How Are Tax Returns Calculated?

By Phil West, WCI Contributor

How are tax returns calculated? That has a lot to do with how much money you make, of course, but it’s not that simple (nothing ever really is when it comes to taxes.) Let’s look at it . . .  and then, ultimately, think about how to be strategic in your investments, retirement contributions, and charitable contributions before it comes time to calculate taxes.

Filing Status

It’d be easy to say that it starts with how much money you make, but it really starts with your filing status. Single applies to people who are not married as well as those who are divorced and haven’t yet remarried. But single can also apply to those legally separated.

Married Filing Jointly applies to a married couple pooling all their income and deductions together into a single return. Married couples can also choose to file separate tax returns which, in some instances, may result in less tax owed than filing a joint tax return.

There’s an additional category—head of household—designed for an unmarried person who “must have paid more than half the cost of keeping up a home for themselves and a qualifying person living in the home for half the year.” There’s also the qualifying widow(er) with dependent child category for someone who had a spouse die in one of the previous two years.

More information here:

You Should Do Your Own Taxes at Least Once – Here’s How I Do Mine

Form 1040

After knowing your filing status, the standard 1040 tax form is fairly streamlined. The tax form is only two pages long, and “it is imperative that you UNDERSTAND what is being filed on your behalf.” The form is divided into sections where you report your income and deductions to determine the amount of tax you owe or the refund you can expect to receive. Each tax year can be different depending on your situation, so it's imperative that you review this form and understand the numbers annually. Real estate or business losses, accumulated depreciation, or other types of deductions change from year to year so be sure to pay attention.

Tax Brackets

Tax returns generally hinge on tax brackets, which are determined by contracts and then overseen by the IRS. As of 2024, they range from 10% at the low end to 37% at the high end. If you’re a couple filing jointly and you make $364,200 in taxable income, for example, that’s the dividing line between the 24% and 32% tax brackets. Make $364,201, and you’re paying 8% more tax. In a graduated tax system like ours, they do have to draw the line somewhere.

There’s really two sides of the coin when it comes to calculating tax returns. One side of it helps you arrive at your adjusted gross income and, ultimately, your taxable income. Deductions and tax credits shave dollars off your adjusted gross income to help you arrive at the final number that determines your tax bracket.

More information here:

12 Things I Learned From Doing My Own Taxes as a Kid

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Your Tax Rate

It’s also helpful to know your effective tax rate vs. your marginal tax rate and what you can do to impact those rates. As we've previously written, “Remember that your marginal tax rate, or tax bracket, is the rate at which your next dollar earned will be taxed. Your effective tax rate is the total tax paid divided by your total income. Your effective tax rate is always less than your marginal tax rate.” In the example above, where the taxable income is $364,201, the marginal tax means you'd only pay the extra 8% on the $1 that brings you from the 24% bracket to the 32% bracket. Every other dollar would be at a lower tax rate.

Of course, there are things you can do to offset how much tax you’ll pay. If you’re moved to donate to charities, you can go several different directions to work those into your itemized deduction tally, including Donor Advised Funds, which have their various pros and cons.

You also can make the maximum allowable donations to your retirement accounts—something you might want to think about doing regardless of its tax implications. And if you’re wondering what you can do beyond that, well, we have for that as well. 

The Bottom Line

While you might rely on an accountant to handle your tax-calculating needs, we’ll reiterate the point that it’s good for you to know how your tax is calculated regardless of how hands-off you might want to be. It’s not only good to know what to expect in the way of taxes but to keep from overpaying, so you don’t cede money you could be investing for yourself to Uncle Sam for the time it takes to get your tax forms in and your return back.

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