a lot of employers try to buy your love

with pizza parties instead of real hard cash anyway. So this is a little bit of a tongue in cheek analogy, but think about it this way. These pizzas come in very different varieties and a lot of different flavors, but for the first 11,600 pizzas that you make, so that's $11,600,

But 11,600 pizzas, you get pesto flavor. And everybody knows that pesto flavor is disgusting, in particular me, because I am allergic to tree nuts and I get very scared eating pesto. But whether you're rich or broke, you are getting paid in pesto pizza for that first 11,600 pizzas. And the government's like, oh, pesto's disgusting. We'll take 10%.

10% per pie. Once you start making more than 11,600 pizzas, you level up to the next flavor, mushroom. The government likes mushroom a little bit more than pesto and they're like, okay, cool. We're going to take 12% per pie. And at this stage, nobody has gotten any good pizza toppings yet because we all level up at the same time. These brackets are the same for everybody. I don't care if you're Richie Rich or broke Becky. This is the same exact case for cornbread.

cold, hard cash. We level up at the same brackets and we have to make sure that we understand that. No matter who you are, for the first $11,600, you are paying 10%. After that, we start to pay 12%. The next bracket after mushroom, we get sausage pizza and the government's like, yum, we love sausage pizza. We want 22% per pie. Great.

The next level after that, pepperoni, they want 24% per pie. This is where most people stop because that's where most people tap out in their earnings.

But there are some really high earners like Richie Rich who keep earning more and more money, and in this case, more and more pizza. They're going to unlock flavors like barbecue or buffalo chicken or even, my favorite, the ultimate pizza flavor, Hawaiian. And the government loves those pies, so they're going to take 32%, 35%, 37% of each type.

This is what marginal means. When you move into a higher tax bracket, you aren't suddenly giving away a bigger slice of every single pizza. You are only giving away a bigger slice of the next incremental flavor. And when it comes to money,

It's the same thing. You are only paying that higher tax bracket amount for those incremental dollars once you bump up into that next bracket. So when you are earning $700,000 a year, you don't suddenly pay 37% on every dollar you made. Just the amount over that takes you out of that top tax bracket.

I hope this really helps you understand a little bit more about what the word marginal means. It's really important that you understand this because I know you have someone in your life who is on Facebook ranting about how they are being taken advantage of at work and how they shouldn't take raises and you don't want a promotion. You don't want to work overtime because when you make more money, you get bumped up into the next tax bracket. That is not how that works. You will never be worse off earning more money. You will pay more taxes,

but you will always end up with more in your pocket and that'll ultimately help you live the life that you want. So do not let this marginal tax concept confuse you. You want to do what you can to make the most of your tax season. Now that we understand marginal taxes a little bit better at the federal level, let's talk a little bit about how to file our taxes or what even really happens when we file our taxes. Because sometimes

We're human, you know, we can make mistakes on them. And we want to make sure we are getting this correct. So when you walk into your first job and you get your first paycheck and you see all of these numbers taken out, when it comes time to file your taxes, you are very confused. Oftentimes you're just confused.

bopping some numbers into an online program and just hoping that it's right. There is so much swirl, but we're gonna go over some of the most common mistakes so that when you file, you do it correctly. And we are going to go step by step to make sure that you have the necessary tools to feel confident when you are filing. Before you can file your taxes correctly, the first thing that you have to do is make sure you have all of the proper documentation. People think filing their taxes is complicated and scary and hard.

It's actually really simple and roughly if you're doing it yourself can take 45 to 60 minutes. The part that is a little bit confusing and can be a little bit complicated and time consuming is making sure that you have all of the appropriate paperwork. So if you have a traditional W-2 job where you work for someone else, they are your employer, that's pretty simple. You're gonna look for a W-2, that is one form.

However, if you are a freelancer or you are working a bunch of different gigs, you are going to be looking for a 1099. This is a different form and it's going to come from every single source of money that is coming in. So for example, I have 1099s that come in from my brand partners. I have 1099s that come in from social media platforms. I have 1099s that come in from my publisher because I got an advance for my book.

