In the United States, the progressive tax system is one of the most important yet misunderstood concepts of tax planning. Whenever people are asked to explain its mechanics, they always say, "The more you make, the more you pay in taxes". Yes, this is somewhat correct. But this system does not imply that earning more makes all your income to be taxed at a higher rate.

What is progressive tax system and how does it work?

Under this system, an individual’s income is being taxed in progressively higher clusters called brackets. The system is like filling every drinking glass (brackets) from a pitcher of water (income). As the income reaches each bracket, only that given amount is taxed at a specific rate. Once it exceeds the bracket, you will move on to the next rate.

If you control the timing of your income or expenses at the end of the year, it makes sense to carry the income or expense toward the end of the year. Either you would want to place the income into the year to be in a lower tax income bracket or your expense to be in a higher income bracket. It is also important for you, taxpayers, to realize the deduction in this tax system may not be as high as what you think. This can take place when a taxpayer has a small amount of income falling in the top bracket, in which most of one or more of their deductions will be levied at the next (lower) bracket.

Most taxpayers are confused with the difference between tax deduction and tax credits. Understanding these two is vital because the tax strategies that you take on can favor one over another and earn significant tax savings, which can help in building your wealth.

For most people, going through their income tax with an accountant is like waiting for the doctor’s diagnosis, whether you will live or die. So they close their eyes and pray hard the outcome would favor them, without really knowing how it is computed. April 14 is a crucial date for people to determine whether they still have balances to be paid or are eligible for a tax refund.

Realistically speaking, there is no mystery behind your tax return. In simplest terms, the tax owed or refund is figured out by subtracting your income from deductions, computing the tax liability on the remaining amount, and comparing that liability against what you have already paid throughout the year. Nevertheless, whether you get money back or still need to pay more, you should sit down with a calculator or the one who prepares your tax in the last few months of each year in order to estimate where you will be at this tax period.