Why Do We Pay Taxes

Why Do We Pay Taxes?

When April 15th comes you have to file a tax return and pay taxes.  But why do we pay taxes?  Is it because you’re “supposed to,” or because most everyone else does?  Is it because of tradition, or social convention?  Do you pay taxes out of patriotic duty, or even as a practical matter, knowing the government has to have money to function?  Or do you file a tax return because of the IRS, for fear of the consequences of what they might do if you don’t?  While some, none, or all of these reasons may come into play for you, what I want to focus on is helping you to understand the legal basis upon which the government of the United States (through the IRS) compels Americans to file Federal income tax returns and pay taxes.

How the Internal Revenue Code became the law of the land

Prior to 1776, the King of England was the supreme sovereign authority over the 13 Colonies.  This included authority in matters of taxation.  So if the king said there was a tax on tea (or whatever), there was a tax on tea.

In 1776 representatives of the 13 Colonies signed the Declaration of Independence, setting forth the rational, legal, and moral basis for America to sever the ties of British authority, including the right of the British to tax the American colonies.  The 13 Colonies fought and won the Revolutionary War in order to preserve that newfound freedom and independence.

Recognizing the need for a governing body “to promote the general Welfare,” in 1789 the 13 Colonies ratified the United States Constitution “in Order to form a more perfect Union.”  At that time, the Constitution became the supreme law of the land.[1]

As prescribed by the Constitution, Congress became the lawmaking branch of the United States government.  In accordance with this authority, Congress has the power to pass legislation which, when signed by the President (and not overturned by the Supreme Court), becomes the law of the land.

Over time the laws of the United States have been organized into what is known as the U.S. Code.  The U.S. Code is further organized into Titles covering specific areas of law.

In 1913 the 16th Amendment of the United States Constitution was ratified.  It states, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived… (italics added).”

In accordance with the authority granted to it by the Constitution, Congress created Title 26 of the U.S. Code, which is also known as the Internal Revenue Code.  The Internal Revenue Code contains the tax laws of the United States.

The Internal Revenue Code requires U.S. citizens and residents to pay taxes

Now that it’s been established that the Internal Revenue Code (or “IRC”) is the law of the land, where does it say in the Code that people have to file income tax returns and pay taxes?

Congress didn’t beat around the bush answering that question.  At the very beginning of the Code, IRC Section 1 states, “There is hereby imposed on the taxable income of [single and married persons]…a taxdetermined in accordance with the following table[s] (italics added).”  Tables are then laid out in the Internal Revenue Code showing the tax you owe on your taxable income based on your filing status (single, married filing joint, head of household, etc.).

If your tax is based on “taxable income,” how is that defined according to the Code?  IRC 63 states, “…the term ‘taxable income’ means gross income minus [allowable deductions].”

And what’s “gross income?”  You’re going to love this.  According to IRC 61, “…gross income means allincome from whatever source derived…”  And what exactly does that mean?  It means that unless the Internal Revenue Code itself provides an exception, the income of all people everywhere is subject to taxation in the United States, and all people, whether married or single, foreign or domestic, on Earth or living in outer space, owe tax on their “taxable income.”

Wow!  Asserting tax jurisdiction over everyone everywhere…that’s bold!  But how can that be?  Did the United States Congress really throw down the gauntlet and declare tax warfare on the rest of the world and you just missed it?  Not quite.  Without getting into mind-numbing detail, I’ll just say that according to IRC 871 it turns out that nonresident aliens are only taxable in the U.S. to the extent that they have meaningful business, employment, or investment connections to the United States.  While that’s good news for foreigners, the flip side is that all of following categories of people are required to pay taxes on their “taxable income.[2]”

  • United States citizens who live anywhere in the world (or anywhere in the known universe for that matter).
  • Green card holders (otherwise known as “lawful permanent residents”) who live anywhere in the world.[3]
  • Non-U.S. citizens who are “effectively connected” to the United States for tax purposes.

The Internal Revenue Code requires you to file tax returns

Okay, you’ve now come to the realization that you legally have to pay taxes.  So how much do you owe?  And how do you determine how much tax you owe?  You do that by filling out the applicable tax return, which for most individuals is Form 1040, “U.S. Individual Income Tax Return.” [4]

As intimidating and confusing as a 1040 can be, it’s actually far better than the alternative, which would be to read through the Internal Revenue Code and manually determine what you owe in taxes with pen and paper or a spreadsheet.  Said another way, Form 1040 is designed to provide you with an organized framework to calculate your income tax obligations in accordance with the laws of the Internal Revenue Code.

