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Federal Income Taxes: A Breakdown Before Filing

Episode 38

Federal Income Taxes: A Breakdown Before Filing

Posted April 1, 2024
Cassidy Clement , Nancy Nelson
Interactive Brokers

Usually, tax talk starts to pick up after January as people gather their income documents. Reviewing these documents and tax rates in the United States can be confusing. Nancy Nelson, CPA and Consultant to Interactive Brokers LLC, joins Cassidy Clement, IBKR’s Senior Manager of SEO and Content to discuss income tax in the US.

Summary – Cents of Security Podcasts Ep. 38

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement

Welcome back to the Cents of Security Podcast!  I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers.  Today, I’m your host for our podcast and our guest is Nancy Nelson, CPA and consultant to Interactive Brokers, LLC.  Usually, tax talks start to pick up after January as people are gathering their income documents.  Reviewing these documents and tax rates in the US can be very confusing.  In this episode, we’re going to cover the basics and try to bring clarity to the topic of federal income tax and their rates in the United States. Welcome back to the program Nancy.

Nancy Nelson

Nice to be here again Cassidy.

Cassidy Clement

Awesome, so we’re going to kick off with just of course the basics; what is federal income tax in the US? How did this start? How does it work?

Nancy Nelson

Well, it’s a huge topic and we don’t have a lot of time. So just understand that we’re just talking at the very top level here. So, I want to go back to the beginning when we first had federal income tax during the Civil War. Most of us don’t realize that and it was obviously to fund the war, but it was then struck down by the Supreme Court and went away until 1913 when the 16th amendment was added to the constitution that allowed for income tax to be assessed at the federal level.  

At that time there were 7 brackets and there’s actually about that right now too.  And most of the American public fell into the 1% bracket, the lowest bracket there was, and that would have been up to about $460,000.00 in income today.  So, that’s very different than the structure that we have today but it’s also been the other extreme in 1945 the top bracket was 94%, there again very different from our top bracket today and remained over 70% until 1975 Ronald Reagan as our president.  Then there was a restructuring of the tax code, and rates went down and since 1990 they’ve been in the 31% – 39% bracket rate.  The bracket for the top bracket in the United States.  In 2023, the top tax rate, is 37%.  

Let’s talk about those brackets a little bit. There’re four sets of brackets: one for taxpayers that files singly, ones that file married filing joint, ones for head of household which is kind of a blend between single and married filing joint, and then married filing separately which is essentially having the married filing joint rate.

So right now, it’s 37% if you’re single if you make over $578,000.00 and change. Married filing jointly is $693,750.00. head of household it’s $578,125.00 again and married filing separately is half of that married filing jointly $346,875.00.

Now, I want to draw your attention to something that has been in the tax code since 1954, which is when the bulk of the tax code we operate under today was kind of sketched out, and that’s single versus married filing jointly.  

It’s 1954 model and in 1954 our households were structured a lot differently.  Cassidy and I wouldn’t be here talking with you because it’s likely that we would have been home caring for the household, children, and everyone else while our other halves work. If we did work we would have been teachers or nurses or something of that nature however the tax code at this point doesn’t reflect that we now have two earner households for the most part because if you look at it the 37% rate for single people, kicks in at $578,000.00,  I’m just going to round it to that but married filing jointly logically you’d think it would be double that, so over a million dollars.

No, it’s only a $130,000.00 more or $693,000.00.  Now, there steps taken in the 1990’s to fix that but that all was allowed to expire and has never been put back in the code. So, when we talk about tax brackets, we talk about mainly the income that we earn, our interest income. Business income has some different categories that are pretty complex and we’re not going to get into all of them in this, but we’re not talking about gains and losses on securities.  Gains and losses on securities are really a separate area. This includes capital gain distributions from mutual funds when I talk about this.  Capital gains are either taxed at 0%, really you have very little income to hit that 0%,15% is the bulk of the population.  And then 20% rate on capital gains kicks in and it varies again whether you’re single, married filing jointly, head of household, or separately.  Single it’s $492,000.00 and change married filing jointly, it’s $553,000.00 again not a double, head of household is $523,000 someplace between the two, and married filing separately is $276,000.00 half of that $553,000.00.  

