The deadline for the 2019 tax filing is fast approaching. In case you are not aware of the date, yet, it is 15 April 2020. The earlier you file your taxes, the sooner you can pay your tax liability or claim that tax refund.
We know things taxation is not as easy as we all would like. While you have the option of getting a tax accountant or a financial advisor to help you, you can also spare some few minutes of your time to estimate your income tax for the current year.
The first step to estimating your income tax for the current year is to gather all the necessary information, starting with your total taxable income. According to the IRS, the below are the common sources of taxable income:
Income from employment - this is any income you earn from employment in the form of salaries, wages, tips, fees, commission, stock options, or fringe benefits.
Your employer should provide you with Form W-2 that shows your employment payments. Employment income also includes any money earned from babysitting and child care.
Income from a partnership - partnerships are not taxable business entities. However, partners share the income, losses, credits, and deductions of a partnership amongst themselves.
In case you are in a partnership, and the company makes a profit, your share of the profit is what you report as partnership income.
Investment and business income - this is income from personal property you rent out and make money through.
Income from S Corporation - if you are a shareholder of an S Corporation, then your share of the profits will pass through your personal income filing. S Corporations do not pay income taxes.
However, the tax on the company's profits passes through the individual returns of the owners or shareholders.
Royalties - if you receive royalties from patents, copyrights, mineral properties, oil, or gas, then you need to include these as your income as they are taxable.
You will report these under Schedule E Part I of Form 1040 or 1040-SR. However, if your royalties income is from your business as a self-employed artist, writer, inventor, etc., then you will use Schedule C. Schedule C also applies to anyone who holds an operating gas, oil, or mineral interest.
Now that you know the sources of taxable income, the next step is to calculate your income tax for the year. The US uses a progressive tax system, which means that individuals with higher incomes also face higher tax rates compared to those with lower incomes.
The rates are also marginal, meaning that your income is taxed at a graduated scale and not on the total taxable income. The tax margins or ranges are referred to as tax brackets. Your tax bracket will, therefore, depend on your taxable income and your filing status.
The below table shows you the tax brackets you can use this season of 2019/2020
Example: if you are filing using the single status and your annual taxable income is $60,000, then your highest tax bracket is 39,475 - 84,2000, with a tax rate of 22%. However, your whole taxable income of 60,000 is not subject to the entire 22%. The first $9,700 is subject to 10%, and the next $29,775 is subject to the next tax rate of 12$.
The balance of $20,525 is subject to 22%. In this case, your total tax credit will be $9,058.50. Marginal tax rates only apply to the portion of your income that falls within that tax bracket.
Let's use our above example; your tax liability is $9,058.50. Quite a lot of money, but do you know that there are legal ways to reduce this liability? By utilizing allowable tax deductions and tax credits, you can reduce your tax liability. In some instances, you might even get a tax refund from the IRS.
Tax deductions allow you to reduce your taxable income, which in turn might help you get to a lower tax bracket. Let's say your Adjusted Gross Income (AGI) is 60,000, and you have qualifying deductions of $20,000, then your taxable income will be $40,000.
These deductions ultimately get you to 2 tax brackets instead of the first 3 tax brackets, thus reducing your tax liability.
You can either claim the allowable tax deductions depending on your filing status or itemize your deduction. However, you are allowed to pick the one with the higher deductions between the two.
The standard deductions you can claim for this current year are:
In case you chose to itemize your deductions, you can include the below deductions:
Also, if you do choose to itemize your deductions, be sure to have proof of these expenses in case the IRS wants to audit your tax returns.
Tax credits do not reduce your taxable income but will directly reduce your tax liability. Let's say your tax liability after factoring in deductions is $800, and you qualify for a tax credit of $300.
Then your tax liability reduces to $500. A tax credit can be refundable or non-refundable. A refundable tax credit means that you can get a refund from the IRS even when you do not have any income tax.
The most tax credits you can claim are:
Child and dependent care tax credit - it is non-refundable. You can claim up to $6,000 for 2 or more children and up to $3,000 for 1 child.
Earned income tax credit - applies to taxpayers with incomes below a particular set level. It is refundable. Taxpayers with 3 or more kids can claim up to $6,557 as a tax credit. If you have 1 or 2 children, you can claim less this amount.
Adoption credit - it is also non-refundable. The amount varies from one adoption case to the other.
American opportunity tax credit - it is partially refundable up to $2,500 per annum. It applies to expenses on tuition, enrollment fees, and school materials spent over the first 4 years of your post-secondary education.
If you were wondering how you can estimate your income tax for the current year, then you are in the right place. All you need to do is to calculate your taxable income from all your sources of income.
Once you have your AGI, itemize your deductions or use the standard deductions depending on your filing status to reduce your taxable income. Depending on your taxable income, you then calculate your income tax depending on your tax brackets to get your tax liability. Do not forget to utilize tax credits that you qualify for to reduce your tax liability for the year.