Chapter 2

Determination of Tax

Learning Objectives

• Use the tax formula to compute an individual’s taxable income

• Determine the amount allowable for the standard deduction

• Determine the amount and the correct number of personal and dependency deductions

Learning Objectives

• Determine the amount of child credit• Determine the filing status of individuals• Explain the tax formula for corporations• Explain the basic concepts of property

transactions

Formula For Individual Income Tax

• INCOME FROM WHATEVER SOURCE DERIVED minus EXCLUSIONS= GROSS INCOME minus DEDUCTIONS FOR ADJUSTED GROSS INCOME= ADJUSTED GROSS INCOME - deduct GREATER OF ITEMIZED OR STANDARD DEDUCTION and PERSONAL AND DEPENDENCY EXEMPTIONS= TAXABLE INCOME. TAXABLE INCOME times TAX RATE (tax table or schedule) = GROSS TAX minus CREDITS AND PREPAYMENTS= NET TAX PAYABLE OR REFUND DUE

Formula For IndividualIncome Tax

Income from whatever source derived

Minus: Exclusions

Gross Income

Minus: Deductions for Adjusted Gross Income

Adjusted Gross Income(AGI)

Minus: Deductions from adjusted gross income:

Greater of itemized deductions or the standard deduction

Personal and dependency exemptions

Taxable Income

Times: Tax rate or rates (from tax table or schedule)

Gross tax

Minus: Credits and prepayments

Net tax payable or refund due

$ xxx,xxx

(xxx)

$ xx,xxx

(xxx)

$ x,xxx

(xx)

(xx)

$ x,xxx

.xx

$ xx

(x)

$ xx

Definitions

• Income

• Exclusion

• Gross income

• Deductions for adjusted gross income (AGI)

• Adjusted gross income (AGI)

• Deductions from AGI

Definitions

• Itemized or standard deductions

• Personal and dependency exemptions

• Taxable income

• Tax rates and gross tax

• Credits and prepayments

Itemized Deductions

• Qualifying medical expenses, taxes, investment and residential interest, charitable contributions, personal casualty and theft losses, & miscellaneous if greater than standard deduction

• Some items limited by varying percentages of adjusted gross income

• Maximum reduction in such itemized deductions is 80% of total itemized deductions

Standard Deduction

• Varies based on:– Filing status– Age– Vision

• Used when greater than

Itemized

• Loss of the Standard Deduction

Personal Exemptions• Unless claimed as

dependent on another return, each allowed one

• Additional allowed for spouse on joint return or separate return if no gross income/not dependent of another

Dependency Exemptions

• Dependency exemption allowed if:– Provides over 50% support– Dependents gross income < exemption

amount– No joint return filed by married dependent

(except if sole purpose is refund)– Related to or resided with taxpayer for the

entire tax year (no cousins) and– Dependent is U.S. Citizen, U.S. Resident, or

they must resides in Canada or Mexico

Determine The Amount Of Child Credit

• $1000 per qualifying child , falls to $700 in 2005 - 2008– Must be US citizen,

national, or resident under the age of 17

• Credit is reduced if MAGI exceeds threshold– 110,000 for MFJ– 75,000 for Single– 55,000 for MFS

Determining The Amount Of Tax

• Filing status – Joint– Surviving spouse– Head of household– Single– Married filing separately

Relative Tax By Filing Status

• Joint return

• Surviving spouse

• Head of household

• Abandoned spouse

• Single

• Married - filing separately

LOWESTLOWEST

HIGHESTHIGHEST

Dependents With Unearned Income

• Dependent does not receive a personal exemption on their own return.

• A dependent’s standard deduction is reduced to the greater of earned income or $800 or the dependent’s earned income plus $250.

• The tax on the net unearned income of a child under age 14 is figured by reference to the parents’ tax rate if it is higher than the child’s (known as the “kiddie tax”).

Corporate Tax Formula & Rates

• “C” Corporations - Table I 2-7

• “S” Corporations - no formula/based on ordinary income (Flow-through Entity)

Corporate Tax RatesFirst $50,000 15 % Of Taxable Income

Over $50,000 But Not Over $75,000 $7,500 + 25% Of Taxable Income

Over $75,000 But Not Over $100,000 13,750 + 34% Of Taxable Income Over $75,000

Over $100,000 But Not Over $335,000 $22,250 + 39% Of Taxable Income Over

$100,000

Over $335,000 34% Of Taxable Income

Over $10,000,000 But Not Over 15,000,000

3,400,000 + 35% Of Taxable Income

Over $15,000,000 But Not Over $18,333,333

$5,150,000 + 38% Over $15,000,000

Over $18,333,333 35% Of Taxable Income

Tax Formula for C Corporations

Income from whatever source derived

Minus: Exclusions

Gross Income

Minus: Deductions

Taxable Income

Times: Tax rates

Gross Tax

Minus: Credits and prepayments

Net tax payable or refund due

$xxx

(xxx)

$xxx

(xxx)

$xxx

.xx

$xxx

(xxx)

$xxx

Treatment Of Capital Gains And Losses

• Capital gains and losses have been accorded favored tax treatment since 1922

Treatment Of Capital Gains And Losses

• Definition of capital assets– Assets other than inventory, trade

receivables, certain properties created by efforts of taxpayer, depreciable business property, business land, and certain government publications

Tax Treatment Of Gains And Losses

• Capital gains and losses are divided into 2 categories– Long-term is held for over 12

months– Short-term is held less than

12 months

Tax Treatment Of Gains And Losses

• Net long-term gain is taxed at 20% tax (10% if in the 15% tax bracket)

• Net short-term gain is taxed at the same rate as other income

Tax Treatment Of Gains And Losses

• Individuals who suffer net capital losses can deduct only up to $3,000 of the losses from other income.

• Losses over $3,000 are carried over and offset against future gains.

Tax Planning Considerations

• Shifting income between family members

• Splitting income

• Maximizing itemized deductions

• Filing joint or separate returns

• Innocent spouse provision

Compliance And Procedural Considerations

• Who must file– See Chart on page 2-31

• Due dates for filing return– Individuals and Partnerships (15th day of

4th month).– Corporations (15th day of 3rd month)

• Use of forms 1040, 1040EZ, and 1040A