1. Chapter 2 Determination of Tax

2. Learning Objectives Use the tax formula to compute an individual’s taxable income Determine the amount allowable for the standard deduction Determine the amount and the correct number of personal and dependency deductions

3. Learning Objectives Determine the amount of child credit Determine the filing status of individuals Explain the tax formula for corporations Explain the basic concepts of property transactions

4. Formula For Individual Income Tax INCOME FROM WHATEVER SOURCE DERIVED minus EXCLUSIONS= GROSS INCOME minus DEDUCTIONS FOR ADJUSTED GROSS INCOME= ADJUSTED GROSS INCOME - deduct GREATER OF ITEMIZED OR STANDARD DEDUCTION and PERSONAL AND DEPENDENCY EXEMPTIONS= TAXABLE INCOME. TAXABLE INCOME times TAX RATE (tax table or schedule) = GROSS TAX minus CREDITS AND PREPAYMENTS= NET TAX PAYABLE OR REFUND DUE

5. Formula For Individual Income Tax Income from whatever source derived Minus: Exclusions Gross Income Minus: Deductions for Adjusted Gross Income Adjusted Gross Income(AGI) Minus: Deductions from adjusted gross income: Greater of itemized deductions or the standard deduction Personal and dependency exemptions Taxable Income Times: Tax rate or rates (from tax table or schedule) Gross tax Minus: Credits and prepayments Net tax payable or refund due $ xxx,xxx (xxx) $ xx,xxx (xxx) $ x,xxx (xx) $ x,xxx.xx $ xx (x) $ xx

6. Definitions Income Exclusion Gross income Deductions for adjusted gross income (AGI) Adjusted gross income (AGI) Deductions from AGI

7. Definitions Itemized or standard deductions Personal and dependency exemptions Taxable income Tax rates and gross tax Credits and prepayments

8. Itemized Deductions Qualifying medical expenses, taxes, investment and residential interest, charitable contributions, personal casualty and theft losses, & miscellaneous if greater than standard deduction Some items limited by varying percentages of adjusted gross income Maximum reduction in such itemized deductions is 80% of total itemized deductions

9. Standard Deduction Varies based on: – Filing status – Age – Vision Used when greater than Itemized Loss of the Standard Deduction

10. Personal Exemptions Unless claimed as dependent on another return, each allowed one Additional allowed for spouse on joint return or separate return if no gross income/not dependent of another

11. Dependency Exemptions Dependency exemption allowed if: – Provides over 50% support – Dependents gross income < exemption amount – No joint return filed by married dependent (except if sole purpose is refund) – Related to or resided with taxpayer for the entire tax year (no cousins) and – Dependent is U.S. Citizen, U.S. Resident, or they must resides in Canada or Mexico

12. Determine The Amount Of Child Credit $1000 per qualifying child, falls to $700 in 2005 - 2008 –Must be US citizen, national, or resident under the age of 17 Credit is reduced if MAGI exceeds threshold –110,000 for MFJ –75,000 for Single –55,000 for MFS

13. Determining The Amount Of Tax Filing status – Joint – Surviving spouse – Head of household – Single – Married filing separately

14. Relative Tax By Filing Status Joint return Surviving spouse Head of household Abandoned spouse Single Married - filing separately LOWESTHIGHEST

15. Dependents With Unearned Income Dependent does not receive a personal exemption on their own return. A dependent’s standard deduction is reduced to the greater of earned income or $800 or the dependent’s earned income plus $250. The tax on the net unearned income of a child under age 14 is figured by reference to the parents’ tax rate if it is higher than the child’s (known as the “kiddie tax”).

16. Corporate Tax Formula & Rates “C” Corporations - Table I 2-7 “S” Corporations - no formula/based on ordinary income (Flow-through Entity)

17. Corporate Tax Rates First $50,00015 % Of Taxable Income Over $50,000 But Not Over $75,000$7,500 + 25% Of Taxable Income Over $75,000 But Not Over $100,00013,750 + 34% Of Taxable Income Over $75,000 Over $100,000 But Not Over $335,000 $22,250 + 39% Of Taxable Income Over $100,000 Over $335,00034% Of Taxable Income Over $10,000,000 But Not Over 15,000,000 3,400,000 + 35% Of Taxable Income Over $15,000,000 But Not Over $18,333,333 $5,150,000 + 38% Over $15,000,000 Over $18,333,33335% Of Taxable Income

18. Tax Formula for C Corporations Income from whatever source derived Minus: Exclusions Gross Income Minus: Deductions Taxable Income Times: Tax rates Gross Tax Minus: Credits and prepayments Net tax payable or refund due $xxx (xxx) $xxx (xxx) $xxx.xx $xxx (xxx) $xxx

19. Treatment Of Capital Gains And Losses Capital gains and losses have been accorded favored tax treatment since 1922

20. Treatment Of Capital Gains And Losses Definition of capital assets – Assets other than inventory, trade receivables, certain properties created by efforts of taxpayer, depreciable business property, business land, and certain government publications

21. Tax Treatment Of Gains And Losses Capital gains and losses are divided into 2 categories – Long-term is held for over 12 months – Short-term is held less than 12 months

22. Tax Treatment Of Gains And Losses Net long-term gain is taxed at 20% tax (10% if in the 15% tax bracket) Net short-term gain is taxed at the same rate as other income

23. Tax Treatment Of Gains And Losses Individuals who suffer net capital losses can deduct only up to $3,000 of the losses from other income. Losses over $3,000 are carried over and offset against future gains.

24. Tax Planning Considerations Shifting income between family members Splitting income Maximizing itemized deductions Filing joint or separate returns Innocent spouse provision

25. Compliance And Procedural Considerations Who must file –See Chart on page 2-31 Due dates for filing return –Individuals and Partnerships (15 th day of 4 th month). –Corporations (15 th day of 3 rd month) Use of forms 1040, 1040EZ, and 1040A