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Federal Taxation -- Chapter 2
Terms in this set (50)
individual tax formula
<deductions FOR AGI>
adjusted gross income
deductions FROM AGI:
<itemized or standard deduction>
<personal and dependency exemptions>
x tax rate or rates (from tax table or schedule)
<credits and prepayments>
net tax payable or refund due
includes both taxable and nontaxable income.
meaning is close to that of the term revenue. However, it does not include a return of capital. In case of sale of property, only the gain, not the entire sales proceeds, is viewed as income.
not all income is taxable. An exclusion is any item of income that the tax law says is not taxable. Exclusions on page 2-3
income reduced by exclusions.
deductions for adjusted gross income
trade and business deductions
losses from sale or exchange of property
deductions attributable to rents and royalties
contributions to IRAs
one-half of self-employment taxes paid
jury duty pay remitted to an individual's employer
interest on education loans
contribution to medical savings account
adjusted gross income
measure of income that falls between gross income and taxable income
itemized deductions and standard deduction
charitable contributions and medical expenses. itemize expenses related to production or collection of income, management of property held for the production of income,
personal and dependency exemptions
personal exemption generally is allowed for each taxpayer and his or her spouse and an additional dependency exemption is permitted for each dependent.
is adjusted gross income reduced by deductions FROM AGI. It is the amount of income that is taxed.
which include prepayments, are amounts that can be subtracted from the gross tax to arrive at the net tax due or refund date. Credits may be classified as either refundable or nonrefundable tax credits
refundable tax credits
allowed to reduce a taxpayer's tax liability to zero, and, if some credit still remains, are refundable (paid) by the government to the taxpayer. Prepayments of tax, which are amounts paid to the government during the year through means such as withholding from wages, and selected other items are classified as refundable tax credits.
nonrefundable tax credits
are allowances that have been created by Congress for various social, economic, and political reasons such as the child and dependent care credits. nonrefundable tax credits can be subtracted from the tax and may reduce the tax liability to zero. However, if the nonrefundable credits exceed the tax liability, none of the excess will be paid to the tax payer.
claimed only if the total of such expenses exceeds the standard deduction.
itemized deduction floors
*medical expenses: only medical expenses over 7.5% of AGI are deductible...Increases to 10% in 2013.
**casualty loses: only casualty losses in excess of 10% of AGI are deductible.
**miscellaneous itemized deductions: only miscellaneous itemized deductions in excess of 2% of AGI are deductible.
generally increases each year because it is indexed to the rate of inflation. rules 2-11
Loss of the standard deduction
*** individual filing a return for a period less than twelve months because of a change in accounting period.
** married taxpayer filing a separate return in instances where the other spouse itemizes.
limitation on the standard deduction
rule applies to any individual for whom the dependency exemption is allowable to another taxpayer. the standard deduction of the dependent is limited to the greater of (1) the dependent's earned income plus $300 or (2) $950.
personal exemption of $3800
virtually all taxpayers can claim a personal exemption for themselves. In addition, taxpayers may also claim a dependency exemption for each dependent.
**have a qualifying identification number- SSN
**meet a citizenship test- U.S., nationals, or residents of U.S., Canada, Mexico for some part of the year
**meet a separate return test
** not themselves claim another person as a dependent
Additional requirement also must be met depending on whether the dependent is a qualifying child or a qualifying relative.
additional requirements for qualifying children
eligible children include the taxpayer's children (including natural, adopted, foster, and stepchildren) and the taxpayer's siblings (including half-siblings and step-siblings) along with descendants of any of the above. A child is adopted if the child has been legally adopted or has been legally placed in a home for adoption.
qualifying child must be under age 19, a full-time student under age 24, or a permanently and totally disabled child. A child is considered to be a student if he or she is in full-time attendance at a qualified educational institution during at least five months of the year. To be full-time, a student must carry the number of hours or course the educational institution requires a student to take to be considered full-time.
a qualifying child must have the same principal abode as the taxpayer for more than half of the year. A noncustodial parent meets this requirement if the custodial parent agrees in writing.
a qualifying child may not provide more than one-half of his or her own support during the year. Support is defined below in connection with the discussion of other dependents. Unlike other dependents, there is no requirement that the taxpayer provide more than one-half of the qualifying child's support, only that the dependent cannot provide more than one-half of his or her own support. This can be important in situations such as divorces where one spouse provides support, but the other has custody.
