Presentation on theme: "Individual Income Tax Overview"— Presentation transcript:
1 Individual Income Tax Overview Prof Myles BassellIndividual Income Tax Overview
2 Learning ObjectivesDescribe the formula for calculating an individual’s tax liability and generally explain each formula component.Explain the requirements for determining a taxpayer’s personal and dependency exemptions.Determine a taxpayer’s filing status.
3 Individual Income Tax Formula Realized income from whatever source derivedMinus: Excluded or deferred incomeEquals: Gross incomeMinus: For AGI deductionsEquals Adjusted gross income
4 Individual Income Tax Formula Adjusted Gross IncomeMinus: From AGI deductions:Greater of (a) Standard deduction or(b) Itemized deductionsandPersonal and dependency exemptionEquals Taxable incomePlease insert exhibit 4-1 on this slide where indicated
5 Individual 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
6 Individual 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
7 Individual Income Tax Formula Excluded incomeIncome never included in taxable incomeMunicipal bond interestGain on sale of personal residenceDeferred incomeIncome included in a subsequent tax yearInstallment salesLike-kind exchanges
8 Individual 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
9 Individual Income Tax Formula Capital assetsGenerally all assets exceptAccounts receivableInventoryAssets used in trade or business, including supplies
10 Individual Income Tax Formula Capital gains and lossesLong-term capital gains generally taxed at 0% or 15%Short-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
11 Individual Income Tax Formula Deductions for AGIDeductions “above the line”Deducted in determining adjusted gross incomeAlways reduce taxable income dollar for dollar
12 Individual 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?
13 Individual Income Tax Formula 2011 Standard deduction amounts$11,600 Married filing jointly$11,600 Qualifying widow or widower$5, Married filing separately$8, Head of household$5, SingleAdditional standard deduction amounts for age and eyesight (discuss in Chapter 6)
14 Individual 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.
15 Individual Income Tax Formula Other taxes include:Alternative minimum taxSelf-employment taxesTax creditsReduce tax liability dollar for dollar
16 Individual 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
17 Personal and Dependency Exemptions Personal exemptionsFor taxpayer and spouse if married filing jointlyDependency exemptionsFor those who qualify as the taxpayers’ dependentsExemption amount for 2011 is $3,700
18 Personal 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
19 Personal and Dependency Exemptions Qualifying childRelationship testAge testResidence testSupport test
20 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.
21 Qualifying 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.
22 Qualifying 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
23 Qualifying Child Tie breaking rules Parents first Days living with each parent if parents living apartAGI– higher AGI gets exemption
24 Personal and Dependency Exemptions Qualifying relativeRelationship testSupport testGross income test
25 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, unclein-law (mother-in law, father-in-law, sister-in-law, and brother-in-law) of the taxpayer, orunrelated person who lives in taxpayer’s home entire year
26 Qualifying 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
27 Filing Status Five different filing statuses Married filing jointly Married filing separatelyQualifying widow or widower (surviving spouse)SingleHead of household
28 Filing 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
29 Filing 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
30 Filing 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
31 Filing StatusSingleUnmarried unless qualify for head of household
32 Filing 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)
33 Filing Status Qualifying person Qualifying child Qualifying relative Parent (even if parent doesn’t live with taxpayer)Taxpayer must pay > ½ cost of maintaining separate household for taxpayer’s mother or fatherParent must qualify as taxpayer’s dependent
34 Filing Status Head of household Abandoned spouse treated as not married and is eligible for head of household ifSpouse has not lived in home for last six months of year andSpouse who stays in home pays > ½ the cost of maintaining a household that serves as principal abode for qualifying child