Chapter 3 Questions

Question 1

What is “adjusted gross income”?

Answer 1

The calculation of an individual taxpayer’s adjusted gross income (AGI) is an intermediate step in the process of determining taxable income. To ascertain AGI, certain deductions are subtracted from the taxpayer’s gross income. These deductions are referred to as “above-the-line” deductions and are available regardless of whether the taxpayer claims “itemized” deductions. Above-the-line deductions reduce AGI, which is one of the most important tax planning objectives for individual taxpayers because if AGI exceeds certain specified amounts, many tax benefits are either reduced or “phased out.”

Question 2

List several items that are deductible from gross income in determining adjusted gross income.

Answer 2

Above-the-line deductions generally relate to business or income-producing activities of the taxpayer. Although not an all-inclusive list, the following are several of the more important above-the-line deductions claimed by individual taxpayers:

• deductible contributions to pension and profit-sharing plans of self-employed individuals
• deductible alimony payments for divorce or separation agreements completed before December 31, 2018
• deductible moving expenses for members of the armed forces
• contributions to medical savings accounts or health savings accounts
• deductible contributions to IRAs
• deductible interest payments made on qualified education loans
• penalties or other forfeitures resulting from premature withdrawals from time savings accounts or deposits

Question 3

What is the standard deduction and how is it used?

Answer 3

The standard deduction is a specified amount, indexed annually for inflation, that may be claimed in calculating taxable income by taxpayers who do not itemize their deductions. The amount of the taxpayer’s standard deduction is based on filing status. Increased amounts are available for blind taxpayers and taxpayers aged 65 and over. In choosing between itemizing deductions and taking the standard deduction, the typical taxpayer would opt to itemize if the total amount of such deductions exceeds the applicable standard deduction.

Question 4

Explain how the standard deduction available to a taxpayer who is the dependent of another taxpayer is limited.

Answer 4

Dependents are not eligible to claim the regular standard deduction amounts on their own tax returns. The special standard deduction amount allowable on a dependent’s tax return is the greater of a specified dollar amount, or a smaller dollar amount plus the dependent’s earned income for the year (but not more than the regular standard deduction amount). The dollar amounts are indexed annually for inflation. For tax years 2018 through 2025, the dependency exemption is zero.

Question 5

Explain the additional amounts that increase the standard deduction for aged and blind taxpayers.

Answer 5

A special rule applies to taxpayers who are 65 years of age or older and/or are legally blind. Such taxpayers (including dependents) are entitled to increase their standard deduction by specified amounts. For married taxpayers filing jointly, each spouse who qualifies may add the additional amount or amounts to the standard deduction claimed on the joint return.

Question 6

Does the fact that a taxpayer is the dependent of another for tax purposes affect the availability of someone else to claim that person as a dependent? Explain.

Answer 6

A taxpayer may only be claimed as a dependent on a single return.

Question 7

Who may a taxpayer claim as a dependent for tax purposes?

Answer 7

A taxpayer may claim any individual as a dependent who meets the definition of either a “qualifying child” or a “qualifying relative.” Such individuals must also meet the following additional requirements:

• First, the individual being claimed as a dependent may not claim any other individual as his or her own dependent for income tax purposes.
• Second, the individual being claimed as a dependent may generally not file a joint return with his or her spouse for the year.
• Third, an individual who is not a U.S. citizen or national generally cannot be claimed as a dependent unless that individual is a resident of either the United States or a country contiguous to the United States. However, a legally adopted child of the taxpayer (or one legally placed for adoption) can be claimed as a dependent of the taxpayer if the child has the same principal place of abode as the taxpayer for the year and is a member of the taxpayer’s household (provided that the taxpayer is a U.S. citizen or national).

Question 8

Describe the “tie-breakers” that determine what taxpayer is entitled to claim an individual as a dependent.

Answer 8

First, if only one of the taxpayers eligible to claim an individual is a parent of that individual, the parent is entitled to the exemption. This can occur, for example, where both a grandparent and a parent are eligible. Second, if a child’s parents don’t file a joint return, and each of them is eligible to claim the child as a dependent, the parent with whom the child resided for the longer period of time during the year gets the exemption. If that amount of time is equal, then the parent with the greater amount of adjusted gross income (AGI) for the year gets the exemption. Third, if the child or other individual is not claimed as a dependent by either of his or her parents, and other taxpayers are able to claim the individual as a dependent, then the taxpayer with the highest AGI for the year gets the exemption. Note that these rules will apply where more than one taxpayer attempts to claim an exemption for the same person.

Question 9

Explain when the phasing out of a deduction or tax credit can combine to change the effective marginal tax rates of individual taxpayers.

