Summary
This report describes the terms most commonly used when discussing the federal individual income tax. Most of these tax terms are explained in the order that they occur in the process of determining one's income tax on the Form 1040.
Total (or gross) income is the sum total of all income required to be reported for tax purposes. Total income does not include exclusions, items specifically excluded from determination of gross income. Total income may be reduced by certain adjustments to income for special types of expenses that Congress has determined should be considered in calculating gross income. These adjustments, often referred to as above-the-line deductions, can generally be claimed by all eligible taxpayers, not just those who itemize deductions. For 2020 and 2021, taxpayers who did not itemize their deductions could claim an additional deduction for charitable contributions.
Adjusted gross income (AGI) equals gross income less above-the-line deductions (i.e., qualifying adjustments to income). It is the income measurement before a taxpayer claims either the standard deduction or the sum of all their itemized deductions (whichever is greater). Itemized deductions are subtracted from AGI and are allowed for certain types of expenditures for which income taxation is deemed inappropriate or inadvisable. The standard deduction, by contrast, is a set amount that varies by filing status and may be subtracted from AGI if it is greater than a taxpayer's itemized deductions. An additional standard deduction amount is available to the blind and elderly. Deductions function like adjustments and exclusions in their effect on tax liability.
Taxable income is adjusted gross income reduced by either the standard deduction (plus the additional standard deduction in some cases) or itemized deductions along with a deduction for qualified pass-through business income, when applicable. Taxable income is the base to which the income tax rates are applied to calculate income tax liability. Tax liability is calculated by applying the marginal tax rate and schedule to taxable income. Tax credits are then subtracted from gross tax liability to arrive at a taxpayer's final tax liability. Hence, tax credits reduce tax liability directly, on a dollar-for-dollar basis. Tax credits are available to all qualifying taxpayers, whether they itemize deductions or not.
Total tax liability is the amount of federal income tax owed by the taxpayer to the federal government. When a taxpayer's final tax liability exceeds federal taxes withheld, estimated quarterly taxes paid, and certain other credits, then the taxpayer has taxes due and must pay the federal government additional federal income taxes to cover the shortfall. A refund is a payment by the federal government to a taxpayer whose withheld taxes and/or estimated tax payments or refundable credits exceeded final tax liability.
A copy of the most recent version of income tax return to date, the 2021 IRS Form 1040, is included at the end of this report.
Introduction
This report describes the terms most commonly used when discussing the federal individual income tax.1 The structure of this report follows the general order of the IRS Form 1040—the form individuals use to determine their income tax. Tax forms can change, and all references in this report are to the 2021 Form 1040.2 Many taxpayers determine their tax liability with the use of tax preparation software (e.g., TurboTax®) and paid tax preparers, which eliminates the need to be familiar with the Form 1040. Therefore, taxpayers who rely on tax preparation software or services may not be familiar with some of the concepts presented in this report.
Total income, also sometimes referred to as gross income, is the broadest measure of income used for tax purposes. It is the total of all realized income recognized by the tax law. It is measured net of business expenses but before any other deductions or adjustments. It includes employee compensation such as wages, salaries, and tips; taxable interest and dividend income; business and farm income (net of expenses); realized capital gains; income from rents, royalties, trusts, estates, and partnerships; and taxable pensions and annuities.
Gross income does not include income explicitly excluded from tax. An exclusion is an item of income that is not included as income for tax purposes because the tax code or other law explicitly excludes—or exempts—it from taxation.3 Examples of items of income which are exempt from federal income taxation and, hence, excluded from gross income, are state and local bond interest income, public assistance (welfare), small gifts, employer contributions for health care, and employer-provided contributions to retirement plans. Social Security and Railroad Retirement income may or may not be excluded from income subject to tax.4 The taxability of Social Security and Railroad Retirement depends on the amount of other income the taxpayer receives.
Other forms of income excluded from taxation are a clergy member's tax-free housing allowance, qualified foster care payments, and qualified scholarship and fellowship grants. Under certain conditions, a taxpayer can exclude a limited amount of disability pay such as workers' compensation. Except for tax-exempt interest, exclusions generally are not required to be reported to the Internal Revenue Service.
