As this Blog gets posted on our website, Tax Filing Day 2024 is behind us. That is not a good reason to put taxes out of your mind for another 11+ months. Instead, since memories are fresh, we will continue our exploration of the process by which we pay our mandated share of income to the Treasury, all the while doing what we can to pay not one dollar more than necessary. Understanding the Tax Code formula and its impact on our own situations improves our ability to avoid overpayment. This year’s lessons may become next year’s savings.
In early April we discussed the concepts of Total Income and its subset, Adjusted Gross Income, or AGI. In order to arrive at the actual tax we owe, the next step is to apply Tax Deductions, as defined in the Code. Whatever deductions we are allowed further reduce the taxable portion of our AGI. Again, our goal is to reduce the taxable amount of income by all legal means.
For generations, Americans have had the right to itemize allowable deductible expenses, and to subtract that total from Adjusted Gross Income, or AGI. Americans have also had a “shortcut” alternative available in the form of a Standard Deduction. Every year, each taxpayer gets to decide which to apply in preparation for their Form 1040 Individual Tax Return.
Since the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), fewer taxpayers have chosen to itemize deductions. This was by design and has been largely successful. Simplifying Form 1040 and its preparation was a laudable goal. One of TCJA’s primary objectives was to increase the proportion of taxpayers who opt for the Standard Deduction, so the amount of the Standard Deduction was increased substantially. Raising the level had the desired effect of migrating many taxpayers to the simplified system, and away from Itemized Deductions.
Simplification of our Tax Returns was a bit oversold to the public, but in reality, because a higher percentage of Americans did switch to the Standard Deduction, they now have to devote less time and energy annually to tax preparation.
Allowable deductions are found on Schedule A of Form 1040. There are 5 general categories, including Medical and Dental Expenses, State and Local Taxes (SALT), Deductible Interest, Charitable Gifts, and Casualty Losses, many of which have restrictions and/or limitations.
Once the deductible portion in each category is computed, deductions are totaled and compared to the Standard Deduction. Taxpayers may use either the Itemized or the Standard Deduction and generally choose the highest number. The Net from AGI becomes Taxable Income. Tax is then applied from a Table or a Formula, and you are nearly done. Next week, we’ll examine Tax Credits and Other Taxes, the final steps before filing your 1040 with the IRS.
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