Did you know that you don’t actually have to pay taxes on every penny of income you earn? That’s because there is a difference between your gross income (the amount your employer pays you in wages or salary) and your taxable income (the part of your wages or salary that you owe tax on). Here’s a quick summary to help you understand.
Your gross income is everything you make in a year. This is essentially your starting number. Your gross income is then adjusted by subtracting costs for things like higher education interest and insurance premiums. These adjustments can be made regardless of whether you itemize your deductions. Then, once you have determined your adjusted gross income, that is further reduced by your deductions. Most taxpayers can claim at least the basic standard deduction ($6,300 in 2016); many choose to itemize their deductions (such as mortgage interest, charitable contributions, health care costs, and other qualified expenses) if itemizing creates a greater tax savings than taking the standard deduction. Most taxpayers also qualify for an exemption for themselves, their spouse, and any dependents, which reduces your taxable income even further. After all deductions and exemptions have been taken, you’re left with your taxable income. The tax you owe the IRS is calculated based on that taxable income number, not the gross income number you started with. The end result is that you don’t end up paying tax on a solid portion of your income!
Even better, there are some tax credits (such as the Adoption Credit and Earned Income Credit) that further reduce the tax you owe itself.
Confused about what all these different terms mean? Need a hand sorting out your taxes this year? Call on Taxation Solutions, Inc. to get professional guidance backed by over 40 years in the industry. We are well-versed in all aspects of taxation, and we are standing by to be your tax help pro. Contact us now to get started.