The federal income tax is one of the most complicated innovations in human history. But we’re going to try and simplify the whole enchilada with this handy federal income tax guide. Use it as a reference to help you prepare your tax return.
It’s a “high altitude look” at dozens of tax issues, just to keep you on track. You’ll need to do a deep dive to get more information if anything about your tax situation is the least bit unusual.
Do You Need to File a Tax Return?
If you don’t know if you’re required to file an income tax return, you can use the IRS Do I Need to File a Return tool. But here are the general requirements.
You are required to file if your income exceeds the following limits for 2017:
- Single, under 65 – $10,400
- Single, 65 or older – $11,950
- Married filing jointly, both spouses under 65 – $20,800
- You're Married filing jointly, one spouse 65 or older – $22,050
- Married filing jointly, both spouses 65 or older – $23,300
- Married filing separately, any age – $4,050
- Head of household, under 65 – $13,400
- Head of household, 65 or older – $14,950
- Qualifying widow(er) with dependent child, under 65 – $16,750
- Qualifying widow(er) with dependent child, 65 or older – $18,000
You will still need to file a tax return if any of the following apply:
- You have at least $400 in self-employment income
- Received unemployment income
- You owe household employment taxes
- Social Security and Medicare taxes are owed on unreported tip income
- You received a distribution from a medical savings account (MSA) or a health savings account (HSA)
- You received an advance payment on the Premium Tax Credit
- Expect to qualify for the earned income tax credit (EIC)
- You’re claiming education credits, and must file to be refunded under the American Opportunity Credit
- You want to claim a refundable Health Coverage Tax Credit
- You adopt a child, and want to claim the Adoption Tax Credit
How to Determine Your Tax Filing Status
There are five basic tax filing statuses:
Married filing jointly (MFJ): This is generally the most beneficial filing status since it offers lower tax brackets and a higher standard deduction. You’re eligible if you’re married as of December 31 of the tax year.
Married filing separately (MFS): This will usually result in a higher tax liability. But there are times when it makes sense. This can happen when one partner is self-employed and makes much less money than the other. It can also make sense if one partner has a much higher level of deductible itemized expenses. You may also want to file separately if you lived apart during the year.
Head of household (HOH): You can claim this status when you are a single taxpayer, legally separated, or when your spouse didn’t live with you during the second half of the tax year. But here is the determining factor: you must have a qualifying child or dependent, for which you paid at least half of their support.
You don’t qualify for this status if you are otherwise married, or your spouse spent even one night in the same residence with you. You may need to provide specific documentation to prove the status (separation agreement, evidence of separate residences, documentation that you provided more than half of the dependence support).
Single: This is your tax status if you are not married – or legally separated – as of December 31 of the tax year.
Qualifying Widow(er): You must have a qualifying dependent to be eligible for the status. It enables you to have the same tax benefits as if you are married filing jointly. You are only eligible for this status in the year in which your spouse died, and the following year.
DIY Tax Preparation
Millions of people are now preparing and filing their own tax returns. This is easier to do than ever since there are so many very affordable tax preparation software packages. Even if you don’t know much (or anything) about preparing taxes, most are incredibly user-friendly. All you need to do is gather your information, and put the required numbers in the boxes that appear in sequence.
TurboTax can accommodate some of the most complicated tax situations.
You don’t need experience either. The software is intuitive, and has informational resources to answer any question you have. They’re now even offering live assistance from either a CPA or an enrolled agent.
CPA vs. Enrolled Agent (EA)
If you still don’t feel comfortable preparing your own taxes, or if you’re tax situation is incredibly complicated, you can use a tax professional. The two most reliable preparers are certified public accountants (CPA) and enrolled agents (EA).
A CPA is a professionally licensed accountant who works in public accounting, and usually prepares income taxes. To get the license, you have to pass a rigorous multi-day examination, and meet certain state issued education and experience levels. CPAs are best used by people who have the most complicated tax returns.
EAs aren’t accountants (or CPAs), but they are licensed to prepare taxes, as well as represent their clients before the IRS. They generally charge lower preparation fees then CPAs.
A Checklist to be Ready to File
No matter how you decide to prepare your taxes, you’ll need to assemble all the documents needed. Having them available will make the entire preparation process much easier.