This is how it differs. And 1099s can be a bit more confusing. So just know that you may have to do a little bit more organizational prep work in the meantime if you are filing as a freelancer. So let's start with the most straightforward,

straight from the government, easiest filing concept, there is something called IRS Direct File. In 2024, the IRS launched a new pilot direct-to-file program that helps people get their taxes done quicker and cheaper because for decades before that, all of us were complaining

hey, why does it cost money to file our taxes? This is something that we legally need to do. It's confusing. It's burdensome. Why can't the U.S. government just help us the same way that so many other developed nations' governments help them file their taxes? So this new tax tool was rolled out. It allows you to file your federal taxes online directly with the IRS, and it's 100% free to use. So instead of going through an outside tax provider like a CPA or using an online service, you can just file online.

in one place with the IRS. You can also get 24-7 support from tax professionals through the service so that they can help answer any tough tax questions you might have. And again, this is all free, which makes it so appealing. However, we do need to bring into the conversation some recent changes. As the Trump administration took office, there are things to call out.

Elon Musk and the Department of Government Efficiency has made statements about how this service will maybe not remain around for much longer. Elon Musk specifically claimed that he, and I quote,

deleted the team behind the direct file program. So we'll have to wait and see what happens there. Admittedly, I'm not even sure if this program will still be around by the time this podcast gets released, but if it is, I encourage you to check it out. There are limitations. Certainly you have to have certain types of income. You have to live in certain States. Your tax filing situation has to be relatively straightforward, but if it is available to you, it could be a really great option up next.

If IRS direct file is not available to you, you still should not be paying to file your taxes online if you make less than $84,000 a year. Reason being, this tax filing availability should be given to you for free, and

And the problem that most people run into is that the first thing they do when they want to file their taxes is they Google file taxes for free. You are going to get a couple links right at the top that are sponsored, and it's going to say something like TurboTax free edition, zero fed, zero state, zero to file. But in fact, TurboTax free edition is riddled with booby traps where you'll be forced to pay to file things like collecting unemployment, childcare, student loans, really, really basic

stuff. And we have to take a little bit of a rewind to understand what the issue is. You see, at one point, the US government was thinking about creating its own free filing tax software for low income filers, and thus eventually came about the direct file program. But

Before that, brands like TurboTax and H&R Block knew that if the US government had their own direct file program, that it would cost them a bunch of money. So in 2002, they schemed their way in and they said, "No, no, let us create free filing software." And the IRS agreed. So all of these major filing software brands have true free filing programs because they have to. They agreed with the US government to do so.

they do everything that they can to prevent you from finding it in the hopes that you'll just spend your money to pay to file. Now that direct file exists directly from the IRS, that is always going to be my recommendation as your first step. If you do not

qualify, there still is that free filing software from these paid programs that are offered to people who make an adjusted gross income of $84,000 or less. What I encourage you to do is actually go to the irs.gov website. It's a really long URL. We'll put it in the show notes, but it's

www.irs.gov slash filing slash free dash file dash do slash your dash federal dash taxes dash for dash free. We'll put it in the show notes so you don't have to remember that. There, you're going to be able to find multiple free online filing options and you can choose the IRS partner that you feel most comfortable and confident using. This message is brought to you by Apple Card.

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The benefit to this is if you don't actually qualify for the direct file program straight from the IRS is you can still file your taxes for free. Those are two great options to file your taxes for free, but now we should also understand your potential deductions and credits. Tax deductions reduce your taxable income, essentially decreasing the total tax owed, while tax credits are money that taxpayers can subtract from the taxes that they owe or

add to their potential refund. Typically, tax credits are more favorable than tax deductions because they directly reduce your tax liability dollar for dollar, whereas tax deductions just make the

the taxable amount you have slightly less. Tax deductions are things like charitable contributions or contributions to a traditional IRA or a traditional 401k plan or any other qualified retirement plan. Common tax credits would include things like the child tax credit or the lifetime learning credit. These are both great ways to reduce your tax burden

and make sure that you are keeping as much money as possible in your pocket. So I would actually research what deductions and credits you qualify for to help maximize your refund or lower your tax bill. One other thing to call out is that frankly, we should just remember that most people take the standard deduction, which is essentially the government's way of trying to save you time by estimating the average American's deductions.

For the 2024 tax year, which is the year that you would be filing for this April, the standard deduction is $14,600 for individuals, $29,200 if you're married and filing jointly, and $21,900 if you're a head of household. So unless you have more deductions than these numbers, you'd be better off just snagging the standard deduction.

Now that you won't be confused with the standard deduction, let's also go into some common mistakes to avoid when you are filing your taxes. First up, I hate to sound like Father Time, but you gotta make sure you are filing your taxes on time or making sure to get an extension

or you're at risk of getting hit with some major fees. If you file your taxes too late without an extension request, you are subject to a failure to file penalty. The penalty is 5% of the unpaid taxes for each month or partial month that the return is late. And the maximum penalty is 25% of your unpaid taxes.

taxes, which can certainly end up being a hefty chunk of change. This penalty can become very pricey very quickly, so please avoid this. If you don't think you'll be able to file by the April deadline, or if you'd prefer to file at a later time, you can request an extension by filing form 4868.