But let’s just say for argument’s sake that you don’t feel like filling out a 1040, or any other IRS-published income tax form.  Can you just calculate your tax by hand, send a check to the U.S. Treasury and be done with it?  The answer is no.  IRC Section 6011 states, “…any person made liable for any [income taxes]…shall make a return or statement according to the forms and regulations prescribed by the Secretary [of the Treasury] (italics added).”  And what are the prescribed forms?  It’s those developed and published by the Internal Revenue Service, the division of the U.S. Treasury charged with administering and enforcing the revenue laws of the United States.

There are no exceptions to paying taxes if you have enough income

After reading all of this you might say, “But wait, you probably didn’t realize there’s an exception to paying Federal taxes for me because I’m…”  You’re what?  A senior?  A child or a student?  A descendent of an enslaved, oppressed, or persecuted people?  A member of a certain religion?  That you’re opposed to the current President or other elected officials?  That you’re against some aspect of U.S. foreign policy?  Or perhaps you’ve been led to believe that you’re exempt from Federal income taxes based on some kind of intellectual, pseudo-legal, wacko argument that you found on the Internet?  Despite all of the myths, misinformation, and clever scams out there, none of these are exceptions to filing income tax returns and paying taxes.  In short, all Americans whose income exceeds a certain threshold are subject income taxes…period.

Follow the law…or face the consequences

Here’s what it all boils down to.

  • The United States Constitution is the supreme law of the land.
  • The Constitution grants Congress the power to tax income.
  • The Internal Revenue Code contains the tax laws of the United States.
  • According to the law, United States citizens, green card holders, and certain foreigners have to pay taxes on their taxable income.
  • Taxes have to be calculated on official government (IRS) forms.

That said, the government realizes that regular people often have a hard time understanding and applying the tax laws, and they will generally work with you if you’re making an honest effort to meet your income tax obligations.  But if you try to avoid paying taxes through the use flimsy or impassioned arguments that have no basis in the law, you’re going suffer some serious pain when the IRS brings your fantasy world comes crashing down on you because, like it or not, agree with it or not, or want it or not, the Internal Revenue Code is the law of the land.


[1] Quotes are from the preamble to the United States Constitution.  The Constitution can be referenced at http://www.ushistory.org/documents/constitution.htm

[2] A “nonresident alien” is essentially a foreigner who does not reside in the United States.  For a more formal definition see IRC 7701(b) and related references.

[3] Why would green card holders be subject to U.S. tax if they don’t even live in the States?  It’s because they have the right to live and work in the U.S. anytime they want, and for that privilege the United States requires that they pay taxes.

[4] If you meet the qualifications, you can instead file a Form 1040A or a 1040EZ.  In theory your tax will come out just the same as if you had filed a full-blown 1040, but these forms are designed to be shorter and easier to complete.

how do taxes work

An Overview of How Taxes Work

An Overview of Paying Taxes, Filing a Return, and Getting a Refund

Form 1040 is used to calculate your income taxes

The purpose of a tax return (such as IRS Form 1040) is to calculate the total Federal income tax you owed for the prior year.

While a tax return is used to calculate your tax, it is not necessarily used to paytaxes.  Instead, most regular people pay Federal (and state) income taxes over the course of the year through their paychecks.  To verify this, check your most recent pay stub to see how much Federal tax is being taken out of each pay period.

“Federal income tax” does not include Social Security and Medicare

In examining your pay stub, it’s important to clarify that while Social Security and Medicare are also taxes imposed by the Federal government, they are not the “Federal income taxes” that are calculated on IRS Form 1040.  Rather, Social Security and Medicare are separate taxes known as “FICA” or “payroll taxes.”  The good news is that you don’t have to file any tax returns to report and pay Social Security and Medicare taxes.  The bad news is that your employer deducts these taxes directly from your paycheck and pays the money to the IRS on your behalf.  Your employer also files payroll tax returns on a combined basis for all of its employees (IRS Form 941).  In summary, you don’t have any tax filing responsibilities when it comes to payroll taxes, but you do have to stick you chin out and get socked by Social Security and Medicare tax withholding.

