1. Income Taxation of Individuals
Chapter 11
Income Taxation of Individuals

2. Individual Income Tax Model
Gross income
Less: Deductions for adjusted gross income
Equals: Adjusted Gross Income (AGI)
Less: Itemized or standard deduction
Less: Personal & dependency exemptions
Equals: Taxable income

3. Tax Model (continued) Taxable income Times: Tax rate
Equals: Gross income tax liability
Less: Tax credits
Plus: Additions to tax
Less: Tax prepayments
Equals: Net tax due or tax refund

4. Deductions For AGI Deductions discussed in previous chapters
Retirement plan contributions including IRAs
Moving expenses
50% of self-employment taxes
Self-employed health insurance
Alimony paid

5. Deductions For AGI Deductions discussed in this chapter
Educator expenses
Student loan interest expense
Tuition and fees deduction
Health savings accounts
Penalty on early withdrawals of savings
Other deductions for AGI

6. Educator Expenses
Kindergarten through 12th grade teachers may deduct up to $250 of unreimbursed expenses for books, supplies, computer equipment, software, and other supplemental materials used in the classroom

7. Student Loan Interest
Deduction allowed for interest paid on qualified student loans incurred and used for tuition, fees, room, board, books, and supplies
Deduction limit is $2,500
Limit is phased out for modified AGI of $60,000 - $75,000 ($120,000 - $150,000 for married persons filing jointly)
Individuals claimed as dependents cannot take deduction on their own tax return
Eligible expenses must be reduced for tax-exempt scholarships and education credits

8. Tuition & Fees Deduction
$4,000 deduction for tuition & fees for taxpayer, spouse, and dependents
Income limits apply ($65,000 if single and $130,000 if married filing jointly)
Deduction is reduced to $2,000 for singles with income $65,000 - $80,000 ($130,000 - $160,000 for joint filers)
Individuals who are claimed as dependents cannot take deduction on their own tax return

9. Health Savings Accounts
Taxpayers covered by high-deductible medical insurance policies only may deduct amounts set aside in an HSA
Contributions and earnings on HSAs are not taxed when withdrawn to pay medical expenses
Distributions not spent on qualifying expenses are included in income and subject to a 10% penalty

10. Health Savings Accounts
To qualify for an HSA in 2009, individuals must have health insurance with deductibles of at least $1,150 ($2,300 for families)
Maximum deductible contribution to HSA for 2009 is $3,000 ($5,950 for families)

11. Medical Savings Accounts
MSAs are similar to HSAs but with different limits
Qualified policies are those with deductibles of $2,000 - $3,000 for individuals ($4,000 - $6,050 for families) in 2009
Contributions to MSAs are limited to 65% of policy deductible for individuals (75% for families)
Distributions not spent on qualifying expenses are included in income and subject to a 15% penalty

12. Penalty on Early Withdrawals
Penalties assessed on premature withdrawals from certificates of deposits or other savings accounts are deductible
Gross interest income, unreduced by the penalty, is included in taxable income
Deducting the penalty ensures that only net interest income is included in taxable income

13. Other Deductions For AGI
Unreimbursed travel expenses to attend National Guard or military reserve meetings more than 100 miles from home
Maximum deduction is general government per diem rate for the area
Expenses of fee-basis government officials
Expenses of performing artists

14. Exemptions
Each taxpayer (who is not a dependent) is entitled to one personal exemption
Exemption deduction is $3,650 for 2009
Additional exemptions allowed for each person who is considered a dependent
Anyone who is claimed as a dependent cannot claim a personal exemption
For purposes of the dependency exemption, a dependent is a qualifying child or qualifying relative

15. Qualifying Child Must meet four tests
Residency test - live with taxpayer more than 6 months
Relationship test - son, daughter, brother, sister, or descendant
Age test - under 19 (or under 24 if full-time student)
Support test - child cannot provide more than half his own support

16. Qualifying Relative
If not a qualifying child, then three similar tests must be met:
Relationship test - must either be a qualifying relative of the taxpayer or a resident in the taxpayer’s household for the entire year
Gross income test - the qualifying relative's gross income from taxable sources must be less than the exemption amount ($3,650 for 2009)
Support test

