1. CHAPTER 1 The Individual Income Tax Return Income Tax Fundamentals 2007 edition Gerald E. Whittenburg & Martha Altus-Buller

2. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Objectives of Tax Law  Raise revenue  Tool for social and economic policies Social policy encourages desirable activities and discourages undesirable activities  Can’t deduct penalties  Can deduct charitable contributions Economic policy as manifested by fiscal policy  Encourage investment in capital assets by accelerating depreciation Both economic and social  Exclude gain on sale of personal residence up to $250,000 [$500,000 if married]

3. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Primary Entities/Forms  Individuals Taxable income includes wages, salary, self- employment earnings, rent, interest and dividends An individual may file the simplest tax form that he/she qualifies for  1040EZ  1040A  1040

4. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Tax Formula for Individuals This follows form 1040 Gross Income less:Deductions for Adjusted Gross Income [AGI] AGI less:Greater of Itemized or Standard Deduction less:Exemptions Taxable Income times:Tax Rate Gross Tax Liability less:Tax Credits and Prepayments equals: Tax Due or Refund

5. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Filing Status  Single Unmarried or legally separated as of 12/31  Married Filing Jointly [MFJ] If married on 12/31 - if spouse dies during year you can file MFJ  Married Filing Separately [MFS] Each file separate returns Must compute taxes the same way - both itemize or use standard If living in community property state, must follow state law to determine community and separate income  Head of Household [HOH] Taxpayer can use file as HOH if unmarried as of 12/31and paid > 50% of cost of keeping up home that was principal residence of dependent  Surviving Spouse - Qualifying Widow[er] Applies in year of spouse’s death and in two subsequent years Must pay over ½ price of maintaining a household with a dependent child

6. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Standard Deductions & Exemption  2006 standard deductions Single $ 5,150 Married Filing Joint [MFJ] $10,300 Surviving Spouse [SS] $10,300 Head of Household [HOH] $ 7,550 Married Filing Separate [MFS] $ 5,150 *Taxpayers 65 or older and/or blind get an additional amount $1000 if MFJ, MFS or SS $1250 if HOH or Single  2006 exemption$3300 per person

7. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Standard Deduction - Dependents The special rule for standard deduction for dependents is “deduction = greater of $850 or earned income + $300 but only up to basic standard deduction” Example 1: Jaime is 23 and a full time student and her folks claim her as a dependent; she earned $2,000 in 2006. 2,000 earned income (2,000) standard deduction $0 taxable income Example 2: Tia is 18 and has dividend income [not earned] of $1,500 1,500 dividend income ( 850) standard deduction $ 650 taxable income

8. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Itemized Deductions  Use itemized deductions if they exceed standard deduction  Phased out for high income taxpayers 2% x (AGI - Threshold Amount)  Threshold amount $ 75,250 for MFS or $150,500 (all other filing types)  Phase-out calculation  (AGI – Threshold Amount) x 2% but limited to 80% x all itemized deductions except medical, investment interest expense, casualty losses and wagering losses

9. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Personal/Dependency Exemptions  For taxpayer and each dependent - $3,300 per person Phased out for high income taxpayers  2% per $2,500 [$1250 if MFS] over threshold See p. 1-14 for limits based on filing status  Phase out limited to 2/3 of exemption amount

10. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Capital Gains/Losses  A capital asset is any property [personal or investment] held by a taxpayer, with certain exceptions as listed in the tax law Gains/losses on these assets are subject to special rates  Holding period of asset determines treatment Long term - held >12 months (taxed at capital rates) Short term - held <= 12 months (taxed at ordinary rates)