A taxpayer's gross income is listed on line 9 of the Form 1040 found in Appendix A. Exclusions are not listed explicitly on the Form 1040.
Adjustments to Income (Above-the-Line Deductions)
Adjustments to income, also known as above-the-line deductions, are allowed for certain payments made by the taxpayer and are generally related to the earning of income. These payments are deducted from gross income in arriving at adjusted gross income. Examples of payments that may qualify for an above-the-line deduction include contributions to Keogh or traditional (but not Roth) individual retirement accounts (IRAs), forfeited penalties on early withdrawals of savings, and interest paid on student loans. Adjustments to income function similarly to deductions that are applied later in the calculation of taxable income (i.e., itemized deductions or the standard deduction). However, unlike these deductions, above-the-line deductions can generally be claimed by all qualified taxpayers, whether or not they use the standard deduction or itemize deductions (see "Deductions").
The sum of the taxpayer's adjustments to income is listed on line 10 of the Form 1040. A taxpayer's total adjustments to income are also listed on lines 11 to 24z of Schedule 1 found in Appendix A. For 2021, nonitemizers were able to claim an additional temporary deduction for charitable contributions. This amount is listed on line 12b of the Form 1040.
Adjusted gross income (AGI) is equal to a taxpayer's total income minus adjustments to income. AGI is the basic measure of income under the federal income tax and is the income measurement before deductions (see below) are taken into account.5 AGI is commonly used as the base for computing many of the limits under the tax law, such as those on the itemized deduction for medical and dental expense and miscellaneous itemized deductions.
A taxpayer's adjusted gross income is listed on line 11 of the Form 1040.
Deductions from adjusted gross income are allowed for certain types of expenditures of income. Deductions may be claimed in one of two ways. First, taxpayers can choose to itemize (explicitly list) their deductible expenses. Itemized deductions are allowed for many purposes, including certain medical expenses; state and local property taxes, income (or sales) taxes, and a few other taxes; home mortgage interest, points, and limited amounts of other interest paid (but not personal interest); contributions to charitable organizations; certain casualty and theft losses; and a few other "miscellaneous" expenses.
Alternatively, a taxpayer can choose to claim the standard deduction, which was intended to reduce the complexity of paying taxes. The standard deduction varies depending on filing status (single, married filing jointly, head of household), whether the taxpayer is over 65, and whether the taxpayer is blind. For 2021 the standard deductions were as follows: $25,100 for married taxpayers filing jointly or qualified widow(er)s; $12,550 for single taxpayers; and $18,800 for taxpayers who qualify as the head of a household. The standard deductions in 2021 for those who are 65 or older and for those who are legally blind are increased by $1,700 if single or head of household and $1,350 if married filing jointly. These increases apply per classification. Thus, a 70-year-old blind and single taxpayer would be eligible for a $3,400 ($1,700 plus $1,700) increase in his or her standard deduction. These amounts are adjusted annually for inflation.
Only individuals with deductions that can be itemized in excess of the standard deduction find it worthwhile to itemize. These tend to be taxpayers in the middle- to high-income ranges. In the 2019 tax year (the most recent data available), 11.0% of taxpayers itemized their deductions.6 Whichever deduction the taxpayer claims—total itemized or standard—the deduction amount is subtracted from AGI.
Additionally, individuals with pass-through business income may deduct up to 20% of their qualified business income when determining their taxable income through 2025. This deduction is often referred to as the 199A deduction and is subtracted from AGI after either total itemized deductions or the standard deduction.7 Pass-through businesses include sole proprietorships, partnerships, and S corporations. Pass-through owners pay taxes on their share of the business's income according to the individual income tax rates. In contrast, the income of C corporations is taxed once at the corporate level according to the corporate tax system, and then a second time at the individual-shareholder level.
Deductions function like adjustments and exclusions in their effect on tax liability. Deductions reduce a taxpayer's tax liability, but only by a percentage of the amount deducted. An individual in the 35% tax bracket would receive a reduction in taxes of $35 for each $100 deduction while an individual in the 24% tax bracket would receive a reduction in taxes of $24 for each $100 deduction. Hence, the same deduction can be worth different amounts to different taxpayers depending on their marginal tax bracket. More simply stated, the tax savings from deductions are generally equal to the taxpayer's tax rate times the amount of the deduction. So higher-income taxpayers typically benefit more than lower-income taxpayers from deductions.
