Refund or Bust: The Conclusion of Wealth Club's Tax Guide

The final installment of our tax filing trilogy takes you right down to the refund wire.

In our financial advice column for the centsless, Michael Fleck fields questions on how to get your money right.

Refill that drink, it’s time for part three of our tax tutorial. Two weeks ago, we laid the groundwork. Last week, we started working through the tax filing process by examining the 1040, the main tax form for individual filers. Today, we’re going to go through the second half of your 1040—deductions and credits—to figure out what you owe the government, or what the government owes you.

Remember, we’re starting with your adjusted gross income, which determines whether you qualify for certain tax credits. It’s also used outside of the world of taxation—on your FAFSA, for example, when you apply for educational financial aid. Just like last week, we’re going to go through the 1040 line-by-line so you can see what’s happening below the surface, but for a simple return, check out online tax services at TurboTax, TaxACT, or H&R Block.

Taxes and Credits

· Line 40 – Deductions allow you to reduce the amount of money that is taxed based on how you spent your money in 2011—the government, to create incentives or avoid penalizing people, doesn’t tax income spent in certain ways. You get to choose to take either the standard deduction of $5,800 or to itemize a list of specific deductions on a form called Schedule A. The only time someone would itemize their deductions is when they can amass more than $5,800 by doing so. The standard deduction is the government’s way of making your life a little bit easier by not making you itemize. A back-of-the-envelope rule of thumb is that once you own a home, you’ll be able to exceed $5,800, as mortgage interest and property tax are deductible. State income tax that you paid last year is also deductible. Theft losses, charitable donations, and large medical expenses can also be itemized as deductions.

· Line 42 – Remember last week, when you had to indicate how many exemptions you were taking—that is, how many people, including yourself, you’re filing taxes for? Well, for each one you took, subtract another $3,700. The result is your taxable income, not to be confused with adjusted gross income.

· Line 44 – This is the scariest part. You consult the tax table (see above) and find how much your tax liability is for 2011. I won’t go into the calculation, which can be found here. One common misconception I want to point out is that tax brackets reflect marginal tax rates. Going one dollar into a higher tax bracket does not mean all your income gets taxed at the higher rate; only what crosses the threshold. That is, everyone’s first $8,500 is taxed at the same rate, 10 percent. The next $26,000 is taxed at 15 percent for everyone, as so on.

· Line 45 – Alternative Minimum Tax. Each year, you’re required to pay whatever is lower, the amount of tax calculated on Line 44 or the AMT, a virtually flat tax rate on all income intended to make sure wealthy people who take advantage of many different tax breaks still pay their fair share. It shouldn’t affect anyone making only five figures. The AMT has become controversial as more "middle-class" households are affected by the tax because it is not been linked to inflation, making its threshold creep steadily lower.

· Lines 47-53 – Let it rain tax credits! We have credits for children. A couple for going back to school. One if you’re kind of poor, but still saved for retirement. This is a fairly straightforward guide to the major tax credits. Some of them will be accounted for here, some in the next section. Either way, the result of the tax credit, as compared to a deduction, is the same: Less tax is owed. However, deductions are less valuable, as they merely decrease your taxable income, whereas a credit is dollar-for-dollar offset towards the amount you owe.

· Lines 56-60 fall under the category of other taxes, as if we are really interested doing any more math.

· Lines 61 – Total tax.


· Line 62 – This shows the amount of tax that was withheld from all of your paychecks from all of your employers over the course of 2011. This is key in figuring out whether you receive of a refund (withholdings > tax liability) or get a tax bill (withholdings < tax liability). You see now why it’s not a terrible idea to have money withheld from your paycheck; otherwise, you’d be stuck with the full bill in April.

· Line 63 – Payments already made toward 2011 taxes. If you were owed a refund in 2010, you had the option to apply it to your 2011 tax liability. I’ve never done this, and don’t particularly recommend it. I suppose if you knew you were going to be receiving a large chunk of taxable income this year, and nothing was going to be withheld from this chunk, you could apply some of your 2011 refund to soften the blow next year. But honestly, take the honey.

· Line 64 – Earned Income Credit. A tax credit for especially low-income earners. Your chosen tax preparation software will be able to calculate whether or not you can receive this. The credit is refundable, meaning if you owe $500 in taxes, and earn a credit of $750, $250 can actually be paid back to you in cash. Many tax credits work this way, and it’s one of the main reasons you should file a tax return even if you did not make a lot of money. You may be able to claim enough credits to be owed a refund.

· Lines 65-67 – More of those tax credits for additional children, more education and first-time home buyers.

· Line 68 – If for whatever reason you filed for an extension, and at that time paid some money towards your eventual tax liability, it would be entered here. I’m guessing this doesn’t apply to most of you.

· Line 72 – Total payments.

Refund or What You Owe

The very last step requires comparing your Total Tax (Line 61) to your Total Payments (Line 72). If you overpaid, probably due to the taxes your employer withheld, you’re due a refund, and you can elect to have the money returned to you or apply it to you 2012 tax bill. If you owe, you‘ll have to cut a check to the United States Treasury for the difference. Hopefully this amount isn’t too high. If it is, and you’re hoping not to get stuck with a similar tax bill in 2012, now’s the time to request that new W-4 from your employer, and raise your exemptions.

You’ve pressed the final e-file button, and it’s now a waiting game. You wait for confirmation that the IRS has accepted your federal return. Save a copy of your return, and shut it down. Wealth Club Rule: Do not go back to not thinking about taxes for 11 months. You don’t need a running total of your tax liability, but you should know how weighty life decisions such as buying a house, having a child, going back to school, dealing with practically any type of investment, will affect your tax liability the following year. You may be surprised to find out what could be awaiting you on or before April 15th—for 2011, you actually have until April 18th to file. Thanks, Abe!

Congratulations if you were able to get through all three installments. Let me take this opportunity to express my frustration that specialized degrees and/or years of training are necessary if you want any hope in understanding the full tax code. I suppose that’s what tax accountants and lawyers are for, but c’mon, I find it hard to believe that it can’t be slightly more user-friendly. Top White House economist Austan Goolsbee once proposed an automatic tax payment program that would apply to 40 percent of Americans and save $2 billion a year in tax preparation fees, plius many people’s sanity. With any luck, policymakers will start listening to such advice and let ordinary Americans focus on working and earning money, not deciphering the IRS Rubik’s cube.

Don’t hesitate to shoot an email to with any obscure tax questions, or really about anything affecting your wallet. I can’t guarantee that I’ll be able to find a perfect answer, but I’ll always do my best to point you in the right direction.

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