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As of 2012, the Internal Revenue Service offered taxpayers six income tax brackets. Your tax rate depends on your net income -- the money that remains after you've taken any and all deductions, exemptions and tax credits. In this important calculation, gross income becomes just a memory.
Gross income means everything you earn, either through wages or salary, investment income, dividends, rents, royalties and so on. You arrive at this number by adding all income together and entering the result on line 22 of Form 1040. You then subtract adjustments to income, such as contributions to individual retirement accounts, moving expenses and interest you paid on student loans. The result is line 37, your adjusted gross income.
The IRS allows you to subtract exemptions and deductions from your adjusted gross income. You can take an exemption for yourself, your spouse and your dependents. The exemption amount is adjusted each year for inflation -- in 2012, it is $3,800 per exemption. You can also take a standard deduction, which in 2012 the IRS set at $11,900 for married (joint) filers and $5,950 for singles and heads of household. Alternatively, you can itemize deductions, which are expenses you can subtract from your adjusted gross income. You have finally arrived at taxable income, line 44, which determines your tax bracket.
The IRS sets different tax brackets depending on your filing status. If you're filing as single, the 15 percent bracket applies if your net taxable income falls between $8,700 and $35,350. For those filing "married, joint" returns, the 15 percent bracket covers those with net income between $17,400 and $70,700. Different 15 percent rate brackets apply for those filing "married, separate" returns and those filing as a head of household.
The IRS tax bracket that you belong to is actually a "marginal" rate, meaning it is applied only to your highest level of income. For example, single taxpayers pay only 10 percent on income up to $8,699, and then 15 percent on any income higher than $8,700, up to and including $35,350. If you can take enough exemptions and deductions to get your income below the upper limit of the 15 percent marginal rate, you belong to the 15 percent bracket. After you calculate how much tax you owe, any tax credits you can take (for example, the child tax credit) will further reduce the tax you owe.
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