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Intuit Academy:
Tax Level 1 Study Guide
Study Guide Objectives:
After successful completion of the Intuit Academy Tax Level 1 modules, you will be ready to take the Tax
Level 1 Exam. This study guide is a combination of the Pre-Assessment readings that appear in each course.
The purpose of this study guide is to organize and summarize tax information.
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Good luck with the Tax Level 1 exam and we look forward to you advancing to the Intuit Academy Tax Level
2 Training Course.
Disclaimer:
This content is for information purposes only and information provided should not be considered legal, accounting or
tax advice. Additional information and exceptions may apply. Applicable laws may vary by state or locality. No
assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a
customer’s particular situation. Intuit Inc. does it have any responsibility for updating or revising any information
presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent
research. Intuit Inc. does not warrant that the material contained herein will continue to be accurate, nor that it is
completely free of errors when published. Readers should verify statements before relying on them.
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Table of Contents
Filing Status and Qualifying Dependents (OICS_6718)
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Sources of Income (OICS_6719)
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12
Form 1040 (OICS_6721)
13
Business Income & Expenses (OICS_6722)
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Schedule 1 (OICS_6723)
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The W-2 (OICS_6720)
Tax Liability – Interest & Dividends (OICS_6724)
Deductions (OICS_6725)
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Types of Tax Credits (OICS_6726)
Gross Income – Exclusions (OICS_6727)
Tax Liability Partnerships (OICS_6729)
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Other Gross Income Items (OICS_6730)
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Adjusted Gross Income (OICS_6728)
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Filing Status and Qualifying Dependents (OICS_6718)
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There are five types of tax filing statuses: head of household, qualified widow(er), married filing jointly,
married filing separately and single. Your tax filing status can have a big effect on your tax bill and which tax
forms you’ll need to fill out.
Here's how your tax filing status can affect which tax deductions and credits you can claim, so you can select the right
one when you file your taxes.
Tax Filing Status Options
Filing status
Who might use it
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Unmarried people paying at least half the cost of housing and support for others.
Married high earners, people who think their spouses may be hiding income, or people whose
spouses have tax liability issues.
Most married couples.
People who lost a spouse recently and are supporting a child at home.
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Head of household
Married filing
separately
Married filing jointly
Qualified widow or
widower
Single
Unmarried people who don’t qualify for another filing status.
HEAD OF HOUSEHOLD
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Who can use it:
Typically, unmarried people who paid more than half the cost to keep up a home for the year and provided most or all
the support for at least one other person for more than half the year.
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How it works:
● It's not arbitrary. You can’t use this tax filing status if you’re simply the one who “wears the pants” in your family
or makes the most money. In the eyes of the IRS, this tax filing status is only for unmarried people who have to
support others.
● There are rules about being unmarried. The IRS considers you unmarried if you’re not legally married. But you
can also be considered unmarried for this purpose if your spouse didn’t live in your home for the last six
months of the tax year (temporary absences don’t count), you paid more than half the cost of keeping up the
house, and that house was your child’s main home. The cost of keeping up a home includes the property taxes,
mortgage interest or rent, utilities, repairs and maintenance, property insurance, food and other household
expenses.
● There are rules about kids. Speaking of children, to use this filing status, there also has to be a “qualifying
person” involved. In general, that can be a child under 19, or under 24 if the kid’s a student, who lives in your
house for more than half the year. It can also be your mother or father, and in that case, mom or dad doesn’t
have to live with you — you just have to prove you provide at least half their support. In some situations, your
siblings and in-laws also count if you provide at least half their support. Be sure to read IRS Publication 17 for
specifics.
What it gets you:
This filing status gets you bigger tax deductions and more favorable tax brackets than if you just filed single. The
standard deduction for single status is $12,400 in 2020 — but it’s $18,650 for head of household. And $50,000 of
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taxable income will land you in the 22% tax bracket if you're a single filer, but if you're filing as head of household,
you'll only be in the 12% bracket.
QUALIFIED WIDOW(ER)
Who can use it:
People who lost a spouse recently and are supporting a child at home.
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How it works:
● You have time. If your spouse died during the tax year and you could’ve used the “married filing jointly” tax
filing status before his or her death (even if you didn’t actually file jointly), you can file jointly in the year your
spouse died. Then, for the next two years you can use the qualified widow or widower status if you have a
dependent child. For example, if your spouse died in 2019 and you haven't remarried, you can file jointly in
2019 and then file as a qualified widow or widower (also called “surviving spouse”) in 2020 and 2021.
● The kids are key. If the kids are already out of the house when your spouse dies, this status probably won’t work
for you, because you have to have a qualifying child living with you. You also have to provide more than half of
the cost of keeping up the house during the tax year.
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What it gets you:
The qualified widow or widower status lets you file as if you were married filing jointly. That gets you a much higher
standard deduction and better tax bracket situation than if you filed as single.
MARRIED FILING JOINTLY
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Who uses it:
Most married couples.
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How it works:
● You file together. You report your combined income and deduct your combined allowable deductions and
credits on the same forms. You can file a joint return even if one of you had no income or deductions.
● There are rules about divorce. If you were legally divorced by the last day of the year, the IRS considers you
unmarried for the whole year. That means you can’t file jointly that year. If your spouse died during the tax year,
however, the IRS considers you married for the whole year. You can file jointly that year, even if you don’t have
kids in the house.
● You're both responsible. Note that when you file jointly, the IRS holds both of you responsible for the taxes and
any interest or penalties due. This means you could be on the hook if your spouse doesn’t send the check or
flubs the math.
What it gets you:
Probably a lower tax bill than if you file separately; your standard deduction — if you don’t itemize — could be higher,
and you can take deductions and credits that generally aren’t available if you file separately.
MARRIED FILING SEPARATELY
Who uses it:
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High earners who are married, people who think their spouses may be hiding income, or people whose spouses
have tax liability issues. For example, if you're thinking of or are in the process of divorcing and don't trust that your
spouse is being upfront about income, this option might be for you. If you've recently married someone who is
bringing tax problems into the mix, filing separately might be worth thinking about.
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How it works:
● Filing separately isn’t the same as filing single. Only unmarried people can use the single tax filing status, and
their tax brackets are different in certain spots from if you’re married and filing separately.
● People who file separately often pay more than they would if they file jointly. Here are a few reasons:
o You can’t deduct student loan interest.
o You can’t take the credit for child and dependent care expenses. Also, the amount you can exclude
from income if your employer has a dependent care assistance program is half what it is if you file
jointly.
o You can’t take the earned income tax credit.
o You can’t take exclusions or credits for adoption expenses in most cases.
o You can’t take the American Opportunity or Lifetime Learning credit.
o You can take only half the standard deduction, child tax credit or deduction for retirement savings
contributions.
o You can deduct only $1,500 of capital losses instead of $3,000.
o If your spouse itemizes, you have to itemize too, even if the standard deduction would get you more.
You’ll also have to decide which spouse gets each deduction, and that can get complicated.
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What it gets you:
Usually just a bigger tax bill, but there are a few possible perks.
● If you’re on an income-based student loan repayment plan that keys off adjusted gross income, filing
separately could reduce your monthly bill if your payments are based only on your income rather than on your
joint income as a couple.
● If you live in a community property state — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas,
Washington or Wisconsin — anything couples earn generally belongs to both spouses equally, which kills off
most of these perks.
SINGLE
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Who uses it:
Unmarried people who don’t qualify for another filing status.
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How it works:
● There are rules about being unmarried. If you’re legally divorced by the last day of the year, the IRS considers
you unmarried for the whole year. If your marriage is annulled, the IRS also considers you unmarried even if
you filed jointly in previous years.
● Don't be sneaky. The IRS can make you use the “married filing jointly” or “married filing separately” tax filing
status if you get a divorce just so you can file single and then remarry your ex in the next tax year. Translation:
Don’t get divorced every New Year’s Eve for tax purposes and then get married again the next day — the IRS is
onto that trick.
What it gets you:
Possibly lower taxes if you make a lot of money. That’s because at the very highest tax brackets, the income levels that
determine the tax brackets for married people filing jointly are less than double the income levels that determine the
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tax brackets for single people. It’s a phenomenon called “the marriage penalty,” and it means married couples end up
in higher tax brackets faster than single people do.
For example, let’s assume you and your partner were single in 2020 and you each had $325,000 of taxable income.
You each use the single tax filing status. You’ll each be in the 35% tax bracket. Now let’s assume you and your partner
are married and use the married filing jointly tax filing status. You still each make $325,000. You might expect to remain
in the 35% bracket, but that’s not the case anymore. If you’re married and filing jointly, your income — simply because
it’s combined — puts you squarely in the 37% bracket.
Residency Status
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OVERVIEW OF TAX RESIDENCY
In the U.S. tax system, foreign nationals are considered either ‘non-residents for tax purposes‘ or ‘residents for tax
purposes’. Your tax residency status depends on your current immigration status and/or how long you’ve been in the
U.S. See below to determine whether or not you are considered a ‘resident for tax purposes’.
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DETERMINING RESIDENCY STATUS
If you are not a U.S. citizen, you are considered a ‘non-resident for tax purposes’ unless you meet the criteria for one of
the following tests:
1. The “Green Card” Test You are a ‘resident for tax purposes’ if you were a legal permanent resident of the
United States any time during the past calendar year.
OR
2. The Substantial Presence Test. You will be considered a ‘resident for tax purposes’ if you meet the Substantial
Presence Test for the previous calendar year. To meet this test, you must be physically present in the United
States for at least:
● 31 days during the current year, and 183 days during the 3-year period that includes the current year and the 2
years immediately before that, counting:
o All the days you were present in the current year, and
o 1/3 of the days you were present in the first year before the current year, and
o 1/6 of the days you were present in the second year before the current year.
● If total equals 183 days or more = Resident for Tax
If total equals 182 days or less = Nonresident for Tax
● EXCEPTIONS to the Substantial Presence Test:
o F or J students receive 5 “exempt”** years. Not exempt from tax, but of counting physical days of
presence in the U.S. towards Substantial Presence Test.
o J Non-Students (including Non-Degree Visiting Students) receive 2 “exempt”** years (of the past 6
years).
o **“Exempt” years are CALENDAR years, not years from date of arrival (e.g. if you arrived 8/23/2017,
2017 would be counted one, total calendar year).
DUAL-STATUS RESIDENT ALIEN
In the year of transition between being a nonresident and a resident for tax purposes, you are generally considered a
Dual-Status Taxpayer. A Dual-Status Taxpayer files two tax returns for the year—one return for the portion of the year
when considered a nonresident, and another return for the portion of the year considered a resident. In some
situations, a taxpayer can elect to be treated as a full-year resident in the transition year to avoid having to file two
separate returns. If you think you may be a Dual Status Alien,
visit the Dual-Status IRS website for more information.
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Qualifying Dependent
DETERMINING A TAX DEPENDENT
A tax dependent is a child or relative whose characteristics and relationship to you allow you to claim certain tax
deductions and credits, such as head of household filing status, the Child Tax Credit, the Earned Income Tax Credit or
the Child and Dependent Care Credit.
Determining whether someone is a tax dependent can be difficult. For all the details, check out IRS Publication 501.
For tax purposes, there are two kinds of dependents:
● A qualifying child
A qualifying relative
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QUALIFYING CHILD
To claim a child as a dependent on your tax return, the child must meet all of the following conditions.
● The child has to be an eligible relative of the taxpayer
o This is the relationship test. The child must be your son, daughter, stepchild, foster child, brother, sister,
half brother, half sister, stepbrother, stepsister or a descendant of any of those people.
● The child has to be under a certain age
o This is the age test. One of these three things has to be true to pass this test:
0. The child was 18 or younger at the end of the year and younger than you or your spouse (if
you're married and filing jointly).
1. The child was 23 or younger at the end of the year, was a student and was younger than you or
your spouse (if you're married and filing jointly). “Student” in this case means the kid was a
full-time student for at least five calendar months of the year.
2. The child is over these age limits but is permanently and totally disabled, as determined by a
doctor.
● The child has to live with you
o This is the residency test. The child must have lived with you for more than half the tax year. There are
certain exceptions for temporary absences (such as if the child was away at college, in the hospital or in
juvenile detention), for children who were born or died during the tax year, for kids of divorced or
separated parents and for kidnapped kids.
● The child can't provide more than half of his or her own financial support
● The child has to have certain residency or citizenship status
o This is the citizen or resident test. The child has to be a U.S. citizen, U.S. resident alien, U.S. national or a
resident of Canada or Mexico.
QUALIFYING RELATIVE
A qualifying relative can be any age. But to claim a relative as a tax dependent on your tax return, the person must
meet all of the following conditions.
● The person can’t be anyone else’s qualifying child
● The person has to be related to you or live with you
● Only one of these two things has to be true:
o The person has one of these relationships to you. He or she is your child, stepchild, legally adopted
child, foster child, or a descendant of any of those people (for example, your grandchild) or is your
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sibling, half sibling, stepsibling, niece or nephew (including the kids of your half siblings), or is your
parent or grandparent, stepparent, aunt or uncle, or in-law (but not your foster parent).
o The person lived with you all year. There are exceptions for temporary absences (such as if the child
was away at college), for children who were born or died during the tax year, for kids of divorced or
separated parents and for kidnapped kids.
The person’s gross income is below the limit (less than $4,300 in 2021)
You have to provide more than half the person’s total financial support for the year
o Support generally includes household expenses such as rent, groceries, utilities, clothing,
unreimbursed medical expenses, travel costs and recreation expenses.
Tax Return Filing Decisions:
Not everyone is required to file an income tax return each year. Generally, if your total income for the year doesn't
exceed certain thresholds, then you don't need to file a federal tax return. The amount of income that you can earn
before you are required to file a tax return also depends on the type of income, your age and your filing status.
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Gross Income Threshold
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GROSS INCOME THRESHOLD UNDER 65
Most taxpayers are eligible to take the standard deduction. The standard tax deduction amounts that you're eligible for
are primarily determined by your age and filing status. These amounts are set by the government before the tax filing
season and generally increase for inflation each year.
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The standard deduction, along with other available deductions, reduces your income to determine how much of your
income is taxable. As long as you don't have a type of income that requires you to file a return for other reasons, like
self-employment income, generally you don't need to file a return as long as your income is less than your standard
deduction.
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For example, in 2020, you don't need to file a tax return if all of the following are true for you:
● Under age 65
● Single
● Don't have any special circumstances that require you to file (like self-employment income)
● Earn less than $12,400 (which is the 2020 standard deduction for a single taxpayer)
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GROSS INCOME THRESHOLD OVER 65
If you are at least 65 years old, you get an increase in your standard deduction. You also get an increased standard
deduction if:
● You are blind
● Or your spouse is also at least 65
● Or if your spouse is blind
The largest standard deduction would be for a married couple that are both blind and both over 65 years old.
Having a larger standard deduction can allow you to have more income than someone under age 65 and still not have
to file a return.
Qualifying Dependent Tax Return
Taxpayers who are claimed as a dependent on someone's tax return are subject to different IRS filing requirements,
regardless of whether they are children or adults. A tax return is necessary when their earned income is more than their
standard deduction.
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The standard deduction for single dependents who are under age 65 and not blind is the greater of:
● $1,100 in 2020
● Or the sum of $350 + the person's earned income, up to the standard deduction for an unclaimed single
taxpayer which is $12,400 in 2020.
A dependent's income can be "unearned" when it comes from sources such as dividends and interest. When a
dependent's unearned income is greater than $1,100 in 2020, the dependent must file a tax return.
Submit A Tax Return For A Tax Refund
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With all the above being said, there are years when you might not be required to file a tax return but may want to. If
you have federal taxes withheld from your paycheck, the only way you can receive a tax refund when too much was
withheld is if you file a tax return.
● For example, if you are a single taxpayer who earns $2,500 during the year, with $300 withheld for federal tax,
then you are entitled to a refund for the entire $300 since you earned less than the standard deduction.
● The IRS doesn't automatically issue refunds without a tax return, so if you want to claim any tax refund due to
you, then you should file one.
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Social Security
In most cases, if you only receive Social Security benefits you wouldn't have any taxable income and wouldn't need to
file a tax return.
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One catch with Social Security benefits is if you are married but file a separate tax return from your spouse who you
lived with during the year. Then you will always have to include at least some of your Social Security benefits in your
taxable income to see if it is greater than your standard deduction.
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Taxable Social Security
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When determining whether you need to file a return and you receive Social Security benefits, you need to consider
tax-exempt income because it can cause your benefits to be taxable even if you don't have any other taxable income.
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Here's an example of where you may need to file, even with tax-exempt income:
● You are under age 65 and receive $30,000 in Social Security benefits, but also receive another $31,000 in
tax-exempt interest. $14,700 of your Social Security benefits will be considered taxable income.
● This is greater than your standard deduction ($12,400 for a single taxpayer in 2020) and you would need to file
a tax return.
To figure out if your Social Security benefits are taxable:
● Add one-half of the Social Security income to all other income, including tax-exempt interest.
● Then compare that amount to the base amount for your filing status.
● If the total is more than the base amount, some of your benefits may be taxable.
Sources of Income (OICS_6719)
Global Income Taxes
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If you are a U.S. citizen or a resident alien, your income is subject to U.S. income tax, including any foreign income, or
any income that is earned outside of the U.S. It does not matter if you reside inside or outside of the U.S. when you
earn this income. In addition, even if you do not receive a Form W-2, a Wage and Tax Statement, or a Form 1099 from
the foreign payer, you are still required to report this income.
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If you are a U.S. citizen or a resident alien, your income—including any foreign income, or any income that is
earned outside of the U.S.—is subject to U.S. income tax.
If you meet certain requirements related to the length and nature of your stay in a foreign country, you may
qualify to exclude some of your foreign earned income from your U.S. federal income tax return.
Some taxpayers may qualify for the Foreign Tax Credit, a tax break provided by the government to reduce the
tax liability of certain taxpayers.
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U.S. Citizen vs. U.S. Resident Alien
For tax purposes, if you are not a citizen of the U.S., the IRS will either consider an individual a resident alien or a
nonresident alien. You are a resident alien of the U.S. for tax purposes if you meet either the green card test or the
substantial presence test for the calendar year.
IRS Publication 519, U.S. Tax Guide for Aliens, provides more information about the qualifications for being considered
a U.S. resident alien for tax purposes. Both U.S. citizens and U.S. resident aliens are required to report all of their
income to the U.S. government so that it can be taxed appropriately.
Total Income Includes Both Earned and Unearned Income
The amount that you are taxed on includes earned income and unearned income from both foreign and non-foreign
sources. The IRS considers these sources to be earned income: wages, salaries, bonuses, commissions, tips, and net
earnings from self-employment.
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According to the IRS, unearned income is income from investments and other sources unrelated to employment.
Examples of unearned income include interest from savings accounts, bond interest, alimony, and dividends from
stock.
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If you are a U.S. citizen or U.S. resident alien, you report your foreign income where you normally report your U.S.
income on your tax return. Your earned income is reported on line 7 of IRS Form 1040; interest and dividend income
are reported on Schedule B; income from rental properties is reported on Schedule E, and so on, depending on the
type of income you are reporting.
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Foreign Earned Income Exclusion
If you meet certain requirements related to the length and nature of your stay in a foreign country, you may qualify to
exclude some of your foreign earned income from your tax return. For the tax year 2020, you may be eligible to
exclude up to $107,600 of your foreign-earned income from your U.S. income taxes.For the tax year 2021, this amount
increases to $108,700.2This provision of the tax code is referred to as the Foreign Earned Income Exclusion.
