2017 Annual Federal Tax Refresher (AFTR) - CE Self Study · 2017. 7. 1. · e. Gambling losses up...

2017 Annual Federal Tax Refresher (AFTR) |

2017 Annual Federal Tax Refresher (AFTR)

Table of Contents Domain 1: New Tax Law/Recent Updates .................................................................................................... 3

1.1 Annual Inflation Adjustments (new filing requirement thresholds amounts, new personal

exemptions, new standard deduction amounts) ...................................................................................... 3

1.2 Increase in Repair Regulation Safe Harbor Amount (Notice 2015-82) ............................................... 8

1.3 Summary of PATH Act of 2015 for Individuals (Permanent vs. Temporary Tax Extenders) ............... 8

1.4 Review of Tax Return Due Dates (April 18, 2017), Including Extensions ............................................ 9

Domain 2: General Review.......................................................................................................................... 10

2.1 Tax Related Identity Theft ................................................................................................................. 10

2.2 ITINs .................................................................................................................................................. 12

2.3 Determination of all Five Filing Statuses........................................................................................... 17

2.4 Claiming a Dependent ....................................................................................................................... 21

2.5 Taxability of Wages, Salaries, Tips, and Other Earnings ................................................................... 33

2.6 Interest and Dividend Income ........................................................................................................... 37

2.7 Schedule B, Part III Foreign Accounts and Trusts .............................................................................. 40

2.8 Taxable Refunds ................................................................................................................................ 41

2.9 Unemployment Compensation ......................................................................................................... 41

2.10 Schedule C Self Employment Income and Expenses ....................................................................... 42

2.11 Reporting and Taxability of Social Security Benefits ....................................................................... 54

2.12 Overview of Capital Gains and Losses............................................................................................. 55

2.13 Pensions, Annuities, and Individual Retirement Accounts (IRAs) ................................................... 57

2.14 Adjustments to Income ................................................................................................................... 62

2.15 Standard Deduction vs. Itemized Deductions ................................................................................. 72

2.16 Overview of Schedule A Deductions ............................................................................................... 75

2.17 Child and Dependent Care Credit ................................................................................................... 92

2.18 Education Credits ............................................................................................................................ 96

2.19 Retirement Savings Contribution Credit ....................................................................................... 100

2.20 Child Tax Credit and Additional Child Tax Credit .......................................................................... 100

2.21 Affordable Care Act (ACA) provisions ........................................................................................... 102


2.22 Earned Income Tax Credit (EITC) including eligibility rules ........................................................... 105

2.23 Tax Withholding and Estimated Tax Payments ............................................................................. 115

2.24 Payment and Refund Options, Including Maximum of 3 Deposits in One Account ..................... 115

Domain 3: Practices, Procedures and Professional Responsibility ........................................................... 117

3.1 Requirement to Furnish Taxpayer with a Copy of a Return and Related Penalty .......................... 117

3.2 Requirement for Signing the Return as a Return Preparer and Related Penalty ........................... 117

3.3 Requirement to Furnish Identifying Number as Return Preparer and Related Penalty ................. 118

3.4 Requirement to Retain Copy of Return or List and Related Penalty .............................................. 118

3.5 Prohibition on Negotiation of Client Refund Check ........................................................................ 118

3.6 Due Diligence in Preparing Returns ................................................................................................ 118

3.7 Compliance with e-file procedures: Timing of taxpayer signature, timing of filing, recordkeeping,

prohibited filing with pay stub, proper handling of rejects, etc. .......................................................... 125

3.8 Penalties to be assessed by the IRS against a preparer for negligent or intentional disregard or

rules and regulations, and for a willful understatement of liability, including PATH ACT changes to

§6694(b) ................................................................................................................................................ 131

3.9 Annual Filing Season Program Requirements ................................................................................. 133

3.9a Adherence and consent to duties and restrictions found in subpart B and section 10.51 of Circular

230 ........................................................................................................................................................ 133

3.9b Limited Representation Rights ...................................................................................................... 137

AFTR Test Instructions .............................................................................................................................. 138

Glossary ..................................................................................................................................................... 139

Notice

This information is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice and assumes no liability whatsoever in connection with its use. Because tax laws are constantly changing, and are subject to differing interpretations, we urge you to do additional research before acting on the information contained in this document.


Domain 1: New Tax Law/Recent Updates 1.1 Annual Inflation Adjustments (new filing requirement thresholds amounts, new personal exemptions, new standard deduction amounts) Filing Requirement Thresholds You must file a tax return or claim for refund if your gross income exceeds the following thresholds:

Filing Status Age Gross Income

Single Under 65 $10,350

65 or older $11,900

Head of Household Under 65 $13,350

65 or older $14,900

Married Filing Jointly Under 65 (both spouses) $20,850

65 or older (one spouse) $22,100

65 or older (both spouses) $23,350

Married Filing Separately Any age $4,050

Qualified Widow(er) with Dependent Children Under 65 $16,650

65 or older $17,900

Personal Exemption For 2016 the personal exemption is $4,050. The personal exemption credit for 2016 will be reduced based on the taxpayer's adjusted gross income and filing status. The personal deduction phaseout threshold is:

Single

Begins to phase out

$259,400

Completely phases out

$381,900 MFJ $311,300 $433,800

Head of Household $285,350 $407,850

Married filings separate $155,650 $216,900

The exemption completely phases out at $381,900 and $433,800 for married filing jointly taxpayers. If the expected income will be more than the above phaseout, the taxpayer should consider changing Form W-4 to reduce the amount of personal allowances that are claimed. Standard Deduction Amounts


Due to inflation adjustments, the 2016 standard deduction amounts will be as follows:

Single or married filing separately: $6,300

Married filing jointly: $12,600

Head of household: $9,300

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,250 for married taxpayers or $1,550 for unmarried taxpayers. Standard mileage rates: The 2016 business rate is 54 cents per mile and medical rate is 19 cents per mile. Charitable mileage stays at 14 cents per mile for the 2016 tax year. Itemized Deduction Phaseout Threshold The 2016 itemized deductions may be phased out or reduced based on the taxpayer's adjusted gross income and filing status.

Single $259,400

MFJ $311,300

MFS $155,650

Head of household $285,350

When figuring the withholding amount, the following itemized deductions can be taken into consideration: 1. Medical and dental expense that are more than 10% (7 .5% if either taxpayer or spouse is over 65) 2. State and local income tax 3. Property taxes 4. Deductible home mortgage interest 5. Investment interest up to net investment income 6. Charitable contributions 7. Casualty and theft losses that are more than $100 and 10% of AGI 8. Fully deductible miscellaneous itemized deductions including:

a. Impairment-related work expenses of a person with disabilities b. Federal estate tax on income with respect of a decedent c. Repayment of more than $3,000 of income held under a claim of right that is included in income

in an earlier year because the taxpayer had an unrestricted right to claim it d. Unrecovered investments in an annuity contract under which payments have ceased because of

the annuitant's death e. Gambling losses up to the amount of gambling winnings reported on the return f. Casualty and theft losses from income-producing property

9. Other miscellaneous itemized deductions that are more than 2% of AGI including: a. Unreimbursed employee business expenses, such as education expenses, work clothes and

uniforms, union dues and fees, and the cost of work-related small tools and supplies b. Safe deposit box rental c. Tax counsel and assistance d. Certain fees paid to an IRA trustee or custodian.


For more information about tax withholding and estimated tax, see Publication 505. Long Term Care

Age before December 31, 2016 Premium Limitation

40 or younger $390

More than 40 under 50 $730

More than 50 under 60 $1,460

More than 60 under 70 $3,900

More than 70 $4,870

AMT Exemption Amount After adjusting for inflation, the following are the AMT exemptions for 2016:

$53,900 for single and head of household taxpayers

$83,800 for married taxpayers filing jointly

$41,900 for married taxpayers filing separately 2016 AMT phaseout range:

$119,700 - $335,300 for single and head of household

$159,700 - $494,900 for MFJ and surviving spouse

$79,850 - $247,450 for MFS For 2016, the 28% tax rate applies to taxpayers with taxable income above $186,300 for all filing statuses other than married filing separately, which would be $93,150. For 2016 the 39.6% tax rate affects single taxpayers when the income exceeds $415,050 and for MFJ whose income exceeds $466,950 2016 Lifetime learning credit income limits: In order to claim a lifetime learning credit, MAGI must be less than $55,000 ($111,000 if married filing jointly). 2016 Interest on Education Loans: The $2,500 maximum deduction for interest paid on qualified education loans begins to phase out for taxpayers with MAGI over $65,000 ($130,000 for MFJ). The deduction is completely phased out for taxpayers with MAGI over $80,000 ($160,000 for MFJ). Adoption credit or exclusion: The maximum adoption credit or exclusion for employer-provided adoption benefits has increased to $13,460. In order to claim either the credit or exclusion, MAGI must be less than $241,920. The credit begins to phase out at $201,920. Foreign Earned Income Exclusion: is $101,300. Earned income credit (EIC): May be able to take the EIC in 2016 if:

Three or more children lived with the taxpayer and earned less than $47,955 ($53,505 if married filing jointly),


Two children lived with the taxpayer and earned less than $44,648 ($50,198 if married filing jointly),

One child lived with the taxpayer and earned less than $39,296 ($44,846 if married filing jointly), or

A child did not live with the taxpayer and earned less than $14,880 ($20,430 if married filing jointly). The maximum EITC that a taxpayer who is filing jointly can receive with 3 or more qualifying children is $6,269. Social Security and Medicare Tax for 2016 The social security tax is 6.2% for the employer and the employee. The wage limit is $118,500. The Medicare tax rate is 1.45% for the employer and the employee-there is no wage base limit for the Medicare tax. Employers who pay household workers $2,000 or more in cash or an equivalent form of compensation will need to pay social security and Medicare tax for the employee. Medicare taxes apply to election workers paid $1,700 or more in cash or equivalent form of compensation. Additional Medicare Tax A 0.9% Additional Medicare Tax applies to Medicare wages, Railroad Retirement Tax Act compensation, and self-employment income over $200,000 in a calendar year. The taxpayer may need to include this amount when figuring the estimated tax. To avoid a balance due, the taxpayer can request from their employer to deduct and withhold an additional amount of income tax withholding on Form W-4, Employee’s Withholding Allowance Certificate. Net Investment Income Tax The taxpayer may be subject to Net Investment Income Tax (NUT). NUT is a 3.8% tax on the lesser of net investment income or the excess of the taxpayer modified adjusted gross income (MAGI) over the threshold amount. NIIT may need to be included when figuring estimated tax. To avoid a balance due, the taxpayer can request from their employer to deduct and withhold an additional amount of income tax withholding on Form W-4, Employee’s Withholding Allowance Certificate. This tax is reported on Form 8960, Net Investment Income Tax. IRA and 401(k) Contribution Limits For 2016, the contribution limit to Roth and traditional IRAs is unchanged at $5,500, with an additional catch-up contribution of $1,000 for people age 50 or older. The contribution limit for 401(k), 403(b), and most 457 plans, however, is increased to $18,000, with an additional catch-up contribution of $6,000 for people age 50 or older. The maximum possible contribution for defined contribution plans (e.g., for a self-employed person with a sufficiently high income contributing to a SEP IRA) is increased from $52,000 to $53,000. Medical Savings Account (MSA) For 2016, individuals who have a self-only coverage must have an annual deduction that is not less than $2,250 and not more than $3,350. For self-coverage the maximum out-of-pocket expense remains at $4,450.


For family coverage, the floor for the annual deduction remains at $4,450. The deductible portion cannot be more than $6,700. The out-of-pocket expense remains at $8,150. Qualified Transportation Fringe Benefit The monthly limitation for transportation remains at $130 per month. The qualified parking goes to $255 for 2016. Household Workers (Nanny Tax) The nanny tax threshold is $2,000 for 2016. 2016 Tax Brackets Single

Taxable Income Tax Bracket:

$0—$9,275 10% of taxable income

$9,276—$37,650 $927.50 plus 15% of the amount over $9,275

$37,651—$91,150 $5,183.75 plus 25% of the amount over $37,650


$190,151—$ 413,350 $46,278.75 plus 33% of the amount over $190,150


$415,051 or more $120,529.75 plus 39.6% of the amount over $415,050

Married Filing Jointly or Qualifying Widow(er)



$18,551—$75,300 $1,855 plus 15% of the amount over $18,550






Married Filing Separately



$9,276—$37,650 $927.50 plus 15% of the amount over $9,275







Head of Household








$441,001 or more $125,936 plus 39.6% of the amount over $441,000

1.2 Increase in Repair Regulation Safe Harbor Amount (Notice 2015-82) Effective for costs incurred during taxable years beginning on or after January 1, 2016. The de minimis safe harbor does not limit a taxpayer's ability to deduct otherwise deductible repair or maintenance costs that exceed the amount subject to the safe harbor. The safe harbor merely establishes a minimum threshold below which all qualifying amounts are considered deductible. Consistent with longstanding federal income tax rules, a taxpayer may continue to deduct all otherwise deductible repair or maintenance costs, regardless of amount. The maximum amount is $5,000 per invoice. The invoice has to be equal to or greater than $5,000. If the invoice is $2,500, then that is the amount the taxpayer can take. For taxable years beginning before January 1, 2016, the IRS will not raise upon examination the issue of whether a taxpayer without an applicable financial statement (AFS) can utilize the de minimis safe harbor provided in § 1.263(a)-1(f)(1)(ii) for an amount not to exceed $2,500 per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements of § 1.263(a)-1(f)(1)(ii). Included in materials and supplies are tangible, non-inventory property used and consumed in the business such as:

Costs of components acquired to maintain, repair, or improve tangible property owned, leased, or serviced as part of a larger item of tangible property

Costs of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less

Costs of tangible property that has an economic useful life of 12 months or less, beginning when the property is used or consumed

Costs of tangible property that has an acquisition cost or production cost of $200 or less. The property need only fit into one of the above categories to qualify as a material or supply. 1.3 Summary of PATH Act of 2015 for Individuals (Permanent vs. Temporary Tax Extenders) The following list (in alphabetical order) is of tax extenders that were passed and signed into law December 18, 2015 with dates of when they will expire if at all. 1. 7-year depreciation for motorsports entertainment - Made permanent 2. 15-year depreciation for certain real estate-Made permanent 3. Additional Child Tax Credit-Made permanent at $3,000


4. Bonus depreciation-Extended through 2019 5. Credit for certain nonbusiness energy property - Extended through 2016 6. Contributions of food inventory - Made permanent 7. Deduction for expenses of school teachers - Made permanent 8. Deduction for state and local tax-Made permanent 9. Deduction for tuition-Extended through 2016 10. Discharge of indebtedness on a principal residence -Extended through 2016 11. Enhanced § 179 - Made permanent 12. Expanded Earned Income Tax Credit - Made permanent 13. IRA-to-charity exclusion -Made permanent 14. Mortgage insurance premiums deductible-Extended through 2016 15. Parity for exclusion of employer-provided mass transit -Made permanent 16. Shortened recognition period for S corporation BIG tax -Made permanent 17. Special rules for qualified small business stock - Made permanent 18. Work Opportunity Tax Credit-Extended through 2019 1.4 Review of Tax Return Due Dates (April 18, 2017), Including Extensions Tax Deadlines Occurring in Calendar Year 2017 (for Tax Year 2016 Returns) Individual Tax Returns (Forms 1040, 1040NR, 1040A, and 1040EZ)

First deadline is April 18, 2017.

Extended deadline is October 16, 2017. Partnership Returns (Form 1065)

First deadline is March 15, 2017 (note change of deadline).

Extended deadline is September 15, 2017. Trust and Estate Income Tax Returns (Form 1041)

First deadline is April 18, 2017.

Extended deadline is October 2, 2017

Note change: extensions for fiduciary returns are now five and a half months instead of five months. C-Corporation Returns (Form 1120)

First deadline is April 18, 2017 for corporations on a calendar year (note change of deadline).

Extended deadline is October 16, 2017 (note change of deadline, corporations are now permitted a six-month automatic extension).

For corporations on a fiscal year other than a calendar year, the first deadline is the 15th day of the fourth month following the end of the corporation's fiscal year.

EXCEPTION: for corporations with a fiscal year from July 1 to June 30, the first deadline will remain September 15th (which is the 15th day of the third month following the end of the fiscal year) and the extended deadline will remain February 15 (five months after the first deadline) through fiscal year ending June 30, 2026.

Starting with the fiscal year ending June 30, 2027, the deadline moves to October 15th (the 15th day of the fourth month following the end of the tax year) and the extended deadline moves to March 15th (six months after the first deadline).


S-Corporation Returns (Form 1120S)

First deadline is March 15, 2015 for corporations on a calendar year (note there is no change of deadline).

Extended deadline is September 15, 2017. Foreign Bank Account Reports (FinCen Form 114)

Deadline is April 15, 2017 (note change of deadline).

Extended deadline is October 15, 2017 (note: this is the first time ever that extensions are available for FBARs).

Note that unlike tax returns, FBARs do not have a next-business-day rule if the deadline falls on a Saturday, Sunday, or legal holiday.

Domain 2: General Review 2.1 Tax Related Identity Theft Safeguarding Taxpayer Information Identity thieves are a fearsome enemy. They are an adaptive adversary, constantly learning and changing their tactics to circumvent the safeguards and filters put in place to stop them from committing their crimes. Some of the individuals committing identity theft refund fraud are members of high-tech global rings engaged in full-scale organized criminal enterprises for stealing identities and profiting from that information. As the criminals' efforts increase in sophistication, so do the number and scope of data breaches, which serves to further expand the network and warehousing of stolen and compromised identity information, and in turn increases the potential for that stolen identity information to ultimately resound through the tax system. Safeguarding taxpayer information is a top priority for the IRS. It is the responsibility of governments, businesses, organizations, and individuals that receive, maintain, share, transmit, or store taxpayers' personal information. Taxpayer information is information that is furnished in any form or manner in person, over the phone, or by mail or fax for or by the taxpayer for preparing his or her tax return. It includes but is not limited to the taxpayer's:

Name

Address

Identification number

Income

Receipts

Deductions

Exemptions

Tax liability Under Title 26 IRC §301 7216.1, criminal penalties may be imposed on any person engaged in the business of preparing or providing services in connection with the preparation of tax returns who knowingly or recklessly makes unauthorized disclosures or uses information furnished to him or her in connection with


the preparation of an income tax return. Title 26 can also impose monetary penalties on the unauthorized disclosures or uses of taxpayer information by any person engaged in the business of preparing tax returns. Some common safeguarding ideas are: 1. Locking doors to restrict access to paper or electronic files 2. Require passwords to restrict access to computer files 3. Encrypting electronically stored taxpayer data 4. Keeping a backup of electronic data for recovery purposes 5. Shredding paper containing taxpayer information before throwing it in the trash To Do List for Safeguarding Personal Information 1. Maintain a List of all locations you handle taxpayer information.

a. Office buildings, self-storage facilities, residences, temporary return preparation sites b. Filing cabinets, desk drawers, boxes c. Computers, optical disks, zip drives, USB removable media (thumb drives, memory sticks)

2. Assess the Risk of unauthorized access, use disclosure, modification, or destruction of the taxpayer's information being handled. The following are questions that need to be asked. a. Can visitors access taxpayer's information in the office? b. Can an employee with malicious intentions modify taxpayer information on a return? c. Can the return preparation software provided for the customers cause an inadvertent disclosure

of a taxpayer's information to another? d. Can a computer virus corrupt taxpayer returns you transmit? e. Can a flood destroy paper and electronic taxpayer records the tax practitioner is required to

maintain? 3. Assess the Impact of unauthorized access, use, disclosure, modification, or destruction of taxpayer

information being handled by the company. a. Can one of your clients become the victim of identity theft from your office? b. Can a denial of service attack cause the company to lose business? c. Can the business incur criminal or civil penalties?

4. Write and follow an information security plan that shows how the company addresses risks. a. Describe the paper/electronic information system(s) used to handle taxpayer information b. Document the safeguards the business needs and has in place

i. Locks on file cabinets ii. Backups of taxpayer's records

iii. Background checks, information security training, and identity authentication for employees who have access to taxpayer information

iv. Electronic information system passwords that meet industry standards for strong passwords v. Encryption of taxpayer information electronically stored and during electronic transmissions

vi. Firewalls, routers, or gateways to protect computer systems used for taxpayer information vii. Automatic updates of antivirus and antispyware software

viii. Monitoring of computer system logs for unauthorized access ix. Authorization requirements for the removal of taxpayer information on any media x. Requirements and the capability to securely destroy expired taxpayer information (for

example: shredders for paper and overwrite software for hard drives) xi. Security certification for computer systems used for taxpayer information


5. Specify in Contracts with service providers the safeguards they must follow. Monitor how contractors handle taxpayer information.

6. Test, Monitor, and Revise your information security plan on a periodic basis. a. Can the business owner recover records from backup files and systems if primary records are

destroyed? b. What are the consequences if the company's employees leave taxpayer information unsecured

on desk, copiers, in mailboxes, vehicles, trash cans, or rooms in the office or at home? c. Are employees following information security procedures? d. Does the computer system pass a vulnerability testing? e. Are the employees using shredders when discarding taxpayer paper records? f. Are the contractor service providers following an acceptable Information Security Plan?

7. Put in place additional safeguards as needed. 8. Provide privacy notices and practices with your customers. 9. Follow the federal, state, and local laws and regulations. For more information about safeguarding personal information, go to www.ftc.gov. Verifying Taxpayer Identification Numbers (TINs) To safeguard IRS e-file from fraud and abuse, an ERO (electronic return originator) should confirm identities and TINs of taxpayers, spouses, and dependents listed on returns prepared by him or her. TINs include SSNs, EINs, adopted taxpayer identification numbers (ATINs), and individual taxpayer identification numbers (ITINs). To confirm identities, the paid preparer should request to see the original TIN and a photo ID if available. It is helpful if the identification has the same address that the taxpayer is filing on the tax return but not required. Using incorrect TIN s, using the same TIN on more than one return, or associating the wrong name with a TIN are some of the most common causes of rejected returns. To minimize TIN-related rejects, it is important to verify taxpayer TINs and his/her name control information prior to submitting electronic return data to the IRS. The IRS requires taxpayers filing tax returns using an ITIN to include the TIN, usually an SSN, shown on Form W-2 from the employer in the electronic record of Form W-2. This may create an identification number mismatch because taxpayers must use their correct ITIN as their identifying number on Form 1040, US. Individual Income Tax Return. The IRS's e-file system can now accept returns that have identification numbers that do not match the taxpayer's W-2. EROs should enter the TIN/SSN in the electronic record exactly as shown on Form W-2 provided to them by taxpayers. 2.2 ITINs The Role of an ITIN An individual tax identification number (ITIN) plays a key role in the tax administration process and assists with the collection of taxes from foreign nationals, nonresident aliens, and resident aliens who have filing or payment obligations under U.S. law. Designed specifically for tax administration purposes, ITINs are only issued to people who are not eligible to obtain a social security number. The ITIN is issued for federal tax purposes only. It does not entitle the taxpayer to social security benefits or the individual applicant's


immigration status. The taxpayer would complete Form W-7 to apply for an ITIN. The ITIN is issued by the Internal Revenue Service. A taxpayer identification number must be furnished on all tax returns, statements, and other related tax documents. If an individual does not qualify for a social security number, then the individual needs to apply for an ITIN. Individuals who may need an ITIN include:

A nonresident alien individual eligible to obtain the benefits of a reduced rate of withholding under an income tax treaty

A nonresident alien not eligible for a SSN required to file a U.S. tax return or filing a U.S. tax return only to claim a refund

A nonresident alien not eligible for a SSN electing to file a joint tax return with a spouse who is a U.S. citizen or resident alien

A U.S. resident alien who files a U.S. tax return but is not eligible for a SSN

An alien individual, claimed as a spouse for an exemption on a U.S. tax return, who is not eligible for a SSN

An alien individual, who is not eligible for a SSN, claimed as a dependent on another person's U.S. tax return, and

A nonresident alien student, professor, or researcher filing a U.S. tax return or claiming an exception to the tax return filing requirement who is not eligible for a SSN

Purpose of an ITIN An ITIN is a tax processing number, issued by the IRS, for certain resident and nonresident aliens, their spouses, and their dependents. It is a nine-digit number beginning with the number 9. The ITIN range was expanded on April 13, 2011, to include "90" as the middle digits (70 to 88, 90-92, and 94-99) and is formatted like a SSN. The IRS started issuing ITINs in 1996 and required foreign individuals to use an ITIN as their unique identification number on federal tax returns. Taxpayers need to be identified effectively, and tax returns need to be processed efficiently. ITINs play a critical role in the tax administration process and assist with the collection of taxes from foreign nationals, nonresident aliens, and others who have filing or payment obligations under U.S. law. The ITIN is only available to individuals who are required to have a taxpayer identification number for tax purposes, but who do not have, and are not eligible to obtain, a SSN from the Social Security Administration. Only individuals who have a valid filing requirement, a withholding requirement, or are filing a U.S. federal income tax return to claim a refund of over-withheld tax are eligible to receive an ITIN. The ITIN does not provide social security benefits, is not valid for identification outside of the tax system, and does not change immigration status. The ITIN holder enters their ITIN in the space provided for the SSN when completing and filing their federal income tax return. The ITIN is applied for with a W-7 or W-7SP (Espanol). The W-7 application is attached to a valid federal tax return, unless the taxpayer qualifies for an exception.


Original Documentation The IRS requires original documentation, and one must include a recent photograph. The identity documents are needed to both verify the applicant's foreign status and the applicant. The following is a list of current original documentation that can be used:

Passport (standalone document)

U.S. Citizenship and Immigration Services (USCIS) photo identification

U.S. state identification card

U.S. driver's license

U.S. military identification card

National identification card

Visa issued by U.S. Department of State

Foreign driver's license

Foreign military identification card

Foreign voter's registration card

Civil birth certificate

Medical records (for dependent applicants under age 6)

School records (for dependent applicants under age 14, under age 18 if student) The IRS heard from stakeholders that it was difficult in some instances for individuals to be without documents such as passports for extended periods of time. As a result, the IRS determined that other outlets will be available to review original documentation. As part of this effort, while original documents or copies certified by the issuing agency are still required for most applicants, there will be more options and flexibility for people applying for an ITIN. These options provide alternatives to mailing passports and other original documents to the IRS. Individual Applicants For individuals applying directly to the IRS for an ITIN, original documents or copies certified by the issuing agency are required. The IRS will accept only original identification documents or certified copies of these documents from the issuing agency with the Form W-7 and federal tax return attached. Document Standards for Dependent Children To adequately substantiate identity and foreign status and assist in ensuring the integrity of important child tax credits, dependent ITIN applications will continue to require original documents or copies certified by the issuing agency. Dependent ITIN applications submitted to the IRS by CAAs (Certifying Acceptance Agent) will continue to require attachment of original documents or copies certified by the issuing agency. For children under six, one of the documents can include original medical records. For school-age children, the documentation can include original, current year school records such as a report card. If the ITIN is for a dependent, the documentation must prove that the dependent is a U.S. national or a resident of the United States, Mexico, Canada, Republic of Korea (South Korea), or India. However, if you are living abroad and have adopted, or have had legally placed in your home pending an adoption, a foreign child, that child may be eligible for an ITIN. If the dependent is a minor, the documentation must


establish the relationship between the dependent and the representative signing the application on the dependent's behalf. Documentation could include a birth certificate, adoption papers, or other court-appointed papers showing legal guardianship. In the case of dependents that are residents of the Republic of Korea (South Korea) or India, refer to Publication 519, US. Tax Guide for Aliens, for additional documentation that may be required. Expiration of ITIN s ITINs will expire if not used on a federal income tax return for any year during a period of five consecutive years, according to the Internal Revenue Service. The IRS will not deactivate an ITIN that has been used on at least one tax return in the past five years. To give taxpayers time to adjust and allow the IRS to reprogram its systems, the IRS will not begin deactivating ITINs until 2016. The new, more uniform policy applies to any ITIN, regardless of when it was issued. Only about a quarter of the 21 million ITINs issued since the program began in 1996 are being used on tax returns. The new policy will ensure that anyone who legitimately uses an ITIN for tax purposes can continue to do so, while at the same time resulting in the likely eventual expiration of millions of unused ITINs Tax Return Compliance In addition to the changes in the ITIN application process, the IRS is enhancing compliance activities relating to certain credits, including the child tax credit. The changes will improve the ability of the IRS to review returns claiming this credit, including those returns utilizing ITINs for dependents. For example, additional residency information will be required on Schedule 8812, Child Tax Credit, to ensure eligibility criteria for the credit are met. Information derived from the ITIN process will be better utilized in the refund verification process. New pre-refund screening filters were put in place starting filing season 2013 to flag returns for audits that claim questionable refundable credits. Increased compliance resources will also be deployed to address questionable returns in this area. As part of these overall efforts, ITIN holders may be asked to revalidate their ITIN status as part of certain audits to help ensure the numbers are used appropriately. Reason to Apply for an ITIN Nonresident alien required to get an ITIN to claim tax treaty benefit: Box a would be checked for certain nonresident aliens who must get an ITIN to claim certain tax treaty benefits whether they file a tax return or not. If box a is checked, then check box h as well. Enter on the dotted line next to box h the exceptions that relate to the taxpayer's situation. Box b Nonresident Alien Filing a US. Tax Return This category includes:

1. A nonresident alien who must file a U.S. tax return to report income effectively or not effectively connected with the conduct of a trade or business in the United States

2. A nonresident alien who is filing a U.S. tax return only to get a refund Box c US. Resident Alien (Based On Days Present in the United Sates) Filing a US. Tax Return


Box c would be checked for a foreign individual living in the United States, who does not have permission to work from the USCIS and is ineligible for a SSN, but may still have a filing requirement. Box d Dependent of a US. Citizen/Resident Alien Box d would be checked for an individual who can be claimed as a dependent on a U.S. tax return and is not eligible to get a SSN. Dependents of U.S. military personnel are exempt from the requirements of submitting original documents or certified copies of identifying documents, but a standard copy is required. A copy of the U.S. military ID is required or the applicant must be applying from an overseas APO/FPO address. Box e Spouse of a US. Citizen/Resident Alien This category includes:

1. A resident or nonresident alien spouse who is not filing a U.S. tax return (including a joint return) and who is not eligible to get a SSN, but who as a spouse, is claimed as an exemption

2. A resident or nonresident alien electing to file a U.S. tax return jointly with a spouse who is a U.S. citizen or resident alien

A spouse or a person in the U.S. military is exempt from submitting original documents or certified copies identifying documents, but a standard copy will be required. A copy of a U.S. military ID will be required or the applicant must be applying from an overseas APO/FPO address. Box f Nonresident Alien Student, Professor, or Researcher Filing a US. Tax Return or Claiming an Exception Box f is checked if the individual applicant has not abandoned his or her residence in a foreign country and who is a bona fide student, professor, or researcher coming temporarily to the United States solely to attend classes at a recognized institution of education, to teach, or to perform research. If this box is checked, complete lines 6c and 6g and provide passport with a valid U.S. visa. If the applicant is present in the U.S. on a work-related visa (F-1, J-1, or M-1), but will not be employed (applicant's presence in the U.S. is study-related), attach a letter from the DSO (Designated School Official) or RO (Responsible Officer) instead of applying with the SSA for a SSN. The letter must be stated clearly that the applicant will not be securing employment while in the U.S. and their presence here is solely study-related. This letter can be submitted with the applicant's Form W-7 in lieu of the denial letter from the SSA. Box g Dependent/spouse of a Nonresident Alien Holding a US. Visa Box g is checked when the individual can be claimed as a dependent or a spouse on a U.S. tax return and is unable or not eligible to get an SSN and has entered the U.S. with a nonresident alien who holds a U.S. visa. If this box is checked, be sure to include a copy of the visa with the W-7 application. Box h Other If box h is checked, it is because box a-g does not apply to the applicant. Be sure to describe in detail the reason for requesting an ITIN and attach all supporting documents.


Common Errors Name Mismatch: This is the number one reason ITIN applications are rejected. We need to make sure that the W-7 applications have the same name that is on the tax return being submitted. If we abbreviate names, use initials, or leave off the second last name on the tax return or the W-7 application, IRS employees don't know if it is the same person on the application or the tax return. W-2 Issues: Many taxpayers who need an ITIN work under a different name and a different social security. When the W-7 application is submitted with a tax return, the names on the W-2's should match the application. The IRS wants to make sure that the person reporting W-2 income is the income they earned. Remember the purpose of the ITIN is for foreign individuals to report their income. The tricky issue is to get the W-2 to match the legal name. Taxpayers who need an ITIN do not want to ask their employer to change their records for fear of being dismissed for submitting inaccurate information. Date of Entry: Applications are being submitted with dates of entry but need other substantiating documents. For example, submit documents that establish when they began working and the type of work they have been doing; this will help the ITIN reviewer tie in the date entered and when work began. Passport Rejection: The most common reason the IRS rejects passports is because they are not signed. The IRS will not accept an original passport that is not signed. Everyone entering the U.S. with a passport must sign it. Some countries do not allow children to sign passports, such as India; the IRS is still working on a solution to this. 2.3 Determination of all Five Filing Statuses Filing Status Filing status at first glance appears to be very simple to determine. Tax professionals need to know and understand the requirements for the different filing statuses. Filing status is used to determine filing requirements, standard deduction, correct tax, and taxpayer's eligibility for certain credits and deductions. If more than one filing status applies to the taxpayer, the tax professional should choose the one that lowers the amount of tax for the taxpayer. Detailed information on filing status can be found in Publication 17 and Publication 501. The five federal filing statuses are:

1. Single (S) 2. Married filing jointly (MFJ) 3. Married filing separately (MFS) 4. Head of household (HH) 5. Qualifying widow(er) (QW) with a dependent child

A taxpayer is generally considered unmarried for the whole year if, on the last day of the current tax year, the taxpayer is unmarried or legally separated from his or her spouse under a divorce or separate maintenance decree. State law governs whether a taxpayer is married or legally separated under a divorce or separate maintenance decree.


On August 29, 2013, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) ruled that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for federal tax purposes. The ruling, Revenue Ruling 2013-17, applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage. For couples registered as registered domestic partners (RDPs), and have not been married in a state recognizing same-sex marriage, the revenue ruling does not apply. Under the ruling, same-sex couples will be treated as married for all federal purposes, including income, gift, and estate taxes. The ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming a person and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA, and claiming the earned income tax credit or child tax credit. The application of the ruling depends on the tax year in question:

For tax year 2012 and all prior years, same-sex spouses who file an original tax return on or after September 16, 2013 (the effective date of Revenue Ruling 2013-17), must file as married taxpayers.

For tax year 2012, same-sex spouses who filed their tax return before September 16, 2013, were permitted to (but not required to) amend their federal tax returns to file as married.

For tax years 2011 and earlier, same-sex spouses who filed their tax returns timely may choose (but are not required) to amend their federal tax returns to file as married, provided the statute of limitations for amending the return has not expired.

For tax year 2013 and going forward, same-sex spouses must file using a married filing status (generally married filing jointly or married filing separately).

Single (S) if on December 31:

The taxpayer is unmarried on the last day of the year.

The taxpayer is legally separated by divorce or separate maintenance decree.

The taxpayer does not qualify for another filing status. A widow(er) may be single if he or she was widowed before January 1 of the current tax year and did not remarry before the end of the current tax year. However, the taxpayer may qualify for another filing status that could lower his or her tax. State law governs whether the taxpayer is married or legally separated under a divorce or separate maintenance decree. Married Filing Jointly (MF J) if on December 31:

The taxpayers are married and filing a joint return, even if one had no income or deductions.

The taxpayers are living together in a common law marriage that is recognized in the state where the taxpayers now live, or in the state where the common law marriage began.

The taxpayers are married and living apart but not legally separated under a decree of divorce or separate maintenance.

The spouse died during the tax year, and taxpayer did not remarry before the end of the current tax year.

If the spouse died during the current tax year and taxpayer remarried before the end of the tax year, the taxpayer and the new spouse may file MFJ. A tax return must be filed for the deceased spouse, whose filing status would be MFS for the tax year.


The taxpayer and spouse are both responsible, jointly and/or individually, for the tax plus any interest or penalty due on a joint return. Married Filing Separately (MFS) if on December 31:

The taxpayer may choose this status if he or she is married, living together, or apart.

The taxpayer and/or spouse want to be responsible for their own tax liability.

The taxpayer and/or spouse may choose MFS if it results in less tax than they would owe on a joint return; however, taxpayers who consider MFS should be advised that this filing status has severe limitations in deductions, adjustments, and credits. In addition, the taxpayer must check the box on line 3 of Form 1040. The taxpayer must also enter the spouse's full name and the spouse's social security number or ITIN in the spaces provided.

Generally, taxpayers who elect to file MFS are subject to the following special rules: 1. Must itemize deductions if spouse itemizes deductions 2. Cannot deduct student loan interest 3. Cannot claim earned income credit 4. Generally cannot take credit for childcare and dependent-care expenses; the amount that can be

excluded from income under an employer's dependent-care assistance program is limited to $2,500 (instead of $5,000 if filing MFJ)

5. Cannot exclude interest from qualified U.S. savings bonds used for higher education expenses 6. Cannot take credit for the elderly or disabled (unless the couple lived apart the entire year) 7. Cannot take education credits 8. Cannot take adoption credits 9. May be required to include more Social Security or railroad retirement benefits in taxable income

(unless the couple lived apart the entire year) 10. Individual retirement account (IRA) contributions may be limited due to income amount 11. Capital loss deduction may be limited to $1,500 12. Passive activity loss may be limited ($12,500) 13. Tax rates are generally higher 14. The exemption amount for figuring the alternative minimum tax will be lower than if filing MFJ 15. The child tax credit and the retirement savings account may be reduced at income levels that are half

of those filing MFJ If the taxpayers live in a community property state and file separate returns, the laws of the state in which the taxpayers reside govern whether they have community property income or separate property income for federal tax purposes. See Publication 555. Head of Household (HH) if on December 31: To qualify, the taxpayer must be either unmarried or considered unmarried on the last day of the year. The taxpayer needs to have paid more than half the cost of keeping up a home for the year. A qualifying person must have lived with the taxpayer in the home for more than half the year (except for temporary absences, such as school). If the qualifying person is the dependent parent of the taxpayer, he or she does not have to live in the home of the taxpayer. The taxpayer is considered to be unmarried on the last day of the year if the following apply:

The taxpayer filed a separate return.

The taxpayer paid for more than half the cost of keeping up the home for the tax year.


The taxpayer's spouse did not live in the home during the last six months of the tax year.

The taxpayer's home was the main home for a child, stepchild, or foster child for more than half the year.

The taxpayer must be able to claim the exemption for the child. Children of divorced or separated parents or parents who live apart in most cases can claim a child because of the residency test (discussed in detail later). The taxpayer is considered unmarried for head of household filing status if the spouse was a nonresident alien at any time during the tax year, and they do not choose to treat the spouse as a resident alien. The spouse does not qualify the taxpayer for head of household filing status. The taxpayer must have another qualifying person and meet the other tests to be eligible to file head of household. Keeping Up a Home To qualify for the head of household filing status, the taxpayer must pay more than half of the cost for maintaining a household. Expenses can include rent, mortgage interest payments, repairs, real estate taxes, insurance on the home, utilities, and food eaten in the home. Costs do not include clothing, education, medical treatment, vacations, life insurance, and the rental value of the home the taxpayer owns. If the taxpayer receives payments from Temporary Assistance for Needy Families (TANF) or any other public assistance programs to pay rent or upkeep on the home, those payments cannot be included as money the taxpayer paid. However, they must be included in the total cost of keeping up the home to figure whether the taxpayer paid over half of the cost. Qualifying Widow(er) (QW) with Dependent Child A taxpayer's status can be qualifying widow(er) (QW) with dependent child if the taxpayer meets all of the following requirements:

Was entitled to file a joint return with his or her spouse for the tax year in which the spouse died (whether or not the taxpayer actually filed a joint return)

Did not remarry before the end of the tax year

Has a dependent child who qualifies as the taxpayer's dependent for the tax year.

