California-Federal ITC Textbook 2015

Income Tax Course
Textbook
2015
Item # D2H124792
Income Tax Course (2015)
Textbook
Product # D2H124792
Income Tax Course (2015)

A Publication of
H&RBlock Services, Inc.
Kansas City, Missouri
Laura Arruda, EA
Daniel Woodard, CPA
This publication was written and produced at

the Client Support Center (CSC).
Disclaimer
The following training was developed by the Client Support Center (CSC) for use by both Companyowned and Franchise-owned offices. Although some aspects of this training may not apply to
employees of a Franchise-owned office, training issues regarding customer service, client experience, tax law, or IRS rules and regulations apply to all Company and Franchise associates. If your
Franchise-office training policies differ from those presented, please bring them to the attention of
your respective Franchisee.
Acknowledgments
This book has been produced with the support of:
Proofreaders: Stephanie Crumpton, Lynne Rice, Jabari Johnson, Kristia Lantz, Nancy
Lowdon, Patricia Potts.
The Editors: Lauren Aspenlieder, Chris Fischer, Connie White, Steve Wilton
Production: Sue Jayaratne, Steve Wilton, Lauren Aspenlieder
The Review Board: Brian Delossantos, Jonathan Meier, Sandra Villanueva, Leslie
Williams, Susan Hammer Cantrell, Rebecca Goodell, Alex Graham, Linda Winfrey, Carlos
Gallastegui, Linda Caton, Christine Grybel, Diane A. Greenberg, Margaret Kropp, Holly
Alspaw, Betty Hughes Balo, Lori J. Cronk
HRB Tax Group, Inc. 2015

Copyright is not claimed in any material secured from official U.S. government sources.
All Rights Reserved
No part of this book may be reproduced or transmitted in any form or by any means, electronic or
mechanical, including photocopying, recording, or by any storage or retrieval system, without
permission in writing from HRB Tax Group, Inc.
Printed in the U.S.A. 2015

The information in this textbook is for general use in teaching an income tax course and is not for the
purpose of rendering legal or other professional services or advice. The information is as timely and
accurate as possible as of the publication date, but because of legislative changes and administrative
interpretations subsequent to that date, caution must be used in the application of any information
contained herein.
REFER A FRIEND
to the
H&R Block
Income Tax Course

If you know someone who would make a great Tax Professional,* refer them to the
H&R Block Income Tax Course. Your friend will get the skills to prepare taxes like a
pro. And youll receive $50 when your friend completes the course.
Visit https://www.hrblockreferafriend.com to submit your referrals. You enter your
friends contact information and well send an email to your friend with information
about the Income Tax Course and a link to enroll. Its that easy.
Please note all referrals must be submitted online to be eligible.
To recommend a friend, visit

https://www.hrblockreferafriend.com
*Enrollment in, or completion of, the H&R Block Income Tax Course is neither an offer nor a
guarantee of employment. Additional qualifications may be required. Enrollment restrictions apply. State
restrictions may apply. Additional training may be required in MD and other states. Valid at participating
locations only. Void where prohibited. H&R Block is an equal opportunity employer. This course is not intended for, nor open to any persons who are either currently employed by or seeking employment with any
professional tax preparation company or organization other than H&R Block.
All referrals must be submitted at https://www.hrblockreferafreind.com and must be recorded prior to the
students enrollment date. If a student is referred by multiple referrers, the first recorded referral will be
used to determine eligibility for payment. Limit maximum five referrals paid per person. OBTP# B13696
2015 HRB Tax Group, Inc.
Table of Contents
INTRODUCTION TO TAXATION
Overview..................................................................................................................................................... 1.1
Objectives.................................................................................................................................................... 1.1
Blended Learning....................................................................................................................................... 1.2
Instructor-Led Sessions.......................................................................................................................... 1.2
Homework............................................................................................................................................ 1.2
Self-Study Sessions................................................................................................................................. 1.2
Participant Materials................................................................................................................................. 1.3
Job Aids................................................................................................................................................... 1.3
Participant Materials............................................................................................................................. 1.3
History and Theory of Income Taxes........................................................................................................ 1.4
The Internal Revenue Service............................................................................................................... 1.4
Who May Practice before the IRS?........................................................................................................... 1.5
Limited Practice for Paid Tax Preparers.............................................................................................. 1.6
Circular 230............................................................................................................................................. 1.6
Layout of an Income Tax Return.............................................................................................................. 1.6
E-file......................................................................................................................................................... 1.7
Tax Research.............................................................................................................................................. 1.7
Tax Law Authority................................................................................................................................. 1.7
Primary Authority.............................................................................................................................. 1.7
Secondary Authority .......................................................................................................................... 1.8
Forms and Publications...................................................................................................................... 1.8
Other Tax Information Resources......................................................................................................... 1.8
Tax Terms................................................................................................................................................... 1.9
Wages, Income, and Taxes........................................................................................................................ 1.9
What is Income?....................................................................................................................................... 1.10
Gross Income......................................................................................................................................... 1.10
The Individual Income Tax Forms......................................................................................................... 1.11
Schedules and Forms........................................................................................................................... 1.11
Statements............................................................................................................................................ 1.22
Worksheets............................................................................................................................................ 1.22
State and Local Tax Returns............................................................................................................... 1.22
Rounding................................................................................................................................................... 1.22
Wages........................................................................................................................................................ 1.23
Form W-2 Wage and Tax Statement................................................................................................. 1.23
Specific Form W-2 Box Information.................................................................................................... 1.24
Box a Employees Social Security Number (SSN)....................................................................... 1.24
Box b Employer Identification Number (EIN)............................................................................ 1.24
Box c Employers Name, Address, and ZIP Code........................................................................ 1.24
Box d Control Number.................................................................................................................. 1.24
Box e/f Employees Name, Address, and ZIP Code..................................................................... 1.24
Box 1 Wages, Tips, Other Compensation.................................................................................... 1.27
Box 2 Federal Income Tax Withheld............................................................................................ 1.27
Box 3 Social Security Wages......................................................................................................... 1.27
Box 4 Social Security Tax Withheld............................................................................................. 1.27
Box 5 Medicare Wages and Tips.................................................................................................. 1.27
Box 6 Medicare Tax Withheld...................................................................................................... 1.27
Box 7 Social Security Tips............................................................................................................. 1.27
i
Box 8 Allocated Tips...................................................................................................................... 1.27

Box 9 No Entry in Box 9............................................................................................................... 1.27
Box 10 Dependent Care Benefits.................................................................................................. 1.28
Box 11 Nonqualified Plans............................................................................................................ 1.28
Boxes 12ad....................................................................................................................................... 1.28
Box 13................................................................................................................................................. 1.28
Box 14 Other.................................................................................................................................. 1.28
Boxes 1520....................................................................................................................................... 1.30
Substitute W-2...................................................................................................................................... 1.30
Unemployment...................................................................................................................................... 1.33
Preparing the Form 1040EZ................................................................................................................... 1.33
Heading the Return.............................................................................................................................. 1.33
Taxpayer Identification Numbers.................................................................................................... 1.33
Determining the Income Tax.................................................................................................................. 1.35
Adjusted Gross Income (AGI).............................................................................................................. 1.35
Taxable Income..................................................................................................................................... 1.36
Using the Tax Table................................................................................................................................. 1.36
Third-Party Designee........................................................................................................................... 1.39
Signing the Return................................................................................................................................... 1.39
Chapter Summary.................................................................................................................................... 1.40
Suggested Reading............................................................................................................................... 1.41
FILING REQUIREMENTS
Overview.................................................................................................................................................... 2.1
Objectives................................................................................................................................................... 2.1
Tax Terms................................................................................................................................................... 2.1
Filing Requirements................................................................................................................................... 2.2
Nondependents........................................................................................................................................... 2.2
Filing Status............................................................................................................................................ 2.2
Common-Law Marriages.................................................................................................................... 2.3
Same-Sex Marriages........................................................................................................................... 2.4
Age........................................................................................................................................................... 2.4
Gross Income........................................................................................................................................... 2.5
Standard Deductions.............................................................................................................................. 2.5
Increased Standard Deductions......................................................................................................... 2.7
Blindness............................................................................................................................................. 2.7
Personal Exemption Amount............................................................................................................. 2.7
Dependent Taxpayers............................................................................................................................. 2.9
Certain Children Under Age 19 or Full-Time Student..................................................................... 2.11
Others Who Must File.......................................................................................................................... 2.12
Taxpayer Should File........................................................................................................................... 2.12
Filing Return Penalties........................................................................................................................... 2.13
Filing Status............................................................................................................................................. 2.13
Single..................................................................................................................................................... 2.13
Married Filing Jointly and Married Filing Separately..................................................................... 2.14
Nonresident Alien Spouse................................................................................................................ 2.15
Injured Spouse Allocation........................................................................................................................ 2.15
Request for Innocent Spouse Relief........................................................................................................ 2.16
Chapter Summary.................................................................................................................................... 2.16
ii
DEPENDENT EXEMPTIONS AND SUPPORT

Overview..................................................................................................................................................... 3.1
Objectives.................................................................................................................................................... 3.1
Tax Terms................................................................................................................................................... 3.1
Dependency Exemptions............................................................................................................................ 3.2
Who Is a Dependent?.............................................................................................................................. 3.2
What Is a Qualifying Child?.............................................................................................................. 3.2
What Is a Qualifying Relative?.......................................................................................................... 3.4
Dependent Taxpayer Test...................................................................................................................... 3.7
Joint Return Test.................................................................................................................................... 3.7
Citizen or Resident Test......................................................................................................................... 3.8
Exception for an Adopted Child......................................................................................................... 3.8
Childs Place of Residence.................................................................................................................. 3.8
Determining Support................................................................................................................................. 3.8
Lodging.................................................................................................................................................... 3.9
Education Expenses............................................................................................................................... 3.9
Items Not Included in Support............................................................................................................ 3.10
Health Insurance Benefits................................................................................................................... 3.10
Multiple Support Agreements............................................................................................................. 3.11
Child Tax Credit....................................................................................................................................... 3.11
Income Phaseout................................................................................................................................... 3.11
Interaction With Other Credits........................................................................................................... 3.14
Computing the Child Tax Credit......................................................................................................... 3.14
Dispensing with the Worksheets..................................................................................................... 3.15
Chapter Summary.................................................................................................................................... 3.15
DEPENDENT-RELATED FILING STATUSES
Overview..................................................................................................................................................... 4.1
Objectives.................................................................................................................................................... 4.1
Tax Terms................................................................................................................................................... 4.1
Filing Statuses and Dependents............................................................................................................... 4.2
Head of Household.................................................................................................................................. 4.2
The Cost of Maintaining a Household.............................................................................................. 4.3
Exceptions to the Head of Household Requirements...................................................................... 4.6
Married, But Unmarried For Tax Purposes..................................................................................... 4.7
Qualifying Widow(er)............................................................................................................................. 4.8
Children of Divorced or Separated Parents............................................................................................. 4.9
Temporary Absences Involving Divorced or Separated Parents........................................................ 4.9
Form 8332............................................................................................................................................. 4.12
Tie-Breaker Rules.................................................................................................................................... 4.13
Chapter Summary.................................................................................................................................... 4.15
INTEREST AND DIVIDEND INCOME
Overview..................................................................................................................................................... 5.1
Objectives.................................................................................................................................................... 5.1
Tax Terms................................................................................................................................................... 5.1
Interest........................................................................................................................................................ 5.2
iii
Schedule B............................................................................................................................................... 5.2

Foreign Investments............................................................................................................................... 5.5
Not Attributable to the Taxpayer......................................................................................................... 5.5
Seller-Financed Mortgage...................................................................................................................... 5.6
Tax-Exempt Interest.............................................................................................................................. 5.6
Form 1099-INTInterest Income............................................................................................................ 5.6
Box 1........................................................................................................................................................ 5.6
Box 2........................................................................................................................................................ 5.6
Penalty on Early Withdrawal of Savings Adjustment.................................................................... 5.6
Box 3........................................................................................................................................................ 5.7
Box 4........................................................................................................................................................ 5.7
Box 5........................................................................................................................................................ 5.7
Box 6........................................................................................................................................................ 5.8
Box 7........................................................................................................................................................ 5.8
Box 8........................................................................................................................................................ 5.8
Box 9........................................................................................................................................................ 5.8
Boxes 10 and 11...................................................................................................................................... 5.8
Box 12...................................................................................................................................................... 5.8
United States Treasury Obligations......................................................................................................... 5.8
Other Interest Income.............................................................................................................................. 5.10
Municipal Bond Interest...................................................................................................................... 5.10
Dividends.................................................................................................................................................. 5.10
Form 1099-DIVDividends and Distributions................................................................................. 5.11
Tax Computation for Qualified Dividends and Capital Gain Distributions....................................... 5.13
Chapter Summary.................................................................................................................................... 5.15
BLOCKWORKS PRACTICE 1
Overview..................................................................................................................................................... 6.1
Instructions................................................................................................................................................. 6.1
EARNED INCOME CREDIT
Overview..................................................................................................................................................... 7.1
Objectives.................................................................................................................................................... 7.1
Tax Terms................................................................................................................................................... 7.1
Credits vs. Deductions............................................................................................................................... 7.2
Child Tax Credit......................................................................................................................................... 7.2
Additional Child Tax Credit...................................................................................................................... 7.3
Earned Income Credit................................................................................................................................ 7.6
Qualifying for EIC...................................................................................................................................... 7.6
Taxpayers Without Qualifying Children.............................................................................................. 7.6
Taxpayers With Qualifying Children................................................................................................... 7.6
Rules for Taxpayers With or Without a Qualifying Child.................................................................. 7.6
Understanding the rules............................................................................................................................ 7.7
Being a Dependent................................................................................................................................. 7.7
Living in the U.S.................................................................................................................................... 7.7
Relationship, Age, Residency, and Joint Return................................................................................. 7.7
Relationship......................................................................................................................................... 7.7
Age........................................................................................................................................................ 7.7
iv
Residency............................................................................................................................................. 7.8
Joint Return........................................................................................................................................ 7.8
Tiebreaker Rules A Reminder............................................................................................................ 7.8
Social Security Numbers........................................................................................................................ 7.8
U.S. Citizen or Resident Alien All Year............................................................................................... 7.8
Form 2555 or Form 2555-EZ................................................................................................................. 7.8
MFS Filing Status.................................................................................................................................. 7.9
Investment Income Limitation.............................................................................................................. 7.9
Support.................................................................................................................................................... 7.9
Being a Qualifying Child....................................................................................................................... 7.9
Computing the Earned Income Credit................................................................................................... 7.11
Step 1 All Filers............................................................................................................................. 7.11
Step 2 Investment Income............................................................................................................ 7.11
Step 3 Qualifying Child................................................................................................................. 7.11
Step 4 Filers Without a Qualifying Child.................................................................................... 7.12
Step 5 Earned Income................................................................................................................... 7.12
Step 6 How to Figure the Credit.................................................................................................. 7.12
Earned Income Credit due diligence...................................................................................................... 7.17
Complete and Submit an Eligibility Checklist.................................................................................. 7.17
Computing the Amount of Credit........................................................................................................ 7.17
Complying With the Knowledge Requirement.................................................................................. 7.17
Retaining Records................................................................................................................................. 7.18
Chapter Summary.................................................................................................................................... 7.24
CREDITS
Overview..................................................................................................................................................... 8.1
Objectives.................................................................................................................................................... 8.1
Tax Terms................................................................................................................................................... 8.1
Credits VS. Deductions.............................................................................................................................. 8.2
Child and Dependent Care Credit............................................................................................................ 8.2
Requirements.......................................................................................................................................... 8.2
Qualifying Persons................................................................................................................................. 8.3
Qualified Expenses................................................................................................................................. 8.3
Computing the Credit............................................................................................................................. 8.4
Credit Limitation................................................................................................................................ 8.6
Employer-Provided Benefits.................................................................................................................. 8.6
Credit for the Elderly or the Disabled.................................................................................................... 8.10
Premium Tax Credit................................................................................................................................ 8.13
Eligibility............................................................................................................................................... 8.13
Tax Household...................................................................................................................................... 8.14
Qualified Health Insurance................................................................................................................. 8.14
Monthly Coverage................................................................................................................................. 8.15
State and Federal Marketplaces......................................................................................................... 8.16
Form 1095-A.......................................................................................................................................... 8.16
Form 8962............................................................................................................................................. 8.17
Part 1.................................................................................................................................................. 8.17
Part 2.................................................................................................................................................. 8.19
Part 3.................................................................................................................................................. 8.19
v
Shared Policy Allocation...................................................................................................................... 8.19

Groups Exempt from the Individual Mandate................................................................................... 8.20
Exemptions Available Due to Circumstances................................................................................ 8.20
Chapter Summary.................................................................................................................................... 8.24
EDUCATION CREDITS
Overview..................................................................................................................................................... 9.1
Objectives.................................................................................................................................................... 9.1
Tax Terms................................................................................................................................................... 9.1
Credits VS. Deductions.............................................................................................................................. 9.2
Education Credits....................................................................................................................................... 9.2
American Opportunity Credit................................................................................................................ 9.2
Who Can Claim the AOC................................................................................................................... 9.2
Who Cannot Claim the AOC.............................................................................................................. 9.3
Qualified Education Expenses........................................................................................................... 9.3
Qualifying Academic Periods............................................................................................................. 9.6
Eligible Student...................................................................................................................................... 9.6
Calculating the AOC.............................................................................................................................. 9.7
Income Limitation............................................................................................................................... 9.7
Form 1098-T............................................................................................................................................ 9.7
Claiming the AOC............................................................................................................................... 9.9
Nonrefundable AOC............................................................................................................................. 9.10
Lifetime Learning Credit......................................................................................................................... 9.10
Qualified Expenses............................................................................................................................... 9.10
Claiming the Lifetime Learning Credit.......................................................................................... 9.11
Tuition and Fees Deduction.................................................................................................................... 9.19
Who Is an Eligible Student?................................................................................................................ 9.19
Who May Claim the Deduction?.......................................................................................................... 9.19
Phaseout of Tuition and Fees Deduction............................................................................................ 9.20
Qualified Expenses............................................................................................................................... 9.20
Tuition and Fees Deduction................................................................................................................. 9.21
Who Can Claim a Dependents Expenses?..................................................................................... 9.21
Chapter Summary.................................................................................................................................... 9.24
RETIREMENT
Overview................................................................................................................................................... 10.1
Objectives.................................................................................................................................................. 10.1
Tax Terms................................................................................................................................................. 10.2
Types of Retirement Plans...................................................................................................................... 10.2
Qualified Plans.................................................................................................................................. 10.2
Nonqualified Plans............................................................................................................................ 10.3
Qualified Plans......................................................................................................................................... 10.3
401(k) Plans.......................................................................................................................................... 10.4
Employer-Matching Contributions.................................................................................................. 10.4
403(b) Plans........................................................................................................................................... 10.4
457 Plans............................................................................................................................................... 10.5
Contribution Limits.............................................................................................................................. 10.5
vi
Identifying Contributions to a Deferred-Compensation Plan........................................................... 10.5

IRAs........................................................................................................................................................... 10.7
Compensation........................................................................................................................................ 10.7
Traditional IRAs....................................................................................................................................... 10.8
Different Sets of Rules......................................................................................................................... 10.8
Who Is an Active Participant?............................................................................................................. 10.8
Taxpayers Who Are Not Active Participants..................................................................................... 10.9
Taxpayers Who Are Active Participants............................................................................................ 10.9
Nonparticipating Spouses.................................................................................................................. 10.10
Roth IRAs................................................................................................................................................ 10.11
Simple IRA.............................................................................................................................................. 10.16
Retirement Savings Contribution Credit............................................................................................. 10.17
Qualified Contributions...................................................................................................................... 10.17
Amount of Credit................................................................................................................................ 10.18
Social Security and Equivalent
Railroad Retirement Benefits................................................................................................................ 10.19
Full Retirement Age........................................................................................................................... 10.21
Reporting Social Security and Equivalent Railroad Retirement Benefits.................................... 10.21
Computing Taxable Benefits............................................................................................................. 10.23
Tier 1 Railroad Retirement Benefits................................................................................................. 10.26
Retirement Account Distributions........................................................................................................ 10.26
Taxable Distribution.............................................................................................................................. 10.28
Simplified Method........................................................................................................................... 10.29
General Rule.................................................................................................................................... 10.31
IRA Distributions................................................................................................................................... 10.33
Early Distributions from Qualified Retirement Plans........................................................................ 10.35
Chapter Summary.................................................................................................................................. 10.38
Suggested Reading............................................................................................................................. 10.38
MIDTERM REVIEW
Overview................................................................................................................................................... 11.1
Instructions............................................................................................................................................... 11.1
MIDTERM EXAM
Overview................................................................................................................................................... 12.1
Instructions............................................................................................................................................... 12.1
TAX ESSENTIALS FORM 1040
Overview................................................................................................................................................... 13.1
Objectives.................................................................................................................................................. 13.1
Tax Terms................................................................................................................................................. 13.1
Form 1040................................................................................................................................................. 13.2
Who Must File Form 1040....................................................................................................................... 13.5
Form 1040 Other Income..................................................................................................................... 13.6
Long-Term Disability Income.............................................................................................................. 13.7
Reporting Disability Benefits........................................................................................................... 13.7
Unreported Tips ................................................................................................................................... 13.8
Allocated Tips...................................................................................................................................... 13.11
vii
Employee Treated as an Independent Contractor........................................................................... 13.11

Alimony................................................................................................................................................ 13.13
Bartering............................................................................................................................................. 13.13
Gambling Winnings............................................................................................................................ 13.13
Line 21 Income.................................................................................................................................... 13.14
Hobby vs. Business Activity........................................................................................................... 13.16
Form 1040 Adjustments..................................................................................................................... 13.16
Certain Business Expenses of Reservists, Performing Artists,
and Fee-Basis Government Officials................................................................................................. 13.16
Health Savings Accounts (HSAs)...................................................................................................... 13.16
Eligibility......................................................................................................................................... 13.17
Qualified Medical Expenses........................................................................................................... 13.18
Contribution Limits........................................................................................................................ 13.18
Form 8889........................................................................................................................................ 13.18
Excess Contributions...................................................................................................................... 13.20
Distributions.................................................................................................................................... 13.21
Nonqualified Distributions Penalty............................................................................................... 13.21
Rollovers.......................................................................................................................................... 13.21
Qualified Distributions to HSAs.................................................................................................... 13.21
Penalty on Early Withdrawal of Savings......................................................................................... 13.22
Alimony................................................................................................................................................ 13.22
Payments That Are Not Alimony.................................................................................................. 13.23
Alimony vs. Child Support............................................................................................................. 13.23
Special Rules Regarding Alimony and Separate Maintenance Payments................................ 13.24
Moving Expenses................................................................................................................................ 13.24
Distance Requirement.................................................................................................................... 13.24
Work Time Requirement................................................................................................................ 13.25
Married Couples.............................................................................................................................. 13.25
Closely Related in Time to Start of Work..................................................................................... 13.25
Closely Related in Place to Start of Work.................................................................................... 13.26
Deductible Moving Expenses......................................................................................................... 13.26
Form 3903........................................................................................................................................ 13.27
Student Loan Interest Deduction...................................................................................................... 13.27
Form 1098-E........................................................................................................................................ 13.30
Who Can Claim the Student Loan Interest Deduction................................................................... 13.30
Computing the Student Loan Interest Deduction........................................................................... 13.30
Other Form 1040 Adjustments to Income........................................................................................ 13.34
Personal Exemption Phaseout ............................................................................................................. 13.34
Personal Exemption Phaseout........................................................................................................... 13.34
Form 1040 Credits.................................................................................................................................. 13.35
Adoption Credit................................................................................................................................... 13.35
When to Claim the Credit.............................................................................................................. 13.36
Qualified Expenses......................................................................................................................... 13.36
Eligible Child................................................................................................................................... 13.36
Credit Phaseout............................................................................................................................... 13.39
First-Time Homebuyer Credit........................................................................................................... 13.39
Repayment....................................................................................................................................... 13.39
Residential Energy Efficient Property Credit.................................................................................. 13.42
Nonbusiness Energy Property Credit............................................................................................... 13.42
Foreign Tax Credit............................................................................................................................. 13.43
viii
Mortgage Interest Credit................................................................................................................... 13.43

General Business Credit.................................................................................................................... 13.43
Credit for Prior-Year Minimum Tax................................................................................................. 13.44
Form 1040 Taxes.................................................................................................................................... 13.44
Net Investment Income Tax (NIIT).................................................................................................. 13.44
Types of Income Subject to the 3.8% NIIT................................................................................... 13.44
Additional Medicare Tax.................................................................................................................... 13.45
Household Employment Tax............................................................................................................. 13.45
Excess Social Security or Tier 1 Railroad Retirement Tax............................................................. 13.46
Chapter Summary.................................................................................................................................. 13.46
TAX ESSENTIALS ITEMIZED DEDUCTIONS I
Overview................................................................................................................................................... 14.1
Objectives.................................................................................................................................................. 14.1
Tax Terms................................................................................................................................................. 14.1
Itemizing vs. Standard Deductions........................................................................................................ 14.2
Medical and Dental Expenses................................................................................................................. 14.4
Medicine and Drugs............................................................................................................................. 14.4
Medical Insurance Premiums.............................................................................................................. 14.4
Long-Term Care Insurance.............................................................................................................. 14.5
Ineligible Insurance.......................................................................................................................... 14.5
Medical and Dental Expenses............................................................................................................. 14.5
Stop-Smoking Programs................................................................................................................... 14.6
Weight-Loss Programs and Surgery............................................................................................... 14.6
Cosmetic Surgery.............................................................................................................................. 14.6
Medical Aid Items and Equipment..................................................................................................... 14.6
Capital Expenditures........................................................................................................................... 14.7
Transportation...................................................................................................................................... 14.7
Meals and Lodging............................................................................................................................... 14.8
Special Care.......................................................................................................................................... 14.8
Cafeteria Plans..................................................................................................................................... 14.9
Reimbursement for Medical Expenses............................................................................................... 14.9
Excess Reimbursements....................................................................................................................... 14.9
Determining the Medical and Dental Expense Deduction................................................................... 14.9
Taxes You Paid....................................................................................................................................... 14.10
State and Local Taxes........................................................................................................................ 14.10
Income Taxes................................................................................................................................... 14.10
Sales Taxes...................................................................................................................................... 14.10
Real Estate Taxes............................................................................................................................... 14.14
Personal Property Taxes.................................................................................................................... 14.14
Foreign Taxes...................................................................................................................................... 14.14
Nondeductible Taxes.......................................................................................................................... 14.14
Interest You Paid................................................................................................................................... 14.15
Qualified Home Mortgage Interest................................................................................................... 14.15
Prepaid Interest.................................................................................................................................. 14.17
Points............................................................................................................................................... 14.17
Reporting Home Mortgage Interest on Schedule A......................................................................... 14.19
Qualified Mortgage Insurance Premiums........................................................................................ 14.19
Investment Interest............................................................................................................................ 14.20
ix
Nondeductible Interest....................................................................................................................... 14.20

Charitable Contributions....................................................................................................................... 14.21
Cash Donations................................................................................................................................... 14.22
Volunteer Work................................................................................................................................... 14.23
Contributions of Property.................................................................................................................. 14.24
Chapter Summary.................................................................................................................................. 14.26
TAX ESSENTIALS ITEMIZED DEDUCTIONS II
Overview................................................................................................................................................... 15.1
Objectives.................................................................................................................................................. 15.1
Tax Terms................................................................................................................................................. 15.1
Casualty and Theft Losses...................................................................................................................... 15.2
Proof of Loss.......................................................................................................................................... 15.2
Amount of the Casualty or Theft Loss................................................................................................ 15.3
When to Deduct a Loss........................................................................................................................ 15.4
Net Operating Losses........................................................................................................................... 15.5
Form 4684 Casualties and Thefts........................................................................................................ 15.5
Miscellaneous Deductions........................................................................................................................ 15.7
Expenses Subject to the 2% Limitation.............................................................................................. 15.7
Transportation Expenses................................................................................................................. 15.9
Education Expenses........................................................................................................................... 15.11
Job-Seeking Expenses........................................................................................................................ 15.13
Other Employment-Related Deductions........................................................................................... 15.13
Tax Preparation Fees......................................................................................................................... 15.14
Investment Expenses......................................................................................................................... 15.14
Hobby Expenses.................................................................................................................................. 15.15
Nondeductible Expenses.................................................................................................................... 15.15
Other Miscellaneous Deductions.......................................................................................................... 15.16
Gambling Losses to the Extent of Winnings.................................................................................... 15.16
Itemized Deduction Phaseout............................................................................................................... 15.17
Alternative Minimum Tax..................................................................................................................... 15.17
Credit for Prior-Year Minimum Tax................................................................................................. 15.18
Recovery of a Prior Years Itemized Deduction................................................................................... 15.18
Partially Taxable................................................................................................................................ 15.21
Summary................................................................................................................................................. 15.25
Overview................................................................................................................................................... 16.1
Instructions............................................................................................................................................... 16.1
TAX ESSENTIALS SELF-EMPLOYMENT INCOME
Overview................................................................................................................................................... 17.1
Objectives.................................................................................................................................................. 17.1
Tax Terms................................................................................................................................................. 17.1
The Sole Proprietor.................................................................................................................................. 17.2
Accounting Periods................................................................................................................................... 17.3
Schedule C, The Heading........................................................................................................................ 17.4
x
Schedule C, Part I, Income...................................................................................................................... 17.7

Schedule C, Part III.............................................................................................................................. 17.9
Schedule C, Part II, Expenses............................................................................................................... 17.10
Other Self-Employment-Related Topics............................................................................................... 17.14
Direct Sellers....................................................................................................................................... 17.14
At-Risk Limitation.............................................................................................................................. 17.15
Net Operating Loss............................................................................................................................. 17.15
Self-Employment Tax............................................................................................................................. 17.18
Self-Employed Health Insurance Deduction........................................................................................ 17.19
Home-Office Expenses........................................................................................................................... 17.21
Who Can Deduct Home-Office Expenses?........................................................................................ 17.21
Figuring the Deduction...................................................................................................................... 17.23
Using the Simplified Method............................................................................................................. 17.23
What Expenses Are Deductible under the Actual Expenses Method?.......................................... 17.25
Form 8829............................................................................................................................................... 17.25
Farming Income..................................................................................................................................... 17.27
Course Summary.................................................................................................................................... 17.28
TAX ESSENTIALS DEPRECIATION
Overview................................................................................................................................................... 18.1
Objectives.................................................................................................................................................. 18.1
Tax Terms................................................................................................................................................. 18.2
Depreciation.............................................................................................................................................. 18.2
Depreciable Basis..................................................................................................................................... 18.4
Form 4562 ................................................................................................................................................ 18.5
Amortizing................................................................................................................................................ 18.8
Methods Used to Depreciate Property.................................................................................................... 18.8
MACRS...................................................................................................................................................... 18.8
General Depreciation System (GDS)...................................................................................................... 18.9
Computing the MACRS GDS Depreciation Deduction..................................................................... 18.9
Half-Year, Mid-Quarter, and Mid-Month Conventions...................................................................... 18.11
Half-Year Convention......................................................................................................................... 18.11
Mid-Quarter Convention.................................................................................................................... 18.12
Mid-Month Convention...................................................................................................................... 18.12
MACRS Percentage Tables.................................................................................................................... 18.12
Computing MACRS GDS Depreciation Deduction for Real Property............................................... 18.14
Residential Rental Real Property ................................................................................................. 18.14
Nonresidential Real Property........................................................................................................ 18.16
Reporting MACRS Depreciation on the Tax Forms............................................................................ 18.17
Depreciation Worksheet..................................................................................................................... 18.17
Reporting Depreciation on Form 4562 ............................................................................................ 18.22
Alternative Depreciation System (ADS)............................................................................................... 18.24
Listed Property....................................................................................................................................... 18.25
Restrictions.......................................................................................................................................... 18.25
179 Depreciation Deduction................................................................................................................ 18.26
Other 179 Restrictions..................................................................................................................... 18.33
Special Depreciation Allowance............................................................................................................ 18.34
Mid-Quarter Convention....................................................................................................................... 18.37
xi
Which Assets to Include..................................................................................................................... 18.40

Depreciation Recapture......................................................................................................................... 18.41
Tangible Property Regulations (TPRs)................................................................................................. 18.41
Chapter Summary.................................................................................................................................. 18.42
TAX ESSENTIALS PASSIVE INCOME
Overview................................................................................................................................................... 19.1
Objectives.................................................................................................................................................. 19.1
Tax Terms................................................................................................................................................. 19.1
Passive Income......................................................................................................................................... 19.2
Real Estate Professional...................................................................................................................... 19.2
Trade or Business Activities................................................................................................................ 19.2
Nonpassive Income............................................................................................................................... 19.3
Rental Income and Expenses.................................................................................................................. 19.6
Gross Rent............................................................................................................................................. 19.6
Rental Expenses................................................................................................................................... 19.6
Depreciation.......................................................................................................................................... 19.8
Personal and Rental Use of Property................................................................................................. 19.9
Vacation Homes................................................................................................................................ 19.9
Rental Not for Profit........................................................................................................................... 19.14
Royalties.................................................................................................................................................. 19.14
Depletion................................................................................................................................................. 19.15
Cost Depletion................................................................................................................................. 19.16
Percentage Depletion...................................................................................................................... 19.17
Other Schedule E Income...................................................................................................................... 19.17
Estates and Trusts............................................................................................................................. 19.17
Partnerships........................................................................................................................................ 19.17
Subchapter S Corporations................................................................................................................ 19.18
Passive Loss Rules................................................................................................................................. 19.19
Active-Participation Rental Activities........................................................................................... 19.20
Working Interest in Oil and Gas Properties................................................................................ 19.21
Chapter Summary.................................................................................................................................. 19.21
Overview................................................................................................................................................... 20.1
Instructions............................................................................................................................................... 20.1
TAX ESSENTIALS PENALTIES AND AMENDED RETURNS
Overview................................................................................................................................................... 21.1
Objectives.................................................................................................................................................. 21.1
Tax Terms................................................................................................................................................. 21.1
Other Tax Penalties................................................................................................................................. 21.1
Failure-to-File Penalty......................................................................................................................... 21.2
Failure-to-Pay Penalty......................................................................................................................... 21.2
Combined Penalties.............................................................................................................................. 21.2
Penalty Exceptions............................................................................................................................... 21.3
Failure-to-File.................................................................................................................................... 21.3
xii
Failure-to-Pay.................................................................................................................................... 21.3
Amended Returns..................................................................................................................................... 21.3
Due Date for Filing Form 1040X......................................................................................................... 21.3
Form 1040X........................................................................................................................................... 21.4
Changing Amounts........................................................................................................................... 21.4
Income and Deductions.................................................................................................................... 21.5
Tax Liability...................................................................................................................................... 21.6
Payments........................................................................................................................................... 21.6
Refund or Amount You Owe............................................................................................................ 21.9
Exemptions........................................................................................................................................ 21.9
Presidential Election Campaign Fund............................................................................................ 21.9
Explanation of Changes................................................................................................................... 21.9
Signature......................................................................................................................................... 21.10
Interest on Refunds............................................................................................................................ 21.10
Amended Returns in BlockWorks......................................................................................................... 21.10
Demonstration Information............................................................................................................... 21.11
The Process......................................................................................................................................... 21.19
Household Employment Taxes.............................................................................................................. 21.19
Course Summary.................................................................................................................................... 21.20
Research Question.............................................................................................................................. 21.20
TAX ESSENTIALS TAX PLANNING
Overview................................................................................................................................................... 22.1
Objectives.................................................................................................................................................. 22.1
Tax Terms................................................................................................................................................. 22.1
Pay As You Go.......................................................................................................................................... 22.2
Withholding.............................................................................................................................................. 22.2
Form W-4............................................................................................................................................... 22.3
Page 2 Worksheets............................................................................................................................. 22.10
Supplemental Wages...................................................................................................................... 22.12
Other Withholding Forms.................................................................................................................. 22.12
Pensions........................................................................................................................................... 22.12
Sick Pay........................................................................................................................................... 22.12
Gambling Winnings........................................................................................................................ 22.13
Unemployment Compensation....................................................................................................... 22.13
Social Security Benefits.................................................................................................................. 22.13
Education Tax Planning........................................................................................................................ 22.14
Education Savings Bond Program................................................................................................. 22.14
Coverdell Education Savings Account (ESA)............................................................................... 22.16
Estimated Tax........................................................................................................................................ 22.17
Computation of Estimated Tax......................................................................................................... 22.18
When to Pay Estimated Tax.............................................................................................................. 22.21
Underpayment of Estimated Tax...................................................................................................... 22.22
Completing Form 2210....................................................................................................................... 22.23
Computing the Penalty...................................................................................................................... 22.24
Extensions............................................................................................................................................... 22.27
Automatic Extension.......................................................................................................................... 22.27
Outside the United States................................................................................................................. 22.27
Serving in Combat Zone..................................................................................................................... 22.28
xiii
Direct Deposit of Refund to More than One Account.......................................................................... 22.29

IRAs..................................................................................................................................................... 22.29
TreasuryDirect Account.................................................................................................................. 22.29
U.S. Series I Savings Bonds.............................................................................................................. 22.29
Installment Agreement Request........................................................................................................... 22.30
Payment Methods............................................................................................................................... 22.30
Chapter Summary.................................................................................................................................. 22.32
TAX ESSENTIALS CAPITAL ASSETS
Overview................................................................................................................................................... 23.1
Objectives.................................................................................................................................................. 23.1
Tax Terms................................................................................................................................................. 23.1
Introduction to Property.......................................................................................................................... 23.2
Types of Property.................................................................................................................................. 23.2
Uses of Property.................................................................................................................................... 23.2
Capital Assets........................................................................................................................................... 23.3
Basis.......................................................................................................................................................... 23.4
Holding Period.......................................................................................................................................... 23.5
Gain or Loss.............................................................................................................................................. 23.5
Form 1099-B........................................................................................................................................... 23.12
Capital Gains Tax Rates........................................................................................................................ 23.13
Normal Capital Gains........................................................................................................................ 23.14
28% Gain............................................................................................................................................. 23.14
Taxable Gain or Deductible Loss.......................................................................................................... 23.18
Capital Loss Carryover.......................................................................................................................... 23.21
Form 1099-S............................................................................................................................................ 23.27
Sale of Taxpayers Home....................................................................................................................... 23.27
Chapter Summary.................................................................................................................................. 23.28
ETHICS
Overview................................................................................................................................................... 24.1
Objectives.................................................................................................................................................. 24.1
Tax Terms................................................................................................................................................. 24.1
Due Diligence............................................................................................................................................ 24.2
Accurate and Complete........................................................................................................................ 24.2
Thorough Interview.............................................................................................................................. 24.2
Reasonability Check............................................................................................................................. 24.2
BlockWorks Notes............................................................................................................................. 24.2
Conflict of Interest.................................................................................................................................... 24.3
Exceptions to Conflict of Interest Rules............................................................................................. 24.4
Taxpayer Confidentiality......................................................................................................................... 24.4
Privileged Communications................................................................................................................. 24.5
Privilege Under 7525 Is Narrow.................................................................................................... 24.5
Unenrolled Tax Return Preparers ..................................................................................................... 24.5
Annual Filing Season Program Participants................................................................................. 24.5
PTIN Holders.................................................................................................................................... 24.6
Noncompliance.......................................................................................................................................... 24.6
xiv
Disreputable Conduct.............................................................................................................................. 24.6

Examples of Disreputable Conduct..................................................................................................... 24.7
Sanctions Related to Disreputable Conduct....................................................................................... 24.7
Terminology....................................................................................................................................... 24.8
Chapter Summary.................................................................................................................................... 24.9
STATE-SPECIFIC TRAINING
California.................................................................................................................................................. 25.1
FINAL EXAM REVIEW
Overview................................................................................................................................................... 26.1
Instructions............................................................................................................................................... 26.1
FINAL EXAM
Overview................................................................................................................................................... 27.1
Instructions............................................................................................................................................... 27.1
xv
Introduction to Taxation
OVERVIEW
The hardest thing to understand is the income tax.
Albert Einstein, Physicist
Congratulations on enrolling in the H&R Block Income Tax Course (2015). You are embarking on a
course of study that is challenging and ever-changing. This course will provide a solid foundation on
the subject of taxes, and the preparation of an accurate and complete income tax return.
The course is designed to teach four primary concepts:
Tax theory and law. The course covers federal and state tax law.
Conducting a thorough taxpayer interview.
Offering tax advice and explanations to taxpayers.
Electronic tax preparation through the usage of BlockWorks tax preparation software.
You will understand and develop the ability to explain income taxes in a way that Albert Einstein
could not, undoubtedly because he did not have the benefit of the H&R Block Income Tax Course
(2015)!
OBJECTIVES
This chapter will introduce you to the course schedule, course materials, and information on how to
successfully complete the course. We will then begin an introduction into the exciting field of income
tax! At the conclusion of this chapter, you will know:
Who may practice before the IRS.
The layout of an income tax return.
The role research plays for a Tax Professional.
How to define the various types of income.
How to round cents to the nearest dollar and percentages to two places past the decimal point.
How to interpret the information found on Form W-2, and where it is entered on Form 1040EZ.
How to complete the heading and signature sections of an income tax return.
How to compute Adjusted Gross Income (AGI) and taxable income on Form 1040EZ.
How to determine tax liability using the Tax Tables.
1.1
1.2 H&R Block Income Tax Course (2015)
BLENDED LEARNING
The H&R Block Income Tax Course features a blended-learning approach for participants. It combines instructor-led sessions taught by experienced Tax Professionals with self-study. This innovative
approach provides participants with the best features of classroom instruction and the flexibility and
convenience of self-study.
Instructor-Led Sessions
This course includes 48 hours of instructor-led sessions facilitated by experienced instructors. The
sessions are a combination of tax theory training and software practice. The instructors will show you
how the return is prepared in BlockWorks, giving you adequate exposure to the software before you
actually start using it later in the course.
The instructor-led sessions consist of:
Reviewing and expanding on the tax knowledge you gained from reading the textbook.
Reviewing and explaining the workbook exercises, including the solutions to the hand-prepared
income tax returns.
Software demonstrations and practice in most sessions.
Homework
Prior to arriving for each instructor-led session, you should have:
Read the assigned chapter(s) of the textbook. This includes both federal and state books.
Completed the workbook exercises, including hand-preparing the tax returns.
Written down any questions you have about any of the assignments, including the self-study
chapters.
Homework Tip: Make the effort to familiarize yourself with all forms and schedules. You need to
know where the numbers come from, and where they show up on the return. You should know which
forms and schedules apply to various income documents and tax situations.
This is a challenging course. Do not cheat yourself by trying to get through your reading or workbook
assignments quickly. Make sure you understand the material in each chapter before moving on to the
next chapter. Each chapter builds upon the knowledge you gained from previous chapters.
Self-Study Sessions
This course includes six self-study sessions. The amount of time spent on self-study assignments will
vary by student. You will receive two hours of Qualifying Education (QE) credit for each self-study
session, with the exception of the midterm review, which is one hour of QE. We all have different
learning styles, and as an adult learner, you certainly know what works best for you.
The self-study sessions are comprised of completing the following tasks in the following order:
Reading the assigned chapters of the textbook.
Completing the respective workbook exercises, including hand-preparing income tax returns.
Completing the web-based training (WBT) modules that supplement the textbook and workbook.
Introduction to Taxation 1.3
Your effort with the self-study assignments will directly affect your comprehension of important tax
topics that will be incorporated throughout the course.
PARTICIPANT MATERIALS
You should familiarize yourself now with the materials provided to you in this course. We all have
different ideas of organization. You are encouraged to tab or label the books as you see fit. Your
instructor may have suggestions, or your fellow participants may share their ideas when you attend
an instructor-led session.
Job Aids
Tax Computation Process.
Filing Status.
A Dependent Is
BlockWorks Hot Keys card.
Participant Materials
The following items are available from your instructor:
Important Notice to Potential and Incoming Students of H&R Blocks Income Tax Course.
Computer Usage Agreement.
Course syllabus.
Course schedule.
Textbooksone with federal tax content and one with state tax content, where applicable.
Workbook, including a forms section for preparing tax returns.
WBT access.
The graphic job aids will help visual learners understand fundamental tax concepts. They should
be referred to as often as necessary. The BlockWorks Hot Keys card will be needed once you begin
preparing income tax returns on the computer. You should become very familiar with the hot keys.
You may use your textbook to help you complete any of the exercises in the workbook or the WBTs.
For your convenience, a PDF copy of the textbook is posted in the same location as the WBTs. You
can use the search for keywords by right-clicking in the PDF, scrolling down to Find, typing in the
tax topic you need to find and hitting enter on your keyboard.
Your instructor will be able to address any course-related questions. The focus of this chapter will now
begin your introduction to the field of taxation.
HISTORY AND THEORY OF INCOME TAXES

Taxes are what we pay for civilized society.
Oliver Wendell Holmes, Jr., U.S. Supreme Court Justice
After the U.S. Constitution was ratified in 1788, federal revenues were raised through tariffs and
excise taxes. The Civil War required much more revenue for the federal government than the tariffs
and excise taxes could raise. The income tax was established in 1862 but was repealed in 1872, after
the war.
On February 3, 1913, the states ratified the 16th Amendment to the U.S. Constitution. It reads:
The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived,
without apportionment among the several States, and without regard to any census or enumeration.
The U.S. income tax is considered progressive, because it taxes a larger percentage of income on higher-income taxpayers than on lower-income taxpayers.
Our communities receive public goods and services paid for by the federal government with money
raised through income taxes. Governments use the money collected to pay for items such as public
roadways, schools, and libraries. Tax revenue is also used to pay for services, such as police and fire
protection, subsidized school lunches, and defense funding.
The Internal Revenue Service

The Internal Revenue Service oversees the execution of the Internal Revenue Code, as enacted by
Congress. The IRS administers the Tax Code by collecting income taxes and advocating taxpayer
compliance.
The IRS Mission, according to the IRS website:
Provide Americas taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.
This mission statement describes our role and the publics expectation about how we should perform
that role.
In the United States, the Congress passes tax laws and requires taxpayers to comply.
The taxpayers role is to understand and meet his or her tax obligations.
The IRS role is to help the large majority of compliant taxpayers with the tax law, while ensuring
that the minority who are unwilling to comply pay their fair share.
WHO MAY PRACTICE BEFORE THE IRS?

Practice before the IRS covers all matters related to the following:
Communicating with the IRS for a taxpayer regarding the taxpayers rights, privileges, or liabilities under laws and regulations administered by the IRS.
Representing a taxpayer at conferences, hearings, or meetings with the IRS.
Preparing and filing documents, including tax returns, with the IRS for a taxpayer.
Providing a taxpayer with written advice which has a potential for tax avoidance or evasion.
Furnishing information at the request of the IRS or appearing as a witness for a taxpayer is not practice before the IRS.
Five categories of professionals can practice before the IRS:
1. Attorneys who are members in good standing of the bar of the highest court in a state or the
District of Columbia.
2. Certified Public Accountants (CPAs) are accountants who are qualified and licensed by a state,
possession, territory, commonwealth, or the District of Columbia to practice as CPAs.
3. Enrolled Agents (EAs) are individuals who have enrolled with the IRS and have remained in
active status.
4. Enrolled actuaries are enrolled as actuaries by the Joint Board for the Enrollment of Actuaries.
Actuaries are individuals who assess the financial consequences of risks, and use mathematics,
statistics, and financial theory to analyze and determine the financial impact of uncertain future
events. However, their practice before the IRS is limited to matters related to sections of the
Internal Revenue Code (IRC) within their area of expertise (primarily sections governing employee retirement plans).
5. Enrolled retirement plan agents, like EAs, are individuals who have been approved for active
enrolled retirement plan agent status by the IRS. However, their practice before the IRS is limited to matters related to sections of the IRC within their area of expertise (primarily sections
governing employee retirement plans).
Limited Practice for Paid Tax Preparers

Paid tax preparers do not have all of the privileges to practice before the IRS that are given to
Enrolled Agents, CPAs, and attorneys. A paid tax preparer may represent a taxpayer before revenue
agents, customer service representatives, or similar officers and employees of the IRS, including the
Taxpayer Advocate Service, during an examination, if the paid tax return preparer signed the tax
return or claim for refund that is under examination.
A paid tax return preparer cannot:
Represent a taxpayer before any of these IRS officers: appeals, revenue, counsel, or similar officers
and employees of the IRS.
Provide tax advice other than advice necessary to prepare a return, a claim for refund, or other
document intended to be submitted to the IRS.
mExample: Sam is a paid tax return preparer who prepares and signs Megs tax return every year.
Meg received a CP 2000 Notice (a letter to the taxpayer proposing changes to one of her tax returns.
If Meg wants Sam to help her, he may contact the IRS on her behalf to request a 30-day extension,
prepare a response to the letter, and provide the IRS with more information. If Meg disagrees with
the letter and wants to appeal, she will have to do so through the IRS Office of Appeals where she can
represent herself or seek help from an Enrolled Agent, CPA, or attorney.m
Circular 230
Circular 230 is a publication that covers U.S. Treasury regulations on the rules governing practice before the IRS. These rules require attorneys, those qualified to practice as Certified Public
Accountants, Enrolled Agents, and others persons who prepare tax returns and provide tax advice
to conduct business with high ethical standards that protect the taxpayers. Circular 230 also covers
prohibited conduct and the penalties for noncompliance. You should familiarize yourself with Circular
230.
LAYOUT OF AN INCOME TAX RETURN

Forms 1040EZ, 1040A, and 1040 are the base forms of most individual income tax returns. There are
guidelines to determine which form is appropriate for each taxpayer. In addition, numerous other
forms and schedules are required to support the line entries on these base forms. Tax preparation
software automatically generates the forms, schedules, and worksheets according to the information
the Tax Professional inputs.
Tax Professionals should be able to explain the final income tax return to taxpayers. They should be
comfortable with the layout and be able to easily identify the location of the following sections and
how they affect each other:
Income.
Adjustments.
Tax.
Credits
Other Taxes.
Payments.
Refund or Balance Due.
E-file
As of January 1, 2012, any tax return preparer who prepares and files 11 or more Forms 1040, 1040A,
1040EZ, and 1041 during a calendar year, must use IRS e-file (unless the preparer or a particular
return is exempt from the e-file requirement or the return is filed by a preparer with an approved
hardship waiver). Authorized e-file providers are required to:
Manage the e-file process as directed by the IRS.
Protect the privacy of all e-filed documents.
Practice due diligence on behalf of taxpayers in regards to accepted and rejected returns.
TAX RESEARCH
Tax research skills are important to all Tax Professionals. You will not learn everything you need to
know about a tax topic in any one tax course. You will inevitably have questions that have not been
addressed.
Tax Law Authority

There are many tax research resources available. It is important to know which law has precedence,
based on authority. In tax law there are two authorities, primary and secondary.
Primary authority
Primary authority for tax issues consists of:
The Internal Revenue Code.
Regulations issued by the Treasury Department.
Judicial decisions.
Primary authority sources, as listed above in descending order of authority, are the highest authority
in determining the answer to tax-related questions.
Secondary authority
Secondary authority examples are
Commentaries.
Publications.
Tax periodicals.
Common reference materials such as dictionaries and encyclopedias.
Secondary authority sources can help you understand the intent of the law, or provide an interpretation of the law. They are not binding authority.
Although secondary sources are not binding, they can provide what is known as persuasive authority.
For example, the published work of a tax scholar may influence how the IRS executes the law, influences the opinion of a court, or assists in legislation changes.
The IRS website, <www.irs.gov>, is comprehensive and informative. The search function is similar to
most search engines on the Internet. It is not case-sensitive and has advanced search capabilities. It
is to your benefit to familiarize yourself with the content and the navigation of the site.
Primary reasons to use the IRS website:

Researching tax topics.
Information on news and training specific to Tax Professionals.
Obtaining copies of forms, schedules, and publications.
Forms and Publications
The Forms and Publications section of the IRS website provides links to download and print forms,
publications, and schedules. Schedules are found in the Forms section.
The forms and schedules provided in the forms section of your workbook were current as of the date
this course was printed. The IRS does not update all forms and schedules every year. You may see
forms that have a year other than 2014 printed on them.
Other Tax Information Resources
Working Tax Professionals have access to other research services and publications. Some require fees,
and others are benefits of membership. H&R Block Tax Professionals receive complimentary research
services provided by the Tax Research Center from The Tax Institute (TTI) at H&R Block. TTI publishes a weekly newsletter called, Tax in the News. At the end of most chapters in this course, you will
see an example of questions that TTI answers for Tax Professionals. These questions and answers will
give you an idea of how tax theory is applied to taxpayer circumstances.
TTI endorses The Tax Book, published by Tax Materials, Inc., as the exclusive in-office tax reference
book. TTI, in partnership with Tax Materials, makes a customized copy of federal and state material
available to each office.
H&R Block Tax Professionals may purchase a copy of these reference materials at their own expense
for the same reduced rate.
TAX TERMS
Look up the definitions of the following terms in the glossary:
Adjusted Gross Income.
Credits.
Earned income.
Exemption.
Federal income tax withheld.
Gross income.
Income.
Medicare Part A.
Social security tax withheld.
Social security wages.
Tax liability.
Taxable income.
Unearned income.
WAGES, INCOME, AND TAXES

A wage is compensation, usually financial, received by workers in exchange for their work. The
Internal Revenue Service (IRS) states that wages received by an employee for performing services for
an employer must be included in gross income (defined later in this chapter).
This chapter focuses on wages as income and how that income is taxed by the federal and most state
governments. You will examine the different tax forms used to report income and taxes to those governments. You will also learn how wages are reported to an employee by an employer. Finally, you
will complete a simple tax return.
WHAT IS INCOME?
Generally speaking, income is financial gain derived from labor (work), capital (money), or a combination of the two. The financial gain derived from labor is generally referred to as wages. Unless specifically exempt or excluded by law, all income is subject to income tax and is reported on a tax return.
Gross Income
Gross income means all world-wide income from whatever source derived, unless specifically excluded
from taxation by law. Gross income includes income realized in any form, whether in money, property,
or services.
See Illustration 1.1 on the next page for some items of income both included and excluded from gross
income.
Illustration 1.1
SOME ITEMS OF INCOME

INCLUDED IN GROSS INCOME*
SPECIFICALLY EXCLUDED FROM

GROSS INCOME**
Compensation for services, including fees, commissions, and certain fringe benefits
Life insurance payments, if paid by reason of

the death of the insured
Net income derived from business
Gifts and inheritances
Gains derived from dealings in property
Interest on state and local bonds
Interest
Compensation for personal injuries
Rents
Qualified clergy housing allowances
Royalties
Federal income tax refunds
Dividends
Qualified scholarships and fellowships
Alimony and separate maintenance payments
Meals or lodging furnished for the convenience

of the employer
Income from life insurance and endowment con- Certain foster care payments
tracts
Pensions
Disaster relief payments
Certain income from the discharge of indebtedness
Certain income from the discharge of indebtedness
Distributive share of partnership gross income

Income in respect of a decedent
Income from an interest in an estate or trust
*Gross income not limited to these items

**Other excluded items are beyond the scope of
this course
There are two types of gross income:

Earned income is received for services performed. Some examples are wages, commissions, tips,
and, generally, farming and other business income.
Note: Disability retirement benefits qualify as earned income until the taxpayer reaches minimum
retirement age. Minimum retirement age is the earliest age the taxpayer could have received a pension or annuity if they did not have the disability. Social security disability payments, Social Security
Disability Insurance (SSDI)payments, and military disability pension payments are not considered
earned income.
Unearned income is taxable income that does not meet the definition of earned income. It includes
money received for the investment of money or other property, such as interest, dividends, rents,
and royalties. It also includes pensions, alimony, unemployment compensation, and other income
that is not from performing services.
Note: Social security benefits may be included in taxable income. Benefits are included in the taxable
income (to the extent they are taxable) of the person who has the legal right to receive the benefits.
You will learn more about social security benefits when you read about retirement distributions.
Complete Exercise 1.1 before continuing to read.
THE INDIVIDUAL INCOME TAX FORMS

U.S. citizens and resident aliens are required to file Form 1040EZ, Form 1040A, or Form 1040.
Nonresident aliens who are required to file a U.S. return file Form 1040NR. Residents of Puerto
Rico file Form 1040PR. Completion of Forms 1040NR and 1040PR are not discussed in this course.
For more information, see IRS Publication 519, U.S. Tax Guide for Aliens, or Publication 179, Guia
Contributiva Federal para Patronos Puertorriqueos. Examine the copies of Form 1040EZ, Form
1040A, Form 1040, Form 1040NR, and Form 1040PR, found in Illustrations 1.21.11. Note the similarities and differences. Only the first two pages of Form 1040NR and the first two pages of Form
1040PR are shown. With only 14 lines, Form 1040EZ is the simplest to complete. Form 1040A, popularly referred to as the short form, is getting fairly long, as new items are added almost every
Form 1040, also known as the long form, is the most comprehensive of the three forms. Generally,
additional schedules and forms are required when a taxpayer uses Form 1040A, Form 1040, Form
1040NR, or Form 1040PR.
Schedules and Forms

Schedules and forms are official IRS documents used to report various types of income, deductions,
and credits. Totals determined on each schedule or form are entered on the appropriate line of Form
1040A or Form 1040 or occasionally on another schedule. Schedules and forms are part of the return
and are submitted to the IRS along with Form 1040A, Form 1040, Form 1040NR, and Form 1040PR.

