Unit 4 - Taxable And NT Income PART 1 Flashcards
“Exclusion” income
All income is taxable except for specific exclusions.
For example, municipal bonds are non-taxable, but they still need to be reported.
Compensation for physical injuries or lawsuit settlements are not taxable and do not need to be reported on the return
There is a difference between an exclusion and a deduction, as some deductions and credits are phased out at higher gross income levels
Gross income includes…
Wages, salaries, commissions, tips, and self-employment income
Non-monetary forms of compensation, like goods, property, services, and taxable fringe benefits
Interest, dividends, capital gains, and stock options
Adjusted gross income (AGI)
= gross income minus
Certain specific deductions or adjustments
Examples include IRA contributions, expenses for self-employed, individuals, deductible, student loan, interest, and penalties paid to banks on early withdrawals of savings.
Commonly referred to as above the line
How to calculate Taxable income
Start with Gross income
Subtract adjustments to income (“ above the line” deductions)
= adjusted gross income
Subtract the greater of itemized deductions or the standard deduction
= taxable income
X tax rate
= gross tax liability
Subtract credits
= net tax liability or refund receivable (based on the amount of tax , if any)
FICA taxes
Earned income vs. unearned income
Earned income is generally subject to Social Security and Medicare taxes, also called FICA taxes.
Investment income and other unearned income are generally not subjective like taxes
Constructive receipt of income
The doctrine of constructive receipt requires that cash basis taxpayers be taxed on income when it becomes available
And is not subject to substantial limitations or restrictions
Regardless of whether it is in their physical possession
Income is not considered to have been constructively received if a taxpayer declines to accept an item like a prize or award
Fair market value is used
The “claim of right” doctrine
An event that requires a taxpayer to pay back (refund/return) and amount over $3000 which they had included in income in a previous year
They may be eligible for a deduction or a tax credit
IRC section 1341
The repayment is deducted on the same form or schedule on which it was previously included … schedule C, schedule D, schedule a
If the repayment is less than $3000, it cannot be deducted
Self-employment income includes these type of businesses
Income from ministers, priest, and rabbis for the performance of services, such as baptisms and marriages
The distributive share of trade or business income allocated by a partnership (k-1)
Schedule k-1 from a partnership
Individuals report their distributive share of income from a K-1 on form 1040, schedule E part 2.
The income is considered self-employment income and is subject to self-employment tax
FICA tax (payroll tax)
The federal insurance contributions act tax.
Includes two separate taxes :
Social Security tax is 6.2% for the employer and 6.2% for the employee or 12.4%
Medicare is 1.45% for the employee and 1.54% for the employer or 2.9% total
The combined FICA tax rate is 15.3%
FICA applies to…
A taxpayers combined earned income, including wages, tips, and 92.35% of net earnings from self-employment.
Social Security tax only applies up to $160,200
There is no yearly maximum for Medicare tax
Additional Medicare tax
An additional 0.9% Medicare tax is applied on earned income exceeding the following thresholds
Married filing jointly $250,000
Married filing separately, $125,000
Single, HOH, and QSS $200,000
RRTA
Railroad retirement
Credit for excess Social Security and RRTA tax withheld
When Social Security tax withheld is more than it should be
Usually occurs when a person changes jobs mid year
Fully refundable on a taxpayer individual return
Schedule 3
OASDI
Social Security
Means old age, survivors, and disability insurance
Self-employment tax
Self-employed individuals are responsible for paying the entire amount of Social Security and Medicare taxes
Calculated on schedule, SE, self-employment tax
Adjustments related to the self-employment tax
These adjustments will reduce overall taxes for a taxpayer with self-employment tax
- Taxpayers net earnings from self-employment are reduced by 7.65%. Similar to the employers share of Social Security tax, not considered wages to the employee. This reduction removes a corresponding amount from the net earnings before the SE taxes calculated.
- Taxpayer can deduct the employer equivalent portion of his self-employment tax and determining his adjusted gross income.