In order to be eligible for the foreign-earned income exclusion, you must meet the following three requirements:
● Your tax home must be in a foreign country. Your tax home is defined as the general area of your main place of
employment—where you are permanently or indefinitely engaged to work as an employee
or self-employed individual—regardless of where you maintain your family home. It's important to note that
your place of residence can be different from your tax home.
o You must have foreign-earned income.
You must be either:
A U.S. citizen who is a bona fide resident of a foreign country for an entire tax year.
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A U.S. resident alien who is a citizen or national of a country with which the United States has
an income tax treaty in effect and who is a bona fide resident of a foreign country for an entire tax year.
● A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330
full days during any period of 12 consecutive months.
Other rules apply that could affect your eligibility to claim the foreign-earned income exclusion. IRS Publication
54 provides more complete information regarding the eligibility of taxpayers.
Foreign Tax Credit
Although it depends on what country you earned the income in, it is likely that your foreign source income will be
taxed in two countries—both the U.S. and the respective country it was earned in. In order to compensate for this, the
U.S. government offers a tax break to reduce the tax liability of certain taxpayers, called the Foreign Tax Credit.
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This tax credit is a non-refundable tax credit for income taxes paid to a foreign government as a result of foreign
income tax withholdings. The foreign tax credit is available to anyone who either works in a foreign country or has
investment income from a foreign source.
Taxable & Non-Taxable Income
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What's taxable income?
Money, property, or services that are received are all considered income. Certain types of income may be taxed.
However, some may not be taxed.
What is taxable income? It’s income that is taxed or income in which personal exemptions and deductions are taken
out, including:
● wages, salaries, tips, bonuses, vacation pay, severance pay, commissions
● interest and dividends
● certain types of disability payments
● unemployment compensation
● jury pay and election worker pay
● strike and lockout benefits
● bank “gifts” for opening or adding to accounts if more than “nominal” value
● cancellation of debt (unless excludable by law or regulation)
● alimony
● recoveries of items deducted in previous year
● gain from the sale of property, stocks and bonds, stock options, etc.
● pension and annuity distributions (amounts not contributed by taxpayer with after-tax dollars)
● traditional IRA distributions (amounts deducted in prior years)
● rental income, farm income, business income
● royalties
● trust/estate income, Partnership/S-corporation income
● executor’s commissions
● Social Security benefits (above the base amount)
● notary fees
● most court awards or damages
● fees or property received for services or barter income
● prizes, awards, gambling winnings, and illegal income
● certain scholarships, fellowships and grants
What's non-taxable income?
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Nontaxable income won’t be taxed, whether or not you enter it on your tax return. The following items are deemed
nontaxable by the IRS:
● Inheritances, gifts and bequests
● Cash rebates on items you purchase from a retailer, manufacturer or dealer
● Alimony payments (for divorce decrees finalized after 2018)
● Child support payments
● Most healthcare benefits
● Money that is reimbursed from qualifying adoptions
● Welfare payments
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Under certain circumstances, the following items may be nontaxable.
● Money you receive from a life insurance policy when someone dies is not taxable. However, if you cash in a life
insurance policy, then a portion, if not all of it, is likely taxable.
● Money from a qualified scholarship is not taxable. However, if you use the money for room and board, or use it
to pay other personal expenses, that portion is normally taxable.
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Compensation
Generally, income can be received in three ways: money, services and property. But, you can also pay tax on income
not yet in your possession. For example, if you receive a check but don’t cash it by the end of the tax year, it is still
considered income for the year you received the check.
The IRS requires that you declare all income on your return. This can include:
● Wages
● Salaries
● Commissions
● Strike pay
● Rental income
● Alimony (for divorce decrees finalized before 2019)
● Royalty payments
● Stock options, dividends and interest
● Self-employment income
Typically, unemployment compensation is also considered taxable income. However, for the 2020 tax year, up to
$10,200 of unemployment benefits can be excluded from income. If you are married, each spouse can exclude this
amount. Amounts over this remain taxable and if your modified adjusted gross income (AGI) is greater than $150,000
then you can't exclude any unemployment compensation.
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Income from fringe benefits
If you receive fringe benefits for services you render, they are usually considered taxable income, even if someone else
receives them, such as your spouse. These taxable benefits and perks may include:
● A company-paid off-site gym membership
● A company vehicle for personal use
● Holiday gifts in the form of cash or gift certificates from your employer
● A certain portion of employer-paid dependent care
● Company-paid tuition fees over a certain amount
● Company-paid financial counseling fees
● Employer-paid group life insurance over a certain amount
Miscellaneous income
Income that may not be readily identified as taxable but generally must be included on your tax return includes:
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Employer contributions to an unqualified retirement plan
The fair-market value of property received for your services
Disability retirement payments from an employer-paid plan
Sickness and injury payments from an employer-paid plan
Property and services for which you bartered
Money and income from offshore accounts
The remaining amount of a debt or loan that is canceled or forgiven
The W-2 (OICS_6720)
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What is a W-2?
IRS Form W-2, the “Wage and Tax Statement,” reports an employee’s income from the prior year, how much tax the
employer withheld and other information. Employers send employees a Form W-2 in January (and a copy to the IRS).
Employees use Form W-2 to prepare their tax returns.
● Every employer that paid you at least $600 during the year has to provide you with a W-2 and send a copy to
the IRS and the state. Tip income may be on your W-2.
● Don’t confuse a W-2 with a W-4 — that’s the form you use to tell your employer how much tax to withhold from
your paycheck every pay period (learn how withholding taxes work).
● Freelancers or independent contract workers get 1099s from their clients, not W-2s.
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How do I get my W-2?
If you're looking for a copy of an old W-2 that you attached to a prior tax return and you can't get a copy from the
employer that originally issued it, you can request an IRS tax transcript online or use IRS Form 4506 to request a copy
of your tax return.
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When should I receive my W-2?
The IRS requires employers to furnish W-2s to the government and employees by Jan. 31 or face penalties. The IRS
generally defines furnish as “get it in the mail,” which means you should have yours in hand by the first week of
February. Employers can also send employees their W-2s electronically, but it’s not required. That means you may be
able to get yours online. Even if you quit your job months ago, your ex-employer can still wait until Jan. 31 to send you
a W-2 — unless you ask for it earlier, in which case the employer has 30 days to provide it.
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How a W-2 works
You use the W-2 to file your tax return. Form W-2 shows more than just what you were paid. It also details how much
you contributed to your retirement plan during the year, how much your employer paid for your health insurance,
or even what you received in dependent care benefits. All of that data affects your tax picture — your retirement
contributions might not be taxable, for example.
● Box 1: Details how much you were paid in wages, tips and other compensation.
● Box 2: Shows how much federal income tax was withheld from your pay.
● Box 3: Shows much of your pay in Box 1 was subject to Social Security tax.
● Box 4: Shows how much Social Security tax was withheld from your pay.
● Box 5: Shows how much of your pay in Box 1 was subject to Medicare tax.
● Box 6: Shows how much Medicare tax was withheld from your pay.
● Box 7: Shows how much of the tip income you reported to your employer (those tips are included in Box 1) was
subject to Social Security tax.
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Box 8: Shows the amount of other tips your employer allocated to you. This pay isn't included in Box 1. (Learn
how to report tips on your income tax return.)
Box 10: Shows the amount of dependent care benefits your employer paid to you or incurred on your behalf.
Generally, anything over $5,000 ($2,500 if you're married by filing separately) is also included in box 1.
Box 11: Generally, this box shows how much money was distributed to you during the year from your
employer's deferred compensation plan.
Box 12: Here, there are four areas in which the employer can provide more detail about some or all of the pay
reported in Box 1. For example, if you've contributed to your company's 401(k) plan, the amount of your
contributions might show up in Box 12 with the code letter "D." There are many codes, which you can see in
the IRS's W-2 instructions.
Box 13: This box indicates whether your earnings are subject to Social Security and Medicare taxes but aren't
subject to federal income tax withholding, whether your participated in certain types of retirement plans, or
whether you got certain kinds of sick pay.
Boxes 16-19: Shows how much of your pay is subject to state income tax, how much state income tax was
withheld from your pay, how much income was subject to local taxes, and how much local tax was withheld
from your pay.
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Tax Formula:
Distilled to its simplest form, the Individual Federal Income Tax formula can be seen as:
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Gross income – Generally entails ALL income that you earn. Wages, interest income, canceled debts, gig work,
and so many other forms of income get included in gross income.
Deductions for AGI – Also known as “above-the-line deductions,” these are certain deductions such as
contributions to retirement plans, alimony, and student loan interest. These items lower the gross income and
the total is called Adjusted Gross Income.
Adjusted Gross Income (AGI) – This number is significant because it can determine if you qualify for certain
deductions and tax credits.
Itemized Deductions – Also known as “below-the-line deductions,” these are certain deductions such as
medical expenses, charitable donations, and state & local taxes paid. These items lower AGI and what
calculates taxable income.
Standard Deduction – A deduction of a set number subtracted from AGI if itemized deductions are less than
the standard deduction. See our article for more details on standard vs itemized. Currently, the standard
deduction is $12,400 (2020) or $12,550 (2021) for single filers.
Taxable Income – The amount after subtracting deductions. This number determines the applicable tax
bracket that you will fall under. Check out Form 1040 Instruction for current brackets. Once the rate is applied,
you get your gross tax liability, or more simply, what you owe to the IRS.
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Gross Income
–Deductions for Adjusted Gross Income
=Adjusted Gross Income (AGI)
Standard Deduction OR Itemized
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Deductions
=Taxable Income
xTax Rate
=Gross Tax Liability
–Tax Credits and Prepayments
=Tax Due OR Tax Refund
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Tax Credits & Prepayments – These items directly lower your gross tax liability. Taxes your employer withheld
and qualified tax credits fall in this category.
Form 1040 (OICS_6721)
The IRS 1040 form is one of the official documents that U.S. taxpayers use to file their annual income tax return. The
1040 form is divided into sections where you report your income and deductions to determine the amount of tax you
owe or the refund you can expect to receive. Depending on the type of income you report, it may be necessary to
attach additional forms, also known as schedules.
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Why are there different versions of the 1040 form?
There are now four variations of the 1040 form (1040A and 1040EZ no longer exist):
● Form 1040: This is the one the majority of taxpayers will use to report income and determine their tax for the
year and any refund or additional tax owed.
● Form 1040-SR: This version is for senior taxpayers (age 65 and older). Form 1040-SR is nearly identical to Form
1040, but is printed using a larger font and includes a chart for determining the taxpayer's standard deduction.
● Form 1040-NR: This form is for non-U.S. citizens who do not hold a green card, and it is several pages longer
than the other 1040 form versions.
● Form 1040-X: This form is for taxpayers who need to make amendments to their tax return after previously
filing a Form 1040.
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What is the purpose of a 1040 form?
Taxpayers use the federal 1040 form to calculate their taxable income and tax on that income. One of the first steps is
to calculate Adjusted Gross Income (AGI) by first reporting your total income and then claiming any allowable
adjustments, also known as above-the-line deductions. Your AGI is an important number since many deduction
limitations are affected by it.
On line 11 of the tax year 2020 Form 1040, you will report your AGI. You can reduce it further with either the standard
deduction or the total of your itemized deductions reported on Schedule A. Itemized deductions include expenses
such as:
● Mortgage interest, state and local income taxes or sales taxes, charitable contributions, and excess medical
expenses.
If the total of your itemized deductions does not exceed the standard deduction for your filing status, then your taxable
income will usually be lower if you claim the standard deduction. Beginning in 2018, exemption deductions are
replaced with higher child tax credits and a new other-dependent tax credit.
What are the most recent changes to Form 1040?
The biggest change to Federal Form 1040 is that a new Line 30 has been added for the Recovery Rebate Credit. This is
for taxpayers who didn't receive payments or could have received a larger payment from the government when
economic impact payments (stimulus checks) went out in 2020. These taxpayers can claim that amount as a refundable
credit here.
Additionally, the "Amount You Owe" section of Form 1040, will now state: "Schedule H and Schedule SE filers, line 37
may not represent all of the taxes you owe for 2020." This means that since employers were allowed to defer payments
of the employer's share of social security tax due to the CARES Act, this deferred amount will be reported in the
payments section of Form 1040, Schedule 3, Line 12e. It will be entered as a "Deferral for certain Schedule H or SE
filers."
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Another change to Form 1040 is that there are now three lines to report withholdings. On Form 1040, Line 25a will be
for W-2 withholdings, Line 25b will be for 1099 withholdings, and Line 25c will be for other withholdings.
There is also a new deduction for charitable cash contributions of up to $300. These will be reported on Schedule A,
Line 10b for taxpayers taking the standard deduction.
Finally, there is a new credit for sick and family leave for certain self-employed individuals. This credit will be entered
on Schedule 3, Line 12b and will be calculated on Form 7202.
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Form 1040 Schedules:
What are the different schedules used with Form 1040?
Even though Form 1040 is relatively short, there are various schedules, or additional forms, that help taxpayers
calculate specific items that apply to Form 1040:
● Schedule 1: This form is used for reporting several common additional income sources or adjustments to
income. Some common examples of items reported on Schedule 1 include alimony, gains or losses from the
sale of a business property, unemployment compensation, educator expenses, tuition and fees deductions,
and health savings account contributions.
● Schedule 2: This form is used for reporting additional taxes, and it now consists of two parts. The first part is for
reporting alternative minimum tax and repayments of excess premium tax credits for health insurance
purchased through the health insurance marketplace. The second part is for reporting self-employment taxes,
unreported social security and Medicare tax, additional tax on IRAs or other tax-favored accounts, household
employment taxes, repayment of first-time home buyer credit, and section 965 net tax liability for foreign
corporations.
● Schedule 3: This form is for reporting additional credits and payments, and it's split into two parts: refundable
credits and non-refundable credits. Credits reported here include credits for child and dependent care
expenses, residential energy credits, overpayment of taxes in previous years, and previously paid excess social
security taxes.
● Schedule A: This common form is used to enter all itemized deductions. These can include medical and dental
expenses, mortgage interest, state and local taxes, charitable donations, and casualty and theft losses.
● Schedule B: This form is used to report interest and dividend income that is greater than $1,500. If you have
interest and dividend income under that amount, you will enter that on Form 1040, Lines 2 and 3.
● Schedule C: This form is for reporting profit or loss from business. It's used by independent contractors,
freelancers, and owners of sole proprietorships or single-member LLCs.
● Schedule D: This form is used for reporting capital gains or losses from investments.
● Schedule E: Those who have income or losses from rental real estate, royalties, partnerships, S corporations,
estates, trusts, REMICs, or other pass-through entities will report those amounts on this form.
● Schedule F: This form is used by farmers to report income and expenses from farming.
● Schedule H: This form is used by taxpayers with household workers, such as a nanny or caretaker. Since the
taxpayer is responsible for withholding income for social security and Medicare taxes, those are reported here.
● Schedule J: This form is used by farmers and fisherman who choose to figure their income tax by averaging
their three previous years' worth of taxes in order to more evenly distribute tax liability.
● Schedule R: This form is for claiming the senior or disability tax credit.
● Schedule SE: For business owners or independent contractors who made a profit of at least $400, this form is
used to calculate self-employment tax.
● 8812: This form is for claiming the additional child tax credit on your 2020 tax return. If the total child tax credit
amount for all qualifying children in your household exceeds the amount of tax you owe for the year, then you
will prepare this form to calculate the refundable portion of the credit. For tax year 2021, the entire child tax
credit is refundable so it is expected that Form 8812 will not be necessary for your 2021 tax return.
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Business Income & Expenses (OICS_6722)
What Is Business Income?
Business income is a type of earned income and is classified as ordinary income for tax purposes. It encompasses any
income realized as a result of an entity’s operations. In its simplest form, it is a business entity’s net profit or loss, which
is calculated as its revenue from all sources minus the costs of doing business.
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KEY TAKEAWAYS
● Business income is earned income and encompasses any income realized from an entity’s operations.
● For tax purposes, business income is treated as ordinary income.
● Business expenses and losses often offset business income.
● How a business is taxed depends on whether it is a sole proprietorship, a partnership, or a corporation.
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Understanding Business Income
Business income is a term commonly used in tax reporting. According to the Internal Revenue Service (IRS), “Business
income may include income received from the sale of products or services. For example, fees received by a person
from the regular practice of a profession are business income. Rents received by a person in the real estate business
are business income. A business must include in income payments received in the form of property or services at the
fair market value of the property or services.”
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Business expenses and business losses can offset business income, which can be either positive or negative in any
given year. The profit motive behind business income is universal to most business entities. However, the way in which
business income is taxed differs for each of the most common types of businesses: sole proprietorships, partnerships,
and corporations.
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How a business is formed determines how it should report its income to the IRS.
● A sole proprietorship is not a legally separate entity from its owner. Therefore, business income from a sole
proprietorship is reported on that individual’s Form 1040 tax return using Schedule C: Profit or Loss From
Business.
● A partnership is an unincorporated business that is jointly owned by two or more individuals. It reports
business income on Form 1065. However, the partnership itself does not pay income tax. All partners receive a
Schedule K-1 and report their share of the partnership’s income on their own individual income tax returns.
● A limited liability company (LLC) can be a sole proprietorship, partnership or corporation. Sole Proprietorships
can become Single Member LLCs and report their business income on Form 1040, Schedule C. LLCs with two
or more members will be treated as a partnership and report their business income on Form 1065. An LLC can
elect to become a C Corporation and will report their business income on Form 1120.
● A corporation is a legally separate entity from any individual who owns it. Corporations are each generally
taxed as a C corporation (C-corp), which means they are taxed separately from their owners. Business income
from a corporation is reported on Form 1120.
● An S corporation (S-corp) is a corporation that elects to be taxed as a pass-through business. Business income
for an S-corp is reported on Form 1120-S. Like a partnership, the S-corp does not pay income tax. Shareholders
receive a K-1 and report their share of the company’s income on their individual tax returns. Note that an
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S-corp is not a type of business entity; it is a tax filing election that an LLC or a C-corp can elect to S status after
forming.
What Are Business Expenses?
Business expenses are costs incurred in the ordinary course of business. They can apply to small entities or large
corporations. Business expenses are part of the income statement. On the income statement, business expenses are
subtracted from revenue to arrive at a company’s taxable net income.
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Business expenses may also be referred to as deductions. In general, companies have some limitations and special
considerations for business expense deductions. They are generally divided into capital expenditures and operational
expenditures.
Understanding Business Expenses
Section 162 of the Internal Revenue Code (IRC) discusses guidelines for business expenses. The IRC allows businesses
to report any expense that may be ordinary and necessary.
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Business expenses need not be required to be considered ordinary or necessary. Generally, ordinary means that the
expense is common in the industry and most business owners in the same line of business or trade would potentially
expense these things. Necessary means that the expenses help in doing business are appropriate and a business
owner might not be able to handle the business if they did not make the expenditure.
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An expense that meets the definition of ordinary and necessary for business purposes can be expensed and, therefore,
is tax-deductible. Some business expenses may be fully deductible while others are only partially deductible.Below
are some examples of allowable, fully deductible expenses:
● Advertising and marketing expenses
● Credit card processing fees
● Education and training expenses for employees
● Certain legal fees
● License and regulatory fees
● Wages paid to contract employees
● Employee benefits programs
● Equipment rentals
● Insurance costs
● Interest paid
● Office expenses and supplies
● Maintenance and repair costs
● Office lease
● Utility expenses
Income Statement Reporting
The income statement is the primary financial statement used by entities to record their expenses and determine their
taxes. Entities will typically have three categories of expenses which are broken down by direct costs, indirect costs,
and interest on the income statement.
