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 What is Income Tax Laws?

Income tax lawyers advise clients on complex tax issues. They also prepare income tax returns for individuals and businesses. In addition, tax lawyers handle disputes with the Internal Revenue Service (IRS) and state taxing agencies.

Disputes can often be resolved by filing an amended tax return. If a dispute over taxes is significant, the case could end up in court, and a tax lawyer can represent the taxpayer.

How Is Income Tax Calculated?

To calculate their income tax, the taxpayer must first calculate their Gross Income (GI). GI is essentially all of the income earned in a year. Next, deductions are subtracted from GI to arrive at Adjusted Gross Income (AGI). The applicable tax rate is applied to AGI, resulting in the income tax the person owes.

What Is Gross Income?

Section 61 of the Internal Revenue Code defines gross income as “all income, from whatever source derived.” In other words, gross income is any income received during the tax year, including a salary, wages from a job, profits from the sale of stocks, rental income, and even income from illegal activities. This includes income from non-U.S. sources, such as a job abroad.

For most taxpayers, the tax year is the calendar year, so income received between January 1 and December 31 of a calendar year is gross income for that year.

Not all income is taxed. Some kinds of income are exempt from taxation. Note that there may be qualifications and limitations to these exemptions. Some examples are as follows:

  • Capital Gain on Sale of a Principal Residence: If a person makes a profit selling their primary home, the gain is not taxable. There are qualifications and limits to this exemption.
  • Income Earned by Residents of 7 States: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have an income tax. New Hampshire and Tennessee only tax income from interest on accounts and dividends, not income such as salaries and wages
  • Disability Insurance Payments: Payments received from private disability insurance are not taxable. Similarly, a state’s workers’ compensation insurance system payments are not taxable.
  • Accident or Health Insurance Payments: Payouts from accident insurance and an employer’s provision of health insurance are not treated as income
  • Life Insurance: Payments made according to a life insurance policy are not considered income Some states do not tax Social Security income or income from a pension
  • Money or Property Received as an Inheritance: The recipients of inherited property do not have to pay taxes on their inheritance
  • Income from Foreign Sources: Some types of income from foreign sources do not count as taxable income in the U.S. For example, social security from a foreign government might be exempt from taxation.

What Is Adjusted Gross Income?

Adjusted gross income (AGI) is a taxpayer’s gross income minus certain deductions the Internal Revenue Code allows. A taxpayer does not pay taxes on income deductible from gross income.

Do not confuse a deduction with a tax credit. A deduction is applied at the time income is calculated. It lowers the income attributable to the taxpayer but does not directly reduce taxes. On the other hand, a tax credit is applied after taxes have been calculated and reduces the amount of tax owed dollar for dollar.

The following are the most commonly claimed deductions for individual taxpayers. Note that each type of deduction is subject to its own restrictions, rules, and qualifications. The dollar values and percentages are valid as of 2023:

  • Mortgage Interest: The interest on a mortgage with a value of up to $750,000 is deductible
  • Charitable Contributions: Charitable gifts and payments are deductible, up to 50% of the taxpayer’s AGI (with certain adjustments)
  • Medical Expenses: Medical expenses are deductible only in an amount that is more than 7.5% of the taxpayer’s AGI
  • Property Taxes: Property taxes paid on real property, an auto, or other personal property are deductible up to 10% of the taxpayer’s AGI
  • Contributions to an IRA: Contributions to an Individual Retirement Account (IRA) of up to $6,000 (or $7,000 if a person is over 50) are deductible
  • HSA and FSA Contributions: Contributions to a Health Savings Account (HSA) or a Flexible Savings Account (FSA) to cover eligible healthcare expenses are at least partially deductible, depending on the facts
  • Student Loan Interest: Up to $2500 in student loan interest can be deducted per year

Significant additional deductions are available to self-employed individuals. They are as follows:

  • Qualified Business Income: The QBI deduction allows most self-employed taxpayers to deduct 20% of their income. The QBI is complicated. Speak with a tax attorney to determine the amount you are eligible for.
  • The Home Office Deduction: The home office deduction applies if you are self-employed and use part of your home exclusively for business.
  • Self-employment Tax: Half of the self-employment tax, i.e., the withholdings that a person must pay for Social Security and Medicare, is deductible as a business expense
  • Retirement Account Contributions: Several retirement savings accounts are available to the self-employed, and contributions to these accounts are deductible. There are contribution limits, but they are relatively high.
  • Other Costs of Doing Business: Such items as travel expenses, office supplies, advertising expenses, and expenses for business purposes are all deductible for the self-employed.

What Is Taxable Income?

Taxable income is the amount of income on which taxes must be paid. As mentioned, taxable income is determined by subtracting deductions from gross income. Every taxpayer needs to decide whether to take the standard deduction or itemize their deductions when considering deductions.

The standard deduction is an amount of money the government specifies that taxpayers can subtract from their gross income. For filing taxes in 2023 for 2022, the standard deduction ranges from $12,950 to $25,900, depending on the type of tax return filed. Most taxpayers take the standard deduction because that results in the lowest AGI for them.

Itemizing deductions involves listing a set of deductions to which a person is entitled and subtracting each from gross income. If the taxpayer’s available deductions are greater than the standard amount allowed, then itemizing deductions will result in a lower AGI for the taxpayer.

Once the taxpayer has calculated their taxable income, they can calculate their tax. Income tax is calculated by applying the taxpayer’s current tax rate to their taxable income. Tax rates vary depending on the taxpayer’s adjusted gross income, marital status, and the number of dependents they may have.

If a taxpayer has been paying their anticipated federal or state taxes throughout the year by having them withheld from their income, then the final step is to compare how much they owe in taxes to how much they have already paid and then either pay for what they still owe or file for a refund if they overpaid.

Should I Contact an Income Tax Lawyer?

Tax issues can be complex and may require professional assistance. If you do not correctly include all the income for the year, the IRS may consider this tax fraud. Tax fraud can result in serious consequences, such as substantial fines or prison time. If you have failed to pay taxes for several years, have substantial back taxes, or are being audited, contact an experienced tax lawyer for help.

Similarly, if the IRS notifies you that you have underpaid your tax obligation or misapplied a deduction, you will want to consult an experienced tax lawyer. A tax lawyer can calculate your taxes and figure out how much tax you rightly owe the IRS. If you must go to court, your tax lawyer can represent you in litigation. Having an experienced tax lawyer fighting for you in disputes with the IRS is always a good idea.

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