Illustration 1.2

Illustration 1.3

Illustration 1.4

Illustration 1.5

Illustration 1.6

Illustration 1.7

Illustration 1.8

Illustration 1.9

Illustration 1.10

Illustration 1.11
Statements
Statements may or may not be official IRS forms. They are attached to the return to explain various
types of income, deductions, and credits reported either on a schedule or directly on Forms 1040EZ,
1040A, 1040, 1040NR, or 1040PR.
Worksheets
Worksheets are not sent to the IRS with the return. They are useful in compiling information and are
kept with the taxpayers copy of the return. You will be using various worksheets in many exercises
and review problems during this course.
State and Local Tax Returns

Most states and some cities require residents and individuals who earn income or own property within
their jurisdictions to file state and/or local returns. This course will cover state content as it is applicable to your geographic area.
ROUNDING
The IRS prefers rounding cents to the nearest dollar on all individual income tax returns. This course
adopts this procedure throughout. Rounding increases the accuracy and efficiency of each computation. When rounding cents, (50) fifty cents through ninety-nine cents (99) are rounded up to the
next highest dollar. One cent (1) through forty-nine cents (49) are simply dropped. Unless otherwise
specified, percentages are rounded to two places past the decimal point.
mExample: A total of $23.50 is rounded up to $24; $23.49 is rounded down to $23.m
mExample: The 3.454% rounds to 3.45% (or .0345 as a decimal); 3.456% rounds to 3.46% (or .0346 as
a decimal).m
When rounding income from multiple source documents, Publication 17 says to include cents when
adding the amounts and round off only the total. In this course, we round the amount on each document before entering it into the software.
ax Tip: The instructions in most IRS publications say to round the total,
but when filing electronically, the amounts from each source document
must be rounded. Each Form W-2 is entered into the computer; however, IRS
electronic filing specifications do not allow for the entry of cents.
mExample: Heather received three Forms W-2. The first shows $2,368.43 wages, the second
$5,299.37, and the third $1,022.46. If she adds the amounts together before rounding, her total is
$8,690.26, rounded to $8,690. If she rounds the amount on each document before adding them, her
total is $8,689 [$2,368 + $5,299 + $1,022 = $8,689].m
WAGES
One type of income familiar to just about everyone is wages. Most taxpayers are employees and must
report their employment income and income tax withholding on their tax returns. Every employee
should receive a Form W-2, Wage and Tax Statement, from their employer by January 31 each year,giving plenty of time to file. This reporting form contains a great deal of information that you need to
understand.
Employee compensation that must be reported on the tax return includes wages, salaries, commissions, bonuses, gifts of more than minimal value received from an employer, tips, back pay, severance
pay, and vacation pay. Certain expense reimbursements for which the employee has not adequately
accounted to the employer are also included in income and entered on Form W-2.
Cash allowances for meals and lodging, and the value of meals and lodging furnished as an employment incentive, are compensation includible in wages. On the other hand, meals and lodging furnished on the employers business premises and for the employers convenience and, in the case of
lodging, as a condition of employment, are not includible in wages.
mExample: Bess Rymon and her coworkers worked late into the evening to fill a rush order for their
employer. Because the workers were missing dinner, the boss sent out for pizza, which he gave to the
workers to eat. The value of the pizza is not taxable to Bess because the meal was consumed on the
employers premises and was provided for the employers convenience.m
FORM W-2 WAGE AND TAX STATEMENT

A Form W-2 is provided to each employee who received payment during the tax year for services performed for an employer. The 2014 standard IRS version of Form W-2 is shown in Illustration 1.12.
Forms W-2 take on many different appearances, but the format and information provided must meet
specific requirements established by the IRS. The complete Form W-2 consists of six copies:
Copy A is sent to the Social Security Administration by the employer along with Form W-3,
Transmittal of Wage and Tax Statements, by February 28 (or March 31, if they are filed electronically).
Copy 1 is sent to the state, city, or local taxing authority, if such authority assesses an income tax.
Copy B is given to the employee to be attached to their federal income tax return. See Illustration
1.12.
Copy C is given to the employee for their records.
Copy 2 is given to the employee to be attached to their state, city, or local income tax return, if
applicable.
Copy D is kept by the employer for their records.
Wages shown on Form W-2 are not reduced by any withholding for taxes, union dues, and other items.
Taxable wages may be reduced, however, by certain elective salary reductions and deferrals, such as
those to a 401(k) plan. You will learn more about these reductions later in the course.
.
The amount of wages and tax withheld, as shown on Form W-2, must be reported on the return. Some
employers may issue two Forms W2, because they operate on a fiscal year or use an accrual accounting system, or because the employee worked in more than one state. If the taxpayer believes a W-2
is incorrect, they should discuss the matter with the employer who issued the document and request
that the employer issue a Form W-2c (corrected).
Employees who change jobs or have more than one job, should receive a Form W-2 from each employer. Also, if a married couple files a joint return and both husband and wife are employed, each should
receive one or more Forms W-2. Regardless of the number of Forms W-2, one total is entered on the
appropriate line of Form 1040EZ, Form 1040A, or Form 1040.
Specific Form W-2 Box Information

Study the Form W-2 shown in Illustration 1.12. The boxes of Form W2 are explained below. We first
concentrate on boxes a through f. Then we will continue, discussing boxes 1 through 20. Illustration
1.12 is a guide to help you see how the information flows from the document to the software screen
and ultimately ends up on the tax form.
Box a Employees Social Security Number (SSN)
Verify the employees social security number. If it is not right, it must be corrected by the taxpayers
employer.
Box b Employer Identification Number (EIN)
Box c Employers Name, Address, and ZIP Code
The employers name, address, and ZIP code are printed here. This information will be entered in the
tax preparation software just as it appears here.
Box d Control Number
This space is for the employers convenience. It may contain an entry, but it has no tax consequence.
Box e/f Employees Name, Address, and ZIP Code
Verify the accuracy of this information, keeping in mind that if the employee moved during the
year, the W-2 may reflect a previous address.
Note: It is important to verify the accuracy of the information in boxes a, e, and fparticularly
if you use it to complete the heading of the tax return. The employer should be notified so they
may correct their records and send the correct social security information to the Social Security
Administration.
If a taxpayer submits Form(s) W-2 in which the taxpayers social security number, name, or address
have been altered, the Tax Professional is responsible for questioning the taxpayer to be sure the SSN,
name, and address reported on the tax return are all correct and documenting how this determination
was made. Then:
If the social security number, name, or address have been altered, check the Yes box below line 11
on the Wage W2 screen in the software.
Inform the taxpayer that the IRS will later send them a notice that the information on the return
does not match the information they have previously received from an employer. The IRS notice
will request additional or updated information.

Illustration 1.12
Form W-2
Software Form W-2 Entry screen

Illustration 1.13
Box 1 Wages, Tips, Other Compensation

This box represents the taxable amount of wages paid, noncash payments, tips reported, certain reimbursements for business expenses, and other employee compensation. Box 1 does not include amounts
paid into most deferred compensation plans. All box 1 amounts are totaled and then carry to Form
1040EZ, line 1 or Form 1040A, line 7.
Box 2 Federal Income Tax Withheld
Total federal tax withheld is entered on Form 1040EZ, line 7 or Form 1040A, line 40.
Box 3 Social Security Wages
On a single Form W-2, the amount in box 3, combined with any amount in box 7, should not exceed
$117,000 for 2014. If it does, the employer should correct it. Unlike box 1, box 3 includes payments the
employee may have made to deferred compensation plans and therefore may exceed box 1.
Box 4 Social Security Tax Withheld
Most employees are taxed 6.2% on their wages and tips up to $117,000 (for 2014) as their contribution
to the social security system. The tax withheld for this purpose is shown in box 4 for 2014. It should
not exceed $7,254.00 [$117,0006.2%].
Box 5 Medicare Wages and Tips
This box reflects the taxpayers wages and tips subject to the medicare tax. Unlike the amount of
social security wages in box 3, there is no limit on wages for medicare; therefore, this box represents
the total wages from the employer.
Box 6 Medicare Tax Withheld
Employees are taxed 1.45% on all of their wages and tips for medicare. In addition to withholding
medicare tax at 1.45%, the employer must withhold a 0.9% additional medicare tax from wages paid
to employees in excess of $200,000 in a calender year. Box 6 shows the amount withheld for this tax.
This figure has no consequence on the federal return, except for the Additional Child Tax Credit studied later in this course.
Box 7 Social Security Tips
Tips subject to social security tax received by the employee and reported to the employer are entered
in box 7. This amount includes all tips reported by the employee, even if the employees wages were
insufficient to collect the required social security tax on the tips.
Box 8 Allocated Tips
Employees of food or beverage establishments may have a portion of computed tips allocated to them.
These amounts may be taxable, but are not included in boxes 1, 3, 5, or 7.
Box 9 There should be no entry in box 9.
Box 10 Dependent Care Benefits

Some employers help their employees pay for child and dependent care expenses. These (usually) taxfree benefits are entered in box 10. In Chapter 14, you will learn about the child and dependent care
credit and how any box-10 entry figures into the credit computation.
Box 11 Nonqualified Plans
This box is for distributions (payments) from nonqualified retirement plans. A nonqualified plan is a
retirement plan that does not meet certain requirements of the Internal Revenue Code. Any amount
shown in box 11 usually has been included in box 1 and is taxable.
Boxes 12ad
These boxes are used to report a variety of information. The entries in these boxes are accompanied
by letter codes. The codes are described in Illustration 1.14 for your reference, but the ones you see
most often are C, D, E, J, L, and DD.
The employer may enter up to four codes in box 12. A separate Form W-2 should be issued if more
than four codes apply.
Note: Any amounts coded A, B, M, or N will be entered on the dotted line next to Form 1040, line
61, along with the notation UT (uncollected tax), and should be included in the total tax on line 61.
Box 13
The employer will mark each box that applies:
Statutory employee. An employee whose earnings are subject to social security and medicare tax
withholding but not to income tax withholding. A statutory employee may report their income and
related expenses on Schedule C, a form that can only be filed with Form 1040. Certain full-time life
insurance salespersons are the most common examples of statutory employees.
Retirement plan. The employer should mark this box if the employee is an active participant
during any portion of the year in a qualified retirement plan maintained by the employer, such as
a 401(k) plan. If this box is marked, it may limit the amount of traditional individual retirement
arrangement (IRA) contributions the employee may deduct on their return. You will learn about
IRAs later in the course.
Third-party sick pay. This box should be marked if the employee received sick pay from an insurance provider other than the employer. Third-party sick pay may be treated differently from regular wages on the taxpayers state and local tax returns.
Box 14 Other
The employer may use this box to enter any other information they wish the employee to have.
Examples include educational assistance payments, union dues, health insurance premiums, and
charitable contributions. Any entry should be labeled.
Box 14 may also include certain contributions to retirement plans for which there is no applicable code
in box 12, or other deferred compensation or salary reduction plans, such as cafeteria plans.
mExample: Carlos Montana works for a state government and contributes to a 414(h) retirement
plan. There is not a box-12 code for such a plan, so their employer enters their pre-tax contributions
in box 14.m

Illustration 1.14
is an entry in box 14 that you do not understand, ask the

TtaxpayerIf ifthere
they know what it represents. It may have a tax consequence
ax Tip:
or it may not, but you will not know unless you find out what it is. Additional
information not shown on Form W-2 can often be found on the stub attached to
it or on the taxpayers paycheck stubs.
Boxes 1520
State and local wage and tax information. These are amounts to be reported on the state and local
income tax returns.
Totals in the state and local tax columns are entered on the appropriate state and local returns and
on Form 1040, Schedule A, if they are included in the taxpayers itemized deductions. You will learn
about itemized deductions later in the course.
Substitute W-2
If an employee is unable to obtain a Form W-2 from an employer, total wages paid and taxes withheld
should nonetheless be determined and reported on the return. A statement, such as the H&R Block
Substitute Statement for Form W-2, should be attached, indicating how the determination was made
and what efforts were made to obtain the W-2. (IRS Form 4852 serves the same purpose as the H&R
Block statement, but the statement has an area to compile pay stub or similar information to arrive
at the totals.)
Study the sample substitute statement in Illustration 1.15. Notice that on the statement, the taxpayer
declares they have informed the IRS they did not receive a Form W-2. This is done by calling a toll-free
number for the taxpayers area of the country. The appropriate number may be found in the instructions for Forms 1040EZ, 1040A, and 1040. The taxpayer should wait until February 15 to make this
call. Also note the Important Notice in the middle of Illustration 1.15. Finally, the taxpayer should
sign this form after photocopies have been made. Only original signatures (not photocopies) should be
sent to the IRS and the Social Security Administration, if necessary. Illustration 1.16 shows an IRS
Form 4852.
a Tax Professional may prepare a return using the taxTpayers Although
paycheck stubs, that return may not be filed electronically without
ax Tip:
a Form W2 or its substitute. The IRS will not accept returns with substitute
W-2s prior to February 15. The electronic return originator must retain copies
of all Forms W2 and signed substitute statements.

Illustration 1.15

Illustration 1.16
Unemployment
Unemployment compensation generally includes any amounts received under the employment compensation laws of the United States or of a state. If a person received unemployment compensation
during 2014, they should receive Form 1099-G, showing the amount they received. A Form 1099-G is
shown in Illustration 1.17. The amount of unemployment compensation is reported in box 1 and will
go on Form 1040EZ, line 3, or Form 1040A, line 13.
Illustration 1.17
PREPARING THE FORM 1040EZ

Heading the Return
The heading of Form 1040EZ is where the taxpayer enters their personal information and filing information. Taxpayers should always double check the information entered in the heading. For taxpayers
using a professional tax service, the service will enter the correct information and provide an envelope
with the IRS address if the return is not e-filed. Most returns filed by professional tax services are
electronically filed.
Taxpayer Identification Numbers
Most taxpayers have social security numbers, but the IRS can issue an individual taxpayer identification number (ITIN) to taxpayers who are ineligible to get social security numbers. Generally, this
applies to nonresident aliens. Certain tax benefits cannot be claimed by taxpayers without social
security numbers. An ITIN can be obtained by applying to the IRS with Form W-7.
When a tax return is submitted to the IRS with a name or social security number (SSN) that does not
match the information on file with the Social Security Administration (SSA), the return is rejected.
This means the IRS has not accepted it, and it is considered to be unfiled. This often happens, for
example, when a married or divorced person fails to report a name change to the SSA. It is important
that the taxpayer verifies all personal information before filing a tax return. Besides preventing difficulties in processing the tax return, the correct name and SSN helps ensure that the taxpayer receives
all the future social security benefits to which they are entitled.
To head a return being done by hand, clearly print the following (preferably in capital letters, which
tend to be easier to read):
The taxpayers first name, middle initial, last name, and social security number.
The spouses first name, middle initial, last name, and social security number if the couple is filing jointly. (If they are filing separately, they cannot use Form 1040EZ. On the other two forms,
the spouses social security number is entered on this line, but their name is entered on the filing
status line 3.)
The taxpayers street address (including apartment number, if appropriate) or post office box. (If
the taxpayers post office does not deliver mail to their home, enter the post office box rather than
the street address.)
The taxpayers city, town, or post office, followed by the state and five- or nine-digit ZIP code.
The taxpayers Presidential Election Campaign Fund choicetaxpayer(s) should mark the box if
they wish to participate. Marking the box does not change the tax situation; it gives the government permission to transfer $3 of income tax collected from the general tax fund to the campaign
fund. This fund is allocated to presidential candidates based on the amount of money each candidate has received from contributions of individuals.
The taxpayers filing status.
Married taxpayers filing jointly may list their names in either order in the heading of the return.
The name listed first will be the primary taxpayer. Any mention of the taxpayer later in the return
refers to the primary taxpayer. They must be careful, however, to list the social security numbers in
the same order as their names. Married taxpayers should choose the order for entering their names
and social security numbers on their returns and consistently present their names and social security
numbers in that order in order to avoid confusion and delays in processing their returns.
Usually, the first social security number listed in the heading should also be used in the heading on
any other form or document attached to the return. Certain forms, however, require that the social
security number of the taxpayer who earned the income be used in the headings of those forms. Such
forms are identified when they are discussed during the course.
DETERMINING THE INCOME TAX

There are several methods used to compute a taxpayers tax. Most taxpayers use one of two methods:
the Tax Table or the Tax Computation Worksheet. Other methods used to calculate the tax (instead
of the Tax Table or the Tax Computation Worksheet) are for taxpayers with certain types of income,
such as capital gains, qualifying dividends, or foreign earned income. The following worksheets are
used when these other types of income are included in the tax return:
Qualified Dividends and Capital Gains Tax Worksheet.
Schedule D Tax Worksheet.
Schedule J, Income Averaging for Farmers and Fishermen.
Foreign Earned Income Tax Worksheet.
This chapter covers the Tax Tables and the Tax Computation Worksheet. We will cover the Qualified
Dividends and Capital Gains Tax Worksheet in Chapters 5. Schedule J, Income Averaging for Farmers
and Fishermen and the Schedule D Tax Worksheet are not covered in this course because they must
be filed with Form 1040. The Foreign Earned Income Tax Worksheet is beyond the scope of any beginning or intermediate tax course, but you can learn about it in continuing education courses in the
international tax field.
Before the taxpayer can determine their tax, they must determine their taxable income. The following
sections describe the steps taken to compute taxable income. You may want to look at Illustrations
1.21.7 as you read these sections. Also, the beginning of IRS Publication 17 has a topic, Which
Form Should I Use? that explains which types of income, deductions, credits, and other items may
be reported on each form. Do not worry that you are not familiar with themyou will learn about
most of them before the course is finished. When you begin using the software, you will see that it
automatically determines which base form to use according to the input. However, you will need to
know and understand other forms and schedules because there will be times when you need to select
them based on information the taxpayer shares with you.
Adjusted Gross Income (AGI)

The first step in computing taxable income is to determine the taxpayers adjusted gross income, or
AGI. To compute AGI:
Add up all the income items. The sum of Form 1040EZ, lines 13, is entered on line 4. On Form
1040A, enter the sum of lines 714b on line 15.
Total all income adjustments on Form 1040A, lines 1619. Form 1040EZ does not allow for any
adjustments to income.
Subtract the total adjustments from the total income to arrive at adjusted gross income on Form
1040A, line 21. Because no income adjustments are allowed on Form 1040EZ, line 4 of that form
already reflects adjusted gross income.
Taxable Income
The next step in computing taxable income is to determine the taxpayers allowable standard deduction for their filing status or compute their total itemized deductions.
The standard deduction reduces the amount of income subject to tax and varies based on the taxpayers filing status. The regular standard deduction amounts are shown in the left-hand margin on page
2 of Form 1040A. A complete discussion of the standard deduction is contained in Chapter 2.
The standard deduction is entered on Form 1040A, line 24, and subtracted from the taxpayers AGI.
On Form 1040EZ, the standard deduction and exemption amount (described below) are combined on
line 5.
The final step in computing taxable income is to subtract the taxpayers exemption amount.
An exemption is a dollar amount ($3,950 for 2014) allowed by law as a reduction of income that
would otherwise be taxed. Every taxpayer, except one who may be claimed as a dependent on another
taxpayers return, may claim their own personal exemption. Thus, most tax returns will show one
personal exemption, or two in the case of a married couple filing jointly.
One additional exemption is allowed for each person who qualifies to be claimed as a dependent on
the taxpayers return. Dependent exemptions are discussed in Chapter 3.
The total exemption amount is entered on Form 1040A, line 26. Remember, the standard deduction
and exemption amount are combined on Form 1040EZ, line 5.
mExample: Mark (43) and Linda (42) Ferris file a joint return, shown in Illustration 1.13 on page
1.26, and have no dependents. Their AGI is $41,250, and they use the standard deduction. Their
taxable income is $20,950 [$41,250 AGI $12,400 standard deduction ($3,950 2 2 exemptions) =
$21,250].m
USING THE TAX TABLE

The Tax Table is used by taxpayers whose taxable incomes are less than $100,000. The Tax Table is
located in the Appendix of this text on pages A.5A.16. To determine the taxpayers income tax, look
at the column for the appropriate filing status and the line in the table containing the taxpayers taxable income (Form 1040EZ, line 6; Form 1040A, line 27).
The income tax is entered on Form 1040EZ, line 10 or Form 1040A, line 28. Illustration 1.18 shows
the relationship between the Tax Table and Form 1040EZ for Mark and Linda Ferris, from the preceding example.
The Tax Table is the most common way of computing the tax on federal tax returns. However, the
Tax Computation Worksheet (see Illustration 1.19) is required if taxable income is $100,000 or more.
There are also several other methods of computing the tax for taxpayers with special situations. You
will learn how to use the other tax computation methods in future chapters.

Illustration 1.18

Illustration 1.19
The amount of income tax is reduced by any applicable credits and increased by any additional taxes
to arrive at the total tax. These items will be discussed later in the course.
If the payments are more than the tax, the difference is entered on Form 1040EZ, line 13a; Form
1040A, line 48a. This is the overpayment. A taxpayer who files Form 1040A may choose to have some
or all of their overpayment applied to their next years estimated tax bill. Any applied amount will be
entered on Form 1040A, line 49. Form 1040EZ does not allow an overpayment to be applied to next
years tax. We will discuss estimated taxes later in the course.
Of course, most taxpayers choose to have the full amount of the overpayment refunded to them. They
enter the amount to be refunded on Form 1040EZ, line 13a or Form 1040A, line 48a. The IRS will
mail a check to the taxpayer or make a direct deposit to the taxpayers bank account if so requested.
The bank account information for direct deposit must be entered on lines b, c, and d of the refund line
of the return. If direct deposit is not requested, fill the boxes in lines b and d with Xs or draw lines
through them.
If the tax is more than the payments, the difference is entered on Form 1040EZ, line 14 or Form
1040A, line 50. This is the taxpayers balance duethe amount owed. The balance may be paid by personal check, by money order, through a direct debit from the taxpayers checking or savings account,
or with a major credit card.
Third-Party Designee
Notice the area above the signature section in any of the forms shown in Illustrations 1.2-1.11 beginning on page 1.12. Sometimes the IRS needs additional information to process a tax return. If the
taxpayer wishes to designate the preparer or a third party, such as a friend or family member, as the
person to be contacted by the IRS to obtain the necessary information, he may check the Yes box. If
the paid preparer is designated, the taxpayer should simply enter the word Preparer as the designees name. Otherwise, they must provide the designees name and telephone number along with a
five-digit personal identification number (PIN) selected by the designee.
Complete Exercises 1.5 and 1.6 before continuing to read.
SIGNING THE RETURN

Every taxpayer must sign their own return. A joint return must be signed by both the taxpayer and
the spouse. The date of signing, occupations, and daytime telephone number should be entered in the
appropriate spaces.
If a spouse died before the end of the year, and the surviving spouse files a joint return, the executor
or administrator must sign the return for the deceased spouse. If no one has been appointed executor
or administrator, the surviving spouse can sign the joint return and enter Filing as surviving spouse
in the signature area.
Paid tax return preparers must sign every return they are paid to prepare. The date the return was
prepared should also be entered. The preparer must enter their preparer tax identification number
(PTIN) in the space provided. In addition, the tax preparer must be sure their employers company
name, address, ZIP code, phone number, and employer identification number are entered in the signature section. A self-employed preparer should enter their own name, PTIN, the address, ZIP code,
and phone number where they can be reached all year and should check the self-employed box.
In these early chapters of the course, you will be doing the returns by hand. A few of these may be
done in class; however, the majority of them will need to be completed as homework. For those completed as homework, your instructor will review them and demonstrate how they should be entered
in the software. At the bottom of each return, you will always need to sign the returns, but when you
start doing them in the software, the H&R Block Tax Professional information will be automatically
entered.
Note: If you plan to prepare tax returns for compensation in the upcoming tax season, visit with your
instructor about the process to apply for a PTIN. Your instructor should be able to provide the details
about how and when you should apply.
CHAPTER SUMMARY
In this chapter, you learned the information you need to succeed in this course. You also began your
introduction into the field of taxation with information on:
General facts on the history and theory of taxes.
Who may practice before the IRS.
The layout of an income tax return.
The role research plays for a Tax Professional.
That the tax forms for individual taxpayers are Form 1040EZ, Form 1040A, Form 1040, Form
1040NR for nonresident aliens, and Form 1040PR for residents of Puerto Rico.
Form W-2 is used by employers to report wages and various tax withholdings, as well as a variety
of other information, to the IRS, the Social Security Administration, state and local taxing agencies, and the employee.
To arrive at taxable income for a taxpayer who does not itemize deductions, subtract the taxpayers
standard deduction and total exemption amount from their adjusted gross income.
To use the Tax Tables to determine the income tax for most taxpayers with taxable incomes of less
than $100,000.
Suggested Reading
For further information on the topics discussed in this chapter, you may wish to read Chapter 1 of
IRS Publication 17.
he Tax Institute Tax in the News Research Question: My client

received a W-2 and a 1099-MISC from her employer. Her year-end bonus
was reported as other income in box 3 of the 1099. What is the proper tax
treatment of the bonus?
nswer: The bonus should be treated as wages, and not as other income or
self-employment income.
Many employers mistakenly report any pay outside of regular salary such as
bonus, commission, or severance pay on form 1099-MISC instead of on Form
W-2. Your client should first ask her employer to rescind the 1099 and issue a
corrected W-2.
If she cannot contact her employer, or the employer wont make the change,
report the correct total wages, including the bonus, on line 7 of Form 1040,
using a substitute W-2 (Form 4852). To pay her share of payroll taxes, complete Form 8919, Uncollected Social Security and Medicare Tax on Wages, and
check box H on the form: I received a Form W-2 and a Form 1099-MISC from
this firm for 2014. The amount on Form 1099-MISC should have been included as wages on Form W-2.
Since your clients regular pay is reported on Form W-2, it is presumed
that her employer is treating her as an employee and not as a contractor.
Therefore, she should not complete Form SS-8 to request a determination of
worker status.
Filing Requirements
OVERVIEW
Not every taxpayer with gross income must file a tax return. Some taxpayers who meet certain
requirements do not have to file a tax return. However, those who do not have a filing requirement
may benefit from filing a tax return in order to get a refund.
This chapter discusses the preliminary information of a tax return. The first step in preparing an
income tax return is to determine if the taxpayer is required to file one in the first place. In this chapter, you will study the filing requirements for federal income tax purposes.
OBJECTIVES
At the conclusion of this chapter, you will be able to:
Determine whether a tax return must be filed based on the taxpayers filing requirements.
Determine the taxpayers standard deduction and personal exemption amount.
Determine whether a taxpayer may use the single, married filing jointly, or married file separate
filing statuses.
Explain the differences between the injured spouse allocation and the innocent spouse relief.
TAX TERMS
Community income.
Community property.
Dependent.
Gross income.
Joint return.
Married filing jointly (MFJ).
Married filing separately (MFS).
Standard deduction.
2.1
2.2 H&RBlock Income Tax Course (2015)
FILING REQUIREMENTS
Filing requirements differ among the following:
Nondependents.
Dependents.
Certain children under age 19 or full-time students under age 24.
Self-employed individuals.
Aliens.
This chapter focuses on the first three categories. We will also briefly cover the filing requirement for
the self-employed. The filing requirements for aliens are covered in IRS Publication 519, U.S. Tax
Guide for Aliens.
Tfollowing:A thorough client interview begins with questions about the

ax Tip:
Marital status.
Age.
Gross income.
Dependent status.
his important information is a part of every return that is accurate and

complete. This information also helps to determine the taxpayers filing status, standard deduction, and personal exemption amount.
NONDEPENDENTS
The following three factors determine the filing requirement for nondependents:
Filing status.
Age.
Gross income.
See the chart in Illustration 2.1 on page 2.6 for the filing requirement guidelines that apply to nondependents.
Filing Status
For federal income tax purposes, there are five filing statuses:
1. Single.
2. Married filing jointly.
3. Married filing separately.
4. Head of household.
5. Qualifying widow(er).
Filing Requirements 2.3
Specific requirements must be met in order to qualify for each filing status. We will discuss filing statuses 13 later in this chapter. Filing statuses 4 and 5 are a bit more involved and are discussed in
Chapter 4.
The first step in determining a taxpayers filing status is to determine the taxpayers marital status.
Marital status (married or unmarried) is determined on the last day of the tax year. The marital status of a person who died during the year, as well as that of the surviving spouse, is determined as of
the date of death.
mExamples: Bob and Carol were married on December 31, 2014. They are considered married for the
2014 tax year.
Ted and Alices divorce became final on December 31, 2014. They are considered unmarried for the
2014 tax year.
Russell and Dawn have been married for several years. Russell died on March 27, 2014. Russell and
Dawn are considered married for the 2014 tax year.m
If a taxpayer is considered unmarried on the last day of the tax year, then the taxpayer may be eligible
to file as single, head of household, or qualifying widow. If a taxpayer is considered married on the last
day of the tax year, then the taxpayer may file as married filing jointly or married filing separately.
Common-Law Marriages
A taxpayer is considered married if, at the end of the tax year, the taxpayer is in a common-law marriage that is recognized in the state where the couple is residing or was at the time recognized by the
state where the common-law marriage began. Your instructor will inform you about further details
on common-law marriages in your state.
While specific requirements vary by state, a common-law marriage generally must meet four legal
standards:
1. The parties must have the legal capacity to marry.
2. Single parties must have the current intent to marry. That is, they must intend to be married
and must communicate that intent to one another.
3. The couple must live together.
4. The parties must publicly present themselves to others as a married couple.
It is a common misconception that a couple must live together for a set number of years to have a
common-law marriage. In reality, there is no time limit if the four conditions listed above are met.
While some states allow common-law marriages, there is no such thing as a common-law divorce.
If the partners decide to go their separate ways, they must petition the state court for a decree of
divorce just like any other married couple.
is not the job of a Tax Professional to determine whether a relaTtionshipItconstitutes
a common-law marriage. If a couple is in doubt as to
ax Tip:
their legal marital status, they should seek the advice of an attorney.
Same-Sex Marriages
For federal tax purposes, individuals of the same sex are considered married if they were lawfully
married in a state (or foreign country) whose laws authorize the marriage of two individuals of the
same sex, even if the state (or foreign country) in which they now reside does not recognize same-sex
marriage. For federal tax purposes, the term spouse includes an individual married to a person
of the same sex if the couple is lawfully married under state(or foreign) law. However, individuals
who have entered into a registered domestic partnership, civil union, or other similar relationship
that is not considered a marriage under state (or foreign) law are not considered married for federal
tax purposes. For more details, see Publication 501, Exemptions, Standard Deduction, and Filing
Information.
Age
For general tax purposes, a person is considered to have attained any given age on the first moment
of the last day of that year of his lifethat is to say, the day before his birthday.
mExample: Deanna Shoenburger was born on January 1, 1974. For general tax purposes, she is considered to be age 41 for the 2014 tax year, even though her 41st birthday does not occur until January
1, 2015.m
A taxpayer is considered to have attained the age of 65 on the day before his 65th birthday.
mExample: Jane McGuires 65th birthday is January 1, 2015; for tax purposes, she is considered age
65 for the 2014 tax year.m
The age of a person who dies during the year is determined as of the date of death.
mExample: Shelly Burrows died on September 21, 2014, a month before her 65th birthday. She is age
64 for purposes of her 2014 tax return.m
you may be aware that normal retirement age for social
TsecurityAlthough
purposes is increasing to age 67, the age of 65 retains its signifax Tip:
icance for general tax purposes. You will discover more about the change in
retirement age later, when you learn about social security benefits.
As you will discover throughout this course, some special rules apply to children with regard to age.
For several specific tax purposes, children are considered to have attained a certain age on their
birthday, rather than on the preceding day.
mExample: Jared Peterson, dependent son of Beverly Peterson, was born on January 1, 1998; his
17th birthday is January 1, 2015. When determining whether Beverly may claim the Child Tax
Credit (which you will learn about in Chapter 3), Jared is considered to be 16 years old on December
31, 2014. However, for general tax purposes, Jared is considered to have attained the age of 17 as of
December 31, 2014.m
Gross Income
As discussed in the last chapter, gross income is total worldwide income subject to tax. There are two
aspects to determining gross income:
Who owns the income.
What income should be reported on a tax return.
Ownership of income, in the case of a married couple, is determined by state law. The laws regarding
the ownership of income and property in most states are based on British common law. These states
are called separate property states. In separate property states, income received belongs to the spouse
who earned it or who owns the property that produced the income.
Nine states are community property states. See the chart in Illustration 2.2 for a list of these nine
community property states. With the exception of Wisconsin, the laws of community property states
are based on Spanish civil law. Generally, in community property states, income received for services
performed is considered to belong half to the spouse and half to the other spouse, regardless of which
spouse earned it. The laws regarding the ownership of income from property vary among these states.
Generally, ownership of income needs to be determined only if the couple files separate returns.
When determining if a taxpayer is required to file, generally the nondependent taxpayer would be
required to file an income tax return if their gross income equals or exceeds a gross income threshold
amount. This gross income threshold amount changes based on the taxpayers filing status and age
(see the chart in Illustration 2.1). The gross income threshold amount generally consists of the sum of
the taxpayers standard deduction and personal exemption amount. These two separate items reduce
the taxpayers income subject to income tax on their return. If a taxpayer has gross income less than
the sum of their standard deduction or personal exemption, then it is generally safe to say that their
gross income is reduced to zero and the taxpayer may not be required to file a tax return. The standard deduction and personal exemption amounts will be discussed next in the chapter.
As a general rule, a nondependent taxpayer is required to file a tax
Treturn when
their gross income is equal to or greater than the sum of the
ax Tip:
taxpayers standard deduction and personal exemption amount. However, a

married taxpayer using the married filing separately status must file a return
when their gross income equals or exceeds the personal exemption amount
($3,950 for 2014).
Standard Deductions
The standard deduction reduces the amount of income that is subject to tax. This amount varies,
according to the taxpayers filing status. The following are the regular standard deductions for 2014:
$6,200 Single or married filing separately.
$12,400 Married filing jointly or qualifying widow(er).
$9,100 Head of household.

(2014)
Illustration
Illustration X.X
2.1
GROSS INCOME FILING REQUIREMENTS FOR 2014 (NONDEPENDENTS)

Individuals Who Are:
Are Required to File

Individuals Who Are:
If Gross Income Is:
Single
Married Filing Jointly

Under age 65
$10,150
Both under age 65
$20,300
Age 65 or older
$11,700
One spouse age 65 or older
$21,500
Both age 65 or older
$22,700
Head of Household
Under age 65
Age 65 or older
$13,050 Married Filing Separately

$14,600
Regardless of age
Qualifying Widow(er)
Under age 65
$16,350
Age 65 or older
$17,550
Illustration 2.2
COMMUNITY PROPERTY STATES

Arizona
New Mexico
California
Texas
Idaho
Washington
Louisiana
Wisconsin
Nevada
Are Required to File

If Gross Income Is:
$3,950
Increased Standard Deductions

Taxpayers who are age 65 or older and/or blind are entitled to the following increased standard deduction amounts:
$1,550 (per condition) for singles and heads of households.
$1,200 (per condition) for all married taxpayers and qualifying widow(er)s.
The increased amounts are calculated per the boxes checked on line 23a, Form 1040A (see Illustration
2.3.).
The filing requirement computation for taxpayers age 65 and over includes the extra amount for age,
but the extra amount allowed for blindness is not included in the computation.
Blindness
A taxpayer may claim the additional standard deduction for blindness if they are totally or partly
blind at the close of the tax year. Partly blind means that the person is able to see no better than
20/200 in the better eye with corrective lenses, or the person has a field of vision not more than 20
degrees.
A taxpayer who is partly blind and whose sight will never improve beyond these limits, must obtain
a certified statement from their eye doctor or registered optometrist. The statement must be retained
by the taxpayer with their records; it need not be attached to the return or sent to the IRS.
can be corrected beyond the limits by contact lenses that
Tcan onlyIfbevision
worn briefly because of pain, infection, or ulcers, the higher
ax Tip:
standard deduction for blindness still applies.
Illustration 2.3
Personal Exemption Amount

An exemption is a dollar amount ($3,950 for 2014) allowed by law as a reduction of income that would
otherwise be taxed. The exemption is in addition to the taxpayers standard deduction. Every taxpayer, except those who may be claimed as a dependent on another taxpayers return, may claim his own
personal exemption. Thus, most tax returns will show one personal exemption, or two in the case of
a married couple filing jointly.
mExample: Matthew (42) and Sue (41) Calendo will file a joint return. Their standard deduction is
$12,400. Their gross income filing requirement is $20,300 [$12,400 + $7,900 personal exemptions =
$20,300].m
mExample: Larry White (66) uses the single filing status. His standard deduction is $7,750 [$6,200 +
$1,550 = $7,750]. His gross income filing requirement is $11,700 [$6,200 + $1,550 + $3,950 personal
exemption = $11,700].m
mExample: Larrys brother, Jeff White (56), is blind and uses the single filing status. His standard
deduction is also $7,750 [$6,200 + $1,550 = $7,750]. His gross income filing requirement is $10,150
[$6,200 + $3,950 personal exemption = $10,150]. Notice that the extra $1,550 standard deduction for
blindness does not count in the computation of his gross income filing requirement.m
One spouse is never the dependent of the other spouse. When the married filing separately status is
used, however, a taxpayer may claim his spouses personal exemption only if the spouse:
Has no gross income.
Is not filing a return.
Is not a dependent of another person.
If the taxpayers spouse is a nonresident alien, the taxpayer may also claim an exemption for their
spouse if the nonresident alien spouse meets the three requirements listed above.
mExample: Ral and Leah Martinez are married. Leah has no income of any kind and does not receive
any other support, but she does not wish to file a joint return with Ral. Ral may claim Leahs
exemption on his married filing separate return.m
In 2012, the Personal Exemption Phaseout (PEP) was reinstated by the American Taxpayer Refund
Act of 2012 (ATRA). This means that the PEP will reduce the taxpayers personal exemption by 2% for
every $2,500 ($1,250 for married filing separately) that exceeds certain AGI thresholds. The exemption deduction begins to phase out when the taxpayers 2014 AGI exceeds the following amounts:
$305,050 Married filing jointly and qualifying widow.
$254,200 Single.
$152,525 Married filing separately.
For more information on PEP, see IRS Publication 17, page 36.
is also allowed for each person who qualifies to be
TclaimedAnas exemption
a dependent on a tax return. Dependent exemptions are not to
ax Tip:
be confused with personal exemptions. They will be discussed in Chapter 3.
Dependent Taxpayers
A taxpayer who may be claimed as a dependent on another taxpayers return is considered a dependent taxpayer. A taxpayer becomes a qualifying dependent on another taxpayers return because the
taxpayer meets the qualifying child or qualifying relative tests. These tests are discussed in more
detail in Chapter 4. A taxpayer who may be claimed as a dependent on another taxpayers return may
not, under any circumstances, take their own personal exemption. This is true even if the taxpayer
entitled to claim the dependents exemption chooses not to for any reason.
mExample: Mark and Janice Hall may claim their daughter, Linda (18), as a dependent. Because
Linda holds a part-time job and must file a return, they decide not to claim Linda in the mistaken
belief that she may then take her own exemption on her return. This tactic does not work. The fact
that Linda may be claimed on her parents return precludes her from claiming her own personal
exemption. If Mark and Janice do not claim Lindas exemption, no one will benefit from the $3,950
reduction in taxable income.m
The nondependent filing requirements do not apply to dependent taxpayers. Whether a dependent
taxpayer must file a return depends on the dependent taxpayers unearned income, earned income,
gross income, marital status, age, and whether the dependent taxpayer is blind. See the flowchart in
Illustration 2.4 for details on determining if a dependent taxpayer must file a return. This flowchart
is also available in IRS Publication 17, page 7.
When determining if a dependent taxpayer is required to file, first look at their amount of unearned
income received during the year. If the dependent taxpayers unearned income is greater than $1,000,
then the taxpayer must file. Next look at the dependent taxpayers earned income. If the dependent
taxpayers earned income exceeds a specific threshold amount based on the taxpayers marital status, age, and whether the taxpayer is blind, then the dependent taxpayer is required to file a return.
Next, determine if the dependent taxpayer is married and if their spouse is filing a separate return
and itemizing deductions. If this is true and the dependent taxpayer has at least $5 of gross income,
then the married dependent taxpayer must file a return. Last, determine if the dependent taxpayers
gross income exceeds a specific threshold amount. If the dependent taxpayers gross income exceeds
a specific threshold amount based on the taxpayers marital status, age, and whether the taxpayer is
blind, then the dependent taxpayer is required to file a return.
For dependent taxpayers, the earned income and gross income filing requirement thresholds are
based on the dependents standard deduction. These threshold amounts change based on the dependent taxpayers marital status, age, and whether they are blind.
mExample: Markus Kleen (16) is a dependent on his parents return. He is single, not legally blind,
and his gross income for the year is $1,200 ($800 earned income + $400 unearned income). When
determining if Markus is required to file a return, his unearned income is below the $1,000 threshold amount and his earned income is also below the $6,200 threshold amount. When applying the
gross income threshold, first determine if the maximum threshold amount is the greater of $1,000 or
Markus earned income plus $350. Because Markus earned income is $800, his gross income threshold amount is set at $1,150 [$800 + $350 = $1,150]. Markus is required to file a return because his
gross income of $1,200 is greater than his gross income threshold amount of $1,150.m

Illustration 2.4
When a married taxpayer wishes to file a married filing separate

Treturn and
their spouse itemizes deductions on their return, the taxpayer
ax Tip:
should itemize deductions on their return because their standard deduction is

reduced to $0.
A dependents standard deduction is generally equal to the greater of the following:

$1,000.
Their earned income plus $350.
A dependent taxpayers standard deduction may not exceed the regular standard deduction for their
filing status, which is $6,200 for the single filing status. Dependent taxpayers are also entitled to
increase their standard deduction by additional amounts ($1,550 if single or $1,200 if married) if they
are age 65 or older and/or if they are legally blind. Review Illustration 2.4 and see how the $1,000
gross income threshold amount increased if the dependent taxpayer age 65 or older or blind.
It is interesting to note that, while blindness is not a factor in determining the gross income filing
requirements for nondependents (as mentioned in the Larry and Jeff White examples earlier on page
2.8), it is a factor in determining the gross income filing requirements for dependents.
Certain Children Under Age 19 or Full-Time Student

If a child is under the age of 19 or a full-time student under the age of 24 at the end of the tax year and
the childs only income is interest and dividends, a parent may be eligible to elect to include the childs
income on the parents return, which in turn releases the child from filing an income tax return.
A parent can make this election if the following items are met:
The child is under the age of 19 or under the age of 24 if a full-time student at the end of the tax
year.
The child had income only from interest and dividends.
The childs gross income was less than $10,000.
The child is required to file a return, unless the parent makes this election.
The child does not file a joint return for the year.
No federal income tax was withheld from the childs current year income, no current year estimated tax payments were made by or for the child, or no previous year overpayments were applied
against the childs current year tax liability.
For more information about a parent claiming their childs interest and dividends income, see IRS
Publication 17, page 206.
Others Who Must File

There are circumstances under which a return must be filed, even if the taxpayer(s) does not meet the
gross income filing requirements. The most common situations are when an individual:
Owes uncollected social security or medicare tax on tips not reported to the employer or on wages
the taxpayer received from an employer who did not withhold these taxes.
The taxpayer received HSA, Archer MSA, or Medicare Advantage MSA distributions during the
tax year.
Has net profit from self-employment of $400 or more. Self-employment income is generally income
earned by a taxpayer who owns a business and files a Schedule C, Profit or Loss From Business.
Received an advanced premium tax credit (APTC) during the tax year. The taxpayer is required to
file a tax return and attach Form 8962, Premium Tax Credit, even if they did not otherwise have a
filing requirement for the year.
A more detailed list of other situations when a taxpayer must file a 2014 tax return can be found in
IRS Publication 17, page 8.
Taxpayer Should File

Even if a taxpayer is not required to file, they should file a return to get money back or a refund if they
had federal income tax withheld or made estimated tax payments, they qualify for the Earned Income
Tax Credit (EITC), Child Tax Credit (CTC), premium tax credit (PTC), or American Opportunity
Credit (AOC).
Affortable Care Act (ACA) may allow qualified taxpayers to

Treceive The
an advance premium tax credit (APTC) by applying for heath insurax Tip:
ance through the Marketplace. The APTC helps taxpayers pay for all or part of
their marketplace health insurance during the tax year. Taxpayers who receive
the APTC will receive a From 1095-A, Health Insurance Marketplace Statement,
showing the total amount of the APTC received. Taxpayers receiving the APTC
are required to file a tax return and attach Form 8962, Premium Tax Credit.
The Form 8962 reconciles any advanced payments of premium tax credit with
the actual premium tax credit the taxpayer is eligible to receive.
FILING RETURN PENALTIES

For taxpayers who are required to file a 2014 return, generally they are required to file their annual
return by April 15, 2015. For a taxpayer who has a tax balance due and fails to file their return by
the due date of their return, they may be subject to a failure to file penalty. The penalty is based on
the tax not paid by the due date (without regard to extensions). The penalty is generally 5% for each
month or part of a month that a return is late, but not more than 25%. If the taxpayers failure to file
is found to be due to fraud, the penalty may increase substantially.
If the taxpayer is not able to file their return by the original due date, the taxpayer may have the
option to file for a six-month extension by filing Form 4868, Application For Automatic Extension of
Time To File U.S. Individual Tax Return, by the regular due date of their return. By filing this form,
the taxpayer would need to file their return by October 15 to avoid the failure to file penalty. However,
the automatic extension to file does not release the taxpayer from paying their tax liability by the
original due date of their return. If the taxpayer fails to pay their tax liability due, the taxpayer will
have to pay a failure-to-pay penalty of 0.5% of the unpaid taxes for each month or part of a month
after the due date that the tax is not paid. This penalty cannot be more than 25% of the unpaid tax.
However, this penalty does not apply during the automatic six-month extension of time to file period
if the taxpayer paid at least 90% of the actual tax liability on or before the due date of the return and
the balance was paid when the return was filed. For more information on these two penalties, see IRS
Publication 17, page 19.
FILING STATUS
The first step in determining filing status is to determine the taxpayers marital status on the last day
of the tax year, as you learned earlier in this chapter. If a taxpayer is married, they may nonetheless
be treated as unmarried for tax purposes if they qualify. You will learn more about this in Chapter 4.
Single
Taxpayers who are unmarried and who do not qualify to use the head of household or qualifying
widow(er) filing status must use the single filing status. For the remainder of this chapter, unless
otherwise stated, you may presume that all unmarried taxpayers are using the single filing status.
The other filing statuses available to unmarried taxpayers will be covered in Chapter 4.
Married Filing Jointly and Married Filing Separately

Individuals are considered married if they were legally married and not legally separated under a
decree of divorce or separate maintenance as of the last day of the tax year. This provision includes
common-law marriages if such marriages are recognized by the state in which the marriage began or
by the state where the couple resides.
A married couple may choose to file a joint return or separate returns. A joint return often results
in a lower federal tax. If separate returns are filed, the effective tax rates are generally higher and
several deductions and credits are reduced, limited, or not allowed at all. If one spouse files separately, the other must file separately, unless they qualify as unmarried for tax purposes (covered in
Chapter 4). Additionally, if both spouses choose to file married filing separately and one spouse itemizes, the other spouse must either itemize or use the standard deduction of zero ($0).
Whether the couple files jointly or separately, each spouse must report the social security number of
the other spouse in the heading of Form 1040A, Form 1040, or Form 1040EZ. On a joint return, the
spouses name is entered in the heading; on a separate return, the spouses name is entered next to
line 3.
The total income, exemptions, and deductions of both spouses must be included on a joint return, and
they must use the same accounting period. Usually, the spouses can be held liable, together or individually, for the entire tax plus any penalties on a joint return.
The advantages and disadvantages of filing separate returns should
Tbe weighed
carefully. Generally, a married couple who files separately
ax Tip:
will pay higher taxes and be ineligible to claim tax credits that may help to
reduce their income tax liability. You will learn more about this as you progress
through the course.
As you have already learned, a married person who dies during the year is considered married for that
tax year. The surviving spouse is also considered married for that tax year. If the surviving spouse
does not remarry before the end of the year, a joint return or separate returns may be filed.
A surviving spouse who does remarry may file a joint return with the new spouse, or they may file
separate returns. The filing status of the deceased taxpayer in such a case must be married filing
separately.
mExample: Jerry and Betsy were married. Jerry died on January 27, 2014. On December 1, 2014,
Betsy married John. Betsy and John may file a joint return, or they may file separately, whichever
they choose. Jerrys filing status is married filing separately.m
The most common reason married couples choose to file separate returns is that they do not wish to
be liable for each others taxes. Some couples prefer to keep all their financial matters, including tax
returns, separate. Once in a while, separate returns can result in a lower tax, but most couples would
not find the small tax savings worth the effort of filing two returns.
In many states, the filing status on the state return generally must
Tfollow that
on the federal return. If state tax rates are less for the married
ax Tip:
filing separately status in your state, the larger federal tax liability may be
more than offset by a smaller state tax liability.
Nonresident Alien Spouse

A nonresident alien may file a joint return only if they are married to a U.S. citizen or resident alien
at the end of the year and both spouses agree to report their total worldwide income for the entire year
on their joint U.S. return. You will want to do some additional research if you encounter this situation.
IRS Publication 519 would be a good place to start.
INJURED SPOUSE ALLOCATION

All income tax refunds are subject to offset against past-due debts. These debts might include pastdue federal income tax, student loans, or child and spousal support payments. When taxpayers file
jointly and only one spouse owes a past-due amount, the other spouse can be considered an injured
spouse.
Form 8379, Injured Spouse Allocation (see Illustrations 2.5 and 2.6), is filed when the injured spouse
wants their share of the refund shown on the return and both of the following apply:
1. The injured spouse is not legally obligated to pay the past-due debt.
2. The injured spouse made or reported tax payments (income tax withholding or estimated tax
payments) or claimed a refundable tax credit.
Note: In community property states, the injured spouse must only meet the first statement.
Form 8379 is filed by itself if the refund has already been offset. If the taxpayer expects that a refund
will be offset, Form 8379 can be filed with a return. A separate Form 8379 must be filed for each tax
year for which injured spouse allocation should be considered. If you think you have a situation where
Form 8379 should be filed, consult with an experienced Tax Professional before filing the return.
REQUEST FOR INNOCENT SPOUSE RELIEF

As discussed earlier, when taxpayers file a joint return, both spouses are held responsible for the tax,
interest, and any penalties due on a return. Form 8857, Request for Innocent Spouse Relief, can provide three types of relief from joint responsibility:
Innocent spouse relief.
Separation of liability.
Equitable relief.
Innocent spouse relief can be requested after a joint return has been filed and it is discovered that
one spouse has understated the income (or overstated a deduction or credit). For more information,
see IRS Publication 971, Innocent Spouse Relief. Form 8857 is shown in Illustrations 2.72.13. This is
a complex form; if you identify a taxpayer who may qualify for innocent spouse relief, please consult
with an experienced Tax Professional.
CHAPTER SUMMARY
In this chapter, you learned that:
Nondependent taxpayers requirements to file a tax return are based on their filing status, age, and
gross income. Most nondependent taxpayers must file a return when their gross income equals or
exceeds the sum of the standard deduction and personal exemption amount, which changes due to
the taxpayers filing status and age.
Dependent taxpayers are taxpayers who may be claimed as a dependent on another taxpayers
return. In turn, the dependent taxpayer is not able to claim their own personal exemption on their
tax return. This is true even if the other taxpayer refrains from claiming the dependency exemption. The dependent taxpayers requirement to file is based on their unearned income, earned
income, gross income, marital status, age, and whether the dependent taxpayer is blind.
Nondependent and dependent taxpayers may be required to file a return due to specific circumstances, regardless of whether their income is less than their filing requirement thresholds. These
circumstances include but are not limited to receipt of self-employment income, unreported tips to
employer, distribuitons from an HSA or MSA, or the receipt of the advanced premium tax credit.
Married taxpayers may choose to file jointly or separately. In most cases, filing jointly is more
beneficial than filing separately. If a taxpayer is considered unmarried at the end of the tax year,
then the taxpayer may file single, head of household, or qualifying widow, assuming the taxpayer
is eligible to claim the filing status.
The IRS provides injured spouse relief for the taxpayer to protect their portion of the refund from
their spouses past-due federal income tax, unpaid student loans, or unpaid child and spousal support payments. The IRS also provides innocent spouse relief to taxpayers who file a joint return
and later learn that their spouse has understated the income (or overstated a deduction or credit)
on the return.
Suggested Reading
For further information on the topics discussed in this chapter, you may wish to read the following
sections in IRS Publication 17:
Chapter 1, Subchapter, Do I Have To File a Return?
Chapter 1, Subtopic Joint Return and Injured Spouse.
Chapter 2, Filing Status.
Can our clients claim
Ttheir son, who is 22 years old and in his third year of incarceration
(of a fivehe Tax Institute Tax in the News Research Question:
year sentence) on their tax return? They say they give him $150 a month for
support. Wouldnt our state (North Carolina) be giving him more support than
that? Also, obviously the son is not living in the home of the taxpayer.
Your clients son is 22 years old and not a full-time student, so it
Ais the qualifying
relative, rather than the qualifying child, tests that must
nswer:
be considered. While incarceration may sometimes be considered a temporary

absence from home (depending on the facts and circumstances), for qualifying
relative purposes, a son or daughter need not live at home, so the absence does
not necessarily prevent the taxpayer from claiming the dependent exemption
for a qualifying relative.
However, the relevant qualifying relative test that could prevent the taxpayer
from doing so in this case is support. Although estimates vary based on region
of the country, the particular facility, and the individuals circumstances, it is
clear that the average cost of incarceration in North Carolina, as in all states,
is several thousand dollars per month at a minimum. Thus, the $150 per month
your clients contribute toward their sons support would not be anywhere near
the qualifying relative requirement to provide more than one-half of his support. Your supposition is correct: it is the state (i.e., a third party) that is providing most of the support.
Because your clients do not provide more than one-half of their sons support,
they cannot claim him for the dependency exemption or any other dependent-related tax benefits.

