A clear concept of the computation of taxable income under Internal Revenue Code can actually simplify your understanding of US tax laws. The tax is computed on an income that is computed in a prescribed manner . If you mix the steps , the taxable income will be wrongly computed. So here are the step :
How to Compute Tax – in Steps
Step1 : Add all your earned income and unearned income ( taxable plus non-taxable in your opinion ). This maybe called Gross Income.
[ In step 1 , you should write down all earned and unearned income -wages,perquisites,gifts, alimony , lottery income,dividend,interest etc and aggregate it to represent all income you received during the tax year.]
Step 2: From Gross Income – deduct Non-taxable Income . This is Gross Income.
[ Then , find out which receipts during the tax year , added in step 1 , falls under the definition of term Non-Taxable Income . For example , disaster relief or federal tax refund or child support etc are non-taxable income . See the list of non-taxable income under US tax laws.]
Step 3 : Then deduct above the line deductions from Gross Income. The net balance i,e( Step 2- Step3) is Adjusted Gross Income.
[ Read more what is adjusted gross income ? There are a number of tax deductions available to a tax payer as detailed below
- Tax Deductions for Life-Changing Events
- Tax Deductions for Families and Parents
- Tax Deductions for Teachers, Educators
- Tax Deductions for Employees/Workers
- Medical Tax Deductions
- Tax Deductions for Homeowners
- Charity Tax Deductions
- Tax Deductions for Car and Travel
- Student Tax Deductions ]
Step 4 : Deduct following from Adjusted Gross Income
(i) Standard deduction or Itemized Deductions , whichever is higher.
After deducting , both , the adjusted gross income becomes taxable income.
Step 5 : On the taxable income ( step 4) , apply the tax bracket to find out tax payable by you.
Step 6: From tax payable deduct the tax credit available to you.
Step 7 : The balance ( Step 5 – Step 6) is the tax to be deposited .