Gross income includes all income, unless the tax law provides for a specific exclusion. The exclusions from gross income are discussed in Chapter 3, Income: Personal Wages and Investments of this text. It is important to note that there is not a line on the federal tax forms titled “gross income.” Instead, the different types of income are added to a subtotal called “total income” from which items are deducted.

Deductions for adjusted gross incomedeductions for adjusted gross incomeReductions of AGI that can be taken by a taxpayer in addition to a standard deduction or itemized deductions. include trade or business expenses, certain employee business expenses reimbursed by employer, alimony payments, moving expenses, certain educator expenses, student loan interest, tuition and fees deduction, the penalty on early withdrawal from savings, and contributions to qualified retirement plans. Chapter 4, Adjustments to Income will discuss these deductions.

The first deductions in the formula are the deductions for adjusted gross income. A distinction is made in tax publications about deductions for and from adjusted gross income. The importance of the distinction will be illustrated throughout the text.

Adjusted gross income (AGI) is an important amount because it is the basis for several deduction limitations, such as the limitation on medical expenses and miscellaneous itemized deductions. A taxpayer’s AGI is also used to determine the phaseout (reduction) of personal and dependency exemption amounts and total allowable itemized deductions.

Standard deduction or itemized deductions. Itemized deductions are personal items that Congress has allowed as deductions. Included are deductions for medical expenses, certain interest expense, certain taxes, charitable contributions, casualty losses, and other miscellaneous items. Taxpayers will choose to itemize deductions when the total amount exceeds the standard deduction amount. New in 2008, taxpayers who select the standard deduction but have paid property taxes on their residence can add up to $1,000 to the standard deduction. Details of the standard deduction, the new deduction, and all itemized deductions are covered in Chapter 5, Standard and Itemized Deductions of the text.

Table 2.1, “Standard Deduction—2008” gives the standard deduction amounts for 2008.

Exemptions. Exemptions are worth $3,500 each for 2008. The two types of exemptions, personal and dependency, will be described later in this chapter.

Gross tax liability. A taxpayer’s gross tax liability is obtained by reference to the tax table or use of a tax rate. For taxpayers with a taxable income of less than $100,000, the tax must be determined from the Tax Tables included in the instructions for federal tax forms 1040, and 1040A. The tables build in the taxpayer filing status and list the amount of tax for each $50 increment in taxable income.

For taxpayers with taxable incomes of $100,000 or more, the Tax Computation Worksheet is used (prior to 2006, Tax Rate Schedules were used); the Tax Computation Worksheet, guides a taxpayer step-by-step in applying the tax rates to a specific taxable income).

The federal individual tax rates are 10%, 15%, 25%, 28%, 33%, and the highest rate is 35%. For comparison, the list below provides the tax rate by other taxable entities:

Credits and prepayments are dollar-for-dollar reductions in the gross tax liability granted for items such as child care payments, education, earned income, and children. Credits will be covered in Chapter 6, Special Tax Issues and Tax Credits. Prepayments include income tax withholdingwithholdingAmount of income not paid directly to an employee; instead, it is remitted to the federal government as a prepayment of a future income tax liability., estimated taxestimated taxPrepayments of income, employment and alternative minimum taxes required of certain taxpayers. payments, and refunds applied from a prior year.