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Unformatted text preview: 13011 1301 5 13025 Individual Taxation—An Overview 3—3 COMPONENTS OF THE TAX FORMULA Taxable income is computed using one of the two overall accounting methods, the cash method or the accrual method. It is also possible to use a combination of the two overall methods. Un- der the cash method, income is reported when it is received and deductions are taken when the expense is paid. The accrual method requires income to be reported when all the events necessary to fix the right to receive payment have occurred and there is reasonable certainty regarding the amount. Likewise, accrual basis taxpayers usually claim a deduction in the year in which all events that fix the liability have occurred, provided the amount of the liability is reasonably determinable. Abasic understanding of the method used to calculate the tax liability is a necessity in the study of federal income taxation. That method is as follows: Gross Income — Deductions for Adjusted Gross Income = Adjusted Gross Income - Greater of Itemized Deductions or Standard Deduction — Personal Exemptions = Taxable Income >< Tax Rate = Tax Liability — Tax Credits and Prepayments = Net Tax Due or Refund GROSS INCOME Gross income includes all items of income from whatever source unless specifically excluded. Examples of gross income include compensation for services, interest, rents, royalties, dividends, and annuities. An individual’s income from business is included in gross income after deducting the cost of goods sold. The receipt of income can be in different forms such as cash, property, services, or even a forgive- ness of an indebtedness. However, income is not reported by a taxpayer until it is realized. Gross income and inclusions and exclusions will be discussed in further detail in Chap- ters 4 and 5. DEDUCTIONS FOR ADJUSTED GROSS INCOME To arrive at adjusted gross income, all deductions specifically allowed by law are subtracted from gross income. Some of the items allowed as deductions for adjusted gross income include: 1. Trade or business expenses, such as advertising, depreciation, and utilities. 2. Certain reimbursed employee expenses, such as travel, transportation, and entertain- ment expenses. 3. Moving expenses. 4 Losses from sale or exchange of property. These deductions are sometimes referred to as "deductions from gross income” or, since almost all the allowable deductions in this section are business expenses, the deductions are sometimes referred to as "business deductions.” These deductions are discussed in Chapter 6. ADJUSTED GROSS INCOME In the tax formula there are deductions for adjusted gross income and then deductions from adjusted gross income. It is important to take these deductions in the proper categories. Adjusted gross income is an important subtotal because certain other items are based on the amount of adjusted gross income. The credit for child and dependent care expenses along with itemized deductions for medical expenses, charitable contributions, personal casualty losses, and miscellaneous expenses are all based on adjusted gross income. c113025 113035 EXAMPLE 3.1 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS ITEMIZING v. STANDARD DEDUCTION Itemized deductions are certain expenses of a personal nature that are specifically allowed as a deduction. Items included in this group are: medical expenses, state and local income taxes, property taxes, home mortgage interest, charitable contributions, personal casualty losses, and miscellaneous employee expenses. Taxpayers receive the benefit of a minimum amount of itemized deductions called the standard deduction. The standard deduction is a fixed amount used to simplify the computation of the tax liability. It is also designed to eliminate lower-income individuals from the tax rolls. All taxpayers subtract the larger of their itemized deductions or the standard deduction. The standard deduction is based on the filing status of the taxpayer and is made up of the “basic standard deduction” plus any “additional standard deduction.” The standard deduction is adjusted annually, if necessary, for inflation. Basic Standard Deduction 201 1 Filing Status Single . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,800 Married Filing Jointly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1,800 Married Filing Separately . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,800 Head of Household . . . . . . . . . . . . .‘ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,500 Surviving Spouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1,800 John and Mary Ward will take a standard deduction of $11,600 since it exceeds their itemized deductions of $10,500. The standard deduction is of principal benefit to moderate and low income level tax- payers since the amount is usually more than the total itemized deductions, which means that such taxpayers need not report their itemized deductions. Thus, the need to audit such returns by the IRS is substantially reduced since the opportunities for error or misstatement of taxable income are lessened. Overall Limitation on Itemized Deductions For tax years beginning after 1990, an individual whose adjusted gross income exceeds a threshold amount was required to reduce the amount allowable for itemized deductions by 3 percent of the excess over that threshold. For 2011 and 2012, there is no reduction in itemized deductions. Additional Standard Deduction for Age and Blindness An additional standard deduction is allowed for aged or blind taxpayers. The additional stan- dard deduction is the total of the additional amounts allowed for age and blindness. The dollar value of an additional amount will depend on the taxpayer’s filing status. The extra standard deductions effective for 2011 are shown below. The amounts are adjusted for inflation. Dollar Value of One Additional Filing Status Amount 2011 Single ............................................................................................................................................... .. $1,450 Married Filing Jointly ................................................................................................................ .. 1,150 Married Filing Separately ....................................................................................................... .. 1,150 Head of Household .................................................................................................................... .. 1,450 Surviving Spouse ........................................................................................................................ .. 1,150 EXAMPLE 3.2 EuMPLE 3.3 EXAMPLE 3.4 ZEJLMPLE 3.5 d» AMPLE 3.6 Individual Taxation—An Overview 3—5 Taxpayers can receive an additional standard deduction for being both aged and blind. Thus, a married couple, both of whom are aged and blind, receive an additional standard deduction of $4,600 ($1,150 x 4). Rebecca Greene, 55, qualifies as a head of household in 2011. Her basic standard deduction is $8,500. She is not entitled to an additional standard deduction. Assume the same facts as in Example 3.2, except that Rebecca is 67 and legally blind. Her basic stande deduction for 2011 is $8,500. She is also entitled to an additional standard deduction of $2,900 ($1,450 for her age and $1,450 for her blindness). Her total standard deduction is $11,400. Jeffrey and Donna Dirk are both 72 and file a joint return for 2011. Donna is blind. Their basic standard deduction is $11,600. They are entitled to an additional standard deduction of $3,450 ($1,150 x 2 for their age plus $1,150 for Donna’s blindness). Their total standard deduction is $15,050. To qualify for the old-age additional standard deduction, the taxpayer and/ or spouse must be age 65 before the close of the year. For purposes of the old—age additional standard deduction, an individual attains the age of 65 on the day preceding the 65th birthday. Thus, an individual whose 65th birthday falls on January 1 in a given year attains the age of 65 on the last day of the calendar year immediately preceding. A person is considered blind for the extra standard deduction if that person’s central visual acuity does not exceed 20/ 200 in the better eye with correcting lenses, or if visual acuity is greater than 20/ 200 but is accompanied by a limitation in the fields of vision such that the widest diameter of the visual field subtends an angle no greater than 20 degrees. If the taxpayer or spouse dies during the year, the number of additional standard deduc- tion amounts for age or blindness is determined as of the date of death. Thus, the additional standard deduction for age will not be allowed for an individual who dies before attaining the age of 65 even though the individual would have been 65 before the close of the year. The additional standard deductions for age 65 or older and blindness apply only to taxpayers and their spouses. No additional standard deduction amounts are allowed to taxpayers who claim an exemption for dependents who are aged or blind. Darren Davidson is single and fully supports his 70-year-old father. Darren qualifies as a head of household. Darren’s regular standard deduction is $8,500 for 2011. Darren may claim a dependency exemption for his father but may not claim the additional _ standard deduction amount for his dependent father. Married Taxpayers Filing Separately All taxpayers may not be able to take the larger of itemized deductions or the standard deduc- tion. Rules require both spouses to either itemize or use the standard deduction. If one spouse takes itemized deductions the other spouse is required to also itemize even if itemized deduc- tions are less than the stande deduction for married individuals filing separately. Joe and Mary Bloome are married but decide to file separate returns for 2011. Joe has ad- justed gross income of $30,000 and $6,200 of itemized deductions, while Mary has $25,000 of adjusted gross income and $3,300 of itemized deductions. Joe and Mary can elect not to itemize, in which case they will each use the standard deduction of $5,800. However, if they decide to itemize, Joe will have itemized deductions of $6,200 and Mary will have $3,300 of itemized deductions. Since Joe itemizes, Mary is also required to itemize. 