Tax Accounting - Chapter 4

The gross income test requires that a qualifying relative's gross income for 2020 be less than $

$4,300

Deductions from AGI

-Deducted from adjusted gross income to determine taxable income •"Deductions below the line" -Deduction for qualified business income (not an itemized deduction) •Deduction = Qualified business income × 20% -Greater of the standard deduction or itemized deductions

Which taxes may be imposed in addition to the individual income tax and are calculated on tax bases other than the regular taxable income?

1. Alternative minimum tax 2. Self-employment tax

Tax Prepayments

1. Income taxes withheld from wages by the employer 2. Estimated tax payments made during the year 3. Taxes overpaid in the prior year and applied toward the current year's liability (If prepayments exceed tax liability after credits, the taxpayer receives a refund)

Which of the following criteria is necessary to qualify as a dependent of another taxpayer?

1. Must be a citizen of the U.S. or a resident of the U.S., Canada, or Mexico. 2. Must NOT file a joint return unless there is no tax liability on the couple's return and no tax liability on either return if they filed separately. 3. Must be considered either a qualifying child or a qualifying relative.

An individual will qualify as a qualifying child if he satisfies

1. Relationship test 2. Age test 3. Residence test 4. Support test

Qualifying relative

1. Relationship test 2. Support test 3. Gross income test

The three tests that must be met to qualify as a qualifying relative are:

1. Relationship test 2. Support test 3. Gross income test

When can the married filing jointly or married filing separately filing status be used?

1. When one spouse died during the year and the surviving spouse has not remarried 2. When the taxpayers are married as of the last day of the tax year

Five different filing statuses

1.Married filing jointly 2.Married filing separately 3.Qualifying widow or widower (surviving spouse) 4.Single 5.Head of household

In a situation where the parents are divorced and the child resides with both parents for the same amount of time during the year, the parent with the ______ should claim the child as his or her dependent. A. highest AGI B. lowest taxable income C. highest taxable income D. lowest AGI

A. highest AGI

Why are for AGI deductions preferable to from AGI deductions? Multiple choice question. A. For AGI deductions reduce AGI thus increasing deductibility of from AGI deductions based on AGI. B. For AGI deductions cause a dollar for dollar drop in tax liability. C. For AGI deductions are only taken if itemized deduction exceeds standard deduction.

Answer: A Reason: For AGI deductions reduce AGI thus increasing deductibility of from AGI deductions based on AGI.

Which of the following taxes may be imposed in addition to the individual income tax and are calculated on tax bases other than the regular taxable income? (Check all that apply.) Multiple select question. A. Alternative minimum tax B. Value-added tax C. Capital gains tax D. Self-employment tax

Answer: A & D Alternative minimum tax Self-employment tat

Which of the following choices are forms of tax prepayments? (Check all that apply.) Multiple select questions. A. An overpayment of taxes in the prior year that was applied as an estimated payment for the current year B. Income tax withheld from a taxpayer's salary or wages by an employer C. Estimated tax payments the taxpayer made directly to the IRS D. A tax credit used to reduce the tax liability in the current year E. A tax refund received in the current year for the prior year

Answer: A, B & C 1. An overpayment of taxes in the prior year that was applied as an estimated payment for the current year 2. Income tax withheld from a taxpayer's salary or wages by an employer 3. Estimated tax payments the taxpayer made directly to the IRS

Which of the following statements are true regarding the qualifying widow or widower filing status? (Check all that apply.) Multiple select questions. A. The surviving spouse must have dependents. B. The surviving spouse must NOT have remarried during the year. C. The surviving spouse can NOT use this status if he or she has dependents. D. The status is used in the year that one spouse died. E. The status may be used for up to two years after the year the other spouse died.

Answer: A, B & E •The surviving spouse must have dependents. •The surviving spouse must NOT have remarried during the year. •The status may be used for up to two years after the year the other spouse died.

Which of the following statements are true regarding the qualifying widow or widower filing status? (Check all that apply.) A. The surviving spouse must NOT have remarried during the year. B. The status may be used for up to two years after the year the other spouse died. C. The status is used in the year that one spouse died. D. The surviving spouse can NOT use this status if he or she has dependents. E. The surviving spouse must have dependents.

Answer: A, B, E •The surviving spouse must NOT have remarried during the year. •The status may be used for up to two years after the year the other spouse died. •The surviving spouse must have dependents.

