1. Individual Income Tax Overview, Exemptions, and Filing Status
Chapter 4
Individual Income Tax Overview, Exemptions, and Filing Status

2. Learning Objectives
Describe the formula for calculating an individual taxpayer's taxes payable or refund and generally explain each formula component.
Explain the requirements for determining a taxpayer’s personal and dependency exemptions.
Determine a taxpayer’s filing status.

3. The Individual Income Tax Formula
Gross income
Minus: For AGI deductions
Equals: Adjusted gross income
Minus: From AGI deductions:
Greater of (a) Standard deduction (increased) or
(b) Itemized deductions
and (elimination of some individual deductions)
Personal and dependency exemption (gone)
Equals: Taxable income

4. The Individual Income Tax Formula (2)
Taxable income
Times: Tax rates (new rates)
Equals: Income tax liability
Plus: Other taxes
Equals: Total tax
Minus: Credits (increase in the child tax credit)
Minus: Prepayments
Equals: Taxes due or (refund)
Please insert exhibit 4-1 on this slide where indicated

5. What are some of the lost deductions:
All miscellaneous deductions subject to the 2% of AGI threshold
Employee business expenses
Broker and IRA fees
Hobby expenses
Tax preparation fees
Theft losses
Alimony post 2018 divorce decrees
Casualty losses, except presidentially declared disaster areas
Phase out of itemize deductions
Limitation on state and local sales and property tax deductions
Interest on home equity loans eliminated
Education expenses
Moving expenses

6. The Individual Income Tax Formula (3)
Individuals report taxable income to the IRS
Reported on Form 1040
U.S. tax laws use all-inclusive income concept
Realized income
Measurable change in property rights
All realized income included in gross income unless specifically excluded or deferred
Recognized income
Reported on tax return

7. The Individual Income Tax Formula (4)
Excluded and deferred income not included in gross income
Excluded income
Income never included in taxable income
Municipal bond interest
Gain on sale of personal residence
Deferred income
Income included in a subsequent tax year
Installment sales
Like-kind exchanges (applies only to real property)

8. The Individual Income Tax Formula (5)
Character of income or loss
Determines rates applicable to income or loss in current year
Tax exempt – no tax
Tax deferred – no tax in current year (current year tax rate is zero)
Ordinary – ordinary rates from tax rate schedule
Qualified dividends taxed at 0%, 15%, or 20% depending on taxpayer’s income level
Capital gain or loss – depends on whether short-term or long-term
From selling capital asset
If held capital asset more than a year gain or loss is long-term, otherwise it is short-term
Net long-term gains taxed at preferential rates

9. The Individual Income Tax Formula (6)
Capital assets
Generally all assets except
Accounts receivable
Inventory
Assets used in trade or business, including supplies

10. The Individual Income Tax Formula (7)
Capital gains and losses
Net long-term capital gains in excess of net short-term capital losses are generally taxed at 0%, 15%, or 20% depending on the taxpayer’s taxable income
Short-term capital gains taxed at ordinary rates
Net capital losses (losses in excess of gains for year)
$3,000 deductible against ordinary income for year
Losses in excess of $3,000 carried forward

11. The Individual Income Tax Formula (8)
Deductions for AGI
“Deductions above the line”
Deducted in determining adjusted gross income
Always reduce taxable income dollar for dollar

12. The Individual Income Tax Formula (9)
Deductions from AGI
“Deductions below the line”
Deducted from adjusted gross income to determine taxable income
Greater of standard deduction or itemized deductions
Personal and dependency exemptions
Why might a from AGI deduction not reduce taxable income?

13. The Individual Income Tax Formula (10)
2017 standard deduction amounts, 2018 amounts in red
$12,700/$24,000 Married filing jointly
$12,700/$24,000 Qualifying widow or widower
$6,350/$0 Married filing separately
$9,350/$18, Head of household
$6,350/$12, Single
Additional standard deduction amounts for age and eyesight ($1250 or $1550) (discuss in Chapter 6)

14. The Individual Income Tax Formula (11)
Tax calculation
The U.S. uses a progressive tax rate schedule
Some items are taxed at preferential rates
Long-term capital gains
Qualified dividends
Tax on these items is calculated separately from income taxed at ordinary rates

15. 2017 Tax Cut and Jobs Act Updates
Individual Tax Formula New tax rate schedules apply for all taxpayers.
Married Filing Jointly
2018 tax rates under old law
2018 tax rates under new law
Tax rate
If taxable income is:
Tax Rate
10%
$0 to $19,050
15%
$19,051 to $77,400
12%
25%
$77,401 to $156,150
22%
$77,401 to $165,000
28%
$156,151 to $237,950
24%
$165,001 to $315,000
33%
$237,951 to $424,950
32%
$315,001 to $400,000
35%
$424,951 to $480,050
$400,001 to $600,000
39.6%
Over $480,050
37%
Over $600,000

