- Gross Income
- Less: Deductions FOR AGI
- Equals: Adjusted Gross Income
- Minus: FROM AGI deductions:
- 1. Greater of
- a. Standard deductions
- b. Itemized deductions, and
- 2. Personal & Dependency Exemptions
- Equals: Taxable Income
- Times: Tax Rates
- Equals: Income tax liab.
- Plus: Other taxes
- Equals: Total Tax
- Minus: Credits
- Minus: Prepayments
- Equals: Taxes Due or (refund)
Deductions FOR AGI:
- -Ordinary & necessary expenses incurred in a trade or business.
- -One-half of self-employment tax paid.
- -Alimony Paid
- -Certain pmts to an IRA and HSA
- -Reimbursed moving expenses
- -Fees for college tuition and related exp.
- -Interest on student loans (limits apply)
- -Capital loss deduction (limit 3k)
- Serves as basis for computing % limits on certain itemized deductions:
- - Medical Exp.
- -Charitable contributions
- -Certain Casualty losses
- -Misc itemized deductions
AGI: Medical expenses
- Are deductible only to the extent they exceed 10% of AGI
- - Limit might be described as a 10% 'floor' under the medical exp. deduction
Deductions FROM AGI:
- The greater of:
- - Itemized deductions, or
- - Standard Deduction
Personal and Dependency Exemptions
Deductions FROM AGI: Partial list
- Medical Expenses: in excess of 10% AGI
- Taxes: State income (or sales tax) and property taxes
- Interest: Mortgage and investment
- Charitable Contributions:
- Casualty Losses: (in excess of 10% of AGI)
- Misc Itemized: (in excess of 2% of AGI) expenses related to production or collection of income, and managment of property held for the production of income.
Deductions FROM AGI: Standard deduction is sum of two components
- Basic Standard Deduction: Amount allowed is based on taxpayer's filing status.
- Additional Standard Deductions: Available for taxpayers who are 65+ and/or blind. Amt allowed depends on filing status.
Standard Deduction limit for a person claimed as a dependent - Special Rule.
- Individual claimed as a dependent has a basic standard deduction in 2013 limited to the greater of:
- -$1,000 or
- -$350 plus earned income (but not exceeding normal basic standard deduction, $6,100)
- Additional standard deduction amount(s) are still available.
Personal and Dependency Exemption Amounts
2013: $3,900 per exemption
- Personal and dependency exemptions:
- -One per taxpayer (two personal exemptions when married, filing jointly) and for each dependent.
- Exception: Individual claimed as a dependent by another taxpayer does not receive a person exemption.
Personal and Dependency Exemptions in Year of Death
A personal exemption is allowed on a joint return for a spouse who dies during the year.
Dependency Exemptions: Qualifying Child Tests
Qualifying Child: Relationship Test
- Must be Taxpayer's:
- Son or daughter
- Stepson or stepdaughter
- Brother or Sister
- Half brother or half sister, or
- A descendant of such individual (eg. grandchildren, nephews, nieces.
- Child who has been adopted, or adoption pending qualifies
A foster child may also qualify.
Qualifying Child: Abode Test
- Must live w/ taxpayer for more than half the year.
- Temp absences from household due to special circumstances like illness, college, ect are not considered.
Qualifying Child: Age Test
- Child must be under age 19 or under age 24 in the case of a student.
- -A student is a child who, during any part of five months of the year, is a full-time student.
- -Dependent must be younger than the taxpayer.
- -Individuals who are disabled are not subject to the age test.
Qualifying Child: Support Test
- Must not be self-supporting
- -Cannot provide more than one-half of his/her own support.
- -In the case of a full-time student, scholarships are not considered to be support.
Qualifying Child: Tiebreaker Rules
- One of the person is parent = Parent
- Both are parents and child doesn't live w/ one = parent w/ longer period of residence.
- Both persons are parents and equal residence time = Parent w/ higher AGI
- None of the persons is the parent = person w/ highest AGI
Qualifying Relative Tests
- Gross Income
Qualifying Relative: Relationship Test
More expansive than for qualifying child, Basically anyone but cousins.
Also includes unrelated parties who live w/ the taxpayer as a member of the household all year.
