This document provides an overview of Chapter 3 and its exhibits on individual taxation. It includes 15 exhibits that cover topics such as the federal tax formula, definitions of gross income and adjusted gross income, personal and dependency exemptions, standard deductions, itemized deductions, filing status requirements, tax rates and schedules, self-employment taxes, and special rules for dependents. The exhibits provide definitions, examples, and criteria for key concepts in individual income taxation.

1. Chapter 3
Individual Taxation
An Overview
©2012 CCH. All Rights Reserved.
4025 W. Peterson Ave.
Chicago, IL 60646-6085
1 800 248 3248
www.CCHGroup.com

2. Chapter 3 Exhibits
1. Federal Tax Formula
2. Gross Income
3. Examples of “For” AGI Deductions
4. Personal and Dependency Exemptions
5. Dependency Exemptions—Qualifying Child
6. Dependency Exemptions—Qualifying Relative
7. Dependency Exemptions—Married Dependents
8. Dependency Exemptions—Multiple Support Agreement
9. Dependency Exemptions—Divorced Parents—Post 1984
Chapter 3, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 37

3. Chapter 3 Exhibits
10. Itemizing v. Standard Deduction
11. Examples of Itemized Deductions (Deductions “From” Adjusted Gross Income)
12. Additional Examples of Itemized Deductions
13. Standard Deduction Filing Status
14. Additional Standard Deduction
15. Criteria for Abandoned Spouse
16. Criteria for Surviving Spouse
17. Criteria for Head of Household
Chapter 3, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 37

4. Chapter 3 Exhibits
18. Tax Returns of Dependents
19. Tax Returns of Dependents—The Kiddie Tax
20. Kiddie Tax
21. Self-Employment Tax
22. Filing Requirements
23. Tax Tables v. Tax Rate Schedule
Chapter 3, Exhibit Contents C CCH Federal Taxation Basic Principles 4 of 37

5. Federal Tax Formula
Step 1: Compute taxable income
Gross Income
– Deductions FOR Adjusted Gross Income
= Adjusted Gross Income
– Greater of
Standard Deduction OR Itemized Deductions
– Personal Exemptions
= Taxable Income
Chapter 3, Exhibit 1a CCH Federal Taxation Basic Principles 5 of 37

6. Federal Tax Formula
Step 2: Compute tax due (or refund)
Taxable Income
x Tax Rate
= Tax Liability (Total Tax)
– Tax Credits and Prepayments
+ Alternative Minimum Tax (if any)
+ Employment Taxes (if any)
= Net Tax Due or Refund
Chapter 3, Exhibit 1b CCH Federal Taxation Basic Principles 6 of 37

7. Gross Income
 Gross income includes all items of income from whatever
source unless specifically excluded.
 Examples of gross income include wages, salaries, tips,
interest, dividends, alimony received, business income,
rental income, royalties, pensions, and annuities.
Chapter 3, Exhibit 2 CCH Federal Taxation Basic Principles 7 of 37

8. Examples of “For” AGI Deductions
 Trade or business expenses
 Student loan interest
 One-half of self-employment tax
 Alimony payments
 Certain moving expenses
 IRA deductions
 100% of medical and insurance premiums for self-
employed taxpayers, their spouses, and dependents
Chapter 3, Exhibit 3 CCH Federal Taxation Basic Principles 8 of 37

9. Personal and Dependency Exemptions
In computing taxable income, an individual is allowed a
deduction for each personal exemption allowed.
An exemption is allowed for each of the following:
(1) Individual taxpayer and spouse.
(2) Dependents of the taxpayer
- qualifying child or
- qualifying relative
Chapter 3, Exhibit 4a CCH Federal Taxation Basic Principles 9 of 37

10. Personal and Dependency Exemptions
The deduction amount is $3,800 per exemption allowed for 2012.
Example: Bob and Donna Jones are married and filed a joint
return. They have 3 dependent children. For 2012, their total
exemption is $19,000 ($3,800 x 5 exemptions).
Chapter 3, Exhibit 4b CCH Federal Taxation Basic Principles 10 of 37

11. Dependency Exemptions—Qualifying Child
 Taxpayers are allowed to take an exemption for each
qualifying child. Must meet 4 tests.
R – Relationship
A – Age
S – Support
H – Housing
Chapter 3, Exhibit 5a CCH Federal Taxation Basic Principles 11 of 37

12. Dependency Exemptions—Qualifying Child
Relationship – child, stepchild, sibling (or a descendent of
any of these individuals).
Age – under 19 or under 24 and full time student.
Support – a child who provides over ½ of its own
support is not a qualifying child.
Housing – child lived with the taxpayer for over ½ the year.
Chapter 3, Exhibit 5b CCH Federal Taxation Basic Principles 12 of 37

13. Dependency Exemptions—Qualifying Relative
A taxpayer is allowed an exemption for each qualifying relative. The
potential dependent must meet 4 tests.
1. Relationship/Household Test
Either of the following must be satisfied.
1) Relationship test: Dependent must be a relative. Aunts and
uncles qualify, first cousins do not.
2) Household test: Dependent must occupy the taxpayer’s
household during the entire year (exceptions include birth,
death, illness, education, military and business travel).
Chapter 3, Exhibit 6a CCH Federal Taxation Basic Principles 13 of 37

