Income tax for year 2012:

Single taxpayer, no children, under 65 and not blind, taking standard deduction;

• $40,000 gross income – $5,950 standard deduction – $3,800 personal exemption = $30,250 taxable income

  • $8,700 × 10% = $870.00 (taxation of the first income bracket)

  • $30,250 – $8,700 = $21,550.00 (amount in the second income bracket)

  • $21,550.00 × 15% = $3,232.50 (taxation of the amount in the second income bracket)

• Total income tax is $870.00 + $3,232.50 = $4,102.50 (~10.26% effective tax)

Note that in addition to income tax, a wage earner would also have to pay Federal Insurance Contributions Act tax (FICA) (and an equal amount of FICA tax must be paid by the employer):

• $40,000 (adjusted gross income)

  • $40,000 × 4.2%^[10] = $1,680 (Social Security portion)

  • $40,000 × 1.45% = $580 (Medicare portion)

• Total FICA tax = $2,260 (5.65% of income)

• Total federal tax of individual = $4,102.50 + $2,260.00 = $6,362.50 (~15.91% of income)

Further information: Rate schedule (federal income tax)

[edit]Effective income tax rates

While the top marginal tax rate on ordinary income is 35 percent, average rates that a household in the upper income bracket pays is less. Much of the earnings of those in the top income bracket come from capital gains, interest and dividends, which are taxed at a maximum of 15 percent. Also because only income up to $106,800 is subject to payroll taxes of 15.3%, which are paid by the employer and employee, individuals in the upper income bracket pay on average an effective rate not much different than that of other income brackets. The effective tax rate paid by an individual in the upper income bracket is highly dependent on the ratio of income they earn from capital gains, interest and dividends. The table below shows the average effective income tax rates for different income groups for 2007.^[11]

Quintile	Average Income Before Taxes	Effective Income and Payroll Tax Rate	Income from Capital Gains, Interest and Dividends
Lowest	$18,400	2.0%	1.3%
Second	$42,500	9.1%	1.6%
Middle	$64,500	12.7%	2.5%
Fourth	$94,100	15.7%	3.7%
Highest	$264,700	20.1%	21.4%
Top 10%	$394,500	20.7%	26.7%
Top 5%	$611,200	20.9%	32.1%
Top 1%	$1,873,000	20.6%	43.4%
Top 400[12]	$344,831,528*	16.6%	81.3%
	*Adjusted Gross Income(AGI)

[edit]Taxable income

Income tax is imposed as a tax rate times taxable income, less applicable tax credits. Taxable income is gross income less allowable tax deductions. Taxable income as determined for federal tax purposes may be modified for state tax purposes.

[edit]Gross income

Main article: Gross income

The Internal Revenue Code states that "gross income means all income from whatever source derived," and gives specific examples.^[13] Gross income is not limited to cash received. "It includes income realized in any form, whether money, property, or services."^[14] Gross income includes wages and tips, fees for performing services, gain from sale of inventory or other property, interest, dividends, rents, royalties, pensions, alimony, and many other types of income.^[13] Items must be included in income when received or accrued. The amount included is the amount the taxpayer is entitled to receive. Gains on property are the gross proceeds less amounts returned, cost of goods sold, or tax basis of property sold.

Certain types of income are subject to tax exemption. Among the more common types of exempt income are interest on municipal bonds, a portion of Social Security benefits, life insurance proceeds, gifts or inheritances, and the value of many employee benefits.

Gross income is reduced by adjustments and tax deductions. Among the more common adjustments are reductions for alimony paid and IRA and certain other retirement plan contributions. Adjusted gross income is used in calculations relating to various deductions, credits, phase outs, and penalties.

[edit]Business deductions

Main article: Tax deduction

Deductions are permitted for most business expenses of entities and individuals. There are limits on some types of these deductions. The deduction for depreciation expense must be computed under MACRS rules. Deductions for meals and entertainment are limited to 50% of the amount incurred.

Certain deductions must be capitalized or deferred. These include: