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CHAPTER 2 – PAGES 1-32 FORMULA FOR INDIVIDUAL INCOME TAX: Basic Formula: Taxpayers generally are not required to report exclusions (nontaxable income) on their tax returns. One exception requires taxpayers to disclose tax exempt interest income. Income from a sole proprietorship is reported on Schedule C, only net income from the business actually appears on Form 1040 and its also used to collect other taxes such as self employment Main reason for difference between formula and the form is administrative convenience. Tax Formula For Individuals: Income from whatever source derived xxx,xxx Minus: Exclusions (xxx) Gross Income xx,xxx Minus: Deductions FOR adjusted gross income (xxx) Adjusted gross income x,xxx Minus: Deductions FROM adjusted gross income Greater of itemized deductions or standard deduction (xx) Personal and dependency exemptions (xx) Taxable Income x,xxx Times: Tax rate or rate (from tax table or schedule) X .xx Gross tax xx Minus: Credits and prepayments (x) Net tax payable or refund due xx Definitions: Income: both taxable income and nontaxable income, income from any source Does not include return of capital (with sale of property thus its only the gain you make) Gross profit is viewed as income, as opposed to the sale price Exclusions: any item of income that the tax law says is not taxable (for various social, economic, and political reasons) Major Exclusions: *Gifts and inheritances *Certain improvement by lessee property *Life insurance proceeds *Welfare and certain other transfer payments *Child support payments *Certain scholarships and fellowships *Certain interest of Series EE bonds *Certain payments for injury and sickness *Property settlements pursuant to a divorce *Certain employee fringe benefits *Gain from sale of person residence -Health plan premiums *Certain foreign earned income -Group term life insurance premiums (limited) -Personal physical injury settlements -Meals and lodging -Workers compensation -Employee discounts -Medical expense reimbursements -Dependent care Gross Income: income reduce by exclusions, income from taxable sources and is reported on the return. Even though an item is omitted from the list does not mean it is excluded, for example illegal income is not shown but is taxable. Major Items: *Compensation for services, including fees, commissions, fringe benefits, and similar items *Gross income derived from business *Rents *Gains derived from dealings in property *Royalties *Alimony and separate maintenance payments *Pensions
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*Income from life insurance and endowment contracts *Income in respect of a decedent *Income from discharge of indebtedness *Dividends *Distributive share of partnership gross income *Annuities *Income from an interest in an estate or trust *Interest Deductions for Adjusted Gross Income: taxpayers may deduct expenses that are specifically allowed by tax law. Include business and investment expenses generally, also
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