5 Factors that Determine Your Tax Position
Many different factors determine your tax position or how much tax you owe. Below are the five main factors that determine your tax position.
- Total earnings or the total income you made for the year; this includes your wages, salary, commission, dividends, capital gains, business income, retirement distributions, as well as other income. From there, the IRS allows you to have certain deductions taken off of your earnings.
- Adjusted Gross Income (AGI) is defined as gross income minus adjustments to income. Adjustments to income include educator expenses, student loan interest, or contributions to a retirement account and a health savings account. Your AGI will never be more than your Gross Total Income on your return and, in some cases, may be lower.
- Taxpayers have the option to take a standard deduction or to itemize deductions. A standardized deduction is given on federal taxes for most individuals. The amount of the federal standard deduction varies by year and is based on the taxpayer’s filing characteristics. If a taxpayer chooses to itemize deductions, then deductions are only taken for any amount above the standard deduction limit. Standard deductions are often the easiest route to choose because there is no need to make a calculation—the amount is already set and determined. Itemized deductions require some calculation and work on the part of the tax filer. Once you get your deductions, you get your actual taxable income; this is the amount of a person’s gross income that the government deems subject to taxes.
- Next, you have the tax rate based on the tax bracket you’re in; this is the percentage at which an individual or corporation is taxed. You are going to multiply your taxable income times your tax rate; from there, you will arrive at the amount of tax that you owe.
- The final factor is the tax credit. A tax credit is an amount of money that taxpayers can subtract from taxes owed to their government. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed. The value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or businesses in specific locations, classifications, or industries.
Deductions: Your deductions reduce the amount of income that is subject to taxes, determining the amount of your income that is taxable.
Tax Rate: The Tax Rate, (determined by your tax bracket) multiplied by your taxable income, determines the amount of tax you owe.
Tax Credits: Is an actual dollar for dollar reduction on the amount of taxes you owe, reducing your actual tax liability.
(For more information on how tax breaks work, watch this video on how a progressive tax system works)