3. Income Taxation Fundamentals Flashcards
Define
“Marginal Tax Rate”
- 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.
Define
“Effective Tax Rate”
- 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
Identify the acronym
“FICA”
Federal Insurance Contributions Act
Identify the acronym
“FUTA”
Federal Unemployment Tax Act
Identify the
“Federal Income Tax Formula”
Income - Deductions = Taxable Income X Tax Rate
=
Tax Liability
Define
“Progressive Tax System”
- 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.
Describe
“Gross vs Adjusted Gross Income”
Income - Exclusions = Gross Income
and
Gross Income - Deductions* = Adjusted Gross Income
* deductions are considered to be above the line deductions
Describe
“Expanded Federal Income Taxable Formula”
Gross Income
-
Greater of Itemized or Standardized Deductions
(Below the Line Deductions)
-
Personal and Dependency Exceptions
-
20% Qualified Business Income Deduction
=
Taxable Income
Describe
“Tax Liability”
Taxable Income
X
Applicable Tax Rate
-
Tax Credits
=
Tax Liability
Define
“Gross Income”
All income from whatever source derived
Identify
“Inclusion of Gross Income”
- 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)
Identify
“Exclusions from Gross Income”
- 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
Explain the importance of
“Adjusted Gross Income”
“The Line”
AGI is used to determine
- limitations on deductions
- limitation on credits
- phase-outs of certain tax benefits
Identify
“Above the Line Deductions”
- 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
Identify the
“2020 Standard Deduction Amounts”
Identify the
“Additional Deductions”
(Blind and/or Age 65+)
Identify
“Taxpayers Who Must Itemize Deductions”
- 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.
Identify
“Common Itemized Deductions”
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
Define
“2% AGI Deduction”
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.
Identify the
“Qualified Education Interest Deductible Amount”
$2,500 of the qualified education interest expenses (the deductible amount is limited to $2,500)
Identify the
“Educators Expense Deduction”
The deductible amount of educator expenses is limited to $250 in 2020.
Describe the
“20% Qualified Business Income Deduction”
- TBD
- Available for tax years 2018-2025
Identify the
“Standard Deductions by Income Bracket”
TBD
Define
“Regressive Tax”
- 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
