IG10040 — The Individual Income Tax, 2023

/ The Individual Income Tax, 2023 How Income Tax Liability Is Calculated for Individuals, Families, and Passthrough Businesses taxable income + positive income tax liability investment income long-term capital gains & qualified dividends - negative income tax liability investment Calculate Taxable Income Add up income from various sources to calculate gross income (or total income). Then subtract allowable deductions to arrive at taxable income. All income is generally counted toward gross income, unless it is excluded by law; i.e., there is an exclusion. Gross income may be further characterized between ordinary income and long-term capital gains and qualified dividends (referred to in this infographic as “investment income”) which are taxed at different rates. Any above-the-line deductions are subtracted from gross income to calculate adjusted gross income (AGI). Above-the-line deductions include those for student loan interest, individual retirement account (IRA) contributions, certain educator expenses, and health savings accounts (HSAs). Then, either the standard deduction or the sum of itemized deductions (whichever is greater) is subtracted from AGI. Itemized deductions include those for charitable giving, mortgage interest, state and local taxes (SALT), and medical expenses. Finally, other deductions are subtracted to arrive at taxable income. In 2023, the other deduction is the 199A deduction for passthroughs. Apply Marginal Rates Marginal tax rates are applied to taxable income to arrive at precredit income tax liability. Special reduced rates apply to investment income, with overall taxable income determining the applicable rate. If a married couple les their taxes jointly in 2023 with $250,000 of taxable income ($220,000 ordinary income / $30,000 investment income): Subtract Tax Credits Nonrefundable tax credits are subtracted from precredit income tax liability, followed by refundable tax credits to calculate income tax liability. Tax credits reduce income tax liability dollar for dollar the amount of the credit. Nonrefundable tax credits—including the child and dependent care credit, the Lifetime Learning credit, the saver’s credit, and the credit for other dependents—cannot be greater than precredit income tax liability. Hence, these credits cannot reduce income tax liability below zero. In contrast, refundable tax credits—like the earned income tax credit (EITC), the child tax credit, and the American Opportunity tax credit—which are claimed after nonrefundable credits, are not limited by income tax liability, (meaning they can reduce income tax liability below zero). ordinary income 37% 35% 32% 24% 22% 12% 10% $0 $0 taxable income other standard or sum of itemized above-the-line gross income ordinary wages, exclusions salaries, & tips rents & royalties small business/self employment retirement interest other Examples of exclusions include employer contributions to health and retirement plans, returns to tax-advantaged savings accounts (e.g., 529s), child and dependent care benefits, adoption benefits, a portion of capital gains from the sale of a primary residence, and interest on certain bonds. ordinary income $220,000 subject to increasing marginal rates with a top rate of 24%. investment income $30,000 subject to a 15% rate. 0% 15% 20% The portion of a refundable tax credit which reduces income tax liability to zero is sometimes called the “Nonrefundable portion.” nonrefundable credits precredit liability refundable credits income tax liability A negative income tax liability means the taxpayer is receiving an increase in after-tax income. The portion of a refundable tax credit which exceeds income tax liability is sometimes called the “Refundable portion.” taxable income increases taxable income increases $220K $30K investment adjusted gross income AGI) Information prepared by Margot L. Crandall-Hollick, Specialist in Public Finance and Jamie L. Hutchinson, Visual Information Specialist. Notes: Various provisions of the tax code may vary by ling status, which is not depicted in this infographic. In addition, certain taxpayers’ investment income may be subject to a 3.8% net investment income tax (NIIT), which is also not depicted in this graphic. The different sizes of income in section 1 do not reflect actual shares of different types of income reported on tax returns. In addition, the relative size of precredit liability and tax credits in section 3 do not reflect actual amounts reported on tax returns.

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