DETERMINATION OF TAX (1 of 2)

1. ©2007 Prentice Hall, Inc.

2. DETERMINATION OF TAX(1 of 2) • Formula for individual income tax • Deductions from adjusted gross income • Determining the amount of tax • Business income and business entities • Treatment of capital gains and losses ©2007 Prentice Hall, Inc.

3. DETERMINATION OF TAX(2 of 2) • Tax planning considerations • Compliance and procedural considerations ©2007 Prentice Hall, Inc.

4. Formula for IndividualIncome Tax(1 of 2) Income from whatever source derived - Exclusions = Gross Income - Deductions for Adjusted Gross Income = Adjusted Gross Income (AGI) ©2007 Prentice Hall, Inc.

5. Formula for IndividualIncome Tax(2 of 2) = Adjusted Gross Income (AGI) - Deductions from AGI: Greater of itemized deductions or std deduction Personal and dependency exemptions = Taxable Income X Tax rate or rates (tax table or schedule) = Gross tax - Credits and prepayments = Net tax payable or refund due ©2007 Prentice Hall, Inc.

6. Deductions from Adjusted Gross Income • Itemized deductions • Standard deduction • Personal exemptions • Dependency exemptions • Child credit ©2007 Prentice Hall, Inc.

7. Itemized Deductions(1 of 2) • See Table I2-5 for partial list • Medical expenses • Taxes • Investment and residential interest • Charitable contributions • Personal casualty and theft losses • Miscellaneous deductions ©2007 Prentice Hall, Inc.

8. Itemized Deductions(2 of 2) • Only claim itemized deductions if greater than standard deduction • Some items limited by varying percentages of adjusted gross income • Itemized deductions reduced if AGI exceeds certain amount • Max reduction in itemized deductions is 80% of total itemized deductions ©2007 Prentice Hall, Inc.

9. Standard Deduction • Varies based on: • Filing status • Age • Vision • Used when > itemized deductions • Loss of or limited standard deduction in certain situations ©2007 Prentice Hall, Inc.

10. Personal Exemptions • Generally, each taxpayer allowed one • Unless claimed as dependent on another return • $3,300 in 2006 • Additional allowed for spouse on joint return ©2007 Prentice Hall, Inc.

11. Dependency ExemptionsRequirements for All Dependents • Have a qualifying identification number • Meet a citizenship test • Meet a separate return test • Not themselves claim another person as a dependent ©2007 Prentice Hall, Inc.

12. Dependency ExemptionsAdditional Requirements for Qualifying Children • Relationship test • Age test • Abode test • Support Test ©2007 Prentice Hall, Inc.

13. Dependency ExemptionsRequirements for Other Relatives • Relationship test • Gross income test • Support test • Personal and dependency exemptions phased out for high income taxpayers ©2007 Prentice Hall, Inc.

14. Child Credit • $1000 per qualifying child • Under 17 and a “qualifying” child • Credit reduced if MAGI exceeds threshold • Child credit refundable to extent of 15% of taxpayer's earned income of 11,000 ©2007 Prentice Hall, Inc.

15. Determining the Amount of Tax • Filing status • Joint return • Surviving spouse • Head of household • Single taxpayer • Married filing a separate return • Abandoned spouse • Dependents with unearned income ©2007 Prentice Hall, Inc.

16. Filing Status(1 of 2) • Married filing jointly • Surviving spouse • Head of household • Single • Married filing separately ©2007 Prentice Hall, Inc.

17. Filing Status(2 of 2) • Relative tax liability by filing status from lowest to highest • Married filing jointly • Surviving spouse • Head of household • Abandoned spouse • Single • Married filing separately ©2007 Prentice Hall, Inc.

18. Dependents with Unearned Income • No personal exemption on own return • Standard deduction reduced to greater of • Earned income OR • $800 OR • Dependent’s earned income plus $250 • Kiddie tax • Tax on child’s net unearned income if < 14 same as parents’ rate if higher than child’s ©2007 Prentice Hall, Inc.

19. Business Income & Bus Entities C Corporation Formula Income from whatever source derived - Exclusions = Gross Income - Deductions = Taxable Income X Tax rates = Gross Tax - Credits and prepayments = Net tax payable or refund due ©2007 Prentice Hall, Inc.

20. Business Income & Bus Entities C Corporation Tax Rates ©2007 Prentice Hall, Inc.

21. Business Income & Bus Entities Flow-through vs. Non Flow-through • Flow-through entities do not pay tax at the entity level • C corporations pay tax at the entity level and the owners pay tax on corporate earnings (dividends) when received ©2007 Prentice Hall, Inc.

22. Capital Gains & LossesCapital Asset Definition • Capital asset defined in §1221 • Assets other thaninventory, trade receivables, certain self-created works, depreciable business property, business land, and certain government publications ©2007 Prentice Hall, Inc.

23. Capital Gains & LossesClassification of Capital Gains and Losses • Capital gains and losses are divided into 2 categories • Long-term is held for over 12 months • Short-term is held less than 12 months ©2007 Prentice Hall, Inc.

24. Capital Gains & LossesTax Rates on Net Capital Gains • Net long-term gain • Taxed at maximum of 15% • 5% if in the 10% and 15% tax bracket • Net short-term gain • Taxed at the same rate as other income ©2007 Prentice Hall, Inc.

25. Capital Gains & LossesTax Treatment of Net Capital Losses • Individuals can deduct only up to $3,000 of net capital losses from their other income • Unused losses are carried over and offset against future gains ©2007 Prentice Hall, Inc.

26. Tax Planning Considerations • Shifting income between family members • Splitting income • Maximizing itemized deductions • Filing joint or separate returns • Innocent spouse provision ©2007 Prentice Hall, Inc.

27. Compliance and Procedural Considerations • Who must file • See Chart on page 2-33 • Due dates for filing return • Individuals and Partnerships • 15th day of 4th month after year end • Forms 1040, 1040EZ, and 1040A • Corporations • 15th day of 3rd month after year end ©2007 Prentice Hall, Inc.

28. ©2007 Prentice Hall, Inc.