In: Accounting
describe the components that comprise the tax formula and their role in the computation of the amount of federal income tax.
What are the key components that are used to determine the amount of federal income tax that an individual will pay in income tax? What is the difference between a tax deduction versus a tax credit? Can everyone use the tax tables? Are there limitations on deductions?
Difference between tex deduction and tex credit :--
As you know ,Tax credit and tex deduction can help reduce your overall income tax libality. Every year, millions of taxpayers search for credits and deductions that can help them save money. While you should take advantage of as many of these as possible, don’t overlook the fact that tax credits and deductions are not the same thing.
Tax Credits:--
Tax credits can help reduce your liability dollar-for-dollar. However, they cannot reduce your income tax liability to less than zero. In other words, your gross income tax liability is the amount you are responsible for paying before any credits are applied.
The majority of tax credits are non-refundable. With non-refundable tax credits, any excess amount expires in the year in which it was used, meaning that the additional amount is not refunded to you. There are some refundable tax credits, though, and these can be used to help grow your tax refund
Tax Deductions
As we learned earlier, tax deductions lower your taxable income, and they are calculated using the percentage of your marginal tax bracket. For example, if you are in the 25% tax bracket, a $1,000 tax deduction saves you $250 in tax (0.25 x $1,000 = $250).
There are 2 main types of tax deductions: the standard deduction and itemized deductions. A taxpayer must use one or the other, but not both. It is generally recommended that you itemize deductions if their total is greater than the standard deduction.
The Standard Deduction:--
The standard deduction is a dollar amount that reduces your taxable income. It is typically adjusted up for inflation each year. Your standard deduction amount is based on your filing status and is subtracted from your AGI (adjusted gross income).
Itemized Deductions:-
If you do not qualify for the standard deduction, you may choose to itemize your deductions. A taxpayer will usually itemize deductions if it offers them more benefits than the standard deduction (i.e., when the amount of qualified deductible expenses totals more than the standard deduction).
can everyone use the tax tables:--
the amount of tax you owe is based on a number of different factors such as your filing status, your deductions and exemptions and the amount of income you earn. Tax tables show the specific dollar amount of tax you owe based on these variables and the applicable tax rates for the year.
Using the right tax table:-
Your filing status determines which tax table you must use to compute your income tax. According to the IRS, your filing status should reflect your marital status on December 31, regardless of your status throughout the rest of the year.
The list of qualifying deductions is fairly extensive, and limitations apply to some of them. Generally, you can claim itemized deductions in the following categories, but some of these are subject to change as well under the pending legislation. And this list is by no means comprehensive. There are a few additional, less utilized itemized deductions.
Itemized deductions are also limited when a taxpayer's AGI exceeds certain limits based on his filing status.