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Pour Yourself a Drink—Wealth Club Walks You Through Your Tax Forms Wealth Club Walks You Through Your Tax Forms

In the second week of our tax tutorial, Wealth Club breaks down the basics of filing your federal income taxes.

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

Last week, we started preparing for tax time. This week, we’ll delve a little deeper by looking at the first page of the 1040, the U.S. Individual Tax Return, the document that is the backbone of filing your taxes. There exists a 1040 A (simpler) and a 1040 EZ (simplest), but for the purposes of this column, I’m going to walk through the standard 1040. Why? Anyone can use it. If you grasp the basics of the 1040, you will understand the other two versions.

It gets wonky, but you’re a grownup now. You can have one drink while you’re reading this. I suggest whiskey. Remember that the goal isn’t for you to be a tax do-it-yourselfer. It’s simply to gain an understanding of the process.

The good news is that an instruction manual exists for completing your 1040. The bad news is that it’s 189 pages. Wealth Club is here to translate the big picture. If at any point you want more detail, certainly consult the manual. If you’re confused about the manual, as always, don’t hesitate to contact the IRS tax help line for individuals at (800) 829-1040. They’re open from 7 to 7, local time.

I’m going to walk you through the moving parts of the 1040 as if you were meant to print the pdf and fill it out by hand. You probably won’t do that, as you’ll most likely be using some tax software—I recommend an electronic filing service like TurboTax, TaxACT, or H&R Block—but seeing the order of operations will be helpful when navigating these services and understanding what they’re trying to do for you.

Hopefully, you can handle your name, address and social security number. Next, you’ll be asked how you’re filing. Since misery loves company, I’m going to assume all my lovely readers will be filing as single (Happy belated Valentine’s Day) and have no children, which makes the Exemptions section easy. An exemption is given for every person, including yourself, that you are responsible for. Each exemption decreases your taxable income by $3,700 for 2011. We’ll factor these exemptions back into the equation next week; we have other work to do first. For now I’m going to break apart the 1040 into four easy-to-assemble parts, and look at the first two today.

Part 1: Finding your Income:


This section takes all the money you received in 2011 and lumps it together as your income. Hopefully you’ve gathered your W-2s, which show your wages, salaries and tips. There are also quite a few forms in the 1099 series, a collection used to report various other means of income, and most correspond with one of the lines in this section. A number of them are either self-explanatory (alimony received), probably not applicable (taxable refunds, farm income) or for an older crowd (IRA distributions, Social Security benefits)—I’m working under the assumption that if you are 65, you probably already know tax basics. Here are some highlights:

· Line 7 – Wages, salaries, tips, etc. Copied directly from Box 1 of your W-2 form. If you had more than one job and received more than one W-2, you simply add up the amounts and put the total in Box 1 of the 1040. Don’t worry about all those pre-tax items—401(k) contributions, flexible spending contributions, pre-tax medical, dental and vision—since these have already been taken into account on the W-2.

· Lines 8a & 8b – Taxable and Tax Exempt Interest. The interest earned on your standard savings accounts. Your financial institution should mail you a1099-INT form showing your earned interest. If the amount is under $1,500, you can simply write it in. If it’s over $1,500, you must provide more detail with Schedule B. Although, if this is the case, you have roughly $100,000 in savings, and your own accountant.

· Line 9a & 9b – Ordinary and Qualified Dividends. If you own stocks, either by themselves or within a mutual fund, you were probably paid some dividends, even if you never saw them because they were automatically reinvested, which is totally normal. It’s still taxable income. The 1099-DIV from your financial institution will break everything out. Just as with interest, if they total over a certain amount, you’ll have to report on the Schedule B.

· Line 12 – Business income (or loss). For those who do contract or freelance work and earned more than $600, you should receive a 1099-MISC, a form which also covers income from rent, royalty, crop insurance proceeds, and, most importantly, fishing boat proceeds. Use your 1099-MISC to fill out Schedule C.

· Line 19 – Unemployment Compensation. I hate to be the messenger on this one, but unemployment benefits are a form of income, and you have to pay taxes on them. They’re reported to you on a 1099-G, Certain Government Payments.

When you get to line 22, you’ve calculated your total income. You’re rich! Maybe. Now it’s time for the slightly more fun part—reducing your income. While that sounds depressing, it actually means you’ll be paying fewer taxes.

Part 2: Your Adjusted Gross Income, aka the amount on which you’re taxed

Just as you used W-2s and a series of 1099s to sum up your income, now you get to adjust your income downward. Don’t get this confused with your deductions—we’re not there yet. What I’m about to break down are referred to as ‘above the line’ adjustments, meaning they’re utilized before the final calculation of your AGI. These are especially advantageous because they can be taken regardless of whether you’re taking the standard deduction or itemizing (again, this is something I’ll get to next week). Furthermore, they don’t phase out for wealthier taxpayers, like many ‘below the line’ items. Here’s what you can expect:

· Line 23 – Educator expenses. If you’re a K-12 teacher, instructor, counselor, principal or aide, you can deduct up to $250 for qualified expenses.

· Line 25 – Health Savings Account deduction. You’ll know if you have an HSA, a savings account specifically for medical purposes. Contributions are not subject to federal income tax at the time of the deposit and therefore can be deducted.

· Line 26 – Moving Expenses. As long as your move is job-related, consider it the government’s way of fostering your adventurous side. To claim this, the distance between your new job and your old home must be 50 or more miles more than the distance between your old job and your old home.

· Lines 27, 28 & 29 – Self-Employment. If you’re self-employed, I suggest you read here for more information. There are very specific definitions, and it can be very involved.

· Line 30 – Penalty on Early Withdrawal of Savings. For example, you cashed out a 401(k) worth $10,000. Not only do you have to pay ordinary income tax on that $10,000, but also a 10 percent penalty (which is why you need to think very carefully before ditching an IRA). However, the penalty itself is tax deductible. The penalty is $1,000, but if you’re in the 15 percent tax bracket, you’ll essentially get $150 back by claiming this adjustment.

· Line 32 – IRA Contributions. Money you put into a traditional IRA is tax deductible. That’s not the case with Roth IRAs, which I’ve previously advocated for. The overall tax treatment of the Roth is eventually nicer, but since Traditional IRAs are funded with pre-tax dollars, you’re allowed to reduce your income by the amount you contributed to a traditional IRA.

· Line 33 – Student Loan Interest Deduction. If you paid interest on student loans in 2011, your student loan administrator (e.g. Sallie Mae) will give you 1098-E that tells you what to put here.

· Line 34 – Tuition and Fees. This can reduce your income by up to $4,000 depending on whether or not your expenses qualify. Beware, though. There are some pretty rockin’ tax credits for going to school, and you cannot take both a credit and this deduction. I’ll explain the distinction further next week, but the key is you would only take the Tuition and Fees deduction if you didn’t qualify for one of the credits.

· Line 37 – Your Adjusted Gross Income!

What a journey this has been. I hope you have a sense of the types of situations that will increase and decrease your income and get you to your AGI. We’re about halfway through the 1040. When I round out this tax trilogy next week, we’ll dissect the remainder of the 1040 and get to the finish line, where, with any luck, you’ll have both a refund to look forward to and a broad sense of how this whole damn thing works.

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