Edit: I made a mistake with the standard deduction math and explanation near the end of the original version of this post. I have since corrected it. Thanks to the readers who pointed it out.

Monica writes in:

Last year, I took the advice of my older brother and made several charitable donations during December to help out my taxes for the year. When I filed them, I did get a return, but it wasn’t nearly as big as I expected. Are charitable donations really a big deal or did I do something wrong?

Charitable donations do provide a reduction in your taxes, but it’s not the huge reduction that many people often think they are or expect that they are.

To understand the benefit that charitable donations give to your taxes, first you have to understand how income taxes work. This is something that many people surprisingly misunderstand.

When you earn ordinary income from working at a job, you have to pay income taxes on it. We all know that, of course. What many people don’t quite understand is how the amount you pay is calculated.

Let’s say you are a single person earning $50,000 this year (we’re not going to worry about issues like personal exemptions and other tax issues that would further complicate the issue – we’ll just look at $50,000 in taxable income after such things). To figure out how much taxes you have to pay, you have to look at the income tax rate table. For 2011, it looks like this for single people (there’s a different table for married couples):

For income between $0 and $8,500, you pay 10% in taxes.
For income between $8,500 and $34,500, you pay 15% in taxes.
For income between $34,500 and $83,600, you pay 25% in taxes.
For income between $83,600 and $174,400, you pay 28% in taxes.
For income between $174,400 and $379,150, you pay 33% in taxes.
For income over $379,150, you pay 35% in taxes.

So, as I mentioned, we’re looking at a single person who makes $50,000 a year.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($15,500), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $3,875 for this bracket (25% of $15,500).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $8,625. This person will owe $8,625 on their taxes this year.

Now, how can a person lower that amount? The most common way is through deductions. The government gives out standard deductions each year on a person’s taxes. For 2011, that amount is $5,800 for a single person. How that works is that you simply subtract that deduction from the total amount of income the person earned for the year. So, this person’s income for tax purposes is actually $44,200.

So, let’s look at this person’s actual taxes after their standard deduction.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($9,700), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $2,425 for this bracket (25% of $9,700).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $7,175. This person will owe $7,175 on their taxes this year.

So, that person’s standard deduction on their taxes actually saved him $1,450. The standard deduction may be $5,800, but it only saved the guy $1,450 because the deduction just reduces his total income for the year in terms of taxes.

Charitable giving works exactly the same way. Every dollar you donate to a registered charity becomes a deduction on your taxes, just like a standard deduction.

Let’s say the person above donates $5,000 to his church (a 10% tithe) and $2,000 to Doctors Without Borders and another $2,000 to L’arche Tahoma Hope. That’s a total of $9,000 in charitable donations.

So, this person makes $50,000 a year. From that, he can either subtract his standard deduction ($5,800) or he can subtract his charitable donations ($9,000). This means that his taxable income – the amount he pays on his federal income taxes – would likely be $41,000. Let’s look at his taxes now.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($3,700), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $1,625 for this bracket (25% of $6,500).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $6,375. This person will owe $6,375 on their taxes this year.

In other words, this person’s $9,000 charitable contribution saved them $2,250 on their taxes. That’s because the person was in the 25% tax bracket before the donation and in the 25% tax bracket after the donation, which means that they essentially saved 25% of their donation on their taxes. (Sometimes, a donation will drop you to a lower tax bracket, which is fine.)

However (and this is where the readers pointed out my mistake in the original version of this post), the standard deduction would save the person $1,450. The actual savings – compared to the standard deduction – for this charitable giving is $800. Charitable giving works best as a tax deduction if it’s coupled with other deductions, such as home mortgage interest.

So, charitable donations are a great thing and they do offer some tax savings, but you don’t save $1 for every dollar you donate. Instead, you often reduce your tax bill roughly a quarter or so for every dollar you donate. That’s still a great little bonus.

Hopefully that clears things up for you!

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

Tammy on Facebook wants to know about “How to know when your part-time small business can transition into your full-time income.”

This is an experience I went through in 2007 and 2008 and an experience I’ve discussed privately with several other small business owners. It’s a scary transition indeed.

For me, there were five real factors I looked at before deciding to make the transition.

First, could I do the work consistently over a long period of time? In other words, would I still want to be doing this in, say, five years? I asked myself this question in 2007 and it’s now 2011, so I think I got the answer here right.

This is basically a passion gut check. It takes… something to be able to write two personal finance articles a day every day for years. Whatever it is that you’re doing, can you see yourself doing it every single day for years? Is this something that excites you from the moment you wake up?

