Taxation I Chapter 2 Individual Tax Formula

Taxation I Chapter 2 Individual Tax Formula
Accounting 421 Taxation I Chapter 2 Individual Tax Formula 9/22/05 Chapter 2

Individual Tax Formula
The tax formula is the organizing structure of the material we will cover in the remainder of the course Students should memorize the tax formula. It will enable you to organize your tax knowledge. In addition, it will enable you to differentiate between deceptively similar sounding rules, for example exclusions and deductions and deductions for and from agi.. 9/22/05 Chapter 2

Gross income less exclusions Reportable income (Form 1040) less deductions for agi Adjusted gross income less deductions from agi standard deduction, or itemized deductions less personal and dependent exemptions Taxable income Tax – (rate x filing status) Add other taxes collected with the Form 1040 less credits Amount due or refundable 9/22/05 Chapter 2

Gross income - Section 61 …gross income means all income from whatever source derived, including but not limited to the following: compensation for services, including fringe benefits …. 9/22/05 Chapter 2

Gross income compensation for services, including fringe benefits income from business gains from property transactions interest, dividends, rents, royalties annuities, pensions, alimony income from partnerships, LLCs, S-Corps income from estates and trusts discharge of indebtedness gambling winnings etc. 9/22/05 Chapter 2

Glenshaw Glass, U.S. Supreme Court (1954) gross income means any transaction or event that is 1. an accretion to wealth 2. clearly realized 3. over which the taxpayer has dominion and control 9/22/05 Chapter 2

Exclusions - Why is an item of income excluded? Because Congress says so! Examples are gifts, inheritances, death proceeds from life insurance scholarships child support personal injury payments municipal bond interest, certain Federal bond interest social security benefits etc. 9/22/05 Chapter 2

Exclusions from income - workplace benefits Examples of workplace fringe benefits excludable from income - medical benefits, disability benefits, $50k of group term life insurance, meals and lodging, child care, educational assistance, cafeteria plan benefits, pension and 401(k) benefits, employee discounts, certain employee awards, parking and transportation benefits, etc.. 9/22/05 Chapter 2

Reportable income This is my term, not the textbook authors’. I use the word “reportable” because, generally, items that are includable and not excludable must be reported on a tax return and included in the computation of taxable income. That is, they must be reported to the IRS on the Form 1040. 9/22/05 Chapter 2

Deductions for AGI - (above the line) (Adjustments) trade or business expenses losses from property transactions expenses of rent and royalty activity reimbursed employee expenses alimony paid contributions to IRAs and certain other retirement plans, moving expenses CD early withdrawal interest forfeitures jury compensation paid to employer contributions to Health Savings Accounts 1/2 self-employment tax paid, etc. 9/22/05 Chapter 2

Individual tax Formula
Deductions for AGI - (above the line) Student loan interest Classroom teachers deduction - $250 Sec 222 – Higher education expenses - $4,000 Certain deductions of performing artists Amortization of reforestation expenses 9/22/05 Chapter 2

Adjusted gross income - The term agi is very important in the calculation of taxable income for individuals. Only individuals calculate agi. An incorrect agi computation can result in many errors on a return the decision to elect standard or itemized deductions many itemized deductions are affected by the agi amount many eligibility rules are affected by agi, for instance the education tax credits and IRA contributions many benefits are subject to phase out according to agi, such as exemptions and itemized deductions 9/22/05 Chapter 2

Standard deduction v Itemized deductions taxpayers may make an election annually Examples of itemized deductions medical (7.5%), charitable (50%), state income tax and property tax, residence mortgage interest, investment interest, casualty losses (10%), miscellaneous itemized deductions (2%) - union dues, uniform expenses, expenses of investment activity, unreimbursed employee expenses, safe deposit box rental, tax preparation fees other miscellaneous deductions - gambling losses 9/22/05 Chapter 2

Standard deduction Statutory amount - two parts - Basic standard deduction mfj mfs h/h single Additional standard deduction - (age 65 or blind) married single 9/22/05 Chapter 2

Standard deduction Exceptions to rules, the following are ineligible - individuals who are claimed by another as a dependent earned income plus $300 or $850 non-resident aliens not eligible MFS status where spouse itemizes taxpayer with a short year due to a change in accounting methods 9/22/05 Chapter 2

Exemptions - ($3,300 in 2006) personal exemptions for taxpayer and spouse dependency exemptions - five part test support test - over 50% dependent may not have income over the dependency amount - $3,300, unless a child under 19 or a full time college student under 24 dependent must be a relative closer than cousin or a 12 month resident of taxpayer’s home dependent may not file a joint return with spouse dependent must be a citizen or resident of the US, Canada, Mexico; under treaty Korea and Japan 9/22/05 Chapter 2

Support test - The taxpayer must provide over 50% of the support of the dependent support includes food, shelter, clothing, medical care, education, and like expenses in calculating the 50% consideration must be given to amounts provided by the dependent for his/her own care scholarships are not considered welfare type government payments are considered provided by the state In close cases make a spread sheet and consider all amounts paid for support by all providers of items of support. 9/22/05 Chapter 2

