CHAPTER 1 The Individual Income Tax Return

Transcription

1 CHAPTER 1 The Individual Income Tax Return 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 Determine filing status and understand calculation of tax according to filing status Calculate number of exemptions and exemption amounts Calculate correct standard or itemized deduction amount Compute basic capital gains and losses Identify new tax rules for high income taxpayers Access and use various Internet tax resources Understand the basics of e-filing 1

2 History of Taxation Since 1913, when 16 th amendment was passed, the constitutionality of income tax has never been questioned by federal courts Income taxes serve a multitude of purposes 2

3 Objectives of Tax Law Raise revenue Tool for social and economic policies o Social policy encourages desirable activities and discourages undesirable activities Deductions for charitable contributions Credits for higher education expenses Credits for taxpayers living in disaster areas o Economic policy as manifested by fiscal policy Encourage investment in capital assets through depreciation Credits for investment in solar and wind energy o Both economic and social Exclude gain on sale of personal residence up to $250,000 ($500,000 if married) 3

4 Primary Entities/Forms Individual o Taxable income includes wages, salary, self-employment earnings, rent, interest and dividends o An individual may file simplest tax form qualified for 1040EZ 1040A 1040 See next slide o If error made on one of the three above forms, can amend with a 1040X 4

5 Primary Entities/Forms Individual o 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, unemployment and a few others, and not more than $1,500 taxable interest income Not claim any credits other than the earned income credit 5

6 Primary Entities/Forms Individual (continued) o 1040A Generally used by taxpayers who are not self-employed and don t itemize deductions o 1040 If taxpayer doesn t qualify to use 1040EZ or 1040A, should complete a 1040 with appropriate 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 6

7 Primary Entities/Forms Corporations o Tax rate schedule found on page 1-4 o Corporations need to file 1120 or 1120S o 1120S is used by corporations that elect S corporation status Don t pay regular corporate income taxes Instead, pass through items of income or loss to shareholders Partnerships o Reporting entity, not taxable entity o 1065 reports partnership income/loss and allocation to partners Pass through items of income or loss to partners 7

8 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 (TI) times: Tax Rate (using tax tables or rate schedules) Gross Tax Liability less: Tax Credits and Prepayments Tax Due or Refund 8

9 Standard Deduction & Exemptions 2014 standard deduction Single $ 6,200 Married Filing Joint (MFJ) 12,400 Qualifying Widow(er) 12,400 also known as Surviving Spouse Head of Household (HOH) 9,100 Married Filing Separate (MFS) 6,200 *Plus additional amounts for blindness or over 65: $1,200 if MFJ, MFS or qualifying widow(er) and $1,550 if HOH or Single Exemption = $3,950/person 9

10 Using Tax Formula Facts: Juan (age 29) is a single taxpayer. In 2014, his salary is $39,000 and he has dividend income of $1,000. 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 10

11 Solution Gross income $40,000* Deductions for AGI 2,500 Adjusted gross income $37,500 Greater of standard or itemized deductions 6,200** Exemptions 3,950 Taxable income $27,350 * ($39, ,000) ** greater of standard ($6,200) or itemized ($3,000) 11

12 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 $1,000 or Earned income + $350 See Figures 1.1 and 1.2 on pages 1-7 and 1-8 But never more than standard deduction 12

13 Who Must File Taxpayer must file if o Owe any special taxes See Figure 1.3 on page 1-8 o Had self-employment income >= $400 o Other special situations as outlined on Chart C (Figure 1.3) 13

14 Which Taxpayers are Required to File Note: Must analyze each independent situation to determine if the taxpayer is required to file a return for 2014 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. See Figure 1.3 on p

15 Which Taxpayers are Required to File Simone is single (age 31) and blind, and has income of $10,370; is she required to file? No, because standard deduction = $7,750 ($6, ,550); exemption= $3,950. These amounts total to $11,700 and exceed her gross income. See Figure 1.1 on p

16 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 = $14,800 ($12, , ,200); exemptions = $7,900. These amounts total to $22,700 and exceed their gross income. See Figure 1.1 on page

17 Which Taxpayers are Required to File Taig is a single full time college student, age 21, with wages from a part-time job of $7,340. He is claimed as a dependent by his parents; is he required to file? Yes, because Taig s standard deduction = $6,200 and his income exceeds this amount. His exemption is 0, as he s claimed by his parents. 17

