29

Chapter 3 Individual TaxationAn Overview

SUMMARY OF CHAPTER
A basic understanding of the method used to calculate the tax liability is a necessity in the study of federal income taxation. The basic tax formula for individuals is as follows: = = = = Gross Income Deductions for Adjusted Gross Income Adjusted Gross Income Greater of Itemized Deductions or Standard Deduction Personal Exemptions Taxable Income Tax Rate Taxable Liability Tax Credits and Prepayments Net Tax Due or Refund

Components of the Tax Formula 3001 Gross Income

Gross income includes all items of income from whatever source unless specifically excluded. Examples of gross income include compensation for services, interest, rents, royalties, dividends, and annuities. An individuals income from business is included in gross income after deducting the cost of goods sold.

3015 Deductions for Adjusted Gross Income

To arrive at adjusted gross income, all deductions specifically allowed by law are subtracted from gross income. Some of the items allowed as deductions for adjusted gross income include (1) trade or business expenses, such as advertising, depreciation, and utilities, (2) moving expenses, (3) reimbursed employee expenses, such as travel, transportation, and entertainment expenses, and (4) losses from the sale or exchange of property.

3025 Adjusted Gross Income

In the tax formula there are deductions for adjusted gross income and then deductions from adjusted gross income. It is important to take these deductions in the proper categories. Adjusted gross income is an important subtotal because certain other items are based on the amount of adjusted gross income.

3035 Itemizing v. Standard Deduction

Itemized deductions allowed as a deduction include: medical expenses, state and local income taxes, property taxes, mortgage interest, charitable contributions, personal casualty losses, and miscellaneous employee expenses. The standard deduction is a fixed amount based on the filing status of the taxpayer and is adjusted annually for inflation. Taxpayers subtract the larger of their itemized deductions or the standard deduction. For 2008, the standard deduction amounts are $10,900 for married taxpayers filing jointly and surviving spouses, $5,450 for single taxpayers, $8,000 for heads of households, and $5,450 for married taxpayers filing separately.

Chapter 3

30
3045 Personal Exemptions

CCH Federal TaxationComprehensive Topics

Individual taxpayers can reduce their income tax liability by properly claiming exemptions for themselves, their spouses, and their dependents. For 2008, taxpayers are allowed a $3,500 deduction for each personal exemption.

3055 Tax Rates

Tax liability is either derived from the appropriate column of the Tax Tables or is computed from the appropriate line in the Tax Rate Schedules. The tax rate schedules include six tax brackets in 200810, 15, 25, 28, 33, and 35 percent.

3065 Tax Credits and Prepayments

Tax credits are applied against the income tax. The principal credits include the earned income credit, child tax credit, credit for the elderly, general business credit, dependent care credit, and foreign income tax credit. The tax liability is further reduced by the amounts withheld on income and by any estimated tax payments made during the year.

3075 Net Tax Due or Refund

The tax result after applying the credits and prepayments to the tax liability is the amount that must be paid to the Internal Revenue Service or the amount overpaid and to be refunded to the taxpayer.

3085 Classification of Taxpayers

A proper classification is essential in determining the type of tax return to be filed. The term taxpayer is defined as any person subject to any internal revenue act. The term person includes any individual, a trust, estate, partnership, association, company, or corporation.

Personal Exemptions 3201 Taxpayer and Spouse

Two exemptions are allowed on a joint return even though there may be only one individual earning income. Further, the taxpayer is allowed an exemption for the spouse on a separate return; however, the spouse must have no income for the year and must not be the dependent of another taxpayer.

3225 Dependents
To qualify for the dependency exemption, the taxpayer must pay over one-half of the support of the dependent, the dependent must be related to or living with the taxpayer, and the dependent must have gross income of less than $3,500 unless a child of the taxpayer. Multiple support agreements may be used when several individuals contribute to the support of a dependent and one contributes over one-half of the support. Special rules for divorced parents allow the noncustodial parent the dependency exemption where the custodial parent signs a waiver.

3227 High-Income Phaseout of Exemptions

The deduction for personal exemptions is reduced or eliminated for high-income taxpayers whose adjusted gross income exceeds the threshold amount assigned to a specific filing status ($159,950 for single individuals; $239,950 for married taxpayers filing jointly).

