Many taxpayers are starting to gather tax documents and consider their tax returns for tax year 2014. If you’re starting that process, here are ten tax issues that are often misunderstood by taxpayers. You can download all of the tax forms mentioned below at www.irs.gov.
1. Self-employed people and the personal tax return
Not every business requires a separate tax return. Check with your CPA to determine the type of business entity you operate. Many self-employed people are able to post their business profit on Schedule C of Form 1040 as part of a personal tax return.
2. Mortgage interest may not be fully deductible
Taxpayers itemize their deductions on Schedule A of Form 1040. One type of deduction is interest incurred on a home mortgage. At the bottom of Schedule A, you’ll see a line for Total Itemized Deductions. Note that your deductions may be limited, depending on your total adjusted gross income. If you are considering a new home loan, it’s important to understand your mortgage interest may not be fully deductible.
3. Alternative Minimum Tax
When you calculate the tax on your income, note that you need to perform an additional calculation for alternative minimum tax, or AMT. AMT takes your taxable income and adds certain items that are not included in your original taxable income, e.g. interest on certain types of municipal bonds is added back to income.
If the new level of income is high enough, you may need to pay tax based on the AMT income instead of your original taxable income total.
4. Marginal Tax Rate
Your marginal tax rate is not the tax you pay on all of your taxable income.
Keep in mind that nearly all taxpayers pay more than one tax rate on their income. A single person, for example, pays a tax rate of 10% on the first $9,075 of taxable income in 2014. That same single person will pay 15% on income between $9,076 and $36,900.
Your marginal tax rate is defined as the tax you pay on an additional dollar of income (www.investopedia.com). For a single person with total income of $30,000, the marginal tax rate is 15%. That’s the tax rate the individual would pay on the next $1 of income.
5. Spouses can file separate tax returns
Spouses are not required to file a joint return. However, if the spouses file separately, they will each pay tax at a higher rate. That’s because the tax rates for single people are higher than the tax tables for married couples.
6. Realized vs. recognized gains
A taxpayer must have a buy and a sell to have a realized gain. If an investor buys 100 shares of IBM common stock at $50 per share and holds it, no gain or loss is recognized until the stock is sold.
Not all realized gains and losses are recognized. A gain or loss is recognized when it is posted to a tax return. Gains and losses on investments in many retirement plans are deferred, i.e. they are taxed at a later date.
7. Tax credit vs. tax deduction
Think of a tax credit as a “gift certificate.” A credit reduces your tax liability dollar-for-dollar. If you have a $5,000 tax liability and a $500 tax credit, the credit can reduce your liability to $4,500.
A tax deduction reduces your taxable income. If you have $50,000 in income and $5,000 in tax deductions, your taxable income is $45,000. You then compute the tax liability on the $45,000.
8. Itemized deduction vs. standard deduction
Every individual tax return is allowed some sort of deduction. When you complete your tax return, you add up your potential itemized deductions on Schedule A of the Form 1040 Personal Tax Return. Itemized deductions include mortgage interest, medical expenses, and other items.
Even if your itemized deductions are very small, you are still allowed a standard deduction. For Tax Year 2014, the standard deduction for single taxpayers is $6,200
9. Tax withholdings vs. estimated payments
There are two primary ways that individuals pay their tax liabilities. Many people have taxes withheld from their paychecks throughtout the year. Your Form W-2 shows your gross pay for the year and the amount of federal taxes withheld.
Some people also make estimated tax payments during the year. If an individual believes that their tax withholdings will not pay their entire tax liability for the year, he or she can make estimated tax payments. Check with your CPA to determine if you need to make estimated tax payments.
10. Extending your filing date vs. payments
If your tax situation is more complex than normal – or if you are missing tax documents – you may need to request an extension. If the extension is approved, you can file your tax return after the normal deadline, which is April 15 for individuals.
Keep in mind, however, that your tax liability is still due on April 15. If you don’t make a payment on that due date, you may be assessed interest and penalties.
These explanations should help most individuals understand basic tax terminology and complete accurate tax returns for the 2014 Tax Year. If you have additional tax-related questions or more complex returns to file, it’s always best to check with a CPA for more information and help with your filing.
Ken Boyd is the owner of St. Louis Test Preparation, where he provides tutoring, podcasts, blogs, articles, and speaking services on accounting and finance. Ken is the author of several accounting guides, including Cost Accounting For Dummies, Accounting All-in-One For Dummies, CPA Exam For Dummies, and Accounting: 1,001 Practice Problems For Dummies.