Key tax terms | Taxes and tax forms | Financial Literacy | Khan Academy

What we're going to do here is a little bit of a case study in doing taxes.

So, we have a situation where someone is bringing in fifty thousand dollars in this current tax year and gross income. This is everything from their salaries, tips they might make if they act as a contractor, payments for that. It could be dividend income if they own stocks; it could be interest on bank accounts or CDs that they might have.

So, when you add up all of that, we get to fifty thousand dollars. Now, you aren't taxed on your gross income, just as is typically the case. You're going to adjust it to figure out what your taxable income is, and then you will go and look at the various tax brackets and calculate your taxes.

Just so you know, these are not the real tax brackets in the United States; these have never been the real tax brackets in the United States. I simplified it, one, to make the numbers easy so I can do it with back-of-the-envelope math, but also these are constantly changing in the real world, and I don't want to have to keep redoing this video every time they change the tax brackets. But it's going to give you the general idea of what's going on.

So, these are made-up tax brackets and tax rates, and this is also a made-up standard deduction. We're going to talk in a little bit about what a standard deduction is.

So, going back to the case study of this person in this taxable year: gross income fifty thousand dollars, and then they have what we're calling above-the-line deductions. Above-the-line deductions you can view as deductions to your gross income that you can make no matter what.

The history of why it's called above the line is the first form of the typical tax form. So, let me say, above the line: above the line, you can make these types of deductions no matter what. This isn't an exhaustive list, but these are ones that are actually reasonably typical. Things like a 401(k) contribution, which is a pre-tax contribution to a retirement account—a defined contribution retirement account, so to speak—where you put a certain amount of money every year, and that money is pre-taxed.

So it gets taken down from your gross income to figure out what your actual taxable income is going to be. Student loan interest is also typically deductible from your gross income. When we deduct those, we are left with our adjusted gross income.

Let me write here: adjusted gross income, which in this case is going to be what's going to be fifty thousand dollars minus two thousand minus three thousand. So that gets us to forty-five thousand dollars. Now we're not ready to just take this forty-five thousand dollars and figure out how that would be taxed based on this schedule here, this chart right over here. We're not ready to make more deductions, and we can view these as below-the-line deductions.

This is where it gets interesting. You could go the path of itemized deductions. So, that's looking at things like, okay, did you make any donations to charity or do you have any mortgage interest on your home mortgage?

So let me write these. These are itemized deductions. If you itemized your deductions, you'd say, okay, I have a total of nine thousand dollars of itemized deductions right over here. I would take that from the forty-five thousand dollars, and I could have a situation where my taxable income would be forty-five thousand minus nine, which is going to be—let me draw a little line over here—this is going to be thirty-six thousand dollars of taxable income.

Now, you could just take that and figure out what you're now going to have to pay, but there's another interesting alternative path that you should know about. As opposed to itemizing your deductions, your below-the-line deductions, so to speak, where you have to list them all out, your other option is to just take the standard deduction.

Now, in this situation, the standard deduction is ten thousand dollars. So let's see what happens if instead of itemizing our deductions, we were to just take out the ten thousand dollar standard deduction. Well, in that situation, our taxable income is going to be forty-five thousand minus ten thousand, which is going to be thirty-five thousand dollars.

Now, generally speaking, unless you just like giving money to the government, you want to minimize your taxable income. You want to do that legally, and in this situation, when we pick the standard deduction route, we actually have a lower taxable income. So this is the path that you're going to want to take.

And now that we've calculated this taxable income—this thirty-five thousand dollars—we are ready to now actually calculate based on the schedule of the actual tax brackets.

One way to think about it is the first ten thousand, right over here, we are going to have no tax. So let me put that here: we have 10K, no tax.

Now, the next ten thousand dollars right over here is going to be taxed at ten percent. So the next 10K is going to be taxed at 10 percent. Now, sorry, my dog barked.

So now we've accounted for 20K. We have fifteen thousand dollars left, so we go into the next bracket. The next bracket actually accounts for the next twenty thousand. We don't have that much, but if I just right over here say okay, my next 15K, which is all I have, falls over here.

So I'm going to say the next 15K is going to be taxed at 20 percent, and this is federal taxes that we are talking about here. You're going to have to do it another time for your state taxes, but now let's calculate our total tax.

First ten thousand dollars, no tax, so we'd have to worry about that. Now, ten thousand dollars being taxed at ten percent: ten percent of ten thousand is one thousand dollars.

Then, fifteen thousand dollars being taxed at twenty percent: that's going to be three thousand dollars.

And so, you add these up and you get a total federal tax in this situation—and this made-up tax bracket that I just did in this made-up example—of four thousand dollars. But hopefully, that gives you an idea of how taxes are actually calculated and a little bit of the terminology.