University of Florida

It's Tax Time Again

Written Dec. 2006; edited Feb. 2008.


Paying taxes isn't fun, but it is required by law. The U.S. government spends money on many areas, such as city improvement, building and maintenance of schools, environmental protection, and national defense. The revenue that funds these programs comes primarily from taxes--sales, property, income, and others. The federal income tax is a major source of revenue.

Introduction

Ideally, your employer will withhold enough taxes during the year to meet the tax due. If you owe additional taxes, money must be available in your budget, or you will have to find another source of income to pay the additional tax. Check with your employer if you have questions about your withholding.

In order to achieve your goals and aspirations, it is important to take every opportunity to minimize your tax bill. Remember, you don't have to pay more in taxes than the law demands. Paying less in taxes by carefully planning and using the tax laws is wise and legal, but you must pay what the law requires.

Filing taxes is easier when you keep financial records. If the Internal Revenue Service (IRS) audits your return, you must be able to prove that your math is correct. The most acceptable forms of proof are your records and receipts--canceled checks, vouchers, sales slips, and statements of earnings, dividends, and interest. If you cannot back up your figures, you may be required to pay more taxes, as well as penalties and interest.

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Who Must File a Return?

Your filing status, age, and gross income determine whether or not you must file a return. For more information, check the 1040EZ, 1040A, and 1040 Forms and instruction booklets. If you did not receive any tax forms, visit the IRS Web site or call 1-800-829-1040.

Common Tax Forms

Forms 1040EZ and 1040A--intended for people making low to moderate incomes--are simpler and can be completed in less time and with fewer calculations. You can use these forms if you meet the specified guidelines found in the instruction pages.

In some cases, you may want to file the 1040 form even if you qualify to use the simpler forms. For example, if your charitable giving is greater than the standard deduction allowed on 1040EZ or 1040A, you can use a Schedule A with the 1040 Form to reduce your adjusted gross income. If you qualify for Head of Household filing status, using the 1040A or 1040 Form may result in a lower tax than the 1040EZ Form's Single filing status.

Advantages of Filing

If your income is very low, you may not have to file an income tax return. However, it may be to your advantage to do so. If an employer has withheld from your wages more taxes than you owe, you must file a return to get that money refunded.

A tax advantage for low and moderate income workers called the Earned Income Tax Credit (EITC) reduces the taxes you owe. If you qualify, you may receive a refund even if no tax was withheld. Check with your employer to see if you are eligible for this benefit.

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Tax Terms to Know

Filing Status

A taxpayer's filing status is determined by his or her marital status on December 31 of the tax year. Married people can file one joint return or they may each file separately. Depending on specific circumstances, unmarried taxpayers may be classified as Single, Head of Household, or Qualifying Widow(er).

  • Head of Household. An unmarried person who paid over half of the cost of keeping up a home for qualified live-in dependents such as minor children or elderly parents.
  • Qualifying Widow(er). A person whose spouse has died during one of the previous tax years and who has a child living with her or him that can be claimed as a dependent.

Gross Income

It is important to know what is included in or excluded from gross income.

Taxable Income

Examples of taxable income include:

  • Wage/Salary. Your gross income includes wages, salaries, commissions, bonuses, tips, and income from second jobs. Generally, the IRS will not tax the cost of most fringe benefits. By January 31, your employer must give you a W-2 Form showing your total earnings for the previous year and the amounts withheld for taxes and other purposes. Attach a copy of your W-2 to your income tax form. If you are paid on a commission basis, your employer will send you a 1099 Form.
  • Unemployment Compensation. All unemployment benefits are taxable.
  • Interest Income. Most interest income, whether accrued or received by the taxpayer, must be reported as income. By January 31, the bank or other institution that holds your savings account will send you a 1099 Form showing your earned interest for the year.
  • Dividends. If you own stocks, you will receive a year-end statement of dividends paid to you either from your brokerage firm (if it holds your stock) or directly from the issuing company (if you hold the stock yourself).
  • Capital Gains and Losses. Capital gains or losses are your profits or losses from the sale of any property that you own and use for personal purposes or investments.
  • Rents. All income and expense records for rental property that you own--such as taxes, interest, and depreciation--should be kept separate from records for property that you use yourself.
  • Pensions. At the end of the year, your pension fund trustee will send you copies of the W-2P Form for pension and certain other periodic payments or the 1099-R Form for lump sum distributions. You may receive either or both forms. In addition, your former employer will send you annual statements breaking down benefits paid to you in taxable and non-taxable portions.
  • Alimony. Alimony is taxable as regular income.
  • Child support. Child support payments are neither taxable (if received) nor deductible (if paid).
  • Social Security. A portion of your Social Security benefits may be taxable. Check the instructions on the 1040 Form for details.
Non-taxable Income

Non-taxable income does not have to be reported. Examples of non-taxable income include:

  • Child support payments received
  • Life insurance death benefits
  • Divorce settlements (lump sum)
  • Money from lawsuits for accidents
  • Gifts and inheritances
  • Workers compensation
  • Income from municipal bonds
  • Value of food stamps
  • Proceeds from sale of personal items sold for less than purchase price, such as iname garage sales
  • Veteran benefits
  • Part of Social Security benefits
  • Employer-provided benefits, up to specific limits
Adjusted Gross Income

You can deduct some expenditures--such as moving costs--from your gross income. These deductions are called adjustments to gross income. You can determine your adjusted gross income by subtracting your adjustments to income from your gross income.

