Exclusions- items specifically removed from the tax base by law Deductions- subtracted from the tax base rather than fully excluded. Flat tax- one single rate applied to the entire tax base. Progressive tax- rates increase as tax base increases. (Federal income tax) Tax credit- authorized deduction in gross tax liability
Real and personal property taxes- Real (real estate) Personal (difficult to enforce because property is easily concealed or moved, with the exception of vehicles which must be registered) Excise tax- imposed on sale of specific items (cigarettes, luxury goods, etc.) Use tax- Purpose is to prevent avoidance of sales tax (i.e. buying goods in Oregon). Imposed on use of personal property Transfer tax- tax imposed on the right to transfer property, either by gift or inheritance. Tax imposed on the donor. Includes a once-in-a-lifetime exclusion and per donee exclusion. Two categories- Gift and Estate taxes Gift tax- Allowed a $13,000 per year per donee exclusion (26,000 if given jointly with spouse). Unlimited marital deductions and charitable contribution. Taxable gifts allowed an once-in-a-lifetime credit of $1,730,000 and for the taxable estate, an exemption equivalent of credit of 1,730,000 for 2012 to the extent the credit was not used for the gift tax. Estate tax- Combined with taxable gifts. Can deduct contributions to spouse and charity. Once-in-a-lifetime exemption equiv. of $5,000,000 to the extent it was not used for gift tax purposes. FICA tax-Social security and medicare. Employee:S.S- 4.2% $110,000 base medicare-1.45%. Employer:S.S-6.2% medicare- 1.45% Self-employment tax- same as FICA 13.3% $110,000 base 2.9% in excess of base FUTA tax- Employer tax. 6.2% on first $7000 of covered wages
= Gross income
– Above-the-line deductions from gross income
= AGI adjusted gross income
– Below-the-line deductions from AGI
1. Itemized deductions or standard deduction (greater of two)
2. Exemption deductions
= Taxable income
* Applicable tax rate(s)
= Gross tax liability
– Tax credits and prepayments
= Net tax or refund payable
Exclusions are like income items that do not show up on a return. Deductions are like expenses and do show up on a return. Types of exclusions- municipal bonds interest, gifts, inheritances, child support payments, and loans Standard deduction- Married filing jointly (surviving spouse) $11,900, Head of household $8,700 Additional standard deductions- Not married: $1,450 if over 65, $1,450 if legally blind Married: $1,150 if 65 or over, $1,150 if legally blind (each married taxpayer) Dependency exemption- $3,800 each dependent (including self and spouse if married). If death occurs during year entitled to exemption for the year for deceased spouse. If divorces or legally separates during year, not entitled to exemption for spouse. Qualifying child tests-1) must be taxpayers child, stepchild. Also included grandchildren, siblings, niece, or nephew. 2) Child must live with taxpayer for more than half the year. 3) Child must be under 19 or 24 if child is full-time student. Classified as full-time student if attends college any 5 months during year. 4) Child can’t provide more than ½ of their own support. Support includes food, clothing, med. care, housing, or education.
If dependent does not spend funds received, they don’t count towards support. Scholarship is excluded from support test. Qualifying relative- 1) relationship test is met if dependent is relative or household member. Relative includes all relationships for qualifying child category and parents, uncles, aunts, and certain in-laws. Test can be met even if dependent is not related to the taxpayer, but lives with them. 2) taxpayers must provide over ½ of dependent’s support for the year. Possible to meet support test even if no single person provides more than ½ the support. Under multiple support agreement person who wants to claim dependent must contribute more than 10% of support and all others who provide more than 10% of support must agree in writing to let person claim exemption. M.S. agreement most common with an elderly parent where no single child contributes more than 50% of the support. 3) dependent must have gross income less than the amount of the exemption (3,800).
Scholarships only count if they are taxable (for room & board). Social security payments don’t count in gross income test but do count in support test (to the extent spent) Dependent’s death- If deceased during the year they may be claimed if general conditions were satisfied to day of death. Children of divorced parents- 1) Generally, parent with custody of child for more than half the year would be eligible to claim (custodial parent) 2) Custodial parent may agree to allow noncustodial spouse to claim the child Personal exemption for dependents- No deduction is allowed on the return for someone claimed as a dependent. For earned income a taxpayer claimed as a dependent on someone else’s return is entitled to a standard deduction up to the amount of earned income plus $300, not to exceed the standard deduction for single taxpayers (5,950). Standard deduction for dependents- May claim standard deduction equal to the greater of 1) $950 2) person’s earned income plus $300 up to standard deduction amount of $5950 (Single individual rate) Kiddie Tax (children under 19 or 24 if student)- For unearned income once standard deduction is used up, the first $950 of unearned income is taxed at child’s rate and unearned income in excess of that amount is taxed at parent’s rate.