16. 2017 Tax Cut and Jobs Act Updates
Individual Tax Formula New tax rate schedules apply for all taxpayers (continued).
Single
2018 tax rates under old law
2018 tax rates under new law
Tax rate
If taxable income is:
Tax Rate
10%
$0 to $9,525
15%
$9,526 to $38,700
12%
25%
$38,701 to $93,700
22%
$38,701 to $82,500
28%
$93,701 to $195,450
24%
$82,501 to $157,500
33%
$195,451 to $424,950
32%
$157,501 to $200,000
35%
$424,951 to $426,700
$200,001 to $500,000
39.6%
Over $426,700
37%
Over $500,000

17. 2017 Tax Cut and Jobs Act Updates
Individual Tax Formula New tax rate schedules apply for all taxpayers (continued).
Married Filing Separately
2018 tax rates under old law
2018 tax rates under new law
Tax rate
If taxable income is:
Tax Rate
10%
$0 to $9,525
15%
$9,526 to $38,700
12%
25%
$38,701 to $78,075
22%
$38,701 to $82,500
28%
$78,076 to $118,975
24%
$82,501 to $157,500
33%
$118,976 to $212,475
32%
$157,501 to $200,000
35%
$212,476 to $240,025
$200,001 to $300,000
39.6%
Over $240,025
37%
Over $300,000

18. 2017 Tax Cut and Jobs Act Updates
Individual Tax Formula New tax rate schedules apply for all taxpayers (continued).
Head of Household
2018 tax rates under old law
2018 tax rates under new law
Tax rate
If taxable income is:
Tax Rate
10%
$0 to $13,600
15%
$13,601 to $51,850
12%
$13,601 to $51,800
25%
$51,851 to $133,850
22%
$51,801 to $82,500
28%
$133,851 to $216,700
24%
$82,501 to $157,500
33%
$216,701 to $424,950
32%
$157,501 to $200,000
35%
$424,951 to $453,350
$200,001 to $500,000
39.6%
Over $453,350
37%
Over $500,000

19. The Individual Income Tax Formula (12)
Other taxes include:
Alternative minimum tax
Self-employment taxes
3.8% net investment income tax
.9% additional Medicare tax
Tax credits
Reduce tax liability dollar for dollar

20. The Individual Income Tax Formula (13)
Tax prepayments
Payments already made toward tax liability including:
Income taxes withheld from wages by employer
Estimated tax payments made during the year
Taxes overpaid in prior year and applied toward current year’s liability
If prepayments exceed tax liability after credits, taxpayer receives a refund

21. Personal and Dependency Exemptions can you say bye bye
Personal and Dependency Exemptions can you say bye bye. Still important regarding child tax credit, earned income credit, American opportunity credit and other tax benefits
Personal exemptions
For taxpayer and spouse if married filing jointly
Dependency exemptions
For each person who qualifies as the taxpayer’s dependent
Exemption amount for 2017 is $4,050

22. Personal and Dependency Exemptions (2)
Dependency requirements
Citizen of U.S. or resident of U.S., Canada, or Mexico
Must not file joint return with spouse
Exception – if no tax liability filing jointly or separately
Must be qualifying child or qualifying relative of taxpayer

23. Personal and Dependency Exemptions (3)
Qualifying child
Relationship test
Age test
Residence test
Support test

24. Qualifying Child Relationship test
Taxpayer’s son, daughter, stepchild, an eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister or a descendant of any of these relatives

25. Qualifying Child (2)
Age test: child must be younger than the individual claiming the child as a qualifying child and either:
Under age 19 at the end of the year,
Under age 24 at the end of the year and a full-time student, or
Permanently and totally disabled

26. Qualifying Child (3) Residence test Support test
Same residence as taxpayer for more than half the year
Exception for temporary absences such as education
Support test
Child must not provide more than half of his or her own support
Scholarships of actual child (not grandchild, for example) are excluded from support computation

27. Qualifying Child Example
Rodney and Anita have two children: Braxton, age 12, who lives at home, and Tara, age 21, who is a full-time student and does not live at home. While Tara earned $9,000 in a summer job, she did not provide more than half of her own support during the year. Are Braxton and Tara qualifying children of Rodney and Anita?

28. Qualifying Child Example Solution
Test
Braxton
Tara
Relationship
Yes, son
Yes, daughter
Age
Yes, < 19 at year-end (and younger than his parents)
Yes, < 24 at year-end and full-time student (and younger than her parents)
Residence
Yes, lived at home entire year
Yes, temporary absences such as school OK
Support
Yes, he provides < ½
Yes, parents provide > ½ (scholarship does not count as self-support)

29. Qualifying Child (4) Tiebreaking rules Parents first
Days living with each parent if parents living apart
AGI – higher AGI gets exemption

30. Qualifying Child Example (2)
Braxton’s uncle Shawn (Rodney’s brother) lived in the Halls’ home (the same home Braxton lived in) for more than 11 months during the year. Does Braxton meet the requirements to be considered Shawn’s qualifying child?

31. Qualifying Child Example Solution (2)
Test
Is Braxton Shawn’s qualifying child?
Relationship
Yes, son of Shawn’s brother
Age
Yes, < 19 at year-end (and younger than Shawn)
Residence
Yes, lived in the same residence as Shawn for more than half the year
Support
Yes, does not provide more than half of own support

32. Qualifying Child Example (3)
Braxton is considered to be Rodney and Anita’s qualifying child and he is considered to be Shawn’s qualifying child. Under the tiebreaker rules, who is allowed to claim Braxton as a dependent for the year?

