Tara crunched some numbers and put together a summary of her parents’ taxable income calculation. She determined that her parents will receive a $369 tax refund when they file their tax return. Tara’s summary is provided in Exhibit 4-10, and Exhibit 4-11 presents pages 1 and 2 of the Halls’ Form 1040.
EXHIBIT 4-10 Taxable Income and Tax Calculation Summary for Rodney and Anita Hall
Description Amount Explanation
(1) Gross income 130,600.00 Example 4-1
(2) For AGI deductions (5,000.00) Example 4-2, line (2)
(3) Adjusted gross income $ 125,600.00 (1) + (2)
(4) From AGI deductions $ (24,000.00) Example 4-3
(5) Taxable income $101,600.00 (3) + (4)
(6) Income tax liability $ 14,231.00 Example 4-4
(7) Credits (2,500.00) Example 4-5, line (2)
(8) Tax prepayments (12,100.00) Example 4-5, line (3)
Tax (refund) $ (369.00) (9) + (10) + (11)
EXHIBIT 4-11 Form 1040
Form 1040 Department of the Treasury—Internal Revenue Service (99)
U.S. Individual Income Tax Return 2017 OMB No. 1545-0074 IRS Use Only—Do not write or staple in this space.
For the year Jan. 1–Dec. 31, 2017, or other tax year beginning , 2017, ending , 20 See separate instructions.
Your first name and initial Last name Your social security number
If a joint return, spouse’s first name and initial Last name Spouse’s social security number
c Make sure the SSN(s) above and on line 6c are correct.
Home address (number and street). If you have a P.O. box, see instructions. Apt. no.
City, town or post office, state, and ZIP code. If you have a foreign address, also complete spaces below (see instructions).
Foreign country name Foreign province/state/county Foreign postal code
Presidential Election Campaign Check here if you, or your spouse if filing jointly, want $3 to go to this fund. Checking a box below will not change your tax or
refund. You Spouse
Filing Status Check only one box.
1 Single
2 Married filing jointly (even if only one had income) 3 Married filing separately. Enter spouse’s SSN above
and full name here. a
4 Head of household (with qualifying person). (See instructions.) If the qualifying person is a child but not your dependent, enter this child’s name here. a
5 Qualifying widow(er) (see instructions)
Exemptions 6a Yourself. If someone can claim you as a dependent, do not check box 6a . . . . . b Spouse . . . . . . . . . . . . . . . . . . . . . . . . }
c Dependents:
(1) First name Last name
(2) Dependent’s social security number
(3) Dependent’s relationship to you
(4) if child under age 17 qualifying for child tax credit
(see instructions) If more than four
dependents, see instructions and check here a
d Total number of exemptions claimed . . . . . . . . . . . . . . . . .
Boxes checked on 6a and 6b No. of children on 6c who:
• lived with you
• did not live with you due to divorce or separation (see instructions) Dependents on 6c not entered above Add numbers on lines above a
Income
Attach Form(s) W-2 here. Also attach Forms W-2G and 1099-R if tax was withheld.
If you did not get a W-2, see instructions.
7 Wages, salaries, tips, etc. Attach Form(s) W-2 . . . . . . . . . . . . 7 8a Taxable interest. Attach Schedule B if required . . . . . . . . . . . . 8a
b Tax-exempt interest. Do not include on line 8a . . . 8b
9 a Ordinary dividends. Attach Schedule B if required . . . . . . . . . . . 9a b Qualified dividends . . . . . . . . . . . 9b
10 Taxable refunds, credits, or offsets of state and local income taxes . . . . . . 10 11 Alimony received . . . . . . . . . . . . . . . . . . . . . 11 12 Business income or (loss). Attach Schedule C or C-EZ . . . . . . . . . . 12 13 Capital gain or (loss). Attach Schedule D if required. If not required, check here a 13 14 Other gains or (losses). Attach Form 4797 . . . . . . . . . . . . . . 14
15 a IRA distributions . 15a b Taxable amount . . . 15b
16 a Pensions and annuities 16a b Taxable amount . . . 16b
17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17 18 Farm income or (loss). Attach Schedule F . . . . . . . . . . . . . . 18 19 Unemployment compensation . . . . . . . . . . . . . . . . . 19
20 a Social security benefits 20a b Taxable amount . . . 20b