Illustration 2.5

Illustration 2.6

Illustration 2.7

Illustration 2.8

Illustration 2.9

Illustration 2.10

Illustration 2.11

Illustration 2.12

Illustration 2.13
Dependent Exemptions and Support

OVERVIEW
Taxpayers who have children have an opportunity to qualify for many tax benefits that may reduce
their overall tax liability. Having dependents can affect a taxpayers filing status and tax rate. This
chapter focuses on determining who is a qualifying child (QC) and who might be a qualifying relative
(QR). The chapter ends by beginning to examine how adding a QC or QR impacts the tax return.
OBJECTIVES
Determine whether an individual is a qualifying child or qualifying relative and who may be
claimed as a dependent of a taxpayer.
Compute the total support to determine if an individual meets the qualifying relative support test.
Determine eligibility for the Child Tax Credit and compute the credit.
Explain how a multiple support agreement works.
TAX TERMS
Custodial parent.
Dependent.
Eligible foster child.
Full-time student.
Multiple support agreement.
Noncustodial parent.
Permanent and total disability.
Physical custody.
Principal place of abode (principal residence).
Qualifying child (QC).
Qualifying relative (QR).
Support.
3.1
DEPENDENCY EXEMPTIONS
As you have learned, most taxpayers may reduce their otherwise taxable incomes by $3,950 for each
exemption allowed on their 2014 tax returns. You studied personal exemptions in Chapter 2. Now it
is time to learn about dependency exemptions.
mExample: A taxpayer in the 10% tax bracket saves $395 [$3,950 2 10% = $395] for each allowable
exemption; a taxpayer in the 15% tax bracket saves $593 [$3,950 2 15% = $593] for each exemption.m
The examples above show how the taxpayers tax liability is decreased by reducing his taxable income
using the exemption amount. Keep in mind, however, that the tax savings may be further increased
by other deductions and credits associated with dependency. You will learn more about these tax benefits as you proceed through this course.
One $3,950 exemption is allowed for each dependent on a taxpayers return. An exemption cannot be
divided; it is allowed in full or not at all.
Note: In this chapter, the term dependent is sometimes used to refer to a potential dependent, or a
would-be dependent. In every case, all the necessary requirements must be met to claim the dependency exemption.
Who Is a Dependent?
According to the Tax Code, a dependent is a qualifying child or a qualifying relative for whom all of
the following tests are met:
Dependent taxpayer test.
Joint return test.
Citizen or resident test.
These tests are explained in detail beginning on page 3.7.
mExample: Kimberly is a qualifying child of Martha. Martha cannot be claimed by anyone else as
a dependent. Kimberly is a citizen of the U.S. and is not married. Martha may claim Kimberly as a
dependent on her tax return for 2014.m
What Is a Qualifying Child?
For an individual to be a qualifying child (QC) of a taxpayer, an individual must meet five tests:
Relationship.
Age.
Residency.
Support.
Joint return.
If a child meets the five tests to be the qualifying child of more than one person, a special rule applies
to determine which person can actually treat the child as a qualifying child.
Dependent Exemptions and Support 3.3
Relationship. In order to satisfy the relationship test, an individual must be related to the taxpayer
in one of the following ways:
Son or daughter.
Brother or sister.
Adopted child.
A descendant of any of these (this includes all grandchildren, nieces, and nephews).
Stepsons, stepdaughters, stepbrothers, and stepsisters all satisfy the relationship test. Half-brothers
and half-sisters and their descendants also meet this requirement.
Adopted children satisfy the test even if the adoption is not yet final, provided the child has been
lawfully placed for adoption with the taxpayer.
A foster child must be placed with the taxpayer by an authorized placement agency or by judgment,
decree, or other order of any court of competent jurisdiction.
Age. To meet this test, the child must meet one of the following tests:
Under age 19 at the end of the year and younger than the taxpayer (or the taxpayers spouse, if
filing jointly).
A full-time student under age 24 at the end of the year and younger than the taxpayer (or the taxpayers spouse, if filing jointly).
Permanently and totally disabled at any time during the year, regardless of age.
For an individual to be a qualifying child for a taxpayer filing jointly, the individual must be younger
than the taxpayer or the taxpayers spouse. As stated above, a permanently and totally disabled child
qualifies, regardless of age.
mExample: Tim (23) and his brother, Dave (21), lived together all through 2014. Tim is a full-time
student and is not disabled. Dave may not claim Tim as a qualifying child since Dave is younger than
Tim.m
mExample: Mikes 23-year-old brother, Paul, who is a full-time student and unmarried, lives with
Mike and Mikes spouse. Paul is not disabled. Mike is 21, and his spouse is 24 years old. Because
Mikes brother, Paul, is younger than Mikes spouse and the two of them are filing a joint return, Paul
is Mikes qualifying child.m
Residency. The residency test is satisfied if the individual lived with the taxpayer for more than six
months of the year. An individual who was born or died during the year is considered to have met this
test regardless of how long they lived with the taxpayer, provided they lived with the taxpayer the
entire time they were alive during 2014. There are also exceptions for children who were kidnapped
or temporarily absent from the home. Attending college is an example of a temporary absence. There
are also exceptions for children of divorced or separated parents.
Support. An individual cannot have provided more than one-half of their own support during the
tax year.
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 are considered support provided by the state or county. A persons own funds are not
support unless they are actually spent for support.
mExample: Dakota, a child actress, has significant income and pays over half of her own support.
Dakota cannot be claimed as a dependent.m
Note: The taxpayer does not have to provide over one-half of the support to satisfy the support test for
a qualifying child. Rather, the qualifying child cannot provide more than one-half of his own support.
This test differs from the support test for a qualifying relative, as you will see in a moment.
Joint return. To meet this test, the child cannot file a joint return for the year unless they file a joint
return merely as a claim for refund.
Special test. Sometimes a child meets the relationship, age, residency, support, and joint return
tests to be a qualifying child of more than one person. Although the child meets the conditions to be
a qualifying child of each person, only one person can actually treat the child as a qualifying child.
To meet this test, you must be the person who can treat the child as a qualifying child. Both of the
sections Children of Divorced or Separated Parents and Tiebreaker Rules, covered later in the next
chapter, will help you understand this test.
What Is a Qualifying Relative?
For an individual to be a qualifying relative of a taxpayer, an individual must satisfy four tests:
Relationship or member of the household.
Gross income.
Support.
Not a qualifying child.
Relationship. The relationship test for a qualifying relative is broader than the test for a qualifying
child. Relationships that satisfy this test:
All relationships included for a qualifying child.
Father, mother, or ancestor of either.
A brother or sister of your father or mother.
In-laws, including brother, sister, son, daughter, father, or mother.
Any individual who lived with the taxpayer the entire year.
Any of these relationships that were established by marriage are not ended by death or divorce.
If you file a joint return, the person can be related to either you or your spouse. For example, your
spouses uncle who receives more than half of his support from you may be claimed as your qualifying
relative, even though he does not live with you. However, if you and your spouse file separate returns,
your spouses uncle can be your qualifying relative only if he lives with you all year.
A person does not meet this test if at any time during the year the relationship between you and that
person violates local law.
Gross income. An individual must have a gross income of less than the exemption amount ($3,950
for 2014).
mExample: Tony (28) and Adam (27) are cousins and lived in the same home throughout 2014. Adam
only earned $2,500 in 2014. Tony earned $25,000 in 2014. Adam meets the relationship test for Tony
since Adam lived with Tony the entire year. Assuming that Adam meets the remaining tests, Tony
may be able to claim Adam as a dependent.
Note: Being cousins alone will not meet the relationship test. A cousin, like other non-relatives, must
also live in the home the entire year with the taxpayer in order to meet the relationship test.m
Support. As mentioned earlier, the support test for a qualifying relative is different than for a qualifying child. The taxpayer must provide over one-half of the support for an individual to satisfy the
test to be a qualifying relative.
Remember, a persons own funds are not support unless they are actually spent for support.
In figuring a persons 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. If a married couple each receive social security 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 their own support, the benefits are
considered as provided by the child.
mExample: John lives with Robert, his father. John provides 30% of Roberts support. John may not
claim Robert as a dependent.m
Not a qualifying child. The individual must not be the qualifying child of the taxpayer or of any
other taxpayer.
mExample: Yolanda lives with her daughter, Elizabeth. Elizabeth is the qualifying child of Yolanda.
Neither Yolanda nor anyone else can claim Elizabeth as their qualifying relative since she meets the
definition of a QC.m
mExample: Recall Tony and Adam from an earlier example. Tony provided more than half of Adams
support. Adam is not permanently and totally disabled. Tony may claim Adam as a dependent
because he meets all four tests for qualifying relative. Adam is too old to be someone elses qualifying
child, and his gross income is less than $3,950.m
mExample: Ron (35) and Sue (35) are married and have two children, Todd (8) and Tracy (6). Neither
child has any income. Stacy (13), Sues child from a previous marriage, came to live with them on
July 4, 2014. Prior to that, Stacy was supported by and lived with her father.
Todd and Tracy are qualifying children of Ron and Sue. Stacy is neither a qualifying child nor a qualifying relative of Ron and Sue. Because she was supported by and lived with her father for more than
six months, she cannot be a qualifying child for Sue (residency test) and is not a qualifying relative of
Ron and Sue (qualifying child test).m

Illustration 3.1
Important: On January 14, 2008, the IRS issued Notice 2008-5. This notice clarifies that an individual is not a qualifying child of any other taxpayer if the individuals parent (or other person with
respect to whom the individual is defined as a qualifying child) is not required by 6012 to file an
income tax return and either:
Does not file an income tax return.
OR
Files an income tax return solely to obtain a refund of withheld income taxes.
mExample: In 2007, Mark and Mindy lived together as an unmarried couple all year. Mindy has a sixyear-old daughter, Marissa, from a previous relationship. Mark is the only member of the household
with income.
In 2007, Mark was able to claim Mindy as a qualifying relative, but not Marissa, since she was the
qualifying child of Mindy. Marissas exemption went unclaimed by anyone because Mindy had no
income.
Notice 2008-05 remedies this situation. Beginning in 2008, Mark (still, with the only household
income) may claim both Mindy and Marissa as qualifying relatives. Mindy will not file an income tax
return, making it possible for Mark to claim them both.m
Dependent Taxpayer Test

Any taxpayer who may be claimed by another person on their return may not claim any dependents.
Even if the other person does not claim the taxpayer, the taxpayer still may not claim any dependents.
If a taxpayer has a qualifying child or a qualifying relative, this does not exempt them from this
requirement. Also, if the taxpayer is filing a joint return and their spouse can be claimed on someone
elses return, then the taxpayer and spouse cannot claim any dependents on their joint return.
mExample: Lori (18) and her qualifying child, Cheryl (5 months), lived together with Loris mother,
Brenda (41), for all of 2014. Lori is Brendas qualifying child, and Brenda will claim Lori as a dependent on her tax return. Lori cannot claim herself nor can she claim Cheryl. Brenda may also claim
Cheryl if she meets all the required tests.m
mExample: Amparo (32) and her qualifying child, Miguel (3), lived together for all of 2014. No one can
possibly claim Amparo on their return. Amparo may claim Miguel on her return, assuming the other
tests are met.m
Joint Return Test

Generally, a taxpayer may not claim a married person as a dependent if the married dependent files
a joint return. There is, however, an exception to this rule. In order to claim a married person as a
dependent, the married couple files a joint return merely as a claim for refund.
mExample: Ian (51) lived together with his qualifying child, Robert (21), for all of 2014. In October
2014, Robert married Veronica (21), and both lived with Ian for the remainder of the year. Robert, a
full-time student, did not work in 2014, and Veronica earned only $3,000. Robert and Veronica filed
a joint return to get a refund of $102 withheld from Veronicas wages. Neither Robert nor Veronica
claimed his or her own exemption. Ian may still claim Robert as his dependent.m
mExample: Ronald (54) and Wendy (52) are married and lived with their qualifying relative, Gwyn
(26), for all of 2014. In November 2014, Gwyn married Tim (27), and both lived with Ronald and
Wendy for the rest of the year. Gwyn earned $2,400, and Tim earned $20,500 in 2014. Ronald and
Wendy may not claim Gwyn as their dependent on their return if Tim and Gwyn file a joint return.m
Citizen or Resident Test

A taxpayer may not 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. 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.
Exception for an Adopted Child
If the taxpayer is a U.S. citizen and has legally adopted a child who is not a U.S. citizen, U.S. resident,
or U.S. national, the citizenship test is met if the child lived with the taxpayer all year. This exception
also applies if the child was lawfully placed with the taxpayer for legal adoption.
Childs Place of Residence
Generally, a child is a citizen or resident of the country of their parents. If the taxpayer was a U.S.
citizen when the 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.
DETERMINING SUPPORT
Items to consider in computing a dependents support include, but are not limited to, the following:
Food.
Lodging (housing).
Clothing.
Grooming and personal care items.
Most medical and dental expenses, including health insurance premiums (however, see Items Not
Included in Support in this chapter).
Most education expenses, including tuition, books, supplies, room and board, and meals consumed
at school (however, see Education Expenses in this chapter).
Child and dependent care (such as day care).
Transportation.
Charitable contributions made on the dependents behalf.
Recreational activities.
Capital items (such as a car, computer, stereo, or television) purchased for the dependents individual use.
Support includes those items necessary for a dependents care, as well as luxuries and items used
purely for personal enjoyment.
Lodging
When determining whether the taxpayer provided over half of a dependents support, you must use
the value of the lodging rather than the actual costs. We refer to this as the fair rental value of the
dependents residence. In addition to the fair rental value of the residence as furnished, household
expenses include the actual amounts spent for repairs, utilities, and food consumed in the home.
The total expenses for the household are divided by the number of persons living in the home to arrive
at the lodging cost per occupant.
mExample: Mary Lightfoot owns and maintains a home for herself and her father, Adam, who lived
with her all year. In 2014, she paid $9,000 in mortgage payments, $3,500 for food consumed in the
home, and $1,800 for utilities. A similarly furnished home would rent for $900 per month in her neighborhood without utilities ($10,800 for the year).
Notice that the actual mortgage payments do not count in the support computation.
Fair rental value of lodging
$10,800
Utilities
1,800
Food consumed in home
3,500
Total for year
$16,100
When computing Adams support, Mary will include $8,050 [$16,100 3 2 occupants = $8,050] that she
provided for Adams lodging.m
Education Expenses
Tuition generally is support provided in the year paid. If money is borrowed to pay the tuition, the
tuition is considered to be provided by the person who is responsible for repayment of the loan.
mExample: Sierra received a Stafford loan to help pay her college tuition. She is legally obligated to
repay the loan after she graduates. The loan proceeds are considered amounts Sierra provided toward
her own support.m
mExample: Sierras father took out a home equity loan to help Sierra pay her college tuition. He is
responsible for repayment of the loan. The loan proceeds are considered amounts he provided toward
Sierras support.m
Tax-exempt education benefits, such as those received under the G.I. Bill and federal Pell
grants, are considered to be funds provided by the recipient for his own support. However, see the
Scholarships on the following page.
ax Tip: During the client interview, if there is any question in your mind,
use the support worksheet found on the Qualifying Individual Information
& Tiebreaker screen to determine support.
Items Not Included in Support

Certain items are not included in support. These include, but are not limited to:
Capital items purchased for general household use, such as furniture and appliances (however, the
availability of these items is taken into account in determining the fair rental value of housing).
Federal, state, and local income taxes paid from the dependents income.
Social security and medicare taxes paid from the dependents wages.
Life insurance premiums.
Funeral expenses.
Survivors and Dependents Educational Assistance payments (used for the support of the child
who receives them).
Certain scholarships.
Scholarships. If the dependent is a full-time student and is the taxpayers son, daughter, stepson,
or stepdaughter, do not include in the support computation any expenses paid with scholarships,
whether taxable or nontaxable.
mExample: Justin is a full-time student at Rutgers University. He received a full scholarship to pay
his college tuition. The remainder of his support was paid by his parents. Because neither the tuition
nor the scholarship is included in the support computation, his parents are considered to have paid
100% of his support.m
mExample: Angelica is a full-time student at Princeton University. She also received a full scholarship to pay her college tuition. The remainder of her support was paid by her aunt. In this case,
Angelicas tuition and the scholarship proceeds are included in the support computation.m
Health Insurance Benefits

Medical and dental expenses paid by a health insurance policy are not included in support, and the
insurance proceeds are not included in income.
mExample: Gerald (69, his birthday is 06/05/1945) is single and lives with his son, Kyle (49), and
Kyles wife, Kim (48). The fair rental value of their home is $18,000. They pay the $1,500 per month
in rent, and the utilities cost another $4,500. The food cost for the family is $7,500. Entertainment
expenses for Kyle and Kim were $6,000.
Geralds income consists of $9,658.80 in social security benefits (his medicare cost was $1,258.80) and
interest income of $450. After paying his medicare, Gerald puts one-half of the remaining social security in savings (at the end of the year, he had $18,500 in his savings account) and spends the other
$4,200 for a golf membership and tickets to sporting events. The interest income is used for personal
grooming items. Kyle and Kim pay Geralds health costs not covered by medicare, which were $3,200
in 2014, and all household expenses.
Gerald will meet all of the requirements to be a qualifying relative if Kyle and Kim provide more
than one-half of his support. Remember, his social security does not count in determining whether
his income is greater than $3,950. Your instructor will lead a discussion around items listed on the
support worksheet in Illustration 3.2.m
Multiple Support Agreements

A multiple support agreement may be made when no individual provided more than half of a persons
support, but two or more taxpayers together provided more than half of the persons support. To qualify to participate in a multiple support agreement, a taxpayer must provide over 10% of total support
for the other person. The qualified taxpayers then may decide among themselves which one will claim
the dependency exemption, provided they meet all the other requirements to claim the exemption.
The taxpayer claiming the exemption must complete and file Form 2120, Multiple Support Declaration,
a copy of which is shown in Illustration 3.3. Each taxpayer agreeing not to claim the exemption must
be listed on Form 2120 by name, address, and social security number and must provide a signed statement waiving his right to claim the exemption to the taxpayer claiming the exemption. The taxpayer
claiming the exemption must retain the signed agreements with his records.
Taxpayers who together are supporting a qualifying relative may use any method on which they agree
to decide who will claim the exemption. This includes taking turns or allowing the exemption to be
claimed by the one who will gain the greatest tax advantage. The other dependency requirements
must be met for the current tax year in order for a taxpayer to claim the exemption.
In any situation where one taxpayer cannot prove that they provided over half of the persons support
and all of the qualified taxpayers will not agree on who will be allowed to claim the exemption, no one
is allowed to claim it.
CHILD TAX CREDIT

At this time, it is necessary to introduce you to the concept of tax credits because many of the taxpayers and returns we will be examining will have dependent children on them. The Child Tax Credit is
worth up to $1,000 for each qualifying child. The credit starts out as nonrefundable, but some taxpayers may qualify for the Additional Child Tax Credit, which is refundable. You will study the difference
between refundable and nonrefundable credits later in the course.
In order to qualify for the Child Tax Credit, all of the following must be true:
The taxpayer must have a qualifying child.
The qualifying child must be under the age of 17 at the end of the year.
The qualifying child must be claimed on the taxpayers return.
The qualifying child must be a U.S. citizen, U.S. national, or resident of the United States.
On Form 1040 or 1040A, line 6c, check the box in column 4 for each child who qualifies the taxpayer
for the Child Tax Credit.
Income Phaseout
If the taxpayers income is above a certain level, the allowable Child Tax Credit begins to phase out.
The amount disallowed will be $50 for every $1,000 (or portion of $1,000) by which the taxpayers
modified adjusted gross income exceeds:
$75,000 (single, head of household, or qualifying widow(er)).
$110,000 (married filing jointly).
$55,000 (married filing separately).

Illustration
Illustration X.X
3.2

Illustration 3.3
Modified adjusted gross income is another phrase you will see many times during this course.
Unfortunately, Congress has not yet established a uniform definition, so you must be aware that it
does not mean the same thing for every purpose. Modified AGI (MAGI) always begins with the taxpayers adjusted gross income (AGI), which is then modified for each individual purpose.
Modified AGI, for purposes of the Child Tax Credit, consists of adjusted gross income without regard
to any exclusions for foreign earned income or U.S. possession income. Because we do not cover these
topics in this course, you may assume that, in each situation you encounter, the taxpayers modified
AGI is their adjusted gross income.
mExample: Pat and Geri Dale are filing a joint return and have an adjusted gross income of $124,000
and three qualifying children. Their AGI exceeds $110,000 by $14,000, so their credit is reduced by
$700 [$50 2 14 increments of $1,000 = $700]. Thus, their tentative Child Tax Credit is $2,300 [$3,000
$700 = $2,300]. Their actual credit may be further limited, as explained on the following page.m
Interaction With Other Credits

No portion of the Child Tax Credit may be carried over to future years. In order to maximize the
benefits of each credit, nonrefundable credits must be taken in a specific order. For this reason, other
credits must sometimes be computed first in order to properly apply the Child Tax Credit. The Child
Tax Credit Worksheet is a valuable tool to help you accomplish this.
Computing the Child Tax Credit

The Child Tax Credit may be computed using the IRS Publication 972 worksheet shown in
Illustrations 3.6 and 3.7. Throughout this course, we will use the Child Tax Credit Worksheet, shown
in Illustrations 3.4 and 3.5.
If you wish to check the instructions for the Child Tax Credit placed on line 33 of Form 1040A, you
will find different worksheets. H&R Block has combined the various worksheets into the one shown,
and that is the one we will use in this course.
mExample: Joyce Potter (39) uses the head of household filing status and has three qualifying children. Her adjusted gross income, all from wages, is $87,563. She has no foreign or U.S. possession
income. Her tax before credits, Form 1040A, line 28, is $10,081. She is claiming a $1,200 Child Care
Credit Form 1040A, line 31.
Examine her Child Tax Credit Worksheet in Illustration 3.4 as you read the following explanations of
certain lines.
Line 3. These are the income levels at which the phaseout begins for each filing status.
Line 5. The credit is reduced by $50 for each $1,000 (or portion thereof) by which modified AGI
exceeds the threshold amount. For this reason, the result of line 4 is rounded up to the next $1,000,
multiplied by 5% [$1,000 2 5% = $50], and entered on line 5 [$13,000 2 5% = $650].m
Dispensing with the Worksheets

You can skip the worksheet and enter the Child Tax Credit directly on Form 1040A, line 35, if the
taxpayer meets all of the following conditions:
The taxpayer is not excluding any foreign earned income, U.S. possession income, or income from
Puerto Rico.
The taxpayers AGI is not more than the phaseout threshold amount for his filing status.
The taxpayers tax before credits (Form 1040A, line 30) is not less than the number of qualifying
children multiplied by $1,000.
The taxpayer is not claiming any other credits.
If the taxpayer meets all of the above conditions, simply enter $1,000 for each qualifying child on
Form 1040A, line 35. If the taxpayer does not meet these qualifications, the Child Tax Credit must be
calculated using the worksheet.
CHAPTER SUMMARY
In this chapter, you learned:
Each dependent a taxpayer may claim generally reduces otherwise taxable income by $3,950 in
2014.
A qualifying child is someone who meets the relationship, residency, age, support, joint return, and
special case tests.
A qualifying relative is someone who is related to the taxpayer (or who lived with the taxpayer for
the entire year), earned less than $3,950 gross income (in 2014), and for whom the taxpayer provided more than half of their support. Also, the potential qualifying relative cannot be the qualifying
child of the taxpayer or of any other taxpayer.
The Child Tax Credit is worth up to $1,000 for each qualifying child. The credit is generally nonrefundable, but certain taxpayers may qualify for the refundable Additional Child Tax Credit.
Suggested Reading
For further information on the topics discussed in this chapter as they relate to 2014 tax returns, you
may wish to read the following chapters in IRS Publication 17:
Chapter 3, Personal Exemptions and Dependents.

Illustration 3.4

Illustration 3.5

Illustration 3.6

Illustration 3.7
X.X
client lives with

This fianc and her two children (ages 7 and 9). She hadMya part-time
job early
he Tax Institute Tax in the News Research Question:
in the year and earned about $4,000; then, she lost the job and has no other
source of income. Her ex-husband stopped paying child support in June. She has
taken her ex-husband to court but so far he has not resumed paying support.
She has never given him a Form 8332 and has no intention of doing so. My client supports the entire household and would like to claim the children as his
dependents. May he claim the dependency exemption and Child Tax Credit for
the children and file using the head of household filing status? His income is out
of EITC range, so could his fianc claim the children for EITC only?
Your client may be able to claim the children as his dependent qualAifying relatives,
but there are several points to be clarified in order for him
nswer:
to do so.
First, verify that the children actually did live with your client the entire tax
year. Since the children are not related to your client, they meet the QR relationship test only if they were members of his household all year. From the facts
youve given, earlier in the year your clients fianc had some income and was
receiving child support, so they could have been living on their own and moved
in with your client when all sources of income stopped.
Second, verify that your client provided more than half of the childrens support
for 2014 by completing the support worksheet for qualifying relatives. While
your client may have started supporting the children at some point during the
year, youve stated that their father paid child support for nearly six months.
Without knowing exactly how much either taxpayer (your client and the childrens father) paid, we dont know which one of them provided more than half of
the childrens support. With some support provided by their mother early in the
year and possible third party support, such as AFDC, it could be that nobody
provided more than half of the childrens support.
Third, in order for your client to claim the children as his qualifying relatives,
they must not be qualifying children of any other taxpayer. The children meet
all tests to be QCs of their mother, so the issue is whether she is considered a
taxpayer. Under Notice 2008-5, an individual is not a taxpayer if she 1) does
not have a return filing requirement, and 2) she does not file a tax return for
any reason other than to claim a refund of all withheld taxes. If your clients
fianc filed a return to claim the children for the EITC, he could not claim them.
Additionally, he would be precluded from claiming them because child-related
benefits cannot be split among taxpayers. Also, even if she claimed only one of
the children for the EITC, she would be considered a taxpayer (because of filing a return for a reason other than getting a refund of withheld taxes) and he
could not claim the other child as his dependent.
any one of these tests is not met with respect to the

Achildrene.g., theyIf did
not live with him the entire tax year, or he did not
nswer continues:
provide more than half of their support, or their mother is a taxpayer because
she files a returnthen your client cannot claim them on his tax return.
If all tests are met and he is able to claim them, it would be only for the dependency exemption. He cannot claim the Child Tax Credit or the EITC (even if his
income was within range) because they are not his qualifying children, nor can
he file as head of household. Unrelated individuals who are treated as dependents only because they are members of the taxpayers household all year are
not qualifying individuals for head of household filing purposes.
It may be more beneficial for your clients fianc to claim the children because
she would get the EITC and some part of the refundable Child Tax Credit, all of
which may be a better tax benefit than the dependency exemption would be for
your client.
Dependent-Related Filing Statuses

OVERVIEW
In this chapter, we will discuss how having dependents can affect a taxpayers filing status and tax
rate. Dependents will also qualify many taxpayers for valuable tax credits, which may further reduce
their tax liability or even eliminate it completely. You will learn more about those benefits as you
proceed through this course.
OBJECTIVES
Determine whether a taxpayer qualifies to file as head of household.
Explain how to determine the cost of maintaining support of a household.
Determine whether a taxpayer qualifies as unmarried for tax purposes.
Determine the correct filing status for any unmarried taxpayer and report it on the tax return.
Determine which parent may claim the dependency exemption for a qualifying child when the
parents are divorced or separated.
Determine which taxpayer will be awarded a qualifying child when more than one taxpayer claims
the child.
TAX TERMS

Custodial parent.
Dependent.
Fair rental value.
Full-time student.
Multiple support agreement.
Nonresident alien.
Physical custody.
4.1
FILING STATUSES AND DEPENDENTS

In Chapter 2, you learned there are five filing statuses recognized by the Tax Code:
Single.
Married filing jointly.
Married filing separately.
Head of household.
Qualifying widow(er).
The first three statuses are allowed regardless of whether the taxpayer has a dependent. These statuses were discussed in depth in Chapter 2. The last two statuses require that the taxpayer have at
least one dependent.
Head of Household
Taxpayers may file as head of household if they meet all of the following requirements:
The taxpayer is unmarried or considered unmarried on the last day of the tax year.
The taxpayer paid more than half of the cost of maintaining the household for the year.
The taxpayer maintains a household for either of the following:
A qualifying child or qualifying relative (see exceptions to the head of household requirements
on page 4.6) who lived with the taxpayer for more than half the year and the taxpayer can claim
an exemption for them.
Their mother or father for the entire year and who the taxpayer may claim as an exemption on
their return.
mExample: Herbert (34) is unmarried and pays 100% of the cost of maintaining a household for
Clarice (5). Clarice is Herberts qualifying child. Herbert may file as head of household.m
mExample: Juanita (42) is unmarried and pays 65% of the cost of maintaining a home for her father,
Bernabe (77). Juanita will claim Bernabe on her tax return in 2014. Juanita may file as head of
household.m
Dependent-Related Filing Statuses 4.3
The Cost of Maintaining a Household

In order to file as head of household, a taxpayer must have paid more than half the cost of maintaining
a household for the year. The costs included when making this determination:

Rent.
Mortgage interest.
Real estate taxes.
Insurance on the home.
Property taxes.
Repairs.
Utilities.
Food eaten in the home.
Do not include the costs of the following items:

Clothing.
Education.
Medical treatment.
Vacations.
Life insurance.
Transportation.
Rental value of a home owned by the taxpayer.
Services provided by the taxpayer or other members of the household.
The fair rental value of a home owned by the taxpayer is not included in tallying the cost of maintaining a home. The same is true when that home is owned by one of the taxpayers dependentsfor
example, a parent.
If the total amount paid by the taxpayer is more than the amount others paid, including amounts paid
from government assistance programs, then the taxpayer meets the requirement of paying more than
half the cost of maintaining the household for the year.
When there is doubt as to whether an individual paid more than half the cost of maintaining the
household for the year, use the Worksheet 2-1, Cost of Keeping Up a Home, found in IRS Publication
17, page 23. This worksheet is shown in Illustration 4.1. BlockWorks also provides a Household
Support Worksheet. This worksheet is available on the Filing Status input screen in the software.
This BlockWorks worksheet is shown in Illustration 4.2. After the appropriate lines are filled in and
totaled, divide the amount the individual pays by the total amount of the cost.

Illustration X.X
4.1

Illustration 4.2
X.X
the Household Support Worksheet found on the Filing

BStatus screen toUse
determine if a taxpayer has paid more than half the cost of
lockWorks Tip:
keeping up a home for the year, if there are concerns as to whether the taxpayer actually qualifies. This worksheet is very helpful if the clients income level
makes it seem unlikely they could be paying one-half of the cost of maintaining
the household. An example of this worksheet is shown in Illustration 4.2.
mExample: Tim is not sure whether he or his father pays more than one-half the cost of maintaining the household. If Tim pays more than half the cost, he will qualify to file as head of household.
The total costs for maintaining the home were $45,450, and Tim paid $22,950 of the costs. Since
Tim pays 50.5% of the costs [$22,950 Tim paid 3 $45,450 total costs = 0.5050], Tim will file as head
of household.m
Exceptions to the Head of Household Requirements
Married qualifying child. The qualifying child of a taxpayer for head of household purposes cannot
be married unless the taxpayer can claim an exemption for that child.
Nonrelative dependent. A dependent who meets the relationship test because they live in the same
household with the taxpayer for the entire year cannot qualify the taxpayer for head of household
status. To qualify the taxpayer for head of household, the dependent must actually be related to the
taxpayer as indicated in the relationship test for a qualifying relative.
mExample: Lets revisit the cousins, Tony and Adam, from Chapter 3. Adam is Tonys dependent.
However, Tony may not file as head of household unless he has some other qualifying child or another
dependent who is related to him. Although Tony and Adam are cousins, this relationship does not
meet the requirements of the relationship test. Tony must file as single.m
Multiple support agreements. A taxpayer who has a dependent because of a multiple support
agreement cannot file as head of household. Taxpayers who have qualifying relative dependents must
have provided over half of the support for those dependents by themselves.
Nonresident aliens. A taxpayer who is a nonresident alien for any part of the tax year may not file
head of household.
Married, But Unmarried For Tax Purposes

To be considered unmarried for tax purposes, a married person must be legally separated under a
decree of divorce or separate maintenance or must meet all of the following requirements:
The person must file a separate return from their spouse.
The person must have provided more than half the cost of maintaining their home for the tax year.
The home must have been the principal place of abode of the taxpayer and their dependent son,
daughter, or eligible foster child (qualifying child or qualifying relative) for more than half the tax
year. This includes a child who would be a dependent except that the exemption was awarded to
the noncustodial spouse by (a) a post-1984 divorce or separation agreement or (b) a waiver by the
custodial parent (Form 8332).
The persons spouse must not have lived in the home at any time during the last six months of the
tax year.
This does not include those situations in which the spouse is living away from the home temporarily
(job assignment, military deployment, etc.) as opposed to the couple being estranged from each other.
mExample: Sandy Remington has lived apart from her husband since February 3, 2014. She does not
wish to file a joint return with her husband. They do not have a decree of divorce or separate maintenance or a written separation agreement. She has provided more than half of the cost of the maintenance of the home where she and her son, Mark, have lived all year. Sandy qualifies as unmarried
for tax purposes. Sandy may file as head of household.m
Recall that a persons principal place of abode does not change if an absence from the home is temporary in nature due to special circumstances. Examples include absences due to vacation, business,
hospitalization, education, military service, or short-term incarceration.
mExample: Thelma lived apart from her husband for all of 2014 and does not wish to file a joint return.
She paid the entire cost of maintaining her home in Paducah, Kentucky. She maintains a room in the
home for her dependent daughter, Daphne, who is currently attending college in Los Angeles, where
she shares a dorm room with two other students. Most of Daphnes belongings remain at Thelmas
home. Daphne seldom visits her father and does not keep any of her belongings at his home.
It is clear from the circumstances that Daphnes principal place of abode is Thelmas home. Thus,
Thelma would qualify to be considered unmarried for tax purposes. Thelma may file as head of household.m
A married taxpayer who does not wish to file a joint return generally will benefit from the rule allowing them to be considered unmarried, if they so qualify. If they do not qualify, they must file a joint
return with their spouse (which often is not an option) or use the married filing separately status. The
disadvantages of the married filing separately status include:
The standard deduction is $0 if the other spouse itemizes.
The effective tax rates are higher.
Many deductions and credits are phased out at lower income levels or disallowed completely.
Qualifying Widow(er)
Taxpayers may file as qualifying widow(er) if they meet both of the following requirements:
The taxpayers spouse died in either of the two tax years immediately preceding the current tax
year.
The taxpayer paid over half the cost of maintaining their household, which is the home of their
dependent son, stepson, daughter, or stepdaughter for the entire year.
In the actual year the spouse died, the taxpayer must have been eligible to file married filing jointly
in order to use the qualifying widow(er) status for the next two years afterward. For the next two
years, the taxpayer may file as qualifying widow(er) if they have a dependent son, stepson, daughter,
or stepdaughter. If a taxpayer remarries during any of these years, the taxpayer cannot file as qualifying widow(er).
mExample: Helen and Charles were married for 15 years before Charles unexpectedly passed away
in 2013. Helen has a dependent son, Dennis, who lived with her all year long. In 2013, Helen filed her
tax return as married filing jointly. In 2014 and 2015, Helen may file as qualifying widow (provided
she does not remarry during that time), Dennis remains her dependent for both years, and she pays
over half the cost of maintaining the home.m
mExample: George and Ingrid were married for ten years before Ingrid died in 2012. George has a
dependent daughter, Alice, who lived with him all year long. George remarried in January 2014.
Unfortunately, his marriage did not last, and he was divorced in November of 2014. In 2012, George
filed his tax return as married filing jointly. In 2013, he filed his tax return as qualifying widower.
Now in 2014, George may either file his return as single or head of household. He may no longer use
the qualifying widow(er) status because he remarried in 2014.m
CHILDREN OF DIVORCED OR SEPARATED PARENTS

The rules for qualifying children are handled a bit differently in cases involving divorced or separated
parents. For tax purposes, the custodial parent is the parent with whom the child lived for the greater
number of nights during the year. The other parent is the noncustodial parent. In the case where parents divorce or separate 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 number of nights during the
rest of the year.
Note: If the number of nights is equal, the custodial parent is the parent with the higher AGI.
Generally, it is the custodial parent who may claim the qualifying childhence, the dependency
exemptionfor that child.
When dealing with divorced or separated parents, always determine
Tthe custodial
and noncustodial parent. Generally the custodial parent is the
ax Tip:
one with whom the child lived for the greater number of nights during the year.
A child is treated as living with a parent for a night if the child either:
Sleeps at that parents home, whether or not the parent is present.
Is in the company of the parent, when the child does not sleep at a parents
home (for example, vacation).
If the child lived with each parent for an equal number of nights during the
year, the custodial parent is the parent with the higher adjusted gross income
(AGI).
Temporary Absences Involving Divorced or Separated Parents

Generally, a temporary absence from the home due to special circumstances does not constitute a
change in the persons principal place of abode. However, in cases involving divorced or separated
parents, any time the child spends with either parent is not treated as a temporary absence from the
other parent. The number of nights the child spent with either parent during the year is totaled, and
the parent with whom the child spent more nights is, for tax purposes, the custodial parent. This is
true regardless of which parent has legal custody or which claims to maintain the childs permanent
place of abode. The designation of custodial parent is determined by the circumstances each year.
mExample: Tyree and Brenda Butler were divorced in 2008. The divorce decree grants them joint
legal custody of their son, Adam (13). Brenda usually has Adam living with her, but Adam visits
Tyree every weekend and for four weeks in the summer (124 nights in 2013). For 2013, Brenda was
the custodial parent because Adam stayed with his mom for 241 days.
In 2014, Brenda was incarcerated for six months of the year. As a consequence of this unfortunate
event, Tyree became the physical custodian of Adam for over six months of 2014, and Tyree is now
the custodial parent for 2014.m
The rules for divorced and separated parents apply if all of the following conditions exist:
One or both of the parents provided more than half the childs total support (explained in Chapter
3) for the year.
At the end of the year, the parents of the child are one of the following:
They are divorced or legally separated under a court decree of divorce or separate maintenance.
They are separated under a written separation agreement.
They have lived apart for the last six months of the year, regardless of whether they were ever
married.
The child lived with one or both parents for more than half the year.
These rules also apply even if the parents were never married to each other.
mExample: Butch and Melanie Garrison were divorced in 2005. The divorce decree granted them joint
custody of their son, Brian.
Brian, now age 16, lived with Melanie until June 24. During the tax year, Brian decided that life
would be more fun to live with his father, Butch. Brian went to stay with Butch on June 25 and lived
there the remainder of the year.
Brian stayed with Melanie 175 nights and with Butch 190 nights during the year. Butch is entitled
to claim Brian as a qualifying child because Brian lived with his parents combined for more than half
the year and spent more time with Butch.m
mExample: Suppose that, after Brian moved out of Melanies home, he stayed with his older sister
for three weeks before moving in with Butch. Thus, he stayed with Melanie 175 nights, his sister 21
nights, and Butch 169 nights. Although Brian did not stay with either parent individually for more
than half the year, Melanie is now entitled to claim him as a qualifying child because Brian lived with
his parents combined for more than half the year and he spent the longer amount of time with her.m
Any decree of divorce or separate maintenance or written separation agreement that became effective
after 1984 and prior to 2009 must state the following three facts:
The noncustodial parent can claim the child as a dependent without regard to any conditions, such
as payment of support.
The custodial parent will not claim the child as a dependent for the year.
The years for which the noncustodial, rather than the custodial, parent can claim the child as a
dependent.

