Anyone filing income taxes for the first time is likely to be at least a little nervous. Much has been made over the years about how complicated the system is, but great software is available to help, often for free, and tax professionals are usually very affordable for people who have common sources of income and expenses. Here are a few terms to understand before getting started.
What is taxable income?
Taxable income is the amount of earnings you took home after deducting eligible expenses. If you are filing with form 1040EZ, only the most basic deductions are withheld, with criteria generally based on aspects like whether or not you are married (filing jointly as a couple or single as individuals) or if you can be claimed as a dependent on someone else’s return. According to the Internal Revenue Service, one can file using 1040EZ if:
• Your taxable income is below $100,000
• Your filing status is single or married filing jointly
• You and your spouse – if married – are under age 65 and not blind
• You are not claiming any dependents
• Your interest income is $1,500 or less
If your finances are more complex, then form 1040 will allow you to itemize expenses, meaning you can list more specific items to write off, but you will also need to be more specific about any additional income you received.
Any deductions or earnings you claim will require a paper trail, so if in doubt, leave it out. Be sure to have receipts and mileage logs and anything else that can help verify income and expenditures.
What are brackets?
Tax brackets are defined income ranges and the tax percentage assigned to them. In other words, the percentage you will pay in taxes is based on how much you earned, or your income. This amount isn’t limited to wages, but can also include gifts, lottery winnings, dividends earned through stocks or bonds, sales made online through sites like ebay, or profit made from selling other property.
For example, in 2013, single filers (married or not) who earned up to $9,075, or someone who qualifies for head of household who earned up to $12,950 or a married couple who file jointly who earned $18,150 collectively will pay the lowest tax rate of only 10 percent. The next tax bracket for single filers is between $9,076 and $36,900, and they will pay 15 percent of their income in taxes. The next bracket charges 25 percent to single filers who earned between $36,901 and $89,350; more for married filers or head of household. The next brackets charge 28, 33, 35, and 39.6 percent for the highest earners. The IRS provides a simple worksheet based on a few questions to determine if you can file as head of household.
However, the taxes you will owe aren’t based on total earnings, they are based on adjusted gross income. This is the amount you made after you subtract eligible deductions.
Deductions a person is able to make on eligible expenses don’t reduce the amount owed; they reduce the amount of income claimed as having been earned. A base amount, called the standard deduction, is taken off the total income just for being a person, and the amount is higher if you have children or other dependents. After that, other eligible expenses can be subtracted to reduce the adjusted gross income.
For example, if your income after subtracting the standard deduction is $10,000 but you were able to claim expenses, such as eligible medical expenses of $1,000, then your adjusted gross income is $9,000, and you would pay 10 percent in taxes on that amount if you are a single filer or head of household. If you made more than $9,075 as a single filer after adjustments, you would owe 15 percent of your income in taxes.
Deductions can help you get into a lower tax bracket, but that is only likely if you are close to a threshold already. However, the more you reduce your adjusted gross income, the less you will have to pay. Chances are that you’ve already paid something toward your taxes.
Taxes already paid
Most people who are employed through a company as an employee, not a contractor, have wages withheld from their paychecks to go toward taxes. If you filled out a W-2 form when you first started working, and have had wages withheld from paychecks toward taxes, then this amount will also reduce what you owe.
Keep in mind you will need to file federal income tax paperwork, and most likely, other forms specific to your state. In larger municipalities like New York City, local city taxes will also need to be paid, but usually through state forms, which streamlines the process.
Help is available
A lot of this may sound confusing to new and old tax filers alike, but help is available. The IRS website www.irs.gov has a treasure trove of information available at no cost, and some tax preparation services online are available for free to qualified filers with certain income restrictions. Other online and desktop software is available, and will put you through a series of questions and do the difficult calculations for you for a small price tag. Meeting with a qualified tax preparer is also an ideal way to make sure you get the most deductions so that you’re not paying more in taxes than you really owe.