The content contained on or made available through this website is not intended to and does not constitute as legal or investment advice. Please use and refer to the information at your own risk, and consult with a professional before making any finance-related decisions. Refer to the full Terms & Conditions here. Last updated January 1st, 2020.


  1. Understand the taxes for which you will be accountable

  2. Ensure that you get the most out of your Federal Income Tax deduction

  3. Set aside the correct amount each paycheck (considering W-4 allowance, tax credits, etc.)

  4. Appropriately file and report investment gains & losses

  5. If necessary, utilize online software to guide you through filing


Taxation in the United States is highly complicated; the subject can, however, be simplified when broken down into its individual components. This article is therefore divided into four major sections: terminology, income taxes, capital gains taxes, and tax filing documents. 

Check out the Finance in a Flash Income Tax Calculator!



  • Taxable Income: The portion of your income that will be subject to Federal, State, and other income taxes. Each taxing entity has a unique system for calculating taxable income from gross income.


  • Deductions: Deductions represent the portion of your income that is not subject to income tax. The larger your deductions, the less you pay in taxes.


  • Tax Brackets: The tax bracket system works to ensure that higher earners owe a relatively higher percentage of their income. However, it is constructed so that increasing your income will never decrease your take-home pay.


Income Taxes


Federal Income Tax (FIT)


  • FIT Taxable Income: The portion of Gross Income subject to Federal Income Tax. This can be calculated as follows:

  • FIT Tax Methodology: Federal Income Tax utilizes tax brackets, so that relatively higher earners pay more in taxes as a percentage of their income than low earners. However, the system works in such a way that your first $30,000 will always be taxed at the same rate, regardless of whether you make $50,000 annually or $100,000.

    • Tax Bracket Example: If you have $50,000 of taxable earnings in 2019, the first $9,700 will be taxed at 10%. The next $29,775 will be taxed at 12%, and the remaining $10,525 will be taxed at 22%. Total tax in this case is $6,859 (or 14% of your taxable income). 

​​​* The table illustrates the above example and shows how everyone is taxed equally for their first $50,000 earned

  • FIT Tax Deductions: Federal Income Tax includes three main components to calculating your maximum allowable tax deduction:

    • Above-the-Line Deductions: Even though these are called “deductions,” they are technically reductions to your Adjusted Gross Income (AGI). This means that you can reduce your overall taxable income with above-the-line deductions and receive your standard or itemized deduction afterwards. Items that qualify for above-the-line deductions include: insurance premiums, Traditional IRA and HSA contributions, qualified student loan interest payments, penalties on early withdrawals of tax-deferred savings, etc.

    • Standard Deduction: The Standard Deduction for singles filing in 2019 is $12,200. Everyone filing in the U.S. is allowed to claim at least the standard deduction. As an example, this means that if you make $60,000 a year, then at most you will be taxed on $47,800 (or $60,000 - $12,200).

    • Itemized Deductions: The goal with itemization is to find out whether or not your combined tax-deductible activities exceed your standard deduction. Things that are tax-deductible include: mortgage payments, property taxes, state income tax, sales tax, charitable donations, medical expenses, etc. If you are filing as "single" for the 2019 tax season and your itemized deductions exceed the $12,200 standard deduction, then you will ultimately owe less money to the Government through itemization.

Especially if you are newer to the workforce, do not own a home, or have large charitable contributions, you will likely be all set with the Standard Deduction.

  • W-4 Withholdings (Employee’s Withholding Allowance Certificate): Upon employment you will receive this form and be asked to select a number of “allowances.” The number you choose will help determine the amount withheld from each paycheck to pay FIT. A safe assumption is to elect the number of people that depend on you, including yourself. So, for a single filer, electing one allowance will almost guarantee a tax refund. Technically, the best financial strategy is to withhold the perfect amount each paycheck and receive a $0 tax return. In this case you receive the full correct amount of take-home pay without owing anything come tax season. Check out for the official IRS tax-withholding calculator. Doing so will ensure you elect the appropriate number of allowances each year.

  • Tax Credits: Deductions refer to a certain portion of your income that is not subject to FIT. For instance, if you claim the $12,200 standard deduction as a single filer and your uppermost tax bracket is 20%, then you are (roughly) saving $12,200 * 20% or $2,440. With tax credits, on the other hand, you receive the full value of the credit (i.e. a $1,000 tax credit is worth $1,000 in your pocket). Tax credits include items such as: Child and Dependent Care Credit, Earned Income Tax Credit, Low-Income Housing Credit, and many others (see for a comprehensive list). Each credit comes in one of two forms:

    • Non-Refundable Tax Credit: You will receive a refund only up to the full amount of taxes that you owe.