17. The Support Test
Taxpayer must provide more than 50% of the dependent's total support
Support includes amounts spent for food, clothing, shelter, medical care, education and capital expenditures such as a car
Value of services and scholarship funds are omitted in determining support received by a student
Dependent’s nontaxable income used for support must be included

18. Multiple Support Agreement
Multiple support agreements allow one member of group of support providers to claim the exemption when
Together the group meets the support test
All other dependency tests are met
Member who claims exemption must provide more than 10% of the total support and other members providing more than 10% support agree to exemption

19. Phaseout of Exemptions
One-third of both personal and dependency exemptions are phased out at a rate of 2% for each $2,500 ($1,250 if MFS), or fraction thereof, of AGI (up to a maximum of 100%) above thresholds for 2009 of
$166,800 if single
$208,500 if head of household
$250,200 if married filing jointly
$125,100 if married filing separately

20. Exemption Phaseout
(AGI – threshold AGI)/$2,500 = Phaseout Factor (always round up to next whole number)
Phaseout Factor x 2 = Phaseout Percentage
Phaseout Percentage x Exemption Amount x 1/3 = Exemption Reduction
Exemption Amount – Exemption Reduction = Allowable Exemption Deduction
Once AGI exceeds the threshold AGI by more than $122,500 ($61,250 for MFS), the maximum deduction is $2,433 per exemption

21. Filing Status
Taxpayer’s filing status determines standard deduction and tax rate schedule
Marital status determined on the last day of the tax year
Separated spouses are considered married until divorce becomes final

22. Filing Status - Married
Can file jointly if both spouses are US citizens or US residents (or if nonresident alien agrees to be taxed on worldwide income)
If the couple files separately, both must itemize deductions or both must use the standard deduction

23. Surviving Spouse
Marital status is determined at the date of death so a joint return can be filed for the year in which a spouse dies
A surviving spouse may continue to use the tax rates and standard deduction for married persons filing jointly for the next 2 years only if a dependent child lives with the taxpayer

24. Filing Status – Unmarried
Unmarried taxpayers file as
Head of household – an unmarried person who provides more than half of the cost of maintaining a home in which a qualifying child or other qualifying relative lives for more than half the year
Single – taxpayer who does not qualify for another filing status

25. Head of Household
Claimed if taxpayer is unmarried (and not a surviving spouse)
Taxpayer pays more than half the cost of maintaining home which is the principal residence for more than half the year of
A qualifying child
An individual for whom the taxpayer may claim a dependency exemption
A parent is not required to live with the taxpayer

26. Abandoned Spouse
A taxpayer who is married but whose spouse did not live with him or her at any time during the last six months of the tax year and who provides more than half the cost of maintaining the home in which a dependent child lives
A qualifying abandoned spouse uses head of household tax rates and standard deduction

27. Standard Deductions Standard Deductions for 2009
$11,400 married filing a joint return
$5,700 married filing separately
$8,350 head of household
$5,700 single individual
Additional standard deduction if taxpayer is elderly (age 65 or older) or blind
$1,400 if single or head of household
$1,100 if married

28. Temporary Additions to Standard Deduction
To promote the sales of automobiles, taxpayers can increase their standard deduction for sales tax paid on the purchase of an automobile
Vehicle must be purchased after 2/16/09 and before 1/1/2010
Deduction limited to tax on no more than $49,500
Deduction is phased out for modified AGI between $125,000 and $135,000 ($250,000 and $260,000 if MFJ)
Taxpayers who itemize can claim the sales tax on an automobile as part of their overall sales tax deduction

29. Temporary Additions to Standard Deduction
Taxpayers will be allowed an additional standard deduction in 2008 and 2009 equal to the lesser of
State and local real property taxes paid or
$500 ($1,000 if married filing a joint return)
Taxpayers with personal casualty losses incurred in federally declared disaster areas than occur before 1/1/2010
Can increase their standard deduction for their casualty loss or
Claim the casualty losses with itemized deductions

30. Dependent’s Standard Deduction
Dependent’s standard deduction is limited to the greater of:
$950 or
Earned income + $300 (up to otherwise allowable standard deduction)
Earned income includes salary and wages
Earned income does not include interest income, dividend income, capital gains, or income as beneficiary of a trust

