05 Sep 4 Things You May Not Know About Taxes
The process of filing your tax return can be confusing and stressful, because the tax laws become more complex each year. Even if you use tax software, the preparation of your taxes is a time-consuming task, and educating yourself about tax issues can be overwhelming. To help make the tax preparation process easier, here’s an overview of four items that are often misunderstood by taxpayers.
#1- Some business owners must report business income on their personal tax return
Many taxpayers work for themselves on a full-time basis or operate a part-time business, and the process of reporting business income can be confusing.
Most self-employed people operate as sole proprietors, and as a result, they are required to report all of their business income and expenses on Schedule C of their individual tax return (Form 1040). It’s important to know that self-employed people do not file a separate tax return for the business. The profit calculated on Schedule C is added to the other income earned by the taxpayer on page one of Form 1040. The business income is subject to both income tax and self-employment tax.
#2- Partnerships do not pay taxes; partners do
A business operating as a partnership is considered a pass-through entity for tax purposes, which means that the profit and loss of the partnership flows through to the personal tax returns of each partner. While the partnership files an informational tax return, the ratable share of partnership income is reported to each partner on Schedule K-1. If a partner’s share of annual partnership profits is $20,000, for example, the $20,000 is added to the gross income section of the partner’s Form 1040.
#3- The alternative minimum tax may increase your tax liability
The alternative minimum tax (AMT) is an additional tax that applies to many taxpayers. AMT adjusts the regular tax liability by adding amounts to the calculation, such as state and local income taxes and real estate taxes. If the AMT tax liability is higher than your original tax calculation, you pay tax on the higher liability.
If you use tax software, the majority of the AMT calculation will be performed automatically.
#4- Itemized deductions are reduced for higher-income taxpayers
Many taxpayers assume that itemized deductions taken on Schedule A of Form 1040 are fully deductible, but that is not the case for all taxpayers. Itemized deductions include real estate taxes, mortgage interest, and charitable contributions.
At the bottom of Schedule A, there is a reduction of itemized deductions based on the taxpayer’s adjusted gross income (AGI). Once a taxpayer’s AGI exceeds roughly $310,000 (for married filing jointly), the itemized deductions begin to get reduced. These itemized deductions are generally reduced by 3% of the excess AGI over the phase-out limit.
Use these tips to gain a better understanding of your personal tax return. Preparing your return can be confusing, but knowing how these four concepts work can help simplify the process. Consider each of these tips as you plan for next year’s personal tax return.