    • Refundable Tax Credit: You receive the full value of the tax credit, regardless of how much in taxes you owe.

Federal Insurance Contributions Act (FICA) Taxes


  • FICA Taxable Income: The portion of Gross Income subject to FICA taxes. This is typically set equal to the following:

  • FICA Eligible Pre-Tax Contributions: These include the majority of non-retirement Above the Line Deductions. For example: health insurance premiums, bought paid time off, HSA contributions, etc. Note therefore that Traditional 401(k) and IRA contributions are subject to FICA tax.


  • Types of FICA Taxes: FICA are mandatory payroll taxes paid both by the employer and employee that are used to fund the Medicare and Social Security System for the aged and disabled population. The two FICA taxes are as follows:

    • Medicare: This piece is taxed at rate equal to 1.45% of your FICA taxable income, and 0.9% of FICA taxable income in excess of $200,000 in 2019, and is matched by your employer.

    • Old Age, Survivors, and Disability Insurance (OASDI): This piece is taxed at 6.2% of your first $132,900 of FICA taxable income for 2019, and is matched by your employer.


State Income Tax (SIT)


  • SIT Taxable Income: The portion of Gross Income subject to State Income Tax. This will vary state-by-state, and is typically derived from your Federal Income Tax return. SIT taxable income can be approximated by the following equation: 

  • Taxation Methodology: Each state utilizes one of the following three approaches:

    • No state income tax

    • Flat rate income tax (e.g. 4% of all taxable income)

    • Tax brackets similar to those used for Federal Income Tax


  • On Average: For states that do tax their residents’ income directly, the rate is typically within 2% - 6% of SIT taxable income.


Local Income Tax


  • Wage Tax: Certain municipalities (e.g. Philadelphia) include additional taxation if you work within their boarders. This is often levied as a flat percentage of taxable income.


Capital Gains Tax

These taxes apply only to investment returns (e.g. through a taxable brokerage account).


Taxable Income

  • Dividends: Dividends are typically categorized as either qualified or unqualified (this will be apparent on your 1099-DIV tax form). Qualified dividends are taxed at the capital gains tax rate (0% - 20%, depending on income bracket), while unqualified dividends are taxed as regular income.

  • Capital Gains: This tax is only applicable upon selling stocks/bonds/ETFs/mutual funds for a profit in the filing year. For instance, if you purchased a stock for $200 2 years ago, and sold it in 2018 for $300, you have now realized a $100 profit. This is classified as a capital gain, and is categorized as follows:

    • Short-Term: Capital gains realized within one year of purchasing the underlying asset are said to be short-term in nature. Short-term capital gains are taxed as income.

    • Long-Term: Capital gains realized after one year of purchasing the underlying asset are said to be long-term in nature. Long-term capital gains are taxed at the Capital Gains tax rate.



  • Cost Basis: In order to calculate capital gains on a portfolio of multiple stocks/bonds/etc. purchased at different times and at multiple prices, you must first develop what is called a “cost basis.” The cost basis represents the dollar value to which a sold stock will be compared in order to determine the realized profit. In the example above with $100 realized profit, $200 is the cost basis. Easy. But what about the following scenario?

Cost Basis Methods

  • Average Basis: The simplest method. As the name implies the cost basis equals the average of all share prices at the time of purchase. Shares are then sold in the order of purchase. In the example above, the average of all shares in the portfolio is $258. So a share sold in 2018 would realize long-term capital gains of the $300 sale price - $258 average purchasing price = $42. Note that if you use the Average Cost Basis once, often no other cost basis may be chosen for all investments within the same fund or portfolio.

  • First in First Out (FIFO): Another relatively simple method, shares are sold in order, using the earliest purchasing date and price first. In other words, the first share sold is assumed to be the first share purchased, and so on. In the example above, the share sold would realize $300 sale price - $200 cost basis = $100 of long-term capital gains.

  • Specific Share Identification (SpecID): The most complex method, which requires the most documentation and attention to detail, offers the highest potential tax savings. Under SpecID, you may pick and choose exactly which shares are being sold. In the example above, the share sold can use any of the available purchase prices. For instance, you can use the last purchased share in order to be accountable for $300 sale price - $300 purchase price = $0 capital gains. Note that the period of ownership of the specified share will impact whether it will be taxed at the Capital Gains or Income Tax rate.