Filing Status and Requirements 3301 Married Individuals Filing Jointly

A married couple may file a joint return including their combined income, or each spouse may file a separate return reflecting his or her income only.

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

31

3315 Married Individuals Filing Separately

If a husband and wife file separate returns, they should each report only their own income and claim only their own exemptions and deductions on their individual returns.

3325 Single Individuals

A single individual for tax purposes is an unmarried person who does not qualify as head of household.

3345 Heads of Households

Unmarried individuals who maintain a household for dependents are entitled to use the head of household rates.

3355 Surviving Spouses

Special tax benefits are extended to a surviving spouse. In addition to the right to file a joint return for the year in which a spouse dies, a taxpayer whose spouse died in either of the two years preceding the tax year, and who has not remarried, may file as a surviving spouse provided the surviving spouse maintains a household for a dependent child or stepchild.

3365 Dependents
The standard deduction for an individual who can be claimed as a dependent on the tax return of another taxpayer is the greater of the individuals earned income plus $300 or $900 (up to the maximum allowable standard deduction).

3375 Filing Requirements

The obligation to file a return depends on the amount of gross income, marital status during the year, and age. Only income which is taxable is included in the computation of gross income in order to determine whether or not a return must be filed.

3385 Tax Tables

The tax tables are based on taxable income. The tables apply to taxpayers with taxable income of less than $100,000. Separate tables are provided for taxpayers based on their filing category.

3395 Tax Rate Schedules

The tax rate schedules are used by those taxpayers not eligible to use the tax tables.

3405 Self-Employment Tax

Individuals with net earnings from self-employment of $400 or more are subject to the tax. The rate for 2008 is 15.3 percent on a maximum of $102,000. A taxpayer is entitled to a deduction from gross income of one-half the selfemployment tax. Taxpayers are required to pay social security tax (the nanny tax ) on behalf of qualified domestic employees. Generally, the household employer and domestic employee share the burden of the nanny tax. The household employers share is not deductible unless it can be classified as a business expense. The domestic employees share is never deductible.

ANSWER TO KEYSTONE PROBLEMCHAPTER 3

( 3225.) When the opportunity arises to choose which taxpayer is to be given the personal exemption, it should always be given to the taxpayer who will receive the greatest tax savings from the deduction. That may not necessarily be the taxpayer with the highest income since the personal exemption may be phased out for highincome individuals. The tax savings can then be shared among the other taxpayers eligible to take the personal exemption.

Chapter 3

32

CCH Federal TaxationComprehensive Topics

ANSWERS TO QUESTIONSCHAPTER 3
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Topical List of Questions Tax Formula Components ( 3001) Deductions for and from Adjusted Gross Income ( 3025) Deduction v. Tax Credit ( 3065) Deductions for Adjusted Gross Income Terminology ( 3015) Standard Deduction v. Personal Exemption ( 3035 and 3045) Standard v. Itemized Deductions ( 3035) Partial Standard Deduction ( 3035) Standard Deduction for Dependent Child with Unearned Income ( 3365) Spouse Exemption on Separate Return ( 3045) Additional Old Age and Blindness Standard Deduction ( 3035) Dependency Exemption: Support Test ( 3225) Dependency Exemption: Birth and Death ( 3225) Dependency Exemption: Full-Time Students ( 3225) Joint Return of Dependent ( 3225) Multiple Support Agreement: Requirements ( 3225) Multiple Support Agreement: Allowable Exemptions ( 3225) Dependency for Pre-1985 Divorce ( 3225) Dependency for Pre-1985 Divorce ( 3225) Dependency for Post-1984 Divorce ( 3225) Comparing Pre-1985 and Post-1984 Divorce Exemptions ( 3225) Calculating Standard Deduction and Exemptions ( 3035 and 3225) Definition of Filing Status ( 3301) Determining Filing Status ( 3301) Head of Household Expenses v. Support Test Expenses ( 3345) Return Requirements: Minimum Gross Income ( 3375) Return Requirements: Dependents with Unearned Income ( 3375) Return Requirements: Refunds and Credits ( 3375) Return Requirements: Taxable Income ( 3375) Tax Tables v. Tax Rate Schedules ( 3385 and 3395) Self-Employment Tax Limit ( 3405) Answers to Questions

Tax Formula Components 1. An understanding of the components of the tax formula is required in order to properly determine a taxpayers tax liability. It is particularly important to distinguish between deductions toward adjusted gross income and deductions from adjusted gross income. Deductions for and from Adjusted Gross Income 2. Deductions for adjusted gross income are primarily of a business nature. Deductions from adjusted gross income are primarily of a personal, nonbusiness nature. Deductions for adjusted gross income are allowable whether or not a taxpayer itemizes while deductions from adjusted gross income are valuable only if they exceed the standard deduction. Certain itemized deductions, personal exemptions, and credits are based on adjusted gross income.

