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Publication #FCS7026

Federal Income Tax Management1

Josephine Turner, Michael S. Gutter, Nayda I. Torres, Horacio Soberon, and Vervil Mitchell2

You can assume there will always be some type of tax during your lifetime. Taxes are levied for many reasons, but primarily to fund government activities that should benefit the populace. Examples of these activities include education, defense, infrastructure, and environmental protection. Developing solutions and programs for citizens requires creative leadership, good management, and a great deal of money.

Revenue to meet these needs comes primarily from taxes—sales, property, income, and others. A major source of revenue is the federal income tax. Tax laws were created not only to raise money for government expenditures but also to encourage or discourage some behaviors. For example, tax laws encourage people to purchase homes because homeowners have tax deductions available to them. On the other hand, heavy taxes on liquor and cigarettes can discourage excessive use.

Income tax time is stressful for many people. Ideally, your employer will withhold enough taxes during the year to meet the tax due, but if you have to pay additional taxes, money must be available from the family budget. Otherwise, another source must be found to pay the additional tax. If you have questions about your withholding, check with your employer. Tax management involves minimizing the effects of taxes in order to help maintain a lifestyle compatible with your goals and aspirations. It is important that you take every opportunity to minimize your tax bill. Remember, you don’t have to pay more in taxes than the law demands. Paying less in taxes by carefully planning and using the tax laws is wise and legal, but you must pay what the law requires.

If you keep records throughout the year, filing at the end of the tax year is easier. However, if the Internal Revenue Service (IRS) questions your figures, the burden is on you to prove they are incorrect. The most acceptable forms of proof are your records and receipts, such as canceled checks, vouchers, sales slips, earning statements, dividends, and interest. If you cannot back up your figures with these or other means, you may be required to pay more taxes, as well as penalties and interest.

Figure 1. 

You will have to pay income taxes throughout your lifetime, so you will need to understand how to file your taxes and follow the tax laws.


Credit:

iStockphoto


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Filing Advantages

Even though some people who are employed do not have to file an income tax return because of low earnings, it may be to their advantage to file for several reasons:

  • If an employer has withheld tax from your wages and the amount is more than you owe, you must file a return to get the money refunded.

  • A tax advantage for low and moderately paid workers called the Earned Income Tax Credit reduces taxes owed, and, if you qualify, it may give you a refund even if no tax was withheld. Check with your employers to see if you are eligible for this benefit. In 2013, low- to moderate-income workers could be eligible for an Earned Income Tax Credit return up to $6,044. (See the worksheet and table at the end of this publication to learn more about qualifying for the Earned Income Tax Credit.)

Who Must File a Return

Your filing status, age, and gross income determine whether or not you have to file a return. To check if you have to file, a chart is listed in the 1040EZ, the 1040A and 1040 forms and instruction booklets. If you did not receive the forms, you can visit the IRS website at http://www.irs.gov or call 1-800-829-1040.

Forms 1040EZ and 1040A can be used for low to moderate incomes if you meet the guidelines. These forms are simpler and can be completed in a shorter time and with fewer calculations than the 1040 form, but you must fall within the specified guidelines found in the instructions. In some cases, even if you qualify to use the simpler forms, it may be to your advantage to file the 1040 form. For example, if your charitable giving is greater than the standard deduction allowed on 1040EZ or 1040A, you can use a Schedule A with the 1040 form to reduce your adjusted gross income. If you qualify for Head of Household filing status, using 1040A or 1040, may result in a lower tax than filing the Single filing status on 1040EZ. The following information refers to the 1040 form:

  • Filing Status. A taxpayer’s filing status is determined by his/her marital status on December 31 of the tax year. Married people can file one joint return or they may each file separately. Depending on specific circumstances, unmarried taxpayers may be classified as Single, Head of Household (unmarried person who paid over half of the cost of keeping up a home for qualified live-in dependents such as minor children or elderly parents), or Qualifying Widow(er) (person whose spouse has died during one of the previous tax years and has a child living with him/her whom he/she can claim as a dependent).