Direct Costs
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The value of inventory on-hand at the beginning and the end of each tax year is used in determining the cost of goods
sold (COGS), which is a large direct expense for many companies.
COGS is deducted from an entity’s total revenue to find the gross profit for the year. Any expenses included in COGS
cannot be deducted again. Expenses that are included in calculating COGS may include direct labor costs, factory
overhead, storage, costs of products, and costs of raw materials.
Indirect Costs
Indirect costs are subtracted from gross profit to identify operating profit. Indirect costs typically include things like
executive compensation, general expenses, depreciation, and marketing costs. Subtracting indirect costs from gross
profit results in operating profit which is also known as earnings before interest and tax.
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Depreciation
Expensing of business assets is usually done by deprecation. Depreciation is a tax-deductible expense on the income
statement that is classified as an indirect expense. Depreciation expenses can be deducted over a number of years and
include costs of computers, furniture, property, equipment, trucks, and more.
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Gifts, Meals, and Entertainment Costs
There are several costs that the IRS has restrictions on, primarily associated with gifts, meals, and entertainment.
Generally, you can only deduct up to $25 for gifts, deduct only 50% of the cost of providing meals to employees,
although certain meals may be fully deducted. The rules may change so you should just double-check the current
restrictions on the IRS website.
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Interest Expenses
The last section of the income statement involves expenses for interest and tax. Interest is the last expense a company
subtracts to arrive at its taxable income, sometimes called adjusted taxable income.
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Personal Expenses
In some cases, expenses incurred by a business owner may be both personal and business-related. For example, a
small business owner might use his car for both personal purposes and business-related activities.
In this case, the portion of miles used for business purposes can be deducted. In the case of home offices, costs
associated with the portion of the home that is exclusively used for business are generally deductible.
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Non-Deductible Expenses
Some expenses incurred by a business are not reportable. These expenses include bribes, lobbying costs, penalties,
fines, and contributions made to political parties or candidates.
Calculating Business Auto Expenses
The IRS offers two ways of calculating the cost of using your vehicle in your business: The Actual Expenses method or
Standard Mileage method. Each method has its advantages and disadvantages, and they often produce vastly
different results. If you want to use the standard mileage rate for a car or truck you use for your business, you must
choose to use it in the first year the car is available for use in your business. In later years, you can choose to use either
the standard mileage rate or actual expenses. Each year thereafter, you’ll want to calculate your expenses both ways
and then choose the method that yields the larger deduction and greater tax benefit to you.
Actual Expenses vs. Standard Mileage Method
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If you drive for a company such as Uber, the business use of your car is probably your largest business expense. Taking
this tax deduction is one of the best ways to reduce your taxable income and your tax burden.
This is important because you have to pay two separate taxes on your ridesharing income—one for your income tax and
one for your self-employment tax (the amount you contribute as a self-employed individual to Social Security and
Medicare). Both taxes are based on the net profit of your business, which can be reduced by taking a deduction for the
use of your car for your business.
The IRS offers two ways of calculating the cost of using your vehicle in your business:
1. The Actual Expenses method or
2. Standard Mileage method
Each method has its advantages and disadvantages, and they often produce vastly different results. Actual Expenses
might produce a larger tax deduction one year, and the Standard Mileage might produce a larger deduction the next.
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If you want to use the standard mileage rate method, you must do so in the first year you use your car for business. In
later years you can choose to switch back and forth between the methods from year to year without penalty. Each year,
you’ll want to calculate your expenses both ways and then choose the method that yields the larger deduction and
greater tax benefit to you.
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Below you’ll find an easy-to-follow road map to choosing the best method for you this year.
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Two types of expenses
As a self-employed owner of a ridesharing business, you’ll report your business income as well as your business
expenses on Schedule C. The chart below breaks your total business expenses into two main groups:
1. Common operating expenses and
2. Vehicle expenses
Many of the items listed on the chart apply both to your business and to your personal use. For example, you might
use the same phone and wireless plan for both your business and your personal life.
● For tax purposes, you need to calculate the percentage of each expense that applies to your business and
deduct only that portion from your business income.
● The IRS can disallow any expenses that are not supported by receipts, mileage logs, and other documentation.
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The Actual Expenses Method
As the name suggests, the Actual Expenses method requires you to add up all the money actually spent in the
operation of your vehicle. You then multiply this figure by the percentage of the vehicle’s business use.
● For example, if half the miles you drive are for business and half are for personal use, you will multiply your
total vehicle expenses by 50% to arrive at the business portion (e.g. $9,500 total expenses x .50 business use =
$4,750 business expenses).
Some of the costs you can include in your Actual Expenses are:
● Lease payments
● Auto insurance
● Gasoline
● Maintenance (such as oil changes, brake pad replacements, tire rotations)
● New tire purchases
● Title, licensing, and registration fees (not deductible in all states)
● Vehicle depreciation (use a depreciation table to calculate the amount, and then deduct only the portion that
applies to the business use of your vehicle)
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The Standard Mileage Method
The Standard Mileage method is a much simpler way of calculating the business use of your car. It does not require
you to track individual purchases and save receipts. Instead, you simply keep track of your mileage for the tax year.
(Tip: Take a photo of your odometer on New Year’s Day and save it, so you can always see where your mileage stood at
the beginning of the tax year.)
As with other tax deductions, you must determine the percentage of your mileage that applies to your business.
● If half the miles you drive are for business and half are for personal use, you will multiply your total mileage by
50% to arrive at the business portion (e.g. 10,000 miles x .50 business use = 5,000 business miles).
Once you have determined your business mileage for the year, simply multiply that figure by the Standard Mileage
rate. For tax year 2021, the Standard Mileage rate is 56 cents/mile. When you use the Standard Mileage deduction,
you can’t deduct individual expenses for your car. For example, if your transmission broke down and had to be
replaced, you might be better off using the Actual Expense method to take advantage of this large expense. The only
way to know for sure is to keep good records and to calculate your tax savings both ways.
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Qualified Business Income (QBI) Deduction:
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What is the qualified business income deduction?
The qualified business income deduction (QBI) is a tax deduction that allows eligible self-employed and small-business
owners to deduct up to 20% of their qualified business income on their taxes.
In general, total taxable income in 2020 must be under $163,300 for single filers or $326,600 for joint filers to qualify.
In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers.
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If you’re over that limit, complicated IRS rules determine whether your business income qualifies for a full or partial
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Here's how the qualified business income deduction generally works.
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Who qualifies for the qualified business income deduction?
The qualified business income deduction is for people who have “pass-through income” — that’s business income that
you report on your personal tax return.
Entities eligible for the qualified business income deduction include:
● Sole proprietorships, Partnerships, S corporations & Limited liability companies (LLCs).
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You must have "qualified business income"
The qualified business income deduction by definition applies to "qualified business income," or QBI. Qualified
business income is defined as "the net amount of qualified items of income, gain, deduction and loss with respect to
any trade or business." Broadly speaking, that means your business's net profit.
But it also means that not all business income qualifies. QBI excludes:
● Capital gains or losses.
● Dividends.
● Interest income.
● Income earned outside the U.S.
● Certain wage and guaranteed payments made to partners and shareholders.
Your income level matters
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If your total taxable income — that is, not just your business income but other income as well — is at or below $163,300
for single filers or $326,600 for joint filers, then in 2020 you may qualify for the 20% deduction on your taxable
business income. In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers.
If you’re over the income limit
If you’re over the income limit, there are a few tests that determine whether you qualify for the qualified business
income deduction. One such test is this: Is your business a “specified service trade or business"?
If you’re a doctor, lawyer, consultant, actor, financial planner — and the list goes on — then your business is deemed a
“specified service trade or business,” and many high earners in these fields won’t qualify for this tax break, because it
disappears once you hit total taxable income of $213,300 if you’re single, and $426,600 if you’re married filing jointly.
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Tests for pass-through businesses over the income limit
● If your business is a “specified service trade or business” in 2020 and your income is from $163,300 to
$213,300 (single filers) or from $326,600 to $426,600 (joint filers), there are some tests to determine whether
you can claim the qualified business income deduction, and, if so, whether it’ll be reduced.
● The same goes if you own a business with pass-through income that’s not a “specified trade or business”:
There are tests that determine how much you can claim of the deduction.
● Specifically, the amount of your deduction is based on a calculation tied to the amount of wages you paid to
employees (including yourself), as well as the value of the property the business owns. The higher those
figures, the better your chances of being able to qualify for the deduction.
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How the qualified business income deduction works
There are a couple of aspects of the pass-through deduction to keep in mind:
1. There are actually two 20% figures. The qualified business income deduction is worth up to 20% of your taxable
business income. But it’s also true that when claiming this pass-through deduction, it can’t add up to more than 20% of
your total taxable income.
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Here’s how it works: You figure your business income and expenses on Schedule C, as normal. And you figure your
adjusted gross income on Form 1040, as usual. Only after that do you start calculating this pass-through deduction.
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2. You can claim the qualified business income deduction even if you don’t itemize. That is, if you use the standard
deduction, this deduction is still available to you.
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Schedule 1 (OICS_6723)
What Is Miscellaneous Income?
If you don’t work a typical nine to five, tax season can get complicated. Whether you’re self-employed or just running
an Etsy shop on the side, it’s difficult to know what needs to be reported on your taxes and what you can safely omit
without fear of being dishonest. Below are definitions of numerous types of miscellaneous income.
Miscellaneous Income Definition: Miscellaneous income is any income besides regular employee wages, as reported
on the IRS tax form 1099-MISC. Most people think of non-employee compensation when they hear miscellaneous
income, but as of 2020, the IRS moved it to its own dedicated form, the 1099-NEC. The 1099-MISC is the form for
miscellaneous income, and it includes specific categorizations as to what is miscellaneous income and what is not.
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IRS Definition
You will receive Form 1099-MISC from a payer that paid you:
● at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest;
● at least $600 in:
o rents;
o services performed by someone who is not your employee;
o prizes and awards;
o other income payments;
o medical and health care payments;
o crop insurance proceeds;
o cash payments for fish (or other aquatic life) you purchase from anyone engaged in the trade or
business of catching fish;
o generally, the cash paid from a notional principal contract to an individual, partnership, or estate;
o payments to an attorney; or
o any fishing boat proceeds,
● For direct sales of at least $5,000 of consumer products for resale anywhere other than a permanent retail
establishment.
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Form 1099-MISC
The most common reason that you might receive a Form 1099-MISC is for non-employee compensation. If a business
pays you for services, but does not classify you as an employee, then you should receive a Form 1099-MISC if they paid
you over $600 in a tax year. The amount of compensation will be shown in Box 7. Even though you may not think of
yourself as having a business, for tax filing purposes, you are considered self-employed if you receive a Form
1099-MISC with income in box 7.
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Types of Miscellaneous Income
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BOX 1: RENTS
“Rents” refers to real estate rental income, machine rental (like bulldozers) income, and pasture rentals (when a farmer rents out his
land for grazing.)
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Real estate rents are specifically rents paid for office space. Additionally, if you paid them to a real estate agent or property
manager, it’s not your responsibility to report them.
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When reporting miscellaneous income, rents can also refer to coin-operated amusements (think pinball machines and gumball
vendors), but it depends if the machine is used in a rented space. If you make or pay more than $600/year in running one of these
machines, it may need to be reported in box 1 of the 1099-MISC.
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BOX 2: ROYALTIES
Royalties are an exception to the $600/year rule- you must report royalties of $10 or more on the miscellaneous income tax form.
These royalties can come from oil, gas, mineral properties, patents, copyrights, trade names, and trademarks. A few types of
royalties (surface royalties, timber royalties under a pay-as-cut contract, or oil and gas payments for a working interest) are reported
elsewhere.
BOX 3: OTHER INCOME
This is the “catch-all” box. If you made more than $600 of miscellaneous income that isn’t reported on another box, record it here.
These are things like payments or compensation from medical research studies, punitive damages. Do not report anything that
should be reported on another form, like non-employee compensation (independent contractor wages) as of 2020. This box also
includes prizes and awards, like merchandise or cash won on game shows or sweepstakes. It doesn’t include gambling winnings—
that’s reported on Form W-2G.
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BOX 6: MEDICAL AND HEALTH CARE PAYMENTS
This box is for payments made in business to providers of health care services. Common services include “injections, drugs,
dentures, and similar items”. You do not need to report payments to pharmacies for prescription drugs.
BOX 7: PAYER MADE DIRECT SALES OF $5000 OR MORE OF BOX CONSUMER PRODUCTS TO A BUYER (RECIPIENT) FOR
RESALE
This box is a yes or no, not a dollar amount! If you made more than $5000 of sales, put an x in this box. If not, leave it blank. This is
for miscellaneous income tax purposes besides adding taxable income amounts and is typically accompanied by a report of the
commissions, prizes, or awards.
BOX 10: GROSS PROCEEDS PAID TO AN ATTORNEY
Gross proceeds are amounts paid in a settlement, but not all of it is taxable income. The specific tax on this miscellaneous income is
decided elsewhere – this box is simply for the gross amount.
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There are a few other boxes not included in this list, but the ones we omitted don’t directly add to your year’s
miscellaneous income. If you have questions about these boxes you should probably contact a tax professional.
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Do I Have to Report Miscellaneous Income?
If you made more than $10 in royalties or more than $600 in any other category, you’ll need to report it as
miscellaneous income. As a business owner making payments to contractors or other individuals, you’ll need to report
the payments you make in the payment categories to the IRS each time you make a payment. This is so the IRS can
have a record of what that individual should be reporting at the end of the year. (It also why as a recipient of payments
you should be honest in your end-of-year reporting).
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What Is the Tax Rate on Miscellaneous Income?
If your miscellaneous income is from self-employment (ie you do something consistently as a form of income, like
running a business or even consistent side gigs), it will have an additional 15% self-employment tax liability. This is a
federal tax that goes towards medicare and social security. Your normal tax rate will apply, and there will be extra taxes
for things like prize winnings.
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Filing Miscellaneous Source of Income:
What Is Form 1099-MISC: Miscellaneous Income?
Form 1099-MISC: Miscellaneous Income (or Miscellaneous Information, as it's called starting in 2021) is an Internal
Revenue Service (IRS) form used to report certain types of miscellaneous compensation, such as rents, prizes and
awards, healthcare payments, and payments to an attorney. Before the 2020 tax year, Form 1099-MISC was also used
to report non-employee compensation for independent contractors, freelancers, sole proprietors, and self-employed
individuals. Starting with 2020, this non-employee pay is reported on Form 1099-NEC: Nonemployee Compensation.
These forms generally report business payments—not personal ones.
A 1099-MISC form is one of many in the 1099 series and among those commonly used. Taxpayers receive 1099s,
including Form 1099-MISC, shortly after the end of the tax year.
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Form 1099-MISC is used to report miscellaneous compensation such as rents, prizes and awards, medical and
healthcare payments, and payments to an attorney.
Until 2020, it also was used to report the income of taxpayers who are not employees, such as independent
contractors, freelancers, sole-proprietors, and self-employed individuals.
Non-employee compensation is now reported on Form 1099-NEC.
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A taxpayer receives a Form 1099-MISC if you paid them $10 or more in royalties, or $600 or more in other
types of miscellaneous income during a calendar year.
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Who Files Form 1099-MISC: Miscellaneous Income?
Form 1099-MISC: Miscellaneous Income (aka Miscellaneous Information) is completed and sent out by someone who
has paid at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest to another person. It's
also sent to each person to whom you paid at least $600 during the calendar year in the following categories:
● Rents (real estate agents and property managers report rent paid to property owners, for instance, or you
report the office space rent you paid)
● Prizes and awards
● Other income payments
● Medical and healthcare payments (made in the course of your trade or business)
● Crop insurance proceeds
● Cash payments for fish (or other aquatic life) purchased from anyone who makes a living catching fish
● Cash paid from a notional principal contract to an individual, partnership, or estate
● Payments to an attorney
● Any fishing boat proceeds
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The form is also used to report direct sales of at least $5,000 of consumer products to a buyer for resale anywhere
other than a permanent retail establishment.
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The IRS overhauled Form 1099-MISC in 2020 and introduced a new form, called Form 1099-NEC, for non-employee
compensation (which previously was reported in Box 7 of Form 1099-MISC). Payers who still need to report for tax year
2019, should make sure to use the older 2019 version of Form 1099-MISC.
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Incorporating Miscellaneous Sources of Income
Many people get income from more than one source. Whether you work a side gig or get a tidy sum each year from
interest and investments, here’s help for reporting your various income sources on your tax return. For many
Americans, a 9-to-5 job pays the bills, but for some, it’s additional income — like investments or side hustles — that
helps them get ahead. Many people have multiple sources of income. Whether it’s a second job, freelance work or
interest and dividends from investments and financial accounts, if you have more than one source of income, you’ll
want to report it correctly on your federal tax return.
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Here are some key things to know about filing taxes when you have multiple sources of income.
● Types of income that could be taxable
● Hustling on the side? You’re self-employed
● Reporting your self-employment income on your tax return
● Expenses offset self-employment income — and can lower your tax
● A word about self-employment tax
● Other multiple sources of income
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Types of income that could be taxable
So much can happen in a year. You can work a full-time job, then get laid off from that job, withdraw from your 401(k)
retirement plan, receive unemployment compensation, and start a side hustle to help make ends meet.
Or you could make a smart investment and find yourself with a nice dividend check. Maybe you won big at the casino
or rented out your home through a vacation app.
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All of these are examples of how you can have multiple streams of income within the same year. But is all that income
taxable? For the most part, yes.
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Whether your income is earned or unearned, it can be taxable. Some examples of taxable income include:
● Wages from an employer
● Money you earned freelancing
● Rental income from leasing your personal property
● Unemployment compensation
● Interest or dividends from investments
● Canceled debts, unless they are canceled as part of a bankruptcy
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Hustling on the side? You’re self-employed
If you work in a trade or business as a sole proprietor, independent contractor or partner, the IRS considers you
self-employed, whether you do the work full time or just part time. That includes your side hustle. The tax rules for
self-employment income are different than the rules that apply to your W-2 earnings. In many cases, the income you
make from self-employment gets reported on a 1099-MISC.
1099-MISC income statement
These year-end statements are for people who worked for a company, but not as an employee of the company. The
1099-MISC also reports rental payments, services (including parts and materials), prizes and awards.
If you’re not sure whether the self-employment income you received is taxable or nontaxable, check out Publication
525, Taxable and Nontaxable Income.
Reporting your self-employment income on your tax return
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With multiple streams of income, you could end up receiving a lot of 1099-MISC income statements and other types of
income forms in the mail at the end of the year.
What is Schedule C?
Depending on the nature of the different businesses, you may have to file two or more Schedule C forms. You possibly
could group activities together on the same Schedule C form if there are some similarities in the activities.
For example: You sell pet toys online and drive an Uber on the weekends. Those are two distinctly different types of
business activities, so they can’t be grouped together into one Schedule C. But say you had an online pet toy store,
and you also had a dog-sitting service. You could possibly group these into one Schedule C because both activities are
related to running a pet service business.
The IRS will generally allow you to group like businesses if you can support the grouping with facts and circumstances.
