ACCT 538 Individual Income Tax
ACCT 538 – Individual Income Tax
Chapter 4 – Individual Income Tax Overview, Exemptions, and Filing Status
- 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.
- 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)
- Married individuals treated as unmarried (abandoned spouse) if individual