What Is A Tax Return And How Does It Work?

At certain times of the year, everyone talks about taxes. The reason is simple: If you make more than a certain amount of money, you have to pay taxes. And the way you do that is via a tax return.

A tax return is a collection of documents you file with the government that reports your income, expenses and other relevant financial information. The information you provide in a tax return allows you to calculate your tax liability and either claim a refund or settle an outstanding tax debt.

What Is A Tax Return?

A tax return is a series of forms that you fill out to show the government how much money you earned and how much you paid in taxes during the year.

Armed with this information, the IRS and your state government taxing bodies determine if you’ve paid enough taxes throughout the year or if you owe the government more money. These bodies will also use your tax returns to determine if you’re owed a refund.

If you are an hourly or salaried employee, your employer withholds a percentage of your paycheck every pay period to cover the taxes you owe the government. Depending on how much your employer withholds, you might end up paying too much in taxes during the year.

If this happens, you get a refund. Why? Because you overpaid throughout the year, so the government will pay you back the amount you overpaid.

How Do Tax Returns Work?

Tax returns contain all the documents taxpayers use to report their income to the IRS, and are used to determine whether they owe a tax bill or are due a refund. The government pays taxpayers back a certain amount if it’s found they overpaid on their taxes throughout the year.

Whether you are a salaried or hourly employee, you are self-employed or you are an independent contractor, you can file your taxes by filling out IRS Form 1040.

You’ll report your income and tax deductions on this form. Your income includes money you earn from wages, salary, tips, dividends, alimony, business income, capital gains, individual retirement account (IRA) distributions, Social Security benefits and other money sources. Any 401(k) contributions are not included in your taxable income.

You can also claim deductions that lower your yearly taxable income. Allowable deductions might include payments you’ve made throughout the year to an IRA, student loan interest and any contributions you’ve made to a health savings plan.

When you subtract any deductions from your yearly gross income, you arrive at your adjusted gross income. This is the income on which you must pay taxes.

Tax Return Vs. Tax Refund

A tax return is different than a tax refund. The former is a comprehensive document that you submit to the tax authorities that details your income, deductions, credits and overall financial situation for a specific tax year. It enables you to report your taxable income to determine the amount of taxes owed or refunded.

A tax refund refers to the amount of money that’s returned by the government when the tax liability is less than the total amount of taxes withheld or paid during the year — essentially, a tax refund is what the government reimburses you because you overpaid your taxes.

Sections Of A Tax Return

A tax return is divided into several different sections, which helps you calculate how much you owe the government. The sections are defined below:

Income

The amount of tax you owe is largely based on your income, or how much money you earned over the previous tax period. But while that might sound simple, there are several different types of income, and they affect your tax rates differently.

These types of income are included, unsurprisingly, in the income section of your tax return, and they typically include sources of earnings such as wages, salaries and tips. Other types of income, including unemployment and capital gains, may be included here. Definitions for various types of income include:

• Gross income: This is the amount you earn from all forms of income before taxes and other deductions, such as Social Security benefits or retirement.
• Net income: This is the amount of money you keep after taking out expenses from your paycheck, such as deductions and taxes. In other words, it’s the amount you take home versus your total income. Common alternative names for net income are net pay and take-home pay.
• Unemployment: This refers to payments you receive from the United States government when you are unemployed and meet certain eligibility criteria. These payments, commonly known as unemployment benefits, offer temporary financial support to people who have lost their jobs involuntarily.
• Capital gains: This term refers to earnings from selling a capital asset, which can be both tangible (like a car) or intangible (like a trademark or patent). Your home is also a capital asset, so when you sell your home, you might see a capital gain. Long-term capital gains are often taxed at a lower rate than short-term gains, which creates an incentive for long-term investment.

Deductions

The tax deductions section of a tax return includes eligible (a key word here) expenses that taxpayers can subtract from their total income, thereby reducing their taxable income — and potentially lowering their tax obligation. Common deductions include:

• Interest paid on your mortgage
• Interest paid on student loans
• Charitable donations you made
• Contributions to IRAs and health savings accounts
• Self-employment expenses

You may also choose not to itemize your deductions and instead opt for the standard deduction, which is the amount of money that you can deduct from your taxes if you don’t itemize other deductions. (Note: You can’t itemize deductions and also file for the standard deduction.) That amount varies by year and based on your filing status — the standard deduction for someone filing a separate return as a head of household in 2022 was $12,950; for the 2023 tax year, that number was $13,850.

Tax Credits

The IRS defines a tax credit as a dollar-for-dollar reduction in the income tax you owe. If that sounds complicated, trust us — it’s not.

Here’s an easy way to think about it: Say you qualify for $1,000 in tax credits. That simply means that the income tax that you owe taxes on will then be reduced by a total of $1,000. If you owed $5,000 in income taxes, your tax credits would reduce your income tax bill to $4,000.

There are many different types of tax credits, but one of the most popular is the child tax credit, which lets you claim a credit of up to $2,000 for every qualifying child you are supporting. A qualifying child is typically considered a dependent under the age of 17.

How To File Your Tax Return

So now that we’ve discussed what a tax return is, you need to know how to file it after you’ve filed it out. Here are some of the important steps:

1. Gather documents and receipts. In order to file your taxes accurately, it’s critical that you collect your W-2 forms, 1099s and receipts for deductible expenses like medical costs and charitable contributions before filing your tax return. This will help ensure you can accurately report your income and deductions, which could mean you earn a tax return.
2. Select your filing status. There are several different tax brackets (single, married filing jointly, married filing separately and head of household), and they determine how much tax you pay. Having a dependent — a child, close family member or distant relative — that you support also affects your tax rate. A dependent can essentially lower your taxable income through various credits and deductions, which could reduce your overall tax liability.
3. Choose how to file your taxes. You can choose to file your taxes via various methods, including online filing, which provides a convenient and efficient way to submit returns and often minimize errors. You can also, of course, still file by mailing in your return via the U.S. Post Office, or work with a tax professional to have them file your return for you.
4. Decide between itemizing or taking the standard deduction. You need to decide whether to itemize deductions — for example, listing each deductible expense separately — or take the standard deduction, which is a fixed amount based on filing status. This decision impacts your amount of taxable income and potential tax liability.
5. Submit your tax return by the deadline. Submitting taxes by the tax return deadline is crucial to avoid penalties and interest. Failing to meet the deadline may result in financial consequences, so it’s critical to file on time.

The Bottom Line

Let’s be honest: no one likes filing taxes. But if you do it on time, and in a thorough way, you can make it less painful — and could even get a refund. So when you fill out your tax return, be methodical and prepared. Getting your finances in order can give you a strong start, and signing up for the Rocket Money℠ app is a great way to organize your money.