Your gross income includes all of your income, wages, interest earned on investments, stock dividends, business income, rental income, alimony, prize money and tips. The majority of your income is documented in the various W-2s and 1099s you receive at the beginning of the year.
You may or may not receive documentation for income like tips, but you must report all of your income. Bartending, waitressing and other cash-based jobs are red flags to the IRS.
When prompted by the software, your accountant or IRS Form 1040, supply the income figures documented on your W-2s, 1099s and any other applicable documents.
If you are doing your return by hand, you will write these figures into Form 1040 on Lines 7-22, and you will need to physically attach your W-2s to this part of the form.
There are certain deductions you can claim to reduce your taxable income, and thus, reduce your tax obligation. Potential tax deductions include: IRA contributions, moving expenses, student loan interest and, for the self-employed, health insurance.
When prompted by the software, your accountant or IRS Form 1040, supply the relevant adjustment, deduction, credit and exemption figures. If you are doing your return by hand, you will write these figures into Form 1040 on Lines 23-37.
You have a choice when you do your taxes to take the "standard deduction" or "itemize your deductions."
The standard deduction is a set amount that the government allows you to subtract from your gross income to arrive at your AGI. That figure allows you to avoid all the accounting necessary to itemize your deductions and, if you don't think you have many expenses that qualify as deductible, than you can go with the standardized amount.
However, if you believe you'll be able to take more money off your gross income by itemizing and subtracting all your qualifying expenses, than you should consider itemizing. Here's what qualifies:
- Medical Expenses
- Mortgage Interest
- Certain taxes; e.g., State Income Tax, Real Estate Tax
- Charitable Contributions
- Casualty and Theft Losses
- Business-Related Expenses
- Educational Expenses
- Miscellaneous Itemized Deductions
The rule of thumb is that you should itemize if your allowable itemized deductions equal a greater amount than the standard deduction. The only time you are required to itemize is if you and your spouse file separately. If one of you itemizes, you both must itemize.
Be cautious if you wish to itemize - don't claim anything dubious. Have documentation for every penny you deduct, and seek help from a tax professional if you need it.
Now that you've determined your taxable income, you can apply your tax rate. This rate is based on your calculated taxable income and your filing status. Computerized software programs and online tax preparation services automatically calculate the tax for you, but you may want to confirm the number by running the calculations yourself.
If your taxable income total is $100,000 or less, you can use the the tax tables listed on the 1040 instruction guide on the IRS website. Look for your taxable income total on the chart, then move across the row until to locate your filing method listed at the top of the column. The amount listed at the intersection of your taxable income and filing method is your tax rate. Place this total in line 44 on your 1040.
The IRS will compute your tax for you if you have a basic return and are willing to receive any refund by check. If your taxable income is more than $100,000, you have foreign earned income, lump-sum distributions, alternative minimum tax, qualified adoption expenses or a health savings account, you do not qualify for this tax preparation option. Other restrictions may apply based on your filing needs. Review Publication 967 for complete details.
If you qualify, the IRS will complete the taxes for you for Form 1040EZ, 1040 or 1040A as long as you send in your basic form by the tax deadline. If the IRS calculates that you overpaid, they will send a refund. If you didn't pay enough, they will send you a bill for what you owe.
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