Paid more than half the cost of keeping up a home that was the main home for the taxpayer and the dependent child for the entire year

For the tax year in which the spouse died, the taxpayer can file MFJ. If the taxpayer meets the requirements for the next two years, the taxpayer may qualify to file as QW with a dependent child. After two years, the taxpayer's filing status would change to head of household, as long as the taxpayer has not remarried and has a qualifying dependent child living with them. Example: John's wife died in 2015. John has not remarried and has continued to keep up a home with his qualifying children, Riley and Galvan. For tax year 2015, John may file MFJ. In 2016 and 2017, he would qualify to file as QW(er) with qualifying dependents. Starting in tax year 2018, if John still has qualifying children and has not remarried, he would qualify to file as head of household.


2.4 Claiming a Dependent Standard Deduction for Dependents The standard deduction is generally limited if the taxpayer can be claimed as a dependent on someone else's return. The limitation is the greater of $1,050 or the taxpayer's earned income for the year plus $350 (not to exceed the regular standard deduction amount, $6,300). If the taxpayer is age 65 or older and/or blind, he or she may be eligible for a higher standard deduction. Earned income for purposes of the standard deduction consist of salaries, wages, tips, professional fees, and amounts received for work the taxpayer actually performed. To calculate the standard deduction, scholarships or fellowship grants must be included in gross income. See Publication 970 for information on what qualifies as a scholarship or fellowship grant. Dependent Filing Requirements If a parent (or someone else) can claim a person as a dependent, and any of the situations listed below apply, the dependent must file a return. Unearned income includes taxable interest, dividends, capital gains, unemployment compensation, taxable Social Security, pensions, annuities, and distributions of unearned income from a trust. Earned income includes wages, tips, taxable scholarships, and fellowship grants. Caution: If gross income is $4,050 or more, generally the taxpayer cannot be claimed as a dependent unless the taxpayer is under age 19 or under age 24 and a full-time student. Dependent Exemptions The taxpayer is allowed one exemption for each person claimed on the tax return. The taxpayer can claim an exemption for a dependent even if the dependent files a tax return. Dependent means a qualifying child or a qualifying relative. The taxpayer can claim an exemption for a qualifying relative or qualifying child only if the following three tests are met:

Dependent taxpayer test

Joint return test

Citizen or resident test Dependent Taxpayer Test If the taxpayer can be claimed as a dependent by another person, he or she cannot claim anyone as a dependent. Even if the taxpayer has a qualifying child or a qualifying relative, the taxpayer cannot claim that person as a dependent. Joint Return Test If the taxpayer is filing a joint return and the spouse can be claimed as a dependent by someone else, the taxpayer and spouse cannot claim any dependents on their joint return.


The taxpayer generally cannot claim a married person as a dependent if a joint return is filed. The joint return test does not apply if a joint return is filed by the dependent and the spouse to claim a refund. Example: April, age 18, is married to Joe, age 18, and they live with April's parents. Both April and Joe have some earned income but are not required to file a return. The only reason for them to file a joint return is to get a refund on the withheld taxes. April's parents may be able to claim both Joe and April and claim exemptions for both, if all the other tests are met. Citizen or Resident Test The taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico. However, there is an exception for certain adopted children. Adopted Child Exception If the taxpayer is a U.S. citizen who legally adopted a child who is not a U.S. citizen or U.S. national, the citizen test is met if the child lived with the taxpayer as a member of the taxpayer's household all year. This also applies if the child was lawfully placed with the taxpayer for legal adoption. Child's Place of Residence Children usually are citizens or residents of the country of their parents. If the taxpayer was a U.S. citizen when his or her child was born, the child may be a U.S. citizen even if the other parent was a nonresident alien and the child was born in a foreign country. If so, the citizen test is met. Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary period generally are not U.S. residents and do not meet the test. The taxpayer cannot claim an exemption for them. However, if the taxpayer provided a home for a foreign student, the taxpayer may be able to take a charitable contribution deduction. See "Expenses Paid for Student Living with You" in Publication 526, Charitable Contributions, for more information. A U.S. national is an individual who, although not a U.S. citizen, owes his allegiance to the United States. U.S. nationals include American Samoans and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens. Qualifying Child There are five tests that must be met for a child to be considered a qualifying dependent of the taxpayer. The five tests are:

1. Relationship 2. Age 3. Residency 4. Support 5. Joint return

Relationship Test


To meet this test, a child must be:

The taxpayer's son, daughter, stepchild, foster child, or a descendant (for example, the taxpayer's grandchild) of any of them

The taxpayer's brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant (for example, the taxpayer's niece or nephew) of any of them

Adopted Child An adopted child is always treated as the taxpayer's own child. The term "adopted child" includes a child who was lawfully placed with the taxpayer for legal adoption. Foster Child A foster child is an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Age Test To meet this test, a child must be:

Under age 19 at the end of the year, and younger than the taxpayer or spouse if filing a joint return

A full-time student under age 24 at the end of the year, and younger than the taxpayer or spouse if filing jointly

Permanently and totally disabled at any time during the year, regardless of age Example 1: Mr. and Mrs. Swift have Jonathon, Mr. Swift's brother, living with them. Jonathon, age 23, is a full-time student. Mr. and Mrs. Swift are both 21-years-old. Jonathon cannot be their dependent since he is older than both of them. Example 2: Mr. and Mrs. Swift have Jonathon, Mr. Swift's brother, living with them. Jonathon, age 23, is a full-time student. Mr. and Mrs. Swift are both 25-years-old. Jonathon can be their dependent since he is younger than both of them, if all of the other tests are met. Full-Time Student A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance. To qualify as a student, during some part of each of any five calendar months of the year, the taxpayer's dependent must be: A full-time student at a school that has a regular teaching staff, course of study, and regularly enrolled student body at the school A student taking a full-time, on-farm training course given by a school as described above or by a state, county, or local government agency The five calendar months do not have to be consecutive. School


A school can be an elementary school, junior or senior high school, college, university, technical, trade, or mechanical school. However, on-the-job training courses, correspondence school, or Internet schools do not count as a school. Vocational high school students who work on "co-op" jobs in private industry as part of a school's regular course of classroom and practical training are considered to be full-time students. Permanently and Totally Disabled The taxpayer's child is permanently and totally disabled if both of the following apply:

1. The child cannot engage in any substantial gainful activity because of a physical or mental condition.

2. A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death.

Residency Test To meet this test, the taxpayer's child must have lived with the taxpayer for more than half of the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents. Temporary Absences The taxpayer's child is considered to have lived with him or her during periods of time when one or both are temporarily absent due to special circumstances such as:

Illness

Education

Business

Vacation

Military service Death or Birth of Child A child who was born or died during the year is treated as having lived with the taxpayer the entire year while he or she was alive. The same is true if the child lived with the taxpayer all year except for any required hospital stay following birth. Child Born Alive The taxpayer may be able to claim an exemption for a child who was born alive during the year, even if the child lived only for a moment. State or local law must treat the child as having been born alive. There must be proof of a live birth shown by an official document, such as a birth certificate. The child must be a qualifying child or qualifying relative, as well as meet all the other tests to claim an exemption for a dependent. The taxpayer cannot claim an exemption for a stillborn child.


Kidnapped Child A kidnapped child can meet the residency test, but both of the following statements must be true:

The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the taxpayer's family or the child's family.

The child lived with the taxpayer for more than half of the year on the year prior to the date of the kidnapping.

This treatment applies until the child is returned. However, the last year this treatment can apply is the earlier of:

The year the child is returned.

The year there is a determination that the child is dead.

The year the child would have reached age 18. Children of Divorced or Separated Parents or Parents Who Live Apart In most cases the child will be treated as the dependent of the custodial parent. A child will be treated as the qualifying child of his or her noncustodial parent if all of the following apply:

1. The parents a. Are divorced or legally separated under a decree of divorce or separate maintenance; b. Are separated under a written separation agreement; and c. Lived apart at all times during the last six months of the year, whether or not they are married

or were married. 2. The child received over half of the support for the year from the parents. 3. The child is in the custody of one or both parents for more than half of the year. 4. Either of the following is true:

a. The custodial parent signs a written declaration, which states that the custodial parent will not claim as a dependent for the current year and the noncustodial parent attaches the documentation to the return.

b. A pre-1985 decree of divorce or separate maintenance or written separation agreement that applies to 2015 states that the noncustodial parent can claim the child as a dependent, and the noncustodial parent provides at least $600 for the support of the child during the year.

Custodial Parent and Noncustodial Parent The custodial parent is the parent with whom the child lived for the greater part of the year. The other parent is the noncustodial parent. If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one with whom the child lived for the greater part of the rest of the year. A child is treated as living with a parent for a night if the child sleeps:

1. At the parent's home, whether or not the parent is present 2. In the company of the parent when the child does not sleep at a parent's home, as in the case of

going on vacation This special rule for divorced or separated parents also applies to parents who never married and lived apart for the last six months of the year.


Written Declaration Form 8332, "Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent" The custodial parent should use Form 8332 to make the written declaration to release the exemption to the noncustodial parent. The exemption can be released for one year, for a number of specified years (for example, alternate years), or for all future years, as specified in the declaration. If the custodial parent released his or her claim to the exemption for the child for any future year, Form 8332 must be attached to each future year that the taxpayer can claim the exemption. A good tax professional will keep copies for his or her records. If the return is filed electronically, Form 8332 should be filed with Form 8453 and mailed to the correct processing center. See Instructions Form 8453. Important: The household of the divorced or separate parent who has been given legal and physical custody by a court order is the child's principal place of residency. Make sure to ask the taxpayer qualifying questions when they add a dependent that is not a newborn baby. Support Test to Be a Qualifying Child To meet this test, the child cannot have provided more than half of his or her own support for the year. This test is different from the support test to be a qualifying relative, which is discussed later. The taxpayer should complete the "Cost of Keeping Up a Home" found in Publication 501 (Worksheet 1). A scholarship received by a child who is a full-time student is not taken into account in determining whether the child provided more than half of the child's support. Example: Debbie is 16-years-old and has a part-time job and made $6,000. Her mother Caroline provided $4,000 toward her support. Debbie does not qualify to be Caroline's dependent. Foster Care Payments and Expenses Payments received as a foster parent from a placement agency for the support of the child are considered support provided by the agency. If the agency is a state or county, provided payments are considered support from the state or county for the child. If the taxpayer is not in the trade or business of providing foster care and has unreimbursed expenses, and the expenses were mainly to benefit an organization qualified to receive deductible charitable contributions - see Publication 526 for more information. If the taxpayer is in the trade or business of providing foster care, the unreimbursed expenses are not considered support by the taxpayer. Example: Larry, a foster child, lived with Mr. and Mrs. Lazzeroni for the last three months of the calendar year. The Lazzeroni's cared for Larry because they wanted to adopt him. They did not care for Larry as a trade or business or to benefit from the agency that placed Larry in their home. The Lazzeroni's unreimbursed expenses are not deductible as charitable contributions but are considered support they provided for Larry. Joint Return Test to Be a Qualifying Child To meet this test, the child cannot file a joint return for the year. The exception to this rule is if the taxpayer's child and spouse file a joint return only to claim a refund.


Qualifying Child of More than One Person Special Rule Sometimes, a child meets the relationship, age, residency, and support tests to be a qualifying child of more than one person. Although the child is a qualifying child of each of them, only one person can actually treat the child as a qualifying child. To meet this special test, the taxpayer must be the person who can treat the child as a qualifying child. If the taxpayer and another person have the same qualifying child, the taxpayer and the other person(s) can decide who will treat the child as a qualifying child. That person can take all of the following tax benefits (provided the person is eligible for each benefit) based on the qualifying child:

The exemption for the child

The child tax credit

Head of household filing status

The credit for child and dependent care expenses

The earned income credit

The exclusion from income for dependent expense The other person cannot take any of these benefits based on the qualifying child. The taxpayer and the other person cannot choose to divide the tax benefits between them. If the taxpayer and the other person cannot agree on who can claim the child, and more than one person files a return claiming the same child, the IRS will disallow all but one of the claims using the tie-breaker rules. Tie-Breaker Rules To determine which person can claim the child as a qualifying child, the following rules apply: 1. If only one of the persons is the child's parent, the child is treated as the qualifying child of the parent. 2. If the parents do not file a joint return, the IRS will treat the child as a qualifying child of the parent

with whom the child lived for the longest period of time for the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent with the highest AGI for the year.

3. If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person with the highest AGI for the year.

4. If a parent can claim the child as a qualifying child but no parent claims the child, the child is treated as the qualifying child of the person with the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child.

5. If the parents file a joint return together and can claim the child as a qualifying child of the parent. Qualifying Relative There are four tests that must be met for a person to be a qualifying relative. The four tests are:

Not a qualifying child test

Member of household or relationship test

Gross income test

Support test Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative.


Kidnapped child A taxpayer can treat a child as his or her qualifying relative even if the child has been kidnapped, but both of the following statements must be true:

The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the taxpayer's family or the child's family.

In the year the kidnapping occurred, the child met the tests to be the taxpayer's qualifying relative for the part of the year before the date of the kidnapping.

This treatment applies for all years until the child is returned. However, the last year this treatment can apply is the earlier of:

The year the child is returned

The year there is a determination that the child is dead

The year the child would have reached age 18 Not a Qualifying Child Test A child is not the taxpayer's qualifying relative if the child is the taxpayer's qualifying child or the qualifying child of anyone else. A child who is not the qualifying child of any other taxpayer may qualify as the taxpayer's qualifying relative if the child's parent (or other person for whom the child is defined as a qualifying child) is not required to file an income tax return because either of the following apply: Does not file a tax return Files a return only to get a refund of income tax withheld or estimated tax paid Member of Household or Relationship Test To meet this test, a person must either: Live with the taxpayer all year as a member of the taxpayer's household Be related to the taxpayer in one of the ways listed below under "Relatives Who Do Not Have to Live with the Taxpayer." A legally adopted child is considered the taxpayer's child. If at any time during the year the person was the taxpayer's spouse, that person cannot be the taxpayer's qualifying relative. Relatives Who Do Not Have to Live with the Taxpayer A person related to the taxpayer in any of the following ways does not have to live with the taxpayer all year as a member of the taxpayer's household to meet this test.

The taxpayer's child, stepchild, eligible foster child, or a descendant of any of them (for example, a grandchild)

The taxpayer's brother, sister, half-brother, half-sister, stepbrother, or stepsister

The taxpayer's father, mother, grandparent, or any other direct ancestor, but not foster parent

The taxpayer's stepfather or stepmother

A son or daughter of the taxpayer's brother or sister

A son or daughter of the taxpayer's half-brother or half-sister

A brother or sister of the taxpayer's father or mother


The taxpayer's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

Any of these relationships that were established by marriage are not ended by death or divorce. Foster Child A foster child is an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Joint Return If the taxpayer files a joint return, the qualifying relative can be related to either the taxpayer or the taxpayer's spouse. The person does not need to be related to the spouse who provides support. For example, the taxpayer's spouse's uncle, who received more than half of his support from the taxpayer, may be the taxpayer's qualifying relative, even though he does not live with the taxpayer. However, if the taxpayer and his spouse file separate tax returns, his spouse's uncle is a qualifying relative only if he lives there with him all year as a member of the taxpayer's household. Temporary Absence A qualifying relative is considered to have lived with the taxpayer as a member of the taxpayer's household during periods of time when either the taxpayer or spouse is absent due to special circumstances such as:

Illness

Education

Business

Vacation

Military service If the person has been placed in a nursing home for an indefinite period of time to receive medical care, the absence could be considered temporary. Death or Birth A person who died during the year, and lived with the taxpayer as a member of the household until death meets the test. The same is true if a child was born during the year and lived with the taxpayer. Local Law Violated A person does not meet this test if at any time during the year the relationship between the taxpayer and that person violates local law. Example: The taxpayer's girlfriend lived with him as a member of his household all year. However, his relationship with her violated the laws of the state where he lives, because she is married to someone else. Therefore, she does not meet this test and cannot be claimed as his dependent. Adopted Child


The term "adopted child" includes a child who was lawfu11y placed with the taxpayer for legal adoption. An adopted child is treated as the taxpayer's own child. Cousin A cousin is a descendant of a brother or a sister of the taxpayer's mother or father. If the cousin lives with the taxpayer all year as a member of the taxpayer's household, the cousin may meet the member of household relationship test. Gross Income Test To meet this test, a person's gross income for the year must be less than $4,000. Gross income is all income in the form of money, property, and services that is not exempt from tax. Gross receipts from rental property are gross income. Gross income also includes all taxable unemployment compensation and certain scholarships and fellowship grants. Gross income includes a partner's share of the gross (not net) income from a partnership. See Publication 501. Tax-exempt income, such as certain Social Security benefits, is not included in gross income. Disabled Dependent Working at Sheltered Workshop For the purposes of the gross income test, the gross income of an individual who is permanently and totally disabled at any time during the year does not include income for services that the individual performed at a sheltered workshop. The availability of medical care at the workshop must be the main reason for the individual's presence there. The income must come solely from activities at the workshop that are incidental to medical care. A "sheltered workshop" is a school that:

Provides special instruction or training designated to alleviate the disability of the individual

Is operated by certain tax-exempt organizations, or by a state, a United States possession, a political subdivision of a state or possession of the United States, or the District of Columbia

Support Test to Be a Qualifying Relative The taxpayer can figure whether he or she has provided more than half of a person's total support by comparing the amount the taxpayer contributed to the person's support with the entire amount of support that the person received from all sources. This includes support the person provided from his or her own funds. A taxpayer's own funds are not support unless they are actually spent for support. See Worksheet 1inPublication501 to help determine support. Example: The taxpayer's mother received $2,400 in social security benefits and $300 in interest. She paid $2,000 for lodging and $400 for recreation. She put $300 in a savings account. Even though the taxpayer's mother received a total of$2,700, she spent only $2,400 for her own support. If the taxpayer spent more than $2,400 for the mother's support and no other support was received, the taxpayer has provided more than half of the mother's support.


The taxpayer(s) cannot include in their contribution to the child's support any support that is paid for by the child with the child's own wages, even if the taxpayer paid the wages. In figuring a person's total support, include tax-exempt income, savings, and borrowed amounts used to support that person. Tax-exempt income includes certain Social Security benefits, welfare benefits, nontaxable life insurance proceeds, armed forces family allotments, nontaxable pensions, and tax-exempt interest. Child Wages Used for Own Support The taxpayer cannot include in his or her contribution to the child's support any support that is paid for by the child's own wages even if the child was paid by the taxpayer. Support is calculated for the year in which it was paid. The taxpayer cannot use support that was paid in 2015 for 2015. If the taxpayer uses a fiscal-year accounting method, his or her support is still calculated on a calendar year. Tax-Exempt Income When calculating a person's total support, be sure to include tax-exempt income, savings, and borrowed amounts that were used to support the qualifying relative. Tax-exempt income includes:

Certain Social Security benefits

Welfare benefits

Nontaxable life insurance proceeds

Armed forces family allotments

Nontaxable pensions

Tax-exempt interest Example: Danelle is Jose's brother's daughter who lives with Jose. Danelle has taken out a student loan of $2,500 and uses it to pay her college tuition. Jose has provided $2,000 for Danelle's support. Jose is unable to claim an exemption for Danelle, since he has not provided more than half of her support. Social Security Benefits for Determining Support If a husband and wife each receive benefits that are paid by one check made out to both of them, half of the total paid is considered to be for the support of each spouse, unless they can show otherwise. If a child receives Social Security benefits and uses them toward his or her own support, the benefits are considered as provided by the child. Support Provided by the State (Welfare, Food Stamps, Housing, etc.) Benefits provided by the state to a needy person generally are considered support provided by the state. However, payments based on the needs of the recipient will not be considered as used entirely for that person's support if it is shown that part of the payments were not used for that purpose.


Foster Care Payments and Expenses Payments received for the support of a foster child from a child placement agency are considered support provided by the agency. Similarly, payments received for the support of a foster child from a state or county agency is considered support provided by the state or county. If the taxpayer is not in the trade or business of providing foster care and the taxpayer's unreimbursed out-of-pocket expenses in caring for a foster child were mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable contributions but are not considered support the taxpayer provided. If the taxpayer is in the trade or business of providing foster care, his or her reimbursed expenses are not considered support provided by the taxpayer. Total Support Total support needs to be determined before the taxpayer can claim the qualifying relative. Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. Generally, the amount of an item of support is the amount of the expense incurred in providing that item. For lodging-as an example-it is the fair rental value of the lodging. Expenses that are not directly related to any one member of a household, such as food, need to be divided between the total members of the household. For example, the food bill for the year was $7,200 and there are four members of the household, so $7,200 divided by four equals $1,800 per member of the household. Overview of the Rules for Claiming an Exemption for a Dependent

The taxpayer cannot claim any dependents if he or she files a joint return or could be claimed as a dependent by another taxpayer.

The taxpayer cannot claim a married person who files a joint return as a dependent unless the joint return is only a claim for a refund and there would be no tax liability for either spouse on separate returns.

The taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico for some part of the year; there are exceptions to this rule.

The taxpayer cannot claim a person as a dependent unless that person is his or her qualifying child or qualifying relative.

Tests to Be a Qualifying Child 1. The child must be the taxpayer's son, daughter, stepchild, eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of these. 2. The child must be (a) under age 19 at the end of the year, (b) under age 24 at the end of the year and a full-time student, or (c) any age if permanently and totally disabled. 3. The child must have lived with the taxpayer for more than half of the year. Exceptions apply. 4. The child must not have provided more than half of his or her own support for the year. 5. If the child meets the rules to be a qualifying child of more than one person, the taxpayer must be the person entitled to claim the child as a qualifying child.


Tests to Be a Qualifying Relative 1. The person cannot be the taxpayer's qualifying child or the qualifying child of another taxpayer. 2. The person either (a) must be related to the taxpayer in one of the ways listed under "Relatives Who Do Not Have to Live with the Taxpayer," or (b) must live with the taxpayer all year as a member of his or her household. This relationship must not violate local law. 3. The person's gross income for the year must be less than $4,000. Exceptions apply. 4. The taxpayer must provide more than half of the person's total support for the year. 2.5 Taxability of Wages, Salaries, Tips, and Other Earnings Wages and Other Compensation (Form 1040 Line 7) If the taxpayer is an employee, the taxpayer receives a Form W-2 showing the wages he or she received in exchange for services performed. Total wages are reported on line 7 of Form 1040 and Form 1040-A, and on line 1 of Form 1040-EZ. Wages include salaries, vacation allowances, bonuses, commissions, and fringe benefits. Compensation includes everything received in payment for personal services. Other Types of Employee Compensation Advance Commission and Other Earnings If the taxpayer received an advance commission or other amounts for services to be performed in the future, that amount is included in income in the year received. If the taxpayer repays unearned commission in the same year received, then the amount included in income is reduced by the repayment. If the repayment is in a later year, then the taxpayer would deduct the repayment on Schedule A as an itemized deduction. Back Pay Awards If a taxpayer receives a settlement or judgment for back pay that is included in their income. Payments made to the taxpayer for damages, unpaid life insurance premiums, and unpaid health insurance premiums are reported to the taxpayer on Form W-2. Severance Pay When an employee receives a severance package, any payment for the cancellation of his or her employment contract is included in the employee's income. Sick Pay Pay received from an employer while the employee is sick or injured is part of the employee's salary or wages. Taxpayers must include in their income sick pay benefits received from any of the following sources:

A welfare fund

A state sickness or disability fund

An association of employers or employees


An insurance company, if the employer paid for the plan (third-party sick pay) However, if the employee paid the premiums on an accident or health insurance policy, the benefits received under the policy are not taxable. Sick pay is intended to replace regular wages while an employee is unable to work due to injury or illness. Payments received from the employer or an agent of the employer qualify as sick pay and must have federal withholding, just as any other wage compensation. Payments under a plan in which the employer does not participate (the taxpayer paid all the premiums) are not considered sick pay and are not considered taxable. Important: Do not report as income any amounts that were reimbursed for medical expenses incurred after the plan was established. Tips All tips received are income and subject to federal income tax. The value of all noncash tips, such as tickets, passes, or other items of value, is also income and subject to tax. Reporting tip income correctly is easy if the taxpayer does the following: 1. Keep a daily tip record 2. Report tips to the employer 3. Report all tips on the income tax return Employees who receive tips should keep daily records of the tips received. A daily report will help the employee when it comes to filing his or her tax return. Employees should: 1. Report tips accurately to their employer 2. Report tips accurately on their tax return 3. Provide their tip income if their tax return is ever audited There are two ways to keep a daily tip log. Employees can: 1. Write information about their tips in a tip diary 2. Keep copies of documents that show their tips This daily record should be kept with tax and other personal records. The daily tip report should include the following:

Cash tips received directly from customers or other employees

Credit and debit card charges customers paid directly to the employer

Amount of tips paid out to other employees through tip pools or tip splitting

The value of noncash tips received, such as tickets, passes, etc. Tips of $20 or more per month from one employer must be reported to the taxpayer's employer on Form 4070, Employee's Report of Tips to Employer. Form 4070 should be filed with the employer no later than the 10th of each month. If the 10 of the month falls on a Saturday, Sunday, or legal holiday, the due date to report tips becomes the next business day. The employer will withhold social security, Medicare, and federal and state taxes from the employee's paycheck. The withholding will be based on the employee's regular wages and reported tips. If the taxpayer fails to report tips, the taxpayer may be subject to a penalty equal to 50% of the social security and Medicare taxes or railroad retirement tax owed on unreported tips.


Service charges that are added to the customer's bill and paid to the employee are treated as wages. These are not added to the taxpayer's tip diary. Allocated tips are tips that the taxpayer's employer assigns to the employee because the employee's reported tips are less than his or her share of 8% of the employee's gross receipts. Allocated tips are shown in box 8 of Form W-2 and should be reported as wages on Form 1040, line 7. In addition, allocated tips are also subject to social security and Medicare taxes and must be reported on Form 4137, Social Security Tax on Unreported Tip Income. Employers must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips. If the taxpayer fails to report tips to his or her employer, the taxpayer must report his or her tips to the IRS using Form 4137, Social Security Tax on Unreported Tip Income. Tips not reported to the employer must be included as income on Form 1040. Allocated tips are calculated by adding all employees' reported tips on food and drink sales (not including carryout sales and sales with a service charge of 10% or more). The employee's share is figured on his or her sales or hours worked. If the employee does not report at least 8%, he or she is subject to "allocated tips." Allocated tips are shown separately on Form W-2, box 8. Tax is not withheld directly from tip income. The employer, however, will take into account the tips the taxpayer reports when figuring how much to withhold from the taxpayer's regular pay. If the taxpayer's regular pay is too low for the employer to withhold all the tax (including social security tax or railroad retirement tax and Medicare tax) due on the taxpayer's pay plus his or her tips, the taxpayer can give his or her employer money to cover the shortage. If the employee does not give the employer money to cover the shortage, the employer will first withhold as much social security tax or railroad retirement tax and Medicare tax as possible, up to the correct amount, and then withhold income tax up to the full amount of the taxpayer's pay. If enough tax is not withheld, the taxpayer may be required to make estimated tax payments. The taxpayer may also have to pay social security tax or railroad retirement tax and Medicare tax his employer could not withhold when the return is filed. Tips received from customers are included in income. The IRS states that an employer's characterization of a payment as a "tip" is not determinative for withholding purposes, but some tips are actually service charges. The absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:

The payment must be made free from obligation

The customer must have an unrestricted right to determine the amount

The payment should not be the subject of negotiation or dictated by employer policy

The customer has the right to determine who receives the payment Example: Joe’s Burgers specifies that an 18% charge will be added to bills with parties of six or more. Julio's bill included the service charge for food and beverages for the party of eight he served. Under these circumstances, Julio did not have the unrestricted right to determine the amount of payment because it was dictated by Joe’s Burgers. The 18% charge is not a tip; it is distributed to the employees as wages. Julio would not include that amount in his tip diary. Note: The taxpayer can use Publication 1244 to track their daily tips totals and amount reported to their employer. Other Income (Form 1040, line 21)


Use Form 1040, line 21, to report any other income not reported on other lines of the tax return or other schedules. If necessary, attach a statement to give required details concerning the income. The type of income should be specified on the dotted line. Expenses related to gambling income reported on line 21 can be deducted on Schedule A, line 28, Other Miscellaneous Deductions (not subject to the 2% floor). Expenses related to hobby income are deducted on Schedule A, line 23 and subject to the 2% floor. If the taxpayer does not use a Schedule A, the taxpayer cannot deduct any expenses associated with the income reported on Form 1040, line 21. Schedule A is discussed later. Examples of other income are:

Hobby income

Awards

Gambling winnings, including lottery and raffles

Prizes

Jury duty pay

Alaska Permanent Fund dividend

Taxable distributions from a Coverdell education savings account (ESA) or a qualified tuition program (QTP); see Publication 970 for more information

Reimbursements or other amounts received for items deducted in an earlier year, such as medical expenses, real estate taxes, or home mortgage interest

Form 1099-C (cancellation of personal debt)

Loss on certain corrective distributions of excess deferrals

Dividends on insurance policies if they exceed the total of all net premiums paid

Recapture of charitable contributions

Taxable part of disaster relief payments

Bartering

Sales parties at which the taxpayer is the host or hostess

Taxable distributions on insurance policies

Not-for-profit rental income

Itemized deduction recoveries

Private unemployment fund

Union benefits paid to an unemployed member

Bribes See Publication 525 for more information. Important: Do not include income from Form 1099-MISC, Nonemployee Compensation; that information generally goes on Schedule C. Gambling Winnings There are two types of withholding on gambling winnings: regular gambling withholding and backup withholding. Regular gambling is withheld at a flat 25% rate from certain kinds of gambling. Gambling winnings of more than $5,000 (minus the wager) from the following sources are subject to income tax withholding:


Any sweepstakes, wagering pool (including payments made to winners of poker tournaments), or lottery.

Any other wage if the proceeds are at least 300 times the amount of the bet. Regular gambling withholdings are calculated on the total amount of gross proceeds (winnings minus the amount wagered). Generally, the 25% withholding is not withheld from bingo, keno, or slot machines. It does not matter how the taxpayer is paid for the winnings-it could be in cash, in property, or as an annuity. Winnings not paid in cash are taken into account at their fair market value. The taxpayer may need to provide the payer his or her social security number to avoid withholding. Gambling winnings are reported on Form W-2G, showing the amount won and the amount withheld. The tax withheld (box 4) is reported with all other federal income tax withholding on Form 1040, line 64. "Backup" withholding on gambling winnings occurs when the payee does not give the payer his or her social security number. The withholding rate will be 28%, and this applies to winnings of at least $1,200 from bingo or slot machines, $1,500 from keno, and certain other gambling winnings of at least $600. Cancellation of Debt (Form 1099-C) A debt is any amount owed to the lender, including but not limited to, stated principal, stated interest, fees, penalties, administrative costs, and fines. The amount of debt canceled can be all or part of the total amount owed. For a lending transaction, the taxpayer is required to report only the stated principal. This amount is reported on Form 104, line 21. 2.6 Interest and Dividend Income Interest Taxable interest includes interest received from bank accounts, loans made to others, and interest from other sources. Interest is money paid for the use of money. The taxpayer could be the payer or the recipient of the interest. Examples of sources of interest are as follows:

Banks

Credit unions

Government entities (federal and state)

Certificates of deposits (CDs)

Life insurance

Installment sales When to Report Interest Income Interest income is reported based on the accounting method the taxpayer is using to report his or her income. If taxpayers use the cash method, they generally report their interest income in the year in which it was actually or constructively received. However, there are special rules for reporting the discount on certain debt instruments, such as U.S. savings bonds and original issue discount (OID). Taxable Interest


Income from interest is taxable when earned or constructively received. Interest is reported to the taxpayer on Form 1099-INT. Form 1099-INT is issued for amounts of$10 and more. Dividends That Are Really Interest Certain distributions often reported as "dividends" are actually interest income. If the taxpayer received dividends from deposits or on share accounts from the following sources, they are reported as interest income:

Credit unions

Cooperative banks

Domestic building and loan associations

Federal savings and loan associations

Mutual savings banks These dividends will be reported as interest in box 1 on Form 1099-INT. Tax-Exempt Interest Certain types of interest income are tax-exempt. Interest paid by state and local governments are exempt from federal taxation but may be taxable at the state level. The fact that this interest is tax exempt does not mean that it is not reported. Tax-exempt interest must be reported. Tax-exempt interest should be listed on Schedule Band the total carried to Form 1040 or 1040-A on line 8b. Taxpayers who receive tax-exempt interest cannot use Form 1040-EZ. Tax-exempt interest is included when determining taxable social security. Where to Report Common Types of Interest

Income Form 1040 Form l040A Form 1040EZ

Taxable interest that totals $1,500 or less

Line 8a (Schedule B may be required)


Line 2

Taxable interest that totals more than $1,500

Line 8a (must use Schedule B) Line 8a (must use Schedule B)

Cannot use

Savings bond interest excluded because of higher education expenses

Schedule B; also use Form 8815, Exclusion of Interest from Series EE and I US Savings Bonds Issued after 1989

Schedule B; also use Form 8815

Cannot use

Nontaxable interest Line 8b Line 8b Cannot use

Dividend Income Dividends are distributions of money, stock, or other property paid by a corporation or a mutual fund. The taxpayer may also receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. Some amounts received that are called dividends are actually interest income.


Most distributions are paid in money. However, distributions can consist of more stock, stock rights, other property, or services. Dividends are usually fully taxable to the recipient. Dividends that are reinvested are taxable and must be reported. However, the amounts reported as dividends may be taxed at different rates. Ordinary Dividends Ordinary dividends are the most common type of dividend distributions. Ordinary dividends, including mutual fund dividends, are taxed as ordinary income. They are taxed at the same tax rate as wages and other ordinary income of the taxpayer. Dividends received from common or preferred stock are considered ordinary dividends and shown in box 1a of Form 1099-DIV. Ordinary dividends are received on common or preferred stock and can be reinvested but are still taxed as ordinary income. All dividends are considered ordinary unless they are specifically classified as qualified dividends. Qualified Dividends Qualified dividends are the ordinary dividends received that are subject to the same 0, 15, or 20% maximum tax rate that applies to net capital gain. Qualified dividends are shown in box 1b of Form 1099-DIV. The maximum rate of tax on qualified dividends is:

0% on any amount that otherwise would be taxed at 10% or 15% rate

15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%

20% on any amount that otherwise would be taxed at 39.6% How to Report Dividend Income Dividends are reported to the taxpayer on Form 1099-DIV. Generally, taxpayers can report their dividend income on Form 1040 or Form 1040-A. Dividends and other distributions that have earned $10 or more are reported on Form 1099-DIV. If the taxpayer's ordinary dividends are more than $1,500, the taxpayer would complete Schedule B, Part III. Report ordinary dividends that are reported in box la on line 9a of Forms 1040 or 1040-A. Report qualified dividends on line 9b of Forms 1040 or 1040-A. The amount that is reported on 1b has already been included in box 1 a. Where to Report Dividend Income The following chart provides an overview of where to report dividend income.

Dividend Income Form 1040 Form 1040A Form 1040EZ

Ordinary dividends that total $1,500 or less



Cannot use

Ordinary dividends that total more than $1,500

Line 9a; must use Schedule B, line 5

Line 9a; must use Schedule B, line 5

Cannot use


Qualified dividends Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet, line 2

Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet, line 2

Cannot use

Qualified dividends Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Worksheet, line 2

Cannot use Cannot use

Capital gain distributions (if Schedule D is not required)

Line 13; also use the Qualified Dividends and Capital Gain Tax Worksheet, line 2

Line 1O; also use the Qualified Dividends and Capital Gain Tax Worksheet, line 3

Cannot use

Capital gain distributions (if Schedule D is required)

Schedule D, line 13; also use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Worksheet

Cannot use Cannot use

2.7 Schedule B, Part III Foreign Accounts and Trusts FATCA Filing Requirements of Certain Foreign Financial Institutions (FFIs) The U.S. government passed the Foreign Account Tax Compliance Act (FATCA) in 2010. The intent since inception was based on seeking out undeclared foreign assets, and requires anyone with a U.S. tax liability to be compliant with a set of laws in the U.S. tax code. In addition, certain business and financial institutes are required by law to divulge sensitive taxpayer information. The IRS is responsible for the collection of information and declaration of penalties. FATCA also entails intergovernmental agreements (IGAs) between the U.S. and various countries exchanging tax-related information. FATCA Filing Requirements Form 8938 Form 8938 -the Statement of Specified Foreign Financial Assets - is used to report foreign assets. It is filed with the annual tax return and applies to individuals and businesses with foreign assets above the reporting thresholds (dependent on location of residence and filing status). Domestic Taxpayer Unmarried Taxpayers: The reporting threshold for specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Married Filing Joint: If the taxpayer and spouse file a joint tax return, the reporting threshold for specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.


Married Filing Separate: If the taxpayer and spouse are filing separate tax returns, the reporting threshold for specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Foreign Taxpayer Unmarried Taxpayers: The reporting threshold for specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year. Married Filing Joint: If the taxpayer and spouse file a joint tax return, the reporting threshold for specified foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year. Married Filing Separate: If the taxpayer and spouse are filing separate tax returns, the reporting threshold for specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year. Form 8938 - the taxpayer must declare all foreign assets including mutual funds, life insurance, real estate, and more. Penalties for not reporting foreign assets carry a minimum fine of $10,000 and up to $50,000 plus 40% penalty on an "understatement of tax attributable to non-disclosed assets". 2.8 Taxable Refunds If a taxpayer took the state and local tax deduction in the prior year and itemized, the refund will be taxable this year if the deduction benefitted (reduced) the prior year's tax bill. They may receive a Form 1099-G from that state. But if they took the sales tax deduction or the standard deduction last year, it won't be taxable on the current year's return. It also won't be taxable if last year's return was subject to the AMT (Alternative Minimum Tax) and the refund amount was less than the amount disallowed under AMT. Report taxable refunds on Form 1040 Line 10: Taxable Refunds, Credits, or Offsets of State and Local Income Taxes. Interest received from taxable refunds would be shown on Form 1099-INT, and reported on the Taxable Interest line. 2.9 Unemployment Compensation Unemployment compensation is taxable, and the taxpayer may elect to have taxes withheld for income taxes. To make this choice, the taxpayer will have to complete Form W-4V, Voluntary Withholding Request. The recipient of unemployment compensation should receive Form 1099-G to report the income. Unemployment compensation includes the following benefits:

Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund

State unemployment insurance benefits

Railroad unemployment compensation benefits


Disability payments from a government program paid as a substitute for unemployment compensation

Trade readjustment allowances under the Trade Act of 1974

Unemployment assistance under the Disaster Relief and Emergency Assistance Act

Unemployment assistance under the Airline Deregulation Act of 1974 Program If the taxpayer had to repay unemployment compensation for a prior year, he or she would subtract the total amount repaid from the total amount received for the year and enter the difference on Form 1040, line 19; Form 1040-A, line 13; or Form 1040-EZ, line 3. On the dotted line next to the entry on the tax return, write "Repaid" and the amount repaid. If the taxpayer itemized his or her deductions, the taxpayer can deduct the amount repaid on Schedule A, line 23. If the amount is more than $3,000, more research will be needed. Paid Medical Family Leave Paid family leave is a component of a state disability insurance program, and workers covered by SDI are also covered for this benefit. The maximum claim is six weeks; this is reported as unemployment on the individual's tax return. In some states, paid family leave and unemployment are reported on separate forms. Be aware of how each individual state reports the two. Both are considered to be a form of unemployment compensation that needs to be reported on Form 1040, line 19, Form 1040A, line 13, and Form 1040EZ, line 3. Important: Remember to add paid family leave and unemployment to get the correct unemployment compensation total. 2.10 Schedule C Self Employment Income and Expenses Hobby Income Hobby income is one example of an activity not for profit. Hobby expenses up to the amount of the hobby's income are generally deductible if the taxpayer itemizes on Schedule A, subject to a 2 percent floor. Hobby losses are not deductible from other income, because a hobby is not meant to make a profit. A hobby, however, can become a business. In order to show the IRS that an activity is a business, the taxpayer should maintain the following:

Thorough record keeping

Separate business checking account for the income

Separate credit cards for business and personal purchases

Log book(s) to keep records of business and personal use of such items as computers, charter boats, camcorders, etc.

