Taxable and nontaxable income
To get things started with the very basics, below is a list of everything the government considers taxable income.

• Your salary, less any money put into a retirement plan.
• Interest on any bank accounts.
• Interest on all bonds except municipal (tax-free) bonds.
• Dividends on investments.
• Severance pay, bonuses, and sick pay from your employer.
• Unemployment compensation.
• Tips.
• Capital gains on mutual funds and other investments.
• Bartering, royalties, gambling gains, and lottery winnings.
• Most withdrawals from an individual retirement account or an annuity.

The following nontaxable income is safe from Uncle Sam's clutches.

• Money contributed to retirement accounts such as your 401(k) or IRA.
• Gifts from anyone.
• Disability income on benefits you paid for with after-tax money.
• Childcare financed through a plan at work.
• Return of invested capital.
• 401(k) money rolled over into another plan.
• Child support receipts.
• Money received by you as repayment for a loan.

Adjustments
Everybody wants to reduce his or her taxable income as much as possible. The first place to start is with adjustments, which are special types of tax breaks or deductions the government lets you subtract from your income, thus reducing the amount of tax you pay. One adjustment that might save you quite a bit is if you have contributed as much as possible to tax-sheltered accounts. Another type of adjustment is the expense you incur from moving. For example, if you took a new job at least 50 miles from your old one, you could deduct the cost of changing homes and driving expenses. A third adjustment is possible if, for example, you're still in the first 60 months of repaying student loans, in which case you may deduct interest paid (up to $2,500). Other potential adjustments would be alimony paid and bad debts, but they are subject to strict rules and can be researched further at the IRS website.

Standard and itemized deductions
Deductions can be beautiful if you figure out which ones apply to you. While legal deductions are many and varied, don't expect a free-for-all. If you start itemizing a broad spectrum of expenses you must prove you qualify with supporting documents. Everyone gets to choose between a standard deduction and an itemized deduction. The goal is to use the one that most reduces your taxable income.

If your financial situation is reasonably simple - that is, if you don't own property, run a business from home, or manage a lot of investments - you're probably best off taking the standard deduction. The standard deduction is a fixed dollar amount Congress allows all taxpayers to subtract from their income, even if they don't participate in activities that are deemed deductible by the government. For the year 2000, single persons get a standard deduction of $4,400. Those filing as head of household, which typically refers to divorced or single parents, get a standard deduction of $6,450. Married persons filing jointly, or qualifying widows and widowers, get a standard deduction of $7,350, while married persons filing separately get $3,675. You cannot take the standard deduction if you or your spouse claim itemized deductions.

Itemized deductions are accounted for on Schedule A of IRS form 1040. Itemizing simply means listing the specific items that are deductable according to current tax rules, and then subtracting their costs from your taxable income. This may be the best option for you if your financial life is somewhat complicated or, if, for example, you've had a large number of medical bills, or significant loss. The following expenses can be itemized as legitimate deductions.

• Taxes (such as local income, state, real estate, foreign, and personal property taxes).
• Medical and dental expenses.
• Interest expenses on mortgages, home equity loans, and real estate.
• Charitable work or contributions to tax-exempt organizations.
• Casualty and theft losses.
• Job expenses.
• Impairment-related expenses for persons with disabilities.

The following expenses can also be itemized, but only if they total more than 2 percent of your adjusted gross income.

• Job-related car expenses.
• Business expenses not covered by your employer.
• Educational expenses.
• Professional dues, tools, uniforms, and legal expenses incurred to collect income.
• Tax preparation fees.
• Investment fees.
• Cellular telephones used for business.
• Passport fees (provided the travel is for business).
• Safe deposit box fees, if used for investment protection.
• Subscriptions to professional journals and research.
• The cost of a home computer, if used for work.

Unfortunately, none of the following qualifies as a valid deduction.

• Political contributions.
• Trash collection fees.
• Home owners' association dues.
• Water bills.
• Car loan interest.
• Credit card interest (except for a business).
• Real estate points, if you are the seller.
• Estate, inheritance, legacy, or succession taxes.