Lecture Notes
Chapter 4: Individual income tax overview, Dependents, & Filing Status
ACCT 5400 – Fall 2018 – Demeré
1. The Individual Income Tax Formula (pages 4-2 through 4-12)
Realized income from whatever source derived
Less:
Exclusions
Deferrals
Gross Income
Equals:
_________________________
Less:
Deductions For AGI
Equals:
Adjusted Gross Income (AGI)
Less:
Deductions From AGI:
Greater of (a) standard deduction or (b) itemized deductions
Deduction for Qualified Business Income
Taxable Income
Equals:
_________________________
Times:
Tax Rates
Equals:
Income Tax Liability
Plus:
Other Taxes
Total Tax Liability
Equals:
_________________________
Less:
Tax Credits
Less:
Tax Prepayments
Tax Due/ Refund
Equals:
_________________________
$XXX
(XXX)
(XXX)
$XXX
(XXX)
$XXX
(XXX)
(XXX)
$XXX
$XXX
XXX
$XXX
(XXX)
(XXX)
$XXX
➢ Realized income from whatever source derived (broadly defined):
all-inclusive income
• Tax laws are based on the __________________________
concept implying that
taxpayers generally must include in taxable income all realized income from
whatever source derived
❖ Realized income is generated in a transaction with a second party in which
change in property rights
there is a measurable ___________________________________
between parties
❖ Examples provided in Exhibit 4-3
➢ Exclusions and Deferrals: Income that specific tax provisions allow the taxpayer to
permanently ______________________ or ______________________ from income
• Examples provided in Exhibit 4-4
➢ ________________________________: Realized Income – (Exclusions + Deferrals)
• Character (or type) of income determines the ____________________ at which the
income will be taxed
❖ Tax exempt: Income realized during the year that is excluded from gross
income and is ___________________ taxed
❖ Tax deferred: Income realized during the year that is not included in gross
income until a _____________________________
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❖ Ordinary: Income (loss) included (subtracted) in gross income in the current
year and taxed at the ordinary rates provided in the
______________________________
❖ Qualified dividends and long-term capital gains: Taxed at a maximum rate of
15 or 20% depending on the taxpayer’s taxable income (Chapter 7)
➢ Deductions: Unlike gross income which is all inclusive, taxpayers are not allowed to
deduct ___________________ unless a specific tax provision allows them to do so
➢ Deductions ________ AGI:
• Known as ______________________________ deductions.
• These always reduce taxable income and tend to be associated with business and
certain investing activities.
• Examples provided in Exhibit 4-5
➢ Adjusted Gross Income (________): Gross Income – Deductions for AGI
• AGI is an important reference point in tax formula b/c it is often used in other taxrelated calculations (e.g., limits on from AGI deductions often rely on AGI)
➢ Deductions from AGI:
• Tend to be _______________________ in nature
• The greater of:
(1) The ___________________________________:
▪
Permitted to all taxpayers
▪
Amount of the deduction varies depend on taxpayer filing status
o Taxpayers 65 or older and blind taxpayers are entitled to
additional standard deduction amounts
o Amount is limited if claimed as a dependent on another tax
return (limited to greater of $1,050 or $350 + earned income)
▪
Simplifies compliance for most taxpayers
(2) ________________________________ (Examples provided in Exhibit 4-6)
• Deduction for Qualified Business Income
❖ Is in addition to the greater of the standard or itemized deductions
❖ Discussed more in Chapter 6
➢ _______________________: AGI – Deductions from AGI
➢ Tax Rates:
• Use tax table/schedules to determine tax liability
• Note: Capital gains/dividends may be taxed using preferential rates
➢ Income Tax Liability: _______________________ * _______________________
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➢ Other taxes (e.g., alternative minimum tax, self-employment tax, net investment income
tax, etc.)
➢ Total tax liability = Income tax liability + Other taxes
➢ Tax ____________________:
• Like deductions, credits are specifically granted by Congress.
• Unlike deductions, reduce tax liability (rather than taxable income) _____________.
• Examples: child tax credit, child care credit, earned income credit, American
opportunity credit, lifetime learning credit
➢ Tax ____________________:
• Withholdings
• Estimated tax payments
• Overpaid taxes rolled forward from prior year
➢ Tax due/refund:
• If tax liability > tax payments → _______________________
• If tax liability < tax payments → _______________________
✓ Let’s practice! Example 1: Jon and Ygritte are married with a two-year-old child named
Ghost who lives with them and whom they support financially. In 2018, Jon and Ygritte
realized the following items of income and expense. They also qualified for a $1,000 tax
credit. Their employers withheld $1,800 in taxes from their paychecks (in the aggregate).
