A married couple earning $180,000 asks why their neighbor (same income) pays $9,000 less in federal taxes. The answer is never a single deduction. It is the entire six-step computation chain.
HIGH-FREQUENCY: The six-step tax computation is the backbone of nearly every tax question. Recite it cold.
NOTE: OBBBA changes. Every dollar threshold in this lesson reflects 2026 (post-OBBBA) law: the $40,000 SALT cap, the $16,100 / $32,200 / $24,150 standard deductions, the $2,200 child tax credit, and the alternative minimum tax (AMT) $500,000 / $1,000,000 flat phase-out thresholds. For a focused walk-through of what the One Big Beautiful Bill Act changed versus pre-OBBBA law (with worked examples on the SALT phase-down and the new senior bonus deduction), see lesson E36b: OBBBA Tax Law Changes.
IRC Section 61: "all income from whatever source derived" unless specifically excluded. Inclusions: wages, interest, dividends, rents, royalties, capital gains, alimony (pre-2019), unemployment, gambling winnings, Social Security (up to 85% taxable).
Exclusions: gifts and inheritances, life insurance death benefits, municipal bond interest, qualified Roth distributions, Section 121 home sale gain ($250,000/$500,000 MFJ), employer health insurance, employer retirement plan contributions.
Common mistakes
- Applying marginal rate to total income. The progressive system taxes each bracket's income at that bracket's rate. 12% x $105,000 = $12,600 is wrong. You must compute bracket by bracket. Trap: any answer that multiplies one rate by total income.
- Confusing above-the-line and below-the-line. IRA, student loan interest, HSA are above-the-line (reduce AGI). Mortgage, SALT, charitable are below-the-line (itemized). Mixing them changes AGI and cascades into credit phase-outs and NIIT.
- Forgetting the standard deduction floor. A single filer with $14,000 in itemized deductions gets zero incremental benefit. Standard deduction of $16,100 is higher. Trap: recommending itemizing when the standard deduction wins.
Bottom line
- Six-step chain: Gross income - Adjustments = AGI - Deductions = Taxable income x Rates + AMT/NIIT - Credits = Tax due
- Marginal rate taxes the next dollar; effective rate = total tax / total income. In a progressive system they always diverge, effective below marginal
- Credits reduce tax dollar-for-dollar and beat deductions at every bracket. A $1,000 credit beats a $1,000 deduction; refundable credits can produce a refund
- Above-the-line deductions reduce AGI, cascading into credit phase-outs, Roth eligibility, and NIIT, so they exceed their face-value tax savings
Exam shortcut
When a multi-step question asks for AGI, do not subtract the standard deduction. When it asks for taxable income, do not subtract credits. Watch the question stem: it tests whether you know where each step ends. Whenever MAGI exceeds the NIIT threshold, compute it separately and add. Remember: "GAITER-C". Gross income, Adjustments, Itemized/Standard, Taxable income, Evaluate (rates + AMT + NIIT), Remove Credits = tax due.
The full lesson (about 2,428 words, 16 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- E.36
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