As January 2021 comes to a close Americans everywhere will be receiving W-2 Forms, 1099 forms, and others depending upon their specific financial situation and income scenarios for 2020. So, let’s do a quick overview of tax law in 2020 and how that will affect filing 2020 taxes in 2021.
Tax Basics Form 1040
Let’s begin by kicking out anyone who has unusual scenarios of income or assets. This is going to be a basic tax overview for taxpayers that get W-2 forms, or 1099 forms, or own their own small business. If your income comes from something else like royalties, or mining rights, or whatever, this will not apply to you. This is also true if a trust, or other tax situation drives your income or expenses. Frankly, people in this category probably already have accountants, attorneys, or financial managers. Let’s not clog this up with “But what if…” about situations that don’t apply to “average” scenarios.
The basic tax form is the Form 1040. Before the Republican tax law passed in 2017, the 1040 was one front and back, full size piece of paper with pretty small font. For the most basic scenarios, that form was the only thing a taxpayer needed to file. For others, a variety of Schedules were required, the results of those schedules were then added in a specific locations on the 1040 Form to compute your overall taxes. Under the new tax law, it still works that way, except the 1040 is smaller, and the schedules have changed.
Should I Itemize My Taxes
The main issue in doing taxes used to be whether or not to itemize. One of the main things the 2017 tax law did was to change the standard deduction. In exchange a lot things people were used to being deductible went away. These days, way more Americans take the standard deduction than itemize because the standard deduction is much higher than it used to be. Instead, we move through the tax Schedules and fill out the ones that apply to us.
Before we get into too much tax theory, let’s just jump in and look at the forms to figure out how to actually do taxes for real. As always, the more complicated your taxes are, the better off most taxpayers would be getting one of the major tax software packages, or using a free tax filing service like Credit Karma‘s.
Basic Taxes – What Is On Form 1040?
Form 1040 has two sides, so let’s start with the front.
Let’s jump right in.
The top part is just your name, address, and Social Security numbers. There is also the question about whether or not to contribute $3 to the Presidential Election Campaign Fund. Your taxes stay the same no matter what you check. If you don’t know what the Presidential Election Campaign Fund is, or why you want to check that box, then just leave it blank.
Next, you put your kids’ names and Social Security numbers in there. I once heard a story that the year the IRS started requiring Social Security Numbers for dependents, that millions of dependents suddenly disappeared. If you are divorce, you probably know whether you or your spouse gets to put your kids here. If not, all of your kids go here. You get a deduction, and a $2,000 Child Tax Credit for each one in 2020.
Form 1040 Taxes – Income
Alright, now it’s time to actually start doing your taxes. The first section is income.
If the only income you have is from a regular job where you are an employee (not a contractor), then this is really easy. Add up you and your spouses W-2 Forms and put the income in the box for Line 1.
Important Audit Flag: Your employer sends a copy of your W-2 directly to the IRS. The IRS computers will match the numbers on your W-2 forms to what you report on your income taxes. Do not try and alter this number.
Next up are interest and dividends. Your banks will send you a Form 1099-INT reporting the amount of interest you earned during the year. Your brokerages will send you a 1099-DIV to report any dividends you earned during the year. As you can see, you may need to file a Schedule B in some circumstances.
Line 4 is for if you took any money out of your IRA accounts. Be sure to get the right amounts in 4a versus 4b. 4a won’t be taxed, but 4b will. So, if you are taking money out of a Roth IRA and are over 59 1/2, then chances are it goes in 4a. If it is a regular IRA then chances are that some of it goes in 4b.
Line 5 is for any money received from a pension, or if you own an annuity.
Line 6 is for any Social Security income you recieved.
If you have Capital Gains from selling stocks or other assets, you will most likely need a Schedule D. The final result of the Schedule D gets reported on Line 7.
Add up all of the numbers on the right side (1, 2b, 3b, 4b, 5b, 6b, 7, and 8) and that is your total income. Note that your total income is not the same as your adjusted gross income, which you will compute in a few more lines.
Calculating Adjusted Gross Income
Now that you have your total income it is time to adjust that income with Schedule 1. The Part 1 of the form adds to your income. The Part 2 of the form deducts from your income.
Adding To Your Total Income
The most commonly used lines of Form 1 are:
- Line 1 is if you got a tax refund from a local government that hasn’t already been accounted for on your taxes. – Basically, the IRS let you deduct whatever you paid in those local taxes. But, if you got a refund then you didn’t really pay those taxes and you have to add them back in. Look for a Form 1099-GOV for what goes here.
- Line 3 is if you own your own business and compute the taxes for it on Schedule C. The number you compute on that form goes here on line 3. – One of the big deductions within Schedule C can be the home office deduction. Make sure you buy the more expensive TurboTax Home and Business or equivalent to calculate your home office deduction.
