Throughout the Year

• If you are filing a tax return, you have earned income and paid taxes throughout the year. The tax preparer adds up any income you have received throughout the year, both earned and unearned. Earned income is any taxable income. Unearned income is any other income. After the preparer calculates your total income, he calculates the taxes you paid throughout the year, the expenses you paid and determines if you are eligible for tax credits and other tax benefits.
  
  

Income and Deductions

• As a taxpayer, you want your income low. So, you want to reduce your income as much as possible by deducting expenses or by taking the standard deduction; whichever benefits your situation more. After the preparer adds all of your earned and unearned income and then subtracts your deductions, the number she ends up with, your taxable income, is usually much different than your yearly income from your employer. Based on your taxable income, the IRS determines the appropriate amount of tax you should pay, or your tax liability. According to the 2010 IRS Tax Tables, if your taxable income is $30,000 and your filing status is head of household, your tax liability is $3,906.
  
  

Tax and Credits

• Tax credits reduce your tax liability in two ways. The IRS allows for the direct subtraction of some tax credits from your tax liability amount, such as the child tax credit and education credits. For example, if your tax liability is $3,906 and you receive the child tax credit for two children, your tax liability amount is reduced by $2,000 to $1,906. The IRS also allows for the addition of some tax credits to the amount of taxes you paid throughout the year, such as earned income credit and the first time home buyer's credit. According to the IRS, the maximum earned income credit for two qualifying children is $5,036. If you paid $1,500 in taxes throughout the year and you also receive $5,036 earned income credit for your two children, your total payments are $6,536.
  
  

Overpayment or Underpayment

• In this example, your tax liability is $1,906 and your payments are $6,536. After the preparer subtracts your liability amount from your payments, you have "overpaid" the government $4,630 and you are entitled to a refund. If you had a higher tax liability than the amount of your payments, you would have "underpaid" the government and you would then owe money to the IRS.