Module 2 - Tax Law Basics & Filing Status & Dependency Flashcards
What are the 4 basic things you need to understand about Tax Law?
- Filing Requirements
- Filing Status
- Dependency
- Understanding the Tax Return
What are the IRS Volunteer Resources Available and what do they contain?
IRS Publications:
- 6744: VITA/TCE Volunteer Assistor’s Test/Retest:
- 4012: VITA/TCE Volunteer Resource Guide:
- 4491: VITA/TCE Training Guide:
- 4961: Volunteer Standards of Conduct - Ethics
- 5101 - Intake Interview and Quality Review
- 17: Federal Income Tax for Individuals
In what pub can you find filing requirements?
PUB 4012 - Section A -
Charts A-D
Chart A - For Most People who MUST file
What are the main determinants of whether the person must file?
(4)
- Gross income
- Filing status
- Age
- And whether the spouse is Blind
Chart B -
To be Used for Children and Other dependents
The 2 main determinants
- Unearned income
- Dependents marriage status (single/married)
What is included in unearned income?
Unearned income includes:
- Taxable interest
- Ordinary dividents
- CG distributions
- Unemployment compensation
- Taxable SS benefits
- Pensions,
- annuities,
- Distributions of unearned income from a trust
What is included in earned income?
- Salaries
- wages
- tips
- professional fees
- taxable scholarship
- fellowship grants
what are annuities?
An annuity is a contract between you and an insurance company that requires the insurer to make payments to you, either immediately or in the future. You buy an annuity by making either a single payment or a series of payments. Similarly, your payout may come either as one lump-sum payment or as a series of payments over time.
What are professional fees?
Professional fees are prices charged by individuals specially trained in specific fields of arts and sciences, such as doctors, architects, lawyers, and accountants. “Professional Fees” is usually an income account used by a professional firm in recording its revenues.
What is the Kiddie Tax (Form 8615)?
AKA Tax for Certain Children who have Unearned Income
For children under 18 who have received unearned income of over $2200
What should be included in Gross Income?
Gross income includes all income you received in the form of money, goods property, and services that isn’t exempt from tax. This includes income from sources outside the US or from the sale of your main house (even if you can exclude some or all of it)
GI includes gains but not losses from Form 8948 or Sch. D
Do not include any SS benefits unless:
- You are MFS and you lived with your spouse in the tax year (any time)
- 1/2 of your SS benefits + other gross income and any tax-exempt interest is more than $25k ($32k for MFJ)
What is Schedule D used for? (Form 1040 or 1040-SR)?
SR - senior
Use Schedule D (Form 1040 or 1040-SR) to report the following:
The sale or exchange of a capital asset not reported on another form or schedule.
Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit.
Capital gain distributions not reported directly on Form 1040 (or effectively connected capital gain distributions not reported directly on Form 1040-NR).
Nonbusiness bad debts.
Chart C
Other Situations When you Must File
- You owe any special taxes
- AMT
- Tax on a qual. plan (IRA) or other tax favored account
- Household employment taxes
- SS and Medicare tax on tips you did not report to your employer or on wages you received from an employed who did not withhold these taxes
- Recapture taxes (first-time homebuyer)
- You or your spouse received HSA distributions (if filing jointly), Archer MSA & Medicare Ad. MSA distributions
- You had earning of SE of at least $400
- Earnings from a church (>=$108.28)
- Advance payments of the premium tax credit were made to you
- Advance payments of health coverage tax credit made for you/spouse/dependent
- Amounts in section 965
What is the premium tax credit (PTC)?
The premium tax credit – also known as PTC – is a refundable credit that helps eligible individuals and families cover the premiums for their health insurance purchased through the Health Insurance Marketplace. To get this credit, you must meet certain requirements and file a tax return with Form 8962, Premium Tax Credit.
What Is Depreciation Recapture?
Depreciation recapture is the gain realized by the sale of depreciable capital property that must be reported as ordinary income for tax purposes. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus “recaptured” by reporting it as ordinary income
- Section 1245 Depreciation Recapture
- Unrecaptured Section 1250 Gain
Depreciation recapture is reported on Internal Revenue Service (IRS) Form 4797.
Chart D
Reasons for filing even when you don’t have to:
- Protection from identity theft
- Claim a refund due to excess tax withholdings during the year
- Qualifies for tax credits
Determining the client’s filing status
People are misinformed, so you need to be able to ask questions to decipher their correct filing status.
