Combating the Bag Lady Syndrome - Part 4

Taxes are confusing, but when you already worry about being left destitute, they can seem like a black hole with numbers swirling around in the dark. One of the ways we can combat the Bag Lady Syndrome, the fear of losing everything and being left with no financial means, is to gain a better understanding of our income tax return.

In this blog, we’ll cover page 1 of Form 1040, U.S. Individual Income Tax Return, which is the most common federal tax form filed by taxpayers. Grab your most recent return or get a blank 1040 here, and let’s get started learning about where some of the numbers come from and what they mean:

Line 1, Wages, salaries, tips, etc. – This number usually comes from your Form W-2 and reflects your earnings. Keep in mind, if some of your income is deposited into some type of pre-tax account, like a 401k or Health Savings Account, the number you enter here will be lower than your actual earnings. Only your taxable earnings get reported here.

Lines 2 – 3, Tax-exempt interest, taxable interest, qualified dividends, ordinary dividends – These numbers report the earnings from your cash (bank) and investment accounts.

Lines 4 – 5, IRA distributions, pensions and annuities, and Social Security benefits – These are common for retirees. This is where they report their retirement income. If you are not retired, you won’t likely have anything reported in these boxes.

Line 6, Capital gain or loss – When you sell an investment in a non-retirement account, you realize a gain or loss, and this is where the net of all gains and losses gets reported.

Line 7, Other income and total income – This is where other types of income is reported. Examples of other types of income include, business income if you are self-employed or own a business, real estate income if you own rental properties, and farm income. At the end, you will add up all the above numbers to report your total income.

Line 8, Adjustments to income and adjusted gross income – There are a limited number of adjustments to income as well, such as some education-related expenses and retirement contributions for self-employed persons. These adjustments reduce your total income from line 7, giving you your adjusted gross income, often abbreviated as AGI. AGI is very important because that number is used to determine eligibility for things like making Roth IRA contributions and taxation of government benefits, such as Social Security and Medicare.

Line 9, Standard deduction or itemized deductions – We get to deduct the larger of the standard deduction or our itemized deductions. We complete a separate form (Schedule A) to calculate how much we have in itemized deductions – medical/dental expenses, taxes and mortgage interest we have paid, charitable donations, and a couple of others. We compare that number to the standard deduction - $12,200 for those filing single or married filing separately, $24,400 for those filing married filing jointly and $18,350 for head of household. Again, the larger of the standard deduction or itemized deductions goes in on line 9.

Line 10, Qualified business income deduction – This deduction was created in 2017 to allow some business owners to deduct up to 20% of their business income. Most people won’t have anything on this line.

Line 11, Taxable income – This is the number that determines your tax bracket and your tax rate.

In the next blog, we’ll cover page 2 of Form 1040, U.S. Individual Income Tax Return.

- Juli Erhart-Graves, CFP®, Worley Erhart-Graves Financial Advisors