Illustration X.X
4.3
Illustration
Beginning with 2009 tax returns, divorce decrees or other court documents issued in 2009 and forward do not serve to release the childs exemption to a noncustodial parent. In these cases, Form 8332
must be used. It would be best to secure a Form 8332 any time a custodial parent is sharing benefits
with the noncustodial parent.
Divorced and separated parents. If the noncustodial parent is allowed to take the dependency
exemption for a qualifying child, they are also allowed to claim the Child Tax Credit for that child.
This is true even if their filing status is married filing separately. The custodial parent, in such a case,
may not claim the Child Tax Credit for the child.
Note: The Child Tax Credit is one of the few credits that is allowed to a person using the married filing separately status; however, the phaseout of the credit for married filing separately is substantially
lower than the other filing statuses.
Form 8332
The custodial parent has the option of waiving the right to claim a dependency exemption for a qualifying child, allowing the noncustodial parent to do so. This is usually accomplished by completing
Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.
Illustration 4.3 shows the current version of Form 8332. Prior to 2009, the agreement also may be
contained in the divorce or separation instrument, making Form 8332 unnecessary when all three
conditions are met.
Form 8332 must be attached to the tax return of the noncustodial parent each year they claim the
dependency exemption. If the waiver is contained in the pre-2009 divorce or separation agreement,
copies of the following pages must be attached in lieu of Form 8332:
On the cover page, they should write the other parents social security number.
The pages containing the information required (see the three bullets on page 4.10).
The signature page showing the date of the agreement and the other parents signature.
The child will be considered the qualifying child of the noncustodial parent if the custodial parent
signs such an agreement.
Stepchildren. For tax purposes, a relationship established by marriage is not terminated by divorce.
So, for example, once a taxpayer marries someone with a child, a stepparent/stepchild relationship is
formed. Even if the couple later divorces, the relationship still exists for tax purposes and is subject
to the rules for divorced or separated parents.
Please note that if a taxpayer attaches Form 8332 to their tax return, the return should either be
mailed or, if the return is efiled, Form 8332 should be attached to Form 8453 and mailed within
three business days after receiving acknowledgment that the IRS has accepted the electronically filed
return.
TIE-BREAKER RULES
An individual can be the qualifying child of more than one taxpayer. However, only one taxpayer can
claim the individual. Subject to these rules, the taxpayer and the other person may be able to choose
which of the two claims the child as the qualifying child. In a situation where two or more taxpayers
claim an individual, there are a set of tie-breaker rules outlined in the Tax Code to award the qualifying child to a particular taxpayer. The rules:
If only one of the persons is the childs 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, the IRS will treat
the child as the QC of the parent with whom the child lived for the greater number of nights during
the year. If the child lived with each parent the same amount of time, the IRS will treat the child
as the QC of the parent with the highest AGI for the year.
If no parent can claim the child as a QC, the child is treated as the QC of the person with the
highest AGI for the year.
If a parent can claim the child but no parent does claim the child, the child is treated as the QC of
the person who had the highest AGI for the year, but only if that persons AGI is higher than the
highest AGI of either of the childs parents who could have claimed the child. If the childs parents
file a joint return with each other, this rule can be applied by dividing the parents combined AGI
equally between the two.
mExample: Betty lives with her mother, Stephanie. Stephanies AGI for 2014 is $21,350. Bettys AGI
for 2014 is $32,650. Bettys daughter, Tammi, lives in the same household as Betty and Stephanie.
Tammi is a qualifying child for both Betty and Stephanie. In 2014, Tammis mother, Betty, has the
right to claim Tammi as a qualifying child because the tie-breaker rules state that the parent of the
child has the superior claim to the dependency exemption.m
mExample: In 2014, Paula and David were married and lived with their dependent son, Andrew, from
January 1 until June 30. On July 1, David moved out of the home and filed for divorce. On December
1, their divorce was granted, and Paula was awarded residential custody of Andrew, but the decree
was silent about who could claim the dependency exemption each year.
Prior to the divorce being final, Andrew spent the months of August and October with his father,
David. For the months of September and November, Andrew lived with his grandmother. Andrew
lived with his mother, Paula, the entire months of July and December.
After the separation, in 2014, Andrew spent 62 nights with Paula and 62 nights with David. He also
spent 61 nights with his grandmother. Paulas AGI was $42,000, Davids AGI was $46,500, and the
grandmothers AGI was $58,900. Since Andrew spent an equal amount of time with Paula and David,
David is the custodial parent eligible to claim Andrew as a qualifying child based on the tie-breaker
rules, because he has the higher AGI.m
mExample: Linda, Jim, and Jane all live with Lindas mother, Betty. Jane is Lindas daughter, and
Linda married Jim when Jane was three years old. Jane is an eligible qualifying dependent for either
Linda or Jim or Betty. Jim and Lindas tax return shows an AGI of $23,000. Bettys tax return shows
an AGIof $21,000. Jim and Linda will not claim Jane on their joint return. Therefore, Betty can claim
Jane, since her AGI of $21,000 is treated as higher than the total AGI of the parents divided equally
between Jim and Linda, as if each individual AGI were $11,500 [$23,000 2 = $11,500].m
mExample: Paula and her son, Trey (5), lived all year with Paulas mother, Carolyn, who paid the
entire cost of keeping up the home. Paulas AGI was $10,000. Carolyns AGI was $25,000. Treys
father, Gary, did not live with Paula or their son at any time during 2014. Under the rules for children of divorced or separated parents or parents who live apart, Trey will be treated as the qualifying
child of Gary, who can claim an exemption and the Child Tax Credit, since Paula signed a Form 8332,
releasing her claim to those benefits. Because of this, Paula cannot claim an exemption or the Child
Tax Credit for Trey.
Treys father cannot claim Trey as a qualifying child for head of household filing status, the credit for
child and dependent care expenses, the exclusion for dependent care benefits, or the Earned Income
Credit. Paula and Carolyn do not have any child care expenses, but Trey is a qualifying child of both
Paula and Carolyn for head of household filing status and the Earned Income Credit because Trey
meets the relationship, age, residency, support, and joint return tests for both Paula and Carolyn.
(Note: You will learn in Chapter 8 that the support test does not apply for the Earned Income Credit.
However, Paula agrees to let Carolyn claim Trey. This means Carolyn can claim Trey for head of
household filing status and the Earned Income Credit, but only if she qualifies for each and if Paula
does not claim Trey as a qualifying child for the Earned Income Credit. (Paula cannot claim head of
household filing status because Carolyn paid the entire cost of keeping up the home.)m
mExample: The facts are the same for Paula, Carolyn, Trey, and Gary as in the example above, except
that Paulas AGI is $25,000 and Carolyns AGI is $21,000. Carolyn cannot claim Trey as a qualifying
child for any purpose because her AGI is not higher than Paulas.m
CHAPTER SUMMARY
How to determine whether a taxpayer qualifies to file as head of household.
How to determine who is maintaining the support of a household.
If qualified, a married taxpayer may be considered unmarried for tax purposes.
Unmarried taxpayers may file as qualifying widow(er), head of household, or single. The single
status should be used only if the taxpayer fails to qualify for either of the other two statuses.
In cases of divorced or separated parents, the qualifying child generally may be claimed by the custodial parent. However, the custodial parent may allow the other parent to claim the dependency
exemption if they sign a written agreement waiving their right to claim the exemption.
A multiple-support agreement may be helpful when two or more taxpayers together provide over
half the support of a qualifying relative.
Suggested Reading
Chapter 34, Child Tax Credit.
client received a
TW-2 and a 1099-MISC from her employer. Her year-endMybonus
was reported
as other income in box 3 of the 1099. What is the proper tax treatment of the
bonus?
The bonus should be treated as wages and not as other income or
Aself-employment
income.
nswer:
Many employers mistakenly report any pay outside of regular salary, such as
bonus, commission, or severance pay, on Form 1099-MISC instead of on Form
W-2. Your client should first ask her employer to rescind the 1099 and issue a
corrected W-2.
If she cannot contact her employer, or the employer wont make the change,
report the correct total wages, including the bonus, on line 7 of Form 1040,
using a substitute W-2 (Form 4852). To pay her share of payroll taxes, complete
Form 8919, Uncollected Social Security and Medicare Tax on Wages, and check
box H on the form: I received a Form W-2 and a Form 1099-MISC from this
firm for 2014. The amount on Form 1099-MISC should have been included as
wages on Form W-2.
Since your clients regular pay is reported on Form W-2, it is presumed that her
employer is treating her as an employee and not as a contractor. Therefore, she
should not complete Form SS-8 to request a determination of worker status.
Interest and Dividend Income

OVERVIEW
This self-study chapter will show you that wages are not the only source of income for most taxpayers.
Other types of income must be reported on a taxpayers return unless they are specifically excluded by
law. In this chapter, you will study other common types of income. The specific focus will be on interest income and income from qualified dividends and/or capital gain distributions that can be reported
on Schedule B and filed with Form 1040A, but you will also be provided awareness-level knowledge
on items that are required to be reported and filed with Form 1040.
OBJECTIVES
Recognize several types of interest income and enter them on the tax return appropriately.
Use the Qualified Dividends and Capital Gain Tax Worksheet to compute the tax for taxpayers who
receive qualified dividends and/or capital gain distributions.
TAX TERMS
Basis.
Capital gain distributions.
Mutual fund.
Nontaxable distributions.
Ordinary dividends.
Ordinary income (loss).
Qualified dividends.
Returns of capital.
Stock dividend.
5.1
INTEREST
Interest is money paid or received for the use of money. Banks often pay interest on money their customers deposit. Governments and corporations pay interest on bonds they issue. Insurance companies
pay interest on money left on deposit. The sources of interest income are vast. Most of the interest
we receive is taxable, but some is not. Illustration 5.2 lists some common types of interest and shows
whether or not the interest is taxable on the federal return.
Generally, interest is taxable in the year received or credited to an account, even if it is not withdrawn. Payers of interest of $10 or more to any one person during the year are generally required
to report such payments to the IRS and furnish the recipient with a Form 1099-INT or an approved
substitute form. If less than $10 interest was received from any payer, that interest is still taxable to
the taxpayer, even though a reporting form is not required from the payer. In some cases, especially
with loans or contracts, the taxpayer must determine the amount of interest received from their own
records (for example, from an amortization schedule).
Schedule B
When the taxpayer receives taxable interest totaling more than $1,500, it must be listed on Schedule
B. Schedule B is shown in Illustration 5.3. Interest totaling $1,500 or less can be entered directly on
Form 1040A, line 8a, or Form 1040EZ, line 2.
If the taxpayer received any interest on foreign investments, even if total taxable interest income is
$1,500 or less, Form 1040 and Schedule B must be used. Schedule B also must be filed if the taxpayer
received any of the following:
Interest not properly attributable to the taxpayer.
Interest on a seller-financed mortgage.
Interest from U.S. Savings Bonds that is being excluded from income (covered later in this course).
lockWorks tip: Without regard to dollar limits, BlockWorks will always

show a Schedule B available for printing. Tax Professionals have the option
to suppress printing the Schedule B when it is not required for a specific tax
return. See Illustration 5.1 below.
Illustration 5.1
Interest and Dividend Income 5.3

Illustration 5.2
Interest Income From:
Paid By:
Taxable:
Savings accounts, certificates

of deposits, checking accounts
Banks, savings and loan associations, credit unions
Yes, as accrued.
Certain short-term corporate

obligations
Banks and similar organizations and corporations
Yes, at maturity.
Yes, generally at maturity
or when cashed, though may
elect as earned.
Series E or EE Bonds, Series

I Bonds
U.S. Treasury
No, if proceeds from qualified

bonds are used to pay qualified higher education expenses.
Series H or HH Bonds
U.S. Treasury
Yes, as accrued.
Treasury Bills
U.S. Treasury
Yes, at maturity.
Treasury Notes/Bonds,
all others
U.S. Treasury
Yes, as accrued.
Municipal bonds
State/local governments
No, but still reportable
Exempt-interest dividends
Mutual funds
No, but still reportable.
Corporate bonds
Corporations, including public

utility companies
Yes, as accrued.
Other bonds and notes
Various
Yes, as accrued.
Personal loans/notes
Borrower
Yes, as received.
Sales contracts
Purchaser
Yes, as accrued.
Insurance dividends left on

deposit
Insurance company
Yes, as accrued.
Overpaid income tax
U.S./state/local government
Yes, year received.

Illustration 5.3
X.X
This is reporting a seller-financed mortgage. This is the

interest Paula received.
This $300 is nominee interest
reported to Paula. Notice that
it is reported, then subtracted.
Note: There are two reasons this Schedule B cannot be filed

with Form 1040A:
The interest Paula received from the seller financed mortgage exceeds $1,500.
The nominee distribution is interest not attributable to
the taxpayer.
Paula Pendletons Schedule B must be filed with Form 1040.
Foreign Investments
Interest on foreign investments is taxed the same as interest received on domestic investments.
Investing in U.S. mutual funds that hold foreign debt instruments does not constitute an interest in
a foreign account for this purpose, nor does an account in a U.S. military financial facility.
When a tax return is filed electronically, Tax Professionals must ask the following questions about
foreign accounts and foreign trusts:
At any time during 2014, did you have any financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign
country?
Taxpayers who answer yes to this question may have to file FinCEN Form 114, Report of Foreign
Bank and Financial Accounts, and/or Form 8938, Statement of Specified Foreign Financial Assets.
During 2014, did you receive a distribution from or were you the grantor of or transferor to a foreign trust?
Taxpayers who answer yes to this question may have to file Form 3520, Annual Return To Report
Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.
During 2014, did you have ownership or authority over foreign financial assets worth $50,000?
Form 8938, Statement of Specified Value of Foreign Financial Assets, is required to be filed if the
aggregate value of foreign financial assets exceed $50,000 ($100,000 if MFJ) at the end of the year
or exceeds $75,000 ($150,000 MFJ) at any time during the year. The form is required to be attached
to the tax return. Failure to report can result in a penalty of $10,000.
A Tax Professionals due diligence responsibility is to ask the questions and inform taxpayers if and
when any additional forms are required. These forms should not be completed without the assistance
of an experienced Tax Professional.
Not Attributable to the Taxpayer

There are some circumstances when a taxpayer may receive, in their name, interest income (and often
a Form 1099-INT) that does not actually belong to them. One example is nominee interestinterest
that belongs to another person. It is fairly common for a parent to hold a bank account for a minor
child. If the money in the account actually belongs to the child, so does the interest income it produces.
The taxpayer should report nominee interest on Schedule B. Then, write Nominee Distribution, and
subtract the amount of such interest. The total on line 2 should represent only taxable interest. See
Illustration 5.3 for an example that reports a nominee distribution.
Note: If nominee interest totals $10 or more, the taxpayer must issue a Form 1099-INT to the rightful
owner of the income (other than their spouse) by February 28. The IRSs copy of Form 1099-INT is
filed along with transmittal Form 1096.
Other examples of interest not attributable to the taxpayer include certain accrued interest and original issue discounts (OID), which will not be discussed in this course.
Seller-Financed Mortgage
If a taxpayer sells their home to a buyer who uses the home as their residence, and the taxpayer
finances part or all of the mortgage, the taxpayer must report the buyers name, address, and social
security number on Schedule B (or an attachment), along with the amount of interest received each
year. The interest the taxpayer receives is taxable. There is a $50 penalty for failure to report this
information. The taxpayer is also required to provide the buyer with their name, address, and social
security number. See Illustration 5.3 for an example.
Tax-Exempt Interest
Banks, savings and loans, and other payers of interest will report tax-exempt interest on a Form
1099-INT. The taxpayer should report the tax-exempt interest on Form 1040 or Form 1040A, line 8b.
FORM 1099-INTINTEREST INCOME

Study Form 1099-INT in Illustration 5.4. You need to understand the following entries at this time.
Box 1
This box includes amounts that are paid or credited to the taxpayers account. It includes such items
as interest on bank deposits, corporate bonds, and notes.
If total taxable interest is more than $1,500, it must be reported on Form 1040 or Form 1040A,
Schedule B. Total taxable interest is reported on Form 1040 or Form 1040A, line 8a, or Form 1040EZ,
line 2.
Box 2
If money in a time savings instrument (such as a certificate of deposit) is withdrawn before maturity, interest may revert to a lower rate and there may also be a period when no interest is paid. The
difference (the amount of interest forfeited) will be reported as an early withdrawal penalty in box 2
on Form 1099-INT or similar statement. It is possible that the penalty could be more than the gross
amount of interest reported in box 1.
Penalty on Early Withdrawal of Savings Adjustment
The interest penalty can be subtracted from total income on Form 1040. Forms 1040A or 1040EZ do
not have this line entry. The interest reported on Form 1099-INT is the amount that was received for
the tax year up to the date of withdrawal.
mExample: In January 2012, Margaret Webber invested $10,000 in a five-year certificate of deposit
with her bank. The CD pays 3% interest annually, but if Margaret were to cash it in prematurely, she
would be charged with a % penalty.
In February 2014, Margaret cashed in the CD. The bank computed her interest income for 2014 to be
$35, but she had to pay a $50 penalty [$10,000 .005 = $50]. She would report $35 in taxable interest, and claim an adjustment to income by subtracting $50 from taxable income on Form 1040 only.m
Box 3
Interest from U.S. Savings Bonds and other Treasury obligations is entered here. Generally, this
income is taxable on the federal return, but nontaxable on state returns. Box 3 amounts are entered
on the federal return in the same manner as box 1 amounts. We will further examine this type of
income later in this chapter.
Illustration 5.4
Box 4
Usually, tax is not withheld from interest payments. However, if the taxpayer has failed to provide the
payer with their social security number or other identifying number, the payer is required to withhold
tax on the interest paid. Any withholding is shown in box 4. Include box 4 amounts in the total entered
on Form 1040A, line 40 or Form 1040EZ, line 7.
Box 5
Any amount shown in this box is the taxpayers share of investment expenses from a real estate mortgage investment conduit (REMIC). REMICs are not covered in this course.
Box 6
Foreign tax paid is any foreign tax withheld from the interest income. The taxpayer may deduct the
tax as an itemized deduction or take a dollar-for-dollar credit, both of which are reported on Form
1040. We will not discuss the details of this topic in this course.
Box 7
Foreign country or U.S. possession is the country or possession to which the foreign tax was paid.
Box 8
This box shows the amount of tax-exempt interest received by the taxpayer. Tax-exempt interest may
be entered directly on Form 1040A, line 8b.
Box 9
This box shows the amount of tax-exempt interest that is subject to the Alternative Minimum Tax.
The Alternative Minimum Tax, or AMT as it is commonly known, is beyond the scope of this discussion. The amount shown in box 9 is included in box 8.
Boxes 10 and 11
Both boxes contain information reported for covered securities, which are not covered in this course.
Box 12
This box shows the CUSIP number of the tax-exempt bond for tax-exempt interest reported in box 8.
If the tax-exempt interest is reported in the aggregate for multiple bonds or accounts, enter various.
If a CUSIP number was not issued for the tax-exempt bond, box 10 will be blank.
UNITED STATES TREASURY OBLIGATIONS

The Department of the Treasury of the United States offers several different types of debt instruments, which accrue and pay interest at various intervals. The most commonly held instruments are
U.S. Savings Bonds.
Series EE bonds have been issued by the Treasury since 1980. Series I bonds have been issued since
1998. Their predecessors, Series E, H, and HH bonds, are no longer issued, but many taxpayers still
hold them. See Illustration 5.5.
Series E and EE bonds accrue interest until they mature. Most taxpayers report Series E and EE bond
interest in the year the bond is cashed or the year of final maturity, whichever is earlier.
A taxpayer may elect to report the interest each year as it is earned. This election is made by attaching a statement to the tax return and does not require IRS permission. Once this election is made, the
taxpayer must include in income the interest from all Series E or EE bonds each year. The taxpayer
may only change back to the other method with IRS permission.

Illustration 5.5
Issued
Reach Maturity
After
Through 11/30/65
40 years
12/1/6506/30/80
30 years
EE
Since 1980
30 years
Through 12/31/79
30 years
HH
Through 08/31/04
20 years
Since 1998
30 years
Series
E
mExample: Baby Janet, born in 2014, received several Series EE bonds for her christening. The bonds
were gifts and were issued in her name.
As odd as it may sound, the best tax-saving strategy may be for her parents to file a 2014 tax return
for Janet, electing to report the interest annually. If the interest is her only income, it will probably
be too little to trigger a tax liability each year. After the election is made, a return will not have to
be filed for each year her income is below the gross income filing requirement. When the bonds are
cashed (or reach final maturity), the prior years taxable interest will not be included in her income.
If, instead, the interest is taxed when the bonds are cashed or reach maturity, Janet may have taxable
incomeenough to require her to pay tax on some or all the interest at her marginal tax rate.m
Through August 31, 2004, mature Series E or EE bonds could be traded in for Series HH bonds. Such
a trade was a nontaxable transaction, meaning the previously accrued interest continued to be tax-deferred until distributed. No new Series HH bonds are being issued after August 31, 2004.
Series HH bonds pay interest directly to the taxpayer twice a year. The taxpayer must report the
interest in income in the year it is received if the taxpayer is a cash-method taxpayer.
Series I bonds are inflation-indexed; that is, they are designed to offer a rate of return over and above
the rate of inflation, as measured by the consumer price index (CPI). Other than the inflation aspect,
these bonds are treated very much as Series EE bonds.
U.S. Savings Bonds that have reached final maturity are no longer yielding interest. Bonds that have
reached final maturity should usually be cashed in as soon as possible.
Treasury bills, notes, and bonds are direct obligations of the U.S. Treasury. T-bills mature in one year
or less and are taxed at maturity. Most other Treasury obligations are taxed as the interest is earned.
See Illustration 5.2 for more information.
By federal law, interest from U.S. Treasury obligations is never subject to state or local income taxes.
OTHER INTEREST INCOME

If the IRS sends a tax refund to a taxpayer who has filed an amended return or if it takes more than
45 days to issue a refund, it will pay interest along with the refund. Such interest is taxable. The same
holds true for interest on late refunds from state and local governments. Generally, the IRSwill send
the taxpayer Form 1099-INT for the year in which the interest is paid.
Municipal Bond Interest

Municipal bonds are generally issued by state and local governments to fund capital improvement
projects. Local governments include counties, cities, school districts, and other administrative divisions of the states that have been granted the authority to issue bonds. The federal government does
not tax municipal bond interest.
Some state and local governments do not tax interest from any municipal bonds. Others tax interest
from municipal bonds issued by state or local governments other than their own. Still others tax interest from all municipal bonds, including their own.
State and local governments will report such tax-exempt interest on Form 1099-INT.
DIVIDENDS
Dividends are paid to shareholders (people who own stock) of corporations. They represent the shareholders portion of the corporations profits. In this section, you will learn about the various kinds of
dividends shareholders may receive and their tax treatments.
Note: Certain distributions commonly referred to as dividends are actually interest. Two common
examples are dividends paid by credit unions and exempt-interest dividends paid by mutual funds.
These so-called dividends are properly treated as interestthe former (credit union dividend) is
taxable, and the latter is tax exempt.
Payers of dividends of $10 or more to any one person during the year are required to report such
payments to the IRS and furnish the recipient with a statement of total dividends received for the tax
year. Form 1099-DIV or similar statement of account is used. See Illustration 5.6.
The most common types of distributions are:
Ordinary dividends (including qualified dividends).
Capital gain distributions.
Nontaxable distributions.
Ordinary dividends are the most common type of distribution and are the portion of a corporations
profits paid to the shareholders. While some ordinary dividends are taxed as ordinary income, qual-
ified dividends are treated as long-term capital gains. You will learn why this is important later in
this chapter.
Capital gain distributions are paid by mutual funds, regulated investment companies, and real estate
investment trusts. They represent the shareholders portion of gain from the sale of securities owned
by these investment companies. Capital gain distributions are characterized as long-term regardless
of how long the taxpayer has owned them if they are from a mutual fund or real estate investment
trusts. There are two treatments of capital gain distributions. Both types are taxable for the year
constructively received:
Distributed capital gains are paid in cash to the shareholders or reinvested in additional shares at
the shareholders request.
Undistributed capital gains are retained by the investment company, which pays the tax on them.
These gains are reinvested automatically in additional shares and reported to the taxpayer on
Form 2439 rather than on Form 1099-DIV. An individual who receives Form 2439 may have a
credit which can only be claimed by filing Form 1040.
Nontaxable distributions represent a return of the shareholders capital (original investment), generally made because an excess amount of capital has been accumulated by the corporation. Nontaxable
distributions may be received in cash or reinvested at the shareholders request to acquire additional
shares. The basis of the stock must be reduced by the amount of the distribution. Amounts received
are not taxable until the remaining basis is reduced to zero. It is important to know that returns of
capital are usually not taxable.
Form 1099-DIVDividends and Distributions

Illustration 5.6
Examine the Form 1099-DIV in Illustration 5.6. The entries you will need to understand are:
Box 1a. Ordinary dividends are totaled and entered on Form 1040A, line 9a. If the total is more than
$1,500, the dividends must also be reported in Part II of Schedule B. If the total is $1,500 or less, the
amount is entered directly on Form 1040A, line9a.
Box 1b. Qualified dividends are included in box 1a, but also are shown here because they qualify for
more favorable tax treatment. They are totaled and entered on 1040A, line 9b. We will define qualified
dividends later in this chapter.
Box 2a. Total capital gain distributions are shown here. As mentioned earlier, capital gain distributions represent the shareholders share of capital gains from mutual funds, regulated investment
companies, and real estate investment trusts (REITs). The total gain in box 2a includes any amounts
in boxes 2b2d. Each of these amounts is subject to a different tax treatment and various limitations,
which we will discuss in a moment.
If none of the taxpayers Forms 1099-DIV contain any entries in boxes 2b2d, the taxpayer may report
their capital gain distributions directly on Form 1040A, line 10.
Box 2b. Unrecaptured 1250 gain is a portion of the gain resulting from the sale of certain real estate
used for business purposes. It is taxed at a maximum rate of 25%. A discussion of 1250 gain will not
be held in this course.
Box 2c. Section 1202 gain is gain from the sale of certain small business stock. Some of this gain may
be eligible to be excluded from income. The exclusion will not be discussed in this course.
Box 2d. Gain resulting from the sale of certain collectible items, such as rare coins and works of art,
is taxed at a maximum rate of 28%. We will discuss this category of gain when we discuss capital gain
tax rates.
Box 3. Non-dividend distributions are shown here. These distributions generally are not entered on
the tax return.
Box 4. This is the amount of federal income tax withheld from the taxpayers dividends in the event
the payer has not been provided with the taxpayers identification number. Be sure to include this
amount in the total for Form 1040A, line 40.
Box 5. Usually, this box is empty. If it has an entry, the amount represents the taxpayers share
of expenses paid by a non-publicly offered regulated investment company. The box 5 amounts are
deductible as a miscellaneous itemized deduction on Schedule A. Details of this itemized deduction
are not discussed in this course.
Box 6. Foreign tax paid is the foreign tax withheld from the dividend income. It may be deducted on
Schedule A (if the taxpayer itemizes deductions) or claimed as a foreign tax credit. As mentioned in
the discussion of Form 1099-INT earlier, qualified individuals claim the foreign tax credit by filing
Form 1040.
Box 7. The country or U.S. possession to which the foreign tax was paid.
Boxes 8 and 9. These boxes only apply to corporations that are in partial or complete liquidation;
that is, going out of business. Cash distributions are reported in box 8. The fair market value of items
other than cash distributed as part of a liquidation is reported in box 9. Treatment of liquidation distributions is not discussed in this course.
Many banks and brokerage firms issue their own versions of Forms 1099, sometimes combining multiple reporting forms on one sheet. These substitute statements must contain all the same information,
labeled with box numbers corresponding to the official IRS forms.
These statements include Forms 1099-DIV, 1099-INT, 1099-OID (a form used for reporting interest
from certain bonds), Form 1099-B (not covered in this course), and Form 1099-MISC (a form which
shows miscellaneous income).
TAX COMPUTATION FOR QUALIFIED DIVIDENDS AND CAPITAL

GAIN DISTRIBUTIONS
Qualified dividends (those found on Form 1099-DIV, box 1b) and capital gain distributions (Form
1099-DIV, box 2a) are treated as long-term capital gains, which generally are taxed at lower rates
than ordinary income and short-term capital gains.
Qualified dividends are those received on certain shares of stock held more than 60 days (90 days for
preferred stock). The payer of the dividends should determine if dividends are qualified dividends.
Long-term capital gain treatment is generally reserved for gain from sales or other exchanges of
securities held for more than one year. We will not cover long- and short-term gain and other types
of capital gains in this course. For now, we will concern ourselves only with normal capital gain
distributionsthose shown only in box 2a.
For 2014, the maximum rate of tax on qualified dividends is:
0% on any amount that otherwise would be taxed at a 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 a 39.6% rate.
If a taxpayer has no income eligible for long-term capital gain treatment other than qualified dividends and normal capital gain distributions, the taxpayer may use the Qualified Dividends and
Capital Gain Tax Worksheet to compute their income tax. Taxpayers with other capital gains and
losses must file Schedule D and use the Schedule D tax worksheet. Schedule D must be filed with
Form 1040 and will not be covered in this course.
mExample: Sven and Ingrid Dasen are filing a joint return and are in the 25% federal tax bracket.
Included in their $69,440 taxable income (Form 1040A, line 27) are the dividends and capital gain
distributions shown on the Form 1099-DIV in Illustration 5.6. A portion of page 1 of their Form 1040A
and their Qualified Dividends and Capital Gain Tax Worksheet is shown in Illustration 5.7. Notice
that the reduced capital gains rate saves them $157 in tax (the difference between line 15 and line
14).m

Illustration 5.7
CHAPTER SUMMARY
Interest income is reported to the taxpayer on Form 1099-INT or a substitute statement.
Dividend income may consist of ordinary dividends, capital gain distributions, or nontaxable
(return of capital) distributions. Dividends are reported to the taxpayer on Form 1099-DIV or a
substitute statement.
Generally, if total taxable interest or ordinary dividend income is $1,500 or less, report the income
directly on the front page of Form 1040 or 1040A (or 1040EZ for interest only). If total taxable
interest or ordinary dividend income is $1,501 or more, use Form 1040 or 1040A, Schedule B.
A taxpayer whose only capital gain income is normal capital gain distributions from mutual
funds, regulated investment companies, etc., may use the Qualified Dividends and Capital Gain
Tax Worksheet to compute their tax.
Qualified dividends and normal capital gain distributions are taxed as long-term capital gains.
Suggested Reading
Chapter 7, Interest Income.
Chapter 8, Dividends and Other Distributions.
client, who is a
TU.S. citizen, moved to the U.K. early in 2014 and will beMyliving
and workhe Tax Institute Tax in the News Research Question:
ing there for at least two more years. She has a checking account at a London
branch of a U.S. bank. Although her account balance varies, she has a high
paying job and her pay is directly deposited into this account every other week.
Someone told her that because her money is in an American bank she doesnt
have anything to worry about, but she is concerned that she may have some
type of foreign account reporting requirement. Does she have to file a TD F
90-22.1 or that new Form 8938?
nswer: Your client is correct about not making assumptions about her
reporting responsibility because her account is at an American bank. She
should be aware of the two reporting requirements.
Form TD F 90-22.1 / FinCEN Form 114, Report of Foreign Bank and Financial
Accounts FBAR, is required if a U.S. taxpayer a) has a financial interest in
or a signature authority over at least one foreign financial account and b) the
value of the account(s) is more than $10,000 at any time during the year. For
FBAR purposes, a foreign financial account is any account that is not physically
located in the United States or in one of its possessions or territories. In your
clients case, her checking account maintained in a foreign branch of a U.S. bank
is a foreign financial account. If her checking account balance was more than
$10,000 on any one day during 2014, she must file the FBAR electronically with
FinCEN by June 30, 2015.
Under the Foreign Account Tax Compliance Act FATCA, Form 8938,
Statement of Specified Foreign Financial Assets, is required if a U.S. taxpayer
a) has a specified asset maintained by a foreign financial institution and b) the
value of the asset is over certain thresholds. While a checking account is a specified asset, for this purpose, a foreign branch of a U.S. bank (50 states and D.C.
only) is not considered a foreign financial institution for FATCA purposes. Thus,
given these facts, your client is not required to file Form 8938.
However, if your client decides to transfer her money to a U.K. or other foreign
bank, or opens another account at a foreign financial institution, FATCA may
come into play. For a single U.S. citizen living abroad (assuming your client
meets or will soon meet either the physical presence test or bona fide residence
test), Form 8938 is required if the value of her account is more than $200,000 at
the end of the calendar year or more than $300,000 at any time during the year
but only if the account is maintained in a foreign financial institution.
BlockWorks Practice 1
OVERVIEW
This entire chapter is devoted to the BlockWorks Practice Session 1. This practice session will help
you become familiar with the preparation of taxpayers income tax returns in the BlockWorks software as well as develop your tax interview skills at the tax desk. One of the practice case studies is set
up as a role play to give you the experience of interviewing a client. This will help you start thinking of
ways you will ask questions to conduct a thorough tax interview that results in an accurate tax return.
INSTRUCTIONS
To complete the BlockWorks Practice Session 1, you will first spend one hour completing ITC case
study returns in the BlockWorks software. Your instructor will provide you with guidance as to which
case studies you enter into BlockWorks.
Next, you will spend approximately one hour by yourself completing Case Studies 6.1 and 6.2 in the
BlockWorks software. This case study information can be found on pages W6.1W6.8 in your workbook.
Finally, you will spend the remaining hour of class completing Case Study 6.3 in the BlockWorks
software. To complete Case Study 6.3, you will need to partner with another participant in class. This
case study is set up in your workbook as an interview with a taxpayer at the tax desk. One individual
will play the role of the Tax Professional, and the other individual will play the role of the taxpayer.
Each case study in your workbook is set as two scripts, the Tax Professional and the taxpayer. Use
the script associated with your role to ask or answer questions and complete the case study return
in the BlockWorks software. This case study information can be found on pages W6.9W6.15 in your
workbook.
6.1
Earned Income Credit

OVERVIEW
In this chapter, you will discuss two refundable tax credits for which taxpayers may qualify. The
two credits are the Earned Income Tax Credit (EIC or EITC) and the Additional Child Tax Credit.
The Earned Income Tax Credit can generate tax refunds of a few thousand dollars on very modest
amounts of income. The Additional Child Tax Credit may allow taxpayers with little or no tax liability to receive some of the Child Tax Credit studied in Chapter 3. The chapter ends with a discussion
of the significant responsibilities paid Tax Professionals have regarding Earned Income Credit due
diligence.
OBJECTIVES
State the difference between refundable and nonrefundable credits.
Determine eligibility for the Additional Child Tax Credit and compute the credit.
Understand the rules regarding taxpayer qualifications for receiving the Earned Income Credit.
Understand the important role of the entire tax interview when preparing returns claiming Earned
Income Credit.
Determine eligibility for the Earned Income Credit and compute the credit.
Comprehend the Earned Income Credit due diligence rules.
TAX TERMS
Custodial parent.
Dependent.
Full-time student.
Investment income.
Nonrefundable credit.
7.1

Refundable credit.
Support.
CREDITS VS. DEDUCTIONS

Before we begin a discussion of credits, it is important to understand the difference between credits
and deductions.
While both credits and deductions help taxpayers reduce the amount of tax they must pay, they do so
in different ways. Deductions, such as the standard deduction, lower the tax by reducing the amount
of income that would otherwise be taxable. Lower taxable income results in a lower tax liability.
Unlike deductions, credits do not come into play until after taxable income has been computed and
the tax determined. Then, credits may be used to reduce the tax already determined.
Some credits are nonrefundable, and some are refundable. Nonrefundable means that the combined
amount of these credits cannot reduce the taxpayers tax liability below zero. Refundable credits may
reduce the taxpayers tax liability below zero, and the difference is refunded to the taxpayer.
CHILD TAX CREDIT

Remember, you studied the Child Tax Credit, worth up to $1,000 for each qualifying child, in Chapter
3. In order to qualify for the Child Tax Credit, all of the following must be true:
The taxpayer must have a qualifying child.
The qualifying child must be under the age of 17 at the end of the year.
The qualifying child must be a dependent on the taxpayers return.
The qualifying child must be a U.S. citizen, U.S. national, or resident of the United States.
When a taxpayer has little or no tax liability, they may not receive the entire Child Tax Credit as a
nonrefundable credit. In this case, the Child Tax Credit may be less than the $1,000 per child, since
this credit is nonrefundable. However, if they meet all of the necessary requirements, they may be
able to receive the balance of the credit (any amount not allowed on Form 1040A, line 35) as an
Additional Child Tax Credit, which is a refundable credit.
Earned Income Credit 7.3
ADDITIONAL CHILD TAX CREDIT

A taxpayers nonrefundable credits may be limited by his tax liability. If a taxpayers Child Tax Credit
is limited, they may be eligible to claim the Additional Child Tax Credit. The Additional Child Tax
Credit is a refundable credit, which is available when tax liability limits the Child Tax Credit.
To qualify for the Additional Child Tax Credit, a taxpayer who otherwise qualifies for the Child Tax
Credit must have one of the following:
Earned income exceeding $3,000 for 2014.
Three or more qualifying children.
Any taxpayer with at least one qualifying child may claim a credit of up to 15% of the amount by
which earned income exceeds $3,000. A taxpayer with three or more qualifying children may be able
to claim a higher credit if social security plus medicare tax paid exceeds the Earned Income Tax Credit
(if any). In all cases, the credit is limited to $1,000 per qualifying child and reduced by the nonrefundable portion of the Child Tax Credit.
Earned income. For purposes of the Additional Child Tax Credit, earned income includes both taxable earned income and nontaxable combat pay. When determining the Additional Child Tax Credit,
generally, the more earned income that is taken into account will increase the credit. As you will learn
later in this chapter, more income can either increase or decrease the Earned Income Tax Credit, so
the taxpayer can choose the more advantageous treatment.
The Additional Child Tax Credit is computed using Schedule 8812 (shown in Illustrations 7.1 and 7.2)
and is carried to Form 1040A, line 43. Unless the taxpayer has self-employment income (in which case
a Form 1040 is required), his taxable earned income will be the amount from Form1040A, line 7, plus
any excludible combat pay.
mExample: For 2014, Bill Helget (55) is filing Form 1040A, using the head of household filing status,
and he has five qualifying children under age 17. His earned income and adjusted gross income are
$33,010, and his tax before credits is $21. His employer withheld $2,526 in social security and medicare taxes from his wages. Bill is claiming a $2,942 Earned Income Tax Credit and no nonrefundable
credits other than the Child Tax Credit.
Bill would have been allowed a $5,000 nonrefundable Child Tax Credit, but his tax liability is only
$21. His 2014 earned income exceeds $3,000 by $30,010. Because he has three or more qualifying
children, he may claim an Additional Child Tax Credit for the larger of 15% of that excess [$30,010
2 15% = $4,502] or the amount by which his net social security and medicare tax paid exceeds his
Earned Income Tax Credit, not to exceed his remaining available credit [$5,000 tentative credit $21
nonrefundable credit = $4,979]. Bills social security and medicare tax does not exceed his EIC [$2,526
vs. $2,942]. Illustrations 7.1 and 7.2 show Bills Schedule 8812.m

Illustration 7.1

Illustration 7.2
EARNED INCOME CREDIT

The Earned Income Credit, abbreviated EIC, is a valuable credit available to lower-income taxpayers
with earned income. It can be worth as much as $6,143 for 2014, depending upon the taxpayers filing
status, income, and number of qualifying children involved. The EIC is refundable, which allows the
taxpayer to get the credit as part of their refund, even if their tax liability has been reduced to zero.
QUALIFYING FOR EIC

Taxpayers may qualify for the EIC, even if they have no qualifying children, but the rules are slightly
different than for taxpayers with qualifying children. First, we will examine the rules for those without qualifying children. Then, we will look at the rules for those with qualifying children. Finally, we
will discuss additional rules that apply to both.
Taxpayers Without Qualifying Children

To qualify for the credit, taxpayers without qualifying children must:
Be at least 25 years old, but younger than age 65, on January 1, 2015 (if MFJ, either spouse can
meet this requirement).
Not be able to be claimed as a dependent on another taxpayers return.
Not be a qualifying child of another person.
Live in the United States more than half the year.
Have earned income and AGI of less than $14,590 ($20,020 if married filing jointly).
Taxpayers With Qualifying Children

To qualify for the EIC, taxpayers with one or more qualifying children must:
Have a qualifying child who meets the relationship, age, residency, and joint return tests.
Have a qualifying child who is not claimed by more than one person for EIC.
Not be a qualifying child of another person.
Have earned income and AGI less than one of the following:
$38,511 ($43,941 if married filing jointly) with one qualifying child.
$43,756 ($49,186 if married filing jointly) with two qualifying children.
$46,997 ($52,247 if married filing jointly) with three or more qualifying children.
Rules for Taxpayers With or Without a Qualifying Child

To qualify for the credit, all taxpayers must:
Have a valid SSN.
Not use the filing status MFS.
Be a U.S. citizen or resident alien all year.
Not file a Form 2555 or Form 2555-EZ.

Have investment income of $3,350 or less.
Have earned income.
lockWorks Tip: For EIC purposes, be sure you enter all members of the
household when entering individuals in the Personal Information screen.
You will enter the names, relationships, ages, income, and whether the taxpayer
wishes to claim them or not.
UNDERSTANDING THE RULES

For an in-depth discussion of all the rules, IRS Publication 596, Earned Income Credit, is the best
place to start. A synopsis of these rules also appears in IRS Publication 17 in Chapter 36. What follows
are highlights and important issues to understand for this course.
Whether a taxpayer meets these rules is determined throughout the tax interview performed by the
Tax Professional. Therefore, it is important for the Tax Professional to listen carefully during the
interview to comply with EIC due diligence discussed later in this chapter.
Being a Dependent
If another person may claim the taxpayer (or their spouse if filing a joint return) as a dependent on
their return, the taxpayer cannot take the credit. This is true even if the other person does not actually claim the taxpayer.
Living in the U.S.

The United States consists of any of the 50 states and the District of Columbia. It does not include
Puerto Rico or U.S. possessions, such as the U.S. Virgin Islands and Guam. 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 EIC.
Relationship, Age, Residency, and Joint Return

Relationship
The taxpayers qualifying child must be one of the following:
A son, daughter, stepchild, eligible foster child, adopted child, or descendant of any of them.
A brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them.
Age
The taxpayers qualifying child must be one of the following:
Under the age of 19 at the end of 2014 and younger than the taxpayer (or the taxpayers spouse,
if filing jointly).
A full-time student under the age of 24 at the end of 2014 and younger than the taxpayer (or his
spouse, if filing jointly).
Permanently and totally disabled at any time during 2014, regardless of age.
Residency
The taxpayers qualifying child must have lived with the taxpayer in the United States (defined earlier) for more than half of 2014. The rule for military personnel mentioned previously also applies to
residency.
Joint Return
The taxpayers qualifying child cannot file a joint return, unless merely as a claim for refund.
Married child. If a taxpayers qualifying child is married, the taxpayer must be able to claim a
dependency exemption for that child (unless the divorced parents rules apply).
Tiebreaker RulesA Reminder

If a child is a qualifying child of more than one taxpayer, the taxpayers may decide among themselves,
subject to the tiebreaker rules, which one is to claim the credit along with all the other tax benefits.
(For this purpose, married taxpayers filing a joint return are treated as one taxpayer.) If more than
one taxpayer claims the credit with respect to the same child, the IRS will decide which will receive
the credit, based on the tiebreaker rules described earlier in Chapter 4.
Divorced or separated parents. The waiver of the exemption to the noncustodial parent under the
divorced parents rules does not apply for EIC purposes. Only the custodial parent may claim the EIC
with respect to the child.
Social Security Numbers

To claim the EIC, the tax return must show a valid social security number for the taxpayer, the spouse
(if filing jointly), and all qualifying children.
Note: Some SSNs are issued only to allow taxpayers to receive certain federal benefits. To qualify for
the EIC, a valid SSN is one that allows the holder to work. If the words Not valid for employment
are printed on the social security card, the number is not a valid SSN for EIC purposes, and the taxpayer may not claim the credit.
U.S. Citizen or Resident Alien All Year

Nonresident aliens generally cannot claim the EIC. Resident aliens cannot claim the credit unless
they are authorized to work in the United States. If the taxpayer (or spouse, if married) were a nonresident alien for any part of the year, the taxpayer cannot claim the EIC unless the filing status is
MFJ. The taxpayer can use that filing status only if one spouse is a U.S. citizen or resident alien and
chooses to treat the nonresident spouse as a U.S. resident. If the taxpayer makes this choice, the taxpayer and spouse are taxed on their worldwide income.
Form 2555 or Form 2555-EZ

These forms are filed to exclude income earned in foreign countries from gross income or to deduct or
exclude a foreign housing amount. U.S. possessions are not foreign countries. An in-depth explanation
of these forms is not given in this course.
MFS Filing Status

If the taxpayer is married, they must file a joint return to claim EIC. Their filing status cannot be
married filing separately. However, if the taxpayer meets the rules for being unmarried for tax purposes, which you learned earlier in Chapter 4, then the taxpayer may file as head of household and
be able to claim the credit.
Investment Income Limitation

In order to prevent persons with substantial assets from receiving the EIC, the credit is denied to
any taxpayer with investment income exceeding $3,350 for 2014. For this purpose, investment income
includes the following:
Taxable and exempt interest.
Taxable dividends.
Net capital gain income (excluding 1231 gains), if greater than zero.
Net nonbusiness rents and royalties, if greater than zero.
Net passive income that is greater than zero and is not self-employment income.
This course only covers investment income that can be reported on Form 1040A, such as that which
you learned about in Chapter 5.
Support
A child who would be a qualifying child for dependency under the uniform definition, except that they
provided more than 50% of their own support, may be a qualifying child for purposes of the EIC.
Being a Qualifying Child

If the taxpayer himself is a qualifying child of another taxpayer, they cannot claim the credit.
mExample: Mark Jones (22), a full-time student, and his son, Jeff (3), lived all year with Marks
father. Mark cannot claim the EIC, even if he otherwise qualifies, because Mark is a qualifying child
of his father. Marks father may or may not be able to claim the credit, depending on his earned
income and AGI, along with all the other qualifications.
Note: Even if his earned income and AGI are less than $14,590 (for 2014), Mark may not even claim
the EIC as a taxpayer without a qualifying child because, as a qualifying child himself, he is prohibited from claiming the credit.m

Illustration 7.3
COMPUTING THE EARNED INCOME CREDIT

The first step in claiming the EIC for taxpayers who we have determined are eligible is to complete
Schedule EIC for those taxpayers with one or more qualifying children. Taxpayers eligible for the
credit who do not have a qualifying child do not complete this form.
Schedule EIC calls for information about the qualifying child or children. If a taxpayer has more
than three qualifying children, he enters information about only three of them. Bill Helget, from the
example on page 7.3, has five qualifying children. See his Schedule EIC in Illustration 7.3 where only
three children are listed.
mExample: Carol A. Patel files as head of household and qualifies for the EIC for 2014. She has one
qualifying child, her daughter, Dara, born in 2005. Dara lived with Carol all year.
Carol had earned income of $23,246 and investment income of $795, so her AGIis $24,041. Investment
income was discussed in Chapter 5. For now, we will assume she had $307 interest income reported
on Form 1040A, line 8a, and $488 of ordinary dividend income reported on Form 1040A, line 9a. Her
Earned Income Credit is figured using the worksheets shown in Illustrations 7.4 through 7.7. Unlike
Schedule EIC, the worksheets are not filed with her return; they should be kept with her records.m
H&R Block worksheets for determining EIC are customized for H&R Block use. For learning purposes, we will use the IRS Form 1040A instructions to see how Carols EIC was determined. This will help
you understand the flow of information from the worksheet to the forms and schedules.
Step 1 All Filers
Line 1. Determines eligiblity based on income and number of qualifying children.
Line 2. Determines eligibility based on the taxpayer (and spouse if filing a joint return) having a valid
SSN that allows them to work.
Line 3. Determines eligibility based on filing status. Taxpayers whose filing status is married filing
separately are not eligible for EIC.
Line 4. Qualifies taxpayers according to residency status. Nonresident aliens must be married to a
U.S. citizen or resident alien, file a joint return and choose to be treated as a resident alien.
Step 2 Investment Income
Line 1. Computes the taxpayers total investment income.
Line 2. Determines whether the taxpayers investment income exceeds the maximum of $3,350 for
2014.
Step 3 Qualifying Child
Line 1. Determines whether the taxpayer qualifies as a taxpayer with or without a qualifying child.
Line 2. Determines if the taxpayer is filing a joint return or not.
Line 3. For taxpayers who answered yes to line 2, this line qualifies taxpayers according to their ability to be claimed as a qualifying child on another tax return. Taxpayers who are the qualifying child
of another taxpayer who is required to file a tax return cannot claim EIC.
Step 4 Filers Without a Qualifying Child

Line 1. Determines eligibility according to income and filing status for taxpayers who do not have a
qualifying child. AGI must be less than $14,590 ($20,020 if married filing jointly).
Line 2. Determines eligibility according to age. Taxpayers without a qualifying child must be at least
age 25 but under age 65 at the end of 2014.
Line 3. Determines eligibility according to residency in the United States. Taxpayers whose main
home was not in the U.S. for more than half of 2014 do not qualify for EIC. Members of the military
may qualify under certain circumstances.
Line 4. Determines if the taxpayer without qualifying children is filing a joint return or not.
Line 5. For taxpayers who answered yes to line 4, above, this line qualifies taxpayers according to
their ability to be claimed as a qualifying child on another tax return. Taxpayers who are the qualifying child of another taxpayer who is required to file a tax return cannot claim EIC.
Line 6. Determines eligibility according to the taxpayers dependency status. Taxpayers who can be
claimed as a dependent on another taxpayers tax return cannot claim EIC.
Step 5 Earned Income
Line 1. This line is calculated by adding income from taxable scholarships or fellowships, income from
work performed while in prison, and income from pensions or annuities from nonqualified deferred
compensation plans. The sum total of the above is then subtracted from earned income that was
reported on Form 1040A, line 7. Finally, nontaxable combat pay is taken into consideration, as in
some cases it may increase EIC, and the taxpayer may elect to treat it as taxable.
Line 2. This line takes into consideration the amount from Step 5, line 1, above to make final determination of EIC eligibility.
Step 6 How to Figure the Credit
Part 1. This section determines the EIC based on earned income as calculated in Step 5. Then, AGI
is taken into consideration to see if it differs from earned income. Taxpayers whose earned income
differs from their AGI must go on to Part 2.
Part 2. This section determines EIC based on the taxpayers AGI (see the worksheet for exceptions).
Part 3. The taxpayers EIC is the lesser of the amounts calculated in Parts 1 and 2, above.

Illustration 7.4

Illustration 7.5

Illustration 7.6

Illustration 7.7
EARNED INCOME CREDIT DUE DILIGENCE

Paid tax preparers must exercise due diligence when preparing tax returns claiming EIC. Treasury
regulations require tax preparers to follow four due diligence requirements. Tax preparers must:
Complete and submit an eligibility checklist.
Compute the amount of credit.
Comply with the knowledge requirement.
Retain records.
If tax preparers fail to follow the due diligence requirements, they are subject to a $500 penalty for
each occurrence.
Complete and Submit an Eligibility Checklist

A tax preparer must complete and submit Form 8867, Paid Preparers EIC Checklist, or a document
equivalent to Form 8867. Also, the completion of the checklist must be based on information provided
by the taxpayer to the tax preparer.
Illustrations 7.87.11 show Form 8867 as it would be prepared for Bill Helget from the example on
page 7.3. When using software, the program will usually gather information that should satisfy the
equivalent of Form 8867. It is important that a tax preparer ask every taxpayer every question on
this list every time.
Computing the Amount of Credit

A tax preparer must keep the EIC worksheet or an equivalent that demonstrates how the EIC was
computed. In this course, we have used the Earned Income Credit Worksheet, which can be found in
Illustrations 7.4 through 7.7. Throughout the course, you will be asked to complete this form for each
taxpayer receiving EIC.
Complying With the Knowledge Requirement

A tax preparer is responsible for knowing the tax law and using that knowledge to ensure that the
correct questions are asked to get all the relevant facts as they apply to each EIC return. Each clients
situation is different. You can ask every client the same question, but you should not expect the same
answer. You must be able to apply a reasonability standard. Ask yourself, Does this situation make
sense?
A tax preparer must not know or have reason to know that any information used by the tax preparer
in determining the taxpayers eligibility for, or the amount of, the EIC is incorrect. Also, a tax preparer
may not ignore the implications of information the taxpayer furnished to, or that is known by, the tax
preparer.
Lastly, a Tax Professional must make reasonable inquiries and document those inquiries and the
clients answers at the time of the interview.
Important: Software alone cannot meet the knowledge requirement. A Tax Professional must follow
up on information that appears to be incorrect, inconsistent, or incomplete, and software may not ask
all the questions necessary to fully clarify the situation. Tax Professionals must use their best judgment and develop good interviewing techniques to satisfy this requirement.
Retaining Records
Form 8867, Paid Preparers Earned Income Credit Checklist, is used to retain all the information necessary when taxpayers qualify for EIC. Take a few minutes to review this form found in Illustrations
7.87.11. Note that only Part IV in Illustration 7.10 refers directly to the due diligence requirements.
The answers for Parts I, II, and III are compiled from the information the Tax Professional has been
gathering throughout the tax interview.
To comply with the record retention requirement, a Tax Professional must:
Retain Form 8867 and EIC worksheet or equivalents and maintain a record of how and when the
information used to complete these forms was obtained.
Verify the identity of the person giving you the information and maintain a record of who furnished
the information and when you received the information used to determine the credit.
Keep these records for three years from the latest date of the following that apply:
The original due date of the tax return (this does not include any extension of time for filing).
The date the tax return or claim for refund is filed, if you electronically file the return or claim
for refund and sign it as the return preparer.
The date you present the tax return or claim for refund to the taxpayer for signature, if the
return or claim for refund is not filed electronically and you sign it as the return preparer.
If you prepare part of the return or claim for refund and another preparer completes and signs
the return or claim for refund, you must keep the part of the return you were responsible to
complete for three years from the date you submit it to the signing tax return preparer.
When you prepare returns using the H&R Block BlockWorks software, you should always ask enough
questions so that you are certain the taxpayer qualifies. BlockWorks will often prompt you with certain starter questions noted in Illustration 7.12. However, these software EICquestions are only a
starting point. It is the Tax Professionals responsibility to ask appropriate questions beyond the EIC
questions that BlockWorks prompts you to answer, based on the information entered in the software.
In many cases where tax preparers have been fined, the IRS notes, The preparer did not ask sufficient questions, or if they did ask, they did not ask additional questions to show reasonable inquiries,
where appropriate.

