Federal tax calculations can be difficult and complex for people with investment, rental or self-employment income. In these situations, a tax professional might be necessary to make sure your tax return is complete and accurate. However, armed with a Form W-2 Wage and Tax Statement and enough background information, an average wage earner can usually calculate federal taxes and prepare an accurate return.
Federal Filing Options
The Internal Revenue Service gives you three options for filing federal taxes. These are Form 1040EZ, Form 1040A and Form 1040. The general recommendation is to use the simplest form for your financial situation. If you’re not sure, the Internal Revenue Service website has a free tool to help you choose the right form.
Tax Deductions vs. Tax Credits
The federal return offers opportunities for reducing your income tax bill via tax deductions and tax credits. The standard deduction or itemized deductions, which everyone can use, reduces your taxable income. In contrast, tax credits work to decrease the taxes you'll pay on that income. These are especially helpful if you're a low- to middle-income taxpayer. According to Intuit Turbo Tax, the earned income credit, education credit, child and dependent care expense credit and retirement savings deduction credit are among the most common.
A federal tax return requires four to five basic calculations depending on which form you use. Each succeeding calculation relies on a preceding answer. In the order in which you complete them, five calculations are:
- Total income
- Adjusted gross income
- Taxable income
- Gross tax
- Tax due or tax refund
A total income calculation starts with your annual income from box 1 on your W-2. To this, you add annual income from all other sources, including taxable interest, dividends, taxable individual retirement account distributions, alimony received, rental income, unemployment compensation and Social Security benefits.
Adjusted Gross Income
Adjusted gross income, or AGI, is total income minus the total of certain adjustments to your income. Add allowable adjustments according to the form you are using, and subtract the sum from your total income. Adjustments include those provided for educator expenses, student loan interest, an individual retirement account deduction, moving expenses and a health savings account.
The taxable income calculation is your AGI minus either the standard deduction or the total of Schedule A itemized deductions. Standard deductions are based on the number of exemptions you're able to claim at the beginning of the tax form, right after noting your filing status. As of the date of publication, the standard deduction for the next tax filing period is $6,300 for an individual, $12,600 for a taxpayer filing as head of household and $9,250 for a married couple filing a joint tax return.
Gross tax is often one of the most difficult manual calculations, so most people simply refer to the tax tables included in the instructions for filing a tax return . The issue isn’t that it’s difficult but that tax rates are progressive. This means you’ll pay one tax rate up to a certain income limit and progressively higher tax rates the further you climb up the different income levels. You can find the tax you owe by looking at the federal tax table and locating the tax amount at the intersection between your filing status and your taxable income.
You can also calculate your tax amount by hand. Use your taxable income, filing status and tax rate tables to calculate your gross tax. For example, if your taxable income is $100,000 and your filing status is single, make four multiplication calculations:
- Multiply the first $9,075 by 10 percent
- Multiply the next $27,825 by 15 percent
- Multiply the next $52,450 by 25 percent
- Multiply the remaining $10,650 by 28 percent
Your gross tax is $21,175.75 derived from the calculation $907.50 + 4,173.75 + 13,112.50 + 2,982.
Tax Due or Tax Refund
As a final step, subtract any tax credits for which you qualify from the gross tax calculation. These also vary according to the form you file and include credits to which you're entitled. If you don’t have health insurance, you’ll also need to add the fine in this section.
The IRS owes you a refund if the credits and deductions you subtracted result in a negative balance. If not, the resulting amount is what you owe the IRS.