Module 5: individual income tax formula

Individual Income Tax Formula

• The formula for individual income tax includes several components, making it more complex than the corporate tax formula.

Components of the Income Tax Formula

• Gross Income Calculation:

  • Begins with total income minus exclusions.

  • Example: Wages earned minus any applicable exclusions.

Deduction Categories

• Individual taxpayers have three separate categories for deductions:

  1. Adjustments (Deductions for AGI):

     • Taken right after gross income.

     • Gross income minus adjustments leads to Adjusted Gross Income (AGI).

     • AGI is significant for several tax provisions that rely on this number.

  2. Itemized Deductions or Standard Deductions:

     • Taxpayer can choose between itemized deductions or a standard deduction.

     • Only the larger amount is utilized in the tax calculation.

  3. Qualified Business Income (QBI) Deduction:

     • Also known as Section 199A deduction.

     • Not all taxpayers qualify for this deduction.

Taxable Income and Tax Liability

• After all deductions are taken, the remaining amount is taxable income.

• Tax Calculation for Individuals:

  • Uses graduated tax brackets (unlike the flat rate for C corporations).

  • Higher income results in higher applicable tax rates.

Additional Taxes

• After calculating tax on taxable income, any additional taxes (e.g., self-employment tax, additional Medicare tax) are added to the total.

Subtracting Tax Credits

• Tax credits may include:

  • Federal income tax withheld or prepaid.

  • Various credits (e.g., child tax credit, education credits).

• Total tax minus tax credits results in:

  • Positive number: tax due.

  • Negative number: tax refund.

Example Calculation: Mason's Tax Situation

• Background Information:

  • Age: 35, Single

  • Wages: $76,000

  • Exclusions: $1,000

  • Adjustments: $1,000

  • Itemized Deductions: $12,000

  • Standard Deduction: $14,600

  • Federal Tax Withheld: $5,000

  • Tax Credit: $2,500

Steps in Calculation

1. Gross Income:

   • Calculation: 76,000 - 1,000 = $75,000

2. Adjusted Gross Income (AGI):

   • Calculation: 75,000 - 1,000 = $74,000

3. Taxable Income:

   • Comparison: 12,000 (itemized) vs. 14,600 (standard)

   • Choose: $14,600 standard deduction.

   • Calculation: 74,000 - 14,600 = $59,400

4. Calculate Tax Liability:

   • Tax Rate: For single taxpayers, the taxable income of $59,400 is between $47,151 and $100,525.

   • Formula: $5,426 + 22% of taxable income over $47,150.

   • Calculation for Mason:

     • Tax on $59,400 = $5,426 + 0.22 * ($59,400 - $47,150)

     • Total Tax Liability = $8,121

5. Impact of Withholdings and Credits:

   • Total Tax Liability: $8,121

   • Subtract Withholding: $5,000

   • Subtract Tax Credit: $2,500

   • Final Amount Due: $621

Conclusion

• Mason will need to pay $621 when filing his tax return for 2024.