Answers To The 20 Most Common Tax Questions

If your goal is to make more money, that’s also likely to conflict with paying less in taxes. As a high earner, you probably think that with more money comes more tax problems and there’s nothing you can do about it. That’s not entirely true, there are strategies you can take advantage of in order to maximize the reduction in your tax bracket. Inevitably, with taxes come a lot of tax questions, and sometimes those questions remain unanswered. 

After helping thousands of clients find their ideal wealth planner, we saw patterns in the tax questions that came up over and over again. We created this guide with the purpose of helping you get answers and clarity as you navigate the uncertainty of taxes! 

20 Most Common Tax Questions (and Answers)

1. How do I pay fewer taxes?

There are two min levers that correlate with your tax bill: income and deductions. Reducing or deferring your income will also reduce the taxes owed. Increasing your deductions might also reduce your taxes, but there are limits and nuances related to how much it can. 

2. Why does my tax bill change so much each year?

Because life changes so much each year! Yes, the tax laws will change also and that is certainly a factor, but most commonly your tax situation changes because of your income, deductions, or credits you qualify for. 

3. How are my investment gains taxed?

There are two ways that investments can be taxed: ordinary income or preferential rates. If you sell a stock at a gain that has been held under one year then it will be taxed as ordinary income but if you sell a stock at a gain that has been held over one year you will pay preferential rates (0%,15%, or 20%).

4. Do I still pay taxes on my investments even if I don’t sell anything?

Yes, investments can have taxable events through interest, dividends, or capital gain distributions from mutual funds and ETFs.

5. How is my investment income taxed?

Cash sitting in a savings account produces interest which is taxed just like regular income (ordinary tax rates). Dividends can be taxed as either ordinary income or as a ‘qualified dividend’ depending on the investment. Distributions will also vary based on the investment, so be sure to talk to your advisor about your specific investments. 

6. What income do I have to pay taxes on?

The IRS wants to tax all of your worldwide income. So all of your ‘earned’ income (like salary, bonus, equity awards) and your ‘unearned’ income (like investments or rental).

7. How do tax brackets work?

Tax brackets are set up in a tiered structure. Similar to a ladder, once you make enough income to reach the next rung, the percentage rate will increase. The income made on the first few rungs is still taxed at the lower rates though. 

8. What is ‘marginal’ vs. ‘effective’?

Marginal tax rate refers to the tax rate paid on the last dollar of income (the highest point on the ladder) while the effective tax rate is the actual tax percentage you pay on all of your taxable income (average).

9. Is a tax credit or a tax deduction better?

A tax deduction is a dollar-for-dollar reduction on your taxable income. A tax credit is a dollar-for-dollar reduction on your taxes owed. There is a bigger benefit in reducing your taxable income from an overall math perspective. But emotionally, sometimes a tax credit is more exciting because it reduces the final tax payment. 

10. When do taxes come into play for my retirement accounts?

Taxes occur even when you are done working. If you are withdrawing from pre-tax retirement assets then you will owe ordinary income tax on the distribution. If you are withdrawing from a Roth retirement account, as long as it has been held for five years, the distribution will be tax-free. Keep in mind that early distributions, prior to 59.5, will typically result in a 10% penalty as well as taxes. 

11. Do I pay taxes when I sell my vacation home?

Most likely. You may owe capital gain taxes if there is a gain between the purchase price of your vacation home versus the sale price. However, keep track of any improvements made to your home because they could reduce the taxable gain. 

12. If I work remotely, which state do I owe taxes to?

You could owe taxes to all the states! AHH! The most important factors are where you are a resident, which states you’re earning your money in, and how many days you work in each state. Once you know those things, your tax advisor can help determine which states you need to actually file taxes in. 

13. Why can’t the government tell me what my tax refund/owed is?

The IRS loves a good challenge. The government knows basic information about you like where you work, your W-2 wages, and any interest/dividends. But they need you to fill in the missing pieces like how many children you have and what their care costs or how much your medical expenses are. It’s a joint effort. 

14. Will the IRS arrest me for messing up my taxes?

Probably not. If you make a tax mistake, you can file an amended return to correct it. The IRS may also send you a letter letting you know if there are discrepancies between what you put on your return vs. what they have on file. 

15. Can I get a deduction for charitable contributions?

Probably! You can take a deduction for the first $300 given to a charity. If you make larger donations and itemize your deductions on your taxes, then all of your donations could be deductible. Of course, there are stipulations that the donation has to be made to a 501c3 organization and documented with receipts. 

16. How do I know if I am a dependent?

If you don’t financially support yourself, there is a chance you could be considered a dependent. If you are a child under age 19 (or under 24 if a full-time student) or a qualifying relative. Qualifying dependents may have a job but just cannot provide for more than half of their annual support.

17. What is adjusted gross income?

It’s the number that a lot of tax calculations are based on. It is all of your income minus adjustments (student loan interest, contributions to retirement accounts, etc.). 

18. Does my equity compensation show up on my W-2?

Yes, equity compensation is taxable and your employer will report it on your W-2 box 12V. Different types of equity compensation are taxed differently. Stock options, restricted stock, restricted stock units, stock appreciation rights, phantom stock, and employee stock purchase plans…oh my! 

19. How does student debt impact my taxes?

Luckily, you can get a little break by taking a tax deduction for the interest paid on student loans up to a maximum of $2,500 per year. 

20. Can I deduct contributions to a 529 plan?

Not on your federal income taxes, but most states let you add this as a deduction. There may be limits, for example, New York allows up to a $10,000 deduction for a married couple if you put at least that much into a 529 savings account.

Tax Questions In Summary

The only way to truly win the tax game is to align your strategy with your priorities. Our goal is to make sure you have all of the resources you need to understand your taxes and how to navigate them.  We’re also happy to help you answer any additional tax questions you may have!

If you’re ready to kick off tax planning with a wealth planner, make sure you’re working with one who has your best interest and is sitting on your side of the table. We connect you with the most qualified advisors in the country, that go through our strict vetting process to ensure they have your best interest in mind! Trust and transparency are our golden rules when it comes to vetting advisors!