Those dealing with income taxes only once a year when involved with their own personal tax return often have questions related to tax terminology. The following is a compilation of questions frequently asked by individuals:
What is Filing Status? – Everyone that files a tax return must use one of five possible filing statuses. The tax status used dictates which tax rate schedule is used. The statuses include:
- Single (S) – Used if unmarried on the last day of the year and not qualifying for HH or SS.
- Married Filing Joint (MFJ) – Used if married on the last day of the year and the spouses choose to file together on one return.
- Married Filing Separate (MFS) – Used if married on the last day of the year and the spouses choose not to file together.
- Qualified Surviving Spouse (QSS or SS) – Used by a widow/widower whose spouse died in one of two prior years and who has a dependent child living at home.
- Head of Household (HH) – This is the most complicated of the filing statuses and the following is only an overview. For a single individual to claim HH, the taxpayer must pay more than half of the cost of maintaining a household, which is the principal place of abode for more than one-half the year for an individual that qualifies as their dependent, or half the cost of maintaining a separate household of a dependent parent for the entire year. A married individual can also claim this status instead of MFJ or MFS if they lived apart from their spouse at least the last six months of the year and paid more than half of the cost of maintaining a household for a dependent child.
When is an Individual Required to File? – Generally. an individual is required to file a tax return for a year if their income exceeds the standard deduction for their filing status for that year. Self-employed individuals also must file if their self-employment earnings for the year exceed $400, even if their income does not exceed the standard deduction. Special rules apply to certain children who have taxable income.
However, just because someone is not required to file a return does not mean they shouldn’t. They may have had tax withholding which they are entitled to have refunded by the government but they can receive the refund only by filing a return. They may qualify for refundable tax credits like the child tax credit and the earned income tax credit, which could be thousands of dollars. To get the benefit of a credit, a return must be filed.
What is AGI? – Adjusted Gross Income (AGI) is gross income minus adjustments to income that are permitted by the tax law. Gross income includes wages, dividends, capital gains, business income (before deductible expenses), retirement distributions as well as other income. Adjustments to income include such items as educator expenses, student loan interest, contributions to a retirement accounts and others.
Which is Better, Itemized Deductions or the Standard Deduction? – The standard deduction is an amount based upon a taxpayer’s filing status that they can deduct without substantiation. Itemized deductions, as the name implies, are listed out on a separate schedule of the tax return. Tax law requires records be kept verifying payment of the expenses claimed as itemized deductions. If the total of verified itemized deductions is more than the standard deduction, then the taxpayer uses the itemized deductions instead of taking the standard deduction.
What is a Tax Write-Off? Tax write-offs can be business expenses deductible on business returns or 1040 schedules, capital losses, adjustments to income on a 1040 including items like student loan interest, a limited amount of a teacher’s expenses, and some IRA, and pension contributions. Tax write-offs can also include itemized deductions, such as property and real estate taxes charged by state or local governments and state income taxes paid (subject to the SALT limitation discussed later), medical expenses more than 7.5% of AGI, home mortgage interest, charitable contributions, disaster losses, gambling losses to the extent of gambling winnings plus some other miscellaneous deductions. For an individual who is a resident of a state that has an income tax, the write-offs they may claim on their state return may not be the same as what is allowed on the federal return.
But be cautious of tax write-offs or other tax advice espoused by tax amateurs.
How is Taxable Income Determined? Taxable income is generally AGI less either the standard deduction or the total of allowed itemized deductions.
What is the Difference Between the Graduated Tax Rates and the Tax Bracket? The way individual tax is computed is like a step function (graduated tax rates): each additional block of taxable income is taxed at an increased percentage but does not increase the percentage that applies to the prior block. For example, for a single individual for 2023, the first $11,000 of taxable income is taxed at 10% and the next $33,725 is taxed at 12%, etc., until the maximum rate of 37% is reached. The graduated rates are inflation adjusted annually. An individual’s marginal tax rate is the highest tax percentage that the individual’s income is subject to. Knowing their marginal rate lets a taxpayer estimate the value of a tax deduction.
What is a Tax Credit? – A tax credit is a dollar-for-dollar offset against the tax liability. Some credits can only reduce a tax liability to zero and any excess is either lost or carried over to another year, depending on the credit. Other credits may be refundable, meaning if the credit is more than the individual’s tax any excess credit is refundable. Some credits are partially refundable.
