Taxable income is simple to calculate. The Form 1040 is like a paint-by-numbers guide to getting you there step by step. However, it can be time-consuming, especially if you want to run several scenarios to determine the best filing status, deductions and other factors you wish to manipulate to end up with the lowest tax liability. To make this process run smoother, create a Form 1040 in a spreadsheet such as Excel or Google Sheets with formulas, so you can easily manipulate numbers. Otherwise, hire a tax accountant. Consider doing a cost analysis of your time versus the money spent, considering how much you could save on your federal and state tax bills if you had a professional.
What Is Taxable Income?
How to Determine Your Taxable Income
Filing Status
Income
Income taxable by the Internal Revenue Service (IRS) includes earned income such as wages, tips, salary and income earned by any businesses you may have. Unearned income includes income you have received but not worked for. This includes dividends, interest, unemployment benefits, the distribution of tax-deferred retirement accounts, debt forgiveness, a portion of Social Security benefits, gambling and the sale of investments if you receive more than its cost basis. If you own part of a business but do not actively take part in it, any income you receive from this business is considered passive income. The most common categories of income are ordinary and capital income, passive and non-passive income and business and hobby income. To calculate your total gross income, fill in all relevant lines of the 1040 tax return and add them up. If you file separately, be prepared to prove which assets are in your name or your spouse’s name.
Liability
Once you have added up all of your gross income on lines 7 through 21 on your Form 1040 and summed them up on line 22, you can then reduce your tax liability. Adjustments for taxable income include contributions to qualified Health Savings Accounts and IRA plans, student loan and mortgage interest, employment deductions and other expenses. On line 36, add up all adjustments on lines 23 through 35. Subtract line 36 from line 22 to get your adjusted gross income (AGI). From here, subtract deductions such as personal exemptions and the larger of the standard deduction or itemized deductions. Once you calculate this, you can determine if you’re eligible for credits such as education credits or the child tax credit.
Why Knowing Your Taxable Income is Important
W-2 and 1099 Employee
If you receive both 1099 and W-2 forms consider adjusting your W-4 at your workplace to increase the amount of taxes withheld. You can either reduce the number of deductions you are claiming or opt for a specific additional amount to be withheld from each paycheck. If you can accurately calculate your total tax liability at the end of the year so you will owe less than $1,000 in income tax on your 1099 income, then you no longer must make quarterly payments.
Cash Flow
Some of us have cash flow issues from time to time. To solve these issues, we may charge our credit card and incur interest because we cannot pay the balance off in full on time. Others incur late fees and utility restoration fees because we failed to pay our gas or water bill within the grace period. If you receive a large tax refund after you file your tax return, ask your employer’s human resource department to adjust your W-4, so less money is being withheld from your paycheck. Even if you do not have cash flow issues, you can use this money to aggressively pay off debt, save up for a down payment on a house, prepay your property taxes or invest in high return stock market accounts.