Crack the Code: How Income Taxes Work

Governments need money to maintain roads, fund schools, run the government and manage many other citizen needs. They primarily fund these activities by collecting tax payments from individuals and businesses.

The Basics

Tax Withholding. Work for someone else? Your employer will automatically deduct taxes from your paycheck. (Most will pay part of your Social Security and Medicare taxes.) How much you’ll pay in income taxes will depend in part on what you earn and how many dependents you claim. Then, at the beginning of each year, if you’ve earned enough income or are eligible for a refund, you’ll need to submit an income tax return for the previous year.

If you’re self-employed, you’ll need to pay estimated taxes, since you don’t have an employer doing that for you. You can find information on tax rates, how to pay your tax and more in the IRS article Self-Employment Tax and at their Self-Employed Individuals Tax Center.

Filing Returns. In most cases, you’ll need to file two tax returns—one with the federal government and one for your state. You’ll need to fill out the forms to see whether you owe tax or are due a refund. But, they come with step-by-step instructions on what to put where and how to calculate what you owe.

If you have a balance due, you’ll need to pay what you owe (there also may be an underpayment penalty). If you can’t pay what you owe right away, the IRS may allow you to pay monthly with a payment plan.

If you had more money withheld than you needed to or paid too much in estimated taxes, you’re eligible for a refund. You can have the money sent to your bank, mailed to you as a debit card or a paper check or have the IRS apply it toward your next year’s tax.

What You Should Know About Filing a Federal Income Tax Return

Filing Deadline, Extensions and Penalties

Deadline. The deadline to file your federal income tax return is usually April 15. If April 15 is on a holiday or on a weekend, your return will be due the next business day.

Extensions. You can ask for an extension to file your tax return later using IRS Form 4868. Extension requests must be filed by or before April 15. You should know that the extension only covers filing the paperwork. You’ll still need to pay at least 90% of what you owe. Your request can be filed electronically using tax preparation software or by a tax professional. Then, your new deadline to file your return will be Oct. 15.

Late payment penalties. If you don’t file by the deadline, you may have to pay a late filing penalty, and interest will accumulate on any unpaid or underpaid tax balance.

What You’ll Need to Get Started

What you’ll need depends on whether or not you itemize deductions. Here are some of the most common items:

• Social Security numbers (SSN): You’ll need to list the Social Security numbers for yourself, your spouse and other dependents you’re claiming.
• Bank account information: If you’re expecting a refund and want it to go directly to your bank account, you’ll need the bank’s federal tax ID number, their routing number and your bank account number.
• W-2: Shows your wages, salary and tips.
• Form 1099: Reports income such as self-employment income or interest earned.
• Form 1040: This is the form individuals use to file their annual income tax return.
• Government-issued photo ID (e.g., driver’s license): If you’re planning to use a tax preparation professional or an in-person service at the IRS, you’ll need to prove your identity.
• Documentation. If you plan to itemize, you’ll need things like canceled checks, receipts and bills to support your itemized deductions. A complete list is available on the IRS website. If you own or are buying a home, you’ll also need Form 1098 to list mortgage expenses and the real estate taxes you paid. If you paid for child care, you’ll need that information as well.

Deciding Whether You’ll Itemize or Take the Standard Deduction

The standard deduction is a flat amount you can deduct from your taxable income to lower your tax bill. The amount depends on your filing status (married, single, married filing separately, married filing jointly, head of household, surviving spouse), your age and other factors.

If you itemize, you’re allowed to subtract certain approved expenses to lower your income—which then lowers what you pay in tax. Generally, it makes sense to itemize if the total of your deductible expenses is more than the standard deduction. Here is a list of some IRS-approved deductions:

• state and local income taxes
• sales taxes
• real property taxes
• personal property taxes
• mortgage interest
• disaster losses
• gifts to charities
• some medical and dental expenses

For more information on deductions, see the Instructions for Schedule A.

Options for Preparing Your Income Tax Return

Depending on your situation, there are several options available.