So, it’s interesting that this holds true all the way through the tax code, this idea that we have that traditional 1950’s family.  So that’s kind of interesting in itself.

So, let’s talk about a little bit about the types of income.  We have the income that we earn from our jobs, and for most of us, that’s the bulk of our income get reported that on a W-2. for the most of us again. There are some exceptions to that.  So, you own your own business, you might get it 1099-nec or non-employee compensation. That’s one way to get paid.  You might get that for maybe a job you did just filling in for somebody because you didn’t work for the company permanently, but if you work for a company day after day, you’re going to get a W-2, that’s earned income there.  

That’s the primary example of earned income, then we have investment income. Now investment income, in my head, is interest, dividends, and capital gains. So, we buy a stock. we hold it for a while, we sell it, we have a capital gain, we get a dividend from it.  We get interest from our savings accounts or CD ‘s or Treasuries, those are all investment income.  

We also can have investment income from other types of investments.  We can have an investment in real estate, a rental property which is kind of a blend of income.  It has business income, the rent it generates, and then when you sell the property, it would have capital gain income also.  So, there’s different things like that.

There’s also collectibles income. What’s a collectible?  Well art is a collectible, obviously coins, stamps, gold, silver, jewelry.  So, anything that has a market and a secondary market almost is a collectible. Anything that you see at these big auction houses probably falls into the collectible stance.

So those are also when their bought and sold will have capital gains.  They have a fixed rate capital gain which is currently 28%.  Most of us don’t trade in collectibles, but some people, I had one person who worked with me who traded bought and sold baseball cards and that was a collectible.  So that was something that he needed to consider when he bought and sold his baseball cards.  

Couple of things that are big assets that are personal assets that you don’t consider a capital gain or loss for and that will be your car.  That’s a big one because cars are expensive, let’s be real. If you buy a car and you sell it to somebody else, or you trade it in against something else, it’s not subject to capital gains taxes.  It’s a personal asset but your house is the opposite.  Your house is subject to capital gains taxes so there are special rules about buying your selling your house.   If it’s been your primary residence for two out of the five years, then there are exemptions for part of the gains. Losses from the sale of your primary residence aren’t deductible so that’s another thing to keep in mind. Real estate agents always say, “location, location, location”, and that’s usually what drives that from what I understand.  I’m not a real estate expert.

Let’s talk about business income.  You can have business income from the business you run yourself. So, I have an accounting firm.  I run that business myself, that’s business income that is active income because I work in the business.  If you have a painting business or a landscaping business or something like that, that’s all that, but you can also have passive businesses.  Say four of your friends go together and you buy a ski condo and you rent it out all except for maybe three or four weeks.  That’s a passive investment.  You don’t necessarily get to deduct those losses from that ski condo.  Rental houses and vacation homes are assets, they’re subject to capital gains taxes, but we could spend our entire podcast on that just “owning a vacation home” so we can’t dive into that maybe as much as you need to know but it’s something to ask someone if you’re doing your taxes.  Let’s talk about deductions a little bit.

Cassidy Clement

I was going to bring that up because you mentioned a handful of different things there which covers a lot of people ‘s different ways of making money or earning money through the year.  What is the meaning of tax deductions and credits? Especially because not, everybody understands how the rates are calculated and what is kind of a pro or a con. When you’re starting to see how these rates are calculated, if you can kind of weave those two together.

Nancy Nelson

I’m going to separate credits from deductions because credits work differently the deductions.  You figure out your taxes before you get to your credits whereas your deductions determine how much of your income is taxable so they if you think about your taxable income being the bottom-line deductions are before the bottom-line credits are after the bottom line.  

So, let’s talk deductions first under President Trump the tax code was restructured about five years ago, you know probably six years seven years ago now, to the point where almost everybody body now takes a standard deduction and doesn’t itemize deductions. So standard deductions if you’re single you get $13,850.00.  Why that?  That amount is indexed every year that so that’s the amount for 2023 don’t know the amount yet for 2024 it hasn’t been announced. That’s one of the things that is doubled as you go along so single people get $13,850.00, married filing jointly get $27,700.00, head of household gets $28,000.00 a number in between, and married filing single is $13,850.00 same a single.  If you’re over 65 there’s a bump to that for just being old and there’s no other reason.  It was a compromise when that bill was passed to help senior citizens with their tax.  What they did when that pass was tap state and local tax deductions to $10,000.00.  Up until the passage of this current tax law, state and local taxes were fully deductible against your federal tax. There at various times have been limitations on itemized deductions but they were an itemized deduction, they were fully deductible.