Support test Multiple support agreements In writing, Form 2120, aggregate support of all signatories must be 50% the person given the exemption must have provided at least 10% all other tests for dependency must be met by the person taking the exemption 9/22/05 Chapter 2

Divorced or separated parents – Decree or separation agreement if no agreement, then custodial parent gets the exemption consensual transfer to non-custodial parent must be in writing – Form 8332 may be the writing. 9/22/05 Chapter 2

Relationship test child, grandchild, parent, grandparent, niece or nephew, aunt or uncle - these relationships may be created by blood, adoption, marriage (step). Once the relationship is established it remains even if the basis for the relationship terminates. You may support your mother-in-law for as long as you like, even after your spouse divorces you! Foster children may also qualify for dependency exemption Non-relation; must be a member of household for 12 full months 9/22/05 Chapter 2

Gross income test $3,300 for 2006. Dependent may not have gross income over the amount unless child under age 19 full-time college student under age 24 a full-time college student is one carrying a full credit load for at least 5 months during the year 9/22/05 Chapter 2

Joint income test Dependent may not file a joint return with dependent’s spouse except to get a refund of taxes paid, and neither has a requirement to file a return, and on separate tax returns neither would have a tax liability 9/22/05 Chapter 2

Citizenship or residency test Dependent must be a resident or citizen of the US, Canada or Mexico Dependent may be a resident or citizen of Japan or Korea under special rules set forth in the tax treaties between the US and those countries. 9/22/05 Chapter 2

Exemptions - No personal exemption for taxpayer who is claimed another as an exemption Phase out of exemptions for high agi taxpayers See table in text at page 2- 9/22/05 Chapter 2

Tax Tax is a function of the rate and the filing status. There are four possible filing statuses Married filing jointly Married filing separately Head of household Single Marital status is determined on the last day of the year Dec 31, for most of us 9/22/05 Chapter 2

Filing status Married filing jointly, includes qualifying widow (surviving spouse) Surviving spouse - in the year of death of a spouse mfj status available to surviving spouse for two years after death of spouse a taxpayer may use mfj status if he/she is unmarried and has a dependent child living with taxpayer Married filing separately Marital status is determined on the last day of the taxpayer’s year (12/31) 9/22/05 Chapter 2

Filing status Head of household unmarried with a dependent child living in taxpayer’s home or a dependent parent where the taxpayer provides over 50% of the cost of the dependent’s home separated spouse with a dependent child-separation must be at least six months married taxpayer with a non-resident alien spouse - still needs a child living with taxpayer or a parent he/she supports Single - the default 9/22/05 Chapter 2

Tax Tax tables for taxable incomes to $100,000
Tax schedules for taxable incomes in excess of $100,000 See also the Corporate tax rate schedule See also the rate schedule for Estates and Trusts 9/22/05 Chapter 2

Other taxes collected with the Form 1040 Self-employment tax - (the FICA and Medicare tax on self-employed persons) Payroll taxes on domestic, household employees Alternative minimum tax 9/22/05 Chapter 2

Refundable credits supplemental child credit withheld income tax excess FICA tax withheld estimated taxes paid overpayment of tax from prior year earned income credit Non-refundable credits adoption credit child credit child care credit foreign tax credit research and experimentation credit business energy credits education credits Manufacturing credit 9/22/05 Chapter 2

Dependents with unearned income Recall no personal exemption reduced standard deduction earned income plus $300 or $850 9/22/05 Chapter 2

Kiddie tax Children with one living parent Children under the age of 18 (was 14) Earned income taxed at child’s rate Unearned income taxed First $800 at child’s rate Remainder at parent’s highest marginal rate 9/22/05 Chapter 2

Capital asset transactions - special rules Capital assets are: personal use assets - your home, cabin at the beach etc. investment assets - stocks, bonds etc. Capital assets, if owned for at least a year, and sold at a gain, get taxed at special low rates; if sold at a loss are subject to special limitations Capital asset transactions will be discussed in detail later in the course and in Accounting 422. 9/22/05 Chapter 2

Tax Compliance Who must file
One whose gross income equals or exceeds the applicable standard deduction and personal exemptions. If self-employment income is $400 one must file regardless of gross income. 9/22/05 Chapter 2

Tax Compliance Forms Form 1040, Form 1040A, Form 1040EZ
Tax tables for tax computations where taxable income is $100,000 or less; tax schedules X,Y,and Z for tax calculations where taxable income is over $100,000 9/22/05 Chapter 2

Tax Compliance When to file
On or before the 15th day of the fourth month after the end of the taxpayer’s tax year - for 99.9% of individuals that means April 15th. If the due date is on a weekend or holiday then the first business day thereafter Extensions to file will be granted automatically for up to six months (Oct 15). An extension to file does not act as an extension to pay - full payment of tax is due on the due date of the return and interest will accrue for late payment. Late payment of tax or late filing of a return may also result in a penalty assessment 9/22/05 Chapter 2

Taxation I Chapter 2 Individual Tax Formula

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