21 Other income. List type and amount 21
22 Combine the amounts in the far right column for lines 7 through 21. This is your total income a 22
Adjusted Gross Income
23 Educator expenses . . . . . . . . . . . 23 24 Certain business expenses of reservists, performing artists, and
fee-basis government officials. Attach Form 2106 or 2106-EZ 24 25 Health savings account deduction. Attach Form 8889 . 25 26 Moving expenses. Attach Form 3903 . . . . . . 26 27 Deductible part of self-employment tax. Attach Schedule SE . 27 28 Self-employed SEP, SIMPLE, and qualified plans . . 28 29 Self-employed health insurance deduction . . . . 29 30 Penalty on early withdrawal of savings . . . . . . 30
31 a Alimony paid b Recipient’s SSN a 31a
32 IRA deduction . . . . . . . . . . . . . 32 33 Student loan interest deduction . . . . . . . . 33 34 Reserved for future use . . . . . . . . . . 34 35 Domestic production activities deduction. Attach Form 8903 35
36 Add lines 23 through 35 . . . . . . . . . . . . . . . . . . . 36 37 Subtract line 36 from line 22. This is your adjusted gross income . . . . . a 37
For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see separate instructions. Cat. No. 11320B Form 1040 (2017)
Rodney Hall 2 2 4 5 6 1 2 4 5
Anita Hall 3 2 4 4 3 3 4 7 8
665 Henry Avenue Brookings, SD, 57007
✔
✔
✔
Tara Hall 2 4 2 6 8 9 9 4 5 Daughter
Braxton Hall 2 4 2 2 3 7 8 4 5 Son ✔
2 2
4 130,000
600 300
130,600
5,000
5,000 125,600
(continued)
EXHIBIT 4-11 (continued)
Form 1040 (2017) Page 2
Tax and Credits
38 Amount from line 37 (adjusted gross income) . . . . . . . . . . . . . . 38 39a Check
if: { You were born before January 2, 1953, Blind.
Spouse was born before January 2, 1953, Blind.}Total boxes checked a 39a b If your spouse itemizes on a separate return or you were a dual-status alien, check herea 39b Standard
Deduction for—
• People who check any box on line 39a or 39b or who can be claimed as a dependent, see instructions.
• All others:
Single or Married filing separately,
$6,350 Married filing jointly or Qualifying widow(er),
$12,700 Head of household,
$9,350
40 Itemized deductions (from Schedule A) or your standard deduction (see left margin) . . 40 41 Subtract line 40 from line 38 . . . . . . . . . . . . . . . . . . . 41
42 42
43 Taxable income. Subtract line 42 from line 41. If line 42 is more than line 41, enter -0- . . 43 44 Tax (see instructions). Check if any from: a Form(s) 8814 b Form 4972 c 44 45 Alternative minimum tax (see instructions). Attach Form 6251 . . . . . . . . . 45 46 Excess advance premium tax credit repayment. Attach Form 8962 . . . . . . . . 46
47 Add lines 44, 45, and 46 . . . . . . . . . . . . . . . . . . . a 47
48 Foreign tax credit. Attach Form 1116 if required . . . . 48 49 Credit for child and dependent care expenses. Attach Form 2441 49 50 Education credits from Form 8863, line 19 . . . . . 50 51 Retirement savings contributions credit. Attach Form 8880 51 52 Child tax credit. Attach Schedule 8812, if required . . . 52 53 Residential energy credit. Attach Form 5695 . . . . . 53 54 Other credits from Form: a 3800 b 8801 c 54
55 Add lines 48 through 54. These are your total credits . . . . . . . . . . . . 55 56 Subtract line 55 from line 47. If line 55 is more than line 47, enter -0- . . . . . . a 56
Other Taxes
57 Self-employment tax. Attach Schedule SE . . . . . . . . . . . . . . . 57 58 Unreported social security and Medicare tax from Form: a 4137 b 8919 . . 58 59 Additional tax on IRAs, other qualified retirement plans, etc. Attach Form 5329 if required . . 59 60 a Household employment taxes from Schedule H . . . . . . . . . . . . . . 60a
b First-time homebuyer credit repayment. Attach Form 5405 if required . . . . . . . . 60b 61 Health care: individual responsibility (see instructions) Full-year coverage . . . . . 61
62 Taxes from: a Form 8959 b Form 8960 c Instructions; enter code(s) 62
63 Add lines 56 through 62. This is your total tax . . . . . . . . . . . . . a 63
Payments 64 Federal income tax withheld from Forms W-2 and 1099 . . 64 65 2017 estimated tax payments and amount applied from 2016 return 65 If you have a
qualifying child, attach Schedule EIC.