Required licenses, insurance, certifications, etc.

If operated from home, a separate business line for phone

An attempt to make a profit

Research on market trends or technology related to the taxpayer's business

Employment taxes If the taxpayer has employees, the taxpayer will need to file forms to report employment taxes.


Employment taxes include the following items:

Social security and Medicare

Federal income tax withholding

Federal unemployment (FUTA) tax For more information about employment taxes, see Publication 15 (Circular E), Employer's Tax Guide. Hobby Expenses Hobby expenses related to hobby income are also deducted on Schedule A, line 23. The expenses are deductible to the extent of the income. Losses are not allowed for hobby income. The following items could be listed on Schedule A, line 23: 1. Investment expenses 2. Safe deposit box 3. Hobby expenses to the extent of income 4. Appraisal for charitable contributions 5. Certain legal and accounting fees 6. Trust account custodial fee What can be claimed on line 23 is the total amount paid for the taxpayer to be able to produce or collect taxable income and to manage or protect property held for investment. Personal expenses cannot be deducted. Activity Not for Profit Income received through activities from which the taxpayer does not expect to make a profit must be reported on Form 1040, line 21. Deductions relating to that income are limited. They cannot exceed the income from the activity. Deductions are reported on Schedule A and may be subject to the 2% floor. Deductions for the business or investment activity cannot offset other income. To determine if the taxpayer is carrying on an activity for profit, several factors are taken into account. The following are the factors to consider:

The taxpayer carries on the activity in a businesslike manner.

The time and effort put into the activity indicate the taxpayer intended to make a profit.

Losses are due to circumstances beyond the taxpayer's control.

Methods of operation were changed in an attempt to improve profitability.

The taxpayer or the taxpayer's advisor(s) have the knowledge needed to carry on the activity as a successful business.

The taxpayer was successful in making a profit in similar activities in the past.

The activity makes a profit in some years.

The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.

The taxpayer depends on the income for his or her livelihood.


An activity is presumed to be carried on for profit if it produced a profit in at least three of the last five years, including the current year. Activities that consist of breeding, training, showing, or racing horses are presumed to be carried on for profit if they produced a profit in at least two of the last seven years. The activity must be substantially the same for each year within the period, and the taxpayer has a profit when the gross income from the activity exceeds the deductions. Business Income A sole proprietor is an individual owner of a business or a self-employed individual (such as a contractor). Taxable income is determined using Schedule C and reported on Form 1040, line 12. A business owner may also be required to pay self-employment tax (the social security and Medicare tax equivalent reported on Schedule SE). A sole proprietor with business expenses of $5,000 or less may be able to file a Schedule C-EZ. Sole Proprietorship A sole proprietorship reports the income and expenses from the owner's business on Schedule C, Profit or Loss from a Business. One is self-employed if he or she:

Conducts a trade or business as a sole proprietorship

Is an independent contractor

Is in business for him or herself in any other way Self-employment can include work in addition to regular full-time business activities. It can also include certain part-time work done at home or in addition to a regular job. Minimum Income Reporting Requirements for Schedule C Filers If the taxpayer's net earnings from self-employment are $400 or more, the taxpayer is required to file a tax return. If net earnings from self-employment were less than $400, the taxpayer may still have to file a tax return if the taxpayer meets other filing requirements. Independent Contractor One who owns a business as a sole proprietor could be an independent contractor. This classification permits the taxpayer to certain tax benefits and full responsibility for his or her employment taxes. The independent contractor can itemize all business expenses by using Schedule C. In order to be considered an independent contractor, the taxpayer should set his or her own hours and work schedule, be responsible for having his or her own tools or equipment, and usually work for more than one individual or company. If a taxpayer is an independent contractor, the taxpayer would not fill out Form W-4, Employee's Withholding Allowance Certificate, for individuals for whom the taxpayer works, nor will anything be withheld from the taxpayer's paycheck(s). The independent contractor is responsible for paying self-employment tax (social security and Medicare) and making estimated tax payments to cover both the self-employment tax and his or her income tax. The following factors generally label workers as employees:


Must comply with the employer's work instructions

Receives training from the employer or the employer's designee

Provides services that are integral to the employer's business

Provides services that are personally rendered

Hires, pays, and supervises workers for the employer

Has an ongoing working relationship with the employer

Must follow set hours of work

Works full time for the employer

Works on the employer's premises

Works in a sequence set by the employer

Submits regular reports to the employer

Receives payments of regular amounts at regular intervals

Receives payments for business/travel expenses

Relies on employer to provide tools and materials

Does not have a major investment in resources for providing service

Does not make a profit or suffer a loss from services provided

Works for one employer at a time

Does not offer services to the general public

Can be fired by the employer

May quit anytime without incurring liability

Are statutory employees If one qualifies as a statutory employee for income tax purposes, the box titled "Statutory Employee" on Form W-2, Wage and Tax Statement, will be checked. Income and expenses should be reported on Schedule C. Business deductions are not taken on Form 2106 and are not subject to the 2% floor. Schedule C-EZ While most taxpayers are required to use Schedule C to report their business income, others are eligible to report their income on Schedule C-EZ. The taxpayer may use Schedule C-EZ if all of the following apply:

Business expenses are $5,000 or less.

The taxpayer must use the cash method of accounting.

The taxpayer did not have an inventory at any time during the year.

The taxpayer did not have a net loss from his or her business.

The taxpayer had only one business as a sole proprietor.

There were no employees during the year.

The taxpayer is not required to file Form 4562.

The taxpayer did not deduct expenses for business use of the home.

The taxpayer did not have prior year unallowed passive activity losses from the business. Gross Income Receipts Self-employment income is income earned from the performance of personal services but cannot be classified as wages, since an employer-employee relationship does not exist between the payer and the payee. The self-employment tax is imposed on any U.S. citizen or resident alien who has self-employment income. If one is self-employed in a business that provides services (where products are not a factor), the


gross income goes on line 7 of Schedule C. Gross income is gross receipts from the business. It also includes amounts reported on Form 1099-MISC. Different Kinds of Income The taxpayer must report on his or her tax return all income received in business unless it is excluded by law. In most circumstances, income will be in the form of cash, checks, and credit card charges. Bartering is another form of income and its fair market value needs to be included in income. Example: Ernest operates a plumbing business and he uses the cash method of accounting. Ernest joined a bartering club to increase his sales. The bartering club has a member directory and each member has access to the list of the members and their services available. The bartering club members contact each other directly. Jim, who owns a computer store, contacted Ernest for his plumbing services. Jim wanted Ernest to fix the clogged pipes in his store in exchange for a laptop for Ernest's business. Ernest needs to report the fair market value of the laptop as income on his current year tax return. Expenses An expense must meet the following requirements (the taxpayer must keep written records of expenses):

Paid within the taxable year (for cash-basis taxpayers)

Not a capital investment (most capital investments are depreciated)

Must be ordinary and necessary

Not start-up or organization costs

Not inventory

Not prepaid expenses (e.g., two years insurance) The following are examples of expenses that can be deducted: Advertising: All advertising expenses can generally be deducted if the expense is related to the business. Advertising for purposes of influencing legislation is not deductible. The IRS views these expenses as nondeductible political contributions (line 8). Car and Truck Expenses: The taxpayer may choose between using actual expenses or the standard mileage rate of a car, van, pickup truck, or panel truck used for business. The taxpayer should include in his or her daily mileage records the following:

Beginning mileage

Ending mileage

Commuting mileage If the vehicle is used for both business and personal purposes, you must divide your expenses based on actual mileage used for business. The 2016 business rate is 54 cents per mile. Notes about the destination and reason for travel should be made on the daily mileage record. Office Expense: Office expenses that are not included in office-in-home expenses are deducted here. The following are examples of deductible expenses on line 18:

Postage

Office supplies


Rent or Lease: Schedule C, line 20a, is used for the lease of vehicles, machinery, and equipment rentals. Line 20b is used for leasing other rental property, such as rent for an office, building, or warehouse. Taxes and Licenses: The following are examples of deductible expenses on line 23:

License and regulatory fees for the trade or business

Real estate and personal property taxes on business assets

State and local sales tax imposed for the selling of goods or services

Social security and Medicare taxes paid to match the employee wages

Federal unemployment tax paid

Federal highway use tax

Contributions to state unemployment insurance fund or disability benefit fund if considered to be taxes under state law.

Do not deduct the following:

Federal income tax, including self-employment

Estate and gift taxes

Taxes assessed to pay for improvements, such as paving and sewers

Taxes on the taxpayer's primary residence

State and local sales taxes on property purchased for use in the business

State and local sales taxes imposed on the buyer that were required to be collected and paid to state and local government

Other taxes and licenses fees not related to the business Travel: The following are examples of business travel expenses that can be deducted on line 24a:

Airfare

Hotels

Taxi fares

Tips Meals and Entertainment: Includes expenses for meals and entertainment while traveling away from home. In general, one can deduct only 50% of business-related meal and entertainment expenses (line 24b). Utilities: Expenses include water, gas, electric, and telephone. The telephone expenses do not include the base rate of the first phone line into the taxpayer's house if used for the business. If the taxpayer has additional costs related to the business use of the phone, such as long-distance calls the taxpayer can deduct those expenses. If the taxpayer has a dedicated second phone line for business, all expenses may be deducted in regards to the second phone line (line 25). Wages: The gross amount paid in wages (minus employment credits) to employees is deducted. If the taxpayer paid himself or herself, these wages cannot be deducted. This is considered a draw and is not a deductible expense (line 26). Other Expenses: Other expenses are deducted in Part V, Schedule C. Other expenses include any expense that does not fit the description of another category and is ordinary and necessary in the operation of the taxpayer's business (line 27).


Recordkeeping is essential for the sole proprietor. The taxpayer should have detailed documentation of the date of use, the amount of time used for business, and the amount of personal use regarding computer and cell phone use. Other Expenses Include all ordinary and necessary business expense not deducted elsewhere on Schedule C. List the type and amount of each expense separately in the space provided. If more space is needed, use another sheet of paper. Do not include:

Charitable contributions

Cost of business equipment or furniture

Replacements or permanent improvements to property

Personal, living, and family expenses

Fines or penalties paid to a government for violating any law Include:

Amortization that begins in 2015

Bad debts

At-risk loss deduction

Business start-up costs

Cost of making commercial buildings energy efficient

Deductions for removing barriers to individuals with disabilities and the elderly

Excess farm loss

Film and television production expenses

Forestation and reforestation costs See Publication 535. Business Use of Home The taxpayer may be able to deduct certain expenses for business use of his or her home. To claim this deduction, the taxpayer would use Form 8829. Form 8829: Office in the Home Self-employed taxpayers who claimed a deduction for an office in the home should report it on Form 8829, Expenses/or Business Use of Your Home. A taxpayer must use the space exclusively and regularly. Day-care providers would use Form 8829. Day-care providers will use hours spent caring for children or disabled dependents instead of number of rooms or square feet for the percentage of business use. The time also includes the time to clean house before and after children arrive or leave and time spent preparing activities for child care.


If child-care providers do not use their entire home for child care, they will use a combination of hours and square feet to determine business use. The home portion does not have to meet the exclusive-use test if the use is for an in-home day-care facility. Business Use of Home Business expenses that apply to a part of the taxpayer's home may be a deductible business expense if the part of the home was exclusively used on a regular basis:

As the principal place of business for any of the trades or business

As a place of business used by patients, clients, or customers to meet or deal with the normal course of trade or business

In connection with the trade or business if it is a separate structure that is not attached to the taxpayer's home

Some exceptions to the "space rule used on a regular basis" are:

Storage of inventory or product samples

Certain day-care facilities The taxpayer needs to determine whether the office in the home qualifies as the taxpayer's principal place of business. The following items must be considered: 1. The relative importance of the activities performed at each place where one conducts business 2. The amount of time spent at each place where the business is conducted To qualify the office in the home as the primary place of the business, the following requirements must be met: 1. The taxpayer uses the home exclusively and regularly for administrative or management activities of

the taxpayer's trade or business. 2. The taxpayer has no other fixed location where the taxpayer conducts substantial administrative or

management activities of his or her trade or business. Administrative or Management Activities There are many activities that can be considered administrative or managerial in nature. Some of the most common include:

Billing customers, clients, or patients

Keeping books and records

Ordering supplies

Setting up appointments

Forwarding orders or writing reports If the following activities are performed at another location, the taxpayer would be disqualified for being able to claim the "office in the home" deduction: 1. The taxpayer conducts administrative or management activities at other locations other than the

home.


2. The taxpayer conducts administrative or management activities at places that are not fixed locations of his or her business, such as in a car or a hotel room.

3. The taxpayer occasionally conducts administrative or management activities at an outside location (not home).

4. The taxpayer conducts substantial nonadministrative or nonrnanagement business activities at a fixed location outside of the home.

5. The taxpayer has suitable space to conduct administrative or management activities outside of the home but chooses to work at home for these activities.

Example: Peter is a self-employed plumber. Most of Peter's time is spent at customers' homes and offices, installing and repairing plumbing. He has a small office in his home that he uses exclusively and regularly for the administrative or management activities of his business, such as calling customers, ordering supplies, and keeping his books. Fernando writes up estimates and records of work completed at his customers' premises. He does not conduct any substantial administrative or management activities at any fixed location other than his office in the home. Fernando does not do his own billing. He uses a local bookkeeping service to bill his customers. Fernando's office in the home qualifies as his principal place of business for deducting expenses for its use. Simplified Option for Home Office Deduction Taxpayers may use a simplified option to figure the home office business deduction. Revenue Procedure 2013-13 provides an optional safe harbor method that taxpayers may use. This safe harbor method is an alternative to the calculation, allocation, and substantiation of actual expenses for purposes of satisfying the Internal Revenue Code section 280A. These new rules do not change the home office criteria for claiming business use; they only simplify the ruling for record keeping and calculation. The major highlights of the simplified option are: 1. Standard deduction of $5 per square foot of home used for business with a maximum 300 square feet 2. Allowable home-related itemized deductions claimed in full on Schedule A 3. No home depreciation deduction or later recapture of depreciation for the years the simplified option

is used When selecting a method, the taxpayer can: 1. Choose to use either the simplified method or the regular method for any taxable year 2. Choose a method by using that method on their timely filed original federal tax return Once the method has been chosen for the year, the method cannot be changed. If the methods are used in different tax years, the correct depreciation table must be used. Year-by-year determination is acceptable. The deduction under the safe harbor method cannot create a net loss; it is limited to the gross income derived from the business reduced by business deductions unrelated to the home office deduction. Any excess is disallowed and cannot be carried over or back, unlike the carryover of unallowed expenses that is available to offset income from that activity in the succeeding year when using the actual expense method.


Regardless of the method that is used to claim the home office, there are two basic requirements needed: 1. Regular and exclusive use 2. Principal place of business Regular and Exclusive Use The portion of the home that is used must be used exclusively for conducting business. Example: Nadine teaches piano lessons in her home. She has a piano in her spare bedroom and a grand piano in her living room. She uses the piano in her spare bedroom to teach her students and the grand piano for the students' recitals. Nadine does not use the spare bedroom for anything else except teaching students and storing music books related to her students. Her spare bedroom is used exclusively and regularly for business, but her grand piano is not; it is only used for recitals for her students. Therefore she would only be able to claim the spare bedroom as a deduction and not the living room. Principal Place of Business If the taxpayer conducts business outside of the home and also uses his or her home substantially and regularly to conduct business, he or she may qualify for a home office deduction. The taxpayer an also deduct expenses for a separate freestanding structure such as a studio or a barn, but the regular and exclusive use must apply. Deducting Expense There are three types of expenses included in the operation of a home when considering an office in the home: 1. Direct Expenses incurred only for the business part of the home such as painting and repairs in the

area used for business. These expenses are fully deductible. 2. Indirect Expenses for running the home such as insurance, utilities, and general repairs (e.g., roof, HV

AC, etc.). These expenses are deducted based on the percentage of business use of the home. 3. Unrelated Expenses only for parts of the home not used for businesses such as lawn care and painting

a room not used for business. These expenses are not deductible. Samples of direct expenses include:

Real estate taxes

Mortgage interest

Casualty losses

Insurance: indirect insurance covers the entire home; direct insurance covers the business (a rider insurance policy can be a direct expense)

Rent

Repairs Samples of indirect expenses include: 1. Security system: The cost to maintain and monitor the system is considered an indirect cost. However,

the taxpayer may depreciate the percentage of the system that relates to his business.


2. Utilities and services: Includes electricity, gas, trash removal, and cleaning services. 3. Telephone: The basic local service charge, including taxes for the first line into the home, is a

nondeductible personal expense. Business long distance and the cost of a second line into the home used exclusively for business are deductible.

4. Depreciation: If the taxpayer owns the home, he or she may deduct depreciation. (For more information, see Publication 587.) Before calculating the depreciation deduction, the following information is needed: a. The month and year the taxpayer began using the home for business b. The adjusted basis and fair market value of the home at the time the taxpayer began using it for

business (the cost of the home plus any improvements, minus casualty losses or depreciation deducted in earlier years; land is never considered part of the adjusted basis)

c. The cost of improvements before and after the taxpayer began using the home for business d. The percentage of the home used for business

Expenses that cannot be deducted

Bribes and kickbacks

Charitable contributions

Demolition expenses or losses

Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs

Lobbying expenses

Penalties and fines paid to a governmental agency for breaking the law

Personal, living, and family expenses

Political contributions

Repairs that add value or increase the property life Recordkeeping Anyone who is in business for himself should keep a system of books and records. The system of records should include enough information to correctly determine gross receipts of the business and the expenses incurred. The records should also include inventory, purchases, payroll, and other transactions that occur while operating a business. The taxpayer's books and records should include all the supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These records can also help the taxpayer to determine inventory at the end of their tax year. Good recordkeeping will help the taxpayer do the following: 1. Monitor the progress of their business 2. Identify source and amount of receipts 3. Keep track of deductible expenses 4. Prepare accurate tax returns 5. Support items reported on tax returns Monitor the Progress of the Business


A taxpayer in business needs records to monitor the progress of the business. Good records can show whether the business is improving, what items are selling, or what changes may need to be made. When a business owner keeps good records it can increase business success. Identify Source and Amount of Receipts Good records can identify the source of the receipt and give the taxpayer the ability to determine which expenses are business related and which are taxable or nontaxable business income. Keep Track of Deductible Expenses A taxpayer is required to deduct the correct amount of expenses and only the allowable expenses. Good records should determine the source and amount of the expenses and credits for the business. Prepare Accurate Tax Returns Records need to support the credits, income, and expenses claimed on the tax return. Support Items Reported on Tax Returns Taxpayers must keep business records available at all times in case the IRS wants to inspect the records. If the taxpayer has been audited, the IRS Revenue Officer can ask for the supporting documentation for the income and expenses that were claimed on the taxpayer's return. A complete set of records will speed up the audit process. Remember that a business can deduct ordinary and necessary expenses for their trade or business. An ordinary expense is one that is common and accepted for that business type or trade or profession. Necessary expense is one that is helpful and appropriate for the trade, business, or profession. For the Schedule C to be correct and complete, the allowable business expenses should be reported. The taxpayer should not include any personal expenses. For more information on what is an ordinary or necessary expense, please see Publication 535 and Publication 587. If the taxpayer does not have records, the tax professional still needs to comply with the due diligence requirement. The tax preparer should make sufficient inquiries to satisfy their due diligence. The tax professional should make sure that the taxpayer is carrying on a business and the income they are reporting is legitimate. If the taxpayer has poor recordkeeping the client can reconstruct the records. Reconstruction will demonstrate that the paid preparer exercised due diligence and was also teaching recordkeeping skills to the taxpayer. The goal of reconstruction is to use available documentation to develop a sound and reasonable estimate for the taxpayer's business income and expenses to support what is being reported on Schedule C. Partial records are a great place to start for reconstruction of records. Knowledgeable tax preparers can guide their clients through reconstruction with partial records in case of an audit.


As a tax professional the preparer must make a decision whether they are comfortable that the information presented by the client is substantially correct. The tax preparer can always refuse to prepare the return if they are not satisfied with the accuracy of the reconstructed records. If the tax preparer is not satisfied with the taxpayer's records they may:

Request the taxpayer to attempt to reconstruct their own records

Assist the taxpayer with reconstruction of the records

Suggest filing without claiming EITC

Refuse to prepare the Schedule C return altogether The taxpayer is ultimately responsible for the figures that they give to the tax preparer. As a professional, your responsibility is to prepare accurate tax returns. Important: Remind your clients of the repercussions of filing a false and inaccurate tax return. 2.11 Reporting and Taxability of Social Security Benefits The social security system was designed to provide supplemental monthly benefits to taxpayers who contributed to the system. In addition, it provides Medicare benefits and certain death and disability insurance. It is indexed for inflation. For 2016 there is no increase for inflation. Social security is reported on Form SSA-1099. Box 5 is the amount that will be reported on the taxpayer's return. The Medicare payment is deductible on Schedule A under medical expenses, subject to the 7.5% floor for taxpayers over age 65, or 10% for taxpayers under age 65. Taxpayers also have the option to have federal taxes withheld from social security. The benefits are not taxable if income, which includes any tax-exempt interest and half the social security, does not exceed these base amounts:

$25,000: If single, head of household, or qualifying widow(er)

$25,000: If married filing separately and lived apart from spouse the entire year

$32,000: If married filing jointly

$0: If married filing separately and lived with spouse at some time during the year How Much Is Taxable? 50% taxable: If the income plus half of the social security benefits is more than the above stated base amounts, up to half of the benefits must be included in taxable income. The following are base amounts for the applicable filing status:

$25,000-$34,000: Single, head of household, qualifying widow(er), and married filing separately and lived apart from spouse

$32,000-$44,000: Married filing jointly

$0: Married filing separately and lived with spouse 85% Taxable: If the income plus half the benefits is more than the following adjusted base amounts, up to 85% of the benefits must be included in taxable income.

$34,000: Single, head of household, or qualifying widow( er)

$34,000: Married filing separately and lived apart from spouse for entire year

$44,000: Married filing jointly


$0: Married filing separately and lived with spouse at any time during the tax year Taxpayers who file MFS and live with their spouse, 85% of their benefits would be taxable. Most taxpayers assume that if their income falls below the base amount, they will not be taxed. They fail to add in tax-exempt interest or half their social security income. Example: Napoleon and Ilene file a joint return, both are over the age of 65, and they received social security benefits during the current tax year. In January 2015, Napoleon received his Form SSA-1099 showing benefits of $7,500 in box 5. Ilene received her form showing a net benefit of $3,500 in box 5. Napoleon received a taxable pension of $22,800 and interest income of$500. They did not have any tax-exempt interest income. Their benefits are not taxable for 2015 because their income is not more than the base amount of $32,000, even though the pension exceeds the minimum filing requirement for their filing status. Any repayments of benefits made during 2015 would be subtracted from the gross benefit received in 2015. It does not matter whether the repayment was for a benefit received in 2015 or an earlier year. 2.12 Overview of Capital Gains and Losses Capital Assets Held for Personal Use Generally, gain from a sale or exchange of a capital asset held for personal use is a capital gain. This transaction is reported on Form 8949, Part I or Part II, with box C checked. If the taxpayer converted the depreciable property to personal use, all or part of the gain on the sale or exchange of the property may have to be recaptured as ordinary income. The amount to be recaptured is reported on Form 4797, line 31, and line 13. The gain is not entered on Form 4797, line 32. The loss from the sale or exchange of a capital asset held for personal use is not deductible. If Form 1099-S was received, even if the transaction results in a loss, the personal property must still be reported on Form 8949. Calculating the Sales Price Anytime the taxpayer sells a home, land, stock, or other security, he or she will receive either Form 1099-S, Proceeds from Real Estate Transactions, or Form 1099-B, Proceeds from Broker and Barter Exchange Transactions. Forms 1099-S and 1099-B are reporting documents that provide the gross proceeds or sales price. If the taxpayer sold one stock several times, Form 1099-B may only report the gross proceeds lumped together. The taxpayer can divide the gross proceeds by the total number of shares sold to arrive at an average price per share. The taxpayer can then multiply the price per share by the number of shares sold on each occasion to arrive at the sales price. Capital Losses The taxpayer can deduct up to a $3,000 loss ($1,500 if filing MFS). The capital loss that exceeds the limit amount may be taken in future years.


Form 8949 Form 8949 is used to report sales and exchanges of capital assets. Individual taxpayers report the following information on Form 8949:

Sale or exchange of a capital asset

Gains from involuntary conversions

Nonbusiness bad debts

Worthlessness of a security When using Form 8949, the taxpayer separates his or her short-term and long-term capital gains and losses. Generally, if the disposed property was inherited, it is treated as a long-term asset. Remember, when figuring the holding period, the calculation starts one day after the property has been received. Short-term losses and gains are reported in Part I. Long-term losses and gains are reported in Part II. Example: Rachel owned three hundred shares of Imperial Soap, which she purchased for $1,000. She sold the stock this year for $1,200. Rachel realized a gain of $200, not the $1,200 proceeds she received from the sales. Only the $200 is included in gross income. The $1,000 is Rachel's return of capital. Codes for Form 8949, Column F B - The taxpayer received Form 1099-B or substitute statement, and the basis in box le is incorrect. C - The taxpayer disposed of collectibles. D - Taxpayer received Form 1099-B showing accrued market discount in box lg. E - The taxpayer received Form 1099-B or 1099-S or substitute statement for a transaction and there are selling expenses or option premiums that are not reflected on the form or statement by an adjustment to either the proceeds or basis shown. H - The taxpayer sold or exchanged his or her primary residence for a gain and must be reported on Form 8949, Part II. L - The taxpayer has a nondeductible loss other than a loss indicated by code W. M - The taxpayer reported multiple transactions on a single row. N - The taxpayer received Forms 1099-B or 1099-S as a nominee for the actual owner of the property. O - The taxpayer has an adjustment not explained in earlier codes. Q - The taxpayer sold or exchanged qualified small business stock and can exclude part of the gain. R - The taxpayer is electing to postpone all or part of the gain under the rules explained in the Schedule D instructions for rollover of gain (for example from QSB stock or publicly traded securities).


S - The taxpayer had a loss from the sale, exchanged, or worthlessness of small business (section 1244) stock and the total loss is more than the maximum amount that can be treated as an ordinary loss. T - Taxpayer received Form 1099-B or substitute statement and the type of gain or loss (short term or long term) in box 2 is incorrect. W - The taxpayer has a nondeductible loss from a wash sale. X - The taxpayer can exclude all or part of the capital gain under the DC Zone assets or qualified community asset rule. If none of the other statements in column F apply, leave columns F and G blank. If more than one code is entered in column F on the same row, enter the net adjustments in column G. For example, if one adjustment is $5,000 and another is ($1,000), enter $4,000 ($5,000 - $1,000). Enter all the codes that apply in alphabetical order with no commas, for example BOQ not B,O,Q. Example: Sally sold her main home in 2015 for $320,000 and received Form 1099-S showing the $320,000 gross proceeds. The home's basis was $100,000. Selling expense was $20,000 and her home basis was $100,000. Sally would be able to exclude the entire $200,000 gain from her income.

$320,000 Sales price -$100,000 Basis

-$ 20.000 Selling expenses $200,000 Capital gain (excluded from income)

Schedule D Schedule D is used to:

Figure the overall gain or loss from transactions reported on Form 8949

Report certain transactions that are not reported on Form 8949

Report a gain from Form 2439 or 6252 or Part I of Form 4797

Report a gain or loss from Form 4684, 6781, or 8824

Report a gain or loss from a partnership, S Corporation, estate, or trust

Report a capital gain distribution not reported directly on Form 1040NR

Report a capital loss carryover from 2015 to 2016 If a taxpayer has acquired qualified small business stock after September 27, 2010 for more than 5 years, 100% of the gain could be excluded. 2.13 Pensions, Annuities, and Individual Retirement Accounts (IRAs) A traditional IRA (individual retirement account) is a personal savings plan that offers taxpayers tax advantages to set aside money for their retirement, or, in some plans, for certain education expenses. Contributions may be deductible or nondeductible depending upon the taxpayer's modified AGI. A traditional IRA can be opened at any time during the year, but the contributions are limited depending


upon age and the taxpayer's earned compensation. An individual IRA can be a retirement account or an annuity. A traditional IRA can be opened if:

The taxpayer, or spouse if filing jointly, received taxable compensation during the current tax year

The taxpayer's age was not over 70½ by the end of the year. An individual retirement account is a trust or custodial account that has been set up in the U.S. for the exclusive benefit of the beneficiaries. The account is created by a written document and must meet the following requirements:

The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian

The trustee or custodian generally cannot accept contributions of more than the deductible amount for the year

Contributions, except for rollovers, must be in cash

The taxpayer must have a nonforfeitable right to the amount at all times

Money in the account cannot be used to purchase a life insurance policy

Assets in the account cannot be combined with other property, except in a common trustee or common investment fund

Distributions must begin by April l of the year following the taxpayer reaching 70½ The taxpayer can open an annuity by purchasing an annuity contract from a life insurance company. The individual retirement annuity must meet all the following requirements:

The taxpayer's interest in the contract must be nonforfeitable

The contract must state that the taxpayer cannot transfer any portion of the contract to any person other than the issuer

The premiums must be flexible so that if the compensation changes, so do the payments

The contract must state that contributions cannot be more than the deductible amount for an IRA for the year

Distributions must begin by April 1 in the calendar year after the taxpayer reaches age 70½ There are limits that affect the amount the taxpayer can contribute to an IRA. For 2016 the maximum contribution for a traditional and Roth IRA is the smaller of: 1. $5,500 ($6,500 if over the age of 50) 2. Taxable compensation Example 1: George, age 34, filing single, earns $26,000 in 2016. His IRA contribution can be $5,500. Example 2: Daniel is an unmarried college student who earned $3,500 in 2016. His contribution would be limited to $3,500, the total amount of his compensation. There are limitations for the taxpayer if he or she is covered by an employer retirement plan. For more information, see Publication 590-A. Modified Adjusted Gross Income (AGI) for a Traditional IRA Contribution


Modified AGI is the adjusted gross income from Form 1040 or Form 1040A. It is "modified" by figuring it without taking into account the following items, which are added back to taxable income:

IRA deduction

Student loan interest deduction

Tuition and fees deduction

Foreign earned income exclusion

Foreign housing exclusion or deduction

Exclusion of qualified bond interest shown on Form 8815, Exclusion of Interest from Series EE and I US. Savings Bonds

Exclusion of employer-paid adoption expenses shown on Form 8839, Qualified Adoption Expenses If the taxpayer is covered by a retirement plan at work, his or her deductions for a contribution to a traditional IRA are phased out if the modified AGI is:

More than $98,000 but less than $118,000 if the filing status is married filing jointly or qualifying widow

More than $61,000 but less than $71,000 if the filing status is single or head of household

Less than $10,000 if the filing status is married filing separately When filing a joint return and the spouse was covered by a retirement plan at work, the deduction is phased out if the modified AGI is more than $183,000 but less than $193,000. If the taxpayer's AGI is more than $193,000, no contribution to a traditional IRA can be made. IRA Distributions Any money received from a traditional IRA is a distribution and reported as income in the year it was received. On Form 1040, line 15a, report the nontaxable distribution and on 15b report the taxable distribution. On Form 1040A, line 11a, report the nontaxable distribution and on 11b report the taxable distribution. Distributions from a traditional IRA are taxed as ordinary income, but if the taxpayer made nondeductible contributions, not all of the distributions will be taxable. Form 8606 will need to be completed to report the taxable and nontaxable portions of the IRA distribution. Exceptions to distributions being taxable in the year received are:

A rollover from one IRA to another

Tax-free withdrawals of contributions

The return of nondeductible contributions These funds will be reported as received, but the taxable portion will be reduced or eliminated. Normal IRA distributions, for which contributions were fully tax-deferred when contributed to the IRA account, are usually fully taxable. Form 5329, Additional Taxes on Qualified Plans, is not required if the penalty is the only reason for using the form. Some exceptions to the penalty exist. The penalty is in addition to any tax due on the distributions. Early Distributions If a taxpayer makes an early withdrawal (before age 59½) from a qualified retirement plan (for example, IRA, annuity, or modified endowment contract), the taxpayer must pay a penalty equal to 10% of the


amount withdrawn. If Form 1099-R box 7 shows code 1, the taxpayer does not need to file Form 5329, but add the 10% penalty directly to Form 1040, line 58. If the code in box 7 is not 1 or 2 and an early distribution was received, the taxpayer must file Form 5329. Form 5329 is also filed if the taxpayer:

Owes tax because of excess contributions to an IRA

Did not receive a required minimum distribution from the taxpayer's qualified retirement plan

Received distributions from a qualified retirement plan that exceeded the applicable threshold amount

Taxpayers whose deductions for IRA contributions are reduced or eliminated can still make contributions of up to $5,500 ($6,500 if age 50 or older). The interest earned on the nondeductible portion is tax-deferred until it is withdrawn from the account. Nondeductible contributions must be reported on Form 8606. There are exceptions to the 10% penalty rule if the code in box 7 of Form 1099-R is 1 or 2. Some of the exceptions are:

This distribution is due to unreimbursed medical expenses that are more than 7.5% of AGI.

The distributions are not more than the cost of the medical insurance.

The taxpayer is disabled.

The taxpayer is the beneficiary of a deceased IRA owner.

The taxpayer is receiving the distributions in the form of an annuity.

Distributions are not more than the qualified higher education expense reported on the tax return.

The distribution was to buy, build, or rebuild the taxpayer's first home.

The distribution is due to an IRS levy of the qualified plan. Important: Tax professionals should remind their clients that he or she can only contribute a total of $5,500 ($6,500 if age 50 or older) (or the maximum reduced contribution limit) to an IRA (both traditional and/or Roth). Use Form 5329 to report additional taxes on the following:

IRAs

Other qualified retirement plans

Modified endowment contracts

Coverdell ESAs

QTPs

Archer MSAs

HSAs Additional Tax on Early Distributions Generally, if the taxpayer receives a distribution before age 59½ (including an involuntary cash-out from a traditional IRA, Roth IRA, or other qualified retirement plan) or a modified endowment contract, the taxable part of the distribution is subject to an additional 10% penalty. Early distributions from a SIMPLE IRA within two years of first participation in an employee plan are subject to a 25% early distribution penalty. There are, however, exceptions to the early distribution penalty.


