Now that we’re past the tax deadline of April 18, you may be tempted to throw your tax return into a drawer or folder and not think about your taxable income or deductions until next year. But now is the best time to look over what you filed and think ahead. Brian walks listeners through the 1040 tax form, so you can catch mistakes before it’s too late and start planning for next tax year.
Part 1: Personal information
This is the place to make an excellent first impression. Missing your name, address, and social security number will get you rejected immediately. Make sure your filing status and dependents are correct. The definitions generally focus on your status as of the last day of the last year, and if multiple options apply, pick the one that’s best for you.
This section of the 1040 tax form also has two checkboxes. The first asks if you’d like to contribute $3 of your tax money to the presidential election campaign fund. The second asks about digital assets, such as cryptocurrency, and it’s important to not skip.
Part 2: Gross income
Gross income is pretty much anything and everything you’ve earned. Just some examples listed in IRS Code Section 61 include earnings from fees, commissions, fringe benefits, business gains and dealings, property interest, rent, royalties, dividends, alimony, annuities, and pensions.
Importantly, gross income doesn’t just include cash. For example, exchanging legal services or dental services is also part of your gross income.
Part 3: Above-the-line deductions
Once you have your gross income, it’s time to make some adjustments, deductions, and allowances to figure out the final amount you owe the government. Figuring out your taxable income can be complicated — after all, the tax code is 74,000 pages long. Use the income documents you receive, such as W-2s or NEC-1099s, and any tax software to guide you. Reading the form details can also be surprisingly helpful, and the IRS provides a guidebook called Publication 17.
In the tax world, there are two types of deductions: above-the-line deductions that reduce your total income and below-the-line deductions that reduce your taxable income. There are a lot of adjustments you can make, so take time to read through and figure out which ones apply to you.
Most people can access the above-the-line adjustments if they have a qualifying expense. You can find a list of your adjustments on Part 2 of your Schedule 1, the same document you use to identify additional income sources.
Part 4: Below-the-line deductions
Your gross income minus the above-the-line deductions becomes your adjusted gross income (AGI). Now it’s time to look at the below-the-line deductions to get to the final taxable income figure.
Take a look at the standard and itemized deductions. The standard deduction is the standard amount you can subtract from your AGI based on your filing status. Alternatively, you can deduct itemized deductions if the total adds up to more than the standard deduction. Itemized deductions appear on your Schedule A and include medical and dental expenses, interest paid on your mortgage or mortgage insurance, gifts to charity, casualty and theft losses, certain taxes, and more.
If you’re a business owner, the qualified business income deduction allows the owners of sole proprietorships, partnerships, S-corporations, and some trusts and estates to deduct up to 20% of their qualified business income (QBI).
Part 5: Other taxes
Once you’ve subtracted your below-the-line deductions from your AGI, you have your taxable income. From your taxable income, the IRS uses its tax tables to determine how much tax you need to pay on your income.
The 1040 also has a line for other taxes. Several additional taxes that may need to be paid, such as the alternative minimum tax, which is an alternative form of taxation that applies to some taxpayers.
Part 6: Credits and payments
The last way to reduce your tax involves taking tax credits. While a deduction reduces your taxable income, a tax credit has the advantage of deducing your tax liability dollar-for-dollar. Also, some tax credits are refundable, so even if your credit exceeds your tax liability, you get the excess back.
Credits include the foreign tax credit, the child and dependent care credit, education credits, retirement sayings credits, adoption credits, alternative motor vehicle credits, and residential energy credits. The Schedule 3 form provides more information about the qualifications and restrictions of credits.
Once you have your total tax, whether you get a refund from the government or owe tax money depends on payments made throughout the year through withholding from an employer and estimated tax payments.
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About Brian and the Mission Driven Business Podcast
Brian Thompson, JD/CFP, is a tax attorney and certified financial planner who specializes in providing comprehensive financial planning to LGBTQ+ entrepreneurs who run mission-driven businesses. The Mission Driven Business podcast was born out of his passion for helping social entrepreneurs create businesses with purpose and profit.
On the podcast, Brian talks with diverse entrepreneurs and the people who support them. Listeners hear stories of experiences, strength, and hope and get practical advice to help them build businesses that might just change the world, too.