The most basic information you need to have available includes:
- Social Security numbers for each member of your household
- Complete copies of the prior year’s income tax returns (you’ll need these to provide any carryforward information)
- Income information for your dependent children
- Home office information (if you plan to take the deduction) – square footage of your office, and of your home
- Your ex-spouse’s Social Security number if you receive or pay alimony or child support
- Marketplace exemption certificate, if you received an exemption from your state’s health insurance exchange
Income documentation includes the following:
- W-2s from any employment sources
- 1099-MISC for additional income for which income taxes were not withheld (like contract income)
- 1099s reporting Social Security income, interest and dividends; pension, IRA or annuity income; state income tax refund or unemployment insurance; or reporting the sale of stock or other securities
- K-1’s reporting partnership or S-Corporation income
- W-2G reporting gambling winnings (you should also have records proving gambling expenses)
- Documentation of alimony received, including the social security number of the payee
- If you’re self-employed, a complete accounting of all your business income
- Evidence of rental income received, if you own investment property
A Documentation Checklist for Tax-deductible Expenses
Potentially tax-deductible expenses are reported on the following documents:
- 1098 reporting mortgage interest and property taxes paid, educational expenses, and student loan interest paid
- Statements from charities reporting contributions
- 1095-A, 1095-B, or 1095-C, reporting health insurance premiums paid, and to whom
- Various forms 5498 reporting IRA, HSA or ESA payments made during the year.
There are a lot of situations involving tax-deductible expenses, that are not neatly reported on a government form from third-party sources. You may need documentation for any the following expenses:
- Documentation of all self-employment expenses
- Expenses for rental property
- Documentation for the purchase of depreciable assets for business or investment activity
- Property taxes paid but not reported on Form 1098 by a lender
- Federal and state estimated tax payments made for the tax year
- Cost basis of investments sold (if the information is not provided by a broker)
- Indirect expenses related to investment activity
- Documentation of alimony paid
- Receipts from the purchase of energy efficient equipment installed in your home
- Charitable contributions made but not reported by the receiving organization
- Mileage driven for business, employment, medical or charitable activities, as well as records of payment for tolls, parking and ad valorem taxes
- Evidence of payment of health insurance, out-of-pocket medical, dental and vision expenses, medical mileage and long-term care insurance
- Childcare expenses paid, if not supplied by the provider (including the provider’s tax id number)
- Wages paid to a domestic care provider, including that provider’s tax ID number
- An itemized list of higher education expenses paid out-of-pocket, with documentation
- Moving or job hunting expenses
- Cost of preparation of last year’s income tax returns
- Sales tax paid on major purchases
Federal Income Tax Rates for 2017
Here are the federal income tax brackets for 2017. But be aware that major changes will apply to the rates for 2018.
- $0 to $9,325 – 10%
- $9,325 to $37,950 – 15%
- $37,950 to $91,900 – 25%
- $91,900 to $191,650 – 28%
- $191,650 to $416,700 – 33%
- $416,700 to $418,400 – 35%
- Over $418,400 – 39.6%
Married Filing Jointly or Qualified Widow(er):
- $0 to $18,650 – 10%
- $18,650 to $75,900 – 15%
- $75,900 to $153,100 – 25%
- $153,100 to $233,350 – 28%
- $233,350 to $416,700 – 33%
- $416,700 to $470,700 – 35%
- $Over $470,700 – 39.6%
Married Filing Separately:
- $0 to $9,325 – 10%
- $9,325 to $37,950 – 15%
- $37,950 to $76,550 – 25%
- $76,550 to $116,675 – 28%
- $116,675 to $208,350 – 33%
- $208,350 to $235,350 – 35%
- Over $35,350 – 39.6%
Heads of Household:
- $0 to $13,350 – 10%
- $13,350 to $50,800 – 15%
- $50,800 to $131,200 – 25%
- $131,200 to $212,500 – 28%
- $212,500 to $416,700 – 33%
- $416,700 to $444,550 – 35%
- Over $444,550 – 39.6%
2017 Tax Law Changes
What with the Trump reform plan working its way in, there haven’t been a large number of changes for 2017.
