What is a Tax Return?

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Definition:

A tax return is a document that most people must file annually with the government to report their income and calculate tax liability.

🤔 Understanding tax returns

The US government requires that most people pay taxes on their income. Anyone who earns income over a certain threshold has to submit an income tax return each year to the Internal Revenue Service (IRS) and state tax agencies. In this document, taxpayers report the amount of income they earned that year, as well as any deductions and credits they qualify for to reduce their taxable income or tax liability (how much they owe in taxes). After filing a tax return, taxpayers may find out that they haven’t paid enough income taxes for the year, or that they’ve overpaid and will receive a refund from the IRS.

Example

Suppose Robert earns $75,000 per year. Every month, Robert’s employer withholds money from his paychecks and sends it to the Internal Revenue Service (IRS) for income taxes on Robert’s behalf. At the end of the year, Robert has to file a tax return with the IRS. In this document, he reports his income, tax deductions, and tax credits to determine how much he owes in income taxes for the year. Luckily, Robert’s employer has been sending tax money to the IRS all year on his behalf, so Robert has probably already paid most of his income taxes.

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What is a tax return?

A tax return is a document that most individuals and many companies who earn income have to submit to the Internal Revenue Service (IRS) every year. They use the return to report how much they’ve earned for the year and deductions or credits they qualify for. The form helps them calculate how much (if anything) they still owe in taxes. If a taxpayer has overpaid on their taxes, they may receive a refund.

A tax return, which individuals usually file using IRS Form 1040, requires that you share information such as your name, address, Social Security number, income for the year, and tax deductions and credits you’re eligible for. It helps you calculate your total tax liability (how much you owe in taxes) to determine how much you still need to pay or will receive as a refund. The Internal Revenue Service (IRS) generally requires that anyone earning more than the standard deduction file a tax return by April 15. (The date may vary slightly from year to year).

Why do we file income tax returns?

Tax returns are how taxpayers inform the Internal Revenue Service (IRS) about their tax situation and determine whether they’ve paid enough in income taxes for the year. Throughout the year, employers withhold money from the paychecks of their employees and send that money to the IRS. This money, based on the withholding instructions on the worker’s W-4 form, is meant to cover the employees’ income tax liability. Self-employed people usually have to pay quarterly estimated taxes. Either way, you avoid making a huge lump-sum payment to the IRS by paying throughout the year.

At the end of the year, the IRS needs to verify that everyone paid the appropriate amount of taxes. If you haven’t paid enough, then you will face a tax bill. If you’ve overpaid, then the IRS will send you some money back in the form of a refund. Filing a tax return is what allows you to determine which camp you fall into.

You need to file a tax return for 2020 if your gross income was at least $12,400 for a single filer or $24,800 for married couples filing jointly. (The threshold is different for self-employed people.) You may still want to file even if you don’t have to if you expect a refund.

How do tax returns work?

On your tax return, you report to the Internal Revenue Service (IRS) and state tax agencies all the income you’ve earned for the year, as well as any tax deductions and credits you are eligible for. Tax deductions reduce your taxable income, while tax credits directly reduce the amount of taxes you owe.

Using this information, taxpayers can figure out their tax liability for the year. Depending on how much money your employer withheld and how many deductions and credits you’re eligible for, your total tax liability might be more or less than you’ve already paid. By filling out your tax return, you can calculate whether you owe more money, or whether the government owes you. Your tax return also allows you to provide banking information so you can settle up your tax bill.

How do you file your taxes for the first time?

If you’ve never filed a tax return before, the process can feel daunting. Not only are there several forms to familiarize yourself with, but a mistake could mean your tax bill is higher than it needs to be.

The first step to filing your tax return is to collect all the paperwork you’ll need. For most people, this includes a W-2 form — the document on which your employer reports how much they paid you for the year and how much they’ve already paid on your behalf in income taxes. If you’re a contractor or freelancer, your clients use a 1099 form to report the money they paid you for the year, if it was at least $600.

You may need additional forms, depending on how complicated your tax situation is. If you receive premium credits through the Affordable Care Act, you’ll have to report that information on your return. Other documentation could include proof of additional sources of income (like interest, a pension, or gains from selling investments) or expenses you plan to deduct (like charitable contributions or student loan interest).

When you start filling out your tax return, you’ll need to make a few decisions. First, determine if you’re filing single, married filing jointly, married filing separately, or head of household. For single filers, this is pretty self-explanatory. Head of household is a status for single filers with dependents. Married taxpayers can decide whether to file jointly or separately, depending on what is most beneficial in their situation.

You’ll also have to decide whether to itemize your deductions or claim the standard deduction. The standard deduction is available to anyone and reduces your taxable income by $12,400 per person in 2020 ($12,550 in 2021). If you have deductible expenses, such as mortgage interest or charitable contributions, that exceed the standard deduction, it might make more sense to itemize your deductions. You can’t both claim the standard deduction and itemize your deductions.

Your next step is to determine how you’ll file your taxes. The IRS Form 1040 is the one that most people use to file their taxes, but you don’t necessarily have to do it yourself. You can hire a tax preparer to create and file your return on your behalf. There are also plenty of software programs that walk you through the filing process. The IRS recommends IRS Free File, which is available to anyone with a gross income under $72,000 in 2020.

