You’re almost certainly paying taxes if you work for a regular paycheck. Your employer withholds the taxes you owe from your earnings each pay period and sends them to the appropriate federal and state governments on your behalf. But that's just the first step of the process. A great deal more is involved in filing your taxes correctly and in making sure you're not paying more than you have to.
Why You Have to File a Tax Return
You'll be asked to complete Form W-4 for your employer when you begin a new job. The information you enter on this form determines how much in the way of taxes will be withheld from your pay. The decisions you make when you set up your payroll withholding by completing this form can easily result in under– or over-paying your taxes. Payroll withholding usually isn’t exactly right.
The IRS introduced a revised Form W-4 for the 2020 tax year. It’s much easier to complete, guiding you through the process with various questions and eliminating the complicated allowances that once had to be figured out.
The IRS recommends updating your W-4 and withholding requirements whenever you experience a life event that could affect your tax obligation, such as marriage, the birth of a child, or receiving unexpected sources of income.
You’re required to file a tax return every year to come up with a final tally of your tax situation. The process determines whether you owe taxes beyond what you’ve already paid, or whether you’re owed a refund of the taxes that have been withheld. Your tax return is normally due on or near April 15 of the year following the tax year.
The Biden Administration made an exception to this rule for tax year 2020, the return you'll file in 2021. The filing deadline has been extended from April 15 to May 17, 2021, in response to the ongoing pandemic.
You might be able to reduce the taxes you owe—and get a refund of taxes you've already paid—by taking deductions and credits provided for in the tax code. Or you might have had additional income during the year that you’re legally required to report and from which no taxes were withheld. This can result in you owing the IRS more than you've paid throughout the tax year.
How to File a Tax Return
You have three options when it comes to filing your taxes:
- You can file manually by completing Form 1040 according to instructions provided by the IRS. Mail the form to the IRS, along with any payment you owe.
- You can use a tax software program or the website of a service like TurboTax or H&R Block. It will walk you through a series of questions about your income and potential deductions, fill out your 1040 based on your responses, and file it electronically for you.
- You can get professional help from an accountant or tax professional who will work with you to maximize your refund and fill out your tax return on your behalf.
The first option is free. If you go with the second option, you’ll likely have to pay a fee, although some programs offer free filing if your return is simple enough. The third option—professional help—will almost certainly cost you money.
The Free File partnership between the IRS and select tax preparation companies offers free tax preparation and e-filing to taxpayers who earned $72,000 or less in tax year 2020. This is the return you'll file in 2021. You can also download tax forms and complete them yourself if your income is more than $72,000 and you thus don't qualify for free preparation.
How Tax Brackets Work
How much tax you must pay begins with your total or "gross" income from all sources. You can then claim any deductions to which you're entitled. These subtract from your gross income to arrive at your taxable income.
The federal government uses a progressive tax system, which means that the higher your taxable income, the higher your effective tax rate will be. These rates are determined by tax brackets.
For example, you’re in the 24% tax bracket for tax year 2020 if you were single and your taxable income was between $85,525 and $163,300. But only the portion of your income above $85,525 will be charged at that 24% rate. The IRS adjusts these taxable income amounts annually for inflation. These taxable income thresholds increase to $86,375 and $164,925 for the 24% tax bracket in tax year 2021, the return you'll file in 2022.
How Your Taxes Are Calculated
Your employer will give you a Form W-2 after the close of the tax year if you have a regular job. The form details how much you were paid and how much was withheld from your pay for taxes. This information is then transferred to your tax return and determines how much you owe—or are owed—in taxes or a refund.
Self-employed people and independent contractors receive Forms 1099. These don't detail withholding, because self-employed taxpayers are responsible for remitting their own taxes as the year goes on. Other 1099 forms might be issued to you from banks or investment firms where you’ve accumulated interest or dividend income.
Reducing Income With Tax Deductions
The amount of your income that’s actually taxable can be reduced by claiming tax deductions. For example, you can subtract the amount of a gift you made to a qualifying charity or nonprofit (up to $300 if you don’t itemize deductions).