13—5 Flemmm Pawnee; ($3045 $3055 <H3065 ‘113045 CCH FEDEFIAL TAXATION—COMPREHENSIVE Tones In situations where total itemized deductions are approximately equal to the standard deduc- tion, it is possible for‘ cash basis taxpayers to obtain a deduction for‘ itemized deductions in one year‘ and to use the standard deduction the next year‘ by proper‘ timing of payments. For‘ example, an individual may pay two years’ chur‘ch pledges in one year‘ and nothing the next year: It may also be possible to pay real estate or‘ city and state income tax estimated pay- ments prior to the end of the year: PERSONAL EXEMPTIONS The personal exemption for 2011 is $3,700. From 1979 through 1984, the personal exemption was $1,000. The application of the index for inflation raised the personal exemption to $1,040 for 1985 and $1,080 for 1986. The Tax Reform Act of 1986 raised the personal exemption to $1,900 for 1987, $1,950 for 1988, and $2,000 for 1989. The personal exemption as adjusted for inflation after 1989 was raised to $2,050 for 1990, $2,150 for 1991, $2,300 for 1992, $2,350 for 1993, $2,450 for 1994, $2,500 for 1995, $2,550 for 1996, $2,650 for 1997, $2,700 for 1998, $2,750 for 1999, $2,800 for 2000, $2,900 for 2001, $3,000 for 2002, $3,050 for 2003, $3,100 for 2004, $3,200 for 2005, $3,300 for 2006, $3,400 for 2007, $3,500 for 2008, and $3,650 for 2009 and 2010. No personal exemption amount is allowable on the return of an individual who is eli- gible to be claimed as a dependent on another taxpayer’s return. For example, a child will not be allowed the personal exemption on his or her own return if that child is eligible to be claimed on the parent’s return. In the past, the deduction for personal exemptions was reduced or even eliminated for certain high-income taxpayers. Taxpayers whose adjusted gross income exceeded the appropriate threshold amount (based on filing status) had to reduce exemptions by 2 percent for each $2,500 of adjusted gross income or fraction thereof in excess of the threshold amount. The phaseout of the tax benefit for personal exemptions began in 1991, and the threshold amounts were adjusted for inflation (cost-of-living index adjustment). TAX RATES The tax formula implies that the "Taxable Income” figure is multiplied by the appropriate tax rate to arrive at the "Tax Liability.” In reality, the “Tax Liability” is either derived from the appropriate column of the tax tables or is computed from the appropriate line in the tax rate schedules. Prior to 1986 the maximum tax rate was 50 percent. The tax rate schedules for 1987 ranged from 11 percent to 38.5 percent. The tax rate schedules (reproduced in the Appendix) include six tax brackets for 2011: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. TAX CREDITS AND PREPAYMENTS Any tax credits are applied against the income tax. It is significant to note the difference be- tween a credit and a tax deduction. A deduction reduces income to which the rate applies and indirectly reduces the tax liability. A credit directly reduces the tax liability. The principal credits include the earned income credit, child tax credit, credit for the elderly, general business credit, dependent care credit, education credits, and foreign tax credit. These credits will be discussed in further detail in Chapter 9. The tax liability is further reduced by the amounts withheld on income and by any estimated payments made during the year. Income taxes may be withheld on the various sources of income that a taxpayer receives during the year. Employers are required to with- hold income tax on compensation paid to their employees. In addition, estimated payments may be necessary if enough taxes have not been withheld. 13085 13201 Individual Taxation—An Overview 3—7 NET TAX DUE OR REFUND The tax result after applying the credits and prepayments to the “Tax Liability” is the amount that must be paid to the Internal Revenue Service or the amount overpaid and to be refunded to the taxpayer. CLASSIFICATION OF TAXPAYERS The Internal Revenue Code defines the term “taxpayer” as any person subject to any internal revenue act. The term “person” includes an individual, a trust, estate, partnership, association, company, or corporation. A “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated venture, through or by means of which any business, financial operation, or ven- ture is carried on and which is not a trust or estate or a corporation. The term “corporation” is not defined but is stated to include associations, joint-stock companies, and insurance companies. A proper classification of taxpayers is essential in determining the type of tax return to be filed. Individuals have little trouble choosing the right tax return, but problems often arise with artificial entities such as trusts, estates, partnerships, corporations, and associations. Taxpayers are usually classified according to the type of tax return that they are required to file. Excluding most information returns (which are not tax returns in the strict sense of the term) and returns for organizations exempt from income tax, almost all tax returns will fall into one of the following four categories: TYPE OF RETURN FORM FILED BY Individual 1040 Every natural person with income of statutory minimums Corporation 1 120 Corporations. including organizations taxed as corporations Fiduciary 1041 Trusts and estates with income in excess of statutory minimums Partnership 1085 Partnerships or joint ventures [information return only) Personal Exemptions In computing taxable income an individual is allowed a deduction for each personal exemp- tion allowed. The personal exemption is $3,700 for 2011. After 1989, the personal exemption amount is indexed for inflation. Such exemptions are (1) the exemptions for an individual taxpayer and spouse, and (2) the exemptions for dependents of the taxpayer. However, no personal exemption amount is allowed on the return of an individual who is eligible to be claimed as a dependent on another taxpayer’s return. TAXPAYER AND SPOUSE Since there are two taxpayers on a joint return, two exemptions are allowed on the return even though there may be only one individual earning income. Where a joint return is filed by the taxpayer and spouse, no other person is allowed an exemption for the spouse even if the spouse otherwise qualifies as a dependent of another person. The taxpayer is allowed an exemption for the spouse of the taxpayer if a joint return is not filed. However, the spouse must have no income for the year and must not be the de- pendent of another taxpayer. Thus, a taxpayer is not entitled to an exemption for the spouse on a separate return for the year in which the spouse has any gross income even though the income is not sufficient to require the spouse to file a return. ‘113201 u.r._...m..we...a~...a WW--.~«.W .m..»..m..wt..». $3225 ‘113225 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS return, do not check box 6a . . . . . . . . . . . . . . . WM ea and so Depend”. 