Items Not Included in Gross Income

• Generally, you don't have to include dividends from a participating life insurance policy in your income, as the IRS considers these payments to be a non-taxable return of premium. You also don't have to include payments from qualified Roth IRA (individual retirement accounts) and designated Roth 401k accounts or the non-taxable portion of your Social Security Income. In many cases, you also do not include proceeds from sales of property in your income; these items are accounted for in the capital gains tax system. Even then, you only pay taxes on the difference between all the gains and losses you have realized for the year.
  
  

Adjusted Gross Income

• The amount left over after you have excluded income from these sources is your unadjusted gross income. The next step is to figure out your adjusted gross income. Here, you have a choice: You can elect to take the standard deduction for the year. In that case, you simply subtract the standard deduction from your gross income, along with any exemptions or "above the line" tax deductions. Alternatively, you may choose to itemize your deductions. You can do one or the other; you cannot do both.
  
  

Itemized Deductions

• The IRS generally allows you to deduct miscellaneous items by filing a Schedule A along with your Form 1040 Individual Income Tax Return. You cannot itemize with a 1040EZ return. However, you can only deduct these items to the extent that they exceed 2 percent of your adjusted gross income, except for medical and dental expenses. These you can only deduct to the extent they exceed 7.5 percent of your income. Families subject to the alternative minimum tax face additional restrictions.
  
  

Business Expenses

• If you are the sole proprietor of a business, you must include any net operating profits from your business for the year. However, you may be entitled to a tax credit if you had operating losses in prior years. To account for your expenses, file an IRS Schedule C (Profit or Loss from Business) along with your Form 1040 for the year. To claim credit for a prior year's net operating loss (NOL), file a Form 1045.