Which of the following individuals would meet the relationship test for being a qualifying child of the taxpayer? A. Nephew (younger than the taxpayer) B. Cousin (younger than the taxpayer) C. Stepson D. Half-sister (younger than the taxpayer) E. Aunt F. Grandmother

Answer: A, C & D Nephew (younger than the taxpayer) Stepson Half-sister (younger than the taxpayer)

Under a multiple support agreement, taxpayers whom DON'T pay over half of an individual's support may still be allowed to claim an exemption if which of the following rules apply? (Check all that apply.) A. No one taxpayer paid over one-half of the individual's support. B. The taxpayer contributed over 5 percent of the individual's support for the year. C. The taxpayer and a least one other person provided over one-half of the support of the individual. D. The individual earns more than the exemption amount, but NOT enough to provide half of his support. E. All other individuals contributing more than 10 percent support provide statements to the taxpayer agreeing NOT to claim the individual as a dependent.

Answer: A, C, E No one taxpayer paid over one-half of the individual's support. The taxpayer and a least one other person provided over one-half of the support of the individual. All other individuals contributing more than 10 percent support provides statements to taxpayer agreeing NOT to claim the individual as a dependent.

Will and Lyndsey are married with no dependents and file a joint tax return. In 2020, they paid $3,000 in qualified student loan interest in addition to $22,550 in itemized deductions. What is the total of their "FROM AGI" deductions in 2020? A. $24,800 B. $22,500 C. $27,800 D. $25,550

Answer: A. $24,800 Reason: They can deduct the larger of their itemized deductions or the standard deduction, which for married filing joint couples in 2020 is $24,800. Student loan interest, however, is a FOR AGI deduction.

Which of the following individuals would meet the relationship test for being a qualifying relative of the taxpayer if s/he has only lived with the taxpayer for eight months of the year? (Check all that apply.) A. Cousin B. Brother C. Father D. Niece E. Friend Reason: A friend could qualify if he or she has resided with the taxpayer for the entire year. F. Grandchild

Answer: B, C, D, F Brother Father Niece Grandchild Reason: A friend could qualify if he or she has resided with the taxpayer for the entire year.

Which of the following individuals would meet the relationship test for being a qualifying child of the taxpayer? A. Father B. Niece (younger than the taxpayer) C. Grandchild D. Child E. Cousin (younger than the taxpayer) F. Brother (younger than the taxpayer)

Answer: B, C, D, F Niece (younger than the taxpayer) Grandchild Child Brother (younger than the taxpayer)

Kara is single with no dependents. She has itemized deductions of $5,000 in 2020. What is the total of her "FROM AGI" deductions for 2020? A. $17,400 B. $24,800 C. $5,00 D. $12,400

Answer: D Reason: She can deduct the greater of her standard deduction ($12,400) or her itemized deductions ($5,000), but not both.

Net long-term capital gains in excess of net short-term capital losses

Are generally taxed at 0 percent, 15 percent, or 20 percent depending on the taxpayer's taxable income

Ruida divorced on October 31 of the current year. He does NOT have any dependents. Which filing status should Ruida use for the current year? A. Qualifying widow B. Single C. Married filing separately D. Head of household

B. Single

Chasity is 20, has a full-time job, and supports herself. Her brother, William, age 22, has decided to go back to college. He moved in with Chasity and is attending college full-time. Which of the following statements is accurate regarding the age test for a qualifying child and how it applies to William? A. William does NOT meet the age test because he is not Chasity's child. B. William does NOT meet the age test because he is older than Chasity. C. William does NOT meet the age test because he is not under the age of 19. D. William meets the age test because he is a full-time student under age 24.

B. William does NOT meet the age test because he is older than Chasity.

Which of the following statements is correct regarding the choice of a taxpayer's filing status? A. Filing status depends on the gender of the taxpayer. B. Filing status depends on the age of the taxpayer. C. Filing status depends on marital status and whether the taxpayer has dependents. D. Filing status depends on the level of income generated by the taxpayer.

C. Filing status depends on marital status and whether the taxpayer has dependents

Age test for qualifying child

Child must be younger than the individual claiming the child as a qualifying child and either -Under age 19 at the end of the year, -Under age 24 at the end of the year and a full-time student, or -Permanently and totally disabled.

Which of the following choices is NOT a form of a tax prepayment? A. An overpayment of taxes in the prior year that was applied as an estimated payment for the current year. B. Income tax withheld from a taxpayer's salary or wages by an employer C. Estimated tax payments the taxpayer made directly to the IRS D. A tax refund received in the current year for the prior year

D. A tax refund received in the current year for the prior year

Which of the choices below is NOT one of the tests that must be met to qualify as a qualifying relative? A. Relationship B. Gross income C. Support D. Age

D. Age

If an individual is a qualifying child for both of his parents who divorced during the year, which parent is entitled to claim the child as a dependent? A. The child gets to choose which parent to whom they are dependent B. The parent who files his/her tax return the earliest C. The parent with the lowest adjusted gross income D. The parent with whom the child has lived with the longest during the year

D. The parent with whom the child has lived with the longest during the year

Assuming no multiple-support agreement, to meet the support test to be a qualifying relative of a taxpayer, the taxpayer must pay ______ of the individual's support. A. at least 10 percent B. all C. more than anyone else pays D. over half

D. over half

Capital gain or loss

Depends on whether short-term or long-term •From selling capital asset •If capital asset is held more than a year, gain or loss is long-term; otherwise, it is short-term. •Net long-term gains are taxed at preferential rates.