Your tax return for the prior year is due by April 15th

Safe Harbor 401k Tax Benefits

Returning to Federal income taxes, near the end of January of each year you should get a Form W-2 from your employer.  This is a summary of how much income you received from your employer during the prior year, as well as how much Federal (and state) income tax they paid to the government on your behalf (Form W-2 also summarizes how much Social Security and Medicare tax you paid in over the course of the prior year).

Using the information from your W-2 (and other sources), you complete your prior year tax return by April 15th of the current year.  There is no reward or penalty for filing your tax return before April 15th but, again, the final due date is the 15th (unless it falls on a weekend, which makes the deadline the following Monday).

Upon completing your tax return you will finally know for sure how much tax you owed for the prior year.  You will then compare that with how much you actually paid in through your paycheck.  If you paid in more than you actually owed then you will be due a refund from the IRS.  On the other hand, if you owed more than you actually paid in then you will have to include a check payable to “U.S. Treasury” with your tax return for the balance due.

An example of the tax filing process

To illustrate the concepts above, let’s say that during 2018 you were paid monthly, and you had $100 of Federal tax deducted from each of your paychecks.  That means over the course of the year you paid a total of $1,200 in taxes to the Federal government through your paycheck, and the Form W-2 you receive at the end of January 2019 from your employer confirms that’s the case.

Prior to April 15th, 2019 you complete a 2018 IRS Form 1040 in order to calculate how much tax you owed for the prior year (2018) based on your income and other factors.  After completing all of the appropriate forms and schedules, it turns out that your actual Federal tax liability for 2018 was $700.  As a result, because you paid in ($1,200) more than you actually ended up owing ($700), you’ll end up getting a tax refund from the IRS of $500.

Tax audit IRS

5 Problems With A Federal Income Tax Audit

Federal Income Tax Audit – What does it mean to get audited?

My 2016 Federal tax return was recently audited by the IRS, and I can’t say that I liked it.  Well, that’s pretty obvious, isn’t it?  After all, when it comes to audits, what’s to like?  But aside from the obvious displeasure I had in getting audited in the first place, what problems did I encounter, and what does that mean to you?

Before I answer those questions, let me first clarify what it means to get audited.  Does it mean a pair of men in dark suits, sunglasses, and those little ear devices show up at your doorstep in the middle of the night, or does it mean to be summoned to the nearest IRS office?  While the latter is still a possibility, that’s really not how most audits happen these days.  Instead most audits now are “correspondence audits” (otherwise known as “desk audits”), or a letter in the mail from the IRS stating that they disagree with a specific part of your return, informing you of a corresponding adjustment (which increases your tax bill or decreases your refund), and providing you with information enabling you to contact them if you disagree with the adjustment.  And it’s this kind of audit – a correspondence audit – that I was subjected to. And again, aside from having to devote time and energy to dealing with an audit in the first place, I had 5 problems with the process.

Problem #1 – The IRS will automatically reduce your refund

After completing and filing my 2016 Federal tax return I was due a refund of $1,250, which I requested to be deposited electronically in my bank account.[1]  As a result, you can imagine my disappointment when I only saw a refund of $750 hit my bank account, a full $500 less than I was expecting.  I got out a copy of my tax return and flipped through it.  As far as I could tell, everything looked correct.  And yet there I was, with $500 less than I was expecting.  To make matters worse, because the IRS already had my money I was now forced to deal with their bureaucratic machinery if I wanted it back.  Said another way, if I took no action then my $500 was gone forever.

This situation illustrates an important financial principle.  Whenever you’re in any kind of financial dispute, you want to be the one holding the money if at all possible.  What does that mean as far as filing your tax return goes?  Everyone, it seems, loves a tax refund.  And I admit, it’s nice to get that refund check in the mail (or electronically deposited as the case may be), but it’s really not the ideal tax filing strategy.  The reason is if the IRS calculates a different tax liability than you then they’ll automatically reduce your refund, and the impetus will then be on you to get your money back.  As a result, the sweet spot is to owe $1 upon filing your federal tax return.  Why?  Because the out-of-pocket cost of filing your tax return is low (meaning you just have to send it in with a check of $1 rather than having to suddenly and unexpectedly come up with $1,000) and, if the IRS disagrees with your tax calculation, then they’ll have to bill you.  That wouldn’t be good news, of course, but at least you would still be holding on to your money as you worked things out with the IRS.

