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How to calculate your taxable income

One of the most common questions I'm asked as a tax attorney is "What's taxable?" Believe it or not, that's a pretty difficult question to answer, because the list is so lengthy. A much easier question would be, "What isn't taxable?" This is because our tax system is considered inclusive. In other words, all income is considered taxable unless otherwise excluded.

To figure your taxable income, you must first calculate total income. To do this, include everything you receive in payment for services. That means wages, salaries, commissions, fees, tips, as well as fringe benefits and stock options. Income which is available to you, such as an uncashed check, can still be included under the doctrine of constructive receipt. The same theory applies to deferred compensation: If you could take the income without incurring a significant penalty, it's considered yours when made available -- not when you take it.

In addition to payment for services, you must include other items of income, such as interest and dividends, alimony, business and farm income, capital gains, retirement income, partnership income, net proceeds from rentals and "other income." "Other income" may include income from the pursuit of a hobby; it may also include gambling income or income from illegal activities, like drug sales or prostitution (and no, I'm not making that up).

And don't be fooled: Income doesn't have to be in the form of cash or check. You can also receive income in the form of property or services.

After you've figured your total income, you can deduct some expenses right off the top to determine adjusted gross income (AGI). These include certain qualified expenses for teachers, moving expenses, and student loan interest. It also includes alimony paid out, deductions for IRA contributions and one-half of self-employment tax paid.

Next, subtract personal exemptions and deductions. Use the larger of your standard deduction or your itemized deductions in your calculation. The result is your taxable income.

You can boil these steps down to this basic formula:

Adjusted Gross Income less (deductions + exemptions) = taxable income

Your taxable income is what you'll use to calculate the tax due, using the applicable tax rates.

There are a few special considerations for 2009 to keep in mind:
  • Your economic recovery payment is not taxable for federal income tax purposes.
  • A federal subsidy for payment of COBRA health care coverage continuation premiums is not taxable for federal income tax purposes.
  • The first $2,400 of unemployment compensation is exempt from federal income tax. Unemployment compensation over that amount is taxable.
  • If you benefited from Pay-for-Performance Success Payments under Home Affordable Modification Program (HAMP), the payments are not taxable.
  • Despite rumors that were flying around earlier in the year, the receipt of cash or a voucher under the CARS "cash for clunkers" program to buy or lease a new fuel-efficient automobile is not taxable for federal income tax purposes.
  • Transit exclusion benefits have increased to $230 a month. Employees may exclude up $230 per month in transit benefits and $230 per month in parking benefits. It's not an either/or situation: You can receive benefits for commuter transportation and transit passes and benefits for parking during the same month.
Special rules may apply in some circumstances. Check out IRS Publication 525 for more details.

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Dawud Hasan

Thanks for this post. I have a hard time finding good content
related to this subject when searching most of the time.

We grew up in world in which the news about the failure of
Social Security is almost as constant as the news about the failure HMOs.
We all know that it is unlikely that many people who are currently contributing
to social security will ever see the money we've invested into the program.
At least these funds are probably not coming back to darken our doors.
This means we need to find alternatives and end our reliance on the government
for a comfortable retirement that doesn't appear to be in the wood works.

Check it out and let me know what you think…

Dawud Hasan

April 20 2014 at 8:11 PM Report abuse rate up rate down Reply

Social Security income should not be taxed--period. Social Security (Federal Insurance Contributions Act-FICA) is an insurance policy and SS income is a payment of benefits on that policy. FICA payments (now called payroll taxes) on payroll are premiums on that insurance policy.

April 13 2013 at 3:03 PM Report abuse rate up rate down Reply

There are too many exclusions to limit tax liability for the super-rich and there is where the closing of loopholes must be made. Look closely at the long form 1040, you will find many areas with limitations and exclusions above the Adjusted gross income, and only the richest of the rich fully utilized those areas. Top earners on Wall Street and Banking should have their entire earnings(Up to $5,000,000.00) taxed and not limited to the first $110,100.00 for Social Security and federal taxes. By taking this route, Social Security and Medicare/Medicaid will be funded into the future, as it should have been long ago. Do not put the horse on the shoulders of the middle class. Tax rates do not have to be raised, if all the exceptions, exemptions, deductions and other limiting of totals to be added into the Adjusted Gross Income, would be eliminated and taxed at ordinary tax rates. Further, Social Security benefits should not be taxed on retired peoples tax returns as they have already been taxed and paid into the system to receive these benefits as they are already earned from past employment. It's the middle class who needs the protection!”

April 12 2013 at 11:49 PM Report abuse rate up rate down Reply