Illustration 7.8

Illustration 7.9

Illustration 7.10

Illustration 7.11

Illustration 7.12
Note: BlockWorks will

populate specific EIC Due
Diligence questions based on
the
taxpayers information
entered into the software.
Select the Add New button

to populate an input box to
answer the EICDue Diligence
questions.
CHAPTER SUMMARY
Credits are valuable to taxpayers because they reduce tax liability dollar for dollar. Nonrefundable
credits may not reduce a taxpayers tax liability below zero. Refundable credits may allow a taxpayer to reduce his liability below zero and receive a refund for the difference.
The Additional Child Tax Credit is refundable and may be available to taxpayers with more than
$3,000 earned income for 2014 or more than three qualifying children for the Child Tax Credit.
The Earned Income Tax Credit is a refundable credit.
Taxpayers with no qualifying children and who are at least 25 years of age and younger than age
65 may qualify for the Earned Income Tax Credit.
The tax interview, performed by the Tax Professional, is an essential tool in determining taxpayer
qualification for the Earned Income Credit and fulfilling the due diligence requirement.
The refundable Earned Income Tax Credit may be worth up to $6,143 to working taxpayers with
earned income and AGI of less than $52,247 for 2014.
The taxpayer may elect to include nontaxable combat pay for EIC purposes.
Paid tax preparers are subject to a $500 penalty (per occurrence) for not exercising due diligence
when preparing tax returns claiming EIC.
Suggested Reading
Chapter 34, Child Tax Credit.
Chapter 36, Earned Income Credit (EIC).
client lives with

Ther two sons, a 19-year-old and a 23-year-old. Both wereMyfull-time
students
in 2014. She will not be able to claim the dependency exemption for the 23-yearold this time because he started a regular job and provided more than half of
his own support. Since there is no support requirement for the EITC, will she
still be able to claim the credit for him, or will the tie-breaker rule prevent her
from doing so, as he is claiming his own exemption?
Yes, your client can still claim the EITC for her older son, assuming
Aher income
is within EITC range and he meets the four tests to be a qualinswer:
fying child for EITC (relationship, age, residency, and joint return). In this type
of situation, the tie-breaker rule is not involved.
When a child is a qualifying child of more than one taxpayer, the tie-breaker
rule of 152(c)(4) serves to prevent taxpayers from splitting child-related tax
benefits. For instance, say that your clients father also lived in the home and
had higher AGI than your client. Your client could agree to let her father claim
child-related tax benefits for the younger son because he would be a qualifying
child of both of them. However, tax benefits for the younger son, such as the
dependency exemption and EITC, could not be split between the two of them,
even if it would be financially advantageous for the family to do so.
The tie-breaker rule with its no split restriction does not come into play in
the case of a non-dependent individual who claims his own exemption and who
is also a qualifying child for EITC purposes. Even though the amounts are the
same, it is important to distinguish a personal exemption under 151(b) from a
dependency exemption under 151(c) and 152. Your clients son is a taxpayer
claiming a personal (not a dependency) exemption. He is not a qualifying child
of more than one taxpayer or, to put it another way, he is not his own qualifying
child and this is not a child-related benefit split!
Credits
OVERVIEW
This self-study chapter will show you that credits are valuable tax savers. In Chapter 3, you learned
about the Child Tax Credit. In Chapter 7, you learned about the Earned Income Tax Credit. In this
chapter, you will learn about other credits that may be claimed on Form 1040A. One common credit
is the Child and Dependent Care Credit. Another credit that is less common, but still important to be
familiar with, is the credit for the elderly and disabled. Lastly, the premium tax credit (PTC) will need
to be considered on every tax return that you prepare. Education credits will be covered in Chapter 9.
OBJECTIVES
At the conclusion of this chapter, you will be able to determine the eligibility and calculations for the:
Child and Dependent Care Credit and compute the credit.
Credit for the elderly or disabled.
Premium tax credit (PTC).
TAX TERMS
Advance of the premium tax credit (APTC).
Affordable Care Act (ACA).
Benchmark Premium.
Bronze/Silver/Gold/Platinum plans.
Cafeteria plan.
Child and Dependent Care Credit.
Coverage family.
Credits.
Department of Health and Human Services (HHS and DHHS).
Excess advance premium tax credit.
Federal poverty level (FPL).
Limitation on premium tax credit repayment.
8.1
Marketplace/Exchange.
Net premium tax credit.
Open enrollment period.
Qualified health plan.
Refundable credit.
Savers Credit.
Shared responsibility payment.

Before we begin this discussion of credits, it is important to review the difference between credits and
deductions.
While both credits and deductions help taxpayers reduce the amount of tax they must pay, they do so
in different ways. Deductions, such as the standard deduction, lower the tax by reducing the amount
of income that would otherwise be taxable. Lower taxable income results in a lower tax liability.
the tax determined. Then, credits may be used to reduce the tax already determined dollar for dollar.
Some credits are nonrefundable, and some are refundable. Nonrefundable means that the combined
amount of these credits cannot reduce the taxpayers tax liability below zero. Refundable credits may
reduce the taxpayers tax liability below zero, and the difference is refunded to the taxpayer.
CHILD AND DEPENDENT CARE CREDIT

Single parents and two-career couples must find ways to care for their young children while they
work. The Tax Code provides a way for such parents to recoup some of their expenses for child care
through a nonrefundable tax credit. This credit is also available to taxpayers caring for disabled
dependents and spouses.
Study page 1 of Form 2441 in Illustration 8.1 on page 8.8. A taxpayer who incurred and paid expenses
for the care of a qualifying person while they worked or searched for work may be entitled to a tax
credit based on the amount paid during the year for those services.
Requirements
To claim the Child and Dependent Care Credit, the taxpayer must meet the following requirements:
Married taxpayers generally must file a joint return (but see Married taxpayers below).
The care must have been provided so the taxpayer (and the spouse, if married) could work or look
for work.
Credits 8.3
The taxpayer must have some earned income. Taxpayers who are married and are living together
both must have earned income (unless one spouse was a student or disabled, as explained later).
The taxpayer and the person(s) for whom the care was provided must have lived in the same home.
The person who provided the care must not be someone the taxpayer can claim as a dependent.
Services provided by the taxpayers child under age 19 do not qualify, even if the provider is not a
dependent.
Married taxpayers who meet the following requirements may claim the credit even if not filing a
joint return:
The taxpayer paid over half the cost of maintaining a household for the year, which was the principal residence of both the taxpayer and a qualifying person for more than half the tax year.
During the last six months of the tax year, the taxpayers spouse was not a member of the household.
Qualifying Persons
To claim a credit for qualified expenses (defined below), the care must have been provided for one or
more qualifying persons. Qualifying persons include:
A dependent who is a qualifying child and has not reached their 13th birthday when the care was
provided.
Note: For purposes of this credit, the child is considered to have attained the age of 13 on their birthday, not the day before. Generally, the taxpayer must be entitled to claim a dependency exemption for
the child, but an exception applies for children of divorced or separated parents.
The taxpayers dependent of any age who is physically or mentally incapable of self-care and who
has the same principal place of abode as the taxpayer(s) at the time the care is provided.
The taxpayers spouse who is physically or mentally incapable of self-care and who has the same
principal place of abode as the taxpayer at the time the care is provided.
Exception: In cases of divorced or separated parents, the child will be the qualifying child of the
custodial parent for purposes of this credit, even if the noncustodial parent claims the dependency
exemption for the child.
Qualified Expenses
Qualified child or dependent care expenses are those incurred for the primary purpose of assuring the
well-being and protection of a qualifying person while the taxpayer works or looks for work. Expenses
for care provided outside the home for the qualifying child, disabled dependent, or disabled spouse
can be counted, provided the qualifying person regularly spends at least eight hours each day in the
taxpayers home. If the care is provided in a dependent care center (one that cares for more than six
persons for a fee), the center must comply with all relevant state and local laws.
Certain expenses do not qualify for the Child and Dependent Care Credit. The cost of transportation
to and from the child care facility does not qualify, and neither do overnight camp expenses. Also, any
expense allocable to the education of a child in kindergarten or higher does not qualify. The total cost
of schooling below kindergarten qualifies only if the cost of schooling cannot be separated from the
cost of care.
mExample: June and Henry Stark both work. Their son, Harry, attends first grade at a private school.
After school, the Starks pay to have Harry transported to a child care center where they pick him up
after work. The expenses for the private school and the transportation do not qualify for the Child
Care Credit. The amount they pay the child care center does qualify. If Harry were in an all-day preschool setting where educational activities were part of the child care service, the entire cost would
qualify for the credit.m
Expenses for in-home care of a qualifying child, disabled dependent, or disabled spouse also qualify for
the credit. Qualified expenses for in-home care may include amounts paid for cooking and light housework related to the care of a qualifying individual as well as actual care. Amounts paid for chauffeur
or gardening services do not qualify. Total qualified expenses include gross wages paid for qualified
services, plus the cost of meals and lodging furnished to the employee, plus the employers social security, Medicare, FUTA (federal unemployment), and any other payroll taxes paid on the wages. See the
discussion of Schedule H later for more information about paying employment taxes for household
help. A taxpayer who hires a household worker and pays wages of $1,900 or more during the year to
that worker must pay the employers share of social security and Medicare taxes.
Remember, payments to any of the following do not qualify for the credit:
A person who either the taxpayer or the spouse may claim as a dependent.
The taxpayers child who is under age 19.
An overnight camp.
Computing the Credit

The Child and Dependent Care Credit for 2014 is a percentage of the smallest of the following:
The amount of qualified expenses incurred and paid during the year.
$3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.
The taxpayers earned income (defined later) for the year or, for married taxpayers filing jointly,
the earned income for the year of the spouse earning the lesser amount.
The lines on Form 2441 are, for the most part, self-explanatory. Those that require a bit of added
explanation are discussed below.
Line 1. Taxpayers must report the care providers name, address, and identifying number (the social
security number for an individual or the employer identification number for a business). If the care
provider is a tax-exempt organization (a church, for example) and they do not provide a number, enter
Tax-exempt in column (c). Enter the total amount actually paid to each institution or individual in
column (d).
The IRS provides Form W-10 to assist taxpayers in obtaining information from child care providers.
The taxpayer should direct the provider to complete Form W-10 or a similar document to provide the
necessary information to the taxpayer.
Credits 8.5
The IRS can use the information on line 1 to match what the taxpayer paid the care provider with the
amount the care provider reports as income on their tax return. Therefore, all amounts actually paid
to the care provider (by the taxpayer, their employer, or anyone else) during the year must be entered.
Any amounts incurred, but not yet paid, would not be reported on line 1.
If the taxpayer pays social security, Medicare, and other payroll taxes for a child care providers services within their home, those amounts would not be listed on line 1 because they were not actually
paid to the child care provider. These amounts would, however, be entered as part of the total qualified expenses for each qualifying person in column (c), line 2.
mExample: Carol Cruz hired Michelle Garner to come to her home to care for her five-year-old son
while Carol worked. She paid Michelle $2,000 during the year. In addition, Carol paid the federal
government $153 as the employers share of social security and Medicare taxes. Carol should enter
only $2,000 in column (d), line 1, because thats the amount that is income to Michelle, even though
the full $2,153 expense qualifies for the Child and Dependent Care Credit and would be entered in
column (c), line 2.m
Line 2. On this line, enter the name and social security number of each qualifying person for whom
care was provided, as well as the amount incurred and paid during the taxable year for the care of
each person. If there are more than two qualifying persons, attach a statement. The amount on this
line could be more than the amount on line 1, as seen in the Carol Cruz example above. It could also
be less than the amount on line 1, as in the following example.
mExample: Bess and Jim Franklin paid Betty Gessell $1,200 to look after their three-year-old daughter, Margaret. They took Margaret to Bettys home. Of that amount, $1,000 was for expenses incurred
in 2014, and $200 of that amount was for expenses incurred in December 2013 that they paid in
January 2014. The Franklins should enter the full $1,200 on line 1, column (d), and $1,000 on line 2.m
Often, the total of the amount on line 1 and the amount on line 3 (the total of the line 2 amounts) will
be the same, but not always, as illustrated in the examples above. Also, line 3 cannot exceed the maximum amount ($3,000 for one qualifying individual or $6,000 for two or more qualifying individuals).
Another time when the amount on line 3 might not be the same as the total from line 1 is if the taxpayers employer paid any portion of the child care expenses and excluded the amount from income.
In such a case, the taxpayer must complete Part III on the second page of the form. The amount to be
entered on line 3 is determined in that section of the form. We will defer discussion of these benefits
for the moment and return to them in the next section.
Line 4. Enter the primary taxpayers earned income on line 4. The primary taxpayer is the one named
first in the heading on the first page of the tax return.
Earned income includes taxable salaries, wages, tips, strike benefits, other employee compensation,
disability income reported as wages, and net income or loss from self-employment.
Earned income does not include nontaxable employee compensation (like 401(k) contributions), pensions and annuities, social security and railroad retirement benefits, workers compensation, nontaxable scholarships or fellowship grants, nontaxable workfare payments, income of nonresident aliens
that is not derived from a U.S. business, or income received for work while an inmate in a penal
institution.
Taxpayers have a choice when it comes to nontaxable combat pay. They can elect to treat it as earned
income for the Child and Dependent Care Credit just as they can for the Earned Income Credit. The
credit should be figured both ways to determine which way gives the greater tax benefit.
Line 5. If the taxpayer is filing a joint return, enter the spouses earned income on line 5. Otherwise,
enter the amount from line 4 on line 5.
Student or disabled. If the taxpayer or the spouse was disabled or was a qualified full-time student,
multiply the number of months the taxpayer or spouse met such a condition by $250 ($500 if two or
more qualifying persons are listed on line 2). Add the result to any earned income from other months,
and enter the total on line 4 or 5. Only one spouse may use this adjustment in any given month.
mExample: Wallace and Lena Birch file jointly. Wallace was disabled and incapable of self-care during
2014. He received social security benefits but received no earned income. Lena was a full-time student
through May, and she worked part time through the end of the year, earning $8,000. The remainder
of their income was from investments.
Lena paid a nurse to care for Wallace while she went to school and worked. Wallaces earned income
on line 4 will be $3,000 [$250 2 12 months disabled]. Lenas earned income on line 5 will be $8,000.
Because Wallace used this adjustment every month, Lena may not use it for the months she was a
student; but in this case, it does not matter because she has sufficient earned income.m
Credit Limitation
The taxpayers Child and Dependent Care Credit is limited to their tax liability; any excess is lost.
With certain credits, like the Child Tax Credit or adoption credit, the excess may be refundable.
However, this is not so for the Child and Dependent Care Credit.
Line 10. Taxpayers using Form 1040A will enter the tax liability from Form 1040A, line 28.
mExample: Mary Cubbys tentative Child Care Credit on Form 2441, line 9, is $960. However, her tax
liability on Form 1040A, line 30, is only $693. She will enter $693 on Form 2441, line 10. Her credit
on line 11 will be limited to the lesser of line 9 or line 10.m
Note: If the taxpayer paid qualified expenses in 2014 that were incurred in 2013, they must figure that portion of the credit using Worksheet A, Worksheet for 2013 Expenses Paid in 2014, in
Publication 503, Child and Dependent Care Expenses. Add the amount from the worksheet to the 2013
credit. Such a taxpayer should add the marginal notation CPYE, the name and social security number of the person for whom the expenses were paid, and the amount of the credit based on prior-year
expenses above line 9.
Employer-Provided Benefits
Some employers provide on-site child care for their employees children. Others pay directly for
third-party child care or allow employees to reduce their salaries and save the reduction in accounts
(described below) specifically earmarked to pay for child care expenses. In these cases, the value of
the child care or the amount paid by the employer or from the account is not reported to the employee
as taxable income.
Credits 8.7
Section 125 plans (also called cafeteria plans or flexible spending accounts) are salary reduction
arrangements offered by some employers. These plans allow employees to reduce their salaries by a
certain amount in return for one or more nontaxable benefits. A common example is a flexible spending account (FSA) used to pay child care expenses or medical expenses.
If the employer did not include such amounts in taxable income, the taxpayer must reduce the amount
of expenses eligible for the credit by the amount excluded from income. The amount of child or dependent care benefits (DCB) is shown in box 10 of Form W-2. When a taxpayers W-2 shows dependent
care benefits, they must complete Part III of Form 2441, even if they are not claiming any Child Care
Credit.
Part of the benefits provided by the employer may not be excludible. If the benefits provided by the
employer exceed the smallest of (1) the amount of qualified expenses, (2) the lesser of the taxpayers
or the spouses earned income, or (3) $5,000 ($2,500 MFS), the difference is taxable (see Form 2441,
line 26). Any taxable amount should be added to the taxpayers wages entered on 1040A, line 7, and
the letters DCB written to the left of line 7.
mExample: Becky A. Marshall files as head of household. During 2014, the Tiny Tot Center charged
Becky $2,000 to care for her two-year-old son, Dylan, while she worked. Her employer paid $500 of
the cost of the child care and entered that amount in box 10 of her Form W-2. Becky paid the other
$1,500 herself.
Beckys earned income and adjusted gross income (Form 1040A, line 21) are both $31,600. Her Form
2441 is shown in Illustrations 8.1 and 8.2.m
Most of the entries on Beckys Form 2441 are self-explanatory, but some further explanation may be
helpful. First, consider the order in which the form should be completed. One would logically expect
to complete Part I first, then Part II, and so on, but think again. In this case, because Becky received
employer-provided dependent care benefits, she first completes Part I, then Part III, and then Part II.
Lines 2 and 3. Even though the Tiny Tot Center received $2,000 for caring for Beckys son while she
worked, only $1,500 is entered on line 2, because excluded benefits do not count toward the credit. The
figure on line 3 comes from Part III, line 34, on page 2.
Line 16. This line shows the amount of qualified expenses incurred, the total of line 1, column (d).
Notice that it differs from the amount on line 2, which had to be reduced by the excluded benefits.
Lines 19 and 20. The definition of earned income, for purposes of the exclusion, is similar to that
of the credit. Do not include the dependent care benefits shown on line 12 or any other nontaxable
earned income. However, the taxpayer may elect to include nontaxable combat pay in earned income.
Line 22 asks if any amount on line 12 is from a sole proprietorship or partnership. If so, enter the
amount here. If not, enter zero.
Line 24 is used by those self-employed individuals who file Form 1040 and deduct benefits on
Schedules C, E, or F.
Line 25. Becky is able to exclude from income all of her benefits from her employer. She has no taxable DCB to enter on Form 1040A, line 7.

Illustration 8.1
Credits 8.9
Illustration 8.2
To summarize: Employer-provided benefits for dependent care that are shown in box 10 of a taxpayers Form W-2 must always be entered on Form 2441 to determine the excludible amount. If the
taxpayer is claiming the Child and Dependent Care Credit, the excluded benefits reduce the qualified
expenses eligible for the credit. If the total benefits exceed the allowable excludible amount, the balance is entered as taxable income on 1040A, line 7, with the marginal notation DCB.
CREDIT FOR THE ELDERLY OR THE DISABLED

This is a seldom-used credit because it has not been indexed for inflation since 1985, and the income
limits are very low. Income includes nontaxable social security over $5,000 or other nontaxable pensions.
Taxpayers might qualify for this credit if either of the following applies:
1. Youre age 65 or older.
2. Youre under age 65, and both of these apply:
You retired on permanent and total disability.
You received taxable disability benefits.
Taxpayers who pass the age or disability test must also fall below the limits set for their filing status
to claim this credit.
TAXPAYERS WHO ARE:
GENERALLY CANNOT TAKE THE CREDIT IF:

Their AGI is:
Or they received:
Single, head of household, or

qualifying widow(er).
$17,500 or more
Married filing jointly and only

one passes the age or disability
test.
$20,000 or more
Married filing jointly and both

pass the age or disability test.
$25,000 or more
$7,500 or more of nontaxable

social security or other nontaxable pensions, annuities, or
disability income.
Married filing separately and

lived apart from spouse for the
entire year.
$12,500 or more

disability income.

disability income.
Credits 8.11
Illustration 8.3

Illustration 8.4
Credits 8.13
mExample: Agatha Humphrey is 70 years old and received $13,500 from a taxable pension and $1,500
in nontaxable social security income. From this example, you can see how low the income limits are
to receive the small credit. Agathas Schedule R is in Illustrations 8.3 and 8.4. m
lockWorks Tip: The software has been programmed to automatically

generate Schedule R and calculate the credit when the taxpayer meets the
qualifications for the Credit for the Elderly or the Disabled.
PREMIUM TAX CREDIT

On March 23, 2010, the president signed into law the Patient Protection and Affordable Care Act.
There are various tax implications associated with the Affordable Care Act (ACA), most of which pertain to more complicated tax returns. The provision that we will cover in this course is the individual
mandate, which states that, beginning in January 2014, most U.S. citizens and residents are required
to have qualified health insurance coverage, qualify for an exemption, or be subject to the ACA tax
penalty. As it applies to income tax returns, ACA requires all taxpayers to state whether or not they
had qualified health insurance for themselves and their tax household for every month in 2014.
The premium tax credit (PTC) is a credit that helps pay the cost of coverage through the Marketplace.
It is either advanced to the taxpayer or refunded through their income tax return. It is important that
you understand the basics of ACA compliance so that you can conduct a tax interview that correctly
applies the premium tax credit.
Eligibility
Taxpayers are eligible for the PTC if they meet all of the following requirements:
Purchase coverage through the Marketplace.
Are a U.S. citizen or lawfully-admitted resident.
Have household income for their family size that is 100% through 400% of the federal poverty level
(FPL) in states where Medicaid was not expanded. It is effectively 139% through 400% of FPL in
states where Medicaid was expanded. There are three FPL charts: one for the 48 contiguous states
plus the District of Columbia and separate ones for Alaska and Hawaii. If a taxpayer moves during
the year or if spouses live in separate states and more than one chart would apply, the chart listing
the highest amount is used.
Are not eligible for affordable coverage through an employer-sponsored plan. Coverage is considered affordable if it does not exceed 9.5% of household income for self-only coverage. For this purpose, any additional cost for family coverage is not considered.
Are not eligible for coverage through a government program, such as Medicare, Medicaid,
TRICARE, CHIP, etc.
Do not file a married filing separately tax return. An exception is available to certain victims of
domestic abuse and spousal abandonment.
Cannot be claimed as a dependent by another person.
Tax Household
The individual mandate of ACA requires taxpayers to state, through their tax return, whether they
and everyone in their tax household had qualified health insurance for the tax year. Tax household
includes everyone for whom an exemption is claimed on the tax return and anyone for whom the taxpayer could have claimed an exemption, but did not.
mExample: Miki (34) is a paralegal. She is not married and does not have any children. She shares a
condominium with her brother, Alec (28), who works in construction. Alec is not married and does not
have any children. Miki has one Form W-2 with $48,000 wages and files single using Form 1040-EZ.
Alec also has one Form W-2 with $47,000 wages and files single using Form 1040-EZ. Even though
Miki and Alec share a residence, their tax households consist only of themselves. Mikis tax household
is herself only. Alecs tax household consists of himself only.m
mExample: Manuel (23) works in food service. Manuel and Leticia (25) are the unmarried parents
of Lucas (2). Manuel shared an apartment all year with Lucas and Letitia. Leticia has no income.
Manuel has two Forms W-2 and files head of household claiming both Lucas and Letitia as dependents using Form 1040A. Manuels tax household consists of himself, his son, Lucas, and Lucass
mother, Letitia.m
mExample: Taylor (47) works as a teacher. She is not married and has two children, Francis (20) and
Regina (16). Taylor owns a townhouse where Francis and Regina live. Francis is a full-time student at
the local college and works part-time as a tutor. Regina is a high school student and works part-time
in retail. Neither Francis nor Regina pay more than half of their own support. Taylor files as head of
household claiming Regins as her dependent using Form 1040A. Taylor chooses not to claim Francis,
so that she may claim her own education expenses. Even though Taylor does not claim Francis on her
tax return, she is eligible to do so. Taylors tax household consists of herself and both her children,
Francis and Regina.m
Qualified Health Insurance

Taxpayers and people in their tax household usually have qualified health insurance through one of
the following:
Employer-sponsored coverage.
Government program.
Marketplace.
Direct through the individual market.
Qualified health insurance provides minimum essential coverage to its beneficiaries. Coverage
through any of the plans listed above will generally comply with the individual mandate.
Credits 8.15
The following plans do not provide minimum essential coverage:

Stand-alone coverage for vision care, dental care, accident, disability, or workers compensation.
Coverage in the following TRICARE and Medicaid programs:
Optional coverage of family planning
services.
Coverage for medically needy individuals

(also referred to as spend-down).
Optional coverage of tuberculosis-related

services.
Coverage authorized under 1115(a)(2) of

the Social Security Act (Medicaid demonstration projects).
Coverage under pregnancy-only

Medicaid.
Coverage that is solely limited to space

availability in a facility of the uniformed
services for individuals excluded from
TRICARE coverage for care from private
sector providers (also called space available TRICARE coverage).
Coverage limited to treatment of emergency medical conditions.
Coverage for an injury, illness, or disease

incurred or aggravated in the line of duty
for individuals who are not active duty
(also called line of duty TRICARE coverage).
Note: Although the plans listed in the chart above do not provide minimum essential coverage, taxpayers who have any of these coverages will be able to claim an exemption from the ACA penalty
(more information on this, later).
Monthly Coverage
Coverage is determined every month, so it is possible that there are various scenarios.
mExample: Christopher (45) was an employee at a printing company in January 2014 and had coverage through his employer. He was laid off in mid-May. Christopher was eligible to purchase COBRA
coverage, but chose not to purchase it. Christopher was also eligible to purchase coverage through the
Marketplace because he had a qualifying event, but was unaware of the option. Christopher began
working at a grocery store in mid-September and once again had coverage through his employer
effective on October 1.
In this example, Christopher has qualified coverage for eight months (January through May at the
printing company and October through December at the grocery store) and no coverage for four
months (June through September). Christopher may have to pay the ACA tax penalty unless he qualifies for an exemption, to be discussed later.m
mExample: Raquel (29) works at a hotel. She is unmarried and has two children, Anna (3) and Jeremy
(8). In January 2014, Serena did not have health insurance coverage because her employer did not
offer coverage to its employees and she believed she could not get coverage any other way. However,
Raquel made sure that her children had coverage through the Childrens Health Insurance Plan
(CHIP).
When Raquel had her 2013 tax return prepared at H&R Block and was directed to the health care
portal by her Tax Professional, she purchased health insurance through the Marketplace with coverage beginning in March 2014.
In this example, the tax household consists of Raquel and both of her children. Raquel has qualified
coverage for ten months and no coverage for two months (January through February). The children
had qualified coverage for all 12 months. Raquel may have to pay an ACA tax penalty unless she
qualifies for an exemption, to be discussed later.m
mExample: Warren (57) and Emily (56) Bixby are married and file a joint return. They have four adult
children who do not reside with them. Warren is self-employed and in January 2014 had coverage
he purchased directly from an insurance broker. In March 2014, he learned that he could purchase
lower cost insurance through the Marketplace. His Marketplace plan went into effect beginning May
2014. Emily had employer-sponsored coverage in January 2014. Emily maintained coverage through
her employer all year.
In this example, the tax household consists of Warren and Emily. Each has 12 months of qualified
coverage, but Warren has four months of direct purchase and eight months of Marketplace coverage,
while Emily has 12 months of employer-sponsored coverage.m
State and Federal Marketplaces

Individuals without health insurance coverage or those looking for more affordable coverage may
purchase coverage through a state Marketplace or the federal Marketplace <www.healthcare.gov> if
their state does not operate its own Marketplace. H&R Block offers enrollment services through its
portal <healthcare.hrblock.com>.
Coverage may be purchased during the annual open enrollment period. For coverage in calendar year
2014, the open enrollment period ran from November 15, 2013, through February 15, 2014, to submit
an initial application, plus an extension to April 15 to complete the application, if necessary. For coverage in calendar year 2015, the open enrollment period was November 15, 2014, through February
15, 2015.
Individuals may also purchase coverage outside the open enrollment period during special enrollment
periods, generally 60 days, following certain life events where there was a change in:
Family status (marriage, divorce).
Location.
Citizenship/residency status.
Family size or household income that affects eligibility for the APTC.
Loss of other types of qualifying coverage, such as employer-sponsored coverage.
An insurance plan that is certified by the Marketplace provides minimum essential coverage and
follows established limits on cost-sharing (like deductibles, co-payments, and out-of-pocket maximum
amounts). A qualified health plan will have a certification by each Marketplace in which it is offered.
Plans in the Marketplace are categorized into four typesBronze, Silver, Gold, or Platinumbased
on the percentage the plan pays of the average overall cost of providing coverage to members. The
percentages the plans will spend, on average, are 60% (Bronze), 70% (Silver), 80% (Gold), and 90%
(Platinum).
Form 1095-A
Taxpayers who had coverage through the Marketplace will be sent a Form 1095-A, Health Insurance
Marketplace Statement, regardless of whether they were eligible for the APTC or elected to receive it.
Credits 8.17
The 2014 forms must be issued by January 31, 2015.

All taxpayers who obtained coverage through the Marketplace for themselves, a spouse, or dependents AND received either the APTC or are eligible to claim the PTC on their tax return must have
a Form 1095-A to complete their tax return.
ax Tip: It may be an issue for divorced taxpayers where tax benefits for
dependents are divided between the parents and one parent enrolls the
child in a Marketplace plan, but the other parent claims the childs dependency exemption. This situation requires an allocation of information on the Form
1095-A between the two parents.
Form 1095-A is divided into the following three parts:

Part 1, Recipient Information, reports identification information on the recipient and spouse.
Part 2, Coverage Household, reports information on the individuals covered by the insurance policy
and the dates of coverage.
Part 3, Household Information, reports information required to reconcile the credit. The information is reported for every month of the year. Column A reports the total monthly premium for the
plan without considering any amount that may be paid by the APTC. Column B reports the second
lowest cost silver plan (SLCSP) as determined by the Marketplace. This is the benchmark against
which the taxpayers APTC is calculated. Column C reports the amount of APTC paid, if any. This
information is used to complete Form 8962, Premium Tax Credit.
Using the information from the example above, see Illustration 8.5 for Warren Bixbys Form 1095-A.
Form 8962
Form 8962, Premium Tax Credit, calculates the taxpayers PTC and reconciles it with any APTC
received. Form 8962 must be filed for any taxpayer who received the APTC. Form 8962 may also be
prepared for any taxpayer who is eligible for the PTC but did not receive the APTC. Information from
Form 1095-A is used to complete Form 8962.
Part 1
Part 1 of Form 8962 determines the amount the taxpayers are expected to contribute toward their
own health care insurance premiums.
Line 1. In line 1, family size means the taxpayer; their spouse, if filing a joint return; and the dependents, if any, claimed on the tax return. Compare that to tax household, as previously discussed,
which means the taxpayer; their spouse, if filing a joint return; and all dependents, whether or not
claimed by the taxpayer. Tax family is used to calculate the PTC, while tax household is used to determine if any ACA tax penalty is due.
Lines 2a, 2b, and 3. Household income is the modified AGI of all individuals in the tax family who
are required to file a tax return. Household income does not include the modified AGI for individuals
in the tax family who file a tax return only to claim a refund of withholdings or estimated payments.

Illustration 8.5
X.X
Credits 8.19
Line 4. FPL for family size. As covered earlier, there are three charts.
Line 5. Divide household income by FPL to get the familys household income as a percentage of FPL.
Line 6. If the percentage of FPL is greater than 400%, the client is not eligible for the PTC.
Line 7. Look up the applicable figure in the instructions by the FPL that is calculated in line 5.
Lines 8a and 8b. Multiply household income by the applicable figure to get the familys contribution
amount for their health care insurance, and then divide that amount by 12 to get the amount of their
monthly contribution.
Note: The information above is given to you so that you are aware of how the form is calculated. You
will not have to perform any of the calculations, as the software has been programmed to do so.
Part 2
Part 2 completes the calculation of the PTC and reconciles it with the amount of any APTC the taxpayer received.
Part 3
Part 3 determines the amount, if any, of the APTC the taxpayer owes.
For most taxpayers, the reconciliation process is simple. If the amount of APTC the taxpayer received
exceeds the PTC calculated in Part 1, the taxpayer is required to pay back the excess, up to a limit for
those with income less than 401% of the FPL, through the tax return. If the amount of APTC, if any,
is less than the PTC calculated in Part 1, the taxpayer will receive that amount on their tax return in
the form of a refundable credit.
Shared Policy Allocation

As mentioned earlier, for taxpayers who share a policy with individuals outside their tax family, the
reconciliation process is more complicated and requires information from Form 1095-A to be allocated
between the individuals. Allocation is required for taxpayers who purchased coverage through the
Marketplace and at least one of the following applies to their situation:
An individual in the tax family enrolled someone outside the tax family in qualified coverage.
An individual in the tax family was enrolled in qualified coverage by someone outside the tax family.
The taxpayer got divorced or legally separated in 2014.
The taxpayer is married at the end of the year but filing a separate return.
One policy covers two or more tax families.
Taxpayers who married during the year are also potentially eligible for an alternative calculation
because they may have had both single and family plans in the same year.
mExample: William and Vivienne were married at the beginning of 2014. They have three children
together, and the family of five lived together at the beginning of the year. William and Vivienne
enrolled in Marketplace coverage for themselves and their three children in December 2013. In
April 2014, the couple separated and Vivienne and the youngest children moved out of the home. In
September, the spouses became legally separated. William will file his tax return as head of household
claiming the oldest child as his dependent, and Vivienne will also file as head of household, claiming
the two younger children. William and Vivienne will need to complete a policy allocation because their
Marketplace plan covered individuals in two tax families.m
Groups Exempt from the Individual Mandate

Membership in one of the following groups exempts taxpayers from the individual mandate:
Health care sharing ministry. A health care sharing ministry is a 501(c)(3) organization continuously in existence since December 31, 1999, whose members share a common set of ethical or
religious beliefs and share medical expenses in accordance with those beliefs and without regard
to the state where the member lives or works.
Federally recognized Indian tribes and individuals who are eligible for health services through the
Indian Health Services.
Certain religious sects that have objections to insurance including Medicare and social security.
Non-resident aliens.
Undocumented immigrants.
How individual members of certain groups obtain their exemption from the individual mandate:
Members of health care sharing ministries, federally recognized Indian tribes, and non-tribal
members eligible for Indian Health Services:
Through the Marketplace or on Form 8965,

which is filed with their tax return.
Members of certain religious sects:
Through the Marketplace.
Nonresident aliens:
By filing Form 1040-NR.
Undocumented immigrants:
Form 8965, which is filed with their tax return.
Note: Certain exemptions require the taxpayer to complete a form and mail it with any required documentation to the Marketplace. If approved, the client will receive an exemption certificate number
that will need to be reported on Form 8965, Health Coverage Exemptions.
Exemptions Available Due to Circumstances
The following circumstances make taxpayers eligible for exemptions from the individual mandate:
Household income is below the filing status threshold. The software is programmed to recognize
when a taxpayer is subject to the penalty but qualifies for this exemption.
U.S. citizen or resident living outside the U.S. To qualify, the taxpayer must have spent 330 full
days outside of the U.S. during a 12-month period or have been a resident of a foreign country or
U.S. territory.
Incarceration. Individuals qualify for this exemption for any month they are in a penal institution
or correctional facility. The exemption is obtained by submitting an application to the Marketplace.
Short coverage gap. Individuals qualify for this exemption if they did not have qualified coverage
for less than three consecutive months. This exemption can only be claimed at the first occurrence
and does not apply when the coverage gap is three or more months.
Credits 8.21
Coverage by May 1. This exemption is available for individuals who had a coverage gap at the
beginning of the year. Individuals qualify for this exemption if they purchased qualified health
coverage that went into effect no later than May 1, 2014.
Coverage is considered unaffordable. If the minimum premium amount (either through employer
sponsored or Marketplace coverage) is more than 8% of household income, the coverage is considered unaffordable, and the individual qualifies for an exemption.
CHIP coverage beginning after the start of the year. An exemption is available to individuals who
applied for and obtained CHIP coverage during the open enrollment period, still leaving a gap at
the beginning of the year.
In addition to the circumstances listed above, exemptions are also granted when the taxpayer experienced any of the following hardships (this list is not all-inclusive):
Cancelled health policy.
Lives in a state that did not expand Medicaid coverage.
Domestic violence.
Homelessness.
Eviction in the past six months or facing eviction or foreclosure.
Shut-off notice from a utility company.
Fire, flood, or other natural or human-caused disaster that caused substantial damage to the taxpayers property.
Bankruptcy in the last six months.
Medical expenses in the last 24 months that resulted in substantial debt.
Unexpected increases in necessary expenses due to caring for an ill, disabled, or aging family
member.
Death of a close family member.
mExample: Michael (25) and Michelle (23) are married. They have two children, Thomas (1) and
Stephanie (2), who live with them all year and who do not provide more than half of their own support. Michael and Michelle file a joint return and have combined wages of $18,856. They have no other
income. The couple is not required to file a tax return, but do so to claim the Earned Income Credit and
Additional Child Tax Credit. Neither Michael nor Michelle had health insurance coverage in 2014, but
both children had coverage through CHIP. Michael and Michelle are subject to the ACA penalty, but
because their income is below their filing status threshold, they qualify for an exemption. Their Form
8965 is in Illustration 8.8 on page 8.23.m
The example on page 8.21 requires the following screens for Form 8965 in BlockWorks:
Illustration 8.6
Illustration 8.7
Credits 8.23
Illustration 8.8
CHAPTER SUMMARY
Credits are valuable to taxpayers because they reduce tax liability dollar for dollar. Nonrefundable
credits may not reduce a taxpayers tax liability below zero. Refundable credits may reduce the
taxpayers tax liability below zero, and the difference is refunded to the taxpayer.
Taxpayers who pay someone else to care for their child or disabled dependent or spouse while they
work or look for work may be eligible for the Child and Dependent Care Credit. The credit is computed on Form 2441 for taxpayers filing Form 1040 or Form 1040A.
The amount of expenses eligible for the Child and Dependent Care Credit must be reduced by any
employer-provided assistance that qualifies for exclusion from income.
The premium tax credit (PTC) is a credit that helps pay the cost of coverage through the
Marketplace. It is either advanced to the taxpayer, or refunded through their income tax return.
It is important that you understand the basics of ACA compliance so that you can conduct a tax
interview that correctly applies the premium tax credit.
Suggested Reading
sections of IRS Publication 17:
Chapter 32, Child and Dependent Care Credit.
Chapter 33, Credit for the Elderly or the Disabled.
Chapter 37, Premium Tax Credit.
You might also wish to read sections of:
IRS Publication 503, Child and Dependent Care Expenses.
a single
Tparent who works full-time and pays daycare expenses forMyoneclientof hisis two
chilhe Tax Institute at H&R Block Research Question:
dren. His four-year-old goes to a preschool that costs more than $6,000 a year. His
ten-year-old attends an after-school care program free of charge at a community
center. He can claim both as qualifying children on his tax return. The client does
not have a pre-tax dependent care benefit available at work. Can he use $6,000
to compute the child care credit? Or, is he limited to $3,000 because he has paid
expenses for only one of the children?
may figure credit for child and dependent care expenses
Ausing theYourfullclient
$6,000. Under the regulations (Reg. 1.21-2(a)(1)(ii)), the $6,000
nswer:
applies if there are two or more qualifying individuals with respect to the taxpayer. Under Reg. 1.21-1(b)(1)(i), a qualifying individual includes a taxpayers
dependent (who is a qualifying child) who has not attained age 13. Since your
client has two qualifying children under the age of 13, he is considered to have
two qualifying individuals, and the higher (i.e., $6,000) limit applies.
Education Credits
OVERVIEW
Many clients, or their dependents, take education courses. Whether taxpayers are taking classes
themselves or assisting children who are enrolled in education courses, there may be tax benefits
available to clients with expenses for education. This chapter covers three common tax breaks for
higher education: the American Opportunity Credit, the lifetime learning credit, and the tuition and
fees deduction.
OBJECTIVES
Determine which expenses are eligible expenses for the American Opportunity Credit, the lifetime
learning credit, and the tuition and fees deduction.
Determine eligibility for the American Opportunity Credit and compute the credit.
Determine eligibility for the lifetime learning credit and compute the credit.
Determine eligibility for the tuition and fees deduction and compute the deduction.
Compare/contrast the three benefits to obtain maximum benefit for the client.
TAX TERMS
American Opportunity Credit (AOC).
Credits.
Lifetime learning credit.
Refundable credit.
Tuition and fees deduction.
9.1

Recall from previous discussions that both credits and deductions help taxpayers reduce the amount
of tax they must pay, although they do so in different ways. Deductions, such as the standard deduction, lower tax by reducing taxable income. Lower taxable income results in less tax.
the tax determined. Then, credits may be used to directly reduce the tax.
This chapter will focus on two credits and a deduction:
The American Opportunity Credit is a credit that may be partly refundable.
The lifetime learning credit is a nonrefundable credit.
The tuition and fees deduction is taken as an adjustment to income, which means it may reduce
taxable income.
is a helpful rule to think about the tax benefit hierarchy of
TeducationHerebenefits:
ax Tip:
1. Nontaxable benefits (for example, Pell Grants).

2. Refundable credits.
3. Nonrefundable credits.
4. Deductions.
EDUCATION CREDITS
For 2014, there are two education credits: the American Opportunity Credit and the lifetime learning
credit. This chapter will cover qualification and eligibility rules on both.
American Opportunity Credit

The American Opportunity Credit (AOC) was created by the American Recovery and Reinvestment
Act of 2009 (ARRA). The AOC is a modification of the Hope credit and, under current law, is available
only for tax years through 2017. The AOC is a credit of up to $2,500 per eligible student, and up to
40% of the credit may be refundable. Lets take a closer look at the AOC.
Who Can Claim the AOC
Generally, a taxpayer may claim the AOC if they meet all the following requirements:
The taxpayer pays qualified education expenses of higher education.
The qualified education expenses are paid for an eligible student.
The eligible student is the taxpayer, spouse, or dependent for whom the taxpayer actually claims
an exemption.
Education Credits 9.3
Who Cannot Claim the AOC

A taxpayer may not claim the AOC if any of the following are true:
The taxpayers filing status is MFS.
The taxpayer is claimed as a dependent on anyone elses tax return.
The taxpayers modified adjusted gross income (MAGI) is above $90,000 ($180,000 for MFJ).
For the AOC, MAGI equals AGI plus:
Foreign earned income exclusion.
Foreign housing exclusion.
Foreign housing deduction.
Income excluded by bona fide residents of American Samoa.
Income excluded by bona fide residents of Puerto Rico.
Note: The issues in the above list are advanced topics and are not covered in this course. If you have a
client with any of these types of income, please consult an experienced Tax Professional in your office
and/or IRS Publication 970, Tax Benefits for Education.
The taxpayer (or spouse) was a nonresident alien for any part of 2014, and the nonresident alien
did not elect to be treated as a resident alien for tax purposes.
Note: Issues of resident vs. nonresident aliens are beyond the scope of this course. If you have a client
with these issues, please consult an experienced Tax Professional in your office and/or IRS Publication
519, U.S. Tax Guide for Aliens.
The taxpayer claims the lifetime learning credit or the tuition and fees deduction for the same
student in 2014.
Illustration 9.1 on page 9.4 is a very useful guide to who may claim the AOC for 2014.
Dependents. A student who is claimed as a dependent on someone elses return may not claim an
education credit for that tax year on their own return. Any qualified tuition and fees paid on behalf
of a dependent student are treated as paid by the person who claims the dependency exemption. The
expenses may be paid using the taxpayers money, the students money, loans, gifts, inheritances, and
savings.
mExample: Tracy Batts dependent son, Donald (19), is a full-time student at Rowan University. All
of Donalds tuition was paid with his own money and student loan proceeds. Nonetheless, Tracy may
claim the AOC based on all of Donalds qualified expenses.m
If a taxpayer is eligible to claim the student as a dependent but does not do so, only the student may
claim the AOC for their qualifying expenses.
mExample: Tracy Batt (from the preceding example) qualifies to claim Donald as a dependent, but her
taxable income is already zero, so she chooses not to do so. Although Donald may not claim his own
exemption, he may claim the AOC based upon all of his qualified expenses.m
Qualified Education Expenses
Qualified expenses for the AOC are tuition and certain related expenses required for enrollment or
attendance at an eligible educational institution.

Illustration 9.1
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 U.S. Department of Education (USDOE). This includes virtually all
accredited public, nonprofit, and proprietary (privately-owned, profit-making) postsecondary institutions.
Certain related expenses. For purposes of the AOC, expenses for books, supplies, and equipment
needed for a course of study are qualified education expenses, whether or not the materials are purchased from the educational institution.
Expenses involving student activities, sports, games, or hobbies are qualified expenses only if they are
required by the institution as part of a degree program.
Nonqualified expenses. Expenses for meals, room and board, athletic fees, insurance, transportation, and other personal living expenses are not qualified education expenses for the AOC.
mExample: Terri Dougherty is a degree candidate at State University. In addition to her tuition and
required course fees, she purchased her textbooks from an online bookstore not affiliated with the
university. For the AOC, the tuition and course fees and the expense for Terris books are qualified
expenses.m
mExample: Jefferson is a sophomore in Local State Universitys degree program in dentistry. In 2014,
in addition to tuition, Jefferson is required to pay a rental fee to the university for dental equipment
he will use in the program. Because the equipment rental is needed for his course of study, the rental
fee is a qualified education expense for the AOC.m
mExample: In 2014, Krissy enrolled at Private College for her freshman year. In addition to her
tuition, Krissy had to pay a separate student activity fee. The fee is required of all students and is
used solely to fund the student government; none of the fee covers personal expenses for any student.
Although the fee is labeled as a student activity fee, the fee is required for Krissys attendance at
Private College and is a qualified expense for the AOC.m
Reduction of qualified educational expenses. Qualified educational expenses paid with tax-free
funds may not be used to claim the AOC. Qualified expenses must be reduced by any nontaxable:
Scholarships.
Grants.
Veterans or military educational benefits.
Any other nontaxable benefits.
ax Tip: Tax-free funds specifically designated to pay expenses other than

qualified expenses (such as a scholarship specifically designated to pay room
and board) do not reduce qualified educational expenses.
Qualified expenses must also be reduced by excludible amounts withdrawn from the students
Coverdell Education Savings Account (ESA) or qualified tuition plan (QTP).
ax Tip:If you have a client who has taken distributions from an ESA or
a QTP plan, please partner with an experienced Tax Professional in your
office and refer to IRS Publication 970, Tax Benefits for Education.
Qualifying Academic Periods

The AOC is available for the year in which the qualified expenses are paid. The qualifying education
must begin during that year or within three months following that year. For example, amounts paid
in 2014 for an academic period that begins before April 1, 2015, are eligible expenses for 2014. An
academic period begins on the first day of classes.
Student loans. If the proceeds of a loan are used to pay expenses, the education credit is based on
the amount of the expenses paid (rather than the amount of the loan payments) and are considered
paid in the year the institution was paid, not in the year the loan was repaid. When the loan proceeds
are disbursed directly to the institution, the expenses are considered paid when the students account
is credited. If the actual date is unknown, the expenses are considered paid on the last day the institution would have accepted the payment for that academic period.
Third-party payments. In cases where a third party makes a payment directly to the educational
institution to pay for a students qualified expenses, the student is treated as having paid the expenses.
Expenses refunded. If qualified expenses are refunded by the institution (for example, because the
student withdraws from a class) before the filing of the return for that tax year, the credit is based
on the amount paid after subtracting the refund. However, if the student files their return claiming
a credit for the full amount and later receives a refund, they will have to recapture (pay back) some
of the credit claimed. The recapture is beyond the scope of this course. If you have a client with this
issue, please consult an experienced Tax Professional in your office and/or refer to IRS Publication
970.
mExample: In December 2014, Tiffany Knight paid $2,000 in qualified expenses for the spring 2015
semester. Early in 2015, before filing her 2014 tax return, she withdrew from a foreign language class
and received a tuition refund of $400. Her 2014 AOC will be based on $1,600 of qualified expenses.m
Eligible Student
For 2014, an eligible student for the AOC is a student who meets all of the following conditions:
The student has not claimed an AOC in any four earlier tax years (this includes any tax years in
which the Hope credit was claimed for the student).
The student had not completed the first four years (generally, the freshman, sophomore, junior,
and senior years) of postsecondary education before 2014.
Note:Academic credit awarded solely on the basis of performance on proficiency exams is not taken
into account when determining whether the student has completed the four years of postsecondary
education.
The student was enrolled at least half-time in a program leading to a degree, certificate, or other
recognized academic credential for at least one academic period beginning in 2014.
Note: The standard for at least half-time is determined by each eligible educational institution. If
the student is not certain if they were at least a half-time student, the institution can tell them.
The student had not been convicted of any federal or state felony for possessing or distributing a
controlled substance as of the end of 2014.
These requirements are outlined in Illustration 9.2 on page 9.8.
Complete Exercises 9.1, 9.2, and 9.3 before continuing to read.
Calculating the AOC

The AOC is available up to $2,500 per eligible student on the tax return. The amount of the AOC is
the sum of:
1. 100% of the first $2,000 of qualified education expenses paid for the eligible student.
2. 25% of the next $2,000 of qualified education expenses paid for the eligible student.
The maximum AOC, which may be claimed for 2014, is $2,500 times the number of eligible students
on the tax return.
Up to 40% of the AOC may be a refundable credit.
Income Limitation
As mentioned on pages 9.29.3, certain levels of MAGI reduce or eliminate the AOC. We covered the
definition of MAGI on pages 9.2 and 9.3. Now, lets take a look at its effect on the AOC.
The AOC is phased out for clients with MAGI between $80,000 and $90,000 ($160,000 and $180,000
MFJ). The AOC is not available to clients with MAGI above $90,000 ($180,000 MFJ).
The credit for taxpayers filing a joint return is computed by multiplying the tentative credit by:
$180,000 Modified AGI
$20,000
For all other filing statuses, multiply the tentative credit by:
$90,000 Modified AGI
$10,000
mExample: Jack and Jill are married and will file a joint 2014 tax return. They have a tentative AOC
of $2,500 and MAGI of $165,000. Their AOC is reduced to $1,875:
$2,500 2 $180,000 $165,000 = $1,875 m
$20,000
Form 1098-T
Generally, an eligible educational institution must send each enrolled student Form 1098-T (or an
acceptable substitute) each year. Form 1098-T contains the information needed to help claim the
AOC. Refer to Form 1098-T in Illustration 9.3 on page 9.11.

Illustration 9.2
Following is a brief explanation of each entry on Form 1098-T:

Box 1 shows the total amount of payments received by the institution for the students qualified
expenses. This amount has been reduced by reimbursements or refunds, if any.
Box 2 indicates the net amount of qualified expenses billed to the student.
ax Tip: The amount in boxes 1 and 2 of Form 1098-T may differ from the
amount the client actually paid. Be sure to use the amount paid or deemed
paid in 2014 to calculate the AOC.
The institution may choose to report either payments actually received (box 1) or amounts billed
(box 2) during the year for qualified education expenses.
Box 4 contains any adjustments made for a prior years qualified expenses previously reported on
Form 1098-T. If there is an entry in this box, the taxpayer may need to recapture a prior years education credit. See IRS Publication 970 if you encounter this situation.
Box 5 shows the total of all scholarships or grants received by the institution on behalf of the student. As mentioned earlier, these amounts will reduce the amount of qualified expenses in box 1 for
purposes of the education credit.
Box 6 contains adjustments to scholarships or grants for a prior year. As with box 4, if there is an
entry in this box, the taxpayer may be looking at some credit recapture.
Box 7 will be checked if the amount in box 1 or 2 includes amounts for an academic period beginning
after December 31, 2014, and before April 1, 2015. Because these amounts are eligible for a 2014 education credit, this check box does not change any of the entries on the 2014 tax return.
Box 8 will be checked if the student is considered to be carrying at least one-half the normal full-time
work load for their course of study at the institution. As you know, the student must be at least a halftime student for at least one academic period during the year to qualify for the AOC.
Box 9 will be checked if the student is enrolled in a graduate program. Such a student is probably
not eligible for the AOC. If the student is still in the first four years of post-secondary education, they
can receive the AOC.
Box 10 shows the total amount of reimbursements or refunds of qualified expenses made by an
insurer. As with box 4, these amounts will reduce the amount of qualified expenses for purposes of
the education credit.
Claiming the AOC
The AOC is claimed on Form 8863 (refer to Illustrations 9.4 through 9.6 on pages 9.129.14). Were
going to walk through Form 8863 using this example:
mExample: Mary Williams (745-14-8456) is single and cannot be claimed as a dependent by any other
taxpayer. In 2014, Mary enrolled full-time at a local college (the college is a qualifying educational
institution) to earn a degree in law enforcement. The first year of Marys postsecondary education was
2014. Mary received Form 1098-T (on page 9.11) from the college. Marys expenses meet all of the
qualifications for the AOC. In addition to the expenses reported on Form 1098-T, Mary spent $712 for
needed textbooks, which she purchased through an online book retailer. Marys 2014 AGI (and MAGI)
is $39,000. Marys Form 1098-T is shown in Illustration 9.3 on page 9.11.

