CHAPTER 1 The Individual Income Tax Return

1. CHAPTER 1 The Individual Income Tax Return Income Tax Fundamentals 2009 edition Gerald E. Whittenburg Martha Altus-Buller Student’s Copy 2009 Cengage Learning

2. Objectives of Tax Law • Raise revenue • Tool for social and economic policies • Social policy encourages desirable activities and discourages undesirable activities • Can’t deduct penalties • Can deduct charitable contributions • Credits for higher education expenses • Economic policy as manifested by fiscal policy • Encourage investment in capital assets • Both economic and social • Exclude gain on sale of personal residence up to $250,000 ($500,000 if married)

3. 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.

4. 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

5. Standard Deductions & Exemption • 2008 standard deduction • Single $ 5,450 • Married Filing Joint [MFJ] $10,900 • Qualifying Widow(er) $10,900 • also known as Surviving Spouse • Head of Household [HOH] $ 8,000 • Married Filing Separate [MFS] $ 5,450 • *Taxpayers 65 or older and/or blind get an additional amount • $1050 if MFJ, MFS or SS • $1350 if HOH or Single • 2008 exemption$3500 – personal & dependency 2009 Cengage Learning

6. 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

7. 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 • There is one exception to principal residence requirement:if dependent is taxpayer’s parent, he/she doesn’t have to live with taxpayer

8. Filing Status • Surviving Spouse [SS] • Also known as qualifying widow or widower • Available in year of spouse’s death and for two subsequent years • Must pay over half the cost of maintaining a household where a dependent child, stepchild, adopted child or foster child lives

9. 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 2008 each exemption = $3500 • Exemption phased out to $2333 when AGI exceeds thresholds found on p. 1-12

10. 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)