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This article is a part of Wikinvest's Personal Finance section and Guide to Investing. Please contribute or edit to improve it. |
Federal Income Tax refers to the tax levied by a government on the income earned by individuals, corporations and other legal entities under its jurisdiction. This article deals with Federal taxes on indivduals. For an overview of other types of income taxes see the income tax article. In the United States the U.S. government taxes individuals who make over
Taxable income refers to the portion of your total income on which taxes need to be paid to the government. Various adjustments and deductions, including the standard deduction and personal exemptions, all lower your taxable income.
As mentioned above the government taxes income from a variety of sources.
[edit] Types of Income Taxes
[edit] Personal Income Tax
The government taxes individuals based on their total income for the year. Sources of taxable income include wages, dividends from stocks, gains from the sale of stock held for one year or less and unearned income (gifts over a certain amount). One can file his or her taxes individually or as part of a couple (if married). The filer adds up all of his sources of income and deducts any relevant deductions.
[edit] Deductions, Above and Below the Line, AGI and other cool stuff
The amount of income that a person makes is rarely the same as his or her taxable income (the actual amount that he or she is taxed on). Instead, the filer starts by calculating his or her gross adjusted income. This is his or her income after certain items known as above the line deductions are are subtracted. Some common above the line deductions include, include higher education expenses, losses on the sale of property and moving expenses.
Subtracting above the line expenses from Gross Income gives the filer his or her gross adjusted income. He or she now has the option of taking a standard deduction or itemizing his or her deductions. The resulting number is the filer's taxable income.
Example
Joe the Plumber has a salary of $100,000 per year. He has no other sources of income, so his gross income for 2007 is $100,000.
Joe, however, paid $5,000 in student loan interest during the year in addition to $15,000 in alimony for a total of 80,000 in above the line deductions.
Joe's adjusted gross income is $80,000.
Joe now has the option of subtracting the standard deduction from his AGI or itemizing his deductions. The standard for a single filer was 5,350 in 2007. [1] On the other hand, in 2007 Joe Donated 8,000 to charity in 2007, and paid 7,000 in state income taxes.
In this case his itemized deductions add up to 15,000, far more than the standard deduction, so Joe will choose to itemize.
After taking all of his deductions, Joe is left with 65,000 in taxable income.
[edit] Tax Brackets: The more you make, the more it hurts
The United States uses a progressive tax system. Under this system a person's income is divided into brackets. As a person earns more, he or she pays a proportionately greater percentage of his or her income in taxes. For instance, Joe has taxable income of 65,000. He will be taxed 10% on the first $8025, 15% on the next $25,000 and 25% on the next $32,000 or an average tax rate of 19%. Someone who made 50,000 would pay an average tax rate of 15%.
Click here to 'See 2008/2009 marginal tax rates below
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