Problem #2 – The reasons the IRS provides for reducing your refund can be VERY vague

Naturally I wanted to know why I got less of a refund that I expected.  With no correspondence from the IRS yet (remember, at first I only saw that less hit my bank account than I expected), I went to the IRS website (www.irs.gov) and clicked on “Where’s My Refund” to find out more specific information on what was going on.

What a disappointment.  Instead of seeing a line-by-line comparison along the lines of, “Here was your tax calculation, here is where our tax calculation was different, and this is the difference,” the only information that was given was a vague statement that the adjustment was related to “Self-Employment Tax.”  Once again I looked at a copy of my 2016 Federal tax return, this time focusing on the self-employment tax-related sections, and I still didn’t notice any errors.  A bit frustrated at this point, I now realized that I had to wait on a formal correspondence letter from the IRS that would provide more details.

When the letter finally did come it was also a disappointment, telling me little more than the information I had gotten from the IRS’s website.  The one page letter said, “We believe there’s a miscalculation on your 2016 Form 1040, which affects the following area of your return: Self-Employment Tax.  We made changes to your return that correct this error.  As a result, you are due a refund of $750 (again, $500 less than the $1,250 that I was expecting).”  There was a little more information in a section titled, “Your tax calculations,” but it was just top-level information from Form 1040.  In summary, given the fact that the IRS clearly performed a specific calculation to come up with an adjusted refund amount for me ($500 less than I was expecting), it was disappointing that that they didn’t give me enough information on what they had done to clearly understand what was going on.

Problem #3 – You’ll be the one that has to do the heavy lifting

Since it was obvious that no more information from the IRS was forthcoming, I had no choice (if I wanted my $500 back) but to roll up my sleeves and get to the bottom of things.  When I finally got a block of time (something which doesn’t always come easy for a regular person), I used the information on my tax return and my supporting documentation to build a spreadsheet analysis of the IRS’s adjustment.  My objective was to figure out what calculations the IRS used to arrive at my adjusted refund.  Once I knew that, I could make a judgment on whether they were correct or whether my tax return as originally filed was correct.  After about an hour and a half or two of sustained effort I finally determined how the IRS arrived at their adjustment, and when I compared it to my own figures it was clear to me that I had been right all along.  While that was good news, I didn’t exactly feel like celebrating.  After all, I had already put in a good deal of time, focus, and energy into determining what was going on, but I still had to deal with the IRS directly in order to get the remaining portion of my refund back, and that’s something that can be difficult and time-consuming as well.

Problem #4 – You’ll be at the mercy of the IRS in getting in touch with someone who can help you

In responding to the IRS I essentially had 2 options.  I could write them or I could call them (both an address and a phone number were provided for in their correspondence audit letter, otherwise known among tax professionals as an “IRS notice”).  After giving it some thought I decided to call.  Why?  First of all, I had done my calculations, so I knew exactly what the problem was and what the IRS needed to do to fix it.  Second, since that was the case, I knew that if I got the right person on the phone then I could get my issue resolved in short order.  Finally, I figured that if a phone call didn’t work the way that I hoped it would then I could always send a formal letter to the IRS using the address that they provided.

I was fortunate when I called that I got an IRS employee who was reasonable, helpful, knowledgeable and responsive.  I explained my issue to her and she listened to what was going on, giving me the benefit of the doubt.  To some degree I believe her attitude had to do with the fact that I was prepared and knew exactly what I was talking about, and I was careful not to complain.  In any case, shortly into our conversation she asked me to fax her my tax calculations, which I did.  Upon examining them she agreed the problem was on the IRS’s side and, after further investigation, she realized it was because an IRS employee had incorrectly keyed my return into the system.  As a result, she agreed right then and there that my return was correct as originally filed, and she authorized the remaining portion of my refund ($500) to be wired to my bank account within a few business days.  And, fortunately, that is indeed what happened.

As you can see, while my audit took some time and effort to resolve (even though I was right all along), it did end up working out without an excessive degree of difficulty.  However, an important factor in things going as smoothly as they did was because I was fortunate to have gotten ahold of someone at the IRS who was both competent and helpful.  While that is often the case, sometimes it is not.  The IRS is a huge, bureaucratic government agency, and unfortunately I’ve run into some hardheads over time.  When that happens – even if you’ve got your ducks in a row – it can be tough sledding.  And if that happens then what do you do?  Well, that’s when things get hard, because you have to either keep dealing with a difficult person, call back and try to get someone else, or respond in writing.  With any of those choices the resolution of your situation can stall as you find yourself getting stuck in the bureaucratic mire of the IRS.