3) Dependent-s (4) n qualifyi “Elm “vim my! W mm g than“: _ 6a l: Voursell. If your parent (or someone else] can claim you as a dependent on his or her ta Na. «1 boxes Exemptions c Dependents: (1) First name dilatation 6c m o livedwifliyou _ O manulivewilh If more than six dependents, see page 19. Source: Form 1040 DEPENDENTS Taxpayers are allowed to claim a personal exemption and receive a $3,700 deduction in 2011 for each dependent. The statutory definition of a dependent has been rewritten to categorize each dependent as a qualifying child or a qualifying relative. The new definition also creates a uniform defi- nition of child for dependency exemption, child credit, earned income tax credit, dependent care credit, and head of household filing status. Qualifying Child A child is a qualifying child of a taxpayer if the child satisfies each of four tests: Principal Abode. The child has the same principal place of abode as the taxpayer for more than one half the taxable year. Temporary absences due to special circumstances, including absences due to illness, education, business, vacation, or military service, are not treated as absences. Relationship. The child has specified relationship to the taxpayer. The child must be the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual. An individual legally adopted by the taxpayer, or an individual who is lawfully placed with the taxpayer for adoption by the taxpayer, is treated as a child of such taxpayer by blood. A foster child who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of compe- tent jurisdiction is treated as the taxpayer’s child. Age. The child has not yet attained a specified age. In general, a child must be under age 19 (or 24 in the case of a full-time student) in order to be a qualifying child. In general, no age limit applies with respect to individuals who are totally and permanently disabled at any time during the calendar year. The prior-law requirements are retained that a child must be under age 13 for purposes of the dependent care credit, and under age 17 for purposes of the child tax credit. A tie-breaking rule applies if more than one taxpayer claims a child as a qualifying child. First, if only one of the individuals claiming the child as a qualifying child is the child’s parent, the child is deemed the qualifying child of the parent. Second, if both parents claim the child and the parents do not file a joint return, then the child is deemed a qualifying child first with respect to the parent with whom the child resides the longest period of time, and second with respect to the parent with the highest adjusted gross income. Third, if the child’s parents do not claim the child, then the child is deemed a qualifying child with respect to the claimant with the highest adjusted gross income. The prior-law support and gross income tests (discussed below) for determining de- pendency do not apply to a child who meets the requirements of the uniform definition of qualifying child. Support. A child who provides over half of his or her own support is not considered a qualifying child of another taxpayer. Qualifying Relative Taxpayers generally may claim an individual who does not meet the uniform definition of qualifying child with respect to any individual who is a qualifying relative. A qualifying rela- tive must meet all of the following tests: EXAMPLE 3.7 Individual Taxation—An Overview 3—9 1. Relationship or member of household 2. Gross income 3. Support 4. Not a qualifying child Relationship or Member of the Household Test The dependent must be a relative of the taxpayer or a member of the taxpayer’s household. Individuals considered to be related to the taxpayer and eligible for the dependency exemp- tion include: a child or a descendant of a child; a brother, sister, stepbrother, or stepsister; the father or mother, or an ancestor of either; a stepfather or stepmother; a son or daughter of a brother or sister of the taxpayer; a brother or sister of the father or mother of the taxpayer; and a son-in-law, daughter-in—law; father-in-law, mother-in-law, brother-in-law, or sister- in-law. A nonrelated person must be a member of the taxpayer’s household for the entire year to qualify as a dependent. The taxpayer must maintain and occupy the household. An individual is not a member of the taxpayer’s household if any time during the year the relationship between the individual and the taxpayer is in violation of local law. Gross Income Test A taxpayer is allowed an exemption for each dependent whose gross income for the year is less than the personal exemption amount ($3,700 for 2011). Colleen Drew, age 21, earned $4,000 working part-time while attending school full-time. Colleen’s lives the entire year with her friend who pays more than one-half of Colleen’s support. Colleen’s friend will not be able to claim Colleen as a dependent since Colleen made more than $3,700. The gross income amount is determined before the deduction of any expenses, such as materials, taxes, and depreciation. Thus, a taxpayer would not be able to claim his grand- mother for 2011 if she received $3,800 in rental income, even though her expenses reduced the net income to less than $3,700. However, cost of goods sold is subtracted from gross receipts to determine gross income. Receipts which are excludable from gross income are not counted in applying the gross income test. Support Test Over one-half of the support of a dependent must be furnished by the taxpayer. In determin- ing whether the taxpayer has provided over half of the support, the support received from the taxpayer as compared to the entire amount of support which the individual receives from all sources, including support which the individual supplies, will be taken into account. In computing the amount which is contributed for the support of an individual, there must be included any amount which is contributed by the individual for his or her own sup- port, including receipts which are excludable from gross income, such as benefits received under Social Security or money withdrawn from a savings account. However, it is only the amount actually spent on support which is taken into consideration, not the total amount available for support. The term "support" includes food, shelter, clothing, medical and dental care, education, and similar items. Generally, the amount of an item of support will be the amount of expense incurred by the one furnishing the item. If the item of support furnished by an individual is in the form of property or lodging, it will be necessary to measure the amount of the item of support in terms of its fair market value. The value of personal services is not included in support determination. P. Markarian, 65-2 USTC 1110,755, 352 F.2d 870 (CA-7 1965), cert. denied, 384 US. 988, 86 S.Ct. 1886. Where the taxpayer owns the home in which the dependent lives, the fair rental value of the lodging furnished is part of the total support. However, this does not mean an equal 113225 3—10 EXAMPLE 3.8 113225 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS allocation between taxpayers and dependents. It is recognized that an adult has certain minimum base housing costs which cannot be treated as equal to the minimum housing costs of minor children. In one case, the court allocated 60 percent of the housing costs to the mother and 40 percent to be divided equally among three children. ].D.M. Cameron, 33 TCM 725, Dec. 32,654(M), T.C. Memo. 1974-166. Amounts paid to others to care for children while working are included as part of support. T. Lovett, 18 TC 477, Dec. 19,018 (1952), Acq., 1952-2 CB 2. The amount paid may also qualify for the dependent care credit. Some capital expenditures may qualify as items of support. The cost of an automobile is counted in determining who furnished over half of a dependent’s support. A television set furnished and set apart in the child’s bedroom is also an item of support. Rev. Rul. 77—282, 1977-2 CB 52. Welfare payments made by a state agency to or on behalf of a dependent are attributable to the agency rather than the taxpayer. H. Johnson, 33 TCM 659, Dec. 32,630(M), T.C. Memo. 1974—150; H.M. Lutter, 75-1 USTC $10,439, 514 F.2d 1095 (CA—7 1975), cert. denied, 423 US. 931, 96 S.Ct. 283. This may deny a dependency exemption to the taxpayer since the agency may have provided more than half the support of a child. However, amounts expended by a state for training and education of handicapped children are not taken into account in determin- ing support. This rule applies only if the institution qualifies as an "educational institution” and the residents qualify as “students.” Rev. Rul. 59-379, 1959-2 CB 51, clarified by Rev. Rul. 60-190, 1960—1 CB 51. Social Security Medicare benefits are disregarded in the computation of support. Rev. Rul. 79—173, 1979-1 CB 86. Amounts received as scholarships for study at an educational institution are not con- sidered in determining whether the taxpayer furnishes more than one-half the support of the student. Amounts received for tuition payments and allowances by a veteran are not considered scholarships in determining the support test. John has a cousin who lives with John and who receives a $5,000 scholarship to Aca— demic University for one year. John contributes $4,100, which constitutes the balance of the cousin's support for that year. John may claim the cousin as a dependent, as the $5,000 scholarship is not counted in determining the support of the cousin and, therefore, John is considered as providing all the support of the cousin. Not a Qualifying Child Test An individual who is a qualifying child of the taxpayer or of any other taxpayer cannot be a qualifying relative. Special Rules Applying to Dependents The taxpayer and the dependent will be considered as occupying the household for the entire year notwithstanding temporary absences from the household due to special circumstances. A nonpermanent failure to occupy the common abode by reason of illness, education, busi- ness, vacation, military service, or a custody agreement under which the dependent is absent for less than six months in the tax year, will be considered temporary absence due to special circumstances. The fact that the dependent dies during the year will not deprive the taxpayer of the deduction if the dependent lived in the household for the entire part of the year preceding death. Similarly, the period during the year preceding birth of an individual will not prevent the individual from