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How do tax returns work

how do tax returns work

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Total Income

The basis for preparing your Form 1040 Individual Income Tax Return is your total income. Total income refers to your total worldwide income from all sources during the tax year (the calendar year). It is important to keep in mind that it does not refer merely to income you earned from employment -- interest on savings, stock market profits, tips and even unemployment compensation are included in total income. If you were employed during the tax year, you will need to include your W-2 forms with your tax return. You are not taxed on all of your total income; the purpose of calculating total income is simply to provide a basis for calculating taxable income later on in the process.

Adjusted Gross Income

Calculate your adjusted gross income. Your adjusted gross income is calculated by deducting certain expenses that the IRS specifically allows you to deduct from total income to in lines 22 to 35 of Form 1040. These expenses include relocation expenses, self-employment expenses, contributions to individual retirement funds and other expenses specifically listed in Form 1040.

Taxable Income

Calculate your itemized deductions as listed in Schedule A of Form 1040. These are certain other personal expenses similar the deductible expenses you calculated to obtain your adjusted gross income. Compare the total of these deductions with your standard deduction as listed in line 40 of Form 1040, and

determine which figure is larger, your itemized deductions or your standard deduction. This larger figure represents your allowable deductions. Subtract your allowable deductions from your adjusted gross income and write this number down. Now check to see how many exemptions you can claim in line 6 (this number represents the number of dependents you are claiming). Multiply your number of exemptions by $3,500, and subtract this product from the number that you just wrote down. The remainder represents your taxable income.

Total Tax Due

The IRS publishes a separate instruction book for Form 1040 (see References below). Refer to it to find the tax rate schedule that lists applicable tax rates according to amount of taxable income. Find your taxable income range and note the tax rate applicable to it. Multiply this tax rate by your taxable income. The result is your tentative total tax. Now calculate your Alternative Minimum Tax (AMT) using IRS Form 6251 and the accompanying instructions. Compare your AMT with your tentative total tax, and choose the higher of the two figures. The result is your total tax. From total tax, subtract any taxes you have already paid (your W-2 forms will list taxes already deducted from your paycheck). If the result is greater than zero, this is the amount you must pay the IRS. If the result is less than zero, then it is the amount of refund that the IRS owes you.

Category: Taxes

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