Problem #5 – It’s unlikely that “regular people” will be able to resolve many tax problems on their own

Look, I’m a regular person in many ways.  I can’t tell what that rattle in the car means, I don’t know why my rose bush is dying, and when my TV remote starts acting weird I don’t really know what to do.  But when it comes to income taxes (and personal finance in general) then I’m in my element; that’s what I do, and that’s what I’m good at.  So even though things worked out well for me as far as my audit was concerned, as I said above, I think in large part it had to do with the fact that I’m a tax professional who knows my way around the system.  In short, I don’t think a “regular person” (as far as taxes goes) could have resolved an audit similar to mine, at least not without a lot more time, pain, and/or expense.  And specifically what would a regular person’s options have been in a situation similar to mine?  Here they are, and none of them are attractive.

  1. Spend lots of time – The first option would have been to spend substantially more time than I did (remember, I’m a tax professional).  But unfortunately time alone is not enough to resolve your tax problems if you don’t really know what you’re doing any more than I can make my TV remote work without understanding the technology behind it.
  2. Spend lots of money – Another alternative would be to hire a tax professional to help you, but that could cost you anywhere from $75 to $200 an hour.  As a result, you could lose a massive chunk of your refund before you ever see any money…and that’s if you’re right in the first place!  If you’re tax return turned out to be wrong then you will get hit with the double-whammy of by spending money on professional fees only to confirm that you do indeed owe the IRS more money.
  3. Do nothing – Finally, if dealing with the IRS seems like it’s going to be too expensive, bewildering, and/or intimidating relative to the time and/or money you would have to put into it then the final option would be to just eat the $500 assessment and write it off to bad luck.

In summary, while I won’t be happy about it, you can drop a tax professional like me in the middle of an IRS-created wilderness with very little to go on and I’ll find my way out.  But unless the IRS does a better job of providing clearer, more understandable guidance in their correspondence audits then regular people stand to lose a lot of money, either in tax assessments or professional fees.  And that’s precisely the kind of time-consuming, stressful, unexpected, and expensive situation that regular people need all the help they can get as they deal with all of the other pressures of day-to-day life.

What is the solution to successfully dealing with IRS audits?

Given the significant problems you can encounter with an IRS audit, what should you do?  There are no easy answers, but you basically have two alternatives.  First, you can have your tax return prepared by a competent tax professional who will stand behind their work in the event that you are audited.  Second, you can roll up your sleeves, learn how to deal with your own tax situation, and then take care of your problems yourself.

I believe the latter – tax self-sufficiency – is the best route to take.  Taxes can be a significant expense, so it’s unwise to be totally unaware of how they’re calculated if you can at all help it (register with this website or like it on Facebook for more guidance from future articles!).  Finally, even if you find you cannot handle a certain tax issue yourself, the efforts you do make to understand it will almost certainly pay off since it will better enable you to make informed decisions based on the guidance of your tax advisor.


[1] Note that I have changed the actual amounts to easier illustrate the principles outlined in this article.

Do I Have To File Taxes

Do I Have To File A Federal Income Tax Return?

 “If it makes you smile, you gotta file.”

Identify all of your sources of income

When it comes to taxes, the first thing you need to do is determine whether you are even required to file an income tax return in the first place.  And since it’s an income tax return, the easiest, most intuitive way to get a handle on whether you have an April 15th tax filing requirement is to first list all of your sources of income for the prior year.[1]  To be comprehensive, don’t worry right now about whether the income may or may not be taxable; just list the source of any money or property that you received during the year, which may include:

  • Salary, wages, bonuses, commissions, or any other kind of employee-based compensation or earnings[2]
  • Interest and investment income (dividends, gains from the sales of investments, etc.)
  • Gross self-employment (or “side business”) income[3]
  • Social Security
  • Scholarship income[4]
  • Any other type of income.

Now that you’re thinking about all of your sources of income for the prior year, there are a few that you can scratch off your list, because they don’t count as “income” for tax purposes.

  1. Gift income and other support – While there may be tax implications for the giver of substantial gifts (those exceeding $13,000), there are none for the person receiving the gift.
  2.  Inheritance income – Similar to gifts, there may be income tax implications for the estate of the deceased individual, but there are none for the beneficiary of an inheritance.
  3. Loan proceeds – Loan proceeds are considered debt, not income, so cash you receive from any kind of loan is not taxable.

