Answer:
Ahmed's ranking is Third (Lowest Taxable Income)
Baker's ranking is Second
Chin's ranking is First (Highest Taxable Income)
Explanation:
In order to determine the rankings, lets compute each taxpayer's taxable income by making the necessary deductions as applicable. Taxable income calculated for each taxpayer below in serial order. Before we calculate, lets have an idea of how deductions are made.
AGI is defined as the adjusted gross income which is calculated as an individual's gross income minus the expenses that qualify as deductible. These expenses include the likes of contributions to the IRA, payment of interest on student loans, alimony payments, contributions to self-employment insurance, moving expenses, some business related expenses pertaining to educators, artists etc, and some rental expenses associated with a business activity. Therefore, intuitively, we can see that a taxpayer with the <u>highest</u> amount of deductions for AGI would benefit the <u>most</u> when calculating taxable income.
Itemized deductions are expenses that a taxpayer can incorporate to lower their taxable income by reducing their adjusted gross income (AGI). These include certain medical expenses, markup on house loans and charities. Taxpayer's can chose between either opting to deduct itemized expenses or <em>standard deductions </em>which is a fixed deduction allowed under tax law. Obviously, a taxpayer would go for the deduction amount which is the highest. Standard deduction is $ 5,950. Therefore, among the taxpayer's, the one with the highest amount of itemized deductions would benefit the most.
Lets calculate taxable income now.
(1) Ahmed
Gross Income: 80,000
<em>Less</em> Deduction for AGI: (8,000)
Adjusted Gross Income: 72,000
<em>Less</em> higher of itemized deduction or standard deduction: (5,950)
Taxable Income: 66,050
(2) Baker:
Gross Income: 80,000
<em>Less</em> Deduction for AGI: (4,000)
Adjusted Gross Income: 76,000
<em>Less </em>higher of itemized deduction or standard deduction: (5,950)
Taxable Income: 70,050
(3) Chin:
Gross Income: 80,000
<em>Less </em>Deduction for AGI: (0)
Adjust Gross Income: 80,000
<em>Less</em> higher of itemized deduction of standard deduction: (8,000)
Taxable Income: 72,000
As we can see from the above, since Ahmed has the highest deductions for AGI he has the lowed adjusted gross income. He can then take use of the fact that he can deduct a standard deduction of 5,950 (while not having any itemized deductions) to further lower his taxable income.
Chin did not have an deductions for AGI which made his taxable income the highest.
<u><em>Note: Taxpayers can also deduct personal and dependency deductions but these have been excluded in the context of the question based on the assumption that these deductions have either not been made or would be equal for all three taxpayers. The answer would not be affected in either case.</em></u>
