An Overview of Form 1040

Most tax forms just look overwhelming, don’t they?  It can take a few minutes to get your eyes oriented to figure out what it is you’re looking at – not to mention the confusing language!

For those who use online return preparation tools or use a personal tax preparer, it might have been a while since you have actually studied a copy of your return. It may not be the most fun activity you could think of, but we encourage you to grab a copy of your most recent return and follow along. Understanding the gist of a basic tax return can go a long way to helping you know what to look for when you are thinking about saving on taxes.

Let’s take apart your average tax return and look at what is included, and what’s involved.  We’ll also discuss some key terms and concepts that you’ve probably heard before but may not have understood. A basic tax return usually involves two components: the Form 1040 and the accompanying schedules. If you want some more information on the basic schedules, check our recent article.

The Form 1040 is the main component of your tax return; it is also the tax form you are likely most familiar with.  It is your main dashboard for calculating your income tax liability.

You begin the form by accumulating your sources of income, whether W-2 wages, self-employment, pension income, etc. From there the form guides you through deductions and exemptions which reduce your income down to what is known as “taxable income”.

From “taxable income”, it is easy to determine how much income tax the IRS expects from you. After determining how much you may have already paid or withheld during the year, you then see how much you stand to pay or receive back as a refund.

Conceptually, it is not too difficult. But just below the surface lurks a little more complicated implications. Here are some key concepts built into the Form 1040 that you have probably seen and heard, but may not have understood.

Filing Status

The first questions on a 1040 relate to your filing status, which is essentially asking about your marital, family, and household situation. The most common filing statuses are “single” and “married filing jointly”. Some other options include “married filing separately” and “qualifying widow with a dependent child”.  Choosing the right filing status is crucial – they each have their own unique tax brackets.

Exemptions

To put it simply, an exemption is an amount that you can use to offset your taxable income. As long as you cannot be claimed as a dependent on someone else’s return, you are at least guaranteed one personal exemption to lessen your tax burden. You can also receive exemptions for qualifying children or dependents.

Adjusted Gross Income

Adjusted gross income, often abbreviated AGI, is one of the most important numbers on your tax returns. AGI includes income from all taxable sources minus certain specific deductions.  This line usually holds a prominent plan on the Form 1040 – it is often the last line on the first page. AGI matters because it is used to determine phaseouts for certain tax deductions and is used in certain calculations regarding Social Security benefits.

Deductions & Credits

Both deductions and credits lower your taxable burden, but they are not one in the same.

A deduction lowers your taxable income, while a credit lowers your actual tax bill; this means dollar for dollar a tax credit is much more valuable than a deduction.

It is important to remember that not all deductions are created equally. Some deductions only count after they have reached certain thresholds, other deductions are phased out if your AGI is too high, while others still can be capped.

Payments & Refunds

Payments and refunds are pretty simple. Based on what your tax burden is for the given year, and how much you have already remitted to the IRS, you may be entitled to receive some of the money back, or you may be on the hook to owe more than you expected. Obviously, one of those outcomes is preferable to the other.

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