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

33

Deduction v. Tax Credit 3. A tax deduction reduces taxable income before the determination of the tax liability. A tax credit reduces the tax liability. A tax credit reduces the tax liability dollar for dollar. A tax deduction will reduce the tax liability only proportionately based on a taxpayers marginal tax bracket. A $1 deduction at the 35 percent tax bracket saves 35 cents in taxes while a $1 credit saves $1 in taxes. Deductions for Adjusted Gross Income Terminology 4. Other terms used to describe deductions for adjusted gross income include deductions from gross income and business deductions. Standard Deduction v. Personal Exemption 5. The standard deduction allows taxpayers to earn an amount of income with no tax being assessed. One purpose is to keep low-income taxpayers off the tax rolls. Increasing personal exemptions instead of the standard deduction would be beneficial to families with more dependents. Standard v. Itemized Deductions 6. Where taxpayers have total itemized deductions each year that are reasonably close to the standard deduction they may benefit by shifting deductions and placing as many of the itemized deductions in one year as possible. This will allow the taxpayer to itemize deductions for the one year and to use the standard deduction in another. This shifting will increase the total amount of deductions and reduce taxable income. Partial Standard Deduction 7. Passive or unearned income can be placed in the hands of a dependent and taxed at lower rates. Special rules reduce the amount of the standard deduction for dependents with unearned income. Married couples filing separately could arrange their affairs to have one of the spouses take all the itemized deductions while the other uses the standard deduction, and the result would be a smaller taxable income than if they filed jointly. Special rules eliminate this possibility. Standard Deduction for Dependent Child with Unearned Income 8. The standard deduction for a dependent child with unearned income is limited to the larger of the amount of earned income plus $300 or $900. Spouse Exemption on Separate Return 9. No. The spouse must have no income, earned or unearned, in order to be claimed as an exemption on Georges separate return. Additional Old Age and Blindness Standard Deduction 10. Taxpayers are allowed an additional standard deduction for being over age 65 or blind. The extra amounts do not apply to dependents. Dependency Exemption: Support Test 11. In determining whether a taxpayer has paid over one-half of the support of a dependent, the value of lodging is determined using a marginal cost approach. A minimum base housing cost must be allocated to the taxpayer. The remaining or additional cost is then allocated to the dependent in the support determination. Dependency Exemption: Birth and Death 12. Bill and Becky are allowed a dependency exemption for the child. Birth during the year or death during the year does not prevent an individual from qualifying as a dependent. Dependency Exemption: Full-Time Students 13. Yes. School attendance exclusively at night cannot qualify as full-time attendance. Full-time attendance may include courses taken at night. Attendance at night does not disqualify a person from meeting the full-time attendance requirement. Joint Return of Dependent 14. Yes. Normally a dependent may not file a joint return and still qualify as a dependent of someone else. However, if the joint return is filed only as a claim for refund and no tax liability exists for either spouse on separate returns, the dependency exemption is still allowed. Neither Rhoda nor Mike will have a tax liability on separate returns.

