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MODULE 1 – 2 FEDERAL INCOME TAX FORMULA & TAX PLANNING I. STANDARD FEDERAL INCOME TAX FORMULA ( Ref. ¶3001 - 3085). The formula appearing below is slightly different from the one in the text (see above references). Instead of “deductions for” and “deductions from” Gross Income, it uses the terms “above-the-line” (or “deductions for AGI”), and “below-the- line” (or “deductions from AGI”). You should be familiar with both terminologies, as they are used interchangeably, in practice and theory. Gross Income -Above the Line Deductions Adjusted Gross Income (“the line”) -Standard Deduction or Itemized Deductions - Exemptions Taxable Income X Tax Rate Gross Tax -Credits -Prepayments Net Tax You need to know the following: (1) Examples of “Above the line” deductions. (2) What is “the line”? 1
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(3) Examples of “Below the line” deductions. (4) Which type of deduction is better? Why? (5) What is the difference between a tax deduction and a tax credit? In a nutshell the critical advantages of “above-the-line” deductions are: (1) You can always take them. [In contrast, many “below-the-line” deductions are available only if you “itemize” your deductions (example – mortgage interest), or, only if you aren’t claimed by a dependent by someone else (example – exemption and the full amount of the standard deduction)] (2) An "above-the-line" deduction will often increase the amount of some of the "below-the-line" deductions. For example, the deduction for medical expenses (a below-the-line deduction that you can take if you choose to itemize) is reduced by 7.5% of AGI (the "line"), and AGI is lower by an above-the-line deduction. So, if an above-the-line deduction lowers AGI, it lowers the 7.5% reduction in the medical expenses deductions. Thus the above- the-line deduction had two effects - (a) it lowered income directly when it is applied, and (b) it lowered income indirectly by causing a later below-the-line deduction to be larger.
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  • Fall '13
  • jackson
  • Accounting, Taxation in the United States

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