Chapter 20 Income Taxes


I.                     Basic concept of income taxes


a.      Add up your income from all sources


b.      Subtract exemptions and deductions to calculate the taxable income


c.      Determine tax owed on the taxable income


d.      Subtract tax credits from the taxes owed


e.      Compare the taxes owed to witholdiings


II.                   Who must file


a.      Almost anyone who has received income


III.                  Forms


a.      1040EZ


                                                              i.      Less than $50,000


                                                            ii.      interest income less than $400


                                                          iii.      Not itemizing deductions


b.      1040A – 1040 short form


                                                              i.      For those not itemizing deductions


c.      1040 – 1040 long form


                                                              i.      Those itemizing deductions


IV.               Filing status


a.      Single


b.      Married filing jointly


c.      Married filing separately


d.      Head of household


                                                              i.      Unmarried with dependents


e.      Qualifying widow or widower


                                                              i.      If without the death you could have filed jointly


f.        Marriage penalty controversy


                                                              i.      Graduated income tax  taxes higher incomes at a higher percentage


                                                            ii.      Married couples combined incomes push them into higher bracket compare to two singles of cohabitate and file separately.


1.      Effect is to economically penalize marriage


                                                          iii.      Solution is to put singles and married in separate tax tables


                                                           iv.      Not possible to make a tax system that is progressive but neutral with regards to marriage


V.                 Exemptions and Dependents


a.      $3,200 reduction for head of household, spouse, and each dependent


b.      Dependent is anyone you support.


c.      Need social security number


d.      Can only be claimed once as a dependent


e.       Exemption tests page 588


VI.               Income


a.      Income from employment


                                                              i.      Reported on a W2 or a 1099


b.      Interest and dividend income –Schedule A


c.      Alimony – Taxable – child support payments are not taxable


d.      Business Income or Loss – Schedule C


                                                              i.      Pay taxes on profits which is revenue minus costs


e.      Capital gains or losses – Schedule D


f.        Other non taxable or taxable income – page 592


                                                              i.      Gifts - $10,000 from each parent


g.      Adjustments to Income


                                                              i.      Contributions to IRAs


                                                            ii.      Alimony


VII.              Deductions


a.      Standard deduction - $5,000 single or $10,000 married


b.      Itemize deductions – Schedule B


                                                              i.      If itemized deductions are greater than the Standard Deduction you should Itemize


                                                            ii.      Deductions


1.      Medical if more than 7.5% of your income


2.      State and local income taxes or sales taxes – your choice


3.      State and local property taxes


4.      Mortgage interest


5.      Charitable contributions


6.      Casualty losses and theft losses


7.      Miscellaneous


a.      Union dues


b.      Moving expenses may be deductible


VIII.            Computing taxes owed on taxable income

a.      Use tax tables


IX.               Tax credits


a.      Earned Income Tax Credit


                                                              i.      Tax credit for employed persons/families with low income


1.      $37,000 for married couple with two children for example


2.      Benefit declines with rising income - $3,900 to $0


                                                            ii.      Key feature is EITC  may be greater than taxes owed resulting in money in excess of a refund of taxes withheld


b.      Child care tax credit – may be 20% to 35% of your qualifying expenses


c.      Educational tax credits


                                                              i.      Hope tax credits -$1,500 a year for two years per student


                                                            ii.      Lifetime Learning tax credit – $2,000 per household


X.                 Withholding


a.      Required to have enough money withheld from your pay to pay your taxes


                                                              i.      Use W4 form


b.      Pay quarterly estimated taxes on income with no withholdings


c.      Penalty for under withholding


d.      Many people use withholding as a form of forced savings


XI.               Strategies


a.      Income shifting where income varies a lot from year to year


b.      Capital losses on investments


                                                              i.      Capital losses first offset capital gains


                                                            ii.      Then up to $3,000 other income


                                                          iii.      Replace the security after 31 days


c.      Unreimbursed business expenses


                                                              i.      Must exceed 2% of taxable income




d.      Shift assets and income to children


XII.              Audits


a.      Screening


                                                              i.      All forms are screened for things a computer can scan and check


1.      Completeness


2.      Valid SSN


3.      Consistency with W2 and 1099


4.      Correct interpretation of tax tables


5.      Correct arithmetic


                                                            ii.       Differences settled by mail


1.      May include a penalty


2.      Tax payer may disagree, ask for a hearing etc.


3.      But, don’t be frivolous with the IRS


b.      A sample of forms will be selected for closer scrutiny


                                                              i.      Selection process


1.      Discriminate Income Function


a.      Numbers indicate tax fraud


b.      Tips for example in jobs where tips are common


2.      Taxpayer Compliance


a.      Random sample


b.      Are people complying with the law


3.      Related pickup


a.      somebody turned you in


b.      May get 10% of recovered tax money not to exceed $10,000,000


c.      Crime to file a false or malicious accusation


4.      Multi year


5.      Refunds


6.      Miscellaneous


                                                            ii.      Audit will ask for documents to verify deductions, credits, etc.


1.      Supporting documents not submitted with tax form


2.      you should have a document to back up every claim on your form


a.      receipts for charitable deductions


b.      real estate tax bills


c.      Unreimbursed business expenses


3.      Documents should be retained for three years


4.      Always make copies of your tax returns

5.      Use tax software – TaxAct –Turbo Tax etc.


                                                          iii.      Questionable deductions may lead to hearing and/or negotiations


1.      For example the value of in-kind charitable deductions


2.      For example the value of non cash reimbursement