How to determine your tax liability

Every year, many taxpayers have no idea whether or not they will owe taxes. Often some taxpayers feel they may owe, but have no idea how much or why. Understanding how to determine your tax liability will not only help you make better decisions about how you treat income, it will go a long way in relieving the stress often experienced when it comes time to file your taxes.

Obviously, the first variable in the tax formula is gross income. This is the total of all earned and unearned income from various sources throughout the year. Income is earned or unearned. Earned income is benefits in cash or in kind that people receive in exchange for work or service, including employment and self-employment. Unearned income is cash or in-kind benefits that people receive without being required to perform work or service. Depending on the type of income you receive, as well as other variables, your tax result could vary.

Then certain deductions are subtracted from the gross income. These deductions are known as above-the-line deductions and are used to arrive at adjusted gross income, or AGI. The name comes from its paperwork location. They are found on page one of Form 1040, just above the line where adjusted gross income is tabulated. They include contributions to a traditional IRA, alimony, moving expenses, and many others. For a complete list of “above the line” deductions, visit irs.gov/pub. 17

After reaching AGI, there is another round of deductions known as personal and dependency exemptions. The amount of the personal exemption in 2016 is $4,050.00 dollars. The IRS allows all resident taxpayers to deduct this amount from their personal income. Dependency exemptions are personal exemptions allowed for taxpayers who have qualified dependents. For example, if a taxpayer filed a joint return if they are married and have 2 children; the number of personal exemptions would be 4. See IRC section 152 for additional information.

There are two types of additional deductions. One is called a standard deduction, or taxpayers can itemize deductions. Generally, a comparison is made to derive which type of deduction is more advantageous. The standard deduction is a predetermined amount based on filing status. The standard deductions for the year ending December 31, 2016 are as follows:

Single – $6,300.00
Married Filing Jointly – $12,600.00 Married Filing Separately – $6,300.00
Head of Family – $9,300.00
Qualifying Surviving Spouse – $12,600.00

At this point, both personal exemptions and standard or itemized deductions are subtracted from AGI to arrive at taxable income. To determine your tax rate, review the applicable tax tables on irs.gov.

Take into account any additional deductions (credits, prepayments of taxes, overpayments or credits from prior years, and taxes withheld by an employer or previously made estimated tax payments) that are subtracted from your tax liability to determine the net tax due.