PERSONAL INCOME TAX RETURNS
The Internal Revenue Service (IRS) requires that taxpayers determine and report their taxable income each year and pay any tax due. For most taxpayer’s this is a simple reconciliation of the taxable income earned during the year against the amount of tax withheld. For some taxpayer’s, it can be a complicated compilation of the year’s financial transactions.
Personal Tax Forms
Personal income tax returns are filed using federal Form 1040, Form 1040A, or Form 1040EZ. States that have an income tax have their separate forms that must be filed. These three federal forms are updated every year but are very similar because they all report income, deductions & exemptions, the tax is withheld, and any refund or payment due. The Form 1040 is sometimes referred to as the “Long Form” because it is two pages and has 78 lines, whereas the Form 1040EZ is called the “Short Form” because it only has 14 lines. Form 1040A has 50 lines. The Form 1040 is “longer” because it allows filers to report a wider variety of income, deductions, and credits. The Form 1040EA is “shorter” because it is for simpler tax returns and is designed only for reporting wage and interest income. The more complicated a tax return, the more likely the taxpayer benefits from a tax professional.
BREAKING DOWN THE FORM 1040
Most tax professionals prefer to use the same form for all clients, and we tend to file most returns using Form 1040. It is the most versatile form and using the same form allows us to compare return information easily from year to year.
Taxpayers must identify themselves on the tax returns by listing their legal name and their social security number. When electronically filing a tax return, the names on the return must match the names as associated with the social security number. In short, if you get married and change your name, you must change the name with social security also, or the return may not be accepted. The first name line is usually referred to as the “taxpayer” and the second name as the “spouse”. The address listed on the return become the official address on file with the IRS. Physical street addresses are preferred to PO Boxes.
The first five boxes of the tax return are for the selection of proper filing status. The filing status determines how much of a standard deduction is allowed; the marginal tax rates applied to the income, and any credits that the taxpayer is eligible to receive. Filing status can be one of the trickiest parts of filing tax returns, as there are many rules, requirements, and exceptions that create pitfalls for taxpayers.
Taxpayers are generally allowed an exclusion from income of a standard amount for each taxpayer and dependent claimed on the tax return. This amount is $4050 in 2016 and it is indexed for inflation.
The Internal Revenue Code §61 defines Gross Income as “all income from whatever source derived…” including, (1) Compensation for services, including fees, commissions, fringe benefits, and similar items; (2) Gross income derived from business; (3) Gains derived from dealings in property; (4) Interest; (5) Rents; (6) Royalties; (7) Dividends; (8) Alimony and separate maintenance payments; (9) Annuities; (10) Income from life insurance and endowment contracts; (11) Pensions; (12) Income from discharge of indebtedness; (13) Distributive share of partnership gross income; (14) Income in respect of a decedent; and (15) Income from an interest in an estate or trust.
Lines 7 through 22 on the Form 1040 capture the reporting of this income and segregates it into its various types of income, because different types of income are treated differently for tax purposes.
ADJUSTMENTS TO INCOME
Adjustments to income are expenses that reduce your total, or gross, income. You enter income adjustments directly onto Form 1040 of your tax return. The amount remaining after deducting these expenses is "adjusted gross income." Adjustments to income reduce your tax bill but are not itemized deductions, which you list separately on Schedule A and Schedule C. That means you benefit from adjustments to income whether you itemize deductions or take the standard deduction.
Above the Line
Adjustments to income are "above-the-line" deductions because they appear on page one of Form 1040, above the line that reports your adjusted gross income. Contrast these adjustments to "below the line" deductions, which appear on page two of Form 1040. There are two types of below-the-line deductions. The first is the standard deduction, which in 2015 is $6,300 per individual. The second type is itemized deductions that you list on separate tax forms and summarize the amount on Form 1040, below the adjusted gross income line. If your itemized deductions exceed your standard deduction, you'll pay less tax by itemizing.
Contributions to Tax-Deductible Accounts
Several adjustments to income stem from contributions you make to certain tax-deductible accounts, such as individual retirement accounts (IRAs), qualified employer plans -- for example, 401k's and 403b's -- and health savings accounts (HSAs). For 2014 and 2015, you can contribute up to $5,500 of your annual income to a traditional IRA -- $6,500 if you're age 50 or older -- and deduct the contribution as an income adjustment, subject to certain limitations if you also contribute to a qualified employer plan. The contribution limits on other retirement accounts vary but normally exceed those for IRAs. For 2015, an individual can deduct up to $3,350 in contributions to HSAs, which are accounts you can use to help pay for medical expenses.
Adjustments for the Self-Employed
Certain adjustments to income apply to self-employed individuals. Self-employment tax consists of Social Security and Medicare taxes. As a self-employed individual, you must figure and pay this tax yourself. The 2014 self-employment tax rate is 15.3 percent of your gross income, but you can deduct half of the tax as an adjustment to income. Self-employed individuals can also adjust gross income for the cost of health insurance and for contributions to self-employed retirement plans, such as a simplified employee pension or a personal 401(k).
Other adjustments to gross income include moving expenses, certain business expenses for reservists, any penalties paid for an early withdrawal of savings from, for example, a certificate of deposit, and alimony paid. Subject to certain requirements, you can deduct up to $2,500 of interest you paid on student loans and up to $4,000 in tuition and fees. Quicken includes a Tax Planner Tool that allows you to enter and calculate your adjustments to income. You also can assign Quicken transactions to particular tax categories, such as adjustment to income, and export the information to your tax preparation software when preparing your return.
ADJUSTED GROSS INCOME
Adjusted Gross Income is defined as gross income minus adjustments to income.
Taxpayers may take the standard deduction or itemize their deductions on Schedule A. Taxpayers generally pick the method that gives the higher deduction, but in some circumstances, taxpayer must itemize. Most taxpayers take the standard deduction unless they own real property and pay mortgage interest or real estate taxes.
A dependent is your qualifying child or qualifying relative. If you are entitled to claim an exemption for a dependent, that dependent cannot claim a personal exemption on his or her own tax return. Phase-out of exemptions — Your deduction is reduced if your adjusted gross income is more than a certain amount.
CALCULATING THE TAX
The tax can be calculated using the tax tables, a straight calculation, or by using the Schedule D Qualified Dividends and Capital Gains Method.
The tax may be offset by non-refundable tax credits including the Foreign Tax Credit from Form 1116; Education Credits from Form 8863; Retirement and Savers Credit from Form 8880; Child Tax Credits from Form 8812; Residential Energy Credits from Form 5695; and other General Business Credits from Form 3800 or Credit for Prior Years Minimum Tax from Form 8801.
Other taxes include the self-employment taxes from Schedule SE; Uncollected or Unreported Social Security and Medicare Tax from Form 4137 and Form 8919; Household Employment taxes from Schedule H; First Time Homebuyer Repayment from Form 5405; Individual Responsibility Payment (Healthcare tax); Additional Medicare Tax from Form 8959; and Net Investment Tax from Form 8960.
Federal Income Tax withheld from W-2; Estimated taxes paid on 1040-ES; Earned Income Tax Credit Schedule EIC; Additional Child Tax Credit from Form 8812; refundable portion of the American Opportunity Credit from Form 8863; Net Premium Tax Credit from Form 8962; Amount Paid with Request for Extension from Form 4868; Excess Social Security and Tier 1 RRTA Tax Withheld; Credit for Federal Tax on Fuels from Form 4136; Tax Paid by RIC or REITon Form 2439; Health Coverage Tax Credit on Form 8885
FORMULA: Income Less Adjustment = Adjusted Gross Income
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