Calculating Your Taxes

What is total or gross Income? [Line 22]

Your total or gross income includes:

• Earned income, which comes from employment and can take the form of wages, salary, tips, commissions and bonuses. Earned income may be subject to both income and payroll taxes.
   
• Unearned income, which comes from sources other than employment, such as dividends, interest, capital gains or U.S. savings bonds. Most unearned income is subject to income taxes.

Important things to remember

• Other sources of taxable income include alimony, unemployment compensation, gambling winnings or lottery winnings.
   
• Income that's not taxable (these are called exclusions) include: a gift or inheritance, child support, life insurance proceeds following the death of the insured, interest from municipal bonds (may be subject to federal alternative minimum tax, plus state tax for out-of-state bonds), disability income if you paid the premium with after-tax dollars, and certain employee fringe benefits.
   
• If you have stocks, bonds or other investment assets in a taxable account your profit or loss is known as a capital gain or a capital loss. Capital gains are currently taxed at a maximum rate of 20 percent, but only for people in the highest tax brackets. Otherwise, long-term capital gains are taxed at 15% or 0%, depending on your marginal tax bracket.

How to calculate your adjusted gross income [Line 37]

Your adjusted gross income (AGI) is an important part of your tax calculation. To get your AGI, you can subtract certain deductions from your income to reduce the amount of income that will be taxed.

Some examples of deductions that help determine your AGI:

• Deductible IRA contributions
   
• Contributions to a Keogh (self-employed) retirement plan
   
• Self-employed health insurance deductions
   
• One-half of self-employment tax
   
• Alimony paid
   
• Qualified moving expenses
   
• Penalty on early withdrawal of savings
   
• Qualified higher education expenses
   
• Teacher's education expenses up to $250
   
• Qualified education interest

Choosing standard or itemized deductions [Line 40]

Once you know your AGI, you have the opportunity to lower your taxable income even more by subtracting either the standard deduction or your itemized deductions—whichever is greater.

When to consider the standard deduction

If your financial situation is straightforward, the standard deduction might be the best and simplest choice. The standard deduction for 2014 is $6,200 for single filers, $12,400 for married filing jointly and $9,100 for head of household.

When to consider itemizing deductions

If you pay a lot in state income taxes, have a mortgage on your home, give a lot to charity, have paid extensive medical bills or manage a lot of investments, you might be better off taking the extra time to itemize your deductions.

Examples of legitimate itemized deductions:

• Property taxes
   
• State and local income taxes (or state sales taxes if your state does not have an income tax)
   
• Specified medical and dental expenses that exceed 10 percent of your AGI (or 7.5 percent if you are 65 or older), including limited amount of premiums paid for long-term care policies
   
• Mortgage interest on first and secondary residences (up to maximum debt of $1 million), plus interest on home equity loans (maximum debt up to $100,000)
   
• Charitable contributions to tax-exempt organizations
   
• Casualty and theft losses (see IRS guideline)
   
• Investment interest expense (e.g., margin interest expense)
   
• Miscellaneous expenses, including impairment-related expenses for persons with disabilities and gambling losses to the extent of gambling winnings
   
• In addition, the following can be itemized if the cumulative total is more than 2 percent of your AGI:
  • Business expenses not paid by your employer (such as union or professional dues, unreimbursed travel or uniforms)
     
  • Tax-preparation fees
     
  • Investment advisor fees

How many personal exemptions you can claim? [Line 6d]

A personal exemption is an amount you can subtract from your AGI that is determined by the government and indexed annually for inflation. For 2014, the personal exemption is $3,950.

You can claim three kinds of personal exemptions:

• For yourself—You're allowed one exemption for yourself.
• For your spouse—If you're married and filing a joint return, you're allowed two exemptions: one for yourself and one for your spouse.
• For your dependents—You're allowed an exemption for each qualified dependent, which can be a child or other relative.

Determining taxable income [Line 43]

Once you know your AGI and the deductions and exemptions you qualify for, you can calculate your taxable income and your tax due. On the IRS website, you’ll find tips on taxable and nontaxable income as well as detailed tax tables (PDF)

What's your tax rate?

You pay a proportionately larger amount of taxes on higher amounts of income. This results in two different tax rates:

• Your marginal tax rate is the percentage of tax you pay on your last dollar of taxable income.
   
• Your average tax rate is just that—the average amount that you pay taking into consideration all of your income.

For example, if you are single and your taxable income is $40,000, your marginal income tax rate is 25 percent, but your average tax rate is likely quite a bit lower.

Making use of tax credits [Lines 47–54]

A tax credit reduces the taxes you owe dollar for dollar. A credit is more valuable than a deduction. A $100 credit means that you pay $100 less in taxes. A deduction simply reduces your taxable income.

There are a number of tax credits available, depending on your income and personal situation. A few examples include:

• Credit for qualified adoption expenses
• Credit for a qualified child under the age of 17
• Child and dependent care credit
• Residential energy credit
• American Opportunity education tax credit (formerly the Hope credit) for qualified expenses during the first four years of college.
• Lifetime learning credit for expenses related to improving job skills and for pursuing an undergraduate, graduate or professional degree. Learn more at IRS.gov.

How to arrive at your tax due [Line 63]

After you've figured out your taxable income, there are a few more steps to arriving at your actual tax due.

• Subtract any payments and/or credits from your taxes owed. [Line 74]
• On lines 75 and 76, you will determine whether you owe taxes or will receive a refund.

If you're getting a big refund, you're probably having too much withheld from your paycheck. In effect, this means you're giving the government an interest-free loan. On the other hand, if you have too little withheld, you may be charged an underpayment penalty.

Payroll taxes 101.

Who pays FICA and Medicare taxes?

• An additional 12.4 percent of your income (up to $142,800 in 2021) will be paid into Social Security, and 2.9 percent (with no limit) will be paid to Medicare on your behalf.

If you're a wage or salaried employee, your employer will pick up half of this tab (so you'll pay 6.2 percent into Social Security and 1.45 percent into Medicare). This means that a total of 7.65 percent of your paycheck will be withheld, and your employer will also pay 7.65 percent.