CHAPTER 1 The Individual Income Tax Return

Transcription

1 CHAPTER 1 The Individual Income Tax Return Income Tax Fundamentals 2011 Gerald E. Whittenburg Martha Altus-Buller 2011 Cengage Learning 1

2 Learning Objectives Understand history/objectives of U.S. tax law Describe different entities subject to tax/reporting requirements Understand and apply tax formula Identify who must file tax returns and select filing status Calculate number of exemptions and exemption amounts Calculate standard/itemized deductions Compute basic capital gains and losses Access and use various internet tax resources 2011 Cengage Learning 2

3 History of Taxation Since 1913, when 16 th amendment was passed, the constitutionality of income tax has never been questioned by the federal courts 2011 Cengage Learning 3

4 THE 16 TH AMENDMENT OF THE UNITED STATES CONSTITUTION The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration Cengage Learning 4

5 What does the 16 th Amendment mean? This amendment allows the Congress to levy an income tax without apportioning it among the states or basing it on Census results. This amendment exempted income taxes from the constitutional requirements regarding direct taxes, after income taxes on rents, dividends, and interest were ruled to be direct taxes in Pollock v. Farmers' Loan & Trust Co. (1895). It was ratified on February 3, Cengage Learning 5

6 2011 Cengage Learning 6

7 Income taxes serve a multitude of Raise revenue purposes: Objectives of Tax Law Tool for social and economic policies Social policy encourages desirable activities and discourages undesirable activities Credits for investment in solar and wind energy Can deduct charitable contributions Credits for higher education expenses Economic policy as manifested by fiscal policy Encourage investment in capital assets through depreciation Both economic and social Exclude gain on sale of personal residence up to $250,000 ($500,000 if married) 2011 Cengage Learning 7

8 Primary Entities/Forms Individual Taxable income includes wages, salary, selfemployment earnings, rent, interest and dividends An individual may file simplest tax form qualified for 1040EZ 1040A 1040 See next slide If error made on one of the three above forms, can amend with a 1040X 2011 Cengage Learning 8

9 Primary Entities/Forms Individual 1040EZ Single or Married Filing Jointly (MFJ) Must not be 65 or older and/or blind Must not claim any dependents Taxable income must be under $100,000 Only wages, salaries or unemployment and not more than $1,500 taxable interest income Not received advance earned income credit 2011 Cengage Learning 9

10 Primary Entities/Forms Individual (continued) 1040A Generally used by taxpayers who are not selfemployed and don t itemize deductions 1040 If taxpayer doesn t qualify to use 1040EZ or 1040A,should complete a 1040 with possible schedules attached Schedule A to itemize deductions Schedule B to report dividends/interest income > $1500 Schedule C to report trade/business income Schedule D to report capital gains/losses Schedule E to report rental/royalty income Schedule F to report farm/ranch activities 2011 Cengage Learning 10

11 Primary Entities/Forms Corporations Tax rate schedule found on page 1-4 Corporations need to file 1120 or 1120S 1120S are for corporations that elect S Corporation status Don t pay regular corporate income taxes Instead, pass through items of income or loss to shareholders Partnerships Reporting entity, not taxable entity 1065 reports income/loss and allocation to partners Pass through items of income or loss to partners 2011 Cengage Learning 11

12 Tax Formula for Individuals This formula follows Form 1040 Gross Income less: Deductions for Adjusted Gross Income (AGI) AGI less: Greater of Itemized or Standard Deduction less: Exemption(s) Taxable Income times: Tax Rate (using tax tables or rate schedules) Gross Tax Liability less: Tax Credits and Prepayments Tax Due or Refund 2011 Cengage Learning 12

13 Standard Deduction & Exemptions 2010 standard deduction ($) Single 5,700 Married Filing Joint (MFJ) 11,400 Qualifying Widow(er) 11,400 also known as Surviving Spouse (SS) Head of Household (HOH) 8,400 Married Filing Separate (MFS) 5,700 *Taxpayers 65 or older and/or blind get an additional amount $1,100 if MFJ, MFS or SS $1,400 if HOH or Single 2010 exemption $3,650 personal & dependency 2011 Cengage Learning 13

14 Using Tax Formula Facts: Juan (age 29) is a single taxpayer. In 2010, his salary is $39,000 and he has dividend income of $1000. In addition, he has deductions for AGI of $2,500 and $3,000 of itemized deductions. If Juan claims one exemption for this year, calculate the following amounts: Gross income Deductions for AGI Adjusted gross income Greater of the standard deduction or itemized deductions Exemptions Taxable income 2011 Cengage Learning 14

15 Solution Gross income $40,000 Adjusted gross income Greater of the standard deduction or itemized deductions Exemptions Taxable income Gross income = $39, , Cengage Learning 15

16 Solution Gross income $40,000 Adjusted gross income 37,500 Greater of the standard deduction or itemized deductions Exemptions Taxable income AGI = $40,000 2, Cengage Learning 16

