CHAPTER 1
The Individual
Income Tax Return
Income Tax Fundamentals 2012
Gerald E. Whittenburg
Martha Altus-Buller
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Learning Objectives
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Understand history/objectives of U.S. tax law
Describe different entities subject to tax/reporting
requirements
Understand and apply tax formula
Identify who must file tax returns
Determine filing status & understand calculation of tax
according to filing status
Calculate number of exemptions and exemption amounts
Calculate correct standard or itemized deduction amount for
taxpayers
Compute basic capital gains and losses
Access and use various internet tax resources
Understand the basics of e-filing
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History of Taxation
1913, when 16th amendment was
passed, the constitutionality of income
tax has never been questioned
 Since
 Income
taxes serve a multitude of
purposes
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Objectives of Tax Law

Raise revenue
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Tool for social and economic policies
◦ Social policy encourages desirable activities and discourages
undesirable activities
 Credits for investment in solar and wind energy
 Can deduct charitable contributions
 Credits for higher education expenses
◦ Economic policy as manifested by fiscal policy
 Encourage investment in capital assets through depreciation
◦ Both economic and social
 Exclude gain on sale of personal residence up to $250,000 ($500,000 if married)
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Primary Entities/Forms
 Individual
◦ Taxable income includes wages, salary, selfemployment earnings, rent, interest and dividends
◦ An individual may file simplest tax form qualified for
 1040EZ
 1040A
See next slide
 1040
◦ If error made on one of the three above forms, can
amend with a 1040X
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Primary Entities/Forms
 Individual
◦ 1040EZ
 Single or Married Filing Jointly (MFJ)
 Must not be 65 or older and/or blind
 Must not claim any dependents
 Taxable income must be under $100,000
 Only wages, salaries or unemployment and not more
than $1,500 taxable interest income
 Not claim any credits other than the earned income
credit
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Primary Entities/Forms
 Individual (continued)
◦ 1040A
 Generally used by taxpayers who are not selfemployed and don’t itemize deductions
◦ 1040
 If taxpayer doesn’t qualify to use 1040EZ or
1040A,should complete a 1040 with possible
schedules attached
◦ Schedule A to itemize deductions
◦ Schedule B to report dividends/interest income > $1500
◦ Schedule C to report trade/business income
◦ Schedule D to report capital gains/losses
◦ Schedule E to report rental/royalty income
◦ Schedule F to report farm/ranch activities
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Primary Entities/Forms
 Corporations
◦ Tax rate schedule found on page 1-4
◦ Corporations need to file 1120 or 1120S
◦ 1120S is for corporations that elect S Corporation status
 Don’t pay regular corporate income taxes
 Instead, pass through items of income or loss to shareholders
 Partnerships
◦ Reporting entity, not taxable entity
◦ 1065 – reports income/loss and allocation to partners
 Pass through items of income or loss to partners
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Tax Formula for Individuals
This formula follows Form 1040
Gross Income
less:
Deductions for Adjusted Gross Income (AGI)
AGI
less:
Greater of Itemized or Standard Deduction
less:
Exemption(s)
Taxable Income
times: Tax Rate (using tax tables or rate schedules)
Gross Tax Liability
less:
Tax Credits and Prepayments
Tax Due or Refund
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Standard Deduction & Exemptions
2011 standard deduction ($)
Single
Married Filing Joint (MFJ)
Qualifying Widow(er)
5,800
11,600
11,600
also known as Surviving Spouse (SS)
Head of Household (HOH)
Married Filing Separate (MFS)
8,500
5,800
*Taxpayers 65 or older and/or blind get an additional amount
$1,150 if MFJ, MFS or SS
$1,450 if HOH or Single
2011 exemption
$3,700 – personal & dependency
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Using Tax Formula
Facts: Juan (age 29) is a single taxpayer. In 2011, his
salary is $39,000 and he has dividend income of $1000.
