Exemptions and deductions

Once you determine your adjusted gross income (AGI), you subtract the exemptions and deductions you’re entitled to take to find your taxable income. On IRS Forms 1040 and 1040A, you enter those amounts on separate lines. But on Form 1040EZ, the two are combined and entered on a single line.

Exemptions and deductions can save you money because they reduce the amount of income on which tax is due. But if you’re eligible for substantial reductions you may find that you must pay the alternative minimum tax (AMT). If that’s the case, you’re likely to pay more in tax than you would otherwise, and there may be very little you can do to avoid it. You should consult a tax adviser in this situation.

Exemptions

Exemptions are amounts that you can subtract for yourself, your spouse if you file married filing jointly and each of your dependents. The value of the exemption is fixed, but generally increases each year to account for inflation. For example, for 2006, you can deduct $3,300 for yourself, another $3,300 for your spouse and so on. The more dependents you have, the higher your exemptions.

The dependents for whom you claim an exemption must be either your children or another qualifying relative. You can use the instructions that accompany the tax form you’re using to determine whom you’re entitled to claim. Remember that each qualifying dependent must have a Social Security number or an individual taxpayer identification number (ITIN).To obtain an ITIN, you need to complete IRS Form W-7, which is also available in Spanish. For information, visit the IRS website at www.irs.gov.

Deductions

Deductions are amounts you can subtract from income to offset certain expenses you had during the year. Most taxpayers use the standard deduction, which is a fixed amount that generally increases each year. In 2006, the standard deduction is $5,150 for a single filer, $10,300 for married couples filing a joint return and $7,550 for heads of household. The standard deduction is higher if you’re 65 or older and/or if you’re legally blind.