chapter 1 the individual income tax return · pdf filechapter 1 the individual income tax...

CHAPTER 1The Individual Income Tax Return

©2015 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE SCANNED, COPIED, OR DUPLICATED, OR POSTED TO A PUBLICLY ACCESSIBLE WEBSITE, IN WHOLE OR IN PART. 1

Understand history/objectives of U.S. tax law

Describe different entities subject to tax/reporting requirements

Understand and apply tax formula

Identify who must file tax returns

Determine filing status and understand calculation of tax

according to filing status

Calculate number of exemptions and exemption amounts

Calculate correct standard or itemized deduction amount

Compute basic capital gains and losses

Identify new tax rules for high income taxpayers

Access and use various Internet tax resources

Understand the basics of e-filing

History of Taxation

Since 1913, when 16th amendment was

passed, the constitutionality of income tax

has never been questioned by federal

courts

Income taxes serve a multitude of

purposes

2©2015 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE SCANNED, COPIED, OR DUPLICATED,

OR POSTED TO A PUBLICLY ACCESSIBLE WEBSITE, IN WHOLE OR IN PART.

Objectives of Tax LawRaise revenue

Tool for social and economic policies

o Social policy encourages desirable activities and discourages undesirable activities

• Deductions for charitable contributions

• Credits for higher education expenses

• Credits for taxpayers living in disaster areas

o Economic policy as manifested by fiscal policy

• Encourage investment in capital assets through depreciation

• Credits for investment in solar and wind energy

o Both economic and social

• Exclude gain on sale of personal residence up to $250,000 ($500,000 if married)



Primary Entities/Forms

Individual

o Taxable income includes wages, salary, self-employment

earnings, rent, interest and dividends

o An individual may file simplest tax form qualified for

• 1040EZ

• 1040A

• 1040

o If error made on one of the three above forms, can amend

with a 1040X

4

See next slide

©2015 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE SCANNED, COPIED, OR DUPLICATED, OR POSTED TO A PUBLICLY ACCESSIBLE WEBSITE, IN WHOLE OR IN PART.


Individual

o 1040EZ

• Single or Married Filing Jointly (MFJ)

• Must not be 65 or older and/or blind

• Must not claim any dependents

• Taxable income must be under $100,000

• Only wages, salaries, unemployment and a few others, and not

more than $1,500 taxable interest income

• Not claim any credits other than the earned income credit




Individual (continued)o 1040A

• Generally used by taxpayers who are not self-employed and don‟t

itemize deductions

o 1040

• If taxpayer doesn‟t qualify to use 1040EZ or 1040A, should

complete a 1040 with appropriate schedules attached

Schedule A to itemize deductions

Schedule B to report dividends/interest income > $1500

Schedule C to report trade/business income

Schedule D to report capital gains/losses

Schedule E to report rental/royalty income

Schedule F to report farm/ranch activities




Corporations

o Tax rate schedule found on page 1-4

o Corporations need to file 1120 or 1120S

o 1120S is used by corporations that elect S corporation status

• Don‟t pay regular corporate income taxes

• Instead, pass through items of income or loss to shareholders

Partnershipso Reporting entity, not taxable entity

o 1065 reports partnership income/loss and allocation to partners

• Pass through items of income or loss to partners



Tax Formula for IndividualsThis formula follows Form 1040

Gross Income

less: Deductions for Adjusted Gross Income (AGI)

AGI

less: Greater of Itemized or Standard Deduction

less: Exemption(s)

Taxable Income (TI)

times: Tax Rate (using tax tables or rate schedules)

Gross Tax Liability

less: Tax Credits and Prepayments

Tax Due or Refund



Standard Deduction & Exemptions

9

2014 standard deduction

Single $ 6,200

Married Filing Joint (MFJ) 12,400

Qualifying Widow(er) 12,400also known as Surviving Spouse

Head of Household (HOH) 9,100

Married Filing Separate (MFS) 6,200

*Plus additional amounts for blindness or over 65: $1,200 if MFJ,

MFS or qualifying widow(er) and $1,550 if HOH or Single

Exemption = $3,950/person


Using Tax Formula

10

Facts: Juan (age 29) is a single taxpayer. In 2014, his salary is $39,000 and he has dividend income of $1,000. In addition, he has deductions for AGI of $2,500 and $3,000 of itemized deductions. If Juan claims one exemption for this year, calculate the following amounts:

Gross income ___________

Deductions for AGI ___________

Adjusted gross income ___________

Greater of the standarddeduction or itemized deductions ___________

Exemptions ___________Taxable income ___________


Solution

Gross income $40,000*

Deductions for AGI 2,500

Adjusted gross income $37,500

Greater of standardor itemized deductions 6,200**

Exemptions 3,950

Taxable income $27,350

* ($39,000 + 1,000)** greater of standard ($6,200) or itemized ($3,000)