Marys AOC is claimed on Form 8863 (see Illustrations 9.4, 9.5, and 9.6). Mary had no other credits
on her tax return.
Note: Marys total qualified education expenses are $6,312. Subtracting out the $1,000 grant leaves
expenses of $5,312. However, only $4,000 is entered in Form 8863, Part III, line 28. This is because
$4,000 is the maximum amount of qualified education expenses upon which the AOC is based. m
Nonrefundable AOC
We have mentioned several times that up to 40% of the AOC may be available to the taxpayer as a
refundable credit. However, it is extremely important to note that the refundable part of the AOC is
not available to all taxpayers. Taxpayers who do not qualify for the refundable credit:
A taxpayer who is any of the following:
Under age 18 at the end of 2014.
Age 18 at the end of 2014 and earned income was less than one-half of the taxpayers support.
A full-time student over age 18 and under age 24 at the end of 2014 and earned income was less
than one-half of the taxpayers support.
And
Has at least one parent who was alive at the end of 2014.
Is not filing a joint return for 2014.
LIFETIME LEARNING CREDIT

The amount of the lifetime learning credit is 20% of the total qualified expenses for all eligible students on the tax return. The maximum amount of expenses allowed per tax return is $10,000; therefore, the maximum annual credit is $2,000 per return, regardless of the number of eligible students.
This is significantly different than the AOC maximum of $2,500 per student. However, the lifetime
learning credit may be claimed for an unlimited number of tax years.
Qualified Expenses
Qualified expenses for the lifetime learning credit include expenses incurred by a student for either of
the following reasons:
The student is enrolled in a course that is part of a degree program for undergraduate or graduate-level courses.
The student took courses to acquire or improve job skills.
There is no requirement that the student attend school on at least a half-time basis. For example, a
Tax Professional may claim the lifetime learning credit for a tax course provided by an eligible educational institution (as defined earlier), even if this is the only class they take. They need not be enrolled
on a half-time basis or in a degree program.

For purposes of the lifetime learning credit, qualifying expenses generally do not include books. This
is a significant difference from the AOC we covered earlier.
The lifetime learning credit phases out for taxpayers with MAGI between $54,00064,000 ($108,000
128,000 MFJ).
mExample 1: John and Lisa Proctor have modified AGI of $75,000. Their dependent son, Joseph, is a
college freshman at the beginning of the tax year. Joseph does not attend school on at least a half-time
basis. The Proctors paid qualified education expenses totaling $6,000. The lifetime learning credit for
2014 is $1,200 [$6,000 2 20% = $1,200].m
mExample 2: The facts are the same as in Example 1, except the qualified expenses are $12,000. In
this case, the lifetime learning credit would be $2,000 [$10,000 2 20% = $2,000].m
The lifetime learning credit and the AOC may not be claimed for the same student for the same year,
but each credit may be claimed for different students for the same year.
The flowchart in Illustration 9.7 is an excellent reference to help determine who may claim the lifetime learning credit for 2014.
Claiming the Lifetime Learning Credit
The lifetime learning credit is claimed on Form 8863, Part III. As with the AOC, the calculation is
pretty straightforward.
Lets assume Mary Williams (from the example on page 9.9) is in her fifth year of college in 2014. In
this case, Mary will not qualify for the AOC (she has completed her first four years of postsecondary
education), but she will qualify for the lifetime learning credit. Marys completed Form 8863 is presented in Illustrations 9.8, 9.9, and 9.10 on pages 9.16 through 9.18.
Illustration 9.3

Illustration 9.4

Illustration 9.5

Illustration 9.6
X.X

Illustration 9.7

Illustration 9.8
X.X

Illustration 9.9

Illustration 9.10
X.X
TUITION AND FEES DEDUCTION

Congress has extended the tuition and fees deduction through 2014. Taxpayers may deduct up to
$4,000 as an adjustment to income for qualified tuition and related expenses. The deduction is a
per-return limit, not a per-student limit. The deduction is figured on Form 8917, Tuition and Fees
Deduction, and claimed on Form 1040A, line 19. See Illustration 9.13 on page 9.22.
Who Is an Eligible Student?

An eligible student is any student who is enrolled in any postsecondary educational institution eligible
to participate in a student aid program administered by the Department of Education. This would
include almost all accredited public, nonprofit, and proprietary (privately-owned, profit-making) postsecondary institutions.
Illustration 9.11
Who May Claim the Deduction?

In order to claim the deduction, the taxpayer must have paid the qualified expenses for themselves, a
spouse, or a dependent who is claimed as an exemption by the taxpayer. If the taxpayer did not pay
the expenses, they cannot claim the deduction. If the dependent paid the expenses and the taxpayer
claims the dependency exemption, no one claims the deduction. The chart in Illustration 9.12 on page
9.21 is a helpful guide to determine who may claim the deduction in the case of a dependent student.
Phaseout of Tuition and Fees Deduction

The tuition and fees deduction phases out for taxpayers with MAGI between $65,000 ($130,000 MFJ)
and $80,000 ($160,000 MFJ). Unlike some tax benefits, which phase out at a more or less constant
rate, the tuition and fees deduction phases out in steps, as shown above.
mExample: Lets assume Mary Williams (from previous examples) has an AGI of $70,000 and is in her
fifth year of college. In this case, Mary does not qualify for the AOC because she is in her fifth year and
she will not qualify for the lifetime learning credit because her income is too high. Mary qualifies for
the tuition and fees deduction. The first page of her 1040A and her completed Form 8917 is presented
in Illustrations 9.13 and 9.14 on pages 9.22 and 9.23.m
Qualified Expenses
Qualified expenses for the tuition and fees deduction are tuition and certain related expenses required
for enrollment or attendance at an eligible educational institution. Related expenses may include student-activity fees and expenses for course-related books, supplies, and equipment. These are eligible
expenses only if they must be paid to the institution as a condition of enrollment or attendance. Room
and board are not qualified expenses.
mExample: Blake is a sophomore in University Ks degree program in microbiology. This year, in
addition to tuition, he is required to pay a fee to the university for the rental of the lab equipment
he will use in the program. Because the equipment rental fee must be paid to the university, it is a
qualified expense.m
mExample: Stacy attends College J. Her tuition and fees for the year were $3,458. She also purchased
books costing $257 for her classes at the off-campus Wildcat Bookstore. Her qualified expenses for
the tuition and fees deduction would be $3,458 because this expense was not paid to the institution.m
Remember:Expenses used for education credits are not necessarily qualified expenses for the tuition
and fees deduction. Also, any student who uses an education credit cannot use the tuition and fees
deduction even for expenses above those used for the credit.

Illustration 9.12
Tuition and Fees Deduction

Who Can Claim a Dependents Expenses?

Illustration 9.13

Illustration 9.14
CHAPTER SUMMARY
Which educational expenses are eligible expenses for the tuition and fees deduction, the American
Opportunity Credit (AOC), and the lifetime learning credit.
The tuition and fees deduction of up to $4,000 is available for degree candidates and students
taking college courses to maintain or improve their current job skills. The deduction is figured on
Form 8917 and entered on Form 1040A, line 19.
Taxpayers who pay for higher education may qualify for one or more education tax breaks.
The AOC is available for the 20092017 tax years for degree candidates who have not completed
their first four years of post-secondary education as of the beginning of the tax year.
The lifetime learning credit is available for all years of higher education for degree candidates and
students taking college courses to maintain or improve their current job skills.
Suggested Reading
Chapter 19, Education-Related Adjustments.
IRS Publication 970, Tax Benefits for Education, is also an invaluable resource for this topic.
he Tax Institute Tax in the News Research Question: Our clients

have contributed about $5,000 to a Coverdell ESA for their son. They
opened the account when he was a child (when they were still called Education
IRAs!) and have contributed intermittently since then. Unfortunately, their son,
who will soon turn 18, told them he has no intention of continuing his education
after high school. What happens to the money at this point? Can the funds be
rolled over to another kind of savings account for him, such as a Roth IRA?
nswer: Your clients may not roll over the unused ESA funds into any type
of IRA, either for themselves or for their son. There are three possibilities
for the ESA, rather than closing the account and distributing all of the funds.
First, your clients should keep in mind that the ESA can remain intact
until their son turns 30. Although he may be adamant about not going to
college right now, he could change his mind in a few years. Also, education expenses for ESAs include tuition and other costs for qualifying vocational schools, which may be a type of education that interests their son.
Second, the ESA can be rolled over tax-free to an ESA for another family
member who is related to their son in one of several ways, including his
siblings and first cousins.
Finally, as a point of information, the ESA can be rolled over tax-free to a
qualified tuition program (QTP) for their son. Obviously, for this family, a
QTP rollover may not be a good choice.
nswer continues: If your clients decide to close the account and distribute all of the funds, the earnings portion of the distribution will be taxable
to their son. The distribution will be reported on Form 1099-Q, Payments from
Qualified Education Programs.
For more information, including a list of acceptable relatives for rollover purposes, see Coverdell Education Savings Account (ESA) in IRS Pub. 970, Tax
Benefits for Education, and instructions to Form 1099-Q. Note that we assume
your clients son is not a special needs beneficiary. If he were, the age limitation
does not apply and the funds could remain in the ESA indefinitely.
10
Retirement
OVERVIEW
You have probably read or heard news stories stating that Americans are not saving nearly enough
for retirement. The IRS Tax Code seeks to encourage retirement savings by making a variety of tax
breaks available to taxpayers when they save for retirement. This chapter will cover some of the more
common retirement savings plans available to individual taxpayers.
In retirement planning, generally there are two parts. The first part of retirement is building your
retirement accounts, so that when you retirethe second partyou can strategically withdraw the
funds to live out your retirement. This chapter covers a brief overview of both contributing to and
taking distributions from retirement plans.
OBJECTIVES
Explain the features of commonly available retirement accounts and the tax benefits of contributing to these accounts.
Determine if a taxpayer is eligible to contribute to a traditional or Roth IRA, and determine the
deductible amount of traditional IRA contributions.
Determine a taxpayers eligibility for the retirement savings contribution credit and calculate the
amount of the credit.
Determine and accurately report the taxable portion of social security or tier 1 railroad retirement
benefits.
Identify and accurately report taxable qualified retirement plan and IRA distributions.
Explain the consequences of an early retirement plan and IRA distributions.
10.1
TAX TERMS
401(k) plan.
403(b) plan.
457 plan.
Annuity.
Contribution.
Defined benefit plan.
Defined contribution plan.
Distribution.
Pension.
Rollover.
Roth IRA.
Traditional IRA.
TYPES OF RETIREMENT PLANS

While there are a wide variety of retirement plans, for our purpose, we are going to focus on qualified
plans and nonqualified plans.
Qualified Plans
A qualified plan is a plan that is eligible for favorable tax treatment because it meets the requirements of both the following:
IRC 401(a).
The Employment Retirement Income Security Act of 1974 (ERISA).
A qualified plan is allowed some very advantageous tax treatment:
Employers may deduct the annual allowable contributions that they make for each plan participant.
Contributions and earnings on those contributions are tax-deferred until withdrawn for each participant.
In some cases, taxes may be deferred even further through a transfer into a different type of IRA
account (we will cover IRA accounts later in this chapter).
Retirement 10.3
Nonqualified Plans
As you probably suspect, a nonqualified plan is basically the opposite of a qualified plan. Nonqualified
plans do not meet the requirements of IRC 401(a) and ERISA and do not qualify for favorable tax
treatment. Nonqualified plans are:
Usually designed to meet specialized retirement needs of key executives and other select employees.
Exempt from the discriminatory and top-heavy testing to which qualified plans are subject.
Contributions to a nonqualified plan are usually nondeductible to the employer. Nonqualified plans do
allow employees to defer taxes until retirement; at retirement, distributions from a nonqualified plan
are usually made in the form of an annuity.
Note:You do need to know the basic features of qualified vs. nonqualified plans, but do not get too
wound up in it. We are going to concentrate on contributions to and distributions from qualified plans
or plans that are basically treated as qualified plans.
QUALIFIED PLANS
There are two kinds of qualified plans, defined benefit and defined contribution plans. A defined benefit plan is a retirement plan where the employee receives a predetermined formula-based benefit at
retirement. The most common known type of defined benefit plan is a pension in which the retirement
benefit is calculated by a formula based on number of years worked, age, and their history of earnings
with the employer. Another type of defined benefit plan is an annuity. An annuity is a series of payments under a contract made at regular intervals over a period of more than one year. The taxpayer
can buy the annuity contract alone or with the help of their employer. Annuities are often purchased
from life insurance companies. For these types of retirement accounts, generally the employer and/or
employee makes payments to fund the pension or annuity.
A defined contribution plan (also called a deferred compensation plan) is a retirement plan where the
employee and/or employer make pre-tax contributions into a retirement account where the contributions and earnings grow tax-free until the money is withdrawn. The most commonly known type of
deferred compensation plan is a 401(k). The following are common types of deferred compensation
plans that you may encounter at the tax desk.
401(k) Plans
A widely available and popular type of qualified deferred compensation plan is the 401(k) plan. 401(k)
plans take their name from IRC 401(k), which governs their existence. As a qualified plan, 401(k)s
offer significant tax advantages:
Employee contributions to the plan are tax-deferred. This means the employee does not pay federal
income tax on the amount of the contributions in the year contributed. Most states also allow contributions to be tax-deferred, although some contributions may be subject to local income tax. Tax
is not paid until the taxpayer receives a distribution, or in other words withdrawal, from the plan.
Earnings on the contributions are also tax-deferred until the taxpayer receives a distribution from
the plan.
Employer-Matching Contributions
The 401(k) plans may also have another potential benefit. The employer may opt to match all or part
of the employees contributions to the account. This may be done by:
Making an additional contribution to the account on behalf of the employee.
Offering a profit-sharing contribution to the plan.
mExample: Teds employer offers their employees a 401(k) plan. The employer offers a matching contribution for each percent the employee contributes, up to 5%, of their annual salary to the plan. If
Ted contributes 10% of his annual salary to the plan, his employer will make matching contributions
equal to 5%. This means Ted is saving 15% of his annual salary for an out-of-pocket expenditure of
only 10%.m
advantage of any employer-matching contribution is a fanTtastic wayTaking

to help build retirement savings. Depending on the taxpayers
ax Tip:
available cash flow, it is always advantageous for the taxpayers to make the
minimum contribution to the retirement plan to receive the employers maximum matching contribution, because the employers matching contribution is
free money.
403(b) Plans
A 403(b) plan is a tax-advantaged retirement savings plan available for employees of the following
types of organizations:
Public education.
Some non-profit.
Cooperative hospital service.
Employee contributions to a 403(b) plan are tax-deferred and so are earnings on the plan.
Retirement 10.5
Note:Technically, 403(b) plans are not qualified plans. However, their main features are identical to
those of qualified plans. For our purpose, we are going to treat 403(b) plans the same as a qualified
plan.
457 Plans
The 457 plans are tax-advantaged, deferred-compensation retirement plans available primarily to
governmental employees. These 457 plans are not qualified plans, but their primary features are
identical to qualified plans. Contributions to the plan, and earnings on those contributions, are tax-deferred until the employee receives distributions from the plan.
Contribution Limits
As wonderful a deal as a deferred-compensation plan is, employees are not allowed to contribute an
unlimited amount to their plan. The IRS does set annual maximum limits on the amount that can
be contributed. These amounts are indexed for inflation and generally rise each year (much as the
allowable amount for the standard deduction generally rises each year).
For 2014, the maximum annual allowable contribution is $17,500. Taxpayers over the age of 50 are
allowed an annual catch up contribution of $5,500.
Note:As mentioned, allowable contributions to plans are generally set as a percentage of an employees salary. Therefore, the maximum amount any one taxpayer can contribute is a function of both the
maximum annual limit and the allowable percentage of salary that may be contributed.
mExample: John Conners annual salary is $100,000. His employer sponsors a 401(k) plan, which
allows each employee to contribute a percentage of their annual salary up to the IRS annual contribution limit. John chooses to contribute the amount of 5% of his annual salary. Therefore, for 2014,
Johns 401(k) contribution is $5,000 [$100,000 2 5% = $5,000].m
Identifying Contributions to a Deferred-Compensation Plan

In order to accurately and completely prepare a tax return, it is essential to know how much the taxpayer contributed to a deferred-compensation plan. Fortunately, the taxpayers Form W-2 generally
contains all the information you need. Recall from Chapter 2 that there are a variety of codes that
can be entered on Form W-2 to communicate a great deal of information. We are interested in box 12
and the codes that identify deferred-compensation plans. Refer to Illustrations 10.1 and 10.2 on the
following page.
mExample: Illustration 10.1 shows John Conners W-2 (from our earlier example). Notice the difference between the amount in box 1 and the amounts in boxes 3 and 5. The $5,000 difference is the
amount John contributed on a tax-deferred basis to his 401(k) plan. The $5,000 401(k) contribution is
reported in box 12 with the code D.m

Illustration 10.1
Illustration 10.2
Retirement 10.7
IRAS
An individual retirement arrangement (IRA) is a personal savings plan that gives taxpayers tax
advantages for saving money for retirement. Two tax advantages of an IRA are that:
Money contributed to the IRA may be fully or partially deductible.
Amounts in the IRA grow tax-free and are not taxed until the money is withdrawn from the IRA
account.
Generally, a qualifying taxpayer has the option to fund two types of IRA accounts, a traditional IRA
and a Roth IRA. Details about both types of IRAs will be discussed later.
Compensation
To qualify to contribute to an IRA, a taxpayer must have earned income, or compensation. For IRA
purposes, compensation includes wages, salaries, tips, commissions, professional fees, bonuses, net
self-employment income, and other amounts the taxpayer receives for providing personal services as
well as alimony payments. If the taxpayers Form W-2 shows any nonqualified plan distribution or
457 plan distribution in box 11, that amount must be subtracted from the taxpayers wages when
determining their compensation for IRA purposes.
Investment income, foreign earned income, or business income where the taxpayer does not actively
participate does not qualify as compensation for IRA contributions. Any foreign earned income or
housing exclusion or deduction the taxpayer is claiming must be subtracted to arrive at total compensation.
For 2014, the maximum allowable contribution to an IRA (traditional or Roth) is the lesser of the
following:
$5,500 ($6,500 if the taxpayer has reached age 50 by the end of the tax year).
100% of the taxpayers compensation.
For this purpose, a taxpayer is considered to have reached age 50 on the day before their birthday.
Thus, a taxpayer born January 1, 1965, is considered to have reached age 50 at the end of 2014.
Please note that the total of all traditional and Roth IRA contributions combined for the year cannot
exceed $5,500 ($6,500 if age 50 or older). So a taxpayer could contribute $5,500 to their traditional
IRA or $5,500 to the Roth IRA, but not $5,500 to both their traditional and Roth IRAs because their
combined IRA contribution would equal $11,000. If the taxpayer wishes to contribute to both their
traditional and Roth IRA, they would have to split the $5,500 maximum contribution limit between
both accounts. For example, a taxpayer could contribute $2,500 to their traditional IRA and $3,000
to their Roth IRA.
TRADITIONAL IRAS
In order to establish and contribute to a traditional IRA, a taxpayer must have taxable compensation
and must not have reached age 70 by the end of the tax year. For this purpose, a taxpayer is considered to have reached age 70 six months after their 70th birthday.
Contributions to traditional IRAs may be deductible from gross income, as an adjustment to income
on Form 1040A, line 17, if the taxpayer qualifies for the deduction. The advantage of a traditional IRA
is that the taxpayer can often deduct amounts set aside for retirement and then watch the fund grow
tax-free while in the IRA account. When the taxpayer reaches age 59, they can withdraw the funds
from the IRA without a penalty. However, the money is generally taxable at that time. The taxpayer
is often in a lower tax bracket due to retirement and will pay less income tax. Money placed in an
IRA should be considered a long-term investment because amounts withdrawn before the taxpayer
reaches age 59 are usually subject to an early withdrawal penalty.
Different Sets of Rules

There are separate sets of rules concerning the deductibility of traditional IRA contributions for each
of three different types of taxpayers:
Taxpayers who are active participants in employer-maintained retirement plans at any time
during the year.
Taxpayers who are not active participants, including joint filers whose spouses are not active participants.
Joint filers who are not active participants, but whose spouses are active participants.
Who Is an Active Participant?

A taxpayer is an active participant in an employer-maintained retirement plan if they participate at
any time during the year in any of the following:
A qualified retirement, profit-sharing, or stock bonus plan (for example, a 401(k) plan).
A qualified annuity plan.
A 403(b) tax-sheltered annuity plan (available to employees of public schools and certain tax-exempt organizations).
A SIMPLE plan.
A government plan (other than a 457 plan).
Certain pension plans funded solely by employee contributions.
A plan established by a self-employed taxpayer (for example, a qualified plan or SEP).
You do not need to become an expert in retirement plan terminology to know if an employee is covered
by an employer-maintained plan. If box 13, the Retirement plan box, on the employees Form W-2 is
marked, the employee is an active participant. If the employee believes the box should not have been
marked, they should obtain a corrected Form W-2 from their employer.
Retirement 10.9
An individual is not treated as an active participant solely because of their coverage under social
security or railroad retirement (tier 1 or tier 2). A person who is receiving retirement benefits from a
former employers plan is not treated as an active participant unless they are covered under a current
employers plan.
Taxpayers Who Are Not Active Participants

IRA contributions made by taxpayers who are not active participants (and whose spouses are not
active participants) are fully deductible up to the maximum allowable contribution amount. A taxpayer who uses the married filing separately status and who did not live with their spouse at any time
during the year is treated as a single taxpayer for this purpose.
If a married couple each have compensation, each spouse may establish an IRA, contribute, and deduct
an amount within the limits. The allowable IRA contribution (and deduction) is computed separately
without regard to any community property laws. An eligible married taxpayer may also establish a
spousal IRA (an IRA for their spouse) even if the spouse has received little or no compensation for the
tax year. A couple making contributions to a spousal IRA must file a joint return.
mExample: Jim (48) and Sally (51) Spencer are filing jointly for 2014. Jim earned $35,000, and Sally
earned $2,500. Jim may contribute up to $5,500 to his IRA for 2014. If Jim contributes the $5,500,
Sallys compensation for IRA purposes is $32,000 [$35,000 + $2,500 $5,500 = $32,000]. The Spencers
may contribute up to $6,500 to Sallys IRA for 2014.m
An IRA may be established and contributed to until the due date (not including extensions) of the
return for the year. That is, a contribution made to an IRA on or before April 15, 2015, may be designated for 2014, and a deduction is allowed on the 2014 return. Therefore, contributing to an IRA is
one of the few actions a taxpayer can take to reduce tax liability after the tax year has ended.
mExample: Lorna Mendiola (39), a single taxpayer who is not an active participant in an employer-maintained retirement plan, computed her taxable income to be $54,689 and her tax to be $9,525.
Because she had only $9,431 withheld from her pay, she would owe the federal government $94.
Lorna did not like the idea of paying additional income tax, so on April 14 she opened a traditional
IRA at her bank and contributed $4,000. She changed her return to show a $4,000 IRA deduction.
Now, her taxable income is reduced to $50,689, and her tax becomes $8,525. Thus, Lorna receives a
refund of $906, and she saved $4,000 for her retirement.m
Taxpayers Who Are Active Participants

When considering taxpayers who are active participants in an employer-maintained retirement plan,
we must be mindful of the distinction between contributing to an IRA and deducting that contribution.
For active participants, the amount that may be contributed to a traditional IRA is the same as it
is for nonparticipants. However, the amount that may be deducted is often limited. The limitation
depends on the taxpayers modified AGI.
Modified AGI (MAGI), for traditional IRA purposes, is determined by adding the following amounts
to regular AGI (without regard to any IRA deductions):
Student loan interest deduction from Form 1040A, line 18 (or Form 1040, line 33).
Tuition and fees deduction from Form 1040A, line 19 (or Form 1040, line 34).
Excludible employer-provided adoption benefits from Form 8839, line 20.
Excludible U.S. Savings Bond interest from Form 8815, line 14.
Domestic production activity deduction from Form 1040, line 35 (beyond the scope of this course).
Certain excludible foreign and U.S. possession income (beyond the scope of this course).
The chart in Illustration 10.3 below summarizes the phaseout ranges for 2014.
Illustration 10.3
2014 TRADITIONAL IRA MODIFIED AGI PHASEOUT RANGES FOR ACTIVE PARTICIPANTS
Filing Status
S, HH, MFS*
Full Deduction
$60,000 or less
Deduction Reduced
$60,00169,999
No Deduction
$70,000 or more
MFJ, QW
MFS**
$96,000 or less
$96,001115,999
$116,000 or more
$19,999
$10,000 or more
*Did not live with spouse at any time during the year
**Lived with spouse at some time during the year
Nonparticipating Spouses
A separate set of deduction limitations applies to married taxpayers who are not active participants
in employer-maintained retirement plans, but who are filing joint returns with spouses who are
active participants in such plans. These taxpayers are referred to as nonparticipating spouses.
For 2014, a nonparticipating spouse is allowed a full deduction for a traditional IRA contribution
if the couples modified AGI is $181,000 or less. If their modified AGI is greater than $181,000 but
less than $191,000, the maximum deduction allowed is reduced. If their modified AGI is $191,000 or
higher, no deduction is allowed.
BlockWorks provides a two-page worksheet, called the IRA Deduction Worksheet Line 32, to help
Tax Professionals compute taxpayers total allowable contributions to their traditional IRAs and to
determine how much of any traditional IRA contributions is deductible. The worksheet is shown in
Illustrations 10.4 and 10.5.
Retirement 10.11
mExample: Henri (39) and Michelle (39) Duval are married and filing a joint return on Form 1040A.
Henri earned $67,700 and is an active participant in an employer-maintained retirement plan.
Michelle earned $32,500 and is not an active participant. The Duvals total income is $100,200. Their
only adjustment to income is a $151 student loan interest deduction, which makes their adjusted
income $100,049. When determining MAGI for the traditional IRA deduction, the $151 student
loan interest deduction is added back. This makes their MAGI equal $100,200 [$100,049 + $151 =
$100,200].
Henri and Michelle would like to contribute $5,500 each to their traditional IRAs for 2014, but they
do not want to contribute more than they can deduct. Because Henri is an active participant in an
employer-maintained retirement plan and the Duvals modified AGI is greater than $95,000, Henris
traditional IRA contribution deduction is limited to $4,350. However, Michelle is able to make the
full $5,500 traditional IRA contribution because she is not an active participant in an employer-maintained retirement plan and the Duvals modified AGI is less than $178,000. The Duvals BlockWorks
IRA Deduction Worksheet Line 32 is shown in Illustrations 10.410.5. The Duvals are excited they
are receiving a $9,850 IRA deduction on their Form 1040A, line 17.m
ROTH IRAS
Roth IRAs are an excellent way to save, not only for retirement, but beyond. Unlike traditional IRAs,
taxpayers can make contributions to their Roth IRA after they reach age 70. Since Roth IRAs do
not have required distributions, the taxpayer could leave contributions in the account as long as they
wish. Unless specific rules prescribe otherwise, the rules that apply to traditional IRAs also apply to
Roth IRAs. For instance:
To make contributions, the taxpayer must receive compensation during the year.
Contributions must be made by the due date of the return, not including extensions.
Contributions for each spouse are limited for 2014 to the lesser of $5,500 ($6,500 for those age 50
and older) or total compensation.
Taxpayers can make contributions for themselves and a nonworking or lower-income spouse, if
they file a joint return.
Allowable Roth IRA contributions must be reduced by any amounts contributed to a traditional IRA,
regardless of whether such contributions were deductible.
Not Deductible. The main difference between a traditional IRA and a Roth IRA is that contributions
to a Roth IRA are not deductible on Form 1040Aqualified distributions, however, are exempt from
tax. This means that the money earned inside the Roth IRA is usually tax-free. Because Roth IRA
contributions are not deductible, these contributions are not reported on the tax return. However, it
is important for the taxpayer to keep records of their Roth IRA contributions.

Illustration 10.4
Retirement 10.13
Illustration 10.5
The maximum allowable Roth IRA contribution is phased out based on the taxpayers modified
adjusted gross income. This phaseout range applies whether or not the taxpayer or spouse is an
active participant. Participation in an employer-maintained retirement plan has no effect on Roth
IRA contributions, and contributions can be made even after the taxpayer has reached age 70. See
Illustration 10.6 for a table of the 2014 Roth IRA modified AGIphaseout ranges based on the taxpayers filing status.
Illustration 10.6
2014 ROTH IRA MODIFIED AGI PHASEOUT RANGES

Filing Status
S, HH, MFS*
Full Contribution
Less than $114,000
Contribution Reduced
$114,000128,999
No Contribution
$129,000 or more
MFJ, QW
MFS**
Less than $181,000
$181,000190,999
$191,000 or more
$0
$19,999
$10,000 or more
*Did not live with spouse at any time during the year
**Lived with spouse at some time during the year
For Roth IRA purposes, modified AGI is computed in the same manner that it is for traditional IRAs,
except that income resulting from the conversion of a traditional IRA into a Roth IRA is not included.
The BlockWorks 2014 Maximum Roth IRA Contribution Worksheet is used to compute the amount
of Roth IRA contributions a taxpayer (and spouse) may make to their Roth IRA accounts. This worksheet is shown in Illustration 10.7.
For taxpayers whose traditional IRA deduction is reduced because they participate in an employer
retirement plan and their modified AGI exceeds the threshold amount per filing status, the taxpayer may wish to contribute the exact amount of their traditional IRA contribution deduction to their
traditional IRA and contribute the remaining portion to their Roth IRA, assuming their Roth IRA
contribution is not limited due to their MAGI.
mExample: Henri and Michelle Duval (from the preceeding example) still wish to maximize Henris
2014 IRA contribution limit, because the Duvals are very proactive about saving for their retirement.
Because Henris traditional IRA contribution deduction is limited to $4,350, he wants to contribute as
much as he can to his Roth IRA.
Because the Duvals modified AGI is below $181,000, Henri is allowed to contribute $1,150 to his Roth
IRAaccount [$5,500 $4,350 = $1,150]. This way, he maximizes his $5,500 IRA contribution limit.
Henris BlockWorks 2014 Maximum Roth IRA Contribution Worksheet is shown in Illustration 10.7.m
Retirement 10.15
Illustration 10.7
10.16
10.16 H&RBlock
H&R Block Income
Income Tax
Tax Course
Course (2015)
(2015)
Roth IRA Conversion. Taxpayers who have a traditional IRA have the ability to transfer all or part
of the funds from their traditional IRA into a separate Roth IRA account. This transfer is called a
Roth IRA conversion. The taxpayer is required to pay income tax on the transferred amounts in the
year of conversion. The Roth IRA conversion is reported using Form 8606, Nondeductible IRAs. The
traditional IRA funds may be transferred to the Roth IRAusing the following methods:
The taxpayer receives a distribution from their traditional IRA and personally contributes the
money into their Roth IRA. This is called a rollover.
The taxpayer requests the traditional IRAtrustee to transfer the funds directly into their Roth
IRA. This is called a trustee-to-trustee transfer.
The taxpayer reclassifies their traditional IRA account as a Roth IRA, if the account is maintained
by the same trustee.
The taxpayer transfers all or part of their traditional IRAfunds into a new Roth IRA account that
is maintained by the same trustee.
If you are preparing a return for a taxpayer who has made a Roth IRA conversion, additional research
may be required. More information about a Roth IRAconversion can be found in IRS Publication 590,
Individual Retirement Arrangements (IRAs).
SIMPLE IRA
A SIMPLE IRA is a retirement plan generally setup by small employers to allow employees to contribute pre-tax compensation into the plan. Employers are required to either make a matching contribution based on the employees elective deferred compensation or a nonelective contribution that must
be paid to all eligible employees regardless if the employee makes contributions to their account. The
employer receives a deduction on the business return for the contribution they made to the employees
accounts. Unlike a traditional IRA, the employee does not receive a contribution adjustment on their
return, because their contributions are made by their employer on their behalf prior to calculating
and remitting federal and state income tax. The employee taxpayers are then taxed on the SIMPLE
IRA funds when they take distributions from the account. For more information, see IRS Publication
560, Retirement Accounts for Small Businesses.
Retirement 10.17
RETIREMENT SAVINGS CONTRIBUTION CREDIT

Qualified lower- and middle-income taxpayers who make retirement plan contributions may be eligible to claim a nonrefundable credit on their tax returns. This Savers Credit, for short, is available in
addition to any allowable deductionwhich makes this one of the very few situations where a double
benefit may be claimed.
A 2014 Savers Credit is not available to taxpayers who were:
Born after January 1, 1997. The year changes each year.
Claimed as a dependent on someone elses 2014 return.
Full-time students during any part of five calendar months in 2014.
Qualified Contributions
Contributions that qualify for the Savers Credit include:
Contributions to traditional and Roth IRAs. (As with the traditional IRA deduction, contributions
for 2014 made in 2014 give rise to a credit for 2014.)
Voluntary salary deferrals to 401(k) plans, 403(b) tax-sheltered annuity plans, governmental
457 plans, SEPs, and SIMPLE plans.
Voluntary employee contributions to qualified retirement plans.
Contributions to 501(c)(18)(D) plans.
While a thorough understanding of the details of each plan type is not necessary at this time, it is
important to be aware of the types of plans that are available.
Generally, when qualified contributions are made by an employee to an employer-maintained plan,
they can be found in box 12 of their Form W-2 denoted by code D, E, F, G, H, or S. You may want to
review the box 12 codes for Form W-2 (Illustration 10.2).
Employers matching contributions do not count toward the credit. Also, mandatory contributions do
not qualify for the credit. Contributions are considered mandatory if they are required as a condition
of employment.
mExample: Michael Oxenbacher (46) voluntarily deferred $1,000 of his salary into his employers
401(k) plan. He also contributed $500 to a traditional IRA and $250 to a Roth IRA. All of these contributions are qualified contributions for the Savers Credit.m
Contributions that qualify for the Savers Credit must be reduced by any distributions from the same
types of plans made in the two tax years prior to the current year until the due date of the current
years return (including extensions). Thus, for 2014, distributions made after December 31, 2011, and
before April 15, 2015, (October 15, 2015, if an automatic six-month extension was requested) reduce
the amount eligible for the credit.
mExample: Suppose that Michael Oxenbacher (from the preceding example) had taken a $600 distribution from his 401(k) plan on January 8, 2014. His $1,750 qualified contributions must be reduced
by the $600 distribution when computing the Savers Credit.m
The following do not reduce the amount eligible for the Savers Credit:
Distributions directly rolled over or transferred from one trustee to another.
Distributions of funds converted from a traditional IRA to a Roth IRA.
Loans from qualified employer plans treated as distributions.
Distributions of excess contributions or deferrals (plus earnings).
Distributions of contributions made during the tax year (plus earnings) and withdrawn before the
due date of the return (including extensions).
Distributions of dividends on stock held by an employee stock ownership plan.
Distributions from a military retirement plan.
mExample: On June 17, 2014, Robert Demler withdrew $1,300 from his traditional IRA. On August
13, 2014, he rolled over the funds into a new traditional IRA. On December 3, 2014, he contributed
$2,000 to the new IRA. Robert is not required to reduce his $2,000 contribution, which qualifies for
the Savers Credit, by the amount he rolled over in 2014. However, if he had kept the money from the
original distribution, he would have been required to reduce his qualified contribution to $700 [$2,000
$1,300 = $700].m
Amount of Credit
The Savers Credit is based on qualified contributions up to $2,000 per taxpayer or $2,000 for each
spouse on a joint return in 2014. The credit rates are 10%, 20%, or 50%, depending upon filing status
and modified AGI. In this case, AGI is modified only for certain excluded foreign and U.S. possession
income. The rates are shown on the following page in Illustration 10.8.
Retirement 10.19
Illustration 10.8
SAVERS CREDIT RATES

Modified Adjusted Gross Income
Married Filing
Head of Household
Jointly
All Others
Credit Rate
Up to $36,000
Up to $27,000
Up to $18,000
50%
$36,00139,000
$27,00129,250
$18,00119,500
20%
$39,00160,000
$29,25145,000
$19,50130,000
10%
Over $60,000
Over $45,000
Over $30,000
0%
The credit is computed on Form 8880, Credit for Qualified Retirement Savings Contributions, shown
in Illustration 10.8. The credit is then entered on Form 1040A, line 34.
mExample: Stephanie Ackerman (35) is a teacher using the head of household filing status. During
2014, she deferred $2,150 of her salary into her employers 403(b) tax-sheltered annuity plan. On
April 13, 2015, she contributed $4,000 to her Roth IRA for 2014. Back in 2012, she had withdrawn
$750 from the Roth IRA when she was having a tough time making ends meet. Stephanies modified
AGI is $33,600, and her Form 1040A, line 28, amount is $1,846. Based on Stephanies modified AGI,
she qualifies for a $200 retirement savings contributions credit (Savers Credit), which is reported on
her From 1040A, line 34. Her completed Form 8880 is shown in Illustration 10.9.m
SOCIAL SECURITY AND EQUIVALENT

RAILROAD RETIREMENT BENEFITS
Many taxpayers who are retired or disabled or whose spouses or parents are deceased receive social
security or equivalent tier 1 railroad retirement benefits (RRB). Like many other amounts in tax law
(such as the allowable standard deduction), social security benefit amounts are indexed for inflation,
which generally results in the benefit amount increasing from year to year.

Illustration 10.9
Retirement 10.21
Depending upon each taxpayers situation, up to 85% of a taxpayers social security or equivalent
tier 1 RR benefits may be taxable. Taxpayers with income above a certain threshold will pay tax on
a portion of their benefits.
Note: For purposes of this section, the term social security benefits applies only to payments made
under the Old-Age, Survivors, and Disability Insurance (OASDI) program. OASDI benefits are funded
through the social security payroll tax, are based upon prior earnings, and may be partially taxable.
Social security benefits do not include Supplemental Security Income (SSI). SSI is a federal program
providing income assistance based on financial need for the aged, blind, and disabled. While the Social
Security Administration administers both programs, SSI benefits are not taxable.
Full Retirement Age

For workers born before 1938, full retirement age is age 65. The retirement age is gradually being
increased to age 67 for workers born after 1937. The table in Illustration 10.10 shows how this change
is being phased in. Barring change, the entire process will be complete in 2027.
Illustration 10.10
FULL RETIREMENT AGE

Year of Birth
1937 and earlier
Full Retirement Age

65 years
Year of Birth
19431954
Full Retirement Age

66 years
1938
65 years, 2 months
1955
66 years, 2 months
1939
65 years, 4 months
1956
66 years, 4 months
1940
65 years, 6 months
1957
66 years, 6 months
1941
65 years, 8 months
1958
66 years, 8 months
1942
65 years, 10 months
1959
66 years, 10 months
The full retirement age is 67 years for everyone born in 1960 and later.
Reporting Social Security and Equivalent Railroad Retirement Benefits

Form SSA-1099 is used to notify the taxpayer of total social security benefits received during the year.
This form is shown in Illustration 10.11. Form RRB-1099 is used to notify the taxpayer of tier 1 RRB
received during the year. This form is shown in Illustration 10.12.

Illustration 10.11
Illustration 10.12
Retirement 10.23
Study Form SSA-1099, Social Security Benefit Statement, in Illustration 10.11 and Form RRB-1099 in
Illustration 10.12 as you read through the next section describing the forms. Note: There are minor
differences between the forms. The following references are for the SSA-1099.
Box 1. Recipients name.
Box 2. Recipients social security number.
Box 3. Total amount of benefits paid. This figure may not agree with the actual money the taxpayer
received due to adjustments for items withheld, such as Medicare Part B premiums. All adjustments
are itemized in the box labeled Description of Amount in Box 3 (SSA-1099).
Box 4. Recipients who have not yet reached full retirement age and who earned more than $15,480
in wages and net self-employment income during 2014 may be required to pay some of their benefits
back to the Social Security Administration. Box 4 shows the total amount of benefits repaid, if any.
The earnings limit, above which some benefits may need to be repaid, is $41,400 for taxpayers who
reached full retirement age in 2014. There is no earnings limit for recipients who reached full retirement age before 2014.
Box 5. Net benefits received. This amount is the difference between the figure in box 3 and the figure
in box 4.
Box 6 (Box 10 on RRB-1099). Taxpayers may choose to have federal income tax withheld from their
benefits. The amount of tax withheld is shown here and should be included on Form 1040A, line 40.
Computing Taxable Benefits

The amount of a taxpayers social security or tier 1 RRB subject to federal tax varies from zero to 85%,
depending upon filing status and income. The level of taxability is based on modified AGI (defined
below) increased by one-half of the net benefits received by the taxpayer (and spouse, if MFJ). See
Illustration 10.13 for the taxability ranges.
Illustration 10.13
TAXABLE SOCIAL SECURITY BENEFITS
S, HH, QW
None of Benefits
Taxable
$025,000
Up to 50% of Benefits
Taxable
$25,00134,000
Up to 85% of Benefits
Taxable
$34,001 & over
MFJ
$032,000
$32,00144,000
$44,001 & over
Filing Status
$1 & over
MFS*
* If married filing separately and did not live with spouse at any time during the year, use single.
is a handy rule of thumb to help determine if a portion of social

TsecurityHere
or RRB benefits are taxable: Generally, if 50% of the total benefits
ax Tip:
plus all other income do not exceed $25,000 ($32,000 MFJ, $0 if MFS and the
taxpayers lived together at any point during the year), none of the benefits are
taxable.
Modified adjusted gross income is the sum of the following:

Regular AGI (without taking any social security or RRB tier 1 benefits into account).
Any excluded employer-provided adoption benefits.
Tax-exempt interest (for example, municipal bond interest).
Any interest from qualified U.S. Savings Bonds excluded because the taxpayer has qualified education costs.
Any excluded foreign earned income or housing allowance, or certain U.S. possession income.
Any student loan interest deduction.
Any tuition and fees deduction.
Any domestic production activities deduction.
H&R Block provides a worksheet you will use to determine the taxable amount of social security benefits. The BlockWorks Social Security Taxable Benefits Worksheet is shown in Illustration 10.14. The
worksheet looks intimidating, but dont worryit is very easy to use if you read each line carefully
and follow the instructions.
The taxable amount of the social security or RRB income appears on line 19 of the worksheet.
If line 19 of the worksheet shows that some of the benefits received are taxable, enter the taxable
amount on Form 1040A, line 14b. Also, enter the benefits received (line 1 of the worksheet) on line
14a.
If line 19 of the worksheet shows that none of the benefits received are taxable, enter net benefits
for this income on Form 1040A, line 14a, and enter $0 on line 14b. If the taxpayer is married filing a
separate return and did not live with their spouse at any time during the year, they would also enter
D in the space to the left of line 14a and enter $0 on line 14b.
mExample: Samuel and Carol Walters are filing a joint return. Their Form 1040A, before calculating
taxable social security, shows AGI of $50,000, made up of the following entries:
Line 7 (wages) $40,000.
Line 8a (taxable interest) $10,000.
They also received nontaxable municipal bond interest of $2,000 (Form 1040A, line 8b). Box 5 of Sams
Form SSA-1099 shows $6,000.
On Form 1040A, $6,000 is entered on line 14a, and $5,100 is entered on line 14b. The Walters Social
Security Taxable Benefits Worksheet is shown in Illustration 10.14.m
Retirement 10.25
Illustration 10.14
Tier 1 Railroad Retirement Benefits

Generally, social security benefits and tier 1 RBB receive the same tax treatment. However, railroad
retirement disability benefits that are payable to individuals who would not be entitled to social security disability benefits, or that are in excess of the social security benefits to which an individual would
be entitled, generally are fully taxable. Similarly, railroad retirement benefits that are payable at an
age earlier than comparable social security benefits, or in an amount greater than the social security
benefits, are generally fully taxable. See IRS Publication 575, Pension and Annuity Income, for more
information. Railroad retirement benefits described in this paragraph are reported to the taxpayer
on Form RRB-1099-R (rather than on Form RRB-1099) and are treated as pension income. Pension
income is discussed in the next section.
RETIREMENT ACCOUNT DISTRIBUTIONS

A distribution is when a taxpayer takes money out of a retirement account. Generally, distributions
from pensions, annuities, profit-sharing and retirement plans (including 457 state and local government plans), IRAs, insurance contracts, etc., are reported to the recipient taxpayer on Form 1099-R,
Distribution From Pension, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts,
etc. This form is shown in Illustration 10.15.
Illustration 10.15
Retirement 10.27
Study Form 1099-R in Illustration 10.15 as you read through the next section describing this form.
Box 1. Gross distribution. This is the gross amount the taxpayer received for the year.
Box 2a. Taxable amount. This is generally the taxable portion of the amount received. If there is
no entry in this box, the payer may not have all the facts needed to figure the taxable amount. In that
case, the first box in box 2b, taxable amount not determined, should be checked.
Box 2b. Taxable amount not determined. If the first box is checked, the payer was unable to
determine the taxable amount, and box 2a should be blank, except for an IRA. In that case, the recipient must compute the taxable amount.
Box 2b, Total distribution. If the total distribution box is checked, all the funds in the account
were distributed to close out the account. A lump sum distribution or rollover could trigger a total
distribution of account funds.
Box 3. Capital gain (included in box 2a). If the participant was in the plan prior to 1974, this
portion of the distribution may be eligible for the capital gain election. See the instructions for Form
4972 or IRS Publication 575.
Box 4. Federal income tax withheld. If any federal tax has been withheld, the amount is shown
here. Include this amount on Form 1040A, line 40.
Box 5. Employee contributions or insurance premiums. This box may contain the amount of
the employees after-tax contributions to the plan. If the Form 1099-R is for a pension rather than
a total distribution, the total employee contributions should be shown in box 9b in the first year of
periodic payments. For succeeding years, any amount shown in box 5 will be the amount of employee
contributions recovered tax-free during the year.
Box 6. Net unrealized appreciation in employers securities. Net unrealized appreciation
(NUA) is the untaxed increase in value in employers securities received as part of the distribution.
This amount generally is not taxed until the securities are sold. If you encounter a Form 1099-R with
an entry in box 6, you will need to do some reading about net unrealized appreciation. Here again, the
instructions for Form 4972 will give you a good start.
Box 7. Distribution code(s). As you know, this box contains one or two codes that describe the distribution. Although there may be both a number and a letter entered in box 7, there generally should
be no more than one of each.
With all of the different types of distributions that can be reported on Form 1099-R, the list of codes
has grown quite long. Here is a list of the more common ones along with their meanings for 2014. A
complete list of codes can be found on the back of copy C of Form 1099-R. If you encounter a Form
1099-R with a code you do not understand, you will need to do some research or consult with a more
experienced Tax Professional:
1
Early distribution; no known exception to penalty applies (as far as the payer knows).
Early distribution; exception to penalty applies (for example, conversion to a Roth IRA).
Disability.
Death (includes payments to a beneficiary).
Normal distribution.
May qualify for ten-year averaging and/or capital gain election (as far as the payer knows).
Direct rollover to a qualified retirement plan, tax-sheltered annuity, 457(b) plan, or IRA, or
from a conduit IRA to a qualified plan.
Early distribution from a Roth IRA, no known exception to penalty applies (as far as the
payer knows).
Qualified distribution from a Roth IRA.
Roth IRA distribution due to death or disability or taxpayer has reached age 59, but the
payer does not know if the five-year holding period was met.
Box 8 is used to show the current actuarial value of an annuity contract. This amount may be needed
for Form 4972.
Box 9a is used when the total distribution is made to more than one person. The taxpayers percentage of the total distribution is shown here.
Box 9b shows the amount of the employees total investment in the retirement account. This amount
is used to compute the taxable portion of the distribution.
Boxes 1217. State and local tax information. Any state or local income tax withheld will be
shown in boxes 12 and 15, respectively. Enter these amounts on the appropriate lines of the state
and local tax returns. Also, include them in itemized deductions on line 5 of federal Schedule A, if the
taxpayer itemizes and does not elect instead to deduct state and local general sales taxes. If the state
or local distribution amount is different from the federal amount, the appropriate amounts will be
shown in boxes 14 and 17, respectively.
TAXABLE DISTRIBUTION
Distributions from a qualified retirement account are generally fully or partially taxable because the
retirement account was funded with pre-tax contributions and the earnings grew tax-free while in
the account. Depending on the type of retirement account the taxpayer owns may play a factor into
whether part of or the entire distribution is subject to tax.
Retirement 10.29
A fully taxable distribution is a distribution where the taxpayer did not make after-tax contributions
or is a distribution from which all after-tax amounts have been recovered in previous years.
If the taxpayer made no contribution to the pension plan or annuity (for example, the employer paid
all the costs), or if the taxpayer made only pre-tax contributions to a plan (such as in a 401(k) plan),
the entire distribution amount received during the year is taxable.
Examine line 12 on the first page of Form 1040A. When a distribution from a retirement account,
excluding an IRA, is fully taxable, enter the total amount directly on line 12b and make no entry on
line 12a.
mExample: Harry Murphy (67) receives a fully taxable monthly distribution from his 401(k) of $1,600
($19,200 annually). His Form 1099-R is shown in Illustration 10.15. Harry's fully taxable 401(k) distribution of $19,200 is reported on his Form 1040, line 12b.m
A partially taxable distribution is a distribution where the taxpayer is made after-tax contributions to the retirement account. When the taxpayer receives a distribution from this account, a portion
of the distribution represents a nontaxable return of their after-tax contribution (investment or cost).
Fortunately, most payers will have the required information to compute the taxable amount of the
distribution and report it to the recipient on Form 1099-R, box 2a. For payers who do not know the
amount of after-tax contributions made by the taxpayer, the payer will leave box 2a blank and check
box 2b, taxable amount not determined. In this situation, the taxpayer is required to determine
their taxable amount of the distribution.
When reporting a partially taxable distribution from a retirement account, excluding an IRA, the total
distribution amount received for the year is entered on Form 1040A, line 12a. The taxable amount is
entered on Form 1040A, line 12b.
There are several methods for computing the taxable amount of a partially taxable distribution.
Which one you will use depends mostly on when the payments started. The methods have undergone
considerable changes over the years, but we will concentrate on the most recent rules. The older general rule will be presented later for your awareness.
Simplified Method
The simplified method may be used to compute the taxable portion of a pension or annuity with a
starting date after July 1, 1986, where the taxpayer has after-tax contributions in the plan. The pension or annuity must meet the following three conditions to use the simplified method:
The payments must be from a qualified pension, profit-sharing, or stock bonus plan; a qualified
employee annuity plan; or a tax-sheltered annuity (403(b) plan).
The annuitant (the receiver of the payments) must be under 75 years of age when the payments
begin, or, if 75 or older, there must be fewer than five years of guaranteed payments.
The payments are for either the annuitants life or the joint life of the annuitant and a beneficiary.
Under the simplified method, the taxpayers excludible amount is determined by using a simple table.
The table included on the Simplified Method Worksheet shows the anticipated number of monthly
payments based on the age of the annuitant(s) for a pension or annuity starting after November 18,
1996. Note, the joint and survivor columns are to be used only for pensions and annuities starting
after December 31, 1997.
The age of the taxpayer is their age on the date the pension payments begin. This is important to note
since often a pension will begin in a year before the taxpayer reaches their full retirement age.
mExample: Thomas Blooms birthday is November 15, 1949. His first pension payment was made
on March 1, 2014. Therefore, the age to use for the table is 64, as he would not reach age 65 until
November 15, 2014.m
The taxpayers after-tax investment, or cost, in the pension or annuity is divided by the appropriate
number from the table to determine the excludible amount of each payment.
For partly taxable pensions and annuities with starting dates after December 31, 1986, part of each
payment received is excludible until the taxpayer has recovered their cost. Once the cost is recovered,
the pension or annuity is fully taxable. If the taxpayer (and their beneficiary, in the case of a joint and
survivor annuity) dies before the cost has been fully recovered, the unrecovered amount is deducted
on the taxpayers (or beneficiarys) final return as a miscellaneous itemized deduction on their Form
1040, Schedule A.
The excludible amount of each payment never changes (until it ceases entirely when the final beneficiary dies or the cost is fully recovered), even though the annuity or pension payments may increase
due to cost-of-living provisions or for other reasons.
mExample: George Castle (69), a single taxpayer, began receiving a pension of $1,500 per month for
life from the Leisure Retirement Funding Pension Fund on March 1, 2014. His Form 1099-R is shown
in Illustration 10.16. Georges after-tax investment in the pension was $74,100. In 2014, he recovered
$3,529 of his investment ($352.86 per month for ten months). Georges Simplified Method Worksheet
is shown in Illustration 10.17. He will report $15,000 on line 16a (12a) and $11,471 on line 12b of his
2014 Form 1040A.m
entering a partially taxable qualified retirement plan

Bor traditional IRAWhen
distribution into BlockWorks, scroll to the bottom of the
lockWorks Tip:
pension input screen in BlockWorks. Here, you will make entries to compute
the taxable amount using the simplified method. Table 1 is used unless the
spouse is a beneficiary of the pension, in which case Table 2 is used and the sum
of both taxpayers ages is entered in the Age at starting date box, such as in
Illustration 10.18.
Retirement 10.31
General Rule
The general rule for calculating the excludible portion of pension and annuity payments may be used
if a taxpayer started receiving payments before November 19, 1996. If the taxpayer started receiving payments on or after that date, the simplified method must be used in most cases. In cases of
purchased annuities and other nonqualified plans, the general rule must be used regardless of the
annuity starting date.
Because the general rule involves using complex actuarial tables, we will not discuss it in this course.
If you encounter a pension or annuity that must be (or is being) recovered using the general rule, you
will need to do some research and partner up with an experienced Tax Professional. IRS Publication
939, General Rule for Pensions and Annuities, is a good place to start.
There was also a death benefit exclusion available for certain beneficiaries of pensions and annuities
in the past. This exclusion was repealed for deaths occurring after August 20, 1996. If you ever need
more information about this exclusion, see IRS Publication 939.
Illustration 10.16

Illustration 10.17
Retirement 10.33
Illustration 10.18
IRA DISTRIBUTIONS
Distributions from traditional and Roth IRAs are also shown on Form 1099-R. If a distribution is from
an IRA (or a SEP or a SIMPLE IRA), an appropriate code will be entered in box 7, and the small box
to the right of box 7 will be checked.
Traditional IRAs. Distributions from traditional IRAs are usually reported on Form 1099-R as fully
taxable because the IRA trustee does not know how much, if any, of the taxpayers IRA contributions
were nondeductible. Sometimes, the Taxable amount not determined box is checked. If any nondeductible contributions had been made, the taxpayer must use Form 8606 to compute the taxable
portion of any distributions.
If the IRA distribution is fully taxable, enter the full amount on Form 1040A, line 11b. If the distribution is partly taxable, enter the gross amount on line 11a and the taxable portion on line 11b.
mExample: Mildred Zigler (69), a single taxpayer, withdrew $3,000 from her traditional IRA on
December 11, 2014. She made no contributions to her traditional IRA in 2014. Mildred has an $800
basis in her IRA from a nondeductible contribution she made in 1997 (report on Form 8606, line 2).
According to her IRA trustee statement, her IRA was worth $17,582 at the end of 2014 (report on
Form 8606, line 6). Midreds Form 8606 is shown in Illustration 10.19.
After completing Form 8606, Mildred will enter $3,000 on Form 1040A, line 11a and $2,883 on line
11b. The amount on line 14 of her Form 8606 is her remaining basis, and she will carry it to line 2
(unless the line number changes) of the next Form 8606 she files.m
Roth IRAs. Qualified distributions from Roth IRAs are exempt from tax. A qualified distribution is
one that:
Is taken after the end of the five-year period that began January 1 of the tax year for which the
account was set up.
Is made after the account owner has died, becomes disabled, or reaches age 59 or is used to buy,
build, or rebuild the taxpayers first home.
Part III of Form 8606 (on page 2, which is not shown) is used to determine the taxable amount of any
nonqualified distribution. If you need additional information, see IRS Publication 590.

