Income Tax Fundamentals 2010 edition
Gerald E. Whittenburg
Martha Altus-Buller
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Since 1913 - adoption of 16th
amendment - the constitutionality of
income tax has never been questioned

Income taxes serve a multitude of
purposes
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Raise revenue

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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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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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 received advance earned income credit
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Individual (continued)
◦ 1040A
 Generally used by taxpayers who are not self-employed 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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Corporations
◦ Tax rate schedule found on page 1-3
◦ 1120
or
◦ 1120S - 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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This formula 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 (using tax tables or rate schedules)
Gross Tax Liability
less: Tax Credits and Prepayments
Tax Due or Refund
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2009 standard deduction
Single
Married Filing Joint (MFJ)
Qualifying Widow(er)
$ 5,700
$11,400
$11,400
also known as Surviving Spouse
Head of Household (HOH)
Married Filing Separate (MFS)
$ 8,350
$ 5,700
*Taxpayers 65 or older and/or blind get an additional amount
$1,100 if MFJ, MFS or SS
$1,400 if HOH or Single
2009 exemption
$3,650 – personal & dependency
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Facts: Juan (age 29) is a single taxpayer. In 2009, 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
___________
Adjusted gross income
___________
Greater of the standard
deduction or itemized deductions
___________
Taxable income
___________
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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’s return, dependent’s standard
deduction is:
 Greater of $950
or
 Earned income + $300
 But never more than standard deduction
See Figures 1 and 2 on pages 1-7 and 1-8
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Taxpayer must file if
◦ Owe any special taxes (See Figure 3 on page 1-8)
◦ Received Advanced Earned Income Credit
payments from employer
◦ Had self-employment (SE) income >= $400
◦ Other situations outlined on Chart C
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Note: Must analyze each independent situation to determine if the
taxpayers are required to file a return for 2009
Miles (age 45) is a single waiter and has unreported tips
of $1,510; is he required to file?
Yes, because taxpayer owes social security taxes on
unreported tips.
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Taxpayer is single (age 31) and blind and has
income of $9,950; is the taxpayer required to file?
No, because standard deduction = $7,100 ($5,700
+ 1,400); exemption= $3,650. These amounts
total to $10,750 and exceed income.
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Husband (age 67) and wife (age 69) have income of
$19,180 and MFJ; are the taxpayers required to file?
No, because standard deduction = $13,700 ($11,400 +
1,100 + 1,100); exemptions = $7,300. These amounts
total to $20,900 and exceed income.
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Taxpayer is a single full time college student, age
21, with wages from a part-time job of $6,340.
He is claimed as a dependent by his parents;
is the taxpayer required to file?
Yes, because standard deduction = $5,700;
exemption = 0 (as he’s claimed by parents).
Income exceeds these amounts.
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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)

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
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Head of Household (HOH)
*See p. 1-10 for
requirement for
abandoned spouse
◦ 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 exspouse
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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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Six brackets (in Appendix)
◦ 10%, 15%, 25%, 28%, 33%, 35%
◦ Tax rate schedules for different filing types
◦ Marginal rate may exceed 35% when taxpayers are
required to phase-out exemptions and deductions

Qualifying dividends and net long-term
capital gains may be taxed at lower rates
◦ Rates based on ordinary tax bracket
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Provisions includes Making Work Pay Credit
◦ $400 ($800 MFJ) refundable credit on 2009 tax return
 Reduced by any automatic rebate received by certain
taxpayers in 2009
 Reflected in new FIT withholding tables which directly
infused cash into economy through increased wages
 Phases-out $75,000 ($150,000 MFJ)
 Complete Schedule M to calculate credit
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

Personal exemptions may be taken for
self/spouse
Additional exemptions may be taken for
individuals who are either
◦ Qualifying child
or
◦ Qualifying relative


For 2009 each exemption = $3,650
Exemption phased-out to $2,433 when AGI
exceeds certain AGI thresholds
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Dependency exemption allowed for child
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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


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).
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.
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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Dependency exemption may be granted
for a qualifying relative (who is not a
qualifying child).
Note: A taxpayer’s child who does not meet
qualifying child test may meet qualifying
relative test!!
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
Relationship or Member of Household Test – list of
relatives that qualify is available at IRS web site
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 $3,650
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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2009 standard deduction
Single
Married Filing Joint (MFJ)
Qualifying Widow(er)
$ 5,700
$11,400
$11,400
also known as Surviving Spouse
Head of Household (HOH)
Married Filing Separate (MFS)
$ 8,350
$ 5,700
*Plus additional amounts for blindness or over 65: $1,100 if MFJ, MFS or
qualifying widow(er) and $1,400 if HOH or Single
For 2009 only, may add sales tax on qualified motor vehicle
purchased after 2/16/09 and lesser of $500 (or $1,000 MFJ) or
actual real estate taxes paid to standard deduction
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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 2009.
$2,000 earned income
(2,000) standard deduction
$0 taxable income
Example 2: Tia is 18 and has dividend income of $1,500 (not earned)
$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
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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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Long term capital gain
◦ Special rates depending upon taxpayer’s bracket
Ordinary Tax Bracket

Capital Gains Tax Rate
10% or 15%
0%
All other brackets
15%
Long term capital loss
◦ Only allowed $3,000 net capital loss per year against
ordinary income
◦ Carry-forward any unused balance
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Facts: Noah purchased Sony AAA bonds in
2001 for $47,600. In 2009, 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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