How Income Taxes Work

How Income Taxes Work

Taxpayers and businesses spend an estimated 7.1 billion hours a year complying with tax-filing requirements, which is worth $388 billion in economic value just to comply with tax regulations.

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 half hire a tax professional to assist in their annual filing.

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 taxpayer’s gross income.

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.

Itemized deductions can include state and local taxes, charitable contributions, the interest on a home mortgage, and certain unreimbursed job expenses, among other things.

Once deductions have been subtracted, the result is taxable income. Taxable income leads to gross tax liability.

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

The result is the taxpayer’s net tax.

To learn more, schedule a meeting with one of our financial professionals today.