A taxpayer's standard or total itemized deductions are listed on line 12a of the Form 1040. The individual components of the itemized deduction are listed on lines 1 to 16 on Schedule A to Form 1040 in Appendix A. The 199A deduction for qualified business income, if applicable, is listed on line 13 of the Form 1040.
Taxable income, the narrowest measure of income used on the income tax return, is equivalent to adjusted gross income reduced by either the standard deduction or itemized deduction and the personal exemption (as noted in footnote 5, the personal exemption is suspended until 2026). Taxable income is the base upon which the income tax rates are applied to calculate income tax liability.
Taxable income is listed on line 15 of the Form 1040.
Tax liability, also sometimes referred to as gross tax liability, is a taxpayer's tax liability prior to the subtraction of tax credits. For most taxpayers, gross tax liability is equal to regular income tax liability, which is calculated by applying the marginal tax rate schedule to taxable income. The structure of the marginal tax rate schedule is progressive, which means higher-earning taxpayers face higher tax rates on the last dollar that they earn. To understand how the marginal tax structure is applied, consider the 2021 marginal tax rate schedule provided in Appendix B.8 The 2021 tax schedule shows the various tax rates and income ranges to which those rates are applied. A married couple with a taxable income of $80,000 would fall into the 12% tax bracket. This means that the first $19,900 of their taxable income would be taxed at a rate of 10%, and their next $60,100 of income would be taxed at 12%.
A small fraction of taxpayers (0.3% in 2021) must also account for the alternative minimum tax (AMT) when computing their gross tax liability.9 The AMT is calculated in the following manner. First, an individual adds back certain tax deductions and tax preference items to taxable income. This amount then becomes the AMT tax base. Next, a basic exemption is allowed and subtracted from the AMT tax base. A two-tiered tax rate structure of 26% and 28% is then assessed against the remaining AMT tax base to determine the AMT liability. If the AMT liability exceeds a taxpayer's regular income liability a taxpayer must add the difference between the two to their regular income tax liability to arrive at gross tax liability. Congress, in 1969, enacted the predecessor to the current individual AMT to make sure that everyone paid at least a minimum amount in taxes while still preserving the economic and social incentives in the tax code.10
A taxpayer's regular income tax liability is listed on line 16 of the Form 1040. The AMT liability is listed on line 1 of Schedule 2 of the Form 1040 in Appendix A. A taxpayer's gross tax liability is listed on line 18 of the Form 1040.
Nonrefundable tax credits are subtracted from gross tax liability to arrive at a taxpayer's final tax liability. Thus, nonrefundable tax credits reduce an individual's tax liability directly, on a dollar-for-dollar basis, and are available to all qualified taxpayers. A taxpayer may not claim more nonrefundable tax credits than his or her tax liability. Therefore, the only time in which nonrefundable tax credits do not result in a dollar-for-dollar reduction in an individual's tax liability is when the amount of nonrefundable tax credits exceeds the individual's tax liability. A different class of tax credits, known as refundable tax credits, can be claimed even when they exceed an individual's tax liability. Refundable tax credits are discussed later in this report. Examples of nonrefundable credits are the credit for the elderly and the permanently and totally disabled, the credit for child and dependent care expenses, and the foreign tax credit.11
Most individual nonrefundable tax credits are listed on Schedule 3 to the 2021 Form 1040 in Appendix A. The sum of the nonrefundable tax credits from schedule 3 plus any amounts of the nonrefundable credit for other dependents (sometimes referred to as the other dependent credit or ODC) is found on line 21 of the 2021 Form 1040.12
Total tax liability, also sometimes referred to as final tax liability, is the amount of federal income tax owed by the taxpayer to the federal government after taking into account allowable refundable tax credits. Thus, total tax liability represents the taxpayer's total federal income tax bill for the tax year.
A taxpayer's total tax liability is found on line 24 of the Form 1040.
