The following section explains basic tax terminology, concepts and procedures currently being used by the IRS.
- State, local and foreign income taxes
- State, local and foreign real estate taxes
- State, and local personal property taxes, and
- State and local general sales taxes
State and local income taxes withheld from your wages during the year appear on your Form W-2. You can elect to deduct state and local general sales taxes instead of state and local income taxes, but you cannot deduct both. If you elect to deduct state and local general sales taxes, you can use either your actual expenses or the optional sales tax tables. The following amounts are also deductible:
- Any estimated taxes you paid to state or local governments during the year, and
- Any prior year’s state or local income tax you paid during the year.
Generally, you can take either a deduction or a tax credit for foreign income taxes imposed on you by a foreign country or a United States possession. As an employee, you can deduct mandatory contributions to state benefit funds that provide protection against loss of wages.
Deductible real estate taxes are generally any state, local, or foreign taxes on real property levied for the general public welfare. They need to be charged uniformly against all real property in the jurisdiction at a like rate. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. However, you can increase the cost basis of your property by the amount of the assessment. Local benefits taxes are deductible if they are for maintenance or repair, or interest charges related to those benefits.
If a portion of your monthly mortgage payment goes into an escrow account, and periodically the lender pays your real estate taxes out of the account to the local government, do not deduct the amount paid into the escrow account. Only deduct the amount actually paid out of the escrow account during the year to the taxing authority.
Deductible personal property taxes are those based only on the value of personal property such as a boat or car. The tax need to be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year.
Some taxes and fees you cannot deduct on Schedule A include federal income taxes, social security taxes, transfer taxes (or stamp taxes) on the sale of property, homeowner’s association fees, estate and inheritance taxes, and service charges for water, sewer, or trash collection.
Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income is not enough.
How to Figure Estimated Tax
To figure your estimated tax, you need to figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
When figuring your estimated tax for the current year, it may be helpful to use your income, deductions, and credits for prior year as a starting point. Use your prior year’s federal tax return as a guide. You can use the worksheet in Form 1040-ES to figure your estimated tax.
Payroll Taxes and Federal Income Tax
- Gross Pay is the amount the employee earns.
- Net pay, or take-home pay, is the amount the employee receives after deductions. Deductions will include Social Security taxes, Medicare taxes, and other amounts.
Employers send the withheld taxes to the taxing authorities. Employees must complete Form W-4, an Employee’s Withholding Allowance Certificate, to determine how much federal income tax to withhold.
The amount of federal income tax withholding depends on the employee’s marital status, the number of withholding allowances claimed by the employee, any additional amount the employee wants to withhold, and any exemptions from withholding that the employee claims.
Wage and Tip Income include wages, salaries, bonuses, and commissions received by employees for services performed. Tips are received as gratuities by food servers, baggage handlers, hairdressers, and others for services performed. Tips go beyond the stated amount of the bill and are given voluntarily. Employee compensation and tips may be in the form of cash, goods and services, awards, and taxable benefits.
There are two types of exemptions, personal exemptions and dependency exemptions. Each exemption reduces the income that is subject to tax by the exemption amount. The exemption amount changes every year. In 2009, the exemption amount is $3,650. In 2013 the exemption amount is $3,900. A taxpayer cannot claim an exemption for a person who can be claimed as a dependent on another tax return.
The standard deduction reduces the income that is subject to tax. The amount of the standard deduction depends on the filing status, the age of the taxpayer and spouse, whether the taxpayer or spouse is blind, and whether the taxpayer can be claimed as a dependent on another taxpayer’s return.
The child tax credit allows taxpayers to claim a tax credit of up to $1,000 per qualifying child. To claim the child tax credit, there are requirements for the qualifying child, requirements for the taxpayer and limits on the amount of credit. In order to claim the child tax credit, the taxpayer must have at least one eligible child. The tax credit for child and dependent care expenses allows taxpayers to claim a dollar for dollar credit for expenses paid for the care of children under age 13 or a disabled spouse or dependent . To claim the credit, there are requirements for the taxpayer, child or dependent. There is a limit to the amount of qualifying expenses which is a percentage of the qualifying expenses.
There are two tax credits taxpayers may claim for themselves or their dependents, for higher education, the American Opportunity Credit (previously known as the Hope Credit) and the Lifetime Learning Credit. Form 8863, Education Credits, is used to determine eligibility and figure each credit. Students receive Form 1098-T, Tuition Statement, from eligible educational institutions, which identify tuition and any related expenses paid to the educational institution, and/or reimbursements or refunds.
Taxpayers can choose the credit that will give them the lower tax; but they cannot claim both credits for the same expenses. Tax payers who are eligible to claim the American Opportunity Credit and the Lifetime Learning Credit for the same student in the same year, can choose to claim either credit, but not both.
