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Chapter 16. Individual Income Tax and Tax Planning. Federal Income Tax Law Objectives. Revenue-raising objectives Economic objectives Social objectives. Income Tax Planning. Data Collection and Risk Analysis Use a Client Questionnaire Gather prior income tax returns

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Chapter 16 l.jpg

Chapter 16

Individual Income Tax and Tax Planning

Chapter 16: Individual Income Tax and Tax Planning


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Federal Income Tax Law Objectives

  • Revenue-raising objectives

  • Economic objectives

  • Social objectives

Chapter 16: Individual Income Tax and Tax Planning


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Income Tax Planning

  • Data Collection and Risk Analysis

    • Use a Client Questionnaire

    • Gather prior income tax returns

    • Gather information returns

      • Form W-2

      • Form 1098

      • Form 1099

Chapter 16: Individual Income Tax and Tax Planning


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Individual Income Tax Rates

  • Ordinary rates

  • Capital gain rates

    • Capital asset/Dividends

    • Sale or exchange

    • Long-term holding period

  • Alternative Minimum Tax (AMT) rates

Chapter 16: Individual Income Tax and Tax Planning


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Determining Income Tax Liability – Taxable Income

Total Income

Less: exclusions from gross income

Gross Income

Less: deductions for Adjusted Gross Income

Adjusted Gross Income (AGI)

Less the larger of:

Standard Deduction or Itemized Deductions

Less: personal and dependency exemptions

Taxable Income

Chapter 16: Individual Income Tax and Tax Planning


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Deductions for AGI

  • Business expenses

  • Net capital losses ($3,000)

  • Self-employed expenses

  • Alimony paid

  • IRA contributions

  • Moving expenses

  • Education expenses

Chapter 16: Individual Income Tax and Tax Planning


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Itemized Deductions

  • Medical expenses (> 7.5% AGI)

  • State & local income taxes

  • Property taxes

  • Mortgage interest

  • Investment Expenses (< Investment Income)

  • Charitable contributions

  • Casualty/Theft losses (> 10% AGI + $100)

  • Miscellaneous (> 2% AGI)

Chapter 16: Individual Income Tax and Tax Planning


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Tax Avoidance vs. Tax Evasion

  • Tax avoidance is the legal minimization of taxes

  • Tax evasion is any of the fraudulent methods by which a taxpayer may pay less than his or her proper tax liability

Chapter 16: Individual Income Tax and Tax Planning


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The Internal Revenue Service and Its Administrative Issues

  • The IRS

    • is part of the Treasury Department

    • is responsible for administering and enforcing federal tax laws

    • issues Revenue Rulings and Revenue Procedures as official interpretations of the tax laws

Chapter 16: Individual Income Tax and Tax Planning


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IRS Guidance

  • Letter rulings

  • Determination letters

  • Revenue rulings

  • Private letter rulings

  • Revenue procedures

  • Technical advice memoranda

Chapter 16: Individual Income Tax and Tax Planning


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The IRS Audit Process

  • The Discriminant Index Function System

  • Types of Audits

    • Correspondence audit

    • Office audit

    • Field audit

Chapter 16: Individual Income Tax and Tax Planning


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The IRS Audit Process (cont’d)

  • Outcomes of Audits

    • No change to return

    • Taxpayer agrees with examiner’s findings

    • Taxpayer does not agree with examiner’s findings

    • Taxpayer partially agrees with examiner’s findings

  • If a taxpayer exhausts all administrative remedies, the case may be brought to court

Chapter 16: Individual Income Tax and Tax Planning


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The IRS Audit Process (cont’d)

  • Penalties

    • Failure-to-file penalties

    • Failure-to-pay-tax penalties

    • Accuracy-related penalties

    • Fraud penalties

Chapter 16: Individual Income Tax and Tax Planning


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Payroll Taxes

  • FICA taxes for employers and employees

    • 6.2% OASDI on $87,900 (2004)

    • 1.45% Medicare

  • Self-employment tax

    • Double the employee’s rate

  • FUTA tax calculation

Chapter 16: Individual Income Tax and Tax Planning


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Tax-Advantaged Investments

  • Investment in tax-exempt securities

  • Tax shelters

  • Employee benefits

  • Acceleration of deductions

  • Deferral of tax gains

  • Exemption opportunities

Chapter 16: Individual Income Tax and Tax Planning