qualifying as a dependent. No exemption will be allowed for any dependent who has filed a joint return with the dependent’s spouse. However, the dependency exemption will still be allowed where a joint return is filed by a dependent and spouse merely as a claim for refund and where no tax liability would exist for either spouse on the basis of separate returns. Rev. Rul. 65-34, 1965-1 CB 86. EXAMPLE 3.9 Individual Taxation—An Overview 3—1 ’I The term "dependent" does not include an individual who is not a citizen or national of the United States unless such individual is a resident of the United States or a country contiguous to the United States. This exception does not apply to any child that has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household and the taxpayer is a citizen or national of the United States. The term "student" means an individual who, during each of five calendar months during the calendar year, is a full-time student at an educational institution, or is pursuing a full—time course of instructional on-farm training. A full-time student is one who is enrolled for some part of five calendar months for the number of hours or courses which is considered to be full-time attendance. The five calendar months need not be consecutive. School attendance exclusively at night does not constitute full-time attendance. However, full-time attendance may include some attendance at night in connection with a full-time course of study. Dependents will not be allowed to claim exemptions for dependents in any year they are themselves a dependent. Social Security numbers are required for all individuals who are claimed as dependents. Failure to include the Social Security number or other required information can result in the loss of the exemption. Multiple Support Agreements Special rules allow a taxpayer to be treated as having contributed over half of the sup- port of an individual where two or more taxpayers contributed to the support of the individual if (1) no one person contributed over half of the individual’s support, (2) each member of the group which collectively contributed more than half of the support of the individual would have been entitled to claim the individual as a dependent except for the fact that they did not contribute more than one-half of the support, (3) the member of the group claiming the individual as a dependent contributed more than 10 percent of the individual’s support, and (4) each other person in the group who contributed more than 10 percent of the support files a written declaration that they will not claim the individual as a dependent for the year. Brothers Alfred, Bill, Chuck, and Don contributed the entire support of their mother in the following percentages: Alfred, 30 percent; Bill, 20 percent; Chuck, 29 percent; and Don, 21 percent. Any one of the brothers, except for the fact that he did not contribute more than half of her support, would have been entitled to claim his mother as a dependent. Conse- quently, any one of the brothers could claim a deduction for the exemption of the mother provided a written declaration from each of the brothers is attached to the return of the individual taking the exemption. If, on the other hand, Don were a neighbor instead of a brother, he would not qualify as a member of the group for multiple support agreement purposes. He would not be eligible to claim the mother since she was not a member of Don’s household. Don would not be required to sign the multiple support agreement. Divorced or Separated Parents When taxpayers are divorced, legally separated, or never married, special rules apply to determine which one is entitled to exemptions for their children. These rules may result in a taxpayer who did not provide more than half of the support of the child being entitled to the exemption. To qualify, the parents must be divorced or legally separated under a decree of divorce or separate maintenance, separated under a written separation agreement, or lived apart at all times during the last six months of the year. In addition, both parents together must provide more than one—half of the child’s support. The child must be in the custody of one or both parents for more than one—half of the calendar year. Thus, a dependency exemption may not be claimed by one of the parents if a person other than the parents provides one- half or more for the support of the child during the year or has custody of the child for one half or more of the year. 113225 3—’|2 EXAMPLE 3.10 EXAMPLE 3.11 113225 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS As a general rule, a child will be treated as receiving over half of the support from ‘ the parent having custody for the greater number of nights for the year. If the parents of the child are divorced or separated for only a portion of a year after having joint custody for the prior portion of the year, the parent who has custody for the greater number of nights of the remainder of the year after divorce or separation will be treated as having custody for a greater portion of the year. Bill, a child of Jim and Cathy Durell, who were divorced on June 1, received $5,000 for support during the year, of which $2,200 was provided by Jim and $1,950 by Cathy No multiple support agreement was entered into. Prior to the divorce, Jim and Cathy jointly had custody of Bill. For the remainder of the year, Jim had custody of Bill for the months of October through December, while Cathy had custody of Bill for the months of June through September. Since Cathy had custody for four of the seven months following the divorce, she had custody for the greater number of nights and is the custodial parent for the year and is treated as having provided over half of the support for Bill for the year. Post-1 984 Divorces For divorces taking place in years after 1984, the custodial parent is entitled to the exemption in all cases unless he or she expressly waives the right to the exemption. This may be done I by the custodial parent signing a written declaration that he or she will not claim the exemp- 1 tion. The noncustodial parent is required to attach this declaration to his or her tax return each year when claiming the exemption. Failure to attach Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, means that the noncustodial parent cannot claim the exemption, regardless of the amount of support furnished. .0... 8332 (Rev. February 2009) Department of the Treasury lntemal Revenue Service Name of noncustodiai parent OMB No. 1545-0074 Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent b Attach a separate form for each child. Nomnodial parent‘s social security number (SSN) > Name of child Attachment Sequence No. 115 Release of Claim to Exemption for Current Year I agree not to claim an exemption for for the tax year 20 . Signature of custodial parent releasing claim to exemption Custodial parent‘s SSN Date Note. If you choose not to claim an exemption for this child for future tax ears, also complete Part II. Release of Claim to Exemption for Future Years (If completed, see Noncustodial parent on page 2.) I agree not to claim an exemption for Name of child for the tax year(s) (Specify. See instructions.) Signature of custodial parent releasing claim to exemption Custodial parent's SSN Date Revocation of Release of Claim to Exemption for Future Year(§) | revoke the release of claim to an exemption for Name of child for the tax year(s) (Specify. See instructions.) Signature of custodial parent revoking the release of claim to exemption Custodial parent‘s SSN Date Mike and Jennifer are divorced. Mike pays over half of the support of their child, Amanda. Mike is unable to claim Amanda as a dependent on his return because he does not have a signed Form 8332 from Jennifer. we 13 individual Taxation—An Overview 3—1 3 “as 1 e personal exemption reduces taxa e income by $3,700 in 2011. In certain situations, j : such as multiple support agreements and children of divorced parents, it is possible to assign the personal exemption for a dependent to one of the eligible parties. What should be taken into consideration in determining which party should receive the personal exemption? Filing Status and Requirements The tax liability of an individual not only varies with the amount of income but also depends upon marital status. Taxpayers must determine their income tax liability from among five different filing statuses: 1. Married individuals filing jointly 2. Married individuals filing separate returns 3. Single individuals 4 Heads of households 5 Surviving spouses . . 