Presentation on theme: "Individual Income Tax Overview"— Presentation transcript:
1Individual Income Tax Overview Chapter 04Individual Income Tax Overview
2Individual Income Tax Formula Gross incomeMinus: For AGI deductionsEquals Adjusted gross incomeMinus: From AGI deductions:Greater of (a) Standard deduction or(b) Itemized deductionsandPersonal and dependency exemptionEquals Taxable income
3Individual Income Tax Formula Taxable incomeTimes: Tax ratesEquals: Income tax liabilityAdd: Other taxesEquals: Total taxMinus: CreditsMinus: PrepaymentsEquals: Taxes due or (refund)Please insert exhibit 4-1 on this slide where indicated
4Individual Income Tax Formula Individuals report taxable income to the IRSReported on Form 1040U.S. tax laws use all-inclusive income conceptRealized incomemeasurable change in property rightsAll realized income included in gross income unless specifically excluded or deferredRecognized incomeReported on tax return
5Individual Income Tax Formula Excluded and Deferred income not included in gross incomeExcluded incomeIncome never included in taxable incomeMunicipal bond interestGain on sale of personal residenceDeferred incomeIncome included in a subsequent tax yearInstallment salesLike-kind exchanges
6Individual Income Tax Formula Character of income or lossDetermines rates applicable to income or loss in current yearTax exempt – no taxTax deferred – no tax in current yearOrdinary – ordinary rates from tax rate scheduleQualified dividends – 0 or 15%Capital gain or loss – depends on whether short-term or long-termFrom selling capital assetIf held capital asset more than a year gain or loss is long-term, otherwise it is short-term
7Individual Income Tax Formula Capital assetsGenerally all assets exceptAccounts receivableInventoryAssets used in trade or business, including supplies
8Individual Income Tax Formula Capital gains and lossesLong-term capital gains generally taxed at 0%, 15%, or 20% depending on the taxpayer’s taxable incomeShort-term capital gains taxed at ordinary ratesNet capital losses (losses in excess of gains for year)$3,000 deductible against ordinary income for yearLosses in excess of $3,000 carried forward
9Individual Income Tax Formula Deductions for AGIDeductions “above the line”Deducted in determining adjusted gross incomeAlways reduce taxable income dollar for dollar
10Individual Income Tax Formula Deductions from AGIDeductions “below the line”Deducted from adjusted gross income to determine taxable incomeGreater of standard deduction or itemized deductionsPersonal and dependency exemptionsWhy might a from AGI deduction not reduce taxable income?
11Individual 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, SingleAdditional standard deduction amounts for age and eyesight (discuss in Chapter 6)
12Individual Income Tax Formula Tax calculationThe U.S. uses a progressive tax rate scheduleSome items are taxed at preferential ratesLong-term capital gainsQualified dividendsTax on these items is calculated separately from income taxed at ordinary rates.
13Individual Income Tax Formula Other taxes include:Alternative minimum taxSelf-employment taxesMedicare Contribution tax on net-investment incomeTax creditsReduce tax liability dollar for dollar
14Individual Income Tax Formula Tax prepaymentsPayments already made towards tax liability including:Income taxes withheld from wages by employerEstimated tax payments made during the yearTaxes overpaid in prior year and applied toward current year’s liabilityIf prepayments exceed tax liability after credits, taxpayer receives a refund
15Personal and Dependency Exemptions Personal exemptionsFor taxpayer and spouse if married filing jointlyDependency exemptionsFor those who qualify as the taxpayers’ dependentsExemption amount for 2013 is $3,900
16Personal and Dependency Exemptions Dependency requirementsCitizen of U.S. or resident of U.S., Canada, or MexicoMust not file joint return with spouseException – if no tax liability filing jointly or separatelyMust be qualifying child or qualifying relative of taxpayer
17Personal and Dependency Exemptions Qualifying childRelationship testAge testResidence testSupport test
18Qualifying 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.
19Qualifying ChildAge 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, orpermanently and totally disabled.
20Qualifying Child Residence test Support test Same residence as taxpayer for more than half the yearException for temporary absences such as education.Support testChild must not provide more than half of his or her own supportScholarships of actual child (not grandchild, for example) are excluded from support computation
21Qualifying Child Example Rodney and Anita have two children: Braxton, age 12, who lives at home and Tara, age 21 who is a full-time student and does not live at home. While Tara earned $9,000 in a summer job, she did not provide more than half of her own support during the year. Are Braxton and Tara qualifying children to Rodney and Anita?
22Qualifying Child Example Solution TestBraxtonTaraRelationshipYes, sonYes, daughterAgeYes, < 19 at year-end (and younger than his parents)Yes, < 24 at year-end and full-time student (and younger than his parents)ResidenceYes, lived at home entire yearYes, temporary absences such as school okSupportYes, he provides < ½Yes, parents provide > ½ (scholarship does not count as self -support)
23Qualifying Child Tie breaking rules Parents first Days living with each parent if parents living apartAGI– higher AGI gets exemption
24Qualifying Child Example Braxton’s uncle Shawn (Rodney’s brother) lived in the Halls’s home (the same home Braxton lived in) for more than 11 months during Does Braxton meet the requirements to be considered Shawn’s qualifying child?
