Determination of income is a three step process starting with determining the gross monthly income. The second step in the process involves the assessment of the tax burden and the taxpayer’s ability to pay. The third step is the allocation of the income among the various classes based on their net income. Determining income from products involves several techniques that include Gross Merchandise Revenue, Sales, and Allowance for Business Use. The concepts and calculations for each step in the process are as follows:
Cost of Goods sold – This refers to the difference between the selling price and the cost of production. This is important in determining the taxable income. The sales volume is a direct reflection of the income from services. In general terms, the more the service sales, less the cost of production, and vice versa.
Net earnings from self-employed activities – Self-employed persons can also have gross income from self-employment activities. Under section 561, the court shall determine the net earnings from self-employment. For the purpose of computing the net earnings from self-employment, the court may consider the gross receipts of commissions and payments received by the self-employed person from selling a product or providing a service. Payments made by a client to a business for recommendations are also considered as part of the gross income from self-employment.
Allowance for temporary assistance – When a person is receiving temporary assistance under the Medicaid program, or the State child assistance programs, and the requirement is to make monthly payments to the government, the person is entitled to an additional amount on the basis of gross monthly income. Usually, the income from temporary assistance is determined on a per month basis. This usually takes care of the expenses such as insurance premiums, transportation expenses, home maintenance, and child care. However, the eligibility for the grant is determined on the basis of the gross monthly income. If the applicant qualifies for the assistance, he may apply for the grant.
Consumption Based Receipts – The income from PCA includes the incomes from rents, miscellaneous receipts such as credit card charges, purchases with a business credit or store cards. In certain states, like Florida, the gross income from PCA does not include income from rent receipts. Under such condition, the state allows a deduction for income from PCA. Similarly, if the cost of living increases by a percentage more than the income from PCA, the seller is permitted a flat discount on the price of PCA. The seller has the right to apply for a refund, if the price of PCA is higher than his usual market price.
Computation of Self-Employment Tax Deduction – There are several situations when an individual has to make an income tax return and has to include certain deductions. Among these are the self-employed individuals. In general, it is mandatory for the filer to include an income tax deduction in the return and pay the tax through the government agency. However, the IRS rules state that there are certain categories of self-employed people who are exempted from the requirement to pay through the government agency.
One of the most common forms of such categories is the self-employed person who has his own house, vehicle and other financial resources. This category is further divided into three parts: the commissioned agents, commercial brokers and those who perform self-employment services only. The income earned by such agents is taxable only if they receive a portion of the total income of their clients. This also includes people who work on commission. The income from such brokers comes under the category of income from property used exclusively for trade.
Computation of Indirect Expenditures – There are situations when an individual has to compute the indirect expenses that he has incurred during the year. There are three different methods of computing indirect expenses: the quadrant theory, the division of direct and indirect costs and the functional decomposition. The first method, the quadrant theory, states that the income is computed by dividing the total cost of service of the principal and the interest by the income of the principal. The second method, the division of direct and indirect costs, states that the cost of production of the item or group being sold is deducted from the income of the principal. The third and the functional decomposition, which mean the allocation of the expenses among the functions, is the most widely used method of determination of income by the IRS and many other tax agencies around the world.