Upload
hugo-taylor
View
224
Download
2
Embed Size (px)
Citation preview
Chapter 8Chapter 8
Taxation of IndividualsTaxation of Individuals
©2008 South-Western©2008 South-Western©2008 South-Western©2008 South-Western
Kevin MurphyKevin MurphyMark HigginsMark Higgins
Kevin MurphyKevin MurphyMark HigginsMark Higgins
Transparency 8-2Transparency 8-22008 South-Western2008 South-Western
Taxation of IndividualsTaxation of Individuals
Individuals are the biggest single
group of taxpaying entities.
As taxpaying entities, they must adopt an annual accounting period
and method of accounting.
Transparency 8-3Transparency 8-32008 South-Western2008 South-Western
Review of Tax FormulaReview of Tax Formula
The formula for calculating taxable income generally is gross income minus allowable deductions.
For individuals, deductions are split into two classesDeductions for adjusted gross incomeDeductions from adjusted gross income
Transparency 8-4Transparency 8-42008 South-Western2008 South-Western
Individual Tax FormulaIndividual Tax Formula
Gross Income
minus: For Deductions not restricted based on taxpayer’s income generally trade, business, rent or royalty
expenses
Adjusted Gross Income
minus: From Deductions generally personal expenses amount is the greater of
– Itemized deductions, or
– standard deduction allowable
Transparency 8-5Transparency 8-52008 South-Western2008 South-Western
Individual Tax FormulaContinued
Individual Tax FormulaContinued
Adjusted Gross Income [AGI]
minus: From Deductions
minus: Personal & Dependency Exemptions
• $3,400 per person
Transparency 8-6Transparency 8-62008 South-Western2008 South-Western
Individual Tax FormulaTo Taxable Income
Individual Tax FormulaTo Taxable Income
Gross Income
minus: For Deductions
equals: Adjusted Gross Income [AGI]
minus: From Deductions
minus: Exemptions
equals: Taxable Income
Transparency 8-7Transparency 8-72008 South-Western2008 South-Western
Individual Tax FormulaThe Tax
Individual Tax FormulaThe Tax
Taxable Incometimes: Tax Rate equals: Income Tax Liabilityminus: Prepayments & Creditsequals: Tax (or Refund) due
Transparency 8-8Transparency 8-82008 South-Western2008 South-Western
Personal and Dependency Exemptions
Personal and Dependency Exemptions
Each individual taxpayer is allowed one personal exemption
May also claim one exemption for each dependent
Only one exemption may be taken per person per year
Transparency 8-9Transparency 8-92008 South-Western2008 South-Western
Dependency RequirementsDependency Requirements
Two types of dependentsQualifying child
Must pass five tests: age, non-support, relationship, principal residence, and citizenship
Qualifying relative Must also pass five tests: gross income,
support, relationship, citizenship, and joint-return
Transparency 8-10Transparency 8-102008 South-Western2008 South-Western
Qualifying Child TestsQualifying Child Tests
Age Test – Must beyounger than 19, or a full-time student younger than 24, orPermanently and totally disabled
Transparency 8-11Transparency 8-112008 South-Western2008 South-Western
Qualifying Child TestsQualifying Child Tests
Non-Support Test – Child may notSupply more than 50% of their own support
Scholarships don’t count
Note: the taxpayer who claims the child does not have to provided more than 50% of the support
Transparency 8-12Transparency 8-122008 South-Western2008 South-Western
Relationship Test – Child must be taxpayer’s:ChildStepchildFoster childSiblingStepsibling Decedent of any of the above
Qualifying Child TestsQualifying Child Tests
Transparency 8-13Transparency 8-132008 South-Western2008 South-Western
Qualifying Child TestsQualifying Child Tests
Principal Residence TestChild must live with taxpayer more than
50% of the year Absence due to illness, vacation, education, or
military service does not count
Transparency 8-14Transparency 8-142008 South-Western2008 South-Western
Qualifying Child TestsQualifying Child Tests
Citizen or Resident TestChild must be a U.S. citizen, or Resident of the U.S., Canada, or Mexico
Transparency 8-15Transparency 8-152008 South-Western2008 South-Western
Qualifying Relative TestsQualifying Relative Tests
Gross Income Test Gross income must be less than the
exemption amount of $3,400
Transparency 8-16Transparency 8-162008 South-Western2008 South-Western
Qualifying Relative TestsQualifying Relative Tests
Support TestThe taxpayer must provide more than 50%
of a dependent’s support for the year Two exceptions apply
Custodial parent may always claim a child
Multiple Support Agreement
Transparency 8-17Transparency 8-172008 South-Western2008 South-Western
Qualifying RelativeTestsMultiple Support Agreement
Qualifying RelativeTestsMultiple Support Agreement
When two or more people together provide over half of another’s support, any one who contributes over 10% of the support may claim the exemptionGroup must sign a support agreementMay rotate the exemption among the group
Transparency 8-18Transparency 8-182008 South-Western2008 South-Western
Qualifying Relative TestsQualifying Relative Tests
Relationship TestA dependent must be related to or reside
with the taxpayer Relatives are ancestors, descendants, and
other blood or in-law relations such as siblings, aunts, uncles, nieces and nephews (cousins don’t count, but adopted children do)
Non-relatives must reside in the taxpayer’s home for the entire year
Transparency 8-19Transparency 8-192008 South-Western2008 South-Western
Dependency TestsDependency Tests
Citizenship or Residency Test A dependent must be a U.S. citizen or a
resident of a country adjacent to the U.S.