In addition, he has deductions for AGI of $2,500 and
$3,000 of itemized deductions. If Juan claims one
exemption for this year, calculate the following amounts:
Gross income
___________
Deductions for AGI
___________
Adjusted gross income
___________
Greater of the standard
deduction or itemized deductions
Exemptions
___________
___________
Taxable income
___________
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Solution
Gross income
$40,000
Adjusted gross income
___________
Greater of the standard
deduction or itemized deductions
___________
Exemptions
___________
Taxable income
___________
Gross income = $39,000 + 1,000
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Solution
Gross income
Adjusted gross income
$40,000
37,500
Greater of the standard
deduction or itemized deductions
___________
Exemptions
___________
Taxable income
___________
AGI = $40,000 – 2,500
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Solution
Gross income
Adjusted gross income
Greater of the standard
deduction or itemized deductions
$40,000
37,500
5,800
Exemptions
Taxable income
___________
The standard deduction of $5,800 exceeds itemized
deductions of $3,000
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Solution
Gross income
Adjusted gross income
$40,000
37,500
Greater of the standard
deduction or itemized deductions
5,800
Exemptions
3,700
Taxable income
$28,000
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Who Must File
 Based
on filing status and gross income
◦ Generally, if exemptions
plus
greater of standard or itemized deductions exceed
income, then filing is not necessary
◦ If taxpayer is claimed as a dependent on another
taxpayer’s return, dependent’s standard deduction is:
 Greater of $950
See Figures 1.1
or
and 1.2 on page 1-8
 Earned income + $300
 But never more than standard deduction
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Who Must File
 Taxpayer
must file if
◦ Owe any special taxes
 See Figure 1.3 on page 1-9
◦ Had self-employment income >= $400
◦ Other special situations as outlined on Chart C
(Figure 1.3)
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Which Taxpayers are
Required to File
Note: Must analyze each independent situation to
determine if the taxpayer is required to file a return
for 2011
Miles (age 45) is a single waiter and has
unreported tips of $1,510; is he required
to file?
Yes, because Miles owes social security
taxes on unreported tips.
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Which Taxpayers are
Required to File
Simone is single (age 31) and blind and has
income of $10,370; is she required to file?
No, because standard deduction = $7,250
($5,800 + 1,450); exemption= $3,700.
These amounts total to $10,950 and exceed
her gross income.
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Which Taxpayers are
Required to File
Eamon (age 67) and his wife, Roisin, (age 69)
have income of $19,180 and file jointly; are
they required to file?
No, because standard deduction = $13,900
($11,600 + 1,150 + 1,150); exemptions =
$7,400. These amounts total to $21,300 and
exceed their gross income.
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Which Taxpayers are
Required to File
Taig is a single full time college student, age 21,
with wages from a part-time job of $7,340. He
is claimed as a dependent by his parents; is
he required to file?
Yes, because Tai’s standard deduction = $5,800
and his income exceeds this amount. His
exemption is 0 as he’s claimed by parents.
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Filing Status
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Single
◦ Unmarried or legally separated as of 12/31
◦ And not qualified as married filing separately, head of household or
qualifying widow(er)
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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
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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
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Filing Status
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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 child or other qualifying dependent
relative
 There is one exception to principal residence requirement. If
dependent is taxpayer’s parent, he/she doesn’t have to live with
taxpayer.
Note: A divorced parent who meets above rules and has signed IRS/legal document,
may still claim HOH even if dependency exemption shifted to ex-spouse
*See pages 1-10 and 1-11 for requirement for abandoned spouse
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Filing Status
 Qualifying
Widow(er) with Dependent Child
◦ Also known as surviving spouse
◦ Available for two subsequent years after death
of spouse
 Must pay over half the cost of maintaining a
household where a dependent child, stepchild,
adopted child or foster child lives
◦ Gets benefits of married filing joint tax rates
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Tax Computation
 Six brackets (in Appendix)
◦ 10%, 15%, 25%, 28%, 33%, 35%
◦ Tax rate schedules for different filing types
 Qualifying
dividends and net long-term
capital gains may be taxed at lower
rates
◦ Rates based on ordinary tax bracket
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Personal/Dependency
Exemptions
 Personal
exemptions may be taken for self
and spouse
 Additional exemptions may be taken for
individuals who are either taxpayer’s
◦ Qualifying child
or
◦ Qualifying relative
 For
2011 each exemption = $3,700
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Dependency – Qualifying Child
Dependency exemption allowed when six
tests met
 Relationship Test - child is taxpayer’s child, stepchild,
adopted child or taxpayer’s sibling, half- or step-sibling,
or a descendant of any of these. Foster child may also
qualify. Child must be younger than person claiming
him/her, unless permanently disabled.
 Domicile Test- child has same principal place of abode
as taxpayer for more than ½ the year.
 Age Test – child is under 19 or a full-time student under
24 (enrolled at least 5 months of year).
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Dependency – Qualifying Child

Joint Return Test – child doesn’t file joint return with
spouse (exception: if it’s only to claim refund, then
considered to have passed this test).
