Written by North Carolina Treasurer Brad Briner
We’ve all got strong opinions on taxes. I certainly do, too. It’s hard to even write about the topic objectively, but as taxes are the single biggest expense most people will incur in their lives, it’s important for financial literacy purposes to address them. The timing here is intentional too – having just completed tax filing day on April 15, everyone has quite a bit of time to think about their plans this year as it relates to next year’s taxes. As Ben Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.”
There are three basic kinds of taxes we pay – taxes on earnings, taxes on property and taxes on purchases. In some sense, that makes all taxes voluntary – you must do something to incur them. Which means with smart planning, you can reduce your tax burden, too. But we’ll come to that later.
I think everyone has the same experience when getting their first paycheck, and I certainly did too from my first real job – cleaning movie theaters at the age of 15. I started at the then minimum wage of $4.25 an hour and somehow thought that’s what I would get in my check … only to be unpleasantly surprised by withholding and payroll taxes. One of my daughters recently had the same experience and expressed her frustration memorably: “Who is this FICA, and why is he taking so much of my money?” While there are many taxes that can’t be avoided, with some more knowledge of how the system works, you can plan your taxes much more efficiently.
In the United States, taxes are used to fund essential services on the local, state and federal levels. We have what is called a progressive system of taxation on earnings. Meaning that the more you make, the higher the percentage of your income that goes to fund the government. This gives rise to the first concept to truly understand as it relates to being smart about taxes – the difference between your effective tax rate and your marginal tax rate. With a progressive tax rate and substantial deductions and credits that reduce tax burdens to encourage certain activities, the difference between these two rates can be enormous. In fact, for the median income household in the U.S. today, the marginal income tax rate is about 12%, while the effective rate is about half that, or 6%.
The second thing to know comes further along in your financial journey. It’s that income taxes from wages are taxed differently from income earned on investments, at least at the national level. People discuss the merits of this distinction all the time and it often turns into partisan and political debates. Learning when it is taxed and how much it is taxed are key when you start to have discussions about creating wealth.
Now that we’ve covered some basics of how these taxes work, here are a couple of things to think about in managing your taxes:
- Be thoughtful about how much you withhold from your paycheck. If you end up owing a large payment each year (and paying penalties), or getting a large refund each year, adjust how much you have taken out of your paycheck. Although getting a refund feels good, it means that you have typically made an interest-free loan to the government all year. Better to be more precise with your withholding and earn that interest yourself!
- The good news is that about 90% of Americans take what is called the standard deduction, which greatly simplifies tax planning. The standard deduction means you don’t have to track a bunch of items like mortgage interest, state and local taxes paid or charitable contributions as the standard deduction covers all of those for you. Unless you have a complicated financial life, take the standard deduction and make your life simple.
- Take as much advantage as you can of “pre-tax” dollars. What this means is that there are certain retirement and health care programs that allow you to put money into programs which reduce your taxable income for now, for your benefit later. The most common example is a retirement plan like a 401(k) plan. If your employer offers one, and particularly if they offer an employer match (it’s free money … you should take it!), this is a great way to benefit in the future and reduce your tax bill today at the same time.
There are hundreds of other topics we can talk about over time with taxes. They are everywhere and should be thoughtfully considered. But I think with these three pieces of advice, you’ll be off to a great start to make next April 15 a little less stressful than this year’s!
Brad Briner was elected North Carolina Treasurer in 2024 after working as the co-chief investment officer for Willett Advisors and has held positions at Morgan Creek Capital, the UNC Management Company, ArcLight Capital and Goldman Sachs. He started writing “Bottom Line with Brad” as a way to educate North Carolinians on complicated financial matters in the Department of State Treasurer’s monthly “Finance Fridays” newsletter. The column is published in partnership with Chapelboro and is not a sponsored series.
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