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2 THE INDIVIDUAL TAX FORMULA Corporate vs. individual tax model Filing status for individuals Overview of taxable income Alternative minimum tax Payment and filing requirements

3 Corporate vs. Individual Tax Models CORP MODEL Gross Income -Deductions =Taxable Income xCorp Tax Rate (%)Corp Tax Rate (%) =Gross Tax Due -Credits & PaymentsCredits & Payments =Tax or Refund Due INDIVIDUAL MODEL Gross Income -Deductions for AGIDeductions for AGI =AGI -Deductions from AGIDeductions from AGI =Taxable Income xIndividual Tax RateIndividual Tax Rate =Gross Tax Due -Credits & PaymentsCredits & Payments =Tax or Refund Due

4 Filing Status for Individuals (1 of 5) There are 5 filing statuses Single Married, filing jointly Surviving spouse (qualifying widow(er)) Married, filing separately Head of household Filing status affects tax rate brackets, standard deduction, and other amounts

5 Filing Status for Individuals (2 of 5) Single Unmarried individual Residual category (i.e., do not meet any of other statuses) Married, filing jointly (MFJ) Married as of last day of taxable year, or Spouse dies during taxable year

6 Filing Status for Individuals (3 of 5) Surviving spouse Same tax rate brackets as married, filing jointly File as surviving spouse for 2 years after death of spouse if taxpayer maintains a home in which a dependent child lives Married, filing separately Married but not filing a return with spouse and not abandoned spouse

7 Filing Status for Individuals (4 of 5) Head of household (HH) Must be unmarried as of end of year or an abandoned spouse Must pay > half the cost of maintaining a household which is the principal home of a dependent relative for more than half of tax year

8 Filing Status for Individuals (5 of 5) 2 Exceptions to the HH requirements HH may be claimed if taxpayer maintains a separate home for his or her parents if at least one parent qualifies as a dependent If the qualifying individual is an unmarried child or grandchild, the child or grandchild need not be taxpayers dependent

9 Overview of Taxable Income (1 of 2) Gross Income (§61) (lines 7-22 on 1040; p. 345) - Exclusions (e.g., muni-bond interest) - Deductions from gross income (for AGI) = Adjusted Gross Income (lines on 1040) - > of Itemized deductions (Sch A; p.349) or std. deduction (from AGI deductions) - Personal & dependency exemptions = Taxable Income

10 Overview of Taxable Income (2 of 2) = Taxable Income x Tax Rate (%) =Gross Tax +Other taxes - Credits and Payments =Tax or Refund Due

11 Deductions from Gross Income (for AGI Deductions) Many limitations based on AGI Deductions for AGI include: Payments to IRAs Student loan interest (limited to $2,500) Tuition and fees (limited to $3,000) Moving expenses 1/2 of self-employment tax paid 100% of health ins if self-employed Alimony paid

12 Standard Deduction (1 of 2) Depends on filing status. For 2003: MFJ = $9,500 (new) MFS = $4,750 (new) HOH = $7,000 (new) Single = $4,750 (new) Extra ded if blind or aged ( age 65). Add to std ded for each occurrence of MJF, MFS = additional $950 HOH or Single = additional $1,150

13 Standard Deduction (2 of 2) Special limitations on basic std. ded. for individuals claimed as dependent on another individuals tax return Greater of $750 or $250 + earned income (but not exceeding the normal basic standard deduction Additional std. deductions for age and blindness still available.

14 Itemized Deductions (Schedule A; 1 of 2) If itemized deductions are about equal to standard deduction each year, bunch deductions on alternate years and claim standard deduction on other years. Example: Bob gives $5,000 to charity each year. He is 77 and single. Does he itemize? Suppose he gave $10,000 to the church every other year?

15 Itemized Deductions (Schedule A; 2 of 2) Phase-out of itemized deductions If AGI > $139,500 ($69,750 MFS) in 2003, itemized deductions are reduced by 3% of income > $139,500. Itemized deductions cannot be reduced more than 80% Some items exempt from phase-out: Medical exp., investment interest exp., casualty/theft loss, gambling losses See Appendix 13-A.

