Easy and Simple Outline of How a Refund (or Amount Owed) is Calculated on a Federal Form 1040

It’s the same thing every year, you gather up your W-2 and payment receipts, throw them at the tax preparer that probably only had a week of training, and cross your fingers that you don’t owe tax and cross your toes that you’ll get some money back – without a single clue of how these amounts are determined. Let’s end that cycle – well, at least end the ‘not having a single clue’ part of it anyway.

The summary of the Federal form 1040 are the first two pages with Lines 1 through 79, the remaining pages are worksheets to determine credits, itemize deductions, and etc. Now let’s move on to the good stuff – what goes into the Federal form 1040 that determines what the outcome will be.

How a Refund or Amount Owed on a Federal Form 1040 is Calculated – in a Mathematical Format:

Step 1: Your Income – Your Deductions = Adjusted Gross Income (AGI)

Step 2: AGI x Your Tax Rate = Tax Owed

Step 3: Tax Owed – Your Credits = New Tax Amount Owed (which could be $0)

Step 4: New Tax Amount Owed + If You Have Any Other Taxes Due = Total Tax Owed (which could still be $0)

Step 5: Total Tax Owed – Your Tax Payments Made = Amount to be refunded or tax amount you need to pay

Now that we have the format, let’s get up and personal with the key players on the Federal form 1040:

Income

After moving past your social information, your filing status and naming off your dependents, calculating your income is the first section of the form. You can learn more about taxable versus nontaxable income at the IRS’s website by clicking here.

Adjusted Gross Income

Ah, the infamous AGI (Adjusted Gross Income) – this is the IRS’s starting point when it comes to calculating your tax. Basically, your AGI is what you get when you subtract your deductions from your taxable income.

You can either itemize your deductions or take the standard deduction (which varies year to year and depends on your filing status). You can learn more about deductions at the IRS’s website by clicking here.

Contributions to deductible Individual Retirement Accounts (IRAS), higher education expenses, and health savings accounts are considered above-the-line deductions, meaning you are given this deduction in addition to your itemized or standard deductions.

Your tax rate can be found using the Tax Table printed by the IRS every year and is available on their website here.

Your Income – Your Deductions = Adjusted Gross Income (AGI)

AGI x Your Tax Rate = Tax Owed

Credits

Credits are subtracted from your tax owed. The most common credits are the education credit, child tax credit and child care expense credit (which goes goodbye the year the qualifying child turns 17). You can learn more about credits at the IRS’s website by clicking here. The Earned Income Credit isn’t used at this point, but a little further down the stream.

Tax Owed – Your Credits = New Tax Amount Owed (which could be $0)

Other Taxes

If you have to pay any other taxes (self-employment tax, penalty payment if you or your dependent didn’t have health care coverage, etc.), you will total these amounts and add them to the new tax amount owed. The amount you come up with now, is your total amount of tax owed.

New Tax Amount Owed + If You Have Any Other Taxes Due = Total Tax Owed (which could still be $0)

Payments

The finish line is in site – and here we go, add your Earned Income Credit (if you qualify) and any additional credits to all the tax payments you made this year (this includes federal tax withheld out of your paycheck which is reported on your W2, any estimated tax payments you made throughout the year, etc.) and subtract the total from your total amount of tax owed – and now you’ll know if you owe or not.

Total Tax Owed – Tax Payments = Amount to be refunded or tax you owe

Refund or Amount Owed

Total Tax Owed – Tax Payments = Amount to be refunded or tax you owe

If your above calculation results in a positive number, then you’ll have to make a payment to the IRS. If your above calculation equals zero, then you don’t owe the IRS but won’t be getting a refund either. But if your above calculation results in a negative number, you’ll be getting a refund from the IRS.

Of course, things can get more complicated but this outline is for your basic Federal form 1040 filer (i.e. an individual that has an employer, makes contributions to an IRA, and has kids that have child care fees).

So the next time you file your taxes, rather than entering a Jackson Hewitt answering questions like a robot with no idea of what the numbers they’re telling you mean, you now have a better understanding of why you will receive or owe the amount calculated (and may even point out corrections to the preparer).

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