There has been a change in the way that medical deductions are calculated. Up until 2016, taxpayers 65 and older could deduct medical expenses that exceeded 7.5% of adjusted gross income. But for 2017, the 10% threshold applies to all age groups.
As is the case every year, mileage allowances have changed a bit since 2016. The mileage allowances for 2017 are as follows:
- Business mileage – 53.5 cents per mile
- Charitable mileage – 14 cents per mile
- Medical and moving mileage – 19 cents per mile
How to Lower Your Tax Bill This Year
For the calendar year just past (2017), your options here are limited.
There are two you can make, however, as long as you act prior to April 17:
- Make an IRA contribution, if it will be tax-deductible. You’re eligible to make this contribution right up until the tax filing deadline.
- Make a contribution to a health savings account (HSA).
For the current tax year (2018) you have a lot more options.
- Increase your tax withholding, or your estimated tax payments.
- Pay any allowable deductible expenses before the current year end (expenses that could be paid in either December or January).
- Maximize contributions to retirement plans.
- Make an IRA contribution, if it is deductible under IRS income limits.
- Purchase energy efficient equipment for your home and get a tax credit.
- Sell losing investment positions just before year-end, to offset gains.
- Purchase a hybrid or electric car. You can get a tax credit of up to $7,500.
- Take advantage of any available education tax credits.
Tax Deductions and Credits
The personal exemption is $4,050 per person for 2017. The standard deductions for the 2017 tax year are as follows:
- Married filing jointly and surviving spouses – $12,700
- Heads of household – $9,350
- Single, or married filing separately – $6,350
You can itemize your deductions if they exceed the limits above.
Itemized deductions include medical expenses (in excess of 10% of your AGI), taxes (state, local, real estate and sales taxes), mortgage interest, charitable donations, and certain expenses related to your job.
In addition to standard deductions and itemized deductions, the IRS has dozens of credits that directly reduce your tax liability.
Some of the more popular tax credits include:
Earned income tax credit (EIC). This credit is generally available for low income taxpayers. It’s based on adjusted gross income, earned income and investment income.
American Opportunity Tax credit. You’re eligible for a credit of up to $2,500 for the cost of qualified tuition and course materials. You must be enrolled at least half-time, and meet income guidelines to qualify.
Child and Dependent Care credit. This credit applies to dependents under age 13. It’s also available for the care of a spouse or dependent of any age who is incapable of taking care of themselves. It provides a credit of up to 35% of the qualifying expenses, based on adjusted gross income.
Savers Tax credit. This credit applies if you make contributions to a retirement plan. The credit can be as high as $1,000 for single filers, and $2,000 if you’re married filing jointly. The income thresholds are fairly low, but it’s worth applying for if you make a retirement contribution and you have a moderate income.
Paying Taxes on Earned Income
If you’re paid by salary, taxes will be withheld and paid to the IRS for you.
But if you’re self-employed, or a contractor, you’ll need to set up estimated tax payments.
To do that, you’ll first have to make a reasonable estimate of the income you expect to receive during the course of the year. You will also have to make a good estimate of the expenses incurred to produce that income. You will then have to calculate your income tax liability based on your net profit.
You’ll also have to pay self-employment tax, which is the self-employed equivalent of the FICA tax. It’s equal to 15.3% of your net profit. That’s in addition to federal income tax.
Estimated taxes are due on four dates each year:
- April 15
- June 15
- September 15
- January 15 of the following year
You can make the payments either by completing form IRS 1040-ES, Estimated Tax and mailing it with a check to the United States Treasury, or by making your payment online from your bank account through IRS Direct Pay.
Paying Federal Income Tax on Retirement or Bonus Income
What can you do if you receive bonus, one large enough to impact your tax situation? Or, how do you handle the tax liability on retirement income?
You can avoid the tax liability at filing time by making additional tax payments.
There are three ways that you can do this:
- If the bonus comes early in the year, contact your payroll department and have your withholding tax increased.
- If it occurs later in the year, make estimated tax payment directly to the IRS. Using IRS Direct Pay you can make a payment using a credit card or directly from your bank account.
- Ask your retirement plan trustee to withhold income taxes on your distributions, similar to federal withholding on your payroll.
