- Learn about filing status, AGI, basis, RMD, the SALT limit, and more.
- Differentiate when to itemize deductions or use the standard deduction.
- Learn the difference between tax credits and deductions.
- Identify what the IRS determines as taxable income and what income you have to pay taxes on.
- What is the difference between the graduated tax rates and the tax brackets?
- What is an information return?
- Are inheritances or gifts taxable?
- Understand individual taxes deadlines, refund turn-around time, and late filing penalties.
Those dealing with income taxes only once a year when involved with their tax return often have questions related to tax terminology. Below, Fiducial offers a compilation of questions frequently asked by individuals.
What is Filing Status?
Everyone that files a tax return must use one of five possible filing statuses. The tax status used dictates which tax rate schedule one uses. The statuses include:
- Single (S) – Used if unmarried on the last day of the year and not qualifying for HH or SS.
- Married Filing Joint (MFJ) - Used if married on the last day of the year and the spouses choose to file together on one return.
- Married Filing Separate (MFS) - Used if married on the last day of the year and the spouses choose not to file together.
- Qualified Surviving Spouse (QSS or SS) – Used by a widow/widower whose spouse died in one of two prior years and who has a dependent child living at home.
- Head of Household (HH) – This is the most complicated of the filing statuses and the following is only an overview. For a single individual to claim HH, the taxpayer must pay more than half of the cost of maintaining a household, which is the principal place of abode for more than one-half the year for an individual that qualifies as their dependent, or half the cost of maintaining a separate household of a dependent parent for the entire year. A married individual can also claim this status instead of MFJ or MFS if they lived apart from their spouse for at least the last six months of the year and paid more than half of the cost of maintaining a household for a dependent child.
When is an Individual Required to File?
Generally, an individual must file a tax return for a year if their income exceeds the standard deduction for their filing status for that year. Those couples that choose MFS must file if their income exceeds $5. Self-employed individuals also must file if their self-employment earnings for the year exceed $400, even if their income does not exceed the standard deduction. Special rules apply to certain children who have taxable income.
However, just because someone does not have to file a return does not mean they shouldn’t. They may have had tax withholding which they are entitled to have refunded by the government but they can receive the refund only by filing a return. They may qualify for refundable tax credits like the child tax credit and the earned income tax credit, which could be thousands of dollars. To get the benefit of a credit, a return must be filed.
What is AGI?
Adjusted Gross Income (AGI) is gross income minus certain adjustments to income permitted by the tax law. Gross income includes wages, dividends, capital gains, business income (before deductible expenses), retirement distributions as well as other income. Adjustments to income have such items as educator expenses, student loan interest, contributions to retirement accounts, and others.
Itemized Deductions or the Standard Deduction?
The standard deduction is an amount based upon a taxpayer’s filing status that they can deduct without substantiation. Itemized deductions, as the name implies, are listed on a separate schedule of the tax return. Tax law requires taxpayers to keep records verifying payment of the expenses claimed as itemized deductions. If the total of verified itemized deductions is more than the standard deduction, then the taxpayer may use the itemized deductions instead of taking the standard deduction.
What is a Tax Deduction?
Tax deductions can be business expenses deductible on business returns or 1040 schedules, capital losses, adjustments to income on a Form 1040 including items like student loan interest, a limited amount of a teacher’s expenses, and some IRA, and pension contributions. Tax deductions can also include itemized deductions, such as property and real estate taxes charged by state or local governments and state income taxes paid (subject to the SALT limitation discussed later), medical expenses more than 7.5% of AGI, home mortgage interest, charitable contributions, disaster losses, gambling losses to the extent of gambling winnings plus some other miscellaneous deductions. For an individual who is a resident of a state that has an income tax, the deductions they may claim on their state return may not be the same as those allowed on the federal return.
But be cautious of tax deductions or other tax advice espoused by tax amateurs.
How is Taxable Income Determined?
Taxable income is generally AGI less either the standard deduction or the total of allowed itemized deductions.
What is the Difference Between the Graduated Tax Rates and the Tax Bracket?
The way we compute individual tax is like a step function (graduated tax rates). Each additional block of taxable income is taxed at an increased percentage but does not increase the percentage that applies to the prior block. For example, for a single individual in 2023, the first $11,000 of taxable income is taxed at 10% and the next $33,725 is taxed at 12%, etc., until the maximum rate of 37% is reached. The graduated rates are inflation adjusted annually. An individual’s marginal tax rate is the highest tax percentage that the individual’s income is subject to and is commonly considered to be that person's tax bracket. Knowing their marginal rate lets a taxpayer estimate the value of a tax deduction.
What is a Tax Credit?