The taxpayer may not have to pay the additional tax on an early distribution before age 59½ if one of the following situations applies: Taxpayer has unreimbursed medical expenses that are more than 10% (or 7.5% if the taxpayer or spouse is over age 65) of his or her adjusted gross income Distributions are not more than the cost of the medical insurance due to period unemployment

The taxpayer is totally and permanently disabled

The taxpayer is a beneficiary of a deceased owner's IRA

The taxpayer is receiving distributions in the form of an annuity

The distributions are not more than the taxpayer's qualified higher education expenses

The taxpayer uses the distributions to buy, build, or rebuild a first home

The distributions are due to an IRS levy of the qualified plan

The taxpayer is a qualified reservist Rollovers and Transfers Rollovers are tax-free transfers of funds from one qualified retirement plan to another qualified retirement plan. The taxpayer cannot deduct a rollover contribution made to a traditional IRA, but must report a rollover distribution on Form 1040, line 15a or 16a, or Form 1040A, line 11a or 12a. If the distribution was a rollover to a traditional IRA, when the taxpayer withdraws the rollover amount, the taxpayer is unable to use the optional methods to calculate the tax. If the distribution is an indirect rollover, the taxpayer must complete the rollover within 60 days after receiving the distribution. If the taxpayer does not roll over all of the distribution that was received, the remaining amount is taxable and subject to a 10% penalty if distributed prior to age 59½. Rollovers can be done only once in any tax year and are reported on Form 1040, line 15b or 16b, or Form 1040A, line 11b or 12b. Transfers move the taxpayer's money from one retirement plan into an IRA, or from one IRA to another. Transfers are tax-free because there is no distribution to the taxpayer, and the taxpayer is not affected by the one-year waiting period that is required with rollovers. Transfers are still reported on the tax return. For rollover purposes, the following are qualified retirement plans from an employer's plan into an IRA:

An employer's qualified pension plan, profit-sharing, or stock bonus plan

An annuity plan

A tax-sheltered annuity plan, for example, a section 403(b) plan

An eligible state or local government section 457 deferred compensation plan An eligible rollover distribution is any distribution of all or part of the balance to a qualified retirement plan. Exceptions to an eligible rollover are: 1. Any series of substantially equal distributions paid at least once a year over:

a. The taxpayer's lifetime or life expectancy b. The joint life expectancies of the taxpayer and the beneficiary c. A period of 10 years or more

2. Required minimum distribution 3. Hardship distributions 4. Corrective distributions of excess contributions or excess deferrals


5. A loan treated as a distribution because it does not satisfy certain requirements, either when made or later, unless the participant's accrued benefits are reduced to pay the loan

6. Dividends paid on employer securities 7. The cost of life insurance coverage The taxpayer may be able to roll over the nontaxable portion of the distribution (such as after-tax contributions) made to a different qualified retirement plan if the rollover is to a qualified plan, 403(b) plan, traditional IRA, or Roth IRA. If the taxpayer rolls over only part of the distribution, but the distribution contains both taxable and nontaxable portions, the distribution is treated as coming from the taxable portion. Any after-tax contributions that are rolled over into a traditional IRA become part of the basis in the IRA. When distributions are taken from the IRA, to recover the basis of the IRA, Form 8606 must be completed. Pensions and Annuities Distributions A distribution is a payment received by taxpayers from their pension or annuity. If taxpayers contributed "after-tax" dollars to their pension or annuity plan, they can exclude part of each annuity payment from income as a recovery of their cost. This tax-free part of the payment is figured when their annuity starts and remains the same each year, even if the amount of the payment changes. Pension is a contract for a fixed sum to be paid regularly following retirement from service. The rest of each payment is taxable. The tax-free portion of the payment is calculated using one of the following methods: General rule: This method is generally used to determine the tax-free treatment of pension and annuity income from nonqualified plans. The taxpayer must use the general rule if: 1. The taxpayer receives pension and annuity payments from a nonqualified plan (such as a private

annuity, a purchased commercial annuity, or a nonqualified employee plan) 2. The taxpayer is age 75 or older on the annuity starting date, and the annuity payments are guaranteed

for at least five years. Simplified method: Using the simplified method, the taxpayer will figure the tax-free part of each monthly annuity payment by dividing his cost by the total number of expected monthly payments. For an annuity that is payable for the life of the annuitant, this number is based on the annuitant's age on the annuity starting date and is determined from a table. For any other annuity, this is the number of monthly annuity payments under the contract. If the taxpayer received a pension or annuity payment from a qualified plan and he or she is not able to use the general rule, the taxpayer must use the simplified method. 2.14 Adjustments to Income Adjustments are certain expenses that directly reduce the taxpayer's total income. Adjustments are also known as "above the line" tax deductions. These expenses are taken directly on Form 1040, and the taxpayer does not file a Schedule A to claim these adjustments. This section "adjusts" or reduces the taxpayer's income to arrive at his or her adjusted gross income. Some adjustments can be taken on Form 1040-A, but none on Form 1040EZ. Adjustments that can be taken on Form 1040A are:


1. Educator expenses (line 16) 2. IRA deduction (line 17) 3. Student loan interest deduction (line 18) 4. Tuition and fees (line 19) All other adjustments must be reported on lines 23-35, Form 1040. Adjustments reduce total income to arrive at the adjusted gross income (AGI), which is total income from all sources minus any adjustments to income. Educator Expense If the taxpayer was an eligible educator, he or she may deduct up to $250 of qualified expenses paid in 2016. An eligible educator is defined as a teacher for kindergarten through 12th grade, instructor, counselor, principal, or aide, who works in a school for at least 900 hours during a school year. If the taxpayer and spouse are filing jointly and both are eligible educators, the maximum deduction is $500. Neither spouse may deduct more than $250 of qualified expenses on line 23 of Form 1040 or line 16 of Form 1040A. Qualified expenses include ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom. An ordinary expense is one that is common and accepted in the taxpayer's educational field. A necessary expense is one that is helpful and appropriate for the taxpayer's profession as an educator. An expense does not have to be required to be considered necessary. Qualified expenses do not include expenses for home schooling or for nonathletic supplies for courses in health or physical education. Expenses must be reduced by the following:

The interest on qualified U.S. savings bonds that were excluded from income paid for qualified higher-education expenses

Any distribution from a qualified tuition program that was excluded from income

Any tax-free withdrawals from Coverdell education savings account(s) Moving Expenses Form 3903 In order to claim moving expenses, the move must be in conjunction with the taxpayer's job or business. The old home to new workplace must be at least 50 miles more than the old home to old workplace. Deductible expenses are:

The cost of packing and moving household goods and personal effects

Thirty days after the day the move began for storage and insuring household goods

Cost of connecting and disconnecting utilities

Travel (including lodging but not meals) to the new home, limited to one trip (the mileage rate is 24 cents per mile, for tax year 2015 the mileage rate is 23.5)

Tolls and parking fees If the taxpayer did not have any reimbursed moving expenses, report the expenses in the year the expenses were incurred or when the taxpayer paid them. The taxpayer first reports the moving expenses on Form 3903 and then on line 26 of Form 1040. If the taxpayer had reimbursed moving expenses under


an accountable plan, the expenses would be reported on the taxpayer's Form W-2 in box 12 and designated with code P. Reimbursed expenses reported with code P do not need to be reported on the tax return. Since the taxpayer was reimbursed for the moving expenses, the taxpayer cannot double-dip and claim moving expenses on his or her tax return. To be considered an accountable plan, the employer's reimbursement or allowance arrangement must include the following rules: 1. The expenses must have a business connection, which means the taxpayer must have paid or incurred

deductible expenses while performing services as an employee. 2. The taxpayer must adequately account to the employer for these expenses within a reasonable period

of time. 3. The taxpayer must return any excess reimbursement or allowance within a reasonable period of time. Example: Donald lives in Seattle and accepted a job in Portland. Donald's new employer reimbursed him, from their accountable plan, for his actual traveling expenses from Seattle to Portland. Donald's employer would include the reimbursement on his W-2, box 12, with code P. Distance Test The distance between a job location and the taxpayer's main home is the shortest of the more commonly traveled routes between them. The distance test considers only the location of the former home. It does not take into account the location of the new home. If the taxpayer had more than one job at any time during the year, the main job location from where the distance test would be calculated. The factors that need to be considered are:

The total time spent at each job

The amount of work to do at each job

The amount of money earned at each job Time Test The taxpayer must also meet a time test to qualify for moving expenses. If the taxpayer is an employee, he or she must work full time for at least 39 weeks during the first 12 months after the taxpayer arrives in the general area of the new job location. For the time test: 1. Count only full-time work as an employee 2. Do not count any work done as self-employed 3. The taxpayer does not have to work for the same employer for the 39 weeks 4. He or she does not have to work 39 weeks in a row However, the taxpayer must work full time within the same general commuting area. Moving expenses are reported on line 26 of Form 1040. Form 3903, Moving Expenses, is required to be attached to the tax return to claim this adjustment. The taxpayer does not need to itemize deductions to claim the adjustment. Moving Outside the United States


To be able to deduct moving expenses when the taxpayer moves outside the United States, the move must be to a new place of work outside the United States and its possessions. The taxpayer must meet the following requirements:

The move is closely related to the start of work

The taxpayer meets the distance test

The taxpayer meets the time test The deductible moving expenses are:

The cost of moving household goods and personal effects from the former home to the new home

The cost of traveling (including lodging but not meals) from the former home to the new home

The cost of moving household goods and personal effects to and from storage

The cost of storing household goods and personal effects while at the new location Remember, all expenses need to be reasonable expenses. Important: Recordkeeping is important to maintain an accurate record of expenses for the move. The taxpayer should save receipts, bills, canceled checks, credit card statements, and mileage logs. Self-Employment Tax Self-employment tax is how an independent contractor or a self-employed individual, pays social security and Medicare payroll taxes. In the situation of an employer and employee, the employer and employee split the tax. A self-employed person is both the employer and the employee, so he or she has to pay the entire 15.3% tax. The self-employment tax is only for those individuals who work for themselves. The self-employed person pays 15.3% on all earnings up to and including $118,500 per year. The social security tax is 12.4%, and the Medicare portion is 2.9%. An additional .09% Medicare tax may apply based on the taxpayer's filing status and total gross income. The threshold amounts are:

Single, head of household, or qualifying widow(er): $200,000

Married filing jointly: $250,000

Married filing separately: $125,000 If the taxpayer has both wages and self-employment income, the threshold amount for applying the additional tax is reduced on the self-employment tax based on the amount of wages subject to the tax, but not below zero. Since the self-employed person pays the entire amount, he or she is allowed to take an adjustment to income of one-half of the total self-employment tax. This tax is figured on Schedule SE, and the adjustment is then carried to Form 1040, line 27. If the taxpayer has W-2 wages as well, the taxpayer's net self-employment earnings are combined with his or her wages when determining the earning limit for the SE tax. Self-employed tax does not apply to income earned as a shareholder of an S corporation or as a limited partner of a partnership (except for guaranteed payments). Self-employment tax is calculated on Schedule SE and must be paid if the following applies:

Net earnings from self-employment (excluding income as a church employee) were $400 or more.

Church-employee income is more than $108.28.


The self-employment tax rules apply even if the taxpayer is receiving social security and Medicare benefits. Special rules apply to workers who perform in-home services for elderly or disabled individuals (caregivers). Caregivers are typically classified as employees of the individuals to whom they are giving the care. Self-employed individuals may have to pay estimated payments, sometimes referred to as "quarterlies." For more information, see Publication 505, Tax Withholding and Estimated Tax. Self-Employed SEP, SIMPLE, and Qualified Plans This line item for adjustments is for self-employed taxpayers who provide retirement plans for themselves and their employees. The plans that can be deducted on this line are: 1. SEP (simplified employee pension) plans 2. SIMPLE (savings incentive match plan for employees) 3. Qualified plans, including HR (10) or Keogh plans SEP (Simplified Employee Pension) A business of any size may establish a SEP, which allows employers to contribute to traditional IRAs (SEP-IRAs) for their employees. There are three basic steps in starting a SEP: 1. Must have a formal written agreement to provide benefits to all eligible employees 2. Must give each eligible employee certain information 3. A SEP-IRA must be set up for each employee The formal written agreement must state that the self-employed employer will provide benefits to all eligible employees under the SEP. The employer may adopt an IRS model by filing Form 5305-SEP. Professional advice should be sought when setting up the SEP. Form 5305-SRP cannot be filed if any of the following apply: 1. The company already has a qualified retirement plan other than a SEP. 2. The company has eligible employees whose IRAs have not been set up. 3. The company uses the service of leased employees who are not common-law employees. 4. The company is a member of one of the following trades or business:

a. An affiliated service group described in section 414(m) b. A controlled group of corporations described in section 414(b) c. A trade or business under common control described in section 414(c)

5. The company does not pay the cost of the SEP contributions. The contributions are made to IRAs (SEP-IRAs) of the eligible participant in that plan. Interest accumulates tax-free until the participant begins to make withdrawals. A self-employed person is also eligible to participate in this plan. Contribution limits are based on net profits. A taxpayer is considered to be an eligible employee if he or she meets the following requirements:

Has reached age 21

Has worked for the employer for at least 3 of the past 5 years

Has received at least $600 in compensation from the employer during 2016 tax year


The employer may contribute annually to each employee's IRA the lesser of:

$53,000 (for 2016)

25% of the employee's compensation, or 20% for the self-employed taxpayer Contributions made by the employer are not reported as income by the employee, nor can they be deducted as an IRA contribution. Excess contributions are included in the employee's income for the year and are treated as contributions. Do not include SEP contributions on the employee's Form W-2 unless the contributions are pretax contributions. Example: Susan Plant earned $21,000 for 2015. Because of the maximum contribution for 2015, the employer can contribute only $5,250 to her SEP-IRA. (25% x $21,000) SIMPLE (Savings Incentive Match Plan for Employees) Retirement Plan A SIMPLE plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. A SIMPLE plan can be established for any employee who received at least $5,000 in compensation during the two years prior to the current calendar year and is reasonably expected to receive at least $5,000 during the current calendar year. Self-employed individuals are also eligible. The plan may use less restrictive guidelines but not more stringent ones. The employee's elective deferrals from salary reduction are limited to $12,500, or $15,500 (an additional $3,000) if age 50 or older (for 2015 and 2016). Salary-reduction contributions are not treated as catch-up contributions. The employer can match employee deferrals, dollar for dollar, up to 3% of the employee's compensation. SIMPLE (Savings Incentive Match Plan for Employees) IRA A SIMPLE retirement plan is a plan that uses separate IR.As for each eligible employee. Under a SIMPLE plan, a separate account must be established for each eligible employee. A SIMPLE plan is a written agreement (salary-reduction agreement) between the taxpayer and his or her employer that allows the taxpayer to choose to:

Reduce the taxpayer's compensation by a certain percentage each pay period.

Have the employer contribute the salary reductions to a SIMPLE IRA on the taxpayer's behalf. These contributions are called "salary-reduction contributions."

All contributions under a SIMPLE IRA plan must be made to SIMPLE IR.As, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account or an individual retirement annuity. In addition to salary-reduction contributions, the employer must make either matching contributions or nonelective contributions. The taxpayer is eligible to participate in his or her employer's SIMPLE plan if the taxpayer:

Received compensation from his or her employer during any two years prior to the current year


Is reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made

The difference between the SIMPLE retirement plan and the SIMPLE IRA is that the retirement plan is part of a 401(k) plan, and the IRA plan uses individual IR.As for each employee. For more information, see Publication 560. Self-Employed Health Insurance Deduction Self-employed taxpayers can deduct as an adjustment to income on line 29, Form 1040, 100% of the amount paid in 2015 for medical insurance and qualified long-term care insurance for the taxpayer and the taxpayer's family if any of the following apply:

The taxpayer is a self-employed individual.

The taxpayer is a general partner (or limited partner receiving guaranteed payments) in a partnership.

The shareholder owns more than 2% of the outstanding stock of an S corporation. Premiums are not deductible any month that the taxpayer or spouse was eligible to participate in an employer-subsidized health plan. The deduction is also limited by the earned income. For Schedule C, it would be the net profit less the SE tax deduction (line 27) and SEP deductions (line 28). If the taxpayer is also itemizing, amounts listed on line 29 cannot be deducted as a medical expense on Schedule A. Self-employed individuals need to have a net profit for the year to deduct their premiums paid as an adjustment to income. The self-employed health insurance deduction should be calculated by using Worksheet for the Health Insurance Deduction found in Publication 535. If any of the following apply, the worksheet cannot be used:

The taxpayer had more than one source of income subject to self-employment

The taxpayer filed Form 2555 or Form 2555-EZ

The taxpayer is using amounts paid for qualified long-term care insurance to figure the deduction Penalty on Early Withdrawal of Savings If a taxpayer withdraws money from a savings program and incurs a penalty, the penalty is an allowable adjustment to gross income. This penalty is reported to the taxpayer on Form 1099-INT or Form 1099-0ID. The early withdrawal penalty is imposed by the bank or other private institution. Report the early withdrawal penalty on Form 1040, line 30, as an adjustment to income. Alimony Paid Alimony is a payment or a series of payments to a spouse or former spouse required under a divorce or separation instrument and must meet certain requirements. Alimony received should be reported on Form 1040, line 11. Alimony paid should be deducted on Form 1040, line 3 la, as an adjustment. If a spouse must report the alimony payments received as income, it is reasonable that the paying spouse deducts the amount from gross income. The paying spouse must report the recipient's social security


number on line 31b along with the amount paid. Not all payments received from a spouse are considered alimony. For a description of what is considered alimony, see Publication 17. The term "divorce or separation instrument" refers to:

A decree of divorce or separated maintenance or a written instrument incident to that decree

A written separation agreement

A decree or a type of court order requiring a spouse to make payments for the support or maintenance of the other spouse

Payments that are not alimony:

Child support

Noncash property settlements

Payments that are the taxpayer's spouse's part of community income

Payments to keep up the payer's property

Use of the payer's property

Noncash property settlements, whether in lump sum or installments

Voluntary payments Community property laws may not apply to an item of community property income. Special rules may apply to community property states. More research may be needed if the taxpayer lives in a community property state. Individual Retirement Account (IRA) Deduction Taxpayers may participate in a personal savings plan that offers tax advantages to set aside money for retirement or educational expenses. This personal savings plan is known as an individual retirement account or IRA. There are different types of IRAs: traditional, Roth, SIMPLE, or education. It is necessary to understand the difference between a contribution and a deduction. Contributions are the amounts contributed to the taxpayer's plan. Deductions are the actual amount by which the taxpayer may reduce taxable income. Individuals who have not reached age 7012 with taxable compensation may contribute to an IRA (with certain other conditions). Compensation for IRA purposes includes wages, salaries, commissions, tips, professional fees, bonuses, and other amounts received for personal services. Also included are taxable alimony and separate maintenance payments. The deductible amount of the IRA contribution may be limited depending on two factors:

If the taxpayer or spouse had an employer-provided pension plan

The amount of the modified adjusted gross income The maximum a single taxpayer can contribute is the smaller of $5,500 or the taxpayer's taxable compensation. If the taxpayers are married and only one spouse has taxable compensation, the maximum contribution the couple can make is $11,000. The maximum that can be contributed to one account is $5,500. If the married spouses have compensation in excess of$5,500 each, they both may contribute $5,500.


If the taxpayer is 50-years-old or older, he or she may make a "catch-up" contribution to his or her IRA account in the amount of $1,000. Taxpayers may not contribute more than $6,500 to their IRA account during the tax year. Contributions must be in the form of money. Property cannot be contributed to an IRA. If a taxpayer contributes more than $5,500 ($6,500 if age 50 or older) in one year to an IRA, the taxpayer will be penalized with a 6% tax on the excess contribution and its earnings each year until the taxpayer withdraws the excess contribution and its earnings. This penalty is not limited to the year in which the excess contribution is made. The excess contributions must be reported on Form 5329, Additional Taxes Attributable to IRAs, Other Qualified Retirement Plans, Annuities, Modified Endowment Contracts, and MSAs, Part II. In addition to the adjustment to the taxpayer's gross income, interest earned on a traditional IRA account is accumulated tax-deferred until it is withdrawn, thus benefiting the taxpayer. Qualified Student Loan In order to have a reportable student loan for 2016 the loan must be either: 1. Subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the

federal, state, or local government or of a postsecondary educational institution. 2. Certified by the borrower as a student loan incurred solely to pay qualified higher education expenses. The student will not receive Form 1098-E unless the student loan interest is $600 or more from a borrower regardless of the number of student loans obtained. To be reportable for 2016 the student loan must be either: 1. Subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the

federal, state, or local government, or a postsecondary educational institution 2. Certified by the borrower as a student loan incurred solely to pay qualified higher education expenses Box 1: The interest received by the taxpayer for their student loan. The interest includes capitalized interest as well as loan origination fees. Box 2: This box is checked if box 1 has loan origination fees and or capitalized interest, not included in box 1. Student Loan Interest Deduction Taxpayers who have education loans can deduct up to $2,500 of education loan interest paid in 2016. The deduction is taken as an adjustment to income on line 33 of Form 1040 or line 18 of Form 1040A. The deduction is allowed on qualifying loans for the benefit of the taxpayer or the taxpayer's spouse or dependent at the time the debt was incurred. The deduction begins to phase out at income in excess of $65,000 ($130,000 for joint filers) and completely phases out at $80,000 ($160,000 for MFJ). MFS


individuals are unable to deduct student loan interest. If more than $600 was paid in interest on the student loan, Form 1098-E will be received. The person for whom the expenses were paid must have been an eligible student. However, a loan is not a qualified student loan if:

Any of the proceeds were used for other purposes

The loan was from either a related person, a person who borrowed the proceeds under a qualified employer plan, or a contract purchased under such a plan

An eligible student is a person who: a. Was enrolled in a degree, certificate, or other program (including a program of study abroad that was

approved for credit by the institution where the student was enrolled) leading to a recognized educational credential at an eligible educational institution

b. Carried at least half of the normal full-time workload for the course of study the student is pursuing Tuition and Fees Deduction (Form 8917) - This adjustment has been extended through 2016. The taxpayer may be able to deduct qualified tuition and related expenses paid during the year for the taxpayer, spouse, or a dependent. The taxpayer cannot claim this deduction if his or her filing status is married filing separately or if another person is entitled to claim the exemption. The tuition and expenses must be for higher education, as explained in the next section. The taxpayer may claim this deduction only if all five of the following apply: 1. The taxpayer paid qualified tuition and fees in 2015 for himself, his spouse, or his dependent(s). 2. The taxpayer's filing status is any status except married filing separately. 3. The taxpayer's modified adjusted gross income (MAGI) is not more than $80,000 ($160,000 if MFJ). 4. The taxpayer cannot be claimed as a dependent on someone else's (such as his or her parents') 2015

tax return. 5. The taxpayer is not claiming an education credit on line 49 for the same student. The tuition and fees deduction can reduce the amount of income subject to tax by up to $4,000. Tuition and fees are taken as an adjustment to income. This means the taxpayer can claim this deduction even if the taxpayer does not itemize deductions on Schedule A (Form 1040). This deduction may be beneficial to taxpayers who cannot take either of the education credits because their income is too high. Use Publication 970, Tax Benefits for Education, if the taxpayer filed Form 2555, Form 2555-EZ, or Form 4563, and if excluding income from sources within Puerto Rico. What Expenses Qualify for Tuition and Fees Deduction? The tuition and fees deduction is based on qualified education expenses the taxpayer pays for himself or herself, his or her spouse, or a dependent that the taxpayer claimed an exemption on his or her tax return. Generally, the deduction is allowed for qualified education expenses paid in 2015 in connection with enrollment at an institution of higher education during 2015 or for an academic period beginning in 2015 or in the first three months of 2016. For example, if the taxpayer paid $1,500 in December 2015 for qualified tuition for the spring 2016 semester beginning in January 2016, he or she may be able to use that $1,500 in figuring the 2015 deduction. Basically, an eligible educational institution is one that participates in the U.S. Department of Education's Federal Student Aid (FSA) programs.


Tuition and Fees Deduction Form 8917 This deduction is based on the qualified education expenses paid to an eligible postsecondary educational institution. The taxpayer may be able to take the deduction if the taxpayer, his or her spouse, or a dependent claimed on his or her tax return was a student who was enrolled in or attended an eligible educational institution. When claiming this credit, Form 8917 needs to be attached to the tax return. Academic Period An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period. 2.15 Standard Deduction vs. Itemized Deductions The taxpayer can either take itemized deductions or a standard deduction to reduce his or her taxable income. The standard deduction is based on the taxpayer's filing status. Itemized deductions are taken when the taxpayer's deductions exceed the standard deduction. Subtracting the appropriate deductions and exemptions gets the taxpayer to his or her taxable income. Tax tables are based on taxable income. Tax tables can be found in Publication 17. Once tax has been determined, nonrefundable credits can be applied to reduce the tax liability. Some nonrefundable credits can be claimed on Form 1040-A and not on Form 1040-EZ. Standard Deduction There are two types of deductions available to taxpayers: the standard deduction or itemized deductions. Itemized deductions are certain expenses of a personal nature that are specifically allowed as a deduction, and they will be discussed in a later chapter. Both deductions are subtracted from the taxpayer's adjusted gross income, reducing the taxable liability of the taxpayer. As a tax professional, you should always choose the method that will give the taxpayer the lowest tax. The standard deduction is an established dollar amount, eliminating the need for the taxpayer to save receipts for actual expenses such as medical expenses, charitable contributions, and taxes. Most taxpayers have the option of choosing the method that result in the lowest tax liability. However, the standard deduction is not an option for all taxpayers. The taxpayer's standard deduction is zero, and he or she should itemize deductions if any of the following apply:

The taxpayer is married and filing a separate return and the taxpayer's spouse itemizes deductions.

The taxpayer is filing a tax return for a short tax year because of a change in his or her annual accounting period.

The taxpayer is a nonresident or dual-status alien during the year. The taxpayer is considered a dual-status alien if he or she was both a nonresident and resident alien during the year. If the nonresident alien is married to a U.S. citizen or resident alien at the end of the year, the nonresident alien or resident alien can choose to be treated as a U.S. resident.


See Publication 519 for more information. Standard Deduction Amount The standard deduction amount varies depending on the taxpayer's filing status. Other factors that determine the amount of the allowable standard deduction are:

Whether or not the taxpayer is considered age 65 or older

Whether or not the taxpayer is blind

Whether or not the taxpayer can be claimed as a dependent on another individual's tax return Standard Deduction for Most People*

Filing status and standard deduction Tax Year 2016

Single $6,300

Married filing jointly and qualifying widow (er) $12,600

Married filing separately $6,300

Head of household $9,300

Example 1: Lilly is 26-years-old, has never been married, and does not have children or other dependents. Lilly will file a tax return using the single filing status. Her standard deduction will be $6,300. Example 2: The scenario is the same as example 1 with one change: Lilly is now married. She and her husband plan to file a joint return. Lilly and her husband will use the standard deduction. Their standard deduction will be $12,600. Example 3: The scenario is the same as example 2 with one change: Lilly and her husband now have a son who was born during the tax year. Lilly and her husband have decided to file separate tax returns. Since they are still married and living together, they must use the MFS filing status. Lilly's standard deduction will be $6,300. Example 4: The scenario is the same as example 3 with one change: Lilly and her husband divorced during the tax year. Lilly now has sole custody of her son. Lilly is eligible to file using the head of household filing status. Lilly's standard deduction will be $9,250 Standard Deduction for Age 65 and Older or Blind A higher standard deduction is allowed for taxpayers who are age 65 or older at the end of the tax year. The taxpayer is considered to be age 65 on the day before their 65th birthday. Therefore, the higher standard deduction would be allowed for a taxpayer if the taxpayer's 651 h birthday was on or before January 1. A higher standard deduction is also allowed for taxpayers who are considered blind on the last day of the year. If the taxpayer is partially blind, he or she must get a statement from an eye physician (an optometrist or ophthalmologist) stating that the taxpayer cannot see better than 20/200 in the better eye with glasses or contact lenses or that the taxpayer's field of vision is not more than twenty degrees. If the examining physician determines that the eye condition will never improve beyond its limits, the physician must include this fact in his or her statement. If the vision can be corrected beyond the limits


only by contact lenses that can be worn only briefly due to pain, infection, or ulcers, the taxpayer is entitled to take the higher standard deduction if he or she otherwise qualifies. This statement should be kept with the taxpayer's records. The higher standard deduction is also allowed for the taxpayer's spouse who is age 65 or older or blind if:

The taxpayer and their spouse file a joint return.

The taxpayer files a separate return, the spouse had no gross income, and an exemption for the spouse could not be claimed by another taxpayer.

The increase in the standard deduction for MFJ and MFS individuals is $1,250. Single and head of household individuals are allowed an additional standard deduction of $1,550. Note: If the taxpayer is MFS and his or her spouse itemizes, or if he or she is a dual-status alien, the taxpayer cannot take the standard deduction if he or she was born before January 2, 1951 or is blind. Example 1: David and his wife, Nancy, are both over age 65. They are required to file a tax return and will file MFJ. Neither is blind. They will use the standard deduction.

Standard deduction for MFJ taxpayers: $12,600 Additional standard deduction for MF J, 65+ $2,500 ($1,250 x 2) Total standard deduction: $15,100

Example 2: The scenario is the same as in example 1 with one change: Nancy is legally blind. The couple will file MFJ and use the standard deduction.

Standard deduction for MFJ taxpayers: $12,600 Additional standard deduction for MFJ, blind $1,250 Additional standard deduction for MFJ, 65+ $2,500 ($1,250 x 2) Total standard deduction: $16,350

Example 3: David, Nancy's husband, died two years ago. Nancy is over age 65 and legally blind and is required to file a return. She files using the single filing status and uses the standard deduction. Standard deduction for single taxpayers: $6,300

Additional standard deduction for single, blind $1,550 Additional standard deduction for single, 65+ $1,550 Total standard deduction: $9,400

Standard Deduction for Dependents The standard deduction is generally limited if the taxpayer can be claimed as a dependent on someone else's return. The limitation is the greater of $950 or the taxpayer's earned income for the year plus $350 (not to exceed the regular standard deduction amount, usually $6,300). If the taxpayer is age 65 or older and/or blind, he or she may be eligible for a higher standard deduction.


Earned income for purposes of the standard deduction consist of salaries, wages, tips, professional fees, and amounts received for work the taxpayer actually performed. To calculate the standard deduction, scholarships or fellowship grants must be included in gross income. See Publication 970 for information on what qualifies as a scholarship or fellowship grant. Married Filing Separately Taxpayers If taxpayers are filing MFS and one spouse itemizes, the other spouse must itemize, regardless of the fact that the spouse's total deductions may be less than the standard deduction to which he or she would otherwise be entitled. If either taxpayer later amends the return, the spouse must also amend his or her return. Both taxpayers must file consent to assessment for any additional tax that one might owe as a result of the amendment. In the case of a spouse who qualifies to file as head of household, this rule will not apply. The spouse who qualifies as head of household is not required to itemize deductions, even if the spouse who is required to file MFS decides to itemize his or her deductions. However, if the spouse filing head of household decides to itemize deductions, the spouse filing MFS is required to itemize deductions. The taxpayer must decide to use the itemized deduction or the standard deduction. The standard deduction is a dollar amount that reduces the amount of income on which the taxpayer is taxed. The itemized deduction can be greater than the standard deduction. Some taxpayers must itemize their deductions because they do not qualify to use the standard deduction. In computing taxable income, personal, living, or family expenses are generally disallowed. There is an overall limitation on the amount of itemized deductions that can be taken. High-income taxpayers whose AGIs exceed a certain threshold amount are required to reduce the allowable itemized deductions by a designated percentage. 2.16 Overview of Schedule A Deductions Medical and Dental Expenses Medical care expenses can be deducted if amounts are paid for the diagnosis, cure, treatment, or prevention of a disease or ailments affecting any part or function of the body. Procedures such as facelifts, hair transplants, hair removal, and liposuction generally are not deductible. Cosmetic surgery is only deductible if it is to improve a deformity arising from or directly related to a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease. Medications are only deductible if prescribed by a doctor. The taxpayer can deduct medical and dental expenses that exceed 7.5% of the taxpayer's AGI (found on Form 1040, line 38 if the taxpayer is 65 or older); otherwise it is 10% of AGI. Examples of deductible medical expenses include medical insurance premiums including Medicare, dental treatment, prescription medicines, medical service fees, mileage, taxi, ambulance, or cost of other transportation for needed medical care, legal abortions, acupuncture, cost and care of guide dogs, eye exams, eyeglasses, contact lenses, solutions to clean contact lenses, eye surgery for nearsightedness, hospital fees, lab fees, X-rays, psychiatric care, hearing aids and batteries, other medical aids, nursing care, artificial limbs and teeth, birth control pills, chiropractor services, meals during inpatient care, lodging during hospital treatments while away from home for inpatient and outpatient care, and capital expenses for medical equipment. Improvements to the home may be deducted if their main purpose is to provide


a medical benefit. The deduction is limited to the difference between the increase in the fair market value of the home and the cost of the improvements. Examples of nondeductible medical expenses include over-the-counter medications, bottled water, diaper service, expenses for general health items, health club dues (unless related to a specific medical condition), funeral expenses, illegal operations and treatments, weight-loss programs (unless recommended by a doctor for a specific medical condition), and swimming pool dues. However, prescribed therapeutic swimming costs are deductible. Insurance premiums paid for life insurance; loss of earnings, limbs, or sight; guaranteed payments for days the taxpayer is hospitalized for sickness or injury; and the medical insurance coverage portion of the taxpayer's auto insurance are not deductible. Cafeteria plans are not deductible unless the premiums are included in box I of Form W-2. The standard mileage rate for 2015 medical miles is 23 cents per mile. The standard mileage rate for 2016 is 19 cents per mile. Spouse and Dependent Medical Expenses The taxpayer is allowed to claim medical expenses that he or she paid for his or her spouse. To claim the expenses, they must have been married at the time the spouse received medical treatment or at the time the expenses were paid. If the taxpayer and spouse do not live in a community property state and file separate returns, each can claim only the medical expenses that each actually paid. If the taxpayer and spouse live in a community property state and file separate returns, the medical expenses must be divided equally if they were paid out of community funds. The taxpayer is allowed to claim medical expenses that were paid for any dependent(s). To claim these expenses, the individual must have been a dependent at the time he or she received medical treatment or at the time the expenses were paid. Generally, an individual qualifies as a dependent if:

The individual lived with the taxpayer the entire year as a member of the household, or is related to the taxpayer.

The individual was a U.S. citizen or a resident of Canada or Mexico for some part of the calendar year in which the taxpayer's tax year began.

The taxpayer provided over half of the individual's total support for the calendar year. Medical expenses can be deducted for any individual who is a dependent of the taxpayer, even if the taxpayer cannot claim the exemption for the individual on his or her return. Medical Expenses for an Adopted Child Medical expenses paid for an adopted child (prior to the adoption becoming final) can be deducted if the child qualified as the taxpayer's dependent. If the taxpayer reimbursed an agency or another person for medical expenses the taxpayer paid under an agreement with the taxpayer (after the adoption process began), the taxpayer would be allowed to deduct those expenses. If the expenses were paid before the adoption process began, they would not be deductible.


Medical expenses must be reduced by any reimbursement received for the expense(s). Only the part that is more than 10% of the AGI (adjusted gross income Form 1040, line 38) is deductible. The term "10% limit" is used to refer to 10% of AGI (the phrase "subject to the 100/o limit" is also used). These two phrases mean that the taxpayer must subtract 10% of his or her AGI from his or her medical expenses to figure the medical expense deduction. Example: Ryan's AGI is $40,000, and 10% of $40,000 is $4,000. Ryan had medical expenses of only $2,500; therefore Ryan will not be able to deduct his medical expenses since they are not over $4,000. Medical Expense Reimbursement Taxpayers can deduct as medical expenses only those amounts paid during the taxable year for which they received no insurance or other reimbursement. The taxpayer must reduce the total medical expenses for the year by all reimbursements, for medical expenses that were received from insurance or other sources during the year. This includes payments from Medicare. Taxpayers cannot take a medical deduction if they are reimbursed for the medical expenses. If taxpayers are reimbursed for more than their medical expenses, they may have to include the excess as income. If the taxpayer paid the entire premium for medical insurance or all of the costs of a plan similar to medical insurance, he or she generally does not include an excess reimbursement in gross income. If both the employee and his or her employer contribute to a medical insurance plan and the employer's contributions are not included in the employee's gross income, the employer must include in the employee's gross income the excess portion of the reimbursement attributable to the employer's contribution. Example: Debbie is covered by her employer's medical insurance policy. The annual premium is $2,000. The employer pays $600 of that amount, and the balance of $1,400 is taken out of Debbie's wages. The part of any excess reimbursement the employee received under the policy attributed to her employer's contribution is figured as follows:

$600 ÷ $2,000 = 30% The taxpayer must include in her gross income 30% (.30) of any excess reimbursement she received for medical expenses under the policy. If the employer or former employer pays the total cost of the medical insurance plan and the employer's contributions are not included in the employee's income, the taxpayer must report all of the excess reimbursement as other income. Certain improvements made to the taxpayer's home may increase the fair market value of the home. Examples of the types of improvements that may affect the fair market value of the taxpayer's home are: construction of entrance or exit ramps, widening doorways or hallways, lowering cabinets and countertops, installing lifts, modifying stairways, and adding handrails or grab bars anywhere in the home. The cost of permanent improvements that increase the value of the property may be partly included as a medical expense. If the cost of the improvement is more than the new fair market value, then the difference is a medical expense.


Example: Caroline had a lift installed in her two-story house for medical reasons. The cost of the lift was $12,000. The increase in her fair market value was $10,000. Therefore she can deduct $2,000 as a medical expense. Premiums paid for qualified long-term care insurance contracts can be deducted within limits for long-term care insurance. The qualified long-term insurance contract must: 1. Be guaranteed renewable 2. Not provide a cash surrender value or other money that can be paid, assigned, pledged, or borrowed 3. Provide refunds, other than refunds on the death of the insured or upon complete surrender or

cancellation of the contract, and dividends under the contract may be used to reduce future premiums or increase future benefits

4. Generally not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses

Qualified long-term care premiums are limited to the following and are reported on Schedule A:

Age 40 or under $370 Age 41-50 $700 Age 51—60 $1,400 Age 61-70 $3,720 Age 71 or over $4,660

Fees paid to retirement or nursing homes that are designed for medical care and psychiatric care are deductible. Meals, lodging, and prescriptions are deductible only if the individual is in the home primarily to get medical care. If the main reason the individual is in the home is personal, meals and lodging are not deductible. A deduction may be taken for inpatient treatment at a drug or alcohol therapeutic treatment center for addiction. Meals and lodging while at the center are deductible. Travel expenses are deductible if it is deemed necessary as part of the treatment for alcoholism that the taxpayer attend Alcoholics Anonymous meetings. Stop-smoking programs are deductible as a medical expense. Medications and aids used to help stop smoking must be prescribed to the taxpayer by a doctor to be deductible. The taxpayer can include amounts paid for admission and transportation to a medical conference concerning the chronic illness of the taxpayer, his or her spouse, or any dependent. The cost of the medical conference must be primarily for education and necessary to the medical care of the taxpayer, spouse, or dependent. The taxpayer must spend the majority of his or her time at the conference attending sessions on medical information. The cost of meals and lodging while attending the conference is not a deductible medical expense. Taxes Paid


Certain taxes such as state, local, or foreign taxes, real estate taxes, and personal property taxes can be deducted by the taxpayer. Property taxes can only be deducted by the owner of the property. Real estate taxes are deductible on Schedule A for all property owned by the taxpayer; it is not limited to personal residences, like mortgage interest. Deeded time-shares may have a deductible real estate tax as well. State and Local Income Taxes State and local taxes withheld from wages can be deducted on line 5 of Schedule A. The taxpayer may deduct the following state and local taxes:

Taxes withheld from wages during the current tax year

Estimated tax payments made during the current year

Taxes paid in the current tax year for a prior tax year

Mandatory contributions made to the California, New Jersey, or New York Nonoccupational Disability Benefit Fund

Mandatory contributions made to the Rhode Island Temporary Disability Fund or Washington State Supplemental Workmen's Compensation Fund

Mandatory contributions to the Alaska, California, New Jersey, or Pennsylvania state unemployment fund

Mandatory contributions to state family leave programs, such as the New Jersey Family Leave Insurance (FLI) program and the California Paid Family Leave program

Interest and penalties for late payment of taxes are never included as a deduction. State and Local General Sales Tax If the taxpayer elects to deduct state and local sales tax, the taxpayer would check box b on line 5 of Schedule A, Form 1040. The taxpayer can deduct either actual expenses or an amount figured using the Optional State Sales Tax Tables. If the Optional State Sales Tax Tables amount is chosen, you need to check the sales tax tables for certain local jurisdictions (with rates that may be higher) and follow the calculation instructions found at www.irs.gov/individuals/sales-tax-deduction-calculator. If the filing status is MFS and one spouse elects to use the sales tax, the other spouse must use the sales tax method as well. Actual receipts showing general sales taxes paid should be kept. Note: The taxpayer can either deduct state and local general sales taxes or state and local income taxes. Not both. Real Estate Taxes State, local, or foreign real estate taxes paid for real estate owned by the taxpayer-only if the taxes are based on the assessed value of the property-are deducted on line 6 of Schedule A. If the taxpayer's real estate taxes are included in the mortgage and paid out of an escrow account, the amount paid by the mortgage company is the amount that can be deducted. If the taxpayer bought or sold real estate during the year, the real estate taxes charged to the buyer should be reported on the settlement statement and in box 5 of Form 1099-S.

http://www.irs.gov/individuals/sales-tax-deduction-calculator


This amount is considered a refund of real estate taxes. Real estate taxes are based on the assessed value of the real property, and the taxing authority charges a uniform rate. The assessed tax must be for the welfare of the general public and not be a payment for a special privilege granted or service rendered to the taxpayer. If the monthly mortgage payment includes an amount placed in an escrow account for real estate taxes, the taxpayer may not be able to deduct the total amount placed in escrow. Only deduct the real estate taxes that the third party actually paid to the taxing authority. If the third party does not notify the taxpayer of the amount of real estate tax that was paid for the taxpayer, the taxpayer should contact the third party or the taxing authority to find the correct amount to report on the return. Personal Property Taxes Personal property taxes are deducted on line 7 of Schedule A. The taxpayer should deduct personal property tax only if it is a state or local tax that was imposed yearly based on value of the property. Example: Lourdes pays a yearly registration fee for her car. Part of her fee is based on value and part is based on weight of the car. Lourdes can only deduct the fee that was based on the value of the car, not the entire amount paid for the registration fee. The taxpayer should be careful not to include refunds, rebates, interest, or penalties. Other Taxes The taxpayer can claim a credit for foreign taxes on Form 1040, line 48, or take it as an itemized deduction on Schedule A under "other taxes." The taxpayer may or may not have to complete Form 1116, Foreign Tax Credits, if the taxpayer elects not to deduct any foreign taxes paid on Schedule A as an itemized deduction. A good tax professional always reviews the forms that are given to the taxpayer. Nondeductible Taxes and Fees

Federal income tax

Employment tax

Estate, inheritance, legacy, or succession tax

Fines and penalties

Gift tax

License fees

Per capita tax Home Mortgage Interest and Points A home mortgage is any loan that is secured for the taxpayer's main home or second home. To make the mortgage interest deductible, the loan needs to be secured and can be a first or second mortgage, a home improvement loan, or a home equity loan. The interest is deductible on the first $1 million of debt ($500,000 for married filing separately) used for acquiring, constructing, or substantially improving the residence.


