Taxable Income Formula for Individuals Gross Income $XX Less Adjustments (deductions ‘for’ AGI) ($XX) Equals Adjusted Gross Income (AGI) $XX Less Greater of Itemized or Standard Deductions ($XX) Less Personal and Dependency Exemptions ($XX) Equals Taxable Income $XX

Filing Status Married filing jointly - legally married at year end, and widows and widowers for year of death Widows/widowers with dependents qualify as surviving spouse for 2 years following year of death of spouse, and continue to use MFJ rates and standard deduction amount Married filing separately - married individuals choosing to file separate returns Head-of-household - Single individual maintaining household for a dependent relative, not qualifying as a surviving spouse Single - everyone else

Standard Deduction Indexed for inflation Depends on filing status – 2003 amounts Single - $4,750 Married filing jointly and surviving spouse - $7,950 Married filing separately - $3,975 Head of household - $7,000 Additional Standard deduction if over 65 or blind $1,150 for single and head of household $950 for all others

Personal & Dependency Exemptions Artificial deductions, representing an amount of income not taxed that varies with the number of persons supported by that income 2003 exemption - $3,050 per person exemption allowed for taxpayer, spouse (on a joint return) and supported dependents

Personal & Dependency Exemptions continued ‘Support’ requires: 50% of financial support provided by taxpayer Gross income less than exemption Waived for child who is a minor or full-time student under 24 Family member or resident in taxpayer’s home Phase-out for high income taxpayers MFJ threshold AGI of $209,350 (2003) H-of-H threshold $174,400 Single threshold $139,500 MFS threshold $104,625

Other Issues Phase-out of itemized deductions Higher income taxpayers are limited in their ability to use itemized deductions Total deductions reduced by 3% of AGI in excess of threshold amount ($139,500 in 2003) Medical, investment interest, gambling and personal casualty loss deductions not subject to reduction Reduction cannot exceed 80% of total remaining itemized deductions Motivation for phase-out? Impact of phase-out on marginal tax rate?

Other Issues continued Why does it matter if a deduction is ‘for’ or ‘from’ AGI? AGI used to calculate limits such as medical expense and miscellaneous itemized deductions If taxpayer claims the standard deduction, any benefit of a ‘for’ deduction inadvertently treated as a ‘from’ deduction is lost

Other Issues continued Marriage penalty Federal income tax system is not marriage neutral Why does a marriage penalty occur? MFJ standard deduction amount is not 2 times Single amount MFJ rate brackets are not 2 times Single brackets Do all married taxpayers experience a marriage penalty? Which taxpayers would receive a marriage benefit?

Computation of Tax Liability Regular tax liability on ordinary income, calculated using rate schedules based on filing status Special tax rates on capital gains Individual tax credits: Child credit - $600 per child, phased out for higher-income taxpayers Dependent care credit Earned income credit Excess payroll tax withholding

Individual Alternative Minimum Tax Basic approach similar to corporate AMT standard deduction and exemptions are AMT adjustments Individual AMT exemption amounts: MFJ - $49,000 (phased out if AMTI > $150,000) MFS - $24,500 (phased out if AMTI > $75,000) Single - $35,750 (phased out if AMTI > $112,500) Individual AMT rates: 26% on AMTI up to $175,000 28% on excess

Payment and Filing Requirements Most individuals meet payment requirements via payroll withholding Estimated payments may be required for taxpayers with substantial non-payroll income Safe harbor payment requirements: Form 1040 required by 15th day of 4th month following close of taxable year Automatic 4-month extension possible; can request additional 2-month extension