Payments and Refundable Credits
Most taxpayers make periodic tax payments throughout the year via income withholdings that are credited against their federal income tax liability. Employees typically have a certain percentage of their paycheck withheld (W-2 withholding, named for the IRS Form W-2) each pay period by their employer. Taxpayers who receive nonwage or nonemployee compensation income, such as interest or dividend payments, debt cancelation, and certain other types of income, may have a fraction of this income withheld (1099 withholding, again, named for IRS Form 1099) by the compensating party.13 The withheld amounts are then forwarded to the IRS.
Some taxpayers make estimated tax payments throughout the year—typically quarterly. There are a variety of reasons why estimated tax payments may be required—for example, when the taxpayer earns income not subject to withholding or when there is an expectation that a taxpayer may owe more than a certain amount in taxes even after accounting for withholdings and credits. A taxpayer estimates the taxes owed on the income he or she earned in a particular quarter and pays this amount during the year rather than waiting until April 15 of the following year.
Refundable tax credits are another form of tax "payment." Refundable tax credits are similar to nonrefundable tax credits except that a taxpayer may claim refundable tax credits in an amount greater than his or her tax liability. When the amount of refundable credits exceeds a taxpayer's tax liability, the Treasury makes a direct payment to the taxpayer for the difference. The primary refundable credits are the earned income tax credit and the child tax credit.14
A taxpayer's total tax payment is found on line 33 of the Form 1040.
A tax refund is a payment by the federal government to a taxpayer whose withheld taxes, estimated tax payments, and refundable credits exceeded final tax liability, entitling him or her to a refund for overpayment of the tax bill.
The amount of refunded taxes owed to a taxpayer may be found on line 34 of the Form 1040.
When a taxpayer's total tax liability exceeds federal taxes withheld, estimated tax payments, and refundable credits, then the taxpayer will owe the federal government an additional amount to cover the shortfall in paid taxes.
Taxes owed are found on line 37 of the Form 1040.
Appendix A. 2021 IRS Form 1040
2021 IRS Schedule 1 (Form 1040)
2021 IRS Schedule 2 (Form 1040)
2021 IRS Schedule 3 (Form 1040)
2021 IRS Schedule A (Form 1040)
Appendix B. 2021 Marginal Tax Rate Schedule
|
Married Filing Jointly |
|||
|
If taxable income is: |
Then, tax is: |
||
|
$0 |
to |
$19,900 |
10% of the amount over $0 |
|
over $19,900 |
to |
$81,050 |
$1,990 plus 12% of the amount over $19,900 |
|
over $81,050 |
to |
$172,750 |
$9,328 plus 22% of the amount over $81,050 |
|
over $172,750 |
to |
$329,850 |
$29,502plus 24% of the amount over $172,750 |
|
over $329,850 |
to |
$418,850 |
$67,206 plus 32% of the amount over $329,850 |
|
over $418,850 |
to |
$628,300 |
$95,686 plus 35% of the amount over $418,850 |
|
over $628,300 |
plus |
$168,993.50 plus 37% of the amount over $628,300 |
|
|
Single |
|||
|
If taxable income is: |
Then, tax is: |
||
|
$0 |
to |
$9,950 |
10% of the amount over $0 |
|
over $9,950 |
to |
$40,525 |
$995 plus 12% of the amount over $9,950 |
|
over $40,525 |
to |
$86,375 |
$4,664 plus 22% of the amount over $40,525 |
|
over $86,375 |
to |
$164,900 |
$14,751 plus 24% of the amount over $86,375 |
|
over $164,900 |
to |
$209,400 |
$33,603 plus 32% of the amount over $164,900 |
|
over $209,400 |
to |
$523,600 |
$47,843 plus 35% of the amount over $209,400 |
|
over $523,600 |
plus |
$157,804.25 plus 37% of the amount over $523,600 |
|
|
Heads of Households |
|||
|
If taxable income is: |
Then, tax is: |
||
|
$0 |
to |
$14,200 |
10% of the amount over $0 |
|
over $14,200 |
to |
$54,200 |
$1,420 plus 12% of the amount over $14,200 |
|
over $54,200 |
to |
$86,350 |
$6,220 plus 22% of the amount over $54,200 |
|
over $86,350 |
to |
$164,900 |
$13,293 plus 24% of the amount over $86,350 |
|
over $164,900 |
to |
$209,400 |
$32,415 plus 32% of the amount over $164,900 |
|
over $209,400 |
to |
$523,600 |
$46,385 plus 35% of the amount over $209,400 |
|
over $523,600 |
plus |
$156,355 plus 37% of the amount over $523,600 |
|
Source: Internal Revenue Code.