  • Age. Individuals receive an extra bump on their standard deduction if they are over age 65.

  • Gross Income. The last part of the filing formula is the gross income of the taxpayer. Therefore, it is important to know what is included in or excluded from gross income.

  • Wage/Salary. The employee’s gross income includes wages, salaries, commissions, bonuses, tips, and income from second jobs. Generally the IRS will not tax the cost of most fringe benefits. By January 31 each year, your employer must give you a W-2 form showing your total earnings for the previous year and the amounts withheld for taxes and other purposes. Attach a copy of your W-2 to your income tax form. If you are paid on a commission basis, your employer will send you a 1099 form.

  • Unemployment Compensation. All unemployment benefits are taxable.

  • Dividends. If you own stocks, you will receive a year-end statement of dividends paid to you, either from your brokerage firm if it holds your stock, or directly from the issuing company if you hold the stock yourself.

  • Capital Gains and Losses. Capital gains or losses are your profits or losses from the sale of any property you own and use for personal purposes or investments.

  • Rental Income and Expenses. All of your income and expense records (such as taxes, interest, and depreciation) for rental property should be kept separately from records for property you use yourself.

  • Pension, Retirement Plans, and Annuities. At the end of the year, your pension fund trustee will send you copies of either (or both, if necessary) the W-2P form for pension and certain other periodic payments or the 1099-R form for lump sum distributions. In addition, your former employer will send you annual statements breaking down benefits paid to you in taxable and non-taxable portions.

  • Alimony. Alimony is taxable as regular income. Child support payments are neither taxable if received, nor deductible if paid.

  • Social Security. A portion of your Social Security benefits may be taxable. Check the instructions on Form 1040 for details.

Non-taxable income does not have to be reported. Examples of non-taxable income include the following:

  • Child support payments received

  • Life insurance death benefits

  • Divorce settlements (lump sum)

  • Money from lawsuits for accidents

  • Gifts and inheritances

  • Workers’ compensation

  • Income from municipal bonds

  • Value of food stamps

  • Proceeds from sale of personal items sold for less than purchase price (such as in garage sales)

  • Veteran benefits

  • Part of Social Security benefits

  • Employer-provided benefits, up to specific limits

Some expenses, such as moving costs, you can deduct from your gross income. These are called adjustments to gross income. Your adjusted gross income (AGI) is your gross income less your adjustments to income. The AGI is used to determine eligibility for many tax breaks, including personal exemptions, itemized deductions, and credits. Those with higher AGIs may face reduced benefits.

Examples of adjustments to income are follows:

  • Contributions to qualified retirement plans such as IRAs, Keough, or SEP

  • Moving expenses (restricted)

  • Alimony paid

  • 1/2 of self-employment tax

  • Penalty for early withdrawal of CDs

  • Medical savings account deduction

  • Self-employed health insurance deduction

Itemized Deductions

Deductions are expenditures you made during the year that can be subtracted from your adjusted gross income. The tax laws specify which expenses are deductible. Note you must choose between the Standard Deduction and Itemized Deductions. Once you know your total Itemized Deductions, you compare this to the Standard Deduction provided on form 1040. Use whichever is greater.

The following are examples of tax-deductible expenses that may be itemized on Schedule A:

  1. Mortgage interest

  2. Gifts to charity (50% ceiling)

  3. State and local income taxes

  4. Property taxes

  5. Job expenses (2% floor)

  6. Medical expenses (7.5% floor)

  7. Casualty and theft losses (10% floor)

The expenses labeled with floor or ceiling have built-in limits as to how much of the expenses may be deducted. These limits are often tied to AGI. The percentages indicate a floor or ceiling relative to adjusted gross income (AGI). A ceiling represents a maximum, while a floor represents a minimum level of expense. For instance, out-of-pocket medical expenses in excess of 7.5% of AGI may be deducted, but the amount less than this cannot. The amount deducted for charitable gifts cannot exceed 50% of AGI. Expenses you have to pay for your job, but not reimbursed and exceeding 2% of AGI may be included. Losses resulting from casualty or theft, not reimbursed by insurance and in excess of 10% of AGI, may be included as an itemized deduction. Many taxpayers do not have a large amount of deductible expenses. They would use the standard deduction shown on each tax form. The amount of the standard deduction depends on the filing status of the taxpayer. In addition, the standard deduction increases if the taxpayer and/or spouse are blind or if either or both are 65 or older.

