Calculating Income Tax: The Tax Formula

The Tax Formula for Individuals:

This is just a basic explanation of the tax formula for individual tax payers. I hope someone can find this information useful when trying to understand taxes better. Individual tax payers calculate their tax in accordance with a tax formula. Understanding the formula is important, since all tax determinations are based on the result. The formula is as follows:

GROSS INCOME

-DEDUCTIONS FOR AGI (adjusted gross income)

=AGI

-GREATER OF ITEMIZED DEDUCTIONS OR STANDARD DEDUCTION

-EXEMPTIONS

=TAXABLE INCOME

x TAX RATE (using appropriate tax tables or rate schedules)

=GROSS TAX LIABILITY

-TAX CREDITS AND PREPAYMENTS

=TAX DUE OR REFUND

Gross Income:

The calculation of taxable income begins with gross income. Gross income includes ALL income, unless the tax law provides for a specific exclusion.

Deductions for Adjusted Gross Income:

The first category of deductions includes the deductions for AGI. These deductions include student loan interest, a tuition and fees deduction, certain educator expenses, alimony payments, trade or business expenses, certain reimbursed employee business expenses paid under an accountable plan, moving expenses, the penalty on early withdrawal from savings, and contributions to qualified retirement plans. I am not going to go into detail about these deductions however if I can provide more detail in a later hub if enough people request it.

Adjusted Gross Income:

The amount of adjusted gross income is sometimes referred to as the “magic line”, since it is the basis for several deduction limitations. For example, the limitation on medical expenses is one. A tax payer’s AGI is used to determine the phase-out of the otherwise allowable itemized deductions and personal dependency exemption amounts.

Standard Deduction or Itemized Deductions:

Itemized deductions are personal items that congress has allowed as deductions. Included in this category are medical expenses, certain interest expenses, certain taxes, charitable contributions, casualty losses, and other misc. items. Tax payers should itemize their deductions only if the amount exceeds the standard deduction amount. The table below gives the standard amounts for 2010.

Exemptions:

The personal exemption and the dependency exemption were $3650 for 2009 and have remained the same for 2010. Keep in mind that there is a Phase-out tax bracket for high-income families. (This can also be discussed in detail in a later hub if requested)

The Gross Tax Liability:

A tax payer’s gross tax liability is obtained by reference to the tax table or use of a tax rate schedule (which is provided below). Tax credits and prepayments are subtracted from gross tax liability to calculate the net tax due the government or the refund due the tax payer.

2010 Tax Rate Tables

Married Individuals Filing Joint Returns and Surviving Spouses

If Taxable Income Is: 

The Tax Is:

• Not over $16,750 10% of the taxable income
• Over $16,750 but not over $68,000 $1,675 plus 15% of the excess over $16,750
• Over $68,000 but not over $137,300 $9,362.50 plus 25% of the excess over $68,000
• Over $137,300 but not over $209,250 $26,687.50 plus 28% of the excess over $137,300
• Over $209,250 but not over $373,650 $46,833.50 plus 33% of the excess over $209,250
• Over $373,650 $101,085.50 plus 35% of the excess over $373,650

Unmarried Individuals (other than Surviving Spouses and Heads of Households)

If Taxable Income Is: 

The Tax Is:

• Not over $8,375 10% of the taxable income
• Over $8,375 but not over $34,000 $837.50 plus 15% of the excess over $8,375
• Over $34,000 but not over $82,400 $4,681.25 plus 25% of the excess over $34,000
• Over $82,400 but not over $171,850 $16,781.25 plus 28% of the excess over $82,400
• Over $171,850 but not over $373,650 $41,827.25 plus 33% of the excess over $171,850
• Over $373,650 $108,421.25 plus 35% of the excess over $373,650