For me, I often start my days with such relish that I can’t wait to get started with the writing. I’ll write my posts (an average of about three per weekday all year long), plus other contracted writing, plus additional things I’m writing for my own enjoyment (like my sometimes-mentioned fantasy novel). I love to write.

Second, is there a way to consistently earn money from this work? As long as I can consistently write content of a reasonably high quality, I’ll be able to earn enough money to get by with my work. The Simple Dollar earns money from ad revenue, but I have several outstanding offers to write for other sources.

Unless the environment of writing online drastically changes, I should be able to earn at least a limited income from my writing online. This gives me a route to consistently earn money.

What’s your pathway to consistent income? Do you have an abundance of prospects for earning money, or are those prospects limited?

Third, are you able to market yourself effectively to find more work? Are you able to find new clients for your work? Are you able to reach an audience for your work? Are you able to grow both of these things?

This likely involves the use of things like social media, effective emailing strategies, and so on. Without clients, fans, or customers, you can’t make it. Without tools with which to contact them, you can’t build them up.

I had the advantage of already having a large audience for The Simple Dollar when I chose to play it full time, and the site itself incorporates a lot of tools for audience members to share the content, which further expands the audience. For many people, social media (like a Facebook fan page or a Twitter account) is the tool with which they reach and expand their audience of readers, followers, clients, and employers.

Fourth, do you have an extremely healthy emergency fund? Do not dive into a side business, freelancing, or any form of self-employment without some sort of significant financial safety net. If you can’t live for a few months without any income, you’re not ready to make that jump.

Going solo means that you don’t have the reliability of a regular paycheck to rest your head upon. Instead, you will be going through periods with a lot of income and other periods with little income. The only real way to survive that is to have cash on hand to supplement your income during the dry periods.

When I walked away from my previous job, we had enough cash in savings to survive for several months even if I didn’t earn a dime in income. I would not have walked away without that support in hand.

Finally, do you have a sensible grasp of your accounting needs? Paying taxes, continuing to save for future goals, and maintaining a working household budget are tricky things to juggle when you’re self-employed (welcome to quarterly taxes!). You’ve got to have a plan for keeping things in order or else you’re going to wind up not getting financially ahead or, even worse, finding Uncle Sam on your tail.

You’ll find a lot of solutions out there for this. For me, the best approach was to take every dollar I earned and split it in half. Half of it went into a “tax” account and the other half went into our normal household account. Each quarter, I would pay income taxes out of the “tax” account, and I’d make up any shortfalls at the end of the year out of that account. Anything left would be rolled back into our household money.

You may find a different solution that works well for you. However, if you don’t have a clear plan in place for all of this, you’re going to run into some serious problems down the road. This must be in place before your business is large enough for you to seriously consider making the leap.

Cover these bases thoroughly and you’ll be in a much better position to transition from side business to full time concern.

I considered posting this article during the actual tax season, but I decided to wait until the rush of actually filing taxes was over.

Almost all of you who live in the US have filed your income taxes by now. Some of you – the self-employed or functionally self-employed, like I am – have filed first quarter estimated taxes as well. Others may have filed business taxes.

We’ve all gone through a process that, at the very least, involves filling out forms and hoping that others have done their part to make it all right. In other cases, like my own, it involves lots of pages of forms, tons of calculations, the near-requirement of buying software or hiring a specialist, and hoping that you didn’t overlook one out of a thousand little things. Because if one thing is wrong, you’re probably going to get fined and audited.

The process of filing income taxes needs to be simplified. Period.

Please note that I’m not talking about political theories and philosophies here. I fully know that some people out there would like to see lower taxes and reduced government programs, while others would see higher taxes and more/better government programs. I also know that some people would shift the tax burden in various ways, reducing taxes on various income brackets and raising taxes on other brackets.

Instead, I’m talking about the unnecessary challenge and risk of filing taxes for most ordinary people.

Here are five simple suggestions that the IRS could follow to make this process easier for everyone – including themselves.

They should make it possible to file taxes using a web form. Just log on to a secure IRS site using some credentials they’ve sent you, fill in the form online, and perhaps print out a confirmation page and send it in with any papers you need to send. The process of filing taxes could easily be handled by a well-designed web form. Not only that, the data would go straight into their database without any fuss and without middlemen.

They should use the best possible security. One concern I’ve always had with filing taxes is with identity theft in the process of filing it. A highly secure online system, while not eliminating identity theft avenues, does reduce them.