But just make sure to file that form before April 15th, something that you should know about the IRS and the tax filing system. It is considered worse, quote unquote, to not file than it is to not be able to pay your taxes on time. The IRS will certainly work with you to get on a payment plan or pay over time, but the

If you don't actually file, that is the bigger offense of the two and will likely have more negative outcomes. So even if you don't have the money to pay your taxes right away, you didn't do the budget right, you had a little bit of an issue with your W-4, whatever, just file. They can make concessions and exceptions and help you be flexible with the timing of the payment, but...

The timing of filing is pretty set in stone, so just don't miss that. Additionally, make sure to file your taxes under the correct filing status. Taxes and all of the forms and acronyms that go along with it can be super confusing and sometimes taxpayers choose the wrong filing status,

But this is where you're going to be marking single, married, you have dependents, our head of household. And it might seem really straightforward, but more people than you'd realize often misinterpret these filing statuses. So to avoid this, there is a tool that I love. It's called the Interactive Tax Assistant on IRS.gov, which can help taxpayers choose the correct status, especially if more than one filing status might apply.

apply. So you need to be making a selection. If you're also using additional tax software or working with a CPA, they can certainly help prevent any mistakes with your filing status. But the key here is to always double check it, especially if you aren't 100% clear, because even if you have a licensed CPA do your taxes, you are still the one responsible for making sure that it is done correctly. You have to check it. That's why your accountant will usually send it to you before they officially file it.

for you. Really encourage if you have a more complex tax situation to speak to a licensed tax professional or check out the exact explanations on irs.gov. Where else should you go? Then directly to the horse's mouth to make sure you are getting the right information. And now that we know how we are supposed to do our taxes, let's also get into some accounts that you can take advantage of to reduce your taxable income. We all have to pay taxes, but

the government puts certain incentives to help you prepare for retirement and manage healthcare costs by creating these tax advantaged accounts. We want to use these to pay as few taxes as possible because we are legally able to use the tax code to our advantage.

I promise you rich people do. You should not feel bad about this. You are just playing by their rule book. When it comes to retirement accounts, these help individuals reduce their tax liability and save more effectively for specific financial goals, like I mentioned, retirement or healthcare. So let's talk a little bit about maximizing tax-advantaged accounts.

So to name a couple of the most popular accounts that you can utilize to lower your tax burden, we'd be remiss if we didn't mention things like IRAs, 529s, HSAs, and 401ks. As soon as you are financially able to, you are going to want to try and max out these plans because not only does each plan provide a slightly different tax advantage, but

But the main idea is that you are paying fewer taxes while also using these accounts to invest in your future or for future goals. So let's go over them. First up, individual retirement accounts, IRAs. These are such powerful tools for retirement savings. Whether it's a traditional IRA or a Roth IRA, both do offer tax benefits. The difference is at what point. So

Contributions to a traditional IRA are often tax deductible that year, reducing your taxable income right now. Meanwhile, Roth IRA contributions are made post-tax after tax, so you don't get any benefits now, but withdrawals in your future retirement age, those are typically tax-free. By contributing to an IRA, you're not only saving for retirement and investing for your future, but you are also potentially reducing your tax burden now or later.

you retire. So this is a win-win-win. The max contribution for a Roth IRA and an IRA in 2024 was $7,000 and $8,000 for those who are 50 or older who are looking to make catch-up contributions. The one thing to flag is that once you make over a certain amount, you may no longer qualify to contribute to a Roth IRA. However, you can certainly still use a backed

door Roth IRA, which is where you contribute to a traditional IRA and then roll those funds over to a Roth IRA. But this is certainly something that you can chat with your CPA about to make sure that it makes sense for you. Up next, we're going to work. 401k plans are a form of employer-sponsored retirement account that allows employees to contribute a portion of their pre-tax income.