additional requirements for qualifying relative
*gross income test
Other relatives must either be related to the taxpayer or reside in the taxpayer's household for the entire year. Although this group is referred to as "other qualifying relatives," that term is misleading because individuals who live with the taxpayer do not actually have to be related to the taxpayer. The relationship between the taxpayer and the dependent cannot violate local law. Relatives who can be claimed as dependents even if they do not live with the taxpayer include the taxpayer's parents and their ancestors and siblings, the taxpayer's stepparents, and specified in-laws (mother, father, brother, sister, son, and daughter) along with qualifying children discussed above. As a result, a qualifying child may be claimed as a dependent if the child meets the tests described here even if the child fails the requirements for qualifying children.
gross income test
the dependent's gross income must be less than the exemption amount for the year ($3,800). The statutory definition of gross income is used in applying this limitation. Therefore, nontaxable scholarships, tax-exempt bond interest, and nontaxable social security benefits are not considered, but salary, taxable interest, and rent are considered in deciding whether the person meets this test.
The taxpayer must normally provide more than one-half of a dependent's financial support during the year. Support includes amounts spent by the taxpayer, the dependent, and other individuals. Welfare and social security benefits spent on support count even if they are excluded from gross income. Scholarships, however, do not count as support if the amounts are tax exempt.
Support includes amounts spent for food, clothing, shelter, medical and dental care, education, and the like. Support is not limited to these items. Support does not include the value of services rendered by the taxpayer to the dependent.
Generally, the amount of support equals the cost of the item, but in the case of support provided in a noncash form, such as lodging, the amount of support equals the fair market value or fair rental value. The cost of an item such as a television or an automobile is included in support if the item actually is support.
Tie-breaker rules for dependency exemptions
More than one person can meet the requirements to claim someone as a dependent. Tie-brakers decide who receives the exemption in such situations, as follows:
*First, taxpayers who meet the requirements to claim the dependent under the qualifying child rules have priority over individuals who meet the requirements for other relatives.
* The next priority provides that parents have priority over other individuals.
* Finally, if neither of the first two tie-breakers apply, the third tie-breaker specifies that the exemption is awarded to the taxpayer with the highest AGI.
Multiple Support Agreements
Often several people contribute to the support of a dependent. When a group provides over one-half of the support of an individual but no one member of the group provides over one-half of the support, eligible members of the group are allowed to designate one group member to claim the exemption. Each eligible member (other than the taxpayer receiving the exemption) must agree in writing. The taxpayer claiming the exemption must complete a Multiple Support Declaration. An eligible member is one who contributes more than *
10% of the dependent's support and meet all requirements for claiming a dependency exemption except the support requirement.
In the case of divorced or separated parents, the dependency exemption of children generally is awarded to the custodial parent. However, the noncustodial parent may claim the dependency exemption if the divorce or separation instrument specifies so, or if the custodial parent agrees in writing. The signed statement must be attached to the noncustodial parent's return each year in which the exemption is claimed.
Individual taxpayers may claim a "child credit" of $1,000 for each qualifying child. The credit is reduced by $50 for each $1,000 by which the taxpayer's modified adjusted gross income exceeds a threshold amount ($110,000 on joint returns, $75,000 for single taxpayers, and $55,000 for married persons filing separate returns). Modified adjusted gross income is AGI plus any amounts excluded from gross income. To qualify for the credit, a child must be **
under the age of 17 and be a qualifying child
individual taxpayers tax brackets
six tax brackets: 10%, 15%, 25%, 28%, 33%, 35%. Progressive rates...
Five filing statuses: married filing jointly, surviving spouse, head of household, single, married filing separately
filed by man and woman if:
* They must be legally married as of the last day of the tax year under the laws of the state of residence. Common law marriages are recognized. On the other hand, an annulled marriage is viewed as never having been valid. It is unclear whether same-sex couples can file joint federal tax returns.
* They must have the same tax year-end (except in the case of death.)
* Both the husband and wife must be U.S. citizens or residents. An exception allows joint return if the nonresident alien spouse agrees to report all of his or her income on the return.
A widow or widower can file a joint return for the year his or her spouse dies if the widow or widower does not remarry. For the two years after the year of death, the widow or widower can file as a surviving spouse only if he or she meets specific conditions. The surviving spouse must:
* Have not remarried as of the year end in which surviving spouse status is claimed.
* Be a U.S. citizen or resident.
* Have qualified to file a joint return in the year of death.
* Have at least one son or daughter living at home during the entire year and the tax-payer must pay over half of the expenses of the home.
Surviving spouse (2)
In the year of death, a joint return can be filed. On the joint return, the income of the deceased spouse (earned before death) and the survivor are both reported. Personal exemptions are allowed for both spouses. In the two years following death, surviving spouse status can be claimed only if the conditions outlines above are met. Only the surviving spouse's income is reported and, of course, no personal exemption is available for the deceased spouse.
head of household
* Be unmarried as of the last day of the tax year. Exceptions apply to individuals married to nonresident aliens and to abandoned spouses. An individual cannot claim head-of-household status in the year his or her spouse died. Such individuals must file a joint return or a separate return.
