Individual Tax Formula
Individual Income Tax Computation
Gross Income (§61)
Wages, salaries, tips
Interest and dividends
Business income (Sch C)
Capital gains/losses
Rental income (Sch E)
Alimony (pre-2019 agreements)
Adjustments (Above the Line)
IRA contributions
Student loan interest
Self-employment tax (50%)
HSA contributions
Alimony paid (pre-2019)
Adjusted Gross Income (AGI)
Deductions (Below the Line)
Standard deduction OR
Itemized deductions (Sch A)
Taxable Income
Tax Computation
Apply tax rate brackets
− Credits (nonrefundable, then refundable)
+ Self-employment tax, AMT, etc.
− Payments and withholding
Tax due or refund
Passive Activity Loss System
Loss Limitation Tiers (S Corp / Partnership)
Tier 1 — Basis Limitation
S Corp: stock basis + direct loans
Partnership: outside basis (incl. liabilities)
Tier 2 — At-Risk Limitation (§465)
Cash + basis of property contributed
+ Recourse borrowing
+ Qualified nonrecourse real estate financing
Tier 3 — Passive Activity Limitation (§469)
Passive losses offset passive income only
$25K rental allowance (active participation)
Full release on complete disposition
Tier 4 — Excess Business Loss (§461(l))
$322K single / $644K MFJ (2026)
Excess becomes NOL carryforward
Passive vs. Active vs. Portfolio Income
Is the income from rental activity or a business in which the taxpayer does NOT materially participate?
YesIs it rental activity (regardless of participation level)?
YesDoes the taxpayer qualify as a real estate professional (>750 hrs, >50% of services)?
YesActive income if the taxpayer materially participates in each rental; otherwise passive
NoPassive income — subject to §469 passive loss limits ($25K rental allowance may apply)
NoPassive income — losses limited to passive income only
NoIs the income from interest, dividends, annuities, or capital gains on investment property?
YesPortfolio income — not passive, cannot be offset by passive losses
NoActive (nonpassive) income — wages, active business income, material participation income
Adjusted Gross Income (AGI)
Gross Income − Above-the-Line Deductions
Self-Employment Tax
Net SE Income × 92.35% × 15.3% (first $176,100 SS + unlimited Medicare)
50% is deductible above-the-line. Additional 0.9% Medicare on SE income over $200K/$250K.
Net Investment Income Tax (NIIT)
3.8% × Lesser of (Net Investment Income, MAGI − Threshold)
Thresholds: $200K single, $250K MFJ, $125K MFS. Not indexed for inflation.
Social Security Taxability
Provisional Income = AGI + Tax-Exempt Interest + 50% of SS Benefits
Single: <$25K = 0%, $25K–$34K = up to 50%, >$34K = up to 85%. MFJ: <$32K = 0%, $32K–$44K = up to 50%, >$44K = up to 85%.
Seven Material Participation Tests (Reg. §1.469-5T)
| Test | Requirement |
|---|
| 1 | More than 500 hours during the tax year |
| 2 | Taxpayer's participation constitutes substantially all participation |
| 3 | More than 100 hours and no other individual participated more |
| 4 | Significant participation activities (>100 hrs each) aggregate to >500 hrs |
| 5 | Materially participated in any 5 of the prior 10 tax years |
| 6 | Personal service activity — materially participated in any 3 prior years |
| 7 | Based on all facts and circumstances, regular, continuous, and substantial participation |
I SAIDInterest (tax-exempt), State/local tax refunds (if didn't itemize), Alimony (post-2018), Inheritances, Damages (physical injury)
Common exclusions from gross income under §61. If you I SAID it's excluded, it's not taxable.
SID BURNSSalary/wages, Interest, Dividends, Business income, Unemployment comp, Rents/royalties, Notional income (partnerships K-1), Social security (up to 85%)
Common items included in gross income. SID BURNS through your money with taxes.
BARPBasis limitation, At-risk limitation, (Passive) activity loss rules, (Excess business loss) Post-TCJA cap
The four-tier loss limitation order for S corp and partnership losses. Losses must pass each BARP gate before deduction.