in this report are the terms most commonly used when discussing the federal
individual income tax. Most of these tax terms are explained in the order
that they occur in the process of determining one’s income tax on the Form
1040. Total income is the sum total of all income required to be
reported for tax purposes before adjustments to income are made for special
types of expenses which Congress has determined should be considered in
calculating gross income. These adjustments function like deductions,
except that unlike deductions, adjustments are calculated in arriving at
adjusted gross income, and thus can be claimed by all taxpayers, not just those
who itemize deductions. An exclusion from income refers to an item
specifically excluded from determination of gross income.
Adjusted gross income (AGI) equals gross income less qualifying adjustments
to income. It is the income measurement before deductions and personal
exemptions are taken into account. Deductions from adjusted gross
income are allowed for certain types of expenditures for which income
taxation is deemed inappropriate or inadvisable. Deductions function like
adjustments and exclusions in their effect on tax liability. In addition
to the standard deduction, an additional standard deduction amount is
available to certain individuals, for example the blind or elderly. Personal
exemptions are allowed for the taxpayer, his or her spouse and each
dependent. Exemptions affect tax liability like deductions, adjustments to
income, and exclusions.
Taxable income is adjusted gross income reduced by either the standard
deduction (plus the additional standard deduction in some cases) or
itemized deductions along with personal exemptions. Taxable income is the
base to which the income tax rates are applied to calculate income tax
liability. Tax liability is calculated by applying the marginal tax rate
and schedule to taxable income. Tax credits are then subtracted
from gross tax liability to arrive at a taxpayer’s final tax liability.
Hence, tax credits reduce tax liability directly, on a dollar for dollar basis.
Tax credits are available to all qualifying taxpayers, whether they
itemize deductions or not. Total tax liability is the amount of
federal income tax owed by the taxpayer to the federal government. When a
taxpayer’s final tax liability exceeds federal taxes withheld, estimated
quarterly taxes paid, and certain other credits, then the taxpayer has taxes
due and must pay the federal government additional federal income
taxes to cover the shortfall. A refund is a payment by the federal
government to a taxpayer whose withheld taxes and/or estimated tax payments or refundable
credits exceeded his final tax liability.
A copy of the 2011 IRS Form 1040 is included at the end of this report.
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