1 Single {1 films sums 2 Married filing joint return (even if only one had income) 3 Married filing separate return. Enter spouse‘s social security no. above and lull name here, > 0 Check only 4 Head of household (with qualifying person). (See page 18.) If the qualifying person is a child bul not your dependent, [t I one box. enter this child's name here. > Qual' in widowler) wim de endent child ears ouse dieO 19 ). (See a 18.) Source: Form 1 040 i A married taxpayer meeting the “abandoned spouse” requirements may be considered I ‘ as an unmarried person for tax purposes. These requirements are: (1) the taxpayer must file a separate return, (2) the taxpayer’s spouse cannot be a member of the household during the last six months of the year, (3) the taxpayer must furnish over half the cost of maintain- ing the taxpayer’s home, and (4) the taxpayer’s home must be the principal residence of a dependent child for more than one-half of the year. EXAMPLE 3.12 Melvin Moore left Esther and their two children on April 15, 2011, and has not been heard from since. Esther furnishes the entire cost of the household and the support of ‘ the two children for the remainder of the year. For 2011, Esther would qualify as an abandoned spouse and thus be considered as unmarried. If Melvin had left during the last half of the year, or if there were no children, Esther would not qualify as unmarried under the abandoned spouse rules. She would file as married filing separately An individual qualifying as an abandoned spouse will qualify for head of household status. Head of household status provides the spouse with a lower rate than the tax rate for a married person filing a separate return or a single individual. Married persons are taxed at the lowest rate if they file jointly, and at the highest rates if they file separately. Unmarried taxpayers who are heads of households use a set of rates between those for single people and those for married couples filing jointly. Surviving spouses use the same rates as those married filing jointly. All unmarried taxpayers who do not qualify for another filing status must file as single taxpayers. ' 13301 MARRIED INDIVIDUALS FILING JDINTLY A married couple may file a joint return including their combined incomes, or each spouse may file a separate return reflecting his or her income only A joint return is not allowed if either the husband or wife is a nonresident alien at any time during the tax year, or if the husband and wife $13301 3—14 $3315 (11331 5 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS have different tax years. However, if at the end of a tax year one spouse is a US. citizen or a resi- dent alien and the other spouse is a nonresident alien, a special election may be made to treat the nonresident spouse as a US. resident. If no election is made, the taxpayer ’s status is married filing separately unless there is a dependent which would allow head of household status to be used. Joint returns were originally enacted to establish equity for married taxpayers in com- mon law states since in community property states married taxpayers are able to split their income. Therefore, the progressive rates are constructed upon the assumption that income is earned equally by the two spouses. A joint return may be filed and the splitting device may be used even if one spouse has no income. If a joint return is filed, the income and deductions of both spouses are combined. The exemptions to which either spouse is entitled are combined, and both spouses sign the return. In a joint return, the general rule is that both spouses are jointly and severally liable for any deficiency in tax, interest, and penalties. A joint return may be made for the survivor and a deceased spouse or for both deceased spouses. The tax year of such spouses must begin on the same day and end on different days only because of the death of either or both spouses. The surviving spouse must not remarry before the close of the tax year and the spouses must have been eligible to file a joint return on the date of death. The determination of whether an individual is married is made as of the close of the tax year, unless the spouse dies during the year, in which case the determination will be made as of the time of death. A married couple does not have to be living together on the last day of the tax year in order to file a joint return, but an individual legally separated under a decree of divorce or separate maintenance will not be considered married. MARRIED INDIVIDUALS FILING SEPARATELY If a husband and wife file separate returns, they should each report only their own income and claim only their own exemptions and deductions on their individual returns. Separate returns will result in approximately the same tax liability as a joint return where both spouses have approximately equal amounts of income. However, when the incomes are unequal, it is generally advantageous for married taxpayers in noncommunity property states to file a joint return since the combined amount of tax on separate returns is higher than the tax on a joint return. Special circumstances may warrant the use of separate returns. Where one spouse incurs significant medical expenses, the smaller adjusted gross income of a separate return results in a larger medical deduction since medical expenses are allowed only to the extent they exceed 7.5 percent of adjusted gross income. It may be desirable to file separate returns to protect against a potential deficiency on the other spouse’s return where there is some concern over the tax liability or there is a questionable item on the return itself. In community property states, a married couple’s income is treated as earned equally by the two spouses. Income earned on capital investment made from a spouse’s separate property in most community property states remains the separate property of that spouse. There are three community property states in which income from separate property is treated as community property (Texas, Idaho, and Louisiana). See discussion of the “Texas Rule” at 114215. Community property income and deductions must be accounted for on the same basis. Deductions pertaining to the separate property of one spouse must be taken by that spouse. However, where the income from that property is taxable one—half to each spouse, the deductions must be divided between the husband and wife. The Code places numerous limitations upon deductions, credits, etc., where married tax- payers file separately If both husband and wife have income, they should generally figure their tax both jointly and separately to insure they are using the method resulting in less tax. If an individual has filed a separate return for a year for which a joint return could have been filed and the time for filing the return has expired, a joint return by the husband and wife may still be filed. The joint return must be filed within three years of the due date of the original return for which a change is requested. All payments, credits, refunds, or other payments made or allowed on the separate return of either spouse are taken into account in determining the extent to which the tax based on the joint return has been paid. p—‘w.....v 13325 13345 EXAMPLE 3.13 EXAMPLE 3.14 Individual Taxation—An Overview 3—1 5 If a joint return has been filed for a year, the spouses may not thereafter file separate returns for that year after the time for filing the return for that year has expired. SINGLE INDIVIDUALS A single individual for tax purposes is an unmarried person who does not qualify as head of household. Generally, if only one of the two individuals is working, it is advantageous from a tax standpoint to enter into marriage. However, where the incomes are approximately equal, the total tax will be smaller if they are not married. HEADS DF HDUSEHDLDS Unmarried individuals who maintain a household for dependents are entitled to use the head of household rates. The definition of a dependent for purposes of head of household status is the same as the uniform definition contained in the dependency exemption rules. The dependent must be a qualifying child or a qualified relative of the taxpayer. Over one-half of the cost of maintaining the household must be furnished by the tax- payer. The household must be the principal abode for more than one-half of the year. A qualifying relative must qualify as the taxpayer’s dependent. A dependent relative who is a dependent only because of a multiple-support agreement cannot qualify a taxpayer for head of household status. A legally adopted child of a taxpayer is considered a child of the taxpayer by blood. A dependent foster child is treated like a dependent blood son or daughter, rather than as an unrelated individual. However, the foster child must be a dependent to enable the parent to use head of household status. Rev. Rul. 84-89, 1984-1 CB 5. A taxpayer with a qualifying child is not required to claim the qualifying child as a dependent in order to qualify for head of household status. Sara Shuster is unmarried and maintains a household in which she and her son reside. The son is claimed by his father as a dependent. Since Sara is not required to claim the dependency exemption on her child, she may use the head-of-household tax rate schedule. If the son is married, Sara must be able to claim him as a dependent in order to file as head of household. The taxpayer’s dependent parents need not live with the taxpayer to enable the taxpayer to qualify as a head of household. The household maintained by the taxpayer must actually constitute the principal place of abode ofrthe father or mother or both of them. The father or mother must occupy the household for the entire year. A rest home or home for the aged qualifies as a household for this purpose. Meg Morgan, an unmarried individual living in Baltimore, maintains a household in Los Angeles for her dependent mother. Meg may use the head-of-household tax rate schedule even though