Self-employment tax for more than one business
Taxpayer must net the profit or loss from each business to determine the total earning subject to SE tax
Marriage taxpayers cannot combine their income or loss from self-employment to determine their individual earnings subject to SE tax
Employee vs independent contractor
Misclassification
If a worker receives a form 1099 – NEC but believes they are an employee, they can file form SS – eight, determination of worker status for purposes of federal, employment, taxes, and income tax withholding with the IRS
If a determination is made that they are an employee, they will file form 8919, uncollected, Social Security, and Medicare tax on wages, with their tax return
Wages from form 8919 also are reported on the form 1040 on line 1g
Advance wages
If an employee request an advance on wages, it would be considered constructively received THEN
Even though he will not actually earn the money until later
Supplemental wages
Compensation paid to an employee in addition to their regular pay
Listed on the employees form W-2 and our taxable
Examples …
Vacation and pay
Bonuses, commissions, prizes
Severance pay, backpay, holiday pay
Payment for nondeductible moving expenses
Garnished wages
Ex child support
Full amount of gross wages must be included in taxable wages at your end (before the garnished wages)
Property or services in Lou of wages
Wages paid in any other form, other than cash are measured by their fair market value
However, if an employee receives stock or other property that is restricted, the property is not included in income until it is available to the employee without restriction.
Student teachers that receive tuition reduction and or free on campus housing in Lou of wages would need to report it as taxable wages
Tip income
Tips received our taxable income
Individuals who receive $20 or more per month and tips must report the tip income to their employer
Tips less than $20 are exempt from Social Security and Medicare taxes, but are still subject to federal income tax
More than one job - the $20 tip reporting threshold applies on a purge job basis, not on an overall basis
Reporting tip income
An employee who does not report all their tips to their employer generally must report the tips and related Social Security and Medicare taxes on form 1040
Form 4137, Social Security and Medicare tax on unreported tip income, is used to compute the additional tax
Taxpayers who are self-employed and receive tips must include their tip income and gross receipts on schedule C
Non-cash tips
Do not have to be reported to the employer, but they must be reported and included in the taxpayers gross income at their fair market value
Example – concert tickets
Fringe benefits for employees
Any additional cash, property, or service given to employees on top of their regular taxable wages
Usually offered as part of a compensation package
Common examples being health insurance, retirement, plans, and parking passes
Most fringe benefits are not subject to taxes, but there are some exceptions
Taxable fringe benefits for employees
Concert and athletic event tickets
Offsite athletic facilities and health club memberships
The value of employer provided life insurance over $50,000
Any cash benefit in the form of a credit card or gift card?
Transportation benefits, exceeding the monthly max of $300 per month
Employer provided vehicles if they are used for personal purposes
Non-taxable fringe benefits for employees
Accident or health plan coverage
Retirement plans
Cafeteria plans
Flexible, spending arrangements (FSAs)
Retirement plans
Employer contributions to qualified retirement plans are not taxable to the employees when they are made
When employee receives distributions from a retirement plan, the amounts received our taxable income
Elective deferrals are excluded from taxable compensation for income tax purposes, but is subject to Social Security and Medicare taxes
Cafeteria plans
Employees receive certain benefits before taxes are taken out
Examples of qualified benefits are
accidental, dental, vision, and medical insurance
flexible spending accounts
Adoption assistance
Dependent care assistance
Employee contributions are typically deducted through salary, reduction agreements, and they do not count as taxable income
Flexible, spending arrangements (FSAs)
An FSA is a form of cafeteria plan benefit that reimburses employees for expenses incurred for certain qualified, benefits, such as healthcare and daycare expenses
HCFSA
Healthcare flexible, spending arrangement
Capped at $3050
Both employer and employee may contribute to the healthcare FSA, but contributions from all sources must not exceed the annual maximum
Typically subject to an annual use it or lose it rule with a short 2 1/2 month grace period after year end to claim subsequent year qualifying expenses
Normally healthcare FSA funds that are not spent or forfeited back to the employer
Employee plans can also offer a carryover option with the maximum amount that can be carried forward being 20% of the maximum available salary reduction equals $610
DCFSA
Dependent care, flexible spending arrangement or dependent care assistance plan
For unmarried taxpayers and married filing jointly, the annual limit is $5000
For married couples filing separately, the limit is $2500
Funds are used to pay for eligible daycare services, before or after school programs, and adult daycare for disabled dependence
The accounts may only reimburse up to the amount the account is funded .