Joint Return Test A dependent must not file a joint returnA joint return may be filed simply to claim a
refund of all withheld tax
Transparency 8-20Transparency 8-202008 South-Western2008 South-Western
Filing StatusFiling Status
Tax law recognizes the difference in ability-to-pay by basing exemptions, standard deductions and tax rates on an individual’s filing status.
Transparency 8-21Transparency 8-212008 South-Western2008 South-Western
Filing StatusMarried, Filing Jointly
Filing StatusMarried, Filing Jointly
Taxpayers must be legally married on the last day of their tax year
A Surviving Spouse may continue to use Married, Filing Jointly status For two subsequent yearsIf at least 1 dependent child lives at homeAnd the surviving spouse has not
remarried
Transparency 8-22Transparency 8-222008 South-Western2008 South-Western
Filing StatusMarried, Filing Separately
Filing StatusMarried, Filing Separately
Taxpayers married as of the last day of the year may choose to file separately
Transparency 8-23Transparency 8-232008 South-Western2008 South-Western
Filing StatusHead of Household
Filing StatusHead of Household
Unmarried taxpayers qualify if they Are legally unmarried or an “abandoned
spouse” at end of tax year, and Provide over 50% of the cost of a home for
A qualifying dependent, or A qualifying child, or A parent
Parent does not need to live with the taxpayer
Transparency 8-24Transparency 8-242008 South-Western2008 South-Western
Filing StatusSingle
Filing StatusSingle
Taxpayers who are not legally married on the last day of the year and do not qualify as Head of Household must file Single
Transparency 8-25Transparency 8-252008 South-Western2008 South-Western
Deductions From AGIDeductions From AGI
Individual taxpayer’s may deduct the larger of either a standard deduction or total itemized deductions.
Transparency 8-26Transparency 8-262008 South-Western2008 South-Western
Standard DeductionsStandard Deductions
• The standard deduction is based on filing status• Taxpayers who are over 64 years of age
receive extra amounts, as do blind taxpayers
Filing Status Standard Deduction
Additional Age/Blind
Single $5,350 $1,300 MFJ $10,700 $1,050 MFS $5,350 $1,050 H of H $7,850 $1,300
Transparency 8-27Transparency 8-272008 South-Western2008 South-Western
Itemized DeductionsItemized Deductions
Through legislative grace, there are 6 categories of personal expenses individual taxpayers may deduct.
Medical
Taxes
Interest
CharitableContributions
Casualty Losses
Miscellaneous
Transparency 8-28Transparency 8-282008 South-Western2008 South-Western
Medical ExpensesMedical Expenses
Unreimbursed medical expenses of the taxpayer(s) and medical dependents are deductibleMedical dependents may violate the gross
income and the joint return testsCosts include premiums for health and
accident insurance and transportation at 18 cents per mile
Deduction is limited to the excess of total costs over 7.5% of AGI
Transparency 8-29Transparency 8-292008 South-Western2008 South-Western
TaxesTaxes
Amounts paid for either sales taxes or state and local income taxes are deductible
Amounts paid for real estate and other personal property taxes are deductibleNo payments for federal taxes are allowedProperty taxes must be based on value
Transparency 8-30Transparency 8-302008 South-Western2008 South-Western
InterestInterest
Qualified home mortgage interest is deductibleDebt must be secured by a principal
residenceQualified interest is interest paid for
Acquisition debt up to $1 million Home equity debt up to $100,000
Transparency 8-31Transparency 8-312008 South-Western2008 South-Western
InterestInterest
Points on a qualified mortgage are deductible if paid to acquire financingMust be stated as a % of the loan valueDeductible currently if paid on acquisition
debt If for refinancing, amortize over the life of the
loan
Transparency 8-32Transparency 8-322008 South-Western2008 South-Western
InterestInterest
The deduction for investment interest is limited to the amount of net investment income
Investment Incomeless: Investment Expenses
Net Investment Income
• investment income = portfolio income plus gross income and gains from investment assets• investment expenses do not include interest
Charitable ContributionsCharitable Contributions
Contributions made to qualifying charitable organizations are deductibleOrganizations established for religious,