You may have also heard of things like a 403B or a 457, a TSP. All of these are employer-sponsored retirement accounts. It just depends on what your job is. One great thing about these employer-sponsored retirement accounts is that a lot of employers also offer matching contributions.

which is one of the only cases in finance where you can get free money. By maxing out your 401k contributions, you're not only taking advantage of tax deferred growth, but you're also benefiting from that free money that your employer is providing to you. So you're going to be able to accelerate your retirement savings. Matching often works dollar for dollar or percentage per dollar. So in my first job, it was dollar for dollar up to $6,000. So I

When I would put in $6,000, I would magically have $12,000. That is amazing. At my second job, it was a little less generous. It was quarter for dollar. So for every dollar I put in, I would have in total $1.25 because my employer would match everything.

the quarter. As of 2024, you can contribute up to $23,000 for employee salary deferrals, so that's what you can put in, and $69,000 for the combined employee and employer contributions. I know all of us are thinking about healthcare these days, so let's talk a little bit about the health savings account. They are unique in that they offer a triple tax advantage. Contributions to an HSA are tax deductible, the funds grow tax-free, and withdrawals for qualified medical expenses are also tax

HSAs not only help you save for medical expenses that you can then spend on, but they can also serve as supplemental retirement account income if you don't use all the money that you contribute. This is great because as we get older, our medical expenses typically do get higher. And if you are perfectly healthy, this works exactly as a traditional IRA or a 401k would. For 2024, contribution limits for an HSA are $4,150 for self-only coverage,

and $8,300 for family coverage. And last but certainly not least, 529 plans are specifically designed to save for educational expenses. So a lot of parents use these to help save for their kids' future college. These plans offer tax-deferred growth, meaning your investments can grow without being taxed as long as the funds are then used for qualified educational expenses. This tax advantage makes 529 plans an attractive option for parents or guardians

saving for those future educational expenses for their kiddos. And while there aren't any federal tax benefits for using one, over 30 states do offer state tax breaks for utilizing these 529s. And with the 529s, the exact max contribution limits do differ state to state.

One thing I should mention, people ask me this all the time. They're like, well, what about if my kid doesn't go to college? Don't worry. A 529 can cover trade school, beauty school, culinary school. And if your kid happens to be an amazing track star and gets a scholarship to go to college, you can actually roll up to $35,000.

from your 529 for your kiddo into a Roth IRA for them. And if you even still have money left over, you can actually change the beneficiary of that account over and over again. So maybe you roll it to their sibling who isn't as star-studded of an athlete, or you can roll it to yourself and you can take golf lessons at the local golf academy or learn Spanish at the local community college in your retirement. It's something fun to do and a great way to put that money to use. Okay.

So to kind of wrap up our episode, the takeaway here is that being prepared is going to save you time and money this tax season. Make sure to double check your paperwork and use available tax credits to help you prepare for the future and use the tax code to help you prepare for the future and maximize the money that you get to keep in your pocket.

And the final tip that I'm going to leave you with is this. I know it may feel fun to get a windfall of money in April or whenever it happens, but getting a tax refund is actually very bad. You do not want a tax refund. When you file a tax return, you are either going to end up with one of two things, a refund or a bill. The reason you do not want a refund is that it means that you essentially for the past year have given the government an interest-free loan.

you would have been better off keeping that money yourself, putting it in a high yield savings account or investing it, or frankly, even just treating yourself because that is your money. You let someone else hold it. Again, I also recognize that owing the US government a bunch of money in April is also not ideal because sometimes it's really hard to pull a thousand dollars out or a couple hundred dollars out, especially when you weren't planning for that. So once you file your tax return this year, I want you to take a look at the

outcome. And instead of just being happy, you got a little bit money back or sad that you have to pay a little bit more. I want you to adjust your W-4 accordingly. I want you to change your withholding if you have a traditional W-2 job, or I want you to plan a little bit better if you are a freelancer and set aside a little bit more or a little bit less money for taxes. You want to make sure that your bill or refund is as close to zero.

as humanly possible. So you are paying $0 on a bill, you're getting $0 as a refund. It's much, much harder done than said, but getting close to zero would essentially mean you are paying the correct amount of taxes throughout the year. Good luck, don't be scared, and if you're really out of sorts, contact a CPA that specializes in tax prep

You are going to be able to get through this the sooner you start and the earlier you are prepared, the better. Do not let me catch you April 14th scrambling to get all your documents together. I know you've got this. Catch you next week.

Bye. Thanks for tuning into this week's episode of Net Worth and Chill, part of the Vox Media Podcast Network. If you liked the episode, make sure to leave a rating and review and subscribe so you never miss an episode. Got a burning financial question that you want covered in a future episode? Write to us via podcast at yourrichbff.com. Follow Net Worth and Chill Pod on Instagram to stay up to date on all podcast related news. And you can follow me at yourrichbff for even more financial know-how. See you next week.