Income Tax Concepts
Your filed income tax return fulfills your obligation to the IRS and the State to report your income and to reconcile your tax obligation. This annual reporting is both the duty and the right of every citizen. Matters of taxation are also one of the most complex areas in which the citizen and their govenment interact on matters of money. One of the roles of the professional tax preparer is to assist the client to successfully navigate their report of money. That having been said, here are some important concepts to understand that underlie this annual reporting:
Income Tax Return – your report to the government once each year that reports your income and defines your tax obligation.
Taxable Income – is an artificial dollar amount that is computed by reducing your gross income by all allowable deductions and adjustments according to a complex series of rules and regulations, e.g. the tax code.
Tax Obligation – is based on your “taxable” income not your gross or total income.
Tax Payments – are required to pay a portion of your tax throughout the year according to the amount of your earnings, whether received as wages or through self-employment. This is called either “withholding” for earned wages, or “estimated tax payments” for self-employment income.
Tax Deductions – the government defines two kinds of deductions: (a) the standard deduction is a fixed amount the government assumes the average taxpayer spends during the course the year; and (b) the itemized deduction is an amount that is specific to a particular taxpayer, not just the average taxpayer.
Itemize – the word to know is “item - ize” which means that you must describe each dollar you spent during the course of the year, item by item, that are permitted under the current tax code.
Receipts - when you itemize, you are also required to be able to document each expense; your recordkeeping during the course of the year is very important. The best advice is to simply obtain and keep a receipt for all expenses. You can throw receipts away at the end of the year if not needed but it is much more difficult to recreate them later.
Tax Rate – your tax obligation is computed as a percentage of your taxable income with the percent varying according to the size of your taxable income. In other words – the smaller your taxable income, the smaller your percent – and the smaller your tax.
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