- 1). Calculate your total income. This is comprised of the sum of all payments received as wages, salaries, commissions, tips, fringe and employee benefits, and stock options. The IRC contains special rules for certain employees, such as clergy, members of religious orders, military, volunteers, and employees of a foreign employer with respect to determining taxable income.
- 2). Add business and investment income, such as rents from personal property, sole proprietorship, partnership and S corporation profits, royalties, farm income, and payments received for services to total income. Also, included is income from interest, dividends, and capital gains from sales of property.
- 3). Add payments received from any retirement pensions or annuities, alimony, survivor benefits, unemployment benefits to total income. In addition, payments from sickness and injury benefits, such as disability pensions, long-term care insurance contracts, and workers' compensation. Also included are the amounts of canceled debts, recoveries, and damages awarded for pain and suffering, and punitive damages either by judgment or settlement. Furthermore, the IRS sets out another category of income labeled "other income", which includes money earned from a hobby, and income from illegal activities, such as gambling, drug sales or prostitution. This total is your gross income.
- 4). Deduct the amounts that qualify for business and investment deductions and personal deductions. Business and investment deductions include, but is not limited to, business travel and meals, business entertainment, job-required education, attorney’s fees and litigation costs, permanent improvements to business property, acquiring goodwill, depreciation, amortization, depletion, and business or investment losses, and bad debt. Personal deductions include job-related moving expenses, interest payments on debt secured by a personal residence or designated second residence; state and local taxes paid on income and real or personal property; charitable contributions; medical expenses; casualty losses; and personal and dependency exemptions. The amount remaining after all the applicable deductions are applied is your taxable income.
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