31. Itemized Deductions
Itemized deductions provide tax benefit only to the extent that, in total, they exceed the taxpayer’s standard deduction
Taxpayers can maximize use of the standard deduction and itemized deductions by timing certain deductible payments

32. Medical Expenses
Medical expenses paid for the taxpayer, spouse and dependents, after reduction for insurance reimbursements, are deductible only to the extent they exceed 7.5% of AGI for the year
Qualified medical costs includes prescription drugs and insulin, costs of a hospital, clinic, doctor, dentist, eyeglasses, contract lenses, transportation for medical care and health insurance costs

33. Medical Expenses
Health insurance premiums for taxpayers and their dependents are deductible only if paid from after-tax income
Premiums paid through an employer-sponsored cafeteria plan are not deductible
Premiums for disability insurance and for loss of life, limb or income are not deductible
Premiums for long-term care insurance are deductible, subject to limits based on age

34. Deductible Taxes Deductible taxes include
State, local, and foreign real property taxes
State and local personal property taxes
State, local, and foreign income taxes
Other federal, state, local, and foreign taxes incurred in a business or other income-producing activity

35. Deductible Taxes
Taxpayers can elect to deduct state and local general sales taxes instead of state and local income taxes as itemized deductions
Taxpayers who pay sales tax on the purchase of an automobile will only get a tax benefit from the sales tax deduction if they do not claim a deduction for state or local income taxes
Taxpayers can use the actual sales tax paid or IRS-published tables (if tables used the actual sales tax paid on an auto can be added to the table amount)

36. Nondeductible Taxes Nondeductible taxes include Federal income taxes
Employee's share of payroll taxes
Federal excise taxes not incurred for business
Assessments on property that increase property value

37. Interest Expense Deductible interest includes
Investment interest
Home mortgage interest
No deduction for most other personal interest (except previously mentioned student loan interest) including interest on
Auto loans
Life insurance loans
Credit card debt
Delinquent tax payments

38. Investment Interest Expense
Investment interest includes interest on loans to acquire or hold investment property and margin account interest paid to a broker
Investment interest expense is only deductible to the extent of net investment income
Net investment income = excess of investment income over investment expenses
Excess is carried forward (indefinitely) subject to same limit in future years

39. Investment Interest Expense
Investment income includes gross income from interest, annuities, and short-term capital gains from investment property
Long-term capital gains or dividends taxed at favorable rates are excluded unless election made to forgo the favorable rate
Investment expenses include safe deposit box rental fees, investment counsel fees, brokerage account maintenance fees
Limited to the lesser of total investment expenses or net miscellaneous itemized deductions after reduction for 2% AGI floor

40. Qualified Residence Interest
Interest paid for acquisition debt or home equity debt for up to 2 qualified residences
Interest on acquisition debt of up to $1 million principal amount (combined limit for 2 homes) is deductible
Acquisition debt includes mortgage to buy, construct, or improve the residence

41. Qualified Residence Interest
Interest on up to $100,000 principal amount of home equity loan is deductible
Loan proceeds can be used for any purpose
Points (loan origination fees) paid on initial home mortgages are deductible
Points paid to refinance an exiting loan must be amortized over life of loan
For 2007 – 2010, an additional deduction is allowed for mortgage insurance premiums paid on home acquisition debt

42. Charitable Contributions
Congress allows individuals, corporations, estates and trusts to deduct contributions to certain qualified organizations
Partnerships and S corporations pass the contributions through to their partners and shareholders who then claim the deductions on their own income tax returns

43. Charitable Contributions
Qualified charitable organizations
Governmental units (federal, state and local governments) and entities formed and operated exclusively for religious, charitable, scientific, literary or educational purposes, including churches, nonprofit hospitals, school and universities, libraries, and social service agencies
Direct contributions to needy individuals are not deductible

44. Charitable Contributions
No deduction allowed to the extent that valuable goods or services are received in return for the contribution
Exception - contributors to universities who receive preferred rights to purchase tickets for university athletic events may deduct 80% of the amount of their contribution
Individual’s deduction limited to 50% of AGI
Excess contributions may be carried forward up to 5 years

