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Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
Itf ipp ch01_2012_final
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Itf ipp ch01_2012_final

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  • 1. CHAPTER 1 The IndividualIncome Tax Return Income Tax Fundamentals 2012 Gerald E. Whittenburg Martha Altus-Buller 2012 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 Determine filing status & understand calculation of tax according to filing status Calculate number of exemptions and exemption amounts Calculate correct standard or itemized deduction amount for taxpayers Compute basic capital gains and losses Access and use various internet tax resources Understand the basics of e-filing 2012 Cengage Learning 2
  • 3. History of Taxation Since1913, when 16th amendment was passed, the constitutionality of income tax has never been questioned Incometaxes serve a multitude of purposes 2012 Cengage Learning 3
  • 4. Objectives of Tax Law Raise revenue 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) 2012 Cengage Learning 4
  • 5. Primary Entities/Forms Individual ◦ Taxable income includes wages, salary, self- employment earnings, rent, interest and dividends ◦ An individual may file simplest tax form qualified for  1040EZ  1040A See next slide  1040 ◦ If error made on one of the three above forms, can amend with a 1040X 2012 Cengage Learning 5
  • 6. 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 claim any credits other than the earned income credit 2012 Cengage Learning 6
  • 7. Primary Entities/Forms Individual (continued) ◦ 1040A  Generally used by taxpayers who are not self- employed 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 > $1500 ◦ Schedule C to report trade/business income ◦ Schedule D to report capital gains/losses ◦ Schedule E to report rental/royalty income ◦ Schedule F to report farm/ranch activities 2012 Cengage Learning 7
  • 8. Primary Entities/Forms Corporations ◦ Tax rate schedule found on page 1-4 ◦ Corporations need to file 1120 or 1120S ◦ 1120S is for corporations that elect S Corporation status  Don’t pay regular corporate income taxes  Instead, pass through items of income or loss to shareholders Partnerships ◦ Reporting entity, not taxable entity ◦ 1065 – reports income/loss and allocation to partners  Pass through items of income or loss to partners 2012 Cengage Learning 8
  • 9. Tax Formula for Individuals This formula follows Form 1040 Gross Incomeless: Deductions for Adjusted Gross Income (AGI) AGIless: Greater of Itemized or Standard Deductionless: Exemption(s) Taxable Incometimes: Tax Rate (using tax tables or rate schedules) Gross Tax Liabilityless: Tax Credits and Prepayments Tax Due or Refund 2012 Cengage Learning 9
  • 10. Standard Deduction & Exemptions2011 standard deduction ($) Single 5,800 Married Filing Joint (MFJ) 11,600 Qualifying Widow(er) 11,600 also known as Surviving Spouse (SS) Head of Household (HOH) 8,500 Married Filing Separate (MFS) 5,800 *Taxpayers 65 or older and/or blind get an additional amount $1,150 if MFJ, MFS or SS $1,450 if HOH or Single2011 exemption $3,700 – personal & dependency 2012 Cengage Learning 10
  • 11. Using Tax FormulaFacts: Juan (age 29) is a single taxpayer. In 2011, hissalary 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 oneexemption 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 11
  • 12. SolutionGross income $40,000Adjusted gross income ___________Greater of the standard deduction or itemized deductions ___________Exemptions ___________Taxable income ___________Gross income = $39,000 + 1,000 2012 Cengage Learning 12
  • 13. SolutionGross income $40,000Adjusted gross income 37,500Greater of the standard deduction or itemized deductions ___________Exemptions ___________Taxable income ___________AGI = $40,000 – 2,500 2012 Cengage Learning 13
  • 14. SolutionGross income $40,000Adjusted gross income 37,500Greater of the standard deduction or itemized deductions 5,800ExemptionsTaxable income ___________The standard deduction of $5,800 exceeds itemizeddeductions of $3,000 2012 Cengage Learning 14
  • 15. SolutionGross income $40,000Adjusted gross income 37,500Greater of the standard deduction or itemized deductions 5,800Exemptions 3,700Taxable income $28,000 2012 Cengage Learning 15
  • 16. 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 See Figures 1.1 or and 1.2 on page 1-8  Earned income + $300  But never more than standard deduction 2012 Cengage Learning 16
  • 17. Who Must File Taxpayer must file if ◦ Owe any special taxes  See Figure 1.3 on page 1-9 ◦ Had self-employment income >= $400 ◦ Other special situations as outlined on Chart C (Figure 1.3) 2012 Cengage Learning 17
