This one's for you, Dave!

This post is a general tax guide for those who don't "get" taxes--a little bit of background information to get you started.

The first set of equations shows where your taxable income comes from, and the second equation shows where your refund comes from.

Definitions

Income: all sources of earned and unearned income, such as W-2's (normal jobs), 1099-MISC (self-employment, odd jobs, business income), and interest income.

Adjustments: this is a specific set of tax breaks the IRS has made available to us. You can deduct them from your pre-tax income. Some examples: student loan interest, contributions to traditional IRA's, contribution to health savings accounts.

Adjusted Gross Income: also known as AGI, this is a number that will get repeated on several different forms on your return. Many of the tax breaks mentioned in this post are limited by your AGI.

Deductions: this is another set of tax breaks, distinct from adjustments, that get grouped together and subtracted from your AGI. The IRS allows you to either "itemize" your deductions, that is, figure out the specific amount in each category of allowed deductions and add them up, or just use the "standard deduction" (currently $5450 single and $10,900 married), so you want to use the greater of the two. Generally, the deciding factor is whether or not you have a mortgage. Examples of common deductions: medical expenses (in excess of 7.5% of AGI), state/property taxes, mortgage interest paid, charitable donations, and unreimbursed employee expenses like mileage.

Exemptions: the purpose of exemptions is to adjust taxable income to account for how many people are living on that income. You multiply $3500 by the number of taxpayers and dependents listed on the return and subtract the total from AGI as well.

Taxable income: this is the number you look up in the tax tables to figure your tax for the year.

Credits: tax credits are great--rather than subtracting credits from your taxable income, you subtract them from your tax. Most credits are limited by your tax liability, so you can't get back more than you owe. There are a couple "refundable credits," which show up on your return under the category of payments (next). Examples of credits: child/dependent care credit, education credits (for college expenses), saver's credits (for putting money away for retirement), and the child tax credit ($1000 per child).

Payments: your tax payments during the year are normally withheld by your employer from your paycheck, and they submit that money to the IRS in your behalf. Some people also make estimated tax payments quarterly during the year. (If you make estimated tax payments, you probably don't need any of this information. *wink*) Examples of refundable tax credits, shown as payments on the return: earned income credit and additional child tax credit (designed to help low-income families), and the recent "first-time homebuyer credit."