In order to calculate income tax liability, a person needs to consider a number of figures. Depending on where the taxpayer lives and to what entity he is required to pay taxes, he will usually need to add his income and then subtract any allowed deductions and credits. This will leave a figure that represents the amount of money on which the taxpayer must pay taxes. Finally, the taxpayer may need to apply a percentage as provided by the taxing agency by multiplying his adjusted income by the tax percentage rate. The answer would be the taxpayer’s liability.
A good place to start is with figuring out the total amount of income the person has received for the year. Depending on the taxing agency’s regulations, a taxpayer may have to include income he earned, certain types of unearned income, and gifts. He may also have to include income and interest from investments. In some cases, property acquired within a taxing period may count as well. Income tax liability calculations may even include things like bonuses and tips.
Once the taxpayer has a total income amount, calculating income tax exemptions is the next step. A tax exemption allows a taxpayer to keep a portion of his income separate from his taxable income. For example, in some countries, a portion of a taxpayer’s income is exempt from taxes if he has dependents, and he may enjoy more exemptions if he has more than one dependent. There may be other types of exemptions as well, and each one can be used to reduce the taxpayer’s taxable income and total liability.
Next on the list are income deductions. Often, these are expenses the taxpayer had that can be deducted from his total income. For example, in some countries, a taxpayer can deduct a portion of his business expenses from his taxable income. Some taxing agencies also allow deductions for things like child care expenses, medical expenses, uniforms purchased for work, and moving expenses that are related to employment.
After using exemptions and deductions to reduce taxable income, a taxpayer typically refers to the taxing agency's guidelines to calculate his income tax liability. In some places, the taxpayer will use a percentage to figure out his liability. For example, he may be required to pay 10 percent of his income after exemptions and deductions. Other taxing agencies may require taxpayers to refer to a table or other documentation to determine liability, which is the amount the taxpayer must pay.
In some tax jurisdictions, a taxpayer may also use tax credits to reduce the amount he has to pay in taxes. These credits are often applied after the tax liability is calculated. Instead of using them to reduce taxable income, a taxpayer may use them to reduce his tax payment. For example, if a taxpayer has calculated his income tax liability and discovered that he owes $1000 US Dollars (USD), he may apply a tax credit of $200 USD and pay $800 USD in taxes instead of $1000 USD. A tax entity may allow tax credits for a variety of reasons, including overpayment of taxes in a previous year, being a low-income taxpayer, or adopting a child.