 Income tax 2021-2022, income tax formula using tax software. Get ready to get refunds to the max, diving into income tax 2021-2022. Here we are in our LASERT tax software. You don't need access to the LASERT tax software to follow along. If you don't have access to it or any software, then you might want to have the PDF formats of the forms, which you can find on the IRS website at irs.gov, irs.gov. So as we take a look at the software, we want to think about the three different angles that we're considering the tax preparation from, all of them somewhat related. One being the actual tax forms, including the Form 1040 for individual taxes. The other being the software, which is helping us to do the data input to create the Form 1040, although when we do the data input, the 1040 is created basically automatically. When we're thinking about looking at the data with the forms, we're talking about actually reading through line by line, in essence, on the forms to understand it in that form. The data input format with the software is us putting the data into the system and letting it then generate. Oftentimes we look at the check numbers at that point in time. The bottom line in terms of what the refund or the tax do would be, for example, in a tax formula, which we're often going to be looking at in terms of an Excel worksheet. So an Excel worksheet looking like this. This looks like the formula that we put together or we looked at in a prior presentation. And this helps us to visualize the tax return. It also helps us to give kind of a double check to the data input in the software, a double check, which is nice because note that when we do taxes, unlike when you do accounting, there's no double entry accounting system because we're just basically looking at an income statement. So a double check of some kind is useful to have. So if you look at the formula here in basically an Excel worksheet type format, you can think about it in terms of the actual tax formula being the end result, and then possibly having your other sheets that would expand on that, giving more detail that then pulls over to the summary sheet. That is a similar format that you can think of as the actual tax return is, meaning the form 1040 is like the summary sheet. All other forms and schedules are basically falling into or giving more information on expanding to the data that is ultimately pulling over to the tax formula. So when you start to visualize this thing, we're going to say, okay, here's the income line item. What are the things that are going to pull into that line item in my tax formula? If you visualize it this way, it becomes a lot easier to actually pull all this data in. You've got to kind of organize it in some way, and this is actually possible to do in a way to visualize it. So then you can say, okay, all the income things that might go in there, W2 income, of course, interest income, dividend income, retirement plan income, so on and so forth. All that stuff that we're going to then categorize and we'll talk more about that later is all income stuff which would pull into the income line item. So with the whole Schedule C for businesses, that would be the net income on the Schedule C would pull into the top line item. So with a Schedule E for rental income, for example, then we have the adjustments to income. The adjustments to income is going to be here in the formula. So income minus the adjustments or you could call them above the line deductions and that will give you to the AGI. Those adjustments then you can start to think what categorizes as an adjustment. You've got the one half of the self-employment, typically self-employed SEP, self-employed health insurance, alimony paid possibly, penalty on savings on the IRAs, individual retirements and so on and so forth, are kinds of things which we'll get into more detail later that might go into this category and then you can visualize them there and say, okay, that's going to be subtracted out to get to the AGI. Then you've got the itemized deductions and the standard deductions. You're going to take the greater of the two. So you can start to think of what's the floor on the standard deduction and you want to think about that by filing status, single, $12,550, married, $251, for example, and so on. And the itemized deductions, we can see a sub-schedule, a Schedule A, which is going to give us the more detail and we can start to think, okay, medical, taxes, interest. And when you think about itemized deductions, now we have to think, okay, are they going to itemize? And when they do itemize is that particular deduction, deduction has some kind of AGI phase out limitation on it, for example. And then what's going to be the impact if I pull it over to the front line of the formula. And so then if I go on and then you got down below the credits, of course, they're going to be after the taxes down below and then the payments that are taking place. And again, you could break those out in like sub-schedules. That's the same kind of thing that's happening here on the actual Form 1040. So you can see up top, here's this whole top section is basically the income type of section. Notice that they're breaking out some of the detail instead of on a separate schedule. They're just putting it on the first page of the 1040. But then you have, if I hit the little plus button here on the