The first step is to add all the wages, interest, dividends, net income from rental properties, net business profits, various pension payments, and net capital gains (losses) – everything taxable and received during the reporting year.
Next, take deductions. Deductions come in two important distinctive types, informally called “above the line” and “below the line.” It is essential to know the type of deduction because “above the line” deductions, in addition to lowering your taxable income, reduce your “adjusted gross income” (AGI) (special amount important for various calculations). “Below the line deductions” only reduce your taxable income and usually have more limitations on deductibility.
Popular above the line deductions are contributions to retirement plans, health insurance for self- employed, student loan interest, and tuition.