1. CHAPTER 1
The Individual
Income Tax Return
Income Tax Fundamentals 2012
Gerald E. Whittenburg
Martha Altus-Buller
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2. Learning Objectives
 Understand history/objectives of U.S. tax law
 Describe different entities subject to tax/reporting
requirements
 Understand and apply tax formula
 Identify who must file tax returns
 Determine filing status & understand calculation of tax
according to filing status
 Calculate number of exemptions and exemption amounts
 Calculate correct standard or itemized deduction amount for
taxpayers
 Compute basic capital gains and losses
 Access and use various internet tax resources
 Understand the basics of e-filing
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3. History of Taxation
 Since1913, when 16th amendment was
passed, the constitutionality of income
tax has never been questioned
 Incometaxes serve a multitude of
purposes
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4. 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)
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5. Primary Entities/Forms
 Individual
◦ Taxable income includes wages, salary, self-
employment earnings, rent, interest and dividends
◦ An individual may file simplest tax form qualified for
 1040EZ
 1040A
See next slide
 1040
◦ If error made on one of the three above forms, can
amend with a 1040X
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6. Primary Entities/Forms
 Individual
◦ 1040EZ
 Single or Married Filing Jointly (MFJ)
 Must not be 65 or older and/or blind
 Must not claim any dependents
 Taxable income must be under $100,000
 Only wages, salaries or unemployment and not more
than $1,500 taxable interest income
 Not claim any credits other than the earned income
credit
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7. Primary Entities/Forms
 Individual (continued)
◦ 1040A
 Generally used by taxpayers who are not self-
employed and don’t itemize deductions
◦ 1040
 If taxpayer doesn’t qualify to use 1040EZ or
1040A,should complete a 1040 with possible
schedules attached
◦ Schedule A to itemize deductions
◦ Schedule B to report dividends/interest income > $1500
◦ Schedule C to report trade/business income
◦ Schedule D to report capital gains/losses
◦ Schedule E to report rental/royalty income
◦ Schedule F to report farm/ranch activities
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8. Primary Entities/Forms
 Corporations
◦ Tax rate schedule found on page 1-4
◦ Corporations need to file 1120 or 1120S
◦ 1120S is for corporations that elect S Corporation status
 Don’t pay regular corporate income taxes
 Instead, pass through items of income or loss to shareholders
 Partnerships
◦ Reporting entity, not taxable entity
◦ 1065 – reports income/loss and allocation to partners
 Pass through items of income or loss to partners
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9. Tax Formula for Individuals
This formula follows Form 1040
Gross Income
less: Deductions for Adjusted Gross Income (AGI)
AGI
less: Greater of Itemized or Standard Deduction
less: Exemption(s)
Taxable Income
times: Tax Rate (using tax tables or rate schedules)
Gross Tax Liability
less: Tax Credits and Prepayments
Tax Due or Refund
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10. Standard Deduction & Exemptions
2011 standard deduction ($)
Single 5,800
Married Filing Joint (MFJ) 11,600
Qualifying Widow(er) 11,600
also known as Surviving Spouse (SS)
Head of Household (HOH) 8,500
Married Filing Separate (MFS) 5,800
*Taxpayers 65 or older and/or blind get an additional amount
$1,150 if MFJ, MFS or SS
$1,450 if HOH or Single
2011 exemption $3,700 – personal & dependency
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11. Using Tax Formula
Facts: Juan (age 29) is a single taxpayer. In 2011, his
salary is $39,000 and he has dividend income of $1000.