Examples of adjustments to gross income include:

  • Contributions to qualified retirement plans such as IRAs, Keogh, or SEP
  • Moving expenses (restricted)
  • Alimony paid
  • Half of self-employment tax
  • Penalty for early withdrawal of CDs
  • Medical savings account deduction
  • Self-employed health insurance deduction

Deductions

Deductions are expenditures that you made during the year that can be subtracted from your adjusted gross income. The tax laws specify which expenses are deductible.

Here are some examples of tax deductible expenses which may be itemized on Schedule A.

  • Mortgage interest
  • Gifts to charity
  • State and local income taxes
  • Property taxes
  • Job expenses (restricted)
  • Medical expenses (restricted)
  • Casualty and theft losses (restricted)
Standard Deduction

If you--like many taxpayers--do not have a large amount of deductible expenses, you should use the standard deduction shown on each tax form. The amount of the standard deduction depends on your filing status. The standard deduction increases if you (and/or your spouse) are blind or at least 65 years old.

Personal Exemptions

Although it may seem time-consuming, find out whether taking the standard deduction or itemizing your deductible expenses will result in a greater deduction. You can deduct a personal exemption for every person in your household who can be claimed as a dependent, including you and your spouse.

If an individual is eligible to be claimed as a dependent on someone else's return, he or she cannot take a personal exemption on his or her own return. For example, a child who is claimed as a dependent on a parent's return cannot claim a personal exemption against his or her own income.

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Income Tax Rates & Computation

Tax Brackets

Currently there are six basic income tax rates: 10%, 15%, 25%, 28%, 33% and 35%. These rates are called tax brackets. Your tax bracket is determined based on your taxable income and your filing status.

Tax brackets are often misunderstood. An increase in your taxable income that pushes you into a higher tax bracket does not result in a lower "take-home" income. Tax rates are applied in income steps, so only the additional income is taxed in the higher bracket, while the lower part of your earnings is taxed at the lower rate.

Most people do not have to compute taxes themselves. Instead, they can use the tax tables provided with the tax forms to determine how much they owe. These tables have been calculated using the procedure discussed above.

Credits

After determining your tax, you may find that you qualify for additional credits, such as child and dependent care expenses, credit for the elderly or disabled, and/or adoption credit. Credits are deducted dollar for dollar from taxes due.

Other Taxes

Depending on your sitution, other taxes may be added. These taxes may include self-employment tax, Social Security and Medicare, tip income not reported to the employer, tax on qualified retirement plans, advanced Earned Income Credit payments, and household employment taxes.

Final Calculations

After you deduct any credits and add any other applicable taxes to the computed tax amount, deduct the withholding payments found on your W-2 form(s) and Earned Income Tax Credits (if you qualify) to calculate the amount of tax you must pay or the refund you will receive.

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Keeping Records

Be sure to keep all the records that you used to file your income tax return. If the IRS audits a return, they will ask to see these records.

Income Records

  • Keep your copy of all the W-2 or 1099 forms you and your spouse received from employers for wages, salaries, commissions, bonuses, and tips.
  • Unemployment compensation statements or check stubs.
  • 1099 forms for interest or dividend income received.
  • All records to verify capital gains or losses.
  • Records of income and expense for rental properties. Keep separate from your home.
  • Annual statements from pensions and/or Social Security.
  • Statement of alimony received.

Expense Records

  • Year-end statements that show interest paid on your mortgage.
  • Receipts and canceled checks for charitable contributions.
  • Receipts for taxes paid--real estate, state, and local income taxes.
  • Receipts for qualified medical expenses, job-related expenses, and casualty and theft losses.

How Long to Keep Records

Keep a copy of your records until the statute of limitations for the return expires; usually three years from the date the return was filed or due.

Save canceled checks, insurance claims, travel diaries, receipts, sales slips, invoices and medical bills for three years.

Some records should be kept permanently. These include complete copies of previous tax returns, proof of when you bought and sold investments, all records of real estate or personal property, and divorce decrees or separation agreements that justify alimony or child-support payments.

