Income Taxes: Decoding the Mystery

Income Taxes: Decoding the Mystery

April 08, 2024

According to estimates from the Internal Revenue Service, firms and taxpayers devote around 8 billion hours annually to fulfilling tax filing obligations. To put this into perspective, if a single company did all this work, it would need about four million full-time employees and be one of the largest industries in the U.S.

Even though tax details can be complicated, the income tax process is relatively straightforward. Still, the majority of Americans would rather spend time on something other than preparing taxes, which explains why more than half hire a tax professional to assist in their annual filing.2

Remember, this material is not intended as tax or legal advice.

Getting Started

Income is the first step in the tax process, and most income is taxable. A taxpayer’s gross income includes income from work, investments, interest, pensions, and other sources. The income from all these sources is added together to arrive at the taxpayer’s gross income.

What does not qualify as income? Gifts, inheritances, workers’ compensation benefits, welfare benefits, or cash rebates from a dealer or manufacturer.3

Then, adjustments are subtracted from gross income. These adjustments may include retirement plan contributions, half of self-employment, and other items.

The result is adjusted gross income.

From adjusted gross income, deductions are subtracted. With deductions, taxpayers have two choices: the standard deduction or itemized deductions. The standard deduction amount varies based on filing status, as shown below: 

Source: IRS.gov, 2023 

Itemized deductions can include state and local taxes, charitable contributions, the interest on a home mortgage, and certain unreimbursed job expenses, among other things. Keep in mind that there are limits on the amount of state and local taxes that can be deducted.4

Once deductions have been subtracted, the result is taxable income. Taxable income leads to gross tax liability. 

But it's not over yet.

Any tax credits are then subtracted from the gross tax liability. Taxpayers may receive credits for a variety of items, including energy-saving improvements.

The result is the taxpayer's net tax. 

Understanding how the tax process works is one thing. Doing the work is quite another.

1. NTU.org, April 18, 2022
2. IRS.gov, 2023
3. The tax code allows an individual to gift up to $17,000 per person in 2023 without triggering any gift or estate taxes. An individual can give away up to $12,920,000 without owing any federal tax. Couples can leave up to $25,840,000 without owing any federal tax. Also, keep in mind that some states may have their own estate tax regulations. This material is not intended as tax or legal advice. Please consult a professional with tax or legal experience for specific information regarding your situation.
4. The mortgage interest deduction is the first $750,000 of the loan for a home, and the state and local income tax deduction is capped at $10,000. 

The content is developed from sources believed to provide accurate information. The information in this material is for educational purposes only and is not intended as tax, investment, or legal advice. It may not be used to avoid any federal tax penalties. Please consult legal, investment, or tax professionals for specific information regarding your situation. Mayfair Financial and FMG Suite developed and produced this material to provide information on a topic of interest. FMG is not affiliated with the named state-registered investment advisory firm. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.


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