Individual Income Tax Overview

1. 1 Chapter 4 Individual Income Tax Overview

2. 2 Individual Income Tax Formula Realized income from whatever source derived Minus: Excluded or deferred income Equals: Gross income Minus: For AGI deductions Equals Adjusted gross income Please insert exhibit 4-1 on this slide where indicatedPlease insert exhibit 4-1 on this slide where indicated

3. 3 Individual Income Tax Formula Adjusted Gross Income Minus: From AGI deductions: (1) Greater of (a) Standard deduction or (b) Itemized deductions and (2) Personal and dependency exemption Equals Taxable income Please insert exhibit 4-1 on this slide where indicatedPlease insert exhibit 4-1 on this slide where indicated

4. 4 Individual Income Tax Formula Taxable income Times: Tax rates Equals: Income tax liability Add: Other taxes Equals: Total tax Minus: Credits Minus: Prepayments Equals: Taxes due or (refund) Please insert exhibit 4-1 on this slide where indicatedPlease insert exhibit 4-1 on this slide where indicated

5. 5 Individual Income Tax Formula Individuals report taxable income to the IRS Reported on Form 1040 U.S. tax laws use all-inclusive income concept Realized income measurable change in property rights All realized income included in gross income unless specifically excluded or deferred Recognized income Reported on tax return

6. 6 Individual Income Tax Formula Excluded income Income never included in taxable income Municipal bond interest Gain on sale of personal residence Loans Gifts Deferred income Income included in a subsequent tax year Installment sales Like-kind exchanges

7. 7 Individual Income Tax Formula Deductions for AGI Deductions �below the line� Deducted in determining adjusted gross income Always reduce taxable income dollar for dollar

8. 8 Individual Income Tax Formula Deductions from AGI Deductions �above the line� Deducted from adjusted gross income to determine taxable income Greater of standard deduction or itemized deductions Personal and dependency exemptions Why might a from AGI deduction not reduce taxable income?

9. 9 Individual Income Tax Formula 2009 Standard deduction amounts $11,400 Married filing jointly $11,400 Qualifying widow or widower $5,700 Married filing separately $8,350 Head of household $5,700 Single Additional standard deduction amounts for age and eyesight (discuss in Chapter 6)

10. 10 Individual Income Tax Formula Tax calculation The U.S. uses a progressive tax rate schedule Some items are taxed at preferential rates Long-term capital gains Qualifying dividends Tax on these items is calculated separately from income taxed are ordinary rates.

11. 11 Individual Income Tax Formula Other taxes include: Alternative minimum tax Self-employment taxes Tax credits Reduce tax liability dollar for dollar

12. 12 Individual Income Tax Formula Tax prepayments Payments already made towards tax liability including: Income taxes withheld from wages by employer Estimated tax payments made during the year Taxes overpaid in prior year and applied toward current year�s liability If prepayments exceed tax liability after credits, taxpayer receives a refund!

13. 13 Personal and Dependency Exemptions Personal exemptions For taxpayer and spouse if married filing jointly Dependency exemptions For those who qualify as the taxpayers� dependents Exemption amount for 2009 is $3,650 Qualifying child or Qualifing Relative

14. 14 Personal and Dependency Exemptions Dependency requirements Resident of U.S., Canada, or Mexico Must not file joint return with spouse Exception � if no tax liability filing jointly or separately Must be qualifying child or qualifying relative

15. 15 Personal and Dependency Exemptions Qualifying child Relationship test Age test Residence test Support test

16. 16 Qualifying Child Relationship test taxpayer�s son, daughter, stepchild, an eligible foster child, brother, sister, half brother, half sister, stepbrother, stepsister or a descendant of any of these relatives.

17. 17 Qualifying Child Age test: child must be either- under age 19 at the end of the year, under age 24 at the end of the year and a full-time student, or permanently and totally disabled.

18. 18 Qualifying Child Residence test Same residence as taxpayer > � of the year Exception for temporary absences such as education. Support test Child must not provide > � own support Scholarships of actual child (not grandchild, for example) are excluded from support computation

19. 19 Qualifying Child Example Rodney and Anita have two children: Braxton, age 12, who lives at home and Tara, age 21 who is a full-time student and does not live at home. While Tara earned $9,000 in a summer job, she did not provide more than half of her own support during the year. Are Braxton and Tara qualifying children to Rodney and Anita?

20. 20 Qualifying Child Example Solution

21. 21 Qualifying Child Tie breaking rules Parents first Days living with each parent if parents living apart AGI� higher AGI gets exemption

22. 22 Qualifying Child Example Braxton�s uncle Shawn (Rodney�s brother) lived in the Halls�s home (the same home Braxton lived in) for more than 11 months during 2009. Does Braxton meet the requirements to be considered Shawn�s qualifying child?

23. 23 Qualifying Child Example Solution

24. 24 Qualifying Child Example