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The Schedule C form shows whether you made a profit or loss. To fill out the Schedule C, you’ll need to know how
much income you made from the side hustle. This is where you’ll input certain income from your 1099-MISC, along
with reporting any additional cash payments and checks that you may have received.
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Expenses offset self-employment income — and can lower your tax
Earning an income from your side hustle doesn’t always mean you made a profit — especially when you factor in the
expenses that came along with trying to run your side business. As the saying goes, you have to spend money to make
money. Self-employed people typically have to spend money on their businesses.
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After you put your income on the Schedule C, calculate the expenses that came along with running your side hustle.
You can only deduct expenses that you incurred to run your side business. The expenses must be ordinary and
necessary for you to conduct your business. By entering in your expenses on the Schedule C, you’ll either generate a
profit or loss that will be reported on the 1040.
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If you made a profit, then you must add that amount to your taxable income. If you had a loss, you can subtract it from
your taxable income. You only pay taxes on your business or side hustle profits.
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Here are some of the most common expenses claimed on the Schedule C:
● Supplies
● Car and truck expenses (operation and maintenance)
● Depreciation
● Legal and professional services
● Taxes
● Utilities
● Insurance
● Home office
However, there are about 30 expense categories on the Schedule C.
A word about self-employment tax
Until now, we’ve been talking about income tax that you must pay on the income you receive as a self-employed
individual. But self-employed people must also pay something call “self-employment tax.”
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Everyone who works is required to pay Social Security and Medicare taxes. When you earn a salary, your employer
withholds this tax for you. When you’re self-employed, you have to make your own contributions to Social Security and
Medicare.
The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for Social Security (old-age, survivors, and
disability insurance) and 2.9% for Medicare (hospital insurance). It’s important to remember, however, that
self-employment income doesn’t get reported as “other income” on Line 21 of Schedule 1. It should be reported as
“business income” on Line 12 of your 1040, with Schedule C or Schedule C-EZ attached. If you fail to calculate the
self-employment tax on your extra income, the IRS could possibly alert you by letter that you owe additional taxes and
penalties for failure to pay.
It’s important you report side hustle income correctly so you can pay your portion of self-employment tax.
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Other multiple sources of income
What about other sources of income you might need to report to the IRS? How do you file them?
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Examples of other sources of income are interest received from your checking or savings account, dividends from
stocks, Social Security benefits or unemployment compensation. All these types of income will be reported on the new,
shorter 1040 and on the new Schedule 1 Additional Income and Adjustments to Income.
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Bottom line
Having multiple streams of income doesn’t have to complicate your taxes when you’re ready to file. But it’s crucial that
you keep up with the various income statements you may receive — and that you keep good records of all the extra
income coming in and expenses going out. Staying organized and knowing how to report your multiple sources of
income are key to filing your tax return correctly.
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Tax Liability – Interest & Dividends (OICS_6724)
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Companies can financially reward their investors by paying shareholders dividends. Certain dividend income may
receive special tax treatment under the current tax code. This could potentially allow you to pay less income tax on
some dividends.
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What are dividends?
Dividends are payments, usually earnings, from a company to certain shareholders. Generally, companies must declare
dividends before paying them. This is typically authorized by the company's board of directors.
You may receive dividends if you own stocks, mutual funds, or exchange-traded funds (ETFs) that have stocks as a
holding in the fund.
What are qualified and unqualified dividends?
For dividends to fall in the qualified dividend category, they typically must be paid by a U.S. corporation or a qualifying
foreign corporation. Generally, you must also meet the holding period requirement.
The holding period requirement for most types of dividends states you must have held the investment unhedged for
more than 60 days during the 121-day period that starts 60 days prior to the ex-dividend date. An ex-dividend date is
typically one day before the date of record or record date. If you purchase a dividend generating investment on its
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ex-dividend date or after, you typically will not receive the next dividend payment. Generally, the holding period
doesn't include the day you purchased an investment, but it does include the day you sold it.
Ordinary dividends are the total of all the dividends reported on a 1099-DIV form. Qualified dividends are all or a
portion of the total dividends. They're reported in box 1a on Form 1099-DIV.
While this sounds complicated, your financial institution should clarify which dividends are qualified when they report
your dividends to you on Form 1099-DIV. Qualified dividends appear in box 1b.
How do interest dividends on state or municipal bonds work?
Mutual funds and ETFs may have state or municipal bonds as holdings. These bonds pay interest that's often exempt
from federal income tax. When mutual funds or ETFs distribute this interest, they usually do it through an interest
dividend.
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What are tax-free dividends?
You may have some dividends that you don't end up paying federal income tax on. Some people refer to these as
tax-free dividends. This can happen if your dividends are qualified and your taxable income falls below a certain
threshold or if they are tax-free dividends paid on municipal bonds.
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What are the tax rates for dividends in different tax brackets?
Ordinary dividends are taxed using the ordinary income tax brackets for tax year 2021.
Qualified dividend taxes are usually calculated using the capital gains tax rates. For 2021, qualified dividends may be
taxed at 0% for low taxable income. Qualified dividend income above the upper limits of the 15% bracket requires
paying a 20% tax rate on any remaining qualified dividend income. Depending on your specific tax situation, qualified
dividends may also be subject to the 3.8% Net Investment Income Tax.
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What is Form 1099-DIV?
Form 1099-DIV Dividends and Distributions is the form financial institutions typically use to report information to you
and the IRS about dividends and certain other distributions paid to you.
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The financial institutions are required to fill out this form if your total dividends and other distributions for a year
exceed $10. It includes information about the payer of the dividends, the recipient of the dividends, the type and
amount of dividends paid, and any federal or state income taxes withheld.
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What is Schedule B?
Schedule B Interest and Ordinary Dividends is the schedule you use to list interest and ordinary dividends when filing
your tax return with the IRS. As far as dividends go, you only have to use this form if you have over $1,500 in taxable
interest or ordinary dividends in a tax year, or if you receive interest or ordinary dividends as a nominee.
The IRS states you must also use this form to report dividends if you are a signer on an account in a foreign country, or
if you grant, transfer, or receive any funds to or from a foreign trust. You may have to use Schedule B for other
situations as well.
What tax forms are needed for dividends?
Dividends are reported to you on Form 1099-DIV, but you need to include all taxable dividends you receive regardless
of whether or not you receive this form. To report your dividends on your tax return and pay the applicable taxes, you
include the appropriate amounts on Form 1040 and fill out the related line items on Schedule B if required.
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What Are Dividends?
When a company or mutual fund earns profits, it will sometimes share those profits with its shareholders. The
payments it makes to shareholders, typically each quarter, are dividends. Most companies pay dividends as cash, but
it’s possible to get them as stock, stock rights or property.
There are two types of dividends: qualified and non-qualified. A dividend is typically qualified if you have held the
underlying stock for a certain period of time. According to the IRS, a dividend is “qualified” if you have held the stock
for more than 60 days during the 121-day period that begins 60 days prior to the ex-dividend date. Companies use
ex-dividend dates to determine if a shareholder has held stocks long enough to be entitled to receive the next
dividend payment.
Non-qualified dividends, which are sometimes called ordinary dividends, include a wide range of other dividends you
may receive, including dividends on employee stock options and real estate investment trusts (REITs). The major
difference between the two types of dividends is the tax rate you pay.
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How Are Dividends Taxed?
Yes – the IRS considers dividends to be income, so you usually need to pay taxes on them. Even if you reinvest all of
your dividends directly back into the same company or fund that paid you the dividends, you will pay taxes as they
technically still passed through your hands. The exact dividend tax rate depends on what kind of dividends you have:
non-qualified or qualified.
The federal government taxes non-qualified dividends according to regular income tax rates and brackets. Qualified
dividends are subject to the lower capital gains tax rates. Naturally, there are some exceptions though.
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If you are unsure what tax implications dividends will have for you, the best thing to do is talk to a financial advisor. A
financial advisor will be able to look at how an investing decision will impact you while also considering your overall
financial picture. Try using our free financial advisor matching tool to find options in your area.
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The tax rates for non-qualified dividends are the same as federal ordinary income tax rates. For 2021, these rates
remain unchanged from 2020. However, the income thresholds for each bracket have been adjusted to account for
inflation.
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How to Report Dividends on Your Tax Return
If you have dividend income, you enter it directly on your Form 1040. The form asks for dividend income on lines 3a
(qualified) and 3b (non-qualified). The amounts that you put on your 1040 will come right from your 1099-DIV. If you
receive dividends throughout the year, the brokerages and other financial institutions through which you received
them will send you 1099-DIV forms.
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You may not receive a 1099-DIV if you had less than $10 in dividends. Even if that’s the case, you should still report that
income on your tax form. If you have more than $1,500 in non-qualified dividends, you will need to report those on
Schedule B. Then you will attach Schedule B to your 1040.
Some people will also receive a Schedule K-1. This form is for people who receive dividends (or other income) from a
trust, estate, partnership, LLC or S corporation. It’s also possible you get a Schedule K-1 if you invest in a fund
or exchange-traded fund (ETF) (ETF) that operates as a partnership. However, even if you get a Schedule K-1, you will
get a 1099-DIV reporting the dividends you received.
Avoid Dividend Taxes With a Retirement Account
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The best way to avoid taxes on dividends is to put dividend-earning stocks in a pre-tax retirement account. The benefit
of retirement accounts is that your money grows tax-free until retirement. You still need to pay taxes either before or
after you contribute the money, but you will not have to pay tax as your savings grow within the account.
What kind of retirement account you should use depends on your personal needs. Two common options are a 401(k)
or Roth individual retirement account (IRA). A 401(k) is sponsored by your employer and takes pre-tax money, and you
pay income tax when you withdraw funds. A Roth IRA instead takes post-tax money, so you don’t get to deduct the
money you put in, but once it’s there, it will grow tax-free. You can even withdraw it tax-free in retirement.
What Is a Withdrawal Penalty?
A withdrawal penalty refers to any penalty incurred by an individual for early withdrawal from an account that is either
locked in for a stated period, as in a time deposit at a financial institution, or where such withdrawals are subject to
penalties by law, such as from an individual retirement account (IRA).
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A withdrawal penalty refers to the charge given to an individual if they perform an early withdrawal from a
locked or time-specific account.
The amount of a withdrawal penalty depends on many factors, including the type of financial instrument
involved.
In the case of an IRA, there are specific allowances made for early withdrawal without incurring a penalty tax.
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How a Withdrawal Penalty Works
A withdrawal penalty can vary depending on the type of funds or financial instrument involved, along with other
factors. The penalty can be either in the form of forfeiture of interest or an actual dollar amount. When you open an
account or become a participant in a retirement plan, you will generally receive in-depth documentation that spells out
all of the terms of the arrangement or contract. This typically includes details about what constitutes an early
withdrawal, and what penalties, if any, you would incur should you decide to make an early withdrawal from that
account.
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For example, an early withdrawal from a certificate of deposit (CD) at most financial institutions would result in the
customer forfeiting interest for a period ranging from one month to several months. Generally speaking, the longer the
term of the initial certificate of deposit, the longer the interest forfeiture period.
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Special Considerations
It's important to note that a qualified plan, such as a 401(k), can have different rules and penalties for early distributions
versus a traditional IRA. For example, the early-withdrawal exception for IRAs doesn't apply to qualified plans for those
who are unemployed and wish to use IRA funds for health insurance premiums.
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The withdrawal penalty for taking funds from an IRA or other accounts can be steep, so it is wise to consider other
strategies for obtaining necessary funds that would not involve the possibility of a significant penalty.
An alternative option might be to take a qualified retirement plan loan. The proceeds of that type of loan are not
taxable if the loan abides by certain rules, and repayment follows the required schedule and terms.
What is Interest Income:
Taxpayers who invest their money in savings accounts, certificates of deposit or money market accounts receive
interest income from their financial institutions.
How is interest income taxed?
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Interest income is taxed as ordinary income and the taxpayer will pay their top marginal tax rate on this income.
Financial institutions will provide the taxpayer with Form 1099-INT for all of their interest income earned. The Form
1099-INT will provide the details on the amount of interest to enter on your federal income tax return.
How to Report Interest Income:
If you have interest income, you will enter it directly on your Form 1040. Interest income will be provided on lines 2a
(tax exempt interest) and 2b (taxable interest). The amounts that you put on your Form 1040 will be provided from your
1099-INT. If you receive interest throughout the year, the brokerages and other financial institutions through which you
received them will send you 1099-INT forms.
You may not receive a 1099-INT if you had less than $10 in interest. Even if that’s the case, you should still report that
income on your tax form. If you have more than $1,500 in interest and dividends, you will need to report those on
Schedule B. You will attach Schedule B to your Form 1040.
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Some taxpayers will also receive a Schedule K-1. This form is for taxpayers who receive income from a trust, estate,
partnership, LLC or S corporation. It’s also possible you get a Schedule K-1 if you invest in a fund or exchange-traded
fund (ETF) (ETF) that operates as a partnership. If a taxpayer receives a Schedule K-1, the taxpayer will need to include
the interest income from the Schedule K-1 and report it on their Form 1040.
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Deductions (OICS_6725)
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What Is a Deduction?
A deduction is an expense that can be subtracted from a taxpayer's gross income in order to reduce the amount of
income that is subject to taxation.
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For example, if you earn $50,000 in a year and make a $1,000 donation to charity during that year, you are eligible to
claim a deduction for that donation, reducing your taxable income to $49,000.
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A deduction is an expense that can be subtracted from taxable income in order to reduce the amount owed.
Most taxpayers who take the standard deduction only need to file Form 1040.
Taxpayers who itemize deductions must use Schedule A Form 1040 to list all of their allowable deductions.
The standard deductions for tax years 2020 and 2021 are almost double the amounts allowed prior to the
passage of the Tax Cuts and Jobs Act.
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The Internal Revenue Service (IRS) often refers to a deduction as an allowable deduction.
Understanding Deductions
Taxpayers in the United States have the choice of claiming the standard deduction or itemizing their deductions.
Claiming the standard deduction is easier and requires less paperwork and record-keeping. The Internal Revenue
Service (IRS) has revamped Form 1040, which most taxpayers now use, and retired the old 1040A and 1040EZ forms.
90%
The estimated percentage of taxpayers who used the standard deduction for the 2020 tax year.
Taxpayers who itemize deductions must use Schedule A Form 1040, an attachment to the standard 1040 form, and are
required to fill in a list of their allowable deductions and keep receipts to prove them if they are audited.
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This longer form is used by filers who have substantial deductions that add up to more than the standard deduction.
Common itemized deductions include interest on a mortgage loan, unreimbursed healthcare costs, state and local
taxes, and charitable contributions.
Standard Deduction vs. Itemized Deductions
The vast majority of Americans now take the standard deduction instead of itemizing. Why? Because the standard
deduction literally nearly doubled with the Tax Cuts and Jobs Act of 2017, and is revised upwards a bit each year to
keep pace with inflation.
● For the 2020 tax year, the standard deduction is set at $12,400 for individuals. It is $24,800 for married couples
filing jointly and $18,650 for heads of household.
● For the 2021 tax year, the standard deduction is set at $12,550 for singles and married people filing separately.
It is $25,100 for married couples filing jointly. For heads of households, the standard deduction is $18,800.
If you opt to claim the standard deduction, there are still some itemized deductions you can claim on your income tax
return, including eligible student loan interest and tuition and fees.
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Deductions vs. Credits
A deduction should not be confused with a tax credit. A tax credit is subtracted from the amount of tax you owe, not
from your reported income.
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There are both refundable and non-refundable credits. Non-refundable credits cannot trigger a tax refund,
but refundable credits can.
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For example, imagine that after reporting your income and claiming your deductions you owe $500 in income tax.
However, you are eligible for a $600 credit. If the credit is non-refundable, your tax bill is erased but you do not receive
any extra money. If the credit is refundable, you receive a $100 tax refund.
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Special Considerations
All of the above works for individual taxpayers. Business owners have a much more strenuous chore at tax time. This is
because they are taxed on their business profits, not their business proceeds. That means documenting their costs of
doing business in order to subtract them from the gross proceeds, revealing the taxable profits.
These allowances are a significant upgrade from levels before the Act was passed. In the 2017 tax year, the standard
deduction was $6,350 for single filers and $12,700 for married people filing jointly.
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Businesses are required to report all of their gross income and then deduct all of their business expenses from it. The
difference between the two numbers is the business' net taxable income. Thus, business expenses work in a way that is
similar to deductions.
Standard vs Itemized Deductions
The difference between the standard deduction and itemized deduction comes down to simple math. The standard
deduction lowers your income by one fixed amount. On the other hand, itemized deductions are made up of a list of
eligible expenses. You can claim whichever lowers your tax bill the most.
Standard deduction
When we hear the question “what is a standard deduction?” – we think of two things. First, let’s start with a definition.
The standard deduction is a fixed dollar amount that reduces the income you’re taxed on. Your standard deduction
varies according to your filing status. Secondly, you may want to know what is the standard deduction amounts are.
They are:
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● For single or married filing separately — $12,400
● For married filing jointly or qualifying widow(er) — $24,800
● For head of household — $18,650
Your standard deduction increases if you’re blind or age 65 or older. It increases by: $1,650 if you’re single or head of
household and by $1,300 if you’re married or a qualifying widow(er).
Most taxpayers claim the standard deduction. The standard deduction:
● Allows you to take a tax deduction even if you have no expenses that qualify for claiming itemized deductions
● Eliminates the need to itemize deductions, like medical expenses and charitable donations
● Lets you avoid keeping records and receipts of your expenses in case you’re audited by the IRS
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What is an itemized deduction?
After defining standard deductions, we’ll walk through “what is an itemized deduction?” Itemized deductions also
reduce your adjusted gross income (AGI), but it works differently than a standard deduction. Unlike the standard
deduction, the dollar amount of itemized deductions differs from taxpayer to taxpayer. While standard deductions are
–as the name implies – a standard (or fixed) amount, itemized deductions are calculated by adding up all applicable
deductions, then subtracting that number from your taxable income.
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Here’s an example using 2020 amounts: If you’re single and your AGI is $40,000 with itemized deductions of $14,000
your taxable income is $26,000. If you elected to use the standard deduction, you would only reduce AGI by $12,400
making your taxable income $27,600, so in this case, you’d want to take itemized deductions.
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When to itemize vs. take the standard deduction?
In some situations, it makes sense to itemize vs. take the standard deduction on Form 1040. Itemizing your tax
deductions makes sense if you:
● Have itemized deductions that total more than the standard deduction you would receive (like in the example
above)
● Had large, out-of-pocket medical and dental expenses
● Paid mortgage interest and real estate taxes on your home
● Had large, uninsured casualty (fire, flood, wind) or theft losses
● Made large contributions to qualified charities
● Have gambling losses
● Have other allowable deductions such as impairment-related work expenses of a disabled person or
repayment of amounts subject to a claim of right over $3,000
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Standard deduction vs. itemized deductions – state tax considerations
There’s one situation where you may want to itemize deductions even if your total itemized deductions are less than
your standard deduction. You might want to do this if you’d pay less tax overall between your federal and state taxes.
This can happen if you itemize on your federal and state returns and get a larger tax benefit than you would if you
claimed the standard deduction on your federal and state returns. Note that some states don’t allow itemized
deductions, such as Michigan or Massachusetts.
Deductible Items:
Taxpayers may be able to take advantage of numerous contributions and deductions on their taxes each year that can
help them pay a lower amount of taxes or receive a refund from the IRS.
There are two main types of deductions—the standard deduction and itemized deductions. Here’s how they differ and
how you can choose the right path for your situation.