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Citizenship Test – child is a US citizen, a resident of the
US, Canada or Mexico, or an alien child adopted by and
living with a US citizen.
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Self-Support Test – child who provides more than ½ of
his/her own support cannot be claimed as a dependent of
someone else. Funds received by students as scholarships
are excluded from support test.
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What if Child Meets Dependency
Requirements for More than One Taxpayer?
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If one of the parties is a parent, he/she can claim
If both parties are a parent, then one with whom the
child resides longest can claim
o If not ascertainable, parent with highest AGI may
claim
If no parents are involved, person with highest AGI
may claim
Note: If parents are legally separated/divorced, person
with whom child resides more than 6 months may
claim.
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Exemption can shift if custodial parent signs Form 8332 and
form is attached to noncustodial parent’s tax return
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Dependency – Qualifying Relative
Dependency exemption may be granted
for a qualifying relative (who is not a
qualifying child) based on tests on next
slide.
Note: A taxpayer’s child who does not meet
qualifying child test may meet qualifying
relative test!!
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Dependency – Qualifying Relative
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Relationship or Member of Household Test – list of
relatives that qualify is available at IRS web site
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Note: A member of household (even if unrelated) for entire
year meets the relationship test
Gross Income Test – individual may not have gross
income in excess of $3,700
 Support Test – dependent must receive over ½ of
his/her support from taxpayer
 Joint Return Test – dependent may not file a joint return
unless it’s solely to claim refund
 Citizenship Test – dependent must meet the citizenship
test identified in the qualifying child slide
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Standard Deduction
2011 standard deduction
Single
Married Filing Joint (MFJ)
Qualifying Widow(er)
$ 5,800
$11,600
$11,600
also known as Surviving Spouse
Head of Household (HOH)
Married Filing Separate (MFS)
$ 8,500
$ 5,800
*Plus additional amounts for blindness or over 65: $1,150 if MFJ,
MFS or qualifying widow(er) and $1,450 if HOH or Single
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Standard Deduction - Dependents
The special rule for standard deduction for dependents is
“Deduction = Greater of $950 or earned income + $300, but only
up to basic standard deduction”
Example 1: Jaime is 23 and a full time student and her parents
claim her as a dependent; she earned $2,000 in 2011, how
much is taxable income?
$2,000 earned income
(2,000) standard deduction
$0 taxable income
Example 2: Tia is 18 - has dividend income of $1,500 (dividends are
considered unearned income), how much is taxable income?
$1,500 dividend income
( 950) standard deduction
$ 550 taxable income
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Basic Gain & Loss Model
Amount Realized*
- Adjusted Basis**
Realized Gain/Loss
* Sales Price - Sales Expenses
** Cost - Accumulated Depreciation
Note: Most realized gains/losses are also
recognized (i.e. – included in taxpayer’s income)
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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 – see next
screen)
◦ Short-term is held <= 12 months (taxed at ordinary rates)
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Capital Gains/Losses
 Long
term capital gain
◦ Special rates depending upon taxpayer’s bracket
Ordinary Tax Bracket
Capital Gains Tax Rate
10% or 15%
All other brackets
 Long
0%
15%
term capital loss
◦ Only allowed $3,000 net capital loss per year against
ordinary income
◦ Carry-forward any unused balance
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Calculating Gain/Loss
Facts: Noah purchased Sony AAA bonds in
2006 for $47,600. In 2011, he sold the bonds
for $51,500, paying commission of $515. What
is his:
Amount realized
___________
Adjusted basis
___________
Realized gain/loss
___________
Recognized gain/loss ___________
Type of gain/loss
___________
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Solution
Amount realized *
Adjusted basis
$50,985
47,600
Realized gain/loss
3,385
Recognized gain/loss
3,385
Type of gain/loss
Long term capital gain
*Amount realized = $51,500 – 515
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Tax and The Internet
 Volumes of tax information available on
internet
o http://www.irs.gov contains forms and
publications and a search engine to aid the
user in obtaining useful information
 The IRS has also launched a YouTube video site
and an iTunes podcast site featuring topics like
how to obtain refund or file an extension
 Other good sites include www.hrblock.com and
www.willyancey.com
 In some states, names of delinquent taxpayers
posted on web sites
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Electronic Filing
 Rules in constant transition, as IRS attempts to
transition all taxpayers to e-filing
 Taxpayers may prepare electronic returns using
own PC and tax preparation software
or
 May utilize a paid preparer who employs e-filing
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The End!
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