Gross income is the starting point for determining the total amount of income tax due. Gross income is all income you receive from money, goods, property, and services that is not exempt from taxation. Unless the item is specifically excluded in the Internal Revenue Service (IRS) code, you must include it in gross income. Thus, gross income includes wages and salaries, commissions and fees, profit from a business, interest, dividends, rents, capital gains, royalties, tips, prices, gambling winnings, pension income, and similar items.
For most workers, wages and salaries are the largest component of gross income. Certain items are excluded from gross income, including gifts and inheritances, life insurance death benefit, workers compensation benefits, tax exempt interest on securities issued by state and municipalities, and certain other items.
During the current tax year, Michelle received $40,000 in salary as a marketing analyst, $350 in interest and dividends in a stock brokerage account, $50,000 as beneficiary of her mother’s life insurance policy, and $500,000 as her share of her deceased mother’s estate. The salary, dividends and interest must be included in Michelle’s gross income. However, the IRS Code excludes life insurance proceeds and inheritances from gross income.
Adjustments to income
After gross income is terminated, it is reduced by certain deductions to arrive at adjusted gross income. Adjusted gross income is gross income less certain deductions. The fallowing deductions can reduce gross income: Individual retirement account (IRA) contributions, allowable moving expenses, one half the self-employment tax, self-employed health insurance deduction, Keogh retirement plan and simplified employee pension (SEP) contributions, penalty for early withdrawal of savings, alimony paid. Adjusted gross income is an important calculation since it is the base for calculating certain itemized deductions, such as medical expenses and miscellaneous deductions.
The next step is to determine your taxable income. Taxable income is the actual amount of income that is subject to taxation for a giving year. Taxable income is calculated by subtracting the standard deduction (or itemized deductions) and all exemptions for adjusted gross income. The standard deduction is a specific amount that taxpayers who do not it itemize their deductions may deduct from adjusted gross income. Itemized deductions are deductions for various types of personal expenses. You should use the standard reduction if it exceeds the total of your itemize deductions. Most taxpayers filing individual returns take the standard deduction. The amount of the standard deduction depends on your filing status and age.