After filling out your tax return, you’ll probably find out that you either owe additional money to the IRS or, more likely, that you’ll receive a refund from the government. If you owe money, you’ll have to provide payment information to the IRS, generally a bank account number. If the IRS owes you money, you’ll provide details about where the agency can direct deposit your refund. Most years the tax deadline is April 15, though in 2020 the deadline was pushed back to July 15.

What are the sections of a tax return?

Most people use the Form 1040 to file their tax returns. The form includes the following sections:

  1. Personal information: Fill out your name, address, Social Security number, and other personal details.
  2. Dependent information: Share whether you have dependents or are someone else’s dependent. If you have dependents, you’ll share their personal information.
  3. Income: Report all income you earned. Common sources of income include wages, interest, dividends, retirement distributions, Social Security benefits, and capital gains.
  4. Deductions: When you file your tax return, you’ll choose between the standard deduction or itemizing your deductions.
  5. Adjustments: There are some deductions you can claim alongside the standard deduction. Known as adjustments, these include the student loan interest deduction.
  6. Tax credits: While deductions and adjustments reduce your taxable income, tax credits reduce your tax liability. You subtract these after you’ve determined your total tax liability for the year. For example, the Child Tax Credit allows parents to reduce their tax liability for each eligible child they have.
  7. Refund: Many people end up getting a refund from the Internal Revenue Service (IRS). If this is the case for you, the 1040 includes a section to input your routing number and bank account number.
  8. Amount you owe: There’s another section of the tax return specifically for those who owe money. In this section, you’ll include the dollar amount that you owe to the IRS.

Depending on your financial situation, your tax return might be a bit more complicated. The IRS has several forms called schedules that you can use in addition to the Form 1040. On these, you can account for information such as unemployment compensation, self-employment taxes, or business credits.

How do you calculate your taxes?

Figuring out your total tax refund or tax bill when you fill out your return can be complicated. If you hire a tax preparer or use tax software, they’ll probably run these numbers for you. But it’s still useful to understand how the calculations work.

First, you’ll need to know what your income was for the tax year. If you have a traditional employer, you can find this information on your W-2 form. If you’re self-employed or a contractor, you’ll have to use your own records or any 1099 forms you received.

Next, you’ll have to decide between claiming the standard deduction and itemizing deductions. Because of the increase in the standard deduction under the Tax Cuts and Jobs Act of 2017, the vast majority of taxpayers claim the standard deduction. Whichever option you choose, your deductions will reduce your taxable income. So, if you made $50,000 for the year and you claim the standard deduction of $12,400 for 2020, your taxable income becomes $37,600. You can claim some deductions, such as the student loan interest deduction, even when you claim the standard deduction.

Once you know your taxable income for the year, you can determine the rate at which you have to pay taxes on each chunk of your income. The US has marginal tax rates, meaning your tax rate goes up depending on how much you earn. Suppose you had taxable income of $50,000 in 2020. Your tax liability would look like this:

  • 10% on the first $9,875 of income = $987.50
  • 12% on income $9,876 - $40,125 = $3,629.88
  • 22% on income $40,126 - $85,525 = $2,172.28

In this example, your tax liability is $6,789.66.

Once you know your tax liability, the last step is to account for any credits you’re eligible for. Unlike deductions, which reduce your taxable income, credits reduce your tax liability. Some tax credits are refundable, meaning if the credit exceeds your tax liability, you can get the excess as a refund. Adding your tax credits into the mix will give you the total amount you owe or will get as a refund amount. The good news is that, if you’re a W-2 worker, your employer has probably already withheld most of your tax liability from your paychecks throughout the year.

This is a fairly simplistic explanation of how calculating your taxes works, and trying to figure the nuances out on your own can be confusing. Hiring a tax professional or using tax software can help make sure you fill out your return correctly.

What happens if you forget to file your taxes?

The federal government requires that everyone who earns a certain level of income in a given year file a tax return, with few exceptions. If you fail to do so and owe money to the government, whether that failure was intentional or you just forgot, the Internal Revenue Service (IRS) may penalize you.

First, you could end up with a failure-to-file penalty, which is 5% of the amount you owe for each month that you owe it (up to 25% of your unpaid taxes). You may be able to avoid paying if you can prove there was a “reasonable cause” for filing late. There’s also a separate penalty for failing to pay the taxes you owe. The IRS will charge the federal short-term rate plus 3% in interest on unpaid taxes beginning on the date the return was due. You may also end up with a failure-to-pay penalty of half a percent each month the tax is overdue, up to 25%, until you pay your tax bill. (The penalty won’t apply if you can show “reasonable cause” for not paying on time.)

If you won’t meet the filing deadline, you can apply for an extension ahead of time. If you’re having trouble paying taxes you owe, the IRS may be able to help you set up a payment plan.

If you fail to file your tax return on time and the IRS owes you a refund, you won’t have to pay a penalty. However, that means you won’t get your refund and are leaving money on the table. The good news is that, as long as you file within three years of the tax return due date, you should still be able to get your refund.

The information provided is for informational purposes only and not to be construed as tax advice.

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