Where do your tax dollars actually go?


For most Americans, spending $10,000 remains a big deal. That's the kind of money we spend on cars, down payments for homes, once-in-a-lifetime vacations, or parties marking major life events.

Not many of us can shell out $10,000 so casually that, if asked about where it went, they wouldn't even know. However, the average American family pays the federal government at least that amount in taxes each year, and many of us only have a vague sense of where the money goes.

Yes, we know taxes pay for everything from roads to defense, social programs to public television. But the specific breakdown of tax spending is something most Americans give little thought to -- even though taxes are the biggest single line item for many Americans each year.

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11 ways to reduce next year's tax bill
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11 ways to reduce next year's tax bill

1. Contribute to a 401K or IRA

Contributing to a retirement fund is an important way to ensure financial independence in your golden years, but it can also convey short-term tax benefits. In most cases, the contributions you make to your 401K and IRA plans are tax-deductible and are not included in your taxable income at the end of the year. (Note: If you didn’t contribute to an IRA in 2016, you still have time. You have until April 18 to contribute up to the maximum amount and shave off a good chunk of your tax bill. Filed your taxes already? That’s OK. You can file an amended return to reflect the contribution.)

2. Buy a Home

There’s a distinct tax benefit to home ownership. The interest you pay on your mortgage is tax-deductible, and the interest is front-loaded. For the first several years, most of your mortgage payment goes toward interest, which will drastically reduce your adjusted gross income at tax time. Want an extra boost for your taxes next year? Consider paying January 2018’s mortgage payment in December to get a tax benefit before the end of the year.

3. Donate to Charity or Volunteer

You probably know charitable donations can be itemized and deducted from your income, so you’ll want to save receipts anytime you donate cash or items to charity. You can even deduct miles you travel for volunteering or other charity work.

“Miles you travel on behalf of a charity are deductible at 14 cents per mile for 2017,” said Gail Rosen, CPA.

4. Start a Home Business

Starting a home business can provide you with a new source of income and allow you to take deductions off any income the business generates.

These deductions include business costs you incur throughout the year, a portion of your mortgage and utilities if you use a home office and the cost of goods needed to keep your business running. You can even deduct startup costs.

“Any expenses that are incurred before the first sale are ‘start-up costs,’” Rosen said. “These costs cannot be deducted until the first sale. Then they are deducted over 15 years and you can deduct the first $5,000 in the first year.”

5. Search for a New Job

If you hunt for a new job in your field this year, you can write off some qualifying expenses as you search. There are exceptions, but potential write-offs include things like clothes or travel.

“If you looked for a new job in 2017, you should be aware of the income tax deduction that may be available with respect to job-search costs,” Rosen said. “Qualifying expenses are deductible even if they do not result in a new job being offered or accepted.”

6. Open a Flexible Spending Plan

Many employers offer flexible spending plans that let you contribute toward yearly medical expenses pre-tax. These contributions typically don’t count toward your taxable income.

7. Deduct Medical or Dental Expenses

Many medical and dental expenses are tax-deductible. According to Rosen, the cost of getting to and from medical treatment is deductible at 17 cents per mile, plus the cost of tolls and parking, and dependent expenses are also deductible.

“If you cover the medical cost of dependents, these can be deducted. Additionally, if you are covering the costs of an individual who would qualify as your dependent except that they have too much gross income — for example, an elderly parent — you may be able to deduct these costs as well,” said Rosen.

8. Education-Related Expenses

Current and former students have many eligible deductions and credits related to their education expenses. Paid student loan interest and tuition and fees can be claimed as deductions. Eligible current students can also access the American Opportunity Credit, which can cover up to $2,500 annually for four years, and the Lifetime Learning Credit, which can cover up to $2,000 per tax return.

9. Install Solar Energy

Homeowners who install solar energy systems in their home can get back tax credits at up to 30% of the cost of installation. This credit will begin to decrease after 2019 so you may want to act soon if you’re planning on installing solar panels.

As an added bonus, solar energy can significantly reduce your energy bills.

10. Hunt Down Every Available Tax Credit

We’ve named several tax credits above, but there are more, including credits for adopting children, the cost of child care and low-income households. Tax credits are more valuable than deductions, as they reduce your taxable income on a dollar-for-dollar basis, so make sure you’re taking advantage of every option.

11. Get a Pro to Do Your Taxes

No matter how much research you do, a professional may be able to identify tax deductions and credits that hadn’t occurred to you. Paying a reputable professional you trust can help you stay organized and minimize your tax liability. Here’s a handy guide to finding the right tax professional for your needs.