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Common Itemized Deductions
Itemized deductions are expenses that you can subtract from your adjusted gross income. Deductions are also allowed
for charitable contributions and the payment of certain medical expenses. Here are some of the most common
deductions that taxpayers itemize every year.
1. Property Taxes
Under the Tax Cuts and Jobs Act (TCJA), all state and local income taxes (SALT) including property taxes are limited to
$10,000 in deductions. You can deduct state and local income taxes paid (if you do not own a home) instead of state
and local income taxes, but you can’t deduct both.
2. Mortgage Interest
The interest you pay for your mortgage can be deducted and is limited to interest on $750,000 of mortgage debt for
debt incurred after Dec. 15, 2017.
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3. State Taxes Paid
You can deduct state income taxes that are paid, but it is capped at $10,000 and includes all state and local income
taxes.
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4. Real Estate Expenses
You can deduct mortgage insurance premiums, mortgage interest, and real estate taxes that you paid during the year
for your home.
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5. Charitable Contributions
You can deduct charitable contributions of cash of up to 60% of your adjusted gross income. Donations of items or
property are also considered itemized deductions.
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For 2020 and 2021 only, The CARES Act allows people who donated money to various charitable, educational,
scientific or literary in purpose organizations because of the coronavirus pandemic to take a deduction of up to $300
for 2020—and this can be taken in addition to the standard deduction and doesn’t have to be itemized.
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6. Medical Expenses
You can deduct $0.17 a mile for medical purposes such as driving to doctor’s or hospital appointments. If you file Form
1040, you can only deduct the amount of your medical and dental expenses that is more than 7.5% of your adjusted
gross income. The expenses must have been paid in 2020, unless they were charged to a credit card (in which case
you can deduct the expense in the year you charged the card, and not necessarily the year in which you repaid it).
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7. Lifetime Learning Credit Education Credits
The Lifetime Learning Credit allows people to take credits for taking classes at a community college, university or other
higher education institutions. The maximum amount of expenses you can deduct is up to $10,000 for an unlimited
number of years. However, the maximum you can receive as a credit is $2,000 per tax return.
The credit allows for a dollar-for-dollar reduction on the amount of taxes owed. The expenses can include tuition, fee
payments and required books or supplies for post-secondary education for yourself, spouse or dependent child. The
credit is not refundable, which means the credit can be used to pay any taxes you owe, but you can’t receive any of the
credit back as a refund.
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The credit amount begins to decrease if your modified adjusted gross income (MAGI) is over a certain threshold
($59,000 if single or $118,000 if married, filing jointly). The credit is not available once your income exceeds certain
amounts ($69,000 for single, $138,000 for if married, filing jointly.) Note: this credit cannot be claimed in the same year
as the American Opportunity Tax Credit if the expenses are claimed as the Lifetime Learning Credit.
8. American Opportunity Tax Education Credit
The American Opportunity Tax Credit gives credits for the first four years of higher education. The maximum annual
credit is $2,500 for each eligible student. If the amount of taxes that you owe is zero because of this credit, the IRS says
40% of any remaining amount of the credit (a maximum of $1,000) can be refunded to you. The credit is worth 100% of
the first $2,000 of qualified education expenses paid for each eligible student and 25% of the next $2,000 of qualified
education expenses.
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Qualifying expenses include tuition, fee payments and required books or supplies for post-secondary education for
yourself, spouse or dependent child. The credit is reduced if the modified adjusted gross income is between $80,000
but less than $90,000 for a single filer and $160,000 but less than $180,000 if married filing jointly. This credit can not
be claimed the same year that the Lifetime Learning Credit is claimed.
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9. Retirement Credits
The contributions you make to a retirement plan such as a 401(k) plan or traditional or Roth IRA gives you a tax credit
of 50%, 20% or 10%, depending on your adjusted gross income that you report on Form 1040. Any rollover
contributions do not qualify for the credit.
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10. IRA Contributions
The maximum contribution for 2020 in a traditional or Roth IRA is $6,000, plus another $1,000 for people who are 50
years old or more. Your contributions to a traditional IRA are tax deductible.
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11. Self-Employed Health Care Premiums
If you’re self-employed, you can deduct 100% of the health insurance premiums that you pay monthly for yourself, your
spouse and your dependents whether or not you itemize deductions.
If you have kids and they were under 27 at the end of 2020, you can also deduct their premiums—even if they are not
dependents.
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However, you can’t claim this deduction if you’re eligible to participate in a subsidized health plan from an employer of
either you, your spouse, dependents, or kids under 27.
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Your long-term care insurance premiums may also qualify for the deduction, but there are limits based on your age
and how much your premiums cost.
12. Student Loan Interest
The maximum student loan interest deduction is $2,500. If you are single and your AGI is over $80,000 or you are
married, filing jointly and your AGI is over $165,000, you can’t deduct your student loan interest.
Often Overlooked Tax Deductions
Few realizations are more painful than realizing that you forgot to include a tax deduction that would have lowered
your tax bill or increased your tax refund on your tax return. Here are some tax deductions that you shouldn't overlook.
1. Sales taxes
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You have the option of deducting sales taxes or state income taxes off your federal income tax. In a state that doesn’t
have its own income tax, this can be a big money saver. Even if you paid state taxes, the sales tax break might be a
better deal if you made a big purchase like an engagement ring or a car. You have to itemize to take the deduction
rather than take the standard deduction.
2. Health insurance premiums
Medical expenses can blow any budget, and the IRS is sympathetic to the cost of insurance premiums—at least in some
cases. Deductible medical expenses have to exceed 7.5% of your adjusted gross income (AGI) to be claimed as an
itemized deduction for 2021. However, if you’re self-employed and responsible for your own health insurance
coverage, you might be able to deduct 100% of your premium cost. That gets taken off your adjusted gross income
rather than as an itemized deduction.
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3. Tax savings for teacher
It’s the rare teacher who doesn’t have to reach into her own pocket every now and then to purchase items needed for
the classroom. While it may sometimes seem like nobody appreciates that largesse, the IRS does. It allows qualified
K-12 educators to deduct up to $250 for materials. That gets subtracted from your income, so you can take advantage
of it even if you don’t itemize.
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4. Paying the babysitter
You might be able to deduct the cost of a babysitter if you’re paying her to watch the kids while you are working,
looking for work, or a full-time student. You will need to report the name, and tax ID number of the person or
organization providing the care as well as the address of where the care was provided. Some states also require that
you report the telephone number of the care provider. While this is technically not a deduction, it can be even better
because you don't have to itemize your deductions to receive the credit. This means that it can lower your tax in
addition to taking the standard deduction rather than itemizing.
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5. Lifetime learning
The tax code offers a number of deductions geared toward college students, but that doesn’t mean those who have
already graduated don’t get a tax break as well. The Lifetime Learning credit can provide up to $2,000 per year, taking
off 20% of the first $10,000 you spend for education after high school in an effort to increase your education. This
phases out at higher income levels but doesn’t discriminate based on age.
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6. Self-employed Social Security
The bad news about being self-employed: You have to pay 15.3% of your income for social security and Medicare
taxes, the portions ordinarily paid by both employee and employer. But there's one small consolation—you do get to
deduct the 7.65% employer portion off your income taxes.
What is the Standard Deduction?
The standard deduction is an automatic deduction of your taxable income that you can receive without doing any
itemized deductions.
The standard deduction for married filing jointly nearly doubled to $24,800 for tax year 2020, up $400 from the
previous year. The standard deduction increased to $12,400 in for 2020, up $200 for single taxpayers and married
individuals filing separately. For heads of households, the standard deduction will be $18,650 for tax year 2020, an
increase of $300.
What Is the Foreign Tax Deduction?
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The foreign tax deduction is one of the itemized deductions that may be taken by American taxpayers to account for
taxes already paid to a foreign government, and are typically classified as withholding tax.
The foreign tax deduction is usually taken in lieu of the more common foreign tax credit if the deduction is more
advantageous to the taxpayer than the credit.
● The foreign tax deduction allows American taxpayers to reduce their taxable income by a portion of the
amount of income tax paid to foreign governments.
● The goal is to prevent American citizens from being subject to double taxation for the same income.
● The foreign tax deduction would be taken instead of the foreign tax credit, given that the deduction is more
advantageous for a taxpayer.
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The Basics of the Foreign Tax Deduction
To avoid double taxation in the U.S. and a foreign country, a taxpayer has the option of taking the amount of any
qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. The foreign
tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from his or her taxable
income, and it reduces the total tax bill of an individual dollar to dollar.
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The foreign tax deduction reduces the taxable income of an individual that opts for this method. This means that the
benefit of a tax deduction is equal to the reduction in taxable income multiplied by the individual's effective tax rate.
The foreign tax deduction must be itemized, that is, listed out on the tax return. The sum of the listed items is used to
lower a taxpayer’s adjusted gross income (AGI). A taxpayer that chooses to deduct qualified foreign taxes must deduct
all of them, and cannot take a credit for any of them.
Itemized deductions are only beneficial if their total value of the itemized expenses falls below the tax credit available.
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The foreign tax deduction may be more advantageous if the foreign tax rate is high and only a small amount of foreign
income relative to domestic income has been received. In addition, claiming a deduction requires less paperwork than
the foreign tax credit, which requires completing Form 1116 and may be complex to complete, depending on how
many foreign tax credits claimed. If the foreign tax deduction is taken, it is reported on Schedule A of Form 1040.
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Standard deduction vs. itemized deductions
Deciding how to take your deductions — that is, how much to subtract from your adjusted gross income, thus reducing
your taxable income — can make a huge difference in your tax bill. But making that decision isn’t always easy. The
standard deduction is a flat reduction in your adjusted gross income, the amount determined by Congress and meant
to keep up with inflation. Nearly 70% of filers take it, because it makes the tax-prep process quick and easy.
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People who itemize tend to do so because their deductions add up to more than the standard deduction, saving them
money.
How deductions and credits work
Both reduce your tax bill, but in different ways. Tax credits directly reduce the amount of tax you owe, dollar for dollar.
A tax credit valued at $1,000, for instance, lowers your tax bill by $1,000.
Tax deductions, on the other hand, reduce how much of your income is subject to taxes.
Deductions lower your taxable income by the percentage of your highest federal income tax bracket. For example, if
you fall into the 25% tax bracket, a $1,000 deduction saves you $250.
Estimating a tax bill starts with estimating taxable income. In a nutshell, to estimate taxable income, we take gross
income and subtract tax deductions. What’s left is taxable income. Then we apply the appropriate tax bracket (based
on income and filing status) to calculate tax liability. Tax credits and taxes already withheld from your paychecks might
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cover that bill for the year. If not, you may need to pay the rest at tax time. If you’ve paid too much, you’ll get a tax
refund.
Types of Tax Credits (OICS_6726)
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What Is a Tax Credit?
A tax credit is an amount of money that taxpayers can subtract directly from taxes owed to their government.
Unlike deductions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed. The
value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or
businesses in specific locations, classifications, or industries.
● A tax credit is an amount of money that taxpayers are permitted to subtract, dollar for dollar, from the income
taxes that they owe.
● Tax credits are more favorable than tax deductions because they actually reduce the tax due, not just the
amount of taxable income.
● There are three basic types of tax credits: nonrefundable, refundable, and partially refundable.
● A nonrefundable tax credit can reduce the tax you owe to zero, but it can't provide you with a tax refund.
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Understanding Tax Credits
Governments may grant a tax credit to promote a specific behavior such as replacing older appliances with more
energy-efficient ones. Other tax credits are designed to help disadvantaged taxpayers by reducing the total cost of
housing.
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Tax credits are more favorable than tax deductions because tax credits reduce tax liability dollar for dollar. While a
deduction still reduces the final tax liability, it only does so within an individual’s marginal tax rate.An individual in a
22% tax bracket, for example, would save $0.22 for every marginal tax dollar deducted. However, a credit would
reduce the tax liability by the full $1.
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Types of Tax Credits
Nonrefundable Tax Credits
Nonrefundable tax credits are items directly deducted from the tax liability until the tax due equals $0. Any amount
greater than the tax owed, resulting in a refund for the taxpayer, is not paid out—hence, the name "nonrefundable." The
remaining part of a nonrefundable tax credit that can't be utilized is lost, in effect.
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Nonrefundable tax credits are valid in the year of reporting only, expire after the return is filed, and may not be carried
over to future years. Because of this, nonrefundable tax credits can negatively impact low-income taxpayers, as they
are often unable to use the entire amount of the credit.
As of the 2020 tax year, specific examples of nonrefundable tax credits include credits for adoption, the Lifetime
Learning Credit, the Child and Dependent Care Credit, the Saver's Tax Credit for funding retirement accounts, and the
mortgage interest credit, which is designed to help people with lower incomes afford homeownership.
Refundable Tax Credits
Refundable tax credits are the most beneficial credit because they're paid out in full. This means that a
taxpayer—regardless of their income or tax liability—is entitled to the entire amount of the credit. If the refundable tax
credit reduces the tax liability to below $0, the taxpayer is due a refund.
As of the 2020 tax year, probably the most popular refundable tax credit is the Earned Income Tax Credit (EITC). The
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EITC is for low to moderate-income taxpayers who earned an income, through an employer or working as a
self-employed individual with a business or farm, and meet certain criteria based on income and number of family
members. Other refundable tax credits include the Premium Tax Credit, which helps individuals and families cover the
cost of premiums for health insurance purchased through the health insurance marketplace.
Your first $1,200 ($2,400 for couples) stimulus payment, officially known as a "Recovery Rebate," is an advance
refundable tax credit on 2020 taxes. This means no matter how much you owe (or don't owe) in taxes for the 2020 tax
year, you get to keep all the money with no taxes due on it. The same is true of the second $600 stimulus checks
signed into law on Dec. 27.
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Partially Refundable Tax Credits
Some tax credits are only partially refundable. The Child Tax Credit became refundable (up to $1,400 per qualifying
child) in 2018, as a result of the Tax Cuts and Jobs Act (TCJA). If a taxpayer has a large enough tax liability, the full
amount of the Child Tax Credit is $2,000. However, up to $1,400 is refundable even if it is more than the taxpayer
owes.
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Another example of a partially refundable tax credit is the American Opportunity Tax Credit (AOTC) for post-secondary
education students. If a taxpayer reduces their tax liability to $0 before using the entire portion of the $2,500 tax
deduction, the remainder may be taken as a refundable credit up to the lesser of 40% of the remaining credit or
$1,000.
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2020 and 2021 Stimulus Payments
In 2020, as a result of the coronavirus pandemic and Coronavirus Aid, Relief, and Economic Security (CARES) Act
stimulus bill, taxpayers received up to $1,200 per adult and $500 per child in the form of a stimulus check or direct
deposit. The stimulus payment was an advance on a refundable tax credit for the 2020 tax year; the amount received
will not add to taxable income in 2020 or any future year.
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The same is true of the second $600 stimulus check approved on Dec. 27, which provides $600 for qualifying
individuals ($1,200 for qualifying couples) and $600 for qualifying children. The refundable tax credit for both checks
phased out at an adjusted gross income (AGI) of $75,000 to $99,000 for singles (or $150,000 to $198,000 for joint
taxpayers), at a rate of 5 percent per dollar. It was based on either the taxpayer's AGI for 2018 or 2019 (depending on
whether the taxpayer had already filed a 2019 tax return by that point). But it technically applied to 2020 AGI (for which
a return couldn't have been filed yet), so there may be some discrepancy.
● If it turns out the taxpayer's AGI for 2018 or 2019 (whichever one the IRS based the stimulus payment on), is
lower than 2020, resulting in a higher payment, the taxpayer can keep the overage.
● If the taxpayer's AGI for 2018/19 is higher than in 2020, the taxpayer can claim the additional amount owed for
both stimulus checks when filing 2020 taxes in 2021.
● This applies to dependents under 17 as well. If one taxpayer claimed a child, based on 2018/19 returns, but
another taxpayer can legitimately claim that child on the 2020 tax return, the second taxpayer will get a $500
tax credit when filing a 2020 tax return and the person who received it based on 2018/19 returns will not have
to pay it back.
● If a taxpayer has a child in 2020, they can claim the child when filing the 2020 tax return and receive the $500
credit then.
Finally, the recovery rebate is not taxable. It will not add to taxable income in 2020 (or any future year). All of this is
based on the fact that the CARES Act contains no "clawback" mechanism by which the government can reclaim funds
that were legitimately extended. The same is true of the Consolidated Appropriations Act that includes the new
stimulus funding.
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2021 American Rescue Plan Changes
In March of 2021, Congress passed the American Rescue Plan, which was signed into law by President Biden. Under
the plan, eligible individuals would receive up to $1,400 in stimulus checks. In addition, certain temporary changes
were made to the child tax credit for Married couples filing jointly with a modified adjusted gross income up to
$150,000, heads of household with MAGI up to $112,5000, or single filers with MAGI up to $75,000:
● Originally capped at $2,000 per eligible dependent child, the credit is increased to $3,000 for children
between (and inclusive of) the ages of 6 and 17 and $3,600 for children under six.
● The credit becomes fully refundable; previously, only $1,400 was refundable.
● The IRS may issue up to half of an eligible household’s credit as an advance disbursed between July and
December 2021, using 2020 returns (or 2019 if 2020 is unavailable) to determine eligibility.
● The bill eliminates the minimum income requirement; previously, families earning less than $2,500 a year were
ineligible and credits were calculated based on distance from that minimum at a rate of 15 cents per child for
every dollar of income above $2,500.
Changes were also made to the EITC. Originally capped at $543 for childless households, the maximum earned
income tax credit for those same households in 2021 is $1,502. The bill also expands eligibility for childless
households. Previously, people under the age of 25 and over the age of 65 could not claim the credit. The upper limit
has been eliminated and the lower limit has been reduced to 19 (i.e., anyone 19 or over without a child who meets
income requirements can claim EITC).
All of the measures above (including Child and Child/Dependent Care credits) are temporary. They have only been
approved for 2021.
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Two EITC changes below, however, are permanent:
1. People who otherwise would be eligible for the EITC but whose children do not have Social Security numbers
will be permitted to claim the version of the credit meant for childless households.
2. The investment income limit for 2021 has been raised from $3,650 or less to $10,000 or less. This $10,000
figure will be pegged to inflation and adjusted accordingly every year going forward.
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Common Tax Credits & Forms:
A number of federal tax credits exist to help taxpayers—primarily those in middle-income and low-income
households—reduce the amount of taxes they owe or get the largest refund possible. Here are the 5 biggest tax credits
you just might qualify for that can have a major impact on your income and tax situation.
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1. Earned Income Tax Credit
One of the most substantial credits for taxpayers is the Earned Income Tax Credit. Established in 1975—in part to offset
the burden of Social Security taxes and to provide an incentive to work—the EITC is determined by income and is
phased in according to filing status: single, married filing jointly or either of those with children. Eligibility and the
amount of the credit are based on adjusted gross income, earned income and investment income.
● For 2021, generally, a person must be at least 19 years old except that the minimum age for a former foster
youth or qualified homeless youth is 18, and a specified student must be at least 24. There is no upper age
limit for the 2021 tax year.
● If married, both spouses must have valid Social Security numbers and must have lived in the country for more
than six months.
● If you may be claimed as a dependent on another filer's tax return, you do not qualify.
You won't qualify for the EITC if:
● You earned $10,000 or more in 2021 from investment income. That is considered "disqualified income" and
you cannot qualify for the credit.
