How to Read and Understand Your Federal Individual Income Tax Return, Form 1040 By Christina Wenk, CPA, CFE, MST - Senior Tax Manager at White Nelson Diehl Evans LLP One of the first steps in minimizing your income taxes is understanding your individual income tax return. If you understand the dynamics of your income tax return, you are more empowered to make informed tax decisions. We hope that this article will also prompt you to ask your WNDE tax advisor about the issues described as they pertain to you. You are responsible for what is listed on your income tax return. When you sign your return, you declare under penalties of perjury that to the best of your knowledge it is true and correct. Failure to comply with federal income tax laws can result in serious penalties. The U.S. Individual Income Tax Return, Form 1040, can be difficult to understand. Many of the amounts on the form are from complex computations or come from other forms. This article is a brief summary to assist you in reading and understanding your federal return. Form 1040 is organized into sections. This article will list each section name and then will discuss the most common issues for each section. LABEL - The top of Form 1040 is for your name, address and social security numbers. You should always verify that this information is correct. The IRS reports that many errors are made in this section. FILING STATUS – There are five filing statuses: single, married filing jointly, married filing separately, head of household (with qualifying person) and qualifying widow(er) with dependent child. The filing status is important because different tax rate tables and tax brackets apply to each one. EXEMPTIONS - In this section, your personal income tax exemptions are listed. You will receive a tax deduction for each personal exemption. Exemptions are allowed for you and your spouse, and anybody else you can claim as a dependent. INCOME - Generally, all amounts received are taxable unless they are specifically excluded by law. The most common types of income, in the order listed on the return, are as follows: Line 7: Wages – Wages are reported on Form W-2 provided to you by your employer. Line 8: Interest– This amount is listed in detail on Part 1 of Schedule B. Interest income is usually reported to you on Form 1099-INT, Form 1099-OID, or a substitute statement from a bank or broker. Interest collected on personal notes should be included her also. Line 9: Dividends – This amount is listed on Part II of Schedule B. Dividend income is reported to you by each payer on Form 1099-DIV. Line 12: Business Income or Loss - If you operated a business as a sole proprietor, you report your income and expenses on Schedule C and the net income or loss is carried forward here to Page 1 of your return. 2875 Michelle Drive, Suite 300, Irvine, CA 92606 • Tel: 714.978.1300 • Fax: 714.978.7893 Offices located in Orange and San Diego Counties Line 13: Capital Gains or Losses - A total of all gains and losses from the sale of capital assets (such as stock) and capital gain distributions are reported here and detailed on Schedule D. If your total is a loss, the loss is limited to $3,000 a year. Any unused loss is carried forward until it is utilized. Line 14: Other Gains or Losses – These gains and losses from the sale of business assets are detailed on Form 4797. Line 15: IRA Distributions – Total and taxable amounts are listed on your return. The total amount is reported to you by the payer on Form 1099-R. It is possible that some of your IRA distribution is not taxable, if any part of a prior contribution was not deductible. Line 16: Pensions and Annuities – Total and taxable amounts are listed on your return. The total amount is generally reported to you by the payer on Form 1099-R. The taxable portion is determined based on whether you paid income tax on any prior contributions to the account. Line 17: Income and Losses from Rental Real Estate, Royalties, Partnerships, S Corporations, Trusts, (etc.) – Total income and losses from these activities is reported on Schedule E. Losses may be limited. These are reported separately in detail by property or as net amounts on Form K-1 from a flow-through entity. Line 19: Unemployment Compensation – The total received for the year is reported to you on Form 1099-G and is taxable income on your federal return. Line 20: Social Security Benefits – The total and taxable portion is reported here. The total Social Security benefits paid to you is reported to you on Form SSA-1099. As little as zero and as much as 85% of your benefits may be taxable, depending on the amount of your other income. Line 20: Other income and loss amounts required to be reported include: net operating loss carryforwards, tip income, alimony, prizes, gambling winnings and all other income amounts. ADJUSTMENTS TO GROSS INCOME - This is the last section on Page 1 of Form 1040. In this section, adjustments that reduce your total income to adjusted gross income are listed. These adjustments are known as “above the line” deductions because you do not have to itemize to claim them. The most common adjustments are: educator expenses, contributions to health savings accounts, part of selfemployment tax, health insurance premiums paid by self-employed individuals, alimony paid, and contributions to certain retirement accounts (e.g. - IRAs and SEP IRAs). TAX AND CREDITS - The tax and credits section is the first section on page 2 of Form 1040. The first few lines are used to determine your taxable income. It begins with your adjusted gross income (AGI), the net amount from Page 1. The first subtraction is a line for either the standard deduction or itemized deductions (listed on Schedule A). You may deduct the larger of these two amounts. The amount of the standard deduction ranges between $6,100 and $14,600, depending on your filing status and age. The most common itemized deductions are: home mortgage interest, charitable donations, state income taxes paid, real estate taxes paid, medical expenses, job related and investment expenses. The second subtraction is exemptions. You may deduct $3,900 for each person in the family. Your itemized or standard deduction and your exemptions are subtracted from adjusted gross income to arrive at taxable income. Your regular and alternative minimum income tax is then listed and totaled. The federal income tax is a tiered and progressive tax. There are seven different federal income tax brackets which range from 10% to 39.6%. As your income increases your incremental tax bracket gets higher. Many taxpayers are subject to the Alternative Minimum Tax, which in essence is an adjustment to an overall flat tax of 28%. Next is a listing of tax credits that can reduce your tax liability. These include credits for foreign taxes paid, child and dependent care expenses, education costs, retirement savings contributions, residential energy costs, and several other items. All of these credits require additional forms or schedules be attached to your return. OTHER TAXES - Other taxes are in addition to your income tax. These other taxes include selfemployment (Social Security and Medicare) tax, “penalty” tax on early withdrawals from IRAs and other qualified plans, household employee payroll taxes, and others. PAYMENTS - In this section, federal tax payments are listed including amounts withheld from wages and other payments, estimated tax and extension payments you made, and amounts applied from your prior year return. Also in this section are amounts added as payments that are “refundable” tax credits which are credits that are available, even if you do not have a tax liability. These credits include the earned income credit, an additional child tax credit, American Opportunity education credit, and others. REFUND OR AMOUNT YOU OWE - Total payments are deducted from total tax. If your total payments are greater than your total tax the overpayment is shown as available to you. You can choose to receive the refund or have the overpaid amount applied to next year’s taxes. You may have your refund directly deposited to your bank account by listing your account and bank routing numbers. If your total tax is greater than your total payments, the amount you owe is listed here. You can pay the amount you owe by check with a payment voucher (Form 1040-V). The IRS also offers two electronic payment options: Electronic Funds Withdrawal or you can pay using a credit or debit card. Go to www.irs.gov/e-pay for specific information on both of these electronic payment options. CONCLUSION - This article is a summary of how to easily read and understand your federal income tax return. This information is highly summarized and is not meant to be all-inclusive and only briefly discusses the most common items on an individual federal income tax return. We encourage you to investigate more detailed information regarding your return based on your specific facts and circumstances to take advantage of all current tax laws to reduce your taxes to the lowest amount possible. Please contact your WNDE tax professional with your questions.