This doesn’t mean your total tax bill is reduced by that amount, but rather that your taxable income is reduced by this much—which, in turn, may lower your effective tax rate.
You can’t always deduct all of what you spend. Some itemized deductions, such as for medical expenses and charitable giving, are limited to percentages of your adjusted gross income (AGI). For example, you could only claim an itemized deduction for charitable giving for up to 60% of your AGI through 2019, but the CARES Act has waived this rule for tax year 2020 in response to the coronavirus pandemic. You can deduct donations up to 100% of your 2020 AGI.
Tax filers can itemize their deductions, but there’s also a standard deduction that often works out to more than the total of their itemized deductions for many filers. For the 2020 tax year, the standard deductions are:
- $24,800 for those who are married and file joint returns
- $12,400 for single taxpayers and those who are married but file separate returns
- $18,650 for taxpayers who qualify as heads of household
For the 2021 tax year, the standard deductions increase to:
- $25,100 for those who are married and file joint returns
- $12,550 for single taxpayers and those who are married but file separate returns
- $18,800 for taxpayers who qualify as heads of household
Reducing Taxes Owed With Credits
While tax deductions reduce your taxable income, tax credits come directly off what you owe the IRS—dollar for dollar. The Internal Revenue Code provides for several tax credits, from the child tax credit for each of your child dependents to the earned income tax credit, which is designed to provide refunds to low-income taxpayers and families with children.
Refundable tax credits can sometimes result if any balance is left over after reducing the tax you owe to zero.
You might have owed the IRS $1,000 had you not claimed a $1,500 tax credit. The credit would erase your tax debt, and the IRS would send you a refund for the $500 balance if the credit were refundable. The IRS would keep that $500 if the credit you claimed was non-refundable, but at least it would entirely erase your tax debt.
Each credit comes with its own qualifying rules, and how you can claim it varies a little as well. For example, you can claim the Child Tax Credit directly on line 19 of the 2020 Form 1040 tax return if you qualify, but others must be claimed on Schedule 3, which must accompany your 1040. You would then enter the totals from Schedule 3 on lines 20 or 31 of your Form 1040, depending on whether the credits are refundable or non-refundable.
The American Rescue Plan Act of 2021 eliminates the minimum income requirement for the Child Tax Credit. It increases the maximum benefit to $3,600 for children under age six, and to $3,000 for children ages six through 17. The age-17 cap is one year older than the usual age for qualifying. This applies only to the 2021 tax year, however, and doesn't affect filings for 2020.
Some tax credits, such as the Additional Child Tax Credit, require their own forms that help you calculate how much you're entitled to and show the IRS how you arrived at that amount.
The qualifying rules for tax credits, particularly the earned income credit, can be complex, so consider checking with a tax professional to be absolutely sure you can claim them. But reputable tax preparation software can also be helpful, asking you a series of questions to determine whether you qualify.
If you were ineligible to claim the economic impact payment in the form of a stimulus check based on your 2018 or 2019 tax returns, but your income dropped enough in 2020 to meet the requirements, you may be able to claim it as a tax credit on your 2020 tax return. It’s known as the Recovery Rebate Credit.
Getting Your Refund (or Paying Your Tax Bill)
You’ll be able to determine your tax balance—whether you owe money or are owed a tax refund—after you’ve entered all the relevant information about your income, deductions, and tax credits.
You can send any money due to the IRS and your state’s department of revenue, or you can use one of the online payment options provided by the IRS. Direct Pay allows you to make a direct debit from your bank account payable to the IRS, and the agency accepts credit card payments online as well.
You have a few options for receiving your payment if you're owed a refund, including a mailed check or direct deposit into a bank account. You can even divide your refund into separate bank accounts or use it to purchase savings bonds from the Treasury Department.
Even if you have no income, it may be wise to file a tax return. And don't neglect to save a copy of your return for your records—it will come in handy when you’re doing your taxes next year or, especially, if the IRS has questions or decides to audit you.