Chapter 3

34

CCH Federal TaxationComprehensive Topics

Multiple Support Agreement: Requirements 15. The underlying concept of the multiple support agreement is to allow an exemption where no one person pays over half of the support of an individual. Requirements: (1) no one person paid over half, (2) each member would be allowed the exemption except for the support test, (3) each member contributed more than 10 percent of support, and (4) statement assigning exemption signed by each person contributing more than 10 percent. Multiple Support Agreement: Allowable Exemptions 16. Amos cannot claim mother because he did not meet 10 percent requirement. Other brothers are eligible. Dependency for Pre-1985 Divorce 17. Wilma. The custodial parent is allowed the exemption unless she grants the exemption to the noncustodial parent. Dependency for Pre-1985 Divorce 18. Wilma must sign a Form 8332 or similar statement agreeing that she will not claim an exemption for the child. Homer must attach the statement to his return. Dependency for Post-1984 Divorce 19. Jane is entitled to the exemption. For years after 1984, the custodial parent is entitled to the exemption unless he or she expressly waives the right to the exemption. Comparing Pre-1985 and Post-1984 Divorce Exemptions 20. Form 8332 is used to grant an exemption to the noncustodial parent. Calculating Standard Deduction and Exemptions 21. a. 2 personal exemptionsJohn, wife; $11,950 standard deductionallowed to use the basic standard deduction of $10,900 plus $1,050 for being over age 65. b. 2 personal exemptionsJack, wife; $13,000 standard deductionallowed to use the basic standard deduction of $10,900 plus $1,050 for being blind and $1,050 for being over age 65; January 1 of the following year counts as this year. c. 3 personal exemptionsJim, Mary, father; $10,900 standard deduction (no additional standard deduction for dependents). d. 2 personal exemptionsHarry, son; $9,350 standard deductionbasic standard deduction for head of household of $8,000 plus $1,350 for being over age 65. e. 5 personal exemptionsJackson, Joan, 3-year-old, 7-year-old, deceased daughter; dependent alive part of year counts; $10,900 standard deduction. f. 2 personal exemptionsJoe, wife JoAnne; the daughter is not a qualifying child because she is not a fulltime student under 24 and not a qualifying relative because she earned over $3,500; $11,950 standard deductionbasic standard deduction of $10,900 plus $1,050 for being over age 65. g. 2 personal exemptionsWilliam, mother; $8,000 standard deductionhead of household (mother does not have to live with William for William to qualify as head of household). h. 1 personal exemptionWilliam; does not pay over half of support of his mother and she has too much income; $5,450 standard deduction. i. 3 personal exemptionsBilly Bob, Mary Sue, Jackie Jo; Jackie Jo is a member of the household; $10,900 standard deduction. j. 2 personal exemptionsBenson, Chester; scholarship does not count in support test; $8,000 standard deductionhead of household. k. 1 personal exemptionBenson; support test not met (money spent from savings counts in support determination); $5,450 standard deduction; Chester is not a qualifying child or a qualifying relative, so Benson files as single.

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

35

l. 2 personal exemptionsRichard, son of deceased friend; if son of deceased friend earned more than $3,500, then he would not qualify as a dependent; $8,000 standard deduction; qualifies as head of household because son of deceased friend meets the qualifying relative test since he lived with Richard the entire year. m. 6 personal exemptionsDan, Pam, 3 foster children, son; $10,900 standard deduction. Definition of Filing Status 22. Filing status is determined by a taxpayers marital status and then by other factors within that marital status. A taxpayers filing status determines from which tax table or tax rate schedule the tax liability is computed. The taxpayer attempts to qualify for the filing status generating the least amount of tax. Determining Filing Status 23. Since Darlene is still legally married, she may file a joint return with her husband. Darlene also qualifies as a married individual filing separately. It is unlikely that Darlene would choose the latter status as she qualifies as an abandoned spouse, which allows her to be classified as unmarried. As an unmarried taxpayer she is eligible for single status or head of household status. In that case, Darlenes best filing status would be head of household. Head of Household Expenses v. Support Test Expenses 24. Only those expenses incurred in the support of a dependent are included in the support test. Head of household expenses include only the expenses incurred in running the household. Dependency expenditures for food consumed in the household would count in both computations. Expenditures for food consumed by the dependent outside the household would count only for the dependency exemption. Food consumed by other household members would count only in the household costs while only the portion allocated to the dependent would enter into the dependency computation. Return Requirements: Minimum Gross Income 25. No. Individuals receiving less than certain income amounts are not required to file tax returns. Income filing requirements are based on the basic standard deduction plus taxpayer exemptions. Return Requirements: Dependents with Unearned Income 26. Yes. Since Charles is a dependent and has unearned income exceeding $800. Return Requirements: Refunds and Credits 27. Even though the income received may be less than that required to file a return, a taxpayer may wish to file in order to receive a refund of any income taxes withheld or, as discussed in Chapter 9, to obtain the earned income credit. Return Requirements: Taxable Income 28. Any taxable income requires the filing of a return. In addition, where an individual has $400 or more of selfemployment income, a tax return must be filed in order to determine the self-employment tax. Tax Tables v. Tax Rate Schedules 29. The tax tables divide taxable income into $25 and $50 intervals. The taxpayer finds the interval containing his or her taxable income and the table gives the tax liability. With the tax rate schedules, the taxpayer must find the line containing taxable income and then must go through a computation to arrive at the tax liability. In effect, the tax tables take the midpoint of each interval and determine the tax liability from the tax rate schedules, thus saving the taxpayer the computation procedure. Use of the tax tables is required on taxable income under $100,000. Self-Employment Tax Limit 30. Self-employment income subject to tax is limited to the earnings base ($102,000 for 2008) less any wages and tips subject to the Social Security tax.