Rule does not apply if child ‘s earned income exceeds ½ of their support, if child is married and files jointly, or if both parents are deceased. Married filing jointly- Entitled if married during the year or if spouse dies during the year. Surviving spouse can file joint return for first 2 years following the year the spouse dies provided they maintain a home where a dependent child or stepchild lives. Head of Household- Must generally maintain a home that is the domicile of a dependent who satisfies qualifying child or relative criteria. For qualifying relative taxpayer must be related to dependent. Exceptions: 1) Person who would be tp’s qualifying child if the tp had not released the dependency deduction to the noncustodial parent still counts as a qualifying child. 2) tp’s parent, if he/she qualifies as a dependent, need not live with tp. 3) Abandoned spouse rule permits a married tp to use HOH if the spouse maintains a home for dependent child for the entire year and the tp’s spouse did not live at home during last six months of the tax year. Tp must also pay for more than ½ cost of maintaining home for tax year. Single- Tps single at end of the year use this rate. Includes divorced and separated tps Married filing separately- Married couples unwilling to combine financial records
Recovery of Capital doctrine- generally, no income is subject to tax until the tp recovers the capital investment (common stock) Capital expenditures- property with useful life more than a year is depreciated or amortized over useful life. Cash-equivalent- if tp is paid in kind (stock shares, car, etc.) use FMV of goods/services received to measure income Constructive receipt- tp has taxable income if money is made available to them w/out substantial restrictions (bank interest credit or pay advance) Claim of right doctrine- income is includable when actually or constructively received by the tp even though the tp might be required to repay the amount at a future date. (income from illegal transactions or insurance commissions paid in advance) if tp is required to repay income it may be deducted in the year repaid to the extent it was previously included as income. If amount is greater than $3,000 tp can choose between the greater of the tax reduction due to the deduction or the amount of excess tax paid due to prior inclusion. Accrual basis- generally used by sole proprietors to account for sales and purchases of inventories. Cash basis may be used for other expenses and revenues of the business.
Most large regular (C) corporations must use accrual basis Prepaid income- an accrual basis tp, generally, must recognize income if received from prepaid items such as rents, interest and warrantees. Hybrid basis- combo of cash and accrual. Tp uses this when the business has inventories and wants to account for other expenses using cash basis Assignment of income- tp can’t assign income to someone else. If tp retains ownership of property, tp is taxed on income derived from property Annuities- The payer (usually insurance co. but could be government) makes series of monetary payments (rents) for either a fixed or contingent time period to the annuitant. The owner pays a premium or series of premiums that the insurance co. invests on the owner’s behalf. The owner is not taxed on the yearly inside build up; instead the tax is differed until the owner begins receiving periodic payments under the contract. Funds from annuities are often obtained from proceeds from life insurance policies, pension or profit-sharing plan, or an individual purchase. Term or simple annuity- payable for a fixed time period
Life annuity- a life annuity is payable for the life of the annuitant (most common) Joint & survivor annuity- provides payments for as long as either the annuitant or another person, usually the annuitant’s spouse, shall live. Exclusion ratio- determines the portion of payments, because they represent a return of capital that is tax-free Exclusion ratio= Investment in annuity contract / Expected return under contract “Investment in the contract” is an after-tax investment. Meaning, taxes have already been paid on this amount & shouldn’t have to be paid again Exclusion ratio * annuity payment = the amount that may be excludable from taxable income For a life annuity, the expected return = (payments per year * life expectancy) Unisex tables are used to determine the life expectancy for group annuities but not for individually purchased annuities For annuities with starting date after 1986, if the annuitant dies before recovering after-tax investment, they are allowed to take an itemized deduction on the final tax return to recover the full after-tax investment.
Deduction would be equal to amount of original after-tax investment less the amount of the investment already recovered tax-free Once investor has excluded an amount equal to the original investment in the annuity, all future payments are fully taxable Partial surrender or cash withdrawals prior to starting date- if the cash value of the contract exceeds investment in the contract, withdrawals are treated first as income to the extent that the cash value of the contract exceeds the investment. In addition, early withdrawals may be assessed a 10% penalty on the portion that is taxable If employee contributed nothing or their contributions were tax deductable to a retirement plan, all annuity payments are taxed as ordinary income.
The exclusion ratio is inapplicable since no after-tax contributions have been made. An example would be a military pension Alimony- alimony and separate maintenance payments are generally for AGI deductions by the party making the payments and are includable in the gross income of the party receiving payments. (Child support supports payments are not deductable to the payer or taxable to the recipient) Prizes & awards- both are taxable, including awards for which the tp does nothing to solicit the award such as Nobel or Pulitzer award (unless given to charity). An employee may, however, exclude up to $400 of tangible personal property (i.e. watch) for a nonqualified employee achievement plan or $1,600 of such property for a qualified plan (qualified plan must be nondiscriminatory and detailed in writing) Group Term Life Insurance- If a plan is nondiscriminatory, an employee can exclude from income the premiums paid by the employer on group term life insurance up to face value of $50,000. Premiums on excess coverage are taxable based on a uniform premium table furnished by the treasury.
After-tax return (amount) = Before-tax return (Amount) * (1 – marginal tax rate) Before-tax return (Amount) = After-tax return (Amount) / (1 – marginal tax rate) Tax planning variables- 1) the entity variable is shifting taxable income to an entity in a lower tax bracket or conversely, shifting expenses to a higher bracket tax payer. 2) the time period variable is postponing the payment of taxable income until a future period in order to postpone paying taxes until a later date to take advantage of the time value of money.