Tax Tantrum Tuesdays: The Tax Equation

So recently, we've been talking about a lot of different parts of the individual tax return. Below I've illustrated how all of these parts work together to complete your tax return. Honestly, understanding taxes is as simple as knowing and understanding this equation...and it is simple as pie:

Let me make sure you can read that the way I meant to write it:

It says... Income minus above the line deductions equals adjusted gross income, minus standard or itemized deduction minus exemption(s) equals taxable income, multiplied by your tax rate equals your tax liability, minus your tax credits, minus your tax payments equals the amount you are either refunded or the amount you owe.

I bet a bunch of y'all are finally happy you know what AGI is. lol

This equation helps you understand how deductions and credits work to help lower your tax liability. The goal of claiming deductions is to reduce your taxable income as much as possible. This means even if your income is $100k, you could have enough deductions to reduce the portion of that which you actually pay taxes on to about $60k. If your tax rate is 25%, wouldn't you love to only owe 25% of $60k vs 25% of 100k? Right.

Even once you get that taxable income down, tax credits are a way to reduce the amount of your actual tax. They are a dollar for dollar reduction. So if your tax liability is $10k for 2010 and you can take the $8k homeowners tax credit...now you only have a $2k tax liability. That my friends is a beautiful thing.

Payments are just your withholdings that you've been paying out of your paycheck all year. Remember the red bottoms? Say if you paid $9k during 2010 and your tax liability is $10k and you've taken the $8k credit to reduce your tax liability to $2k. That means a $7k return for you. On the other hand, if you paid in $9k during 2010, your tax liability is $10k and you have no credits. You will end up owing $1k.

Hopefully this equation shows you how all of these parts work together for (or against) your tax benefit.

Feel free to ask questions on this! I feel like it can still be a bit confusing :-)