The Cliff Notes of Form 1040

A lot of taxpayers use a paid preparer when filing their return. It doesn't hurt to understand a few basic rules about Form 1040.

First you need to determine if you have To file a tax return? Once you've done that let's look at the different sections of the tax return.

Filing Status
There are five filing status available. Married taxpayers can file together (Married Filing Jointly) or apart (Married Filing Separate). Single, Head of Household, and Qualifying Widower are filing statuses for unmarried taxpayers.



Exemptions
There are two types of Exemptions: (1) Personal and (2) Dependent. Each exemption is a deduction of $3,650 ($3,700 in 2011) on line 42 of Form 1040.

Generally, a taxpayer is allowed one exemption and for spouses filing together, they are allowed two exemptions. If your spouse died during the year, you can claim the exemption for the deceased spouse. If the taxpayer is a dependent on another person's tax return, he or she can not claim their personal exemption.

You are allowed one exemption for each person you claim as a dependent.

Income
If you are required to file a tax return, you must report all taxable income on lines 7 through 21.

Examples of taxable income include wages, salaries, tips, unemployment compensation, Self-Employment Income, interest, dividends, capital gains, retirement benefits, rental income, alimony and gambling winnings.

Social security benefits are taxable based your other income and filing status. The benefits could be tax-free or you may have to include up to 85% of the benefits in your gross income.

Examples of non-taxable income include deferred compensation, employee contributions to a 401(k) or similar employer retirement plan, SSI payments and child support payments.

Adjusted Gross Income
Adjusted Gross Income (AGI) is total income minus certain deductions called adjustments. Many tax benefits are based on a taxpayer's AGI. Some states including Ohio use AGI as the starting point of their income tax returns. Some of the common adjustments include: Traditional IRA deduction, Student Loan Interest Deduction, Tuition and Fees Deduction, Moving Expenses and Self-Employment adjustments.

Tax and Credits
Now that you've reached page two of the Form 1040, the next decision is to use the Standard or Itemize Deductions. Then subtract the deduction for your personal and dependent exemptions to determine your taxable income.

Your income tax (line 44 of Form 1040) is a percentage of your taxable income. If the taxpayer has qualified dividends or capital gains, you use the Qualified Dividends and Capital Gain Tax Worksheet to determine the tax. For most taxpayers, you will use the Tax Table or Tax Rate Schedules.

Not all of your income is taxed at the same rate. The Federal Income Tax Brackets are set up in tiers. The first tier is taxed at 10%, then 15%, until you reach the maximum tax rate. Being in a given tax bracket does not mean that all of your income is taxed at that rate. Rather, only the portion of your income that is in that bracket is taxed at that rate

When you hear people discussing tax bracket, they are referring to the marginal tax rate. Knowing your marginal rate is important, because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your marginal rate is 25% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $250 in Federal tax ($1,000 x 25%).

Once your tax is computed, tax credits can reduce the tax further. Credits are divided into two categories: those that are nonrefundable and can only offset the tax, and those that are refundable. Examples are nonrefundable credits are: Child and Dependent Care, Retirement Savings Credit and Residential Energy Credit.

Two kinds of credits are both nonrefundable and refundable: Child Tax Credit and Education Credits.

Other Taxes
Up to this point, Form 1040 is calculating income tax that a taxpayer owes the IRS. However, Form 1040 also is used to report other taxes such as: self-employment tax, social security and medicare tax on unreported tip income, tax on qualified retirement plans, including early distributions, advance earned income credit and household employment taxes.

Payments
Payments not only include withholding and estimated taxes but also refundable credits such as Making Work Pay, First Time Homebuyer and Earned Income Credit.

Most employers must withhold social security tax from wages. If you worked for two or more employers during the year, you run the risk of having too much social security tax withheld from your pay. You can claim the excess as a credit on line 69 of Form 1040.

Refund
This is the moment we've all been waiting for. Subtract line 60 from line 72 of Form 1040 and here is your refund. Taxpayers can choose to have their refund distributed by either (1) check mailed to their residence, (2) refund direct deposit by indicating their bank's routing and account numbers on line 74, (3) direct deposit into several bank accounts by completing Form 8888 Allocation of Refund, or (4) apply their refund to next year's estimated tax.