Thursday, November 26th, 2015

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Tax Forms & Deductions, Deferrals, Credits


Learn to Fill out the Basic Tax Form

Now it’s time to get our hands dirty. Let’s talk about actually filling out a tax return. So what form do you choose, 1040, 1040A, 1040EZ? The basic form for individual taxpayers is the Form 1040. The other forms are just variations, some are easier and some are harder. For now, unless you are self-employed, you can ignore all of the other tax return forms. If you are self-employed you will be using a Schedule C in addition to your 1040.

The easiest Form is cleverly titled Form 1040EZ (see, even the IRS can have a little fun). Certain restrictions limit who can use this form, but essentially it is for people who make less than a certain amount of income and have limited deductions. The Form 1040A is more complicated, but only a little. There are not as many restrictions on this form as the 1040EZ, but there is still an income limit, a smaller lists of credits that can be taken and a select list of income sources (such as wages, pensions, etc.). For most recent graduates, the 1040EZ or the 1040A will be the most appropriate. The longest form is the regular Form 1040.  It is definitely the most complicated of the three, but there are no restrictions on who can use this form. If you are going to take itemized deductions (such as mortgage interest), or if you make above a certain amount of income, you must use this form.

Now you have to decide if you are filing as single, married filing jointly, married filing separately or head of household. If you are single and you have a child and you meet certain other criteria, you may be able to file as head of household. This is by far the most lucrative status, as far as taxes are concerned. If you are single and you have no children or you do not meet the requirements for head of household, you must file as single. If you are married, you must decide whether to file separately or file jointly. Joint filers simply add their incomes together and use the married filing jointly column on the tax tables to determine their tax. Taxpayers who are married filing separately simply fill out two separate tax returns, one for each spouse.

Of course, if you file married filing separately you cannot both claim the same deductions. For example, if you have one child, you can’t file separately and each claim the same child as a deduction. It almost always costs more in taxes to file as married filing separately. Sometimes if you have large medical expenses or some other type of similar deduction that has an income floor, it may pay you to file separately. Also, if one spouse makes more than twice what the other makes, it may pay to file separately. In many cases if a couple is separated, but are not yet divorced, they will each file separately. If you are unsure which way you should file, fill out the tax return both ways and see which way costs the least amount in taxes. You can always switch the following year if necessary.

Before you fill in your income, let’s define a few key words.

 Total Income – Also called Gross Income, includes all of your income from your job, small business investments, interest or dividends received, etc.
 Adjusted Gross Income (AGI) – Total Income, minus certain deductions, such as 401(k) or IRA contributions. Your AGI is used to determine your eligibility for certain credits and deductions.
 Taxable Income – AGI minus certain other deductions and personal exemptions. Your Taxable Income is used to calculate your tax liability or Total Tax. You look up your Taxable Income on the tax tables to see what you owe.

Okay, so you have to fill in your Total Income. You should at least be happy for a moment as you see how much you made for the year (until you start wondering where it all went). From here you will take out your deductions and calculate your AGI. Now you get to take your personal exemptions, which includes yourself, your spouse (if you are married filing jointly) and your children (pets do not count). For a brief moment it actually feels like getting married and having children were good ideas (financially speaking, of course).

Your next calculation will tell you what your Taxable Income is. If you compare this number to your Total Income you will definitely feel somewhat relieved. Refer to the tables in your taxpayer instructions and see how much tax you should have paid for the year.

Essentially you look and see which column to use (single, head of household, etc.) and follow that column down until you find the range that has your taxable income. Find your taxable income on the table (it will be within a range) and line it up with your filing selection and see what your taxes owed will be. Write this amount in the Tax Owed box and subtract that amount from what you paid. If what you paid is a bigger number than what your liability is, you will get a refund! If it is smaller, you will owe. It is really that simple.

I would recommend using a spreadsheet if possible, or at least a calculator. A spreadsheet is better because you can see exactly what you entered, which is important if you make a mistake somewhere.

A word of caution: If you owe tax dollars, do not pay with a credit card. I repeat, do not pay your taxes with a credit card. Even if you always pay your card off at the end of each month you are still losing out. If you remember from the credit card chapter credit companies receive a small percentage of each transaction. The IRS will not allow them to receive this percentage, which means you will have to pay it. Essentially you will have to pay an additional 2% on your taxes. It might not seem like much, but money is money. And it is doing you a whole lot better in your pocket than in some bank’s vault. If you owe $500 in taxes, you will pay an additional $10. That’s $10 that you could use for something better. Just have the money taken directly out of your checking account or send a check.

Deductions, Credits and Deferrals

So, what’s the difference between a deduction, a credit, and a deferral? Well, they are all three completely different, but they have one thing in common. They all reduce your current tax bill. Next to earning less money, the only way to pay less in taxes (legitimately) is to use one of these three tax items.


Tax deductions are a great benefit. For instance, if you are eligible to take a deduction for business travel, it can help offset the amount of taxable income. You save an amount equal to your marginal tax rate times the amount of your deduction. For instance, if you have a $500 deduction and you are in the 25% tax bracket, you will save $125 (500 x .25 = 125). Deductions actually reduce your taxable income. If you made $40,000 and you have a $500 deduction, you will be taxed on $39,500 of income. Let’s say on $40,000 your tax liability would be $5,000. Then, your tax liability, after the $500 deduction would be $4,875, since you are only taxed on $39,500.

The most common deduction is the standard deduction (discussed earlier). If you choose to itemize your deductions, the most common is the mortgage interest deduction. You can also deduct certain business expenses, as well as medical expenses, interest paid on student loans, taxes paid, certain charitable contributions, certain job expenses, losses from theft or destruction, and many other miscellaneous expenses. They are all restricted based on certain IRS rules. For more information refer to IRS Publication 17.


