1. 2 THE INDIVIDUAL TAX FORMULA Corporate vs. individual tax model Filing status for individuals...

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THE INDIVIDUAL TAX THE INDIVIDUAL TAX FORMULAFORMULA

Corporate vs. individual tax modelFiling status for individualsOverview of taxable incomeAlternative minimum taxPayment and filing requirements

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Corporate vs. Individual Corporate vs. Individual Tax ModelsTax Models

CORP MODELGross Income

- Deductions= Taxable Incomex Corp Tax Rate (%) = Gross Tax Due- Credits & Payments= Tax or Refund Due

INDIVIDUAL MODEL Gross Income- Deductions for AGI= AGI- Deductions from AGI= Taxable Incomex Individual Tax Rate= Gross Tax Due- Credits & Payments= Tax or Refund Due

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Filing Status for Filing Status for IndividualsIndividuals (1 of 5) (1 of 5)

There are 5 filing statuses Single Married, filing jointly Surviving spouse (qualifying widow(er)) Married, filing separately Head of household

Filing status affects tax rate brackets, standard deduction, and other amounts

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Single Unmarried individual Residual category (i.e., do not meet any of

other statuses)

Married, filing jointly (MFJ) Married as of last day of taxable year, or Spouse dies during taxable year

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Surviving spouse Same tax rate brackets as married, filing jointly File as surviving spouse for 2 years after death of

spouse if taxpayer maintains a home in which a dependent child lives

Married, filing separately Married but not filing a return with spouse and not

abandoned spouse

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Head of household (HH) Must be unmarried as of end of year or an

abandoned spouse Must pay > half the cost of maintaining a

household which is the principal home of a dependent relative for more than half of tax year

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2 Exceptions to the HH requirements HH may be claimed if taxpayer maintains a

separate home for his or her parents if at least one parent qualifies as a dependent

If the qualifying individual is an unmarried child or grandchild, the child or grandchild need not be taxpayer’s dependent

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Overview of Taxable Overview of Taxable IncomeIncome (1 of 2) (1 of 2)

Gross Income (§61) (lines 7-22 on 1040; p. 345)

- Exclusions (e.g., muni-bond interest)

- Deductions from gross income (“for” AGI)

= Adjusted Gross Income (lines 23-35 on 1040)

- > of Itemized deductions (Sch A; p.349) or std. deduction (“from” AGI deductions)

- Personal & dependency exemptions

= Taxable Income

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Overview of Taxable Overview of Taxable IncomeIncome (2 of 2) (2 of 2)

= Taxable Income

x Tax Rate (%)

= Gross Tax

+ Other taxes

- Credits and Payments

= Tax or Refund Due

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Deductions from Gross Income (for AGI Deductions)

Many limitations based on AGIDeductions for AGI include:

Payments to IRAs Student loan interest (limited to $2,500) Tuition and fees (limited to $3,000) Moving expenses 1/2 of self-employment tax paid 100% of health ins if self-employed Alimony paid

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Standard Deduction(1 of 2)

Depends on filing status. For 2003: MFJ = $9,500 (new) MFS = $4,750 (new) HOH = $7,000 (new) Single = $4,750 (new)

Extra ded if blind or aged (≥ age 65). Add to std ded for each occurrence of

MJF, MFS = additional $950 HOH or Single = additional $1,150

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Standard Deduction(2 of 2)

Special limitations on basic std. ded. for individuals claimed as dependent on another individual’s tax return Greater of

$750 or $250 + earned income (but not exceeding the normal basic

standard deduction Additional std. deductions for age and blindness still

available.

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Itemized Deductions(Schedule A; 1 of 2)

If itemized deductions are about equal to standard deduction each year, bunch deductions on alternate years and claim standard deduction on other years. Example: Bob gives $5,000 to charity each year.

He is 77 and single. Does he itemize? Suppose he gave $10,000 to the

church every other year?

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Itemized Deductions(Schedule A; 2 of 2)

Phase-out of itemized deductions If AGI > $139,500 ($69,750 MFS) in 2003,

itemized deductions are reduced by 3% of income > $139,500. Itemized deductions cannot be reduced more than 80%

Some items exempt from phase-out: Medical exp., investment interest exp., casualty/theft

loss, gambling losses See Appendix 13-A.

