To most taxpayers, taxes and how they’re calculated are a mystery. Consisting of 70,000+ pages, the Internal Revenue Code (aka, the Commerce Clearing House [CCH] Standard Federal Tax Reporter) is complicated, and when you’re filling out the forms (on paper, online, or in a tax program), determining what you’re being asked and how to supply the correct information can be both challenging and frustrating. Every so often, a politician expresses a vision of a time when our tax returns will fit on a postcard, but that never happens. (As an aside, the shortened version was attempted with the 2018 tax year and was an unmitigated disaster — the result… the tax return went from two pages to eight pages. In 2019, it was shortened to five pages. Simple, right!?)

Fortunately, people like me who’ve spent five years in college studying accounting and taxes, and countless hours since leaning about the practical application of Title 26 of the United States Code (i.e., the Internal Revenue Code), are available to help you navigate this minefield. We’ve been trained to quickly analyze taxable situations, however simple or complex, and complete our clients’ returns in a way so as to minimize their tax burden.

Still, you can benefit by understanding the fundamentals of how tax bills are calculated. In this post, I explain the process in plain and simple terms.

Seven Steps to Calculate Your Tax Bill

Calculating your tax bill is a seven-step process. Here I present the overall process and then take a deeper dive into each step. Before going there, however, below is a 30,000-foot overview of the seven-step process to calculating your tax bill:

While that may sound like a lot of gibberish to you, to someone like me, it’s music to my ears. Starting with Step No. 1, here’s the deeper dive I promised:

Step 1: Calculate total income

The IRS wants to know how much money you have received over the course of the year — your total income. Total income includes money received from the following sources:

• Earned income from wages, salaries, commissions, and tips
• Profits from business and self-employment
• Interest and dividends
• Capital gains from the sale of property held for investment
• Income from pensions, IRAs, and annuities
• Rents, royalties, and income from flow-through entities
• Alimony (from agreements finalized before January 1, 2019)
• Gambling winnings
• Barter proceeds
• Illegal income (yes, you’re required to disclose income from illegal activities)

Income from certain sources is generally tax exempt, although you may still be required to report it, including the following: Continue reading… Continue reading… Continue reading…