| 1. |
Economic income is the broadest measure of all income, and is an economic concept rather than one contained in the tax code. It is defined as realized monetary compensation plus the value of any other nonmonetary forms of compensation that an individual receives. For example, in addition to the salary employees receive each year, they may also receive compensation in the form of health insurance premiums paid for by their employer. This employee's economic income is their salary plus the monetary value of the insurance premiums paid for by their employer. Economic income, therefore, is a measure of an individual's total compensation. Another example of economic but not monetary income is the imputed rental value of owner-occupied housing, which is not subject to taxation. Understanding economic income is important for constructing tax policies that are efficient and equitable. Economic income is not listed explicitly on the Form 1040 found in Appendix A. |
| 2. |
For official copies of the latest 1040, see Internal Revenue Service, About Form 1040, U.S. Individual Income Tax Return, at https://www.irs.gov/forms-pubs/about-form-1040. |
| 3. |
The expression "tax-exempt" is used to describe types of income and organizations that are not subject to taxation. Interest income from state and local bonds, for example, is exempt from federal income taxes. Certain qualifying nonprofit organizations are exempt from federal income taxation. The provisions are not, however, described as exemptions on the tax return. They are more properly termed "exclusions." |
| 4. |
For more information on the taxability of Social Security benefits, see CRS Report RL32552, Social Security: Taxation of Benefits, by Paul S. Davies. |
| 5. |
P.L. 115-97 substantially changed the individual income tax system, including by temporarily suspending personal exemptions from 2018 through the end of 2025. Before 2018, taxpayers deducted personal exemptions from their AGI when calculating taxable income. Personal exemptions were allowed for taxpayers, spouses, and any dependents. For 2020, the personal exemption amount would have been $4,300 per exemption. Absent any legislative change, personal exemptions will again be in effect beginning in 2026. |
| 6. |
CRS calculations using 2019 Internal Revenue Service, Statistics of Income, Table 1.2. |
| 7. |
For more information on the 199A deduction, see CRS In Focus IF11122, Section 199A Deduction for Pass-through Business Income: An Overview, by Gary Guenther. |
| 8. |
For more information, see CRS In Focus IF12032, How Do Marginal Income Tax Rates Work in 2021?, by Margot L. Crandall-Hollick. |
| 9. |
Tax Policy Center, "T21-0216 - Characteristics of Alternative Minimum Tax (AMT) Payers; Percentage Affected by the AMT, 2017, 2021, 2025-2026 ," updated September 3, 2021, at https://www.taxpolicycenter.org/model-estimates/baseline-alternative-minimum-tax-amt-tables-september-2021/t21-0216-characteristics. |
| 10. |
For more information, see CRS Report R44494, The Alternative Minimum Tax for Individuals: In Brief, by Donald J. Marples. |
| 11. |
For more information, see CRS Report R44993, Child and Dependent Care Tax Benefits: How They Work and Who Receives Them, by Margot L. Crandall-Hollick and Conor F. Boyle. |
| 12. |
On the 2021 Form 1040, taxpayers who are eligible to claim the $500 nonrefundable credit for other dependents or ODC—generally dependents who are not eligible to be claimed for the child credit—report the amount of this credit on line 19. |
| 13. |
Starting in 2020, those with nonemployee compensation (i.e., independent contractors) have such income reported on Form 1099-NEC. |
| 14. |
For more information, see CRS Report R43805, The Earned Income Tax Credit (EITC): How It Works and Who Receives It, by Margot L. Crandall-Hollick, Gene Falk, and Conor F. Boyle; CRS Report R41873, The Child Tax Credit: How It Works and Who Receives It, by Margot L. Crandall-Hollick; and CRS In Focus IF12025, Refundable Tax Credits for Families in 2021, by Margot L. Crandall-Hollick. |