104-1 Income Tax Fundamentals: Inclusions and Exclusions from Income Flashcards
Basic federal income tax formula (as implemented on IRS Form 1040)
Income - exclusions from gross income = gross income - deductions from adjusted gross income (AGI) = AGI - the greater of total itemized deductions or standard deduction OR taxable income x Taxpayer filing status to calculate tax \+ any other taxes - allowable credits = taxpayer’s tax liability
IRS Form 1040EZ
The most user-friendly of all 3 income tax forms and may be used if a # of requirements apply:
A) taxpayer income is derived solely from wages, salaries, or tips
B) taxable income is < $100k annually
C) no adjustments to income are claimed
IRS Form 1040A
Used where the taxpayer does not meet all of the requirements to file IRS Form 1040EZ and if:
A) the only adjustments to taxpayer income are for deductible contributions to an IRA and the student loan interest deduction
B) deductions are not itemized
C) only certain tax credits are claimed
5 types of filing statuses
1) Single (S)
2) Married filing jointly (MFJ)
3) Married filing separately (MFS)
4) Head of household (HH)
5) Qualifying widow(er) w/ dependent child [aka Surviving Spouse (SS)]
Filing status: Single (S)
Umarried, legally separated, or divorced individual who does not qualify for any other filing status
Filing status: Married filing jointly (MFJ)
Usually advantageous for married persons to file a joint return because the combined amount of tax is usually lower
Filing status: Married filing separately (MFS)
Each spouse reports only his own income and applicable deductions and credits
May be used when couple is going through a divorce proceeding or merely do not want to assume the joint and several liability of MFJ status
Filing status: Head of household (HH)
Unmarried individuals who maintain a household for a qualifying child or relative under the tax law (usually a dependent child or dependent parent)
Rates somewhere between MFJ and single filing status
Filing status: Qualifying widow(er) w/ dependent child [aka surviving spouse (SS)]
Taxpayer w/ a dependent child and whose spouse has died within the last three years may use this filing status
Gross income
Defined as all income from whatever source derived except for those items specifically excluded by the Tax Code
Inclusions
Items that are included in an individual’s gross income
FICA (Federal Insurance Contributions Act) payroll tax
Consists of 2 separate taxes:
1) OASDI (Old Age, Survivors, and Disability Insurance, aka social security)
2) Medicare tax
Schedule C Income
If reported on the cash flow statement of any taxpayer, you know the individual is self-employed
Taxation of social security
Retirement beneficiaries of significant total incomes may be required to include up to 85% of their Social Security benefits as income
For single taxpayers w/ income of $25k or less and married taxpayers w/ provisional income of $34k or less, none of the income is taxable
When income is taxed and NOT physically received
1) imputed interest rule
2) constructive receipt income doctrine
Imputed interest rule
Occurs in instances when a lender has engaged in a below-market-IR loan transaction, when the lender may be required to impute (report) interest income even without actually receiving this interest
Imputed interest rules generally apply to the following types of below-market loans
- Gift loans
- Compensation-related loans
- Tax-avoidance loans
Constructive receipt income tax rule or doctrine
Applies when there is no substantial limitation or restriction on a taxpayer’s right to bring the funds under personal control
(E.g. check is ready to be picked up at the desk and person waits until next tax year to pick up)
Windfall taxation
E.g. lottery
The winner of a lottery who is given the option of receiving either a lump sum or an annuity must include the full value of the annuity in income immediately, even if she takes the proceeds over time
Exception: qualified prize option
Structured settlement
A method of compensating a victim for injuries arising, in most cases, as a result of a personal injury lawsuit
May be taken as an annuity or a lump sum
Prior to 1982, could only be taken as a lump sum
Compensatory damages
If the damages arising out of the personal injury lawsuit are considered only to make the injured party whole
Tax free unless it’s payment for discrimination
Punitive damages
Damages arising out of a personal injury lawsuit, intended to punish the offender
Generally taxable
Exclusions
Usually break down into several categories:
- items categorized by love, affection, or assistance
- items that are a return of capital
- items that, per Tax Codec make the taxpayer “whole” again
- items that are socially desirable or a matter of legislative grace
- items or benefits provided by an employer
Fringe Benefits
Part of the compensation package given to an employee that is not salary but consists of valuable consideration
Either nontaxable in full or at least in part
Taxation may result on fringe benefits when they discriminate
Accident and Health Plans fringe benefits
Premiums paid by the employer for accident, health, and disability income insurance plans (group plans) are deductible by the employer and generally excludable from the employee’s income
Meals And Lodging Fringe Benefits
Meals furnished by the employer on its business premises and for its convenience to employees are not taxable
Athletic Facility Provided to Employees fringe benefits
The value of an athletic facility or gym provided by the employer on its premises, if solely for the use of the employee and the employee’s dependents, is nontaxable to the employee
Group Term Life Insurance Fringe Benefits
An employee can exclude the premiums paid by the employer on the first $50k of group term life insurance coverage
If the plan is discriminatory, key employees lose the $50k coverage exclusion
Education assistance fringe benefits
Undergraduate and graduate education assistance is excluded from an employee’s income in any 1 year, up to a max of $5,250
Employer-provided child and dependent care services fringe benefits
An employee can exclude up to $5k annually in child care expenses paid by an employer to enable the employee to work
Employer-provided auto (Company car)
The business use of such auto is excludable without limit from the employee’s income
Adjusted gross income (AGI)
Gross income - deductions = AGI
a taxpayer who does not itemize deductions is still entitled to any of these adjustments to gross income
Capital Loss Carryover
Capital losses may offset capital gains without limit
If capital losses exceed capital gains, they may offset ordinary income up to $3,000
The excess may be carried forward to future tax years
Self-Employed Health Insurance Deductions
Self-employer taxpayers (sole proprietors and partners), as well as taxpayers who are more than 2% shareholders of an S corporation, can take a 100% deduction for amounts paid for health insurance coverage for themselves, their spouses, and eligible dependents
Student Loan Interest Deduction
Interest paid on qualified higher educational loans is generally deductible to reach AGI
Max allowable deduction = $2,500
This is subject to phaseout
Above-the-line deductions
These are allowable regardless of whether the taxpayer claims itemized deductions
These include deductible contributions to IRA’s
These are subtracted from gross income in determining adjusted gross income
Gross Income
All income is included in gross income, unless the Internal Revenue Code specifically excludes that income from taxation
Form 990
Tax filing for charitable organizations
Form 1040 Schedule C
Used to report the income from a sole proprietorship
