Income Tax Fundamentals

Question 1

What is the meaning of filing status and what are the different types?

Answer 1

Filing status has the most significant impact on tax liability

Single
Married filing separately 
Married filing joint
Head of household
Qualifying widower with dependent child: good for 3 years after death of spouse

Question 2

What is a qualified child?

Answer 2

A qualifying child must be the taxpayer’s child, stepchild, foster child, brother, stepbrother, sister, stepsister, or a descendant of any of the previously listed and must have lived with the taxpayer more than half of the tax year. The individual must pass an age test, meeting one of the following standards: „

• Under age 19 at the close of the tax year „
• A full-time student and under age 24 at the close of the tax year. „
• Totally and permanently disabled at any time during the tax year

Question 3

What is a qualified relative?

Answer 3

A qualifying relative is an individual who is not a qualifying child and bears a specified relationship to the taxpayer such as a parent, in-law, niece, nephew, aunt, uncle, or is unrelated to the taxpayer but resided in the taxpayer’s principal home during the tax year. The taxpayer must have provided more than half of the person’s support for the tax year.

Question 4

What are qualified dividends and what tax treatment do they get?

Answer 4

Only dividends from stock - they receive capital gains rates.

Question 5

Alimony payment taxing?

Answer 5

Prior to Dec 31, 2018, they are taxable to the recipient as they are deductible by the payee.

After Jan 1, 2019, payments are not included in income nor are payments tax deductible

Question 6

What are exclusions?

Answer 6

Special income that is not included as income and therefore, not taxed.

Life insurance proceeds received by reason of death of the insured
A gift or most inheritances received,
Interest received from municipal bonds
Child support payments received
Workers’ compensation insurance proceeds
Many employee fringe benefits including employer-provided health insurance coverage, group term life insurance coverage up to $50,000, qualified employee discounts, and employee educational assistance.

Question 7

What are the 1040 schedule forms?

Answer 7

A: Itemized deductions
B: (think bank interests) interest and ordinary dividends
C: Sole proprietorship (tied to schedule SE)
D: Capital gains and losses
E: S Corps, partnerships, rental real estate
SE: self employment (tied to schedule C)

Question 8

What is taxable income?

Answer 8

Amount of taxable income after deductions

Question 9

What is tax liability?

Answer 9

Amount of taxes owed

Question 10

What is a tax credit?

Answer 10

A dollar-for-dollar tax reduction (i.e. it reduces the tax liability)

Question 11

What are tax deductions?

Answer 11

They reduce the taxable income

Question 12

Definition of gross income.

Answer 12

All income from whatever source derived except for qualified exclusions

Question 13

What “extra” tax does self-employed individuals have to pay?

Answer 13

FICA payroll tax of 15.3%. This is made up of SS tax of 12.4% and Medicare tax of 2.9%

There is an additional Medicare tax of .9% for S earning $200k and MFJ over $250k

Question 14

How many years can capital losses carryover?

Answer 14

Until depleted

Question 15

What is the applicable federal interest rate?

Answer 15

It is the minimum interest rate allowed for loans by the IRS

Question 16

What are inputed interest rules?

Answer 16

These are a series of rules to ensure that gifts and loans do not go without proper taxes. Loans between family members, loans between employer and employee are examples

Question 17

What are compensatory damages?

Answer 17

Damages awarded that are only intended to make the injured whole again. This award is not taxable.

Question 18

What are punitive damages?

Answer 18

These are damages awarded which are intended to punish the offender (tortfeasor). These damages are usually taxable

Question 19

What is the purpose of adjusted gross income?

Answer 19

Set the deductible floor for medical expenses
Sets limits on allowable casualty loss deductions
Sets maximum annual deduction limits on charitable contributions
Determines whether contributions to traditional IRA will be deductible. It also limits the ability to contribute to a Roth IRA.

Question 20

What does Modified Adjusted Gross Income (MAGI) determine?

Answer 20

Phaseout limits for student loans, series EE bonds, etc.

Question 21

What is acquisition debt?

Answer 21

Any debt incurred acquiring, constructing, or substantially improving any qualified residence

Question 22

What is the difference between old and new mortgage debt?

Answer 22

Cutoff is Dec 15th, 2017. Prior is qualified debt up to $1M for interest tax deductions. Post is qualified debt up to $750K for interest tax deductions.