Finally, the 2018 standard deduction amount is $24,000. What are the couple's taxes due
or tax refund (use the tax rate schedules)?
Item
Jon's salary
Ygritte's salary
Municipal bond interest income
IRA Contributions (for AGI deduction)
Qualifying interest expense (from AGI deduction)
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Amount
$35,000
$34,400
$400
($7,000)
($10,000)
2. Dependents of the Taxpayer (pages 4-12 through 4-19 and Appendix A)
➢ Determining who qualifies as a dependent is relevant for determining:
• Filing Status
• Eligibility for certain tax credits (e.g., child, American opportunity)
➢ Three requirements must be met for an individual to be claimed as a dependent:
• Must be a _____________ of the US or a _____________of the US, Canada, or
Mexico
• Must not file a _______________________ with the individual’s spouse unless (a)
there is no tax liability on the joint return (i.e., only filing for a refund) and (b) there
would have been no tax on either spouse’s return if they would have filed
separately
• Must be considered either a qualifying child or qualifying relative of the taxpayer
➢ Four tests must be met to be considered a qualifying child of the taxpayer:
• ____________________________ test. The individual must be a:
❖ Child, stepchild, foster child, adopted child, or
❖ Sibling (whole or half), step-sibling, or
❖ Any ______________________ of the preceding relatives.
❖ NOTE: Cousins do not satisfy the relationship test.
• ____________________________ test.
❖ Qualifying child must be _____________________ than the taxpayer claiming
such individual as a qualifying child, and
❖ Either:
▪ Under age _________ at the end of the year, or
▪ Under age _________ at the end of the year and a full-time student (A
person is a full-time student if she was in school full-time during any
part of each of 5 calendar months during the calendar year)
❖ Exception to the age test: An individual who is permanently and totally
disabled is automatically deemed to have met the age test.
• ____________________________ test.
❖ Qualifying child must have the same principal residence as the taxpayer for
_______ than half the year.
▪
Time that a child (or the taxpayer) is temporarily away from the
taxpayer’s home because the child (or taxpayer) is ill or pursuing an
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education is counted as though the child (or taxpayer) were living in the
taxpayer’s home.
• ____________________________ test.
❖ Qualifying child must not have provided _________________________ of
his/her own support for the year.
▪
Support includes food, clothing, recreation, medical care, child care,
lodging, education costs, etc.
▪
Note: When determining who provided the support for a child of the
taxpayer who is a full-time student, scholarships are _________________
from the computation.
• Tiebreaking rules if more than one taxpayer can claim an individual as a qualifying
child:
❖ Qualifying child living with parent and non-parent → __________________ of
the qualifying child has priority (e.g., qualifying child lives with a parent and
grandparents)
❖ Qualifying child to both parents → Parent with whom the qualifying child
has lived with for the ____________________ of the year has priority (e.g.,
parents divorce during the latter part of the year)
▪ Note: Dependency of the child of divorced parents can be allocated to
the non-custodial parent in the divorce decree or separation agreement.
❖ Qualifying child resides with both parents for the same amount of time or the
qualifying child resides with taxpayers who are not the parents → Taxpayer
with the _____________________ AGI has priority.
✓ Let’s practice! Example 2: Bran, an unmarried taxpayer who lives in the United States,
is 12 years old and made an estimated $3,000,000 from movie sales last year. Bran still
lives primarily with his parents, however, who provide most of his living expenses.
Can Bran be claimed as a dependent by his parents? Why?
➢ Qualifying relative is a person who is not a qualifying child and satisfies three tests:
• _________________________ test. A qualifying relative must be:
❖ A descendant or ancestor of the taxpayer (includes adopted children,
stepchildren, and foster children as well as stepparents),
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❖ A sibling of the taxpayer (includes stepsiblings) ,
❖ Nephew/niece, aunt/uncle, or parent/sibling-in-law, (not a cousin), or
❖ An unrelated person who has lived with the taxpayer for the _________ year.
• _________________________ test.
❖ Taxpayer must provide more than ________ of qualifying relative’s support.
❖ Note: When determining who provided the support for a child of the
taxpayer who is a full-time student, scholarships are ___________________
from the computation.
❖ How is this test impacted by multiple support agreements?