66a Earned income credit (EIC) . . . . . . . . . . 66a b Nontaxable combat pay election 66b
67 Additional child tax credit. Attach Schedule 8812 . . . . . 67 68 American opportunity credit from Form 8863, line 8 . . . 68 69 Net premium tax credit. Attach Form 8962 . . . . . . 69 70 Amount paid with request for extension to file . . . . . 70 71 Excess social security and tier 1 RRTA tax withheld . . . . 71 72 Credit for federal tax on fuels. Attach Form 4136 . . . . 72 73 Credits from Form: a 2439b Reservedc 8885 d 73
74 Add lines 64, 65, 66a, and 67 through 73. These are your total payments . . . . . a 74
Refund
Direct deposit?
See instructions.
75 If line 74 is more than line 63, subtract line 63 from line 74. This is the amount you overpaid 75 76a Amount of line 75 you want refunded to you. If Form 8888 is attached, check here . a 76a a
a
b Routing number ac Type: Checking Savings
d Account number
77 Amount of line 75 you want applied to your 2018 estimated tax a 77 Amount
You Owe 78 Amount you owe. Subtract line 74 from line 63. For details on how to pay, see instructions a 78 79 Estimated tax penalty (see instructions) . . . . . . . 79
Third Party Designee
Do you want to allow another person to discuss this return with the IRS (see instructions)? Yes. Complete below. No Designee’s
name a Phone
no. a
Personal identification number (PIN) a
Sign Here
Joint return? See instructions.
Keep a copy for your records.
Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and accurately list all amounts and sources of income I received during the tax year. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.
Your signature Date Your occupation Daytime phone number
Spouse’s signature. If a joint return, both must sign. Date
F
Spouse’s occupation If the IRS sent you an Identity Protection PIN, enter it
here (see inst.)
Paid Preparer Use Only
Print/Type preparer’s name Preparer’s signature Date
Check if self-employed
PTIN
Firm’s name a Firm’s address a
Firm’s EIN a Phone no.
Go to www.irs.gov/Form1040 for instructions and the latest information. Form 1040 (2017)
125,600
24,000 101,600
101,600 14,231
14,231
2,500
2,500 11,731
11,731 12,100
12,100 369 369
. . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Exemptions.If line 38 is $156,900 or less, multiply $4,050 by the number on line 6d. Otherwise, see instructions
Source: www.irs.gov/Form1040
CONCLUSION
Recently enacted tax law introduced changes to the individual income tax formula. This chapter presents an overview of the individual income tax formula under the new tax law and provides rules for determining who qualifies as a taxpayer’s dependents and for de- termining a taxpayer’s filing status. In the Gross Income and Exclusions chapter, we turn our attention to determining gross income. In the Individual Deductions chapter, we de- scribe deductions available to taxpayers when computing their taxable income. In the Individual Income Tax Computation and Tax Credits chapter, we conclude our review of the individual income tax formula by determining how to compute a taxpayer’s tax liabil- ity and her taxes due or tax refund.
Appendix A Dependency Exemption Flowchart (Part I)
Yes
Is the potential dependent filing a joint return for the
year?
Yes Is the potential dependent
filing jointly only to claim a refund?
No
Yes Was the potential dependent a U.S. citizen, U.S. resident, or a resident
of Canada or Mexico at some time during the year?
Was the potential dependent your son, daughter, stepchild, eligible foster
child, brother, sister, half-brother, half-sister, step-
brother, stepsister, or a descendant of any of them?
Was the potential dependent:
• Younger than you (or your spouse if filing jointly) and either
(1) Under age 19 at year- end or
(2) Under age 24 at year- end and a full-time student during any part of five calendar months during the calendar year
• Permanently and totally disabled at any time during the year?
Yes
No Yes
Did the potential dependent live with you as a member of your household, except for
temporary absences, for more than half the year?
Part II Did the potential dependent
provide more than half of his or her own support for the year?
No Yes
You cannot claim this individual as your dependent.
Yes
Yes
Yes
No
Would either the potential dependent or the potential dependent’s spouse (or both) have a tax liability, if they had filed separate tax returns?
You may claim this individual as a dependent qualifying child
subject to the qualifying child tiebreaking rules.
Can you (or your spouse if married filing jointly) be claimed as a dependent on someone else’s tax
return this year?
You cannot claim another as your dependent this year.
No You cannot claim the individual as your
dependent.
No
No
No
This individual is not your dependent as a qualifying child but may
be your dependent as a qualifying relative.
Go to part II of flowchart.
OR Part I
Appendix A (Part II)
Was the potential dependent your son, daughter, stepchild, foster child, or a descendant
of any of them?
OR
Was the potential dependent your brother, sister, or a son or daughter of your brother or sister?
OR
Was the potential dependent your father, mother, or an ancestor or sibling of your father
or mother?