They should auto-fill in as much of the information as they possibly can. If they’re doing this web-based filing, they could auto-fill in a lot of your information based on information filed by organizations that paid you as well as information from your previous year’s tax forms. No more typing in or writing everyone’s names, Social Security numbers, employer information, and so on.

They should simplify electronic payment. If you’re going to receive money, give more options for paying out. If you need to pay, make it easier to pay in when you’re filing. A simple electronic transfer from your bank would be a great choice.

They should not charge for these services. Many people will say that you can just buy software to do all of this stuff. You shouldn’t have to pay for software in order to to a basic tax filing.

Of course, this brings up a few additional questions.

Won’t this destroy the tax filing businesses? Not necessarily. Many people with high incomes might very well still hire professional filing services in order to maximize their return. Similarly, people who want to do it themselves might also get assistant software that will help them identify maximum deductions and so forth. The IRS really has no reason to provide such services, as doing so would reduce their income. When you deduct, you pay less, after all. I would certainly use assistant software.

Wouldn’t this increase IRS costs? In the short term, it might. In the long term, they wouldn’t need people to manually process forms, drastically reducing the manpower needed by the IRS over time. Again, this doesn’t necessarily mean job loss; people could simply not have their positions filled when they leave.

How does this solve the problem with taxes in America? As I stated above, it doesn’t resolve any of the outstanding policy debates about taxes. What it does do is make sure that, whatever the outcome of the debates, it’s easier for people to file their taxes and more efficient for the IRS to process returns. That’s something we can all agree on, I think.

With Christmas comes the new year, and with the new year comes the painful cycle of preparing one’s taxes.

I personally loathe tax time – to me, it’s an example of how the government simply doesn’t work very well at all. The tax code should not be tens of thousands of pages in length when it’s expected that everyone navigate it.

Yet, that’s the situation we’re dealt with.

Thankfully, there are many things we can do – starting right now – to make things easier for us when we actually file. Here are nine steps you can take right now to make things easier.

1. Prepare a central location for all of your tax documents. It might be a desk drawer or it might be a folder. Just be sure you have one single place for the tax documents you’ll receive in January and February, so that when you do file your taxes, you can easily and quickly find all of the documents you need in one place.

2. Use this last week of the year to take advantage of any tax breaks. For example, there are many tax breaks available for simple energy efficiency improvements that you can do in this final week of the year.

3. Finish up your charitable contributions. If you’ve been intending to give money to charity this year, get it done now so that you can claim the deduction on your taxes. Keep careful track of what you donated – perhaps even in that central folder for your documents.

4. Purchase and install the tax software of your choice. The mainstream tax software packages all do a pretty good job. Get one early, install it, and make sure it’s updated (and you know how to use it) before crunch time rolls around. You don’t want April to arrive

5. Start hitting some tax-oriented blogs. If you’re obsessed with squeezing every nickel from your return, you can start subscribing to solid tax-oriented blogs like the WSJ Tax Blog or Tax Rascal. (I’m partial to the TurboTax Blog because I’m occasionally a guest contributor.)

6. Do a rough estimate. This is the perfect time to do a “back of the envelope” estimate to see whether or not you’re actually going to owe taxes this year. It doesn’t have to be perfect, but it’s a good idea to do it – and to estimate high, so you don’t get a nasty surprise in a few months.

7. Start saving. If you do have a bill coming, start saving to make sure that bill is well-covered. Again, aim high – having too much savings isn’t really a problem, but not having enough really can be.

8. If you’re afraid of doing taxes yourself, find a good preparer. This is a good thing to ask your friends and associates about. Who prepares their taxes? Do they do a good job? Is there anyone to avoid? You might even find yourself with a foot in the door of a really good preparer.

9. Come up with a plan. Don’t wait until the last day to do all of your taxes at once. Do it a bit at a time, spread out over a longer period. This allows you to check over your work with fresh eyes (and perhaps notice things you didn’t see before). Come up with a plan – maybe you’ll spend an hour each Saturday starting in February on your taxes. Add it to your calendar now so that you’ll know you’ve got to do it.

Susan writes in:

I feel so helpless as a taxpayer, watching the ridiculous directions the senate, house and president are taking my country. Being self-employed, in the medical field and living in NY I feel like I have three strikes against me. As Emma Goldman, the famous communist said, “If voting changed anything, it would be illegal.” I am seriously considering relocating to my home state of Indiana, where Gov. McConnell seems to be making some very fiscally responsible decisions. I am, however, 58, and moving seems to be more of an issue than is was at 20. What sort of feedback do you get from other taxpayers?

