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Navigating the Form 1040 Federal Income Tax Return

Many taxpayers dread the thought of having to compete federal tax returns.  While our tax laws can be a bit complicated, the Form 1040 and Form 1040 instructions actually do a pretty efficient job in helping taxpayers navigate these laws.  Understanding the structure of the Federal Income Tax Form 1040 goes a long way in demystifying our federal tax laws.

In general the Form 1040 Federal Income Tax Return is structured as follows:

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Items of income

Above the line deductions

Adjusted gross income or AGI

Below the line deductions

Taxable income

Tax rate

Tax credits

Tax withholdings

Tax refund or tax liability

Items of income include employment wages, self-employment income, interest, dividends, rents, royalties, and other income that is received during the year.  These items of income will be entered on the first few lines on the Form 1040, but other items must be listed and tallied up on supporting schedules and then the tallied up total is listed on the first few lines of the Form 1040.  For example, most stock gains are tallied up on Schedule D and business or rental earnings are tallied up on Schedule C or E.

The above the line deductions include deductions for contributions to health savings accounts, tax deductible retirement plans, one half of self-employment taxes for self-employed individuals, etc.  These above the line deductions relate primarily to business related deductions.

Adjusted gross income or AGI is simply the produce left after subtracting the two numbers listed above.  AGI is the measuring mark that is used by various tax code limiting provisions, such as the limitations on contributing to a tax deductible IRA or deducting student loan interest.

The below the line deductions consist of an exclusion amount and the standard or itemized deductions.  The exclusion amount is just a number that each individual is able to deduct each year based on the number of exclusions that the taxpayer can claim.  An exclusion is simply the number of persons that the individual supports.  For example, an individual would only get one exclusion.

Taxpayers have a choice between the standard deduction or taking itemized deductions.  Both of these deductions relate to personal deductions (i.e., non-business deductions).

The standard deduction is a set amount that varies each year, which represents a guess at what an average taxpayer would be entitled to deduct if he or she itemized or listed out each deduction.

The itemized deduction is simply a total of all deductions that the taxpayer is entitled to.  Taxpayers use Schedule A to tally this total.  There is an AGI-based limit on how much itemized deductions a taxpayer can claim.  The alternative minimum tax (AMT) can also limit these deductions.   The AMT is simply a process of adding back these deductions if certain criteria are met (the AMT is not listed in the chart above).

Taxpayers who have medical expenses, mortgages, charitable contributions, or high investment advisor fees usually have a higher itemized deduction than the standard deduction.

The taxpayer’s taxable income is simply the taxpayer’s AGI less these below the line deductions.

The taxpayer’s tax rate is found in the annually published IRS tax tables, and it is based on the number of exclusions and the taxpayer’s taxable income.

The result is the amount of tax that the taxpayer has to pay.  The amount of tax refund or tax liability is reached by subtracting the amounts withheld by employers or remitted quarterly to the IRS for self-employed or independently wealthy persons.

This is the broad overview of the Form 1040 Federal Income Tax Return.  This relatively simple structure helps taxpayers navigate well over one million pages of tax law.  Understanding this form can help taxpayers complete current tax returns and it can help taxpayers understand how to start structuring their tax affairs to increase next year’s federal tax refund or to minimize next year’s federal income tax liability.

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