Comprehending how to calculate the taxable income is fundamental to effective planning and compliance. Computing taxable income correctly ensures you pay exactly what is required, neither more nor less.
L&Y Tax Advisors further guides you how to calculate taxable income using the most up-to-date principles.
What is Taxable Income and How is it Determined?
To know what is the taxable income, know that it is the portion of your gross income subjected to tax after making eligible deductions and adjustments.
- Start with all income you receive during a tax year.
- Reduce that by allowable deductions, exemptions, and adjustments.
- You will arrive at the final amount which the tax authorities use to calculate your tax liability.
Which Type of Income is Taxable?
Taxable income includes:
- Wages
- Salaries
- Bonuses
- Tips
- Freelance income/earnings
- Business earnings
- Rental income
- Investment income (interest, dividends or capital gains)
Based on local regulations, some sources of income may be non-taxable. For example:
- Certain gifts
- Inheritances
- Life insurance proceeds
- Specific types of benefits
Click here to read more about which type of income is taxable.
How to Calculate the Taxable Income?
To compute taxable income, follow these general steps:
- Add up all your gross income from all sources for the year.
- Subtract ‘above-the-line’ deductions or allowable adjustments, such as retirement plan contributions.
- You will arrive at an outcome called ‘Adjusted Gross Income’ (AGI).
- From the AGI, subtract either a standard deduction or your itemized deductions – if itemizing yields greater benefit – along with any applicable exemptions.
- The result will be your taxable income. It is the figure on which the applicable tax rates will be applied.
How to Calculate the Taxable Income Example?
Suppose your gross income for the year is USD 80,000. Now:
- Subtract above-the-line adjustments (say USD 5,000).
- The AGI will be USD 75,000.
- Subtract the standard deduction (say USD 12,000).
- This yields a taxable income of USD 63,000.
- USD 63,000 is the amount subject to tax. Deductions and exemptions have already been accounted for.
Instead, if you itemize deductions (like mortgage interest) and they sum to USD 15,000 – and that exceeds the standard deduction – then subtract USD 15,000. The taxable income will be USD 60,000.
The Bottom Line
Knowing how to calculate taxable income is a structured process. Do this calculation right to stay in compliance. For further clarification, feel free to reach out to us. Our experts are always at your service to help in your personal or professional financial matters.
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