Now that you have a better handle on what counts as “income” for tax purposes, here are the tax filing possibilities that lie before you.

  1. Your income exceeds a certain threshold and you are required to file a tax return.
  2. While your income may be below the applicable thresholds, you should file a tax return because it’s to your advantage to do so.
  3. You are relieved from the burden of filing an income tax return because your income is below the necessary threshold and you don’t have any tax benefits to claim by doing so.

For this article I will focus primarily on Item #1, or determining whether or not you are required to file a tax return.

When are “regular people” required to file a tax return?

If you’re a “regular person” living on your own (meaning you’re no longer a dependent of your parents or a guardian) and you earn most of your money by working, you aren’t required to file a federal income tax return unless your total income for tax purposes exceeds $9,500 (or $19,000 if you’re married).

Example

You’re single, 25 years old, and you just received a $15,000 inheritance from your grandmother.  You use this money to go back to college for an advanced degree.  You also get a student loan of $10,000.  You deposit both the inheritance and the student loan in a savings account and draw upon it as needed for tuition, books, and living expenses.  This account earns $300 of interest over the course of the year.  Also, to make ends meet, you decide to work part-time while taking classes and make an additional $5,000.

In this case you are not required to file an income tax return because your “income” for the year was only $5,300 ($5,000 wages plus $300 of interest), which is below the tax filing threshold of $9,500 for a single person. Remember, the $15,000 you received as an inheritance and the $10,000 school loan are not considered income for purposes of the tax filing purposes.

Self-employed individuals have strict tax filing requirements

The most stringent requirement for having to file a tax return for regular people has to do with self-employed individuals.  For purposes of this test, “self-employed persons” are those who are in business for themselves (which includes having a little “side business”).  It also includes those who are “independent contractors,” as well as those who are partners in a partnership. The rule is this: self-employed people must file a tax return if their net earnings from self-employment are $400 or more.

Example

Let’s assume that you’re still that student above, and that your “income” from wages and interest is still $5,300.  During the year you notice that students like to wear tee shirts having to do with the school’s sports teams.  To make a little extra money, you spend $300 designing and making sports shirts and sell them over the course of the year for $1,000.  Thus, your net income from self-employment was $700 ($1,000 less $300).

Your gross income from self-employment ($1,000) is counted as part of your total income form tax purposes, which is now $6,300 ($5,000 wages, $300 interest, and $1,000 of gross self-employment income).  That’s still below the $9,500 tax filing threshold for a single person.  However, since your net self-employment income of $700 exceeds the $400 threshold, so you are required to file a tax return.

Dependents are not necessarily exempt from filing tax returns

Contrary to the belief of some, there is no automatic tax filing exception for “dependents” solely based on their age.[5]  This is a very important concept, so let me say it again in another way.  No matter how young someone is (it could be an infant) or how reliant one might be on others (they could be someone that’s 100 years old, living under the care of a relative, unable to do anything for themselves), even if you’re a dependent you have to file income tax returns if you meet any 1 of the 3 following tests.

  1. Your employee-related earned income was more than $5,800.
  2. Your unearned income, or income from interest, dividends, and gains on the sale of investments was more than $950.
  3. Your gross income was EITHER more than the larger of $950 OR your earned income up to $5,500 plus an additional $300.

Of the 3 tests, the third one is definitely the most confusing.  It addresses the situation where earned income is below $5,800 and unearned income is below $950, but on a combined basis they exceed the “either/or” threshold outlined above.  Where the third test particularly comes into play if you’re a dependent is if you have a decent amount of earnings and you have more than $300 of investment-type income.

Example 1

You earned $4,800 in wages during the year and also received $200 of interest income from a savings account.  You do not have to file a tax return because your earned income is less than $5,800, your unearned income is less than $950, and your gross income of $5,000 ($4,800 plus $200) is less than the “either/or” filing threshold amount of $5,100, which is equal to your earned income of $4,800 plus $300.

Example 2

You earned $1,000 in wages during the year, and you also received $350 of interest and investment-type income.  While your earned income is less than $5,800 and your unearned income is less than $950, you still have to file a tax return because your gross income of $1,350 ($1,000 plus $350) is greater than the “either/or” filing threshold amount of $1,300, which is equal to your earned income of $1,000 plus $300.

