Chapter 3
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Calculate Taxable Income
Personal and Dependency Exemptions
Standard Deduction
Filing Status
Calculating Tax for Children
Overview -- Taxable Income Formula
• Gross Income
Separate taxable income from
nontaxable items
• less: Deductions FOR AGI
• Adjusted Gross Income
• less: Itemized Deductions (or Std. Deduction)
• less: Exemptions
• Taxable Income
Personal Exemption
Personal Exemptions - exemption for taxpayer
and spouse …………. Each exemption worth
$3,300 in 2006.
Dependency Exemptions
A. Qualifying Child
1. Relationship Test – must be related
2. Abode – must live with the taxpayer > ½ year
3. Age – child must be <19
(< 24 if full time student)
4. Support – must provide > ½ support
Dependency Exemptions
B. Qualifying Relative
1. Relationship Test – expanded to include
individuals that live with the taxpayer
(i.e you don’t have to be related)
2. Gross Income Test – gross income must be
less that the exemption amount ($3,300)
3. Support – must provide > ½ support
Dependency Exemptions
(two last test that apply to both Dependent Child and Dependent Relative)
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Joint Return Test - If dependent is
married, dependent cannot file a joint
return. See exception where there is no
tax liability.
Citizenship or residency - must be a US
citizen or US resident or resident of
Canada or Mexico.
Relationship Test
• The child must be the taxpayer’s:
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Son or daughter
Stepson or stepdaughter
Brother or sister
Stepbrother or stepsister
Half brother or half sister, or
A descendant of such individual (e.g., grandchildren,
nephews, nieces)
• A child who has been adopted, or whose adoption
is pending, qualifies
• A foster child may also qualify
Domicile Test
(also referred to as “Abode”)
• The child must have the same principal
place of abode as the taxpayer for more than
half of the taxable year
– Temporary absences from the household due to
special circumstances (e.g., illness, education)
are not considered
Age Test
• The child must be under age 19 (or under
age 24 in the case of a full-time student)
– Exception - individuals who are disabled are
not subject to any limitations as to age
Support
• Except in one situation, the definition of
qualifying child makes the support of an
individual irrelevant
– The one case where support becomes relevant
involves self-support
• A child who provides more than one-half of his or
her own support cannot be claimed as a dependent
Questions - Exemptions
• Can a parent be considered a “Qualifying
Child”??
• Can a parent be considered a “Qualifying
Relative”??
• At what age does a child stop becoming a
“Qualifying Child” for purposes of the
exemption?
Filing Status
 Single - unmarried or separated by a decree of divorce or separate maintenance.
Status determined at year end.
Abandoned Spouse Rules allow a married taxpayer to file as single.
 Married - Not always advantageous when compared to single rates. Marriage penalty
relief phased in between 2005 and 2009.
Joint rates apply for two years to a surviving spouse who maintains a household for a
dependent child.
 Married Filing Separate - large medical expenses sometimes make this
advantageous. Also, innocent spouse considerations.
 Head of Household - unmarried maintaining a household for a dependent child or
dependent relative. Dependent must be “related” ….. cannot qualify as a member of the
household.
Exception - Maintaining a separate home for a parent (one must be a
dependent).
Filing Status Clarification
Head of Household
Surviving Spouse
Unmarried taxpayer who
maintains a household for a
dependent.
The surviving spouse must
maintain a household for a
dependent child. The child
must be a son / daughter, or
stepchild.
To qualify, a taxpayer must pay
more than half the cost of
maintaining a household. The
household must be the
principal place of abode for the
dependent. (Exception for parents.)
See example 40 & 41, p. 3-30
See example 38, p. 3-30
Standard Deduction
Single
$5,150
Head of Household
$7,550
Married -- Joint
$10,300
Married -- Separate
$5,150
Additional Standard Deduction
• $1,000 or $1,250 dollars each, depending on
filing status (single or married).
• Taken in addition to the:
• $5,150 (single)
• $10,300 (married)
• $7,550 (head of household)
• Available for taxpayers:
• Over age 65
• Legally blind
Standard Deduction and Exemption
for Individuals who can be claimed as a Dependent
 Standard Deduction is $850 or Earned
Income plus $300 (up to the $5,150
standard deduction)
 Personal Exemption - there is no
personal exemption since it is claimed by
another taxpayer
Capital Gains and Losses
 First, net all short term gains/losses and net all long
term gains and losses.
Short Term
Long Term
 Second, then net the gains and losses together. If
both are gains or both are losses, they keep their
character.
 Capital losses are limited to $3,000 per year.
Unused losses are carried forward.
Kiddie Tax
• Investment income in excess of $1,700 for
children under age 14 would be taxed at the
parents rate.
• The Technical Rule:
Unearned income less $850 less the std
deduction (greater of $850 or investment
expenses) = Income Taxed at Parent’s
Rate
Child Tax Credit
• $1,000 Credit per Child
• Child must be:
• under age 17
• claimed as a dependent on the tax return
• Credit is reduced when Modified AGI
exceeds:
• $110,000 for Married Taxpayers
• $75,000 for Single Taxpayers
Capital Gains (Investment Property)
Support
Capital Losses (Investment Property)
Relationship
Alimony Paid
Gross Income
Child Support Paid
Married
Alimony Received
Citizenship
Child Support Received
Inheritance from a Grandparent
Head of Household
Interest Earned
Mortgage Interest Paid
Property Taxes Paid
Dividends Earned
Life Insurance Proceeds Received
Loss on Sale of Motorboat
Gain on Sale of Motorboat
Charitable Contributions
Wages Earned
Loan Proceeds Received from Bank
Scholarship
Lottery Jackpot
Court Award for Personal Injury
Interest Earned on State of Nebraska bonds
Contribution to IRA