In addition, he has deductions for AGI of $2,500 and
$3,000 of itemized deductions. If Juan claims one
exemption for this year, calculate the following amounts:
Gross income ___________
Deductions for AGI ___________
Adjusted gross income ___________
Greater of the standard
deduction or itemized deductions ___________
Exemptions ___________
Taxable income ___________
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12. Solution
Gross income $40,000
Adjusted gross income ___________
Greater of the standard
deduction or itemized deductions ___________
Exemptions ___________
Taxable income ___________
Gross income = $39,000 + 1,000
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13. Solution
Gross income $40,000
Adjusted gross income 37,500
Greater of the standard
deduction or itemized deductions ___________
Exemptions ___________
Taxable income ___________
AGI = $40,000 – 2,500
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14. Solution
Gross income $40,000
Adjusted gross income 37,500
Greater of the standard
deduction or itemized deductions 5,800
Exemptions
Taxable income ___________
The standard deduction of $5,800 exceeds itemized
deductions of $3,000
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15. Solution
Gross income $40,000
Adjusted gross income 37,500
Greater of the standard
deduction or itemized deductions 5,800
Exemptions 3,700
Taxable income $28,000
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16. Who Must File
 Based on filing status and gross income
◦ Generally, if exemptions
plus
greater of standard or itemized deductions exceed
income, then filing is not necessary
◦ If taxpayer is claimed as a dependent on another
taxpayer’s return, dependent’s standard deduction is:
 Greater of $950
See Figures 1.1
or and 1.2 on page 1-8
 Earned income + $300
 But never more than standard deduction
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17. Who Must File
 Taxpayer must file if
◦ Owe any special taxes
 See Figure 1.3 on page 1-9
◦ Had self-employment income >= $400
◦ Other special situations as outlined on Chart C
(Figure 1.3)
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18. Which Taxpayers are
Required to File
Note: Must analyze each independent situation to
determine if the taxpayer is required to file a return
for 2011
Miles (age 45) is a single waiter and has
unreported tips of $1,510; is he required
to file?
Yes, because Miles owes social security
taxes on unreported tips.
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19. Which Taxpayers are
Required to File
Simone is single (age 31) and blind and has
income of $10,370; is she required to file?
No, because standard deduction = $7,250
($5,800 + 1,450); exemption= $3,700.
These amounts total to $10,950 and exceed
her gross income.
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20. Which Taxpayers are
Required to File
Eamon (age 67) and his wife, Roisin, (age 69)
have income of $19,180 and file jointly; are
they required to file?
No, because standard deduction = $13,900
($11,600 + 1,150 + 1,150); exemptions =
$7,400. These amounts total to $21,300 and
exceed their gross income.
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21. Which Taxpayers are
Required to File
Taig is a single full time college student, age 21,
with wages from a part-time job of $7,340. He
is claimed as a dependent by his parents; is
he required to file?
Yes, because Tai’s standard deduction = $5,800
and his income exceeds this amount. His
exemption is 0 as he’s claimed by parents.
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22. 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
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23. Filing Status
 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 pages 1-10 and 1-11 for requirement for abandoned spouse
*See
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24. 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
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25. Tax Computation
 Six brackets (in Appendix)
◦ 10%, 15%, 25%, 28%, 33%, 35%
◦ Tax rate schedules for different filing types
 Qualifyingdividends and net long-term
capital gains may be taxed at lower
rates
◦ Rates based on ordinary tax bracket
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26. Personal/Dependency
Exemptions
 Personal exemptions may be taken for self
and spouse
 Additional exemptions may be taken for
individuals who are either taxpayer’s
◦ Qualifying child
or
◦ Qualifying relative
 For 2011 each exemption = $3,700
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27. Dependency – Qualifying Child
Dependency exemption allowed when six
tests met
 Relationship Test - child is taxpayer’s child, stepchild,
adopted child or taxpayer’s sibling, half- or step-sibling,
or a descendant of any of these. Foster child may also
qualify. Child must be younger than person claiming
him/her, unless permanently disabled.
 Domicile Test- child has same principal place of abode
as taxpayer for more than ½ the year.
 Age Test – child is under 19 or a full-time student under
24 (enrolled at least 5 months of year).
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28. Dependency – Qualifying Child
 Joint Return Test – child doesn’t file joint return with
spouse (exception: if it’s only to claim refund, then
considered to have passed this test).
 Citizenship Test – child is a US citizen, a resident of the
US, Canada or Mexico, or an alien child adopted by and
living with a US citizen.
 Self-Support Test – child who provides more than ½ of his/
her own support cannot be claimed as a dependent of
someone else. Funds received by students as scholarships
are excluded from support test.
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29. What if Child Meets Dependency
Requirements for More than One Taxpayer?
