1. Individual Income Tax Overview, Exemptions, and Filing Status
Chapter 4
Individual Income Tax Overview, Exemptions, and Filing Status
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2. Learning Objectives
Describe the formula for calculating an individual’s tax liability 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. Individual Income Tax Formula
Gross income
Minus: For AGI deductions
Equals Adjusted gross income
Minus: From AGI deductions:
Greater of (a) Standard deduction or
(b) Itemized deductions
and
Personal and dependency exemption
Equals Taxable income

4. Individual Income Tax Formula
Taxable income
Times: Tax rates
Equals: Income tax liability
Add: Other taxes
Equals: Total tax
Minus: Credits
Minus: Prepayments
Equals: Taxes due or (refund)
Please insert exhibit 4-1 on this slide where indicated

5. Individual Income Tax Formula
Individuals report taxable income to the IRS
Reported on Form 1040
U.S. tax laws use all-inclusive gross 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

6. Individual Income Tax Formula
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

7. Individual Income Tax Formula
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 – 0 or 15%
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

8. Individual Income Tax Formula
Capital assets
Generally all assets except
Accounts receivable
Inventory
Assets used in trade or business, including supplies

9. Individual Income Tax Formula
Capital gains and losses
Long-term capital gains 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

10. Individual Income Tax Formula
Deductions for AGI
Deductions “above the line”
Deducted in determining adjusted gross income
Always reduce taxable income dollar for dollar

11. Individual Income Tax Formula
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?

12. Individual Income Tax Formula
2013 Standard deduction amounts
$12,200 Married filing jointly
$12,200 Qualifying widow or widower
$6, Married filing separately
$8, Head of household
$6, Single
Additional standard deduction amounts for age and eyesight (discuss in Chapter 6)

13. Individual Income Tax Formula
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.

14. Individual Income Tax Formula
Other taxes include:
Alternative minimum tax
Self-employment taxes
Medicare Contribution tax on net-investment income
Tax credits
Reduce tax liability dollar for dollar

15. Individual Income Tax Formula
Tax prepayments
Payments already made towards 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

16. Personal and Dependency Exemptions
Personal exemptions
For taxpayer and spouse if married filing jointly
Dependency exemptions
For those who qualify as the taxpayers’ dependents
Exemption amount for 2013 is $3,900

17. Personal and Dependency Exemptions
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

18. Personal and Dependency Exemptions
Qualifying child
Relationship test
Age test
Residence test
Support test

19. 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.

20. Qualifying Child
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.

21. Qualifying Child 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

22. Qualifying Child Tie breaking rules Parents first
Days living with each parent if parents living apart
AGI – higher AGI gets exemption

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

24. 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
in-law (mother-in law, father-in-law, sister-in-law, and brother-in-law) of the taxpayer, or
unrelated person who lives in taxpayer’s home entire year

25. Qualifying Relative Support test Gross income test
Taxpayer must pay > ½ of living expenses (support)
Scholarships of actual child excluded
Gross income test
Gross income < personal exemption amount

26. Personal and Dependency Exemptions

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

28. Filing Status 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 end
Joint and several liability for tax

29. Filing Status 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

30. Filing Status 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

31. Filing Status
Single
Unmarried unless qualify for head of household

32. Filing Status 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)

33. Filing Status 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

34. Filing Status 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.

35. Filing Status 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)