Walking through Form 1040 from the first line to the refund

Every American household knows the scene. It is the evening before the deadline, and somewhere in the house there is a shoebox, a folder, or a pile on the dining table that holds a year of envelopes. Someone is looking for the one form that has not come. Someone else is saying that the whole system was designed to make ordinary people feel stupid. I have some sympathy for that view. The 16th Amendment, ratified in 1913, gave Congress the power to tax incomes without apportioning the tax among the states, and a century of Congresses have been adding to the result ever since.

But here is the thing I want you to hold onto. Form 1040 is not a trap. It is a sequence of about ten decisions, taken in a fixed order, and each one has a reason. Once you know the order and the reason, the form stops being a wall and becomes a staircase. This post walks the staircase. I will tell you what each step is, what to expect, and where to find the numbers that change from year to year, because I will not quote a threshold that may be out of date by the time you read it. When I say "check the instructions," I mean the Instructions for Form 1040 on IRS.gov for your tax year, which have a chart or a table for every one of those numbers.

Before you start: gather the paper

You cannot walk the staircase blindfolded. Put these in a pile first.

1. Social Security numbers (or taxpayer identification numbers) for you, your spouse and every dependent, spelled the way the Social Security Administration has them.
2. Form W-2 from every employer. Box 1 is your taxable wages, and Box 2 is the federal income tax your employer withheld.
3. Forms 1099 for everything else: 1099-NEC for contract work, 1099-INT for bank interest, 1099-DIV for dividends, 1099-B for stock sales, 1099-G for unemployment, 1099-R for retirement distributions, and others. A form is not required for you to owe tax on income, so keep your own records too.
4. Deduction and credit paperwork: mortgage interest statements (Form 1098), property tax bills, charity receipts, childcare provider details, tuition statements (Form 1098-T), and any health-coverage forms.
5. Last year's return. It shows your starting point and your adjusted gross income, which some filing software asks for to verify your identity.

Steps 1 to 3: who you are and what you earned

Step 1: choose your filing status

The first real decision on the form is your filing status. There are five: single, married filing jointly, married filing separately, head of household, and qualifying surviving spouse. Your status decides which brackets and which standard deduction apply, so it sits underneath everything else.

What to expect: for most married couples, filing jointly is the better result, because the brackets and the standard deduction are wider. Married filing separately is a narrow choice for special circumstances. Head of household is for an unmarried person who pays more than half the cost of keeping up a home for a qualifying child or relative, and it comes with a larger standard deduction than single. Your status is based on your situation on the last day of the tax year. The instructions have a flowchart.

Step 2: list your dependents

Next the form asks for dependents. Each qualifying child or relative you list can bring a credit, a different filing status, or both. The rules are about age, residence, relationship and support, and they are specific. A child who qualifies for the child tax credit must meet the age test and have a Social Security number valid for work. The instructions walk through each test in order. If you are divorced, the custodial parent generally claims the child unless a signed release says otherwise.

Step 3: report your income

Now the form asks what you earned. Add up, from each source:

• Wages, salaries and tips from your W-2s.
• Interest and dividends from your 1099-INT and 1099-DIV. Some of the dividends are "qualified" and are taxed at the lower capital gains rates.
• Business or freelance income, reported on Schedule C, where you subtract your business expenses to get net profit.
• Capital gains and losses from selling stocks or property, reported on Schedule D and Form 8949.
• Unemployment compensation, taxable at the federal level.
• Retirement distributions and Social Security benefits, of which some portion may be taxable depending on your total income. The instructions have a worksheet.

The sum is your total income. Hold on to that phrase, because the next step starts from it.

What to expect: this is where most missing-form mistakes happen. If a 1099 never arrives, the income is still reportable. Match every W-2 and 1099 you receive against the totals. The IRS gets copies of these forms and its computers will notice a mismatch.

Steps 4 to 6: from income to taxable income

Step 4: take the adjustments to find adjusted gross income

From total income you subtract certain items called adjustments to income, which are often described as "above-the-line" deductions. They are listed on Schedule 1 and include things such as the deduction for contributions to a traditional IRA (within limits), contributions to a health savings account, the deduction for student loan interest (within limits), educator expenses, and one-half of your self-employment tax if you work for yourself.

The result is adjusted gross income, or AGI. Of all the numbers on the form, this is the one to know. Many later limits, phase-outs and thresholds are based on it. A lot of credits and deductions shrink or vanish as AGI rises. Memorize the formula:

Total income minus adjustments equals AGI.

Step 5: pick the standard deduction or itemize

Now comes a choice: subtract a flat amount, the standard deduction, or add up your actual deductible expenses on Schedule A and subtract that total instead. You take whichever is larger. You cannot take both.

• The standard deduction depends on your filing status and, for some people, on being 65 or older or blind. The amount is adjusted for inflation each year, so look it up in the Instructions for Form 1040, which has a standard deduction chart.
• Itemized deductions on Schedule A include state and local taxes (up to a statutory cap), mortgage interest, charitable gifts, and medical expenses above a percentage of your AGI that the instructions state. If those add up to more than your standard deduction, itemize.

What to expect: since the 2017 law raised the standard deduction, fewer households itemize. The details are in five changes in the 2017 tax law that reached the kitchen table. If you give a lot to your church or charity, Does your giving change your tax bill? A worksheet for church families shows how to test whether itemizing helps. The difference between a deduction and a credit trips up more people than anything else on the form, and four families, one tax change, and how a deduction differs from a credit explains it in plain terms.