Personally, I agree with Susan to a certain extent. However, my interest is mostly in local taxes, to tell the truth. I’m worried about roads. I’m worried about our local fire department. I just tend to focus locally on most of this stuff, without as much concern on the national level.

I’ll be honest: I get next to no feedback at all when it comes to taxes. On the occasions when I do get feedback about taxes, it’s usually in a form described by Susan – they’re angry at the government’s use of their taxpayer dollars.

In truth, taxes are where the rubber meets the road in terms of politics and personal finance. Without tax dollars, the government cannot run.

Few would argue that there aren’t benefits from our tax dollars. Tax dollars pay for roads, bridges, fire departments, and many other services that we simply take for granted every day.

Most would argue that some aspect of their tax dollars’ use doesn’t please them, too. There are endless arguments about public and private funding of various services that people use, and these arguments have been around since nearly the dawn of time.

But when push comes to shove and the tax bill comes due, it’s not looked at as a political issue for most people. Taxes are a bill that need to be paid – and it’s worthwhile to minimize that bill. People seek out tax deductions that are available for them, plan around tax-free holidays, and seek out ways to make purchases that avoid sales tax.

To put it simply, taxes are a personal finance matter for most people, not a political matter. They aren’t worried about where their tax dollars are going as much as they are concerned about minimizing how many dollars they pay out without getting in trouble.

Why is this? I think that for many people, the connection between going to the local polling place to vote and their wallet is too tenuous. Obviously, it exists, but for the most part, the thought processes that go into deciding who to vote for and the thought processes that go into voting are distinct. When they do overlap, it’s usually by people who see it as their goal to minimize taxation at the expense of provided services. That’s why you see tax protests but rarely see people advocating paying more taxes.

Is that a healthy solution? I’m not really qualified to say, but I do think it is a natural solution. It’s much easier to look at things from the perspective of “how does this affect me” than “how does this affect the world” when dealing with the affairs of everyday life, like paying taxes. Given the complexity of modern life, it seems that the political side of taxes is mostly focused on by people who are passionate about politics and largely ignored by people who aren’t similarly passionate.

I look at it much like I do environmentalism. Humanity’s impact on the environment is constantly in our face, from weather changes to trash along the side of the road. For some people, this lights them on fire and they focus intently on reducing their carbon footprint and minimizing their waste. For others? It’s basically a problem that doesn’t fill them with passion and they don’t worry about it too much in their day to day lives. Sure, if there’s something simple to be done, they’ll do it, but they’re not going to start living ultra-green to do it.

I think this is largely driven by the media. A few years ago, being green was “cool” and lots of people were focusing on the environment. Now, frugality seems to be “cool” (at least to some extent) and the media’s giving that attention and thus lots of people are thinking about it. In a few years, it’ll be some other cause that people can take action on with little steps and feel good about themselves for doing something positive. Maybe it’ll be taxes. Or maybe it’ll be something we don’t even foresee, like some sort of local food revolution. It’s very hard to tell.

In the end, though, taxes, for most people, are just another bill to pay. Sure, it’d be great to have a smaller bill, but if that means losing some service they rely on or value, they’re not too interested, and the details are something for people in Washington to work out.

What do you think? Are taxes just another bill to pay, or is excessive taxation something you’re interested in fighting with larger steps (like moving to another state, protesting, or getting politically involved)? I don’t think there’s really a right or wrong answer here at all.

One big point that I often bring up in favor of Roth IRAs is the fact that you’ve already paid your income taxes on it. When you take money out of your Roth IRA at retirement age, you don’t have to pay income taxes on any of your withdrawals. On the other hand, with a 401(k), you’ll owe income tax on all of your withdrawals.

Obviously, the big difference comes when you pay into these accounts. With a Roth IRA, you put your money in after taxes – from your take-home pay. With a 401(k), you invest with money before taxes. Thus, a 401(k) investment reduces your taxes today, while a Roth IRA investment reduces your taxes tomorrow.

Many people want a simple answer to the question of which retirement account type is better – but it’s not that simple at all. To truly know which option is the best one would require a crystal ball.

The best we can do is make the case for a future where a Roth IRA is better – and a future where a 401(k) is better. Let’s look at each one.