Chapter 3

36

CCH Federal TaxationComprehensive Topics

ANSWERS TO PROBLEMSCHAPTER 3
31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62.

Topical List of Problems Taxable Income Computation: Married Taxpayers ( 3001) Taxable Income Computation: Single Taxpayer ( 3001) Itemized Deductions v. Standard Deduction ( 3035) Phaseout of Itemized Deductions ( 3035) Taxable Income: Personal Exemptions and Standard Deduction ( 3001) Phaseout of Itemized Deductions ( 3035) Taxable Income: Standard DeductionDependents ( 3365) Taxable Income: Standard DeductionDependents ( 3365) Taxable Income: Standard DeductionDependents ( 3365) Additional Standard Deduction ( 3035) Support Test: Dependents and Full-Time Students ( 3225) Support Test: Full-Time Students ( 3225) Multiple Support Agreement ( 3225) Post-1984 Divorce Dependency ( 3225) Phaseout of Exemptions ( 3227) Filing Status: Married PersonsJoint and Separate Returns ( 3301 and 3315) Filing Status: Head of Household and Surviving Spouse ( 3345 and 3355) Filing Status: Surviving Spouse ( 3355) Filing Status ( 3301 and 3345) Return Requirements ( 3375) Tax Rate Schedules v. Tax Tables ( 3385 and 3395) Income Tax Computation: Single Person ( 3395) Income Tax Computation: Various Filing Statuses ( 3395) Self-Employment Tax Computation ( 3405) Income and Self-Employment Tax Computation ( 3395 and 3405) Multiple ChoiceFiling Status ( 3315) Multiple ChoiceSupport Requirements ( 3225) Multiple ChoiceHead of Household Requirements ( 3345) Multiple ChoiceHead of Household Requirements ( 3345) Comprehensive ProblemTax Computation Comprehensive ProblemTax Computation Research ProblemDivorce and Remarriage Answers to Problems

Taxable Income Computation: Married Taxpayers 31. Tom and Lindas taxable income is $14,750. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions v. $10,900 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (4 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40,000 11,250 14,000 $14,750

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

37

Taxable Income Computation: Single Taxpayer 32. Maries taxable income is $50,500. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions v. $8,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (3 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Itemized Deductions v. Standard Deduction 33. a. Robert should itemize. His itemized deductions exceed the standard deduction of $5,450. b. Jane will not itemize. Her deductions do not exceed $8,000. c. Brians itemized deductions exceed the $5,450 standard deduction for married individuals filing separately; therefore, he will itemize. d. As a surviving spouse, Lisa has a standard deduction of $10,900. Therefore she will not itemize. Phaseout of Itemized Deductions 34. The $20,000 of itemized deductions must be reduced by $401 (($200,000 $159,950) 3% 1/3) leaving an itemized deduction of $19,599. Taxable Income: Personal Exemptions and Standard Deduction 35. Taxable income is $5,100. a. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (4 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . b. Taxable income is $11,050. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . c. Taxable income is $200. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction (earned income plus $300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . d. Taxable income is $45,600. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions of $8,900 v. standard deduction of $5,450 . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (3 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $65,000 8,900 10,500 $45,600 $3,100 2,900 $200 $20,000 5,450 3,500 $11,050 $30,000 10,900 14,000 $5,100 $70,000 9,000 10,500 $50,500

Chapter 3

38
e. Taxable income is $53,000.