14. Dependency Exemptions—Qualifying Relative
2. Gross Income Test
Dependent’s gross income < $3,800 in 2012.
3. Support Test
A taxpayer must provide over one-half of the amount “actually
spent” on support for the potential dependent. Includes food, shelter,
clothing, medical care and education. Scholarships are not counted in
determining the support of a potential dependent.
4. Not a qualifying child
Chapter 3, Exhibit 6b CCH Federal Taxation Basic Principles 14 of 37

15. Dependency Exemptions—Married Dependents
 An individual (such as a parent) may not claim an
exemption for a dependent who filed a joint return with
the dependent’s spouse unless:
The dependent and the dependent’s spouse are only
filing a return to receive a refund and no tax liability
would exist for either spouse on separate returns.
Chapter 3, Exhibit 7 CCH Federal Taxation Basic Principles 15 of 37

16. Dependency Exemptions—Multiple
Support Agreement
 A taxpayer is considered as having provided over half the
support of an individual where 2 or more people
contributed support if the following 4 tests are met.
1) No one person contributed over half the support.
2) Those who collectively furnished over ½ the support
could have claimed the exemption except for the
support test.
Chapter 3, Exhibit 8a CCH Federal Taxation Basic Principles 16 of 37

17. Dependency Exemptions—Multiple
Support Agreement
3) The taxpayer claiming the exemption paid over 10%
of the support and
4) Each person who paid over 10% files a written
declaration that they will not claim the individual as a
dependent.
Chapter 3, Exhibit 8b CCH Federal Taxation Basic Principles 17 of 37

18. Dependency Exemptions
Divorced Parents—Post 1984
 The general rule is that the custodial parent is entitled to the
exemption in all cases UNLESS the following is met:
The custodial parent files a written declaration waiving the
right to the exemptions
Chapter 3, Exhibit 9 CCH Federal Taxation Basic Principles 18 of 37

19. Itemizing v. Standard Deduction
 All taxpayers receive a minimum deduction called the
standard deduction. The standard deduction is based on
your filing status.
 Some taxpayers may have expenses that qualify as
itemized deductions. Itemized deductions are expenses of
a personal nature that are specifically allowed as a
deduction.
Chapter 3, Exhibit 10a CCH Federal Taxation Basic Principles 19 of 37

20. Itemizing v. Standard Deduction
(You can take one, but not both.)
1. Figure out your standard deduction. (Add your basic
standard deduction plus any additional standard
deductions for age and/or blindness or additional standard
deductions for property taxes and federally declared
disasters).
2. Add up all itemized deductions. Also called deductions
FROM adjusted gross income.
3. Subtract the larger of your itemized deductions
OR your standard deduction.
Chapter 3, Exhibit 10b CCH Federal Taxation Basic Principles 20 of 37

21. Examples of Itemized Deductions
(Deductions “From” Adjusted Gross Income)
 Medical expenses
⇒ exceeding 7.5% AGI floor
⇒ not business related
 Property taxes
⇒ state and local, not federal
⇒ on principal residences, personal-use cars, stock, and other non
business-use property
Chapter 3, Exhibit 11 CCH Federal Taxation Basic Principles 21 of 37

22. Additional Examples of Itemized Deductions
 Income taxes
⇒ state and local, not federal
⇒ on salaries, capital gains, and other non-business income
 Interest on home mortgages (including home equity loans)
 Casualty losses
⇒ exceeding 10% AGI floor
⇒ on principal residences, personal-use cars, and other personal-
use property
 Charitable contributions
⇒ not to exceed 50% AGI ceiling
⇒ in certain cases, not to exceed 30% or 20% ceiling
Chapter 3, Exhibit 12a CCH Federal Taxation Basic Principles 22 of 37

23. Additional Examples of Itemized Deductions
 Most miscellaneous itemized deductions but only the aggregate
amount exceeding 2% AGI floor
Examples:
⇒ unreimbursed employee business expenses
⇒ hobby expenses (out-of-pocket and depreciation)
⇒ tax preparation fees
⇒ investment counseling fees
Exception:
⇒ gambling losses are NOT subject to the 2% AGI floor
Chapter 3, Exhibit 12b CCH Federal Taxation Basic Principles 23 of 37

24. Standard Deduction
Filing Status
 $5,950 Single individuals
 $11,900 Married individuals filing jointly
 $5,950 Married individuals filing separate returns
 $8,700 Heads of households (and abandoned spouse)
 $11,900 Surviving spouses
Remember, you have to know your filing status in order to
determine the amount of your standard deduction.
Chapter 3, Exhibit 13 CCH Federal Taxation Basic Principles 24 of 37