Now the argument laws that this benefited people in high tax states and didn’t benefit people in low tax states. There’s been a lot of talk particularly right now in congress with the current tax bill about the removal of that cap. And obviously some states that want it are New York, California, Connecticut, New Jersey, the high-tech states.  The states that don’t want it or don’t care or places like Florida and Texas, places that don’t have tax state taxes.  We’re going to talk a little bit more about state taxes a little bit later but that’s one thing.  So that’s a piece of it.  

So when you itemize your deductions what are the itemized deductions? So, first of all your itemized deductions have to exceed the standard deduction before there of any benefit for to you because you want to take the most deduction you can.  

So, we’ve already talked about the $10,000.00 on state local taxes. What makes up state and local taxes that are deductible?  House taxes, property taxes in your home.  Property taxes on vehicles, boats, motorcycles.  Some states have those some states don’t, and the state taxes you pay on your wages.  Those are the biggest things.  

So, what other things mortgage interest, there are caps on what you can deduct in terms of mortgage interest. Right now, interest on wages that are less than $750,000.00 in principal, new mortgages are what is deductible. If you have a mortgage that’s bigger than that the $750,000.00 becomes the numerator, the value of the mortgage becomes the denominator and that fraction times the interest is what’s deductible.

Charitable contributions cash and goods. So, if you take all your old clothes to the salvation army those are deductions.  If you take your kitchen cabinets to Habitat for Humanity because you’re redoing the house that can be a deduction.  Issue a word of caution here, any kind of contribution of value of more than $250.00, you must have a receipt or an acknowledgement from the charity.  Now that sounds like it’s easy, but I know myself when I take clothing to goodwill, they don’t give you a receipt.  They hand you a receipt and you have to fill it out yourself, so what do you do?  Nobody knows, we need to give keep a list of what you’ve given them.  So, if you’ve and them five shirts, four pairs of pants, three sweaters, you need to have that list and you need to give them a rough valuation.  

Out on the IRS site, there’s a valuation for those kinds of things what they consider normal. Don’t hesitate to use that.  Books to your library, that’s another one that people forget that they’ve given books to the library and those are a donation. The other thing that can be a donation is say you travel or do go to an event where your part of the event for a charity or not for profit, that also could be a deduction.  So, there’s a lot of examples of that but that’s one thing to consider, but that charity has to acknowledge that you’ve spent that traveling expense for their benefit.  So those are the main things.  Those things are deductible for anybody, no limits on them put them on your tax return.

Let’s talk about the things that have limits.  Everybody thinks they can deduct their medical expenses.  Let’s talk about medical expenses.  Most of us nowadays have insurance.  Some of us have good insurance, where they pay for almost everything, and others of us come out of pocket quite a bit.  

So, nothing covered by insurance is deductible as a medical expense.  If you pay for it or if the insurance pays for it, or reimburses you for it it’s not deductible, it’s a wash. Before you could deduct dollar one of a medical expense, it needs to be more than 7.5% of your income.  So, let’s give an example of that, because it’s really confusing.  So, let’s say you spend $5,000.00 on medical expenses, don’t know why but you did. And your income is a $100,000.00, and I’m using round numbers just because the math is easy. None of that would be deductible, you would have had to spend $7,501.00 before the first dollar would be deductible.  In other words, you’d only get to deduct $1.00.  So just be aware that although we talk a lot about medical expenses being deductible, they’ve really got to be a big number for them to truly be deductible.  

Now oftentimes that’s Ok.  Investment interest, there’s certain limits about that.  So, if you borrow or sell stock or participate in a borrowing program or trade on margin, that’s something that you need to be aware of.  And there are no longer miscellaneous itemized deductions, so they’re not worth talking about.  

