Individual Income Tax Formula

Regarding Income Taxes, the concept of Gross Income means all income that is taxable, which is also known as Total Income. After making some relatively minor adjustments to Total Income, which are additions and subtractions, we arrive at Adjusted Gross Income, or AGI. For AGI includes every type of income that is taxed. For AGI means before AGI. However, not every type of income is taxed. The three requirements for income to be taxable is that the taxpayer must receive an economic benefit, the income must be realized, and the income must be recognized. For example, a loan is not taxable because it does not provide an economic benefit. Common types of income that are taxed include wages and salaries, interest (except municipal bond interest), dividends, capital gains and losses, regular IRA distributions, retirement plan distributions, most Social Security payments, and income from any type of business, including income from any type of rental and royalties. Common types of income that are not taxed include gifts, inheritances, life insurance proceeds, alimony received, child support received, and municipal bonds.Tax planning involves legal methods to lower a taxpayer’s tax liability involving timing strategies and income shifting strategies. Timing strategies include postponing income and accelerating expenses when legally possible. Income shifting strategies include moving income to taxpayers or associated business entities have lower marginal tax rates when legally possible. Tax evasion is the intentional effort to avoid paying the amount of tax that is legally owed. Tax evasion is illegal and it is subject to various civil and criminal penalties. Municipal bonds are bonds issued by any government entity other than the federal government. Thus, municipal bonds are issues by states, counties, cities, towns, school districts, sewer and water districts, state and local transportation authorities, airport authorities, and other similar state and local government entities. Constructive receipt means that a taxpayer needs to include amounts in income when those cash inflows are made available to the taxpayer unconditionally, regardless of whether the taxpayer arranges to put those cash inflows into use. Exclusions refer to income that is never taxed. The gain on the sale of a personal residence is an example of an exclusion. Deferrals refer to income on which the tax is postponed. Examples of deferrals are installment sales and like-kind exchanges. From AGI refers to the fact that each taxpayer needs to take the greater of their Standard Deduction or Itemize their Deductions. The Standard Deduction amounts are based on Filing Status. The available filing statuses are as follows: Single, Head of Household, Married Filing Jointly, Married Filing Separately, and Qualifying Widower (also known as Surviving Spouse.) Taxpayers must qualify for each one of the Filing Statuses. They cannot simply arbitrarily select whatever filing status they wish, except that a couple that is legally married may select to either file as Married Filing Jointly or Married Filing Separately. Itemized Deductions are always for personal expenses. They are never for business expenses, or for expenses related to rentals of any kind. Itemized Deductions are always for items that the taxpayer has paid for. They are never for items that the taxpayer has received payment for. Itemized Deductions are only for specific personal expenses, subject to strict rules that apply to the tax year for which the tax return is being filed. This entire Course is based on tax year 2021. Itemized Deductions are not for expenses that taxpayers think should be deductible, or for items that were deductible in tax years other than 2021 but are not deductible in 2021. For 2021, the available Itemized Deductions are medical and dental expenses; state and local income taxes or general sales taxes; real estate property taxes; home mortgage interest; investment interest; cash gifts to charity; non-cash gifts to charity; gambling losses to the extent that they exceed gambling winnings; and mileage for medical and for charitable purposes. To claim Itemized Deductions, taxpayers are required to keep records of their tax-deductible expenses. Taxable Income is Adjusted Gross Income, less the larger of the taxpayer’s Standard Deduction or their Itemized Deductions. There are two items prior to Taxable Income that it is unlikely that you will be tested on, which are (1) Charitable Contributions for those who take the Standard Deduction and (2) the Qualified Business Income Deduction. After determining Taxable Income, the next step is to determine the Tax, which is also known as the Tax Liability using the Tax Rate Schedule that corresponds to the taxpayer’s Filing Status. It is important to understand that the Tax, also known as Tax Liability, is determined before considering any Credits. Two additional amounts must be added to the Tax, also known as Tax Liability, if either one of both of these two items is applicable. The first is the Self-Employment Tax, which is 15.3% of net earnings from self-employment. The second is the Alternative Minimum Tax (AMT), which is an additional tax that affects a few wealthy taxpayers. Next, we will learn about Credits. Credits reduce the Tax, the same way that payments reduce the Tax. A Nonrefundable Credit can reduce the Tax as low as “0,” but it cannot create a Tax Refund. A Refundable Credit can create a Tax Refund. Many of the Credits require that we understand the rules for Dependents. To qualify as a dependent, a person must be either a Qualifying Child or a Qualifying Relative. A Qualifying Child must be under age 19, under age 24 if a full-time student, or permanently and totally disabled. This child must have lived with you for more than half the year and must not have provided more than half of his or her support. The child must be your son, daughter, stepchild, foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendent of any of them. A Qualifying Relative is not restricted by age. It can also be a non-relative who lives with you all year as a member of your household. You must provide more than half of the support for that person and the Qualifying Relative’s gross income for the year must not exceed $4,300. The family relationships for a Qualifying Relative are broader than for a Qualifying Child. For example, they include parents, stepparents, and grandparents. A taxpayer cannot claim any dependents if they are claimed as a dependent by another taxpayer. There are additional rules regarding dependents that apply in various specialized circumstances. The Child Tax Credit allows taxpayers to claim a credit of $3,000 for each child under the age of 18 and $3,600 for each child under the age of 6. The child needs to be a Qualifying Child as discussed above. Most of this credit is Nonrefundable. However, in some circumstances a portion of this credit is Refundable. The Child and Dependent Care Expenses Credit allows taxpayers to claim a credit of up to $8,000 for one qualifying person and up to $16,000 for two or more qualifying people to allow the taxpayer to work while paying for care of the qualifying person. A qualifying person is the taxpayer’s qualifying child who is their dependent and is under the age of 13, is the taxpayer’s spouse who is not able to care for himself physically or mentally or herself, and certain other members of a taxpayer’s household who are not able to physically or mentally care for themselves. In many cases in 2021, this credit is refundable. The American Opportunity Credit is one of two education credits. The maximum amount of this credit if $2,500 per student per year. To qualify, the student must be pursuing an undergraduate degree at an accredited college or university, and the student must be in the first four years of their degree program. The Lifetime Learning Credit is the second of two education credits. The maximum amount of this credit is $2,000 per taxpayer per year, even if more than one person in the taxpayer’s household qualifies for this credit. The credit exists to help pay for qualified educational expenses, which are tuition and certain related expenses for post-secondary courses taken by the student to acquire or to improve job skills. The Earned Income Credit is a Refundable Credit. To qualify for this credit, a taxpayer must be over the age of 19 if they do not have a qualifying child or they must have a qualifying child, cannot be claimed as a dependent by another taxpayer, unearned income must be $10,000 or less, and earned income must be within certain lower and upper limits. The Recovery Rebate Credit also known as the Individual Recovery Credit was a special cash payment to qualified taxpayers that was made only in 2021 due to Covid-19. Credits, tax withholdings, and estimated tax payments reduce the tax liability. Either a refund will then be owed by the IRS to the taxpayer or the taxpayer will owe an additional amount due April 15 to the IRS.