Taxes – the basics

I have been doing taxes for several years now (six, to be exact). In my experience, I have come to realize that taxes terrify people. They are so afraid of making a mistake trying to do it themselves that they pay other people to do it for them or they use software to walk them through it.

Here’s my advice: Learn the basics. It’s not that hard to do. Once you get the concept and know the vocabulary, then it’s pretty simple, really. And don’t use software unless you already know what you’re doing. This past tax season, probably around 40% of my work was fixing things that Turbo Tax missed. I even went on there to do a return and I had to spend 45 minutes looking for the credit I was trying to find.

I’m going to give you a crash course (very abridged) on the US tax form (1040). I really recommend that you check out a book from your local library and learn how to do your taxes. Once I learned how, I went back and amended my previous years’ returns and got tons more money back!


The first thing on your 1040 is your name social security number and address, and your spouse’s name and social security number if you are married. If you are separated or not filing together but you are still married, some complicated stuff comes into play, so you should do more research on that.

Just below that you have to choose whether or not you want $3 to go to the Presidential Election Campaign Fund. A common misconception is that this is money that you have to pay or money that comes out of your refund. This isn’t true. It’s basically just you telling the government, “hey, I want you to move $3 from this pile of money to that pile of money.”

Filing Status

Next, you choose a filing status. The most favorable is married filing jointly (in most cases), so if you are married, I recommend choosing that one. You can also file married filing separately, or sometimes head of household if you meet certain requirements. Head of household is the filing status usually used if you are unmarried but you are supporting dependents. Qualifying widower is used if you lost your spouse in one of the 2 previous years (not the current tax year, because you still file jointly then since you were married part of the year). Single is the status for everybody else: not married, no dependents, just single.


In most cases, you will claim yourself. The only time you wouldn’t is if your parents claim you on their return or maybe even a child would claim you if you are completely dependent on them. On a joint return, you would claim both spouses. Here, you also list anybody else that you support that you can legally claim. For most people this would be their children. Sometimes people also claim grandchildren or other relatives, or even people who are not related, but again, if you want to do this, you need to look into it further.


Now you list your income. This includes: wages, tips, bonuses, interest from bank accounts, dividends, alimony, business income, capital gains, IRA or pension distributions, income from rental property, farm income, unemployment pay, social security benefits, and any other income you might have earned. All of this is added together and cleverly named Income.


Now you get to subtract adjustments. (Yay!) These are things that come right off the top of your income, without having to deal with the standard vs. itemized deductions (that comes later). There are many adjustments to income, but some of the more common ones are: moving expenses, alimony paid, IRA deduction, student loan interest deduction, and tuition and fees deduction. After all your adjustments are subtracted you arrive at your Adjusted Gross Income, or AGI.


Now here is where people get confused. The standard deduction is a set amount that the IRS allows you to subtract from your income, no questions asked. You don’t need to keep receipts or proof, you just take the standard deduction. If you think you can go over this amount with your own deductions, then it would be beneficial for you to itemize your deductions. Things you get to include in your itemized deductions are: medical and dental expenses (minus 7.5% of your AGI), job and tax preparation expenses (minus 2% of your AGI), state and local income taxes or sales taxes, real estate taxes, home mortgage interest and points, charitable contributions, and casualty and theft losses. You want your deductions to be as high as possible, because you get to subtract that number from your AGI. The lower number you can get, the less money you get taxed on.

You also get to subtract from your AGI an exemption. This is a set amount (it was $3500 for 2008) per person on the return. So, a family of four (married filing jointly with 2 kids) would get to subtract another $14,000 from their income.

After you subtract your deductions (standard or itemized) and your exemptions (# of people times exemption amount), you have your taxable income.


Once you have your taxable income, there are several ways to compute your tax. Most people just use the charts that are released every year by the IRS. A software program will compute it automatically for you.

Nonrefundable Credits

Now we get to the fun part: credits. From your tax, you get to subtract credits. Many people get confused about the difference between a credit and  a deduction:

  • a deduction reduces your taxable income. So, if you are in the 15% tax bracket, you are getting back about 15% of that deduction.
  • a credit reduces your tax owed for the year. So you get a 100%, dollar for dollar credit.

Again, there are several tax credits available, but some of the more common ones are: dependent care expenses (daycare credit), education credits, retirement savings contributions credit, child tax credits, and the first-time homebuyers credit.

These credits are nonrefundable, which means you can only reduce your tax owed to zero. So if you have a tax liability for the year of $1000 but you have $2000 in credits, you don’t get that extra $1000 back.

Refundable Credits

Now you get to add in all of your refundable credits. These are the ones where you CAN get the extra money back. These include the additional child tax credit and the earned income credit. Here is where you also add in all the money you paid in taxes (from your paychecks) throughout the year.

Bottom line

So at the end of it all, you add together all your credits and if it is bigger than your tax liability, you get a refund. If your tax liability is bigger, you owe.

In a nutshell:

Income – adjustments = adjusted gross income

AGI – deductions – exemptions = taxable income

look up tax

tax – credits – what you paid in = amount of refund / amount owed

Like I said before, this is by no means covering everything. You should really read everything you can so you can be informed and make your tax situation the best it can be. You can request all IRS publications free from their website: Publication 17 is the general instruction book, and it usually becomes available in December of the current tax year. All of their publications are also available on the website in PDF format.

So learn, soak up some knowledge, and save some money on your taxes! Once you know all the different tax breaks available to you, you can put them all to good use. After all, nobody knows what’s going on in your life better than you.

Check out this post about planning ahead with your taxes to save even more money! 

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