• Tax preparation software. These programs are relatively inexpensive, provide step-by-step instructions and make calculations for you automatically. You can buy them online and at many department and electronics stores.
• Hire a tax pro. Certified public accountants, tax attorneys and non-credentialed tax preparation services can use the information you provide to prepare your tax return for you.
• IRS Free File. You can file your return electronically using IRS Free file if your adjusted gross income is $79,000 or less. According to the IRS, the IRS Free File Program uses online programs tax preparation companies provide for free.
• IRS free services. The IRS offers two other free services. The Volunteer Income Tax Assistance program (VITA) offers free tax preparation for people with disabilities, limited-English speakers and those who earn $64,000 or less. For people age 60 and older, the IRS offers Tax Counseling for the Elderly (TCE). You can use the VITA Locator Tool or call 800-906-9887 to find the nearest VITA or TCE center.
• Paper returns. You can find the forms and instructions at many post offices and libraries or at IRS.gov.

A word about the IRS Taxpayer Assistance Centers. These centers don’t prepare your tax return for you. They’re available if you want in-person help with questions, adjustments, letters, notices and payment plans if you owe taxes and can’t pay the full amount. To find the center closest to you and to make an appointment, visit the Taxpayer Assistance Center Office Locator page. You can also get help with questions and more by calling 1-800-829-1040.

How to File Your Income Tax Return

Once you’ve finished filling out your return and signed and dated it, you’ll need to file it with the IRS.

• Electronic Filing (E-filing): The quickest and most secure way to file your tax return is electronically, through IRS-approved software or a tax professional. E-filing also ensures faster processing and quicker refunds.
• Free File: This is a free program described above for those who earn $79,000 or less.
• Paper filing: If you prefer, you can fill out a paper tax return and mail it to the IRS. Fill out the forms you need, make 2 copies (one for the IRS and one for your files) and mail one to the IRS. The instruction booklet will tell you where to mail your return, or you can get the information from the IRS online. You should know that the IRS says processing these returns may take much longer than filing electronically.

What to Do If You Owe Tax

Didn’t have enough withheld from your paycheck during the year? Here’s how to settle your tax bill.

• Online payment: You can make secure online payments directly through the IRS website using credit or debit cards, electronic funds withdrawal, or the Electronic Federal Tax Payment System (EFTPS). Keep in mind that you may pay additional interest if you use a credit card to pay.
• Check or money order: You can mail a check or money order payable to the U.S. Department of the Treasury, along with your payment voucher (Form 1040-V), if required.

What to Do If You Can’t Pay Your Balance

If you can’t pay off your tax debt all at once, you have options. Communication with the IRS is key. Gather together all your financial information (e.g., mortgage statements, lease agreements, car loans, utilities and pay stubs) and call the IRS as soon as possible at 800-829-1040.

• Pay something. It’s a good idea to pay as much as you can—even if it’s not the whole amount. Paying even a partial amount will reduce penalties and the amount of interest you’ll pay.
• Apply for a payment plan. If you apply for a payment plan online, the IRS will notify you right away if your plan is approved. The IRS offers two payment plan options.

Short-Term Plan (pay off within 180 days). To be eligible for this plan, you can owe no more than $100,000 in tax, interest and penalties. The IRS will accept your application by phone, online, by mail or in person.

Long-Term Payment Plan or Installment Agreement (pay in monthly installments). To be eligible for this plan, you can owe no more than $50,000 combined tax, interest and penalties. For a $31 setup fee, you can apply online or, if you apply by phone, mail or in person, the set-up fee is $107.

• Offer in compromise. If you can show that paying your tax debt in full would cause financial hardship, you might be eligible for an Offer in Compromise (OIC). If approved, the IRS will agree to settle for less than what you owe. Not everyone will qualify.
• Temporarily delay collection. If the IRS determines that you’re facing financial hardship and can’t afford to make any payments, they may temporarily delay collection efforts. While this doesn’t eliminate your tax debt, it temporarily suspends collection actions.

What You Should Know About Filing a State Income Tax Return

Most states and some localities collect income taxes and require you to file a tax return. But, if you file an itemized federal return, you may be entitled to deduct the state and local taxes you paid.

States That Don’t Have Income Taxes

Although New Hampshire and Tennessee don’t collect taxes on wages, you’ll still have to pay tax on dividends and interest income. (That tax will be eliminated in New Hampshire in 2025.)

States That Do Have Income Taxes

Each state has different requirements, guidelines and forms. Many can only be filed electronically. You can find your state’s requirements in the list below.

If you owe a tax balance and can’t pay, contact your state’s tax authority as soon as possible to work out an arrangement.

Get What You Need at Navy Federal’s Tax Center

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