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Fundamentals of Income Taxation > 3. Income Taxation Fundamentals > Flashcards

3. Income Taxation Fundamentals Flashcards

1
Q

Define

“Marginal Tax Rate”

A
  • Tax rate paid on an additional unit of income.
  • In a graduated or progressive tax regimen, the marginal tax rate increases as the income rises, and the highest income bracket (or band) attracts the highest marginal tax rate.
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2
Q

Define

“Effective Tax Rate”

A
  • Effective tax rate represents the percentage of their taxable income that individuals have to pay in taxes.
  • For an individual:
    • Effective Tax Rate = Total Tax ÷ Taxable Income
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3
Q

Identify the acronym

“FICA”

A

Federal Insurance Contributions Act

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4
Q

Identify the acronym

“FUTA”

A

Federal Unemployment Tax Act

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5
Q

Identify the

“Federal Income Tax Formula”

A

Income - Deductions = Taxable Income X Tax Rate

=

Tax Liability

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6
Q

Define

“Progressive Tax System”

A
  • A progressive tax is based on the taxpayer’s ability to pay. It imposes a lower tax rate on low-income earners than on those with a higher income.
  • This is usually achieved by creating tax brackets that group taxpayers by income ranges.
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7
Q

Describe

“Gross vs Adjusted Gross Income”

A

Income - Exclusions = Gross Income

and

Gross Income - Deductions* = Adjusted Gross Income

* deductions are considered to be above the line deductions

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8
Q

Describe

“Expanded Federal Income Taxable Formula”

A

Gross Income

-

Greater of Itemized or Standardized Deductions

(Below the Line Deductions)

-

Personal and Dependency Exceptions

-

20% Qualified Business Income Deduction

=

Taxable Income

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9
Q

Describe

“Tax Liability”

A

Taxable Income

X

Applicable Tax Rate

-

Tax Credits

=

Tax Liability

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10
Q

Define

“Gross Income”

A

All income from whatever source derived

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11
Q

Identify

“Inclusion of Gross Income”

A
  • Interest and dividends
  • Rents and royalties
  • Annuity payments
  • Discharge of indebtedness
  • Income from an interest in an estate or trust
  • Alimony and separate maintenance payments required by a divorce decree entered into before December 31, 2018 (unless substantially modified after December 31, 2018)
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12
Q

Identify

“Exclusions from Gross Income”

A
  • Interest income from municipal bonds
  • Child support payments from a former spouse
  • Qualifying distributions from a Roth IRA during retirement
  • Alimony from post-2018 divorce
  • Gain on the sale of a principal residence (subject to limitations)
  • Cash or property received by a gift
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13
Q

Explain the importance of

“Adjusted Gross Income”

“The Line”

A

AGI is used to determine

  • limitations on deductions
  • limitation on credits
  • phase-outs of certain tax benefits
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14
Q

Identify

“Above the Line Deductions”

A
  • Deductible contributions to Traditional IRAs
  • Contributions to SEP, SIMPLE or qualified plan
  • Tuition Expenses for Higher Education
  • Interest paid on student loans
  • Health Savings Account (HSA) contributions
  • Business expenses
  • Rental or royalty income expenses
  • Losses from the sale of business property
  • Moving Expense (military only until 2025)
  • Alimony
    • Deductible: if the divorce decree is entered into on or before December 31, 2018
    • Not deductible: for decrees after this date, or decrees before this date that were substantially modified after December 31, 2018
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15
Q

Identify the

“2020 Standard Deduction Amounts”

A
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16
Q

Identify the

“Additional Deductions”

(Blind and/or Age 65+)

A
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17
Q

Identify

“Taxpayers Who Must Itemize Deductions”

A
  • An individual who files a tax return for less than 12 months because of a change in the taxpayer’s annual accounting period is not permitted to use the standard deduction.
  • A married individual filing separately cannot use the standard deduction if their spouse itemizes deductions.
  • Nonresident aliens are not permitted to use the standard deduction.
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18
Q

Identify

“Common Itemized Deductions”

A

The following is a partial list of deductions that can be itemized if a taxpayer is choosing this method:

  • Charitable Contributions
  • Home Mortgage Interest
  • Investment interest expense
  • State and local income taxes
  • Real property taxes on a home
  • Property taxes based on the value of a car
  • Casualty losses in excess of 10% of AGI
  • Medical and dental expenses in excess of 7.5% of AGI
19
Q

Define

“2% AGI Deduction”

A

It essentially means that in order to be able to claim these deductions, they must exceed 2% of the taxpayer’s AGI.

Example

If a taxpayer has an AGI of $100,000 and spent $5,000 on something that qualifies for a deduction that is subject to the 2% limitation, the taxpayer would be able to take a deduction for $3,000 ($5,000 - $2,000), since the 2% limitation (or floor) is $2,000 ($100,000 x 2%). As a result, only the difference between this floor amount and the actual expense would qualify for the deduction.

20
Q

Identify the

“Qualified Education Interest Deductible Amount”

A

$2,500 of the qualified education interest expenses (the deductible amount is limited to $2,500)

21
Q

Identify the

“Educators Expense Deduction”

A

The deductible amount of educator expenses is limited to $250 in 2020.

