What to Know About Income Taxes
What is your favorite cookie?
Personally, I’m fond of a cookie that doesn’t receive its fair share of credit. It is often mistaken, sadly, as a chocolate chip cookie. I love oatmeal raisin cookies! If you look online for a recipe for an oatmeal raisin cookie, you will find hundreds of variations. Picking the perfect recipe may seem impossible.
Income taxes are much like cookie recipes. There are several variations. Your taxes are not necessarily the same as your neighbor's or best friend's. Although there are guidelines and tax laws to follow, there is no cookie cutter in income taxes. Working with your tax professional will provide the best results possible for you.
Your tax professional may talk about things such as gross income, adjusted gross income, and/or credits and deductions. What does this mean to me? Let's break it down a bit:
This is simply your total income before any taxes. This could include wages, profits/commissions, interest payments, dividends, rents, or distributions from a retirement account.
Adjusted Gross Income (AGI)
Or otherwise known as your gross income less any deductions. Some taxpayers may itemize their deductions while others may use a standard deduction. Itemized deductions are allowable deductions that exceed the standard deduction.
PRO-TIP: Standard deductions amounts are as follows:
- $12,550 for single or married filing separately
- $18,800 for head of household
- $25,100 for married filers
- $14,250 for single senior adults
- $27,800 for married senior adults
An amount from the list above is then deducted from your gross income to calculate your adjusted gross income which is referred to as your taxable income. Taxable income is the dollar amount of your income that is used to calculate your income tax liability.
Keep in mind there are several items that can be counted toward itemized deductions. If the total of those items are greater than your standard deduction, then itemized deductions will be used to calculate your AGI. Some examples are medical expenses (totaling at least 7.5% of your adjusted gross income), medical or life insurance premiums (not counted anywhere else), mortgage interest, property taxes (home and vehicle), donations to a non-profit, tax preparation fees, and other state and local taxes. Student loan interest can reduce your taxable income as well.
In a previous blog post, we discussed various credits. Credits reduce your tax liability and are referred to as “below the line”. Some common credits are Child Tax Credit, Education Credit, Earned Income Credit, or Dependent Care Credit. So, what’s the difference in a deduction and a credit? Deductions reduce your gross income calculating your Adjusted Gross Income and are referred to as “above the line”. Your AGI is then used to calculate your tax liability. Your tax liability is the amount of tax you owe based on your income. Any federal and state withholding and credits are then applied to your tax liability. Your tax liability is calculated after deductions and credits are applied. It is ideal to “break even” on your tax return. However, many taxpayers either receive a refund or have a tax liability due.
It’s important to remember your taxes are unique to you. Don’t pay more than you should and take advantage of every credit or deduction available to you! Seek advice from your tax professional. While filing taxes may seem easy, a professional can assist you in maximizing your tax savings.
Happy Tax Season!