Taxpayers should take time to do the math to find whether taking the standard deduction or itemizing deductible expenses will result in a greater deduction from the adjusted gross income.

Personal Exemptions

You can deduct a personal exemption for every person in your household who can be claimed as a dependent, including you and your spouse. If an individual is eligible to be claimed as a dependent on another’s return, he cannot take a personal exemption on his own return. An example of this is when a child is claimed as a dependent on a parent’s return; the child is then unable to claim a personal exemption against his/her own income.

Income Tax Rates and Computation

Currently there are six basic income tax rates: 10%, 15%, 25%, 28%, 33%, and 35%. The rates that apply to you depend on your taxable income and your filing status. These tax rates are called tax brackets.

A common misconception about taxes is that if your taxable income increases and you are pushed into a higher bracket, you will end up with a lower “take-home” income. The way taxes are computed does not allow this to happen because the tax rates are applied in income steps. Only the additional income is taxed in the higher bracket. The lower part of your earnings will still be taxed at the lower rate.

For example: A single taxpayer with a taxable income of $40,000 paid $6,030 in taxes in 2012. The tax rate bracket for $40,000 is 25%. This taxpayer is in the 25% tax bracket, but the first $35,350 of her income was taxed at the lower 15% rate. The remaining $4,650 is taxed at 25%.

Most people do not have to compute taxes themselves; instead they can use the tax tables provided with the tax forms to determine the tax due. These tables have been calculated using the procedure discussed above.

Credits

After the tax has been determined, you may qualify for additional credits, such as child and dependent care expenses, credit for the elderly or disabled, and/or adoption credit. Credits are deducted dollar for dollar from taxes due. On the other hand, deductions reduce your tax at your marginal tax rate.

Other Taxes

Certain other taxes must be added to the tax if they apply to your situation. These include self-employment tax, Social Security and Medicare, tip income not reported to the employer, tax on qualified retirement plans, advanced Earned Income Credit payments, and household employment taxes.

Payment

After any credits have been deducted and other taxes added to the computed tax amount, deduct the withholding payments found on your W-2 form(s) and Earned Income Tax Credits (if you qualify), to find the amount of tax you owe or the refund due to you.

Preparing Your Return

You can easily complete your return if you keep good records and your financial activities are not complicated. If you need it, free help is available.

  1. The IRS provides many resources without charge:

  • IRS office: Contact for advice, forms, instructions and help filling out forms.

  • IRS website (http://www.irs.gov): Visit for forms, instructions, publications, and educational material.

  • Phone: Call 1-800-829-1040 for advice.

2. Many of the forms, instructions, or publications are available at your local library or from http://www.irs.gov. The IRS website allows you to search for and see the forms to determine which form you will need.

3. Tax preparation software is available at local computer retailers, discount stores or through various websites.

4. In some communities, free help is available from trained volunteer groups such as the AARP Tax-Aide group. These sites are known as Volunteer Income Tax Assistance or VITA sites.

If you decide you do not want to prepare the return yourself, commercial tax services are available. Their fees range from $30 up to $150 or more depending on the complexity of the return and the qualification of the tax preparers. Ask for a general estimate or take all of your records to the preparer’s office and ask for a firm quote. Be sure to ask what liability the preparers will assume. For example, ask if they will pay any penalties and interest if they make mistakes. Check to see if the preparers are licensed to fill out the return. Be wary of tax preparation services that promise a quick refund. The fee you pay for this service can be substantial. A quick refund is a loan made to you secured by your tax refund. These loans have an APR interest rate of about 400%. Instead, you can file electronically and supply your bank account number and receive your refund in less than 10 days.