45. Charitable Contributions
No deduction for contributions of the taxpayer’s services and rent-free use of the taxpayer’s property
Out-of-pocket costs incurred for volunteer work for a qualifying charity are deductible
Property other than long-term capital gain property is valued at lesser of FMV or basis

46. Contributions of LTCG Property
LTCG property is valued at FMV (which is usually greater than adjusted basis)
Tangible personalty given to a charity which does not use the property in its tax-exempt activity is valued at adjusted basis, if lower than FMV
Deduction for LTCG property limited to 30% of AGI
30% limit can be avoided (and 50% AGI limit applied) if taxpayer elects to use lower basis
If made, election applies to all LTCG contributions that year

47. Charitable Contributions
Stocks or other income producing property that have declined in value should be sold so that the loss can be claimed with the sale proceeds donated
Fees incurred for appraisals of donated property may be deducted as a miscellaneous itemized deductions
Deduction for donated vehicles sold by charity limited to gross sales proceeds

48. Charitable Contributions
Since 2007, all cash contributions must be substantiated by a
bank record (such as a canceled check, bank copy of a canceled check, credit card statement or bank statement containing the name of the charity, the date, and the amount), or
written communication from the charity including the charity’s name, contribution date, and amount
Payroll deduction records (pay stub or W-2 form) plus pledge card or other document showing name of organization, date, and amount

49. Charitable Contributions
Contributions of $250 or more require
A written acknowledgment showing date & amount of contribution along with an estimate of the value of any goods or services you received
Noncash contributions of up to $500 require
A written acknowledgment showing name of charity, your name, date and location of the contribution, and a detailed description of the property
Documentation of your cost for the property and an explanation of how you determined its fair market value

50. Charitable Contributions
Noncash contributions over $500 require an acknowledgement and written records plus
How you acquired the property (purchase, gift, inheritance or exchange
Date you acquired the property
Cost basis of property
For noncash contributions over $5,000, you must obtain a qualified appraisal

51. Casualty and Theft Losses
Loss is the lesser of
Asset’s adjusted basis or
Decline in asset’s fair market value as a result of the casualty
Loss is reduced for any insurance proceeds received
$500 floor for 2009 ($100 floor for all other years) applies to each casualty
Deductible only to extent total losses exceed 10% of AGI
10% threshold does not apply to presidentially declared disasters in 2008 or 2009

52. Miscellaneous Deductions
Only excess over 2% of AGI is deductible
Unreimbursed employee business expenses
Job hunting expenses (in searching for a new job in current line of business)
Investment-related expenses
Hobby expenses (up to hobby income)
Tax preparation and planning advice

53. Phaseout of Itemized Deductions
Total deductions phased out by 1/3 x 3% of AGI in excess of $166,800 in 2009 ($83,400 if MFS)
Exception - deductions not phased out for
Medical expenses
Investment interest
Casualty and theft losses
Total deductions are not reduced by more than 80% x 1/3 regardless of type

54. Net Operating Losses
Individuals must make several adjustments to arrive at a potential NOL because an NOL can only result from business losses
No deduction for personal or dependency exemptions
Nonbusiness capital losses can only offset nonbusiness capital gains
Nonbusiness deductions (most itemized deductions) can only offset nonbusiness income (such as interest & dividends)

55. Tax Rates for Married Filing a Joint Return
For married filing a joint return for 2009
10% on first $16,700 taxable income
15% on $16,701 - $67,900
25% on $67,901 - $137,050
28% on $137,051 - $208,850
33% on $208,851 - $372,950
35% over $372,950

56. Tax Rates for Married Filing Separately
For married filing separately for 2009
10% on first $8,350 taxable income
15% on $8,351 - $33,950
25% on $33,951 - $68,525
28% on $68,526 - $104,425
33% on $104,426 - $186,475
35% over $186,475

57. Tax Rates for Head of Household
For head of household for 2009
10% on first $11,950 taxable income
15% on $11,951 - $45,500
25% on $45,501 - $117,450
28% on $117,451 - $190,200
33% on $190,201 - $372,950
35% over $372,950