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How much do we actually pay?

Before breaking down where the federal government spends our money, it's worth considering how the amount of taxes the average American pays has been calculated. In a recent article, my Motley Fool colleague Brian Feroldi broke the numbers down using data from the Internal Revenue Service (IRS).

Americans filed more than 150.6 million tax returns in 2015. During that year they also earned $10.17 trillion in adjusted gross income and had a total tax liability of $1.45 trillion. Some quick division means that the average gross income per return was $67,564 while the average federal tax hit was $9,655.

He also noted that many lower-income Americans either pay no taxes or even get money back because of the Earned Income Tax Credit. Take those returns out of the picture, he wrote, and "you are left with 99 million Americans who recorded an average federal tax hit of $14,654."

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Best and worst states for retirement
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Best and worst states for retirement

1. Florida 

You knew it had to be high on the list, didn't you? In terms of affordability, Florida topped the list while it placed fifth in terms of quality of life, overcoming its 20th-ranked healthcare rating.

2. Colorado

Ranked second in healthcare while quality of life came in 8th place, Colorado is constrained by its 23rd-place ranking in affordability.

3. South Dakota

The home of Mount Rushmore is the second most affordable state and ranked sixth when it came to healthcare, but can't break the top half in quality of life (ranked 32nd).

4. Iowa

Not typically thought of as a retirement destination, Iowa has decent rankings across the board (9th in healthcare, 11th in quality of life and 26th in affordability).​​​​​​​

5. Virginia

Quality of life ranks well in Virginia (9th) while affordability and healthcare rankings are above average (18th and 21st respectively).

The next five desirable retirement states are, in order:

Wyoming

New Hampshire

Idaho

Utah

Arizona

46. Arkansas

Dead last in quality of life and 45th in healthcare, Arkansas is pulled up by its 20th-place showing in affordability.​​​​​​​

47. Mississippi

The same principle applies to Mississippi, but even more so. The state is 49th in quality of life and last in healthcare, but it ranks 10th in affordability.

48. Rhode Island

Healthcare is above average (22nd), but quality of life and affordability are poor at 46th and 48th place, respectively.

49. New Jersey

The least affordable state in the union also has below average rankings in quality of life (28th) and healthcare (33rd).​​​​​​​

50. Kentucky

Kentucky ranks 47th in both quality of life and healthcare and only 38th in affordability, earning the Bluegrass State WalletHub's least desirable retirement state ranking for 2018.​​​​​​​

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How are our tax dollars spent?

Whether the average tax liability is just under $10,000 or a little less than $15,000, it's still a lot of money for most people, and it's important to know where those dollars go. Pew Research broke down how the United States federal government spent $3.95 trillion in 2016, with senior writer Drew DeSilver noting that the country is basically a giant insurance company that has a side business in defense:

About $2.7 trillion -- more than two-thirds of the total -- went for various kinds of social insurance (Social Security, Medicaid and Medicare, unemployment compensation, veterans benefits and the like). Another $604 billion, or 15.3% of total spending, went for national defense; net interest payments on government debt was about $240 billion, or 6.1%. Education aid and related social services were about $114 billion, or less than 3% of all federal spending.

Every other program -- public broadcasting, NASA, national parks, foreign aid, and everything else -- adds up to the remaining 6% of the federal budget. Here's how each major spending area breaks down:

  • 24% Social Security
  • 15% Medicare
  • 15% Defense
  • 13% Health
  • 13% Income Security
  • 6% Net Interest
  • 5% Veterans Benefits
  • 6% Other
  • 3% Education

Historically, according to Pew, federal spending has hovered around 20% of gross domestic product (GDP). In 2016 total spending was 21.5% of GDP, and over the long term, the biggest growth in spending has been on the various human services programs (including Medicare and Social Security). The share of GDP spent on defense has actually fallen to 3.3% in 2016 after hitting a high of 6% in 1986.

What does this mean?

While individual Americans have no direct control over how their tax dollars are spent, it's important to know where the money goes. It's especially important to understand that any major increases -- say in defense spending, as President Donald Trump has proposed -- require cuts elsewhere. With more than two-thirds of the budget going to social insurance programs, it's hard, if not impossible, to make major changes without impacting those programs.

Most of your tax dollars go to taking care of other Americans, followed by paying for defense. The amounts devoted to everything else, including the most controversial and hotly debated government programs, amount to a relative pittance compared to the overall amounts being spent.

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