Illustration 10.19
Retirement 10.35
EARLY DISTRIBUTIONS FROM QUALIFIED RETIREMENT PLANS

The Tax Code imposes an additional 10% early withdrawal penalty tax on the taxable portions of most
early distributions from qualified retirement plans and IRAs. An early distribution generally is one
made before the taxpayer has reached age 59 and is denoted by code 1 in box 7 of Form 1099-R. The
10% early withdrawal penalty is only reported on Form 1040. There are, however, several exceptions
to the penalty available. The penalty does not apply to the recovery of cost (investment) or any amount
rolled over in a timely manner. See the IRS Publication 590-A, Contributions to Individual Retirement
Arrangements (IRAs) for a full discussion of IRA rollovers.
mExample: On June 4, 2014, Nahima Meda (33) left her job and took a total distribution from her
401(k) plan. Her Form 1099-R shows a fully taxable distribution of $9,700. She did not roll over any
of the money. The early distribution is also subject to a 10% penalty tax.m
The early distribution penalty is sometimes computed in Part I of Form 5329, shown in Illustration
10.20. There are several exceptions to the penalty. If any of these apply, a code is entered on Form
5329, line 2. The penalty will not apply in the following cases.
Note: Exceptions 01 and 06 do not apply to IRAs. Exception 02 applies to IRAs and to employer
plans, but only if the taxpayer no longer works for that employer. Exceptions 07, 08, and 09 apply
only to IRAs.
01
The distribution was made to an employee who separated from service during or after the
year in which they reached age 55 (age 50 for qualified public safety employees).
02
The distribution is part of a series of substantially equal periodic payments, made at least
annually for the life of the participant (or joint lives of the participant and beneficiary) or
the life expectancy of the participant (or the joint life expectancies of the participant and
beneficiary).
03
The distribution was made due to permanent and total disability.
04
The distribution was made due to the death of the employee.
05
The distribution was made in a year that (and to the extent that) the taxpayers unreimbursed medical expenses exceed 10% (7% if taxpayer or spouse is age 65 or older) of
adjusted gross income (whether the taxpayer itemizes or not).
06
The distribution was made to an alternate payee under a qualified domestic relations order
(usually a separation agreement or divorce decree).
07
The distribution was made from an IRA in a year (and to the extent that) an unemployed
taxpayer paid health insurance premiums.
08
The distribution was made from an IRA to pay qualified higher education expenses for the
taxpayer, spouse, their child, or their grandchild (whether or not the student is the taxpayers dependent).
09
The distribution (up to $10,000 lifetime limit) was made from an IRA to pay qualified firsttime homebuyer expenses.
10
The distribution was made due to an IRS levy of the qualified plan.
11
The distribution was made to a reservist while serving on active duty for at least 180 days.
12
Other. For other exceptions, refer to the instructions for Form 5329. Also, use this code if
more than one exception applies. For additional exceptions applicable to annuities, see IRS
Publication 575 or the instructions for Form 5329.
10.36 H&R
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Further explanation on some of the exceptions may be helpful at this point.

Age 55. Observe carefully the wording of exception 01. The recipient must have separated from the
service of their employer before receiving the distribution. They need not have actually reached their
55th birthday prior to the separation, as long as they do so by the end of the year.
Medical expenses. Exception 05 does not require that the money from the distribution itself be used
to pay the medical expensessimply that the taxpayers medical expenses for the year exceed 10% of
AGI (7% if taxpayer or spouse is age 65 or older), even if the taxpayer doesnt itemize. This exception
may apply to all or part of the distribution.
mExample: Alan Trimble is 40 years old and has an AGI of $40,000, including his $5,000 early IRA
distribution. His unreimbursed medical expenses total $4,800. Alan can escape penalty on $800 using
exception 05 [$4,800 ($40,000 2 10% = $4,000) = $800].m
Unemployed taxpayers. To qualify for exception 07, the distribution must be made to a taxpayer
who has received unemployment compensation payments for 12 consecutive weeks. This exception
does not apply to any distribution made more than 60 days after the taxpayer has returned to work.
This exception only applies to IRAs.
Qualified higher education expenses, for the purpose of exception 08, has the same meaning as
for the education credits, plus room and board if the student is enrolled on at least a half-time basis.
The expenses must be paid for the taxpayer, the spouse, or the child or grandchild of the taxpayer or
spouse. The child or grandchild need not be the taxpayers dependent.
mExample: In 2014, Carmen DiGiorgio (43) took $5,000 out of his traditional IRA to pay toward his
sons college tuition. The distribution is fully taxable, but not subject to the 10% penalty. His Form
5329 is shown in Illustration 10.20.m
Qualified first-time homebuying expenses, for the purpose of exception 09, are any costs of
acquiring or constructing a principal residence for a first-time homebuyer. The term first-time homebuyer is misleading; what it really means is someone who has not owned a home during the two-year
period prior to the date of acquisition of the home to which this exception applies.
The distribution must be used to pay qualified expenses within 120 days after the date of distribution. The expenses must be paid for the taxpayer, spouse, their child or their grandchild, or parent or
grandparent.
Five-year period. A Roth IRA distribution (up to $10,000) used to pay first-time homebuying
expenses not only meets the penalty exception but is not subject to taxation at all if it was made after
the end of the five-year period beginning with January 1 of the year for which the first contribution
was made. So, for example, if you first contributed to a Roth IRA for 2009, you could take a qualified
distribution of up to $10,000 to buy your first home any time after 2013and pay no tax or penalty!
The second page of Form 5329 contains a taxpayer signature section. The taxpayer (and paid preparer, if any) needs to sign Form 5329 and complete the address on page 1 only if the form is not attached
to a tax return, but is sent to the IRS by itself. That could happen, for example, if the taxpayer does
not meet the gross income filing requirements but had an early distribution subject to the penalty.
Retirement 10.37
Illustration 10.20
X.X
10.38 H&R
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If the only penalty a taxpayer owes is the 10% penalty for an early distribution and their Form 1099R correctly shows code 1, Form 5329 need not be completed if they meet none of the exceptions. Such
taxpayers may enter the 10% penalty directly on Form 1040, line 59, and write No to the left of the
line under the heading Other Taxes, indicating that there is no Form 5329 attached.
CHAPTER SUMMARY
In this chapter, you learned how to:
Explain the features of commonly available retirement accounts and the tax benefits of contributing to these retirement accounts.
Determine if a taxpayer is eligible to contribute to a traditional or Roth IRA as well as deductible
amount of traditional IRA contributions.
Determine a taxpayers eligibility for the retirement savings contribution credit and calculate the
amount of the retirement savings contribution credit.
Determine and accurately report the taxable portion of social security or tier 1 railroad retirement
benefits.
Identify and accurately report taxable qualified retirement plan and IRA distributions.
Explain the consequences of early retirement plans and IRA distributions.
Suggested Reading
Chapter 10, Retirement Plans, Pensions, and Annuities.
Chapter 11, Social Security and Equivalent Railroad Retirement Benefits.
Retirement 10.39
Our client turned 55

Tin 2014 and took three early distributions from three different
401(k) plans
during 2014. Two of the 401(k)s are with his two former employers, and one is
with his current employer. Can the age 55 exception apply to all three distributions, or only to the two from the clients previous employers?
nswer: From the facts you have given, all three of the 401(k) distributions
are subject to the 10% early distribution penalty. In order to apply the
72(t)(2)(A)(v) age 55 penalty exception to an early distribution from a retirement plan, two conditions must be met:
1. The distribution must be made to an employee after he or she has separated
from service with the employer maintaining the plan.
2. The separation must occur during or after the calendar year in which the
employee attained age 55.
Unfortunately, many taxpayers do not understand this second condition. They
mistakenly believe that as long as they are either retired or no longer working
for a particular employer, they are free to begin taking distributions from their
former employers plan once they turn 55.
The second condition means that if the separation from service occurs before
the year the employee turned 55whether because of retirement, changing
jobs, a lay-off, etc.the age 55 exception does not apply to that employers plan.
While the distributions from your clients former employers meet the first condition, i.e., they were made after he separated from service, they do not meet
the second condition because he left those companies before the year in which
he turned 55. The distribution from your clients current employers plan clearly
does not qualify for the exception because he has not separated from service for
this employer. Thus, the three distributions are subject to the early withdrawal
penalty unless another exception applies.
Note: It is not clear why your client was able to take a 401(k) distribution from
his current employer. In general, a plan distribution is not permitted unless
an employee has reached age 59, or has left the employer, or is eligible for a
hardship distribution. Plans may allow hardship distributions for certain contingencies, but they are subject to the early distribution penalty.
11
Midterm Review
OVERVIEW
This is a self-study chapter designed to prepare you for the midterm exam. The review consists of:
A game in Compass that focuses on tax theory covering the following:
Correct and most favorable 2014 filing status.
Greatest number of personal and dependent exemptions.
Eligibility to claim the Child Tax Credit.
Determining tax liability according to the tax tables.
Miscellaneous tax topics covered in Chapters 15.
The hand-preparation of two tax returns that include tax topics covered in Chapters 15.
Form 1040EZ.
Form 1040A.
INSTRUCTIONS
During the midterm review, you should use your textbook, along with any notes you took in class.
You are also encouraged to take additional notes, as needed. You may find it helpful to have a copy of
the Tax Season 2015 Desk Card and copies of 2014 Forms 1040EZ and 1040A where they are readily
available for viewing. The Desk Card can be found in the appendix on page A.24. You can see copies
of Forms 1040EZ and 1040A in Chapter 1, beginning on page 1.12.
11.1
12
Midterm Exam
OVERVIEW
This entire session will be devoted to the midterm exam. The midterm will consist of three parts:
Part I Five questions for you to determine a taxpayers:
Eligibility to claim the Child Tax Credit.
Tax liability, using the tax tables.
Part II Ten multiple-choice questions, which may cover any material presented in Chapters 15.
Part III Two tax returns, which you must complete by hand. You will then enter specific information into the online exam.
INSTRUCTIONS
To complete the midterm exam, you should do both tax returns by hand before going to the computer.
Your instructor will give you directions about completing the returns. Once you complete the returns
to your satisfaction, go to your computer, enter Compass, and access your midterm exam.
When you access the site, Part I of the exam will appear. Answer those questions, and then you will
see Part II. After entering the answers for both Part I and Part II, Part III will appear. Use the information from the returns you just completed to enter the requested information.
The midterm is open-book, and you may also use any notes you have taken during the class. You may
find it helpful to have a copy of the Tax Season 2015 Desk Card and copies of 2014 Forms 1040EZ
and 1040A where they are readily available for viewing. The Desk Card can be found in the appendix
on page A.24. You can see copies of Forms 1040EZ and 1040A in Chapter 1, beginning on page 1.12.
12.1
13
Form 1040
OVERVIEW
In this course, you will learn about the Form 1040 and when a taxpayer is required file a Form 1040.
This course will also discuss the common items of income, adjustments, credits, and taxes reported
on the Form 1040. It is important to be aware of these common items of income, adjustments, credits,
and taxes reported on the Form 1040 so that, when you encounter them, you may properly prepare a
Form 1040 return for the taxpayer.
OBJECTIVES
At the conclusion of this course, you will be able to:
Identify when a taxpayer is required to file a Form 1040.
Compute adjusted gross income, taxable income, and tax liability on Form 1040.
Identify common types of other income reported on Form 1040.
Identify common income adjustments reported on Form 1040.
Calculate personal exemption phaseout.
Identify common tax credits reported on Form 1040.
Identify additional taxes reported on Form 1040.
TAX TERMS
Alimony payments.
Child support payments.
Health savings account (HSA).
Necessary (expenses).
Ordinary (expenses).
Adoption credit.
Special needs child.
13.1
FORM 1040
In this course, you will learn about who must file a Form 1040. Then the course will discuss the common Form 1040 items of income, adjustments, credits, and taxes so that, when you encounter them
at the tax desk, you may properly prepare a Form 1040 return for the taxpayer.
The Form 1040 is often referred to as the long form, because it is the most comprehensive of the
three forms. Its the catch-all form that reports all types of income, all types of income adjustments,
and all types of tax credits. It also computes all forms of tax to which an individual is subject to. This
means that the Form 1040 contains all items of income, income adjustments, tax credits, and tax
reported on both Form 1040EZ and Form 1040A.
Similar to the Form 1040EZ and Form 1040A, the Form 1040 computes the taxpayers income tax
liability by first taking the taxpayers total income less income adjustments to compute the adjusted
gross income (AGI) which is reported on Form 1040, line 37. Looking at Illustration 13.1, the Form
1040, page 1, shows that the taxpayers total income, line 22, is calculated by adding up lines 721.
Then the taxpayers total adjustments shown on line 36, is calculated by adding up the taxpayers
total income adjustments reported on lines 2335.
The next step is to determine the taxpayers taxable income, which is reported on Form 1040, line 43.
Taxable income is computed by taking the taxpayers AGI less their allowable standard deduction per
filing status or total itemized deductions and then subtracting the taxpayers total personal exemption
amount. In Illustration 13.2, the Form 1040, page 2, shows that the taxpayers standard deduction
or total itemized deductions is entered on line 40 and their total exemption amounts are entered on
line 42.
The next step is to calculate the taxpayers income tax based on their taxable income. This tax is
reported on Form 1040, line 44. Generally, the Tax Table is the most common way of computing tax for
taxpayers whose taxable incomes are less than $100,000. However, the Tax Computation Worksheet
is required if taxable income is $100,000 or more. There are also several other methods of computing
the tax for taxpayers with special situations. For example, if a taxpayer has long-term capital gains
reported on Form 1040, line 13, the Qualified Dividends and Capital Gain Tax Worksheet, line 44, is
used to compute their income tax on Form 1040, line 44.
Next, the nonrefundable credits reported on Form 1040, lines 4854, are used to reduce the income
tax computed on line 44. Then, additional taxes reported on Form 1040, lines 5762, are added to
compute the taxpayers total tax. Lastly, the total tax is reduced by federal income tax withheld, estimated tax payments, and refundable credits reported on Form 1040, lines 6473, to determine if the
taxpayer overpaid tax or has a tax balance due.
Tax Essentials Form 1040 13.3

Illustration 13.1

Illustration 13.2
WHO MUST FILE FORM 1040

Who is required to file a Form 1040? Generally, this would be a taxpayer who has an item of
income, income adjustment, tax credit, or additional tax not reported on Form 1040EZ or 1040A.
Unfortunately, that answer lacks substance and direction. A better answer would be the following:
A taxpayer must file Form 1040 under certain circumstances, such as:
1. Their taxable income is $100,000 or more.
2. They have certain types of income such as:
Income from self-employment (business, rental, or farm income). These taxpayers may owe
self-employment tax, as well as possibly qualify for the self-employment tax deduction and
health insurance deduction.
Certain unreported tips subject to Social Security and Medicare tax.
Income received as a partner in a partnership, shareholder in an S corporation, or a beneficiary
of an estate or trust.
Dividends on insurance policies if they exceed the total of all net premiums they paid for the
contract.
Distribution from a foreign trust.
Taxable alimony from their ex-spouse.
Taxable refunds, credits, or offsets of state and local income taxes.
Other gains or losses reported on Form 4794.
3. They can exclude certain types of income such as:
Foreign earned income they received as a U.S. citizen or resident alien.
Certain income received from sources in Puerto Rico if they were a bona fide resident of Puerto
Rico.
Certain income received from sources in American Samoa if they were a bona fide resident of
American Samoa for all of 2014.
4. They have certain income adjustments such as:
Deductible health savings account contributions.
Deductible moving expenses incurred during the year.
Penalty on early withdrawal of savings.
Deductible alimony paid to their ex-spouse.
5. They itemize deductions or claim certain tax credits or adjustments to income, or

6. They owe additional taxes such as:
Household employment taxes reported on Schedule H (Form 1040).
Excise tax on insider stock compensation from an expatriated corporation.
Social Security and Medicare tax on wages earned as an employee which their employer did not
withhold.
Additional Medicare Tax or had Additional Medicare Tax withheld and must file Form 8959.
Net Investment Income Tax and must file Form 8960.
Additional tax on IRAs, other qualified retirement plans, etc., reported on Form 5329.
7. They have an alternative minimum tax adjustment on stock they acquired from the exercise of an
incentive stock option.
8. They had a qualified health savings account funding distribution from their IRA.
9. They are a debtor in a bankruptcy case filed after October 16, 2005.
10. They must repay the first-time homebuyer credit reported on Form 5405.
11. They had foreign financial assets in 2014 and must file Form 8938.
12. They are claiming the following tax credits:
The adoption credit or you received employer-provided adoption benefits. See Form 8839 for
details.
Residential energy credits reported on Form 5695.
General business credits reported on Form 3800.
Minimum tax credit reported on Form 8801.
Note: The list above is not all inclusive and a tax situation may exist that is not listed above which
requires a taxpayer to file a Form 1040. This list is based on information provided on the IRS website,
as well as Form 1040A instructions.
FORM 1040 OTHER INCOME

When preparing a return for a taxpayer, it is important to understand and recognize the more common types of other income reported on Form 1040. These types of income may include alimony, gambling winnings, prizes and awards, jury duty, and hobby income.
Long-Term Disability Income

The taxability of long-term disability benefits depends on who paid the disability policy premiums
and whether the disability premiums were paid with pre- or after-tax dollars. Generally, if a taxpayer
retires on disability and the taxpayer paid the premiums with after-tax dollars, then the taxpayers
disability benefits received are tax-free. If a taxpayer retires on disability and the employer or taxpayer paid for the policy with pre-tax dollars, generally, the taxpayer must include in income any
disability benefits received. How the taxable disability benefit is reported on the tax return depends
upon the taxpayers age when the benefit is received:
Until the taxpayer reaches minimum retirement age, the disability pension payments are reported
as wage income (and considered earned income) on Form 1040 and Form 1040A, line 7.
Beginning on the day after the taxpayer reaches minimum retirement age, the disability pension
payments are reported as pension income on Form 1040, line 15a and 15b, or Form 1040A, lines
12a and 12b.
Reporting the disability income as wages can be a little confusing, especially since the taxpayer
receives a Form 1099-R from their employer to report the payments received. Fortunately, disability
pension income is identified with code 3 in Form 1099-R, box 7. Refer to the Form 1099-R example
in Illustration 13.3.
When determining how the taxable disability benefit is reported on
Tthe taxpayers
return, the minimum retirement age for the taxpayer is the
ax Tip:
age at which the taxpayer could have first received a pension or annuity from
the employer if they were not disabled. If the taxpayer does not know if they
have reached the minimum retirement age, please refer the taxpayer to their
employers Human Resources (HR) department (or even better, contact the HR
department while the taxpayer is with you at the tax desk) to find out for certain.
Reporting Disability Benefits

As mentioned earlier, until the taxpayer reaches minimum retirement age, taxable disability pension
payments, reported on Form 1099-R, box 2a, taxable amount, are entered as wage income on Forms
1040 and 1040A, line 7.
Note: Once the taxpayer reaches minimum retirement age, all of their disability pension income for
that year (and subsequent years) is considered and reported as pension income on Form 1040, line
15a and 15b or Form 1040A, lines 12a and 12b. There is no proration in the year the taxpayer reaches
minimum retirement age.
entering taxable disability benefits in BlockWorks,

Byou will enter theWhen
taxpayers Form 1099-R in the Pension input screen.
lockWorks Tip:
After you have entered the Form 1099-R information into the software and you
have determined that the disability benefit is considered wages, check the box
Disability income is earned income in the Special Treatments section within
the Pension input screen. See Illustration 13.4.
mExample: In 2013, William Turner (45) was injured on the job, and on January 1, 2014, his doctor
made the decision that he was permanently and totally disabled. At that point, William retired early
on long-term disability from his employer, A1 Manufacturers. William is receiving benefits under a
long-term disability plan provided by and premiums paid for by his employer. Williams Form 1099-R
is shown in Illustration 13.3.
Because Williams employer paid the disability premiums and William has not reached the minimum
retirement age, the entire $16,954 of disability benefits is taxable and reported as wages on his Form
1040, line 7. Illustration 13.4 shows a BlockWorks screen shot of Williams Form 1099-R information
entered into the software, and Williams Form 1040, page 1, is shown in Illustration 13.5.m
Unreported Tips
Ideally, a tipped employee reports all of their tip income to their employer, and the employer withholds all the required Social Security and Medicare taxes (as well as the appropriate income taxes)
on those tips. The amount of tips the employee reported is included in box 7 of their Form W-2 and is
also included in boxes 1 and 5. The box 1 amount is reported on the employees tax return.
However, sometimes an employee does not report all of their tips to their employer. Even so, tip
income that was not reported to the employer is still subject to income tax, Social Security tax, and
Medicare tax, and must be reported on the tax return.
An employee is not required to report to the employer tip income of less than $20 from any one job
during a calendar month. Such tips that were not reported are entered directly on the wages line of
the tax return. These tips are not subject to Social Security or Medicare tax, but are subject to income
tax.
Employees who have $20 or more in a month in tips from any one job are required to report their tips
to their employers by the tenth day of the following month. Properly reported tips are treated as being
paid in the month they are reported. For example, tips received in December 2013 and reported to the
employer by January 10, 2014, will be included in the employees W-2 for 2014. Tips not reported to
the employer on a timely basis must be included in income in the year received. So, tips received in
December 2013 and not reported by January 10, 2014, must be included on the employees 2013 tax
return by including the unreported tip amount on Form 1040, line 7. Employees with unreported tips
totaling $20 or more in a calendar month must also complete Form 4137 to calculate the amount of
Social Security and Medicare tax due.

X.X
Illustration 13.3
Illustration 13.4

Illustration 13.5
mExample: Julienne Markson worked as a server during the first part of 2014. Julienne thought she
had reported all of her tips to her employer, Dons Speedway Grill and Bar. However, when she began
her tax return for 2014, she discovered she had not reported two months of tips. She did not report
$255 of tips for the month of April and $18 of tips for the month of May. January through March,
she had reported $1,021 of tips to her employer. All of Juliennes unreported tips, $273, are subject
to income tax and reported on Form 1040, line 7. Because Juliennes May tips are below $20, she is
only required to pay Social Security and Medicare tax on her $255 of April unreported tips. Juliennes
Form 4137 is shown in Illustration 13.6.m
Allocated Tips
Certain dining establishments, where tipping is customary, must allocate tip income to their directlytipped employees if the employees do not report a specified minimum amount of tips to the employer.
Any amount shown in box 8 is not included in box 1, and taxes have not been withheld from it.
If a taxpayer has an amount shown in the allocated tips box, they must report that amount, in addition to the amount in box 1, as income on their return, unless they have kept sufficient records to
show they did not actually receive some or all of the money. For this reason, it is important for tipped
restaurant employees to keep accurate, timely records of tips received. If a taxpayer is required to
report any allocated tips on their return, they must also file Form 4137 in order to determine the
amount of Social Security and Medicare tax that they must pay.
Employee Treated as an Independent Contractor

Taxpayers who believe they were employees whose employers did not withhold Social Security and
Medicare tax from their wages must use Form 8919, Uncollected Social Security and Medicare Tax
on Wages, to figure and report their share of uncollected Social Security and Medicare taxes. After
calculating the Social Security and Medicare taxes on Form 8919, these taxes are carried to Form
1040, line 58.

Illustration 13.6
Alimony
Alimony is a payment made to a person pursuant to an agreement or a court decree of divorce or
separation. If a taxpayer is receiving taxable alimony, it is included in income on Form 1040, line 11.
Bartering
Bartering is the trading of one item or service for another. Generally, there is no cash exchanged.
Bartering may take place on an informal basis between individuals and businesses, or it can take
place on a third-party basis through a modern barter exchange company. Taxpayers must include
in their income, at the time received, the fair market value of property or services they receive from
bartering. If they exchange services with another person and both parties have agreed ahead of time
on the value of the services, that value will be accepted as fair market value, unless the value can be
shown to be otherwise.
Generally, income from bartering is reported on Schedule C, Profit or Loss From Business, or Schedule
C-EZ, unless something other than services is exchanged.
mExample: Sam owns an apartment building. In exchange for six months rent-free use of an apartment, an artist gave Sam a work of art she created. Sam must report the fair market value of the art
as rental income on Schedule E, Supplemental Income or Loss, and the artist must report the fair
rental value of the apartment as income on Schedule C or Schedule C-EZ.m
Gambling Winnings
The gross amount of a taxpayers gambling winnings is taxable. This includes amounts won from lotteries, casinos, races, raffles, etc. All winnings are taxable whether or not the winner received a Form
W2G. Gambling winnings, along with several types of other income, are reported on Form 1040, line
21.
Withholding of income tax from certain gambling winnings is required. If a taxpayer had tax withheld
from their winnings, they will receive a Form W-2G, which should be attached to and filed with Form
1040. The tax withheld is included on Form 1040, line 64.
mExample: James Kennedy took a chance one day and bought a $1 scratch-off lottery ticket. It was his
lucky day because he won $100,000! The IRS requires a mandatory 25% withholding on winnings that
exceed $5,000. James received a check for $75,000 and has $25,000 of withholding to report. James
Form W-2G is shown in Illustration 13.7.m
losses may not be netted out of the gross winnings.
TGamblingGambling
losses can only be deducted as an itemized deduction on Form
ax Tip:
1040, Schedule A, and only to the extent of winnings. So, if a taxpayer has gambling losses during the year and no gambling winnings, they are not eligible to
deduct their gambling losses.
t is also important to advise taxpayers who have gambling losses to be certain they maintain full and timely documentation of their wagering amounts,
dates, winnings, and losses. The IRS has been known to audit taxpayers gambling winnings and losses reported on their return. Without proper documentation, the IRS has disallowed gambling losses reported on Schedule A.

Illustration 13.7
Line 21 Income
In addition to gambling winnings, there are several other types of income that may be reported on
Form 1040, line 21. When one entry is made on line 21, the type and amount of income (for example,
Prize $45 or Jury pay $50) needs to be written directly on Form 1040. When more than one entry
needs to be made on line 21, it is necessary to include a statement showing the required information,
and only the sum of these total amounts is placed directly on line 21. Related expenses generally may
be deducted on Form 1040, Schedule A, which is not covered in this course. Form 1040, line 21, Types
of Income, include the following:
Prizes and awards for which no services were performed. Examples include cash and merchandise won in sweepstakes, in contests, and on game shows. These items may or may not be shown in
box 3 of a Form 1099-MISC, but they are taxable, nonetheless. If a prize or award is compensation
for services performed, as one may receive from an employer, the value should be included in the
wages of the recipient (unless the value of the prize is negligible).
Jury duty pay is taxable. However, if an employee is required to surrender his jury duty pay to his
employer in exchange for his regular pay, the amount surrendered may be deducted as an adjustment to income on Form 1040, line 36. Form 1040 adjustments are discussed later in the course.
Canceled debts. If a taxpayer has a debt canceled or forgiven, the amount canceled is usually
taxable income. The taxpayer may receive Form 1099-C, Cancellation of Debt, from the creditor.
If you encounter a taxpayer with canceled debt or foreclosure of property, these are complicated
topics and generally require more research and experience to accurately report on a tax return.
Please partner with a more experienced Tax Professional. For more information about this topic,
see IRS Publication 17.
Reimbursements for items (other than state and local income taxes) deducted in an earlier year,
such as medical expenses, real estate taxes, or general sales taxes.
Alaska Permanent Fund dividends, distributed to residents of Alaska by the state, are taxable
but are not treated as dividends for tax purposes.
Rental of personal property. Income from the rental of personal property, such as equipment, if
the taxpayer is not in the business of regularly renting such property. Not-for-profit rental income
is also reported on Form 1040, line 21.
Taxable distributions from a health savings account (HSA) or an Archer MSA.
Distributions from these accounts may be taxable if (a) they are more than the unreimbursed qualified medical expenses of the account holder or (b) they were not included in a qualified rollover.
The distributions may also be subject to a penalty.
Amounts deemed to be income from an HSA because the taxpayer did not remain an eligible individual during the testing period.
Medical trial income. The compensation received by taxpayers who participate in medical trials
is taxable and generally reported on Form 1040, line 21. In most cases, taxpayers who participate
in such studies will receive a Form 1099-MISC reporting the medical research compensation
received. It is a common misconception that income reported on Form 1099-MISC is automatically
self-employment income reported Schedule C or C-EZ and subject to self-employment tax. However,
in most cases, these taxpayer are not considered to be in the trade or business of participating in
medical research studies and thus their income, while taxable, is not self-employment income.
If the taxpayer is in the trade or business of participating in mediTcal research
studies or trials (in other words, if the taxpayers profession is
ax Tip:
participating in such studies), income received is considered self-employment

income reported on Schedule C or C-EZ and subject to self-employment tax. If
you encounter a taxpayer with such a situation, please partner with an experienced Tax Professional in your office to ensure the income is reported properly.
Hobby income. Gross income from a hobby is taxable. Expenses, to the extent of hobby income,
are deductible as a miscellaneous itemized deduction on Schedule A.
Hobby vs. Business Activity

It is sometimes difficult to distinguish between an activity engaged in as a business and one engaged
in as a hobby. The determining factor is usually the intent of the taxpayerthat is, is the taxpayer
engaged in an activity with the intent of making a profit? However, the IRS may rule that an activity
is a hobby if it does not make a profit in at least three out of five years.
As discussed earlier, if an activity constitutes a hobby, then income is reported on Form 1040, line 21
and expenses on Form 1040, Schedule A. If an activity constitutes a business, Schedules C or C-EZ
(Schedule F for farming) must be used to report income and expenses.
the determination of hobby vs. business is truly a case-by-case
Tdecision,While
the IRS does publish guidance to help taxpayers determine if they
ax Tip:
carry on a business or a hobby. This IRS guidance can be found in Chapter 1 of

IRS Publication 535, Business Expenses.
FORM 1040 ADJUSTMENTS

When preparing a return for a taxpayer, it is important to understand and recognize the more common types of income adjustments reported on Form 1040. These types of adjustments include certain
business expenses for reservists, performing artists, fee-basis government officials, health savings
account (HSA) deductions, moving expenses, penalty on early withdrawal of savings, alimony payments, and other write-in adjustments to income.
Certain Business Expenses of Reservists, Performing Artists, and Fee-Basis

Government Officials
Armed Forces reservists, government officials who are paid on a fee basis, and performing artists may
be entitled to deduct certain business expenses as an adjustment to income on Form 1040, line 24. A
full discussion of who may claim this adjustment can be found in H&R Blocks Advanced Employee
Business Expense course.
Health Savings Accounts (HSAs)

Health savings accounts (HSAs) are tax-advantaged savings accounts used by eligible taxpayers
to pay current and future medical expenses. From a tax standpoint, HSAs represent the best of all
worlds:
After tax contributions to HSAs are tax deductible (subject to limitations) on Form 1040, line 25.
Employers may allow employees to make pre-tax contributions to their HSAs through their cafeteria (125) plans. These contributions are not deductible on Form 1040, line 25 because the contribution was made pre-taxed.
If the employer contributes to the employees HSA, the contributions are tax-free. However, the
employers contribution reduces the total amount an employee can contribute to their HSA. HSA
contributions made through a cafeteria plan are reported on the employees Form W-2, box 12,
code W.
Other parties (such as relatives) may contribute to the taxpayers HSA on their behalf, and the
taxpayer may be eligible to deduct the contributions.
Account funds grow within the account tax-free.
Distributions are exempt from taxation, provided they are used to pay qualified medical expenses.
Eligibility
To qualify to contribute to an HSA, an individual must:
Be in a high-deductible health plan (HDHP).
Not be covered by other health insurance, including Medicare. (Accident, disability, dental, vision,
and long-term care coverage are allowed.)
Not be eligible to be claimed as a dependent on someone elses return.
For HSA purposes, an HDHP is a health insurance plan with a minimum annual deductible of $1,250
for self-only coverage, or $2,500 for family coverage, and maximum annual out-of-pocket expenses not
exceeding $6,350 for self-only coverage, or $12,700 for family coverage (for 2014).
Taxpayers who are eligible for an HSA on the first day of the last month of the tax year are considered eligible for the whole year, provided that they remain eligible during the testing period. For this
purpose, the testing period begins with the last month of the tax year and ends on the last day of the
12th month following that month.
In addition to the deductible and out-of-pocket requirements, an HDHP must not provide any benefits (other than those for preventive care) until the minimum annual deductible is met. Examples of
preventive care include:
Periodic health evaluations, such as an annual physical examination.
Routine prenatal and well-child care.
Screenings for a wide variety of ailments.
Child and adult immunizations.
Tobacco cessation programs.
Obesity weight-loss programs.
Screening services (for cancer and heart and vascular diseases; see IRS Publication 969 for a complete list).
Qualified Medical Expenses

Qualified medical expenses for HSA purposes are unreimbursed medical expenses that would normally be deductible on Schedule A. However, they do not include insurance premiums, except those for:
Long-term care (LTC) insurance.
Health care continuation coverage (such as coverage under COBRA).
Health care coverage while receiving unemployment compensation.
Medicare or other health care coverage for taxpayers age 65 or older (other than premiums for a
Medicare supplement policy).
The HSA must be established and funded before the qualified expenses are incurred.
Contribution Limits
The maximum annual HSA contribution for 2014 is $3,300 for self-only coverage or $6,550 for family
coverage. This amount must be reduced by any employer contributions made to the employees HSA,
Archer MSA, or any qualified HSA funding distributions.
Taxpayers who have reached age 55 by December 31, 2014, may make an additional catch-up contribution of up to $1,000 for 2014. For example, if the taxpayer has self-only coverage, they can contribute up to $4,300 [$3,300 self-only contribution limit + $1,000 age 55 additional contribution = $4,300].
There are no income limits or phaseout ranges with regard to HSA contributions. Taxpayers who
qualify to make HSA contributions may make them up to the due date of their return. This mean that
a taxpayer has until April 15th, 2015 to make an after-tax contributions to their HSA and deduct the
contribution on their 2014 Form 1040, line 25.
mExample: Betty Sloan (40) is single and self-employed. She purchases her own self-only HDHP
insurance plan. She may, by April 15, 2015, establish an HSA and contribute $3,300 for 2014, and her
entire contribution is deductible on her 2014 Form 1040, line 25.m
Form 8889
Form 8889, shown in Illustrations 13.813.9, is used to compute the taxpayers allowable HSA contribution and deduction, as well as the taxable amount of any HSA distributions. If the taxpayer is filing
a joint return and each spouse has an HSA, each spouse must file a separate Form 8889.
Some of the possibilities regarding HSAs can get a bit complex, especially if a family has more than
one HSA or more than one HDHP. In this course, we will keep it simple. The basic instructions are
summarized below. The IRS also provides in the Form 8889 instructions a flowchart and worksheets
to assist taxpayers with Form 8889.
Line 1. If the taxpayer was covered by a self-only plan and a family plan during the year, check the
box for the plan that was in effect for a longer period. If, at any time, the taxpayer was covered simultaneously by a self-only plan and a family plan, they are treated as having family coverage during
that period.

Illustration 13.8

Illustration 13.9
Line 2. HSA contributions for 2014. Do not include employer contributions, pre-tax contributions
made through a cafeteria plan, or amounts rolled over from another HSA or Archer MSA.
Line 3. Enter $3,300 ($6,550 for family coverage) if the taxpayer (a) was under age 55 at the end of
2014 and (b) was enrolled in an HDHP with the same coverage on the first day of every month during
2014. Otherwise, you will need to use the IRS instructions.
Line 4. Enter any contributions to the taxpayers (and/or spouses) Archer MSA. Employer contributions, including pre-tax contributions made through a cafeteria plan, are shown on Form W-2, box 12,
with code R.
Lines 6 and 7 reflect complications into which we shall not delve.
Line 9. Enter any employer contributions to the taxpayers HSA, shown on Forms W-2, box 12, with
code W.
Line 10. Enter any qualified HSA funding distribution. This is a trustee-to-trustee transfer from an
IRA (not a SEP or a SIMPLE IRA).
Line 13. Enter the smaller of line 2 or line 12 here and on Form 1040, line 25. This is the HSA deduction.
Excess Contributions
Taxpayer who make excess contributions (i.e., contribute too much during the year) to their HSA may
be subject to a 6% penalty, plus earnings. This penalty also applies to taxpayers who are ineligible to
contribute to an HSA but do so anyway.
Taxpayers may avoid this 6% penalty by taking a distribution of the excess contribution amount plus
earnings before the due date of the return (including extensions). However, generally the distribution
of earnings is still subject to the 6% penalty.
mExample: Kimberly Thiele (67) is a single employee who was enrolled in a self-only HDHP for all of
2014. On February 18, 2014, she established an HSA for 2014 and contributed $3,300. Unfortunately,
Kimberly was also enrolled in Medicare the entire year, making her ineligible to contribute to an HSA.
Assuming Kimberly does not file an extension for her return, she must withdraw the contribution
plus earnings by April 15, 2015, to avoid a 6% excess contribution penalty. However, the earnings are
subject to the 6% penalty.m
Distributions
Distributions may be taken from an HSA at any time to pay for qualified medical expenses:
There are no age requirements.
Funds do not have to remain in the account for any period of time.
There is no risk of forfeiting the money, as there is with a flexible spending arrangement (cafeteria
plan).
There are no required minimum distributions.
HSAdistributions are reported on Form 1099-SA, which is shown in Illustration 13.10. The HSAdistributions reported on Form 1099-SA are then reported in Part IIof Form 8889. Distributions may be
used to pay qualified expenses for the owner, the spouse, and any dependents claimed on the taxpayers current-year return and are not subject to income tax. This is true even if these individuals are
not covered under the HDHP and cannot make current-year contributions to an HSA.
HSAdistributions not used for qualified medical expenses are taxable income to the taxpayer, and
the HSA taxable distributions are determined in Part II of Form 8889. HSA taxable distributions are
then entered on Form 1040, line 21, and labeled HSA.
Nonqualified Distributions Penalty
If HSA funds are used for any other purpose than to pay qualifying medical expenses, they are subject to tax and a 20% penalty. The penalty is waived if the account owner is age 65 or older, becomes
disabled, or dies.
Rollovers
A rollover is a tax-free distribution of assets from one tax-advantaged plan to another. Generally,
the transaction must be completed within 60 days after receipt of the distribution. HSA owners may
make only one rollover contribution to an HSA during any one-year period. However, if the account
owner instructs the trustee to transfer funds directly to the trustee of another HSA, the transfer is
not considered a rollover. There is no limit on the number of these transfers.
Qualified Distributions to HSAs
Taxpayers may be able to make qualified distributions from their health flexible spending arrangement or health reimbursement arrangement to their HSAs. Testing period requirements apply.
Taxpayers can make qualified HSA funding distributions from their individual retirement arrangement. Testing period requirements apply. Although these distributions are not included in income,
nor are they deductible, they do reduce the amount that taxpayers can contribute to their HSA.

Illustration 13.10
Penalty on Early Withdrawal of Savings

A taxpayer will receive a Form 1099-INT when they receive interest on an account from a financial
institution. Recall also that box 2 of Form 1099-INT may show an amount if money in a time-savings
instrument is withdrawn before maturity.
This early withdrawal penalty is deductible as an adjustment to income on Form 1040, line 30. Both
Forms 1099-INT and 1099-OID may show early withdrawal penalties. Total all of these amounts and
enter them on Form 1040, line 30.
Alimony
Alimony is a payment made to a person pursuant to an agreement or court decree of divorce or separation. Payment of taxable alimony is deducted by the payer as an adjustment to income on Form
1040, line 31a. The recipients Social Security number is reported on line 31b.
If alimony is deductible by the person who pays it, it is taxable income to the person who receives it
and reported on their Form 1040, line 11. The rules governing whether alimony is deductible by the
payer and taxable to the recipient depend on when the divorce or separation instrument (arrangement) was established or revised. The rules discussed here apply to divorce and separation instruments established after 1984. If you ever need to know the rules for divorce and separation instruments established prior to 1985, see IRS Publication 504, Divorced or Separated Individuals.
Deductible alimony or separate maintenance is any payment that is:

Paid in cash (checks and money orders qualify as cash).
Paid under a decree of divorce or separation while the parties are living apart or under a written
separation agreement.
Not specified to be not taxable and not deductible.
To cease upon the death of the recipient.
Payments That Are Not Alimony
Child support, property settlements, voluntary payments not specified in the agreement, and payments not arising from the marital relationship (for example, a bona fide loan from one spouse to the
other spouse) are examples of items that are not alimony. They are not deductible by the payer or
taxable to the recipient.
Alimony vs. Child Support
Payments that are specifically designated in the divorce or separation instrument as child support are
not alimony. Note that amounts not specifically designated as child support will nonetheless be treated as child support if such payments are reduced or eliminated upon the occurrence of a contingency
relating to the child or at a time that is clearly associated with such a contingency.
mExample: Ted Stevens divorce decree states he will pay his ex-wife $400 per month until their son
reaches age 21. Although the divorce decree does not specifically state that the $400 per month is child
support, it will be treated as child support because the payments will cease upon the contingency of
the sons 21st birthday.m
When the divorce decree does not set a specific amount for child support and no child-related contingencies are involved, the entire payment is alimony.
mExample: John and Martha Feinberg are divorced. Martha has custody of the couples two children.
Their divorce decree states only that John will pay Martha $1,200 per month until her death or remarriage. Because the decree does not stipulate a specific amount as child support and no child-related
contingencies are involved, the entire amount is considered alimony.m
When both alimony and child support payments are required to be paid during the year, child support
is always considered to be paid first.
mExample: Bill Drayton is required to make payments of $800 per month until the death or remarriage of his former spouse. The divorce decree designates $600 of this amount as alimony and $200 as
child support. Bill sends only $8,000 in total payments for 2014. Because the first $2,400 paid during
the year [$200 2 12 months] is considered to be child support, Bills alimony deduction is $5,600
[$8,000 $2,400].m
Special Rules Regarding Alimony and Separate Maintenance Payments

There are a number of situations for which you may wish to do additional research, if necessary, such
as:
Alimony payments that decrease by more than $15,000 during the first three years.
Payments made to third parties for expenses of former spouses.
Treatment of separate maintenance payments in community property states.
You can find more information in IRS Publication 17 or Publication 504 if you encounter any of these
situations.
Moving Expenses
Taxpayers who move within one year of starting a new job may be eligible to deduct their moving
expenses as an adjustment to income. The taxpayers moving expense deduction is first reported on
Form 3903, Moving Expenses, before it is reported on Form 1040, line 26.
To claim a deduction for moving expenses, the taxpayer must meet three main requirements:
Distance.
Work time.
Move occurred within one year of the start of work.
Distance Requirement
The distance between the new job location and old residence must be 50 miles farther than the distance between the old job location and old residence. The distance test must be satisfied by all taxpayers other than members of the armed forces who move pursuant to a permanent change of duty
station.
mExample: Danielle Terra, a single taxpayer, works five miles from her residence. She is considering
looking for a new job in another city. In order to deduct moving expenses, her new job location must
be at least 55 miles [50 miles + 5 miles distance between old job and old residence] from her old residence.m
The distance test is measured using the shortest, most commonly-traveled route. A taxpayer who was
not previously employed or who obtains a full-time job after a substantial period of unemployment can
satisfy the distance requirement if the new job location is at least 50 miles from the old residence. The
job location is the place where the taxpayer works most of the time. If the taxpayer has no primary
job location, the job location is the general area where the business activities are centered.
Work Time Requirement

An employee must work full-time in the general vicinity of the new job location for at least 39 weeks
during the 12 months following the move. Temporary layoffs because the work is seasonal or because
of strikes and absences due to illness or vacations are counted as work time. For seasonal work to
count, the off-season period must be less than six months, and the employees work contract must
cover the off-season. The 39 weeks requirement does not need to be completed within one tax year.
If the taxpayer expects to meet the work time test, the deduction is claimed for the year the move
occurred. The 39 weeks of full-time work do not have to be consecutive or with the same employer as
long as the jobs are in the same general location and are classified as full-time work.
mExample: Danielle Terra, from the preceding example, took a new job in another city 59 miles from
her old residence. She moved to the new city on November 1, 2014, and began work on November 3.
Danielle must work full-time in the general area of this new city for at least 39 weeks during the period of November 2014 through October 2015. If she expects to meet this requirement, she may deduct
her moving expenses on her 2014 tax return.m
For self-employed persons, they must complete their work time requirement on a full-time basis for
78 weeks during the 24 months immediately following the move. At least 39 of these weeks must be
within the first 12 months of the move. An employee who becomes self-employed before satisfying the
39-week test must meet the 78-week test to claim moving expenses. A self-employed individual who
becomes an employee before satisfying the 78-week test may use the time spent as an employee to
meet the 78-week test.
There are exceptions to meeting the work time test. If a person dies, becomes disabled, or is involuntarily separated from work (for reasons other than willful misconduct), the work time test is waived.
It is also waived if an employer asks the employee to transfer locations before the end of the 39 weeks,
assuming the employee could reasonably have met the 39-week test had the employer not requested
the employee transfer. Military personnel whose move is due to a permanent change of duty station
and taxpayers who return to the United States because of retirement or who are the survivors of a
person who died while living and working outside the United States are not required to meet the work
time requirement.
Married Couples
Moving expenses of a married couple can be claimed if either spouse separately meets the distance
and work time requirements, but their individual distance to work or duration of full-time work cannot be combined to meet the tests to deduct qualified moving expenses.
Closely Related in Time to Start of Work
In addition to the distance and work time requirements, moving expenses must be incurred close to
the commencement of work, and they must be reasonable. In general, only expenses incurred no later
than one year after beginning the new job are deductible. Moving expenses incurred later than one
year are deductible only if the taxpayer can show that circumstances prevented an earlier move.
mExample: Danielle Terra, from the preceding example, started her new job on November 3, 2014,
but decided to commute the 59 miles each day rather than moving right away. If she later decides to
move to the new city, she will have to incur her moving expenses before November 3, 2015, in order
to deduct them.m
Closely Related in Place to Start of Work

Even if the distance requirement is met, if the distance from the old residence to the new job location
is shorter than the distance from the new residence to the new job location, the move is not considered
as closely related in place to the start of work. In that case, moving expenses are not deductible unless
either of the following are true:
The taxpayer is required to live at the new locality as a condition of employment.
Living at the new place of residence decreases commuting time or expense.
mExample: Suppose this time that Danielle, now living in her old city and working in a new city,
decides to move to a third city before November 3, 2014. The move increases her commute to the new
city from 59 miles to 62 miles. Although the distance and work time requirements have been met,
such a move is not closely related in place to the start of her new job because her commute is now
longer than if she had not moved. The move is not deductible (unless one of the conditions listed above
applies).m
Deductible Moving Expenses
Deductible expenses include the actual cost of moving:
Household goods.
Personal possessions.
Vehicles.
Pets.
This includes expenditures for:
Connecting or disconnecting utilities in order to move appliances, household goods, or personal
effects.
Packing and crating.
Insurance for the transported goods.
In-transit storage and insurance for any 30 consecutive days after the day such goods are moved
from the former residence and before delivery to the new residence.
In addition, the reasonable cost of travel and lodging, but not meals, for all family members during
the actual move may be deducted. This includes expenses for lodging in the old location prior to
departure that are incurred within one day after the furnishings are moved out of the old residence
and lodging expenses incurred on the day of arrival at the new location.
If the taxpayer travels by public transportation, the actual cost may be deducted. If the taxpayer
drives from the old to the new home, they may deduct either the actual cost of gas and oil used
during the trip or the standard mileage rate, 23.5 per mile (generally, whichever is larger).
In either case, the cost of tolls and parking may be added. Depending upon the price of gasoline
and the cars mileage, actual expenses for gas and oil may result in a larger deduction than the
mileage rate for moving.
If a taxpayer later discovers they are ineligible to deduct moving expenses claimed on their income
tax return, they must amend the return or reflect the moving expenses as income in the year the
taxpayer discovers the ineligibility.
mExample: Danielle Terra, from the preceding example, started her new job on November 3, 2014,
which is in another city 647 miles from her residence. Danielle used to live 23 miles from her old job.
She moved to the new city on November 7, 2014, and her work will reimburse her $1,500 for moving
expenses. Danielle incurred $1,800 to move her household goods and personal effects and $169 for
gasoline and oil to drive her personal car 647 miles to her new residence. Danielle is allowed a $469
deduction for her move [$1,800 + $169 = $1,969 total moving expense $1,500 reimbursement for
work = $469]. Note that Danielle deducted her actual gasoline and oil expense because it was greater than her standard mileage rate $152.05 [647 miles 2 23.5]. Danielles Form 3903 is shown in
Illustration 13.11.m
Form 3903
Examine the Form 3903 in Illustration 13.11. Line 1 is for entering the expenses of storing and moving household goods and personal items. Enter only those amounts actually paid by the taxpayer
(including any amounts the employer provided) rather than amounts the employer paid directly to
the movers. Line 2 is for travel and lodging expenses of the move. Line 3 is for totaling lines 1 and 2.
If the taxpayers employer paid for part or all of the move and did not include the payment as part of
taxable compensation in box 1 of Form W-2, enter the employer-paid expenses on Form 3903, line 4.
The amount to be entered on line 4 should be shown in box 12 of Form W2, with the code letter P.
Next, compare the amounts on lines 3 and 4. If total expenses on line 3 are more than the employer
provided, subtract line 4 from line 3 and enter the result on line 5. This is the taxpayers deductible
moving expense. Carry it to Form 1040, line 26.
In the event the employer paid more than the move actually cost, making line 4 larger than line 3,
the excess is taxable income to the employee and must be added to the amount on Form 1040, line 7.
If the taxpayers employer included moving expense reimbursement in the taxpayers income (rather
than as a code P item in box 12 of their W-2), the taxpayer may elect to deduct the expenses in the
year of reimbursement, even if they paid the expenses in a different year.
Student Loan Interest Deduction

In 2014, a taxpayer may deduct up to $2,500 (per return) of qualified student loan interest paid as an
adjustment to income on Form 1040, line 33 (or Form 1040A, line 18). For the loan interest to qualify
for the deduction, the proceeds of the loan must have been used exclusively to pay qualified higher
education expenses at an eligible educational institution for an eligible student.