▪
____________________________________: two or more people combined
to pay for more than 50% of the qualifying relative’s support
▪
Under a multiple support agreement, a taxpayer who doesn’t
individually pay over 50% of qualifying relative’s support may still
claim the qualifying relative as a dependent if:
o No one taxpayer paid _______________________ of support
o The taxpayer and at least one other person provide more than
50% of the qualifying relative’s support and they would have
been able to claim qualifying relative dependency had they
provided more than 50% of support
o Taxpayer contributed _______________________ of qualifying
relative support
o Each other person paying more than 10% of qualifying relative’s
support provides a ____________________________ agreeing not
to claim qualifying relative as a dependent
• _________________________ test.
❖ Qualifying relative’s gross income for the year must be ___________ than the
personal exemption amount (2018: $4,150).
➢ Appendix A in your textbook provides a flowchart for determining whether an
individual qualifies as a taxpayer’s dependent
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✓ Let’s practice! Example 3: Bran, an unmarried taxpayer who lives in the United States,
is 12 years old and made an estimated $3,000,000 from movie sales last year. Bran lived
all year with his older cousin Theon who provides most of his living expenses. Can
Bran be claimed as a dependent by his cousin? Why?
3. Filing Status (pages 4-19 through 4-24, Appendix B, and Appendix C)
➢ Why is a taxpayer’s filing status important?
• A taxpayer’s filing status determines:
❖ The applicable ______________________ schedule (see Appendix D of the
textbook)
❖ The taxpayer’s _______________________________ amount (see Appendix D
of the textbook)
❖ The AGI threshold for reductions in certain benefits such as certain itemized
deductions and tax credits
➢ Five filing statuses:
• Married Filing _________________ (MFJ)
❖ Must be married on the last day of the year, or
❖ Widowed during the year (spouse died during the tax year)
• Married Filing _________________ (MFS)
❖ Same requirements as MFJ
❖ Generally not advantageous for tax reasons but may be advantageous for
non-tax reasons
▪
________ → both spouses are liable for tax liability
▪
________ → each spouse is only responsible for the tax liability reported
on his/her individual return
• Qualifying ____________________________
❖ Allows widow/widower to file as if she/he is married filing jointly for up to
____________ years after the end of the year in which the other spouse dies
❖ To qualify:
▪ Must remain ______________________ and
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▪
▪
Paid _____________________ of the cost of maintaining a household
where a dependent child lived for the entire year
NOTE: Dependent child must be child/stepchild/adopted child (not
foster child)
• Single
❖ ______________________ taxpayers who do not qualify as Head of
Household
• ________________________________________
❖ Unmarried (or considered unmarried under the abandoned spouse
provisions) at year end
❖ Not a qualifying widow or widower
❖ Pay ____________________ of the costs of maintain a household for a
qualifying person
❖ A qualifying person includes:
▪
▪
▪
A qualifying child who qualifies as the taxpayer’s __________________
A qualifying relative who is the taxpayer’s mother or father and qualifies
as the taxpayer’s dependent, or
A qualifying relative other than the taxpayer’s mother or father who
qualifies as the taxpayer’s dependent and: (i) Is actually related to the
taxpayer; (ii) Does not qualify as qualifying relative due to a multiple
support agreement, and (iii) Lives with the taxpayer for more than half
the year
❖ Exhibit 4-9 & Appendix B help determine who is a qualifying person for head
of household filing status
• _____________________________________
❖ Technically married (or not legally separated) but living apart
❖ If filing jointly, taxpayers are legally responsible for paying tax on the income
earned by the other spouse
❖ As an abandoned spouse, a married taxpayer can file as if he/she was
_______________ at the end of the year if the following requirements are met:
▪
▪
Is married at the end of the year (or is not legally separated from the
other spouse)
Does not file a _______________ return with the other spouse
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▪
▪
Pays ___________________ the costs of maintaining his/her home for the
entire year, and this home is the principle reside for a child (who
qualifies as the taxpayer’s dependent) for ___________________ the year
(must be child, adopted child, stepchild, or eligible foster child)
Spouse does not live in the taxpayer’s home for the last ___ months of
the year.
❖ If the taxpayer meets these requirements, he/she also meets the head of
household filing status requirements and may file as _____________________
for the year
✓ Let’s practice! Example 4: Selyse and her husband Stannis have been married for 25
years. In May of this year, the couple divorced. During the year, Selyse provided all the
support for herself and her 22-year-old daughter Shireen who lived in the same home
as Selyse for the entire year. Shireen is employed full-time, earning $29,000 this year.
What is the Selyse's most favorable filing status for the year?
✓ Let’s practice! Example 5: Catelyn's husband Ned died four years ago. Catelyn has not
remarried and she maintains a home for her dependent child Rickon. In 2018, Catelyn
received $70,000 of salary from her employer and she paid $14,500 of itemized
deductions. What is Catelyn's taxable income for 2018?
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