If the taxpayer has a main home and a second home, the home acquisition and home equity debt dollar limit apply to the total mortgage on both homes. If the taxpayer's mortgage fits into one or more of the following categories at all times during the year, the taxpayer can deduct all of the interest on those mortgages. The main home is the property where the taxpayer lives most of the time. It must provide basic living accommodations, including sleeping space, toilet, and cooking facilities. The second home is a similar property that is selected to be the second home. The main or second home may be a boat or recreational vehicle, but it must contain the basic living accommodations. Mortgage interest and points are reported to the taxpayer on Form 1098 and entered on line 10 of Schedule A. Form 1098, Mortgage Interest Statement, usually includes the amount of points paid (points are defined below), mortgage interest, and real estate taxes. Often mortgage companies will "sell" mortgages during the year. If this occurs, the taxpayer will have more than one Form 1098. Note: Remember to ask your clients if they paid more than one mortgage company. If the taxpayer has more than one Form 1098, ask if this was for a second mortgage or if he or she bought and sold homes during the year. Mortgage interest paid to an individual not issued on Form 1098 should be reported on line 11 of Schedule A. The recipient's name and social security number or employer identification number are required. Failure to provide this information may result in a $50 penalty. Points, often called loan origination fees, maximum loan charges, loan discounts, loan placement fees, or discount points, are prepaid interest. Points that the seller pays for the borrower are treated as being paid by the borrower. The seller cannot deduct these points as interest. However, they are selling expenses that reduce the amount of any gain realized by the seller. Generally, the full amount of points paid cannot be deducted in the year paid. Because they are prepaid interest, they must generally be deducted over the life of the mortgage. The taxpayer can fully deduct points in the year paid if they meet the following tests: 1. The loan is secured by the main home (the one the taxpayer ordinarily lives in). 2. Paying points is an established business practice in the area where the loan was made. 3. The points paid were not more than the points generally charged in that area. 4. The cash method of accounting is used. This means the taxpayer reports income in the year received

and deducts expenses paid. 5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement

statement, such as appraisal fees, attorney fees, and property taxes. 6. The loan is used to buy or build the main home. 7. The points were computed as a percentage of the principal amount of the mortgage. 8. The funds provided at or before closing, plus any points the seller paid were at least as much as the

points charged. The funds provided do not have to be applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds paid at or

9. Before closing for any purpose. The funds must not be borrowed from a lender or mortgage broker. 10. The amount is clearly shown on the settlement statement (such as Uniform Settlement Statement,

Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either the buyer's or seller's funds.


Points not reported on Form 1098 are reported on line 12 of Schedule A. Often, points from the purchase of a home are shown on a settlement statement. Points paid to borrow money and for refinancing are generally deductible over the life of the loan. If some of the proceeds are used for home improvements, deduct the amount of points related to the improvements in the year paid. If the taxpayer pays off the mortgage early, the taxpayer can deduct the remaining points in the year the loan was paid off. Points are currently deductible only if paid from the taxpayer's funds. Financed points must be deducted over the life of the loan. If the taxpayer refinances and ends the loan, the remaining points are deducted when the life of the loan ends. Gifts to Charity Contributions made to "qualified domestic organizations" by individuals and corporations are deductible as charitable contributions. Contributions of money or property, such as clothing, to qualified organizations, may be deducted. Dues, fees, or bills to clubs, lodges, fraternal orders, civic leagues, political groups, for-profit organizations, or similar groups are not deductible. Also not deductible are gifts of money or property to an individual, such as a local collection to help a child receive an expensive medical treatment. Raffle tickets or church bingo games would not be a deductible expense (they may count as gambling expenses). If the taxpayer received a benefit (for example, a gift for donating $60) from the donation, the donation amount must be reduced by the value of the benefit. Cash contributions are deducted on line 16 of Schedule A. Contributions other than cash or check are deducted on line 17 of Schedule A. The taxpayer cannot deduct a cash contribution, regardless of the amount, unless a record of the contribution-such as a canceled check, a bank copy of a canceled check, or a bank statement containing the name of the charity, the date, and the amount or a written communication from the charity-is kept. The written communication must include the name of the charity, the date of the contribution, and the amount of the contribution. If the contribution was more than $250, the taxpayer needs to receive a statement from the charitable organization. When figuring the $250 or more, do not combine separate donations. The charitable organization must include the following on the letter or statement: 1. The amount of any money contributed and a description (but not value) of any property donated. 2. Whether the organization did or did not give any goods or services to the taxpayer, a description and

estimate value must be included. If the taxpayer received intangible religious benefits (such as admission to a religious ceremony), the organization must state that, but it does not have to describe or value the benefit.

If noncash charitable contributions are made with a value of more than $500, the taxpayer is required to complete Form 8283, Noncash Charitable Contributions, and attach it to the return. Some costs incurred in giving services to a charitable organization can be deducted. Mileage for charitable services is 14 cents per mile. The value of time, child-care expense, or expenses of others are not deductible. Don't overlook charitable contributions made through payroll deductions. They would appear on the taxpayer's last check stub or W-2. Make sure that the payroll deductions are not pretax contributions. If so, those contributions are not deductible. Advise your clients to make donations with checks, not cash. Make sure they get a receipt for all cash donations.


When taxpayers give items to Goodwill, AMVETS, etc., they need to make sure they keep a list of the items donated and obtain and keep the receipt. Items donated are priced according to their resale value, not the price of the item when it was new. Other Than by Cash or Check If the taxpayer gives items such as clothing or furniture, the taxpayer will be able to deduct the fair market value (FMV) at the time of the donation. The FMV is what a willing buyer would pay to purchase, and both buyer and seller are aware of the condition of the sale. If the noncash deduction amount is over $500, the taxpayer must fill out Form 8283. If the contribution is a motor vehicle, boat, or airplane, the organization accepting the donation must issue the taxpayer Form 1098-C with the required information for the taxpayer to attach it to Form 8283. If the deduction is over $5,000, the taxpayer needs to get an appraisal of the donated property. For more information, see Publication 526 and Instructions for Schedule A. Records Taxpayer Needs to Keep Records prove the amount of the contributions one makes during the year. The kind of records one must keep depends on the amount of the contributions and whether they are: 1. Cash contributions 2. Noncash contributions 3. Out-of-pocket expenses when donating services An organization generally must give a written statement if it receives a payment that is more than $75 and is partly a contribution and partly for goods or services. The statement should be kept with the taxpayer records. Car Expenses If the taxpayer claims expenses directly related to the use of his/her car when providing services to a qualified organization, the taxpayer must keep reliable written records of expenses. Whether the records are considered reliable depends on all the facts and circumstances. Generally, they may be considered reliable if the taxpayer made them regularly and at or near the time the taxpayer had the expenses. For example, the taxpayer's records might show the name of the organization the taxpayer was serving and the dates the car was used for a charitable purpose. If the taxpayer uses the standard mileage rate of 14 cents a mile, records must show the miles driven for the charitable purpose. If the taxpayer deducts actual expenses, records must show the costs of operating the car that are directly related to a charitable purpose. Charitable contributions are reported on lines 16 through 19 of Schedule A (Form 1040). Cash contributions, including out-of-pocket expenses, are reported on Schedule A (Form 1040), line 16. If the taxpayer made noncash contributions, the individual may be required to fill out Form 8283. Use Section A of Form 8283 to report noncash contributions for which the taxpayer claimed a deduction of $5,000 or less per item (or group of similar items). Also use Section A to report contributions of publicly traded securities.


The IRS may disallow deductions for noncash charitable contributions if they are more than $500 and Form 8283 is not submitted with the return. A deduction over $5,000 for one item Section B of Form 8283 must be completed for each item or group of similar items for which the taxpayer claimed a deduction of over $5,000. A separate Form 8283 must be submitted for separate contributions over $5,000 to different organizations. The organization that received the property must complete and sign Part IV of Section B. Casualty and Theft Losses A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. A loss on deposits can occur when a bank, credit union, or other financial institution becomes insolvent or bankrupt. When property is damaged or destroyed as a result of hurricanes, earthquakes, tornadoes, fires, vandalism, car accidents, and similar events, it is called a casualty loss. A casualty loss must be sudden and unexpected; termite damage would not qualify since that would happen over time. Theft is the unlawful taking and removing of money or property with the intent to deprive the owner. If theft occurs, the taxpayer will need to complete Form 4684, Casualty and Theft, and attach it to the return. The loss calculated on Form 4684 is transferred to line 20 of Schedule A. The IRS allows those taxpayers who use Schedule A to deduct, to a very limited extent, these losses. A casualty loss equals the lesser of:

The decrease in fair market value (FMV) of the property as result of the event

The adjusted basis in property before casualty loss, minus any insurance reimbursement After figuring a casualty or theft loss and subtracting any reimbursements, one must figure how much of the loss is deductible. There are two limits on the amount deductible for a casualty or theft loss:

Each separate loss is more than $100.

The total amount of loss is more than 10% of Form 1040, line 38, and must be reduced by $100. Disaster Relief is a form of casualty and theft losses. As a tax professional you need to stay up on the areas that have been considered to be declared a disaster area. Miscellaneous Deductions Miscellaneous itemized deductions include the following items: employee business expenses, job seeking expenses, education expenses, investment expenses, wagering losses, and tax counsel and return preparer fees. Miscellaneous expenses may or may not be subject to a 2% limitation depending on the type of deduction. Only those miscellaneous expenses that exceed 2% of the taxpayer's adjusted gross income can be deducted. This effectively removes the deduction for most taxpayers. The following are examples of deductions that might go on Schedule A, line 21: 1. Dues (only those that are business related; personal memberships are not deductible) 2. Office in the home 3. Job education 4. Job search 5. Unreimbursed business mileage that is reported on Form 2106 and flows to Schedule A 6. Union dues 7. Work-related tools, safety equipment, protective clothing, etc.


8. Work-related publications 9. Medical exams required by employer paid by the employee 10. Nursing license 11. Malpractice insurance Do not include on line 21 any educator expenses that were taken on line 23, Form 1040. The following are examples that are not deductible:

Political contributions

Legal expenses for personal matters that do not produce taxable income

Lost or misplaced cash or property

Expenses for meals during regular or extra work hours

The cost of entertaining friends

Commuting expense

Travel expenses for employment away from home if that period exceeds 1 year

Travel as a form of education

Expense of attending a seminar, convention, or similar meetings unless it is related to employment

Club dues

Expenses of adopting a child

Fines and penalties

Expenses of producing tax-exempt income

Employee Business Expense (Form 2106) An employee may deduct unreimbursed expenses that are paid and incurred during the current tax year. The expenses must be incurred for conducting trade or business as an employee, and the expenses must be ordinary and necessary. An expense is considered ordinary if it is common and necessary in the taxpayer's trade or business. Self-employed taxpayers do not use this form to report their business expenses. For example, a nurse may be required to provide malpractice insurance and is often required to wear a uniform. Since the employer does not reimburse these expenses, the nurse may deduct them on Schedule A as a miscellaneous deduction subject to the 2% AGI limitation. An employee may deduct the following unreimbursed business expenses on Schedule A as a miscellaneous deduction subject to the 2% AGI limitation:

Business bad debt of an employee

Education that is employment related

Licenses and regulatory fees

Malpractice or professional insurance premiums

Occupational taxes

Passport for a business trip

Subscriptions to professional journals and trade magazines related to the taxpayer's trade or business

Travel, transportation, entertainment, gifts, and car expenses related to the taxpayer's trade or business

Tools used in a trade or business

Memberships for professional associations

Uniforms, work clothing, or protective wear, as well as their cleaning and maintenance Employee Auto Expense


Taxpayers may be required by their employers to use their personal vehicles during the course of conducting their trade or business. The taxpayer should include in the daily mileage records the following information:

Beginning mileage

Ending mileage

Commuting mileage

Business mileage (notes about the destination and reason for travel should be made) Taxpayers who itemize deductions and use their personal vehicles for business purposes must deduct those expenses on Form 2106, Employee Business Expense. The total expense from Form 2106 transfers to Schedule A, line 21. The employee business expense deduction is subject to the 2% limitation for miscellaneous itemized deductions on Schedule A. Commuting miles from the taxpayer's home to his or her place of business are not deductible. Within certain restrictions, one can choose between taking actual expenses or a standard mileage rate for all business miles. If the employer reimburses expenses in whole or part, the taxpayer must reduce his or her employee business expense by the amount reimbursed The following examples illustrate the deductible use of the taxpayer's automobile Example 1: Tom, delivery driver for a local lab, is required as a condition of his employment to use his personal vehicle to pick up and deliver lab specimens. His employer does not reimburse expenses. Tom would be eligible to deduct auto expenses on Schedule A, if he qualifies to use Schedule A. Example 2: Jacob, pharmaceutical salesman, travels out of state to make sales calls. He is often away from home overnight. His employer does not reimburse expenses. Jacob would be eligible to deduct auto expenses on Schedule A, if he qualifies to use Schedule A. Example 3: Brittney, receptionist for an insurance company, is required to make daily bank deposits and periodically run errands for the company using her personal vehicle. Her employer does not reimburse expenses. Brittney would be eligible to deduct auto expenses on Schedule A, if she qualifies to use Schedule A. Example 4: Sandra left her full-time job and travels to her part-time job. Sandra would be eligible to deduct auto expenses on Schedule A, if she qualifies to use Schedule A. The expenses of travel to the second job are not deductible if the taxpayer does not work at both jobs in the same day. If Sandra leaves the first job and goes home before traveling to the second job, the auto-expenses are not deductible. Standard Mileage Rate The standard mileage rate usually results in a better deduction for the taxpayer, and it requires less record keeping. A taxpayer who takes the standard mileage rate may also deduct business parking and tolls. Cost to park at the employee's place of business is not deductible. The taxpayer cannot use the standard mileage rate if the taxpayer uses two or more vehicles at the same time for business (such as a taxi or a limousine service). If the taxpayer is alternating between two or more vehicles, he or she may use the standard mileage rate.


Actual Auto Expense Actual auto expense includes gas, oil, tolls, parking, garage rent, lease payments, rental fees, depreciation, repairs, licenses, tires, and insurance. Loan interest on the vehicle is not deductible by employees. It is treated as personal interest, which is not deductible. Taxpayers often think that they can claim both actual expenses and standard mileage. Tax professionals must be sure to point out that they cannot. Tax professionals must also explain how to divide actual expenses based on the percentage use of the vehicle that is for business versus personal use. Example: Jason used his car in the course of his daily business. He drove a total of 43,010 miles for the year, of which 29,525 miles were business and 3,412 miles were commuting. Jason's total nonbusiness mileage is 13,485. The business percentage of Jason's vehicle expenses that may be deducted is 68.6%. If Jason's total actual expenses were $4,835, he would be allowed to deduct $3,317 as a business expense ($4,835 x 68.6% = $3,317). Taxpayers who use actual expenses may be eligible to recover the cost of the vehicle using depreciation or section 179, expense deduction. The allowable deduction depends on when the vehicle was placed in service and what percentage of time it was used for business purposes. Office in Home An employee will deduct home-office expenses on Schedule A, under miscellaneous deductions subject to the 2% limitation. Self-employed taxpayers who file a Schedule C use Form 8829 to claim the home-office deduction; employees would not use Form 8829 to calculate the home-office deduction for Schedule A. "Office in the home" is a deduction for the portion of the home used exclusively in connection with a business and used on a regular basis. The office in the home must be maintained for the convenience of the employer, not just to be helpful in the taxpayer's job. The area or room used for business must be the principal place of business or a place to meet patients, clients, or customers. The area may also be used for administrative work and management duties, such as billing customers, clients, or patients, keeping books or records, etc. A separate structure used in connection with the taxpayer's trade or business may also be considered an office in the home. If the taxpayer rents all or part of his home to his employer and then uses the rented portion to conduct business as an employee, he does not qualify for the home office deduction. The deduction for the business use of a home is limited. The deductions can include repairs, utilities, rent, mortgage interest, real estate tax, depreciation, and insurance based on the percentage of business use. Use the office in the home worksheet to aid in the calculation of this deduction. Exclusive Use To pass the exclusive-use test, the taxpayer must use the area for business purposes only. The taxpayer cannot use the area for personal purposes, such as a guest bedroom, storage room, or playroom. A portion of a room, such as the area that includes the desk and chair, can be an office in the home. The area does not have to be an entire room. There are two exceptions to the exclusive rule:


Storage of inventory or product samples

Day-care facilities If taxpayers are using part of their home for storage of inventory or product samples, they do not have to meet the exclusive-use test. However, they must meet the following tests:

The taxpayer must keep the inventory or product samples for use in their trade or business.

The trade or business is the wholesale or retail sale of products.

The home is the only fixed location of the trade or business.

The storage space is used on a regular basis.

The space used is an identifiably separate space suitable for storage. Regular Use The taxpayer must use the area on a regular and continuing basis to meet the "regular use" test. If the taxpayer uses the area only occasionally, he does not qualify for the "office in the home" deduction. The regular use must be a trade or business use. If the use of the home consists of use for a profit-seeking activity that is not a trade or business, the "office in the home" deduction is not allowed. Example 1: Edward uses an area of his home to read financial periodicals and reports, clip bond coupons, and carry out similar activities related to his investments. He does not make investments as a broker or dealer. His activities are not part of a trade or business; therefore, he would not be eligible for the "office in the home" deduction. Example 2: Bonnie uses an area of her home to conduct a "day trader" business. Since Bonnie is actually making investments as a broker or dealer, her activities make her eligible for the "office in the home" deduction. Principal Place of Business The taxpayer can have more than one business location, including the office in the home, for a single trade or business. The home must be the principal place of business to be eligible for the home-office deduction. To qualify for the business use of home under the principal place of business test, the taxpayer's home must be the principal place of business for that trade or business. To determine whether the home is the principal place of business the following should be considered:

The relative importance of the activities performed at each location

The amount of time spent at each location can be considered The taxpayer's home qualifies as the principal place of business if the following requirements are met:

The office is used regularly and exclusively for administrative or management activities of the taxpayer's trade or business.

There is no fixed location where the taxpayer conducts substantial administrative or management activities of the trade or business.

Examples of administrative or management duties are:

Billing customers, clients, or patients

Keeping books and records

Ordering supplies


Setting up appointments

Forwarding orders or writing reports More Than One Trade or Business Whether the taxpayer's office in the home is the principal place of business must be determined separately for each trade or business activity. One office in the home may be the principal place of business for more than one activity. However, the taxpayer would not meet the exclusive test for any activity unless each activity conducted in that office meets all the tests for the business use of the home deduction. Example: Tracy White is employed as a teacher. Her principal place of business is at school. She also has a mail-order jewelry business. All her work in the jewelry business is done in her office in the home, which is used exclusively for the business. If Tracy also uses the office for work related to her teaching, she would not meet the exclusive-use test for the jewelry business. As an employee, Tracy must meet the convenience-of-the-employer test to qualify for the deduction. Because she does not meet this test for her work as a teacher, she cannot claim a deduction for the business use of her home for either activity. Therefore, she should be advised to do her schoolwork in another room of her house in order to preserve her business deduction. Entertainment Entertainment expenses must be ordinary and necessary. This includes activities generally considered to provide entertainment, recreation, or amusement to clients, customers, or employees. Expenses for entertainment that is lavish or extravagant are not deductible. An expense is not considered lavish or extravagant if the expense is reasonably based on facts and circumstances related to the business. Entertainment expenses are limited to 50% of the actual expense and are further reduced by the 2% floor. Entertainment includes any activity that generally is considered to provide entertainment, amusement, or recreation. It does not include club dues and membership fees for country clubs, airline clubs, and hotel clubs, for example. The taxpayer may deduct entertainment expenses only if they are ordinary and necessary and meet one of the following tests:

The "directly related" test

The "associated" test To meet the "directly related" test for entertainment: 1. The expense has to be directly related to the active conduct of business either before, during, or after

the entertainment or associated with the active conduct of business. 2. The expense was to engage in business with the client during the entertainment period. 3. The entertainment was more than a general expectation of getting income or some other specific

business benefit in the future. To meet the "associated" test, the entertainment must be: 1. Associated with the active conduct of the taxpayer's trade or business 2. Directly before or after a substantial business discussion


Daily lunch or entertainment expenses with subordinates or coworkers are not deductible, even if business is discussed. Business Gifts The taxpayer can deduct up to $25 per client per year for business gifts. This does not include items that cost less than $4, have the taxpayer's name imprinted on them, and are widely distributed (for example, pens, pencils, cases, etc.) Gifts can be given directly to the client or indirectly. If the taxpayer and spouse are both giving gifts, the gifts are treated as one taxpayer's. If a partnership gives gifts, the partnership and the partners are treated as one taxpayer. Any item that could be considered as either a gift or entertainment generally will be considered entertainment. Packaged food and beverage items are treated as gifts. Education The taxpayer can deduct qualifying educational tuition and expenses. The education must be required by the employer or the law to keep one’s salary, status, or job, or maintain or improve skills required in the taxpayer's present job in order to be deductible. Education that qualifies the taxpayer for his or her first job in a specific field is not deductible on Schedule A, nor is education that enables the taxpayer to change jobs; however, these may be deductible as a lifetime learning credit. Deductible expenses are tuition, textbooks, registration fees, supplies, transportation (standard mileage or actual expenses), lab fees, cost of writing term papers or dissertations, student cards, insurance, degree cost, meals (limited to 50% ), and lodging while attending school away from home. The tax professional will need to decide which method will yield the greatest tax benefit for the taxpayer. When making the decision to itemize education expenses or to use them as a credit, the preparer should remember that the education expense might qualify as an itemized deduction; however, the expense may not be considered a qualifying expense when used to calculate the American opportunity credit or lifetime learning credit (books, for example). Recordkeeping Taxpayers must be able to prove their deductions to the IRS if audited. It is very important to keep all receipts related to the tax return. Records should include the following: a. Amount paid b. Time, date, and place c. Purpose of business discussion or nature of business benefit expected d. People present Reimbursements Enter on line 7 of Form 2106 the amounts the employer (or third party) reimbursed that were not reported in box 1 of Form W-2. This includes any amount reported under code Lin box 12 of Form W-2. If the taxpayer was reimbursed under an accountable plan and wants to deduct excess expenses that were not reimbursed, he or she may have to allocate the reimbursement. This is necessary when the employer pays a reimbursement in the following manner:


Pays the taxpayer a single amount that covers meals and/or entertainment, as well as other business expenses

Does not clearly identify how much is for the deductible meals and/or entertainment. The taxpayer must allocate that single payment so that he knows how much to enter in column A and column B of line 7 of Form 2106.

Follow the directions on Form 2106 or Form 2106-EZ to transfer employee business expenses to the appropriate line of the taxpayer's tax return. For most taxpayers, this is line 21 on Schedule A (Form 1040). Tax Preparation Fees (line 22) Tax preparation fees are deductible to the taxpayer. If the taxpayer paid the preparation fee by using a debit or credit card and a convenience fee was charged, the taxpayer can add that amount as well. Other Expenses (line 23) The taxpayer can deduct certain other expenses as miscellaneous itemized deductions subject to the 2% of adjusted gross income limit. The following are examples of deductible expenses:

Expenses to manage, conserve, or maintain property held for producing taxable gross income (such as office space rented to maintain investment property)

To determine, consent, pay, or claim a reformation fund of any tax

Attorney fees and legal expenses paid to collect taxable income

Fees paid to an appraiser to determine the value of a donated party

Fees paid to determine the value of a casualty loss

Custodial fees associated with property held for investment

Fees paid for safe deposit box rental (for income-bearing documents such as bonds, investment documents, etc.)

Fees paid to an agent or broker for financial advice The taxpayer can deduct investment fees, custodial fees, trust administration fees, and other expenses paid for managing investments that produce taxable income. Not Subject to 2% Limit (Schedule A, line 28):

Amortizable premiums on taxable bonds purchased before October 23, 1986

Federal estate tax on income in respect of a decedent

Gambling losses to the extent of gambling winnings

Impairment-related work experience of persons with disabilities

Unrecovered investment in an annuity

Losses from other activities from Schedule K-1(Form1065-B), box 2

Deduction for repayment of amounts under a claim of right if over $3,000

Casualty and theft losses from income-producing property

Losses from Ponzi-type investment schemes Other Miscellaneous Deductions


Only the following expenses can be deducted on line 28. The type and amount of each expense needs to be written on the line provided. If more space is needed, attach a statement page. Gambling Losses Up to the Amount of Gambling Winnings The taxpayer must report the full amount of any gambling winnings for the year on line 21, Form 1040. The taxpayer will deduct gambling losses for the year on line 28, Schedule A (Form 1040). The taxpayer may claim gambling losses up to the amount of gambling winnings. Taxpayers cannot reduce gambling winnings by gambling losses and report the difference. Taxpayers must report the full amount of their winnings as income and claim their losses up to the amount of winnings as an itemized deduction. Therefore, the taxpayer's records should show winnings separately from losses. The taxpayer must keep an accurate diary or similar record of losses and winnings. The diary should contain at least the following information:

The date and type of specific wages or wagering activity

The name and address or location of the gambling establishment

The names of other persons present with the taxpayer at the gambling establishment

The amount(s) won or lost Casualty and Theft Losses of Income-Producing Property from Form 4684, Lines 32 and 38b, or Form 4797, Line 18a

Loss from other activities from Schedule K-1(Form1065-B), box 2

Federal estate tax on income in respect to a decedent

Amortizable bond premium on bonds acquired before October 23, 1986

Deduction for repayment of amounts under a claim of right if over $3,000 (see Publication 525)

Certain unrecovered investments in a pension

Impairment-related work expenses for a disabled person (see Publication 529) Fines or Penalties The taxpayer cannot deduct fines or penalties he or she paid to a governmental unit for violating a law. This includes an amount paid in settlement of his or her actual or potential liability for a fine or penalty (civil or criminal). Fines or penalties include parking tickets, tax penalties, and penalties deducted from teachers' paychecks after an illegal strike. 2.17 Child and Dependent Care Credit A nonrefundable credit of up to 35 % of the expenses incurred for the care of a qualified dependent is allowed when the expenditures are work related. The percentage of credit goes down as income goes up, with 20% of eligible expenses as the smallest amount allowed. Expenses are limited to $3,000 for one and $6,000 for two or more qualified dependents. Child and dependent care is reported on Form 2441 and flows to Form 1040, line 49 or Form 1040A, line 31. Child and dependent care cannot be claimed when filing Form 1040EZ. For example, if a taxpayer and his spouse each made $50,000 and they paid $3,600 for childcare for one child, they would be allowed a $600 credit.


Taxpayer's income $50,000 Spouse's income $50,000 Total $100,000 Incomes over $43,000 are limited to a 20% deduction. Of the $3,600 that was spent on childcare, the maximum on which the credit is figured is $3,000, so

$3,000 x .20 $ 600

To be able to claim the child- and dependent-care credit, the taxpayer must meet all of the following requirements: 1. The care must be for one or more qualifying persons who are identified on Form 2441. 2. The taxpayer and spouse (if filing a joint return) must have earned income during the year. 3. The taxpayer must pay child- and dependent-care expenses so the taxpayer and spouse, if filing jointly,

can work or look for work. 4. The taxpayer must make payments for child and dependent care to someone who cannot be claimed

as a dependent on the taxpayer's return. 5. The filing status may be single, head of household or qualifying widow(er) with a dependent child. If

married, they must file a joint return (unless an exception applies). 6. The taxpayer must identify the provider on his or her tax return. 7. If the taxpayer excludes or deducts dependent-care benefits provided by a dependent-care benefit

plan, the total amount excluded or deducted must be less than the dollar limit for qualifying expenses. Qualifying Person To be able to deduct child- and dependent-care expenses, the qualifying dependent must meet the following requirements: 1. The qualifying child is a dependent under the age of 13 when the care was provided. 2. The spouse was not physically or mentally able to care for himself or herself and lived with the

taxpayer for more than half of the year. 3. The qualifying person who was not physically or mentally able to care for himself or herself and lived

with the taxpayer for more than half of the year either: a. Was the taxpayer's dependent b. Could have been claimed as a dependent except:

i. The disabled person received gross income of $4,000 or more. ii. The disabled person filed a joint return.

iii. The taxpayer or spouse (if filing jointly) could be claimed as a dependent on someone else's current tax year.

Child of Divorced or Separated Parents In addition to meeting the qualifying person requirements, additional rules apply in the case of divorced or separated parents. The credit can be claimed only by the parent who has physical custody of the child for the greater portion of the year. The other parent (noncustodial parent) cannot claim the credit,


regardless of the amount of support provided, even if the custodial parent releases the dependency exemption to the noncustodial parent. Earned Income Test To claim the credit, the taxpayer and spouse (if filing jointly) must have earned income. Earned income includes wages, salary, tips, other taxable employee compensation, and net earnings from self-employment. A loss from self-employment reduces income. If the taxpayer has nontaxable combat pay that is not included in earned income, he or she may include the income to calculate the child and dependent credit. If both the taxpayer and spouse have nontaxable combat pay, both will need to make the election. A good tax professional, should calculate the credit both ways for the taxpayer and see which results in the higher credit amount. Note: Earned income is reduced by any net loss from self-employment. Work-Related Expense Requirement Child- and dependent-care expenses must be work-related to qualify for the credit. Expenses are considered work-related only if both of the following are true:

The dependent care allows the taxpayer and spouse (if filing jointly) to work or look for work.

The expenses are for a qualifying person's care. Example 1: Darlene works during the day. Her spouse, Craig, works at night and sleeps while Darlene is working. Their five-year-old son, Trevor, goes to daycare so Craig can sleep. Their expenses are work related. Example 2: Darlene and Craig get a babysitter on Craig's night off so they can go out to eat and spend some time together. This expense is not work related. The taxpayer and spouse (if filing jointly) must work or be looking for work. Self-employment income is considered earned income. Joint Return Requirement Usually, married couples must file a joint return to take the child- and dependent-care credit. If the taxpayer and spouse are legally separated or living apart, they may still be able to take the credit. For a separated married taxpayer to be eligible for the credit, all of the following must apply:

The taxpayer must file a separate return from the spouse.

The taxpayer's home was the home of the qualifying individual for more than half the year.

The taxpayer paid more than half the cost of keeping up their home for the year.

The taxpayer's spouse did not live in their home during the last 6 months of the year. Rules for Student-Spouse or Spouse Not Able to Care for Self


A taxpayer and spouse are treated as having earned income for any month that one was a full-time student or attended a school during any 5 months of the tax year (the months need not be consecutive) or is physically or mentally disabled or unable to care for himself. This definition of "school" does not include night school or a correspondence school. For each month or part of a month the taxpayer or spouse was a student or was disabled, he or she is considered to have worked and earned income. The earned income for each month is considered to be at least $250 ($500 if more than one qualifying person was cared for during the tax year). If the taxpayer's spouse also worked during that month, use the higher of $250 (or $500) or his or her actual earned income for that month. If in the same month, both the taxpayer and spouse were students or disabled, only one of them can be treated as having earned income in that month. For any month that the taxpayer or spouse was not a student or disabled, use the actual earned income if the taxpayer or spouse worked during the month. Employer Dependent-Care Assistance If the employer provides dependent-care benefits, which are excluded from income (such as those received under a cafeteria plan), the taxpayer must subtract that amount from the applicable dollar limit. Dependent-care benefits include: 1. Amounts the employer paid directly to either the taxpayer or the taxpayer's provider while the

taxpayer worked 2. The fair market value of care in a daycare facility provided or sponsored by the employer 3. Pretax contributions made under a dependent flexible spending arrangement The taxpayer's salary may have been reduced to pay for these benefits. The dependent-care benefits are reported in box 10 on the taxpayer's W-2. If benefits were made to a partner, they would be shown in box 13 on the K-1 for Form 1065 with code O. The amount that can be excluded is limited to the smallest of: 1. The total amount of dependent-care benefits received during the year 2. The total amount of qualified expenses incurred during the year 3. The taxpayer's earned income 4. The spouse's earned income 5. $5,000 ($2,500 if married filing separately) For example, if the taxpayer with earned income of$43,000 qualifies for child- and dependent-care credit and pays $3,000, of which the employer reimburses $1,000, the taxpayer's basis for childcare for one child is $2,000. If the same taxpayer with the same income as above had paid $3,000 for childcare benefits, he would have $400 in eligible benefits.

Maximum allowed $3,000 Benefits excluded from income* -1,000 Reduced limit for figuring credit $2,000


x .20 Childcare credit allowed $400

*This amount is shown on Form W-2 in box 10. When the amount is in box 10 on Form W-2, the second page of Form 2441 must be filled out, even if the taxpayer has no additional eligible benefits. Note: Make sure you always check box 10 of the W-2. If, however, the amount of dependent-care assistance exceeds the amount paid for dependent care, the excess becomes income to the taxpayer and should be reported on line 7 of Form 1040 or Form 1040A. The letters "DCB" (dependent-care benefit) should be written on the dotted line in the space before the entry block for line 7. Dependent-care benefits can be used to pay for dependent care provided in the home. The taxpayer may need to withhold taxes (FICA and FUTA) for the dependent-care provider if dependent care is provided in the taxpayer's home. The taxpayer is not required to withhold tax.es if the dependent care provider is self-employed. Expenses Not for Care Expenses for care do not include amounts the taxpayer pays for food, lodging, clothing, education, and entertainment. Expenses for a child in nursery school, preschool, or similar programs for children below the level of kindergarten are considered expenses for care. Expenses to attend kindergarten or higher are not expenses for childcare. Expenses for before- or after-school care may be expenses for care. Summer school and tutoring programs cannot be used as dependent-care expenses. The cost of sending the dependent to an overnight camp is not considered work related; however, the cost of a day camp may be a work-related expense. Payments to Relatives or Dependents Payments to relatives for dependent care to enable the taxpayer to work when the relative lives in the taxpayer's home may still apply as a dependent-care payment. However, if any of the following apply, the payments cannot be counted as a payment for dependent care: 1. The dependent can be claimed as the taxpayer's dependent (or spouse if filing jointly). 2. The child was under the age of 19 at the end of the year, even if he or she was not the taxpayer's

dependent. 3. The person was not the taxpayer's spouse any time during the year. 4. The parent of the qualifying person, if the qualifying person is the taxpayer's child and he/she is under

the age of 13. Tax Tip: If the dependent care provider cares for the dependent in the taxpayer's home the provider may be considered a household employee. As a tax professional you need to ask questions about dependent care. Document your questions and answers from the taxpayer. 2.18 Education Credits


Education credits are available for taxpayers who pay expenses for postsecondary education. The two credits are: 1. American opportunity credit (AOC) 2. Lifetime learning credit The lifetime learning credit is a nonrefundable credit, and the American opportunity credit is a partially refundable credit. The following rules apply to eligibility for both credits:

Credits are not available to taxpayers filing MFS.

Education expenses must be paid for the taxpayer, the taxpayer's spouse, or the taxpayer's dependents. (If the student can be claimed by another taxpayer, the student cannot claim the credit on his or her own tax return, and expenses paid by the student are considered to have been paid by the taxpayer who can claim the student as a dependent.)

Meals, lodging, student activities, athletics, transportation, insurance, and personal living expenses are not considered qualified expenses.

Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course. However, if the course of instruction is part of the student's degree program, these expenses can qualify.

Prepayments for an academic period that begins during the first three months of the following year are treated as if the academic period begins in the year of the prepayment.

The taxpayer can claim an education credit for qualified education expenses not refunded when the student withdraws.

If the taxpayer was a nonresident alien for any part of the year, the taxpayer cannot claim a credit unless he or she qualifies and elects to be treated as a resident alien.

Credits phase out when modified AGI reaches the following limits:

MFJ: $160,000 for AOC and $111,000 for lifetime learning credit

MFS: $0 (credits are not allowed)

Others: $80,000 for AOC and $55,000 for lifetime learning credit Both credits are reported on Form 8863, Education Credits (AOC and Lifetime Learning Credits). Lifetime Learning Credit The lifetime learning credit is available at any time for the taxpayer, the taxpayer's spouse, or the taxpayer's dependent. The maximum allowed credit is $2,000 or 20% of the first $10,000 of qualified tuition and related expenses paid for all students during the year, being reported on the same tax return. Qualified expenses include tuition and fees required for enrollment at an eligible educational institution. Expenses incurred to acquire or improve the taxpayer's job skills are eligible expenses. An expense related to a course that involves sports, games, or hobbies is not a qualified expense unless it is part of the student's degree program. Taxpayers must reduce their qualified expense by any educational assistance received from the educational institution, scholarships, or amounts used to compute the lifetime learning credit. The lifetime learning credit is not based on the student's workload. Expenses for graduate degree level courses are eligible. The amount of credit a taxpayer can claim does not increase based on the number of


students for whom the taxpayer paid qualified expenses. The student does not need to be enrolled at least half-time in the course of study to be eligible for the credit. The nonrefundable portion of the education credits is found on Form 8863, line 19 and is reported on Form 1040, line 50 or Form 1040-A, line 33. Beginning in tax year 2016 the taxpayer's MAGI will be used to determine the reduction of the lifetime learning credit. If the taxpayer's income exceeds $55,000 ($111,000 for MFJ) the credit will be reduced. American Opportunity Credit (AOC) The AOC is a credit of up to $2,500, of which up to 40% may be refundable. Credit is given based on 100% of the first $2,000 and 25% of the next $2,000, but not in excess of$4,000. Qualified expenses include tuition and fees for enrollment at an eligible institution. In addition to tuition and fees, expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses, whether or not the materials are purchased from the educational institution. In order to be considered eligible, a student must be enrolled in a degree, certificate, or other program leading to a recognized educational credential at an eligible institution. The student must be carrying at least half the normal full-time workload for the course of study in which the student is enrolled. The student must also be free of federal or state felony offenses consisting of the possession or distribution of a controlled substance. The refundable portion of the education credit is found on Form 8863, line 8 and reported on Form 1040, line 68, or Form 1040-A, line 44. Example: Donna and Doug are both first-year students at an eligible educational institution, and they are required to have certain books and other reading materials to use in their mandatory first year classes. Doug bought his books directly from a friend and Donna purchased hers at the college bookstore. Although Donna and Doug purchased their books through different avenues, both are considered to be qualifying education expenses since they qualify for the American opportunity credit. The AOC can be claimed for a student if all of the following requirements are met: 1. The student has not completed his or her first four years of postsecondary education determined by

the eligible education institution. 2. Neither the American opportunity credit nor the Hope Scholarship credit has been claimed (by the

student or anyone else) for any prior four tax years. 3. For at least one academic period beginning in 2015, the student both:

a. Was enrolled in a program that leads to a degree certificate or other credential b. Carried at least one-half of the normal full-time workload for his or her course of study

4. The student has not been convicted of a federal or state felony for possessing or distributing a controlled substance.

No Double Benefit Allowed The taxpayer cannot:

Deduct higher education expenses on his or her income tax return and also claim an education credit based on the same expenses

Claim more than one credit based on the same qualified education expenses


Claim a credit based on expenses paid with tax-free scholarship, grant, or employer provided education assistance

Claim a credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTA)

Academic Period An academic period includes a semester, trimester, quarter, or other period of study determined by the educational institution. Eligible Educational Institution An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell the taxpayer if it is an eligible educational institution. Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs. A list of these foreign schools can be found on the Department of Education's website at www.fafsa.ed.gov/index.htm. Click on "Find my school codes." Complete the two items on the first page and click "Next." Follow the instructions to search for a foreign school. Claiming Credits for More Than One Eligible Student For each eligible student, the taxpayer can claim only one credit (per student) but can claim different credits for different students. For example, if a taxpayer pays qualified education expenses for more than one student in the same year, the taxpayer can choose to take the American opportunity credit for one student and the lifetime learning credit for the other. Remember that a portion of this education credit is refundable. Form 8863, Part III, needs to be completed for each individual who is claiming education credits on the tax return before Part I and Part II are filled out. Form 1098-T To help figure the education credit, which is reported on Form 8863, the taxpayer should receive Form 1098-T. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or an acceptable substitute) to each enrolled student by January 31 of each year. An institution may choose to report either payments received (box 1) or amounts billed (box 2) for qualified education expenses. Form 1098-T should give other information for the institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the taxpayer was enrolled at least half-time or was a graduate student. The eligible educational institution may ask for a completed Form W-9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification, or similar statement to obtain the student's name, address, and taxpayer identification number.


