Welcome to the topic “Computing Your Taxable Income.”
Almost all types of income are considered taxable by the IRS. However, a tiny number of revenue streams are not.
Various tax agencies have different definitions of taxable and nontaxable income.
Here, we shall be discussing what taxable income is, which income is considered taxable, and how one would go about calculating their taxable income.
What Is Taxable Income?
The base on which an income tax system levies tax is referred to as taxable income. To put it another way, the income on which the government levied a tax. In most cases, it covers some or all sources of income, which is then reduced by expenses and other deductions.
The amount of an individual’s or a company’s income used to compute how much tax they owe the government in a given tax year is known as taxable income. Adjusted gross income (AGI) minus permitted itemized or basic deductions is a broad definition.
Wages, salaries, bonuses, and tips are all taxable income, as are investment income and numerous sorts of unearned income.
Essentially, the fraction of a person’s or company’s gross income that the government considers taxable is known as taxable income. Earned and unearned income are both included in taxable income. And, because of deductions, taxable income is typically lower than adjusted gross income.
Canceled debts, alimony payments, child support, government benefits such as unemployment and disability payments, strike benefits, and lottery payments are all examples of unearned income that are taxed.
Earnings from appreciated assets sold during the year, as well as dividends and interest income, are all included in taxable income.
Individual tax filers have the option of taking the standard deduction or a list of itemized deductions when it comes to deductions, according to the Internal Revenue Service (IRS). Itemized deductions include mortgage interest, medical expenditures over a certain amount, and a variety of other expenses.
Businesses do not record their revenue as taxable income when they file their taxes. Instead, they compute their business income by subtracting their business expenses from their revenue. After that, they deduct deductions to arrive at their taxable income.
While forgiven Paycheck Protection Program (PPP) loans are generally taxable, Congress exempted them from federal taxation. However, certain jurisdictions may regard the forgiven amount as taxable income or limit deductions for loan-related expenses.
Computing Your Taxable Income
The first step is to determine your filing status (single, married, etc.) and compile all of your income documentation (W-2, 1099, etc.).
The next step is to figure out your adjusted gross income (AGI), which includes “above-the-line” changes to your gross income, such as contributions to a qualified individual retirement account (IRA).
Then there’s the essential step of figuring out your deductions, which might be either standard or itemized.
After removing all available deductions from your AGI, your taxable income is what’s left.
Given below is a step-by-step guide of how you can accurately compute your taxable income.
1. Assess Your Filing Status
It would be best if you first decided your file status in order to compute your taxable income for an individual tax return.
If you are single and do not have a qualifying person for whom you pay more than half of the support and housing costs, you can file your taxes as a single filer or as a head of household if you have a qualifying person for whom you pay more than half of the support and housing costs.
If you’re married, you should probably file as married filing jointly (MFJ). However, there are a few occasions where filing as married filing separately makes sense (MFS).
2. Paperwork Of Income Sources
You’ll need to gather paperwork for all sources of income for yourself, your spouse (if applicable), and any dependents once you know your filing status (if applicable). Your gross income is the sum of all of these sources of revenue.
3. Compute Adjusted Gross Income (AGI)
The following step is to figure out your adjusted gross income. Your AGI is calculated by subtracting some above-the-line deductions from your gross income, including as contributions to a qualified individual retirement account (IRA), student loan interest, and certain educator expenditures.
These expenses are referred to as “above the line” since they reduce your income before any itemized or standard deductions are taken.
4. Standard Vs. Itemized Deduction
The next step is to figure out how much you’ve saved. As previously stated, you have the option of taking the standard deduction or itemizing your deductions.
If a taxpayer does not have enough itemized deductions, the standard deduction is a fixed amount that they can claim.
These are the records you’ll need if you want to itemize your taxes rather than take the standard deduction:
- Taxes and mortgage interest – This is usually found on a Form 1098, Mortgage Interest Statement, that your mortgage lender sends you. If you don’t have a mortgage and your property taxes aren’t paid through an escrow account, you’ll need to keep track of your payments individually.
- Local and state taxes – If you work for an employer, this will be on your W-2 form. If you work as an independent contractor, you’ll need to keep track of the quarterly scheduled tax payments you make throughout the year.
- Donations to charity – Donations to charity are a tax-deductible expense, but, in most years, the amount you can claim is limited to a percentage of your AGI.
- Expenses related to education – Note: if you use a student loan to pay for eligible educational expenditures, you must claim the deduction in the year the expenses are paid, not the year the loan profits are received or repaid.
- Medical bills that have not been reimbursed.
Qualified business income (QBI) deductions, real estate investment trust (REIT) dividends, and qualified publicly traded partnership (PTP) income may be available to owners of sole proprietorships, partnerships, S corporations, and some trusts and estates.
If you work as an independent contractor, you will almost certainly be eligible for this particular deduction.
5. Compute Taxable Income
You’ll need to subtract all relevant deductions from your AGI, which you computed before, to arrive at your taxable income.
These were the five simple steps that an individual should follow to compute their taxable income accurately.
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Also Read: Traditional IRA Vs. Roth IRA