How is Tax Calculated? The 7 BIG Line Items.

Have you ever looked at a tax return and wondered how accountants read these things? What is with all the numbers and lines? Why is my tax return over 20 pages long? Well, I get it. Tax returns look very intimidating, but they're actually just one big math formula, and if we simplify it, it only boils down to 7 simple lines (and they're not that wordy either).

The general layout for any tax return usually looks like this.

Start with........ Income

Subtract.......... Deductions

Equals............. Taxable Income

Multiply by...... Tax Rates/Brackets

Equals............. Tax Liability (a.k.a Tax Obligation)

Subtract.......... Tax Credits and Withholdings

Equals............. Tax Balance (Owing/Refund If negative)

That's it.

Just 7 lines.

Here's an example:

Start with........ Income Example: $100,000

Subtract.......... Deductions - $10,000

Equals............. Taxable Income =$90,000

Multiply by...... Tax Rates/Brackets x 10% on first $30,000

x 20% on remaining amount

Equals............. Tax Liability (a.k.a Tax Obligation) =$15,000 ($3,000+$12,000)

Subtract.......... Tax Credits and Withholdings - $10,000

Equals............. Tax Balance (Owing/Refund If negative) =$5,000 owing

If you understand each of these lines, you understand the general layout of most tax returns. Whether that's a Canadian tax return, a US tax return, a provincial or state tax return or even a corporate tax return.

If you want to know more about what each of these lines mean, you can check out our article on basic tax terminology here.

So why are there so many pages in a tax return?

While this is the simplified version of a tax return, each of these 7 line items can be comprised of a number of smaller elements. As a starter, you may have multiple income sources such as employment income, business income, capital gain income, investment income, rental income, etc. There are multiple deductions as well such as RRSP/401k, alimony payments, business expenses, investment expenses, etc. The same happens with credits and witholdings. Tax rates can also be complicated depending on the country and how they want to segregate tax rates. For example, in the US, if you file as a married couple instead of individually, there are different tax rates. Unfortunately, in Canada, everyone has to file individually, but, we have provincial and federal tax rates which all have different tax brackets. While it may start to get overwhelming, just remember that everything generally falls within one of those 7 big line items.

Should you need help with your taxes, feel free to contact us for a free tax consultation. Let us know that you've read this article and you can get a 10% discount on your next tax return with us by using code: 02HTFCT26.