A tax credit equals a dollar-for-dollar offset against the tax liability. Some credits can only reduce a tax liability to zero and taxpayers either lose or carry over any excess to another year, depending on the credit. Other credits may be refundable, meaning if the credit is more than the individual’s tax any excess credit is refundable. Some credits are partially refundable.
Which is Better, a Tax Credit or a Tax Deduction?
As discussed in the previous question, a tax credit offsets tax dollar for dollar, whereas a tax deduction reduces the income that is subject to tax. Thus both being the same amount, a tax credit is better, especially if it is refundable.
What is an RMD?
The tax code requires that once individuals reach a certain age they must begin taking Required Minimum Distributions from traditional (not Roth) IRAs and certain other retirement plans. For 2023 the required starting age for required minimum distributions is 73.
What Income Do I Have to Pay Taxes On?
Generally, all sources of income after allowable deductions are taxable unless specifically exempt by the tax code. Examples of income exempt from federal tax include municipal bond interest, welfare, and all or a portion of Social Security income depending upon the taxpayer’s AGI.
What is the SALT Limitation?
SALT is the acronym for State and Local Taxes (state and local income or sales tax, real property tax, and personal property tax). State and local taxes are allowable deductions when itemizing deductions. However, a few years back, Congress limited the SALT deduction to $10,000 per year ($5,000 for MFS filers).
What is an Information Return?
Payers of certain types of income must advise the IRS of the amount paid to the income recipient for the year. Payers do this by filing specified forms to the IRS with a copy to the recipient of the income. We refer to these filings as information returns. The IRS’s computers will match the amounts a taxpayer reports on their income tax return with what the payers have reported. Thus, this is a way of keeping taxpayers honest. Below, you will find a list of commonly encountered information returns.
- 1099-INT – Interest earned from investments.
- 1099-DIV – Dividends from stocks.
- 1099-R – Retirement income
- 1099-NEC – Income earned as an independent contractor.
Taxpayers may be the recipient or the required issuer of these and other forms of 1099s.
What is Basis?
The basis is the value of an asset from which gain or loss is measured for tax purposes. In most cases, the basis starts with the amount that the taxpayer paid for the asset. A modified form of basis is “adjusted basis,” which is an asset’s initial basis increased by improvements and reduced by deductions for depreciation, expensing, casualty losses, etc.
Are Inheritances Taxable To The Recipient?
Generally, no, unless the inheritance includes an item or items on which the decedent deferred income such as an IRA or installment note. However, if an asset is inherited, its basis generally equals the asset’s fair market value on the date of the decedent’s death. This becomes the starting point from which a beneficiary begins tracking their adjusted basis.
Are Gifts Taxable?
No, the recipient of a gift is not taxed on the value of any gifts they receive. However, if the gift generates income, the income is taxable. For example, if a grandparent gave their grandson $10,000 and he invested the money and earned interest on the gift amount, the interest would be taxable to the grandson. Each year an individual may give up to a specified amount, which for 2023 is $17,000, to as many other individuals as they wish. If the donor gifts more than the excludable amount, the donor will need to file a separate tax return reporting the gifts. The donor may have to pay gift tax on the excess over the excluded amount.
Unlike inherited property whose basis generally equals the property’s value on the date of death of the decedent, the property received by gift retains the adjusted basis of the person who made the gift.
How Long Does It Take to Receive a Refund?
Individuals receive refunds the quickest by e-filing their returns and selecting to receive their refunds via direct deposit. The IRS states officially that it "issues most refunds in less than 21 days, although some require additional time."
When Are Individual Taxes Due?
The due date for individual tax returns in the 1040 series is April 15th of the subsequent year. If you are out of the country on the April date, the due date is automatically extended to June 15th. You can also file for an extension of the filing due date (October 15) by filing Form 4868, Application for Automatic Extension, on or before the regular due date. Caution: the extension is an extension to file a return, not an extension to pay any tax due. Interest and penalties will generally apply to any balance due.
Should a 15th due date fall on a weekend or holiday the deadline extends to the next business day. Also, if you are in a Presidentially declared disaster zone, the due date may be extended.
What Are the Late Filing Penalties?
The penalty for late filing is 4-½% per month of the tax due, with a 22-½% maximum. The late payment penalty is ½% per month until paid. There is also a minimum penalty if a taxpayer doesn’t file a return within 60 days of the due date. The minimum penalty equals the lesser of 100% of the tax due or $450 for 2022 returns required to be filed in 2023.
If filing a paper tax return, we highly recommend that you obtain proof of timely mailing from the post office. Mailings dropped in a mailbox may not get postmarked timely and this may create penalties.
Have other burning tax questions - common or otherwise? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.
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