ACCT 538 Individual Income Tax

ACCT 538 – Individual Income Tax

Chapter 4 – Individual Income Tax Overview, Exemptions, and Filing Status

  1. Individual Income Tax Formula
  • Gross income
  • Minus: For AGI deductions
  • Equals: Adjusted gross income
  • Minus: From AGI deductions:
    • Greater of (a) Standard deduction or (b) Itemized deductions and
    • Personal and dependency exemption
  • Equals: Taxable income
  • Taxable income
  • Times: Tax rates
  • Equals: Income tax liability
  • Add: Other taxes
  • Equals: Total tax
  • Minus: Credits
  • Minus: Prepayments
  • Equals: Taxes due or (refund)
  • Individuals report taxable income to the IRS
  • Reported on Form 1040
  • U.S. tax laws use all-inclusive gross income concept
    • Realized income
      • Measurable change in property rights
      • All realized income included in gross income unless specifically excluded or deferred
  • Recognized income
  • Reported on tax return
  • Excluded and Deferred income not included in gross income
  • Excluded income
    • Income never included in taxable income
      • Municipal bond interest
      • Gain on sale of personal residence
  • Deferred income
    • Income included in a subsequent tax year
      • Installment sales
      • Like-kind exchanges
  • Character of income or loss
    • Determines rates applicable to income or loss in current year
    • Tax exempt – no tax
    • Tax deferred – no tax in current year (current year tax rate is zero)
    • Ordinary – ordinary rates from tax rate schedule
    • Qualified dividends tax at 0, 15%, or 20% depending upon taxpayer’s income level
  • Capital gain or loss – depends on whether short-term or long-term
      • From selling capital asset
      • If held capital asset more than a year gain or loss is long-term, otherwise it is short-term
      • Net long-term gains taxed at preferential rates
  • Capital assets
    • Generally, all assets except:
      • Accounts receivable
      • Inventory
      • Assets used in trade or business, including supplies
  • Capital gains and losses
    • Net long-term capital gains in excess of net short-term capital losses are generally taxed at 0, 15%, or 20% depending on the taxpayer’s taxable income
    • Short-term capital gains taxed at ordinary rates
    • Net capital losses (losses in excess of gains for year)
      • $3,000 deductible against ordinary income for year
      • Losses in excess of $3,000 carried forward
  • Deductions for AGI
    • Deductions “above the line”
    • Deducted in determining adjusted gross income
    • Always reduce taxable income dollar for dollar
    • Greater of standard deduction or itemized deductions
    • Personal and dependency exemptions
  • 2015 Standard deduction amounts
    • $12,600 Married filing jointly
    • $12,600 Qualifying widow or widower
    • $6,300   Married filing separately
    • $9,250   Head of Household
    • $6,300   Single
    • Additional standard deduction amount for age and eyesight
  • Tax calculation
    • The U.S. uses a progressive tax rate schedule
    • Some items are taxed at preferential rates
      • Long-term capital gains
      • Qualified dividends
      • Tax on these items is calculated separately from income taxed at ordinary rates.
  • Other taxes include:
    • Alternative minimum tax
    • Self-employment taxes
    • 3.8% Net investment income tax
    • .9% Additional Medicare tax
  • Tax credits
    • Reduce tax liability dollar for dollar
  • Tax prepayments
    • Payments already made towards tax liability including:
      • Income taxes withheld from wages by employer
      • Estimated tax payments made during the year
      • Taxes overpaid in prior year and applied toward current year’s liability
    • If prepayments exceed tax liability after credits, taxpayer receives a refund.
  1. Personal and Dependency Exemptions
  • Personal exemptions
    • For taxpayer and spouse if married filing jointly
  • Dependency exemptions
    • For those who qualify as the taxpayer’s dependents
  • Exemption amount for 2015 is $4,000
  • Dependency requirements
    • Citizen of U.S. or resident of U.S., Canada, or Mexico
    • Must NOT file joint return with spouse
      • Exception – if no tax liability filing jointly or separately
    • Must be qualifying child or qualifying relative of taxpayer
  • Qualifying child
    • Relationship text – taxpayer’s son, daughter, stepchild, an eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of these relatives.
    • Age test – child must be younger than individual claiming the child as a qualifying child and either
      • Under age 19 at the end of the year,
      • Under age 24 at the end of the year and a full-time student, or
      • Permanently and totally disabled.
    • Residence test – Same residence as taxpayer for more than half the year
      • Exception for temporary absences such as education
    • Support test – Child must not provide more than half of his or her own support
      • Scholarships of actual child (not grandchild, for example) are excluded from support computation
    • Tie breaking rules
      • Parents first
      • Days living with each parent if parents living apart
      • AGI – higher AGI gets exemption
  • Qualifying relative
    • Relationship test
      • a descendant or ancestor of the taxpayer
      • a sibling of the taxpayer including a stepbrother or stepsister
      • a son or daughter of the taxpayer’s brother or sister (not cousins)
      • a sibling of the taxpayer’s mother or father
      • in-law of the taxpayer, or
      • unrelated person who lives in taxpayer’s home entire year
    • Support test – Taxpayer must pay > ½ of living expenses (support
      • Scholarships of actual child excluded
    • Gross income test – Gross income < personal exemption amount ($4,000 in 2015)
  • Filing Status
  • Five different filing statuses
    • Married filing jointly
      • Must be married on the last day of the year
        • If one spouse dies the surviving spouse is considered to be married to decedent spouse at year end
          • Exception – The surviving spouse remarries before year end
      • Joint and several liability for tax
    • Married filing separately
      • Taxpayers are married but file separate returns
        • Typically, not beneficial from tax perspective
          • Tax rates and other tax benefits
        • May be beneficial for non-tax reasons
          • No joint and several liability
    • Qualifying widow or widower (surviving spouse)
      • Available for the two years following the year of spouse’s death
      • Surviving spouse does not qualify if remarries during two-year period
      • Surviving spouse must maintain household for dependent child
    • Single
      • Unmarried unless qualify for head of household
    • Head of household
      • Unmarried or considered unmarried at end of year
        • See discussion of married individuals treated as unmarried (abandoned spouses) below
      • Not a qualifying widow or widower
      • Pay more than half the costs of keeping up a home during the year
      • Lived in taxpayer’s home with a “qualifying person” for more than half of the year
        • Exception for parents (see below)
  • Qualifying person
  • Qualifying child
  • Qualifying relative who is taxpayer’s mother or father
    • Parent need not live with taxpayer
    • Taxpayer must pay > ½ cost of maintaining separate household for taxpayer’s mother or father
    • Parent must qualify as taxpayer’s dependent
  • Qualifying relative who is not the taxpayer’s parent
    • Person must have lived with the taxpayer for more than half the year
    • Must qualify as taxpayer’s dependent
    • Must be related to taxpayer through qualified relationship
      • If related only because lived with taxpayer for entire year, not a qualified person.
  • Head of household
    • Married individuals treated as unmarried (abandoned spouse) if individual
      • Is married at end of year (or is not legally separated from the other spouse)
      • Does not file a joint tax return with the other spouse
      • Pays > ½ the cost of maintaining a household that serves as principal abode for qualifying child for more than half the year
      • Lived apart from the other spouse for the last six months of the year (other than temporary absences)
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