educational, charitable, scientific or literary purposes qualify
Deductible amount includes cash paid and the value of property given and $0.14 per mile driven
Three major limitations existContributions in excess of limitations may be
carried forward for five years
Transparency 8-33Transparency 8-33© 2004 South-Western College Publishing© 2004 South-Western College Publishing
Transparency 8-34Transparency 8-342008 South-Western2008 South-Western
Charitable ContributionsCharitable Contributions
Deduction amount for property depends of the type of property givenOrdinary income property or short-term
capital gain property Deduction is the lesser of the property’s
FMV, oradjusted basis
Deduction amount for long-term capital gain property is FMV
Transparency 8-35Transparency 8-352008 South-Western2008 South-Western
Charitable ContributionsLimitations
Charitable ContributionsLimitations
The overall deduction cannot exceed 50% of AGI
Deduction for long-term capital gain property cannot exceed 30% of AGI If the taxpayer elects to deduct the adjusted basis
rather than FMV, the 50% limit is used
Contributions to non-operating private foundations are subject to additional limits
Transparency 8-36Transparency 8-362008 South-Western2008 South-Western
Casualty LossesCasualty Losses
These were discussed in Chapter 7. Loss is the lesser of
The property’s adjusted basis, orThe decline in the value of the property (repair
cost)
Loss is reduced by Insurance proceeds received,$100 per event (Administrative convenience), and10% of AGI per year
Transparency 8-37Transparency 8-372008 South-Western2008 South-Western
Miscellaneous DeductionsMiscellaneous Deductions
Other various expenses are combined as miscellaneous itemized deductions and are either fully deductible or partially deductible
Transparency 8-38Transparency 8-382008 South-Western2008 South-Western
MiscellaneousFully DeductibleMiscellaneous
Fully Deductible
Fully Deductible expenses include: Gambling losses to the extent of
gambling winnings, Impairment-related-work expenses of
disabled taxpayers, and Unrecovered capital from a terminated
annuity
Transparency 8-39Transparency 8-392008 South-Western2008 South-Western
MiscellaneousPartially Deductible
MiscellaneousPartially Deductible
Other miscellaneous expenses are partially deductible to the extent their total exceeds 2% of AGIUnreimbursed employee expensesInvestment expenses other than interestHobby-related expenses
Transparency 8-40Transparency 8-402008 South-Western2008 South-Western
Reductions for High-Income Taxpayers
Reductions for High-Income Taxpayers
Taxpayers whose AGI exceeds set threshold amounts must reduce their total itemized deductions and their total personal & dependency exemptions.
Transparency 8-41Transparency 8-412008 South-Western2008 South-Western
Itemized Deduction Phase-Out
Itemized Deduction Phase-Out
Deductions for medical expenses, investment interest, casualty and theft losses and gambling losses are not subject to reduction
Calculated phase-out amount for taxpayers with AGI over $156,400 is the smaller of3% of (AGI - $156,400), or80% of the amount subject to reduction
Transparency 8-42Transparency 8-422008 South-Western2008 South-Western
Exemption Phase-OutExemption Phase-Out
Initial calculation for taxpayers with AGI over a threshold amount is
AGI - Threshold2% X
$2,500
Transparency 8-43Transparency 8-432008 South-Western2008 South-Western
Exemption Phase-OutThreshold Amounts
Exemption Phase-OutThreshold Amounts
Filing Status Threshold Amount
Phase-out Ends
Single $156,400 $278,900 Head of Household $195,500 $318,000 Married, Joint $234,600 $357,100 Married, Separate $117,300 $178,550
Transparency 8-44Transparency 8-442008 South-Western2008 South-Western
Restrictions on DependentsRestrictions on Dependents
A person claimed as a dependent by another taxpayer May not also claim a personal exemptionMay report a standard deduction of
$850, orThe amount of earned income plus
$300, but not more than the regular standard deduction amount
Transparency 8-45Transparency 8-452008 South-Western2008 South-Western
Restrictions on DependentsRestrictions on Dependents
The net unearned income of a child under the age of 14 is taxed at the parent’s marginal tax rate
Unearned Income
less: $1,700
Net Unearned Income
Transparency 8-46Transparency 8-462008 South-Western2008 South-Western
Tax CreditsTax Credits
A tax credit is a direct reduction of tax liability.