- Line 7 is if you received unemployment benefits during the year. Some of that might be taxable.
- The other lines are all for more complicated taxes than we are reviewing here.
- Add them all up and take the total from Line 9 on this Schedule 1 and put it on Line 8 of the Form 1040.
Subtracting From Your Total Income
Part II of Schedule 1 adjusts your income down.
Line 10 is if you are a teacher and use your own money to buy supplies.
Line 12 is for contributions to an HSA plan. – Keep in mind, you deduct the contributions. If, or when, you spend the money is irrelevant. You deduct the amount you contribute, not the amount you use.
Line 14 lets self-employed taxpayers deduct the employee part of self-employment taxes. It requires Schedule SE. The result of that schedule goes on line 14.
Line 19 is for if you made tax deductible contributions to an IRA.
Line 20 is where you deduct student loan interest – note you do not have to itemize to get a student loan interest deduction. Just fill the amount in on line 20.
Line 21 is for deducting tuition and fees. You have to fill out Form 8917 to calculate the eligible deductible amount.
Add this up and put the total on Line 10a of the Form 1040.
Adjusted Gross Income
Add and subtract like the form says and you’ll get a total on Line 11. This is your adjusted gross income, or AGI. This is the number typically used to determine if you are eligible for income-limited deductions or credits.
Line 12 -> Time to choose your own adventure.
Enter $24,800 if married filing jointly
Enter $12,400 if single
Fill out Schedule A to itemize your deductions.
Remember the standard deductions are higher than they used to be, so itemizing might not be for you anymore, even if you did so in the past.
For most taxpayers how to make the choice between the standard deduction and itemizing comes down to how much interest they pay on their mortgage, or if you have a high amount of deductible medical expenses. Otherwise, it is generally hard to add up the itemizable deductions to over $24,800 ($12,400).
For example, if you paid $20,000 in mortgage interest, then it might be worth looking into itemizing. On the other hand, if you only paid $10,000 in interest and have no deductible medical expenses, chances are the remaining itemizable deductions won’t add up to enough to make it worth not taking the standard deduction.
Reminder that you can only deduct the amount of medical expenses above 7.5% of your adjusted gross income (AGI) – (See above). If you have an AGI of $100,000, you can only deduct medical expenses above $7,500. So, if you have $9,000 in medical expenses, you can only deduct $1,500 of them, a far cry from the $24,800 standard deduction for married filing jointly. You cannot deduct health insurance premiums if they were paid with pre-tax dollars.
Whether you itemize or take the standard deduction, subtract it from your adjusted gross income to get your taxable income.
The Back of Form 1040
To calculate your actual tax, use the tax table, or a tax program. That number goes on Line 16.
Now, it’s time to adjust how much you owe to the IRS.
First up is Schedule 2.
The most common reasons to use Schedule 2 are:
- Self-employment tax
- If you have a nanny
- If you took money out of your IRA or other retirement accounts without being old enough
All of the things on Schedule 2 will add to your tax.
Line 19 is where you put that Child Tax Credit for those dependents you listed on the front.
Then comes Schedule 3.
The most common use for Schedule 3 is deducting child care expenses paid while you were working.
There are a few less common credits on Schedule 3 as well.
Add up the additions and subtractions from Schedule 2 and 3, add in any self-employment tax and you get Line 24. This is your total tax.
Calculating How Much You Owe the IRS
Now you subtract the amount your employer withheld for the year. This number will be on your W2, and less commonly on your 1099s.
If you qualify for the Earned Income Credit (EIC), you subtract that on line 27.
If you get the additional child tax cred, the American opportunity credit, or the Recovery rebate credit, those go on 28, 29, and 30.
If your total tax is more than the amount you withheld plus your credits, then you owe the IRS the difference.
If your total tax is less than the amount you withheld plus those credits, then you get a tax refund. Congratulations! You’re just getting your own money back, but it always seems like a win anyway.
In a surprise move for 2020, Congress sent stimulus payments to taxpayers using this account information entered here. Be sure that you put a permanent checking account here so that if there are any more stimulus payments, or whatever, they actually get to you.
Sign it and mail it, or just as likely, file it electronically. Keep your records, or scan them into your system. You are required to keep these records for three years for most purposes.
So, put this year’s records somewhere safe, and shred your records from four years ago. The rule is that you do not have to keep your records longer than three years. After that, the IRS tax courts must assume that you did have the proper records. However, if you do have the records, you are required to produce them, so keeping them longer can only hurt you.
Once you have your records secure, and your taxes filed, you’re done.
Kick back and relax. Then, start looking into planning for your 2021 taxes so you owe less than you would without tax planning next year.