Like we said earlier, preparing your taxes is a step-by-step approach. When preparing your federal tax return, the first number you need to determine is your Adjusted Gross Income (AGI). This can be found from using the following formula:

Gross Income - Gross Income Deductions = Adjusted Gross Income, or AGI

Gross Income

By gross income, we mean that you'll need to calculate all your earnings from the previous year, from your jobs, investments, or other sources.

Here's a basic (and partial) listing of gross income sources includes:

Salary, wages, tips, commissions, bonuses, profit or loss from a business, up to 85% of social security income
Alimony received (but, not child support)

Basically, your gross income represents the traditional way that most people will earn income (i.e. in the form of compensation for their labor.) For many people, this may be their only source of income. Once your gross income is determined, you’ll want to look for any income deductions you can apply to that income. Some of the more common gross income deductions are:

Gross Income Deductions

Now that you've figured out your gross income, it's time to calculare your gross deduction, which can help lower your AGI, which will lead eventually to a lower tax liability.

Alimony paid (but, not child support paid)
Student loan interest
Penalties on early withdrawals of savings (like CDs)
Part of Self-employment tax, and self-employment health insurance
Health Savings Account or Archer MSA deduction
Certain moving expenses that are job related
Contributions to an Individual Retirement Arrangement (IRA)
In other words, the US Government gives preferential tax treatment to certain uses of your income. For example, if you take out a student loan to further your education and you pay interest on that student loan, you can deduct that from your gross income before you determine your AGI. As you will see later, the more you can reduce your AGI, the lower your tax liability. Yet, while student loan interest might be used to reduce your income tax bill, interest on the loan on your car or credit cards, does not reduce your taxes.