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If you're self-employed, you may qualify for the EITC. Tax experts recommend you check your eligibility every year,
even if you think you won't qualify.
2. American Opportunity Tax Credit
For years, the Hope Credit helped families pay the costs of higher education. Since 2009, that credit has been
rebranded and expanded as the American Opportunity Tax Credit.
● The AOTC covers four years of post-secondary education.
● The full credit is available to people whose modified adjusted gross income (MAGI) is $80,000 or less, or
$160,000 or less for married couples filing jointly.
● Depending on your income (the credit drops as income increases), you may receive up to $2,500 of the cost of
qualified tuition and course materials paid during the taxable year.
● The student must be enrolled at least half-time for at least one academic period.
● This credit is available on a per-student basis.
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3. Lifetime Learning Credit
The Lifetime Learning Credit, also established to offset the costs of post-secondary education, differs from the
American Opportunity Tax Credit in that it is available for any years of post-secondary education, not just the first four.
Also, the credit is available for people not pursuing a degree.
● The Lifetime Learning Credit may be as high as $2,000 per eligible student.
● For 2021 the full credit is available to eligible individual taxpayers who make $80,000 or less, or married
couples filing jointly who make $160,000 or less.
● The credit phases out as income goes beyond these amounts.
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4. Child and Dependent Care Credit
The Child and Dependent Care Credit helps defray costs of babysitting or daycare. It's available to people who must to
pay for childcare for dependents under age 13 in order to work or look for work. The credit is also available for the
cost of caring for a spouse or a dependent of any age who is physically or mentally incapable of self-care. To qualify,
your filing status must be single, married filing jointly, head of household or qualifying widow or widower with a
qualifying child.
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For 2020, the credit—which ranges from 20 percent to 35 percent depending on your income—can be applied to as
much as $3,000 of qualifying expenses if you pay for the care of one qualifying child, or up to $6,000 if you pay for the
care of two or more.
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For 2021, the American Rescue Plan brings significant changes to the amount and way that the child and dependent
care tax credit can be claimed. The plan increases the amount of expense eligible for the credit, relaxes the credit
reduction due to income levels, and also makes it fully refundable. This means that, unlike other years, you can still get
the credit even if you don’t owe taxes.
So, for tax year 2021 (the taxes you file in 2022):
● The amount of qualifying expenses increases from $3,000 to $8,000 for one qualifying person and from $6,000
to $16,000 for two or more qualifying individuals
● The percentage of qualifying expenses eligible for the credit increases from 35% to 50%
● The beginning of the reduction of the credit is increased from $15,000 to $125,000 of adjusted gross income
(AGI).
Also for tax year 2021, the maximum amount that can be contributed to a dependent care flexible spending account
and the amount of tax-free employer-provided dependent care benefits is increased from $5,000 to $10,500.
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5. Savers Tax Credit
The Savers Tax Credit, formerly the Retirement Savings Contributions Credit, is for eligible contributions to retirement
plans, such as qualified investment retirement accounts, 401(k)s and certain other retirement plans. Taxpayers with the
least income qualify for the greatest credit—up to $1,000 for those filing as single, or $2,000 if filing jointly.
● For 2021 the maximum income for the Savers Tax Credit is $33,000 for single filers, $49,500 for heads of
household, and $66,000 for those married and filing jointly.
● Filers must be at least 18 years old and may not have been a full-time student during the calendar year or
claimed as a dependent on another person’s return.
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Can I claim the Earned Income Tax Credit?
If you were married filing jointly and earned less than $57,414 ($51,464 for individuals, surviving spouses or heads of
household) in 2021, you may qualify for this tax credit, or even for a refund check. It's complicated, but the Earned
Income Tax Credit (EITC) is worth exploring if you or someone you know has modest earnings.
● The credit reduces any federal income tax you owe, dollar-for-dollar.
● If the credit completely eliminates your tax bill, and some credit is still left over, you can actually get a cash
refund for the remaining amount.
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Tests for qualifying
First you have to qualify. Then your income has to be within stated limits. Finally, if you have one or more kids, they
have to qualify too for you to receive a larger credit. If you pass all these tests, you could get a credit of as much as
$6,728 for 2021 depending on your income and the number of children you have.
Once you determine that you qualify for the credit, use the Earned Income Credit table found in the instructions for
Form 1040 to look up your income and find out the amount of credit you're entitled to.
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You typically qualify if:
● You have income from earnings (for example, from a job, your own business, union strike benefits, certain
long-term disability benefits).
● You did not receive more than $10,000 in investment income such as interest or dividends, or income from
rentals, royalties or stock and other asset sales during 2021.
● You are single or, if married, do not use the Married Filing Separate status (there is an exception for 2021 for
married couple filing separately).
● You, your spouse and children, if applicable, all have Social Security numbers.
● You and your spouse are not considered as a qualifying child of someone else.
● You are not excluding any income you earned in a foreign country on your return.
● You are a citizen or resident of the United States.
● You have dependents, or if you don't, you are at least 24 if you were at least a part-time student for at least 5
months of the year, or at least 18 if you are a former foster child after turning 14 or homeless youth, otherwise
at least 19, and you have lived in the United States for more than half of the year.
How much can I earn and still qualify?
This credit is targeted at households with modest incomes, so if you earn "too much" you may not qualify. Just how
much can you earn and still qualify? It depends on how many qualifying children you have (we'll define this in a
moment). Those with the lowest income qualify for the biggest credits. Those with incomes above the phase-out
threshold qualify for lower credits until they reach the point where the credit is eliminated completely. The rules have
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been liberalized to result in higher credits for many households, especially those with three or more qualifying
children.
The Consolidated Appropriations Act (CAA) was signed into law on December 27, 2020 as a stimulus measure to
provide relief to those affected by the pandemic. For tax year 2020, the CAA allows taxpayers to use their 2019 earned
income if it was higher than their 2020 earned income in calculating the Additional Child Tax Credit (ACTC) as well as
the Earned Income Tax Credit (EITC). For 2021, you are allowed to use your 2019 or 2021 earned income based on
whichever one gives you the highest credit.
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Does my child qualify?
To qualify, the child must be:
● Your son, daughter, stepchild, adopted child or a descendant.
● Your foster child, placed with you by an authorized agency or court order.
● Your brother, sister, stepbrother, stepsister or a descendant of one of these.
● Age 18 or younger as of the end of the year (unless he or she is a full-time student, in which case the student
must be 23 or younger). Exception: A person who is permanently and totally disabled at any time during the
year qualifies, no matter how old.
● A resident with you in the United States for more than half of the year.
Example:
You and your sister live together. You are 30 and your sister is 15. When your parents died two years ago, you took
over the care of your sister, but you did not adopt her. She is considered a qualifying child because she lived with you
more than half of the year.
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Who is an eligible foster child?
For the Earned Income Credit, a foster child is defined as an individual who is placed with you by an authorized
placement agency or court order. The child must have lived with you for more than half of the year.
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What about my welfare benefits?
The Earned Income Tax Credit has no effect on certain welfare benefits. Any refund you receive because of the EITC
generally will not be considered income when determining whether you are eligible for, or how much you can receive
from, the following benefit programs:
● Temporary Assistance for Needy Families (TANF)
● Medicaid and Supplemental Security Income (SSI)
● Food stamps
● Low-income housing
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What is a tax credit and how does it work?
Be sure you know the difference between a tax deduction and a tax credit.
● A tax credit is a dollar-for-dollar reduction in your actual tax bill. A few credits are even refundable, which
means that if you owe $250 in taxes but qualify for a $1,000 credit, you’ll get a check for $750. (Most tax
credits, however, aren’t refundable.)
● This differs from a tax deduction, which is a dollar amount the IRS allows you to subtract from your adjusted
gross income (AGI), making your taxable income lower. The lower your taxable income, the lower your tax bill.
Either way, as the simplified example in the table shows, a $10,000 tax credit makes a much bigger dent in your tax bill
than a $10,000 tax deduction does.
Some of the most popular tax credits fall into three categories. These are just summaries; tax credits have lots of rules,
so it's a good idea to consult a tax professional. Your state may offer a variety of tax credits as well.
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Tax credits for Taxpayers with Children
Child tax credit.
This could get you up to $3,600 per kid.
The higher your income, the less you’ll qualify for. You may qualify for the full credit only if your modified adjusted
gross income is under:
● In 2020: $400,000 for married filing jointly and $200,000 for everybody else
● In 2021: $75,000 for single filers, $150,000 for married filing jointly and $112,500 for head of household filers
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Child and dependent care credit.
Generally, in 2020 it’s up to 35% of up to $3,000 of child care and similar costs for a child under 13, spouse or parent
unable to care for themselves, or another dependent so you can work — and up to $6,000 of expenses for two or more
dependents. In 2021, it's up to 50% of $8,000 in care costs for one dependent or $16,000 for two or more dependents.
● The percentage of allowable expenses decreases for higher-income earners — and therefore the value of the
credit also decreases.
● For the 2020 tax year, this credit isn't refundable, which means it can take your tax bill down to zero but
you don't get the leftovers. For the 2021 tax year, however, this tax credit is refundable.
● Payments made out of a dependent-care flexible spending account or other tax-advantaged program at work
may reduce your credit.
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Earned income credit.
This credit will get you between $538 and $6,660 in tax year 2020 depending on how many kids you have, your marital
status and how much you make. For 2021, the earned income credit ranges from $543 to $6,728 depending on
tax-filing status and number of children.
● If your AGI was less than about $57,000 in 2020, it’s something to look into, though if you had more than
$3,650 of investment income, dividends, capital gains and a few other things in 2020, you won’t qualify.
● Note: You can get up to $538 in 2020 from the earned income credit even if you don’t have kids, though only if
your income is less than $15,820 as a single filer or $21,710 if you’re filing jointly.
● For the 2020 tax year, there are special rules due to coronavirus: You can use either your 2019 income or your
2020 income to calculate your EITC, and you can use whichever number gets you the bigger EITC. (This is also
the case for the Child Tax Credit.) Be sure to ask your tax preparer to run the numbers both ways.
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Adoption credit.
For the 2020 tax year, this covers up to $14,300 in adoption costs per child. In 2021, it rises to $14,440.
● For 2020, the credit begins to phase out at $214,520 of modified adjusted gross income, and people with AGIs
higher than $254,520 don’t qualify. For 2021, the credit begins to phase out at $216,660 of modified adjusted
gross income, and people with AGIs higher than $256,660 don’t qualify.
● Also, you can’t take the credit if you’re adopting your spouse’s child.
● People who adopt children with functional needs can get up to the full credit even if their actual expenses were
less.
Tax credits for investing in education or for retirement
The saver’s credit.
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This runs 10% to 50% of up to $2,000 in contributions to an IRA, 401(k), 403(b) or certain other retirement plans
($4,000 if filing jointly). The percentage depends on your filing status and income, but generally it's something to look
at if your AGI in 2020 was less than $65,000 if married filing jointly, $48,750 if head of household and $32,500 if single.
American Opportunity credit: This credit runs up to $2,500 per student for tuition, activity fees, books, supplies and
equipment during the first four years of college.
● The student must be enrolled at least half time and can’t have any felony drug convictions.
● You may not qualify if your AGI is higher than $90,000 as a single filer or $180,000 as a joint filer. In 2021, the
thresholds are $80,000 for single filers and $160,000 for joint filers.
● Parents can take the credit if they qualify and claim the student as a dependent on their return.
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Lifetime Learning credit.
With this credit, you can get up to $2,000 for tuition, activity fees, books, supplies and equipment for undergraduate,
graduate or even nondegree courses at accredited institutions.
● Unlike the American Opportunity credit, there’s no workload requirement.
● The $2,000 limit is per return, not per student, so the most you can get back is $2,000 regardless of how many
students you pay expenses for.
● You may not qualify if your modified AGI is higher than $68,000 as a single filer or $136,000 as a joint filer in
2020. In 2021, the thresholds are $80,000 for single filers and $160,000 for joint filers.
● You can claim both the American Opportunity Credit and the Lifetime Learning Credit on the same tax return,
but you can't claim both for the same student.
Tax credits for big-ticket 'green' purchases
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Residential energy tax credit.
This one gets you up to 26% of the cost of solar energy systems, including solar water heaters and solar panels. The
credit dwindles to 22% in 2023 and expires in 2024.
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Plug-in electric-drive motor vehicle credit.
You could get up to $7,500 for buying a plug-in electric vehicle. The credit is $2,500 or 10% of cost depending on
number of wheels and battery capacity. You must buy new; used vehicles don’t count.
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What Is Adjusted Gross Income (AGI)?
Adjusted gross income (AGI) is a figure that the Internal Revenue Service uses to determine your income tax liability for
the year. It is calculated by subtracting certain adjustments from gross income, such as educator expenses, student
loan interest and other adjustments.
After calculating AGI, the next step is to subtract deductions to determine the taxpayers' taxable income. In addition,
the IRS also uses other income metrics, such as modified AGI (MAGI) for certain programs and retirement accounts.
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The Internal Revenue Service uses your adjusted gross income (AGI) to determine how much income tax you
owe for the year.
AGI is calculated by taking all of your income for the year (your gross income) and subtracting certain
"adjustments to income."
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Your AGI can affect the size of your tax deductions as well as your eligibility for some types of retirement plan
contributions.
Modified adjusted gross income is your AGI with some otherwise-allowable deductions added back in. For
many people, AGI and MAGI will be the same.
Understanding Adjusted Gross Income (AGI)
As prescribed in the United States tax code, adjusted gross income is a modification of gross income. Gross income is
simply the sum of all the money you earned in a year, which may include wages, dividends, capital gains, interest
income, royalties, rental income, alimony, and retirement distributions. AGI makes certain adjustments to your gross
income to reach the figure on which your tax liability will be calculated.
Many states in the U.S. also use the AGI from federal returns to calculate how much individuals owe in state income
taxes. States may modify this number further with state-specific deductions and credits.
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The items subtracted from your gross income to calculate your AGI are referred to as adjustments to income, and you
report them on Schedule 1 of your tax return when you file your annual tax return. Some of the most
common adjustments are listed here, along with the separate tax forms on which a few of them are calculated:
● Alimony payments
● Early withdrawal penalties on savings
● Educator expenses
● Employee business expenses for armed forces reservists, qualified performing artists, fee-basis state or local
government officials, and employees with impairment-related work expenses (Form 2106)
● Health savings account (HSA) deductions (Form 8889)
● Moving expenses for members of the armed forces (Form 3903)
● Self-employed SEP, SIMPLE, and qualified plans
● Self-employed health insurance deduction
● Self-employment tax (the deductible portion)
● Student loan interest deduction
● Tuition and fees (Form 8917)
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Calculating Your Adjusted Gross Income (AGI)
If you use software to prepare your tax return, it will calculate your AGI once you input your numbers. If you calculate it
yourself, you'll begin by tallying your reported income for the year. That might include job income, as reported to the
IRS by your employer on a W-2 form, plus any income, such as dividends and miscellaneous income, reported on 1099
forms.
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Next, you add any taxable income from other sources, such as profit on the sale of a property, unemployment
compensation, pensions, Social Security payments, or anything else that hasn't already been reported to the IRS. Many
of these income items are also listed on IRS Schedule 1. The next step is to subtract the applicable adjustments to
income listed above from your reported income. The resulting figure is your adjusted gross income.
To determine your taxable income, subtract either the standard deduction or your total itemized deductions from your
AGI. In most cases, you can choose whichever gives you the most benefit. For example, the standard deduction for
2020 tax returns for married couples filing jointly is $24,800 ($25,100 for 2021), so couples whose itemized deductions
exceed that amount would generally opt to itemize, while others would simply take the standard deduction.
The IRS provides a list of itemized deductions and the requirements for claiming them on its website.
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Adjusted Gross Income (AGI) vs. Modified Adjusted Gross Income (MAGI)
In addition to AGI, some tax calculations and government programs call for using what's known as your modified
adjusted gross income, or MAGI. This figure starts with your adjusted gross income then adds back certain items, such
as any deductions you take for student loan interest or tuition and fees.
Your MAGI is used to determine how much, if anything, you can contribute to a Roth IRA in any given year. It is also
used to calculate your income if you apply for Marketplace health insurance under the Affordable Care Act (ACA).
Many people with relatively uncomplicated financial lives find that their AGI and MAGI are the same number, or very
close.
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Special Considerations
You report your AGI on line 8b of IRS Form 1040 that you use to file your income taxes for the year. Keep that number
handy after completing your taxes because you will need it again if you e-file your taxes next year. The IRS uses it as a
way to verify your identity.
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What Does Adjusted Gross Income (AGI) Mean for Tax Payments?
AGI is essentially your income for the year after accounting for all applicable tax deductions. It is an important number
that is used by the IRS to determine how much you owe in taxes. AGI is calculated by taking your gross income from
the year and subtracting any deductions that you are eligible to claim. Therefore, your AGI will always be less than or
equal to your gross income.
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What Are Some Common Adjustments Used When Determining AGI?
There are a wide variety of adjustments that might be made when calculating AGI, depending on the financial and life
circumstances of the filer. Moreover, since the tax laws can be changed by lawmakers, the list of available adjustments
can change over time. Some of the most common adjustments used when calculating AGI include reductions for
alimony, student loan interest payments, and tuition costs for qualifying institutions.
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What Is the Difference Between AGI and Modified Adjusted Gross Income (MAGI)?
AGI and MAGI are very similar, except that MAGI adds back certain deductions. For this reason, MAGI would always be
larger than or equal to AGI. Common examples of deductions that are added back to calculate MAGI include foreign
earned income, income earned on U.S. savings bonds, and losses arising from a publicly traded partnership.
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What Is the Income Exclusion Rule?
The income exclusion rule sets aside certain types of income as non-taxable.
There are many types of income that qualify under this rule, such as life insurance death benefit proceeds, child
support, welfare, and municipal bond income. Income that is excluded is not reported anywhere on Form 1040.
Income excluded from the IRS's calculation of your income tax includes life insurance death benefit proceeds,
child support, welfare, and municipal bond income.
The exclusion rule is generally, if your "income" cannot be used as or to acquire food or shelter, it's not taxable.
Municipal bond income is only excludable up to a point.
Understanding the Income Exclusion Rule
Generally, there is no limit to the amount of this type of income that can be received. One exception is municipal bond
interest, which may be counted back as an alternative minimum tax preference item.
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Income that is excluded from taxation is generally accorded this status as a measure of relief for the recipient (or else as
the result of powerful lobbying, as is the case with life insurance).
Income Exclusion Rules and Social Security
For Social Security purposes, not everything an individual receives is considered income. For the most part, if an item
received cannot be used as, or to obtain, food or shelter, it will not be considered as income.
For example, if someone pays an individual's medical or automobile repair bills, or offers free medical care, or if the
individual receives money from a social services agency that is a repayment of an amount he/she previously spent, that
value is not considered income to the individual.
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Principal Earned Income Exclusions
● The first $65 per month plus one-half of the remainder
● Impairment-related work expenses of the disabled and work expenses of the blind
● Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
● The first $30 of infrequent or irregularly received income in a quarter4
Principal Unearned Income Exclusions
● The first $20 per month
● Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
● State or locally funded assistance based on need
● Rent subsidies under HUD programs and the value of food stamps
● The first $60 of infrequent or irregularly received income in a quarter
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Income Exclusions for Employer-Paid Health Insurance
One of the biggest tax exclusions in the U.S. is the exclusion that allows workers who get job-based (or
"employer-paid") health insurance coverage not to pay taxes on the value of those policies and employers to deduct
the cost as a business expense.
