The Journey of a Dollar: From the Cash Register to the Tax Return

Money "flows" through and between tax forms, schedules, and returns.

Let me introduce you to the main character of the story: a dollar. Spoiler alert: the dollar will not be getting out alive. Here's the story of its journey as it works its way through a tax return to be taxed into pieces. Accountants like to think of money or value as flowing downhill, like a river, to its ultimate source... your tax return. It all belongs to your until it reaches the top of the second page of your Form 1040. Let’s start with a single dollar of revenue for a cash basis S corporation. From the moment it reaches the cash register, the $1 goes to:

Form 1120-S, U.S. Income Tax Return for an S Corporation, line 1a – Gross receipts or sales: $1.

After escaping the cost of goods sold (COGS) and all the ordinary and necessary business deductions, it ends up on line 22 – Ordinary business income (loss): $1.

From there, it transfers back to Schedule K, Shareholders’ Pro Rata Share Items, line 1: $1

It then flows-through the S corporation without being taxed, onto Schedule K-1 (Form 1120-S), Shareholder’s Share of Income, Deductions, Credits, etc., box 1 – Ordinary Business Income (loss): $1

Now it enters through the back door of the shareholder’s Form 1040, through Schedule E, Supplemental Income or Loss, line 28(k).

After adding up all the income from all taxpayer’s pass-through entities, it gets totaled on line 29a – Totals: $1.

We are still on Schedule E (Form 1040), as it works its way inexorably to the bottom of the page. It gets added on line 30, along with any passive income: $1

After it survives being offset by any losses, it makes it to line 32 – Total partnership and S corporation income or (loss): $1

Finally, it gets combined with all other pass-through income on line 41 – Total income or (loss): $1.

It is then kicked onto Form 1040’s feeder schedule: Schedule 1, Additional Income and Adjustments to Income, line 5 – Rental real estate, royalties, partnerships, S corporations, trusts, etc.: $1.

It gets smushed together with a bunch of other income, as applicable, and ends up on the bottom of page 1 of Schedule 1 (Form 1040), line 10 – Additional Income: $1.

Now our dollar is ready for front and center stage! Form 1040, U.S. Individual Income Tax Return, line 8 – Additional income from Schedule 1 (Form 1040), line 10: $1.

See how everything is linked like a spreadsheet! That’s not by accident. It gets smushed with other income sources on line 9 – Total income: $1.

Now it needs to survive all those above-the-line deductions from page 2 of Schedule 1 (Form 1040), AKA “adjustments.” Finally, our dollar finds itself on line 11 – Adjusted Gross Income: $1.

It must now fight for its life to make it to Valhalla. The two enemies are the Standard Deduction or the Itemized Deductions from Schedule A (Form 1040). Actually, the taxpayer gets to decide which enemy it gets to fight. We usually pick the strongest one.

If the taxpayer is a business owner or self-employed, the last fateful enemy our little dollar will face after the below-the-line deductions is the Qualified Business Income Deduction, which is calculated on Form 8995 or Form 8995-A (for more complicated situations).

It has made it! Line 15 – Taxable Income: $1

Our dollar’s reward is the choice of two beautiful sirens from the government. To be honest, there’s a whole haram from the state, county, local government, property tax, sales tax, etc., but let’s just focus on the federal income tax.

1. Tax Rate Schedule, updated for inflation each year. Depending on the taxpayer’s filing status, our dollar will be multiplied by a percentage ranging from 10% to 37% depending on how many dollars it’s standing on top of. Let’s say it’s the 100,000th dollar for a married couple filing jointly in 2024. It will be multiplied by 22%, then slashed into two pieces. The taxpayer gets to keep 88¢, and the IRS will be entitled to collect 22¢.

   
   

2. Schedule D Tax Worksheet, found at the end of the Instructions for Schedule D (Form 1040), which combines the preferential long-term capital gains tax rates with the marginal tax rates for ordinary income. Most tax liabilities can be calculated using this sheet. Unfortunately, our hero is not a qualified dividend or long-term capital gain. It's just a single dollar of ordinary income.

Regardless of where it’s calculated, the ordinary income tax on every dollar of taxable income will end up on Form 1040, line 16 – Tax: 22¢.

It will then get added by any other additional taxes. For example, if our dollar was self-employment income, we would strip another 15.3¢ away, via line 23. (Self-employment tax will generate a Schedule 1 adjustment, which will lower AGI, but I’m keeping things simple here. Also, distributions from S corporations are not subject to self-employment tax.) Did I mention the tax code is full of rules, exceptions, and landmines?

Assuming there are no tax credits, our 22¢ of tax will end up on line 24 – Total Tax: 22¢.

Unfortunately, this dollar is not considered wages to the taxpayer, so the 22¢ wasn't withheld from their paycheck. As a business owner, hopefully they made their quarterly estimated tax payments. Once the payments, if any, are added up, what ever tax is left over goes on line 37 – Amount you owe: 22¢.

It’s now April 16th. Hopefully you filed your tax return by yesterday or extended its due date. 2024 income taxes were due yesterday. Now you have something called a “balance due:” 22¢.

From now on until your… erm… the US Treasury’s 22¢ is received by government, the IRS will start adding penalties and interest on your balance due. The interest compounds daily. The penalties accrue every month, or part of a month. Meanwhile, your remaining 88¢ gets to meet one or more of the 41 + D.C. other states' income tax systems.

For our next blog, I’ll tell you what a Notice CP14 is.