Do not rely on past year’s status
What are the 5 filing statuses?
What is the first question you should ask to determine the client’s filing status?
- Single
- MFJ
- MFS
- HOH
- Qualifying widower
The first question you should ask when determining filing status:
What is your marital status on December 31, 2020
Who may file as Single?
Taxpayers may file as single if on the last day of the tax year any of the following is true
- have never married
- had marriage legally annulled
- are legally divorced (paperwork signed)
- were widowed before the beginning of the tax year
- are legally separated (does NOT apply in TX)
What marriages are considered?
- Normal
- same-sex marriages
- common law marriage
what is common law marriage?
Informal marriage - legal marriage without a ceremony or other formalities (paperwork)
Conditions to be valid:
- Neither person was married to anyone else
- Both partners are 18 or older
- Both partners agree to be married
- Live in TX as a married couple
- Represent themselves as married to others
You don’t need to ask for evidence, but joint purchases or leases, accounts, health insurance recipient, etc.
No set time frame - don’t need to live with each other for a defined period of time (6 months)
If they’re unsure, take the safer route and do not marry them
What do you do with Death of a Spouse situations?
- Case 1: spouse dies, and they don’t remarry during tax year. File MFJ with dec. spouse or MFS
- Case 2: spouse dies, and they remarry. Must file a MFJ with current spouse or MFS. The deceased spouse’s estate must file MFS return.
What are the 3 things that can invalidate a marriage?
- Dissolved by law (annulment or divorce)
- Death of a spouse
- A violation of local law (person carrying a previous marriage)
Note: US recognizes foreign marriages, and if the marriage occurred in a different state and it was legal, it’s recognized as well.
Requirements for filing MFJ - married filing jointly
- Be married for tax purposes (legally and not ended through law or death)
- Both parties must agree to file MFJ
Both spouses may be held responsible, jointly and individually, for the tax, interest, and penalties on the return.
Can spouses file MFJ even if only one spouse has income?
Yes
Can the married taxpayer filing MFJ claim the spouse as a dependent?
No
When married taxpayers want to file as MFS or do not agree to file as MFJ must file MFS, what should you ask?
WHY? Ensure their reasoning makes sense
What are the advantages of MFJ over MFS?
- MFJ Advantage: Can claim all the credits, all allowable deductions, taxed at a lower rate (dependent care credit, American opp credit, etc).
-
MFS: not responsible for spouse’s tax liability (caveat: TX is a community property state - division is 50/50, ask if they have the information for the other spouse)
- If community property becomes an issue as for help
- MFS Disadvantage: cannot claim most credits, cannot take student loan interest adj. Large portion of SS income may be taxable, higher tax rates
What 3 things does the IRS do with the refund of people with past due amounts?
- Pay federal taxes
- pay owed child support
- student loan repayments
In the case of MFJ refund, the full amount will be applied even if the past amount is only one spouse’s responsibility. Unless the client uses the injured spouse form (This might be the reason a client asks to file MFS).
What should you do if the client wants to file MFS because the other spouse owes, and he doesn’t want to lose the refund?
Suggest the Injured Spouse Form (must be completed by a manager)
Does not divide the refund in half. It allocates the refund b/w spouses based on:
- Respective incomes
- Support of dependents
- Community property laws
Injured spouse must not be legally liable for the past due amount
This is beneficial even if the injured spouse does not receive any refund because they’d use MFJ tax rate, may qualify for credits, may reduce past due amount faster
What are all the requirements that must be met to file head of household (HOH)?
- Unmarried/single on last day of the year
- Paid more than 1/2 of the cost of keeping up a home for the year (rent, mortgage, taxes, insurance, groceries)
- At least 1 qualified person lived with the taxpayer in home for more than half the year
Special rules for dependent parents: they don’t have to live with you during the year, so you only need to show that you are paying for over 1/2 of the home/household.
Exception 2 - “considered unmarried” - person who is married, but spouse has not lived with them for the past 6 months. They’re taking care of a qualifying dependent(child, stepchild, foster child,etc.)
What constitutes a qualifying person for HOH filing status?
Terms for qualifying dependents
- Qualifying child who lived with the taxpayer for more than half the year. (Temporary absences does not disqualify from HOH)
- Qualifying relative - taxpayer’s parents (>50% of parents abode)
- Qualifying relative (by blood or marriage) other than a parent.
What are all the conditions that need to be met to be “Considered Unmarried” for HOH filing?