Who Must File

Based on filing status and gross income

◦ Generally, if exemptions

plus

greater of standard or itemized deductions exceed income, then

filing is not necessary

◦ If taxpayer is claimed as a dependent on another taxpayer‟s return,

dependent‟s standard deduction is:

• Greater of $1,000

or

• Earned income + $350

But never more than standard deduction

12

See Figures 1.1 and 1.2 on

pages 1-7 and 1-8


Who Must File

Taxpayer must file if

o Owe any special taxes

• See Figure 1.3 on page 1-8

o Had self-employment income >= $400

o Other special situations as outlined on

Chart C (Figure 1.3)



Which Taxpayers are Required to File

Note: Must analyze each independent situation to determine if the taxpayer is required to file a return for 2014

Miles (age 45) is a single waiter and has unreported tips of $1,510; is he required to file?

Yes, because Miles owes social security taxes on unreported tips. See Figure 1.3 on p. 1-8.




Simone is single (age 31) and blind, and has income of $10,370; is she required to file?

No, because standard deduction = $7,750 ($6,200 + 1,550); exemption= $3,950. These amounts total to $11,700 and exceed her gross income. See Figure 1.1 on p. 1-7.




Eamon (age 67) and his wife, Roisin, (age 69) have income of $19,180 and file jointly; are they required to file?

No, because standard deduction = $14,800 ($12,400 + 1,200 + 1,200); exemptions = $7,900. These amounts total to $22,700 and exceed their gross income. See Figure 1.1 on page 1-7.




Taig is a single full time college student, age 21, with wages from a part-time job of $7,340. He is claimed as a dependent by his parents; is he required to file?

Yes, because Taig’s standard deduction = $6,200 and his income exceeds this amount. His exemption is 0, as he’s claimed by his parents.



Filing Status

Single

◦ Unmarried or legally separated as of 12/31

◦ And not qualified as married filing separately, head of household or

qualifying widow(er)

Married Filing Jointly (MFJ)

◦ If married on 12/31 – even if didn‟t live together entire year

◦ Based on a 2013 Supreme Court ruling that struck down a portion of the

Defense of Marriage Act (DOMA), same-sex couples may now file jointly

◦ If spouse dies during year, you can file MFJ in current year

Married Filing Separately (MFS)

◦ Each file separate returns

◦ Must compute taxes the same way - both itemize or both use standard

◦ If living in community property state, must follow state law



Filing Status

Head of Household (HOH)

◦ Tax tables have lower rates than single or MFS

◦ Taxpayer can file as HOH if:

Unmarried or abandoned as of 12/31

and

Paid > 50% of cost of keeping up home that was principal

residence of dependent child or other qualifying dependent

relative

There is one exception to principal residence requirement. If dependent

is taxpayer‟s parent, he/she doesn‟t have to live with taxpayer.

Note: A divorced parent who meets above rules and has signed IRS/legal document, may

still claim HOH even if dependency exemption shifted to ex-spouse



Tax Computation

Seven bracketso 10%, 15%, 25%, 28%, 33%, 35%, 39.6%

o Tax rate schedules for different filing types

Qualifying dividends and net long-term

capital gains may be taxed at lower rateso Rates based on ordinary tax bracket



Personal/Dependency Exemptions

Personal exemptions may be taken for self and spouse

Additional exemptions may be taken for individuals who are either taxpayer‟s◦ qualifying child

or

◦ qualifying relative

For 2014 each exemption = $3,950



Dependency – Qualifying Child

Dependency exemption allowed when six tests met

Relationship Test - child is taxpayer‟s child, stepchild, adopted

child or sibling, half- or step-sibling, or a descendant of any of

these. Foster child may also qualify. Child must be younger

than person claiming him/her, unless permanently disabled.

Domicile Test- child has same principal place of abode as

taxpayer for more than ½ the year.

Age Test – child is under 19 or a full-time student under 24

(enrolled at least 5 months of year).



Dependency – Qualifying Child

Joint Return Test – child doesn‟t file joint return with spouse

(exception: if file jointly only to claim refund, then considered to

have passed this test).

Citizenship Test – child is a US citizen, a resident of the US,

Canada or Mexico, or an alien child adopted by and living with a

US citizen.

Self-Support Test – child who provides more than ½ of his/her

own support cannot be claimed as a dependent of someone else.

Funds received by students as scholarships are excluded from

support test.



What if Child Meets Dependency Requirements for More than One Taxpayer?

If one of the parties is a parent, he/she can claim

If both parties are a parent, then one with whom the child resides longest can claimo If not ascertainable, parent with highest AGI may claim

If no parents are involved, person with highest AGI may claim

Note: If parents are legally separated/divorced, person with whom child resides more than 6 months may claim. However, exemption can shift if custodial parent signs Form 8332, and form is attached to noncustodial

parent’s tax return.



Dependency – Qualifying Relative

Dependency exemption may be granted for a

qualifying relative (who is not a qualifying child) based

on five tests on next slide.

Note: A taxpayer’s child who does not meet qualifying

child test may meet qualifying relative test!!