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Minimizing Your Taxes

  • Take advantage of the Earned Income Tax Credit if you qualify.
  • Take advantage of employer-provided benefits.
  • For home owners, interest paid on a mortgage and real estate taxes are deductible.
  • Contribute to your retirement by contributing to an Individual Retirement Account. Contributions may qualify as adjustments to income. Remember, ROTH IRAs earnings are tax free.
  • Take advantage of the tax credit available for day care for dependents if you qualify.

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Preparing Your Return

You can easily complete your return by yourself if you keep good records and your financial activities are not complicated. If you do need help, free assistance is available.

Do It Yourself

The IRS provide many free resources.

  • IRS Office. Advice, forms, instructions, and help filling out forms.
  • IRS Web Site. Forms, instructions, publications, and educational material.
  • IRS Advice Hotline. 1-800-829-1040.

Libraries can provide forms, instructions, and publications. You may also be able to photocopy or print many other publications or forms from a CD-ROM or the Internet. In some communities, free help may be available from trained volunteer groups such as the AARP Tax-Aide group.

Tax preparation software is available at local computer retailers, discount stores, and various Web sites. Some sites may offer software or online programs for free or at very low rates. Be sure that you are using a trustworthy service recommended by the IRS.

Commercial Tax Services

If you decide you do not want to prepare the return yourself, commercial tax services are available. Their fees may range from $30 to $150 or more, depending on the complexity of the return and the qualifications of the tax preparers. You can ask for a general estimate, or you can take all of your records to the preparer's office and ask for a firmer quote.

Be sure to ask what liability the preparers will assume. For example, find out if they will pay any penalties and interest if they make mistakes. Verify that the preparers are licensed to fill out the return.

Be wary of tax preparation services that promise a quick refund. The fee that you pay for this service can be substantial. The quick refund is often a loan made to you that is secured by your tax refund. These loans are not cheap!

Also be wary of firms that promise or guarantee a refund. No reputable tax preparer can promise a refund before they have looked at your individual records. If a tax preparer cheats on your behalf, you are still responsible! Having someone else--even the IRS--complete your return does not relieve you of the responsibility for the accuracy of your return.

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Ways to File

You can file your taxes as soon as you have all the necessary documents. The short turn-around time of refunds--usually two to five weeks--can help you avoid rapid refund anticipation loans, which often have high interest rates.

Mail

Complete your return and mail it to the IRS in the envelope provided. If you lose the envelope or your paperwork won't fit, use your own envelope and send it to the address for your state found in the instruction manual.

Electronic Filing

If you have a modem, computer and tax software, you can e-file your return from home. Using a tax transmitter, you can file 24 hours a day, seven days a week. A tax transmitter may charge a fee for transmitting your return.

Some employers or financial institutions offer e-file services free or for a small fee to their employees or customers.

You can have a professional prepare and transmit your return electronically, or you can prepare your own return and have a professional transmit it. Look for the "Authorized IRS e-File Provider" sign. Tax professionals may charge a fee, which can vary depending on the professional and the services. Be sure to ask what the fee is before you request the service.

Phone

If you received a TeleFile Tax Package in the mail, you are eligible to file your return by using your Touch-Tone phone.

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Splitting Your Refund

In past years, taxpayers could choose between having their refund deposited directly into a checking or savings account or receiving a paper check in the mail. Now you have more options and flexibility for choosing how to receive your federal income tax refunds.

You can opt to have your refund deposited directly into up to three different accounts, such as checking, savings, and retirement. The splitting option makes it easier to increase your savings or retirement account balances. Refunds directed into savings and checking accounts usually arrive within two to five weeks.

To take advantage of the split refund option, you must file Form 888. This simple form allows you to indicate how you would like your refund to be split and the account numbers to which the funds should be deposited. Form 888 is then attached to your 1040 form. If you do not want to split your refund, you do not need to file Form 888.

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IRS Resources & Features

  • 1040 Central. Find the forms, tools and publications that most taxpayers will need to prepare their taxes this year.
  • Free File. If you have an adjusted gross income under $50,000 a year, you may be eligible to file your taxes online at no cost!
  • AMT Assistant. If you are not using software to complete your taxes, this handy calculator will help you determine whether you should pay the alternative minimum tax (AMT).
  • EITC Assistant. This tool assists you in finding out whether you are eligible for this valuable tax credit.
  • Where's My Refund. If you are waiting on a refund, you can trace it online.

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Compiled from:

Federal Income Tax Management (FCS7026) by Josephine Turner, Nayda I. Torres, Horacio Soberon, and Vervil Mitchell. Published by: Department of Family, Youth and Community Sciences (rev. 10/2005).

The IRS Opens 2006 Tax Filing Season by Josephine Turner. Published by: Department of Family, Youth and Community Sciences (rev. 1/2007).

Split Tax Refunds by Josephine Turner. Published by: Department of Family, Youth and Community Sciences (rev. 1/2007).

Related Sites & Articles

IRS Resources