Is excluded and deferred income reported in gross income?

Excluded and deferred income not included in gross income

True or False: The gross income test requires that a qualifying relative's gross income for the year must be equal to or less than $5,000 for tax year 2020.

False Reason: The 2020 income limitation is $4,300.

True or False A taxpayer may deduct both his standard deduction and his itemized deductions from AGI in order to calculate taxable income.

False Reason: He can only deduct the one of these amounts and should usually choose the larger of the two.

True or false: In order to meet the support test for a qualifying child, the taxpayer must provide more than half of the individual's support for the year.

False Reason: The child may be receiving support from someone other than the taxpayer. The rule is that the CHILD cannot provide over half of his/her own support.

Capital Assets

Generally all assets except •Accounts receivable •Inventory •Assets used in trade or business, including supplies

Individual Income Tax Formula

Gross income •Minus: For AGI (above the line) deductions •Equals: Adjusted gross income (AGI) •Minus: From AGI (below the line) deductions: -Greater of (a) Standard deduction or (b) Itemized deductions and -Deduction for qualified business income (QBI) •Equals: Taxable income Taxable income •Times: Tax rates •Equals: Income tax liability •Plus: Other taxes •Equals: Total tax •Minus: Credits •Minus: Prepayments •Equals: Taxes due or (refund)

Gross Income Test (Qualifying Relative)

Gross income < $4,300 in 2020

Adjusted Gross Income (AGI)

Gross income less deductions for AGI. AGI is an important reference point that is often used in other tax calculations.

Deferred income

Income included in a subsequent tax year •Installment sales •Like-kind exchanges

Excluded income

Income never included in taxable income •Municipal bond interest •Gain on sale of a personal residence

Taxable Income

Income on which tax must be paid; total income minus exemptions and deductions (The tax base for the income tax) •Individuals report taxable income to the IRS. -Reported on Form 1040

Dividends from corporations that meet certain requirements may be taxed at a favorable rate. These dividends are referred to as

Qualified Dividends.

Gross Income

Realized income reduced for any excluded or deferred income.

Yolanda is your client. With her current level of taxable income, she is paying tax at a 24% marginal rate. She received $2,000 in qualified dividends this year. What rate of tax do you expect that Yolanda will pay on her dividends?

Reason: Yolanda's 24% marginal tax rate is means her taxable income is more than $85,525 but less than $163,300, and for all values in that range, the long term capital gains rate applied to qualified dividends is 15%. 15% regular rate 20% for high income 0 for low income

Tax credits

Reduce tax liability dollar for dollar

Recognize income

Reported on tax return

Residence test

Same residence as taxpayer for more than half the year (Exception for temporary absences such as education)

In order to meet this test, the taxpayer must pay more than half of the living expenses for the qualifying relative.

Support test

Qualified dividends

Taxed at 0 percent, 15 percent, or 20 percent depending on the taxpayer's income level

Short-term capital gains

Taxed at ordinary rates.

Relationship test

Taxpayer's son, daughter, stepchild, an eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of these relatives

Ordinary

This income or loss that is taxed at the ordinary rate provided in the tax rate schedules in Appendix D, or that offsets income taxed at these rates, and is not capital in character

T/F A taxpayer may deduct the greater of his standard deduction or his itemized deductions from AGI to arrive at taxable income

True

True or False: A taxpayer filing status depends on his or her marital status at the end of the year and whether the taxpayer has dependents.

True

True or False: Deductions for AGI cause a reduction in AGI, which increases the deductibility of from, AGI deductions subject to AGI limitations

True

Single

Unmarried unless qualifying for head of household

What are the primary categories of itemized deductions?

• Medical and dental expenses: Deductible to the extent these expenses exceed 10% of AGI • Taxes: State and Local income taxes, sales taxes, real estate taxes, personal taxes, and other taxes [the annual aggregate deduction for taxes is limited to $10,000 ($5,000 if married filing separately)]. • Interest expense: Mortgage and investment interest expense. • Gifts to charity (charitable contributions). • Other miscellaneous deductions: Gambling losses (to the extent of gambling winnings) and certain other deductions.