25. Additional Standard Deduction
An addition standard deduction is allowed for aged (65 and older) or blind
taxpayers.
The additional standard deduction is $1,450 for unmarried taxpayers
($1,150 for married taxpayers).
Example: Mr. and Mrs. Smith are both over the age of 65. If their filing
status is married filing jointly, they will be allowed a total standard
deduction of $14,200. They are allowed a basic standard deduction of
$11,900 plus a $2,300 additional standard deduction ($1,150 x 2) because
they are both over 65.
Chapter 3, Exhibit 14 CCH Federal Taxation Basic Principles 25 of 37

26. Criteria for Abandoned Spouse
1. Cost of household furnished by taxpayer exceeds one-half of the total
cost.
2. Abode of the taxpayer is the abode of a dependent child over one-
half of the year.
3. Other spouse not member of household during last half of year.
4. Separate return is filed.
Chapter 3, Exhibit 15 CCH Federal Taxation Basic Principles 26 of 37

27. Criteria for Surviving Spouse
1. Taxpayer must be unmarried.
2. Taxpayer must furnish more than one-half of the cost of household
for a child or stepchild.
3. Child or stepchild must be a dependent. No other relatives qualify.
4. Taxpayer's household must be the principal abode for a child or
stepchild for more than one-half the year.
Chapter 3, Exhibit 16 CCH Federal Taxation Basic Principles 27 of 37

28. Criteria for Head of Household
1. Taxpayer must be unmarried.
2. Taxpayer must furnish more than one-half the cost of the household for
a dependent.
3. Unmarried qualifying child need not be a dependent.
Other relatives (including married child or grandchild or unmarried
foster child) must be dependents. Dependency through a multiple
support agreement does not count.
4. Taxpayer’s household must be the principal abode for more than one-half
of the year. However, the taxpayer’s dependent parents do NOT need to
live with the taxpayer.
Chapter 3, Exhibit 17 CCH Federal Taxation Basic Principles 28 of 37

29. Tax Returns of Dependents
 An individual cannot take a personal exemption for
themselves if they can be claimed as a dependent on
another persons return.
 An individual is entitled to a standard deduction equal to
the greater of:
1. $950 or
2. The taxpayers earned income plus $300 (up to the
maximum standard deduction of $5,950 for 2012).
Chapter 3, Exhibit 18 CCH Federal Taxation Basic Principles 29 of 37

30. Tax Returns of Dependents
The Kiddie Tax
 The general rule is that if a dependent child under age 18
has net unearned income in excess of $1,900 the excess
(over $1,900) is taxed at the parents’ top rate.
 Net unearned income is investment income (income from
interest, dividends, capital gains and trusts)
Chapter 3, Exhibit 19 CCH Federal Taxation Basic Principles 30 of 37

31. Kiddie Tax
Step 1: Determine the child’s taxable income
Gross Income (earned and unearned income)
Less standard deduction for a dependent
(the greater of $950 or earned income plus $300)
= Child’s taxable income
Chapter 3, Exhibit 20a CCH Federal Taxation Basic Principles 31 of 37

32. Kiddie Tax
Step 2: Determine how much of the child’s unearned
income is taxed at the parents’ top rate
Unearned Income
- Less $950 (called the first $950)
- Less the greater of (1) $950 or
(2) total allowable deductions associated with
the production of the unearned income
= Unearned income taxed at the parents’ top rate
Chapter 3, Exhibit 20b CCH Federal Taxation Basic Principles 32 of 37

33. Kiddie Tax
Step 3: Determine how much income is taxed at the child’s
rate
Taxable Income from Step 1
Less Unearned income taxed at the parents’
rate from Step 2
= Income taxed at the child’s rate
Chapter 3, Exhibit 20c CCH Federal Taxation Basic Principles 33 of 37

34. Self-Employment Tax
For 2012, the tax rate is 13.3%, made up of two parts:
1) An old-age, survivors, and disability insurance (OASDI)
rate of 10.4% (6.2% of the employer and 6.2% of the
employee) on self-employment income up to $110,100.
2) A medicare hospital insurance (HI) rate of 2.9% without
limit on self-employment income.
Chapter 3, Exhibit 21a CCH Federal Taxation Basic Principles 34 of 37

35. Self-Employment Tax
1) Net self-employment income * .9235
= Net income from self-employment
2) Net income from self-employment * 13.3%
= Self-employment tax
**The employer portion of the self-employment tax is
allowed as a deduction for AGI
Chapter 3, Exhibit 21b CCH Federal Taxation Basic Principles 35 of 37

36. Filing Requirements
 General rule is that if gross income exceeds the standard
deduction plus personal exemptions, the taxpayer must file a
return. There are exceptions to this rule.
 The additional standard deduction for age is added to the basic
standard deduction, however the additional standard deduction
for blindness is not.
 A return must be filed if an individual had more than $400 in
earnings from self-employment.
Chapter 3, Exhibit 22 CCH Federal Taxation Basic Principles 36 of 37

37. Tax Tables v. Tax Rate Schedule
 Taxpayers with less than $100,000 of taxable income should
use the tax tables.
 Taxpayers that cannot use the tax tables should use the tax
rate schedule (see inside front cover of textbook).
Chapter 3, Exhibit 23 CCH Federal Taxation Basic Principles 37 of 37