CCH Federal TaxationComprehensive Topics

Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (3 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Phaseout of Itemized Deductions 36. Adjusted itemized deductions are $16,800. Medical expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,000 Housing interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 Miscellaneous itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 $12,000 Less: 1/3 of 3% of AGI in excess of $159,950 limited to 80% of $12,000 1/3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200

$65,000 1,500 10,500 $53,000

$8,000

8,800 $16,800

Adjusted itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income: Standard DeductionDependents

37. Mary is allowed the full standard deduction since her earned income plus $300 exceeds the standard deduction. She is not allowed a personal exemption. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Income: Standard DeductionDependents 38. Stanleys taxable income is $1,600. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction (earned income + $300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,900 1,300 $1,600 $6,150 5,450 $700

If Stanley is age 16, $1,500 will be taxed at his marginal rate of 10 percent and $100 (net unearned income ($1,900 $900 $900)) will be taxed at his parents marginal rate. Taxable Income: Standard DeductionDependents 39. Bradfords taxable income is $1,100. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,000 900 $1,100

Since Bradford is under age 18, he would be taxed on $900 at his marginal rate of 10 percent and the remaining $200 (net unearned income ($2,000 $900 $900)) would be taxed at his parents marginal rate.

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

39

Additional Standard Deduction 40. The standard deduction for married persons filing jointly for 2008 is $10,900. Dependents do not help qualify a taxpayer for the additional standard deduction. They qualify for three personal exemptions. Support Test: Dependents and Full-Time Students 41. a. Jodi has provided more than 50 percent of her mothers support. Basic Medicare payments do not figure into the computation of support. b. Jodi has not provided over half of her daughters support. The daughter provided $2,400 of her own support. Support Test: Full-Time Students 42. No. Support is determined based on amounts spent. Since Margaret spent $3,500 and her parents contributed only $3,000 toward Margarets support, the parents did not pay over one-half of Margarets support. Multiple Support Agreement 43. Mark and Nancy. To qualify each member of a multiple support agreement must be entitled to claim the individual as a dependent except for the fact that they did not contribute more than one-half of the support but did contribute more than 10 percent of the support. Opel does not qualify since she did not pay more than 10 percent of the total support cost. Fred does not qualify since Myrtle is not related to Fred and did not live with him. Post-1984 Divorce Dependency 44. Annie can claim head of household filing status. She is not required to claim her son as a dependent in order to qualify for head of household status. Phaseout of Exemptions 45. The taxpayer would be allowed a deduction of $6,673 based on the following computation: Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Threshold for phaseout . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess over threshold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Each $2,500 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Number of $2,500s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Number of $2,500s or fractions thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Phaseout rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reduction in personal exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal exemption amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal exemptions (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Initial personal exemption deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal exemption percent allowed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Personal exemption deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Filing Status: Married PersonsJoint and Separate Returns 46. a. Married filing jointly. Marital status is determined as of the last day of the year. b. Married filing separately. To qualify as unmarried under the abandoned spouse rules there must be a dependent child. c. Married filing jointly. A special election can be made to treat the nonresident spouse as a U.S. citizen, otherwise the taxpayer would file married filing separately. $177,250 159,950 $17,300 2,500 6.92 7 2% 1/3 4.67% $3,500 2 $7,000 95.33% $6,673