her mother does not live with her. Although generally a married couple cannot file a joint return if one of them is a non- resident alien, the taxpayer who is a U.S. citizen will qualify as a head of household if the taxpayer is the one providing the maintenance of the household and if there is a related dependent living with the taxpayer the entire year. The law provides that, for purposes of the head of household status, the taxpayer is treated as unmarried. A taxpayer does not qualify for head of household status if the only other person living in his household is a nonresident alien spouse because the spouse does not qualify as a de- pendent. However, a taxpayer having a nonresident alien spouse may qualify if an unmar- ried dependent or unmarried stepchild lives with the taxpayer. Rev. Rul. 55-711, 1955-2 CB 13, amplified by Rev. Rul. 74—370, 1974-2 CB 7. A physical change in the location of a home will not prevent a taxpayer from qualifying as a head of household. The fact that the individual qualifying the taxpayer for head of house- (113345 3—18 $3355 EXAMPLE 3.15 $3365 ‘113355 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS hold status is born or dies within the tax year will not block a claim for head of household status. The household must have been the principal place of abode of the individual for the remaining or preceding part of the year. A nonpermanent failure to occupy the common abode by reason of illness, education, business, vacation, military service, or a custody agreement under which a child or stepchild is absent for less than six months in a year will not bar the head of household status. However, it must be reasonable to assume that the household member will return to the household and the taxpayer continues to maintain the household or a substantially equivalent household in anticipation of such return. The costs of maintaining a household are the expenses incurred for the mutual benefit of the occupants. They include property taxes, mortgage interest, rent, utility charges, upkeep and repairs, property insurance, and food consumed on the premises. Such expenses do not include the cost of clothing, education, medical treatment, vacations, life insurance, and transportation. In addition, the cost of maintaining a household does not include any amount which represents the value of services rendered in the household by the taxpayer or by a person qualifying the taxpayer as a head of household. The taxpayer, for example, cannot irnpute a value for services provided by the taxpayer for cooking, cleaning, and doing laundry It is possible for a household to be a portion of a home. The Tax Court held that a widow and her unmarried daughter occupying one level of a four-level house and sharing two levels constituted a household. ].F. Fleming Est, 33 TCM 619, Dec. 32,611(M), TC. Memo. 1974—137. Since the widow paid more than one-half of the household maintenance expenses attribut— able to her and her daughter, she qualified as a head of household. SURVIVING SPOUSES Special tax benefits are extended to a surviving spouse. In addition to the right to file a joint return for the year in which a spouse dies, a taxpayer whose spouse died in either of the two years preceding the tax year, and who has not remarried, may file as a surviving spouse provided the surviving spouse maintains a household for a dependent child or stepchild. Surviving spouses use the same tax rate schedules and tax tables as married taxpayers filing joint returns. The surviving spouse provisions do not authorize the surviving spouse to file a joint return; they only make the joint return tax rates available. The surviving spouse must provide over half the cost of maintaining the household in which both the surviving spouse and dependent live. Of course, an exemption for the deceased spouse is available in the year of death but is not available on the return of the surviving spouse in the two years following death. Albert Olm’s wife died in 2011, leaving a child who qualifies as Albert’s dependent. In the year of death, Albert and his deceased wife are entitled to file a joint return and claim three exemptions—one each for Albert, his deceased spouse, and the dependent child. If the child continues to live with Albert in a household provided by him and be his dependent, Albert will be allowed to file as a surviving spouse for 2012 and 2013. Only two exemp- tions will be allowed in those years—one for Albert and one for the dependent child. TAX RETURNS OF DEPENDENTS For 2011, the standard deduction for an individual who can be claimed as a dependent on the tax return of another taxpayer is the greater of the individual’s earned income plus $300 (up to the maximum allowable standard deduction) or $950. However, an individual over 18 or a full-time student over 23 will not qualify as a dependent if income exceeds $3,700. An individual may not claim a personal exemption if the individual can be claimed as a dependent on another taxpayer’s return. It does not matter whether the other taxpayer actually claims the exemption. EXAMPLE 3.16- EXAMPLE 3.17 EXAMPLE 3.18 EXAMPLE 3.19 EXAMPLE 3.20 Individual Taxation—An Overview 3—1 7 Michael Turner, who is single, is claimed as a dependent on his parents’ 2011 tax return. He receives $1,500 in interest income from a savings account. In addition, he earns $1,800 while working part-time after school. The standard deduction for a single individual for 2011 is $5,800. However, Michael is limited to a standard deduction of $2,100, the larger of his earned income of $1,800 plus $300 or $950. Sonya Ross is single and claimed as a dependent on her parents’ 2011 tax return. She has $1,200 in interest income and also earns $350 from part—time employment. Her standard deduction is limited to $950, the larger of her earned income of $350 plus $300 or $950. Tom Moss, a 22-year-old, full—time college student, is claimed as a dependent on his parents’ 2011 return. Tom is married and files a separate return. Tom has $1,500 in interest income and wages of $6,000. His standard deduction is $5,800, because the greater of $950 or his earnedincome ($6,000) plus $300 is $6,300, but his standard deduction cannot be more than the $5,800 maximum allowable standard deduction. Kiddie Tax If a dependent child is subject to the kiddie tax and has more than $1,900 of net unearned (investment) income for the year, his or her net unearned income is taxed to the child at the additional rate of tax that the parent would be required to pay if the child’s net unearned income were included in the parents’ taxable income. This applies regardless of the source of the assets creating the child’s net unearned income as long as the child has at least one living parent as of the close of the tax year and does not file a joint return. The income of the cus- todial parent is used for the tax computation in the case of parents that are not married. The parent with the greater taxable income is to be used when married parents file separately. The kiddie tax applies in the following circumstances: 1. 17-year old or younger—subject to the kiddie tax regardless of the amount of his or her earned income. 2. 18-year old—subject to the kiddie tax unless the child has earned income exceeding one-half of their support. 3. 19- to 23-year old full-time student—subject to the kiddie tax unless the child has earned income exceeding one-half of their support. Net unearned income is unearned income (such as interest, dividends, capital gains, and certain trust income) less the sum of $950 (referred to as the first $950 clause) and the greater of: (1) $950 of the standard deduction or $950 of itemized deductions, or (2) the amount of allowable deductions which are directly connected with the production of unearned income. Thus, unearned income is reduced by $1,900 unless the child has itemized deductions con- nected with the production of unearned income exceeding $950. The amount of net unearned income cannot exceed taxable income for the year. The child in each of the following examples is subject to the kiddie tax. In each of the ex- amples no personal exemption is aHOWed since the child is a dependent of another taxpayer. Amy Acorn has $300 of unearned income and no earned income. Amy will have no tax liability since her standard deduction of $950 will reduce taxable income to zero. Bill Barnes has $1,100 of unearned income and no earned income. Bill will have $150 of taxable income ($1,100 gross income — $950 standard deduction). His net unearned income is reduced to zero by the first $950 clause and the $950 standard deduction. The $150 taxable income is taxed at Bill’s tax rate. 3—’l 8 EXAMPLE 3.21 EXAMPLE 3.22 EXAMPLE 3.23 EXAMPLE 3.24 ‘113375 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS Charles Clewis has $2,000 of unearned income and no earned income. His $950 standard deduction reduces taxable income to $1,050. The $2,000 of unearned income is reduced by (1) the first $950 clause and (2) the $950 standard deduction, leaving $100 of net un- earned income. The $100 of net unearned income is taxed at the additional rate of the parents while the remaining $950 of taxable income is taxed at Charles’s rate. Dave Drummer has $800 of earned income and $400 of unearned