Chapter 3 - Fundamentals of Income Taxation Flashcards
Individuals report their income, deductions and other information required for the calculation of the federal tax liability on
Form 1040
Includes taxpayer and dependent information and basic tax formula calculation through the calculation of taxable income.
Form 1040 page 1
A basic tax formula calculation, from taxable income through credits and payments with refund or payment information, and signature lines
Form 1040 page 2
Additional income - alimony, unemployment, business income and rental income - and adjustment information - student loan interest, self employment tax and educator expenses
Form 1040 schedule 1
Calculation of additional taxes including Alternative Minimum Tax, Affordable Care Act Advance Premium Tax Credit repayment, self employment tax and penalties on early distributions from pension plans and IRA
Form 1040 schedule 2
Non-refundable tax credits other than the child tax credit and the other dependent credit and other payments and refundable credits other than the earned income credit, American Opportunity credit or additional child tax credit
Form 1040 schedule 3
Deductions for (before) adjusted gross income
Above the line deductions
Deductions from (after) adjusted gross income
Below the line deductions
The greater of the standard deduction or certain allowable itemized deductions and the qualified business income
Below the line deductions
A standard amount used to offset AGI that is specified by Congress
Standard deduction
Allowed for a taxpayer or spouse - not a dependent - who is 65 years of age or older or blind
Additional standard deduction
NOT for dependents
Three situations where a taxpayer is not allowed to use the standard deduction and must itemize
- Married individual who files a separate return cannot use a standard deduction if the spouse itemizes
- Non-resident alien and a dual status alien is not allowed to use a standard deduction
- An individual who files a tax return for less than 12 months because of a change in annual account period
Determined by reducing the taxpayer’s AGI by the greater of the standard deduction or the taxpayer’s itemized deductions
Taxable income
Highest tax bracket a taxpayer falls in
Marginal tax rate
The average rate of tax paid factoring in the payments at various brackets
Effective tax rate
Three accounting methods for reporting income and deductions
- Cash receipts and disbursements - Cash method
- Accrual Method
- Hybrid Method
Under this method of accounting, income items are reported on a tax return for the year in which they are received in cash and expenses are deducted in the year in which they are paid in cash.
Cash receipts and disbursements (Cash Method)
3 common exceptions to the cash method of accounting
- Doctrine of constructive receipt
- Original issue discount bonds
- Cash received with an obligation to repay
Occurs when income is credited to a taxpayer’s account or when it is made available to the taxpayer without restrictions (ex - interest income credited to a client’s account after the bank closes on the last day of the tax year)
Doctrine of constructive receipt
Interest accrued on a zero coupon bond accrues each year is deemed to be constructively received by the taxpayer
Original issue discount
If a taxpayer receives cash but has an obligation to repay the payor the cash is not included in gross income
cash received with an obligation to repay
Method used by many businesses. Income (revenue) is normally reported when it is earned and expenses are normally deducted when they are incurred.
Accrual method
4 exceptions to accrual method
- Prepaid income
- Advance payment for goods
- Advance payment for services
- Claim of right doctrine
Taxpayer must report the entire payment in gross income in the year of the payment even though part or all of the payment may have to be repaid to the customer. If the customer is repaid in a later year the taxpayer is allowed a tax deduction in the year of repayment
The claim of right doctrine
Includes any other method of reporting that is permitted by the IRC and regulations as long as it is deemed to clearly reflect income
Hybrid method
Surviving spouse filing status eligibility
- Spouse died during either of the 2 preceding tax years
- Taxpayer must maintain a household as their home which is also the principal residence of a dependent child
- Has not remarried
- Taxpayer and spouse were eligible to file a joint return for the spouse’s year of death
Afford the same basic standard deduction and tax rates as the married filing jointly status to surviving spouses
Surviving spouse/Qualifying widower filing status
Provides a basic standard deduction and tax bracket sizes that are less favorable to the taxpayer then those for surviving spouse but more favorable than those for the single filing status
Head of household
Head of household filing status requirements
- Must maintain a household as their home which is also the principal residence for more than 1/2 the year for child who may be claimed as a qualifying dependent, or unmarried qualifying child that lives with taxpayer but is not a dependent, or qualifying relative who is claimed as a dependent
4 tests for qualifying child
- Relationship test
- Abode test
- Age test
- Support test
4 tests for qualifying relative
- Relationship test
- Gross income test
- Support test
- Not a qualifying child test
The taxpayer must provide more than one half support of the dependent
Support test
Dependent’s gross income must be less than the exemption amount which is indexed for inflation annually
Gross income test
Qualifying child does not provide more than one half of his own support during the year
Support test
Qualifying child must be under the age of 19 and younger than the taxpayer or a student under 24 and younger than the tax payer (full time at least 5 months of year)
Age test
Qualifying child must live with the taxpayer for more than half the year - includes temporary absences due to special circumstances like illness, education, vacation or military service
Abode Test
A qualifying child is the taxpayer’s sibling, descendant of the taxpayer or the descendant’s sibling
Relationship test
Taxpayer with higher AGI claims the child as a qualifying dependent
Tie breaker rules
In order to be claimed as a qualifying relative a dependent cannot be a qualifying child of any taxpayer for the tax year
Not a qualifying child test
A married dependent must not file a joint return with a spouse unless a tax return is filed only to claim a refund for tax withheld
Joint return test
A dependent must be a citizen or a national of the US or a resident of the US, Canada or Mexico during some part of the year
Citizenship or residency test
Tax formula for individual taxpayers
Income - Deductions = Taxable Income
Taxable Income x Tax Rate = Tax Liability
Expanded tax formula
Income - Exclusions = Gross Income
Gross Income - Deductions for AGI = Adjusted Gross Income
AGI - Greater of itemized or standard deduction - Personal and dependency exemptions - 20% qualified business income deductions = Taxable Income
Taxable Income x applicable tax rates - Tax credits = Tax liability
Standard deduction
MFJ $25,900
MFS $12,950
Surviving Spouse $25,900
HOH $19,400
Single $12,950
Child claimed as dependent $1,150 or earned income plus $400 limited to $12,950
Additional standard deduction for over 65 or blind - per taxpayer
MFJ $1,400
MFS $1,400
Surviving spouse $1,400
HOH $1,750
Single $1,750
Kiddie tax
Unearned income taxed at parents marginal tax rate above $2,300
Above the line deductions
(MEALBRIC)
Alimony paid
Contributions to IRA
Interest on student loans up to $2,500
Business expenses
Rental income expenses
Losses from sales of business property
Moving expenses
Educator expenses up to $300
Below the line deductions
(CMIIPCM)
Charitable contributions
Mortgage interest
Investment interest
State & local income taxes
Real property taxes
Property taxes based on the value of a car
Medical expenses in excess of 7.5% AGI