How to Pay Your Taxes Online (with a Credit Card)
You can pay your taxes online directly to the IRS, using either a credit or debit card. There is a small fee, of $2 to $2.59 if you pay by debit card, and just under 2% of the amount paid if you use a credit card.
More from GFC, Below
You can use online payments to pay your remaining tax bill, your estimated taxes, or any other tax that’s due to the IRS.
How to Get Your Tax Refund As Soon As Possible
So if you’re in a hurry, e-file.
To get the refund even quicker, set up direct deposit. You can do that on page 2 of your tax return. It will enable the IRS to get your refund in your bank account, without the delay caused by mailing a check.
You’ll probably want to avoid instant tax refund offers. This is where tax preparers offer to provide your refund upon the completion of your return.
But it’s actually what’s known as a refund anticipation loan, not the actual receipt of your refund. You will pay interest and fees on the loan, which will reduce the size of your refund. Exactly how much depends on the tax preparer.
What Out for Income Tax Refund Fraud!
Tax refund fraud is one of the fastest-growing forms of identity theft.
A thief steals your identity, then uses it to file a bogus tax return with the IRS. The return includes a very generous refund, which is paid to the thief. The thief files the return early in the year, before you have a chance to do so. The refund is sent directly to the thief.
Once the fraud occurs, you’re prevented from filing your tax return. You’re notified that it’s already been filed.
It’s a messy situation, but fortunately it can be resolved cleanly. The IRS is aware of the problem, and works with taxpayers to get it resolved.
You need to file IRS form 14039, Identity Theft Affidavit, and attach any necessary documentation. You may be asked to supply your state issued ID card or driver’s license.
The process can take up to six months, but once it’s completed, your tax situation will be corrected. That will include the proper tax refund or liability, based on your actual return.
Tax Deductions and Credits for Small Business Owners
Generally speaking, any expense that’s used in the production of self-employment income is tax-deductible.
The most typical self-employed business expense deductions include:
- The cost of inventory sold
- Expenses connected with the rent, ownership and operating of business property
- Business use of your home, if any
- The costs and expenses for vehicles purchased by and for your business
- Costs and expenses of equipment purchased for your business (Note: you can deduct up to $1 million paid for business equipment under Section 179 depreciation in the year of purchase
- Expenses related to the business use of a personal vehicle
- Sales, marketing and advertising costs
- Legal and professional fees
- Business related education costs
- Start-up costs (usually amortized or depreciated over several years)
- Business insurance premiums paid
- Interest on business-related loans
- Travel expenses for business purposes
- Meals and entertainment (subject to a 50% limit)
- Phones and Internet usage
- Postage and delivery costs
- Miscellaneous office and business expenses
- Contributions to self-employed retirement plans – IRA, Solo 401(k), SEP or SIMPLE IRA
Keep accurate records of all business-related expenses throughout the year, so that you can take advantage of any that apply to you.
If you have children, you’ll want to check out the 529 College Savings Plan.
There’s no immediate tax benefit to you as the contributor to the plan. But it does allow for tax-deferred accumulation of investment earnings that will enable you to save for your childrens’ college educations.
You invest money primarily in mutual funds, and the funds can be withdrawn tax-free when taken for qualified education expenses. In this way, you get an important tax break on the back end, when the funds are withdrawn.
529 plans are administered by each individual state. Check and see the details of the plan available in your state.
Tax Deductible Medical Expenses
There are two ways that you can deduct medical expenses:
By itemized deduction. If you itemize your deductions, you can write off medical expenses. But there is a catch – they are only deductible to the extent that they exceed 10% of your adjusted gross income (AGI). If your AGI is $100,000, then you will only be able to deduct medical expenses to the degree that they exceed $10,000.
Medical expenses can include:
- Premiums paid for health insurance (not as part of an employer-sponsored plan), including Medicare premiums***
- Out-of-pocket costs for medical, dental and vision
- Uncovered medical expenses
- Prescription drugs not covered by insurance
- Medically necessary travel expenses
- Medical mileage
- Deductibles and copayments
- Premiums paid for long-term care insurance
Paying through a Heath Savings Account (HSA). You can set up an HSA either through your employer, or on your own through a bank. By paying medical expenses (not including insurance premiums) through the account, you can deduct up to $3,450 if you’re single, and up to $6,900 if you’re married filing jointly. You don’t need to itemize your deductions to take advantage of this program.
