How Do Tax Returns Work?
Tax returns are the primary way that the federal government and state governments check that they are receiving the correct amount of income tax from you. Income tax is levied on almost every person and business entity living in or operating out of the U.S.
Due to the complexities of the tax system, it’s difficult to know how much tax to apply until all the income for a year has been calculated and reported. That’s what tax returns are for: the final reporting so that the government knows who has been paying too little or too much tax relative to their income.
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What Is a Tax Return?
A tax return is the series of forms that you fill out and send to the Internal Revenue Service (IRS) during tax filing season — normally from January to April. During that time, you are expected to file taxes for the previous year. Most people need to fill out tax returns; however, not everyone does.
Certain exemptions exist for people in low-income brackets, as well as for charitable organizations. Even if you do not owe taxes to the government, it is often still a good idea to file a tax return anyway. This ensures that both you and the government have the results filed and on record.
What Is the Purpose of a Tax Return?
The documents you sign require you to disclose all forms of income to the federal government, so that the IRS can calculate how much tax you should owe, and compare it to how much you paid over the year. This comparison can result in you owing taxes or getting a tax refund.
The document is used to keep track of your legal obligations under the tax code, and the IRS will sometimes conduct an audit into the last several years of your tax returns if they find something concerning. For the most part, however, tax returns are simple. Many Americans receive tax refunds because they often overpay via automatic paycheck deductions.
The Three Sections of a Tax Return
In order to process a tax return, the IRS needs to confirm your identity. Tax fraud and identity theft protection require multiple levels of authentication, usually with your Social Security number, full name, address, and, for some e-filings, photo identification.
Once you get through the biographical information, there are three main sections of a tax return:
Income is, put as simply as possible, any kind of compensation you receive. This includes job paychecks, interest on investments and dividends, or the value of assets like physical items, property, and even cryptocurrency.
Income is divided into “taxable” and “non-taxable.” Taxable income covers most types of income, such as wages, business profits, money from renters, commissions, royalties, and investments.
Non-taxable income is income that is exempt from taxation under special circumstances. This includes disability or welfare benefits, inheritances, child support payments, and payouts after death from life insurance policies.
Most often, people will report income from an employer by filing the W-2 form that their employer sends them.
Deductions allow you to apply a credit to your income that makes a certain amount of it exempt from tax. When you’ve worked out the amount of deductions, you subtract them from your income, and whatever remains is taxable, becoming your adjusted gross income.
Everyone has the option to take a standard deduction that takes into account all the deductions that the average working American would use. This means that everyone has a certain amount of income that won’t be taxed.
Some people choose to use itemized deductions. This is the process of counting out every individual deduction and calculating them. This can be a long, complicated process and is generally only used by businesses, people who are freelancers and/or working at home, or anyone who has a reason to believe that the number of deductions they can take are greater than the standard deduction.
Itemized deductions might include utility bills for a home office, a percentage of gas mileage used for business travel, money spent on tools and supplied for business purposes — the list is long and exhaustive. It’s generally best to get the advice of a tax professional if you think you might want to itemize.
Tax credits are subtracted from the total amount of tax you owe. This is different than deductions, which modify your taxable income. Tax credits act more like refunds and are applied directly to the total amount of tax you pay.
Tax credits come in two types, refundable and non-refundable. According to the IRS:
- “A non-refundable tax credit means you get a refund only up to the amount you owe.
- A refundable tax credit means you get a refund, even if it’s more than what you owe.”
To put it simply, a non-refundable tax credit can reduce your owed tax to zero but won’t net you additional refunds. Refundable tax credits can push your owed tax below zero, meaning you would be entitled to additional refunds.
Child tax credits were recently made to be mostly refundable (up to $1,400). However, the rest of the credit above that number is non-refundable.
What to Do After Filing Your Taxes
Once you’ve completed your return, you’ll be able to calculate whether you owe the government money or whether the government owes you money. Finish the return and send it in. The IRS will either accept or reject the return.
Generally, only returns that are fraudulent or that contain mistakes will be rejected. If you owe taxes, you should send in the amount you owe with the tax return. If you are owed a tax refund, then wait for the estimated time (typically fewer than 21 days) for the IRS to issue refunds and ensure that you get your refund. If the estimated refund time passes and you don’t have your refund yet, then you can get in touch with the IRS to ask about your return.
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Ben Steele is a writer, theatre(re) professional, and nonprofit administrator. He was born in England, spent his teen and early 20s in Canada, and now lives in America. Please excuse his occasionally confused voice and the odd recalcitrant u after an o.
This post was updated November 12, 2019. It was originally published November 12, 2019.