Schedule 1, then you have this additional income, other stuff, just like we saw here with our second page that's going to pull in to the first line on basically our formula, which you can kind of think of basically the front page of the 1040. So the 1040 is a little bit more expanded in its format. And it doesn't look exactly like, if you were to create this, for example, from scratch and it hadn't been something that is always being modified and built on and so on, then you would probably make it look, your 1040 looks something like this. You'd say, okay, I'm just going to put the tax formula up front and then I'm going to have a separate schedule for all the other detail that are going to pull into that line item. The actual tax form has been evolving for as long as it's been in existence. So they did a big revamp on it and they did do some of that. They put these schedules in line here, which kind of simplified it so you had less need for different kinds of Form 1040, like an easy 1040 and a moderate 1040, because if it's easier moderate, it should be on a different schedule. You should just be adding more schedules to make it more complex or not. You would think would be one way you can think about it, a very common way that many people would structure it. So in any case, then you can go through the different line items here and you've got the adjustments to income and those would then be found in the schedule one page two and these adjustments then are going to be on a separate page and then they pull in to the 1040. So you can see when you're actually visualizing this, you're probably not visualizing each line. You're not going to be like unless you have a good photographic memory or something, you're not going to be like, okay, there's line whatever, there's line whatever. I'm pulling it in from this other schedule. You're probably going to visualize it more like a formula and say that's the income line which is supported by the schedule C, which would break out the detail of income and expenses. That's the adjustments to income line that you're talking about which is supported by this other schedule that I'm going to basically be pulling in. So if we start to think about it that way, we can say, okay, obviously the first thing would be like income would be involved. If you had W2 income, I'd say, okay, that's going to be in the income line. I might have another schedule in my worksheet saying that's W2 income which would flow through to the first page of my tax formula. What would be the impact if that was the only thing involved? Well, then if they're taking the standard deduction, they'd have a standard deduction which would be dependent upon whether they're single, married, or so on, which you could have a schedule for, and you could start to kind of get that number down. It increases each year typically. And if that's the only thing involved, then you could basically say, okay, then the income minus that standard deduction would give us the taxable income, $87,450. So I could come back over here and say, let's double check that in the software. The $100,000 minus the $12,005, which they're getting from the standard deduction which we'll talk about later, $12,550 if single, $25,100 if married, and so on gets us to the taxable income of the $87,450. Notice that this whole income statement is something that you could start to visualize. What you can't visualize in your mind very easily, again, unless you're like a math whiz, you've got some kind of thing going on. You can't calculate the progressive tax system in your mind. Why? Because it's a progressive tax system. They have to use the tables, and you might have things like dividends and capital gains. So that's where you have to rely on the software typically. You could double check it, but you're basically relying on the software to actually calculate the tax. In this case, $15,550. So we'd say, okay, the tax is actually $150,005, and then you can get the average rate, and then you've got the second half, which has to do with any credits that are involved and payments that are going to be involved, which you can visualize as well because you're going to say, okay, what happened on the W-2? I made a payment on the W-2 in terms of withholdings, and so you could say, well, once I have the tax, which I can't really visualize to calculate, but I know that the payment is whatever the tax is is going to lower the amount of tax that is actually due and possibly lead to a refund in a similar kind of thing as the credits. So that's how you would kind of visualize it, and then you could see each of these categories. I could go back to the first page of the 1040 and say, okay, well, what if there was something else happening in income, such as interest or something like that? Well, that's another income line item, so you're saying income line item, interest, another $1,000 of interest. I would expect that would increase my income line, which would increase my income line here, possibly having no effect if the only other thing is the standard deduction. So I would think that would increase my taxable income, and then I would think if I knew my marginal tax rate, that would increase my taxes, not by the average tax, but by the marginal tax, so I would have to then put in the tax here again. If I go into the tax software, I could go into the data input and say, okay, there's