58. Tax Rates for Single Individuals
For single individuals for 2009
10% on first $8,350 taxable income
15% on $8,351 - $33,950
25% on $33,951 - $82,250
28% on $82,251 - $171,550
33% on $171,551 - $372,950
35% over $372,950

59. Special Tax Rates
Dividend income is taxed at a maximum of 15% (zero rate for taxpayers in 10% or 15% tax brackets)
Individuals with long-term capital gains file a Schedule D which includes a worksheet for determining the total tax liability
LTCG rate generally 15% (zero rate for taxpayers in 10% or 15% tax brackets)
28% rate for collectibles
25% rate for unrecaptured §1250 gain & taxable portion of §1202 small business stock

60. Credits vs. Deductions
Deductions only reduce tax liability by a percentage based on the taxpayer’s marginal tax rate
Credits are direct dollar-for-dollar reductions in the gross tax liability
Tax credits have the same dollar value to all taxpayers, regardless of their marginal tax brackets

61. Child Tax Credit
$1,000 nonrefundable tax credit for each qualifying child under age 17
Qualifying children include the taxpayer’s son, daughter, stepson, stepdaughter, grandchild, or eligible foster child that the taxpayer claims as a dependent
Phased out at rate of $50 for every $1,000 (or part thereof) of AGI in excess of
$110,000 if married filing jointly ($55,000 if MFS)
$75,000 if single or head of household

62. Education Credits
Two elective nonrefundable tax credits are provided for college or vocational tuition and fees for the taxpayer, spouse, or dependents
American Opportunity Credit – 100% of first $2,000 and 25% of second $2,000 tuition and fees for first 4 years only (maximum $2,500 per student)
Lifetime Learning Credit – 20% of up to $10,000 tuition and fees (maximum $2,000 per taxpayer)
A student who is a dependent cannot claim the credit

63. Education Credits
Expenses paid with a Pell Grant, scholarship, or employer-provided educational assistance do not qualify
Election is separate for each student, so a parent may choose one credit for one child and a different credit for a second child
Credits phase out over modified AGI of
$80,000 - $90,000 if single ($160,000 - $180,000 if MFJ) for American Opportunity credit
$50,000 - $60,000 if single ($100,000 - $120,000 if MFJ) for Lifetime Learning credit

64. Dependent Care Credit
Nonrefundable credit for taxpayers who pay for child or dependent care so they can work
Credit percentage varies from 20% to 35% of up to $3,000 for one qualifying child or $6,000 for 2 or more qualifying children under 13
35% if AGI does not exceed $15,000
Reduced by 1% for each $2,000 (or fraction thereof) AGI exceeds $15,000
20% if AGI exceeds $43,000

65. First-Time Homebuyer Credit
Credit applies to purchase of principal residence if no home owned (by taxpayer or spouse) during 3 prior years. This refundable tax credit is equal to the lesser of
10% of the purchase price of a principal residence
$8,000 maximum ($4,000 for married filing separately) if purchased from 1/1/09 through 11/30/09
$7,500 maximum ($3,750 if MFS) if purchased from 4/9/08 through 12/31/08
Cannot be acquired from a related party

66. First-Time Homebuyer Credit
Credit phases out when modified AGI is between $75,000 and $95,000 ($150,000 - $170,000 for married filing jointly)
Credit is recaptured (must be repaid)
If home purchased in 2009 ceases to be taxpayer’s principal residence within 36 months then lesser of gain on sale or entire credit is recaptured
If purchased in 2008, credit must be recaptured over 15 years (effectively an interest-free loan)

67. New Homebuyer Credit
The credit is recaptured over 15 years, beginning with the second tax year after the home is purchased
For each year, the credit is recaptured as an additional income tax amount equal to 6.67% of the amount of the credit
If the home is sold, any remaining unrecaptured credit is paid with the tax return for the year of sale
No interest is charged (in effect this is an interest-free loan from the government)

68. Earned Income Credit
The purpose is to reduce the impact of payroll taxes for low-income individuals
Credit is equal to a percentage of earned income below a maximum
With one qualifying child, maximum credit is $3,043 ($8,950 x 34%) for 2009
With two or more qualifying children, maximum credit is $5,028 ($12,570 x 40%)
Smaller credit available to taxpayers without children