income. Dave’s standard deduction is $1,100 (the amount of earned income plus $300). His taxable income is $100 ($1,200 gross income - $1,100 standard deduction). Since the unearned income is less than $1,900, there is no net unearned income. The taxable income is taxed at Dave’s tax rate. Frank Fisher has $400 of earned income and $2,000 of unearned income. His taxable income is $1,450 ($2,400 gross income - $950 standard deduction). Frank’s $2,000 unearned income is reduced by $1,900 (the first $950 clause + the $950 standard de- duction), leaving $100 of net unearned income. The $100 of net unearned income is taxed at the parent’s rate. Frank is taxed at his rate on the remaining $1,350 taxable income ($1,450 taxable income — $100 taxed at parent’s rate). Gene Gambol has $1,100” of earned income plus $2,800 of unearned income. He has $1,000 of itemized deductions (net of the 2 percent floor) which are directly connected with the production of the unearned income. Gene has $450 of other itemized deduc- tions. His taxable income is $2,450 ($3,900 gross income — $1,450 of itemized deduc- tions). Gene’s net unearned income of $850 is taxed at his parents’ rate. The unearned income is reduced by $1,950 (the first $950 clause + the entire $1,000 of deductions relating to the production of unearned income since it exceeds $950). Gene is taxed at his rate on $1,600 ($2,450 taxable income - $850 taxed at his parents’ rate). Parents can avoid having a dependent‘s income taxed at their rate by making gifts to children of assets that will not generate income until after the child's income no longer qualifies for the kiddie tax. The tax on the income would then be taxed at the child’s tax rate. Examples of such assets include single premium ordinary life insurance policies, Series EE savings bonds, and property expected to appreciate over time. A parent may elect to include on his or her return the unearned income of a child whose income is between $950 and $9,500. The child’s income must consist solely of interest and dividends. The child is treated as having no gross income and does not have to file a tax return if the election is made. The electing parent must include the gross income of the child in excess of $1,900 on the parent’s tax return for the year, resulting in the taxation of that income at the parent’s highest marginal rate. There is an additional tax liability equal to the lesser of (1) $95 or (2) 10 percent of the child’s income exceeding $950. This liability reflects the child’s unearned income from $950 to $1,900 that would otherwise be taxed to the child at the 10 percent tax rate. FILING REQUIREMENTS The obligation to file a return depends on the amount of gross income, marital status during the year, and age. Only income which is taxable is included in the computation of gross income in order to determine whether or not a return must be filed. With certain exceptions, the gross income level at which taxpayers must file returns is determined by adding the standard deduction to the personal exemptions allowed for the taxpayer. Because married individuals filing separately must both itemize or both use the if: F). L\ HRHH'. M kl a? if: 13385 Individual Taxation—An Overview 3—1 9 standard deduction, the standard deduction amount is not added to the personal exemption to determine the gross income filing figure. The old—age additional standard deduction en— titles an individual to increase the gross income level filing requirement by $1,150 or $1,450. However, no increase is permitted for blindness or for exemptions for dependents. For 2011, Code Sec. 6012 requires a tax return to be filed if gross income for the year is at least as much as the amount shown for the categories in the following table. Filing Status Gross Income Single Under 85 and not blind ........................................................................................................... .. $9,500 Under 85 and blind ............................................................................................................... .. 9,500 85 or older .......................................................................................................... .. 10,950 Dependent with unearned income ........................................................... .. 950 Dependent with no unearned income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 5,800 Married Filing Joint Return Both spouses under 85 and neither blind ...................................................................... .. $19,000 Both spouses under 85 and one or both spouses blind . . . . . . . . . . . . . . . .. 19,000 One spouse 85 or older ............................................................................ .. 20,150 Both spouses 85 or older ...................................................................................................... .. 21,300 Married Filing Separate Return All—whether 85 or older or blind ........................................................................................ .. $3,700 Head of Household Under 85 and not blind ........................................................................................................... .. $12,200 Under 85 and blind .................................................... .. 12,200 85 or older .................................................................................................................................... .. 13,850 Surviving Spouse Under 85 and not blind ........................................................................................................... .. $15,300 Under 85 and blind ......... .. 15,300 85 or older .................................................................................................................................... .. 18,450 Even if the aforementioned gross income requirements are not met, a return nevertheless must be filed if an individual had net earnings from self-employment of $400 or more. A return should be filed by any taxpayer eligible for the earned income credit even though the taxpayer does not meet any of the above filing requirements. A refund can result even if no income tax has been withheld. Taxpayers must record their identifying number (Social Security number) on their returns. Returns filed by taxpayers claiming exemptions for dependents must include the dependents’ Social Security numbers. TAX TABLES The tables are based on taxable income. The tables apply to taxpayers with taxable income of less than $100,000. Separate tables are provided for single taxpayers, married taxpayers filing jointly and surviving spouses, married taxpayers filing separately, and heads of households. Each line of the tax tables represents an interval of taxable incomes. Under $3,050 the intervals are $25 and above $3,050 the intervals are $50. The tax given in the tables is based on the midpoint taxable income of each interval. Thus, the tax from the tables for the interval $40,000—$40,050 is the same as the tax determined from the tax rate schedules for $40,025. The tax tables may not be used by the following taxpayers: 1. Estates or trusts 2. Taxpayers claiming the exclusion for foreign earned income 3. Taxpayers who file a short period return 4. Taxpayers whose income exceeds the ceiling amount It is expected that 95 percent of all individual taxpayers will be able to determine their tax liability from the tables. ‘113385 3—20 113395 113405 113395 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS To find the income tax from the tax tables, the taxpayer must (1) find the line that includes the taxable income and (2) read down the column until the taxable income line is reached. For a married couple filing jointly with taxable income of $72,623, the income tax would be $10,406. Sample Tax Table For 201 1 But Married Married Head Less Filing Filing of a At Least Than Single Jointly Separately Household $72,600 $72,650 $14,281 $10,406 $14,370 $12,924 72,650 72,700 14,294 10,419 14,384 12,936 72,700 72,750 14,306 10,431 14,398 12,949 72,750 72,800 14,319 10,444 14,412 12,961 The 2010 Tax Tables are provided in the Appendix. TAX RATE SCHEDULES Taxpayers using the tax rate schedules must compute their tax based on taxable income. The tax rate schedules are used by those not eligible to use the tax tables. The tax rate schedules are presented in the Appendix and inside the front cover. SELF-EMPLOYMENT TAX The tax on net self-employment income is levied to provide the self—employed with the same benefits that employees receive through their payment of the Social Security tax (FICA). In general, the tax is levied, assessed, and collected as part of the regular income tax. The tax is imposed for the purposes of insuring the self—employed individual for old-age, survivors, and disability benefits and for hospitalization benefits under the Social Security program. For 2011, the tax rate is 13.3 percent, made up of two parts: (1) an old-age, survivors, and disability insurance (OASDI) rate of 10.4 percent and (2) a Medicare hospital insurance (HI) rate of 2.9 percent. The self-employed individual is considered both the employer and the employee. For 2011, the employee's 6.2 percent OASDI portion is reduced to 4.2 percent. In general, net self-employment income equals the gross income derived