income, and I'm doing this in LISERT, but whatever tax software would work, I can kind of double check that and say this is from bank one income, and we'll say that this is $1,000, and bring it on back on over to the forms and see that the forms calculated. Now, notice I'm inputting with the software, I can also double check it with the form by adding up the form, right? Here's the $100,000, there's the $1,000 line taxable interest, then this line 19 says add line 1, 2B, 3B, 4B, 5B, 6B, and so on, there's the $101,000, you're probably not going to think in your head, well line 9 says add line 1, 2B, 3B, that's why the form is way too tedious to visualize, but then you got the $12,550, which brings us down to the $88,450, which we can visualize as an income statement. We can't visualize the actual tax calculation again because it's a progressive tax. We might be able to get an idea of what the added tax would be by applying the marginal tax rate seeing where we left off last time, and then saying well it's another $1,000 that are going to be taxed at the highest tax bracket, and that will be the $15,255, so the $15,255, if we go back on over here, $15,255, and so that's in the wrong spot, we're going to say $15,255, and then about a marginal tax rate of $1,702, and there we have it. Now tax software will often give you a format, Lucerte has it here, most software will have like a formula summary because it's easier to visualize, this looks a lot similar to the Excel worksheet and the tax formula that we set up here, and it'll also give you, this one will give you the marginal tax rate at $24, so I would have expected that that last $1,000 increased the tax liability times $1,000 times the marginal tax rate to 24%, right? So if that was the, if we didn't go up to another tax rate, so if I go back on over and say let's delete that one, let's bring it back to where we were, let's bring it back to our baseline of $100,000, and let's say that something happened on this line, we're going to say okay, something happened that's an adjustment to income, well I could say okay, adjustment to income is going to be here, let's say they put money into an IRA, they put, you know, 1,000 into an IRA now, so 1,000 into an IRA, well what's that going to do? I can visualize that that is going to be here pulling into my first line item on the formula, and that's going to take my income, which I'm going to bring back down to $100,000, what happened? Down to $100,000, there it is, and then my adjustment will be 1,000 bringing it down to $99,000, so I could start to visualize what's going to happen, this is going to be above the line deduction, it's going to have an impact on AGI, and if it has an impact on AGI, that's also possibly going to have an impact on any phase outs and credits that have phase outs and deductions that have phase outs, I don't think it's going to have an impact on the standard deduction, generally if that's what they're taking, so that should give us to the $86,450, I could check that in the software and say, okay, let's go to the software, and let's say we've got a deduction for an IRA, and I'm just going to say, all right, it's $1,000 IRA deduction, pulling it back over, I can kind of double check the scenario and then look at it in terms of the tax software, so I could say, okay, there's my $100,000, and then I've got the $1,000 here that pulls into kind of like the first page or kind of like my formula, the $1,000, which is pulling in from schedule one, to how it works in the software now or in the tax form by reading it and say, okay, it says adjustments to income from schedule one, line 26. Well, now schedule one is something I have to use, that's why it's bold in the cert here, and I can go in here and say, all right, now I've got to go to page two, and there's the $1,000 right there on the IRA that pulled into page one of the Form 1040, bringing the adjusted gross income to the $99,000, matching out to what we have here, and then the deduction standard still at the $12,555, that brings us to the $86,450, $86,450, which I can verify kind of in my mind almost, or just think about the differences or at least the impacts. I can't verify the tax in my mind because it's a progressive tax system, but if I knew where I was at on the baseline of the $100,000, I can predict that I'm going to have a tax benefit if I get this full deduction of $1,000 of the marginal tax rate, the highest tax rate that we're at. So I can go back on over and say, okay, then that's going to be, that's going to be the tax is $14,775 now, so I can say, okay, $14,775 on the tax here, $14,775, and then that gives us the average tax of the $20.6, is that right? So then if I go to the tax summary, the average tax, something doesn't seem right. $14,775, let's go back on over, $14,775, it should be $14,775. There it is, $17.1, $17.1 on the average or effective, $24 is the highest tax bracket. And so you can go into each of these line items and I can say, okay, let's go back to the baseline and say, well, what if I go back to the $100,000 starting point and it's easier if you go back to the $100, obviously this becomes more and more complex when you have all these things building up on each other, but if something's in the itemized deductions, then I have to say, okay, that's going to be an itemized deduction, is it going to be relevant, is