To explain the concept of tax formula, one has to understand several other terms. One of the terms that need to be understood is the gross income, and this is the income that an individual has, the source from which the income is derived does not matter. Income stands for both the taxable and the nontaxable income that an individual receives. However, this does not include the return of capital or money that had been borrowed. For example, if a taxpayer buys a bond that has accrued interest, the taxpayer will be forced to pay for the bond and the accrued interest. When the taxpayer is receiving interest for the next bond payment, the interest will be deductible since the amount that is paid is a return of capital. Similarly, if a bondholder sells his or her bond or redeems, the amount that is gained from the sell is used to determine whether there is a deductible lose or a taxable gain. This case is similar to when a taxpayer borrows money, and this does not have to be reported as income since it is not income. Tax is applied to income regardless of the area that it has been earned from, for instance, if a United States of America citizen earns money from foreign sources, he or she will be taxed. There is a probability that the income could have been taxed from its source. To prevent the phenomenon of double taxation the United States of America allows deductions and credits on income to offset taxes that are paid to other foreign countries. There is also a general tax formula that is used to determine the taxable income;
Income
(Exclusions removed)
= Gross Income
(Deductions to obtain the Adjusted Gross Income)
= Adjusted Gross Income
(The standard deductions and dependency exemptions)
= Taxable Income
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