Note: if any condition is not met, HOH not allowed
- No MFJ filing with spouse
- paid more than 1/2 cost of keeping a home
- spouse did not live in the taxpayer’s home during the last 6 months of the year (7/1 July)
- Taxpayer’s home was the main home of the child for more than half the year.
- Taxpayer can claim the child as a dependent
What are all the requirements needed to be able to file as a qualified widow(er)?
- Spouse died in 2019 or 2020
- Was entitled to file MFJ with the spouse on the year they passed.
- Taxpayer did not remarry before end of year 12-31-20
- Taxpayer paid over half the cost of keeping a home in 2020
- Taxpayer’s child lived in the home all year
- Child can be claimed OR would’ve been claimed as a dependent except:
- Child’s gross income >$4,300
- Child is filing MFJ
- The taxpayer can be claimed as a dependent
Only 1. would disqualify the child
Differences between QW & HOH
Standard deduction, requirements for child, timeframe
Standard deduction
- QW - $24,800
- HOH - $18,650
Requirements for child
- QW - no gross income limitation for child who does not qualify as a qualifying child, and child may file MFJ
- HOH - child must meet the qualifying relative requirements
Timeframe
- QW - applies for a max of 2 years
- HOH - applies as long as the taxpayer has a qualifying dependent.
Filing Status Decision Tree
https://www.irs.gov/pub/irs-pdf/p4012.pdf
What are the 2 classifications of dependents?
- Qualifying child
- Qualifying relative
3 rules for all dependents
3 Criteria or tests that all dependents must pass
- Dependent taxpayer test
- Joint return test
- Citizenship or residency test
What is the dependent taxpayer test?
Making sure the taxpayer is not being claimed as dependent by someone else
What is the joint return test?
Dependent is not filing MFJ return except to claim refund of federal withholdings or estimated taxes.
Most dependents will be single, but in some instances you might run into a spouse and child who are both in school
What does the citizen or residence test for dependents entail?
Dependent must be a:
- US citizen
- US resident alien
- US national
- Resident of Canada or Mexico
In the case of Canada or Mexico, they have to have a social security card or ITIN
What is the ITIN?
An Individual Taxpayer Identification Number (ITIN) is a tax processing number issued by the Internal Revenue Service. The IRS issues ITINs to individuals who are required to have a U.S. taxpayer identification number but who do not have, and are not eligible to obtain, a Social Security number (SSN) from the Social Security Administration (SSA).
4 Criteria to be claimed a qualifying child
In addition to the requirements for all dependents, to be claimed as a qualifying child all these requirements must also be met:
- Relationship
- Age
- Residency
- Support
What is the relationship criteria?
Qualifying Child
Child must be:
Child, adopted child, foster child, or a descendant of any of them
Sibling, half-sibling, stepsibling, or a descendant of any of them
What are the age requirements for qualifying child?
Child must be:
- Under age 19 at end of year and younger than the taxpayer (or spouse)
- Or under age 24 at end of year and a full time student at least 5 months of the year and younger than the taxpayer (or spouse)
- Any age and permanently and totally disabled any time during the year
Residency - Qualifying Child Criteria
Child must live with the taxpayer for more than 1/2 the year
Exceptions: newborns, death of child, or kidnapped
Temporary absences accepted and counted if due to:
illness, education, business, vacation, military service, detention in a juvenile facility
Support - qualifying child
Child must not have provided more than half of own support.
16-18-year-olds need to ask them how they’re using their income. Parents must pay for over half their support.
Qualifying Child of 2+ People
Tiebreaker Rules
- Parent/nonparent –> parent
- Parent filing MFJ –> qual child of both parents
- Parents not filing MFJ –> parent with whom child lived with most time (if tied, parent with highest AGI)
- Parent does not claim child –> person with highest AGI
Qualifying Relative (or Person used interchangeably)
4 Criteria
All of the following must be met:
- not a qualifying child test
- member of household or relationship test
- gross income test
- support test
Not a qualifying child test understanding
Can’t be your qual relative, if the child is your qual child. or the qual child of another taxpayer.