A Roth IRA Is Better If…
… income tax rates go up from where they’re at now. Let’s face it – the United States is deep into debt. The revenue to pay for that debt will have to come from somewhere. At the same time, income tax rates are currently about as low as they’ve been in decades. What’s a reasonable conclusion from this? The government will raise individual income tax rates gradually over time to make up for all of the rampant spending since the start of the Reagan years.

… your earnings go way up from your current level. If you have higher earnings later in life, it’s likely that most of your retirement savings will also come later in life so that you can have a standard of living in retirement that’s notably higher than what you have now. If you need a lot of money in retirement, it’ll be very useful to have some of that money arrive on your plate tax-free, especially if the income tax rates are higher. In other words, if you have a big entrepreneurial bone in your body, a Roth IRA is probably a better option.

… you have other avenues of income in retirement besides the Roth IRA. Most likely, if your income goes way up, you’re going to have investments of all kinds that earn income for you in retirement. Almost all of that will be taxable income. Again, having some of your income in a non-taxable form means substantially less taxes for you, particularly, again, if tax rates are higher.

… your employer isn’t offering matching contributions into a 401(k). If you’re self-employed or with an employer that doesn’t offer a 401(k) – or doesn’t offer any sort of 401(k) contribution matching – a Roth IRA definitely looks good in comparison, since the 401(k) doesn’t have this huge advantage.

A 401(k) Is Better If…
… income tax rates stay at the same level – or go down. Many argue that the best way to increase revenue is to actually lower tax rates, spurring on business growth. If future governments apply this philosophy, it’s likely that tax levels will either stay steady or decline.

… your earnings decline, stay the same, or only go up at a slow rate until retirement. If you’re not entrepreneurial in any way, shape, or form and you’re not interested in battling your way up the corporate ladder, your income will likely remain pretty steady throughout your life. This means you won’t bump yourself up to higher tax brackets later on and you’ll likely be in this tax bracket (or a lower one) in retirement. Thus, deferring the taxes until then is advantageous.

… your main income (besides Social Security) will be your 401(k). If your income in retirement will mostly come from your 401(k) and not from outside investments, your total tax bill will be limited significantly. You won’t have additional income pushing up your tax burden (which your 401(k) will contribute to).

… your employer offers matching 401(k) contributions. This is free money that blows away any tax benefits that might come from a Roth IRA. If your employer matches your contributions, the decision becomes pretty easy – take those matches all the way to the bank.

What About a Roth 401(k)?
Some people also have the option of a Roth 401(k), which essentially works like a 401(k) except with after-tax money. A Roth 401(k) often ends up being like a Roth IRA that gets employer matching, which means that most of the arguments in favor of a Roth IRA apply to it.

In the end, though, you need to decide for yourself where you’re headed and where you believe the government is headed. Of course, all of this is moot if you don’t start saving right now. Regardless of what you choose, you’ll lose any advantage of either choice by putting off saving while you decide. If you’re unsure, sign up for one plan or another and start contributing. If you change your mind later, switch your savings plan. But, no matter what, start saving now – don’t put it off.

(Many apologies to the great Peter King, my favorite football writer, for the title of this article.)

Just this morning, I finished up my income taxes for 2007 (along with my estimated taxes for the first quarter of 2008), wrote a small mountain of tear-stained checks, and dropped them in the mailbox. This was my first year filing taxes with significant income earned from independent work and it was a real eye-opener.

Here are some of my collected thoughts on the income tax process.

1. TurboTax is a miracle worker. In 2007, The Simple Dollar really took off. In 2007, we bought our first house. In 2007, I sold mutual funds for the first time (to help buy the house). As a result, this year was loaded with new experiences when it comes to income taxes. Add into that the fact that my wife and I worked together on our taxes this weekend, working in shifts with the other one of us focusing on child care.

The end result is that TurboTax bailed us out. We’ve been using the bare bones version for years, so it pulled in the stuff we needed for last year, and then it walked us step by step through all of the new stuff. In the end, after several hours of typing away at the keyboard and shuffling through a mountain of papers, we ended up with a neatly filled-out tax return with all of the numbers in the right places. Even better, it got me on the right track with estimating for the future, meaning we actually had a little bit left over after a year’s worth of tax savings even after being hit with a penalty for a low estimate last year. That leftover amount’s going straight towards a student loan, as is our “economic stimulus package.”

2. Children are a splendid tax break. We have two children. Just by existing and by going to day care, they netted us $2,950 in tax credit. That’s right – almost $3,000 of our tax bill went poof because of our two children.

That obviously does not make up for their expense, but it does pay for about a third of their child care over the last year, which softened the burden. To put it simply, if you have a child, the tax system does help you out with those extra costs of parenting – and that’s nice.