There may also be a deduction for qualified business income under section 199A if you own a pass-through business. The instructions and Form 8995 have the rules.

Step 6: arrive at taxable income

This is the arithmetic that matters most:

AGI minus the standard (or itemized) deduction, minus any qualified business income deduction, equals taxable income.

If the result is below zero, your taxable income is zero. Taxable income is the amount on which the tax is actually computed.

Steps 7 to 9: tax, credits and payments

Step 7: compute the tax

Now you find the tax on that taxable income. There are three routes, and the instructions tell you which applies.

1. The Tax Table. For taxable income below a threshold (the instructions state it), you look up your income range and your filing status and read off the tax.
2. The Tax Computation Worksheet. For higher taxable income, you use the rate schedule: apply each bracket's percentage to the slice of income inside it. Remember that the brackets are marginal. Only the dollars above a line are taxed at the higher rate. Going into a higher bracket does not tax your whole income at the new rate, and that is the single most common misunderstanding about taxes. Read seven tax myths that scare working families and cost them money if you want to put that one to rest.
3. The Qualified Dividends and Capital Gain Tax Worksheet. If you have long-term capital gains or qualified dividends, a worksheet taxes those at their special rates and the rest at ordinary rates.

Tax software does all of this for you. But if you ever do it by hand, the logic is just the bracket table applied slice by slice.

Step 8: add other taxes, subtract credits

Some taxes are added on a separate schedule (Schedule 2): self-employment tax if you work for yourself, additional Medicare tax for high earners, and a few others. Then come the credits, which subtract directly from the tax.

The difference matters:

• Nonrefundable credits can reduce your tax to zero, but no lower. Examples include the credit for child and dependent care expenses and the credit for other dependents.
• Refundable credits can produce a refund even if you owe nothing. The earned income credit is the best known, and the child tax credit has a refundable portion. The instructions state each credit's amount, income limits and rules for the year.

For the history of the child credit, which many families use, see the child tax credit from $400 to $2,000, told bill by bill. Credits are dollar-for-dollar, so a $1,000 credit is worth $1,000 of tax regardless of your bracket. A $1,000 deduction is worth only your bracket's percentage of $1,000.

Step 9: count what you have already paid

Now the form asks what you have already paid toward the year's tax. Add up:

• Federal income tax withheld from your W-2s (Box 2) and from any 1099 that shows withholding.
• Estimated tax payments you made during the year, which people with business, investment or other income not subject to withholding must make quarterly.
• Refundable credits from the previous step.

The total is your payments and credits. For the other side of this, how withholding is figured line by line, see a paycheck worksheet that shows where every dollar of your pay goes.

Step 10: the refund or the balance due

The last arithmetic is one subtraction:

Total payments minus total tax equals your refund (if positive) or the amount you owe (if negative).

A worked example, with invented numbers so that you can see the flow. All of these are made up to show the method; your thresholds come from your year's instructions.

• Wages from your W-2: $52,000. Total income: $52,000.
• Adjustment: a $1,000 health savings account contribution. AGI: $52,000 minus $1,000 is $51,000.
• Assume a standard deduction of $14,000 (an invented round number). Taxable income: $51,000 minus $14,000 is $37,000.
• Assume the Tax Table gives $4,300 on $37,000 (invented). No credits. Total tax: $4,300.
• Federal tax withheld per W-2 Box 2: $5,200. Payments: $5,200.
• Refund: $5,200 minus $4,300 is $900.

If you are owed a refund, you can direct deposit it by giving your bank's routing and account numbers on the return. If you owe, you can pay electronically through IRS Direct Pay or with a payment plan, but the due date is the same as the filing date. A refund like this, by the way, signals that you let the government hold your money all year; your big tax refund is a loan you made to the government for free explains why you might want to change your W-4.

After the numbers: sign, file and keep

• Sign the return. If you file jointly, both spouses sign. If someone else prepares it for pay, the preparer must sign and include a preparer tax identification number.
• File by the deadline. The deadline is generally April 15, or the next business day if it falls on a weekend or holiday. An extension (Form 4868) gives you more time to file, not more time to pay. Pay what you estimate you owe by the original due date to avoid penalties and interest.
• Keep your records. The IRS generally has three years from the date you file to assess additional tax, and six years if you leave out more than 25 percent of your gross income. Keep the return and the supporting paperwork at least that long. If you have property, keep the records of its cost for as long as you own it plus the period of limitation after you sell.
• If you disagree with the IRS, you have rights. You can respond to a notice, request an audit reconsideration, or appeal. Look up the Taxpayer Bill of Rights on IRS.gov.

The bottom line

• Form 1040 is ten decisions in a fixed order: filing status, dependents, income, adjustments, deduction, taxable income, tax, credits, payments, and the refund or balance due.
• Memorize two formulas: total income minus adjustments is AGI, and AGI minus deductions is taxable income. Everything else hangs from those.
• Never trust a threshold you read in a blog post, including this one. Open the Instructions for Form 1040 for your year on IRS.gov and read the chart for your filing status.
• Keep your return and your records for at least three years, and file for an extension on time if you need one, but pay what you owe by the deadline anyway.
• Then do something about the system: write to your member of Congress through our members page and ask for a simpler code.