Qualifying Relative: Gross Income Test
Dependent's gross income must be less than the exemption amount. ($3,900 for 2013)
Qualifying Relative: Support Test
- Taxpayer must provide more than 50% of the qualifying relative's support
- -Only amts expended are considered in the support test.
- -Scholarships are not considered in the support est.
- Two exceptions to the support test:
- -Multiple Support agreements
- -Children of divorced parents.
Qualifying Relative: Multiple Support Agreements
- Allows one member of a group providing less than 50% of support to claim individual even though no one person provides more than 50% support.
- -Eligible parties must provide >10% of support
- -Each party must meet all other dependency requirements.
Children of Divorced Parents
- Special rules if parents meet the following:
- -They would have been entitled to the dependency exemption had they been married and filed jointly.
- -They have custody (either jointly or singly) of the child for more than half the year.
General Rule: parent having custody of the child for the greater part of the year is entitled to dependency exemption.
Does not apply if a multiple support agreement is in effect, or custodial parent issues a waiver (Form 8332)
Other Rules for Dependency Exemptions
- In addition to fitting into either the qualifying child or the qualifying relative category, a dependent must also meet:
- -The join return, and
- -The citizenship or residency tests.
Phaseout of Exemptions
Exemption amts are phased out by 2% for each $2,500 by which the taxpayer's AGI exceeds the threshold amount.
- MFJ: $300k
- HoH: $275k
- Single: $250k
Child Tax Credit
- $1,000 tax credit is allowed for each dependent child under age of 17
- Qualifying child includes stepchildren, and eligible foster children.
Filing Requirements : Income
General Rule: Tax return must be filed if gross income is equal to or greater than the sum of the standard deduction and exemption amounts.
-Special rules apply for dependents and self-employed taxpayer, or...
Filing Requirements: Due date and extention
Tax return is due on or before April 15th the following year.
- May obtain 6 month extension of time to file.
- -Excuses taxpayer from penalty for failure to file, not from penalty for failure to pay. If $ is owed, extension form 4868 should be accompanied by check for balance of tax due.
Filing Status: Five
- Surviving Spouse. (qualifying widow or widower)
Single Filing Status
Unmarried or separated from spouse by a divorce decree or separate maintenance agreement and doesn't qualify for another status.
- -Marital status is determined as of the last day of the tax year.
- When spouse dies, marital status is determined as date of death.
- Married as of last day of taxable year, or
- Spouse dies during taxable year.
Married but not filing a return w/ spouse and not abandoned spouse.
Surviving Spouse Filing Status
- Same tax rate as MFJ
- File as surviving spouse for two years after death of spouse if taxpayer maintains a home in which a dependent child lives.
- -For the year of death, surviving spouse is treated as being married, thus a join return can be filed if the deceased spouse's executor agrees.
Head of Household
- -Must be unmarried as of end of year, or an abandoned spouse, and
- -Must pay > than 50% of the cost of maintaining a household which is the principle home of a dependent for more than half of tax year.
- A dependent must statisfy either the qualifying child or relative category.
- A qualifying relative must also meet the relationship test.
Exception to the Head of Household Requirements
- HH may be claimed if taxpayer maintains a separate home for his/her parents.
- -At leat one parent must qualify as a dependent.
- Allows married taxpayer to file as HoH if:
- -Doesn't file a join return
- -Paid>half the cost of maintaining a home.
- -Spouse didn't live in home during last 6 months of tax year.
- -Home was principal residence of taxpayer's child for > half of year.
- -Can claim child as a dependent.
US Individual income tax rates.
- For 2013:
- 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%
- Net UNEARNED income of a child is taxed at parents' rate:
- -Child must be under 19 at end of year (or under 24 if full-time student)
- -Net unearned income generally equals unearned income less $2,000.
Kiddie Tax Cont.
- Net unearned income taxed at parents' rate.
- (remaining of taxable income taxed at child's rate)
- Two options for computing tax:
- -Separate return may be filed for child. Tax on net unearned income is computed as though the income had been included on the parent return (use form 8615)
- -Or parents may elet to report child's income on their own return. (Certain req. must be met)
Gains/Losses from Property Transactions
- Once recognized gains/loses have been determined, they must be classified as ordinary or capital.