Tax Deductions for Charitable Deductions Including Clothing
You can deduct charitable contributions, but only if you itemize your deductions.
Cash donations are easy enough to prove. You’ll typically get a statement from the charity acknowledging how much you’ve contributed throughout the year. If not, you can use copies of canceled checks or other written evidence of your contributions.
Less certain is donations of items, like clothing.
It’s common for people to give clothing donations to organizations like Goodwill and the American Kidney Association. When you do, you can estimate the value of the items given, unless the organization provides you with some sort of written evidence.
You can list the items donated, and use different estimates of value.
One of the most common is what is referred to as Thrift Shop Value. You can do this on items totaling up to $500. If the value is higher than $500, you’ll need to file IRS Form 8283, Noncash Charitable Contributions.
How to Avoid a Tax Audit (And What to Do If You Are Audited)
Your chance of being audited is relatively small, especially if you have a relatively ordinary tax situation. But the likelihood increases if you are high income, self-employed, have unusual income sources, or take very large deductions.
In most audits, the IRS is looking for a specific piece of information.
For example, they may request that you document a certain expense category you have taken. This usually involves supplying information by mail. You should cooperate fully, by providing all information requested in a timely fashion.
The more detailed face-to-face audit occurs in one of two situations:
- You’ve understated your income, and/or
- You’ve overstated your expenses.
You can avoid the first problem by accurately reporting all income. In the second case, make sure that your deductions are reasonable. Outsized expenses are one of the major triggers for audits.
For example, if you claim business travel equal to 60% of your income, you’re inviting an audit. If your business consistently loses money – or earns very little – that’s another red flag. A large deduction for business use of the home is still another factor.
Be sure that you document all expenses, and that they are reasonable in comparison to the income they are producing.
If your tax returns are prepared by a CPA or an enrolled agent, either can represent you before the IRS.
If you use a tax software preparation program, you can often purchase some form of audit defense to provide assistance in an audit.
IRS Gifting Rules
A major area of confusion with gift taxes is who pays it?
It would seem logical that the recipient of the gift pays the tax, but that’s not how it works. Under IRS regulations, it’s the giver of the gift who pays the tax.
Generally speaking, the gift tax comes into the picture only when you are transferring money to someone other than your spouse. It often does apply when you’re transferring money to your children.
Most people won’t be affected by the gift tax, which is also closely tied to the estate tax. For example, for 2017, taxpayers have a lifetime exclusion of $5.49 million ($5.6 million for 2018). The tax is only applicable on amounts that exceed that limit.
For 2017, you can gift up to $14,000 without incurring the gift tax ($15,000 for 2018).
If you exceed that amount in any given year, you can apply the gift as a reduction of your lifetime exclusion. This can be done by filing IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, which will apply the excess against your lifetime exclusion.
Understanding Estate/Inheritance Tax and Inherited IRA Rules
Estate tax – a.k.a., inheritance tax – is closely tied to gift taxes (gifts are essentially an advance on an inheritance). Much like the gift tax, they don’t apply to money inherited by your spouse, but can apply to your children. Once again, they are due only on estates with a value of more than $5.6 million (for 2018).
The estate tax – sometimes known as the death tax – can be as high as 40% of the estate transferred, beyond the lifetime exclusion. But again, because of the exclusion it won’t apply to most people.
Inherited IRAs. There are special rules for these accounts. When a spouse inherits an IRA, it’s subject to required minimum distributions (RMD) after age 70 ½. But if an IRA is inherited by children or grandchildren, the rules are different.
You’ll have to begin taking IRA distributions in one of the following two ways:
- Taking distributions over five years, sufficient to empty the account, or
- Taking annual distributions, determined by the beneficiary’s life expectancy.
The second method will preserve the account for the beneficiary’s lifetime, and enable continued accumulation of tax-deferred investment income.
Should You Do a Charitable Remainder Trust?
This is a type of trust that you set up to provide you with a reliable stream of income for the rest of your life.
It’s also an irrevocable trust, which means that once it’s established it cannot be revoked!