Chapter 3

40

CCH Federal TaxationComprehensive Topics

Filing Status: Head of Household and Surviving Spouse 47. a. Bill is entitled to file as a surviving spouse, using the same tax rate schedule as married persons filing jointly. However, he is entitled to claim only three personal exemptions in 2008. b. Bill meets the requirements to file as head of household. Parents need not live with the taxpayer. c. Bill must file as single. To qualify as head of household, a taxpayer must be able to claim a married child as a dependent. Dependency exemption is not allowed where a married child files a joint return with the spouse. However, if the joint return were filed only to claim a refund and no tax liability would exist for either spouse on separate returns, then Bill would qualify as head of household. Filing Status: Surviving Spouse 48. 2008Married filing jointly and three personal exemptions. Allowed a joint return in year of death. 2009Surviving spouse with two personal exemptions. 2010Surviving spouse with two personal exemptions. 2011Head of household with two personal exemptions. Filing Status 49. Since Mike and Ellen are not divorced they are still eligible to file as married filing jointly. A second alternative would be for Ellen to file as head of household since she has custody of the children and qualifies as an abandoned spouse, while Mike would have to file as married filing separately. Of course they could each file as married filing separately, but that is less favorable than Ellen filing as head of household. Return Requirements 50. a. No return is required. Rebeccas income is less than the total of the standard deduction amount plus the personal exemption. However, if Rebecca is eligible to be claimed as a dependent of someone else, she is required to file a return because her earned income exceeds $5,450. b. A return is required. Gross income exceeds $17,900 ($10,900 + $3,500 + $3,500). c. A return is required. Earnings from self-employment exceed $400 ($450 .9235 = $415.58). Tax Rate Schedules v. Tax Tables 51. Since their taxable income ($93,900) is less than $100,000, they must use the tax tables. Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (2 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Tax Computation: Single Person 52. Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Deductions for adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions v. $5,450 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax from tax rate schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,000 1,800 $28,200 5,650 3,500 $19,050 $ 2,456 $112,000 11,100 7,000 $93,900

Chapter 3

2008 CCH. All Rights Reserved.

Instructors Manual

41

Income Tax Computation: Various Filing Statuses 53. a. b. c. d. $9,306.25 ($8,962.50 + 25% of $1,375) $12,985.00 ($12,775.00 + 28% of $750) $12,962.50 ($4,481.25 + 25% of $33,925) $11,681.25 ($5,975.00 + 25% of $22,825) $102,000 30,000 $72,000

Self-Employment Tax Computation 54. Maximum subject to self-employment tax and Social Security tax . . . . . . . . . . . . . . . . . . . . . . . . . Less: Wages subject to Social Security tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remaining maximum subject to social security tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$18,470 subject to self-employment taxlesser of $72,000 or $18,470 self-employment income ($20,000 .9235). At 15.3 percent, the tax due is $2,825.91. Income and Self-Employment Tax Computation 55. Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Self-employment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Self-employment loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . /2 of self-employment tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: 1 Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax from tax rate schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Self-employment tax (($24,000 $10,000) .9235 15.3%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Multiple ChoiceFiling Status 56. b. Decedents filing status is married filing separate return. A joint return cannot be filed because his surviving spouse has remarried. Multiple ChoiceSupport Requirements 57. d. Scholarships are ignored in the support computation. Multiple ChoiceHead of Household Requirements 58. d. Parents are not required to reside with the taxpayer for the taxpayer to qualify for head of household status. However, the taxpayer must pay over one-half of the household expenses of the parent. Multiple ChoiceHead of Household Requirements 59. e. In addition to the three requirements given in (a), (b), and (c), except for a child or grandchild, the qualifying person must be a dependent. $20,000 24,000 10,000 3,000 5,100 989 $41,111 5,450 3,500 $32,161 $4,384 1,978.14 $6,362

Chapter 3

42

CCH Federal TaxationComprehensive Topics

Comprehensive ProblemTax Computation 60. Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (5 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax from tax rate schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive ProblemTax Computation 61. Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Deductions for adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Itemized deductions v. $10,900 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Personal exemptions (4 $3,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax from tax rate schedule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $74,000 4,200 $78,200 4,000 $74,200 11,100 14,000 $49,100 $6,563 $43,000 2,100 $45,100 10,900 17,500 $16,700 $1,703

Transferring bonds equally to the children will reduce taxable income by $4,200 and reduce the tax by $630. However, each child will have a taxable income of $1,200 ($2,100 income $900 standard deduction) and will incur a $135 tax. Of each childs $1,200 taxable income, $300 ($2,100 $900 $900) will be taxed at the parents 15 percent tax rate and $900 will be taxed at the childs 10 percent rate. The parents savings of $630 is reduced by a $270 ($135 2) increase in taxes on the children. Research ProblemDivorce and Remarriage 62. According to Rev. Rul. 76-255, taxpayers who obtain a divorce at the end of the year and remarry each other in the first month of the following year are considered to be married at the close of the first year. The divorce is not given any effect for federal income tax purposes if it merely serves the purpose of tax avoidance.

Chapter 3

2008 CCH. All Rights Reserved.