25Qualifying Child Example Solution TestIs Braxton Shawn’s qualifying child?RelationshipYes, son of Shawn’s brotherAgeYes, < 19 at year-end (and younger than Shawn)ResidenceYes, lived in the same residence as Shawn for more than half the yearSupportYes, does not provide more than half of own support
26Qualifying Child Example Braxton is considered to be Rodney and Anita’s qualifying child and he is considered to be Shawn’s qualifying child. Under the tiebreaker rules, who is allowed to claim Braxton as a dependent for the year?
27Qualifying Child Example Solution Answer: Rodney and Anita. Under the first tiebreaking rule, Rodney and Anita are allowed to claim the dependency exemption for Braxton because they are Braxton’s parents.
28Personal and Dependency Exemptions Qualifying relativeRelationship testSupport testGross income test
29Qualifying 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 (but cousins do not qualify)in-law (mother-in-law, father-in-law, sister-in-law, brother-in-law, son-in-law, and daughter-in-law) of the taxpayer, orunrelated person who lives in taxpayer’s home entire year (cousins may qualify this)
30Qualifying Relative Support test Gross income test Taxpayer must pay > ½ of living expenses (support)Scholarships of actual child excludedGross income testGross income < personal exemption amount
31Dependency Exemption Example John is a 22-year old student who has lived in the dorms for most of the year but spends the rest of the year living with his parents. He earned a $5,000 scholarship for the school year and has worked hard to support himself through school earning $6,000 to pay for his own expenses. His parents have supported him by paying for $7,000 for food, clothing, and lodging expenses. Are John’s parents able to claim him as a dependent?
32Dependency Exemption Example Solution TestQualifying childQualifying relativeRelationshipYes, childAgeYes, < 24 and full-time studentNot applicableResidenceYes, temporary absences okSupportYes, he provides < ½Yes, parents provide > ½Gross incomeNo, gross income > $3,900
34Filing Status Five different filing statuses Married filing jointly Married filing separatelyQualifying widow or widower (surviving spouse)SingleHead of household
35Filing Status Married filing jointly Must be married on the last day of the yearIf one spouse dies the surviving spouse is considered to be married to decedent spouse at year endException – The surviving spouse remarries before year endJoint and several liability for tax
36Filing Status Married filing separately Taxpayers are married but file separate returnsTypically not beneficial from tax perspectiveTax rates and other tax benefitsMay be beneficial for non-tax reasonsNo joint and several liability
37Filing Status Qualifying widow or widower Available for the two years following the year of spouse’s deathSurviving spouse does not qualify if remarries during two-year period.Surviving spouse must maintain household for dependent child
38Filing StatusSingleUnmarried unless qualify for head of household
39Filing Status Head of household Unmarried or considered unmarried at end of yearSee abandoned spouse discussionNot a qualifying widow or widowerPay more than half the costs of keeping up a home during the yearLived in taxpayer’s home with a “qualifying person” for more than half of the yearException for parents (see below)
40Filing Status Qualifying person Qualifying child Qualifying relative who is taxpayer’s mother or fatherParent need not live with taxpayerTaxpayer must pay > ½ cost of maintaining separate household for taxpayer’s mother or fatherParent must qualify as taxpayer’s dependent
41Filing Status Qualifying relative who is not the taxpayer’s parent Person must have lived with taxpayer for more than half the yearMust qualify as taxpayer’s dependentMust be related to taxpayer through qualified family relationshipIf related only because lived with taxpayer for entire year, not a qualified person.
42Filing Status Head of household Married individuals treated as unmarried (abandoned spouse) if individualIs married at end of year (or is not legally separated from the other spouse)Does not file a joint tax return with the other spousePays > ½ the cost of maintaining a household that serves as principal abode for qualifying child for more than half the yearLived apart from the other spouse for the last six months of the year (other than temporary absences)
43Filing Status ExampleAssume that last year Rodney passed away, and during the current year Anita did not remarry but maintained a household for Braxton and Tara, her dependent children. Under these circumstances, what would Anita’s filing status be?
45Filing Status ExampleAssume Rodney and Anita divorced last year. During the current year, Braxton lives with Anita and Anita pays all the costs of maintaining the household for herself and Braxton. Under these circumstances, what is Anita’s filing status for the current year?
47Filing Status ExampleAssume Shawn (Rodney’s brother) lived with the Halls, but Shawn paid more than half the costs of maintaining a separate apartment that is the principal residence of his mother, Sharon, whose gross income is $1,500. Because Shawn provided more than half of Sharon’s support during the year, and because Sharon’s gross income was only $1,500, she qualifies as Shawn’s dependent (as a qualifying relative). In these circumstances, what is Shawn’s filing status?
48Filing Status ExampleAnswer: Head of household. Shawn paid more than half the costs of maintaining a separate household that is the principal place of abode for his mother, and his mother qualifies as his dependent.