How to Understand Tax Returns

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Review your tax return for accuracy.
Review your tax return for accuracy.

The secret to understanding a tax return lies in identifying the various sections of the tax form and the significance of each. Income tax returns are prepared based on a prescribed formula; each individual return will be unique based on the yearly income history of the taxpayer. Once you comprehend the variables which are peculiar to each section and how they are computed, understanding a tax return becomes a simple matter.

Identify the IRS Form. There are three main forms which may be chosen for individual taxpayers: Form 1040EZ, Form 1040A and Form 1040. If the tax preparer has used Form 1040EZ, this indicates that the income is less than $100,000 and there are no dependents. When Form 1040A is used, the taxpayer will still have an income of less than $100,000 and will probably have dependents or claim credits for child care, retirement savings contributions or earned income. Once the income is over $100,000, the taxpayer must use Form 1040.

Look at the filing status. There are five filing statuses: single, married-filing jointly, married-filing separately, head of household and qualifying widow. The government allows each taxpayer to deduct a standard amount from his taxable income based on the filing status.

Look for the stated number of exemptions. A taxpayer may claim an exemption for a dependent, who is an individual who meets certain criteria based on IRS rules. The amount deductible for each exemption usually increases every year.

Find the gross annual income. For Form 1040EZ, there will be an amount generated from the taxpayer's W-2 indicating how much income was earned from all employers. For the more complex forms, each line will indicate another potential source of income, including interest income, business income, capital gain and social security benefits.

Identify the amount of taxable income, which is calculated from the annual gross income minus a standard or itemized deduction. Look for any credits that will offset the ultimate tax liability.

Figure tax liability according to income brackets, which are available from the IRS and in the forms' instructions. From this figure, subtract any payments made towards the tax liability and amounts for any refundable credits.

Tips & Warnings

  • At least once a year taxpayers should review IRS Form W-4 "Employee's Withholding Allowance Certificate." This form is filed with the employee's payroll department and directs the employer to the number of exemptions the taxpayer will claim throughout the year. Claiming the correct amount of exemptions will help ensure that the proper amount of tax will be withheld from each paycheck, thus minimizing or eliminating any outstanding tax liability at tax time.

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