16 Exemptions (Personal Exemptions) One personal exemption for the taxpayer (2 for MFJ). If you are a dependent on someone elses return, can you still claim yourself? Exemption = $3,050 in 2003 for each personal or dependency exemption.

17 Exemptions (Exemptions for Dependents; 1 of 2) Must meet ALL five requirements: 1. Family member OR live in your home for entire year. What about full-time college student away at school most of the year? 2. You provide > 1/2 financial support. 3. Dependents gross income < exemption amount ($3,050): Waived for child < 19 OR student-child<24

18 Exemptions (Exemptions for Dependents; 2 of 2) Must meet ALL five requirements: 4. Dependent must not generally file a joint return (with a spouse). 5. Dependent must be a U.S. citizen OR a resident of US, Mexico, or Canada.

19 Exemptions (Phase-out of Exemptions) Phase-out of exemptions IF AGI greater than $209,250 (MFJ) in 2003, reduce exemption by 2% for each $2,500 that AGI is above the threshold. Exemptions can be reduced to $0. See Appendix 13-B.

20 Computing Tax Liability (1 of 2) Use schedule applicable to taxpayer. Which rates are most favorable? Least favorable? Marriage penalty What is it? Who benefits? Who is penalized? How does it affect the std. deduction? How does it affect tax brackets?

21 Computing Tax Liability (2 of 2) Computation of capital gains (1 + 2) 1. Compute tax liability on taxable income EXCLUDING capital net LTCG. 2. Compute tax on net LTCG. 15% (or 5% if marginal tax rate 15%). Additional individual taxes Self-employment taxes Both employer and employee portions of payroll taxes on income from Sole proprietors, partnerships, LLCs and LLPs

22 Individual Tax Credits Non-refundable credits Child Credit Child and dependent care credit Refundable credits Earned income credit Excess FICA withholding Refunded through a tax return claim.

23 Child Tax Credit $1,000 per dependent child under 17. Can be a refundable credit if taxpayer has earned income. Phased out by $50 (or fraction thereof) per $1,000 above AGI threshold $110K MFJ $75K single $55K MFS

24 Child and Dependent Care Credit Only for employment related care costs for certain dependents Child < 13 years old or Handicapped dependent or spouse. Credit amount Eligible care costs x credit % (20%-30%) 20% if AGI > $28,000. Lesser of actual qualified costs or $2,400 (1 child) or $4,800 (2 or more children). Also limited to spouses lowest earned income.

25 Earned Income Credit Earned income credit Transfer payment to working poor because credit is refundable. Increases progressivity of tax rates. Credit phases out as income increases. Requirements Must have earned income (wages or SE) Must have qualifying child (exceptions)

26 Alternative Minimum Tax Taxable income ± adjustments + preferences = AMTI before exemption - exemption (less 25% of excess AMTI) = AMTI x 26% (or 28% for higher AMTI levels) = TMT

27 AMT Adjustments Examples of AMT adjustments: + Standard deduction + Personal & dependency exemptions + 2% misc itemized deductions + Deduction for state, local, foreign taxes - Itemized deductions phased out

28 AMT Exemption AMT exemption amounts: MFJ: $58,000 HOH and single: $40,250 MFS: $29,000 AMT phaseout threshholds: MFJ: $150,000 HOH and single: $112,500 MFS: $75,000

29 Payment and Filing Requirements (1 of 3) Pay-as-you-go. Taxes withheld from wages each period Wages deemed to be w/h equally throughout year. Estimated taxes for income not subject to withholding Due on 4/15, 6/15, 9/15, and 1/15.

30 Payment and Filing Requirements (2 of 3) Avoid underpayment penalty Pay 90% of current year tax or 100% of prior year 110% of prior year if 2002 AGI>$150K. ES payments or withholding must be made throughout the year. Withholding deemed to be made evenly throughout year. Limits deferral opportunities w/in a year.

31 Payment and Filing Requirements (3 of 3) Tax return due 4/15 Get automatic extension to 8/15. Need permission to extend to 10/15. Extension only extends time to file, NOT extension to pay tax.

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