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Qualified Distributions from Roth IRAs
There are two basic types of distributions you might take from your Roth IRA: qualified and non-qualified. The basic
difference is this: qualified distributions are generally made after a person reaches age 59½ or when the owner of the
Roth IRA has become permanently disabled or has passed away. Non-qualified distributions are made at any other
time. Additionally, a Roth IRA must have been opened for at least five years for distributions to be qualified. A Roth IRA
and its 100% tax-free distributions can hold huge advantages for retirees. Additionally, Roth IRAs aren’t subject to
required minimum distributions the way traditional IRAs are. That allows you to grow your money without triggering a
tax penalty. If you want help with Roth IRA distributions or any financial issue, consider working with a financial advisor.
Roth IRA Qualified Distribution Explained
Qualified distributions from a Roth IRA are done when a person is over 59.5 years old or meets some special
qualifications. The IRS spells out the rules for Roth IRA qualified distributions. Generally, a distribution or withdrawal is
considered to be qualified if it’s made at age 59.5 or later. It’s also qualified if the IRA’s owner becomes permanently
and completely disabled or if they pass away. A distribution also is qualified when taken as a series of equal periodic
payments. A Roth IRA qualified distribution includes a withdrawal of up to $10,000 if the withdrawal is used for the
purchase of a first home.
However, a Roth IRA must be open for at least five years for any of the above distributions to count as qualified. The
clock starts ticking on the first day of the first year you made a contribution to your Roth IRA.
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The upside of a Roth IRA qualified distribution is that it isn’t included in your gross income. That means you won’t owe
taxes or penalties on the withdrawal. That’s a significant difference from traditional IRAs, for which distributions are
always taxable at your ordinary income tax rate.
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What Is a Non-Qualified Roth IRA Distribution?
A non-qualified distribution from an Roth IRA is any distribution that doesn’t follow the guidelines for Roth IRA
qualified distributions. Specifically, that means distribution:
● Taken before age 59.5.
● That don’t meet the five-year requirement.
● That don’t qualify for an exception.
Non-qualified distributions from a Roth IRA are generally subject to ordinary income tax on earnings as well as a 10%
early withdrawal penalty. Exceptions help avoid that penalty.
The list of exceptions the IRS allows includes:
● Distributions used to buy, build, or rebuild a first home.
● Distributions that are part of a series of substantially equal periodic payments.
● Withdrawals made to cover unreimbursed medical expenses that are more than 7.5% of your adjusted gross
income.
● Withdrawals covering health insurance premiums during unemployment.
● Distributions made to pay qualified higher education expenses.
● A distribution that’s the result of an IRS levy of your Roth account.
● Qualified reservist distributions.
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Qualified and non-qualified distribution rules attempt to encourage savers to preserve their retirement accounts just
for retirement. These exceptions, however, make it possible to access your savings penalty-free if you have certain
financial needs you can’t cover with other savings or assets. Ordinary income tax would still apply to any earnings
withdrawn through a non-qualified distribution.
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It’s important to note that the five-year rule extends beyond age 59.5. If you’re that age or older and take withdrawals
from a Roth IRA that’s less than five years old, those would be non-qualified distributions. You’d pay taxes on
withdrawals of your earnings but not the 10% early withdrawal penalty.
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Roth IRA Tax-Free Withdrawals
The rules for distributions apply solely to withdrawals of earnings on your Roth IRA investments. The IRS includes a
provision that allows savers to withdraw any of their original contributions tax- and penalty-free at any time. There’s no
limit on the amount of contributions you can withdraw.
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However, not everyone can make a contribution to a Roth IRA. Your tax filing status and adjusted gross
income determines whether or not you can contribute. For 2019, single filers, married couples filing separately who
don’t live together, and heads of household can make a full contribution if their modified adjusted gross income
(MAGI) is less than $122,000. The MAGI limit for married couples filing jointly and qualifying widows and widowers is
less than $193,000.
Also, keep in mind that Roth IRA contributions are not tax-deductible. That varies from traditional IRAs, which allow you
to deduct contributions based on your income and filing status.
When Should You Take a Roth IRA Distribution?
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Ideally, you shouldn’t need to tap into your Roth IRA until you retire. A Roth IRA peibution, for example, could create
tax-free income. That income might supplement Social Security benefits, taxable 401(k) withdrawals, or annuity
payments.
But you may experience a financial hardship or emergency that requires a withdrawal from your Roth IRA. In that
scenario, you’d want to weigh the tax implications carefully. You then must determine whether it is subject to ordinary
income tax and the 10% early withdrawal penalty.
It may be helpful to talk to a tax professional about the implications of taking a non-qualified distribution from a Roth
IRA. If you take an early distribution that’s subject to taxes and penalties, they can also help you file Form 5329 to
report those distributions.
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Taxable Income vs. Gross Income: An Overview
Gross income includes all income you receive that isn't explicitly exempt from taxation under the Internal Revenue
Code (IRC). Taxable income is the portion of your gross income that's actually subject to taxation. Deductions are
subtracted from gross income to arrive at your amount of taxable income.
● Gross income is all income from all sources that isn't specifically tax-exempt under the Internal Revenue Code.
● Taxable income starts with gross income, then certain allowable deductions are subtracted to arrive at the
amount of income you're actually taxed on.
● Tax brackets and marginal tax rates are based on taxable income, not gross income.
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Taxable Income
Taxable income is a layman's term that refers to your adjusted gross income (AGI) less any itemized deductions you're
entitled to claim or your standard deduction. Your AGI is the result of taking certain "above-the-line" adjustments to
income, such as contributions to a qualifying individual retirement account (IRA), student loan interest, and some
contributions made to health savings accounts.
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Taxpayers can then take either the standard deduction for their filing status or itemize the deductible expenses they
paid during the year. You're not permitted to both itemize deductions and claim the standard deduction. The result is
your taxable income.
Claiming the standard deduction often reduces an individual's taxable income more than itemizing because the Tax
Cuts and Jobs Act (TCJA) virtually doubled these deductions from what they were prior to 2018.
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For the 2020 tax year, these deductions will increase slightly:
● For single taxpayers and married individuals filing separately, the standard deduction rises to $12,400, up
$200 from the prior year.
● The standard deduction for married people filing jointly is $24,800, up $400.
● For heads of households, the standard deduction is $18,650, up $300.
The standard deduction for 2021 will be $25,100, an increase of $300, for married couples filing joint returns; $12,550,
an increase of $150, for single taxpayers’ individual returns and married individuals filing separately; and $18,800, an
increase of $150, for heads of households.
A taxpayer would need a significantly large amount of medical costs, charitable contributions, mortgage interest, and
other qualifying itemized deductions to surpass these standard deduction amounts.
Gross Income
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Gross income is the starting point from which the Internal Revenue Service (IRS) calculates an individual's tax liability.
It's all your income from all sources before allowable deductions are made. This includes both earned income from
wages, salary, tips, and self-employment and unearned income, such as dividends and interest earned on investments,
royalties, and gambling winnings.
Some withdrawals from retirement accounts, such as required minimum distributions (RMDs), as well as disability
insurance income, are included in the calculation of gross income.
Gross business income is not the same as gross revenue for self-employed individuals, business owners, and
businesses. Rather, it's the total revenues obtained from the business minus allowable business expenses—in other
words, gross profit. Gross income for business owners is referred to as net business income.
Some people confuse their gross income with their wages. Wage earnings often do make up the bulk of an individual's
gross income, but gross income includes unearned income, too.
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Gross income, however, can incorporate much more—basically anything that's not explicitly designated by the IRS as
being tax-exempt. Tax-exempt income includes child support payments, most alimony payments, compensatory
damages for physical injury, veterans' benefits, welfare, workers' compensation, and Supplemental Security Income.
These sources of income are not included in your gross income because they're not taxable.
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Above & Below the Line:
Not all tax deductions are created equal as some can have a more favorable impact on your tax bill than others. And
this is the case with above-the-line and below-the-line deductions. Although both types of deductions ultimately
reduce your taxable income, the amount of above-the-line deductions you take can directly affect the amount and
types of below-the-line deductions for which you're eligible.
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The AGI “Line”
You may be wondering what this so-called “line” is and why it's so important. This important line refers to your adjusted
gross income, or AGI. Adjusted gross income is a preliminary figure calculated on tax returns after reporting all income
that's subject to tax -- including the taxable profits on your Schedule C or C-EZ -- and reducing it with a number of
specific types of deductions, which are commonly referred to as being above-the-line. The amount of AGI you report is
important because the Internal Revenue Service uses it as a threshold amount for assessing your eligibility to take
other tax credits and below-the-line deductions. Generally, the lower your AGI is, the less restrictions you'll face on
other tax benefits.
Above-the-Line Deductions
Some above-the-line deductions, which are also known as “adjustments to income,” will also have limitations, but
they're usually less restrictive than below-the-line deductions and directly offset the income you report. Each
above-the-line deduction that's offered in a particular tax year is listed on separate lines on the first page of the 1040
form. Typically, above-the-line deductions include the contributions you make to health savings and individual
retirement accounts. For self-employed taxpayers who report business earnings on a personal return, deductions for
one-half of self-employment taxes owed, health insurance premiums paid, contributions to certain retirement plans,
like a savings incentive match program for employees, or SIMPLE, simplified employee pension plans, or SEPs, and
domestic production activities are available. Other write-offs that are used to calculate AGI also include the moving
expenses you incur when relocating for business purposes, alimony payments, student loan interest and a number of
others.
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Below-the-Line Deductions
Any deduction that's reported on a line that comes after the AGI calculation on a return is a below-the-line deduction.
This does include personal and dependent exemptions you take, but these aren't affected by your AGI like itemized
deductions are. For example, if you incur deductible medical and dental expenses during the year, the total deduction
amount you can report on Schedule A is limited to the amount that exceeds 7.5 percent of your AGI. And be aware of
the everchanging tax law as job related and other miscellaneous expenses that are reported on Schedule A and
subject to 2% of your AGI have been suspended until 2025. Therefore, the lower your AGI is, the larger your deduction
will be for these and other itemized deductions.
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AGI Thresholds
In addition to limiting deductions, your AGI can also impact your ability to take tax credits. The IRS frequently uses
modified adjusted gross income, or MAGI, as an income threshold for tax credit eligibility. Your MAGI is essentially
your AGI with certain items added to it. Take, for example, the lifetime learning credit. This credit is only available if
your MAGI is equal to or more than the maximum allowed. For this particular credit, your MAGI is calculated as your
AGI plus foreign income that's excluded on your return and the amount of any foreign housing deduction or exclusion
taken.
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What Are Above-the-Line Deductions?
Above-the-line deductions are expenses that are deducted to calculate an individual's adjusted gross income (AGI).
These differ from itemized deductions, which are the dollar amounts deducted from the determined AGI. The
following examples represent above-the-line expenses:
● Retirement Plan Contributions: Contributions made to traditional IRAs and qualified plans such as 401(k),
403(b), and 457 plans are deductible. Taxpayers with incomes above a certain level who contribute to both a
traditional IRA and a qualified plan are subject to a graduated phaseout reduction on the deductibility of their
IRA contributions.
● HSA, MSA Contributions: Contributions to Health Savings Accounts and Archer Medical Savings Accounts are
fully deductible, as long as taxpayers do not have access to any kind of group policy coverage, including that
offered by fraternal or professional organizations. The purchase of a qualified high-deductible health insurance
policy is also required.
● Health Insurance premiums: The cost of premiums paid for individual health insurance policies, including
high-deductible policies, are fully deductible for self-employed taxpayers. As with HSAs and MSAs, the
taxpayer cannot have access to group health coverage.
● Self-Employed Business Expenses, SE Tax: Expenses related to the operation of a sole proprietorship is
deductible on Schedule C. This includes rent, utilities, the cost of equipment and supplies, insurance, legal
fees, employee salaries, and contract labor. This also includes one-half of the self-employment tax that must be
paid on this income.
● Alimony: Payments made to a spouse pursuant to a divorce decree that are not classified as child support
usually count as alimony. Payments of this type are deductible from gross income unless they are "made under
a divorce or separation agreement executed after Dec. 31, 2018" or were modified in certain ways after that
date. If your divorce agreement predates that date, check with your accountant to confirm that alimony
payments are still deductible. This change came as part of the Tax Cuts and Jobs Act of 2017.
● Educator Expenses: These include unreimbursed qualified expenses of up to $250 ($500 for joint filers if both
fall under this category). Qualified expenses include teaching supplies, books, and other ordinary expenses
commonly associated with education. This deduction is available to educators who teach grades K-12 who
work at least 900 hours during the year.
● Early Withdrawal Penalties: Any penalties paid for the early withdrawal of money from a CD or savings bond
that is reported on Form 1099-INT or 1099-DIV can be deducted.
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Student Loan Interest: All interest paid on federally-subsidized student loans up to a certain amount is
deductible, provided the taxpayer's income does not exceed the annual limits. For 2019, those limits are
$85,000 for single, head-of-household, or qualifying widower filers and $170,000 for joint filers.
What is a capital gain?
A capital gain is what the tax law calls the profit you receive when you sell a capital asset, which is property such as
stocks, bonds, mutual fund shares and real estate. This does not include your primary residence. Special rules apply to
those sales.
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What's the difference between a short-term and long-term capital gain?
There's a very big difference. The tax law divides capital gains into two different classes determined by the calendar.
1. Short-term gains come from the sale of property owned one year or less and are taxed at your maximum tax
rate, as high as 37% in 2021.
2. Long-term gains come from the sale of property held more than one year and are taxed at either 0%, 15%, or
20% for 2021.
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What is the holding period?
That's the period you own the property before you sell it. When figuring the holding period, the day you buy property
does not count, but the day you sell it does.
So, if you bought a stock on April 15, 2020, your holding begins on that day. Thus, April 15, 2021 would mark one year
of ownership for tax purposes.
● If you sold on April 15, you would have a short-term gain or loss.
● A sale one day later on April 16 would produce long-term tax consequences, since you would have held the
asset for more than one year.
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How much do I have to pay?
The tax rate you pay in 2021 depends on whether your gain is short-term or long-term.
● Short-term profits are taxed at your maximum tax rate, just like your salary, up to 37% and could even be
subject to the additional 3.8% Medicare surtax, depending on your income level.
● Long-term gains are treated much better. Long-term gains are taxed at 15% or 20% except for taxpayers in the
10% or 15% bracket. For low-bracket taxpayers, the long-term capital gains rate is 0%. There are exceptions, of
course, since this is tax law.
● Long-term gains on collectibles—such as stamps, antiques and coins—are taxed at 28%, unless you're in the
10% or 15 % or 25% bracket, in which case the 10% or 15% rate or 25% rate applies.
● Gains on real estate that are attributable to depreciation—since depreciation deductions reduce your cost
basis, they also increase your profit dollar for dollar—are taxed at 25%, unless you're in the 10% or 15% bracket.
● Long-term gains from stock sales by children under age 19—under age 24 if they are students—may not qualify
for the 0% rate because of the Kiddie Tax rules. (When these rules apply, the child’s gains may be taxed at the
parents’ higher rates.)
What is a capital loss?
A capital loss is a loss on the sale of a capital asset such as a stock, bond, mutual fund or real estate. As with capital
gains, capital losses are divided by the calendar into short- and long-term losses.
Can I deduct my capital losses?
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Yes, but there are limits. Losses on your investments are first used to offset capital gains of the same type. So,
short-term losses are first deducted against short-term gains, and long-term losses are deducted against long-term
gains. Net losses of either type can then be deducted against the other kind of gain.
For example,
● If you have $2,000 of short-term loss and only $1,000 of short-term gain, the net $1,000 short-term loss can be
deducted against your net long-term gain (assuming you have one).
● If you have an overall net capital loss for the year, you can deduct up to $3,000 of that loss against other kinds
of income, including your salary and interest income.
● Any excess net capital loss can be carried over to subsequent years to be deducted against capital gains and
against up to $3,000 of other kinds of income.
● If you use married filing separate filing status, however, the annual net capital loss deduction limit is only
$1,500.
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How to Calculate Adjusted Gross Income (AGI) for Tax Purposes
Calculating your adjusted gross income (AGI) is one of the first steps in determining your taxable income for the year.
Once you have determined what your adjusted gross income is, you can determine your tax liability for the year.
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Here are some helpful tips for how to calculate your adjusted gross income (AGI) for tax purposes.
Before you calculate your AGI, you can determine whether you need to file a tax return for the year. The Internal
Revenue Service (IRS) provides an interactive tax assistant that can be used to help you determine if you need to file a
tax return for the year.
The first step in computing your AGI is to determine your total gross income for the year, which includes your
salary in addition to any earnings from self-employment ventures and any other income reported on 1099
forms, like investment dividends and retirement income.
● To arrive at your final AGI, you are allowed to subtract certain amounts from your total income. For example,
teachers can deduct unreimbursed classroom expenses, self-employed people can deduct insurance
premiums, and everyone can deduct charitable donations.
Even if you are not required to file a tax return, the IRS recommends that you still file a tax return. This is because you
may be eligible for a tax return if you paid income tax, or you may be eligible for certain credits.
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Gather Your Income Statements
The first step in computing your AGI is to determine your income for the year. Income can be in the form of money,
property, or services you receive in the tax year.
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Income includes your traditional salary and wages, which are reported on Form W-2, any earnings from
self-employment ventures, and any other income reported on 1099 forms, like investment dividends and retirement
income. Proceeds from broker and barter exchange transactions reported on Form 1099-B, proceeds from real estate
transactions reported on Form 1099-S, any taxable interest reported on Form 1099-INT, and any investment dividends
reported on Form 1099-DIV are all considered part of your taxable income.
In addition, you will also need to include these sources of taxable income:
● Business income
● Farm income
● Union strike benefits
● Taxable refunds, credits, or offsets of state and local income taxes
● Long-term disability benefits received prior to minimum retirement age
● Jury duty fees
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● Security deposits and rental property income
● Awards, prizes, gambling, lottery, and contest winnings
● Back pay from labor discrimination lawsuits
● Spousal support
● Unemployment benefits
● Capital gains
● Severance pay
● Earnings from rental real estate, royalties, partnerships, S corporations, trusts, and license payments
You can calculate your total income by adding all of these amounts together.
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Income That Is Not Taxed
Some types of income are not taxed. The following sources of income do not count toward your AGI:
● Workers' compensation benefits
● Child support benefits
● Life insurance proceeds (unless the policy was turned over to you for a price)
● Disability payments
● Capital gains on the sale of your primary home
● Money received as a gift or other inherited assets
● Canceled debts intended as a gift to you
● Scholarships or fellowship grants
● Foster care payments
● Money rolled over from one retirement account to another (as long as it was executed via a trustee-to-trustee
transfer)
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Subtract Deductions and Expenses
To arrive at your final AGI, you are allowed to subtract certain amounts from your total income.
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Deduction for Self-Employment Tax
As a self-employed person, you pay the full share of your Social Security and Medicare taxes. Because of this, you are
eligible for a credit from the IRS if you claim the self-employment tax deduction.
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Classroom Expenses for Teachers and Educators
If you are a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide for at least 900 hours a
school year in a school that provides elementary or secondary education, you can deduct up to $250 for unreimbursed
work-related expenses you incur during the tax year.
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Self-Employment Health Insurance Deduction
If you are self-employed, you can deduct the entire amount of what you spend on premiums through
the self-employment health insurance deduction. This also applies if the policy covers your spouse and your
dependents.