The Earned Income Tax Credit, sometimes called EIC, is a tax credit to help you keep more of what you earned. It is a refundable federal income tax credit for low to moderate income working individuals and families. Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work.
When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. To qualify, you must meet certain requirements and file a tax return, even if you do not owe any tax or are not required to file.
A dependent may be either a “Qualifying Child” or a “Qualifying Relative.”
Qualifying child must meet the following requirements: The child must be younger than you. A child cannot be your qualifying child if he or she files a joint return, unless the return was filed only as a claim for refund. If the parents of a child can claim the child as a qualifying child but no parent claims the child, no one else can claim the child as a qualifying child unless that person’s AGI is higher than the highest AGI of any parent of the child. Your child is a qualifying child for purposes of the child tax credit only if you can and do claim an exemption for him or her.
To claim a dependency exemption for a qualifying child, all of the qualifying child dependency tests must be met: Dependent Taxpayer Test, Joint Return Test, Citizenship Test, Relationship Test, Age Test and Residency Test.
- A qualifying person is a child (such as a son, daughter, or grandchild who lived with you more than half the year and meets certain other tests)
- A relative who is your father or mother
- A relative other than your father or mother (such as a grandparent, brother, or sister who meets certain tests)
Non- Qualifying person:
- Boyfriend/Girlfriend. For example, your girlfriend lived with you all year. Even though she may be your qualifying relative if the gross income and support tests are met, she is not your qualifying person for head of household purposes because she is not related to you.
- Girlfriend’s child. The facts are the same as in the previous example except your girlfriend’s 10-year-old son also lived with you all year. He is not your qualifying child and, because he is your girlfriend’s qualifying child, he is not your qualifying relative. As a result, he is not your qualifying person for head of household purposes.
To claim a dependency exemption for a qualifying relative, the person must meet the: the Dependent Taxpayer Test, the Joint Return Test, the Citizenship Test, the Not a Qualifying Child Test, the Member of Household or Relationship Test, the Gross Income Test and the Support Test.
Interest income is the charge for the use of borrowed money. In most cases you will earn interest if you let others use your money. Your money earns interest when it is deposited in accounts in banks, savings and loans or credit unions, used to buy certificates of deposit or bonds, lent to another person or business. Interest is considered unearned income because money, not a person, is working to earn the income. Taxable Interest Income can be earned via savings and checking accounts, U.S. Savings Bonds, savings certificates (certificates of deposit or CDs) or money market certificates.
Tax-exempt Interest Income is earned from bonds issued by entities in states, cities, counties, or the District of Columbia, including port authorities, toll-road commissions, community redevelopment agencies or qualified volunteer fire departments.
Refund, Amount Due, and Record Keeping
- Taxpayers receive refunds when their total tax payments are greater than the total tax. Refunds can be received by check in the mail or by direct deposit. The IRS will keep any refunds if you owe back taxes and apply it toward your balance.
- Taxpayers must pay an amount due when the total tax is greater than their total tax payments. Payments can be made by check, money order, credit card, or direct debit (electronic filers only).
- It is important for taxpayers to keep good records in order to prepare their tax returns and support items on their tax returns.
- Electronic Tax Return Preparation and Transmission Preparation means the completion of all the forms and schedules needed to compute and report the tax.
- Returns can be prepared manually or electronically.
Self-Employment Income/Self-Employment Tax
A business is a continuous, regular activity that has income or profit as its primary purpose. Independent contractors are self-employed. Self-employed workers control the methods and means of performing services for others. In contrast, employers direct or control the work of their employees.
Self-employment profit is the result of self-employment income being greater than self-employment expenses. Self-employment profit increases the income that is subject to tax. Self-employment loss is when self-employment income is less than self-employment expenses.
Self-employment tax is similar to Social Security and Medicare taxes. The self-employment tax rate for 2014 is 15.3 percent of profit. The self-employment tax increases the total tax. One-half of the self-employment tax reduces the income that is subject to tax.
Tax Return Transmission
Transmitting your taxes is the sending of the tax return to the taxing authority. You can transmit your taxes:
- Returns can be transmitted by mail. You can find your local office inside the tax form or online here.
- Taxes can also be transmitted electronically. Electronic options include:
1. Via computer – Online, self-prepared
2. Using an Authorized IRS e-file Provider/Tax Professional. There are numerous benefits to the electronic preparation and transmission of tax returns, they key befits are the confidence that your taxes are done correctly – and the speed at which you get your refund.
The Five IRS Recognized Filing Statuses
- Married Filing a Joint Return
- Married Filing a Separate Return
- Head of Household
- Qualifying Widow(er) with Dependent Child
Some taxpayers qualify for more than one filing status. Usually, taxpayers choose the filing status with the lowest tax.