A guide to the different types of income tax

Income is categorized into approximately 24 types according to the Internal Revenue Service (IRS). Although there are several different types of income, they all can be labeled as taxable income. However, not all kinds of income are taxable at the same rate. Tax rates can also change between tax years due to changes in tax law that can affect how tax is calculated, when tax is calculated and what is or isn’t tax protected.

• Wages and salaries

A common type of taxable income described by the IRS is wages and salaries. This income is reported on the Form W2 that is sent to income recipients near the beginning of tax filing season. Even though this is one type of income, it is taxed at differing rates determined by total taxable income; for the 2010 tax year, these tax rates can range from around 10 percent to 39 percent. Total wages and salaries is not usually the final amount of income that is considered taxable because it doesn’t take into account exemptions, deductions and credits.

• Capital gains

Tax on capital gains varies on whether those capital gains are offset by capital losses and if the capital gains are acquired through a tax protected financial vehicle such as  a Roth IRA. According to the Tax Foundation, the maximum capital gains tax for the 2010 tax year is 35 percent. This amount applies only to short-term capital gains and not long-term capital gains which have a 15 percent maximum rate for the same year.

• Interest and dividends

People also often receive Form 1099s that provide a record of other income such as income from interest and dividends. Tax on dividends can vary and may not be taxable at the same rate as normal income. These types of dividends are called qualified dividends and must meet certain requirements to qualify for the lower tax rate. These qualifications can be reviewed at the University of Connecticut Business School. Interest on financial securities is often taxable unless those financial instruments are non-taxable as is the case with some types of municipal bonds.

• Social Security

Income from Social Security entitlements may or may not be taxable depending on the individual circumstances. The IRS states persons whose only income for a given tax year is social security may not even need to file a tax return. Income from social security is recorded on Form SSA-1099 and is reported on Form 1040. If social security is taxable, it is usually taxed at the same rate as income from wages and salaries or the standard tax rate that applies to the given taxable income amount.

• Retirement income

If income is received from retirement accounts such as Individual Retirement Accounts (IRAs),and 401(k)s, whether or not that income is taxable can also depend on the individual situation. For example, if the income is directly transferred to another retirement plan, i.e. not received but redirected there’s a good chance it may not be taxable. However, if the income is paid to the retiree, and is from a tax deferred retirement account such as a traditional IRA, then the income is more likely to be taxable.

Several additional types of income tax exist and it is always a good idea to verify tax questions and information with the IRS at 1-800-829-1040, or a qualified tax professional before sending a completed tax forms to the IRS for processing. This is because there may be overlooked tax rules, better ways to reduce tax and possible errors in the tax documents to be sent to the IRS.

A Guide to Tax Withholding Forms

Tax withholding forms are documents issued by the U.S. Department of the Treasury's Internal Revenue Service and Individual State governments for the purpose of generating Federal and State income. Similar entities and organizations exist outside of the United States for the same reason(s).

In the case of employers, withholding documents are required by law to be given to employees to complete for the purpose of withholding income for the generation of government tax revenue. This article will outline the forms used by the IRS and State governments for withholding income taxes.

The W series of tax withholding forms

The W series of tax withholding forms are forms given to employers for withholdings on income for the purposes of taxation, pension, advanced payment, voluntary payment and alternate source of payment not usually withheld These types of forms are available through the IRS and can be filed electronically or financial service provider. Instructions for these forms can be found in the IRS Employer's Supplemental Guide i.e. Publication 15-A.

• W-4: The most common W form is the W-4 that pertains to how much of an employees income will be withheld based on exemptions and other criteria. When the fiscal year ends, the total of the withholdings is added and the information is sent to both the employee and the IRS via a W-2. To change the amount of withholdings, consulting a Human resources manager and/or IRS publication 919 may be helpful in submitting a new W-4.

• W-4S: The W-4S is the IRS withholding form that allows employees to deduct taxes from sick pay. This may or may not reduce the amount held from regular income and may be beneficial if sick pay has an expiration and does not roll over.

• W-4P: W-4P is the form that is completed when an employer has a pension or retirement plan. Since this money is withheld it may be tax deferred as one's adjusted gross income will decline by the amount of the withheld amount.

• W4-V: Additional withholdings can be given to the government by completing a form W4-V. This type of withholding may be utilized to reduce taxes, or supplement anticipated tax due at the end of the year.

State tax withholding forms

Since tax withholdings also contribute to State government income, separate tax withholding forms are used for States. The State forms are created by each state and therefore one should be aware of the tax withholding form for their State. The following link is a useful source of State tax withholding forms/documentation requirements. State tax withholdings are also reported on form W-2's after the end of the fiscal year. This information is sent to both the Internal Revenue Service and the income tax payer.

Adjusting withholdings to be more or less

In some cases, either too little or too much income tax is being held back from one's paycheck. Determining the ideal amount of withholding is a matter of calculating how much one's estimated tax due will be after the end of the fiscal year and matching tax withholdings with that amount. Income tax withholding can be adjusted by submitting a revised Form W-4 to one's employer. IRS publication 919 is a Federal publication that illustrates and explains the withholding adjustment process, and provides tips and instructions on why an adjustment may be necessary.

Other tax withholding forms

In addition to standard employee income, withholdings are also required for several other types of income including scholarships, grants, pensions, non-resident employee income, income acquired abroad, interest, rental, and dividend income. In some cases, financial institutions may require a form W-9 for identification and reporting purposes.

