17 Personal Finance Concepts – #4 Personal Income Tax Basics

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Some of the Personal Finance content I will be writing about in this series of articles may be obvious or rudimentary to many of my readers but it also may be of great value to young people you may know. Please share this information with those you believe will best benefit from it.

Income Tax can be a very complex subject. Especially if you have one or more businesses or have significant wealth being managed. For everyone else, below is a good overview of everything you’ll need to know in order to be at least literate as far as Income Tax goes.

Federal Income Tax

From 1040 is the primary tax form individuals must file. Certain individuals may be eligible to file Form 1040A or Form 1040EZ.

Form 1040, 1040A & 1040EZ are due on April 15^th of each year. You can request an Extension to file Form 1040, 1040A or 1040EZ until October 15^th of each year.

Form 1040 can be broken down into Eight sections:

1. Section 1 Total Income: W-2 Wages, Interest Income, Dividend Income, Retirement Income, Social Security Benefits, Capital Gains (Losses), Gambling Income, Unemployment Compensation, Sole Proprietor Business Income, Partner Business Income, S Corporation Income, Royalties, Rental Income, Taxable Alimony and Miscellaneous Other Income.
2. Section 2 Deductions That Reduce Total Income: Deductible Alimony Paid, Health Savings Account Contributions, Educator Expenses, 50% of Self-employment Income Tax, Self-Employed Health Insurance, Certain Retirement Plan Contributions (SEP Contributions & IRA Contributions), Student Loan Interest, Certain Attorney Fees and Miscellaneous Other Deductions. After these deductions, you are left with something called Adjusted Gross Income.
3. Section 3 Standard or Itemized Deductions: If Itemized Deductions exceed Standard Deduction, Itemized Deductions are used. Itemized Deductions include: Medical Expenses in excess of 7.5% of Adjusted Gross Income, Real Estate Tax, State Income Tax, Mortgage Interest, Points Paid on a New Home Purchase, Gambling Losses, Charitable Contributions and Miscellaneous Other Itemized Deductions. After these deductions you are left with something called Taxable Income.
4. Section 4 Income Tax Amount on Taxable Income.
5. Section 5 Additional Taxes: Self-Employment Tax, Additional Medicare Tax, Net Investment Tax
6. Section 6 Credits Against Income Tax: Child Tax Credit, Foreign Tax Credit, Education Credits, Residential Energy Credits, Energy Efficient Home Improvement Credits, Electric Vehicle Credit
7. Section 7 Income Tax Payments Already Made: W-2 Federal Withholding Tax, 1099R Retirement Income Federal Withholding Tax, Estimated Tax Payments you made during the year, Extension Payments you made when you Extended Form 1040 on April 15^th.
8. Section 8 Tax Due or Tax Refund Owed to you.  

At the end of January you will begin receiving certain Tax Documents in the mail that you will need in order to prepare Form 1040: W-2s (Employee Compensation), 1099Rs (Retirement Income), 1099INTs (Interest Income), 1099DIVs (Dividend Income), Year End Brokerage 1099 Tax Summary (Interest Income, Dividend Income and Capital Gains), Form 1098 Mortgage Interest/Real Estate Taxes Paid (This comes from your Bank), 1099s (Non-Employee Compensation – Independent Contractor Income), SSA-1099 (Social Security Benefits).

If you have a Sole Proprietorship, Partnership of are a Shareholder in an S Corporation, you will have to make Federal and State Quarterly Estimated Tax Payments on your business income. Estimated Tax Payments are due as follows: April 15th, June 15th, September 15th and January 15th of the following year.

If you have a Rental Property business, you will need to report the income and expenses on Schedule E, which is attached to your Form 1040. One of the Deductions you are entitled to is Depreciation Expense. With Depreciation Expense, you get a Deduction for the Cost of the Building you are Renting out. So, you will need to break out the Cost of the Building and the Land, as separate components, when you acquire a Rental Property. You do not get a Depreciation Deduction for the Land upon which that building sits. Besides the Building, you can Depreciate a refrigerator, microwave, washing machine, TVs, Routers, Furniture, Lighting Fixtures, Rugs, Bathroom accessories (Faucets, Shower Heads, Shower Doors, Toilets, Sinks, Tubs) and Miscellaneous other things.

If you have a Sole Proprietorship Business, you will need to report your income and expenses on Schedule C, which is attached to Form 1040.

Receipt of Year End Brokerage 1099 Tax Summary Forms are often delayed until March, to avoid having to re-issue Corrected 1099s, which happens a lot.

You report Interest and Dividend Income on Schedule B, which is attached to Form 1040.

You report Capital Gains and Losses on Schedule D, which is attached to Form 1040. Capital Gains can be Short-Term (Holding Period of 1 Year or less) or Long Term (Holding Period of more than 1 Year). You calculate Short-Term Gains (Losses) first and then Long-Term Gains (Losses) next. You net your Short-Term Gain or Loss against your Long-Term Gain or Loss. You calculate Gains (Losses) by Subtracting your Purchase Price from your Sales Price. If your Purchase Price Exceeds your Sales Price, you have a Capital Loss. If your Purchase Price is Less Than your Sales Price, you have a Capital Gain.

You can Automatically Pay your Tax Due with your Form 1040 Filing, by authorizing the IRS to directly pull the Tax Due from your Bank Account. You can also give the IRS Authorization to auto deposit your Refund into your Bank Account. The Routing # and Bank Account # for Auto Payments and Auto Refunds is displayed on the bottom of Page 2 of Form 1040.

If you fail to file a Federal Income Tax Return, when due, you likely will be assessed a Late Payment Penalty, Late Filing Penalty and Underpayment of Tax Penalty, if there is a Tax Due. There are no Penalties if you are entitled to a Refund. However, there is a Statute of Limitations on Refunds of three years. This means that if you are entitled to a Refund, but fail to file your return within three years of the Due Date, you will lose that Refund.

State Income Tax

Each State has their own separate set of Tax Rules. Many States use Federal Taxable Income as a starting point for their own State Tax Returns, which means you don’t have to do as much work reinputting your income and deductions.

Some States, unfortunately, require that you re-input all of your income and this is because those States have unique rules on how they tax different types of income. Also, some states have their own specific Tax Deductions, that differ from Federal Deductions.

City Income Tax

Certain States also have City Income Tax Returns that must be filed every year, like New York and Philadelphia. City Income Tax Returns also have their own unique set of Tax Rules you must follow.

Tom Corley is an accountant, financial planner and author of “Rich Kids: How to Raise Our Children to Be Happy and Successful in Life”, Effort-Less Wealth, Change Your Habits Change Your Life, Rich Habits Poor Habits and “Rich Habits: The Daily Success Habits of Wealthy Individuals.”