Overview of Federal Individual Income Tax

Dan Zhao

ACCY6900 Effective Business Communication

Professor Nicholas Moschovakis

Oct. 6th, 2015

Determination of Federal Income Tax

To understand federal income taxation, you have to know what income is. Unfortunately, that may be too general. Is all of your income is taxable? Of course not. The major body of tax law focuses on what income is taxable and what is not. So how do we get from income from whatever source to taxable income?

This essay will guide a beginner through the process of computing tax, especially on determining taxable income. There will be four steps: First, all of your income excluding certain amount equals gross income. Second, gross income minus deductions equals taxable income. Third, applying the according tax rate to the taxable income gives you gross tax. Last, comparing the gross tax with tax withheld determines if it is tax refund or tax due (Rupert, Pope, and Anderson 2-2). This is the frame work of determining federal income tax.

1. Gross Income and Exclusions

1.1 Gross Income

Gross income meets three requirements determined by law. First, there must be economic benefits. It can be cash, or intangible property; it can be received directly, or indirectly. Second, the income must be realized. Income will be taxed when the taxpayer controls it. For example, until you sell your house, increasing market value of the house is not income. The last element is that income must be recognized by the tax law. When the law specifies this type of income is not taxable, you won’t need to pay tax for it (Rupert, Pope, and Anderson 3-3).

The general types of gross income are: salaries, interests, rents, dividends, alimony, insurance proceeds, pensions, gains from dealing property, and income from the forgiveness of debt (Rupert, Pope, and Anderson 3-4). But trying to include every income source is impractical. This is why the tax law tells you what is excluded from gross income rather than including everything.

1.2 Exclusions

Exclusions from gross income are specific items defined by law. Either it is not income at all, or it is, but the tax law allows it tax exempt. If it is not income, the common ones would fall into the next four categories: unrealized income, self-help income, rental value of personal-use property, and selling price of property (Rupert, Pope, and Anderson 4-2). If it is a specific item defined by law, it is called administrative exclusion. Major administrative exclusions include: gifts, inheritances, life insurance proceeds, payments for physical injuries, social securities benefits, certain awards, employee fringe benefits, foreign-earned income, and interest on state and local government obligations (Rupert, Pope, and Anderson 4-4).