Dependency – Qualifying Relative

Relationship or Member of Household Test – list of relatives that qualify is available at IRS website

Note: A member of household (even if unrelated) for entire year meets the relationship test

Gross Income Test – individual may not have gross income in equal to or in excess of $3,950

Support Test – dependent must receive over ½ of his/her support from taxpayer

Joint Return Test – dependent may not file a joint return unless it‟s solely to claim refund

Citizenship Test – dependent must meet the citizenship test identified in the qualifying child slide



Standard Deduction

27

2014 standard deduction

Single $ 6,200

Married Filing Joint (MFJ) 12,400

Qualifying Widow(er) 12,400also known as Surviving Spouse

Head of Household (HOH) 9,100

Married Filing Separate (MFS) 6,200

*Plus additional amounts for blindness or over 65: $1,200 if MFJ,

MFS or qualifying widow(er) and $1,550 if HOH or Single


Standard Deduction -Dependents

28

The special rule for standard deduction for dependents is “Deduction =

Greater of $1,000 or earned income + $350, but only up to basic

standard deduction”

Example 1: Jaime is 23 and a full time student and her parents claim her as a

dependent; she earned $2,000 in 2014, how much is taxable income?

$2,000 earned income

(2,000) standard deduction

$0 taxable income

Example 2: Tia is 18 - has dividend income of $1,500 (dividends are considered

unearned income), how much is taxable income?

$1,500 dividend income

( 1,000) standard deduction

$ 500 taxable income


Basic Gain & Loss Model

29

Amount Realized*

- Adjusted Basis**

Realized Gain/Loss

* Sales Price - Sales Expenses

** Cost - Accumulated Depreciation

Note: Most realized gains/losses are also

recognized (i.e. – included in taxpayer’s income)


Capital Gains/Losses

A capital asset is any property (personal or

investment) held by a taxpayer, with certain

exceptions as listed in the tax law o Examples: stocks, bonds, land, cars and other items held for

investment

o Gains/losses on these assets are subject to special rates

Holding period of asset determines treatment o Long-term is held >12 months (taxed at capital rates – see next

screen)

o Short-term is held <= 12 months (taxed at ordinary rates)



Capital Gains/Losses

Long term capital gain taxed at special rates depending upon

taxpayer‟s bracket

Ordinary Tax Bracket Capital Gains Tax Rate*

10% or 15% 0%

25% or 35% 15%

39.6% 20%

*Special higher rates for „high income‟ taxpayers (see slide 36)

Long term capital loss are only allowed $3,000 net capital loss

per year against ordinary income

o Carry-forward any unused balance



Calculating Gain/Loss

32

Facts: Noah purchased Sony AAA bonds in 2006 for $47,600.

In 2014, he sold the bonds for $51,500, paying commission of

$515. What is his:

Amount realized ___________

Adjusted basis ___________

Realized gain/loss ___________

Recognized gain/loss ___________

Type of gain/loss ___________


Solution

33

Amount realized * $50,985

Adjusted basis 47,600

Realized gain/loss 3,385

Recognized gain/loss 3,385

Type of gain/loss Long term capital gain

*Amount realized = $51,500 – 515


Special Rules for High-Income Taxpayers

34

Two laws effected tax increases for high-income

taxpayers in 2013

o The Affordable Care Act (“Obamacare”)

o The American Taxpayer Relief Act (“Fiscal cliff” legislation)

Additional 3.8% Medicare tax on net investment income

o If modified AGI > $250,000 (MFJ), $200,000 (S) or $125,000

(MFS)

Additional .9% Medicare tax on earned income

o Same income thresholds as above (details in Chapter 9)

Top tax rate increased to 39.6%

o If TI >$450,000 (MFJ), $400,000 (S), $425,000 (HOH)


Special Rules for High-Income Taxpayers (continued)

35

Top capital gains tax rate increased to 20%

o If taxpayer is in new 39.6% top marginal rate (see prior

slide), then qualified dividends and long-term capital gains

are taxed at 20%

New top rates

o See p. 1-25 for diverse revenue‟s new top rates

Itemized deduction and exemption phase-outs

reinstated


Tax and The Internet

36

Volumes of tax information available on interneto www.irs.gov contains forms and publications and a search engine to

aid the user in obtaining useful information

The IRS has also launched a YouTube video site and an iTunes

podcast site; these feature topics like how to obtain refund or file

an extensiono Also, there are news feeds on Twitter, a Facebook page, and other

social media modalities

Other good sites include www.hrblock.com and

www.willyancey.com

In some states, names of delinquent taxpayers posted on websites


http://www.irs.gov/

http://www.hrblock.com/

http://www.willyancey.com/

Electronic Filing

37

Rules in constant transition, as IRS attempts to

transition all taxpayers to e-filing

Taxpayers may prepare electronic returns using

own PC and tax preparation software

or

May utilize a paid preparer who employs e-filing


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