17 Solution Gross income $40,000 Adjusted gross income 37,500 Greater of the standard deduction or itemized deductions 5,700 Exemptions Taxable income The standard deduction of $5,700 exceeds itemized deductions of $3, Cengage Learning 17

18 Solution Gross income $40,000 Adjusted gross income 37,500 Greater of the standard deduction or itemized deductions 5,700 Exemptions 3,650 Taxable income $28, Cengage Learning 18

19 Who Must File Based on filing status and gross income Generally, if exemptions plus greater of standard or itemized deductions exceed income, then filing is not necessary If taxpayer is claimed as a dependent on another taxpayer s return, dependent s standard deduction is: Greater of $950 or Earned income + $300 But never more than standard deduction See Figures 1.1 and 1.2 on page Cengage Learning 19

20 Who Must File Taxpayer must file if Owe any special taxes See Figure 1.3 on page 1-9 Received Advanced Earned Income Credit payments from employer Had self-employment income >= $400 Other special situations as outlined on Chart C (Figure 1.3) 2011 Cengage Learning 20

21 Which Taxpayers are Required to File Note: Must analyze each independent situation to determine if the taxpayer is required to file a return for 2010 Miles (age 45) is a single waiter and has unreported tips of $1,510; is he required to file? Yes, because Miles owes social security taxes on unreported tips Cengage Learning 21

22 Which Taxpayers are Required to File Simone is single (age 31) and blind and has income of $9,950; is she required to file? No, because standard deduction = $7,100 ($5, ,400); exemption= $3,650. These amounts total to $10,750 and exceed her gross income Cengage Learning 22

23 Which Taxpayers are Required to File Eamon (age 67) and his wife, Roisin, (age 69) have income of $19,180 and file jointly; are they required to file? No, because standard deduction = $13,700 ($11, , ,100); exemptions = $7,300. These amounts total to $20,900 and exceed their gross income Cengage Learning 23

24 Which Taxpayers are Required to File Taig is a single full time college student, age 21, with wages from a part-time job of $6,340. He is claimed as a dependent by his parents; is he required to file? Yes, because standard deduction = $5,700 and his income exceeds this amount. His exemption is 0 as he s claimed by parents Cengage Learning 24

25 Filing Status Single Unmarried or legally separated as of 12/31 And not qualified as married filing separately, head of household or qualifying widow(er) Married Filing Jointly (MFJ) If married on 12/31 even if didn t live together entire year Same-sex couples may not file jointly If spouse dies during year you can file MFJ in current year Married Filing Separately (MFS) Each file separate returns Must compute taxes the same way - both itemize or both use standard If living in community property state, must follow state law to determine community and separate income 2011 Cengage Learning 25

26 Filing Status Head of Household (HOH) Tables have lower rates than single or MFS Taxpayer can file as HOH if: Unmarried or abandoned* as of 12/31 Paid > 50% of cost of keeping up home that was principal residence of dependent child or other qualifying dependent relative There is one exception to principal residence requirement. If dependent is taxpayer s parent, he/she doesn t have to live with taxpayer. Note: A divorced parent who meets above rules and has signed IRS/legal document, may still claim HOH even if dependency exemption shifted to ex-spouse *See pages 1-10 and 1-11 for requirement for abandoned spouse 2011 Cengage Learning 26

27 Filing Status Qualifying Widow(er) with Dependent Child Also known as surviving spouse Available for two subsequent years after death of spouse Must pay over half the cost of maintaining a household where a dependent child, stepchild, adopted child or foster child lives Gets benefits of married filing joint tax rates 2011 Cengage Learning 27

28 Tax Computation Six brackets (in Appendix) 10%, 15%, 25%, 28%, 33%, 35% Tax rate schedules for different filing types Qualifying dividends and net long-term capital gains may be taxed at lower rates Rates based on ordinary tax bracket Tax year 2010 laws are covered in this text. After 2010 many of the tax laws and rate structures passed will sunset. The new tax rate structure will depend upon what Congress enacts Cengage Learning 28

29 Making Work Pay Credit This is a refundable credit amounting to $400 ($800 MFJ) o Phases-out when AGI exceeds $75,000 ($150,000 MFJ) o Complete Schedule M to calculate credit o Available to both employees and self-employed taxpayers 2011 Cengage Learning 29

30 Personal/Dependency Exemptions Personal exemptions may be taken for self and spouse Additional exemptions may be taken for individuals who are either taxpayer s Qualifying child or Qualifying relative For 2010 each exemption = $3,650 In years prior to 2010, exemptions phased-out for highincome taxpayers. It is anticipated that the phase-out will be reintroduced in Cengage Learning 30