OR
Was the potential dependent your half-brother, half-sister, stepbrother, stepsister, stepfather,
stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or
sister-in-law?
Did the potential dependent live with you for the entire year as a member of your
household?
Yes
Did the potential dependent have gross income less than $4,150 for the year (2018)?
Yes
Did you provide more than half the potential dependent’s total support for the year?
Yes
This individual is your qualifying relative.
You may claim this individual as your dependent.
Part II
Yes No
No
No You cannot claim
the individual as your dependent.
No
Appendix B Qualifying Person for Head of Household Filing Status Flowchart
Is the person the taxpayer’s qualifying child?
Is the person the taxpayer’s mother or father?
Yes
No Is the person married at year-end?
Yes
Qualifying person Yes
No No
Did the taxpayer pay more than half the cost of maintaining a household for
the year that was the principal place of abode of the mother or father?
Yes
Yes No Is the taxpayer
allowed to claim the person as a dependent?
Is the person the taxpayer’s qualifying relative and the
taxpayer’s dependent?
Yes
Did the person live with the taxpayer for more than half of the year?
Yes No
No
If the person did not live in the same household as the taxpayer for the entire year, would the person
have qualified as the taxpayer’s dependent?
Qualifying person
Yes Qualifying person Not a qualifying
person
Not a qualifying person
No
No
Notes:
• If a custodial parent agrees under a divorce decree to allow the noncustodial parent to claim the person as a dependent, the agreement is ignored for purposes of this test.
• If the taxpayer can claim the person as a dependent only because of a multiple support agreement, that person is not a qualifying person.
• One qualifying person may not qualify more than one person for head of household filing status.
Appendix C Determination of Filing Status Flowchart
Yes
Yes No
Were you married on the last day of the year?
Start
Yes No
Yes
Married filing jointly or married filing separately
Did you and your spouse live apart (excluding temporary absences) during the last six
months of the year?
Did your spouse die during the year?
Qualifying widow(er)
No Single
Yes Yes
Head of household No
No Do all the following apply?
• Your spouse died in either of the two years prior to the current year.
• In the year of death, you were entitled to file a joint return with your spouse.
• You paid more than half the cost of keeping up your home for the year.
• Your dependent child or stepchild lived in your home all year. (A foster child or grandchild does not meet this test.)
No Do all of the following apply?
• You file a separate return from your spouse.
• You paid more than half the cost of keeping up your home for the year.
• Your home is the main home for your child, stepchild, or foster child for more than half the year.
• You claim the child as a dependent.
Do both of the following apply?
• You paid more than half the cost of keeping up your home for the year.
• A “qualifying person,” as described in Exhibit 4-9, lived with you in your home for more than half the year.
Summary
Describe the formula for calculating an individual taxpayer’s taxes payable or refund.
• Generally, taxpayers are taxed on all income they realize during the year, no matter the source. However, the tax laws allow taxpayers to permanently exclude or to defer to a later year certain types of income they realize during the year.
• Income items that taxpayers are allowed to permanently exclude from income are called exclusions. Realized income items that taxpayers are not taxed on until a future period are called deferrals.
• Taxpayers include gross income on their tax returns.
• The character of the income determines how the income is treated for tax purposes, includ- ing, potentially, the rate at which the income is taxed.
LO 4-1
• Ordinary income is taxed at the rates provided in the tax rate schedules; long-term capital gains (after a netting process) and qualified dividends are taxed at a maximum rate of 0, 15, or 20 percent, depending on the taxpayer’s taxable income.
• Capital gains and losses arise from the sale or disposition of capital assets. In general a capital asset is any asset other than accounts receivable from the sale of goods or ser- vices, inventory, and assets used in a trade or business. If a capital asset is owned for more than a year before it is sold, the capital gain or loss is long-term. Otherwise, it is short-term.
• Taxpayers may deduct up to $3,000 of net capital loss for the year (excess of capital losses over capital gains for the year) against ordinary income. The remainder is suspended and carried over to the next year.
• Even though a personal-use asset meets the capital asset definition, a taxpayer is not allowed to deduct a loss on the sale or disposition of a personal-use asset.
• Deductions reduce a taxpayer’s taxable income. The two types of deductions are for AGI deductions and from AGI deductions.
• Gross income minus for AGI deductions equals adjusted gross income (AGI). For AGI deductions are deductions “above the line,” the last line on the front page of the individual tax form, Form 1040.
• For AGI deductions tend to relate to business activities and certain investment activities.
• AGI minus from AGI deductions equals taxable income.
• From AGI deductions include the deduction for qualified business income and either the stan- dard deduction or itemized deductions. From AGI deductions are referred to as “deductions below the line.”