As a note to parents, if you have a child that has a tax filing requirement because their unearned income exceeded the $950 threshold and they have no other sources of income (from wages, for example), you may have the option to simplify things by reporting their income on your return rather than having them file their own.  To see of you qualify refer to IRS Publication 17, chapter 30.

Do seniors qualify for any tax filing exemptions?

Given that a substantial number of seniors are among the nation’s millionaires and billionaires, you can be sure that age alone does not exempt anyone from having to file a tax return.  But what about seniors at the other end of the financial spectrum, those who are struggling just to make ends meet?  Do they get any tax filing breaks beyond those granted to “regular people?”  The answer is yes, and it has to do with how Social Security is treated.  Specifically, when seniors are evaluating whether their gross income exceeds the tax filing threshold of $9,500 (19,000 for married couples), Social Security does not have to be considered as “income” unless one half of the Social Security benefits plus other gross income (including any tax-exempt interest) is more than $25,000 ($32,000 for married couples).

Example 1

A widow over 65 received $13,000 in Social Security benefits.[6]  She also worked a few times a week, making $1,500 over the course of the year.  To cover other expenses she drew $1,000 from a regular savings account.  The savings account generated $400 of interest income.  Given these facts, did the widow meet the $9,500 tax filing requirement?  At first it might seem like she did, because her total “cash income” for the year was $15,900.  However, upon closer examination the widow does nothave to file a return because her total income for purposes of the tax filing threshold was $8,400, just below the $9,500 filing limit for a single person.  This is illustrated as follows.

Example 2

Assume the same facts as above, except that instead of withdrawing $1,000 from a regular savings account to cover living expenses, the widow took it as a distribution from a tax-favored retirement, pension, or individual retirement account (or “IRA”).  If that were the case then the widow’s income for purposes of the tax filing threshold would increase from $8,400 to $9,400, which is still below the tax filing limit of $9,500.  However, by taking a retirement account distribution the widow will automatically be required to file a tax return (see the section “Other reasons you may have to file an income tax return” below).

Finally, for purposes of the tax filing test, Social Security benefits have to be fully counted as income (meaning you don’t qualify for the 50% exemption) if you’re married filing a separate return (as opposed to a joint return) and you lived together at any point during the tax year.[7]

Advance Earned Income Credit Payments

If you received advance earned income credit payments in your paycheck then you must file a tax return.  However, this would only occur if you provided your employer with a completed IRS Form W-5, “Earned Income Credit Advance Payment Certificate.”

To provide just a little more background, the earned income credit is a tax benefit that’s available for qualifying individuals who have earned income, but they don’t make very much money.  Those to whom the credit applies often get tax refunds after they file their tax returns (see more on this below).  However, rather than wait for a lump sum in the form of a tax refund, some people would rather have more money in each paycheck in the form of advance earned income credits payments (which, again, is the purpose of completing Form 5).

Other reasons you may have to file an income tax return

If you’re still reading this article then it’s probably for 1 of 3 reasons.

  1. You’re captivated by my writing style (unlikely),
  2. You’re very thorough (likely), or
  3. You’re awfully close to not having to file an income tax return.

What I have reviewed so far are the rules that are most likely to cause regular people to have an income tax filing requirement.  However, it’s still possible that you have something else going on that will trigger an automatic filing requirement.  Here are some of the more likely remaining possibilities.

  • You owe Social Security and/or Medicare on unreported cash wages such as services or tip income.  Does this mean the IRS is going to come crashing through the door and cart off your child if they don’t report Social Security and Medicare taxes on a little bit of babysitting income?  As a practical matter, no, probably not (though technically it is reportable for tax purposes).  However, if you receive more than a nominal amount of cash from services or tips then this is something you need to pay attention to.
  • You took taxable distributions from a plan such as an IRA, 401(k), education savings account (or “ESA”), an Archer Medical Savings Account (or “MSA), or some other type of tax-favored account (this is what caught the widow in Example 2 in the “Seniors” section).

If neither of these factors applied to you then you’re at the homestretch, but be aware that there are still some obscure rules remaining that could cause you to have to file a return.  These remaining tax filing requirements fall into 3 categories.

