CH3 Brief - CHAPTER 3 Components of Tax Formula Gross...

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Unformatted text preview: CHAPTER 3 Components of Tax Formula: Gross Income - Deductions [or AGI AGI . - Greater of Itemized Deductions or the Standard Deduction - Exemptions . Taxable Income Tax Rate Tax Liability Tax Credits and Prepaments Net Tax Due or Refund ll ll>< GROSS INCOME: Income from whatever source unless specifically excluded. Examples: wages, interest, rents, dividends. Discussed more in Chapters 4 & 5; DEDUCTIONS FOR AGI: These “PRE” AGI deductions are often called “deductions from gross income.” Examples: Trade or business expenses, student loan interest, moving expenses, losses from sale/exchange of property. Discussed more in Chapter 6. AGI: Important subtotal. Many other items are based on one’s AGI (e. g., credit amounts, actual deduction amounts for certain itemized (because of AGI floors)). STANDARD DEDUCTION OR ITEMIZED DEDUCTIONS: " ' Standard Deduction Basic Standard Deduction. Amount depends on “filing status”. See page 3-4 for 2010 amounts. _ Itemized Deductions more in Cha-ter 8 Exam amples. Certain medical expenses, certain state and local taxes, qualified residence interest, charitable contributions, personal casualty losses, and unreimbursed employee expenses (“AGI floors” may apply). Additional Standard Deduction. Blind (as of last day of the tax year) OR 65 (goofy birthday rule — if you turn 65 on January 1, 2011 you received the Additional Standard Deduction for 2010). Amount also depends on filing status (see page 3-5). Phaseout for Folks with High AGI. Historically, when a TP’s AGI exceeded an inflation-adjusted “threshold” (e. g. , for 2009, the threshold was $166,800 for single and joint TPs and $83,400 for married TPs filing separately), TP’s itemized deductions were reduced by 3% of the excess (however, the reduction/phaseout may not be > 80% of certain allowable itemized deductions). For 2009, only 1/3 of the phase-out was applied (which essentially turned the 3% amount into 1%). For 2010, the phaseout has been eliminated. However, the phaseout is expected to return in 2011. o For 2009, there was potential additional standard deduction for property taxes (up to $500; $1,000 if joint return); qualified disaster losses; and, sales taxes paid on new cars and light-duty trucks. Person dies during year. Government gives you the full deduction for the year — even if you die on January 1St Dependents. Greater of (a) $950 or (b) earned income plus $300 (up to maximum allowable standard deduction) seem Must Itemize. Some taxpayers may not take the standard deduction — including married taxpayers filing a separate return, if his/her spouse itemized. Why might TPs not itemize? Amount is not as high as Standard Deduction OR Compliance costs are too high (this fact is often ignored) EXEMPTION S: 2010 Amount. $3,650 per exemption. In the past, this was also subject to an AGI phaseout — whereby TPs reduced their exemptions by 2% for each $2,500 (or fraction thereof) by which their AGI exceeded a threshold. Note, that the exemption phaseout used a different formula than itemized deductions phaseout (even though both considered AGI). Moreover, as with the itemized deductions phaseout: I For 2009, only 1/3 of the phaseout for exemptions was applied; . For 2010, the phaseout for exemptions has been eliminated; and, I For2011, the phaseout for exemptions is expected to return. Exemptions are for (1) TP and spouse (if joint return or spouse has NO income), and (2) dependents (see below) Dependents. Different tests are applied to two categories of persons — (1) a “Qualifying Child” or (2) a “Qualifying Relative.” Generally, each must (a) have a SS#, (b) be citizen or national of US (some exceptions), and (c) not filed a joint return (unless joint return was filed to get refund and no liability would exist for either spouse on the basis of separate returns). Generally, Qualiflging Child needs to pass each of these four tests: Principal Abode. Child that lives with TP >1/2 tax year (except for temporary absences — which includes education, military, illness, and birth). 2. Relationship. Son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister or a descendant of any such individual. Generally, individuals legally adopted (or foster children placed by authorized agency) are treated as TP’s child. 