Member of Household or Relationship Test
-Qualifying Relative
- Must live with all year as a member of your household or
- Must be related to you in one of the ways listed later in this section
Residency - Qual relative Test
- Considered to live with the taxpayer as member of household during temporary absences due to special circumstances
- Person who was born or died during the year but lived with the taxpayer as a member of the household when alive meets this test
Relatives that do not need to live with taxpayer
(QUAL. RELATIVE)
Taxpayer’s
- Childs or descendants
- Siblings
- Parents, grandparents
- Stepparent
- Child of taxpayer’s siblings
- Sister or brother of taxpayer’s father/mother
- Taxpayer’s son/daughter/mother/father/brother/sister - IN LAW
Note: relationships established by marriage do not end with a divorce or the death of the taxpayer’s spouse
Income Criteria - Qualifying Relative
What is the max income that the dependent can have to be classified as a qual. relative?
The gross income of the qual. relative cannot exceed $4300
Support Test - Qualifying Relative Criteria
- Taxpayer pays over half the person’s support
- Multiple support arrangement:
- Over 50% of the person’s support is provided by others
- Not one person’s share is over 50%
- One person providing over 10% of the support can claim the persona as dependent with agreement from the others. (need to get it in writing)
Is there a worksheet on the volunteer handbook (pub 4012) to help determine support?
Yes. However, if still in doubt, ask your manager
What are some common issues for people trying to claim qualifying children?
- Children cannot provide over half their own support
- Ask questions about child’s income relative to parent’s income
- Go through the support worksheet
What are some common support issues with qualifying relatives?
- Dependent must meet both gross income and support tests
- Percentage of support by taxpayer does not matter if the gross income is too high (>4300)
Decision Trees
Use Qualifying Child & Relative Decision Trees in every return
What is the Earned Income Credit (EIC)?
a good number of VITA clients receive it, master it
You do not need qual. child/relative to qualify for EIC
In the software, you need to enable it
Types of EIC decision trees
- EIC general eligibility
- EIC WITH qualifying child
- EIC W/O qual. child
What does “injured spouse” mean?
Form 8379
Person not able to claim refund due to amounts owed typically by a partner
“injured spouse” – not the one that has the balance due. They could receive up to 50% of the refund. “Injured” means they don’t get their refund.
Does not divide the refund in half – it allocates it between spouses based on: respective incomes, support of dependents, and community property laws.
What is the difference b/w taxable credits and taxable deductions?
Taxable credits – reduces your tax bill
Taxable deductions – reduces your taxable income
Understanding the Tax Return
What are the 5 Tax Return Categories based on what is being reported?
- Income
- Adjustments
- Deductions
- Credits
- Taxes
What is included in Income?
- Multiple sources: wages, pension, gains on stock sales, etc.
- Is not always monetary - could also include pay in the form of goods and services (IT and landscaping barter)
- Includes income received from outside the US
What are the 3 types of Income?
- Earned income - active - wages, self-employment earnings, cash
- Unearned income - passive - interest/dividends/pension
- Tax-exempt income - income received but not subject to income tax. For example: tax-exempt interest, non-taxable portion of SS income
Gross Income equation
Gross income = earned + unearned income
What are Adjustments?
Amounts paid by the taxpayer that can be subtracted from the income
Common adjustments:
- Educator expenses (K-12 educator)
- IRA contributions
- Deductible portion of self-employment tax
- Student loan interest
AGI = Income - Adjustments
AGI affects whether a taxpayer qualifies for all types of credits and government benefits
Income - AKA - Gross Income
What are deductions?
Amounts subtracted from AGI
Two options:
- Standard Deduction OR Itemized Deductions
- Qualified Business Income Deduction - self-employed taxpayers only
Itemized Deductions - MFS
Taxable Income = AGI - Deductions
TAXABLE INCOME EQUATION
TAXABLE INCOME (TI) = AGI - Deductions
Standard Deduction depends on these 2 things?
Filing status and age of the taxpayer
Adjustments vs. Deductions
Similarities & Differences
Both reduce taxable income
Differ in where the reduction occurs in relation to AGI
- Adjustments - subtracted before AGI - above the line
- Deductions - subtracted after AGI - below the line
What are tax credits? and what are the two types?
Tax credits are a reduction in tax liability for specific situations
Two types
- Nonrefundable - credit amount limited by tax liability
- Refundable - taxpayer receives the full amount of credit
Most common credits seen in VITA - BakerRipley
Nonrefundable:
- ODC - other dependent credit
- CTC -child tax credit
- retirement savings credit
- foreign tax credit
- lifetime learning credit (LLC)
- AOC - American opportunity credit
- Dependent care credit
Refundable:
- EITC - earned income tax credit
- ACTC - additional child tax credit
- AOC - American opportunity credit
- PTC - Premium tax credit
Adjutments/Deductions vs. Credits
Adjustments and deductions - dollar for dollar reduction in taxable income. Thus, the reduction in tax depends on the tax bracket. i.e.: $100 adj. or deduction, 10% tax bracket = $10 reduction in tax liability
Whereas credits - are a dollar for dollar reduction in tax liability
i.e.: $100 credit = $100 reduction in tax liability
What are taxes?
