Individual Income Tax and Tax Planning

1
Chapter 16

• Individual Income Tax and Tax Planning

2
Federal Income Tax Law Objectives

• Revenue-raising objectives
• Economic objectives
• Social objectives

3
Income Tax Planning

• Data Collection and Risk Analysis
• Use a Client Questionnaire
• Gather prior income tax returns
• Gather information returns
• Form W-2
• Form 1098
• Form 1099

4
Individual Income Tax Rates

• Ordinary rates
• Capital gain rates
• Capital asset/Dividends
• Sale or exchange
• Long-term holding period
• Alternative Minimum Tax (AMT) rates

5
Determining Income Tax Liability Taxable Income

• Total Income
• Less exclusions from gross income
• Gross Income
• Less deductions for Adjusted Gross Income
• Adjusted Gross Income (AGI)
• Less the larger of
• Standard Deduction or Itemized Deductions
• Less personal and dependency exemptions
• Taxable Income

6
Deductions for AGI

• Business expenses
• Net capital losses (3,000)
• Self-employed expenses
• Alimony paid
• IRA contributions
• Moving expenses
• Education expenses

7
Itemized Deductions

• Medical expenses (gt 7.5 AGI)
• State local income taxes
• Property taxes
• Mortgage interest
• Investment Expenses (lt Investment Income)
• Charitable contributions
• Casualty/Theft losses (gt 10 AGI 100)
• Miscellaneous (gt 2 AGI)

8
Tax Avoidance vs. Tax Evasion

• Tax avoidance is the legal minimization of taxes
• Tax evasion is any of the fraudulent methods by
  which a taxpayer may pay less than his or her
  proper tax liability

9
The Internal Revenue Service and Its
Administrative Issues

• The IRS
• is part of the Treasury Department
• is responsible for administering and enforcing
  federal tax laws
• issues Revenue Rulings and Revenue Procedures as
  official interpretations of the tax laws

10
IRS Guidance

• Letter rulings
• Determination letters
• Revenue rulings
• Private letter rulings
• Revenue procedures
• Technical advice memoranda

11
The IRS Audit Process

• The Discriminant Index Function System
• Types of Audits
• Correspondence audit
• Office audit
• Field audit

12
The IRS Audit Process (contd)

• Outcomes of Audits
• No change to return
• Taxpayer agrees with examiners findings
• Taxpayer does not agree with examiners findings
• Taxpayer partially agrees with examiners
  findings
• If a taxpayer exhausts all administrative
  remedies, the case may be brought to court

13
The IRS Audit Process (contd)

• Penalties
• Failure-to-file penalties
• Failure-to-pay-tax penalties
• Accuracy-related penalties
• Fraud penalties

14
Payroll Taxes

• FICA taxes for employers and employees
• 6.2 OASDI on 87,900 (2004)
• 1.45 Medicare
• Self-employment tax
• Double the employees rate
• FUTA tax calculation

15
Tax-Advantaged Investments

• Investment in tax-exempt securities
• Tax shelters
• Employee benefits
• Acceleration of deductions
• Deferral of tax gains
• Exemption opportunities