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CHAPTER 1 The Individual Income Tax Return. Income Tax Fundamentals 2010 edition Gerald E. Whittenburg Martha Altus-Buller Student’s Copy. Objectives of Tax Law. Raise revenue Tool for social and economic policies
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CHAPTER 1 The Individual Income Tax Return Income Tax Fundamentals 2010 edition Gerald E. Whittenburg Martha Altus-Buller Student’s Copy 2010 Cengage Learning
Objectives of Tax Law • Raise revenue • Tool for social and economic policies • Social policy encourages desirable activities and discourages undesirable activities • Credits for investment in solar and wind energy • Can deduct charitable contributions • Credits for higher education expenses • Economic policy as manifested by fiscal policy • Encourage investment in capital assets through depreciation • Both economic and social • Exclude gain on sale of personal residence up to $250,000 ($500,000 if married)
Primary Entities/Forms • Individuals • Taxable income includes wages, salary, self-employment earnings, rent, interest and dividends • An individual may file the simplest tax form that he/she qualifies for • 1040EZ • 1040A • 1040 • If error made on one of the three above forms, can amend with a 1040X.
Tax Formula for Individuals This model follows Form 1040 Gross Income less: Deductions for Adjusted Gross Income (AGI) AGI less: Greater of Itemized or Standard Deduction less: Exemptions Taxable Income times: Tax Rate Gross Tax Liability less: Tax Credits and Prepayments Tax Due or Refund
Standard Deductions & Exemptions • 2009 standard deduction • Single $ 5,700 • Married Filing Joint (MFJ) $11,400 • Qualifying Widow(er) $11,400 • also known as Surviving Spouse • Head of Household (HOH) $ 8,350 • Married Filing Separate (MFS) $ 5,700 • *Taxpayers 65 or older and/or blind get an additional amount • $1,100 if MFJ, MFS or SS • $1,400 if HOH or Single • 2009 exemption$3,650 – personal & dependency 2010 Cengage Learning
Filing Status • Single • Unmarried or legally separated as of 12/31 • And not qualified as married filing separately, head of household or qualifying widow[er] • Married Filing Jointly (MFJ) • If married on 12/31 – even if didn’t live together entire year • Same-sex couples may not file jointly • If spouse dies during year you can file MFJ in current year • Married Filing Separately (MFS) • Each file separate returns • Must compute taxes the same way - both itemize or both use standard • If living in community property state, must follow state law to determine community and separate income
Filing Status *See p. 1-10 for requirement for abandoned spouse • Head of Household (HOH) • Tables have lower rates than single or MFS • Taxpayer can file as HOH if: • Unmarried or abandoned* as of 12/31 • Paid > 50% of cost of keeping up home that was principal residence of dependent child or other qualifying dependent relative • There is one exception to principal residence requirement:if dependent is taxpayer’s parent, he/she doesn’t have to live with taxpayer Note: A divorced parent who meets above rules and has signed IRS/legal document, may still claim HOH even if dependency exemption shifted to ex-spouse 2010 Cengage Learning
Filing Status • Qualifying Widow(er) with Dependent Child • Also known as surviving spouse • Available for two subsequent years after death of spouse • Must pay over half the cost of maintaining a household where a dependent child, stepchild, adopted child or foster child lives • Gets benefits of married filing joint tax rates 2010 Cengage Learning
Personal/Dependency Exemptions • Personal exemptions may be taken for self/spouse • Additional exemptions may be taken for individuals who are either • Qualifying child or • Qualifying relative • For 2009 each exemption = $3,650 • Exemption phased out to $2,433 when AGI exceeds certain AGI thresholds 2010 Cengage Learning
American Recovery & Reinvestment Act (ARRA) • Provisions includes Making Work Pay Credit • $400 ($800 MFJ) refundable credit on 2009 tax return • Reduced by any automatic rebate received by certain taxpayers in 2009 • Reflected in new FIT withholding tables which directly infused cash into economy through increased wages • Phases out $75,000 ($150,000 MFJ) • Complete Schedule M to calculate credit 2010 Cengage Learning
Capital Gains/Losses • A capital asset is any property [personal or investment] held by a taxpayer, with certain exceptions as listed in the tax law • Examples: stocks, bonds, land, cars and other items held for investment • Gains/losses on these assets are subject to special rates • Holding period of asset determines treatment • Long-term is held >12 months (taxed at capital rates) • Short-term is held <= 12 months (taxed at ordinary rates)