Also, be wary of firms that promise or guarantee a refund. No reputable tax preparer can promise such a thing before they have had a chance to look at your individual records. If a tax preparer cheats on your behalf, you are still responsible. Having someone else—even the IRS—complete your return does not relieve you of the responsibility for the accuracy of your return.

Ways to File

  1. Mail. Complete your return and mail it to the IRS in the envelope provided or send it to the address for your state found in the instruction manual.

  2. Electronically.

  • If you have a modem, computer, and tax software, you can e-file your return from home. Through a tax transmitter, you can file 24 hours a day, seven days a week. A tax transmitter may charge a fee for transmitting your return.

  • You can prepare your own return and have a tax professional transmit it electronically or have your return prepared and transmitted. Look for the "AUTHORIZED IRS E-FILE PROVIDER" sign. Tax professionals may charge a fee, and the amount depends on the professional and the services. Be sure to ask what the fee is before you request the service.

  • Some employers or financial institutions offer e-file services for free or a small fee to their employees or customers.

Records to Keep

Be sure to keep all the records you used to file your income tax return. If the IRS audits a return, they will ask to see these records.

Income Records

Keep your copy of the following records:

  • All the W-2 or 1099 forms you and your spouse received from employers for wages, salaries, commissions, bonuses, and tips

  • Unemployment compensation statement or check stubs

  • 1099 forms for interest or dividend income received

  • All records to verify capital gains or losses

  • Records of income and expense for rental properties (Keep separate from your personal residence records.)

  • Annual statements from pensions and/or Social Security

  • Statement of alimony received

Expense Records

Keep the following expense records:

  • Year-end statements that show interest paid on your mortgage

  • Receipts and canceled checks for charitable contributions

  • Receipts for taxes paid, including real estate, state, and local income taxes

  • Receipts for qualified medical expenses, job-related expenses, and casualty and theft losses

How Long to Keep Records

Keep a copy of your records, as well as copies of previous tax returns, for at least three years. However, you may want to keep them for up to 10 years or until the statute of limitations for that return runs out (Table 1). In instances of fraud or securities transactions, time limits may not apply, so keeping a permanent file of tax records is recommended. The statute of limitations is the period of time in which you can amend your return to claim a credit or refund or the IRS can assess additional tax.

Save the following documents for three years: canceled checks, insurance claims, travel diaries, receipts, sales slips, invoices, and medical bills.

You should keep these records permanently: complete copies of previous tax returns, proof of when you bought and sold investments, all records of real estate or personal property, and divorce decrees or separation agreements that justify alimony or child-support payments.

Table 1. 

Period of Limitations

 

If you...

Then the period is...

1

Owe additional tax and (2), (3), and (4) do not apply to you

3 years

2

File a claim for credit or refund after you filed your return

Later of 3 years or 2 years after tax was paid

3

Do not report income that you should and it is more than 25% of the gross income shown on your return

6 years

4

File a claim for a loss from worthless secures

7 years

5

File a fraudulent return

No limit

6

Do not file a return

No limit

Adapted from IRS Publication 552, Recordkeeping for Individuals (http://www.irs.gov/pub/irs-pdf/p552.pdf).

Filing an Amended Return

Sometimes a mistake has been made on a previous return. The IRS permits you to file a corrected return using Form 1040X. The mistake may mean you owe more or that you are entitled to a larger return. You should file in either case. It’s better to own up to a mistake than face an audit later. Taxpayers have three years from the original filing date to do this. Families who forgot to claim certain credits such as the Earned Income Tax Credit should definitely do this.

Minimize Your Taxes

  • Take advantage of the Earned Income Tax Credit if you qualify.

  • Take advantage of employer-provided benefits.

  • For homeowners, interest paid on a mortgage and real estate taxes are deductible if you itemize on Schedule A.

