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Individual Income Tax Overview

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Presentation on theme: "Individual Income Tax Overview"— Presentation transcript:

1 Individual Income Tax Overview
Chapter 04 Individual Income Tax Overview

2 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

3 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

4 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

5 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

6 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

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

8 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

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

10 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?

11 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)

12 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.

13 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

14 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

15 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

16 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

17 Personal and Dependency Exemptions
Qualifying child Relationship test Age test Residence test Support test

18 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.

19 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.

20 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

21 Qualifying 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?

22 Qualifying Child Example Solution
Test Braxton Tara Relationship Yes, son Yes, daughter Age Yes, < 19 at year-end (and younger than his parents) Yes, < 24 at year-end and full-time student (and younger than his parents) Residence Yes, lived at home entire year Yes, temporary absences such as school ok Support Yes, he provides < ½ Yes, parents provide > ½ (scholarship does not count as self -support)

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

24 Qualifying 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?

25 Qualifying Child Example Solution
Test Is Braxton Shawn’s qualifying child? Relationship Yes, son of Shawn’s brother Age Yes, < 19 at year-end (and younger than Shawn) Residence Yes, lived in the same residence as Shawn for more than half the year Support Yes, does not provide more than half of own support

26 Qualifying 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?

27 Qualifying 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.

28 Personal and Dependency Exemptions
Qualifying relative Relationship test Support test Gross income test

29 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 (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, or unrelated person who lives in taxpayer’s home entire year (cousins may qualify this)

30 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

31 Dependency 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?

32 Dependency Exemption Example Solution
Test Qualifying child Qualifying relative Relationship Yes, child Age Yes, < 24 and full-time student Not applicable Residence Yes, temporary absences ok Support Yes, he provides < ½ Yes, parents provide > ½ Gross income No, gross income > $3,900

33 Personal and Dependency Exemptions

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

35 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

36 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

37 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

38 Filing Status Single Unmarried unless qualify for head of household

39 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 taxpayer’s home with a “qualifying person” for more than half of the year Exception for parents (see below)

40 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

41 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.

42 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)

43 Filing Status Example Assume 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?

44 Filing Status Example Answer: Qualifying widow

45 Filing Status Example Assume 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?

46 Filing Status Example Answer: Head of household

47 Filing Status Example Assume 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?

48 Filing Status Example Answer: 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.

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