Travis H. Long, CPA, Inc. Blog

Originally published in the Cedar Street Times

October 17, 2014

On Wednesday October 15, the 2013 personal tax filing season came to a close.  Or at least it did for most timely filers.  People who requested the six-month extension finally had to lay down their cards, or face increased penalties, and being branded delinquent by the taxing authorities.  But I am sure you had your returns done long ago!

It is hard to believe that 2014 is rapidly drawing to a close, and soon we will start filing taxes all over again.  This coming year, I would like to challenge you to spend some time looking at your tax returns and learning something new.  I am a firm believer that everyone should have at least a basic understanding of the flow of a tax return.  This document is a linchpin in your financial life.  Let’s spend a few minutes talking about the big picture.  You may wish to do this with a copy of a 1040 close at hand.

Tax returns can be hundreds of pages long with many supporting forms and schedules, but it all boils down to a two page summary whether you are John Doe or Warren Buffett…this is your Form 1040.  Essentially, the first page lists your income, adjusted by a few preferential items leaving you with your all important “adjusted gross income.”  “Below the line,” as it is known, is the second page, and lists your deductions and credits, calculates your tax, and determines what you owe or will get refunded.

Looking at page one in more detail, the top section captures your name, mailing address, and Social Security number.  There is also a somewhat passe little box to designate three dollars of the tax you are already paying to the Presidential Election Campaign fund.  If you want to learn more about this, I wrote an entire article on its history on April 18th.  You can find it at www.tlongcpa.com/blog.

The first real section is where you designate your tax return “filing status” – single, married, head of household, etc.  This is very important because it determines how much your standard deduction is and how quickly you will climb the tax brackets as your income increases.  Your status is determined by rules, not choice.  That said, married people do have the choice of the generally unfavorable Married Filing Separate status.

The next section deals with “exemptions.”  This is where you list the dependents in your household – generally your children up through college (even if away at college).  A parent or someone not even related can qualify, but they have to meet strict limiting rules.  You get an exemption from your taxable income of $3,950 (2014 amount) for each of your dependents.  Children under 17 may also qualify you for child tax credits which would go on page two.

The income section falls next.  Wages from your job, interest, dividends, business income, rental income, sales of stock, money received from retirement accounts or plans, pensions, social security, etc.

After getting your total income figure, you then are allowed certain favorable “above the line” deductions for things like educator expenses, moving expenses, retirement plan contributions, health savings account contributions, student loan interest, tuition and fees, etc.  After subtracting these adjustments, you arrive at your AGI (adjusted gross income).  AGI is a key figure and is used in a lot of calculations which could affect your taxes in many areas.  Above the line deductions are therefore preferable for that reason, but also because they will have a direct impact on taxable income. Below the line deductions such as itemized deductions are less certain and do not impact your AGI.

The taxes and credits section is at the top of the second page.  This is where you get to subtract all your itemized deductions listed on Schedule A- things like medical expenses, taxes paid, interest, charitable contributions, and miscellaneous other deductions (like tax preparation fees!).  If you don’t have many itemized deductions you get the standard deduction instead (for example – $12,200 for married status)  as determined by your filing status from the first page.

Next, the number of exemptions you claimed on the first page is multiplied by $3,950 (2014)  and that is subtracted out to leave you with your taxable income.  Your tax is then calculated using tax tables and other rules.

With income generally in the $100,000 to $200,000 range ore more, you may also hit alternative minimum tax (AMT).  In simple terms, AMT is a parallel tax system that has a different set of rules and allows less deductions.  You calculate the AMT system on every return.  If the AMT tax  calculation yields a larger tax bill than the regular system,  you pay the incremental difference as alternative minimum tax. Real estate taxes and miscellaneous itemized deductions subject to two-percent such as unreimbursed employee business expenses are common items that get kicked out in the AMT system.

Next you get to subtract any tax credits you may have.  Tax credits are a dollar-for-dollar reduction of tax owed and are therefore more valuable than deductions, which only save you a fraction on the dollar.  Depending on your circumstances there are credits for education, childcare, children in general, energy efficient upgrades, etc.

The next section is “Other Taxes.”  There are a handful of other taxes people might incur , such as tax on taking money out of retirement plans too early, household employee taxes, repaying a first-time home buyer credit, etc.  The most common, however, is self employment taxes.  Business owners must pay the employer and employee side of their Social Security and Medicare taxes.  After you add these taxes and determine your total tax liability,  you then look at the payments section to see was has been paid in or credited to your account, and whether you will end up owing, or getting a refund.

At the bottom of the second page, you can choose things like direct deposit, or applying  the payment to the following year.  You can also designate a third party such as the tax preparer to be able to discuss the return with the IRS, if the IRS wants to discuss it.  At the bottom, a paid preparer also has places to sign and fill out.

In two weeks we will start examining Schedule A – Itemized Deductions.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.