- -Ordinary gains are fully taxable.
- -Ordinary losses are fully deductible.
- Capital gains and losses are subject to special tax treatment.
Gains/Losses from Capital Asset Transactions
- Capital assets are generally defined as:
- -Investment Assets such as stocks, bonds, land, ect.
- -Personal use Assets owned by individuals are capital assets.
- -It does NOT include business assets.
- Gains and losses from capital transactions must be netted.
- But losses from personal use assets are not deductible.
Max tax rates for net capital gains or individuals
Net LONG TERM capital gains are taxed as special rates depending on taxpayer's marginal income tax bracket for ordinary income.
- Ordinary Bracket Capital Gain Rate
- 39.9% 20%
- 25%-35% 15%
- 10%-15% 0%
Treatment of Capital Losses
- Net capital losses of individuals are deductible FOR AGI up to $3,000 yearly.
- -Excess capital losses are carried over to the next tax year.
- -When carried over, capital losses retain their classification as short- or long-term
- -Generally, losses on the sale or disposition of PERSONAL USE property are not recognized.
- Includes all income from whatever source derived, unless specifically excluded under the Code.
- -Income recognized whether it is in cash or "in-kind" cash equivalents (ie. FMV of property or services)
- -Income doesn't include recovery of the taxpayer's capital investment.
- Cash Receipts and disbursements method
- Accrual method
- Hybrid Method
Cash Receipts Method
Income is recognized in the year is actually or constructively received in cash or cash equivalent.
An amount is constructively received when it is set aside and made available to taxpayer without substantial restrictions.
Exceptions To Cash
- Original Issue Discount (OID) interest is taxable when earned rather than when interest is received
- US Series E and EE Savings Bonds are not subject to the OID rules
- -However, a cash basis taxpayer may elect to recognize the interest when earned
- Income is recognized in the year that it is earned regardless of when it is collectedIncome is earned when:
- -All events have occurred that fix taxpayer’s right to the income, and
- -The amount can be determined with reasonable accuracy
The accrual method is required for determining purchases and sales when inventory is an income-producing factor
Accrual Method Claim of right doctrine
Requires amounts received to be included in income even though the amount is in dispute and might be returned to the payor at a later date
If payment has not been received, no income is recognized until the claim is settled
Exceptions to Accrual Method
•Advance Payment for Goods (unearned
- can elect to defer recognition of income from advance payment for goods if the
- same method of accounting is used for tax and financial reporting purposes
Exceptions to Accrual Method •Advance Payment for Services
- payment for services
- to be performed after year-end is included in income in the year following
- portion of the advance payment that is earned in the current year is included
- in income in the year of receipt
- Prepaid rents are recognized in the year received rather than when earned
•A combination of cash and accrual methods
•Generally, used when inventory is a material income-producing factor
–Use accrual method to account for inventory
–Use cash method for other income and expenses
•Income from personal services is taxable to the person who performs the services
•Income from property is taxable to the owner of the property
–Assignment of income is not permitted
Income Sources •Interest income accrues daily
- –If interest bearing instrument (e.g., bonds) is transferred, interest income must
- be allocated between the transferor and transferee based on the number of days
- during the period that each owned the property
- •Generally, dividends are taxed at the same marginal rate that is applicable to a net
- capital gain
- –Thus, individuals otherwise subject to the 10% or 15% marginal tax rates in 2013 pay
- 0% tax on qualified dividends received
- –Individuals subject to the 25, 28, 33, or 35 percent marginal tax rates pay a 15% tax on
- qualified dividends
- subject to the 39.6% marginal tax rate pay a 20% tax on qualified dividends
- (new for 2013)
•Qualified dividends are still ordinary income, but are taxed at a special rate
Dividends •Thefollowing dividends are not eligible for the reduced tax rates
–Dividends from certain foreign corporations,
–Dividends from tax-exempt entities, and
–Dividends that do not satisfy the holding period requirement
- •Stock on which the dividend is paid must have been held for more than 60 days during
- the 121-day period beginning 60 days before the ex-dividend date to qualify for
- the reduced tax rates
Income From Partnerships
•A partnership is not a separate taxable entity