69. Earned Income Credit This is a refundable credit
Taxpayers with investment income of $3,100 or more are not eligible
Anyone who can be claimed as a dependent is not eligible
A taxpayer without a qualifying child, must be between the ages of 25 and 64 to be eligible
Credit starts phasing out when income exceeds $19,540 if married filing jointly ($16,420 for others)

70. Making Work Pay Credit
New refundable credit for 2009 and 2010 for Social Security taxes paid by middle-income workers of 6.2% of earned income
Maximum credit $400 ($800 for a joint return)
Phased out at rate of 2% of modified AGI in excess of
$75,000 for individuals
$150,000 for married filing jointly
Most taxpayer will get benefit through reduction in income tax withholding

71. Retirement Contributions Credit
To encourage participation by low-income wage earners, a credit is allowed for up to 50% of the first $2,000 contributed to employer-sponsored retirement plans or IRAs
Credit varies with AGI
50% credit for joint filers with AGI up to $33,000 ($16,500 if single)
20% for joint filers with AGI of $33,000 - $36,000 ($16,500 - $18,000 if single)
10% for joint filers with AGI of $36,000 - $55,500 ($18,000 - $27,750 if single)
Dependents or full-time students are not eligible

72. Excess Payroll Tax Credit
Taxpayers working for more than one employer during the year with earnings exceeding the Social Security ceiling ($106,800 for 2009) usually have too much tax withheld
Employee is allowed a refundable credit for any excess Social Security taxes withheld

73. Credits for Energy Efficiency
30% for qualified energy efficiency improvements ($1,500 maximum credit per taxpayer)
30% for solar, wind, and geothermal property
Credit for hybrid vehicles (varies with type of vehicle)
$2,200 credit for Cadillac Escalade 2WD hybrid
$2,300 credit for Mazda Tribute 2WD hybrid
$7,500 to $15,000 credit for plug-in electric cars

74. Payment of Income Tax
Estimated quarterly payments are made by persons with large amounts of income from sources not subject to withholding
Due on April 15, June 15, September 15 of current year and January 15 of following year
If payments are not 90% or more of the total tax owed (or an amount required based on the prior year’s tax), a penalty may be charged, unless balance due is less than $1,000

75. Economic Stimulus Rebates
For 2008 a one-time rebate (tax credit) was paid of $300 to $600 per individual plus an additional $300 for each qualifying dependent child
Most individuals received an advanced payment of their rebate in May 2008
Individuals were not eligible for tax rebates if they were
Eligible to be claimed as dependents or
Nonresident aliens

76. Filing Requirements
Any taxpayer whose gross income is less than the sum of their standard deduction and their personal exemption (but not dependency exemptions) does not have to file a tax return
$9,350 in 2009 for a single individual
Returns should be filed if
Net self-employment income is $400 or more
A child claimed as a dependent has unearned income only of over $950
Any married person filing separately has income over $3,650

77. Alternative Minimum Tax
The purpose of the alternative minimum tax is to ensure high-income taxpayers pay their fair share of tax
Certain deductions are disallowed or reduced and certain exempt income items are subject to the AMT
IF AMT is greater than the regular tax, taxpayers pay the larger amount
Rate is 26% on first $175,000 and 28% on excess for individuals

78. AMT Model Taxable income Plus/minus Adjustments to taxable income
Plus: Tax preferences
Less: Allowable exemptions
Equals: Alternative minimum taxable income
Times: AMT tax rates
Equals: Tentative minimum tax (TMT)
Less: Regular income tax
Equals: AMT

79. AMT Exemptions AMT exemptions for 2009 are
$70,950 if married filing jointly
$35,475 if married filing separately
$46,700 if single or head of household
Exemptions begin to phase out when AMTI reaches $112,500 for singles and $150,000 for married filing jointly ($75,000 if MFS) at a rate of $1 for every $4 above the threshold

80. Alternative Minimum Tax
Itemized deductions are different from those calculated for regular income tax
Medical expenses must exceed 10% AGI
Taxes, home equity loan interest, and miscellaneous itemized deductions are not deductible
Tax preferences that are added include
Nontaxable interest on private activity bonds
Bargain element of incentive stock options

81. The End