The purposes of tax credits areto provide incentives for taxpayers to
engage in specific activitiesto provide equity among taxpayersto provide tax relief for low-income
taxpayers
Transparency 8-47Transparency 8-472008 South-Western2008 South-Western
Child Tax CreditChild Tax Credit
Non-refundable $1,000 credit for each qualifying child who is under age 17
Phased-out at rate of $50 for each $1,000 of AGI greater than$110,000 if MFJ, $55,000 if MFS, $75,000 for
others
Transparency 8-48Transparency 8-482008 South-Western2008 South-Western
Child Credit May Be Refundable
Child Credit May Be Refundable
With one or two childrenRefund amount = 15%(Earned Income - $11,750)
With three or more childrenAmount = 15%(Earned Income - $11,750), butLimited to tax liability + Social Security tax paid -
Earned Income Credit
Transparency 8-49Transparency 8-492008 South-Western2008 South-Western
Earned Income CreditEarned Income Credit
The earned income credit provides tax relief to low-income taxpayers
Credit is refundableThe taxpayer may receive a refund if the
credit exceeds the tax liability
Transparency 8-50Transparency 8-502008 South-Western2008 South-Western
Earned Income CreditEligibility RequirementsEarned Income Credit
Eligibility Requirements
Taxpayer or spouseMust live more than half the year in the U.S.Must be older than 25 and younger than 65Cannot be a dependent of anotherMay not have portfolio or passive income in
excess of $2,800
Married taxpayers must file jointly
Transparency 8-51Transparency 8-512008 South-Western2008 South-Western
Earned Income CreditAmount
Earned Income CreditAmount
Amount of the credit depends on The taxpayer’s earned income
Phased-out after maximum limit is reached
The number of qualifying children living in the taxpayer’s home Child must be less than 19 years old (24 if full-time
student) Must be a natural, step, or foster child and reside with
taxpayer more than half of the year
Amount is determined using an IRS table
Transparency 8-52Transparency 8-522008 South-Western2008 South-Western
Child and Dependent Care Credit
Child and Dependent Care Credit
The child and dependent care credit provides tax relief to taxpayers so that they can be employed
Two qualifying conditions must be metExpenses must be incurred so that
taxpayer can be employedExpenses must be for the care of qualified
individuals
Transparency 8-53Transparency 8-532008 South-Western2008 South-Western
Child and Dependent Care Credit
Qualifications
Child and Dependent Care Credit
Qualifications Qualified individuals are
Dependents younger than 13 years old, orA dependent or spouse who is physically
or mentally incapacitated
The credit amount may not exceed $3,000 ($6,000 if more than one qualified individual)
Transparency 8-54Transparency 8-542008 South-Western2008 South-Western
Child and Dependent Care Credit
Reductions
Child and Dependent Care Credit
Reductions Credit amount is 35% of qualified expense
Percentage is reduced as AGI exceeds $15,000, but never below 20%
AGI - $15,00035% - (1% X )
$2,000
Transparency 8-55Transparency 8-552008 South-Western2008 South-Western
Higher Education CreditsHigher Education Credits
Two creditsHOPE Scholarship CreditLifetime Learning Credit
May claim only one per qualifying studentMust be enrolled at least one semesterMust be enrolled at least half-time
May not claim if deduction taken for Higher Education Expenses
Transparency 8-56Transparency 8-562008 South-Western2008 South-Western
Higher Education CreditQualifying Expenses
Higher Education CreditQualifying Expenses
Expenses must be for higher education of taxpayer, spouse, or dependent
Tuition and related fees are reduced by the amount of any scholarship or fellowship received
Transparency 8-57Transparency 8-572008 South-Western2008 South-Western
HOPE Scholarship CreditHOPE Scholarship Credit
Maximum non-refundable $1,650 credit100% of the first $1,100, plus 50% of the
second $1,100
May be claimed by student or qualifying taxpayer
Separate credit for each student
Transparency 8-58Transparency 8-582008 South-Western2008 South-Western
HOPE Scholarship CreditLimitations
HOPE Scholarship CreditLimitations
Available only for first two years of post-secondary education
Phased-out for AGI greater than$94,000 if MFJ$47,000 if other
Possible credit X [1 - {(AGI - phase-out) / 20,000}]
Lifetime Learning CreditLifetime Learning Credit
Maximum non-refundable $2,000 credit20% of the first $10,000 of qualifying expenses
Only one credit per return (regardless of number of students in household)
Expense can be for any course work to acquire or improve job skills
Phased-out same as HOPE Credit
Transparency 8-59Transparency 8-59
Transparency 8-60Transparency 8-602008 South-Western2008 South-Western
Filing RequirementsFiling Requirements
Individuals must file a return when gross income > (standard deduction + additional deductions for age + personal exemption)
3 exceptions:Self-employment income exceeds $400MFS whose gross income exceeds $3,400Can be claimed as a dependent on another’s
return and unearned income exceeds $850