When you report your taxes to the government, the form you use is called “1040”. This is true whether you do your own taxes, buy a software program, or hire a professional to do them for you. The 1040 is a surprisingly simple, two-sided form, that lists all your income, the deductions and credits to which you are entitled, and the refund you are owed, or the payment you owe. Even if you get a software program or a professional to fill it out for you, you still need to understand the basics of the 1040, so you can be sure it’s right. Fortunately, it’s not difficult to understand.
The front side of the form is all about your income. In the first section, lines 7-21, you list all your income. This could include income reported on a W2 or 1099, and from a variety of sources, e.g., employment, contract work, interest, dividends, rents, alimony, social security payments, and unemployment compensation, to name a few. When you add all these up, your total income is shown on line 22. Don’t panic, the tax you pay isn’t based on this number.
Now you get to adjust your income. As much as this sounds like a maneuver your shady accountant would recommend, adjusting your income is perfectly legit. On lines 23-35, you can subtract from your total income things like moving expenses, contributions to health savings accounts and IRAs, student loan interest paid, and alimony paid. The government wants to encourage you to do these things, so they allow you to reduce your income accordingly. When you add up all your adjustments, and subtract it from your total income, the result is your adjusted gross income, on line 37.
The back side of the form is where we get down to the nitty gritty – how much tax you actually owe. But before you do, you get another chance to reduce your income. The government allows a “deduction” to your income. The standard deduction is $5,450 for an individual, or $10,900 if you are married and filing a joint return. Or, if you think you have more deductions available to you than the standard deduction, you can itemize your deductions. Things you can itemize include mortgage interest paid, and gifts to charities. Again, the government wants to encourage you to do these things, so it lets you lower your tax bill if you do. If your total itemized deductions are greater than your standard deduction, then it makes sense to itemize. You enter your deduction on line 40, your exemptions on line 42, subtract both of those from your adjusted gross income, and the result is your taxable income, shown on line 43.
The amount of tax you owe is a percentage of your taxable income, but must be calculated from one of the tables or forms specified on the 1040. Once you know the number, it goes on line 44.
But don’t panic yet. You can subtract from your tax certain credits for child care, elderly care, and education. Read about these credits carefully. Since credits directly offset your tax, dollar for dollar, you don’t want to miss any credits you are entitled to. After subtracting credits, and adding self-employment tax, your total tax is shown on line 61. But it’s still not time to panic.
In lines 62-70, you add up the amount you have already paid to the government. The largest part of this is usually the withholding shown on your W2, or your quarterly payments, if you are self-employed. The government requires your employer to send in a portion of your paycheck every they pay you. This insures the government that they will get your money. Your total payments is listed on line 71, and hopefully, this amount is greater than your total tax. If so, you get a refund. If not, you may now panic – you have to pay more to the government. The government would rather owe you a refund than wait around with bated breath hoping you send in the extra you owe, so there will be an additional penalty if you didn’t have enough withheld.
So there it is, the 1040 in a nutshell. As always, I suppose I should tell you that I am not a professional, and this is not legal advice. But I think if you spend a few minutes looking at the 1040 and what each line means, you’ll learn a lot about yourself and your government.
Also, it turns out, accountants don’t like the term “shady”.
This article originally appeared in the January 28, 2009, edition of the Greenhorn Valley View.