Understanding Taxes Before Reaching Adulthood

Introduction

Taxes are often a topic that young adults neglect to understand completely. But, ignorance about taxes can lead to mismanaging finances and facing unwanted surprises come tax time. This article aims to highlight essential things every young adult should know about taxes before reaching adulthood.

Key Points for Young Adults

1. The Importance of Proper W2 Setup

One of the most crucial things for young adults to understand is the importance of setting up your W2 form correctly. This form is issued by employers and outlines the total income and the amount of taxes deducted from it. Ensuring that it is set up correctly will help you avoid owing money to the IRS (Internal Revenue Service) by April 15th each year.

2. Refrain from Living Like You’re Getting a Refund

Many young adults live like they are getting a tax refund, which is not a sustainable financial approach. Instead, it is advisable to save any extra money you have, as the government may end up taking more than you think. This practice helps in preparing for unexpected expenses and uncertainties at the end of the year.

Financial Expenses and Taxes

1. Taxes as a Major Expense

It is often a surprise for young adults to learn that taxes are one of the largest expenses they incur, despite the fact that most people only see their 'take-home' pay after taxes.

For instance, if a young adult earns $50,000 per year, a significant portion of their income, roughly between 20-40%, goes toward taxes, including income tax, Medicare, and Social Security. The FICA (Federal Insurance Contributions Act) portion alone is around $3,800 per year, equating to approximately $300 per month.

2. State Taxes and New Tax Laws

Note that the above figures do not include state taxes. Furthermore, the new tax law may change how taxes are calculated in the future. Therefore, it is important to stay informed and adjust your financial strategies accordingly.

Tax Planning and Deferral

1. Deferring Income to Minimize Taxes

A sound financial tip for young adults is to defer income and save for later when they are in a lower tax bracket. This strategy can be achieved by putting money into tax-free savings accounts, such as 401(k)s or IRAs. When income and the tax bracket increase, the income can be withdrawn, and though it will be taxable, it may be at a lower rate.

2. Sales and Excise Taxes

Young adults should also be aware of other types of taxes, such as sales taxes and excise taxes. As highlighted by John Stossel’s program, almost every transaction and purchase involves some form of tax. Understanding these additional taxes can be beneficial in managing overall finances.

Challenge for Young Adults

A practical challenge for young adults is to identify a single instance in their day-to-day lives where they spend money without any tax being levied on it. While this can be a rare occurrence, it underscores the pervasive nature of taxes in everyday life and the importance of understanding and managing them.

Conclusion

By understanding the importance of taxes, setting up W2 forms properly, saving instead of relying on refunds, and planning for the future, young adults can better manage their finances and avoid unnecessary financial stress. Always stay informed about your taxes to make better financial decisions throughout your life.