For years when our W-2s came in the mail, I just plunked our numbers into Turbo Tax, and out popped a form. We sent that form in (or just e-filed) and then boom…a refund check showed up shortly thereafter. Cool. But I really didn’t have an understanding at all about how the form flowed…I just answered the questions.
Now that I prepare tax returns for a living, I’ve come to appreciate how important it is that a taxpayer really understands what they are reporting on the form and how it all flows together. So, without further ado – here it is – the Form 1040 broken down into manageable chunks. I’ll try to keep it in plain English as much as possible.
The main idea is this: take your total income, subtract out deductions and exemptions, and you get your taxable income. Then apply your tax rate to that number, and you get your tax liability (which is how much you owe in income tax for the whole year). There are a couple of credits, so if you’re eligible for any of those (hello child tax credit), then you get to subtract that from your tax liability.
Now, the government doesn’t want all the money for the year in April when the return is due. They want it spread out throughout the year. For most people, that means that part of your tax liability is paid through your withholdings from your paycheck. For some people, this is paid through quarterly estimates.
In essence, these prepay your tax. So take your tax liability and subtract your prepayments. If your prepayments are more than your tax liability, then you’ll get a refund of the overpayment. If your prepayments are less than your tax liability, then you will owe. If your prepayments are substantially less than your tax liability, then you’ll get a penalty as well. They want their money early.
That’s pretty much the basic flow, but there is one more thing that I want to point out. You may have heard of “above the line” deductions. Those are the adjustments that are on page 1 of a 1040. If you take a look at a Form 1040 (2012), you’ll see there are two pages. The first page is for listing all of your income, and then the first round of deductions brings you to your adjusted gross income (or just AGI for short). The AGI is important because there are deductions later on that depend on your AGI. To put it simply, if your AGI is lower, then you could have more in deductions. So, these “above the line” deductions are important because they lower your AGI, which could give you more bang for the buck later on.
So, next time you are plunking those numbers into Turbo Tax, try really taking a look at the form and see how your numbers are flowing. It really does help to understand the process.
Kim is an accountant at a CPA firm in Georgia. She will complete the requirements for her CPA license in the summer of 2013. As every situation is unique, you are encouraged to seek out professional advice for your particular situation. Luke1428.com is not providing legal, accounting, or other professional advice
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