• AGI is an important reference point in the individual tax formula because it is often used in other tax-related calculations.
• Taxpayers generally deduct itemized deductions when the amount of the itemized deductions exceeds the standard deduction. The standard deduction varies by filing status and is indexed for inflation. Special rules may alter the standard deduction amount for certain taxpayers.
• Taxpayers are no longer allowed to deduct amounts for personal and dependency exemptions.
• Taxpayers generally calculate the tax on their taxable income by referring to tax tables or tax rate schedules.
• Taxpayers may be required to pay the alternative minimum tax (AMT), self-employment tax, the 3.8 percent net investment income tax on unearned (investment) income, and/
or the .9 percent additional Medicare tax on earned income in addition to their regular income tax.
• Tax credits reduce taxpayers’ tax liability dollar for dollar, while deductions decrease taxable income dollar for dollar.
• Taxpayers prepay taxes during the year through withholdings by employers, estimated tax payments, or prior-year overpayments applied toward the current-year tax liability.
• If tax prepayments exceed the taxpayer’s total tax after credits, the taxpayer receives a refund. If tax prepayments are less than the total tax after credits, the taxpayer owes additional tax with his or her tax return.
Explain the requirements for determining who qualifies as a taxpayer’s dependent.
• Individuals who qualify as the dependent of another are not allowed to claim any dependents.
• Taxpayers may claim as dependents those who (1) are citizens of the United States or residents of the United States, Canada, or Mexico and (2) meet the joint tax return test, and are considered either a qualifying child or a qualifying relative of the taxpayer.
• A child must meet a relationship test, an age test, a residence test, and a support test to qualify as a qualifying child.
• A person who is not a qualifying child may be considered a qualifying relative by meeting a relationship test, a support test, and a gross income test.
LO 4-2
Determine a taxpayer’s filing status.
• Taxpayers may file their tax returns as married filing jointly, married filing separately, qualifying widow or widower (also referred to as surviving spouse), single, or head of household.
• Married taxpayers may file a joint return or they may file separately. It is generally more advantageous for tax purposes to file jointly, if married. However, for nontax reasons, it may be advantageous to file separately.
• Each spouse is ultimately responsible for paying the tax on a joint return no matter who received the income.
• For two years after the year in which one spouse dies, the surviving spouse may file as a qualifying widow or widower as long as he or she (1) remains unmarried and (2) maintains a household for a dependent child (child, stepchild, or adopted child).
• Unmarried taxpayers who do not qualify for head of household status file as single taxpayers.
• An unmarried taxpayer who is not a qualifying widow or widower may file as head of household if the person pays more than half the costs of maintaining a household that is, for more than half the taxable year, the principal place of abode for a qualifying person (if the qualifying person is a parent, the parent need not reside with the taxpayer). In general, for an individual to be a qualifying person, the taxpayer must be able to claim the person as a dependent and the person must be considered to be related to the taxpayer even if the person does not live with the taxpayer for the entire year. That is, the taxpayer and the person must be related through a qualifying family relationship. See Exhibit 4-9 for a flow- chart for determining whether an individual is a qualifying person for purposes of determining head of household filing status.
LO 4-3
abandoned spouse (4-24)
adjusted gross income (AGI) (4-2) all-inclusive income concept (4-2) alternative minimum tax (AMT)
(4-11)
character of income (4-6) deductions (4-7)
deductions above the line (4-7) deductions below the line (4-8) deferrals (4-5)
estimated tax payments (4-11) exclusions (4-5)
filing status (4-19) for AGI deductions (4-7) from AGI deductions (4-7) gross income (4-2) head of household (4-21) itemized deductions (4-8) legislative grace (4-7) married filing jointly (4-19) married filing separately (4-19) preferential tax rate (4-6) preferentially taxed income (4-6) qualifying child (4-12)
qualifying relative (4-12)
qualifying widow or widower (4-20) realized income (4-2)
self-employment taxes (4-11) single (4-21)
standard deduction (4-8) tax credits (4-11) taxable income (4-2) tax rate schedule (4-10) tax tables (4-10) withholdings (4-11)
KEY TERMS
DISCUSSION QUESTIONS
Discussion Questions are available in Connect®.
1. How are realized income, gross income, and taxable income similar, and how are they different?
2. Are taxpayers required to include all realized income in gross income? Explain.
3. All else being equal, should taxpayers prefer to exclude income or to defer it? Why?
4. Why should a taxpayer be interested in the character of income received?
5. Is it easier to describe what a capital asset is or what it is not? Explain.
LO 4-1 LO 4-1 LO 4-1 LO 4-1 LO 4-1