CHAPTER 1 The Individual Income Tax Return

1. CHAPTER 1The Individual Income Tax Return Income Tax Fundamentals 2014 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill 2014 Cengage Learning

2. History of Taxation • Since 1913, when 16th amendment was passed, the constitutionality of income tax has never been questioned by federal courts • Income taxes serve a multitude of purposes 2014 Cengage Learning

3. Objectives of Tax Law • Raise revenue • Tool for social and economic policies • Social policy encourages desirable activities and discourages undesirable activities • Deductions for charitable contributions • Credits for higher education expenses • Economic policy as manifested by fiscal policy • Encourage investment in capital assets through depreciation • Credits for investment in solar and wind energy • Both economic and social • Exclude gain on sale of personal residence up to $250,000 ($500,000 if married) 2014 Cengage Learning

4. 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 • 1040 • If error made on one of the three above forms, can amend with a 1040X 2014 Cengage Learning

5. 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 times: Tax Rate (using tax tables or rate schedules) Gross Tax Liability less: Tax Credits and Prepayments Tax Due or Refund 2014 Cengage Learning

6. Standard Deduction & Exemptions • 2013 standard deduction • Single $ 6,100 • Married Filing Joint (MFJ) 12,200 • Qualifying Widow(er) 12,200 • also known as Surviving Spouse • Head of Household (HOH)8,950 • Married Filing Separate (MFS) 6,100 • *Plus additional amounts for blindness or over 65: $1,200 if MFJ, MFS or qualifying widow(er) and $1,500 if HOH or Single • Exemption = $3,900/person 2014 Cengage Learning

7. 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 • But never more than standard deduction • See Figures 1.1 and 1.2 on pages 1-7 and 1-8 2014 Cengage Learning

8. 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 2014 Cengage Learning

9. 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 2014 Cengage Learning

10. Tax Computation • Seven brackets • 10%, 15%, 25%, 28%, 33%, 35%, 39.6% • Tax rate schedules for different filing types • Qualifying dividends and net long-term capital gains may be taxed at lower rates • Rates based on ordinary tax bracket 2014 Cengage Learning