Taxes 101: where to start
Tax matter can be complicated, but if you take it step by step they don’t have to be. With basic understanding of your tax situation and with all online tools available today, you can easily prepare and file your taxes yourself.
If you never filed your own taxes before, first, you have to decide what your filing status is. There are five filing statuses:
- Married filing together
- Married filing separately
- Head of household maintained for a child or other relatives
- Qualifying widow or widower (if your spouse died in the previous two years)
The filing status determines the tax rates that apply to your tax return. The most favorable tax rates apply to married filing jointly and qualifying widow or widower, then head of household and the least favorable apply to single and married, filing separately.
Depends on your income and filing status you are going to be in one of the six tax brackets: 10%, 15%, 25%, 28%, 33% and 35%. The bigger your income is the higher your tax bracket.
To calculate your tax liability you have to use the following formula:
- Deductions for Adjusted Gross Income
= Adjusted Gross Income (AGI)
- Greater of Itemized Deductions or Standard Deduction
- Personal Exemptions for you and your dependents
= Taxable Income
x Tax rate
= Tax Liability
- Tax credits and prepayments
= Tax due or Refund
Let’s decipher the formula.
Gross income is all income you received from any source: wages, bonuses, salary, dividends, lottery winning, tips, rents, royalties and so on. Gross income does not include tax-free benefits, tax-free insurance proceeds, gifts and inheritances and other exclusions allowed by tax law.
Deductions for AGI are sometimes called “business deductions” since most of the allowable deductions are business expenses. Some of them include:
- Moving expenses
- Rent and royalty expenses
- Health insurance premiums if self-employed
- Capital loss deduction
- Business expenses
- Alimony payments
- IRA contributions
- Student loan interest
Standard deduction is an “automatic” deduction you can take regardless of your expenses. The new standard deduction for 2011 is $11,600 for married couples filing a joint return, $5,800 for singles and married individuals filing separately, and $8,500 for heads of household. The additional standard deduction for blind people and senior citizens (65 years old and older) is $1,150 for married individuals, and $1,450 for singles and heads of household.
Itemized deductions include mortgage interest, charitable contributions, state and local taxes, medical expenses, miscellaneous expenses, and casualty losses.
Personal exemption is a reduction of your gross income that you are allowed to take for yourself, your spouse and your dependents. The value of each personal and dependent exemption in 2011 is $3,700. The deduction for personal exemption can be reduced or even eliminated for high-income taxpayers.
Tax credit is an amount that is subtracted from the taxpayer’s tax liability in a given taxable year. Tax credit is different from tax deduction since tax credit is subtracted from the tax liability, so it reduces the taxes you own dollar for dollar; tax deduction is subtracted from gross income or AGI, so it reduces the amount of taxable income. Some of the tax credits include: child tax credit, earned income credit, dependent care credit and lifetime learning credit.
If you would like to know more about taxes check this article