Monday, May 14, 2012

Preparing Income Taxes - The Anatomy of Form 1040 and Adjusted Gross Income

We study anatomy to identify parts of the human body. We study physiology to understand how those human parts work together to, for example, find and digest food, procreate, and pay taxes. This simple study approach is the foundation of modern medicine and, for the most part, the basis for most of us living healthy and productive lives. We can apply this same study approach to personal federal income taxes; we need to first classify parts of a federal tax return and then study how parts work together to achieve one end; how much you owe in taxes. With every passing year and the passing of revisions in the income tax code, running your life is increasingly like running a home-based business. There is no valid disagreement that paying our share in taxes is clearly the responsible way to support, at the very least, our great nation but, we similarly want to exercise control over our lives and have the freedom and wherewithal to pursue our own bliss. Careful management of YOUR cash, YOUR credit, and YOUR taxes, now more than ever, are the foundation for maintaining financial health and achieving your life-time goals. Just like sports medicine attempts to optimize speed and strength through knowledge of anatomy and physiology, understanding the interaction of income with deductions and credits can similarly maximize a refund and minimize a tax liability.
In simple "anatomical" terms, your federal personal tax return (whether the short Form 1040EZ, the medium Form 1040A, or the long Form 1040) begins at the top of the page with Income. The long form includes ALL possible forms of earned or unearned income. Income includes for example, daily wages, gains made through sale of assets, savings account interest, stock dividends, rental income, royalty payments, and finally "Other Income" like gambling or lottery winnings.
The next section after Income is called Adjustments because these "subtractions" reflect tax-significant financial decisions that "adjust" (decrease) an individual's annual gross income. Special teacher expenses, student loan interest, moving expenses, special medical/education/retirement payments/contributions, paid alimony, and a portion of self-employment taxes are examples of these adjustments. Our personal income tax system recognizes these "exceptional" events as noteworthy modifications to individual's gross income during the tax year. Thus, a possible fair way to determine the taxes one owes is to adjust (reduce) one's gross income for specific actions or events that are taken or occur in the tax year BEFORE income taxes are calculated. Your gross income is modified and recalculated as Adjusted Gross Income (AGI). It is copied from the bottom of the first page on line 37 of the long IRS Form 1040 over to the top of the second page on line 38 of your federal tax return.
Keep your Adjusted Gross Income handy. This number is used by the Internal Revenue Service (IRS) as a security tool. If you visit the IRS website, IRS.gov, and request personal information, don't be surprised when you are asked for your AGI from the previous tax year! The IRS uses the number to verify your identity online like a password or personal identification number (PIN). Your AGI is more important than you thought!

0 comments: