Taxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.
Arriving at Taxable Income
Both individuals and corporations begin with gross income, the total amount earned in a given year. For individual filers, calculating federal taxable income starts by taking all income minus “above the line” deductions and exemptions, like certain retirement plan contributions, higher education expenses and student loan interest, and alimony payments, among others. This results in a taxpayer’s adjusted gross income (AGI). Upon arriving at AGI, a taxpayer may then take the standard deduction or choose to itemize their below-the-line deductions, which produces taxable income. For corporations, arriving at taxable income involves deductions for compensation, the cost of goods sold, and other business expenses.
Income Starting Points
Most states use either AGI or federal taxable income as a starting point for their own calculations of individual income tax liability. Beginning with federal taxable income incorporates federal standard and itemized deductions, as well as the personal exemption when available (it is currently suspended), whereas beginning with AGI excludes these modifications, leaving states to establish their own deductions and exemptions, or to separately link their codes to the federal provisions.
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The concept of taxable income is fundamental in the realm of taxation. It represents the portion of income that is subject to tax after accounting for various deductions and exemptions. In both individual and corporate taxation, taxable income is derived from the initial gross income but is reduced through specific deductions and exemptions.
For individual taxpayers, the journey to determine taxable income begins with the calculation of gross income. From there, various "above-the-line" deductions and exemptions are subtracted. These deductions include contributions to retirement plans, qualified education expenses, student loan interest, alimony payments, and similar expenses. This process leads to the adjusted gross income (AGI). Subsequently, individuals may opt for the standard deduction or choose to itemize their deductions, which further refines the AGI to arrive at taxable income.
Similarly, corporations start with their gross income and then deduct various expenses such as compensation, cost of goods sold, and other legitimate business expenditures to determine their taxable income.
When considering state income tax, most states either utilize the federal taxable income or AGI as a starting point for their tax calculations. States that begin with federal taxable income incorporate federal deductions and exemptions, while those starting with AGI exclude these modifications. This approach necessitates states to establish their own set of deductions and exemptions or link their tax codes to federal provisions separately.
Understanding the nuances between federal and state tax calculations is crucial in comprehending how taxable income is derived and how it influences tax liabilities for both individuals and corporations.
In essence, taxable income serves as the cornerstone of tax calculations, representing the income upon which taxes are imposed after accounting for various permissible deductions and exemptions at both federal and state levels.