Question 23

When are personal casualty losses tax deductible?

Answer 23

When the event is a federally declared disaster.

Question 24

What is the difference between effective and average tax rates?

Answer 24

Effective uses taxable income, or tax liability to generate a tax rate

Average uses total income to generate a tax rate

Question 25

What is the equivalent tax benefit?

Answer 25

This formula determines the amount of a tax credit that would equal a given deduction or exclusion. You can divide the TC by m to determine what deduction is equal to a given TC.

TC = d x m OR d = TC / m

TC=Tax Credit
d=before-tax benefit
m=marginal income tax bracket

Question 26

What is the difference between a refundable and non-refundable tax credit?

Answer 26

Refundable means that taxes are paid back to the taxpayer even if their tax liability goes to zero. Non-refundable means that taxes are not paid back to the tax payer once their tax liability goes to zero.

Question 27

For the dependent care tax credit, what are the important numbers to remember?

Answer 27

Expenses are capped at $3000 for one child and $6000 for two or more children with the credit of 20% of expenses applying to households earning $43k or more. This usually results in credits of $600 for one child or $1200 for two or more children… usually.

Question 28

What is the child tax credit?

Answer 28

$2000 given for each qualifying child up to a MAGI of over $400k MFJ or $200k any other status. If over, the credit is incremental decreased.

Question 29

What is the adoption credit?

Answer 29

Nonrefundable credit given to the adoption parents in the year the adoption is final. If the adoption credit takes the tax liability to zero, the remaining balance can be carried forward for 5 years.

Question 30

What is the order in which the tax calculation should be made in order to maximize the impact of tax credits?

Answer 30

Subtract the non-refundable tax credits from the total tax liability first.
Then add any other tax liabilities in (i.e. penalties for early IRA withdraws)
Then subtract the refundable tax credits.
Finally, subtract taxes already paid.

Question 31

Difference between child tax credit and dependent care credit?

Answer 31

Child tax credit is up to $2000 per child, $1500 is refundable.

Dependent care credit is usually 20% of $3000 or $6000 (2 or more dependents) and is non-refundable.

Question 32

What is the magic date for divorce and what does it mean?

Answer 32

Dec 31 2018- prior to, alimony is part of income. Post, it is not.

Question 33

What is included in total income prior to Jan 1 2019; alimony and/or child support?

Answer 33

Just alimony and only if prior to Jan 1, 2019. It is not included in the payee’s income or able to be deducted from the payor’s income after Jan 1, 2019.

Question 34

What are the five major itemized deductions?

Answer 34

Medical expenses above 7.5%
Taxes (paid state taxes? deductible - limit $10k)
Interest - mortgage, investment (margin)
Charitable contributions
Personal casualty - must be fed declared disaster

Question 35

When is a home equity loan interest able to be deducted?

Answer 35

When it meets the standard for acquisition indebtedness - home improvements.

Question 36

When can you deduct gambling losses?

Answer 36

Only when you have gambling winnings to offset in the same year.

Question 37

What is the limit for itemized state and local taxes?

Answer 37

$10k

Question 38

When are medical expenses allowed to be deducted from income?

Answer 38

When the expenses exceed 7.5% of AGI and are unreimbursed

Question 39

What is the meaning of the marginal tax rate or tax bracket?

Answer 39

It is the rate of tax imposed on the last dollar earned.

Question 40

What is the American Opportunity Tax Credit?

Answer 40

Undergrade programs, full time student, 100% of first $2000, 25% of second $2000

Question 41

What is the lifetime learning credit?

Answer 41

Allowed 20% of $10000 per person, per year. You don’t have to be full time or enrolled in a college program

Question 42

What is the foreign tax credit?

Answer 42

Prevents double-taxing from foreign and US government. Can apply for tax credit or income exclusion, but not both

Question 43

How is the dependent care tax credit calculated?

Answer 43

Maximum qualifying expenditures are $3000 for one dependent or $6000 for two or more. With an AGI of above $43000, you multiply 20% by the total qualifying expenditures.

Question 44

What is the additional standard deduction?

Answer 44

Over 65 and blindness gets additional deductions

Question 45

How is paid self-employment tax deducted?

Answer 45

The EE can deduct the employer’s 1/2 of the self-employment tax. This helps the self-employed who are responsible for the entirety of the FICA/SS tax.