Chapter 03 - Preparing Your Taxes

4) Adjustments

Deductions such as employee, personal retirement, higher education, and support expenses are included in this category. Adjustments are taken against gross income and include certain employee, personal retirement, insurance, and support expenses. They are usually non-business in nature. Some examples include educator expenses, higher education tuition costs, IRA contributions, self-employment taxes paid, self-employment health insurance paid, penalty on early withdrawal of savings, alimony paid, and moving expenses.

4) Itemized Deductions

Many of these are based on a percentage of AGI. Itemized deductions are personal expenses that are subtracted from AGI. If personal expenses exceed the standard deduction amount, the taxpayer can choose to itemize deductions rather than take the standard deduction. Some itemized deductions are limited based on a taxpayer's AGI.

3) Tax Liability

This is calculated by determining income subject to taxes less adjustments, deductions, and exemptions and applying the appropriate rate(s). To determine the amount of tax owed, taxable income is based on the tax tables or tax rate schedules.

3) Active Income

This term refers to income earned on the job. Active income is income earned on the job, such as wages and salaries, bonuses and tips, and other forms of noninvestment income (such as pension income and alimony received).

3) Sale of a Home

To qualify for exclusion during this transaction, you must have owned and occupied for two of the five prior years. Homeowners receive special tax treatment on the sale of a principal residence. Single taxpayers can exclude from income the first $250,000 of gain ($500,000 for married taxpayers). To qualify, the taxpayer must own and occupy the residence as a principal residence for at least two of the five years prior to the sale.

8) Tax evasion or tax avoidance? Aaron is preparing his tax return for the year and is looking at ways to save on his tax bill. Aaron worked a full-time teaching job and tutored on the side. His employer reported his income from his day job, but the money Aaron earned from tutoring was not reported to the IRS. Aaron is thinking about leaving the tutoring earnings out of his income on his tax return. Is this tax evasion or tax avoidance?

Tax Evasion

1) What are the Economics of Income Taxes? Income taxes are taxes collected by federal, state, and local governments. Within the United States, we have a defined tax structure. Answer the following questions regarding the U.S. tax structure. A tax structure in which additional taxable income is taxed at a higher rate is referred to as a ___________________ The tax paid on the next dollar of taxable income is referred to as the _______________ tax rate. The overall rate at which income is taxed, determined by dividing the tax liability by the taxable income, is referred to as the ________________ tax rate.

- progressive tax structure - marginal - average

2) Ben's Tax Scenario Ben is a young professional who lives in downtown Atlanta. He has taxable income of $63,500 as a medical sales rep for Tull Cybermatic Corp. 1) What is Ben's tax liability? 2) What is Ben's too marginal tax rate? 3) What is Ben's average tax rate?

1) $15,875 2) 25.00% 3) 18.47%

2) Tracy's Tax Scenario Tracy is a young professional who lives in downtown Chicago. She has taxable income of $94,735 as an advertising account executive for Taggart Goods Corp. 1) What is Tracy's tax liability? 2) What is Tracy's top marginal tax rate? 3) What is Tracy's average tax rate?

1) $26,526 2) 29.00% 3) 29.20%

7) When are items due? Part of tax preparation and filing involves understanding when various items are due to the IRS. Complete the statements below as they apply to tax payments, extensions, and amended returns. 1) Some taxpayers must make four quarterly installments. These are due 2) Individual tax filers must file their annual federal return no later than 3) With a filing extension in hand, a taxpayer must pay any taxes owed 4) In some cases, up to six years from when a return was filed, taxpayers can be notified that they are subject to

1) April 15, June 15, September 15, and January 15 2) April 15 3) when the extension request is filed 4) a tax audit

1) In addition to understanding how the tax system is structured, knowing your individual filing status is important because it determines deductions and other considerations that should be taken into account when preparing your tax return. Indicate the correct filing status for each of the definitions provided. 1) A person whose spouse died within two years of the tax year and who supports a dependent child: 2) A person who is unmarried or legally separated from a spouse by either a separation or final divorce decree: 3) A person who is unmarried or considered unmarried and pays more than half of the cost of keeping up a home for himself/herself and an eligible dependent child or relative: 4) A couple in which each spouse files his or her own return: 5) Spouses who combine their income and allowable deductions:

1) Qualifying widow or widower with dependent children 2) Single taxpayer 3) Head of household 4) Married filing separately 5) Married filing jointly

6) The IRS offers a comprehensive reference book on preparing your tax return called "IRS Publication 17, Your Federal Taxes." But you may decide that doing this annual task is not for you. Luckily, help is available! The IRS will compute taxes for those with taxable income under $100,000 and no itemized deductions. Taxpayers whose situations don't qualify for IRS help can turn to professional tax preparation services. Complete the statements below to identify individuals and entities that can help with tax planning, preparation, and filing. 1) Nonlicensed preparers are best for straight forward returns because they are trained only in tax preparation and are usually less expensive. They would be categorized as ____________________. 2) These individuals assist with more complex types of income and expenditures while providing guidance on tax planning strategies; prepare and audit financial statements; and prepare tax returns. These individuals or groups of individuals have passed a certification examination are _______________________________. 3) Individuals federally licensed to assist individuals with tax preparation at various levels of complexity are referred to as _______________________. 4) These individuals are best for complex tax situations which may involve court. They are referred to as __________________________.