  • Contribute to your retirement by contributing to an Individual Retirement Account (IRA). Contributions may qualify as adjustments to income and, remember, Roth IRA earnings are tax free.

  • Take advantage of the tax credit available for day care for dependents if you qualify.

Getting Help

  • Residents of many communities in Florida may be close to a Volunteer Income Tax Assistance (VITA) site. These sites provide free tax preparation and filing for many eligible Floridians. You can call 211 in many counties to find a local VITA site.

  • The IRS hotline for questions about your return is 1-800-829-1040.

  • Florida residents may also call their local IRS office; this can be found on http://irs.gov or a local phone directory.

  • Those needing taxpayer advocacy service in Florida can call either 904-665-1000 (Jacksonville) or 954-423-7677 (Plantation).

References

Garman, E. T. & Forgue, R. E. (2006). Personal finance, 8th edition. New York: Houghton Mifflin Co.

Internal Revenue Service (IRS). (2013). IRS website. Retrieved from http://www.irs.gov/

Earned Income Tax Credit: Are You Eligible?

EIC Eligibility Checklist

You may claim the EIC if you answer “Yes” to all the following questions.*

1. Is your AGI less than:

  • $13,980 ($19,190 for married filing jointly) if you do not have a qualifying child,

  • $36,920 ($42,130 for married filing jointly) if you have one qualifying child,

  • $41,952 ($47,162 for married filing jointly) if you have two qualifying children, or

  • $45,060 ($50,270 for married filing jointly) if you have more than two qualifying children? (See Rule 1.)

2. Do you, your spouse, and your qualifying child each have a valid social security number? (See Rule 2.)

3. Is your filing status married filing jointly, head of household, qualifying widow(er), or single? (See Rule 3.)

Caution: If you or your spouse is a nonresident alien, answer “Yes” only if your filing status is married filing jointly. (See Rule 4.)

4. Answer “Yes” if you are not filing Form 2555 or Form 2555-EZ. Otherwise, answer “No.” (See Rule 5.)

5. Is your investment income $3,200 or less? (See Rule 6.)

6. Is your total earned income at least $1 but less than:

  • $13,980 ($19,190 for married filing jointly) if you do not have a qualifying child,

  • $36,920 ($42,130 for married filing jointly) if you have one qualifying child,

  • $41,952 ($47,162 for married filing jointly) if you have two qualifying children, or

  • $45,060 ($50,270 for married filing jointly) if you have more than two qualifying children? (See Rules 7 and 15.)

7. Answer “Yes” if you (and your spouse if filing a joint return) are not a qualifying child of another

taxpayer. Otherwise, answer “No.” (See Rules 10 and 13.)

Stop: If you have a qualifying child, answer questions 8 and 9 and skip 10–12. If you do not

have a qualifying child, skip questions 8 and 9 and answer 10–12.*

8. Does your child meet the relationship, age, residency, and joint return tests for a qualifying child? (See Rule 8.)

9. Is your child a qualifying child only for you?

Answer “Yes” if (a) your qualifying child does not meet the tests to be a qualifying child of any other person or (b) your qualifying child meets the tests to be a qualifying child of another person but you are the person entitled to treat the child as a qualifying child under the tiebreaker rules explained in Rule 9.

Answer “No” if the other person is the one entitled to treat the child as a qualifying child under the tiebreaker rules.

10. Were you (or your spouse if filing a joint return) at least age 25 but under age 65 at the end of 2012? (See Rule 11.)

11. Answer “Yes” if you (and your spouse if filing a joint return) cannot be claimed as a dependent on anyone else's return. Answer “No” if you (or your spouse if filing a joint return) can be claimed as a dependent on someone else's return. (See Rule 12.)

12. Was your main home (and your spouse's if filing a joint return) in the United States for more than half the year? (See Rule 14.)

*Persons with a qualifying child: If you answered “Yes” to questions 1 through 9, you can claim the EIC. Remember to fill out Schedule EIC and attach it to your Form 1040 or Form 1040A. You cannot use Form 1040EZ.