31 Dependency Qualifying Child Dependency exemption allowed when six tests met Relationship Test - child is taxpayer s child, stepchild, adopted child or taxpayer s sibling, half- or step-sibling, or a descendant of any of these. Foster child may also qualify. Child must be younger than person claiming him/her, unless permanently disabled. Domicile Test- child has same principal place of abode as taxpayer for more than ½ the year. Age Test child is under 19 or a full-time student under 24 (enrolled at least 5 months of year) Cengage Learning 31

32 Dependency Qualifying Child Joint Return Test child doesn t file joint return with spouse (exception: if it s only to claim refund, then considered to have passed this test). Citizenship Test child is a US citizen, a resident of the US, Canada or Mexico, or an alien child adopted by and living with a US citizen. Self-Support Test child who provides more than ½ of his/her own support cannot be claimed as a dependent of someone else. Funds received by students as scholarships are excluded from support test Cengage Learning 32

33 What if Child Meets Dependency Requirements for More than One Taxpayer? If one of the parties is a parent, he/she can claim If both parties are a parent, then one with whom the child resides longest can claim o If not ascertainable, parent with highest AGI may claim If no parents are involved, person with highest AGI may claim 2011 Cengage Learning 33

34 Dependency Qualifying Relative Dependency exemption may be granted for a qualifying relative (who is not a qualifying child) based on tests on next slide. Note: A taxpayer s child who does not meet qualifying child test may meet qualifying relative test!! 2011 Cengage Learning 34

35 Dependency Qualifying Relative Relationship or Member of Household Test list of relatives that qualify is available at IRS web site Note: A member of household (even if unrelated) for entire year meets the relationship test Gross Income Test individual may not have gross income in excess of $3,650 Support Test dependent must receive over ½ of his/her support from taxpayer Joint Return Test dependent may not file a joint return unless it s solely to claim refund Citizenship Test dependent must meet the citizenship test identified in the qualifying child slide 2011 Cengage Learning 35

36 Standard Deduction 2010 standard deduction Single $ 5,700 Married Filing Joint (MFJ) $11,400 Qualifying Widow(er) $11,400 also known as Surviving Spouse Head of Household (HOH) $ 8,400 Married Filing Separate (MFS) $ 5,700 *Plus additional amounts for blindness or over 65: $1,100 if MFJ, MFS or qualifying widow(er) and $1,400 if HOH or Single For (and likely extended to 2010), taxpayer may add lesser of $500 (or $1,000 MFJ) or actual real estate taxes paid to standard deduction amount Cengage Learning 36

37 Standard Deduction - Dependents The special rule for standard deduction for dependents is Deduction = Greater of $950 or earned income + $300, but only up to basic standard deduction Example 1: Jaime is 23 and a full time student and her parents claim her as a dependent; she earned $2,000 in 2010, how much is taxable income? $2,000 earned income (2,000) standard deduction $0 taxable income Example 2: Tia is 18 - has dividend income of $1,500 (dividends are considered unearned income), how much is taxable income? $1,500 dividend income ( 950) standard deduction $ 550 taxable income 2011 Cengage Learning 37

38 Basic Gain & Loss Model Amount Realized* - Adjusted Basis** Realized Gain/Loss * Sales Price - Sales Expenses ** Cost - Accumulated Depreciation Note: Most realized gains/losses are also recognized (i.e. included in taxpayer s income) 2011 Cengage Learning 38

39 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 Examples: stocks, bonds, land, cars and other items held for investment Gains/losses on these assets are subject to special rates Holding period of asset determines treatment Long-term is held >12 months (taxed at capital rates see next screen) Short-term is held <= 12 months (taxed at ordinary rates) 2011 Cengage Learning 39

40 Capital Gains/Losses Long term capital gain Special rates depending upon taxpayer s bracket Ordinary Tax Bracket Capital Gains Tax Rate 10% or 15% 0% All other brackets 15% Long term capital loss Only allowed $3,000 net capital loss per year against ordinary income Carry-forward any unused balance 2011 Cengage Learning 40

41 Calculating Gain/Loss Facts: Noah purchased Sony AAA bonds in 2006 for $47,600. In 2010, he sold the bonds for $51,500, paying commission of $515. What is his: Amount realized Adjusted basis Realized gain/loss Recognized gain/loss Type of gain/loss 2011 Cengage Learning 41

42 Solution Amount realized * $50,985 Adjusted basis 47,600 Realized gain/loss 3,385 Recognized gain/loss 3,385 Type of gain/loss Long term capital gain *Amount realized = $51, Cengage Learning 42

43 Tax and The Internet Volumes of tax information available on internet contains forms and publications and a search engine to aid the user in obtaining useful information is the California Franchise Tax Board s site and contains pertinent information for preparing California taxes The IRS has also launched a YouTube video site and an itunes podcast site In some states, names of delinquent taxpayers posted on web sites 2011 Cengage Learning 43

44 The End! (of Chapter 1!) 2011 Cengage Learning 44