Let’s go backwards or talk a bit, because we’re going to be running out of time here, about state and local taxes. Right now, there are seven states that don’t have any state tax.  In case you want to move there it’s Alaska, Florida, Nevada and South Dakota, Tennessee, Texas, and Wyoming but oftentimes those states make up the revenue and other ways. They may have higher property taxes. They may have taxes on cars, or in a lot of these cases, they have quite high sales tax.  So that’s how they may come up.

There are two more states Washington, which only has investment tax on investment income, and New Hampshire which has tax on investment income and interest but that will be completely phased out by 2027 making eight states that don’t have any state tax.

State taxes get paid to the state. Property taxes and usually personal property taxes like car taxes are payable to the town you live in, the jurisdiction you live in.  The jurisdiction that collects them.  If there’s school taxes, that’s payable to the school district that you’re you live in but those are considered a local tax and would be part of this $10,000.00 limit.

Right now, California is the highest tax state, followed by Hawaii, New Jersey, and New York for the next three.  So just to give you an idea of where you might not want to live, because they’re not going to have any benefit, but it’s not really as plain vanilla as that because sales taxes can make up the difference and sales tax is often fall on everything you buy. So, it’s a little bit different than when you just pay tax on your income.

Cassidy Clement

The last kind of piece because you covered all the different items. If I were just getting my W-2 or my items, my tax documents we could say.  What are some basics to think about when filing your return or, I guess, if you’re a person who goes to someone to file your return like an H&R Block or a family accountant. What are those basics? Maybe a quick bullet list or checklist for our listeners to have in my mind as they approach their tax return filing date.

Nancy Nelson

Well obviously, you need, if it’s the first time you’ve worked with an outside person, meaning that you’ve gone to H&R Block or something like that, you definitely need your prior year’s tax returns.  Because and I’ll give you an excellent example, we talked about capital gains, but we didn’t talk much about capital losses.  Let’s say your capital losses in any one year exceed your capital gain, you’re allowed to take $3,000.00 of those losses against your other types of income, but the rest just sits there until you have more capital gains.  

So it goes, capital gains minus capital losses, anything left capital losses take $3,000.00 and everything else carries forward. Carries forward indefinitely but it carries forward.  

So, they might need to know if you have any of those carry forwards, that’s the first thing.  The second thing is you should obviously need all your documents.  Again, especially if it’s a first-time person with your tax return, they will need your W-2 any 1099’s you have might have.  Now remember in this electronic age, a lot of our tax documents are only online. So, if you have a checking account or savings account at a bank, you might need to log into your site to pull that tax document down.  Certainly, with Interactive Brokers 1099’s are all out in account management.  You might have a 1099-R which would be a distribution from an IRA for some reason that you might have inherited or if you rolled it over and it does have to go on your tax return. It may not be taxable, but it does have to go on your tax return. So, there’s a difference between taxable and reportable.

You might have something from Treasury Direct that you need to go out and pull down, again a 1099 would be out on their site.  So, the key thing is to go to all the places you have accounts and make sure you gather those documents.  Especially if the person is preparing your return for the first time.  They’re not going to know to ask you if you’re missing something, or if it’s a new account they’re just not going to know.  They don’t live next to you day to day.  

If you have a child, you need to know the child ‘s social security number to add them as a dependent, that sometimes is an issue with the new child.  Not so much anymore because they don’t let him leave the hospital without one anymore but used to be an issue.

So those are the kind of things that you need to gather.  On the other side of that, the deductions, you need to have your mortgage statement which is the mortgage company will send you a statement it’s a 1098 which shows your mortgage interest.  Likely if you have an escrow account it will also show your real estate taxes paid which you will also need.  Your car taxes paid, and if you’ve made any charitable contributions, what they are and how much?  And you need to break them down between cash, and goods and services because they get reported separately. Those are the primary things you need.

Now if you’re going to tackle this yourself on TurboTax, I know they advertise this all the time. Be sure that they’re allowing you to capture everything if you can do it for free. The 1099 from Interactive Brokers can’t be downloaded on the free version.  You can download it into the program on the pay version but not on the free version.

So those are some of the things that you should be wary of, and when you download forms into TurboTax or any of the other tax software, Tax Slayer whatever else you might use or as the Super Bowl ad, you know tax accountants aren’t sexy it’s just accountants is the sexiest profession, that you check it.  Take the document and make sure that the numbers have gone in the right box because sometimes just because the way it happens it doesn’t feed into the right boxes.  