3. If you’re making any sort of serious side income, pay the estimated taxes. Not only is paying it all the way along a great way to make sure you aren’t nailed with a giant tax bill at year’s end, but it also ensures you aren’t hit with a nice big fat penalty either. We were hit with a penalty for estimating way too low last year about how The Simple Dollar would grow – one year ago, I honestly had no idea how “big” The Simple Dollar would become.

The second you start getting enough income that you’re getting pretty excited about it, look into form 1040 ES and the equivalent form for your state. Don’t let it slip or else tax day will be very painful.

4. We printed out almost fifty sheets worth of paper just to mail in. That’s just plain silly, especially when most of this could be filed electronically. Even better would be a drastic simplification of the tax code – a true flat tax of some kind. The simple fact that we had to burn a good chunk of a weekend and print out fifty pages of rather confusing documentation just to meet requirements tells me there’s something wrong in the system.

So, yes, I just admitted to being in favor of a flat tax. After burning most of a weekend of lost productivity, printing out fifty sheets of paper, mailing in a bunch of documents, and paying what feels like a pretty arbitrary number in the end, I definitely can see the reasoning behind just writing down your income, taking a handful of very basic deductions, and then paying a certain percentage tax on what’s left. That sounds awful good to me.

5. Signing those checks was painful. I just watched a sizable amount of cash leave my pocket earlier today. It was painful to watch all of those check being written – all of that hard-earned money simply leave my pocket, never to return.

6. But even after all of that, I don’t really mind. When I was writing those checks, I grumbled a lot, but now that they’re in the mail and I’ve had some time to reflect on what that money really means, I don’t mind. It means public education for every child. It means streets and sidewalks and fire departments. It means local parks for my child to play in and national parks for me to look at in awed beauty. It means support for the arts, support for science, and support for people who really do need it, even if the systems aren’t perfect.

Regardless of your feelings about the things that are wrong in this country, our government does a lot that is right and it gives everyone an opportunity to work on fixing what’s wrong through voting and directly participating in the system. Much of the good that I identified does come from local government, but a lot of their funding and protection comes from up the food chain. If writing that check means my son can run down the sidewalk to the park and that some poor child is able to attend school, that’s a check I’m quite happy to write, in the end.

A reader wrote in wanting a simple explanation of a very hairy topic: capital gains and capital gains tax. I’m going to take a crack at explaining it in very simple terms, leaving out some of the specific vagaries of the United States tax code.

Whenever you buy something, then sell it for a higher value, you incur capital gains. For example, let’s say you buy a Wii at a store for $250, then sell it on eBay for $300. You’ve just incurred $50 of capital gains.

Under the United States tax code, you are required to pay taxes on capital gains. If you have held the item or asset for less than one year, it is considered a short term capital gain and you pay taxes on it equal to your normal tax rate. However, if you hold it for longer than a year, you are charged 15% tax on that amount (it’s 5% if you’re in the 10% or 15% income tax bracket).

So, let’s say that you’re making enough money so that you’re in the 28% tax bracket. If you bought the Wii and sold it a month later, you are charged short term capital gains tax on that Wii, you have to pay $14 in capital gains tax when you file your taxes. However, if you wait a year and a half after the purchase to sell the Wii, you pay only $7.50 in taxes, a savings of $6.50 on your tax bill.

It is this difference that is one of the big encouragements for long term investment. Let’s say you buy $5,000 worth of a particular stock and within six months it doubles in value. If you sell immediately (and are in the 28% tax bracket), you’re going to pay $1,400 in capital gains tax. But if you hold onto it for another six months (and it doesn’t go down), you can then sell it and incur long term capital gains tax, paying only $750. That’s $650 in savings in your tax bill.

Another note: before you figure up your final tax bill at the end of the year, you can subtract your capital losses from your capital gains. So, let’s say you bought $5,000 worth of stock and then sold it later for $4,000 – that $1,000 is considered a capital loss and is subtracted from the gain (short term losses are subtracted from short term gains and long term losses are subtracted from long term gains). This is why many people time the selling of their bad stocks to maximize their tax benefit – they may want to sell it in a particular calendar year, or hold onto it for a full year until it becomes a long-term capital loss.

What’s the story here? Uncle Sam tries to make it worthwhile for people to invest for the long term by giving people better tax rates if they do so. For investors, the “buy and hold” strategy has significant tax benefits over rapid trading of stocks.