The lender does not have to file Form 1098-T or furnish a statement for:

Courses for which no academic credit is offered, even if the student is otherwise enrolled in a degree program

Nonresident alien students, unless request by the student

Students whose qualified tuition and related expenses are entirely waived or paid entirely with scholarships

Students whom the eligible education institution does not maintain separate financial accounting and their qualified tuition, and related expenses are covered by a formal billing arrangement between an institution and the student's employer or a governmental entity such as the Department of Veterans

Affairs or the Department of Defense Eligible educational institutions may choose to report payments received, or amount billed, for qualified tuition and related expenses. The same reporting method for all calendar years must be used unless the IRS grants permission to change the reporting method. All filers of Form 1098-T may truncate the student's identification number on payee statements. When completing the tax return the institution's E.IN number will be required. Tax preparer needs to see Form 1098-T and keep a copy in the taxpayer's file. 2.19 Retirement Savings Contribution Credit Retirement savings contribution credit income limits increased: In order to claim this credit the taxpayer's MAGI must be less than $30,500 ($61,000 if married filing jointly; $45,750 if head of household). The taxpayer can take this credit if they or their spouse is filing jointly made contributions to:

A traditional or Roth IRA

Elective deferrals to a 401(k), 403(b), governmental 457(b), SEP, or SIMPLE Plan

Voluntary employee contributions to a qualified retirement plan as defined in section 4974(c) including the federal Thrift Savings Plan

Contributions to a 501(c)(18)(D) plan The credit cannot be taken if either of the following applies:

The amount on Form 1040, line 38; Form 1040A, line 22; or Form 1040NR, line 37 is more than $30,500 ($61,000 if married filing jointly; $45,750 if head of household).

The person(s) who made the qualified contribution or elective deferral o was born after January 1, 1998 o is claimed as a dependent on someone else's tax return o or was a student

2.20 Child Tax Credit and Additional Child Tax Credit The child tax credit is a nonrefundable credit. It is a credit for taxpayers who have a qualifying child, and the maximum amount of the credit is $1,000 for each qualifying child. If the taxpayer was unable to claim the full child tax credit, he or she may be eligible for an additional child tax credit. The child tax credit is limited by the taxpayer's tax liability and modified AGI. Do not get this confused with the Additional Child Tax Credit.


The $1,000 child tax credit has been made permanent under the American Taxpayer Relief Act of 2012 (ATRA). Child tax credit can be refundable and is maxed out at $3,000. Custodial vs. Noncustodial Parent "Custodial parent" means that the child lived with the parent for the majority of nights in the current tax year. The noncustodial parent is the other parent. If the child was with the parents for an equal number of nights, it is the parent with the higher adjusted gross income that will be able to claim the child. Qualifying Child of More Than One Person Only one person can claim the child as a qualifying child (even though the child may be a qualifying child of more than one person), for the following tax benefits, unless the "Special Rule for Children of Divorced or Separated Parents" applies: 1. Dependency exemption 2. Child tax credits 3. Head of household filing status 4. Credit for child- and dependent-care expenses 5. Exclusion for dependent-care benefits 6. Earned income credit The benefits cannot be split between the qualifying child's parents. Substantial Presence Test Generally, the qualifying child for the child tax credit and the additional child tax credit must be a citizen, national, or resident of the U.S. Part I of Schedule 8812 is used to document that any child who has an ITIN and being claimed as a dependent on the tax return meets the substantial presence test and is not a nonresident alien. To meet the test, a child must be physically present in the U.S. on at least: 1. 31 days during 2016 2. 183 days during the 3-year period that includes 2016, 2015, and 2014, counting

a. All days the child was present in 2016 b. 1/3 of the days the child was present in 2015 c. 1/6 of the days the child was present in 2014

Note: If all of the dependents being claimed on the tax return have an SSN or an ATIN and the taxpayer is not claiming the additional child tax credit, they do not have to complete any part of Schedule 8812. Not all the days that the dependent is physically present in the U.S. count as days of presence for the substantial presence test. For more information see Publication 519. Additional Child Tax Credit The additional child tax credit is a refundable credit available for taxpayers who have qualifying children and who are not able to claim the full child tax credit due to it being limited to their tax liability.


The taxpayer should use Schedule 8812, Parts 11-N, to calculate the additional child tax credit. Part I of the schedule is independent of Parts II-IV. To be a qualifying child for purposes of the child tax credit and additional child tax credit, the child must be a citizen, national, or resident of the United States. The substantial presence test (Part I) is completed if the taxpayer has a dependent that has an ITIN and the taxpayer is claiming the child tax credit for the dependent. If the dependent does not qualify for the credit, the taxpayer cannot include the dependent in the calculation for the credit. To meet the substantial presence test, a dependent child with an ITIN generally must be present in the United States for at least: 1. 31 daysduring2016 2. One hundred and eighty-three (183) days during the three-year period that includes 2016, 2015, and

2014 counting: a. All the days the child was present in 2016 b. One-third of the days the child was present in 2015 c. One-sixth of the days the child was present in 2014

2.21 Affordable Care Act (ACA) provisions Reconciliation of the Advanced Premium Tax Credit The premium tax credit (PTC) is a refundable credit that helps eligible individuals and families with low or moderate income afford health insurance purchased through the Health Insurance Marketplace. Taxpayers qualify based on the household income that falls between a certain range. The taxpayer cannot be claimed as a dependent on another return nor file a tax return as married filing separately. The taxpayer or family member may qualify for PTC if in the same month:

Taxpayer and family member enrolled in insurance through the Marketplace

Are not eligible for affordable coverage through an employer-sponsored plan that provides minimum value

Are not eligible for coverage through a government program such as Medicaid, Medicare, CHIP, or TRICARE

Pay the share of premiums not covered by the advanced credit When the taxpayer applies for assistance to help pay the insurance premiums through the Marketplace, the Marketplace will estimate the amount of the PTC that the taxpayer may be able to claim for the current tax year. This amount is calculated by family size, projected household income, and other certain information. The taxpayer is responsible for paying the entire premium if he/she chooses to have all, some, or none of the estimated credit paid in advance directly to the insurance company on his/her behalf. If the taxpayer chooses to receive advanced credit paid toward the insurance premium, a tax return must be filed to reconcile the advanced credit. Taxpayers who do not receive the advance tax benefit would claim the full benefit of the PTC that is allowed when the taxpayer files the current year tax return. Taxpayers should be aware that certain changes in circumstances may affect their PTC. The taxpayer should always report changes to their circumstances to avoid large differences between the advance


credit payments made on their behalf and the amount of PTC allowed on their tax return. Changes in circumstances that can affect the PTC include:

Increase or decreases in household income including lump sum payment of social security benefits

Marriage

Divorce

Birth or adoption of a child

Other changes affecting the composition of the tax family

Gaining or losing eligibility for government sponsored or employer sponsored health care coverage

Moving to a different address If the taxpayer has received advanced credit payments, they must file a current year tax return and complete Form 8962 to reconcile the amount of the advanced credit payments made to the insurance company on their behalf. If the taxpayer is not required to file a tax return, they must do so to report the advanced credit that they have received. If the premium tax credit computed on the return is more than the amount of PTC allowed, the difference will increase the refund or lower the amount of tax liability owed; resulting in either a smaller refund or a larger balance due. This is reported under the Tax and Credit section on the tax return. The taxpayer must file a federal income tax return and attach Form 8962 to the return if:

Advanced credit payments were paid to the health insurer for the taxpayer or a household member

Advanced credit payments were paid for an individual, including the taxpayer, for whom the taxpayer told the Marketplace they would be claiming a personal exemption for that individual

The taxpayer chose to claim the PTC The amount of the excess advanced credit payments that are required to be repaid may be limited based on household income and filing status. If the household income is 400% or more of the federal poverty line, the taxpayer will repay the advanced credit payments. Individual Shared Responsibility Payment If the taxpayer chooses to receive the benefit of the advance credit payments they must file a tax return. Failure to report could result in not receiving future advanced payments. If advanced credit payments were made on behalf of a taxpayer and any member of their household, and a tax return was not filed to reconcile the payments, the taxpayer and members of their household may not be eligible for advanced credit payments or cost-sharing allocation reductions to help pay for the Marketplace health insurance coverage for the next year. The individual shared responsibility provisions require the taxpayer and each member of their household family to do at least one of the following:

Have qualifying health coverage called minimum essential coverage

Qualify for a health coverage exemption

Make a shared responsibility payment with the current federal income tax return for the months that the taxpayer and their household members were not covered

Generally, the annual payment amount is the greater of a percentage of the household income or a flat dollar amount, but is capped at the national average premium for a bronze level health plan available through the Marketplace. Use Form 8965 to make a payment if necessary.


Understanding Forms 1095A, 1095B, and 1095C Form 1095-A is used to report certain information to the IRS about individuals who enrolled in a qualified health plan through the Marketplace. Form 1095-A is furnished to individuals to reconcile the premium tax credit on their current tax return and to file an accurate return. A separate Form 1095-A must be furnished for each policy and the information on the form should relate only to the policy. Statements are furnished to recipients by mail unless the recipient requests to receive the form electronically. The Marketplace must file Form 1095-A to report information on all enrollments in a qualified health plan purchased through the Marketplace. Form 1095-B is used to report certain information to the IRS and to taxpayers who are covered by minimum essential coverage and therefore are not liable for the individual shared responsibility payment. Health insurance issuers and carriers must file Form 1095-B for most health insurance coverage, including individual market coverage and insured coverage sponsored by employers. Insurance carriers do not report coverage under Children's Health Insurance Program (CHIP), Medicaid, Medicare (including Medicare Advantage), or the Basic Health Program provided through health insurance companies. The government sponsor is responsible for reporting on those programs. Health insurance issuers will file Form 1095-B to report coverage for employees who obtained insurance through the Small Business Health Options Program (SHOP). Beginning for tax year 2016 (filing in 2017) health insurance issuers and carriers will report coverage in catastrophic health plans enrolled through the Marketplace. Every person that provides minimum essential coverage to an individual during a calendar year must file an information return reporting the coverage. Filers such as insurance companies and government programs will use Form 1094-B to submit Forms 1095-B returns. The return and transmittal form must be filed with the IRS on or before February 28 (March 31 if electronically filed) of the year following the calendar year of coverage. As with any return not filed timely there are penalties for filing late or not at all. Form 1095-C is for employers with 50 or more full-time employees (including full-time equivalent employees). Form 1094-C and Form 1095-C reports the required information required under sections 6055 and 6056 about offers of health coverage and enrollment in health coverage for their employees. Form 1094-C is used to report to the IRS summary information for each employer and to transmit Forms 1095-C to the IRS. Forms 1094-C and 1095-C are used to determine whether an employer owes a payment under the employer shared responsibility provisions under section 4980H. Form 1095-C is used to determine if the employee is eligible for the premium tax credit. Employer-sponsored self-insured coverage would also use Form 1095-C to report the information to the IRS and to their employees who have minimum essential coverage under the employer plan and are not liable for the individual shared responsibility payment for the months they are not covered. The individual employer has its own reporting obligation related to the health coverage the employer offered (or did not offer) to each of its full-time employees. An employer subject to the employer shared responsibility provisions under section 498H generally refers to an employer with 50 or more full-time employees, also known as Applicable Large Employer (ALE).


2.22 Earned Income Tax Credit (EITC) including eligibility rules EITC, the earned income tax credit, also referred to as EIC, is a tax credit that is refundable for low-to moderate-income working individuals and families. When EITC exceeds the amount of taxes owed, it results in a refundable credit. EITC is reported on Form 1040, line 66a, Form 1040-A, line 42a, or Form 1040EZ, line 8a. EITC is the only refundable tax credit that is reported on Form 1040EZ. Certain states have an EITC program as well as the District of Columbia, New York City, and Montgomery County of Maryland, which have created independent EITC programs based on the federal program. Most use federal eligibility rules, and their credit parallels major elements of the federal structure. In most states and localities, the credit is refundable (as is the federal EITC), although in a few areas, the EITC is used only to offset taxes owed. The city of San Francisco has a ''working family's credit" (WFC). Part of the program is to actively promote the federal EITC program. For more information, go to www.irs.gov/eitc. The taxpayer must have earned income and a valid SSN to be eligible for the earned income credit. Earned income is income the taxpayer received for working. If the taxpayer is filing a joint return, the taxpayer meets the requirement for earned income if at least one spouse worked and earned income. "Earned income" includes all of the following types of income: 1. Wages, salaries, tips, and other taxable employee pay 2. Net earnings from self-employment 3. Gross income received as a statutory employee 4. Union strike benefits 5. Long-term disability benefits received prior to minimum retirement age If the taxpayer received taxable disability benefits and was under the retirement age, those benefits may be considered earned income. Unearned income includes: 1. Interest and dividends 2. Pensions and annuities 3. Social security and railroad retirement benefits (including disability benefits) 4. Alimony and child support 5. Welfare benefits 6. Workers' compensation benefits 7. Unemployment compensation 8. Income while an inmate 9. Workfare payments (see Publication 596 for definition) Uniform Definition of a Qualifying Child The Working Families Tax Relief Act of 2004, amended in 2008, added the joint return test and standardized the definition of a qualifying child for the five child related tax benefits. Tax law also defined exceptions and special rules for dependents with a disability. Divorced parents have separate rules that pertain to the child-related benefits. An adopted child is always treated as the taxpayer's own child and includes a child lawfully placed with the taxpayer for adoption.

http://www.irs.gov/eitc


Taxpayers that have missing or kidnapped children that were abducted by a non-family member may still be able to claim the child. The IRS treats a kidnapped child as living with the taxpayer for more than half of the year if the child lived with the taxpayer for more than half of the part of the year before the date the child was kidnapped. Qualifying Child A qualifying child must meet the four tests: 1. Relationship 2. Age 3. Residency 4. Joint return Relationship Test To be a qualifying child, a child must be the taxpayer's:

Son, daughter, stepchild, foster child, or a descendant of any of them (for example, the taxpayer's grandchild)

Brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them (for example, the taxpayer's niece or nephew)

Adopted child: An adopted child is always treated as the taxpayer's child. The term "adopted child" includes a child who was lawfully placed with the taxpayer for legal adoption. Foster child: For EIC, a person is the taxpayer's foster child if the child is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. An authorized placement agency includes a state or local government agency. It also includes a tax-exempt organization licensed by a state. In addition, it includes an Indian tribal government or an organization authorized by an Indian tribal government to place Indian children. Example: Allison, who is 12-years-old, was placed in the taxpayer's care 2 years ago by an authorized agency responsible for placing children in foster homes. Allison is the taxpayer's eligible foster child. Age Test The child must be: 1. Under age 19 at the end of the current tax year 2. A full-time student under age 24 at the end of the current tax year 3. Permanently and totally disabled at any time during the current tax year, regardless of age 4. Younger than the taxpayer or spouse if filing jointly Example: Napoleon's son turned 19 on December 10 of the current tax year. Unless he is permanently and totally disabled or a full-time student, he is not a qualifying child because at the end of the year, he was not under age 19. A full-time student is a student who is enrolled for the number of hours or courses the school considers full-time attendance.


To qualify as a student, the qualifying dependent must be:

A full-time student at a school that has a regular teaching staff, course of study, and regular student body at the school

A student taking a full-time, on-farm training course given by a school that has a regular teaching staff, course of study, and regular student body at the school, in a state, county, or local government

School defined: A school can be an elementary school, junior high or senior high school, college, university, technical, trade, or mechanical school. However, on-the-job training courses, correspondence schools, and Internet schools do not count as schools for the EIC. Vocational high school students: Students who work in co-op jobs in private industry as a part of a school's regular course of classroom and practical training are considered full-time students. Permanently and totally disabled: The taxpayer's child is permanently and totally disabled if both of the following apply:

The child cannot engage in any substantial gainful activity because of his or her physical or mental condition

A doctor determines that the condition has lasted or can be expected to last continuously for at least a year or can lead to death

Residency Test The child must have lived with the taxpayer in the United States for more than half of the current tax year. The following definitions clarify the residency test. United States: This means the 50 states and the District of Columbia. It does not include Puerto Rico or U.S. possessions such as Guam. Homeless shelter: The taxpayer's home can be any location where he or she regularly lives. The taxpayer does not need a traditional home. For example, if a child lived with the taxpayer for more than half of the year in one or more homeless shelters, the child meets the residency test. Military personnel stationed outside the United States: U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty period for the purposes of the EIC. Extended active duty: Extended active duty means the taxpayer is called or ordered to duty for an indefinite period or for a period of more than 90 days. Once the taxpayer begins serving his or her extended active duty, the taxpayer is still considered to have been on extended active duty even if he or she does not serve more than 90 days. Birth or death of child: A child who was born or died in the current tax year is treated as having lived with the taxpayer all of the current tax year if the taxpayer's home was the child's home the entire time he or she was alive in the current tax year.


Temporary absences: Count time that the taxpayer or the child is away from home on a temporary absence due to a special circumstance as time lived with the taxpayer. Examples of a special circumstance include:

Illness

School attendance

Detention in a juvenile facility

Business

Vacation

Military service Kidnapped child: A kidnapped child is treated as living with the taxpayer for more than half of the year if the child lived with the taxpayer for more than half of the part of the year before the date of the kidnapping. The child must be presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the taxpayer's family or the child's family. This treatment applies for all years until the child is returned. However, the last year this treatment can apply is the earlier of: 1. The year there is a determination that the child is dead 2. The year the child would have reached age 18 If the taxpayer's qualifying child has been kidnapped and meets these requirements, enter "KC" instead of a number on line 6 of Schedule EIC. Joint Return Test The child cannot file a joint return for the current tax year. An exception to the joint return test applies if the child and his or her spouse file a joint return only to claim a refund of income tax withheld or estimated tax paid. Example 1: Carmen supported her 18-year-old daughter, Debbie, who lived with her all year while Debbie's husband was in the armed forces. Debbie and her husband, Sam, file a joint return. Since the couple filed a joint return, Debbie is not Carmen's qualifying child. Example 2: Terry's 18-year-old son, Pat, and his wife, Miranda, live with her. Pat had $800 of wages from part-time jobs and no other income. They do not have a child. Neither is required to file a tax return. Taxes were taken out of Pat's pay, so they will file a joint return only to get the federal tax withholding back. The exception to the joint return test applies. Terry may claim Pat as her qualifying child if all the other tests are met. Even if the taxpayer's child does not file a joint return, if the child was married at the end of the current tax year, the child cannot be the taxpayer's qualifying child unless: 1. The taxpayer can claim an exemption for the child. 2. The reason the taxpayer cannot claim an exemption for the child is that the child's other parent

claimed the exemption under the special rule for divorced or separated parents (see below). A Qualifying Child of More than One Person Sometimes a child meets the rules to be a qualifying child of more than one person. However, only one person can treat that child as a qualifying child and claim the EIC using that child. If the taxpayer and


someone else have the same qualifying child, the taxpayer and the other person(s) can decide which person, if otherwise eligible, will take all of the following tax benefits based on the qualifying child: 1. The child's exemption 2. The child tax credit 3. Head of household filing status 4. The credit for child- and dependent-care expenses 5. The exclusion for dependent-care benefits 6. The EIC The other person cannot take any of these benefits unless the taxpayer has a different qualifying child. If the taxpayer and the other person(s) cannot agree and more than one person claims the EIC or the other benefits listed above using the same child, the tie-breaker rule applies. However, the tiebreaker rule does not apply if the other person is the taxpayer's spouse and the taxpayers file a joint return. What If Another Person Claims EIC Using the Same Child? If the taxpayer's EIC is denied because the qualifying child is treated as the qualifying child of another person for the current tax year, the taxpayer may be able to take the EIC using a different qualifying child; however, the taxpayer cannot take the EIC using the same qualifying child. If the Other Person Cannot Claim the EIC If the taxpayer and someone else have the same qualifying child but the other person cannot claim the EIC because the taxpayer is not eligible or his or her earned income or AGI is too high, the taxpayer may be able to treat the child as a qualifying child. Tie-Breaker Rules The following tie-breaker rules apply if the taxpayer can treat the child as a qualifying child to claim the above tax benefits.

If the taxpayer is the child's parent, the child is treated as the qualifying child of the parent.

If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the current tax year.

If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.

If the parent can claim the child as a qualifying child but no parent claims the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the parents file a joint return with each other, this rule can be applied by treating the parents' total AGI as divided evenly between them.

Example: Jeannie, age 25, and her five-year-old son, Billy, lived with her mother, Sarah, all year. Jeannie is unmarried, and her AGI is $8,100. Her only source of income was from a part-time job. Sarah's AGI was $20,000 from her job. Billy's father did not live with Billy or Jeannie. Billy is a qualifying child of both Jeannie and Sarah, since he meets the relationship, age, residency, and joint return tests. Jeannie and Sarah need to decide who will claim Billy as their dependent.


This means that if Jeannie does not claim Billy as a qualifying child for the EIC or head of household filing status, Jeannie's mother can claim Billy as a qualifying child for each of those tax benefits for which she qualifies. Remember that the support test does not apply for EIC. Special rule for divorced or separated parents: A child will be treated as the qualifying child of the noncustodial parent for purposes of claiming an exemption, but not for the EIC if all of the following apply:

The parents are divorced or legally separated under a decree of divorce or separate maintenance.

The parents are separated under a written agreement.

The parents lived apart at all times during the last six months of the current tax year.

The child received over half of his or her support for the year from the parents.

The child is in the custody of one or both parents for more than half of the current tax year.

The custodial parent signs Form 8332 or a substantially similar statement that the custodial parent will not claim the child as a dependent for the year. Form 8332 must be attached to the noncustodial return.

A pre-1985 decree of divorce or separated maintenance or written separation agreement that applies to 2014 provides that the noncustodial parent can claim the child as a dependent, and the noncustodial parent provides at least $600 for support of the child during 2015.

For more information, see Publication 501 and Publication 596. The Taxpayer Cannot Be a Qualifying Child of Another Person The taxpayer is a qualifying child of another person such as his parent, guardian, foster parent, etc., if all of the following statements are true: 1. The taxpayer is that person's son, daughter, stepchild, grandchild, or foster child, or he or she is that

person's brother, sister, half-brother, half-sister, stepbrother, or stepsister or the child or grandchild of that person's brother, sister, half-brother, half-sister, stepbrother, or stepsister (or a descendant of any).

2. The taxpayer was: a. Under age 19 at the end of the year and younger than the taxpayer or the spouse if filing jointly b. Under age 24 at the end of the year, a student, and younger than the taxpayer or the spouse if

filing jointly 3. Permanently and totally disabled, no matter the age 4. Lived with the taxpayer in the U.S. for more than half the year 5. Did not file a joint return for the year, except to claim a refund If the taxpayer or spouse filing a joint return is a qualifying child of another person, the taxpayer or spouse cannot claim the EIC. This is true even if the person for whom the taxpayer or spouse is a qualifying child does not claim the EIC or meet all of the rules to claim the EIC. Write "No" beside line 64a (Form 1040) or line 38a (Form 1040A). Example: Max and his daughter, Letty, lived with Max's mother all year. Max is 22-years-old and attended a trade school full time. Max had a part-time job and earned $5,100. Max had no other income. Because Max meets the relationship, age, and residency tests, he is a qualifying child of his mother. She can claim the EIC if she meets all the other requirements. Because the taxpayer is his mother's qualifying child, he cannot claim the EIC for his daughter.


EIC for Taxpayers without Qualifying Children Taxpayers who do not have qualifying children may also be eligible for the EIC. To be eligible for the EIC:

The taxpayer must be at least 25-years-old and under age 65 at the end of2015 (the age requirement applies even if the taxpayer is filing a joint return; however, it is not required that both the taxpayer and spouse meet the age requirement).

The taxpayer must not be a dependent of another person.

The taxpayer must not be the qualifying child of another person.

The taxpayer's home must have been in the United States for more than half of the year.

Income needs to be less than $14,820 ($20,330 for married filing jointly). If the taxpayer does not meet the requirements listed above, write "No" next to line 64a, Form 1040; or line 38a, Form 1040A; or line 8a, Form 1040EZ. Schedule EIC Worksheets Taxpayers eligible for the EIC with qualifying children must complete Schedule EIC. Schedule EIC requires the child's name, social security number, year of birth, number of months lived in the home located in the United States, and the child's relationship to the taxpayer. Schedule EIC must be attached to the taxpayer's Form 1040, Form 1040A, or Form 1040EZ. Worksheets are available to help with the calculations of the EIC. The completed worksheet should be placed in the client's file and should not be attached to the federal tax return. Worksheets for the EIC can be found on the IRS website. If the taxpayer files Form 1040 Schedule SE, the taxpayer needs to complete EIC Worksheet B, Part 4, found in Instructions Form 1040 in order to claim EITC. Generally, all other taxpayers would figure their earned income by using the worksheet in step 5 of Form 1040 Instructions. Scholarships or fellowship grants not reported to the taxpayer on a Form W-2 are not considered to be earned income for EIC purposes. EIC Disallowed There are circumstances when the IRS does not allow the EIC. Some of the most common reasons for disallowance of the EIC are:

Claiming a child who does not meet all of the qualifying child tests

The social security numbers are mismatched or incorrect. Example: A couple is married during the current tax year, and the wife does not change her name with the Social Security

Administration. The tax return is filed in her married name; however, her social security number is assigned with her maiden name listed.

Filing as single or head of household when the taxpayer is married

Over- or underreporting income If the taxpayer's EIC has been denied or reduced for any year after 1996, the taxpayer will need to complete Form 8862, Information to Claim Earned Income Credit after Disallowance, and attach it to his


or her 2015 tax return. If the EIC was denied or reduced for any reason other than a math error, Form 8862 must be attached to the 2015 tax return. When interviewing the taxpayer, the tax preparer should ask if the taxpayer has received a letter or notice from the IRS or if the taxpayer has ever filed Form 8862 in any year after 1996. If the taxpayer has received a notice that the EIC was denied or reduced from a previous tax year and the taxpayer is eligible, the preparer should complete Form 8862, Information to Claim Earned Income Credit after Disallowance, so the taxpayer can claim the credit again. The purpose of Form 8862 is to claim the EIC after it has been disallowed or reduced in an earlier year. Form 8862 must be attached to the tax return if all of the following apply: 1. The EIC was reduced or disallowed for any reason other than a math or clerical error for a year after

1996. 2. The taxpayer wants to take the EIC, and he or she meets all the requirements. The taxpayer must attach Schedule EIC and Form 8862 to the return if the taxpayer has a qualifying child or children. The taxpayer may be asked for additional information before any refund on the tax return is issued. If the IRS contacts the taxpayer to request additional information, and the taxpayer does not provide all necessary information or documentation, the taxpayer will receive a statutory notice of deficiency from the IRS. The notice tells the taxpayer that an adjustment will be assessed unless the taxpayer files a petition in the tax court within 90 days. If the taxpayer fails to reply to the IRS or file a petition within 90 days, the IRS will make the assessment, and the EIC will be denied. If the taxpayer was denied EIC after 1996, and it was because of reckless or intentional disregard of the EIC rules, the taxpayer would be unable to claim the EIC for the next 2 years. If the EIC was denied due to fraud, the taxpayer would not be allowed to claim the EIC for 10 years. The date that the EIC was denied and the date of the return affect the years the taxpayer is prohibited from claiming the EIC. Example: Brittni claimed the EIC on her 2015 tax return, which she filed in February 2016. The IRS determined that she was not entitled to the EIC and the error was due to fraud. In September 2016, she received a statutory notice of deficiency telling her of the adjustment that would be assessed unless she filed a petition in the tax court within 90 days. Since Brittni did not file her petition, she was denied the EIC on her return until 2026. Beginning in 2026, Brittni will need to complete and attach Form 8862 to her return. EIC Penalties The IRS may penalize the taxpayer if it is determined that the taxpayer has been negligent or has disregarded rules or regulations relating to the EIC. The taxpayer may be prohibited from claiming the EIC for the next two years if he or she is found negligent. If the taxpayer is found to have fraudulently claimed the credit, the taxpayer will be prohibited from claiming the credit for the next 10 years. The tax preparer may be assessed penalties as well for not performing due diligence. Earned Income Rules To qualify for EIC, the taxpayer's adjusted gross income (AGI) needs to be below a certain amount, and the taxpayer (and spouse if married filing jointly) must:


1. Have a valid social security number (if filing MFJ, the spouse must also have a valid SSN) 2. Have earned income from employment or self-employment income 3. Not file as married filing separately (MFS) 4. Be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident

alien, and file MFJ 5. Not file Form 2555 or Form 2555-EZ 6. Investment income must not be over $3,400 7. Have a qualifying child who meets four tests (age, relationship, residency, and joint return; see

"Qualifying Child" below) a. Be at least age 25 and under age 65 at the end of the year b. Live in the United States for more than half the year c. Not qualify as a dependent of another person

8. AGI must be less than: a. $47,414 ($53,267 MFJ) with three or more qualifying children b. $44,454 ($49,974 MFJ) with two qualifying children c. $39,131 ($44,651 MFJ) with one qualifying child d. $14,820 ($20,330 MFJ) with no qualifying children

Earned income credit (EIC): May be able to take the EIC in 2016 if:

Three or more children lived with the taxpayer and earned less than $47,955 ($53,505 if married filing jointly),

Two children lived with the taxpayer and earned less than $44,648 ($50,198 if married filing jointly),

One child lived with the taxpayer and earned less than $39,296 ($44,846 if married filing jointly), or

A child did not live with the taxpayer and earned less than $14,880 ($20,430 if married filing jointly). The maximum EIC that a taxpayer who is filing jointly can receive with three or more qualifying children is $6,269. Valid Social Security Number The qualifying child must have a valid social security number (SSN), unless the child was born and died in the current tax year. A valid social security number is one that has been issued by the Social Security Administration (SSA). Social security cards with the legend "not valid for employment" are issued to aliens who are not eligible to work in the United States but who need a SSN so they can get a federally funded benefit such as Medicaid. If the immigration status of a taxpayer or spouse has changed to U.S. citizen or permanent resident, the taxpayer should ask SSA for a new social security card without the legend. If the SSN says "valid for work only with INS authorization or DHS authorization, this is considered to be a valid SSN, and the taxpayer may qualify for the credit. Taxpayers with an ITIN do not qualify for EIC. Community Property If the taxpayer is married and lives in a community property state and qualifies to file as head of household under the special rules of taxpayers living apart, the taxpayer's earned income for EIC does not include any amount earned by his or her spouse. That income is treated as belonging to the spouse under the state law. Even though the taxpayer must include it in his or her gross income on the federal tax return, the amount is not earned income for purposes of EIC. The taxpayer's earned income includes the entire


amount he or she earned, even if part of it is treated as belonging to the other spouse under the state's community property laws. The same rules apply to taxpayers living in Nevada, Washington, and California and registered as RDP's. The IRS may ask the taxpayer to provide additional documentation to prove that the qualifying dependents belong to the taxpayer. The documents that might be asked for are:

Birth certificate

School records

Medical records Tax professionals should inform their clients when they interview them for the first time what they might need if they are ever audited for claiming EIC. If a taxpayer receives an audit letter, the letter will include the name, address, telephone number, and name of the IRS employee responsible for the taxpayer's audit. This process will delay the client's refund. If the taxpayer is found to fraudulently claim the EIC, the taxpayer will be denied the credit for the current tax year and for nine more years. Claiming a Child in Error The most common error is to claim a child that is not a qualifying child that meets the relationship, age, and residency requirements. All three tests must be met to be a qualifying child. The knowledge requirement for paid tax preparers states that the preparer must apply a reasonable standard to the information received from the client. If the information provided by the client appears to be incorrect, incomplete, or inconsistent, then the paid preparer must make additional inquires of the client until they are satisfied that they have gathered the correct and complete information. Example: Cindy tells Jack that:

She is 22-years-old

She has two sons, ages 10 and 11 Questions to ask might include:

Are these Cindy's foster sons, adopted sons etc?

Was Cindy ever married to the father?

Were the children placed in Cindy's home for adoption or as foster children?

Did the father live with Cindy?

How long have the children lived with Cindy?

Does Cindy have any records to prove the children lived with her, such as school or doctor records? Example: Maria tells Andres that:

Last year she filed single and claimed the EITC for her child

She has two children to claim for EITC this year Questions to ask might include:

Last year, you claimed one child. What changed?

Did the child live with you?

Do you have any records to prove the child lived with you, such as school or doctor records?


2.23 Tax Withholding and Estimated Tax Payments Federal Income Tax Withheld Form 1040, line 64, Form 1040-A, line 40, or Form 1040EZ, line 7, reports the federal income tax that has been withheld from all forms such as W-2, W-2G, 1099-R, 1099-MISC, SSA-1099, and Schedule K. Tax withheld is found on Form W-2 in box 2 and on the 1099 series in box 4. If the taxpayer had federal tax withheld from social security benefits, it would be shown in box 6 of Form SSA-1099. If the taxpayer had additional Medicare tax withheld by his or her employer, that amount would be included on line 64. That additional Medicare tax is calculated on Form 8959, line 24, and the form needs to be attached to the return. Estimated Tax Payments Form 1040, line 65 or Form 1040-A, line 41, reports any estimated tax payments that were made in the current tax year and any overpayment applied from the prior year's tax return. If the taxpayer and spouse have divorced during the current tax year and estimated payments have been made with the former spouse, enter the former spouse's SSN in the space provided on the front of Form 1040. The taxpayer should attach an explanation to Form 1040 with the payments made and the name and SSN under which the payments were made. 2.24 Payment and Refund Options, Including Maximum of 3 Deposits in One Account On Form 1040, lines 76a through 76d indicate an overpayment of current-year taxes and how the taxpayer would like to receive the overpayment. The options are a paper check from the IRS or a direct deposit into a checking or savings account from the U.S. Treasury Department. After the return has been electronically filed, within 24 hours the taxpayer can go to www.irs.gov and click "Where's My Refund?" and receive information that is available about his or her return. If the amount of the overpayment is different than what the taxpayer was expecting, the taxpayer should receive an explanation from the IRS within two weeks after the refund was deposited. If the taxpayer wants to directly deposit the overpayment, the return should be submitted with a valid routing number and account number. The routing number is a nine-digit number that indicates which financial institute the refund is being directly deposited to. The account number is specific to the taxpayer. The first two digits of the routing number have to be 01 through 12 or 21 through 32. Some financial institutions have a separate routing number for direct deposits. The routing number on a deposit slip may be different than the routing number on the bottom of a personal check. If the tax preparer is entering the numbers from the bottom of the check, make sure that when entering the account number you do not enter the check number. Make sure that checking or savings account is indicated on the Form 1040 series. Important: The IRS is not responsible for a lost refund if the account information is entered incorrectly. The taxpayer is responsible for making sure that the taxpayer's routing number and account number are accurate and that the financial institution will accept the direct deposit. If the account name does not match with the account and routing number, the refund will be mailed to the tax payer's home.


If the taxpayer would like to apply any overpayment to the estimated payment for the following year, enter the amount that he or she would like to have applied on Form 1040, line 77. The amount that is entered on line 77 will be applied to the taxpayer's account. If the spouse needs to have it applied to his or her account, the taxpayer should include a statement requesting the overpayment to be applied to the spouse's social security number. Direct Deposit Limits The IRS has imposed a limit of three for the amount of direct deposits that can be electronically deposited into a single financial account or loaded on a pre-paid debit card. The fourth deposit will be converted to a paper check and mailed to the taxpayer within four weeks. Taxpayers will receive a notification that their account has exceeded the direct deposit limit. The IRS has imposed this direct deposit limit to prevent criminals from obtaining multiple refunds. The new limitations also protect taxpayers from tax preparers who obtain their tax preparation fees from using Form 8888 to split the refund into multiple accounts. When the tax preparer splits the refund by using Form 8888, these actions are subject to penalty. The IRS will allow the taxpayer to have the direct deposit split between multiple accounts, but not all software supports the use of Form 8888. Note: The IRS will send refunds under $1 only if requested in writing. Amount of Refund Applied to 2016 Estimated Tax (Form 1040, line 77) If the taxpayer has an overpayment on line 75 and would like part or the entire refund amount to be applied to 2016 estimated payments, enter the amount on line 77. These amounts will adjust the refund accordingly, if using tax software. Amount Paid with Request for Extension If the taxpayer used Form 4868 to file an extension and is making a payment, the amount of the payment with the extension is reported on Form 1040, line 70. Do not include the convenience fee that the taxpayer was charged if the individual paid by debit or credit card. Note: If the taxpayer itemizes his deductions and paid by credit or debit card, the conveyance fees may be a deduction on Schedule A for the following tax year.


Domain 3: Practices, Procedures and Professional Responsibility 3.1 Requirement to Furnish Taxpayer with a Copy of a Return and Related Penalty IRC §6695(a)-Failure to furnish copy to taxpayer: The penalty is $50 for each failure to comply with IRC §6107 regarding furnishing a copy of a return or claim to a taxpayer. The maximum penalty imposed on any tax return preparer shall not exceed $25,500 in a calendar year. Client Records: On request of a client, the tax professional must promptly return any client records necessary for the client to comply with his or her federal tax obligations, even if there is a dispute over fees. The tax professional may keep copies of these records. If state law allows the tax professional to retain a client's records in the case of a fee dispute, the tax professional need only return the records that must be attached to the client's return, but the tax professional must provide the client with reasonable access to review and copy any additional client records retained by the tax professional that are necessary for the client to comply with his or her federal tax obligations. The term "client records" includes all written or electronic materials provided to the tax professional by the client or a third party. "Client records" also include any tax return or other document that the tax professional prepared and previously delivered to the client, if that return or document is necessary for the client to comply with his or her current federal tax obligations. The tax professional is not required to provide a client with a copy of their work product. That is, any return, refund claim, or other document that the tax professional prepared but not yet delivered to the client if (i) the tax professional is withholding the document pending the client's payment of fees related to the document and (ii) the tax professional contract with the client requires the payment of those fees prior to delivery. See Treasury Circular 230 § 10.28. 3.2 Requirement for Signing the Return as a Return Preparer and Related Penalty IRC §6695(b)-Failure to sign return: The penalty is $50 for each failure to sign a return or claim for refund as required by regulations. The maximum penalty imposed on any tax return preparer shall not exceed $25,500 in a calendar year. A tax return is not considered to be valid unless the return has been signed. If the filing status is MFJ, both the taxpayer and spouse must sign the return. If the spouse is unable to sign the return, see Publication 501 for more information. If the taxpayer and spouse have a representative sign the return for them, they need to make sure that they have attached the power of attorney, Form 2848. If the taxpayer is filing a joint return, and he or she is the surviving spouse, the taxpayer needs to sign the return stating he or she is filing as the surviving spouse. The taxpayer and spouse (if filing jointly) need to make sure that they date the return and enter their occupation(s) and a daytime phone number. If the taxpayer received an identity protection PIN, he or she would enter it in the boxes. The tax professional does not enter it for the taxpayer. If the taxpayer has misplaced his or her IP PIN, the taxpayer should notify the IRS by telephone at 1-800-908-4490. The IP PIN is a 6-digit number. When filing the return electronically, the return must still be signed using a personal identification number (PIN)-this is not the same number as the identity protection PIN. There are two ways to enter the PIN: self-select or practitioner PIN. The self-select PIN method allows the taxpayer and spouse (if filing jointly) to create their own PIN and enter it as their electronic signature. The practitioner PIN method allows the


taxpayer to authorize the tax practitioner to generate or enter the PIN for the taxpayer(s). A PIN is a five-digit combination that can be any number except all zeros. Important: There is a difference between the electronically filed PIN and the IP PIN. Do not mix these numbers up.