 If one of the parties is a parent, he/she can claim
 If both parties are a parent, then one with whom the
child resides longest can claim
o If not ascertainable, parent with highest AGI may
claim
 If no parents are involved, person with highest AGI
may claim
Note: If parents are legally separated/divorced, person
with whom child resides more than 6 months may
claim.
 Exemption can shift if custodial parent signs Form 8332 and
form is attached to noncustodial parent’s tax return
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30. Dependency – Qualifying Relative
Dependency exemption may be granted
for a qualifying relative (who is not a
qualifying child) based on tests on next
slide.
Note: A taxpayer’s child who does not meet
qualifying child test may meet qualifying
relative test!!
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31. Dependency – Qualifying Relative
 Relationship or Member of Household Test – list of
relatives that qualify is available at IRS web site
 Note: A member of household (even if unrelated) for entire
year meets the relationship test
 Gross Income Test – individual may not have gross
income in excess of $3,700
 Support Test – dependent must receive over ½ of
his/her support from taxpayer
 Joint Return Test – dependent may not file a joint return
unless it’s solely to claim refund
 Citizenship Test – dependent must meet the citizenship
test identified in the qualifying child slide
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32. Standard Deduction
2011 standard deduction
Single $ 5,800
Married Filing Joint (MFJ) $11,600
Qualifying Widow(er) $11,600
also known as Surviving Spouse
Head of Household (HOH) $ 8,500
Married Filing Separate (MFS) $ 5,800
*Plus additional amounts for blindness or over 65: $1,150 if MFJ,
MFS or qualifying widow(er) and $1,450 if HOH or Single
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33. Standard Deduction - Dependents
The special rule for standard deduction for dependents is
“Deduction = Greater of $950 or earned income + $300, but only
up to basic standard deduction”
Example 1: Jaime is 23 and a full time student and her parents
claim her as a dependent; she earned $2,000 in 2011, how
much is taxable income?
$2,000 earned income
(2,000) standard deduction
$0 taxable income
Example 2: Tia is 18 - has dividend income of $1,500 (dividends are
considered unearned income), how much is taxable income?
$1,500 dividend income
( 950) standard deduction
$ 550 taxable income
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34. Basic Gain & Loss Model
Amount Realized*
- Adjusted Basis**
Realized Gain/Loss
* Sales Price - Sales Expenses
** Cost - Accumulated Depreciation
Note: Most realized gains/losses are also
recognized (i.e. – included in taxpayer’s income)
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35. 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 – see next
screen)
◦ Short-term is held <= 12 months (taxed at ordinary rates)
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36. Capital Gains/Losses
 Long term capital gain
◦ Special rates depending upon taxpayer’s bracket
Ordinary Tax Bracket Capital Gains Tax Rate
10% or 15% 0%
All other brackets 15%
 Long term capital loss
◦ Only allowed $3,000 net capital loss per year against
ordinary income
◦ Carry-forward any unused balance
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37. Calculating Gain/Loss
Facts: Noah purchased Sony AAA bonds in
2006 for $47,600. In 2011, he sold the bonds
for $51,500, paying commission of $515. What
is his:
Amount realized ___________
Adjusted basis ___________
Realized gain/loss ___________
Recognized gain/loss ___________
Type of gain/loss ___________
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38. Solution
Amount realized * $50,985
Adjusted basis 47,600
Realized gain/loss 3,385
Recognized gain/loss 3,385
Type of gain/loss Long term capital gain
*Amount realized = $51,500 – 515
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39. Tax and The Internet
 Volumes of tax information available on
internet
o http://www.irs.gov contains forms and
publications and a search engine to aid the
user in obtaining useful information
 The IRS has also launched a YouTube video site
and an iTunes podcast site featuring topics like
how to obtain refund or file an extension
 Other good sites include www.hrblock.com and
www.willyancey.com
 In some states, names of delinquent taxpayers
posted on web sites
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40. Electronic Filing
 Rules in constant transition, as IRS attempts to
transition all taxpayers to e-filing
 Taxpayers may prepare electronic returns using
own PC and tax preparation software
or
 May utilize a paid preparer who employs e-filing
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41. The End!
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