CHAPTER 1 The Individual Income Tax Return 2013 Cengage Learning Income Tax Fundamentals 2013 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill

History of Taxation  Since 1913, when 16 th amendment was passed, the constitutionality of income tax has never been questioned by federal courts  Income taxes serve a multitude of purposes 2013 Cengage Learning

Objectives of Tax Law  Raise 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 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) 2013 Cengage Learning

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 2013 Cengage Learning See next slide

Tax Formula for Individuals This 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 times:Tax Rate (using tax tables or rate schedules) Gross Tax Liability less:Tax Credits and Prepayments Tax Due or Refund 2013 Cengage Learning

Standard Deduction and Exemptions 2013 Cengage Learning 2012 standard deduction Single $ 5,950 Married Filing Joint (MFJ)$11,900 Qualifying Widow(er) $11,900 also known as Surviving Spouse Head of Household (HOH) $ 8,700 Married Filing Separate (MFS) $ 5,950 *Plus additional amounts for blindness or over 65: $1,150 if MFJ, MFS or qualifying widow(er) and $1,450 if HOH or Single Exemption = $3800/person

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 $950 or Earned income + $300 But never more than standard deduction 2013 Cengage Learning See Figures 1.1 and 1.2 on page 1-8

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 ◦ Same-sex couples may not 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 2013 Cengage Learning

Filing Status  Head of Household (HOH) ◦ Tables have lower rates than single or MFS ◦ Taxpayer can file as HOH if:  Unmarried or abandoned as of 12/31  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 2013 Cengage Learning

Tax Computation  Six brackets o 10%, 15%, 25%, 28%, 33%, 35% o Tax rate schedules for different filing types  Qualifying dividends and net long-term capital gains may be taxed at lower rates o Rates based on ordinary tax bracket 2013 Cengage Learning