* not be a surviving spouse.
* be a U.S. citizen or resident.
* Pay over half of the costs of maintaining as his or her home a household in which a dependent lives for more than half of the tax year. An exception permits a taxpayer who maintains a household in which a qualifying child lives for more than half of the tax year to claim head-of-household status when the qualifying child is not the taxpayer's dependent. This comes into play in the case of divorced parents when the dependency exemption goes to the non-custodial parent as well as in the case of financially independent children. A second exception permits a taxpayer to claim head-of-household status if he or she maintains a separate household for a dependent parent. This enables the parent to continue living in his or her own home.
head of household (2)
As noted, the taxpayer must pay over half of the costs of maintaining the household. These expenses include property taxes, mortgage interest, rent, utility charges, upkeep and repairs, property insurance, and food consumed on the premises. Such costs do not include clothing, education, medical treatment, vacations, life insurance, transportation, or the value of services provided by the taxpayer.
An unmarried individual who does not qualify as a surviving spouse or head-of-household must file as a single taxpayer. The tax rates progress more rapidly than those that apply to other unmarried taxpayers.
married filing a separate return
Married individuals who choose to file separate returns must use the separate rate schedule. the rates on this schedule increase more rapidly than other individual rate schedules.
*The taxpayer lived apart from his or her spouse for the last six months of the year.
* The taxpayer pays over half of the cost of maintaining a household in which the taxpayer and dependent son or daughter live for over half of the year.
* the taxpayer is a U.S. citizen or resident.
The requirement that the taxpayer have a dependent child is met if a taxpayer who is otherwise qualified to claim the child as a dependent signs an agreement that allows the child's noncustodial parent to claim the dependency exemption for the child.
children with unearned income
* dependents do not receive a personal exemption on their own returns.
* a dependent's standard deduction is reduced to the greater of $950 or the dependent's earned income (such as salary) plus $300.
* The tax on the net unearned income (such as dividends and interest) of a child under age 18 (under age 24 in certain instances described below) is figured by refernce to the parents' tax rate if it is higher than the child's rate. This provision is often called the "kiddie tax".
Prior to the year a child turns 18, the kiddie tax applies if the unearned income exceeds the $1,900 threshold. for the year the child turns 18 (and only that year), the kiddie tax applies if child's earned income is less than or equal to one-half of his or her support and unearned income exceeds the $1,900 threshold. From the year a child turns 19 up to and including the year the child turns 23, the kiddie tax applies only if the child is a full-time student, the child's earned income is less than or equal to one-half of his or her support, and unearned income exceeds the $1,900 threshold.
Kiddie tax equation: (2-25) (2-26)
capital gain or loss
is the gain or loss from the sale or exchange of a capital asset. Divided into long-term (associated with property held over one year) and short-term (associated with property held one year or less.
innocent spouse provision
innocent spouse is relieved of the liability for tax on unreported income if:
* the amount is attributable to erroneous items of the other spouse.
* The innocent spouse did not know and had no reason to know that there was such an understatement of tax.
* under the circumstances, it would be inequitable to hold the innocent spouse liable for the understatement.
* the innocent spouse elects relief within two years after the IRS begins collection activities.
who must file
whether an individual must file a tax return is based on the amount of the individual's gross income. **
The fact that the individual owes no tax does not mean that a return need not be filed
Taxpayers who must file, regardless if gross income is less than chart amounts:
*taxpayers with net self-employment income of $400 or more must file regardless of their total gross income.
due dates and extensions
Returns for individuals and partnerships are due on the fifteenth day of the fourth month following the close of the tax year, which for calendar-year taxpayers is April 15. C corps and S corps--- March 15. A due date that falls on a Saturday, Sunday, or a holiday is automatically extended to the next day that is not a Saturday, Sunday, or holiday.
*Individuals may obtain an automatic extension of 6 months by filing for 4868. C and S corps 6 months. Partnerships.....5 month extension.
form 1040, 1040EZ, 1040A
1040A - Salaries, wages, dividends, interest, pension and annuity income, and unemployment compensation can be reported on Form 1040A.
1040EZ - taxable income of less than $50,000 and claim no dependents. Must consist of salary and wages plus no more than $1,500 of taxable interest income. No deduction (other than the standard deduction) or credit (other than withholding from salary and wages) can be taken on the return.
1040 - complicated returns often involve many additional forms and schedules. 1040EZ and 1040A used for less complicated tax returns.
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