How Income Taxes Work?

The Internal Revenue Service estimates that taxpayers and businesses spend about 8 billion hours a year complying with tax-filing requirements. To put this into perspective, if all this work were done by a single company, it would need about four million full-time employees and be one of the largest industries in the U.S.

As complex as the details of taxes can be, the income tax process is fairly straightforward. However, the majority of Americans would rather not spend time with the process, which explains why more than half hire a tax professional to assist in their annual filing.

Remember, this material is not intended as tax or legal advice. Please consult a professional with tax or legal experience for specific information regarding your individual situation.




Getting Started

The tax process starts with income, and generally, most income received is taxable. A taxpayer’s gross income includes income from work, investments, interest, pensions, as well as other sources. The income from all these sources is added together to arrive at the taxpayers’ gross income.

What’s not considered income? Gifts, inheritances, workers’ compensation benefits, welfare benefits, or cash rebates from a dealer or manufacturer.3

From gross income, adjustments are subtracted. These adjustments may include retirement plan contributions, half of self-employment, and other items.

The result is the adjusted gross income.

From adjusted gross income, deductions are subtracted. With deductions, taxpayers have two choices: the standard deduction or itemized deductions. 

Chart Source: IRS.gov, 2023

Itemized deductions can include state and local taxes, charitable contributions, the interest on a home mortgage, and certain unreimbursed job expenses, among other things. Keep in mind that there are limits on the amount of state and local taxes that can be deducted.4

Once deductions have been subtracted, the result is taxable income. Taxable income leads to gross tax liability. But it's not over yet.

Any tax credits are then subtracted from the gross tax liability. Taxpayers may receive credits for a variety of items, including energy-saving improvements.

Understanding how the tax process works is one thing. Doing the work is quite another.

1. NTU.org, April 18, 2022

2. IRS.gov, 2023

3. The tax code allows an individual to gift up to $17,000 per person in 2023 without triggering any gift or estate taxes. An individual can give away up to $12,920,000 without owing any federal tax. Couples can leave up to $25,840,000 without owing any federal tax. Also, keep in mind that some states may have their own estate tax regulations. This material is not intended as tax or legal advice. Please consult a professional with tax or legal experience for specific information regarding your individual situation.

4. The mortgage interest deduction is the first $750,000 of the loan for a home and the state and local income taxes deduction is capped at $10,000.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2023 FMG Suite.

Comments

Post a Comment

Popular posts from this blog

Why Do You Need Professional Tax Preparation Services in Michigan?

Image
Tax season often brings with it a set of familiar anxieties. The confusion of understanding complex tax laws, the daunting task of organizing financial documents, and the constant worry of potentially missing out on deductions or credits are shared pain points that individuals and businesses experience. However, there is a solution to these annual challenges – professional tax preparation services. These experts are like your tax wizards, making sure you do things right and get the most out of your tax returns. Whether you're an individual, a small business owner, or a corporation. In this blog, we'll explore the essential reasons why relying on professional tax preparers is the key to a hassle-free and financially rewarding tax season. Here are some benefit of Taking Professional Tax Preparation Services:   The Complexity of Tax Laws We all know that tax laws can be quite intricate and are always evolving. Navigating through tax codes can be. If you lack expertise it's e...
Read more

Tax Rules When Selling Your Home

Image
 How the gains from the sale of a primary residence are taxed has changed in recent years. If you have recently sold your home or are considering doing so, you may want to be aware of these new rules. Home Sale If you owned and lived in your home for two of the last five years before the sale, then up to $250,000 of profit may be exempt from federal income taxes. If you are married and file a joint return, then it doubles to $500,000.1 To qualify for this exemption, you cannot have excluded the gain on the sale of another home within two years of this sale. Please consult a professional with tax expertise regarding your individual situation.2 This profit would be excluded from your taxable income. In fact, the sale may not need to be reported unless you receive a Form 1099-S or do not meet the above requirements. If you sold your home at a loss, unfortunately, you can't deduct the loss. There Are Exceptions Even if you do not meet the above requirements, you may qualify for this ex...
Read more