it going to be greater than the standard deduction, and if it is, then what's going to be the benefit on that one? So that would be on the schedule A, so let's go to the interest and let's make the interest just $15,000 just to make it higher than the standard, so now I'm going to take the higher of the two, so I'm taking the itemized as opposed to the standard, I have my formulas, which are the if then formulas, helping me figure that out. And so we'll pick up the 15, and so then that's going to have an impact. In this case, it's a little tricky because the only real benefit I'm getting from that is the difference between the 12, 5, 5, 0 I would have got before and the 15. So although I'm getting a whole $15,000 deduction, really I'm only getting a benefit from the difference of what I would have got to deduct before and how much more I get to deduct after. So in any case, I can see that, so now I'm going to have the taxable income of the $85,000 and then I'll have to figure out the tax. If I was to go to the tax software, say okay, let's check that out, let's get us back to the baseline, let's go to the deductions for the schedule A, let's bring it down to the interest and say we had mortgage interest, I said $15,000 and bring that in. So now I've got the $15,000 on the interest and notice it's a little bit different, right? It calculated $15,875, why? Because I might be able to get other items here. So now I've got to go to the standard to this item. I also had state taxes because state taxes of $879. So I'm going to add that in because now that I've accessed the ability to have those taxes taken, so we'll get into that later. $879, I'll add that in. So now I can see okay, I'm at the $15,879, pulling over to the front page in my formula, that gives me my taxable income $84,121. So that pulls into the first page of the $1040. So I can say okay, $15 and there's the $84,121 and then I'll let the software calculate the tax. So the software is going to calculate the tax at the $14,256. So I'm going to say okay, $14,256 and so there we have it. And again, we'd have to do the same thing for any credits that would be applied down below and then on the payments, typically payments, for example, withholdings from the W-2 or other line items that you could start to visualize. But that's the general idea. We'll start to go through this on a line-by-line component, but that's how you want to start to think about it when people ask you questions. When you just do the tax returns, if you're not talking to anybody when you do the tax returns, then clearly you're just going to do the data input into the system and you still want to be able to visualize the line-by-lines that will be impacted so that you can go to the Form 1040 and then be able to go to the detailed reports and see how the detailed reports fit into the 1040 so that if there's any problems, you can visualize how it is happening. And then when people ask you questions, you can tell them what you can't know and what you can't know. What you can know if it's an income line item is that the income will probably increase and that's going to have generally an increase to the AGI which could affect any phase-outs, could affect any deductions and so on. And if there's a phase-out component and it's normally going to increase the taxes, you can know that if someone asks you about something and you know that it falls into the adjusted to income or the above-the-line deduction, well, that's going to be a kind of deduction above the line. So if you want to get it without itemizing, it's going to decrease your AGI, could have a positive impact on phase-outs for credits and deductions and so on, should be tax benefit. I don't know what the tax benefit will be exactly because the tax rate is complex, but it should be in alignment with your highest tax bracket, your marginal tax bracket. And then itemized deductions. Well, do you itemize? Do you have the capacity to itemize? Only if you itemize, is it going to be beneficial? Is that deduction going to take you over the capacity to itemize? If so, you're probably going to get a benefit in terms of deductions. It's going to take down your taxes, right? And then you go into the tax software and actually input that into the system and be able to see whether or not what you predicted should happen is actually what's going to happen with the software. And usually people do that somewhat intuitively, right? We have an idea of what's going to happen. I'm going to put it into the software. I'm going to see that what I thought was going to happen is going to happen. If it didn't, then I'm going to go in and try to figure out why. Instead of every time you go into the software, you reread every line. It's useful to reread every line in the software, like once or twice, or to do a whole tax return by hand without software. A useful tool, not practical in practice because you can't visualize the whole software. It's too tedious to read through the line-by-line instructions. You've got to have a more simplified kind of model in your mind other than memorizing every line item and the text in terms of which boxes are going to be added together so that you can get an intuitive understanding and then use the software to help you to build that intuitive understanding as you work practice problems and as you run scenarios and as you do projections.