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## Financial Literacy

# Key tax terms

Key tax terms include 'deductions' (expenses that decrease taxable income), 'taxable income' (income subject to tax), 'above the line' (deductions from gross income), 'itemized deductions' (individual expense deductions), and 'standard deduction' (a set deduction amount). Understanding these aids in effective tax planning and financial management. Created by Sal Khan.

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- I cannot hear his dog barking at5:15? Can anyone else hear it?(2 votes)
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- Can someone explain how the tax is calculated at the end of the video? Sal said he didn't have $20 000, but he still calculated the 20%... and why did he add them up instead of just using the 20% in the first place?(1 vote)

## Video transcript

- [Instructor] What we're going to do here is a little bit of a case
study in doing taxes. So we have a situation where someone is bringing in $50,000
in this current tax year in gross income. So this is everything from their salaries, tips they might make, if they act as a contractor,
payments for that. It could be dividend
income if they own stocks. It could be interest
on bank accounts or CDs that they might have. And so when you add up all
of that, we get to $50,000. Now you aren't taxed on your
gross income just as is. Typically, you're going to adjust it to figure out what your taxable income is and then you'll go and look
at the various tax brackets and calculate your taxes. And just so you know, these are not the real tax
brackets in the United States. These have never been
the real tax brackets in the United States. I simplified it, one,
to make the numbers easy so I can do it with
back-of-the-envelope math, but also these are constantly
changing in the real world and I don't wanna have to
keep redoing this video every time they change the tax brackets. But it's gonna give you the
general idea of what's going on. So these are made up tax
brackets and tax rates and this is also a made
up standard deduction. We're gonna talk in a little bit about what a standard deduction is. So going back to the
case study of this person in this taxable year,
gross income $50,000. And then they have what we're calling above-the-line deductions. And above-the-line deductions, you can view these as
deductions to your gross income that you can make no matter what. The history of why it's
called above-the-line, it's the first form of
the typical tax form, so let me say above the line. Above the line. You can make these types of
deductions no matter what. This isn't an exhaustive list but these are ones that are
actually reasonably typical, things like a 401K contribution. This is a pre-tax contribution
to a retirement account, to a defined contribution
retirement account so to speak, where you put a certain
amount of money every year and that money is pre-tax. So it gets taken down
from your gross income to figure out what your
actual taxable income is going to be. Student loan interest is
also typically deductible from your gross income. And when we deduct those, we are left with our
adjusted gross income. Let me write here, add
adjusted, I lost a T there, adjusted gross income, which in this case is going to be, well it's gonna be $50,000 minus 2,000, minus 3,000, so that gets us to $45,000. Now we're not ready to
just take this $45,000 and figure out how that will be taxed based on this schedule here, this chart right over here. We're not ready to make more deductions, and we can view these as
below-the-line deductions. And this is where it gets interesting. You could go the path
of itemized deductions. So that's looking at things like, okay, did you make any
donations to charity? Or do you have any mortgage
interest on your home mortgage? And so let me write these, these are itemized. Itemized. So if you itemized your deductions you'd say, "Okay, I have a total of $9,000 of itemized deductions right over here." I would take that from the $45,000, and I could have a
situation where my taxable, taxable income would be 45,000 minus nine which is going to be, lemme
draw a little line over here. This is going to be
$36,000 of taxable income. Now you could just take
that and figure out what you're now going to have to pay. But there's another
interesting alternative path that you should know about. As opposed to itemizing your deductions, your below-the-line
deductions, so to speak, where you have to list them all out, your other option is to just
take the standard deduction. Now in this situation, the
standard deduction is $10,000. So let's see what happens if instead of itemizing our deductions, we were to just take out the
$10,000 standard deduction. Well, in that situation,
our taxable income is going to be 45,000 minus 10,000, which is going to be $35,000. Now, generally speaking,
unless you just like giving money to the government, you wanna minimize your taxable income. You wanna do that legally. And in this situation when we pick the standard deduction route, we actually have a lower taxable income. So this is the path that you
are going to want to take. And now that we've calculated
this taxable income, this $35,000, we are ready
to now actually calculate based on this schedule of
the actual tax brackets. So one way to think about
it is the first 10,000 right over here, we are
going to have no tax. So let me put that here. So we have 10K, no tax, no tax. Now the next $10,000 right over here is going to be taxed at 10%. So the next 10K is going
to be taxed at 10%. So now, sorry, my dog barked. So now we've accounted for
20K, we have $15,000 left, so we go into the next bracket. The next bracket actually
accounts for the next 20,000. We don't have that much, but if I just write over here, say okay, my next 15K, which is all
I have, falls over here, so I'm going to say the next 15K is going to be taxed at 20%. And this is federal taxes that
we are talking about here. You're gonna have to do it another time for your state taxes. But now let's calculate our total tax. First $10,000, no tax. So we don't have to worry about that. Now, $10,000 being taxed at 10%, 10% of 10,000 is $1,000. And then $15,000 being taxed at 20%, that's going to be $3,000. And so you add these up and you get a total federal
tax in this situation in this made up tax
brackets that I just did, in this made up example of $4,000. But hopefully that gives you an idea of how taxes are actually calculated and a little bit of the terminology.