Throughout March, we have been highlighting the need for people to learn more about money while they are young. April, which has now arrived, is designated National Financial Literacy Month. Hardly surprising, as Personal Income Tax Filing Deadline Day occurs in mid-April. While anyone can request an Automatic Extension of time to file, any amounts owed from the prior year are due and payable on Tax Filing Day, regardless of filing status.
How many of you could come up with a reliable estimate of what you owe? As a “workaround,” many people simply have excess Tax Withholding deducted from their paychecks. While avoiding penalties for underpayment of taxes, these people are essentially making annual interest-free loans to the U.S. Treasury. They justify that nonsense as an informal savings plan and use the refund for vacations or whatever luxury they designate.
Given the importance of Income Tax Returns, we are continually concerned about taxpayers' lack of understanding of how the tax system affects them. Paying the lowest legal tax bill should be everyone’s objective. That requires an understanding of the Tax Code. We start by asking people how much they paid in taxes. Often, we hear, “I didn’t pay anything, I got money back.”
Common sense dictates that we understand at least our own Tax Returns. Overpaying income tax is distasteful, and underpaying is illegal. Given that, instead of simply plugging in numbers to TurboTax or equivalent, filing the resultant Tax Return, and putting the whole concept “on the shelf” for another year, why not learn? Time spent could become very profitable, as well as educational. Here’s a very short course on Tax Return preparation.
Pertinent numbers on the annual required 1040 Income Tax Form begin with Total Income. Just like it sounds, Total Income (or Gross Income) is simply an aggregate of all forms of income received in a Tax Year (usually a calendar year). However, no one pays taxes on their Total Income. Reducing Total Income to Taxable Income is the essence of Tax Preparation.
The next step is to identify Adjustments to Income, which include such items as deductible contributions to Qualified Retirement Accounts, plus a few other items. The resultant Adjusted Gross Income, or AGI, is pivotal in qualifying (or disqualifying) the taxpayer for certain taxes and/or benefits. One derivative from AGI is Modified Adjusted Gross Income, or MAGI. We will explain the importance of MAGI in a later Blog.
From there, another income reduction is applied, using the higher of the statutory Standard Deduction (most people use this) or Itemized Deductions. Again, we’ll address these later. For now, the structure of Tax Return preparation begins with understanding taxes for fun and profit. OK, profit anyway.
Van Wie Financial is fee-only. For a reason.