  1. “Recapture rules” apply to you – This would occur if you had previously claimed a federal tax benefit, but now you no longer qualify.  For example, let’s say (and I’m making this up) that your qualified for a $1,000 Federal tax benefit to complete 2 years of technical training, but you dropped out after the first year.  By not completing the second year you could be subject to “recapture rules,” meaning you would have to pay back the Federal government $500 for not completing the second year of your training.  So again, think about whether you’ve received any special federal tax benefits for which you may no longer qualify.  If that’s the case then recapture rules could potentially apply, but if not then you don’t have anything to worry about.
  2. You owe “alternative minimum tax” – Without getting into a long-winded explanation of the alternative minimum tax (or “AMT”), I will say that it’s extremely unlikely to apply if you fall below the income thresholds listed above.
  3. Household employment taxes – This would only apply to you if you paid $1,000 or more of cash wages to a household employee (such as a gardener or cook), something that would be very unlikely for a regular person who has income below the filing requirement threshold!

If you’ve gone through this entire process and still think you don’t have an income tax filing requirement, the last thing to do is read over the section, “Do I Have To File a Return,” on page 5 in the IRS’s Publication 17, paying particular attention to Table 1-3, “Other Situations When You Must File a 2011 Return.” [8]  If you don’t understand something on the table then you first need to apply some common sense.  For example, you might not have a clue how the first-time homebuyer’s credit works, but if you didn’t buy a home then you can be sure that it doesn’t apply to you!  In summary, for purposes of determining whether you need to file a tax return, it’s often more practical to determine if a tax rule doesn’t apply to you than it is to understand exactly what the rule is and all the details of how it works.

What if you’ve living outside of the United States?

As a final exception, what if you don’t even live in the United States?  Do the tax filing requirements still apply to you?  The answer is whether you’re herding camels in the Sahara, painting on street corners in Paris, or living in an underground cave on the dark side of the moon, if you’re a U.S. citizen or a green card holder with a heartbeat anywhere in the known universe and you meet any of the requirements above then you have an income tax filing requirement (although you many not necessarily owe any taxes with your return).

You “should” vs. you are “required” to file an income tax return

In conclusion, I want to remind you that the focus of this article has been on helping you determine whether you are required file an income tax return as opposed to whether you should file an income tax return.  In other words, if you follow the entire process outlined above and you don’t exceed any of the applicable income thresholds, and none of the automatic filing triggers apply to you, it’s true that you don’t have to file an income tax return.  However, it may still be to your advantage to do so.

But why would you want to go to the trouble to file a tax return if you didn’t have to?  The main reason is to obtain a tax refund from the government that you would lose if you did not file a tax return.  There are 2 common situations where regular people should strongly consider filing a tax return, even when it’s not required.

  1. To get a refund for Federal income taxes deducted from your paycheck over the course of the year when a properly completed tax return will show you didn’t owe any tax at all (or at least you owed less tax than was withheld from your paychecks).
  2. To claim the earned income credit (or “EIC”).  This is the Federal tax program referred to above, which is designed to help low-income individuals and families.  The EIC is what’s known as a “refundable credit,” meaning that if you qualify, you can get a tax refund from the Federal government even though you didn’t make enough money to owe taxes (or the taxes you do owe are less than the total EIC you’re qualified to claim).

In summary, based on the rules outlined in this article, you might flat out be required to file an income tax return.  On the other hand, it may turn out that you’re not required to file a tax return but, as I just pointed out, there are common situations where you should because it’s in your best interest to do so (meaning you’re due a tax refund).  And finally, if you don’t have to file a return and you wouldn’t benefit financially from doing so then don’t worry about it, because you’re off the hook![9]


[1] The tax return you file on April 15th of this year (2019) is to calculate and pay tax on your income from the prior year (2018).

[2] Your employer should report this kind of income to you on a Form W-2 around the end of January each year.

[3] “Gross income” in this case means your total sales, or the full amount of money you took in for your business before taking any expenses into account.

[4] Scholarships can be exempt from taxable income, but a complete analysis is beyond the scope of this article.  For more information see IRS Publication 970.

[5] A complete discussion of who qualifies as a “dependent” is beyond the scope of this article.  For more information see IRS Publication 17.

[6] In 2018 the average Social Security benefit was $1,081 a month.  See http://www.ssa.gov/pressoffice/basicfact.htm

[7] For what it’s worth, if you’re married it’s rarely to your advantage to file separate as opposed to filing a joint return with your spouse, so this situation will only come up in unusual circumstances.

[8] Remember that this article only deals with Federal income tax filing requirements.  You need to check separately to see whether or not you are required to file a state income tax return.

[9] This article is intended to be a summary of the tax rules discussed; it is not a substitute for them.  For more information see this website’s legal disclaimer.