What are the Main Components?

The United States has a progressive income tax. This means higher income is taxed at higher rates. Lower incomes are taxed at a lower rate.

Income levels are organized into ranges called brackets. Income falling within a specific range (bracket) is taxed at the rate for that bracket.

Click the image on the right to see federal income tax brackets for 2019 (for tax reports due in April 2020). You can also find the link here.

What are Tax Deductions?

The government has determined that certain expenditures should not be taxed, so it allows taxpayers to remove those expenses from their taxable income.

Examples of common tax deductions are: educator expenses; certain business expenses; moving expenses; alimony paid; student loan interest; tuition and fees; real estate taxes; personal property taxes; mortgage interest; disaster losses from a Federally declared disaster. You may also include gifts to charity and part of the amount you paid for medical and dental expenses.

What's the Difference Between a Standard Deduction and Itemized Deduction?

An individual has two options for deductions: s/he can either choose to apply the standard deduction amount (determined by the government and a person's filing status) or by listing each individual expense (itemized deduction).

By choosing the standard deduction approach, an individual can reduce their taxable income on a flat basis, no-questions-asked. Meaning: no need to justify the amount with supporting documentation. Click on the image on the right to see the 2019 and 2020 standard deduction amounts based on filing status. A link to the Standard Deduction Table is also provided here.

If an individual chooses an itemized approach, s/he must provide receipts for each deduction claimed. Individuals may choose whichever method is most beneficial and provides the greatest deduction. The majority of individuals benefit most by choosing the standard deduction. You should only itemize deductions if your allowable itemized deductions are greater than your standard deduction.

Additional information about tax deductions can be found at: https://www.irs.gov/credits-deductions-for-individuals

Similar to tax deductions, tax credits reduce the amount of tax owed. However, credits are calculated differently. While tax deductions reduce the amount of taxable income, tax credits are applied after taxable income is determined. As a result, tax credits tend to have greater impact. Click on the image to the right to see the impact of tax credits vs. tax deductions. You can also access the link here.

Examples of tax credits include:

• Earned Income Tax Credit

The earned income tax credit (EITC) provides support to low- and moderate-income working parents, but very little support to workers without children (often called childless workers). The amount of credit varies by family size, with larger credits available to families with more children.

Families with children receive a much larger credit than workers without qualifying children. In 2019, a married couple (earning $55,952 or less) and filing jointly can receive the following tax credits, based on the number of qualifying children:

$6,557 with three or more qualifying children

$5,828 with two qualifying children

$3,526 with one qualifying child

$529 with no qualifying children

Additional information about the Earned Income Tax Credit can be found here: https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit

• Child Tax Credit

The child tax credit provides a credit of up to $2,000 per child under age 17. If the credit exceeds taxes owed, families may receive up to $1,400 per child as a refund. Other dependents—including children ages 17–18 and full-time college students ages 19–24—can receive a nonrefundable credit of up to $500 each.

• Child and Dependent Care Tax Credit

The Child and Dependent Care Credit helps offset costs of babysitting or daycare. It's available to people who must pay for childcare for dependents under age 13 in order to work or look for work. The credit is also available for the cost of caring for a spouse or a dependent of any age who is physically or mentally incapable of self-care.

To qualify, your filing status must be single, married filing jointly, head of household or qualifying widow or widower with a qualifying child.

The credit provides up to 35% of qualifying expenses, depending on adjusted gross income (AGI).

• Residential Energy Efficient Proprty Tax Credit

You may be eligible for the Residential Energy Efficient Property Credit if you are a homeowner who made energy saving improvements to your home. For instance: energy efficient water heaters; energy efficient insulation, solar panels for energy or heating sources; etc. Depending on the type of cost, an individual could be earn a credit between 10% and 30% of the improvement cost.

• Savers Tax Credit

The Savers Tax Credit is for eligible contributions to retirement plans, such as qualified investment retirement accounts, 401(k)s and certain other retirement plans. Taxpayers with the least income qualify for the greatest credit—up to $1,000 for those filing as single, or $2,000 if filing jointly.

For 2019 the maximum income for the Savers Tax Credit is $32,000 for single filers, $48,000 for heads of household, and $64,000 for those married and filing jointly. Filers must be at least 18 years old and may not have been a full-time student during the calendar year or claimed as a dependent on another person’s return.

• American Opportunity Credit (AOTC)

The AOTC covers four years of post-secondary education (e.g. post-high school). The full credit is available to people whose adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing jointly.

Depending on your income (the credit drops as income increases), you may receive up to $2,500 of the cost of qualified tuition and course materials paid during the taxable year. This credit is available on a per-student basis.

• Lifetime Learning Credit

The Lifetime Learning Credit assists with the costs of post-secondary education. It is available for any years of post-secondary education, not just the first four. The credit is also available for people not pursuing a degree.

The Lifetime Learning Credit may be as high as $2,000 per eligible student. For 2019 the full credit is available to eligible individual taxpayers who make $58,000 or less, or married couples filing jointly who make $116,000 or less.

The credit phases out as income goes beyond these amounts.

Additional information about tax credits can be found at: https://www.irs.gov/credits-deductions-for-individuals

The formula to calculate the federal income tax can be broken into three steps:

1. Gross Income - Tax Deductions= Adjusted Gross Income (i.e. taxable income)

2. Adjusted Gross Income x Tax Rate= Calculated Tax

3. Calculated Tax - Tax Credits = Tax Owed

Click on the image to the right to see an example tax calculation. You can also access it here.