Tax season can often bring anxiety or jubilation as you learn what your tax bill or refund could be. While taxes may seem daunting and confusing, we believe understanding the basic structure of the Form 1040 (for US federal taxes) can provide clarity and significantly ease the process. To help minimize the panic and stress, we’re going to walk through the Form 1040, focusing on the major sections. Our goal is not to provide tax advice (see a tax professional for that), but to simplify the form for a better understanding of how it operates and how it can work for you.
What is the 1040?
The Form 1040 is the primary form that U.S. taxpayers use to file their annual income tax return. It's used to calculate your taxable income and determine whether you owe taxes to the government or are entitled to a refund. There are a number of Schedules and additional Forms that can accompany the 1040 depending on your situation, but this review will only focus on the 1040. Included throughout the walkthrough below are screenshots of the specific referenced sections of the 1040 so you can follow along.
Understanding Key Terms
Before we dive into the 1040, we need to define two key terms:
- Deduction: This lowers your income before the tax is calculated. Assuming you have a $10,000 deduction and you’re in the 24% tax bracket, you will save $2,400 in taxes. The savings ultimately depend on your tax bracket.
- Credit: This lowers your tax liability after the tax owed is calculated. Assuming you have a $10,000 credit, you will save $10,000 in taxes, regardless of what tax bracket you’re in.
A Walk Through the 1040:
The 1040 is organized into several sections, each playing an important role in determining your tax liability. Let's explore the key components:
- Personal Information: This section gathers your basic information, including your name, Social Security number, address, filing status (single, married filing jointly, head of household, etc.), and information about your dependents. Accuracy is paramount here, as even small errors can cause processing delays.
- Income: This section reports all your taxable income from various sources. This includes wages, salaries, tips, interest income, dividends, capital gains, retirement income, and other forms of earnings. You'll need various tax documents like W-2s, 1099s, business income, and other forms to accurately report in this section. Some of these lines require additional schedules depending on the type of income you had throughout the year. The result is “Total Income,” as noted below on line 9 of the 1040.
- Adjustments to Income from Schedule 1: There are several “Above the Line” deductions that are reported on Schedule 1, and totaled in Line 8 on the 1040 (see above). These deductions can be important as they both lower your tax liability, as well as your Adjusted Gross Income (AGI). While not an exhaustive list, some of the most common are:
- Educator Expenses
- Self-Employed SEP, SIMPLE and qualified plan contributions
- Health Savings Account (HSA) Contributions
- Deductible part of self-employment tax
- IRA Deduction (if contribution was to Traditional IRA and AGI is under the income limit)
- Student Loan Interest Deduction
- Adjusted Gross Income (AGI): This number is considered “The Line.” This crucial figure is calculated by subtracting certain "above-the-line" deductions from your Total Income. Calculating your AGI is a critical step as it influences eligibility for certain tax credits and deductions. While not the final amount you’re taxed on, you should pay attention to this number!
- Standard Deduction or Itemized Deductions: After calculating your AGI, you can choose to take the standard deduction (a fixed amount based on your filing status) or itemize your deductions. Itemizing involves listing various eligible expenses, such as qualified medical expenses, state and local taxes, charitable contributions, and qualified mortgage interest. If the total of your Itemized Deductions is greater than your Standard Deduction, then you’ll want to itemize. If lower than the Standard Deduction, then you’ll use your Standard Deduction. The 2017 Tax Cuts and Jobs Act significantly increased the standard deduction, making it more common and advantageous for many taxpayers.
- Taxable Income: This is your AGI minus either the standard deduction or your total itemized deductions. This is the income amount that your tax liability is calculated upon.
- Tax Calculation: Once you've determined your taxable income, you'll use the tax tables or tax rate schedules provided by the IRS to calculate your initial tax liability. There are worksheets to use, but most tax software does it behind the scenes in real-time.
- Credits: As noted above, tax credits are a direct reduction of your tax liability, unlike deductions which only reduce your taxable income. Various tax credits are available, such as the child tax credit, earned income tax credit, education credits, and energy-saving credits. Carefully research which credits you might be eligible for, as they can significantly reduce what you owe or even result in a larger refund.
- Other Taxes: This section accounts for other taxes you might owe, such as self-employment tax, alternative minimum tax (AMT), or household employment taxes.
- Payments: Here, you'll report any taxes you've already paid throughout the year, such as withholding from your paycheck, estimated tax payments, or payments made with an extension.
- Refund or Amount Owed: The final calculation will determine whether you're due a refund or if you owe additional taxes. If you've overpaid, you'll receive a refund. If you've underpaid, you'll need to pay the remaining balance.
- Signatures: Finally, you'll need to sign and date your tax return. If you're filing jointly, both spouses must sign.
While tax law has become overly complicated, it can be helpful to simplify it. With this understanding you can hopefully approach tax season with less anxiety and stress. When it comes to completing the 1040 and filing your income taxes, we encourage you to work with a trusted tax professional to help you navigate these forms and file your tax return.
However, tax planning is also an important aspect of financial planning. Our objective is to help you understand how various strategies (deductions & credits) can impact your long-term financial plan. Please contact us if you would like to begin or reengage in the financial planning process to optimize your tax planning.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
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