33. Qualifying Child Example Solution (3)
Answer: Rodney and Anita. Under the first tiebreaking rule, Rodney and Anita are allowed to claim the dependency exemption for Braxton because they are Braxton’s parents.

34. Personal and Dependency Exemptions
Qualifying relative
Relationship test
Support test
Gross income test

35. Qualifying Relative Relationship test
A descendant or ancestor of the taxpayer (e.g., child, grandchild, parent, or grandparent),
A sibling of the taxpayer including a stepbrother or stepsister
A son or daughter of the taxpayer’s brother or sister (not cousins)
A sibling of the taxpayer’s mother or father
An in-law (mother-in-law, father-in-law, sister-in-law, or brother-in-law) of the taxpayer, or
An unrelated person who lives in taxpayer’s home entire year

36. Qualifying Relative (2)
Support test
Taxpayer must pay > ½ of living expenses (support)
Scholarships of actual child excluded
Gross income test
Gross income < personal exemption amount ($4,050 in 2017)

37. Dependency Exemption Example
John is a 22-year-old student who has lived in the dorms for most of the year but spends the rest of the year living with his parents. He earned a $5,000 scholarship for the school year and has worked hard to support himself through school, earning $6,000 to pay for his own expenses. His parents have supported him by paying $7,000 for food, clothing, and lodging expenses. Are John’s parents able to claim him as a dependent?

38. Dependency Exemption Example Solution
Test
Qualifying child
Qualifying relative
Relationship
Yes, child
Age
Yes, < 24 and full-time student
Not applicable
Residence
Yes, temporary absences OK
Support
Yes, he provides < ½
Yes, parents provide > ½
Gross income
No, gross income > $4,050

39. Filing Status Five different filing statuses Married filing jointly
Married filing separately
Qualifying widow or widower (surviving spouse)
Single
Head of household

40. Filing Status (2) Married filing jointly
Must be married on the last day of the year
If one spouse dies the surviving spouse is considered to be married to decedent spouse at year end
Exception – The surviving spouse remarries before year’s end
Joint and several liability for tax

41. Filing Status (3) Married filing separately
Taxpayers are married but file separate returns
Typically not beneficial from tax perspective
Tax rates and other tax benefits
May be beneficial for non-tax reasons
No joint and several liability

42. Filing Status (4) Qualifying widow or widower
Available for the two years following the year of spouse’s death
Surviving spouse does not qualify if remarries during two-year period
Surviving spouse must maintain household for dependent child

43. Filing Status (5) Single
Unmarried unless qualify for head of household

44. Filing Status (6) Head of household
Unmarried or considered unmarried at end of year
See discussion of married individuals treated as unmarried (abandoned spouses) below
Not a qualifying widow or widower
Pay more than half the costs of keeping up a home during the year
Lived in taxpayer’s home with a “qualifying person” for more than half of the year
Exception for parents (see below)

45. Filing Status (7) Qualifying person Qualifying child
Qualifying relative who is taxpayer’s mother or father
Parent need not live with taxpayer
Taxpayer must pay > ½ cost of maintaining separate household for taxpayer’s mother or father
Parent must qualify as taxpayer’s dependent

46. Filing Status (8) Qualifying relative who is not the taxpayer’s parent
Person must have lived with taxpayer for more than half the year
Must qualify as taxpayer’s dependent
Must be related to taxpayer through qualified family relationship
If related only because lived with taxpayer for entire year, not a qualified person

47. Filing Status (9) Head of household
Married individuals treated as unmarried (abandoned spouse) if individual
Is married at end of year (or is not legally separated from the other spouse)
Does not file a joint tax return with the other spouse
Pays > ½ the cost of maintaining a household that serves as principal abode for qualifying child for more than half the year
Lived apart from the other spouse for the last six months of the year (other than temporary absences)

48. Filing Status Example
Assume that last year Rodney passed away, and during the current year Anita did not remarry but maintained a household for Braxton and Tara, her dependent children. Under these circumstances, what would Anita’s filing status be?

49. Filing Status Example Solution
Answer: Qualifying widow

50. Filing Status Example (2)
Assume Rodney and Anita divorced last year. During the current year, Braxton lives with Anita and Anita pays all the costs of maintaining the household for herself and Braxton. Under these circumstances, what is Anita’s filing status for the current year?

51. Filing Status Example Solution (2)
Answer: Head of household

52. Filing Status Example (3)
Assume Shawn (Rodney’s brother) lived with the Halls, but Shawn paid more than half the costs of maintaining a separate apartment that is the principal residence of his mother, Sharon, whose gross income is $1,500. Because Shawn provided more than half of Sharon’s support during the year, and because Sharon’s gross income was only $1,500, she qualifies as Shawn’s dependent (as a qualifying relative). In these circumstances, what is Shawn’s filing status?

53. Filing Status Example Solution (3)
Answer: Head of household. Shawn paid more than half the costs of maintaining a separate household that is the principal place of abode for his mother, and his mother qualifies as his dependent.