Prof Myles Bassell

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Prof Myles Bassell

• Individual Income Tax Overview

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Learning Objectives

1. Describe the formula for calculating an
   individuals tax liability and generally explain
   each formula component.
2. Explain the requirements for determining a
   taxpayers personal and dependency exemptions.
3. Determine a taxpayers filing status.

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Individual Income Tax Formula

• Realized income from whatever source derived
• Minus Excluded or deferred income
• Equals Gross income
• Minus For AGI deductions
• Equals Adjusted gross income

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Individual Income Tax Formula

• Adjusted Gross Income
• Minus From AGI deductions
• Greater of (a) Standard deduction or
• (b) Itemized deductions
• and
• Personal and dependency exemption
• Equals Taxable income

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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)

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Individual Income Tax Formula

• 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

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Individual Income Tax Formula

• 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

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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
• 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

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Individual Income Tax Formula

• Capital assets
• Generally all assets except
• Accounts receivable
• Inventory
• Assets used in trade or business, including
  supplies

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Individual Income Tax Formula

• Capital gains and losses
• Long-term capital gains generally taxed at 0 or
  15
• 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

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Individual Income Tax Formula

• Deductions for AGI
• Deductions above the line
• Deducted in determining adjusted gross income
• Always reduce taxable income dollar for dollar

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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?

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Individual Income Tax Formula

• 2011 Standard deduction amounts
• 11,600 Married filing jointly
• 11,600 Qualifying widow or widower
• 5,800 Married filing separately
• 8,500 Head of household
• 5,800 Single
• Additional standard deduction amounts for age and
  eyesight (discuss in Chapter 6)

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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.

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Individual Income Tax Formula

• Other taxes include
• Alternative minimum tax
• Self-employment taxes
• Tax credits
• Reduce tax liability dollar for dollar

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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 years liability
• If prepayments exceed tax liability after
  credits, taxpayer receives a refund

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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 2011 is 3,700

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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

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Personal and Dependency Exemptions

• Qualifying child
• Relationship test
• Age test
• Residence test
• Support test

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Qualifying Child

• Relationship test
• taxpayers son, daughter, stepchild, an eligible
  foster child, brother, sister, half brother, half
  sister, stepbrother, stepsister or a descendant
  of any of these relatives.

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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.

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Qualifying Child

• Residence 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

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Qualifying Child

• Tie breaking rules
• Parents first
• Days living with each parent if parents living
  apart
• AGI higher AGI gets exemption

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Personal and Dependency Exemptions

• Qualifying relative
• Relationship test
• Support test
• Gross income test

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Qualifying Relative

• Relationship test
• a descendant or ancestor of the taxpayer (e.g.,
  child, grandchild, parent, or grandparent),
• a sibling of the taxpayer or a stepmother,
  stepfather, stepbrother, stepsister, nephew,
  niece, aunt, uncle
• in-law (mother-in law, father-in-law,
  sister-in-law, and brother-in-law) of the
  taxpayer, or
• unrelated person who lives in taxpayers home
  entire year

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Qualifying Relative

• Support test
• Taxpayer must pay gt ½ of living expenses
  (support)
• Scholarships of actual child excluded
• Gross income test
• Gross income lt personal exemption amount

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Filing Status

• Five different filing statuses
• Married filing jointly
• Married filing separately
• Qualifying widow or widower (surviving spouse)
• Single
• Head of household

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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

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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

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Filing Status

• Qualifying widow or widower
• Available for the two years following the year of
  spouses death
• Surviving spouse does not qualify if remarries
  during two-year period.
• Surviving spouse must maintain household for
  dependent child

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Filing Status

• Single
• Unmarried unless qualify for head of household

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Filing Status

• Head of household
• Unmarried or considered unmarried at end of year
• See abandoned spouse discussion
• Not a qualifying widow or widower
• Pay more than half the costs of keeping up a home
  during the year
• Lived in taxpayers home with a qualifying
  person for more than half of the year
• Exception for parents (see below)

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Filing Status

• Qualifying person
• Qualifying child
• Qualifying relative
• Parent (even if parent doesnt live with
  taxpayer)
• Taxpayer must pay gt ½ cost of maintaining
  separate household for taxpayers mother or
  father
• Parent must qualify as taxpayers dependent

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Filing Status

• Head of household
• Abandoned spouse treated as not married and is
  eligible for head of household if
• Spouse has not lived in home for last six months
  of year and
• Spouse who stays in home pays gt ½ the cost of
  maintaining a household that serves as principal
  abode for qualifying child