So, if something happens it doesn’t seem reasonable check it against itself and don’t be so surprised if you’re not getting the refund.  Since 2019 during the pandemic the withholding tables and wages were changed and we’re not having as much withheld on a on a weekly or biweekly or monthly basis from our salaries as we did prior to the pandemic. So, it’s that’s shrunk refunds, so don’t be shocked that you’re not getting as big a refund or any refund especially if you get paid a good portion of your salary in bonuses.  Bonuses has a statutory withholding rate of only 22% which is fairly low in our tax code. So, you need to be aware, if you get bonuses or commissions paid to you in bulk several times a year, they only withhold 22% of that but that might be 75% of your income, and you probably are going to be under withheld so be wary of that too.

Cassidy Clement

Well, there’s a lot of pieces there. Especially with the way you make a living, what stage of your life you are at, what you’re investing in or are inheriting.  I have one last question that I just thought of right now as I had a flashback to my younger years.  When it comes to college tuition is there a tax document that you get that shows that you paid for tuition to help with this return to show that you are paying towards school. Am I remembering a fever dream or does that exists?

Nancy Nelson

No that does exist it’s called a 1099-T and let’s talk about that for a minute.  So, there are all sorts of education credits, and we didn’t dive into credits very far because credits, there’s credits for the biggest one that they talk about on the news is the earned income credit.  But if you’re single and you have no children you aren’t you’re only eligible for the earned income credit if you earned, I think it’s less than about $13,000.00. Well, I’m fairly sure you’re not living on $13,000.00 anywhere in the United States and you can’t be the dependent of anybody else to qualify for that credit.  

But there are all sorts of credits that you can qualify. Obviously, the hot one now are the ones for EV vehicles. The electric vehicles credit, the energy credits, there is an adoption credit, there’s child tax credit which is capped out over a certain amount of earnings which you can get them if you pay for childcare for a child and that can be after school care it can be camp it can be those kinds of things.

There’s a lifetime learning credit for that you can get which phases out depending on where you are, but it phases out starting at $80,000 in earnings.  There’s the American Opportunity credit, another educational credit, and then there’s literally hundreds of credits out there. But you’re right, your 1099-T is what tells the government that you have paid tuition and that you’re possibly eligible for one of these credits.  The other side to that is if you take a distribution from your college savings plan your education savings plan the 529 plan to pay for that tuition, that also gets reported on your return and this is a case where if you take the distribution, you spend it on education it’s not taxable, but it’s reportable.  Again, the difference between taxable and reportable, there are many things that are reportable but not necessarily taxable.

Cassidy Clement

Right, those are super important in my eyes because people forget essentially, at least I didn’t think of that initially when I first started school.  Like I’m paying for this that was money I paid, why would I need to report it? As you mentioned, sometimes it works in your favor or if you’re working a job, even if it’s part time, where there’s some commissions involved you want to make sure that you have everything on your side to make your tax return balance out because you don’t want any surprise bills if you can help it.

Nancy Nelson

Well unfortunately, if you’ve been working on commission or working at a job that is structured so that you make a wage that is minimal versus your commissions or your bonuses then it’s very difficult if you really are successful at it to have enough withheld because the withholding is capped at 22% percent unless you go over a million dollars.  But we’re not going to talk about that because most of them don’t get over a million dollars on our bonuses or commissions.  So, let’s just go with 22%.  Well, if you’re making a reasonable wage, you’re going to hit that 22% bracket at $88,000.00 which depending on where you live in the country, $88,000.00 is either not that much or a lot, but for most especially college graduates starting out today unless you’re in a relatively low paid field, you’re going to be making close to that amount. Especially here on the east coast, you’re going to be hitting that 22% bracket almost right out the pack so you’ve got to be aware of that.

Cassidy Clement

These were all super great points especially timely because we’re approaching you know the months ahead of the big tax deadline so thank you so much for joining us, Nancy!  So as always listeners can learn more about an array of financial topics for free at

Nancy Nelson

Most welcome!

Cassidy Clement

Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening everyone!

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