ASK CARRIE: Tax basics - What's your tax IQ?


Dear Readers:

It’s tax time again, and I’m getting lots of questions, especially from young people facing tax bills for the first time. Understandably, they want to know how they can reduce their taxes.

And I’m glad they’re asking because, while it’s easy to rely on tax software or have a professional do your taxes, I think it’s important to have an understanding of the basics.

What to report? What not to? Should I take the standard deduction or itemize? If you understand these things, it will help you ask smart questions and make sure you’re taking advantage of legitimate breaks.

So whether or not you do your own taxes, I encourage everyone to brush up on a few fundamental tax concepts. It’s worth the time and effort because, ultimately, it’s not how much you earn but what you keep that counts.

—What’s Included in Gross Income?

Your gross income, also called total income, includes two things: your earned income (wages, salary, self-employment income, tips, commissions and bonuses) and your unearned income (dividends, interest, capital gains, as well as Social Security or pension income). That may seem to cover just about everything. In addition, alimony payments you received on a divorce settlement finalized before Dec. 31, 2018, and rental income are included in your total income. But fortunately, there are some types of income the government doesn’t tax.

These are called exclusions—things such as gifts, inheritance, child support, life insurance proceeds following the death of the insured, municipal bond interest, disability income if you paid the premium with after-tax dollars, and certain employee fringe benefits. You typically don’t need to include this type of income or money that you borrow—such as student loans or a mortgage—in your total.

That’s the first bit of good news. The second is that once you’ve added up your total income, you can start subtracting.

—How Do You Determine Adjusted Gross Income (AGI)?

The next step is computing your adjusted gross income. Your AGI is what you get once you’ve done some subtracting (sometimes referred to as “above the line” deductions). For instance, right off the bat, you can subtract certain things from your total income, including a deductible contribution to an individual retirement account or 401(k), alimony payments you were required to make (once again, for divorces settled by Dec. 31, 2018), contributions to a health savings account, qualified moving expenses and certain educator expenses. If you’re self-employed, you can subtract contributions to a small business retirement plan as well as health insurance premiums and half of the self-employment tax. The result is your AGI.

Your AGI is important because it determines your eligibility for certain deductions and credits, as well as for a Roth IRA.

—What Is Your Modified Adjusted Gross Income (MAGI)?

Although you won’t find it on your tax return, another term you might encounter is modified adjusted gross income (MAGI). This is simply a modified (either increased or decreased) version of your AGI to determine if you are eligible for specific deductions such as student loan interest and whether you are eligible to make tax-deductible contributions to IRAs.

—How Do You Choose Between Standard and Itemized Deductions?

Once you know your AGI, the next step is to subtract either the standard deduction or your itemized deductions—whichever is greater—from your AGI. If your financial situation is straightforward, the standard deduction might be the best and simplest choice, especially since the standard deduction was greatly increased under the Tax Cuts and Jobs Act beginning in 2018. The 2018 standard deduction is $12,000 for single filers and $24,000 for married filing jointly.

If you own property, run a business from home or have paid extensive medical bills, you might still be better off itemizing deductions. Itemized deductions include specified medical
and dental expenses that exceed 7.5 percent of your AGI; mortgage interest (interest on up to $1 million of mortgage debt if you took out your loan prior to Dec. 15, 2017, or $750,000 if you took out your loan after that date); margin loan interest paid (with some exceptions and limited to total investment income); charitable contributions; casualty and theft losses if you are in a qualified disaster zone; state, local and property taxes up to $10,000 per year combined; and more. You can get a full list of legitimate itemized deductions on the IRS website. Also note that even if you don’t itemize deductions, you may be able to deduct up to $2,500 of student loan interest.

—What’s the Difference Between Marginal and Average Tax Rates?

Once you’ve done all the subtracting, you’re left with your taxable income—the amount you actually pay taxes on. This also determines your tax bracket. Here’s where more confusion comes in because, in reality, you don’t pay a flat rate on your taxable income. Rather, taxes are graduated. Here’s an example:

Let’s say you’re single and your total wages were $55,000 in 2018. After the standard deduction of $12,000, you’re left with $43,000 of taxable income, which means your federal marginal tax rate is 22 percent. The marginal tax rate is the percentage you pay on the last dollar of your taxable income. In actuality, according to the 2018 tax tables, you’d pay 10 percent on the first $9,525 of taxable income, 12 percent between $9,526 and $38,700 and 22 percent on the amount above that. That would give you an average effective tax rate of about 10 percent. That sounds a lot better. (This only takes into account the federal taxes paid; the effective tax rate will be higher if state and local taxes are due.) Between the two, your effective bracket is the more important because it gives you a better sense of the big picture.

—Who Qualifies for a Tax Credit?

When it comes to reducing taxes, there’s one more thing to be aware of: tax credits. A tax credit reduces the taxes you owe dollar for dollar. A $100 credit means you pay $100 less in taxes. There are a number of tax credits available depending on your income and personal situation, including credits for dependent children, qualified adoption expenses, child and dependent care and residential energy, as well as credits like the Saver’s Credit and the Earned Income Tax Credit, which is available to low- to moderate-income workers.

—Why It Matters

You don’t have to be a CPA or get bogged down in details, but these basics can go a long way in helping you use tax software or talk to a tax professional more knowledgably. Plus, while none of us enjoys paying taxes, feeling confident that you’re not paying more than you owe may make it a little easier.
Carrie Schwab-Pomerantz, Certified Financial Planner, is president of the Charles Schwab Foundation and author of “The Charles Schwab Guide to Finances After Fifty.” Read more at You can email Carrie at The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at

©2019 Charles Schwab & CO., Inc. member SIPC.
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Published: Tue, Mar 26, 2019