Credits are even better than deductions. A credit actually reduces your tax liability dollar for dollar. For instance, using the above example, if you made $40,000, your tax liability would be $5,000. If you can take a $500 tax credit, your taxable income would still be $40,000, but your tax liability would only be $4,500 ($5,000 – $500 = $4,500), because a credit directly reduces your tax liability, not just your taxable income!
Some of the common credits include the Child and Dependant Care Credit, Child Tax Credit, Earned Income Credit, and the Adoption Credit. For more information on credits, see IRS Publication 17.


Deferrals are very similar to deductions. They operate in the same way, by offsetting your taxable income. The most common type of deferral is by contributing to an IRA or 401(k) retirement account. Using the above example again, if you made $40,000, and contributed $2,000 to your 401(k), your taxable income would be $38,000, and your tax liability would be reduced by $500 ($2,000 x .25 = $500). Your total tax liability would be $4,500, instead of $5,000. The reason it is called a deferral is because you will pay taxes on this income when it is distributed from your retirement account years from now. In other words you are deferring these taxes until later.

Explore the filing options, including electronic filing and paid preparers

Perhaps some of you noticed that your parents paid someone else to handle their taxes. Maybe math just isn’t your thing, and you’d rather have someone else do the calculations for you. Before you pay someone else, consider your other options. You could purchase tax software, which is very easy to use, or you could prepare your taxes yourself.

Assuming that your taxes are not very complicated, you could just file them yourself. What do I mean by not very complicated? Well, let’s say that you just graduated from college, you do not have any investments, other than your 401(k) at work, you did not inherit any money this year and you do not receive any money from a trust (wouldn’t that be nice).

If that sounds like you then there is no reason to pay someone else to do your taxes. You can complete them in less than one hour. All you will need will be your W-2 (if you had more than one job then you should have a W-2 from each employer), a statement that says how much interest you paid in student loans, if you have any (Sallie Mae borrowers can log onto their website and print a form that states how much they paid in interest) and your bank account statement that shows how much interest you earned this year. Other than that you will fill in a few extra lines on your return (personal exemption, standard deduction amount, etc.) and you are done. If you’re lucky, you’ll be getting a refund.

If you have a somewhat more complicated tax return, you may want to buy a tax preparation software program such as TurboTax or TaxCut. Once you install the program (either one) you will be asked questions, such as “Did you have medical expenses this year?” As you go through answering the questions, the software will fill in your tax forms for you. The next thing you know, you’ll have a completed tax return with the option to e-file or to print the return and file by mail.

I suggest using e-file only if you can send in for the rebate, so that it does not cost anything. Otherwise just print and send in the return by mail. If you e-file, and you are eligible for a refund, it will be deposited in your account in about 10 days. If you send your payment by mail, and request a direct deposit, it may take an additional five to seven business days. If you mail the payment and ask for a check to be sent, it could take about one full month before you get your refund. Most states also allow the state tax return to be electronically filed on the state website. You do not need any software, as the data can be input directly onto the website.

If you are still uncomfortable, and you would prefer to have a professional look at your taxes, you have several options available. Whatever you decide, this will be the most expensive option. Of course, if your preparer helps you find deductions or credits that you would have missed on your own, it may actually pay you to hire a professional to do your taxes. You are probably wondering what type of professional you should use and how much you should pay.

First, let me tell you that the more work you do on your own; the more it will save you. Most professionals charge by the hour, which means if you have all of your receipts and paperwork organized and ready, you will save money. If your tax preparer has to call you up or have you come back to the office several times to deliver more tax relevant documents, you will be wasting your own time and your own money.

With that said, let’s consider your options. If you have a relatively simple return then you could use a chain preparer such as H&R Block or you could use an independent tax preparer. If your return is more complicated, you could use a trusted independent preparer or an accountant. If it is really complicated, such as business income or difficult issues that deal with estate and inheritance taxes, then I would recommend an attorney, an accountant or an enrolled agent. An enrolled agent is certified by the IRS (by passing certain exams) and is allowed to represent you during an audit (not that you should need one).

Whatever you decide, there are a few things I need to warn you about. Many of the chain tax preparers will try to persuade you to take your refund with you the day they file your taxes, either by a refund anticipation loan, or some other “product.” This really is a waste of money. After all, you will be getting your refund in about a week to 10 days if you file electronically and have your money direct deposited. You are basically paying them to let you borrow your own money for a few days… and you are paying them quite well. They try to feed on the fact that any money coming back to you is “unexpected” or “unbudgeted” income. They figure, and unfortunately they are right in many cases, that a person who is expecting a refund doesn’t consider that the fees they paid cost anything because they are still getting money back. If you are due a $250 refund and they charge you $25 to pay you $225 right away, you may just be happy you got $225. Don’t be “swindled” out of your other $25. Just thank them kindly and wait until the money shows up in your bank a few days later. Then buy yourself a steak dinner or something; it’s your $25.
Also, avoid any type of loan where they pay your tax bill (assuming you owe), if at all possible. Keep in mind that you have until April 15th to pay the money owed, no matter when you file your return. Also, if you are in bad financial shape, consider an offer in compromise. This is not for everybody, but there may be circumstances where you just can’t come up with the taxes owed. Refer to IRS Form 656. Contact the IRS at 1-800-829-1040. Borrowing money to pay your taxes is just a double strike against your finances. Taxes are bad enough without paying extra fees or interest charges on top of what you already owe.


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