- As we prepare to enter the numbers for
Ramone and Kay's income,
We start by gathering up the necessary pile of documents.
First in the United States your employer is
going to send you a document called the form W2.
This form comes right from your employer and it lists
wages, salaries, and income taxes withheld by your employer.
By the way, keep in mind that your employer sends
this exact same information to the Internal Revenue Service.
So the computers at the IRS already know how much of
this income you had
before you ever sent in your income tax filing.
Now if Ramone and Kay had jobs on the side.
Each would get a form 1099 which lists
how much money was paid to them by their clients
or their customers.
Examples of form 1099 income are consulting fees
received by attorneys, accountants and engineers.
And sales commissions received by freelance sales people.
To keep this example simple,
Ramone and Kay do not have any side jobs.
All of their work earnings came from their regular jobs.
Next if Ramone and Kay have bank accounts on which they
earn interest, they'll get an end of year bank statement.
If they have an investment fund on which they earn
dividends or capitol gains,
they'll get a statement at the end of the year for that.
So before you proceed with your tax form just get
documents together, the W2s, the 1099s,
the bank statements, and the investment fund statements.
Now we are ready to enter the income numbers
in the form 1040.
The combined wage and salary income for Ramone and Kay
from their W2 forms is $90,000.
They also earned $1,000 in interest income
so we put all that in.
$90,000 wages and salaries and $1,000 in interest income.
In this simple example, Ramone and Kay don't have
any dividend income from investments.
But it turns out that taxation of dividends
is a little more complicated.
The taxation of dividends is usually done
at a separate rate.
A rate that can be as low as 0%.
So in this simple example, we'll assume that they don't have
any dividend income.
The total income of Ranome and Kay is $91,000.
Now there are other potential sources of income.
Ramone or Kay might operate a small business.
Or they might own some rental properties.
Or they might have made some profit buying some investments
low and then selling them high.
Because this is income created on their own
instead of from working for someone else.
It's not report in a W2 or a form 1099.
This income is reported in different forms
and then summarized in a separate page called Schedule 1.
To keep this example simple, we'll assume that neither
Ramone or Kay had any of this small business or
investment income.
Now while I'm talking about Schedule 1, we should note
that this is where Ramone and Kay report the $8,000
that they set aside in an IRA
or an individual retirement account
to save for their retirement.
The tax rules in the United States allow a couple
to set aside up to $11,000 in an
individual retirement account
and that money will not be taxed until retirement.
The $8,000 IRA contribution is reported in this Schedule 1
and then reflected as a subtraction
in the computation of income.
Most of the items in Schedule 1 are applicable
only to people in special circumstances.
In this Ramone and Kay example the only number that would
come form Schedule 1 is the $8,000 IRA contribution.
So Ramone and Kay are not going to be taxed
on the entire $91,000 income that they made.
They are only going to be taxed on the number called
their adjusted gross income, $83,000.
Which is their W2 wages and salaries of $90,000,
plus $1,000 in interest income
minus the $8000 IRA contribution.
Adjusted gross income
is usually referred to by its abbreviation AGI.
So Ramone and Kay have AGI of $83,000.