Money and You: Course Notes

Gross Income - Your gross income is the total amount of money you’ve made from all sources. Wages, tips, gifts, money you found on the street, interest, capital gains. Everything.

Adjusted Gross Income - In terms of taxes, your adjusted gross income, or AGI, is more important. From the government’s point of view, some of the money you earned isn’t really your income. Some expenses have certain tax privileges that reduce your income in the eyes of the IRS, which is a good thing. Your AGI is calculated as your gross income minus these special expenses. Some of these expenses are listed below:

Taxable Income - Beyond your adjusted gross income, you can reduce your tax burden even more through exemptions and deductions. Your taxable income is the amount of your income that is actually taxed. It is calculated as your AGI minus the allowed amounts from exemptions and deductions.

Tax Bracket - Income tax is a progressive tax, meaning the more money you make, the higher your tax rate. The rate is not linear. There are a number of different ranges of income, and each has a corresponding tax rate. The income range your taxable income fall into is your tax bracket.

Exemptions - Formally, we no longer use the term “exemptions’’ in Federal income taxation; the terms were eliminated in 2018. However, the idea remains. When the term was used, an exemption was an acknowledgement that it costs more to support a family of five than it is to support a family of two. Having to provide for children or other people reduces your tax burden by lowering your taxable income. Today, you provide the same information, such as whether you are married, how many kids you support, etc., which still affects your tax burden. However, the “exemption’’ term is no longer used.

Deduction - A deduction is an expense that lowers your taxable income. Some expenses that are difficult for the IRS to predict have been deemed to be worthy of some tax benefits. There are a great number of things that qualify as deductions. Things like some medical expenses, charitable donations, interest paid on your mortgage, amounts paid in state or local taxes, traditional 401(k)/403(b) contributions, gambling losses, and many more. The list also includes those that determine your AGI.

Standard Deduction - The IRS can’t really track all legitimate deductible expenses for every citizen. So, there is the “standard deduction.’’ The standard deduction is an option for tax payers in which they can claim that they have spent an “average’’ amount of money on deductible expenses. For 2024, the standard deduction was $14,600 for a single person (or married and filing separately) and $29,200 for a married couple. Claiming the standard deduction reduces your taxable income from your AGI by that amount. It is simple and easy. It works well for people who do not want to track their deductible expenses or for families who don’t actually have that much in deductible expenses. If you take the standard deduction, you cannot claim any other deductions. So, for people who have a lot of deductible expenses, they should not take the standard deductible.

Itemized Deduction - For people who do not take the standard deduction, they will need to list out all of their deductible expenses. When they do this, these are called “itemized deductions.’’ While a bit of a pain, this process is well worth it for people with large incomes or a large amount of deductible expenses.

Tax Credit - A tax credit works similar to a deduction. However, a credit reduces how much you owe in taxes dollar-for-dollar. The difference may sound subtle, but it is hugely important. Suppose you have a gross income of $100,000 and that your tax rate on the amount was 25%flat. Suppose you had a $20,000, making your taxable income $80,000. Then you’d pay 25%of that in taxes, or $20,000. Now suppose instead you had a tax credit of the same amount of the deduction: $20,000. You would be taxed on the full $100,000 and would owe $25,000 in taxes. However, your tax credit of $20,000 would go against that tax owed. So, you’d only have to pay $5,000 in taxes. Tax credits are pretty awesome. There are a number of things that earn you tax credits. Some higher-education expenses, having children of certain ages, adopting a child, having lower incomes, self-employment tax write-offs, energy-efficiency credits, and many more are available.

Dependent - A dependent is someone you support financially. The most common example is children or stepchildren (up through age 19 or 24 for full-time students). However, there can be other dependents in the form of elderly parents, siblings, disabled family members, etc. The number of dependents you have affects your tax burden.

Refund - If you overpay in taxes over the year, the IRS owes you the amount you overpaid. A tax refund is this amount you overpaid and are owed by the IRS. If you owe on taxes from a previous year, any refund will automatically be used to pay those backtaxes.