22
Q

Describe the

“20% Qualified Business Income Deduction”

A
  • TBD
  • Available for tax years 2018-2025
23
Q

Identify the

“Standard Deductions by Income Bracket”

A

TBD

24
Q

Define

“Regressive Tax”

A
  • A tax that is levied as a percentage on an item being purchased.
  • Sales Tax is probably the most popular regressive tax since it is paid at the same rate by everyone based on their consumption and not necessarily on their ability to pay
25
Q

Define

“Proportional Tax”

A
  • Commonly referred to as a flat tax, for which the rate that is applied to whatever is being taxed remains constant, while the amount of the tax does not.
26
Q

Describe who can use the

“Single”

Tax Filing Status

A

Most nonmarried and/or taxpayers without children or dependents will use the Single tax filing status.

27
Q

Describe the 2 Exceptions when filing a

“Head of Household”

Tax Filing Status

A

There is no need to maintain a separate house for parents if at least one parent qualifies as a dependent

A married taxpayer may use a head of household filing status if the taxpayer:

  • Is married,
  • Files a separate tax return from the spouse,
  • Maintains as his/her home a household which for more than one-half of the taxable year is the principal place of abode of a child who is a dependent,
  • Furnishes over one-half of the cost of maintaining the household, and
  • The spouse is not a member of the household during the last six months of the year.
28
Q

Describe who can use the

“Head of Household”

Tax Filing Status

A
  • This filing status is available for taxpayers who are unmarried as of the end of the year or qualify as an abandoned spouse.
  • In addition, they must pay more than ½ the cost of maintaining a household for a dependent relative for more than ½ the tax year.
  • NOTE
    • ​While a “dependent relative” may be someone unrelated to the taxpayer for purposes of determining dependency deductions, head of household status cannot be claimed if the taxpayers only dependents are those who are unrelated by blood or marriage
29
Q

Describe who can use the

“Married Filing Separately”

Tax Filing Status

A

This status is typically used when:

  • Spouses are separated
  • One spouse suspects the other is not reporting income
  • Tax minimization purposes
30
Q

Describe who can use the

“Married Filing Jointly”

Tax Filing Status

A

Taxpayers are able to use this tax filing status in the following scenarios.

  • Married as of the last day of the taxable year
  • A spouse dies during the taxable year

Surviving Spouse (Qualifying Widow)

Allowed for 2 years after the death of a spouse if the taxpayer maintains a home in which a dependent child lives

31
Q

Identify

“TCJA”

A

Tax Cuts & Jobs Act

32
Q

Describe the

“Personal & Dependency Exemption”

A
  • They are suspended for tax years 2018-2025
  • Taxpayers are able to claim each individual who is considered either a qualifying child or qualifying relative as a dependent for income tax purposes.
    • A qualifying child might not be the taxpayer’s child at all
    • A qualifying relative in some cases is not a relative of the taxpayer
33
Q

Describe the

“Age Test to Qualify as a Child Dependent”

A
  • Under 19 years old as of the end of a calendar year, or a student under the age of 24
    • Must be a full-time student during 5 months of the year
34
Q

Identify the

“Standard Deduction for Dependents”

A

A taxpayer who is a dependent of another will have a limited standard deduction, equal to the greater of:

  • $1,100 (2020) or $350 plus earned income
    • ​​Keep in mind that the second part of this equation cannot exceed the standard deduction amount for a Single taxpayer set for the current year.
35
Q

Identify the

“Standard Deduction for Disability”

A

For 2020, the standard deduction for disability is $1,300.

36
Q

Identify the

“Standard Deduction for 65+ Age”

A

For 2020, the standard deduction for age 65+ is $1,300.

37
Q

Define

“Kiddie Tax”

A
  • The kiddie tax prevents parents from avoiding taxes by transferring large gifts of stock.
  • The kiddie tax applies to all children who are 19 years of age and younger.
  • This tax applies to most unearned income that a child receives and does not apply to any salary or wages.
38
Q

What is the threshold for Kiddie Tax?

A
  • The first $1,100 represents the basic standard deduction (for unearned income)
  • The second $1,100 of unearned income is taxed at the dependent’s marginal tax rate
  • This means that the net unearned income in excess of $2,200 is taxed at the parents’ marginal tax rate.
  • It applies to children under the age of 19 with a living parent (up to age 24 if the child is a full-time student and can be claimed as a dependent
39
Q

Identify examples of

unearned income for Kiddie Tax purposes

A
  • Interest
  • Dividends
  • Capital gains
  • Royalties
  • Rents
  • Pension and annuity income
  • Unearned income from trusts
40
Q

What’s the best way to avoid Kiddie Tax?

A

Avoiding the kiddie tax can be done by

investing in U.S. savings bonds or growth securities

since these types of investments generate income that is not subject to taxation and focuses on capital appreciation, respectively.

41
Q

Does income from municipal bonds need to be reported as income?

A

No, income from municipal bonds don’t need to be reported

42
Q

What are the four tests that a dependent must meet to claim them as a qualifying dependent?

A
  • relationship test,
  • gross income test
  • support test
  • not a qualifying child test.
43
Q

What are the four tests that a child must meet to claim them as a qualifying child?

A
  • relationship test
  • abode test
  • age test
  • support test.
44
Q
A

Fundamentals of Income Taxation (3 decks)

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