18 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 Based on a 2013 Supreme Court ruling that struck down a portion of the Defense of Marriage Act (DOMA), same-sex couples may now 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 18

19 Filing Status Head of Household (HOH) Tax tables have lower rates than single or MFS Taxpayer can file as HOH if: Unmarried or abandoned as of 12/31 and 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 19

20 Tax Computation Seven brackets o 10%, 15%, 25%, 28%, 33%, 35%, 39.6% o Tax rate schedules for different filing types Qualifying dividends and net long-term capital gains may be taxed at lower rates o Rates based on ordinary tax bracket 20

21 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 2014 each exemption = $3,950 21

22 Dependency Qualifying Child Dependency exemption allowed when six tests met Relationship Test - child is taxpayer s child, stepchild, adopted child or 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). 22

23 Dependency Qualifying Child Joint Return Test child doesn t file joint return with spouse (exception: if file jointly 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. 23

24 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 Note: If parents are legally separated/divorced, person with whom child resides more than 6 months may claim. However, exemption can shift if custodial parent signs Form 8332, and form is attached to noncustodial parent s tax return. 24

25 Dependency Qualifying Relative Dependency exemption may be granted for a qualifying relative (who is not a qualifying child) based on five tests on next slide. Note: A taxpayer s child who does not meet qualifying child test may meet qualifying relative test!! 25

26 Dependency Qualifying Relative Relationship or Member of Household Test list of relatives that qualify is available at IRS website 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 equal to or in excess of $3,950 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 26

27 Standard Deduction 2014 standard deduction Single $ 6,200 Married Filing Joint (MFJ) 12,400 Qualifying Widow(er) 12,400 also known as Surviving Spouse Head of Household (HOH) 9,100 Married Filing Separate (MFS) 6,200 *Plus additional amounts for blindness or over 65: $1,200 if MFJ, MFS or qualifying widow(er) and $1,550 if HOH or Single 27

28 Standard Deduction - Dependents The special rule for standard deduction for dependents is Deduction = Greater of $1,000 or earned income + $350, 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 2014, 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 ( 1,000) standard deduction $ 500 taxable income 28

29 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) 29

30 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 o Examples: stocks, bonds, land, cars and other items held for investment o Gains/losses on these assets are subject to special rates Holding period of asset determines treatment o Long-term is held >12 months (taxed at capital rates see next screen) o Short-term is held <= 12 months (taxed at ordinary rates) 30

31 Capital Gains/Losses Long term capital gain taxed at special rates depending upon taxpayer s bracket Ordinary Tax Bracket Capital Gains Tax Rate* 10% or 15% 0% 25% or 35% 15% 39.6% 20% *Special higher rates for high income taxpayers (see slide 36) Long term capital loss are only allowed $3,000 net capital loss per year against ordinary income o Carry-forward any unused balance 31

32 Calculating Gain/Loss Facts: Noah purchased Sony AAA bonds in 2006 for $47,600. In 2014, 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 32

33 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,

34 Special Rules for High- Income Taxpayers Two laws effected tax increases for high-income taxpayers in 2013 o o The Affordable Care Act ( Obamacare ) The American Taxpayer Relief Act ( Fiscal cliff legislation) Additional 3.8% Medicare tax on net investment income o If modified AGI > $250,000 (MFJ), $200,000 (S) or $125,000 (MFS) Additional.9% Medicare tax on earned income o Same income thresholds as above (details in Chapter 9) Top tax rate increased to 39.6% o If TI >$450,000 (MFJ), $400,000 (S), $425,000 (HOH) 34

35 Special Rules for High-Income Taxpayers (continued) Top capital gains tax rate increased to 20% o If taxpayer is in new 39.6% top marginal rate (see prior slide), then qualified dividends and long-term capital gains are taxed at 20% New top rates o See p for diverse revenue s new top rates Itemized deduction and exemption phase-outs reinstated 35

36 Tax and The Internet Volumes of tax information available on internet o contains forms and publications and a search engine to aid the user in obtaining useful information The IRS has also launched a YouTube video site and an itunes podcast site; these feature topics like how to obtain refund or file an extension o Also, there are news feeds on Twitter, a Facebook page, and other social media modalities Other good sites include and In some states, names of delinquent taxpayers posted on websites 36

37 Electronic Filing Rules in constant transition, as IRS attempts to transition all taxpayers to e-filing Taxpayers may prepare electronic returns using own PC and tax preparation software or May utilize a paid preparer who employs e-filing 37