The method you choose is ultimately up to how closely you wish to manage your investments. If you have a financial advisor or a lot of spare time and interest in the subject, you can optimize your tax savings with SpecID. However, there is nothing wrong with taking the much simpler Average Basis approach. Regardless of the method, whenever possible only withdraw investments that qualify as Long Term Capital Gains in order to avoid the higher Income Tax rates.


  • Broker Purchases & Withdraws: If the broker through which you have invested (e.g. Vanguard) buys or sells portions of a fund you own (often without your explicit knowledge), then those profits/losses will be passed on to you as realized capital gains. Whether they are short or long-term depends on the amount of time they were held by the broker.

  • Investment Losses: If an investment is sold at a loss, the negative balance can be claimed against other capital gains or even income on your tax filings, thus reducing the burden of loss through a decrease in taxes.

  • Keeping Track: The good news is – you do not have to keep track of this yourself! The fund owner (Vanguard, in this example) will provide you with all required documentation for submitting your taxes.


Tax Documents




  • W-2: An essential document that you must receive from your employer(s). A W-2 contains information such as: your total income, tax withholdings, FICA taxes paid, and benefit contributions (e.g. health insurance premiums, 401(k), HSA, etc.).


Paid Interest Deductions


  • 1098: For homeowners, this document provides information such as: mortgage interest payments (which are tax deductible), amounts paid towards property insurance (not tax deductible), and more. Each mortgage provider typically has its own proprietary version of this documentation, so it may not look the same for everyone.


  • 1098-E: For those paying back student loans, this document spikes out the amount of interest paid during the filing year. Interest on student loans (as well as other loan-related expenses) is often at least partially tax-deductible.




  • 1099-INT: This form comes paired with each account in which you received interest payments (income), even if the interest was immediately reinvested.


  • 1099-DIV: This form comes paired with each account in which you received capital gains or dividend payments. Again, these distributions will be taxed regardless of whether or not they were immediately reinvested.


  • 1099-B: This form is distributed whenever you sell stocks, bonds, or mutual funds. Information contained in these documents, along with the date of purchase and original price of shares, will help to calculate your tax liability.


Other Sources of Income


  • 1099-G: If you itemized last year’s deductions and included state and/or local taxes in the itemization, then you will have to incorporate any state or local tax refunds into this year’s tax filing. Essentially, you must “correct” any differences in the amount of state/local tax itemized versus what you actually ended up paying. This form will help you do so.


  • 1099-K: Large payments (in excess of certain thresholds) from credit/debit cards or other payment facilitators (e.g. Amazon, PayPal, etc.) in the filing year will be treated as income. The thresholds here are quite high, so many who receive such payments will not receive this form or be liable for additional income taxes.


  • 1099-R: Any pension or IRA distributions (including rollovers and money transfers between retirement accounts) should come paired with this form, as many of these transactions include a tax liability.


  • 1099-MISC: If you are self-employed, you will receive this form from each company for which you performed services and received payment.




  • Form 5498: Includes contributions made during the filing year to a Traditional IRA as well as transactions made between Traditional and Roth IRAs. This form will help identify amounts that may be tax deductible.


  • Schedule K-1: Includes certain distributions from trust funds, personal estates, and more. These are often quite complex and often come late in the filing season (if not after the filing deadline).


  • Form 4868: An Application for Automatic Extension of Time to File. These are often paired with Schedule K-1, as the documents do not always arrive in time to file.

The most common forms you are likely to receive include: a W-2 (as every employee should), a 1098 for homeowners, a 1098-E for those with student loans, and a 1099 INT/DIV/B for those with or selling interest and dividend bearing savings (such as those within savings and taxable brokerage accounts). You may receive other forms as well, but they are slightly less common.



Taxes can be an incredibly complex topic, even for those extensively familiar with how they work. Thankfully, online programs make the process of submitting taxes relatively painless. FreeTaxUSA (free), TurboTax (paid), and similar software, streamline the filing process by automatically gathering relevant information and prompting you for the rest. These programs will then determine what you owe and whether it is best to proceed under the standard deduction or itemization. And in many cases, Federal and State returns can be submitted electronically.


A fundamental understanding of how taxes work will help you to become a proficient filer; and more importantly, never pay more than you owe.

The content contained on or made available through this website is not intended to and does not constitute as legal or investment advice. Please use and refer to the information at your own risk, and consult with a professional before making any finance-related decisions.

© 2020 London Levinson LLC