  • 18. Which Taxpayers are Required to File Note: Must analyze each independent situation to determine if the taxpayer is required to file a return for 2011Miles (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. 2012 Cengage Learning 18
  • 19. Which Taxpayers are Required to FileSimone is single (age 31) and blind and has income of $10,370; is she required to file?No, because standard deduction = $7,250 ($5,800 + 1,450); exemption= $3,700. These amounts total to $10,950 and exceed her gross income. 2012 Cengage Learning 19
  • 20. Which Taxpayers are Required to FileEamon (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 = $13,900 ($11,600 + 1,150 + 1,150); exemptions = $7,400. These amounts total to $21,300 and exceed their gross income. 2011 Cengage Learning 20
  • 21. Which Taxpayers are Required to FileTaig 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 Tai’s standard deduction = $5,800 and his income exceeds this amount. His exemption is 0 as he’s claimed by parents. 2012 Cengage Learning 21
  • 22. 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 2012 Cengage Learning 22
  • 23. 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 pages 1-10 and 1-11 for requirement for abandoned spouse *See 2012 Cengage Learning 23
  • 24. 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 2012 Cengage Learning 24
  • 25. Tax Computation Six brackets (in Appendix) ◦ 10%, 15%, 25%, 28%, 33%, 35% ◦ Tax rate schedules for different filing types Qualifyingdividends and net long-term capital gains may be taxed at lower rates ◦ Rates based on ordinary tax bracket 2012 Cengage Learning 25
  • 26. 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 2011 each exemption = $3,700 2012 Cengage Learning 26
  • 27. 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). 2012 Cengage Learning 27
  • 28. 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. 2012 Cengage Learning 28
  • 29. What if Child Meets DependencyRequirements 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.  Exemption can shift if custodial parent signs Form 8332 and form is attached to noncustodial parent’s tax return 2012 Cengage Learning 29
  • 30. 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!! 2012 Cengage Learning 30
  • 31. 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 $3,700  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 2012 Cengage Learning 31
  • 32. Standard Deduction2011 standard deduction Single $ 5,800 Married Filing Joint (MFJ) $11,600 Qualifying Widow(er) $11,600 also known as Surviving Spouse Head of Household (HOH) $ 8,500 Married Filing Separate (MFS) $ 5,800 *Plus additional amounts for blindness or over 65: $1,150 if MFJ, MFS or qualifying widow(er) and $1,450 if HOH or Single 2012 Cengage Learning 32
  • 33. Standard Deduction - DependentsThe special rule for standard deduction for dependents is“Deduction = Greater of $950 or earned income + $300, but onlyup to basic standard deduction”Example 1: Jaime is 23 and a full time student and her parentsclaim her as a dependent; she earned $2,000 in 2011, howmuch is taxable income? $2,000 earned income (2,000) standard deduction $0 taxable incomeExample 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 2012 Cengage Learning 33
  • 34. 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) 2012 Cengage Learning 34
  • 35. 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) 2012 Cengage Learning 35
  • 36. 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 2012 Cengage Learning 36
  • 37. Calculating Gain/LossFacts: Noah purchased Sony AAA bonds in2006 for $47,600. In 2011, he sold the bondsfor $51,500, paying commission of $515. Whatis his: Amount realized ___________ Adjusted basis ___________ Realized gain/loss ___________ Recognized gain/loss ___________ Type of gain/loss ___________ 2012 Cengage Learning 37
  • 38. SolutionAmount realized * $50,985Adjusted basis 47,600Realized gain/loss 3,385Recognized gain/loss 3,385Type of gain/loss Long term capital gain*Amount realized = $51,500 – 515 2012 Cengage Learning 38
  • 39. Tax and The Internet Volumes of tax information available on internet o http://www.irs.gov 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 featuring topics like how to obtain refund or file an extension Other good sites include www.hrblock.com and www.willyancey.com In some states, names of delinquent taxpayers posted on web sites 2012 Cengage Learning 39
  • 40. 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 2012 Cengage Learning 40
  • 41. The End! 2012 Cengage Learning 41

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