3.3 Requirement to Furnish Identifying Number as Return Preparer and Related Penalty

IRC §6695(c)-Failure to furnish identifying number: The penalty is $50 for each failure to comply with IRC §6109(a)(4) regarding furnishing an identifying number on a return or claim. The maximum penalty imposed on any tax return preparer shall not exceed $25,500 in a calendar year.

3.4 Requirement to Retain Copy of Return or List and Related Penalty

Any person who is a tax return preparer with respect to any return or claim for refund who fails to comply with section 6107(b) with respect to such return or claim shall pay a penalty of $50 for each such failure, unless it is shown that such failure is due to reasonable cause and not due to willful neglect. The maximum penalty imposed under this subsection on any person with respect to any return period shall not exceed $25,500.

3.5 Prohibition on Negotiation of Client Refund Check

A practitioner may not endorse or negotiate any check including directing or accepting payment by any means into an account owned or controlled by the tax practitioner or any firm or other entity with whom the practitioner is associated. The acceptance of an endorsed check is for both electronically or direct acceptance by the tax practitioner. Beginning tax year 2016 the amount of cashing a client’s check will be $500 per check and there is no limit in the maximum penalty. See Treasury Circular 230 §10.31.

3.6 Due Diligence in Preparing Returns

Section 6695(g) Failure to be diligent in determining eligibility for earned income credit Any person who is a tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements imposed by the Treasury Secretary by regulations with respect to determining eligibility for, or the amount of, the credit allowable by section 32 shall pay a penalty of $500 for each such failure. There are four due diligence requirements (Regulation 1.6695-2) for all paid tax preparers who prepare EITC claims. The paid tax preparer is required to ask all of the questions on Form 8867. The preparer should ask additional probing questions. Additional questions must be asked when the client seems to be inconsistent or incomplete during the required Form 8867 questions. The paid tax preparer must prepare, submit, and keep a copy of Form 8867. The paid preparer needs to understand that if all they are doing is completing Form 8867, that may not fulfill their due diligence requirement. The paid tax preparer must prepare and keep all worksheets showing how the credit was computed. The four requirements are:


1. Complete and submit eligibility checklist 2. Compute the credit 3. Knowledge 4. Keep records Knowledge Regulation l.6695-2(b)(3) The paid tax preparer must:

Know the law and use the knowledge of the law to ensure they are asking the client the accurate questions

Take into account what the client says and what the preparer knows about the client

Not know, or have reason to know, any information used to determine the client's eligibility for, or the amount of EITC is incorrect, inconsistent, or incomplete

Make additional inquires if a reasonable and well informed tax return preparer would know the information is incomplete, inconsistent, or incorrect

Document any additional questions that were asked and the client's answers at the time of the interview

For examples of when to apply the knowledge requirement, see the Treasury Regulations section 1.6695-2. Consequences of Filing EITC Returns Incorrectly Good tax professionals should know that clients come to them to prepare their return, and they expect you to know and understand the guidelines to prepare accurate returns. If a tax preparer incorrectly files EITC returns, it will affect their client, themselves, and, if an employee, their employer. The following are some basic consequences that can occur when a paid tax preparer files an incorrect EITC tax return for them and their client.

The client will have to pay back the amount in error as well as interest on the amount

The client may need to file Form 8862

The client may be banned from claiming EITC for the next two years if the error is because of reckless or intentional disregard of the rules

The client may be banned from claiming EITC for the next 10 years if the error is because of fraud If the IRS examines the EITC tax returns for the preparer and the IRS finds that the preparer did not meet the four due diligence requirements they may get:

A $500 penalty for each failure to comply with EITC due diligence requirements

A minimum penalty of $1,000 if any amount of the taxes owed are a result of unreasonable position

A minimum penalty of $5,000 if the IRS finds any amount of the taxes owed is due to reckless or intentional disregard of rules or regulations

If the tax preparer receives a return-related penalty they can also face: 1. Loss of their registered tax return preparer designation 2. Suspension or expulsion from IRS e-file program 3. Other disciplinary action by the IRS office of Professional Responsibility (OPR)


4. Injunctions barring the preparer from preparing tax returns or imposing conditions on the tax returns they have prepared

The IRS can also penalize the employer if an employee fails to comply with the EITC due diligence requirements. To stay current on EITC changes and due diligence, go to www.irs.gov/eitc. Complete and Submit Eligibility Checklist The paid tax preparer must:

Complete Form 8867 to make sure they have considered all EITC eligibility criteria for each return

Complete the checklist based on information provided by the client

Submit Form 8867 electronically with the tax return if the form was filled out

Submit Form 8867 when the return is mailed to the IRS Computing the Credit The paid tax preparer must complete the EITC worksheet or a document with the same information. The worksheet shows what is included in calculating the income to arrive at the eligibility of the taxpayer to claim EITC. When using software, the paid preparer needs to make sure the worksheet used by the software to calculate the EITC is included in their record keeping. Due Diligence Requirements 1. Complete and submit eligibility checklist:

a. Complete Form 8867 to make sure to consider all EITC eligibility criteria for each return prepared. b. Complete checklist based on information provided by the clients. c. Submit Form 8867 to the IRS with the return. d. Provide a copy of Form 8867 to the taxpayer.

2. Computing the credit: a. Complete EITC worksheets found in Instructions Form 1040 or in Publication 596.

3. Knowledge: The tax professional should: a. Know the law and use the law to ensure that he or she is asking the client the correct questions to

get the relevant facts. b. Take into account what the client says and what the tax professional knows about the client. c. Not know or have reason to know any information used to determine the client's eligibility for or

the amount of EITC if it is incorrect, inconsistent, or incomplete. d. Document any additional questions that were asked of the client and the client's answers at the

time of the interview. 4. Keep records:

a. Keep a copy of Form 8867 and the EIC worksheet and a record of any additional questions that were asked of the client to comply with due diligence requirements and the client's answers to the questions.

b. Keep copies of any documents the client gives to determine eligibility. c. Verify the identity of the person giving the information and keep a record of the provided

information when it was received. d. Keep records for three years from the latest date from:

i. The original due date of the tax return


ii. If the tax return was electronically filed, the date that it was signed or the date the tax return was filed for the claim for a refund

iii. If the return was not filed electronically, the date it was signed or filed for claim for a refund iv. If one tax preparer starts the return and another one completes and signs the return for the

claim for a refund, the preparer needs to keep the part of the return for which he or she is responsible for three years from the date it was submitted

v. Records need to be kept in either paper or electronic format and need to be able to be produced if the IRS asks for them.

Prepare Accurate Tax Returns Records need to support the credits, income, and expenses claimed on the tax return. Adjusted Gross Income EIC is based on a comparison of adjusted gross income (AGI) to earned income. Adjusted gross income is found on line 37 of Form 1040, line 21 of Form 1040A, or line 4 of Form 1040EZ. Completing the EITC worksheets is essential to determining the amount of credit a taxpayer may claim on his or her return. Self-employed Taxpayer's EITC Due Diligence EITC due diligence regarding Schedule C requires the paid preparer to take additional steps to ensure that the taxpayer filing a Schedule C with EITC complies with tax law. According to Internal Revenue Code (IRC) section 6695(g) paid tax preparers are required to make additional inquires of taxpayers who appear to be making inconsistent, incorrect, or incomplete claims for the credit. The additional inquires are found on Form 8867, line 27.

It is very important that this information is documented and the paid tax preparer can prove that they have asked these questions or similar ones that will arrive at the same goal. The IRS is auditing these types of returns and a good tax professional does not want to receive paid preparer penalties or sanctions. Paid tax return preparers can generally rely on the taxpayer's representations, until it involves EITC due diligence requirements. The paid tax preparer needs to take the additional steps to determine the net self-employment income used to calculate EITC eligibility is correct and complete. All additional inquires made to comply with EITC due diligence and the client's response must be documented. The statute requires the EITC return preparer to be reasonable, well-informed, and knowledgeable in the tax law. Types of Documents or Other Information


The paid tax preparer should ask sufficient questions of taxpayers claiming self-employment income. Some questions that need to be asked include: 1. Does the client really have and conduct a business? 2. Does the client have records documenting the support of their income and expenses? 3. Can the client reconstruct that documentation if necessary? 4. Has the client included all income and related expenses reported on the Schedule C or CEZ?

Support Items Reported on Tax Returns Taxpayers must keep business records available at all times in case the IRS wants to inspect the records. If the taxpayer has been audited, the IRS Revenue Officer can ask for the supporting documentation for the income and expenses that were claimed on the taxpayer's return. A complete set of records will speed up the audit process. Remember that a business can deduct ordinary and necessary expenses for their trade or business. An ordinary expense is one that is common and accepted for that business type or trade or profession. Necessary expense is one that is helpful and appropriate for the trade, business, or profession. For the Schedule C to be correct and complete, the allowable business expenses should be reported. The taxpayer should not include any personal expenses. For more information on what is an ordinary or necessary expense, please see Publication 535 and Publication 587. If the taxpayer does not have records, the tax professional still needs to comply with the due diligence requirement. The tax preparer should make sufficient inquiries to satisfy their due diligence. The tax


professional should make sure that the taxpayer is carrying on a business and the income they are reporting is legitimate. If the taxpayer has poor record keeping the client can reconstruct the records. Reconstruction will demonstrate that the paid preparer exercised due diligence and was also teaching recordkeeping skills to the taxpayer. The goal of reconstruction is to use available documentation to develop a sound and reasonable estimate for the taxpayer's business income and expenses to support what is being reported on Schedule C. Partial records are a great place to start for reconstruction of records. The knowledgeable tax preparer can guide their client through reconstruction with partial records in case of an audit. As a tax professional the preparer must make a decision whether they are comfortable that the information presented by the client is substantially correct. The tax preparer can always refuse to prepare the return if they are not satisfied with the accuracy of the reconstructed records. If the tax preparer is not satisfied with the taxpayer's records they may: 1. Request the taxpayer to attempt to reconstruct their own records 2. Assist the taxpayer with reconstruction of the records 3. Suggest filing without claiming EITC 4. Refuse to prepare the Schedule C return altogether The taxpayer is ultimately responsible for the figures that they give to the tax preparer. As a professional, your responsibility is to prepare accurate tax returns. Note: Remind your clients of the repercussions of filing a false and inaccurate tax return. Married Taxpayers Filing Incorrectly This is the second most common error for EITC. The paid tax preparer needs to understand the different filing statuses. A good tax professional asks probing questions and knows what supporting documents to ask for and maintain to prove the correct filing status. For more information on supporting documents, please see 886-EIC. The following examples are from the EITC website. Income Reporting Errors The most common income reporting errors are from Schedule C. Self-employed taxpayers filing a Schedule C must report the correct gross income and all related deductions on their return. The knowledge requirement must be satisfied for correct and complete information. Clients who claim income without expense on a Schedule C need to be asked probing questions, especially if the client claims they have no records to support the numbers given. Once again, be prepared to ask probing questions with supporting documentation supplied to determine the correct facts. Example: Esperanza has a cleaning business and she tells her paid preparer:

She did not receive Form 1099

She was self-employed

She earned $12,000


She had no related expenses to the cleaning business Questions to ask might include:

Do you have records of the amount of money you received from house cleaning?

How much did you charge to clean a house?

How many houses did you clean?

Who provided the cleaning supplies?

If you provided the cleaning supplies, how much did you spend weekly?

Did you provide your own transportation to the houses you cleaned? Ultimately, the goal is for the paid tax preparer to feel confident that the prepared return is correct and complete and the paid preparer knows that they have complied with their EITC due diligence requirements. Suggested Additional EJTC Safeguards Tax preparers should make every effort to be certain that taxpayers qualify for the filing status they choose, the EIC, and all expenses they declare on Schedule C. Appropriate worksheets should be completed by taxpayers and kept in the taxpayers' files. The tax preparer should keep in his paper or electronic files the information necessary to complete the eligibility checklist (the alternative eligibility record). A record should be kept of how and when the information used to complete the paperwork was obtained by the preparer, including the identity of any person furnishing the information. Keeping Records Regulation l .6695-2(b)(4) The paid tax preparer must:

Keep a copy of Form 8867 and EITC Worksheets, and a record of any additional questions asked to the client to comply with the due diligence requirement

Keep copies of any documents the client gives to determine eligibility of, or the amount of, EIC

Verify the identity of the person giving the information; keep record of who provided the information and when it was received

Keep records in either paper or electronic format. If the preparer is ever asked for them by the IRS, they will need to produce them

Keep the records for 3 years from the last date of the following that apply: o The original due date of the tax return (not including extensions) o If the return was filed electronically or claim for a refund and signed by the paid preparer, the date

the tax return or claim for a refund was filed o If the return was not filed electronically and was signed by the paid tax preparer, the date the

client was present and signed the return or claim for refund o If one person prepares part of the return or claim for a refund and another preparer completes

and signs the return or claim for a refund, you must keep the part of the return that each preparer was responsible to complete for 3 years from the date the return was submitted

Keep the records in either paper or electronic format Important: The paid tax preparer cannot solely rely on software for their due diligence for EITC. Professional software may not comply with Treasury Regulation 1.6695(b){3). It is the paid tax preparer's due diligence responsibility to make sure that they have complied with Treasury Regulation 1.6695.


3.7 Compliance with e-file procedures: Timing of taxpayer signature, timing of filing, recordkeeping,

prohibited filing with pay stub, proper handling of rejects, etc.

Submitting the Electronic Return to the IRS All authorized IRS e-file providers must ensure that returns are promptly processed. However, a provider who receives a return for electronically filing on or before the due date of the return must ensure that the electronic portion of the return is transmitted on or before that due date (including extensions). An ERO must ensure that a stockpiling of returns does not occur at his or her firm. Stockpiling is considered: 1. Collecting returns from taxpayers prior to official acceptance in the IRS e-file program. 2. After official acceptance to participate in IRS e-file, "stockpiling" refers to waiting more than three

calendar days to submit the return to the IRS once the ERO has all the necessary information for e-file submission.

The IRS does not consider returns held prior to the date that the firm accepts transmission of e-filed returns "stockpiled." Tax professionals who are EROs must advise their clients that they cannot transmit returns to the IRS until the date the IRS accepts transmissions. Submission of Paper Documents Some documents that have been e-filed with an individual's tax return need to be submitted to the IRS. Attach all appropriate documents to Form 8453 and mail to the address on the form (refer to page 2 of Form 8453 for the mailing address). The following is a list of the supporting documents:

Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, or equivalent contemporaneous written acknowledgments

Form 2848, Power of Attorney

Form 3115, Application of Change in Accounting Method

Form 3468, Investment Credit, Historical Structure Certificate

Form 4136, attach Certificate for Biodiesel and Statement of Biodiesel Reseller if applicable

Form 5713, International Boycott Report

Form 8283, Noncash Charitable Contributions, Section B Appraisal Summary

Form 8332, Release of Claim to Exemption for Children of Divorced or Separated Parents

Form 8858, Information Return of US. Persons with Respect to Foreign Disregarded Entities

Form 8885, Health Coverage Tax Credit

Form 8864, attach Certificate for Biodiesel and Statement of Biodiesel Reseller if applicable

Form 8949, Sales and Other Dispositions of Capital Assets, (or a statement with the same information) if the transactions are not reported electronically

Recordkeeping and Documentation Requirements EROs must retain the following material until the end of the calendar year at the business address from which it originated the return or at a location that allows the ERO to readily access the material, as it must


be available at the time of an IRS request. An ERO may retain the required records at the business address of the responsible official or at a location that allows the responsible official to readily access the material during any period of time the office is closed, as it must be available at the time of IRS request through the end of the calendar year. These records include:

A copy of Form 8453, US. Individual Income Tax Transmittal for an IRS e-file Return, and supporting documents that are not included in the electronic records submitted to the IRS

Copies of Forms W-2, W-20, and 1099-R

A copy of the signed IRS e-file consent to disclosure forms

A complete copy of the electronic portion of the return that can be readily and accurately converted into an electronic transmission that the IRS can process

The acknowledgment file for IRS-accepted returns Forms 8878 and 8879 must be available to the IRS in the same manner described above for 3 years from the due date of the return or the date the IRS received the return, whichever is later. EROs may electronically image and store all paper records they are required to retain for IRS e-file. This includes Forms 8453 and paper copies of Forms W-2, W-20, and 1099-R as well as any supporting documents not included in the electronic record and Forms 8879 and 8878. The storage system must satisfy the requirements of Revenue Procedure 97-22, 1997-1 C.C. 652, Retention of Books and Records. In brief, the electronic storage system must ensure an accurate and complete transfer of the hard copy to the electronic storage media. The ERO must be able to reproduce all records with a high degree of eligibility and readability (including the taxpayer's signatures) when displayed on a video terminal and when reproduced in hard copy. Providing Information to the Taxpayer The ERO must provide a complete copy of the return to the taxpayer. EROs may provide this copy in any media, including electronic, that is acceptable to both the taxpayer and the ERO. The copy need not contain the social security number of the paid preparer. A complete copy of a taxpayer's return includes Form 8453 and other documents that the ERO cannot electronically transmit, when applicable, as well as the electronic portion of the return. The electronic portion of the return can be contained on a replica of an official form or on an unofficial form. However, on an unofficial form, the ERO must reference data entries to the line numbers or descriptions on an official form. If the taxpayer provided a completed paper return for electronic filing and the information on the electronic portion of the return is identical to the information provided by the taxpayer, the ERO does not have to provide a printout of the electronic portion of the return to the taxpayer. The ERO should advise the taxpayer to retain a complete copy of his or her return and any supporting material. The ERO should also advise taxpayers that, if needed, they must file an amended return as a paper return and mail it to the submission processing center that would handle the taxpayer's paper return. Acknowledgment of Transmitted Return Data The IRS electronically acknowledges the receipt of all transmissions. Returns in each transmission are either accepted or rejected for specific reasons. Accepted returns meet the processing criteria and are considered "filed" as soon as the return is signed electronically or the IRS receives a paper signature. Rejected returns fail to meet processing criteria and are considered "not filed." The acknowledgment identifies the source of the problem using a system of error reject codes and form field numbers


(sequence numbers). The error reject codes tell why the return was rejected and the form field numbers tell which fields of the electronic return data are involved. Publication 1345, Handbook for Authorized IRS e-file Providers of Individuals Tax Returns, is issued annually and contains information to help identify the cause of the rejection. The acknowledgment record of an accepted individual income tax return contains other information that is useful to the originator. The record confirms if the IRS accepted a PIN, if the taxpayer's refund will be applied to a debt, if an elected electronic funds withdrawal paid a balance due, and if the IRS approved a request for extension on Form 4868. The ERO should check acknowledgment records regularly to identify returns requiring follow-up action. The ERO should take reasonable steps to address issues identified on acknowledgment records. For example, if the IRS does not accept a PIN on an individual income tax return, the ERO must provide a completed and signed Form 8453 for the return. The ERO must, at the request of the taxpayer, provide the declaration control number (DCN) and the date that electronic individual income tax return data was accepted by the IRS. Form 9325, Acknowledgement and General Information for Taxpayers Who File Returns Electronically, may be used for this purpose. The ERO must also, if requested, supply the electronic postmark if the transmitter provided one for the return. Rejected electronic individual income tax data can be corrected and retransmitted without new signatures or authorizations if changes do not differ from the amount in the electronic portion of the electronic return by more than $50 to "total income" or AGI, or more than $14 to ''total tax," "federal income tax withheld," "refund," or "amount you owe." The taxpayer must be given copies of the new electronic return data. If new signatures are required, the taxpayer must be given copies of the new signatures. Resubmission of Rejected Tax Returns If the IRS rejects the electronic portion of a taxpayer's individual income tax return for processing and the reason for the rejection cannot be rectified, the ERO must take reasonable steps to inform the taxpayer of the rejection within 24 hours. When the ERO advises the taxpayer that the return failed to file, the ERO must provide the taxpayer with the reject code(s) accompanied by an explanation. If the taxpayer chooses not to have the electronic portion of the return corrected and transmitted to the IRS, or if it cannot be accepted for processing by the IRS, the taxpayer must file a paper return. The paper return must be filed by the later of the due date of the return or 10 calendar days after the date the IRS gives notification that the electronic portion of the return has been rejected or that it cannot be accepted for processing. The paper return should include an explanation of why the return is being filed after the due date. Returns Not Eligible for IRS e-File The following individual income tax returns and related return conditions cannot be processed using IRS e-file:

Tax returns with fiscal-year tax periods

Amended tax returns

Returns containing forms or schedules that cannot be processed by IRS e-file.

Tax returns with rare or unusual processing conditions or that exceed the specifications for returns allowable in IRS e-file cannot be processed electronically. These conditions change from year to year. The software should alert to these conditions when they occur.


If an electronic return with one of these conditions is transmitted to the IRS, it will be rejected, and the tax return must then be paper filed. Processing Return Information from Taxpayers When an ERO originates the electronic submission of the return, he or she either prepares or collects from the taxpayer wishing to have a return e-filed. The ERO must always identify the paid preparer (if any) in the appropriate field of the electronic record of returns it originates. EROs may either transmit the return directly to the IRS or arrange with another provider to transmit the electronic return to the IRS. An authorized IRS e-file provider, including an ERO, may disclose tax return information to other providers for the purpose of preparing a tax return under Reg. 301. 7216. For example, an ERO may pass on return information to an intermediate service provider or a transmitter for the purpose of having an electronic return formatted or transmitted to the IRS. An ERO who chooses to originate returns that he or she has not prepared, but only collected, becomes an income tax return preparer of the returns when, as a result of entering the data, the ERO discovers errors that require substantive changes and then makes the changes. A nonsubstantive change is a correction limited to a transposition error, misplaced entry, spelling error, or arithmetic correction. All other changes are considered substantive, and the ERO becomes an income tax return preparer. As such, the ERO may be required to sign the tax return as the income tax return preparer. What the Taxpayer Should Receive Taxpayers should receive and be advised to keep copies of the following:

Form 8879 (PIN program)

Any Form W-2, Form 1099, etc., and any other backup material for their return

A copy of the return that was electronically filed, in a form they can understand

A copy of Form 9325, General Information for Taxpayers Who File Electronically, which tells taxpayers the procedure to follow if they do not receive their refund

For those who request a refund anticipation loan (RAL), a copy of the loan agreement they signed and the disclosure statement

Refund Delays Electronically filed returns could be delayed for any of the following reasons:

Errors in the direct deposit information, which will result in the refund being sent by check

Financial institution's refusal of direct deposit, which will result in the refund being sent by check

Estimated tax payments that differ from amount reported on tax return

Bankruptcy

Inappropriate claims for EITC

Recertification to claim EITC Refund Offsets When taxpayers owe a prior-year balance due, the IRS will offset their current-year refund to pay the balance due. The Financial Management Service (FMS) offsets taxpayers' refunds through the Treasury Offset Program (TOP) to pay past-due:


Back taxes

Child support

Federal agency non-tax debts such as student loans

State income tax obligations If taxpayers owe any of these debts, their refund will be offset until the debt has been paid off. Electronic Postmark A transmitter may provide an electronic postmark that the tax return has been filed electronically. The postmark is created at the time the tax return is submitted. The postmark includes the date and time of the transmitter's time zone. The tax return is considered to be a timely filed return if the postmark is on or before the deadline for filing. Signing an Electronic Tax Return As with an income tax return submitted to the IRS on paper, an electronic income tax return must be signed by the taxpayer as well as, if applicable, by the paid preparer. The taxpayer must sign income tax returns electronically. The taxpayer must sign and date the "Declaration of Taxpayer" to authorize the origination of the electronic submission of the return to the IRS prior to the transmission of the tax return. The taxpayer must sign a new declaration if the electronic return data on an individual's income tax return is changed after the taxpayer signed the Declaration of Taxpayer and the amounts differ by more than $50 to "total income" or AGI, or $14 to "total tax," "federal income tax withheld," "refund," or "amount you owe." Electronic Signature Methods There are two methods of signing individual income tax returns with an electronic signature. One is the self-select PIN, and the other is the practitioner PIN. Both methods allow the taxpayer to use a personal identification number (PIN) to sign the return and the Declaration of Taxpayer. The self-select PIN method requires the taxpayer to provide his or her prior year adjusted gross income (AGI) amount so the IRS can authenticate the taxpayer. When the taxpayer signs using the self-select method and enters his or her PIN directly in the electronic return, signature documents are not required. The practitioner PIN does not require the taxpayer to provide his or her prior year AGI amount. Regardless of the method of electronic signature used, the taxpayer may enter his or her PIN in the electronic return. The ERO may select--or the software may generate-the taxpayer's PIN if the taxpayer agrees by signing an IRS e-file signature authorization containing the PIN. When the taxpayer signs using the self-select method and enters his or her PIN directly in the electronic return, signature documents are not required. In all other instances, the taxpayer must sign signature authorization forms. The practitioner PIN method also requires use of the signature authorization forms.


IRS e-File Signature Authorization When taxpayers are unable to enter their PINs directly in the electronic return, taxpayers authorize the ERO to enter their PINs by completing the appropriate IRS e-file signature authorization form. Form 8879, IRS e-file Signature Authorization, authorizes an ERO to enter PINs on individual income tax returns. Form 8878, IRS e-file Authorization for Application of Extension of Time to File, authorizes an ERO to enter taxpayers' PINs on Forms 4868, Application for Additional Extension o/Time to File US. Individual Income Tax Return, and 2350, Application for Extension of Time to File US. Income Tax Return. The ERO may enter the taxpayer's PIN in the electronic return record before the taxpayer signs Form 8879 or 8878, but the taxpayer must sign and date the appropriate form before the ERO originates the electronic submission of the return. In most instances, the taxpayer must sign and date Form 8879 or Form 8878 after reviewing the return and ensuring the tax return information on the form matches the information on the return. The taxpayer who provides a completed tax return to an ERO for electronic filing may complete the IRS e-file signature authorization without reviewing the return originated by the ERO. The line items from the paper return must be entered on the application Form 8879 or Form 8878 prior to the taxpayer's signing and dating of the form. The ERO may use pre-signed authorizations as authority to input the taxpayer's PIN only if the information on the electronic version of the tax return agrees with the entries from the paper return. The taxpayer and the ERO representative must always complete and sign Forms 8879 or 8878 for the practitioner PIN method of electronic signature. The taxpayer may use the practitioner PIN method to electronically sign Form 4868, Application for Automatic Extension of Time to File US Individual Income Tax Return, if a signature is required. A signature is only required for Form 4868 when an electronic funds withdrawal is also being requested. The ERO must retain Form 8879 and Form 8878 for 3 years from the return's due date or the date received by the IRS, whichever is later. EROs must not send Form 8879 and Form 8878 to the IRS unless the IRS requests they do so. Electronic Signatures for EROs If the taxpayer signs his or her return using either of the electronic signature methods, the ERO must also sign with a PIN. EROs should use the same PIN for the entire tax year. The PIN may be manually inputted or software-generated in the electronic record in the location designed for the ERO EFIN/PIN. The ERO is attesting to the ERO declaration by entering a PIN in the EFIN/PIN field. For returns prepared by the ERO's firm, the return preparer is declaring under penalty of perjury that the return was reviewed and is true, correct, and complete. For returns prepared by someone other than by the ERO's firm, the ERO attests that the return preparer signed the copy of the return and the electronic return contains tax information identical to that contained in the paper return. The paid preparer's identifying information (name, address, and SSN or PTIN) must also be entered in the e-file return. Obtaining, Handling, and Processing Return Information from Taxpayers


An electronic return originator (ERO) originates submission of returns he or she either prepares or collects from taxpayers who want toe-file their returns. An ERO originates the electronic submission of a return after the taxpayer authorizes the tax return to be e-filed. The ERO must have either prepared the return or collected it from a taxpayer. An ERO is the one who originates the submission by:

Electronically sending the return to a transmitter that transmits the return to the IRS

Directly transmitting the return to the IRS

Providing a return to an intermediate service provider for processing prior to transmission to the IRS The ERO must always identify the paid preparer (if any) in the appropriate field of the electronic record of returns that the ERO originates. The ERO must always enter the paid preparer's identifying number (if the paid preparer is a member of the firm). The information needed is:

Name

Address

EIN (when applicable)

PTIN An ERO who chooses to originate returns that he or she has not prepared, but only collected, becomes an income tax return preparer of the returns when, as a result of entering the data, the ERO discovers errors that require substantive changes and then makes the changes. A nonsubstantive change is a correction limited to a transposition error, misplaced entry, spelling error, or arithmetic correction. The IRS considers all other changes substantive, and the ERO then becomes a tax return preparer. As such, the ERO may be required to sign the tax return as the tax return preparer. A tax professional may not file a tax return by using paystubs or other documentation of earnings to e-file or mail in the tax return.

3.8 Penalties to be assessed by the IRS against a preparer for negligent or intentional disregard or rules and

regulations, and for a willful understatement of liability, including PATH ACT changes to §6694(b)

Understatement of Liability Section 6694(a) penalties are imposed for an understatement of liability due to a position for which there is not a realistic possibility of being sustained on its own merits. Some of the key provisions of the §6694(a) penalty are:

Only one individual associated with a firm is considered to be the income tax return preparer. If two or more individuals are associated with a return and one is the signing preparer, only one of the individuals is considered the preparer. This is generally the individual with the overall supervisory responsibility. The firm may also be subject to the penalty, as well as the individual within the firm.

A person who is the preparer and knew, or should have known, of such a position, is subject to a minimum penalty of $1,000 with respect to that return.

Exceptions to the penalty can be granted for adequately disclosing a nonfrivolous position on the return, or if the understatement was due to reasonable cause and the preparer acted in good faith.

The penalty under §6694(a) is not imposed if the preparer can show that he or she acted in good faith and that the understatement was due to reasonable cause. The factors taken into account include:


1. The nature of the error causing the understatement: The exception may apply if the error resulted from a provision that was so complex, uncommon, or highly technical that a competent preparer of returns reasonably could have made the error. However, the exception does not apply to an error that would have been apparent from a general review of the return or claim for refund by the preparer.

2. Frequency of errors: An isolated error (such as an inadvertent math error) may qualify for the reasonable cause and good faith exception. However, if there are multiple errors, or if the isolated error is so obvious, flagrant, or material that it should have been discovered during a review of the return or claim, the exception will not apply.

3. Materiality of errors: If the error is reasonably immaterial, the reasonable cause and good faith exception will generally apply. However, the exception will not apply if the error or errors causing the understatement are significant.

A paid tax preparer who guarantees a specific amount of refund is an example of the kind of action for this penalty. Others would include if the preparer intentionally disregards information given by the taxpayer to reduce the taxpayer's liability; in this case, the preparer is guilty of a willful attempt to understate tax liability. This does not mean that the preparer may not rely in good faith on the information furnished by the taxpayer. However, the tax preparer must make reasonable inquires if the information furnished by the taxpayer appears to be incorrect or incomplete. Preparer's Normal Office Practice If the preparer's normal office practice was followed in preparing the return, along with other facts and circumstances, the reasonable cause and good faith exception may apply. The "normal office practice" must be a system that:

Promotes accuracy and consistency in the preparation of returns or claims

Generally includes checklists

Includes methods for obtaining necessary information from the taxpayer

Includes a review of the prior year's return

Includes other review procedures set up by the practitioner, such as peer reviews Burden of Proof If a penalty imposed by §6694(a) is imposed on a preparer, the issues on which the preparer bears the burden of proof include whether:

The preparer knew, or reasonably should have known, that the questioned position was taken on the return

The preparer feels there is reasonable cause and good faith with respect to the position taken

The position was disclosed adequately in accordance with Reg. §l.6694-2(c)(3) §6694(b) Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a conduct described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of $5,000, or 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim. Willful or reckless conduct described in this paragraph is conduct by the tax return preparer which is a willful attempt in any manner to understate the liability for tax on the return or claim, or a reckless or intentional disregard of rules or regulations.


Failure to File Correct Information Returns §6694(e) If the tax professional is negligent or intentionally files correct information returns the penalty is $50 per return or item on the return with a maximum penalty of $25,500.

3.9 Annual Filing Season Program Requirements

The AFSP is a voluntary program designed to recognize the efforts of non-credentialed tax return preparers who take their professionalism to a higher level. The individual needs to complete 18 hours of continuing education, which includes the Annual Federal Tax Refresher Course (AFTR) portion, which contains a test. All paid tax preparers must maintain a current PTIN (Preparer Tax Identification Number). EAs, CPAs, and attorneys cannot take the AFTR course for credit. The 18 hours include (for non-exempt individuals):

1. 6 hour Annual Federal Tax Refresher Course & Test 2. 10 hours of Federal tax law 3. 2 hours of Ethics

The AFTR course has yearly guidelines. The 100-question 3-hour test covers three domains that the RPO (Return Preparer Office) determines that individuals need to be "refreshed" on for the upcoming tax season. The domains could change yearly. The IRS does not administer the test; only approved vendors administer the timed test. The IRS sets the test parameters that must be followed by the approved vendors. The test must be passed by December 31 and the approved vendor has 10 days to upload hours.

3.9a Adherence and consent to duties and restrictions found in subpart B and section 10.51 of Circular 230

It is imperative that the paid tax preparer understands his or her individual responsibility to prepare tax returns accurately based on tax law and the information provided by the taxpayer. OPR may propose the censure, suspension, or disbarment of any practitioner from practice before the IRS, if the individual shows to be incompetent or disreputable and/or fails to comply with any regulations found in Circular 230. OPR may impose a monetary penalty for an individual or their employer subject to Circular 230. The monetary penalty is connected to the activities that the tax preparer has been associated with on behalf of the employer. The employer should have known what the employee was doing. The following is a summary description of certain obligations under Treasury Circular 230. This summary does not address all provisions of the Regulations. The tax professional should read the Circular/Regulations for a more complete understanding of the duties and obligations of someone practicing before the IRS. Preparing a tax return is considered to be practicing before the IRS. Due Diligence: Tax professionals must exercise due diligence in preparing and filing tax returns and other documents/submissions, and in determining the correctness of representations made by themselves to their client or to the IRS. The tax professional can rely on the work product of another person if the individual used reasonable care in engaging, supervising, training, and evaluating that person, taking into account the nature of the relationship between the tax professional and that person. The tax professional generally may rely in good faith and without verification on information furnished by your client, but the tax professional cannot ignore other information that has been furnished to them or which is actually


known by them. The tax professional must make reasonable inquiries if any information furnished to them appears to be incorrect, incomplete, or inconsistent with other facts or assumptions. For more information see Treasury Circular 230 §10.22, §10.34(d). Competence: Tax professionals must have the necessary knowledge, skill, thoroughness, and preparation for the matter for which the tax professional has been engaged. If the tax professional is not competent in a subject matter, they may consult another individual whom the tax professional knows or believes has established competence in the field of study. When the tax professional does consult with another individual they must consider the requirements of Internal Revenue Code §7216. See Treasury Circular 230 §10.35. Conflicts of Interest: A conflict of interest exists if representing a client will be directly adverse to another client of the paid tax professional. A conflict of interest also exists if there is a significant risk that representing a client will be materially limited by the tax professional responsibilities to another client, a former client or a third person, or by their own personal interests. When a conflict of interest exists, the tax professional may not represent a client in an IRS matter unless (i) they reasonably believe that they can provide competent and diligent representation to all affected clients, (ii) their representation is not prohibited by law, and (iii) all affected clients give informed, written consent to the tax professional's representation. The tax professional must retain these consents for 36 months following the termination of the engagement and make them available to the IRS/OPR upon request. See Treasury Circular 230 §10.29. Tax Return Positions: The tax professional cannot sign a tax return or refund claim or advise a client to take a position on a tax return or refund claim that the tax professional knows or should know contains a position (i) for which there is no reasonable basis; (ii) which is an unreasonable position as defined in Internal Revenue Code §6694(a)(2); or, (iii) which is a willful attempt to understate tax liability, or a reckless or intentional disregard of rules or regulations. An unreasonable position is one that lacks substantial authority as defined in IRC §6662 but has a reasonable basis, and is disclosed. For purposes of Circular 230 disclosure, if the tax professional advised the client regarding a position, or prepared or signed the tax return, the tax professional must inform the client of any penalties that are reasonably likely to apply to the client with respect to the tax return position and how to avoid the penalties through disclosure (or, by not taking the position). Written Tax Advice: In providing written advice concerning any federal tax matter, you must (i) base your advice on reasonable assumptions, (ii) reasonably consider all relevant facts that as a tax professional knows or should know, and (iii) use reasonable efforts to identify and ascertain the relevant facts. The tax professional cannot rely upon representations, statements, findings, or agreements that are unreasonable or that they know to be incorrect, inconsistent, or incomplete. The tax professional must not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit in evaluating a federal tax matter (audit lottery). In providing written advice, the tax professional may rely in good faith on the advice of another practitioner only if that advice is reasonable considering all facts and circumstances. The tax professional cannot rely on the advice of a person whom they know or should have known is not competent to provide the advice or who has an unresolved conflict of interest as defined in §10.29. See Treasury Circular 230 §10.37. Errors and Omissions: If the tax professional knows that a client has not complied with the U.S. revenue laws or has made an error in, or omission from, any return, affidavit, or other document which the client


submitted or executed under U.S. revenue laws, the tax professional must promptly inform the client of the noncompliance, error, or omission and advise the client regarding the consequences under the Code and regulations of that noncompliance, error, or omission. Depending on the particular facts and circumstances, the consequences of an error or omission could include (among other things) additional tax liability, civil penalties, interest, criminal penalties, and an extension of the statute of limitations. See Treasury Circular 230 §10.21. Handling Matters Promptly: The tax professional cannot unreasonably delay the prompt disposition of any matter before the Internal Revenue Service. This applies with respect to responding to the tax professional's client as well as to IRS personnel. The tax professional cannot advise a client to submit any document to the IRS for the purpose of delaying or impeding the administration of the federal tax laws. See Treasury Circular 230 §10.23, §10.34(b). Solicitation: With respect to any Internal Revenue Service matter, the tax professional may not use any form of public communication or private solicitation containing a false, fraudulent, or coercive statement or claim; or a misleading or deceptive statement or claim. The tax professional also may not assist, or accept assistance from, any person or entity that obtains clients or otherwise practices in violation of the solicitation provisions. See Treasury Circular 230 § 10.30. Supervisory Responsibilities: If the tax professional has or shares principal authority and responsibility for overseeing the firm's tax practice, tax professional must take reasonable steps to ensure that the tax professional firm has adequate procedures in place to raise awareness and to promote compliance with Circular 230 by the firm's members, associates, and employees, and that all such employees are complying with the regulations governing practice before the IRS. See Treasury Circular 230 §10.36. Personal Tax Compliance Responsibilities: The tax professional is responsible for ensuring the timely filing and payment of personal income tax returns and the tax returns for any entity over which the tax professional has, or shares control. Failing to file 4 of the last 5 years income tax returns, or 5 of the last 7 quarters of employment/excise tax returns is per se disreputable and incompetent conduct for which a practitioner may be summarily suspended indefinitely. The willful evasion of the assessment or payment of tax is also conduct that violates Circular 230. See Treasury Circular 230 §10.51(a)(6) Best Practices: In addition to the rules with which persons must comply, Treasury Circular 230, § 10.33 includes aspirational best practices for those who provide advice and/or assistance in preparing submissions to the IRS. These best practices include:

Communicating clearly with the client regarding the terms of the engagement.

Establishing facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at conclusions supported by the law and the facts.

Advising clients regarding the meaning of any conclusions reached by the person subject to Circular 230.

Advising clients whether they may avoid accuracy-related penalties if the client acts in reliance on that person's advice.