Common income characters (or types of income) include

• Ordinary • Capital • Qualified Dividend

Deductions for AGI

•"Deductions above the line" • Deducted in determining adjusted gross income • Always reduce taxable income dollar for dollar

Net capital losses (losses in excess of gains for year

•$3,000 deductible against ordinary income for year •Losses in excess of $3,000 are carried forward indefinitely

All-inclusive income concept

•A definition of income that says that gross income means all income from whatever source derived. •All income received is taxable unless some specific provision of the tax law allows exclusion of the item

Relationship Test (Qualifying Relative)

•A descendant or ancestor of the taxpayer (e.g., child, grandchild, parent, or grandparent), •A sibling of the taxpayer, including a stepbrother or stepsister •A son or daughter of the taxpayer's brother or sister (not cousins) •A sibling of the taxpayer's mother or father •An in-law (mother-in-law, father-in-law, sister-in-law, or brother-in-law) of the taxpayer •Other person, with no qualifying family relationship(above), who lives in taxpayer's home entire year. eg. a friend

Character of income or loss

•A type of income that is treated differently for tax purposes from other types of income. •Determines rates applicable to income or loss in the current year. -Tax-exempt—no tax -Tax-deferred—no tax in the current year (current-year tax rate is zero)

Common for AGI deductions

•Alimony paid (pre-2019 divorce decree) •Rental and royalty expenses •Contributions to qualified retirement accounts

What are the FOR AGI Deductions?

•Alimony paid for divorces finalized before 1/1/2019 •Capital losses (net losses limited to $3,000 for the year). •Health insurance for self-employed persons •Contributions to (non-Roth) qualified retirement accounts. •Rental and royalty expenses •One-half of self-employment taxes paid •Business expenses •Losses on the disposition of assets used in a trade or business.

Other taxes include

•Alternative minimum tax •Self-employment tax •3.8 percent net investment income tax •.9 percent additional Medicare tax

Qualifying widow or widower

•Available for the two years following the year of spouse's death •Surviving spouse does not qualify if he or she remarries during the two-year period. •Surviving spouse must maintain household for dependent child.

Support test

•Child must not provide more than half of his or her own support. •Scholarships of actual child (not grandchild, for example) are excluded from support computation.

Determining who qualifies as a taxpayer's dependent is relevant for determining:

•Filing status •Eligibility for tax benefits such as the child tax credit and the American opportunity credit

Realized Income

•Income generated in a transaction with a second party in which there is a measurable change in property rights between parties. •All realized income included in gross income unless specifically excluded or deferred

Married individuals treated as unmarried (abandoned spouse) if individual:

•Is married at end of year (or is not legally separated from the other spouse) •Does not file a joint tax return with the other spouse •Pays > ½ the cost of maintaining a household that serves as principal abode for a qualifying child for more than half the year •Lived apart from the other spouse for the last six months of the year (other than temporary absences)

Items taxed at preferential rates

•Long-term capital gains •Qualified dividends •Tax on these items is calculated separately from income taxed at ordinary rates.

Common itemized deductions from AGI

•Mortgage interest •State income taxes •Charitable contributions

Married Filing Jointly

•Must be married on the last day of the year •If one spouse dies, the surviving spouse is considered to be married to decedent spouse at year-end. (Exception—The surviving spouse remarries before year's end) •Joint and several liability for tax

Tiebreaking rules for qualifying child

•Parent over nonparent •If both parents, based on who child resided with the most (If same, parent with higher AGI). •If nonparents, highest AGI gets exemption

Qualifying relative who is not the taxpayer's parent

•Person must have lived with taxpayer for more than half the year •Must qualify as taxpayer's dependent •Must be related to taxpayer through qualified family relationship (If related only because lived with taxpayer for entire year, not a qualified person)

Qualifying person

•Qualifying child •Qualifying relative who is taxpayer's mother or father -Parent need not live with taxpayer -Taxpayer must pay > ½ cost of maintaining separate household for taxpayer's mother or father -Parent must qualify as taxpayer's dependent

Support Test (Qualifying Relative)

•Taxpayer must pay more than half of living expenses (support) • Scholarships of actual child excluded

Married filing separately

•Taxpayers are married but file separate returns. •Typically not beneficial from tax perspective (Tax rates and other tax benefits) •May be beneficial for nontax reasons (No joint and several liability)

Tax calculation

•The United States uses a progressive tax rate schedule. •Rates range from 10 percent to 37 percent

Head of household

•Unmarried or considered unmarried at end of year (See discussion of married individuals treated as unmarried (abandoned spouses) below.) •Not a qualifying widow or widower •Pay more than half the costs of keeping up a home during the year •Lived in taxpayer's home with a "qualifying person" for more than half of the year (Exception for parents (see below))