Depending on your situation, tax season can either be like an extra holiday — complete with a check from the government, or like going to the dentist — complete with an outstanding balance owed to the government.
In either case staying on top of current tax codes and tax lingo is key to filing accurate returns.
Familiarize yourself with the following key terms and what they mean. These words are sprinkled throughout your tax return. Knowing exactly what they mean is critical.
Earned income – Salaries, wages, tips and professional fees, including taxable scholarships and fellowship grants.
Unearned income – Investment-type income like interest on your savings account, dividends and capital gains, as well as unemployment compensation. Gross income – All income you received in the form of money, goods, property and services that is not exempt from taxes.
Exemptions – A predetermined amount of money you can deduct from your taxable income for basic living expenses. You, as an individual, may be an exemption, and dependent children (which you probably are to your parents) qualify as exemptions.
Standard deduction – A set amount of money that the federal government gives you if you meet certain stipulations. It differs according to marital status.
Itemized deductions – There are six main categories of expenses that can be deducted: medical and dental, taxes, interest, charitable contributions, and casualty and theft losses. Itemized deductions reduce the amount of tax you owe.
W-2 Forms – Wage-income forms that you receive from employers in order to prepare your taxes.
Filing status – Whether you are single, married or head of household. There are several sub-categories within each of these as well.
Deciding Whether (and What) to File
Depending on your gross income, you may or may not be required to file. For example, in 2008, all single individuals under 65 with a minimum gross income of $8,950 were required to file. Even if your parents (or someone else) can claim you as a dependent, you may be required to file if you meet certain income conditions.
When determining your income, be sure to include all taxable income you receive. If your scholarships are not taxable, you need not include them in your income. (Non-taxable scholarships carry no service requirements and are used to cover education-related expenses).
Choosing a Form
To file your taxes, you need to fill out one of three basic forms:
There are a number of different types of income tax returns. You must use the tax form that corresponds with your particular situation and allows you to claim the income, deductions, credits, etc. that apply to you. The most common types of income tax returns include the following:
Form 1040 (U.S. Individual Income Tax Return) (a.k.a. “the long form)
Form 1040A (U.S. Individual Income Tax Return) (a.k.a. “the short form)
Form 1040EZ (Income Tax Return for Single and Joint Filers With No Dependents)
Form 1040NR (U.S. Nonresident Alien Income Tax Return)
Form 1040NR-EZ (U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents)
IRS Tax Form 1040 (U.S. Individual Income Tax Return)
Form 1040 is the standard federal income tax form used to report an individual’s income. It is also known as “the long form” because it is more extensive than the shorter 1040A and 1040EZ Tax Forms.
Before filling out your 1040 or visiting your local tax preparation expert, be sure and have the following documents on hand:
Proof of identification
Filing status and residency status
Social Security Numbers for you, your spouse, and any dependents
Dates of birth for you, your spouse, and any dependents
A copy of your past tax return
Statements of wages earned (e.g., W-2, W-2G, 1099-R, etc.)
Statements of interest/dividends from banks, brokerages, etc.
Proof of any tax credits, tax deductions, or tax exclusions
Your bank account number and routing number (for Direct Deposit)
Income The IRS defines “income” as any money that you receive during the given tax year. Most people can simply review their W-2s (Wage and Tax Statements) to determine their annual income. Taxable income, generally speaking, is the gross income of an individual or corporation, less any allowable tax deductions. It’s important to realize that taxable income can encompass more than just your annual salary.
Taxable income can include profits from stocks or real estate sales, as well as winnings from the lottery, betting on horse races, or any casino (domestic or abroad). Even the cash value of bartered items is considered taxable income. Income that may be part of your gross income but is not identified as “taxable income” would include: child support, proceeds from life insurance policies, inheritances, Workers Compensation payments, Welfare benefits, compensation awarded as a result of physical injury, education scholarships or grants, and income paid to your retirement account (either a 401k or IRA, up to a certain amount).
Overall, taxable income is that portion of your gross income which is subject to taxation by the governing authority, minus any allowable itemized or standardized deductions.
Your taxable income is basically the amount of your income that is subject to income tax. [What qualifies as “taxable income” is defined in Section 63 of the Internal Revenue Code, and “gross income” is defined in Section 61 of the Internal Revenue Code.]
Adjusted Gross Income
Your Adjusted Gross Income (AGI) is defined as your gross income from all taxable sources, minus certain allowable tax deductions. These “allowable deductions” (also known as “above-the-line deductions”) may include unreimbursed business expenses, medical expenses, alimony, moving expenses, or deductible retirement plan contributions.
Your AGI is important when determining your overall tax liability because it can affect your tax bracket, how much you can contribute to qualified retirement accounts, and which tax credits you may qualify for.
On the other hand, “gross income” refers to all income that you received in the form of money, goods, property, and services that is not exempt from tax. This can include any income from sources outside of the United States, as well as income from the sale of your home.
Knowing the difference between deductions and credits — such as the Earned Income Credit (EIC) or Child Tax Credit will make a big difference in your final tax bill or refund so make sure you understand these thoroughly and if not, find someone who does.
Do It Yourself or Pay an Expert?
Filing on one’s own can be intimidating the first time out, but there are plenty of resources provided by the IRS to walk you through the process. If this is outside your comfort zone or you are not finding the answers to your questions, do not hesitate to consult a tax preparer.
Many can be found this time of year locally but rates and fees may differ so shop around. In either case be sure and ask for references and make sure the operation will still be open after filing season in case you or the IRS has any follow up questions.
Just another ShopRTO personal finance tip.