Answer 9

In addition to the marginal rate of tax imposed by the Code, taxpayers lose deductions (and/or credits) with each additional increment of income that results in phaseouts. Therefore the actual effective tax rate on the increments of income that result in the phaseout of tax benefits may be significantly higher than the statutory marginal rate.

Question 10

Explain the rules for divorced and separated parents with regard to the dependency exemption for divorce or separation agreements completed before December 31, 2018.

Answer 10

The general rule for claiming a dependency exemption for a child of divorced or separated parents is that the custodial parent is entitled to the dependency exemption. However, if the custodial parent signs a written declaration that he or she will not claim the child as a dependent for tax purposes (that is, “releases” the exemption), the noncustodial parent may claim the exemption if the written declaration is attached to his or her tax return. A “custodial parent” for this purpose is the parent who has custody of the child for the greater portion of the calendar year. This rule applies regardless of the general requirement that a “qualifying child” have the same principal place of abode as the taxpayer

Question 11

How many basic federal income tax rates are there?

Answer 11

There are seven basic federal income tax rates under current law. The lowest marginal tax rates are 10 and 12 percent. The highest marginal rate is currently 37 percent.

Question 12

What are the five different filing statuses for taxpayers other than corporations?

Answer 12

The filing status for taxpayers other than corporations includes the following five groups:

• married taxpayers filing jointly
• unmarried heads of households
• unmarried or single taxpayers
• married taxpayers filing separately
• estates and trusts

Question 13

What is the general rule regarding the liability of spouses for payment of tax due with respect to a joint return?

Answer 13

The general rule is that each spouse is jointly and severally liable for the tax payable with respect to a joint return. However, the “innocent spouse” rules may provide an exception to this treatment for a spouse who qualifies under those rules.

Question 14

Explain the rules for filing a tax return as a “surviving spouse.”

Answer 14

A “surviving spouse” is permitted to file and use the tax brackets applicable to joint returns. To qualify for joint return status, the surviving spouse must maintain a household that includes a son, stepson, daughter, or stepdaughter who is eligible to be claimed as a dependent under the dependency exemption rules. The surviving spouse must furnish over half the cost of maintaining the household.

Question 15

For how many years may this category be claimed?

Answer 15

The surviving spouse may file under the joint return status for a period of 2 years, beginning with the year following the year of the spouse’s death.

Question 16

How may a taxpayer qualify under the category of “head of household”?

Answer 16

The rules for qualifying as an unmarried head of household can be briefly summarized as follows:

• the marital status requirement. The taxpayer must be unmarried at the close of the taxable year except when he or she is considered an abandoned spouse.
• the household requirement. The taxpayer must maintain a household and furnish over half the cost of doing so during the taxable year.
• the qualifying person requirement. A qualifying person must generally be a member of the taxpayer’s household for more than one-half of the taxable year. That person must be either a “qualifying child” of the taxpayer under the dependency exemption rules, or a “qualifying relative” under those rules who is actually related to the taxpayer.
• the rule for parents. A parent may be a qualifying person, even if the parent does not live in the taxpayer’s household but can still be claimed by the taxpayer as a dependent while living in a long-term care facility.

Question 17

What tax-avoidance technique is the kiddie tax designed to prevent?

Answer 17

Since parents generally have more income than their young children, they desire to transfer investment assets to the children to gain the benefit of lower marginal tax rates. The “kiddie tax” is designed to prevent the parents from shifting large amounts of unearned income to their children and making the shift effective for income tax purposes.

Question 18

Explain the mechanics of the kiddie tax.

Answer 18

The mechanics of the kiddie tax can be summarized as follows:

• If a child under a specified age has unearned income above a specified amount, the excess is taxed at the applicable rates for trusts and estates.
• It applies to unearned income generated by any asset the child owns, regardless of when or by whom the asset was transferred to the child (except for income from certain qualified disability trusts).
• The additional tax paid with the child’s return reflects a tax on the net unearned income taxed at the applicable income tax rate schedule for trusts and estates.
• It applies only if a child has at least one parent living at the end of the taxable year.
• It does not apply if the child is married and files a joint return with his or her spouse.
• The rules become more complicated if a child has both earned and unearned income.

Question 19

Does the kiddie tax generally apply to income generated by assets gifted to a child by his or her grandparents? Explain.

Answer 19

Yes, the kiddie tax rules call for net unearned income of children under a specified age to be taxed at the applicable rate for trusts and estates. Therefore income generated by assets gifted by any family member or friend is generally subject to the kiddie tax.

Question 20

What is the due date for filing individual income tax returns?

Answer 20

Individuals are generally required to file income tax returns by April 15, unless an extension is obtained.