If you answered “Yes” to questions 1 through 7 and “No” to question 8, answer questions 10 through 12 to see if you can claim the EIC without a qualifying child.

Persons without a qualifying child: If you answered “Yes” to questions 1 through 7, and 10 through 12, you can claim the EIC.

If you answered “no” to any question that applies to you: You cannot claim the EIC.

Adapted from IRS publication 596, Earned Income Tax Credit (EIC) (http://www.irs.gov/pub/irs-pdf/p596.pdf). The information on this sheet is based on filing taxes for the year 2012, for more up-to-date information visit the IRS website at http://www.irs.gov.

Table 2. 

Earned Income Credit in a Nutshell1

First, you must meet all the rules in this column.

Second, you must meet all the rules in one of these columns, whichever applies.

Third, you must meet the rule in this column.

Chapter 1.

Rules for Everyone

Chapter 2.

Rules If You Have a Qualifying Child

Chapter 3.

Rules If You Do Not Have a Qualifying Child

Chapter 4.

Figuring and Claiming the EIC

1. Your adjust gross income (AGI) must be less than:

  • $45,060 ($50,270 for married filing jointly) if you have three or more qualifying children,

  • $41,952 ($47,162 for married filing jointly) if you have two qualifying children,

  • $36,920 ($42,130 for married filing jointly) if you have one qualifying child, or

  • $13,980 ($19,190 for married filing jointly) if you do not have a qualifying child

2. You must have a valid Social Security number.

3. Your filing status cannot be “Married filing separately.”

4. You must be a U.S. citizen or resident alien all year.

5. You cannot file Form 2555 or Form 2555-EZ (relating to foreign earned income.)

6. Your investment income must be $3,200 or less.

7. You must have earned income.

8. Your child must meet the relationship, age, residency, and joint return tests.

9. Your qualifying child cannot be used by more than one person to claim the EIC.

10. You cannot be a qualifying child of another person.

11. You must be at least age 25 but under age 65.

12. You cannot be the dependent of another person.

13. You cannot be a qualifying child of another person.

14. You must have lived in the United States more than half of the year.

15. Your earned income must be less than:

  • $45,060 ($50,270 for married filing jointly) if you have three or more qualifying children,

  • $41,952 ($47,162 for married filing jointly) if you have two qualifying children,

  • $36,920 ($42,130 for married filing jointly) if you have one qualifying child, or

  • $13,980 ($19,190 for married filing jointly) if you do not have a qualifying child.

1Adapted from IRS publication 596, Earned Income Tax Credit (EIC) (http://www.irs.gov/pub/irs-pdf/p596.pdf). The information in this table is based on filing taxes for the year 2012, for more up-to-date information visit the IRS website at http://www.irs.gov.

Footnotes

1.

This document is FCS7026, one of a series of the Department of Family, Youth and Community Sciences, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida. Original publication date November 1987. Latest revision May 2013. Visit the EDIS website at http://edis.ifas.ufl.edu.

2.

Originally written by Vervil Mitchell, former family economics specialist; revised by Josephine Turner, former faculty member; Michael S. Gutter, associate professor; Nayda Torres, former faculty member; and Horacio Soberon, former visiting assistant Extension scientist, Department of Family, Youth and Community Sciences; Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL 32611.


The Institute of Food and Agricultural Sciences (IFAS) is an Equal Opportunity Institution authorized to provide research, educational information and other services only to individuals and institutions that function with non-discrimination with respect to race, creed, color, religion, age, disability, sex, sexual orientation, marital status, national origin, political opinions or affiliations. For more information on obtaining other UF/IFAS Extension publications, contact your county's UF/IFAS Extension office.

U.S. Department of Agriculture, UF/IFAS Extension Service, University of Florida, IFAS, Florida A & M University Cooperative Extension Program, and Boards of County Commissioners Cooperating. Nick T. Place, dean for UF/IFAS Extension.