A charitable remainder trust (CRT) has certain tax advantages. The income that it generates is not subject to income tax unless it has unrelated business income. You can transfer appreciated assets into the trust where they can be liquidated. No capital gains tax will apply. Funds will become taxable only when they are distributed to you in accordance with the payout plan set up for the trust.
A CRT can also be a benefit if you have a large estate that may be subject to estate tax. The transferred funds reduce your estate, and thereby the tax that may apply upon your death.
CRTs are complex legal arrangements, that will require the services of an attorney.
What to Do with Unfiled Tax Returns and Back Taxes Owed
Let’s start with unfiled tax returns.
You will need to gather any documents that you need, just as you would for preparing your current your return. Any documents you do not have – maybe due to the passage of time – you may be able to obtain from the IRS. This can include W-2s and 1099s that have been provided to the IRS by employers and vendors.
You should prepare and file each return individually, assuming you need to file for more than one year.
It may turn out that you have a refund coming. But you may also owe taxes.
If you do, you should make payment as soon as possible. The IRS will assess penalties and interest that will be billed at a later date.
If you can’t pay the tax liability due, there are two ways to handle the situation:
- Make an Offer in Compromise. The IRS may agree to accept a lower amount, if you qualify for a hardship.
- Set up an installment agreement. You can arrange to pay your tax liability over as long as 72 months. It won’t make the debt go away, but it will give you an extended time to pay, with an affordable monthly payment.
Custodial Accounts for Minors – UGMAs and UTMAs
Many parents want to create savings and investments for their children. But minors are not legally capable of owning accounts.
The workaround for this limitation is to set up an account under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). With one of these accounts, you act as custodian, then the account transfers to your child once they reach the age of majority.
You can set up one of these accounts in all types of financial institutions, including banks and brokerage firms. There is no ceiling on how much you can contribute, but most parents limit contributions to $15,000 to avoid the gift tax.
Income earned within a UGMA/UTMA account can be subject to the “kiddie tax”. It works like this:
- First $1,050 earned in the account – no tax due
- Next $1,050 earned – income taxed at the child’s rate
- Over $2,100 – income taxed at parent’s tax rate
If the income is over $2,100, and the parents are in the 25% tax bracket, then that’s the tax rate that will apply.
How Starting a Business Can Lower Next Year’s Tax Bill
Starting a business this year can lower your tax bill when you file next spring. It’s because businesses have certain tax advantages that are not available to salaried workers.
There are several ways this is possible:
- You can deduct from your income any expenses incurred to produce that income.
- Self-employed retirement plans are more generous than those typically available for salaried workers.
- Net Operating Loss Carryforward – Most businesses sustain a loss in the first year of operation. But that loss can be carried forward to future tax years, reducing future tax liabilities.
- Tax deductible health insurance premiums. If you’re self-employed, you can deduct the cost of health insurance without needing to itemize your deductions. You can also set up an HSA to pay for out-of-pocket medical costs, and also get a tax deduction.
- Depreciation and amortization. Business equipment purchased can be depreciated over several years. Organization costs can be amortized in the same way. This will give you “paper losses” for tax purposes for several years going forward.
How Does Consumer Debt Affect Your Taxes?
There’s a little-known wrinkle in the tax code when it comes to consumer debt. No, it’s not that the interest on consumer debt is tax-deductible. It generally isn’t. This has to do with unpaid consumer debt.
For example, if you fail to pay a $10,000 credit card debt, the full amount of the debt is considered taxable income. If you pay only $4,000 of the debt, and default on the remainder, then $6,000 is considered taxable income to you.
The debtor can issue IRS Form 1099-C, Cancellation of Debt. You will have to report the amount on your tax return, where it will be taxed as ordinary income.
If the canceled debt is $10,000, and you’re in a 15% tax bracket, you will owe $1,500 in additional income tax.
This guide should cover all the basics of preparing your tax return, as well as introduce you to some of the more complex issues. Use it as a guide to get started, then get as much information as you need wherever necessary.
If you’re using a paid preparer, or a tax preparation software package, most of this will be handled for you automatically.
But it will help to know everything that applies to your tax situation, that way you will be fully prepared with any information or documentation necessary.