What Determines the Return on Income Taxes?
When you file your income tax return, you have two choices for reporting income and expenses. You may take a standard deduction or you may itemize deductions. How you file your income and expenses determines the return you get on your income taxes. Other factors and choices can affect your return; you should understand these before you file.
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Tax Deductions
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Tax deductions include expenses you incur for non-reimbursed medical expenses, non-reimbursed work-related expenses and certain other personal expenses like mortgage interest on your home. These tax deductions lower your gross income and allow you to claim a larger refund. Alternatively, you may take a standard deduction if it gives you a greater refund than itemizing.
Tax Credits
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Tax credits are not deductions but rather a credit for certain financial conditions you must meet. For example, a child tax credit gives you $1,000 for each child you have. These credits are claimed in addition to any deductions you may have. It's possible to receive money from the Internal Revenue Service even when you don't have a refund due to you merely because of tax credits you qualify for.
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Income Tax Bracket
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Your income tax bracket determines the refund you receive. While this ties into your tax deductions, the tax bracket you're in directly determines the tax you pay. The lower the tax bracket, the lower your tax. In lower brackets, a lower percentage is assessed against your income. This naturally lowers the amount of tax you pay on all income in this bracket. As your income increases beyond the maximum income for that bracket, any income exceeding the threshold is taxed at the next highest bracket. Therefore, it's beneficial to use your deductions to reduce your income to the lowest bracket possible.
Taxable Income
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Not all income is taxable. Some investments, like municipal bonds, are not taxable. Also, some retirement accounts, like Roth individual retirement accounts (IRAs), are not taxable. When you receive income from these sources, you must report the income, but it is not used to determine your taxable income. Because of this, you'll receive a return that is higher than it otherwise would be if you had to include this money on your return.
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