Qualified Performing Artists and Other Professions
You can adjust your income if you are a qualified artist, as well as a reservist and some fee-basis government officials.
In addition to these deductions, there are also deductions for charitable contributions and contributions to Health
Savings Accounts (HSA).
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There are other deductions related to self-employment, early withdrawal penalty amounts and student loan interest.
And moving expenses for our Armed Forces.
Modified AGI vs. AGI
A common mistake made by inexperienced tax preparers is to use AGI in cases where the modified AGI should be
used. While your AGI is used to determine the amount of income tax you owe and certain credits for which you are
eligible, your modified AGI is used to determine eligibility for other items such as deducting contributions to a
traditional IRA and eligibility to contribute to a Roth IRA.
Tax Liability Partnerships (OICS_6729)
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What Is Form 1065: U.S. Return of Partnership Income?
Form 1065 does not determine how much tax a partnership owes.
Foreign partnerships with income in the U.S. must also file Form 1065. As of 2018, foreign partnerships earning less
than $20,000 in the country or partnerships that receive less than 1% of their income in the U.S. may not have to file.
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How to File Form 1065: U.S. Return of Partnership Income
This form requires significant information about the partnership's annual financial status. This includes income
information such as gross receipts or sales. Deductions and operating expenses such as rent, employee wages, bad
debts, interest on business loans, and other costs are also included. The form requires information about the partners
and their stake in the company by percentage of ownership.
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Before completing Form 1065, filers need information from:
● Form 4562: Depreciation and Amortization
● Form 1125-A: Cost of Goods Sold
● Form 4797: Sale of Business Property
● Copies of any Form 1099 issued by the partnership
● Form 8918: Material Advisor Disclosure Statement
● Form 114: Report of Foreign Bank and Financial Accounts Disclosure Statement
● Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
Other Relevant Forms
As mentioned above, the taxpayer must also include a completed Schedule K-1. This schedule identifies the
percentage share of gains and losses assigned to each partner for the beginning and end of the reporting period.
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What Is Schedule K-1?
Schedule K-1 is a federal tax document used to report the income, losses, and dividends of a business' or financial
entity's partners or an S corporation's shareholders. The Schedule K-1 document is prepared for each individual
partner and is included with the partner’s personal tax return. An S corporation reports activity on Form 1120S, while a
partnership reports transactions on Form 1065.
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Business partners, S corporation shareholders, and investors in limited partnerships and certain ETFs use
Schedule K-1 to report their earnings, losses, and dividends.
Schedule K-1s are usually issued by pass-through business or financial entities, which don't directly pay
corporate tax on their income, but shift the tax liability (along with most of their income) to their stakeholders.
Schedule K-1 has a section to calculate a partner’s capital account.
Several different types of income can be reported on Schedule K-1.
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Schedule K-1s should be issued to taxpayers no later than Mar. 15 or the third month after the end of the
entity's fiscal year.
Understanding Schedule K-1
The U.S. federal tax code allows the use of a pass-through strategy in certain instances, which shifts tax liability from the
entity (a trust, a partnership) to the individuals who have an interest in it. The entity itself pays no taxes on earnings or
income; rather, any payouts—along with any tax due on them—"pass-through" directly to the stakeholders. This is where
Schedule K-1 comes in.
The purpose of Schedule K-1 is to report each participant's share of the business entity's gains, losses, deductions,
credits, and other distributions (whether or not they're actually distributed). While not filed with an individual partner’s
tax return, the financial information posted to each partner’s Schedule K-1 is sent to the IRS with Form 1065. Income
generated from partnerships is added to the partner’s other sources of income and entered on Form 1040.
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Schedule K-1 is similar to Form 1099, in that it reports dividends, interest, and other annual returns from an investment.
Whether you receive a K-1 or a Form 1099 depends on the investment. Master limited partnerships (MLPs), real estate
limited partnerships (RELPs) and certain exchange-traded funds (ETFs) are all types of investments that routinely issue
K-1s.
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Factoring in Partnership Agreements
A partnership is defined as a contract between two or more people who decide to work together as partners. The rules
of this business arrangement are stated in a partnership agreement. The partnership has at least one general
partner (GP) who operates the partnership.
GPs are liable for their actions as partners and for the activities of other GPs in the partnership. Limited partners, on the
other hand, are liable for the debts and obligations of the partnership based only on the amount of capital they
contribute. The partnership agreement dictates how the partners share profits, which impacts the information on
Schedule K-1.
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Basis Calculation
Schedule K-1 requires the partnership to track each partner’s basis in the partnership. Basis, in this context, refers to a
partner’s investment or ownership stake, in the enterprise. A partner’s basis is increased by capital contributions and
their share of income; it's reduced by a partner’s share of losses and any withdrawals.
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Assume, for example, that a partner contributes $50,000 in cash and $30,000 in equipment to a partnership, and the
partner’s share of income is $10,000 for the year. That partner's total basis is $90,000, less any withdrawals they've
made.
The basis calculation is important because when the basis balance is zero, any additional payments to the partner are
taxed as ordinary income. The basis calculation is reported on Schedule K-1 in the partner’s capital account analysis
section.
Income Reporting
A partner can earn several types of income on Schedule K-1, including rental income from a partnership’s real estate
holdings and income from bond interest and stock dividends.
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Many partnership agreements provide guaranteed payments to general partners who invest the time to operate the
business venture and those guaranteed payments are reported on Schedule K-1. The guaranteed payments are put in
place to compensate the partner for the large time investment.
A partnership may generate royalty income and capital gains or losses, and those items are allocated to each partner’s
Schedule K-1, based on the partnership agreement.
Those receiving K-1-reported income should consult with a tax professional to determine if their proceeds trigger
the alternative minimum tax.
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What Is IRS Schedule K-1?
Schedule K-1 is an Internal Revenue Service (IRS) tax form that's issued annually. It reports the gains, losses, interest,
dividends, earnings, and other distributions from certain investments or business entities for the previous tax year.
These are usually pass-through entities that don't pay corporate tax themselves, because they directly pass profits on
to their stakeholders or investors. Participants in these investments or enterprises use the figures on the K-1 to
compute their income, and the tax due on it.
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Who Gets an IRS Schedule K-1?
Among those likely to receive a Schedule K-1 are:
● S corporation shareholders
● Partners in limited liability corporations (LLCs), limited liability partnerships (LLPs), or other business
partnerships
● Investors in limited partnerships (LPs) or master limited partnerships (MLPs)
● Investors in certain exchange-traded funds (ETFs)
● Trust or estate beneficiaries
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Is IRS Schedule K-1 Income Considered Earned Income?
It varies, depending on the individual's participation and status. For trust and estate beneficiaries, limited partners, and
passive investors, Schedule K-1 income is more akin to unearned income. For general partners and active owners in a
business or pass-through business entity, the income can be considered earned income, and they may owe
self-employment tax on it.
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When Should I Receive My IRS Schedule K-1?
Schedule K-1 forms are notorious for arriving late. The IRS says they are due by March 15 (or the 15th day of the third
month after the entity's tax year ends), but whether that means they need just to be issued by then, or to actually be in
taxpayers' hands by then, seems open to interpretation. Most authorities agree you should receive one by March 15, or
the closest business day to that, though.
Do You Have to File an IRS Schedule K-1?
Yes, you do, if you are a general partner in a limited partnership or owner of a pass-through business entity or S
corporation. The K-1 must be filed with your tax return.
Other Gross Income Items (OICS_6730)
What Is IRS Form 1099-SA: Distributions from an HSA, Archer MSA, or Medicare Advantage MSA?
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When you use the funds from a Health Savings Account (HSA), or a medical savings account (MSA) such as an Archer
MSA or Medicare MSA, the institution that administers the account must report all distributions on Form 1099-SA.
Several tax incentives are available for you to save money on medical care costs. You could get a Health Savings
Account (HSA), or a medical savings account (MSA) such as an Archer MSA or Medicare MSA. When you actually use
those funds, the institution that administers the account must report all distributions on Form 1099-SA.
Can anyone contribute?
Only certain individuals are eligible to contribute to an HSA or MSA. You must be covered under a High Deductible
Health Plan (HDHP) (with no coverage under a non-HDHP health plan), you cannot be enrolled in Medicare and cannot
be eligible to be claimed as a dependent on another person’s return. If you are employed, your employer can make
tax-free contributions as well.
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Plan tax benefits
If you make contributions to one of these accounts, you stand to save a significant amount of money in taxes both in
the short and long term. Not only can you deduct contributions you make to your account in the year made, but the
unspent balances can rollover indefinitely from year to year. These balances can be invested and the earnings from
these investments will never be taxed so long as withdrawals are spent on qualifying health expenses.
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As needed, you can take tax-free distributions from your account to pay for qualified medical expenses of the account
beneficiary or the beneficiary’s spouse or dependents. You will receive a Form 1099-SA that shows the total amount of
your annual distributions (i.e. money you used) reported in box 1. Provided you only use the funds to pay qualified
medical expenses, box 3 should show the distribution code No. 1, which indicates normal tax-free distributions.
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Qualified medical expenses
None of the money received from these plans is taxable if it is spent on "qualified" medical expenses. If the money you
withdraw exceeds your qualified medical expenses, however, the excess is subject to income tax. The IRS does not
provide an exhaustive list of qualified medical expenses, but it does state an expense is qualified if the taxpayer could
report it as an itemized deduction on Schedule A. As a general guideline, the expense should cover the cost of
diagnosing, preventing, curing, mitigating or treating a disease. The cost of medical treatment that affects any part of
the body is also considered a qualified expense.
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If you get a distribution code No. 5 in box 3 of a 1099-SA, it means you did not use all distributions from your account
for qualified medical expenses. That means you must report some of the distribution on your tax return.
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HSA distributions
The IRS requires you to prepare Form 8889 and attach it to your tax return when you take a distribution from an HSA.
However, if your 1099-SA indicates you did not use the distribution for qualified medical expenses, you will pay
income tax on the portion you used for unqualified expenses. You report the taxable amount on the “other income”
line of your tax return and write “HSA” beside it. You will also have to pay an additional tax of 20 percent on the taxable
portion of your distribution, which you’ll calculate on Form 8889.
MSA distributions
MSA distributions not used for qualified medical expenses are subject to the same tax consequences as HSAs. You
report taxable and tax-free distributions on Form 8853, and calculate the 20 percent additional tax on the taxable
portion of your distributions directly on the form. Taxable MSA distributions are reported on your tax return the same
way that HSAs are, but the notation you make on the “other income” line should be “MSA.”
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Is Social Security taxable?
For most Americans, it is. That is, a majority of those who receive Social Security benefits pay income tax on up to half
or even 85% of that money because their combined income from Social Security and other sources pushes them
above the very low thresholds for taxes to kick in.
You can, however, use some strategies, before and after you retire, to limit the amount of tax you pay on Social Security
benefits. Keep reading to find out what you can do starting today to minimize the amount of income taxes you pay
after retiring.
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Up to 50% of Social Security income is taxable for individuals with a total gross income including Social
Security of at least $25,000, or couples filing jointly with a combined gross income of at least $32,000.
Up to 85% of Social Security benefits are taxable for an individual with a combined gross income of at least
$34,000, or a couple filing jointly with a combined gross income of at least $44,000.
Retirees who have little income other than Social Security won't be taxed on their benefits. In fact, you may not
even have to file a return.
Your focus should be on paying less overall taxes on your combined income.
A tax-advantaged retirement account like a Roth IRA can help.
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How Much of Your Social Security Income Is Taxable?
Social Security payments have been subject to taxation above certain income limits since 1983.No inflation
adjustments have been made to those limits since then, so most people who receive Social Security benefits and have
other sources of income pay some taxes on the benefits.
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No taxpayer, regardless of income, has all of their Social Security benefits taxed. The top-level is 85% of the total
benefit.Here's how the Internal Revenue Service (IRS) calculates how much is taxable:
● The calculation begins with your adjusted gross income from Social Security and all other sources. That may
include wages, self-employed earnings, interest, dividends, required minimum distributions from qualified
retirement accounts, and any other taxable income.
● Then, any tax-exempt interest is added. (No, it isn't taxed, but it goes into the calculation.)
● If that total exceeds the minimum taxable levels, at least half of your Social Security benefits will be considered
taxable income. You then have to take the standard deduction or itemize deductions in order to arrive at your
net income.
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The amount you owe depends on precisely where that number lands in the federal income tax tables.
Combined income = your adjusted gross income + nontaxable interest + half of your Social Security benefits
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Individual Tax Rates
Benefits will be subject to tax if you file a federal tax return as an individual and your combined gross income from all
sources is as follows:
● Between $25,000 and $34,000: You may have to pay income tax on up to 50% of your benefits.
● More than $34,000: Up to 85% of your benefits may be taxable.
The IRS has a worksheet that can be used to calculate your total income taxes due if you receive Social Security
benefits. When you complete this typically long-winded exercise in arithmetic, you will find that your taxable income
has increased by up to 50% of the amount you received from Social Security If your gross income exceeds $25,000 for
an individual or $32,000 for a couple. The percentage taxed rises to 85% of your Social Security payment if your
combined income exceeds $34,000 for an individual or $44,000 for a couple.
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For example, say you were an individual taxpayer who received the average amount of Social Security, $16,000, in
2020. You had $20,000 in "other" income. Add the two together and you have a gross income of $36,000, or a
combined income of $28,000 (gross income + half the Social Security benefits). That's within the $25,000 to $34,000
range for 50% of benefits being taxed, so half of your Social Security, or $8,000, is considered taxable income.
Your net income will be based on half of your Social Security income ($8,000) plus all of your other income ($20,000),
minus the standard deduction or your itemized deductions. (Of course, it can get more complicated for some
taxpayers, but we'll keep this example simple.)
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Married Tax Rates
For couples who file a joint return, your benefits will be taxable if you and your spouse have a combined income as
follows:
● Between $32,000 and $44,000: You may have to pay income tax on up to 50% of your benefits.
● More than $44,000: Up to 85% of your benefits may be taxable.
For example, say you are a semi-retired couple filing jointly and have a combined Social Security benefit of $26,000, in
2020. You had $30,000 in "other" income. Add the two together and you have a gross income of $56,000, or a $43,000
in combined income (gross income plus half your Social Security benefits). This combined income falls in the $32,000
to $44,000 range, meaning half of your benefits, or $13,000, will be taxable.
Your taxable net income will be based on half of your Social Security income ($13,000) plus all of your other income
($30,000), minus the standard deduction or your itemized deductions.
Social Security Benefits Tax Tool
This being the IRS, the straightforward example above may not apply to you. This Interactive Tax Assistant will lead you
through the various complications that are possible and calculate what part of your income is taxable.
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Are Spousal, Survivor, Disability, and SSI Benefits Taxable?
These programs all follow the same general rules as the Social Security program for retirees, with one exception:
Supplemental Security Income, or SSI for short, is not a Social Security program. It's a separate program for people
who are disabled, and payments from it are not taxable.
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Spousal Benefits
The rules for the spousal benefit are the same as for all other Social Security recipients. If your income is above
$25,000, you will owe taxes on up to 50% of the benefit amount. The percentage rises to 85% if your income is above
$34,000.
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Survivor Benefits
Survivor benefits paid to children are rarely taxed because few children have other income that reaches the taxable
ranges. The parents or guardians who receive the benefits on behalf of the children do not have to report the benefits
as income.
Disability Benefits
Social Security disability benefits follow the same rules on taxation as the Social Security retiree program. That is,
benefits are taxable if the recipient's gross income is above a certain level. The current threshold is $25,000 for an
individual and $32,000 for a couple filing jointly.
Paying Taxes on Social Security
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You should get a Social Security Benefit Statement (Form SSA-1099) each January, detailing the benefits you received
during the previous tax year. You can use it to determine whether you owe federal income tax on your benefits.The
information is available online if you enroll on the Social Security site.
If you owe taxes on your Social Security benefits, you can make quarterly estimated tax payments to the IRS or have
federal taxes withheld from your payouts before you receive them.
State Taxes on Social Security
There are 13 states which tax Social Security benefits in some cases. If you live in one of those states—Colorado,
Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah,
Vermont, and West Virginia—check with the state tax agency.As with the federal tax, how these agencies tax Social
Security varies by income and other criteria.
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When Social Security Is Not Taxable
You won't owe federal tax on your Social Security benefits if your total income falls below the taxable thresholds set by
the IRS.
You won't owe state taxes on your benefits if you live in any of the 37 states that don't tax this income. You can
minimize the tax burden by adopting one of the strategies below.
How Do I Determine If My Social Security Is Taxable?
Add up your gross income for the year, including Social Security. If you have little or no income in addition to your
Social Security, you won't owe taxes on it. If you're an individual filer and had at least $25,000 in gross income
including Social Security for the year, up to 50% of your Social Security benefits may be taxable. For a couple filing
jointly, the minimum is $32,000. If your gross income is $34,000 or more, up to 85% may be taxable. The minimum for
a couple is $44,000.
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What Percentage of Social Security Is Taxable?
If you file as an individual, your Social Security is not taxable only if your total income for the year is below $25,000.
Half of it is taxable if your income is between $25,000 and $34,000. If your income is higher than that, up to 85% of
your benefits may be taxable.
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If you and your spouse file jointly, you'll owe taxes on half of your benefits if your joint income is between $32,000 and
$44,000. If your income is above that, up to 85% is taxable income.
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Do I Have to Pay Local Taxes on Social Security?
Thirty-seven states do not impose taxes on Social Security benefits. The other 13 tax some recipients under some
circumstances.
Gambling Losses: Gambling losses are indeed tax deductible, but only to the extent of your winnings and requires
you to report all the money you win as taxable income on your return. The deduction is only available if you itemize
your deductions. If you claim the standard deduction, then you can't reduce your tax by your gambling losses.
Keeping track of your winnings and losses
The IRS requires you to keep a log of your winnings and losses as a prerequisite to deducting losses from your
winnings.
This includes:
● Lotteries
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Horse and Dog Races
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Poker Games
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Raffles
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Casino Games
Your records must include:
● The date and type of gambling you engage in
● The name and address of the places where you
gamble
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Sports Betting
The people you gambled with
The amount you win and lose
Other documentation to prove your losses can include:
● Form W-2G
● Wagering tickets
● Form 5754
● Canceled checks or credit
records
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Receipts from the gambling
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Limitations on loss deductions
The amount of gambling losses you can deduct can never exceed the winnings you report as income. For example, if
you have $5,000 in winnings but $8,000 in losses, your deduction is limited to $5,000. You could not write off the
remaining $3,000, or carry it forward to future years.
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Reporting gambling losses
To report your gambling losses, you must itemize your income tax deductions on Schedule A. You would typically
itemize deductions if your gambling losses plus all other itemized expenses are greater than the standard deduction
for your filing status. If you claim the standard deduction,
● You are still obligated to report and pay tax on all winnings you earn during the year.
● You will not be able to deduct any of your losses.
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Only gambling losses
You can include in your gambling losses the actual cost of wagers. Keep in mind that the IRS does not permit you to
simply subtract your losses from your winnings and report the difference on your tax return. And if you have a
particularly unlucky year, you cannot just deduct your losses without reporting any winnings. If the IRS allowed this,
then it's essentially subsidizing taxpayer gambling.
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Disclaimer:
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This content is for information purposes only and information provided should not be considered legal, accounting or
tax advice. Additional information and exceptions may apply. Applicable laws may vary by state or locality. No
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