Already, millions of Americans are starting to file their tax returns, hoping to get refunds back from the IRS as early as possible. One of the last steps in your tax preparation is calculating your taxable income, from which you'll determine your final tax bill. The federal government regularly releases data on American taxpayers on a delayed basis, and its most recent numbers show quite clearly what the average American taxpayer's taxable income is. Yet there's reason to believe that if proposed tax reforms become law, some taxpayers could see that number drop, leading to possible tax savings.
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What's the average American's taxable income?
More than 112 million American households reported their taxable income on their tax returns during 2014, the most recent year for which the IRS has released data. In total, the numbers they reported on their 1040 tax returns added up to almost $7 trillion in taxable income. When you do the math using the precise figures that the federal government released, the average American household reported taxable income of $62,116.
There are a couple things to note with respect to this number. First, it represents taxable households rather than individual Americans, because couples who file jointly will combine their income on a single return. When you take into account the tens of millions of joint returns that got filed and adjust accordingly, the estimate for the average American's taxable income goes down to $45,575.
In addition, this figure leaves out a substantial number of Americans. If your income is low enough that you don't have to file a tax return at all, then the IRS data doesn't reflect that. In addition, if you filed a return but your taxable income was zero or negative, then the IRS data doesn't include the return in its count of taxpayers. It's difficult to estimate precisely for that effect, but what it suggests is that the true average would be lower still if it included all of those who would have no taxable income at all.
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Nevertheless, the figure is interesting, especially when you compare it to gross income figures. With taxpayers reporting nearly $10 trillion in total income figures, a look at where the remaining $3 trillion goes can tell a lot about the tax breaks that Americans claim.
What taxable income is
To figure your taxable income, you start with your total income and then start taking deductions. Certain deductions, such as IRA contributions, student loan interest payments, and self-employment taxes, get subtracted off the top to come up with adjusted gross income. These made up a relatively small amount of about $145 billion.
Two key items are largely responsible for bringing taxable income the rest of the way down. You can take the standard deduction or itemize your deductions, and that accounted for nearly $2 trillion in the reduction in taxable income. Also, most taxpayers get to take personal exemptions, and that slashed taxable income by about another $1 trillion.
What tax reform could do to taxable income
Under current law, the personal exemption for 2016 is $4,050 per taxpayer. Standard deductions range from $6,300 to $12,600 depending on filing status, with additions made for taxpayers who are 65 or older or blind.
However, proposed tax reform would change the way that taxpayers would calculate their taxable income. Instead of having separate standard deductions and personal exemptions, a larger standard deduction would apply. The amount would be $15,000 for single taxpayers and $30,000 for joint filers.
Depending on the number of exemptions claimed, some taxpayers would see larger deductions under this plan, while others would see smaller ones. However, the average return claims roughly two personal exemptions. So for single filers, the proposed $15,000 standard deduction would be slightly higher than the existing $6,300 single standard deduction plus $8,100 for two personal exemptions, adding up to $14,400. For joint filers, the corresponding $20,700 total under current law would be substantially less than the proposed $30,000 standard deduction.
What's not clear yet is what would happen to itemized deductions under tax reform. If new laws take away certain tax breaks, then those who itemize now might end up actually seeing less of a decrease in their taxable income despite the higher standard deduction. Moreover, proposed caps on itemized deductions could dramatically increase taxable income for those who take full advantage of available tax breaks.
Don't be afraid of taxable income
Finally, taxpayers should remember that no matter what happens to taxes, it always pays to take advantage of opportunities to bring in extra income. Even if some of it gets lost to tax, you'll always keep your fair share. That said, the lower taxable income gets without affecting your total income, the more your money stays in your own pocket rather than going to the IRS.
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