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CHAPTER 1

CHAPTER 1 . The Individual Income Tax Return. Objective. Know the history and objectives of U.S. tax law. History of Taxation. Prior to 1913 Only excise taxes & customs duties 1913 16th Constitutional Amendment passed 1939 First IRC 1954 & 1986 Revised IRC.

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CHAPTER 1

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  1. CHAPTER 1 The Individual Income Tax Return

  2. Objective Know the history and objectives of U.S. tax law

  3. History of Taxation • Prior to 1913 • Only excise taxes & customs duties • 1913 • 16th Constitutional Amendment passed • 1939 • First IRC • 1954 & 1986 • Revised IRC

  4. Objectives of Tax Law • Raise Revenue • Tool for social and economic policy • Social - encourage desirable/discourage undesirable activities, for example: • Can’t deduct penalties • Can deduct charitable contributions & medical expenses • IRAs to promote saving for retirement • Economic policy as manifested by fiscal policy • Encourage investment in capital assets • MACRS depreciation • Tax credits - Educational credits, R&D credit

  5. Objective Know the different entities subject to tax and reporting requirements

  6. Primary Entities/Forms • Individuals • 1040EZ • Single or Married Filing Jointly • Under 65 • Under $50,000 taxable income • Only earned income, scholarships, and less than $1,500 interest • 1040A • No self-employment income or don’t itemize • 1040 with schedules attached

  7. Primary Entities/Forms • Partnerships • 1065 and K-1s to each partner • Corporations • 1120 (for C corps) • 1120S (for S corps) and K-1s to each shareholder • Estates/Trust • 1041 and K-1s to each beneficiary or trustee

  8. Objective Understand the tax formula for individual taxpayers

  9. Tax Formula Look at Form 1040 while we go through following formula: Gross Income less: Deductions for AGI Adjusted Gross Income less: Greater of Itemized or Standard Deduction less: Exemptions Taxable Income times: X Tax Rate Gross Tax Liability less: Tax credits and prepayments (withholdings and estimates) Tax Due or Refund

  10. Objective Be able to complete a simple individual tax return

  11. 2002 Standard Deductions & Exemptions Single $4,700 MFJ or Surviving Spouse $7,850 H of H $6,900 MFS $3,925 *Taxpayers 65 or older and/or blind get an additional amount Additional* $900 if Married or SS* Additional* $1150 if Single* 2002 exemption = $3,000 per person

  12. Who Must File Based on filing status and gross income: • If exemptions and deductions exceed income then filing is not necessary • If you are claimed as a dependent on another’s return, you still must file if: • Unearned income > $750 • Earned income > standard deduction, OR • Unearned income + earned income > $750 or (earned income + $250)

  13. Who Must File • You must file if you • Have advanced EIC • Have SE income >$400 • Owe special taxes • recapture, • SS on unreported tips, • AMT

  14. Filing Status Filing status is determined by status on 12/31 • Single - higher tax tables than SS or HOH • MFJ - if married on 12/31 • Common law recognized by state of residence • If spouse dies during year you can file MFJ • MFS - each file separate returns • Must compute taxes the same (both itemized or both standard deduction) • Not often a good choice

  15. Filing Status • HOH - tables have lower rates than S. Can use if: • Unmarried on 12/31 • Paid > 50% of cost of keeping up home that was principal residence of dependent • Exceptions: • taxpayer’s parent doesn’t have to live with taxpayer, and • if qualifying individual is an unmarried child, does not have to be dependent

  16. Filing Status • Qualifying Widow(er) or SS(Surviving Spouse) - tables same as MFJ. • Applies in year of spouse’s death and in 2 subsequent years • Must have qualifying dependent • Cannot remarry

  17. Personal/Dependency Exemptions • For taxpayer and each dependent - $3,000 per person • Phased out for high income taxpayers at 2% per $2,500 over threshold (see text) for limits based on filing status • Example: MFJ with AGI of $215,000 and 2 dependents - what’s the phase out?

  18. Personal/Dependency Exemptions Example Answer: $215,000 -$206,000 = $9,000 $9,000 / $2,500 = 3.6 (round up to 4*) 4 x 2% = 8% The original exemption amount of 4 X $3,000 = $12,000 is reduced by 8%. $12,000 - (.08 x 12,000) = $11,040 allowed. * always round up to next percentage

  19. Personal/Dependency Exemptions Tests Five tests must be met for someone to be claimed as a dependent: • Gross income test - • Dependent’s gross income must be less than $3,000 • Exceptions: • children under age 19, or • under 24 and fulltime student for at least 5 months

  20. Personal/Dependency Exemptions Tests • Support - • Taxpayer must provides more than 50% of dependent’s support (including food, FMV of lodging and clothes, etc.) • Custodial parent usually gets child as dependent unless: • Custodial parent agrees not to claim • Pre-1985 agreement • Multiple support agreement - more than one person providing support (i.e. - three children support their father). • Each person must sign agreement to give exemption to one, but that one has to provide at least 10% of the dependent’s support

  21. Personal/Dependency Exemptions Tests • Joint Return - a dependent cannot file MFJ with spouse unless only to get refund • Citizenship - must be US citizen, resident of an adjacent country, or, if an alien child, must be adopted and living with US citizen • Member of household or relationship test - must be related to, or reside with, the taxpayer for the entire year

  22. Standard Deduction • Use the following standard deduction amounts unless itemized deductions are greater! • 2002 numbers (the amounts increase every year) • Single $4,700 • MFJ $7,850 • MFS $3,925 • HH $6,900 • SS $7,850 • Additional amount for taxpayers over 65 and/or blind: • $900 per person for married and SS • $1,150 person for others

  23. Standard Deduction The special rule for standard deductions for dependents is “deduction = greater of $750 or earned income + $250 up to standard deduction” Example 1: Jaime is 23 and a full time student and her folks claim her - she earned $2,000 2,000 earned income (2,000) standard deduction $0 taxable income Example 2: Tia is 18 and has dividends (unearned) income of $1,500 1,500 unearned income ( 750) standard deduction $ 750 taxable income

  24. Limits on Itemized Deductions • Phase-out for high income taxpayers • 3% x ( AGI - Threshold Amount) • Threshold amount = $68,650 for MFSor $137,300 (all other filing types) • Phase-out is lesser of • (AGI-Threshold) x 3% or • 80% x (all itemized deductions except medical, investment interest expense and casualty, and wagering losses to the extent of wagering gains)

  25. Limits on Itemized Deductions Example: Itemized Deductions = $20,000, AGI = $150,000 and MFJ Answer: 150,000 (137,300) 12,700 x .03 = phase out amount of $381 $20,000 - $381 = $19,619 itemized deduction

  26. Gains and Losses Amount Realized* - Adjusted Basis** Realized Capital Gain/Loss *Sales Price - Sales Expenses **Cost + Capital Improvements - Accumulated Depreciation (also called “book value”)

  27. Capital Gains/Losses • Capital Assets are • Generally, all property except inventory, receivables, or depreciable property used in trade or business • Subject to special rates • Separate by holding period • Long term - held > 12 months • Short term - held < 12 months

  28. Capital Gains/Losses • Netting procedures • Net the ST gains and losses • Net the LT gains and losses • Net LT Capital Gain - 20% rate if taxpayer is in higher bracket • Net LT Capital Gain - 10% rate if taxpayer is in lower bracket • $3,000 net capital loss per year can reduce ordinary income; carry-forward any unused balance

  29. Internet and the IRS http://www.irs.gov Forms & Pubs (publications) Digital Daily Electronic filing Tax Regulations and Interpretations Tax Info

  30. The End!

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