Which is Better, a Tax Credit or a Tax Deduction? – As discussed in the previous question, a tax credit offsets tax dollar for dollar, whereas a tax deduction reduces the income that is subject to tax. Thus both being the same amount, a tax credit is better, especially if it is refundable.
What is an RMD? – The tax code requires that once individuals reach a certain age they must begin taking Required Minimum Distributions from traditional (not Roth) IRAs and certain other retirement plans. For 2023 the required starting age for required distributions is 73.
What Income Do I Have to Pay Taxes On? Generally, all sources of income after allowable deductions are taxable unless specifically exempt by the tax code. Examples of income exempt from federal tax include municipal bond interest, welfare, and all or a portion of Social Security income depending upon the taxpayer’s AGI.
What is the SALT Limitation? SALT is the acronym for State and Local Taxes (state and local income or sales tax, real property tax and personal property tax). State and local taxes are an allowable deduction when itemizing deductions. However, a few years back, Congress limited the SALT deduction to $10,000 per year ($5,000 for MFS filers).
What is an Information Return? Payers of certain types of income are required to advise the IRS of the amount paid to the income recipient for the year. This is done by the payers filing specified forms to the IRS with a copy to the recipient of the income. These filings are referred to as information returns. The IRS’s computers will match the amounts a taxpayer reports on their income tax return with what the payers have reported; thus this is a way of keeping taxpayers honest. Here is list of commonly encountered information returns.
- 1099-INT – Interest earned from investments.
- 1099-DIV – Dividends from stocks.
- 1099-R – Retirement income
- 1099-NEC – Income earned as an independent contractor.
Taxpayers may be the recipient or the required issuer of these and other forms of 1099s.
What is Basis? Basis is the value of an asset from which gain or loss is measured for tax purposes. In most cases basis starts with the amount that the taxpayer paid for the asset. A modified form of basis is “adjusted basis,” which is an asset’s initial basis increased by improvements and reduced by deductions for depreciation, expensing, casualty losses, etc.
Are Inheritances Taxable? Generally, no, unless the inheritance includes an item or items on which the decedent deferred income such as an IRA or installment note. However, if an asset is inherited its inherited basis is generally the asset’s fair market value on the date of the decedent’s death, which becomes the starting point from which a beneficiary begins tracking their adjusted basis.
Are Gifts Taxable? No, the recipient of a gift is not taxed on the value of any gifts they receive. However, if the gift generates income, the income is taxable. For example, if a grandparent gave their grandson $10,000 and he invested the money and earned interest on the gift amount, the interest would be taxable to the grandson. Each year an individual may give up to a specified amount, which for 2023 is $17,000, to as many other individuals as they wish. If the donor gifts more than the excludable amount, the donor will need to file a separate tax return reporting the gifts and may have to pay gift tax on the excess over the excluded amount.
Unlike inherited property whose basis is generally the property’s value on the date of death of the decedent, property received by gift retains the adjusted basis of the person who made the gift.
How Long Does It Take to Receive a Refund? Individuals receive refunds the quickest by e-filing their returns and selecting to receive their refunds via direct deposit. The IRS states officially that it “issues most refunds in less than 21 days, although some require additional time.”
When Are Individual Taxes Due? The due date for individual tax returns in the 1040 series is April 15th of the subsequent year. If you are out of the country on the April date, the due date is automatically extended to June 15th. The filing due date can also be extended until October 15 by filing the Form 4868, Application for Automatic Extension, on or before the regular due date. Caution: the extension is an extension to file a return, not an extension to pay any tax due, and interest and penalties will generally apply to any balance due.
Should a 15th due date fall on a weekend or holiday the deadline is extended to the next business day. Also, if you are in a Presidentially declared disaster zone the due date may have been extended.
What Are the Late Filing Penalties? The penalty for late filing is 4-½% per month of the tax due, with a 22-½% maximum. The late payment penalty is ½% per month until paid. There is also a minimum penalty where a taxpayer doesn’t file a return within 60 days of the due date. The minimum penalty is the lesser of 100% of the tax due or $450 for 2022 returns required to be filed in 2023.
What is Timely Mailing? If filing a paper tax return, it is highly recommended that a proof of timely mailing be obtained from the post office. Mailings dropped in a mailbox may not get postmarked timely and will cause penalties.
If you have questions or need assistance, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
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