Here’s a confidence booster for all of you number-crunching antagonists: you don’t have to be a college educated tax expert in order to understand the line items on a tax return, nor do you need to wade through over 70,000 pages of tax law and code to calculate your tax benefits when you have sophisticated software like TurboTax at the tip of your fingers.
But you will need to be informed. After all, you’ll be paying taxes for the rest of your life if you’re a working professional. So, you want to make sure you have a basic understanding of terms that you’ll hear multiple times during tax season.
Get ready to impress (or bore) your friends and family at the dinner table when you share these three useful tax terms:
Adjusted Gross Income
You won’t have a clue how much you have to pay in taxes until you calculate your adjusted gross income (AGI) and arrive at your taxable income number. Sorry, but if you’re looking to find your taxable income on your W-2 (for employees only) or Form 1099 (independent contractor or self-employed), you will be disappointed.
First, you have to take into consideration all of the money you have earned throughout the year that is subject to income tax. In addition to the earnings you receive at your full-time job, you must report your part-time work at Starbucks (even if it was only 10 hours a week), money you received from self-employment (your Uber driving income you received on the weekends count!), and the payments you receive from a former spouse (rest in peace relationship. Hello, Alimony!).
You can deduct contributions to a traditional IRA (up to a certain amount), un-reimbursed educator expenses up to $250 if you work in a school (teacher, principal, etc.), and that dreaded student loan interest that you’ll be paying.
If you want to make sure you are reporting all of your income that should be reported to arrive at your AGI–and more gratifying, taking advantage of all of your deductions or “adjustments”–log into your TurboTax account to obtain a list of items to consider. Your standard or itemized deduction is not included in the computation needed to determine your AGI.
Standard deduction
Tax returns reveal that 2/3 Americans choose standard deduction over itemized deductions. Why? Standard deductions are quick, simple, and don’t require any convoluted number crunching. All you must do is determine your filing status (head of household, single, married filing jointly, married filing separately, or qualifying widow[er] with dependent child) and then look at the IRS allotted standard deduction amounts that fall under your filing status category for the current year.
Here are the standard deduction amounts for 2016:
· Head of Household - $9300
· Married Filing Jointly or Qualified Widow[er] with Dependent Child -$12,600
· Single or Married Filing Separately - $6300
How does the standard deduction work?
Let’s say that you are filing your taxes as a single person and your gross income is $100,000. According to the IRS deduction benefits listed above, your standard deduction is $6300. This is the amount of your income that will not be taxed. So you can rest peacefully knowing that $6300 of your income is all yours to keep. If you do the necessary calculation, you would only be taxed on $93,700.
Tax Credits
Don’t confuse tax credits with tax deductions. It’s like saying that Chicago style deep-dish pizza is the same as New York’s famous thin crust pizza–and this is a mistake you don’t want to make.
Deductions exist in order to reduce the amount of money you are taxed on. For example, if your income is $100,000 and you qualify for a $6300 standard deduction as a single person, you will be taxed on $100,000 - $6300 = $93,700. If your effective tax rate is 20%, then instead of paying 20% of $100,000 (i.e., $20,000) you can take the deduction and only pay 20% of $93,700 ($18,740). The $6,300 standard tax deduction moves you from paying $20,000 in taxes to $18,740 in taxes, saving you $1,260.
Here’s what you should know: Credits are often more financially rewarding than deductions. A deduction may reduce your tax by only about 25% while each dollar of a tax credit reduces your tax by a dollar.
If you don’t remember anything else, just make sure you file your taxes by the deadline if your income amounts require you to file a return. For 2017, the filing deadline is April 18th. If you don’t pay your taxes and owe the IRS money, the consequences can be costly.