by an individual from a trade or business carried on as a sole proprietor, less any allowable deductions, plus the distributive share of a partnership’s net income. If a self-employed individual has more than one business, the net self—employment income is the total of the net earnings of all busi- nesses. A loss in one business is deductible from the earnings of the other businesses. Not all self-employment income is subject to tax. Remuneration paid for the services of a newsboy under age 18 is exempt from the tax. Dividends are included only by a dealer in stock and securities. Interest is included only if on business loans. Rental in- come is included only by a real estate dealer or in cases in which services are rendered to the occupants. Generally, self—employment income does not include any item that is excluded from gross income. Wages received by a child under 18 from a parent are not subject to the self-employment tax. The self—employment tax is imposed on "net earnings from self-employment.” Net earnings from self-employment is net self-employment income less a special deduction. The actual deduction, however, is not subtracted from a taxpayer’s net self-employment income in computing net earnings from self-employment. Instead, a taxpayer reduces net self-employment income by an amount (termed a “deemed deduction”) equal to net self— employment income multiplied by one-half of the self-employment tax rate, or 7.65 percent. This deduction is incorporated into Schedule SE by multiplying the net self-employment income by .9235. (This gives the same deduction as multiplying net self-employment income by .0765 and then subtracting the result.) A taxpayer is allowed a deduction for one-half of the self-employment tax as a deduc- tion from gross income. EXAMPLE 3.25 EXAMPLE 3.26 EXAMPLE 3.27 individual Taxation—An Overview 3—21 In 2011, Pierre Painter, a self-employed artist, had $45,000 in self-employment income. His deductible business expenses amounted to $15,000. Pierre’s self-employment tax is computed as follows: Gross income from self-employment. ..................................................................... .. $45,000 Less: Business expense deductions 15,000 Net self-employment. income .... ............................................................................... .. $30,000 Less: Deemed deduction [$30,000 X 7.65%] ................................................... .. 2,295 Net earnings from self-employment. ....................................................................... .. $27,705 Self-employment. tax [$27,705 X 13.3%] ............................................................ .. $3,685 On Form 1040, Schedule SE, Pierre would simply multiply his net self-employment income of $30,000 by .9235. The cap on wages and self-employment income that is taken into account in calculat- ing the portion of the FICA tax applicable to old-age, survivors, and disability insurance (OASDI) is $106,800 for 2011. This also applies to wages, self—employment income, and income derived under the Railroad Retirement Act. There is no longer a cap on wages and self-employment income that is taken into account in calculating the Medicare hospital insurance (HI) portion of the self—employment tax. For 1993 the cap on the medical hospital insurance was set at $135,000. Katie Adams has $150,000 in self-employment income for the year. Her net earnings from self-employment is $138,525 ($150,000 x .9235). She will be subject to an OASDI tax of $11,107.20 ($106,800 x 10.4%) and an HI tax of $4,017.23 ($138,525 x 2.9%). Thus, her total self-employment tax is $15,124.43. Thus, self—employment and Social Security (FICA) tax rate parity is achieved between self- employed persons and employees. Both employees and their employers are liable for Social Security tax and the employer must contribute 6.2 cents per dollar earned by the employee up to the cap limitation ($106,800 for 2011) for OASDI and another 1.45 cents per dollar without a cap for H1. However, for 2011 the employee's portion is only 4.2 cents per dollar. The net earnings from self—employment subject to the OASDI portion of the self-employ- ment tax are limited to the self-employment base ($106,800 for OASDI and unlimited for H1 in 2011) less any wages from which Social Security tax was withheld during the year. Thus, the tax is applied to the lesser of (1) the self-employment base ($106,800) minus income subject to Social Security taxes or (2) the net earnings from self-employment. In 2011, Margaret Moore has $108,800 in income from self-employment and receives $8,900 in wages that are subject to Social Security taxes. Margaret’s net earnings from self-employment are $100,477 ($108,800 x .9235). Her net earnings from self- employment subject to OASDI self-employment tax for the year are $97,900 ($106,800 — $8,900, the wages on which Social Security tax was withheld), which is less than net earnings from self-employment. Her net earnings from self-employment subject to the HI self-employment tax are $100,477, the full amount of the net earnings from self—employment. Thus, her total self-employment tax is $13,095.43 ($97,900 x 10.4% + $100,477 x 2.9%). The employer portion of the self-employment tax liability for the year is allowed as a deduction on the tax return. This deduction is taken as a deduction from gross income on the front of Form 1040. 113405 3—2 2 EXAMPLE 3.28 EXAMPLE 3.29 CCH FEDERAL TAXATION—COMPREHENSIVE TOPICS Jim Iergens has $40,000 in self-employment income. His net earnings from self- employment are $36,940 ($40,000 x .9235). The self-employment tax is $4,913.02 ($36,940 x 13.3%). The employer portion of this amount, $2,825.91 ($36,940 x 7.65%), is allowed as a deduction from gross income. If the net earnings from self-employment are less than $400, there is no self-employment tax. However, this does not mean that the first $400 of net earnings from self—employment is not subject to the self-employment tax. Sylvia Knight’s only source of income for 2011 is $433.14 from self-employment. The net earnings from self-employment are $400 ($433.14 x .9235). The self-employment tax is $53.20 ($400 x 13.3%). Sylvia has a deduction from gross income for the employer portion of the self-employment tax, or $30.60 ($400 x 7.65%). If Sylvia had managed to earn less than $433.14, there would have been no self-employment tax. An optional method of computing self-employment income may be used by persons whose net income from a trade or business is relatively low. The details are omitted, but the method enables taxpayers to obtain greater credit for Social Security benefits than their income would normally allow. Employment Taxesfifor Household Employers If a taxpayer hires someone to do household work and was able to control what work he or she did and how he or she did it, the taxpayer has a household employee. The taxpayer has to have an emp10yer identification number (EIN) and pay employment taxes. AForm W-2, Wage and Tax Statement, must be filed for each household employee paid $1,700 or more in cash wages in 2011 that are subject to social security and Medicare taxes. If the wages were not subject to these taxes but the emp10yee wishes to have federal income taxes withheld, a W—2 must be filed for that employee. A Form W—3, Transmittal of Wage and Tax Statements, must also be filed if one or more W-2s are required to be filed. If cash wages are paid of $1,000 or more in any calendar quarter of 2010 or 2011 to house- hold employees for 2011, the taxpayer may also be subject to federal and state unemployment taxes. In the case of persons performing domestic services in a private home of the employer and person performing agricultural labor, if the employer pays the employee’s liability for FICA taxes of state unemployment taxes without deduction from the employee’s wages, those payments are not wages for FICA purposes. Code Sec. 3121(a)(6). _ 113405 1. Sara Michaels and Tommy Tooks marry on December 31. Sara earned $120,000 for the year, and Tommy earned $100,000. If Sara and Tommy had waited until the beginning of the following year to marry they would have realized a significant tax savings. Each filing as single taxpayers will result in less total tax than filing jointly. Assume Sara earned $95,000 and Tommy earned $5,000 because he attended school most of the year and they marry at the beginning of the next year. There would be a significant tax savings in marrying at the end of the first year and filing jointly over each filing as single taxpayers. Sara and Tommy decide to file as married filing separately. Sara has $7,000 in itemized deductions and Tommy has $2,500 in itemized deductions. Since Sara itemized on her return Tommy is required to itemize. They may be better off to have both take the standard deduction since the total standard deductions would be $11,600 while itemizing only results in a $9,500 total deduction. ...
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This note was uploaded on 12/02/2011 for the course ACCOUNTING 4001 taught by Professor Nathanielbell during the Spring '11 term at FIU.

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Ch3 Pdf libro - 13011 1301 5 13025 Individual Taxation—An...

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