Additionally, form 1099's are used to report additional income such as interest, capital gains, non-employee, and dividend income to the IRS. If no income is withheld for this income, the form 1099 will make this clear to the IRS and income recipient, at which point it is the responsibility of the income recipient to report and pay due taxes by filing the necessary tax forms such as the form 1040, and schedule C.

Summary

Tax withholding is reported to State and Federal tax authorities in addition to income sent and/or received. Various forms are used to report tax withholdings or the lack thereof to the tax authority. If tax is not withheld and income received is taxable, tax will become due the following fiscal year after receipt of the income.

Of the forms that record income tax withholdings are the W, and 1099 series of IRS tax forms in addition to State tax forms and income recipient filing forms such as State and Federal income tax forms. Several types of income are subject to income withholding and/or taxation. If tax is not withheld from such income, this tax must be reported to the IRS by the income distributor or facilitator, for example, capital gains acquired through a brokerage would be reported by the brokerage using a form 1099.

Sources:
1. http://www.irs.gov/pub/irs-pdf/fw4.pdf
2.http://www.dornc.com/downloads/wh_forms.html
3.http://www.irs.gov/pub/irs-pdf/p15a.pdf
4.http://www.irs.gov/pub/irs-pdf/p919.pdf
5.http://www.taxadmin.org/fta/link/forms.html
6.http://www.irs.gov/pub/irs-pdf/p919.pdf
7.http://www.irs.gov/businesses/small/international/article/0,id=105155,00.html
8. http://www.irs.gov/pub/irs-pdf/f1040sc.pdf

Taxes on the Exchange of Stocks

Taxes on the exchange of stock are only incurred if 1) the exchange leads to positive gains and 2) the transaction(s) do not take place within tax deferred financial instruments such as a Roth IRA. When earnings are made from the exchange of stock they are called capital gains and come in two types short term and long term. Capital gains are reported on an IRS form 1040, schedule D. There are several rules, and techniques that are relevant to and have the potential to lower taxation of profits arising from the sale of stock.

Short-term capital gains

Short-term capital gains are acquired through positive exchange of stock held less than one year in time. The taxation rate for short-term capital gains is the same as ordinary income taxation rates. For example, if one's total taxable income inclusive of short-term capital gains is between $30,650-$74.200, then income over $30,650 including the capital gains is taxable at 25% . Short -erm capital gains not held and/or exchanged in a tax deferred financial instrument are reported in part 1 of schedule D. This form is available at www.irs.gov.

Long-term capital gains

Long-term capital gains are gains made from the sale of stocks and/or other assets such as property that have been owned for longer than one year. The taxation of long term capital gains is lower than short term capital gains and is determined by completing part II of a schedule D in addition to part III of schedule D and the capital gains worksheet contained in the IRS 1040 instruction manual. The current tax rates for individually held long term stock capital gains as of the writing of this article is 5% for tax filers under the 25% taxable income bracket and 15% for taxable incomes at or above 25%.

Stock tax tips

There are several ways to legally avoid taxation of capital gains i.e. taxes on the exchange of stock. While these methods may not allow free and immediate access to the funds, they may serve as a viable tax hedge in instances where annual income is too high to make net worth and or leveraging outside of tax deferred financial instruments too costly in terms of taxation. It is also important to be aware of any special stipulations or rules within the tax code that may be helpful.

• Stock Transfers: Stocks transferred but not sold, from one account to another can allow the sale of stock in the new account to be taxed at a lower rate if the individual or organization receiving the stock is a child, has lower taxable income or is a non-profit organization.

• Donated Stocks: Transfers may also be considered tax deductible charitable contributions in the case of stock transfers to non-profit organizations or trusts.

• Wash Sales: If stocks are traded more than once within a 30 day period and at least one of the sales resulted in a capital loss, that loss is not deductible as a capital loss and is known as a "wash sale".

• Non-Taxable Distributions: For stocks that also pay special dividends or qualify for dividends to be distributed as non taxable, capital gains can be offset by the cost of stocks in so much as the non taxable distributions have a value equal to or less than the original cost of stock.

• Retirement Accounts: Exchange of stock through a retirement account can be tax deferred meaning any capital gains acquired through the account will not be taxable until withdrawal of that income.

• Irrevocable Trusts: If a stock owner gives stocks to trust before the stock increases in value then 1) one's taxable income will be lowered by the amount of the trust donation if the trust is non-taxable 2) the stocks within the trust may be tax free after sale, if they are less than the estate tax minimum taxable amount and 3) Dividend income earned through the stocks in the trust may also avoid taxation.

• Capital Losses: In cases where net taxable income is just over a new tax bracket for a given year, it may be advantageous to sell at a capital loss if one's investments in tax deferred instruments such as deductible IRA's have been maxed out and if the capital loss is likely to be unavoidable. This in a sense lowers the amount of the capital loss via tax savings between approximately 10%-33% on each dollar of capital loss provided a taxable income exists.

Taxation of capital gains can be thought of as quite straightforward in comparison to some other taxation concerns. Generally, short-term capital gains are not as cost effective as long-term capital gains and in the case of investments sold through a retirement or tax deferred financial vehicle. Some exchanges of stock, such as "wash sales" may not be deductible and capital losses may be offset through certain non -taxable dividend distributions. Other ways to reduce tax on stocks is to transfer ownership of them to a child or non-profit organization before the exchange.

Sources:

1. http://www.irs.gov/publications/p550/ch01.html#d0e4968
2. http://taxes.about.com/od/capitalgains/a/CapitalGainsTax_4.htm
3. http://www.msnbc.msn.com/id/7070269/
4. http://www.inc.com/magazine/19970901/1322.html