Acting fairly and with integrity in practice before the Internal Revenue Service. §10.51 Incompetence and Disreputable Conduct


Incompetence and disreputable conduct for which a practitioner may be sanctioned includes but is not limited to: 1. Conviction of any criminal offense under federal tax laws. 2. Conviction of any criminal offense involving dishonesty or breach of trust. 3. Conviction of any felony under federal or state law for which the conduct involved renders the

practitioner unfit to practice before the IRS. 4. Giving false or misleading information, or participating in any way in the giving of false or misleading

information to the Department of the Treasury or any officer or employee. 5. Solicitation of employment as prohibited under section 10.30, the use of false or misleading

representations with intent to deceive a client or prospective client in order to gain employment or insinuate that the practitioner is able to obtain special consideration with the IRS, or any officer or employee.

6. Willfully failing to make a federal tax return in violation of the federal tax laws or willfully evading or attempting to evade any assessment or payment of any federal tax.

7. Willfully assisting, counseling, encouraging a client or prospective client to violate any federal tax law, or knowingly counseling or suggesting to a client an illegal plan to evade paying federal tax.

8. Misappropriation of, or failure to remit properly or promptly, funds received from a client for the purpose of payment of taxes or other obligations due the United States.

9. Directly or indirectly attempting to influence or offer or agree to attempt to influence the official action of any officer or employee of the IRS by the use of threats, false accusations, duress, or coercion, or any special inducement or promise of an advantage or by bestowing of any gift, favor, or item of value.

10. Disbarment or suspension from practice as an attorney, certified public accountant, public accountant, or actuary by any duly constituted authority of any state, territory, or possession of the United States, including a commonwealth or the District of Columbia, any federal court of record, or any federal agency, body or board.

11. Knowingly aiding and abetting another person to practice before the IRS during a suspension, disbarment, or ineligibility of such other individual.

12. Contemptuous conduct in connection with practice before the IRS, including the use of abusive language, making false accusations or statements, knowing them to be false, or circulating or publishing malicious or libelous matter.

13. Giving a false opinion, knowingly recklessly or through gross incompetence including an opinion that is intentionally or recklessly misleading or engaging in a pattern of providing incompetent opinions on question arising from federal tax laws.

14. Willfully failing to sign a tax return prepared by the practitioner when the practitioner's signature is required by federal tax laws unless the failure is due to reasonable cause and not due to neglect.

15. Willfully disclosing or otherwise using a tax return or tax return information in a manner not authorized by the IRC, contrary to the order of a court of competent jurisdiction or contrary to the order of an administrative law judge in a proceeding instituted under § 10.60.

16. Willfully failing to file on magnetic or other electronic media a tax return prepared by the practitioner when the practitioner is required to do so by federal tax laws unless the failure is due to reasonable cause and not due to neglect.

17. Willfully preparing all or substantially all of, or signing, a tax return or claim for refund when the practitioner does not possess a current or otherwise valid PTIN or other prescribed identifying number.

18. Willfully representing a taxpayer before an officer or employee of the IRS unless the practitioner is authorized to do so.


3.9b Limited Representation Rights

Understanding Tax Return Preparer Credentials and Qualifications For tax year 2016, any tax professional with an IRS Preparer Tax Identification Number (PTIN) is authorized to prepare federal tax returns. Tax professionals, however, have differing levels of skills, education, and expertise. There are several different types of return preparers with credentials. An important difference in the types of practitioners is "representation rights." Unlimited Representation Rights: Enrolled agents, certified public accountants, and attorneys have unlimited representation rights before the IRS and may represent their clients on any matters including audits, payment/collection issues, and appeals. Enrolled Agents - Individuals with this credential are licensed by the IRS and specifically trained in federal tax planning, preparation, and representation. Enrolled agents hold the most expansive license IRS grants and must pass a suitability check, as well as a three-part Special Enrollment Examination, a comprehensive exam that covers individual tax, business tax, and representation issues. EAs continuing education is 72 hours every 3 years. Certified Public Accountants - Individuals with this credential are licensed by state boards of accountancy, the District of Columbia, and U.S. territories; and have passed the Uniform CPA Examination. They also must meet education, experience, and good character requirements established by their boards of accountancy. In addition, CPAs must comply with ethical requirements as well as complete specified levels of continuing education to maintain an active CPA license. CP As may offer a range of services; some CP As specialize in tax preparation and planning. Attorneys - Individuals with this credential are licensed by state courts or their designees, such as the state bar. Generally, requirements include completion of a degree in law, passage of a bar exam and on-going continuing education and professional character standards. Attorneys may offer a range of services; some attorneys specialize in tax preparation and planning. Limited Representation Rights: Preparers without any of the above credentials (also known as "unenrolled preparers") have limited practice rights. They may only represent clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. Paid tax preparers who have an Annual Filing Season Program (AFSP), Record of Completion, and have maintained a PTIN are able to represent, with limitations, the tax returns that they have prepared. PTIN holders without an AFSP-Record of Completion or without professional credentials will not be able to represent clients before the IRS in any matter. To participate in the AFSP, preparers need to adhere to the requirements outlined in Circular 230 Subpart B and section 10.51. The completion of the AFSP is required annually by December 31. PTIN holders without the AFSP Record of Completion or other professional credential will only be permitted to prepare tax returns. The individual will not be allowed to represent clients before the IRS. For more information on the AFSP (Annual Filing Season Program) please visit the following link:


https://www.irs.gov/pub/irs-pdf/p5227.pdf

AFTR Test Instructions The AFTR test consists of 100 questions covering all 3 domains. You will have 3 hours to complete the test. Once you begin the Final Exam, the 3 hour timer will begin and will not stop counting down until the 3 hours has elapsed. If you log out of your test or close your exam, that exam will be lost, it will not be graded, and would count towards one attempt. If you walk away from your test, the timer will continue to countdown. *This course only allows 2 attempts at the Final Exam. A passing score of 70% or better must be achieved by December 31, 2016 by midnight your local time. If you have not passed the test in 2 tries, IRS requires that you are given a test with new questions. Please contact CE Self Study so that we may assigned you a test with new questions [email protected] When you have completed the course and printed your certificate, please make sure that your PTIN number has been entered in your profile page. Thank you for taking our course. Your completed hours (once you have passed the timed test with a 70% or better) will be uploaded to the IRS within 10 business days. To be included in the national database you must have a current PTIN number, and adhere to the practice requirements for tax practitioners outlined in Subpart B and section 10.51 of Circular 230.

mailto:[email protected]


Glossary Abstract fees: Expenses generally paid by a buyer to research the title of real property. Academic period: A semester, trimester, quarter, or other period of study (such as summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period. Accrual method: An accounting method under which income is reported when the taxpayer earned it, whether or not the taxpayer has received it. Expenses are generally deducted when the taxpayer has incurred the liability. Acknowledgment (ACK): A report generated by the IRS to a transmitter that indicates receipt of all transmissions. An ACK report identifies the returns in each transmission that are accepted or rejected for specific reasons. ACRS: The accelerated cost recovery system (ACRS) is a method of depreciation that depreciates an asset using recovery periods instead of useful life. Active conduct of a trade or business: Generally, for the section 179 deduction, a taxpayer is considered to conduct a trade or business activity if he or she meaningfully participates in the management or operations of the trade or business. A mere passive investor in a trade or business does not actively conduct the trade or business. Active participation/Material participation: The taxpayer must have owned at least 10% of the rental property and must have made management decisions in a significant and bona fide sense. Actual auto expense: Expense incurred by the taxpayer during the course of conducting his or her trade or business. Instead of using the standard mileage rate, the taxpayer deducts the actual cost of operating his or her vehicle for business. Adequate disclosure: Sufficient revelation of facts or reasons for a position involving the preparation of a tax return. Adopted child: A child in the taxpayer's home placed by an authorized placement agency. An authorized placement agency includes any person authorized by state law to place children for legal adoption. The adoption does not have to be final. Adjustments to income: Deductions taken from the total income on line 22, Form 1040, or line 15, Form 1040A. This subtraction from total income results in the adjusted gross income. Adjusted basis: The original cost of property, plus certain additions and improvements, minus certain deductions such as depreciation allowed or allowable and casualty losses.


Adjusted gross income (AGI): The income arrived at after adjustments. AGI is determined prior to subtracting the standard or itemized deductions and exemptions. Adjustments may be claimed by the taxpayer even if he or she cannot itemize deductions using Schedule A. Adjusted qualified education expenses (AQEE): Qualified education expenses reduced by any tax-free educational assistance, such as a tax-free scholarship or employer-provided educational assistance. They must also be reduced by any qualified education expenses deducted elsewhere on the return, used to determine an education credit or other benefit, or used to determine a tax-free distribution. Adjusted sales price: Selling price minus expenses of sale, fix-up expenses of property, or assets. Adoption taxpayer identification number (ATIN): A tax-processing number issued by the IRS as a temporary taxpayer identification number for a child in the domestic adoption process who is not yet eligible for a social security number (SSN). An ATIN is not a permanent identification number and is intended only for temporary use. To obtain an ATIN, complete IRS Form W-7 A, Application for Taxpayer Identification Number for Pending US Adoptions. Advanced payment of the premium tax credit (APTC): A payment during the year to the taxpayer's insurance provider that pays part or all premiums for a qualified health plan covering the taxpayer or an individual in the tax family. Advance rent: Any amount of rent the taxpayer receives before the period that the payment covers. Aiding and abetting: The act of helping or assisting another individual in an attempt to evade that individual's tax liability. Alimony: Alimony payments received from the taxpayer's spouse or former spouse; they are taxable in the year received. Alternative minimum tax (AMT): A tax assessed on special-treatment items such as certain types of income, certain deductions, and certain exemptions. Amount realized: The total of all money received plus the fair market value of all property or services received from a sale or exchange. The amount realized also includes any liabilities assumed by the buyer and any liabilities to which the property transferred is subject, such as real estate taxes or a mortgage. Amortization: A gradual deduction for the cost of intangible property over its useful life. Annual additions: Annual additions are the total of all of the taxpayer's IRA contributions in a year, employee contributions (not included rollovers), and forfeitures allocated to a participant's account. Annual benefits: Annual benefits are the benefits to be paid yearly in the form of a straight life annuity (with no extra benefits) under a plan to which employees do not contribute and under which no rollover contributions are made. Annuity: A contract sold by an insurance company that pays a monthly, quarterly, semiannual, or annual income benefit for the life of the annuitant or other specified period of time.


At-risk: The taxpayer's liability for an activity to the extent that cash and the adjusted basis of other property contributed to the activity and certain amounts borrowed for use in the activity. At-risk rules: Rules that limit the amount of loss the taxpayer may deduct to the amount of the loss in the activity. Audits: An examination of a taxpayer's books and records performed by the Internal Revenue Service. Authorized IRS e-file provider: A firm accepted to participate in IRS e-file. Automated clearing house (ACH): A system that administers electronic funds transfers (EFTs) among participating financial institutions. An example of such a transfer is the direct deposit of a tax refund from the IRS into a taxpayer's account at a financial institution. Basis of property: Cost of the property when purchased or built. If acquired by inheritance, it is the fair market value at the date of death. If received as a gift, the recipient's basis is that of the donor's. Batch: A single transmission consisting of the electronic data from single or multiple tax returns. Beginning inventory: The cost of items available for sale. This should be the same as last year's closing inventory. Business: A business is an activity in which a profit motive is present and economic activity is involved. Service as a newspaper carrier under age 18 or as a public officer is not a business. Business mileage: Mileage traveled by a taxpayer during the course of conducting his or her trade or business. The taxpayer must use a vehicle that he or she owns or leases. Business/investment use: Usually, a percentage showing how much an item of property, such as an automobile, is used for business and investment purposes. Capital gain distribution: Paid by mutual funds and real estate investment trusts. Capital gains may be taxed at different rates. Capital improvements: Costs that add to the value of the asset. These do not include repairs or maintenance. Capitalized: Expended or treated as an item of a capital nature. A capitalized amount is not deductible as a current expense and must be included in the basis of property. Carryover: An amount that is unable to be used in the current year due to restrictions. Cash method: An accounting method under which the taxpayer reports income in the year in which it was actually or constructively received. Generally, expenses are deducted in the year they are paid. Casualty and theft: The loss of property through a disaster, fire, storm, or theft.


Class life: A number of years that establishes the property class and recovery period for most types of property under the general depreciation system (GDS) and alternate depreciation system (ADS). Circumstantial evidence: Details or facts that indirectly point to other facts. Codes of conduct: An established set of rules that are designated to determine the boundaries in which behavior is deemed acceptable. Coercion: Intimidation or force. Combat pay, nontaxable: If the taxpayer was a member of the US armed forces and served in a combat zone, certain pay is excluded from his or her income (see "Combat Zone Exclusion" in Publication 3). The solider can elect to include this pay in his or her earned income when figuring EIC. The amount of the taxpayer's nontaxable combat pay should be shown in Form(s) W-2, box 12, with code Q. If he is filing a joint return and both the taxpayer and his or her spouse received nontaxable combat pay, they can each make their own election. Common-law employee: A common-law employee is any individual who, under common law, would have the status of an employee. A leased employee can also be a common-law employee. Commuting mileage: Mileage traveled from home to work and from work to home. Compensation: A direct or indirect monetary or nonmonetary reward given to employees, usually taxed as ordinary income. Constructive receipts: Income that has been credited or made available to the taxpayer even though the taxpayer may not have yet actually received it. Contribution: A contribution is an amount the taxpayer paid into a plan for all those participating in the plan, including self-employed individuals. Limits may apply. Convention: A method established under the modified accelerated cost recovery system (MACRS) to determine the portion of the year to depreciate property both in the year the property is placed in service and in the year of disposition. Cost of goods sold: A total that represents the cost of buying new raw material and the cost of producing the finished goods such as overhead, labor, and utilities. Cost of labor: The cost of labor used in the actual production of the goods. Cost of a retirement plan: All of an employee's contributions paid into a qualified plan and any contributions paid into a plan by an employer that were taxable at the time they were paid. Credits: A tax credit reduces the taxpayer's current tax liability dollar for dollar. There are two Categories of credits: refundable and nonrefundable.


California Tax Education Council (CTEC): The governing board for the state of California that oversees paid tax preparers and the vendors who are able to teach tax courses in the state of California. Debt indicator (DI): A field on an ACK report that indicates whether a debt offset or a taxpayer's refund will occur. It does not indicate how much the offset will be. Offsets taken by the IRS may be for current- and prior-year tax obligations. Offsets taken by the Financial Management IRS (FMS) are for past-due student loans, child support, federal taxes, or other governmental agency debts. Decedent: A person who has died. Declining balance method (DBM): An accelerated method to depreciate property. The general depreciation system (GDS) of MACRS uses the 150% or 200% declining balance methods for certain types of property. A depreciation rate (percentage) is determined by dividing the declining balance by the recovery period for the property. Declaration control number (DCN): A unique fourteen-digit number assigned by the ERO (or transmitter, in the case of online filing) to each electronically filed tax return. Deductible: An amount that allows a reduction of the AGI. Deductions in respect to the decedent: Deductions for which the decedent would have been liable, such as business expenses, interest, taxes, or income-producing expenses, but that were not deductible on the decedent's final tax return. Dependent: A person for whom the taxpayer can claim a dependency exemption. He or she must be supported by the taxpayer and meet all six of the dependency requirements to be claimed as a dependent. The requirements to file a joint return or to be claimed as a dependent by another taxpayer are: support, age, relationship (or household member), citizenship (or residency), and legal relationship tests. Dependency exemptions are not ''tradable." If the person who is entitled to claim the dependency exemption chooses not to do so, the exemption is lost. Depositor account number (DAN): The financial institution account to which a direct deposit refund is to be routed. Depreciation: A method of recovering the cost of an asset over the asset's useful life or recovery period. Designated beneficiary: The individual named in the document creating the account/plan that is to receive the benefit of the funds in the account/plan. Director of Office of Professional Responsibility: An individual assigned to enforce the rules and regulations for tax professionals. Direct deposit: An electronic transfer of a refund into a taxpayer's financial institution account. Direct expense: Expenses incurred only as a result of conducting business in the home. Disreputable conduct: Behavior that is considered dishonest or outside of the rules or guidelines set forth by the Internal Revenue Service.


Disability income: The amount paid to an employee under an insurance or pension plan while the employee is absent from work because of a disability. If the employer paid the insurance premiums, the amount received is taxable income. If the employee paid the premiums, it is nontaxable. Disposed: Permanently withdrawn from use in a trade or business or from the production of income. Distributions: A payment of cash or property made to a taxpayer. Dividends: Distributions of money, stock, or other property or services paid to the taxpayer by a corporation. Documentary evidence: Written records that establish certain facts. Drain: The IRS scheduled time for processing electronically filed return data. Due diligence: The practice of assuring correctness in tax preparation through thorough tax client interviews. Thoroughly completing the proper worksheets and forms will aid in assuring correctness. Early distribution: Amounts received by the taxpayer from a pension, annuity, or IRA prior to reaching age 59Yz. Early distributions are subject to a 10% penalty (some exceptions apply). Earned income: Wages the taxpayer receives from working. There are two ways to receive earned income:

The taxpayer works for someone who pays him or her.

The taxpayer works in a business he or she owns. Earned income credit (EIC): A refundable individual income tax credit for certain persons who work. EIC recertification: A requirement for a taxpayer previously denied EIC to provide additional information on Form 8862, Information to Claim Earned Income Credit after Disallowance, when he or she files a similar EIC claim on a subsequent return. Electronic federal tax payments systems (EFfPS): A free service from the US Treasury through which federal taxes may be paid. Taxes can be paid via the Internet, by phone, or through a service provider. After authorization, payments are electronically transferred from the authorized bank account to Treasury's general account. Electronic filing identification number (EFIN): An identification number assigned by the IRS to accept applicants for participation in IRS e-file. Electronic filing: A system whereby tax returns are transmitted electronically to the Internal Revenue Service. Electronic funds transfer (EFT): The process through which direct refunds are transmitted from the government to the taxpayer's account at a financial institution. Electronic funds withdrawal (EFW): A payment method that allows the taxpayer to authorize the US Treasury to electronically withdraw funds from his or her checking or savings account.


Electronic postmark: The date and time the electronic return is first received on the transmitter's host computer in the transmitter's time zone. The ERO, or the taxpayer in the case of online filing, adjusts the time to his or her time zone to determine timeliness. Electronic Return Originator (ERO): An authorized IRS e-file provider who originates the electronic submission of returns to the IRS. Electronic signature: Method of signing a return electronically through the use of a personal identification number (PIN). Electronic Tax Administration (ETA): The office within the IRS with management oversight of the IRS' s electronic commerce initiatives. The mission of the ET A is to revolutionize how taxpayers transact and communicate with the IRS. Electronic Tax Administration Advisory Committee (ET AAC): An advisory group established by the IRS Restructuring and Reform Act of 1998 to provide an organized public forum for discussion of ET A issues in support of the overriding goal that paperless filing should be the preferred and most convenient method of filing tax and information returns. Electronic transmitter identification number (ETIN): An identification number assigned by the IRS to a participant in IRS e-file that performs activity of transmission and/or software development Electronically transmitted documents (ETD): A system created to process electronic documents that are not attached to a tax return and are filed separately from the tax return. Employee contributions: Amounts paid by the employee into an employee benefit program or plan. Employer identification number (EIN): A taxpayer identification number issued to an entity other than an individual. Ending inventory: The cost of merchandise remaining in stock at the close of the tax year. This is inventory figured at the end of the tax year and is used as the beginning inventory for the next year's return. Enrolled agents: A person who is qualified to practice before the Internal Revenue Service. Enrolled agents have passed a two-day IRS examination or have worked in a technical area of the IRS for at least five years. Error reject code (ERC): Codes included on an acknowledgment (ACK) report for returns that are rejected by the IRS. ERC explanations are published annually prior to the filing season in Publication l 345A, Filing Season Supplement for Authorized IRS e-file Providers of Individual Income Tax Returns, and Publication 1346, Electronic Return File Specifications and Record Layout for Individual Income Tax Returns. Estimated taxes: A quarterly payment made to the US Treasury Department on income not subject to withholding taxes. The payment represents a projection of the taxpayer's ultimate tax liability for the taxable period. Ethics: Standards of conduct and moral judgment; the system of morals of an individual person. Evade: To avoid by deceit or dishonesty.


Excess contributions: Contributions made to a tax-deferred arrangement in excess of the allowed limits. Exchange: To barter, swap, part with, give, or transfer property for other property or services. Exclusively: Must be used for business purposes only. Exemption: An additional amount that the taxpayer may deduct from his or her adjusted gross income to arrive at his or her taxable income. The taxpayer may deduct the personal exemption amount for him- or herself, spouse, and dependents. Fair market value (FMV): The price that property brings when it is offered for sale by one who is willing but not obligated to sell and is bought by one who is willing or desires to buy but is not compelled to do so. Fair rental value: An amount that a person who is not related to the taxpayer would be willing to pay for rental use. Fiduciary: One who acts on behalf of another as a guardian, trustee, executor, administrator, receiver, or conservator. FIFO (first in, first out): A method of inventory valuation in which the first items entered into inventory are considered the first ones sold. Financial Management Service (FMS): The agency of the Department of the Treasury through which payments to and from the government, such as direct deposit of refunds, are processed. Form field number/Form sequence (SEQ) number: The identifier of specific data on an electronic tax return record layout as defined in Publication 1346, Electronic Return File Specifications and Record Layouts for Individual Income Tax Returns. Foster child: A foster child is any child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. For more details on authorized placement agencies, see Publication 596. Fraud: Act of deceiving or misrepresenting. Persons who file or assist in filing a materially false or fraudulent return may be subject to a criminal penalty of up to $100,000 and/or up to three years in prison plus the cost of prosecution. Fraudulent return: A return in which the individual is attempting to file using someone else's name or SSN on the return or where the taxpayer is presenting documents or information that have no basis in fact. Fraudulent returns should not be filed with the IRS. Fringe benefit: An indirect compensation provided to an employee; generally includes life and health insurance, as well as pension plans. Frivolous: Lacking in substantial correctness or containing information that is knowingly incorrect; an attempt at evading taxes.


Fungible commodity: A commodity of a nature that one part may be used in place of another part. Gain: Amount realized from a sale minus the adjusted basis of the property sold. Goodwill: An intangible property such as the advantage or benefit received in property beyond its mere value. It is not confined to a name but can be attached to a particular area where business is transacted, to a list of customers, or to other elements of value in business as a going concern. Gramm-Leach-Bliley Act: An act that imposed requirements on financial institutions to protect the privacy of nonpublic personal information of their clients. Grandchild: Any descendant of the taxpayer's son, daughter, adopted child, or stepchild. For example, a grandchild includes the taxpayer's great-grandchild, great-great-grandchild, etc. Grantor: The one who transfers property to another. Gross income: Amount of total income received by the taxpayer from all sources before any adjustments or deductions are completed. Hobby: An activity not pursued for profit. Home mortgage interest: Interest paid on a personal residence. Improvements: Adds to the value of the property and prolongs its useful life. For example, paving a driveway is considered an improvement. Income in respect of the decedent: An amount that a decedent was entitled to receive as gross income. However, because of his or her method of accounting, it was not included in gross income for any period before death. Independent contractor: A person who is self-employed and contracts his or her services to other businesses. Indirect expenses: Expenses for running the entire home. Individual taxpayer identification number (ITIN): A tax processing number that became available on July 1, 1996, for certain nonresident and resident aliens, their spouses, and their dependents. The ITIN is available only from the IRS for those individuals who cannot obtain a social security number (SSN). To obtain an ITIN, complete IRS Form W-7, Application for IRS Individual Identification Number. Individual retirement account (IRA): A personal savings plan that offers the taxpayer tax advantages to set aside money for retirement or, in some plans, for certain education expenses. Contributions may be deductible or nondeductible depending upon the taxpayer's modified AGL Injured spouse: A taxpayer who files a joint return with a spouse and is due a refund that is likely to be assessed because the spouse owes past-due taxes, child support, or student loans.


Innocent spouse: A taxpayer who files a joint return with a spouse who has incorrectly reported information on their joint return. Intangible property: Property that has value that cannot be seen or touched, such as goodwill, patents, copyrights, and computer software. Interest: Compensation received from investments on which payments received by the taxpayer reflect the time value of money. Internal Revenue Code (IRC): Legislation passed by Congress that specifies what income is to be taxed, how it is to be taxed, and what deductions may be taken from taxable income. Internal Revenue Service (IRS): A division of the Department of Treasury; the agency that is responsible for the administration and collection of federal taxes. Instrument: A legal document that records an act or an agreement. Instruments may also be considered as contracts, notes, and leases. Investment interest: The interest paid or accrued on money borrowed that is allocable to property held for investment. Itemized deduction: Individualized tax deductions of specific items allowed by the Internal Revenue Service. Itemized deduction limitation: A restriction placed on taxpayers with an AGI that exceeds a predetermined threshold and that requires the taxpayer to limit his or her deductions. Joint ownership: Owned equally by all parties on the deed. Keogh: A tax-deferred pension plan designed for self-employed individuals or employees of unincorporated businesses. LIFO (last in, first out): A method of inventory valuation in which the last items entered into inventory are considered the first items sold. Liquidating dividends: Dividends that are issued as a result of the corporation becoming partially or completely liquidated. Listed property: Passenger automobiles; any other property used for transportation; property of a type generally used for entertainment, recreation, or amusement; computers and their peripheral equipment (unless used only at a regular business establishment and owned or leased by the person operating the establishment); and cellular telephones or similar telecommunications equipment. Lump-sum distribution: The payment of a taxpayer's entire retirement or pension plan in one payment, instead of steady payments made over time. MACRS: Modified accelerated cost recovery system (MACRS) is a method of depreciation that replaced the accelerated cost recovery system (ACRS). The asset is depreciated over a longer life than with ACRS.


Medical savings account (MSA): A medical savings account is an account in which tax-deferred deposits can be made for use as medical expenses. Members of the military: If the taxpayer was on extended active duty outside the United States, his or her home is considered to be in the United States during that duty period. Extended active duty is military duty ordered for an infinite period or for a period of more than ninety days. Once the taxpayer begins serving extended active duty, he or she is considered to be on extended active duty even if he or she serves fewer than ninety days. Misrepresentation: To represent falsely. Mutual fund: A mutual fund is a regulated investment company generally created by "pooling" funds of investors to allow them to take advantage of diversity of investments and professional management. Name control: The first four significant letters of a taxpayer's last name used in connection with the taxpayer's SSN to identify the taxpayer, spouse, and dependents. Necessary expense: An expense that is appropriate and helpful to the taxpayer's trade or business. Net earnings: Earnings after deductions; net profit. Net operating loss (NOL): A NOL may occur when the taxpayer's deductions exceed his or her income; the loss may be caused· by one or more of the following:

From a business

From work as an employee

For casualty and theft losses

Moving expenses and rental property Noncapital asset: Property that is not a capital asset. Nondeductible: An expense that does not reduce AGI. Nonrefundable credits: May reduce the taxpayer's tax liability to zero. If the credit is more than the tax liability, the excess is not refunded. Most credits are nonrefundable. Specifically, child- and dependent-care credits, child tax credits, credits for the elderly and disabled, education credits, foreign tax credits, and adoption credits are nonrefundable. (That is, they may reduce the tax due to zero but will not produce payments to the taxpayer.) Nonresident aliens: If the taxpayer's filing status is married filing jointly, more research will be required. Obtain Publication 596. Nonresidential real property: Most real property other than residential real property. Nonqualified employee plan: An employer's plan that does not meet Internal Revenue Code requirements for qualified employee plans. It does not qualify for most of the tax benefits of a qualified plan. Nontaxable income: Income that is exempt from tax. When a return must be filed, nontaxable income will be shown on the return but will not be added into the amount of income.


Nonsubstantive change: A correction or change limited to a transposition error, misplaced entry, spelling error, or arithmetic correction that does not require new signatures or authorizations to be transmitted or retransmitted. Offer in compromise (OIC): An offer of settlement made by a taxpayer to the Internal Revenue Service regarding an unpaid tax when it is unlikely that the tax liability can be collected in full. Ordinary dividends: Dividends that are paid out of the corporation's earnings and profits. Ordinary expense: An expense that is common and accepted in the taxpayer's trade or business. Original issue discount (OID): A form of interest; the amount by which the stated redemption price at maturity of a debt instrument is more than its issue price. Originate/Originator: Originator of an electronic tax return submission occurs when an ERO 1) directly transmits electronic returns to the IRS, 2) sends electronic returns to a transmitter, or 3) provides tax return data to an intermediate service provider. Other costs: A proportion of overhead expenses related to creating a product. Other income: Income that is not reportable under any of the other income categories. Examples of income that may be reportable under this category are commissions, insurance proceeds, patronage distributions, prizes, and racing purses. Part-interest expense: If the taxpayer owns a part in a rental property, the taxpayer can deduct his or her part of the rental expenses for that property. Part-interest income: If the taxpayer owns a part interest in a rental property, the taxpayer must report his or her part of the rental income from that property. Passive activity: An income-producing activity or venture in which the taxpayer does not materially participate. Pension plan: A plan set up by an employer for the benefit of employees that adheres to the rules mandated by the IRS. Permanently and totally disabled child: Any child who cannot engage in any substantial gainful activity because of a physical or mental condition; a doctor has determined that this condition:

Has lasted or can be expected to last continuously for at least a year

Can lead to death Personal exemptions: Additional amount the taxpayer may deduct from adjusted gross income to arrive at taxable income. This amount is adjusted every year. Phaseouts: The reduction or elimination of various tax benefits as a taxpayer's income exceeds specified levels.


Placed in service: Ready and available for a specific use whether in a trade or business, the production of income, a tax-exempt activity, or a personal activity. Points: Interest that the lender charges to make a loan. On the settlement statement, points are "loan origination fees." Premium tax credit (PTC): A tax credit for certain individual or family members who enroll in a qualified health plan. The credit provides financial assistance to pay the premiums for the qualified health plan through a Marketplace by reducing the amount of tax the individual owes, giving the taxpayer a refund or increasing their refund amount. Preparer tax identification number (PTIN): An identifying number issued by the IRS to be used by a paid preparer on a tax return instead of the paid preparer's social security number. Principal place of business: Place where a taxpayer conducts most of his or her business the majority of the time. Professional conduct: Competent, honest, and ethical behavior. Property class: A category for property under MACRS. It generally determines the depreciation method, recovery period, and convention. Purchase: The inventory or raw materials for manufacturing, merchandising, or mining, plus costs of shipping minus purchases for personal use. Qualifying child: There are five tests that must be met for a child to be the taxpayer's qualifying child. The five tests are: 1. Relationship 2. Age 3. Residency 4. Support 5. Special test for qualifying child of more than one person Qualifying relative: The taxpayer can claim an exemption for a qualifying relative only if the following three tests are met: 1. Dependent taxpayer test 2. Joint return test 3. Citizen or resident test Qualified employee annuity: A retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements. Qualified employee plan: An employer's stock bonus, pension, or profit-sharing plan that is for the exclusive benefit of employees or their beneficiaries and meets Internal Revenue guidelines. Qualified expense for higher education: Tuition and fees required for the taxpayer, his or her spouse, and dependents (for whom the taxpayer may claim an exemption) to attend an eligible educational institution.


Railroad retirement tier 1: A retirement plan that is the equivalent of social security benefits. Railroad retirement tier 2: A retirement plan that is treated as a pension. Realistic possibility: A tax position is considered to have a realistic possibility of being sustained on its merits ifthe position has at least a one-in-three, or greater, likelihood of being sustained if challenged by the Internal Revenue Service. Recapture: To include as income on the tax return an amount allowed or allowable as a deduction in a prior year. Recovery period: The number of years over which the basis (cost) of an item of property is recovered. Refundable credits: Treated as tax payments. The credit amount is added to federal income tax withheld. If the total of these credits is more than the tax liability, the excess will be refunded. There are only five refundable credits: additional child tax credit, earned income credit, excess social security withheld, credit for federal tax paid on fuels, and credit for taxes paid by regulated investment companies. Example: Total tax $481

Earned Income Credit -$500 Refund $19

Refund anticipation loan (RAL): Money borrowed by a taxpayer that is based on a taxpayer's anticipated income tax refund. The IRS has no involvement in RALs. A RAL is a contract between the taxpayer and the lender. A RAL may be marketed under various commercial or financial product names. This is a bank product that is not offered as frequently as it used to be. Refund cycle: The anticipated date that a refund would be issued by the IRS either by direct deposit or by mail to a taxpayer for a return included within a specific "drain." However, neither the IRS nor FMS guarantees the specific date that a refund will be mailed or deposited into a taxpayer's financial institution account. Reinvested dividends: Dividends that are used to purchase additional stock. Remainder interest: The part of an estate that is left after all the other provisions of a will have been satisfied. Repairs and maintenance: Expenses incurred to merely keep the asset in good condition do not add value or prolong the life of the property; therefore, repairs and maintenance costs are not added to the basis of the asset. Residential rental property: Real property, generally buildings or structures, if 80% or more of its annual gross rental income is from dwelling units. Return of capital: A distribution paid out of the shareholder's investment in stock of the company.


Return period: The twelve-month period beginning on the same day of each year. For a calendar year taxpayer, this is January 1. Rollover: The timely moving of a taxpayer's pension plan from one financial institution to another without producing a taxable income. Roth IRA: A personal savings plan that offers the taxpayer tax advantages to set aside money for retirement. Contributions are not deductible; however, qualified distributions are tax-free. The earnings from a Roth IRA are also distributed tax-free. Routing transit number (RTN): A number assigned by the Federal Reserve to each financial institution. Royalties: Income the taxpayer may receive from copyrights, patents, and oil, gas, and mineral properties. Savings bond: A US government obligation that pays interest. Salvage value: An estimated value of property at the end of its useful life. Not used under MACRS. Section 179 expense deduction: Allows immediate expensing of tangible personal property. Limits apply and are adjusted annually. Section 1245 property: Property that is or has been subject to an allowance for depreciation or amortization. Section 1245 property includes personal property, single-purpose agricultural and horticultural structures, storage facilities used in connection with the distribution of petroleum or primary petroleum products, and railroad grading or tunnel bores. Section 1250 property: Real property (other than section 1245 property) that is or has been subject to an allowance for depreciation. Self-employment tax (SE tax): Social security and Medicare taxes that self-employed individuals are required to pay. Currently, the self-employed individual pays 15.3% of his or her net self-employment earnings in self-employment taxes. Self-select PIN method: An electronic signature option for taxpayers who e-file using either a personal computer or an ERO. This method requires the taxpayer to create a five-digit personal identification number (PIN) to use as the signature on thee-file return and to submit authentication information to the IRS with the e-file return. Seller-paid points: A ruling in March 1994 made these deductible on the buyer's tax return, on Schedule A. The buyer's basis is then lowered by the amount of the seller-paid points when he or she sells the home. Selling price: Total received for the sale of the property (including money, mortgages, and FMV of property received). Social security number (SSN): For purposes of taking the EIC, a valid SSN is a number issued by the Social Security Administration, unless "Not Valid for Employment" is printed on the social security card and the number was issued solely to apply for or receive a federally funded benefit. The taxpayer should contact his or her local Social Security Administration to obtain a social security card.


Sole proprietor: An individual who is in business for him- or herself. Specific identification: An inventory method that identifies each item by cost and sale. Standard deduction: An amount that the taxpayer may deduct from adjusted gross income to arrive at taxable income. Standard deduction is adjusted yearly for inflation. Start-up costs: Expenses incurred to establish a business. These expenses are incurred prior to the actual beginning of the business. Stockpiling: Waiting more than three calendar days to submit returns to the IRS after the provider has all necessary information for the origination of the electronic return. Stockpiling may also occur when returns are collected fore-file prior to official acceptance for participation in IRS e-file. Collecting tax returns for the IRS e-file prior to the start-up of IRS e-file is not considered stockpiling. However, providers must advise taxpayers that the returns will not be transmitted to the IRS prior to the start-up date. Straight-line method: A method of depreciation whereby the cost of the asset is divided by its useful life in order to obtain the annual expense. Structural components: Parts that together form an entire structure, such as a building. The term includes those parts of a building such as walls, partitions, floors, and ceilings, as well as any permanent coverings such as paneling or tiling, windows and doors, and all components of a central air-conditioning or heating system including motors, compressors, pipes, and ducts. It also includes plumbing fixtures such as sinks, bathtubs, electrical wiring, lighting fixtures, and other parts that form the structure. Tangible property: Property you can see or touch, such as buildings, machinery, vehicles, furniture, and equipment. Taxable income: Any income that is subject to tax. It must be reported on a tax return, unless the amount is so small that the taxpayer is not required to file a return. Tax-deferred: Referring to an investment whose accumulated earnings are free from taxation until the investor takes possession of the assets. Tax court: A judicial system designed specifically for tax laws. Tax evasion: The reduction or avoidance of taxes through illegal means. Tax-exempt: Not subject to tax. Tax home: An individual's main or regular place of business. Tax professional: One who prepares tax returns for individuals, companies, trusts, or nonprofit organizations.


Tax-sheltered annuity (TSA) plan: Often referred to as a "403(b) plan" or a "tax-deferred annuity plan," a TSA is a retirement plan for employees of public schools and certain tax-exempt organizations. Generally, a TSA plan provides retirement benefits by purchasing annuity contracts for its participants. Term interest: A life interest in property, an interest in property for a term of years, or an income interest in a trust. It generally refers to a present or future interest in income from property or the right to use property that terminates or fails upon the lapse of time, the occurrence of an event, or the failure of an event to occur. Third-party designee: A family member, friend, or tax preparer who has been given permission to discuss a particular tax return with the Internal Revenue Service on behalf of the taxpayer. This authorization expires after the due date of the tax return. Transfer: The moving of funds from a traditional IRA account directly into another account. Unadjusted basis: The basis of an item of property for purposes of figuring the gain on a sale without taking into account any depreciation taken in earlier years but with adjustments for other amounts, including amortization, the section 179 deduction, any special depreciation allowance, any deduction claimed for clean-fuel vehicles or clean-fuel vehicle refueling property placed in service before January 1, 2006, and any electric vehicle credit. Uncollected rent: If the taxpayer is a cash-basis taxpayer, the taxpayer cannot deduct uncollected rent. Since the cash-basis taxpayer never included the uncollected rent in income, he or she cannot deduct the uncollected rent as an expense or deduction. If the taxpayer is an accrual-basis taxpayer, he or she had to report income when it was earned. If the taxpayer is unable to collect the rent, he or she may be able to deduct it as a business bad debt. Unearned income: Income that is not considered earned. Unit-of-production method: A way to figure depreciation for certain property. It is determined by estimating the number of units that can be produced before the property is worn out. For example, if it is estimated that a machine will produce one thousand units in a year, the percentage to figure depreciation for that year is 10% of the machine's cost less its salvage value. Unrelated business expenses: Expenses incurred for anything not used for business. Useful life: An estimate of how long an item of property can be expected to be useable in trade or business or to produce income. Under MACRS, the taxpayer can recover the cost of property over a set recovery period. The recovery period is based on the property class to which the property is assigned. The class to which the property is assigned is generally determined by its class life. Wages: Regular compensation received by an employee as a condition of employment. Wages are considered earned income and taxed as ordinary income. Wash sale: A sale of stock or securities at a loss within thirty days before or after the taxpayer purchases or acquires in a fully taxable trade, or acquires a contract or option to buy, substantially identical stock or securities.


Withdrawal: The removal of a taxpayer's funds from a financial institution. This transaction may or may not produce taxable income. Withholding: An employer retains a portion of an employee's wages for the purpose of paying various taxes, insurance plans, pension plans, union dues, and other deductions.

2017 Annual Federal Tax Refresher (AFTR) - CE Self Study · 2017. 7. 1. · e. Gambling losses up...

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