- The amount of tax assessed on taxable income
- Taxes that are assessed in addition to income tax:
- Can be offset by non-refundable credits
- Most common example is premium tax credit (ptc) repayment - helps individuals cover premiums for health insurance
- Other taxes:
- Cannot be offset by nonrefundable credits
- Common examples: self-employment taxes, and penalty on early withdrawal of retirement account
Schedules and Form 1040 relation
Schedules justify the amounts that show up on the 1040
What does Form 1040 include in page 1?
Taxpayer and dependent info
Gross Income
Adjustments
Adjusted Gross Income
Standard or itemized Deductions
Taxable Income
Schedules 1-3
Schedule 1:
- Income
- Adjustments to income
Schedule 2:
- Taxes
- Other Taxes
Schedule 3:
- Nonrefundable credits
- Refundable credits
Tax Return Summary
The 7 Steps of the
Tax Return Process at VITA
- Intake
- Interview
- Return Preparation
- Quality review
- Client review
- Paperwork and notes
- Transmission
What happens at intake?
Initial screening for:
- IDs and proof of SSN/ITIN
- Tax documents
- Scope
Verify completion of intake forms and ensure clients are seen in order by qualified tax preparers (different levels of preparers).
What happens during the interview?
- This is done by you the preparer
- Introduce yourself, explain the process, and encourage questions
- Verify IDs, and proof of SSN/ITIN
- Review intake forms and tax docs to verify info is accurate and complete
- Determine filing status and dependency
- Make corrections as needed
Intake to getting your clients
Client might get through intake and sit in front of you. Introduce yourself and welcome them to the tax neighborhood center.
Might need to ask the intake for the next available client with your certification
4 Intake forms you’ll be verifying and correcting
Make corrections on the form itself
- Form 13614-C IRS intake form - basic info and info about income - make corrections on the form
- BRNTC intake form - contains names
- BRNTC checklist - mainly for intake to determine if they’re eligible for VITA
- BRNTC survey - info to improve the program - not all clients are willing to fill it out - if this happens double check with a manager
Clarify illegible items
Conducting the Interview
- Introduce yourself
- Briefly describe the process and emphasize that you and others might repeat some of the questions in order to ensure that their return is prepared free of errors.
- Encourage the taxpayer to ask questions
- Go through info in client envelope and put away what you don’t need
- Do NOT start entering information into TaxWise until after completing the interview
Tax Preparation Process Instructions
Tell the client that you will be reviewing the forms they filled out for accuracy and omissions.
That you will prepare the tax return and that someone else will perform a quality review
You will explain the return line by line
And then they will sign form 8879 - agreement to e-file
Feel free to ask any questions
Identity verification
- MUST see a valid government issues photo ID for taxpayer and spouse
- Can be a passport or government-issued photo ID from another country
- Must NOT be expired (COVID impact on expired driver’s licenses)
- Note: If doing a return for a spouse, the spouse should be there. Especially in the case of filing MFJ
- If they are not, ask for the reason and call the manager over for help.
-
Must see the Social Security Card/ITIN Letter
- Goal - avoid name and SS mismatches
- Must see for each person listed on the return (electronic copies are acceptable)
- Don’t rely on other documents for the name and watch out for nicknames
- If the name on the intake does NOT match SS speak to your manager
- Compare photo IDs to their SS card or ITIN letters for identity verification
Verifying Tax Forms
- Verify that tax year on form matches year of return
- Name matches SS card/ITIN letter
- Check with manager regarding any discrepancies
Importance of the Interview and things to keep in the back of your mind
Interview can determine things like:
- Is this return within your certification level
- Is the return outside the scope
- Does the taxpayer have all the needed info or documentation
Discovering these things before starting will save you and the taxpayer time and avoid frustration
Due Dilligence
Clarify all situations, for example:
- Self-employment income
- Earned income tax credit
- American opportunity credit
- Child tax credit/additional child tax credit/other dependent credit
- Head of household filing status