3. Age. D is (a) < 19, (b) <24 and a full-time student (for at least 5 months of the year), or (c) any age and totally and permanently disabled. Support: Child who provides >50% his/her own support is not considered qualifying child. Generally, Qualifying Relatives need to pass each of these four tests: Relationship or member of household. See page 3-9 for acceptable relatives; non-related person must be member of TP’s household for the entire year (except for temporary absences — which includes education, military, illness, and birth). 2. Taxable Gross Income. D had < $3,650 of taxable gross income (before deduction of any expenses other than cost of goods sold) 3. Support. TP must fumish > 50% of D’s “support” (includes amounts spent on clothing, food, lodging (or FMV of lodging), medical care, and education). Funds do not count as support unless such funds are actually m on the support. See “Multiple Support Agreements” below for an easier passing of this test in some situations (i.e., “more than 50%” may become “more than 10%”) Not a Qualifying Child of any TP Multiple Support Agreements. Can be used to satisfy the “support” test (i.e., #3 under Qualifying Relatives), if: . No one person contributes >50% of D’s support; 2. Each member of the group which collectively contributes >50% could have claimed the exemption but for the support test; 3. TP contributes >10% of D’s support; AND, 4. All others in the group who contribute more than >10% file a written declaration agreeing to not claim D as an exemption for the applicable tax year. RATES: 2011 Rates (the 6 brackets): 10%, 15%, 25%, 28%, 33% and 35% See inside cover of our text for schedules. Tax Tables v. Schedules. Generally, tables apply to TPs with taxable income < $100k. Those not eligible for tables must use schedules to compute their tax liability. TAX CREDITS AND PREPAYMENTS: Cha ter 9 0 Note difference between credits (applied to the tax) and deductions (applied to income) 0 Withholdings and estimated tax payments made during the year Filing Status: (Starts on page 3—13) Married individuals filing jointly Married individuals filing separately Single individuals Heads of households (generally, unmarried and maintain household for a dependent) Surviving spouses 99959?" Kiddie Tax a. Realize govemment’s goal is to tax CHILD’S net unearned (investment) income at PARENT (higher) marginal rate (otherwise FAMILY has an incentive to shift income). b. Per page 3-18, net unearned income taxed at parent’s rate = kid’s unearned income (e.g., dividends, interest, capital gains) less the sum of $950 and the greater of: i. Another $950; OR, ii. The amount of allowable deductions directly related to the production of unearned income. c. Thus, potential concerns when kids have investment income > $1,900. (1. See examples on page 3-19. Filing Reguirements. Generally, a return must be filed if GROSS INCOME at least equals the sum of T’s standard deduction and exemption(s). See page 3-19. Self-Employment Tax. 1. 2. 5. In general, tax is levied, assessed, and collected as part of the regular income tax. Provides: i. SS* 12.4% (only on first $106,800 for 2010) ii. Medicare 2.9% 1 5.3% * Old-age, survivors, and disability insurance (OASDI or “SS”) Self Employed: 1/2 of self-employment tax liability is a business deduction in figuring AGI (the goal is to simulate the ER/EE world where the ER would get a tax deduction for its employment tax expense relating to the EB) “Net earnings fiom self-employment” = Net self-employment income less a special deduction (= net self-employment income x 1/2 self-employment tax rate). a. Effect is to multiply net self-employment income by .9235 (100% - 7.65%, or V2 the self- employment tax rate) i. Thus, net earnings fiom self-employment (i.e., the amount subject to the tax) = Net self-employment income x .9235 ii. This again is to simulate the ER/EE world where an EE would not have the ER’s employment tax expense included in the EE’s income that is subject to the tax) b. Multiply result in “a” by 15.3% (however, amount > $106,800 will not be subject to SS; also, can “take out” TP’s income that TP has already paid SS on (e. g., from compensation he/she received as an EE from another position». 0. 1/2 of the resulting tax is also DEDUCTED for AGI per item “3” above. Scope of tax: Generally sole proprietorships and partnerships — but it gets tricky. ...
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