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You are here: Home / Podcast Episodes / sos094 Understanding The 1040 tax form

sos094 Understanding The 1040 tax form

By Steve Stewart on January 25, 2013

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  • sos094 Understanding The 1040 tax form
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Income tax returns can be difficult. Breaking the 1040 down into sections helped me to understand it better.

tax returnWhy we file taxes on April 15th

We need to balance our “tax checkbook” once a year. April 15th has been coined “Tax Day” as this is the deadline that all taxpaying Americans must submit their balanced tax checkbook to the IRS.

This allows employers to mail tax withholding and earning statements (better known as W-2s) and the self-employed the time necessary to get their books in order.

Form 1040: Two pages to zero

When you boil it down, there is only one form that reports your income tax: Form 1040. This two page document collects all your personal data into one place and it tells you whether you get a refund or owe more in taxes.

Eight sections to refund

There are eight sections that must be completed before calculating a refund:

Information

For identification and filing purposes only. This has no bearing on your taxes.

Filing Status

You only need to identify how you will file and then check the appropriate box.

Exemptions

The exemption section will have a huge impact on the second page. List yourself and all your dependents here and you will see your taxable income go down on Page 2.

Income

This is the place to be! List all the sources of money that came in during the year like

  • Wages
  • Tips
  • Interest and investment income
  • Social security and Pensions
  • Rental income
  • Annuities (remember, these are taxed at ORDINARY INCOME RATES). Think about it

Line 22 is the total of all these sources of money. It is your Gross Income. Take a good look at it, you might get a wake-up later down the form.

Adjustments to income 

You can reduce the amount of your gross income with qualified

  • Student Loan interest paid
  • Educator expenses (back for 2012!)
  • IRA deductions (similar to the effect of putting money into a 401k)
  • Health Savings Account contributions (HSA)

While the first one, Student Loan Interest, isn’t good for you, it is good to report on your 1040. The others are wonderful tax saving vehicles!

Tax and Credits

This section gets a bit wonky. It performed three actions: It reduces taxable income, finds what your total tax liability is, and then reduces the tax liability with non-refundable credits.

Should I take the Standard Deduction or the Itemized Deduction?

Nearly everyone that files a tax return gets to reduce their taxable income by at least the Standard Deduction. A married couple with an Adjusted Gross Income (AGI) of $100,000 filing their tax return jointly automatically will get to reduce their liability by $11,900.

However, if they have qualified expenses and charitable giving that exceeds that amount it would make more sense to Itemize. Example:

A married couple pays $5,000 in mortgage interest, $3,000 in real estate taxes, and gave $5,000 to their church (a qualified 501c3). This allows them to reduce their liability by $13,000 instead of the standard deduction of $11,900.

Exemptions

Here is where it pays to have children (in a tax-benefit sort of way). Each qualified person in the Exemption section from Page 1 of the Form 1040 gets to reduce the tax liability even more by $3,800 each in 2012.

The family of four with an AGI of $100,000 reduce the amount that on which their income tax is calculated from the Itemized Deduction ($13,000 – bringing the number down to $87,000) and with personal Exemptions (another $15,200. This brings the amount of income they calculate their tax on to $71,800.

Wait, there’s more tax adjustments!

The tax on $71,800 turns out to be about $8,000. But the Tax and Credits section also allows for non-refundable credits like

  • Retirement Savings Contributions Credit
  • Child Tax Credit
  • Dependent Care Credit

These don’t reduce the taxable income, THEY REDUCE YOUR TAX! That’s pretty powerful stuff!

Other Taxes

Your guess is as good as mine. We have over 73,000 pages of our tax code to refer to. I prefer to go to Google to find out more about these, wouldn’t you?

Payments

Ahhh. Here is the bottom line. We finally get to see if we withheld enough from our paychecks or if we have to write a check to Uncle Sam.

The Payments section is where we record how much income tax was withheld, usually found on a W-2 (the self employed will record their Estimated Payments in Line 63).

Then there are Refundable Credits

Yes, this is getting confusing, but we’re almost done.

If you qualify for the Earned Income Credit (EIC) you will get to reduce your tax bill yet again. It is possible that your tax liability on Line 61 was already zero, so you would actually get a check from the IRS even though you didn’t pay (or didn’t have to pay) anything into the system.

Filing a tax return is expensive, time consuming, and often a painful experience. I spend about 8 hours on the whole process every year.

To save time for filing taxes next year you should create simple folders for receipts from deductible purchases, donations, and interest paid like property tax payments and student loans.

To save time in future years – vote for the FairTax! (H.R. 25)

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