–Files an information return (Form 1065)
- •Provides data necessary for determining each partner’s distributive share of
- partnership’s income and deductions
•Each partner reports distributive share of partnership income and deductions
- in year earned, even if not actually distributed
- •Because a partner pays tax on income as the partnership earns it, distributions are
- treated under the recovery of capital rules
Income From S Corporations
•A small business corporation may elect to be taxed similarly to a partnership
–Referred to as an S corporation
- •The shareholders, rather than the corporation, pay the tax on the corporation’s
•Generally, shareholders report their share of the corp’s income and deductions for the year, even if not actually distributed
Income From Estates And Trusts
•Beneficiaries of estates and trusts
- –Generally, taxed on the income earned by the estates or trusts that is actually
- distributed or required to be distributed to them
–Any income not taxed to the beneficiaries is taxable to the estate or trust
Income In Community
•All property is deemed either to be separately owned by the spouse or to belong to the marital community
–Community income is allocable equally to each spouse
–Separate income may be allocable to owner-spouse
•Separate property may produce community income (e.g., TX, LA)
- •No allocation of community income for some spouses living apart for entire year
- and filing separately
Alimony and Separate Maintenance
Payments : Alimony is..
–Deductible for AGI by the payor :)
–Includible in gross income of recipient :(
Alimony and Separate Maintenance
Payments: Pmts may qualify as alimony if...
–Payments are in cash
–Agreement or decree does not specify that the payments are not alimony
–Payor and payee are not members of the same household at the time the payments are made
- –There is no liability to make the payments for any period after the death of the
Alimony and Separate Maintenance
Payments •Property settlements
–Transfer of property to former spouse
–No deduction or recognized gain or loss for transferor
–No gross income, and carryover of transferor’s basis for transferee
–Front-loading of alimony payments
•Alimony recapture (gross income) for payor
•Deduction from gross income for recipient
Alimony and Separate Maintenance
Payments •Child support payments
–Payments made to satisfy legal obligation to support child of taxpayer
- –Nondeductible by payor and
- not taxed to recipient (or child)
- •May be difficult to determine whether an amount received is alimony or child
- –If amount of payment would be reduced due to some future event related to the
- child (e.g., child reaches age 21), such reduction is deemed child support
Imputed Interest on Below-Market
- •Interest is imputed, using Federal government rates, when a loan does not carry a market
- rate of interest
- –Imputed interest = the difference between the amount that would have been charged at
- the Federal rate and the amount actually charged
Annuity Income •Purchaser pays fixed amount for the right to receive a future stream of payments
–Generally, early collections and loans against annuity ≤ increases in cash value are included in gross income
- •Amounts > increases in cash value are treated as a recovery of capital until cost
- recovered; additional amounts are included in income
–Early distributions may also be subject to a 10% penalty
Annuity Income •For collections on and after the annuity starting date
- –The exclusion ratio is applied to annuity payments received under contract to
- determine amount excludable:
- Exclusion ratio = Investment
- in contract Expected return under contract
–Once investment is recovered, remaining payments are taxable in full
Prizes and Awards
•General rule: FMV of item is included in income
- designates qualified organization to receive prize or award (subject to other
•Employee achievement awards of tangible personal property made in recognition of length of service or safety achievement (limits apply)
Group Term Life Insurance Premiums
•Exclude premiums paid by employer on first $50,000 of coverage
–Premiums on excess coverage are included in gross income
•Inclusion amount based on IRS provided tables
- •If plan discriminates in favor of key employees (e.g., officers), key employees
- are not eligible for exclusion
– In such a case, the key employees must include in gross income the greater of:
•The actual premiums paid by the employer, or
•The amount calculated from the Uniform Premiums table
Unemployment compensation is taxable in full
Social Security Benefits
•Up to 85% of benefits may be taxable
•Taxability based on taxpayer’s modified adjusted gross income (MAGI)
- –MAGI= AGI (excluding Social Security) + foreign earned income exclusion + tax
- exempt interest
•Two formulas are used for computing taxable benefits