CPA Exam — REG (Regulation)Federal Taxation of IndividualsMedium
A client, single, age 30, has a gross income of $75,000. They have $12,000 in itemized deductions, which exceeds their standard deduction. They also contributed $3,000 to their traditional IRA. What is their taxable income?
- A$60,000
- B$57,000
- C$63,000
- D$66,000
Show answer & explanationAnswer & explanation
Correct answer: A. $60,000
Taxable income is calculated by starting with gross income, subtracting above-the-line deductions (like IRA contributions) to arrive at AGI, and then subtracting the greater of itemized or standard deduction. Gross Income $75,000 - IRA deduction $3,000 = AGI $72,000. AGI $72,000 - Itemized Deductions $12,000 = Taxable Income $60,000.
Why the other options are wrong
- B. This calculation is incorrect, potentially miscalculating deductions or AGI.
- C. This incorrectly subtracts only the IRA deduction and standard deduction, or makes another calculation error.
- D. This only subtracts the IRA deduction from gross income, ignoring itemized deductions.
Taxable Income Calculation
Taxable income is derived by subtracting above-the-line deductions from gross income to reach AGI, and then subtracting the greater of itemized or standard deduction from AGI.
- Gross Income - Above-the-line Deductions = AGI.
- AGI - (Greater of Standard or Itemized Deductions) = Taxable Income.
- Traditional IRA contributions are an above-the-line deduction.
Memory trick: Gross Income starts the journey; deductions pave the way to taxable money.