1) a national or local tax service firm 2) certified public accountant (CPSs) 3) enrolled agents 4) attorneys

5) What steps should you take when completing a tax return? When preparing a tax return, it is important to complete each step in the order prescribed. Identify each step in completing a tax return by choosing the step from the drop-down fields below B: D: E: G:

B - Adjustments to (gross) income D - Total personal exemptions E - Taxable income G - Other taxes

4) Steps to Taxable Income

Reduce AGI by the standard deduction and allowable exemptions. Continuing from AGI, the taxpayer determines the allowable personal expenses incurred during the tax year. Based on the amount determined, the taxpayer can take the standard deduction or itemize deductions. Once deductions are taken against AGI, taxpayer exemptions are claimed to further reduce income. AGI, less deductions and exemptions, equals taxable income.

4) Capital Gains Tax Category

This figure is based on tax bracket, 5% to 15% tax rate if held over 12 months. The amount of tax to be paid on capital gains (for example, assets such as stocks are sold for more than their purchase price) is determined by the holding period of the asset. In 2014, assets held less than 12 months are taxed as ordinary income. For assets held more than 12 months , the capital gains rate ranges from 15 to 20%.

4) Exemption

This is a claim made by the taxpayer for each person supported by the taxpayer's income. Taxpayers get an exemption for each person they support. They can claim an exemption for themselves, a spouse, and dependents. An exemption can be taken only once. For example, a college-bound child who qualifies as an exemption for his or her parents cannot also claim an exemption on a tax return he or she may be required to file.

4) Standard Deductions

This is adjusted annually for changes in cost of living. A standard deduction is a blanket deduction that includes various deductible expenses that would normally be incurred by a taxpayer. For taxpayers who have little or no personal expenses (for example, property taxes or professional organization dues), the standard deduction is taken to reduce AGI.

4) Itemized Deduction Example

This is mortgage interest expense. There are many examples of itemized deductions. Often taxpayers overlook these expenses when preparing their tax returns. The total amount plays a role in determining whether to take the standard deduction or to itemize deductions. Expenses include (but are not limited to) professional organization dues, cost of a safe deposit box, points paid on a mortgage or refinancing, financial management fees, personal property taxes on vehicles, unreimbursed job-related expenses, and certain types of clean-fuel or hybrid cars.

4) Adjusted Gross Income

This is used to calculate limits for certain itemized deductions. After subtracting the total of all allowable adjustments, the result is adjusted gross income or AGI. Many itemized deductions are based on a percentage of AGI.

3) Taxable Income

This is used to determine tax liability. Taxable income is defined as the amount of income subject to taxes. It includes all income subject to tax and subtracting adjustments, deductions, and exemptions.

4) Steps to AGI

This term includes all income less certain allowable adjustments. When preparing a tax return, a taxpayer begins with gross income. Defined as all income subject to income tax, gross income is then reduced by adjustments. Adjustments are certain expenses and retirement plan contributions that are subtracted from gross income to arrive at AGI.

3) Investment expenses

This term includes expenses that can only offset portfolio income. Portfolio income cannot be combined with passive or active income, and these expenses can be used only to offset the portfolio income to which they relate.

3) Passive Income

This term includes income from tax shelters. Passive income is a special category of income that includes earnings derived from real estate, limited partnerships, and other forms of tax shelters.

3) Gross Income

This term includes wages, salaries, bonuses/commissions, and interest/dividends/alimony. Gross income includes any and all income subject to federal taxes: wages, salaries, bonuses, commissions, interest, dividends, alimony received, business and farm income, gains on the sale of assets, pension income, annuity income, rental income, partnership income, prizes, lottery winnings, and winnings from gambling.

4) Deductions

This term refers to allowable expenses that are deducted from AGI. From AGI, deductions fall into two types: standard or itemized. When a tax return is prepared, the taxpayer can choose the higher of either deduction, which is subtracted from AGI.

3) Capital Gains

This term refers to an asset sold for more than its original value. A capital gain occurs whenever an asset (such as a stock, a bond, or real estate holding) is sold for more than its original price. Additionally, capital gains are taxed at different rates, depending on the holding period of the asset.

3) Portfolio Income

This term refers to earnings and capital gains generated from investment holdings. Portfolio income includes interest, dividends, and capital gains (on the sale of investments) generated from investment holdings. This category also includes income from savings accounts, stocks, bonds, mutual funds, options, and futures.

3) Real Estate or Limited Partnership Expenses

This term refers to passive income offset. Passive income cannot be combined with portfolio or active income, and these expenses can be used only to offset the passive income to which they relate.

8) Money management and tax planning Money management includes effective tax planning. Your financial plan should include ways to lower your tax liability so you have more money to spend, invest, or donate. The key to effective tax planning is to reduce your taxable income, rather than your gross income, through all appropriate and legally available opportunities. The act of reducing taxes in ways that are legal and compatible with the intent of Congress is called

tax avoidance