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Exemptions(Personal Exemptions)

One personal exemption for the taxpayer (2 for MFJ). If you are a dependent on someone else’s

return, can you still claim yourself? Exemption = $3,050 in 2003 for each

personal or dependency exemption.

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Exemptions(Exemptions for Dependents; 1 of 2)

Must meet ALL five requirements:1. Family member OR live in your home for entire year.

What about full-time college student away at school most of the year?

2. You provide > 1/2 financial support.

3. Dependent’s gross income < exemption amount ($3,050):

Waived for child < 19 OR student-child<24

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Exemptions(Exemptions for Dependents; 2 of 2)

Must meet ALL five requirements:4. Dependent must not generally file a joint

return (with a spouse).

5. Dependent must be a U.S. citizen OR a resident of US, Mexico, or Canada.

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Exemptions(Phase-out of Exemptions)

Phase-out of exemptions IF AGI greater than $209,250 (MFJ) in

2003, reduce exemption by 2% for each $2,500 that AGI is above the threshold.

Exemptions can be reduced to $0. See Appendix 13-B.

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Computing Tax Liability(1 of 2)

Use schedule applicable to taxpayer. Which rates are most favorable? Least

favorable?

Marriage penalty What is it? Who benefits? Who is penalized? How does it affect the std. deduction? How does it affect tax brackets?

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Computing Tax Liability(2 of 2)

Computation of capital gains (1 + 2)1. Compute tax liability on taxable income

EXCLUDING capital net LTCG.2. Compute tax on net LTCG.

15% (or 5% if marginal tax rate ≤ 15%). Additional individual taxes

Self-employment taxes Both employer and employee portions of payroll taxes

on income from Sole proprietors, partnerships, LLCs and LLPs

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Individual Tax Credits

Non-refundable credits Child Credit Child and dependent care credit

Refundable credits Earned income credit Excess FICA withholding

Refunded through a tax return claim.

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Child Tax Credit

$1,000 per dependent child under 17. Can be a refundable credit if taxpayer has earned

income.

Phased out by $50 (or fraction thereof) per $1,000 above AGI threshold $110K MFJ $75K single $55K MFS

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Child and Dependent Care Credit

Only for employment related care costs for certain dependents Child < 13 years old or Handicapped dependent or spouse.

Credit amount Eligible care costs x credit % (20%-30%)

20% if AGI > $28,000. Lesser of actual qualified costs or $2,400 (1 child) or $4,800 (2

or more children). Also limited to spouses’ lowest earned income.

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Earned Income Credit

Earned income credit Transfer payment to working poor because credit is

refundable. Increases progressivity of tax rates. Credit phases out as income increases.

Requirements Must have earned income (wages or SE) Must have qualifying child (exceptions)

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Alternative Minimum TaxAlternative Minimum Tax

Taxable income± adjustments+ preferences= AMTI before exemption- exemption (less 25% of excess AMTI)

= AMTIx 26% (or 28% for higher AMTI levels)= TMT

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AMT Adjustments

Examples of AMT adjustments: + Standard deduction + Personal & dependency exemptions + 2% misc itemized deductions + Deduction for state, local, foreign taxes - Itemized deductions phased out

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AMT Exemption

AMT exemption amounts: MFJ: $58,000 HOH and single: $40,250 MFS: $29,000

AMT phaseout threshholds: MFJ: $150,000 HOH and single: $112,500 MFS: $75,000

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Payment and Filing Payment and Filing RequirementsRequirements (1 of 3) (1 of 3)

Pay-as-you-go. Taxes withheld from wages each period

Wages deemed to be w/h equally throughout year.

Estimated taxes for income not subject to withholding Due on 4/15, 6/15, 9/15, and 1/15.

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Avoid underpayment penalty Pay 90% of current year tax or 100% of prior year

110% of prior year if 2002 AGI>$150K. ES payments or withholding must be made

throughout the year. Withholding deemed to be made evenly throughout year. Limits deferral opportunities w/in a year.

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Tax return due 4/15 Get automatic extension to 8/15. Need permission to extend to 10/15. Extension only extends time to file, NOT

extension to pay tax.

1. 2 THE INDIVIDUAL TAX FORMULA Corporate vs. individual tax model Filing status for individuals...

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