Illustration 13.11
A qualified student loan is a loan taken out by the taxpayer solely to pay qualified education expenses
that were:
For the taxpayer, the taxpayers spouse, or a person who was the taxpayers dependent when the
taxpayer took out the loan.
Paid or incurred within a reasonable period of time before or after the taxpayer took out the loan.
For education provided during an academic period for an eligible student.
Loans from a related person or a qualified employer plan are not qualified student loans.
The taxpayers dependent may be either a qualifying child or a qualifying relative. Also, for the purposes of the student loan interest deduction, the following exceptions apply to the general rules for
dependents:
An individual may be the taxpayers dependent even if that taxpayer is a dependent of another
taxpayer.
An individual may be the taxpayers dependent even if that individual files a joint return with a
spouse.
An individual may be a taxpayers dependent even if that individual had gross income that was
equal to or more than their exemption amount for the year ($3,950 for 2014).
An eligible student is a student who was enrolled at least half-time in a program leading to a degree,
certificate, or other recognized educational credential.
For the purposes of the student loan interest deduction, qualified education expenses are the total cost
of attending an eligible educational institution, including graduate school. They include amounts paid
for the following:
Tuition and fees.
Room and board.
Books, supplies, and equipment.
Other necessary expenses (such as transportation).
The cost of room and board qualifies only to the extent that it is not more than the greater of the
following:
The allowance for room and board, as determined by the eligible educational institution, that was
included in the cost of attendance for a particular academic period and living arrangement of the
student.
The actual amount charged if the student is residing in housing owned or operated by the eligible
educational institution.
An eligible educational institution is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the U.S.
Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately-owned, profit-making) post-secondary institutions.
When determining the student loan interest deduction, the taxpayer is required to reduce their total
qualified education expenses by the amount the tax-free funds are used to pay qualified education
expenses during the time the taxpayer was in school. These tax-free funds include the following:
Employer-provided educational assistance.
Tax-free distribution of earnings from a Coverdell Education Savings Account (ESA).
Tax-free distribution of earnings from a qualified tuition program (QTP).
U.S. savings bond interest that were excluded from income because it is used to pay qualified education expenses.
The tax-free part of scholarships and fellowships.
Veterans educational assistance.
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational
assistance.
Form 1098-E
Generally, lending institutions that issue student loans will report the student loan interest paid
during the year on Form 1098-E, Student Loan Interest Statement, or a similar statement. These
lending institutions are required to send Form 1098-E, or a similar statement, by January 31 to borrowers who paid student loan interest of $600 or more. A Form 1098-E is shown in Illustration 13.12.
Who Can Claim the Student Loan Interest Deduction

For a taxpayer to claim the student loan interest deduction, the following four requirements must be
met:
The taxpayers filing status is any filing status except married filing separately.
The taxpayer cannot be claimed as a dependent on another taxpayers return.
The taxpayer must be legally obligated to pay interest on a qualified student loan.
The taxpayer paid interest on a qualified student loan.
When determining the amount of deductible interest, the taxpayer is only to deduct the amount of
interest paid during the current tax year. If another taxpayer makes payments on behalf of the taxpayer who is legally obligated to make the interest payments, the taxpayer is treated as receiving the
interest payments from the other taxpayer and, in turn, paying the interest themselves.
Computing the Student Loan Interest Deduction

This deduction is also limited based on the taxpayers modified AGI (MAGI). For this purpose, MAGI
consists of adjusted gross income without regard to any student loan interest deduction. Also, any
tuition and fees deduction must be added back to regular AGI.
Married couples filing jointly with modified AGIs greater than $130,000, but less than $160,000, must
reduce the deduction by the following fraction:
Interest Paid* 2 (Modified AGI $130,000)
$30,000
For all other taxpayers (except MFS) with modified AGIs exceeding $65,000, but less than $80,000,
reduce the deduction by the following fraction:
Interest Paid* 2 (Modified AGI $65,000)
$15,000
* Limited to the maximum allowable deduction ($2,500).
The IRS Student Loan Interest Deduction WorksheetLine 18, in Illustration 13.13, will assist you
in computing the allowable deduction. This worksheet is located in IRS Form 1040A instructions on
page 32. For this course, you will also use the BlockWorks Student Loan Interest Deduction Worksheet,
shown in Illustration 13.14.
mExample: Helen D. Jenkins, a single taxpayer, paid $2,850 qualified student loan interest in 2014.
Her Form 1098-E is shown in Illustration 13.12. Her total income for the year is $68,940, and she
is deducting a $1,000 IRA contribution. Helen is not taking the educator expense or tuition and fees
deduction on her return, so Helens modified AGI equals $67,940 [$68,940 $1,000 = $67,940]. Helens
student loan interest deduction will be limited because her modified AGI exceeds $65,000. Helen
is required to reduce her student loan interest deduction by $490 [$2,500 2 ($67,940 $65,000) =
$7,350,000 3 $15,000 = $490]. Helens 2014 student loan interest deduction is $2,010 [$2,500 $490
= $2,010], and she will report her deduction on Form 1040, line 33 (or Form 1040A, line 18). Helens
IRS Student Loan Interest Deduction WorksheetLine 18 is shown in Illustration 13.13, and her
BlockWorks Student Loan Interest Deduction Worksheet is shown in Illustration 13.14.m
Illustration 13.12

Illustration 13.13
Illustration 13.14
When preparing a BlockWorks return for a taxpayer with

Bstudent loan interest
reported on Form 1098-E, you will enter the full
lockWorks Tip:
amount of the taxpayers student loan interest, paid in the current year, on
line 33 of the Form 1040 page 1 input pane, and BlockWorks will calculate a
Student Loan Interest Deduction Worksheet for the taxpayer. A screen shot of
the BlockWorks Form 1040 Pg1 input screen is shown in Illustration 13.15.
Illustration 13.15
Other Form 1040 Adjustments to Income

There are other adjustments to income for which there are no corresponding lines on the Form 1040.
These are write-in adjustments. This means that if you encounter one of these types of adjustments,
you must indicate the adjustment by writing its shorthand identifier on the dotted line to the left of
line 36.
Many of these write-in adjustments are not discussed in this course. However, we will list them in
case you happen to encounter them when reviewing a tax return. These adjustments are:
The deductible contribution to an Archer MSA (Form 8853), identified by the letters MSA.
The repayment of jury duty pay to your employer because your employer paid your salary while
you served jury duty, identified by the phrase Jury Duty Pay.
The deductible expenses related to income reported on line 21 from the rental of personal property
engaged in for profit, identified by the letters PPR.
The deductible amortization and expenses for reforestation, identified by the letters RFST.
The repayment of supplemental unemployment benefits under the Trade Act of 1974, identified by
the phrase Sub-Pay TRA.
The deductible contributions to a 501(c)(18)(D) pension plan, identified by 501(c)(18)(D).
The deductible contributions by certain chaplains to 403(b) plans, identified by 403(b).
The deductible attorney fees and court costs for actions settled or decided involving certain unlawful discrimination claims, but only to the extent of gross income from such actions, identified by
the letters UDC.
The deductible attorney fees and court costs paid by you in connection with an award from the
IRS for information you provided that contributed to the detection of tax law violations, up to the
amount of the award includible in your gross income, identified by the letters WBF.
For more information on these other adjustments to income, see IRSForm 1040 instructions.
PERSONAL EXEMPTION PHASEOUT

Personal Exemption Phaseout
For tax years beginning after 2012, the Personal Exemption Phaseout (PEP) has been reinstated by
the American Taxpayer Refund Act of 2012 (ATRA). This means that the PEP will reduce taxpayers personal exemption by 2% for every $2,500 ($1,250 MFS) that exceeds AGI thresholds per filing
status. The exemption deduction begins to phase out when the taxpayers AGI exceeds the following
amounts:
$305,050 Married filing jointly and qualifying widow(er).
$254,200 Single.
For taxpayers whos AGI exceeds the PEP threshold amount, use the Deductions for Exemptions
Worksheet Line 42 Worksheet (Illustration 13.16) to determine their reduced exemption amount.

Illustration 13.16
FORM 1040 CREDITS

When preparing a return for a taxpayer, it is important to understand and recognize the more common types of tax credits reported on Form 1040. These types of tax credits include the Adoption
Credit, First-time Homebuyer Credit, Residential Energy Efficient Property Credit, Nonbusiness
Energy Property Credit, Foreign Tax Credit, Mortgage Interest Credit, General Business Credit, and
Credit for Prior-Year Minimum Tax.
Adoption Credit
In 2014, taxpayers who adopt a child may qualify for a nonrefundable credit for adoption expenses
of up to $13,190 per eligible child. Also, some companies have adoption assistance programs, and
amounts employees receive from their employers for qualified adoption expenses under such programs are generally not taxable up to the same $13,190. How do we know if a taxpayer received
adoption assistance payments from their employer? The amount of adoption assistance is shown on
Form W-2, box 12, with the code letter T.
If you need more information about the adoption credit and exclusion, you should obtain a copy of IRS
instructions for Form 8839, Qualified Adoption Expenses. You can review the form in Illustrations
13.17 and 13.18.
When to Claim the Credit
If the taxpayer adopts a U.S. citizen or resident, they generally will claim the credit in the year following the year in which they paid the expenses. This is true even if the adoption is never finalized.
However, if the adoption becomes final during or before the year in which the taxpayer paid the
expenses, they will claim the credit in the year the expenses were paid.
mExample: Mike and Judy Wisner paid $4,000 of qualified adoption expenses in 2014. Their adoption
became final on January 20, 2014. They will claim their adoption credit on their 2014 tax return. You
can see their Form 8839 in Illustration 13.17.m
mExample: John and Mary Beyers paid $3,000 of qualified adoption expenses in 2014 and $1,000 of
qualified expenses in 2015. If their adoption became final in 2015, they will claim their adoption credit
based on $4,000 of expenses on their 2015 tax return.
If their adoption is never finalized (assuming the child is a U.S. citizen or resident), their 2014 credit
will be based only on the $3,000 of expenses they paid in 2014. They may also claim a credit on their
2015 return based on the $1,000 of expenses they paid in 2015.m
Child not a U.S. citizen or resident. If the taxpayer adopts a child who is not a U.S. citizen or resident, they may claim the credit (or exclude the employers assistance) only for the year the adoption
becomes final.
mExample: Jim and Sally Williams are adopting a Korean child. They incurred $3,000 of qualified
adoption expenses during 2013 and $1,000 of qualified expenses during 2014. Their adoption became
final on March 3, 2014. They may claim their credit, based on their 2013 and 2014 expenses, on their
2014 tax return. Note, however, that if their adoption had fallen through, they would have no credit.
(A similar couple attempting to adopt a U.S. citizen or resident, whose attempt failed, would claim the
2013 expenses on their 2014 return and the 2014 expenses on their 2015 return.)m
Qualified Expenses
Expenses qualifying for the adoption credit or exclusion are reasonable and necessary expenses for
adoption fees, court costs, attorney fees, travel expenses (including meals and lodging), and other
expenses directly related to, and necessary for, the adoption.
Expenses that do not qualify for the credit or exclusion include those that violate state or federal law,
those associated with surrogate parenting expenses, costs of adopting a spouses child, expenses paid
with funds received from any government program, and amounts allowed as a credit or deduction
under any other federal income tax rule.
Eligible Child
An eligible child for purposes of the adoption credit or exclusion must be under age 18 or physically
or mentally incapable of self-care.
A special needs child is a child who the state has determined should not be returned to the parents
home and who probably will not be adopted unless special assistance is provided to the adopting
family. A special needs child must be a U.S. citizen or resident; a foreign child cannot be treated as a
special needs child.

Illustration 13.17

Illustration 13.18
A credit equal to the maximum amount of creditable expenses is allowed for the adoption of each
special needs child, regardless of the actual amount of qualified expenses incurred by the adoptive
parent(s). Thus, a full $13,190 credit is allowed for the adoption of each special needs child that
becomes final in 2014.
mExample: In the process of adopting a special needs child, Lilith Walker paid $1,000 qualified
expenses in 2013 and $800 in 2014. The adoption became final in 2014. Despite the fact that her
qualified expenses total only $1,800, Lilith may claim a $13,190 adoption credit on her 2014 return.m
Credit Phaseout
The amount of the adoption credit begins to phase out when taxpayers MAGI exceeding $197,880 and
is fully phased out when modified AGI reaches $237,880. Modified AGI, for purposes of the adoption
credit, is regular AGI plus certain excludible income from foreign sources and U.S. possessions. The
adoption credit is nonrefundable.
First-Time Homebuyer Credit

There have been various changes to this credit since it was first introduced. The credit expired in
2011. Depending on when the credit was taken, it may or may not have to be repaid.
Repayment
For homes purchased in 2008, the credit is similar to a no-interest loan and must be repaid in 15
equal, annual installments beginning with the 2010 income tax year. If the home ceases to be the
taxpayers main home before the 15-year period is up, they must include all remaining annual installments as additional tax on the return for the tax year the home ceases to be owned by the taxpayer.
This includes situations in which they sell the home or convert it to business or rental property. There
are exceptions for divorce, involuntary conversion, and death.
For homes purchased in 2009 or 2010, the credit does not have to be paid back unless the home ceased
to be the taxpayers main residence within a three-year period following the purchase. Any required
repayment is included in full (i.e., not paid in installments) as an additional tax on the return in the
year the home is no longer the taxpayers main residence.
The credit repayment is computed on the Form 5405, Repayment of the First-Time Homebuyer Credit,
shown in Illustration 13.19. The taxpayer is only required to submit this form to the IRS in the event
there was a disposition or change of use of the home. In this course, we will focus on the repayment
of the credit when there is no disposition or change of use of the home.
mExample: Illustration 13.20 shows the BlockWorks worksheet completed to compute the repayment
for Mary Bateman who purchased her home on May 5, 2008, for $252,750. Mary had not owned a
home prior to this purchase. She claimed the maximum credit available at the time of $7,500. She
began repayment in 2010 and has repaid $2,000.m

Illustration 13.19

Illustration 13.20
Residential Energy Efficient Property Credit

Taxpayers may be able to take a credit of 30% of their costs of qualified solar electric power, solar
water heating property, small wind energy property, geothermal heat pump property, and fuel cell
property. This includes labor costs properly allocable to the on-site preparation, assembly, or original
installation of the property and for piping or wiring to interconnect such property in the home. The
credit amount for costs paid for qualified fuel cell property is limited to $500 for each one-half kilowatt
of capacity of the property.
The credit is calculated on Form 5695, Residential Energy Credits. Part I is used for this credit.
If a home is jointly occupied, each occupant must complete their own Form 5695. Each energy credit
discussed above has different rules for joint occupancy. Therefore, refer to Form 5695 and the instructions that accompany it.
Nonbusiness Energy Property Credit

The Nonbusiness Energy Property Credit applies to improvements such as adding insulation, energyefficient exterior windows and doors, and energy-efficient heating and air conditioning systems. Many
clients believe the credit applies to other energy-efficient appliances, such as washing machines and
dryers. However, it does not.
The credit is calculated on Form 5695, Residential Energy Credits. Part II is used for this credit.
The credit is 10% of the cost of all qualifying improvements, and the maximum credit is $500 for
improvements placed in service in 2014. There is a lifetime limit of $500 for all years after 2005. Of
this $500, only $200 can be for windows; $50 for any advanced main circulating fan; $150 for any
qualified natural gas, propane, or oil furnace or hot water boiler; and $300 for any item of energyefficient building property.
Due to the lifetime limit, if the total of nonbusiness energy property
Tcredits taken
in previous years (after 2005) exceeds $500, the credit cannot
ax Tip:
be taken in 2014.
mExample: In 2014, John Roberts purchased a new gas furnace that cost $1,000, and replaced several
windows for a cost of $3,000. All items were qualifying property installed in his main residence. He
qualifies for a credit of $350 ($200 for the windows and $150 for the furnace).m
To qualify for the credit, the property must be installed in the clients home. A home is where the
taxpayer lived in 2014 and can include a house, houseboat, mobile home, cooperative apartment,
condominium, and a manufactured home that conforms to Federal Manufactured Home Construction
and Safety standards. The home must be located in the United States. The basis of the home must
be reduced for any credit used.
For property placed in service after February 17, 2009, the property must be specifically and primarily
designed to reduce the heat loss or gain of the taxpayers home when installed and must also meet
the prescriptive criteria established by the International Energy Conservation Code (IECC) in effect
on February 17, 2009. However, if the taxpayer purchased property before June 1, 2009, they can still
take the credit if they relied on the manufacturers certification issued before February 18, 2009, that
the property met the standards in effect before February 18, 2009.
Foreign Tax Credit

The purpose of Form 1116, Foreign Tax Credit, is to claim a credit for taxes paid or accrued to certain
foreign countries or U.S. possessions. This form is introduced so that you are aware of it. We introduce
the conditions that must be met which allow taxpayers to claim the credit without filing Form 1116.
The election is only available if the taxpayer meets all of the following conditions:
All of the taxpayers foreign-source gross income was passive category income (which includes
most interest and dividends).
Foreign tax paid is less than $300 ($600 MFJ).
All of the income and any foreign taxes paid on it were reported to the taxpayer on a qualified payee
statement. Qualified payee statements include:
Form 1099-DIV.
Form 1099-INT.
Schedule K-1 (Form 1041).
Schedule K-1 (Form 1065).
Schedule K-1 (Form 1065-B).
Schedule K-1 (Form 1120S).
If the election is available, the credit appears on Form 1040, line 48. Otherwise, Form 1116 must be
completed.
Mortgage Interest Credit

This credit is available to taxpayers only if they were issued a qualified Mortgage Credit Certificate
(MCC) by a state or local government unit or agency under a qualified mortgage credit certificate
program. Certificates issued by the Federal Housing Administration, Department of Veterans Affairs,
Farmers Home Administration, and Homestead Staff Exemption Certificates do not qualify for the
credit.
The home must be the main residence of the taxpayer and must also be located in the jurisdiction of
the government unit that issued the certificate. If the interest on the mortgage is paid to a related person, the taxpayer cannot claim the credit. The credit is taken on Form 8396, Mortgage Interest Credit.
General Business Credit

Form 3800, General Business Credit, is filed by taxpayers to claim any of the numerous general business credits. A list of these credits can be found on the Form 3800. Lines 1a through 1zz in Part III
on page 3 detail the numerous credits allowed for the current year and reported on Form 3800, line
32. Then, the line 32 amount is reported on Form 1040, line 53. For those interested in more information, see the instructions for Form 3800 and IRS Publication 334, Tax Guide for Small Business (For
Individuals Who Use Schedule C or C-EZ).
Credit for Prior-Year Minimum Tax

Form 8801, Credit for Prior-Year Minimum Tax, is used by individuals (also used by estates and
trusts) to figure the current-year nonrefundable credit, if any, for Alternative Minimum Tax (AMT)
a taxpayer incurred in prior tax years; to figure the current-year refundable credit, if any, for any
unused credit carryforward from 2013; and to figure any credit carrying forward to 2015.
The taxpayer should file 2014 Form 8801 if they had:
An AMT liability and adjustments or preferences other than exclusion items.
A carryforward to 2015 (shown on the 2014 Form 8801, line 28).
An unallowed qualified electric vehicle credit.
For those interested in more information, research this credit on the IRS website.
FORM 1040 TAXES

When preparing a return for a taxpayer, it is important to understand and recognize other types of
taxes reported on Form 1040. These types of taxes include the Net Investment Income Tax (NIIT),
Additional Medicare Tax, Household Employment Tax and Excess Social Security or Tier 1 Railroad
Retirement Tax.
Net Investment Income Tax (NIIT)

In 2014, taxpayers with unearned income may be subject to a 3.8% Net Investment Income Tax (NIIT)
if they have net investment income and their modified adjusted gross income (MAGI) exceeds the
following amounts:
Filing Status
MAGI Amount
MFJ and QW
$250,000
S and HOH
200,000
MFS
125,000
Taxpayers with MAGI in excess of the threshold are subject to the 3.8% tax on the lesser of the following:
Net investment income.
The amount of MAGI in excess of the threshold amount.
Taxpayers who are subject to NIIT will first compute the tax on Form 8960 which is then carried to
Form 1040, line 62.
Types of Income Subject to the 3.8% NIIT
Generally, investment income includes, but is not limited to, interest, dividends, annuities, royalties,
passive activity income, and net gains attributed to disposition of property not part of a passive trade
or business.
These net gains include sale of stocks, bonds, mutual funds, investment real estate, sales of passive
interests in partnerships and S corporations, and gains recognized from sales of personal residence in
excess of the $250,000 exclusion ($500,000 MFJ).
It is important to note that income from distributions from qualified plans, IRAs, employee annuities,
pensions, profit-sharing, stock bonus plans, and self-employment income are not subject to NIIT.
Additional Medicare Tax

Taxpayer with wages, compensation, or self-employment income that exceeds the following threshold
amounts based on their filing status are subject to 0.9 percent Additional Medicare Tax:
Filing Status
Income Amount
MFJ
$250,000
MFS
$125,000
$200,000
HOH
$200,000
QW w/ dependent child
$200,000
Employers are required to withhold the Additional Medicare Tax from wages paid to an employee
in excess of $200,000 regardless of the employees filing status. Taxpayers who work two jobs or
have self-employment income in addition to W-2 wages may need to adjust estimated tax payments
or request additional income tax withheld on their Form W4, Employees Withholding Allowance
Certificate, to ensure they pay the correct Medicare tax owed and avoid penalties and interest.
Please be aware that Railroad Retirement Tax Act (RRTA) compensation, tips, and noncash fringe
benefits are subject to this tax. Also, there are no special rules for nonresident aliens and U.S. citizens
living abroad.
Taxpayers will first calculate their Additional Medicare Tax liability on Form 8959 which is then
reported on Form 1040, line 62.
Household Employment Tax

A household employee is an individual who performs nonbusiness services in a taxpayers home. Such
services include child care (hence the informal name nanny tax) as well as cleaning, cooking, yard
maintenance, etc. Individuals who employ such employees may report and pay the payroll taxes on
their individual income tax returns. Payroll taxes include social security tax, Medicare tax, and federal unemployment tax.
Taxpayers who employ household workers must pay social security and Medicare tax for most household employees to whom they pay cash wages of $1,900 or more during the year. They must pay
federal unemployment tax for household employees if they pay cash wages totaling $1,000 or more
to all household employees during any calendar quarter of the tax year or the previous tax year. The
taxpayer is not required to withhold income tax but may do so if the employee requests withholding
and the taxpayer agrees.
The above rules generally do not apply to employees under age 18, the taxpayers child under age 21,
the taxpayers spouse, or the taxpayers parent.
Schedule H is used to compute the tax to be entered on Form 1040, line 60a. An employer identification number (EIN) must be obtained by all household employers. It may be obtained by filing Form
SS-4. This is an awareness-level explanation.
Excess Social Security or Tier 1 Railroad Retirement Tax

If a taxpayer has more than one employer in a calendar year, the taxpayer may have excess Social
Security withheld. Generally, excess withholding will occur when a taxpayers total wages are greater
than $117,000 (for 2014) from all employment for the year. In short, a taxpayer maintains more than
one job during the year, earning over $117,000 in total wages, and they do not inform their employers
of this information. The employers, unaware that their employee will make more than $117,000 in
wages, withholds and remits Social Security tax or Tier 1 Railroad Retirement Tax Act (RRTA) tax
on wages the taxpayer earns. The taxpayer then has Social Security tax or Tier 1 RRTA tax greater
than $7,254 and generally is entitled to claim the excess as a credit against your income tax on Form
1040, line 71.
Most employers must withhold Social Security tax from the taxpayers wages. For railroad employees,
their employer must withhold Tier 1 Railroad Retirement Tax Act (RRTA) tax. Tier 1 RRTA provides
equivalent social security and Medicare benefits.
Joint Returns. If a taxpayer is filing a joint return with their spouse, both the taxpayer and spouse
must figure any excess Social Security tax or Tier 1 RRTA tax separately.
Employers Error. If one employer withheld more than $7,254 in Social Security or Tier 1 RRTA tax,
the taxpayer cannot claim the excess as a credit on Form 1040, line 71. Instead, their employer should
make an adjustment of the excess for the employee. If the employer does not make an adjustment, the
taxpayer may use Form 843, Claim for Refund and Request for Abatement, to claim a refund.
For details, including how to compute the amount of excess credit, refer to Publication 505, Tax
Withholding and Estimated Tax. Also, see the Form 843 Instructions.
CHAPTER SUMMARY
In this chapter, you learned to:
Identify when a taxpayer is required to file a Form 1040.
Compute adjusted gross income, taxable income, and tax liability on Form 1040.
Identify common types of other income reported on Form 1040.
Identify common income adjustments reported on Form 1040.
Calculate personal exemption phaseout.
Identity common tax credits reported on Form 1040.
Identity additional taxes reported on Form 1040.
14
Itemized Deductions I
OVERVIEW
This self-study chapter covers how the Tax Code allows certain personal expenses to be deducted from
gross income. Some of the expenses taxpayers may deduct depend on their adjusted gross income. In
other words, before taxpayers will see any tax benefits from these types of deductions, they will have
to cross a threshold amount. The dollar amount of the threshold is different for every taxpayer, but the
percentages (2%, 7%, and 10%) of AGI are the same. It is not uncommon for a taxpayer to have several thousand dollars of one type of expense, but see no tax benefit from it. Other types of deductions
may be deducted regardless of AGI. This chapter is devoted to a discussion of deductions for medical
expenses, taxes paid, interest paid, and charitable contributions.
OBJECTIVES
Determine when it is advantageous for a taxpayer to itemize deductions.
Calculate medical and dental expenses and enter them on Schedule A.
Determine deductible taxes and enter them on Schedule A.
Calculate deductible interest expenses and enter them on Schedule A.
Determine deductible charitable contributions and enter them on Schedule A.
TAX TERMS
Acquisition debt.
General sales tax.
Itemized deductions.
Medicare Part A and Part B.
Personal property tax.
Points.
Prepaid interest.
Qualified charitable organization.
14.1
ITEMIZING VS. STANDARD DEDUCTIONS

Every taxpayer must decide whether or not to itemize deductions. Generally, taxpayers choose to
deduct the larger of their total itemized deductions or their standard deduction.
ax Tip: Bear in mind that there are two things to consider when deciding
whether to itemize or use the standard deduction. If the itemized deductions do not exceed the standard deduction, one may decide to just use the
standard deduction. First, if using a paid preparer, the cost of itemizing over
the standard deduction may outweigh the tax advantage of itemizing. Second,
returns with a Schedule A are more likely to be audited than a return with the
standard deduction.
When married taxpayers choose to use the married filing separately status and one spouse itemizes
deductions, the standard deduction of the other spouse is $0. Such a taxpayer, while not required to
itemize, benefits from doing sounless the taxpayer has nothing to deduct, which almost never happens. After all, even a small amount of deduction is better than none.
In certain states and under certain circumstances, it may be advantageous for some taxpayers to
itemize deductions on the federal return, even if their federal itemized deductions total less than their
standard deductions. The reason? Itemizing on their federal returns allows them to itemize on their
state returns, thus saving overall tax dollars. Such taxpayers should mark the box on Schedule A, line
30. Your instructor will tell you if this is a consideration in your state.
Schedule A in Illustration 14.1 is completed for taxpayers who itemize deductions. This schedule
contains the following sections:
Medical and Dental Expenses.
Taxes You Paid.
Interest You Paid.
Gifts to Charity.
Casualty and Theft Losses.
Job Expenses and Certain Miscellaneous Deductions.
Other Miscellaneous Deductions.
In this chapter and the next, you will study each section in the order they appear on the Schedule A.
Tax Essentials Itemized Deductions I 14.3

Illustration 14.1
MEDICAL AND DENTAL EXPENSES

Deductible medical expenses include payments made for the diagnosis, cure, mitigation, treatment, or
prevention of disease; for transportation related to medical care; and for insurance covering medical
care for the taxpayer, spouse, and dependents.
Medical expenses are deductible in the year paid regardless of when the services are provided. If
expenses are charged to a credit card, they are considered to be paid on the date charged.
Medical expenses paid by a taxpayer for his spouse are deductible if they were married at the time the
expenses were incurred or at the time the expenses were paid. To be able to deduct medical expenses
paid for a dependent, the individual generally must have been a dependent at the time the expenses
were incurred or at the time they were paid. However, medical expenses paid for an individual who
the taxpayer could claim as a dependent, except that he failed the gross income or joint return test,
are deductible.
A taxpayer may also deduct medical expenses paid by himself for a dependent he is claiming under a
multiple support agreement. The persons who waive the exemption may not deduct medical expenses
paid for the dependent.
If divorced or separated parents who lived apart during the last six months of the year supported
a child together, each parent, whether custodial or noncustodial, is allowed to deduct the medical
expenses actually paid for the child during the year. The deduction may be taken even if the other
parent is allowed to claim the exemption for the child.
Medicine and Drugs

Unreimbursed expenses for prescription drugs and insulin are deductible. Expenses for nonprescription medicines and vitamin and mineral supplements are not deductible. However, certain over-thecounter drugs may be paid for using tax-free dollars. See Cafeteria Plans on page 14.9.
Medical Insurance Premiums

Premiums paid for medical insurance are deductible if they provide for reimbursement for hospitalization, surgical fees, other medical or dental expenses, prescription drugs, or lost or damaged contact
lenses.
The portion of payroll tax allocated to pay for Medicare, Part A, is not deductible. A taxpayer who is
not covered under the social security program and who is not a government employee paying medicare
tax may deduct the premiums voluntarily paid for Medicare, Part A, coverage.
Medicare, Part B, premiums (the premiums paid or withheld from social security benefits for supplemental medicare coverage) are deductible as a medical expense. Medicare, Part D, prescription
premiums are also deductible.
Long-Term Care Insurance

For 2014, premiums paid for qualified long-term care insurance are deductible as a medical expense
up to these amounts:
$370 (age 40 and younger).
$700 (ages 41 through 50).
$1,400 (ages 51 through 60).
$3,720 (ages 61 through 70).
$4,660 (age 71 and older).
A long-term care contract is an insurance contract that provides only coverage for long-term care services. The contract must be guaranteed renewable, have no cash surrender value, and generally must
not cover expenses that would be covered under medicare. Lastly, it must provide that refunds and
dividends under the contract must be used to reduce future premiums or increase future benefits. This
last requirement does not apply to refunds on the death of the insured or surrender or cancellation
of the contract.
Long-term care services are services prescribed by licensed health care practitioners for chronically ill
individuals. These services must be:
Necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, and rehabilitative
services.
Maintenance or personal care services.
Ineligible Insurance
Premiums paid for the following types of insurance policies are not deductible:
Policies covering loss of earnings while injured.
Policies covering loss of life, limb, or sight.
Policies paying a guaranteed amount for each day (or week) for a given period of time while the
taxpayer is hospitalized for sickness or injury. However, if the policy also provides for medical care
and the amounts for each are stated separately, the portion of the premium allocable to medical
care is deductible.
Policies paying for medical care from a portion of automobile insurance premiums.
Medical and Dental Expenses

Deductible medical expenses include most fees paid to medical doctors, dentists, psychologists, psychiatrists, chiropractors, and Christian Science practitioners. Most fees paid for hospital services,
therapy, nursing services, laboratory tests, and payments for acupuncture treatments are deductible.
Stop-Smoking Programs
The cost of a smoking cessation program is deductible as a medical expense. The deduction may
include the cost of treatment and prescription drugs designed to alleviate the effects of nicotine withdrawal. Costs for nicotine gum and patches not requiring prescriptions are not deductible.
Weight-Loss Programs and Surgery
The government and the health care profession recognize obesity as a disease in and of itself. If a
physician has diagnosed a taxpayer as being obese, the cost of a weight-loss program or weight-loss
surgery is deductible as a medical expense.
A deduction is also allowed in cases where the weight-loss program or surgery is used to treat other
diagnosed diseases, such as arthritis, diabetes, high cholesterol, or hypertension (high blood pressure). However, the cost of such a weight-loss program undertaken for general health purposes or
without a doctors diagnosis of obesity is not deductible. In no case is the cost of diet food deductible.
mExample: Sandy, Roxanne, and Alice joined a well-known national weight-loss program that sells
portion-controlled packaged food to its members. Sandy had been diagnosed as obese by her physician.
Roxannes doctor told her that losing weight would help her lower her high blood pressure. Alice is
not obese and does not suffer from any weight-related health problemsshe just wants to lose a few
pounds.
Both Sandy and Roxanne may deduct the cost of the weight-loss program; Alice may not. None of
them may deduct the cost of the food.
After this attempt at weight loss failed, Sandy had obesity surgery at the recommendation of her
doctor. She may deduct the medical expenses connected with the surgery.m
Cosmetic Surgery
While most legal medical services are deductible, the cost of cosmetic surgery (face lifts and the like)
generally is not. Cosmetic surgery is any procedure directed at improving appearance and does not
meaningfully promote the proper function of the body or prevent illness or disease.
There is an exception to the nondeductibility of expenses for cosmetic surgery. If the surgery or procedure is necessary to correct or improve a deformity arising from a congenital abnormality, an accident
or other trauma, or a disfiguring disease, the cost is deductible.
Medical Aid Items and Equipment

The costs of medical aid items and equipment, such as bandages, blood glucose meters, eyeglasses,
contact lenses, hearing aids, prosthetic devices, crutches, and wheelchairs are deductible. The cost of
related supplies, batteries, cleaning, and maintenance of medical items and equipment is deductible.
The cost of purchasing and maintaining a service animal to assist individuals with any kind of physical disability is deductible. The most common example of a service animal is a seeing-eye dog.
Costs to purchase and maintain TTY/TDD (telecommunications devices for the deaf) equipment,
which allows hearing-impaired persons to communicate by text over the telephone, are deductible.
Costs to purchase Braille books and magazines for the blind are deductible to the extent they exceed
the costs of the same printed materials.
mExample: Steve Henderson, a hearing-impaired individual, purchased a TDD unit for $500. He also
purchased some Braille books for his dependent daughter, who is blind. The books cost $350, but the
same printed books would cost $190. Steven may deduct $660 for these items [$500 + ($350 $190)].m
Capital Expenditures
The cost of special equipment and structural improvements installed in a residence for medical purposes is deductible as a medical expense. If the taxpayer rents the residence, these costs are deductible in full. If the taxpayer owns the residence, the part of the cost that exceeds any increase in the
value of the property is deductible.
mExample: On a doctors advice, a taxpayer who owns his home installs central air conditioning to
alleviate his sons severe allergies. The unit cost $5,000 but increased the value of the home by $5,300.
The cost of installation is not deductible because it did not exceed the increase in property value.m
The cost of operating and maintaining special equipment and structural improvements is deductible
for as long as there is a medical purpose for its use. Therefore, although the cost of the air conditioner
in the example above is not deductible, the increase in utility bills from running the air conditioner
and maintenance costs are deductible as long as the taxpayers son remains his dependent and resides
in his home.
The IRS has ruled that the following capital expenditures undertaken to remove structural barriers
for handicapped individuals will not increase the value of the residence and hence are fully deductible:
Constructing exit or entrance ramps.
Widening hallways and doorways, including entrances and exits to the home.
Installing lifts, but generally not elevators.
Installing railings, support bars, and other modifications in bathrooms.
Lowering counters and cabinets.
Adjusting electrical outlets and fixtures.
Modifying fire alarms, smoke detectors, and other warning systems.
Modifying stairs.
Adding handrails or grab bars, whether or not in bathrooms.
Modifying hardware on doors.
Modifying areas in front of entrance and exit doorways.
Grading of ground to ease access to the residence.
Transportation
Deductible transportation expenses incurred in connection with medical care include fares for buses,
taxis, planes, trains, and ambulance hire. Taxpayers using their own cars for medical transportation
may deduct out-of-pocket expenses for gas and oil. In lieu of actual gas and oil expenses, a standard
mileage rate may be used. For 2014, the rate is 23.5 per mile.
Regardless of which method is used to calculate medical transportation, add to the deduction any
medically related parking fees and tolls paid. The transportation expenses of a parent who must take
a child to receive medical care or for a nurse who must travel with a patient to get medical care are
deductible. Transportation expenses for regular visits to see a mentally ill dependent are deductible
if the visits are recommended as a part of the treatment.
Meals and Lodging

If a person is in a hospital, nursing home, or similar institution primarily for medical care, the cost of
the meals and lodging the institution provides is a deductible medical expense.
The cost of non-hospital lodging while away from home primarily for medical care provided by a physician in a licensed hospital or in a medical facility that is related to or equivalent to a licensed hospital
is deductible. The deduction is limited to $50 per night per person. Meals are not deductible.
Lodging expenses for a person accompanying the patient are deductible if the patients expenses are
deductible and the patient is unable to travel alone. No deduction is allowed for either the patient or
the companion if the accommodations are lavish or there is a significant element of pleasure involved.
mExample: Janice Rawlins accompanied her ten-year-old dependent daughter, Rachel, to Rochester,
Minnesota, for some medical tests Rachel needed to undergo at the Mayo Clinic. While in Rochester,
Janice and Rachel stayed for three nights at a motel near the clinic while the tests were conducted.
They spent $90 per night for the motel and a total of $130 for meals. Janice may deduct $270 [$90 2
3 nights] for lodging because the mother and daughter have separate $50-per-night limits. Janice may
not deduct the $130 for meals.m
Special Care
Payments for special care necessitated by a physical or mental handicap or disorder are deductible
medical expenses. Such special care includes care furnished by a special school for the physically or
mentally handicapped, advance payments to an institution for lifetime care, treatment and training
of a mentally or physically handicapped dependent, and tutoring provided for an individual who has
severe learning disabilities caused by mental or physical impairments. Alleviating the handicap or
disorder must be the primary reason for obtaining this special care in order for its cost to be deductible.
Wages paid to individuals who provide nursing care, including meals provided and payroll taxes paid
on their behalf, may be deducted as a medical expense. The care need not be provided by a nurse, but
the services must be of a kind generally performed by a nurse. These include caring for the patients
medical condition, administering medications, and assistance with bathing, grooming, and the like.
Certain expenses of handicapped individuals to assist them in their employment are deductible on
line 28 of Schedule A.
Cafeteria Plans
Some employers allow employees to defer some of their earnings before tax into a flexible spending account (FSA). Funds from the FSA may be used to pay medical expenses after they have been
incurred. These plans also may allow employees to pay for their medical or dental insurance with pretax dollars. These plans are often referred to as cafeteria plans (or 125 plans, referring to the section
of the Internal Revenue Code that defines them) because the employee can choose from a menu of
available benefits, usually before taxable wages are computed.
No deduction may be taken for any medical expense that is paid for with pre-tax money. The logic is
simple: You cannot deduct from taxable income something that was never included in the first place.
Non-prescription drugs and medicines, although non-deductible, may qualify for reimbursement
under a 125 plan if they were prescribed by a doctor and used to treat a specifically diagnosed disease
or condition.
mExample: Lisa Curcio had her employer deposit $10 of her salary per week into her 125 plan. Lisa
is under the care of a doctor to treat her arthritis. Her medical expenses for the year include $300 for
four doctor visits and $220 for over-the-counter pain relievers recommended by her doctor. Lisa may
receive reimbursement from her 125 plan to cover the cost of the doctor visits and the pain relievers.
If she did not have the 125 plan, she could deduct the doctor bills but not the cost of the pain relievers.m
Reimbursement for Medical Expenses

Medical expenses that are reimbursed by an insurance plan or paid with pre-tax money from a 125
plan are not deductible. Expenses that are paid directly by insurance are not entered on the return.
Reduce total medical expenses by any reimbursements received (or expected to be received) before
entering the net amount on Schedule A. Any reimbursement received in excess of an actual expense
must be used to reduce other medical expenses.
Excess Reimbursements
If a taxpayer receives reimbursement in excess of medical expenses from an insurance policy for which
he paid the entire premium, the excess reimbursement is not taxable. The section titled, How Do
You Treat Reimbursements? in Chapter 21 of IRS Publication 17 explains the taxability of excess
reimbursements if the employer paid a portion of the insurance premium.
DETERMINING THE MEDICAL AND DENTAL EXPENSE DEDUCTION

To complete the Medical and Dental Expenses section of Schedule A, first enter total deductible medical expenses on line 1. Medical and dental expenses are deductible to the extent they exceed 10%
(7% if either the taxpayer or their spouse is age 65 or older) of the taxpayers adjusted gross income
(AGI). This limit is computed on lines 2 and 3. Enter AGI (Form 1040, line 38) on line 2, multiply this
amount by the respective percentage, and enter the result on line 3. Subtract line 3 from line 1, and
enter the difference on line 4. This is the deductible portion of the taxpayers medical expenses. If line
3 is more than line 1, enter zero on line 4.
TAXES YOU PAID

In general, taxes that fall into the following categories are deductible:
State and local taxes (income or general sales).
Real property taxes (state, local, and foreign).
Personal property taxes (state and local).
Foreign income taxes.
To be deductible, these taxes must be imposed on, and paid by, the taxpayer. Taxes are generally
deducted the year they are paid. Most taxes are deductible only on Schedule A. However, the taxes
incurred in the operation of a business or farm or in producing rental or royalty income must be
deducted from that income. These types of income and related deductions are introduced in later
chapters.
State and Local Taxes

For 2014, taxpayers have the option of deducting either (1) state and local income taxes paid during
the year or (2) state and local general sales taxes paid during the year, but not both.
Income Taxes
Deductible income taxes include all of the following:
State and local income taxes withheld from income (normally shown on Forms W-2 and 1099).
Mandatory employee contributions to the Alaska, New Jersey, or Pennsylvania Unemployment
Compensation Fund; California, New Jersey, or New York Nonoccupational Disability Benefit
Fund; Rhode Island Temporary Disability Benefit Fund; or Washington State Supplemental
Workmens Compensation Fund.
Payments of state and local estimated taxes, including any portion of a prior-year refund the taxpayer chose to have credited to their 2014 state or local income taxes.
Any balances paid on prior years state and local returns.
When considering the amount of state and local income taxes to deduct on Schedule A, be careful to
include only payments made during the tax year, regardless of the year to which the payments apply.
Sales Taxes
Instead of state and local income taxes paid, individual taxpayers may choose to deduct state and
local general sales taxes. Sales taxes paid on items used in a trade or business may not be deducted
on Schedule A, but are included as part of the cost of the items. Such costs generally are deducted as
current expenses or depreciated over a period of time. You learn more about these expenses later in
this course.
A general sales tax is a sales tax imposed on retail sales of a broad range of items at a single rate.
However, sales taxes imposed at different rates may also be fully or partially deductible, as explained
below.
Certain economically depressed areas impose sales taxes at rates lower than the general sales tax
rate. Also, some areas tax food, clothing, medical supplies, or motor vehicles at reduced rates. If
sales tax was imposed at a rate less than the general sales tax rate, the actual amount of tax paid is
deductible.
Sales taxes on items (generally motor vehicles) that are imposed at rates higher than the general sales
tax rate are deductible only up to the amount of tax that would have been imposed on an item of the
same cost taxed at the general rate. For this purpose, motor vehicles include cars, trucks, vans, SUVs,
recreational vehicles, motor homes, motorcycles, and off-road vehicles. Also include any state and local
general sales taxes paid for a leased motor vehicle.
In order to deduct the actual amount of sales tax paid, the taxpayer must keep receipts supporting
his deduction amount. However, many taxpayers do not bother saving all those receipts. Instead,
Schedule A filers may use the amount found in the Optional State and Certain Local Sales Tax Tables
provided in 2014 Instructions for Schedule A (Form 1040). These tables are based on the taxpayers
state of residence, total available income (defined below), and number of personal and dependent
exemptions claimed. The tables are included in the appendix to your text. An excerpt is shown in
Illustration 14.3.
If married taxpayers file separately and both spouses choose to deduct state and local sales taxes
instead of income taxes, both spouses must use the same method to compute their sales tax deductions. Thus, if one spouse uses the optional sales tax tables, the other spouse also must use the tables.
When figuring general sales tax, total available income is adjusted gross income plus any nontaxable
income, including the following:
Tax-exempt interest.
Veterans benefits.
Nontaxable combat pay.
Workers compensation.
Nontaxable unemployment compensation.
Nontaxable portion of social security and railroad retirement benefits.
Nontaxable portions of IRA, pension, or annuity distributions (but not including amounts rolled
over).
Public assistance payments.

Illustration 14.2

Illustration 14.3
mExample: Russell Kimball lived in Arizona the entire year for 2014. He is single and claims one
exemption. His adjusted gross income is $46,000. In addition, he received $3,820 tax-exempt interest
and $1,850 nontaxable social security benefits. Thus, his total available income is $51,670. His state
sales tax deduction from the Arizona table is $594. See Illustration 14.2.m
In addition to the amount found in the table, taxpayers may add any local general sales taxes plus
the actual amount of state and local sales taxes paid (limited to the general sales tax rate) on certain
specified items. These items include motor vehicles, any aircraft, boats, homes (including mobile and
manufactured homes), and home-building materials.
A worksheet for computing the state and local general sales tax deduction is included in 2014
Instructions for Schedules A and shown in Illustration 14.2. As is our usual practice, round line 5 to
four places instead of the recommended three.
mExample: Russell Kimball, from the preceding example, lived in Scottsdale (Maricopa County) in
2014. The state of Arizona imposes a general sales tax at 6.0137%, and the city of Scottsdale and
Maricopa County imposes an additional 2.35% general sales tax. All items are taxed at the same
general sales tax rate. The only special item he purchased in 2014 was a used boat, costing $4,900,
on which he paid $410 sales tax. Russells state and local general sales tax worksheet is shown in
Illustration 14.2.m
If the taxpayer lived in more than one state during the year, you must prorate the amounts from the
table for each state, based on the number of days lived in each state. Also, prorate any local sales taxes
based on the number of days resided in each locality. See the instructions for Schedule A for more
information if you encounter this situation.
Caution: The decision of whether to deduct state and local general sales taxes instead of state and
local income taxes can get a bit more complex than simply deciding which option gives the greater
Schedule A deduction in the current year. More details will be discussed when we discuss recoveries
in the next chapter.
Real Estate Taxes

Real estate taxes are state, local, or foreign taxes levied on real property for the general public welfare. They usually do not include local assessments for improvements that increase the value of the
assessed property. However, any portion of a local assessment specifically allocated to repairs, maintenance, or related interest is deductible.
Real estate tax paid into an escrow account (sometimes called an impound account) is deductible in
the year the tax is paid from the account to the taxing authority, as opposed to the year the money is
paid into the account. Usually, the account trustee sends the owner a statement of taxes paid during
the year.
The taxes imposed on real estate sold must be apportioned between the buyer and the seller. The
seller may deduct the taxes from the beginning of the year up to (but not including) the date of sale.
The buyer may deduct the taxes from the date of purchase to the end of the year. This proration is
usually shown on the closing statement.
Personal Property Taxes

A personal property tax is similar to a real estate tax, except that it is imposed on personal property.
Examples of personal property are clothing, jewelry, cameras, and automobiles. The most common
personal property tax is the tax certain states impose annually on the value of automobiles and other
vehicles registered in the state.
To be deductible, personal property tax must be based on the value of the property and imposed on an
annual basis, even if collected more (or less) frequently. A tax meeting these requirements is deductible even if it is labeled as a fee. If only a portion of the fee meets these requirements, that portion is
deductible.
mExample: Your state imposes an annual registration fee on motor vehicles. The fee is equal to $25
plus 2% of the assessed value of the vehicle and $1 for every 100 pounds of the vehicles weight.
Your registration fee for 2014 is $175 [$25 + ($6,000 value 2 2%) + (3,000 pounds 3 100 2 $1) =
$175]. You may deduct $120 of the fee as personal property tax [$6,000 value 2 2% = $120]. The
remaining $55 is not deductible because it is not based on the value of the vehicle.m
Foreign Taxes
You may include on Schedule A, line 8, any income taxes paid to a foreign country or U.S. possession.
These taxes may be claimed either as an itemized deduction or as a credit. A full discussion of the
foreign tax credit, which is generally more favorable than this deduction, can be found in the instructions for Form 1040, line 48.
Nondeductible Taxes
Federal taxes, including the taxpayers federal income taxes, social security and medicare taxes,
excise taxes, customs duties, and gift taxes, are not deductible on Schedule A. State and local taxes
that are not deductible on Schedule A include inheritance taxes, gift taxes, taxes on utilities, gasoline,
tobacco, and alcohol, and taxes that are fines or fees for services.
Federal estate taxes attributable to taxable income received in respect of a decedent may be deductible as a miscellaneous expense. We discuss such deductions later in the next chapter.
INTEREST YOU PAID

There are several kinds of loans on which taxpayers may pay interest. Among them are personal
loans, business loans, loans to purchase investments, and home mortgage loans.
Interest paid on personal loans, such as car loans, credit card finance charges, and installment
plans, is not deductible at all. Interest on business loans is deductible from business income on
the appropriate schedule. You will learn how to deduct business-related interest in Tax Essentials,
Self-Employment. Qualified home mortgage interest and investment loan interest are deductible on
Schedule A. Both are described below. For either of these types of interest to be deductible, the taxpayer must be legally liable for repayment of the loan.
Qualified Home Mortgage Interest

Most interest paid on home mortgages is fully deductible, but there are exceptions. It is important
to distinguish qualified home mortgage interest from personal interest because the former is usually
deductible, while personal interest is not deductible.
Home mortgage interest (interest on debt secured by a principal residence or second residence) must
be categorized as interest on acquisition debt or interest on home equity debt. Acquisition debt is debt
incurred to buy, build, or improve the home. Home equity debt is debt incurred for any purpose other
than buying, building, or improving the home and is secured by the taxpayers qualified home.
Interest on acquisition debt is fully deductible as long as the debt does not exceed $1 million ($500,000
MFS) at any time during the tax year. Interest on home equity debt is fully deductible, as long as
the debt does not exceed $100,000 ($50,000 MFS) at any time during the tax year, or the difference
between the fair market value of the home and the remaining acquisition debt, whichever is less.
mExample: In 2008, Mary Mahoney purchased her principal residence for $500,000. In 2012, when
she owed $400,000 on the original mortgage, she borrowed $60,000 secured by the home and used the
proceeds to build a sunroom and install an indoor pool. By 2014, the home was worth $700,000, so
Mary borrowed $130,000 secured by the home and bought a sailboat. On her 2014 return, Mary may
deduct, as qualified home mortgage interest, the interest she pays on:
The $400,000 left on the original mortgage (acquisition debt).
The $60,000 sunroom/pool loan (acquisition debt).
$100,000 of the sailboat debt (home equity debt).
The remaining $30,000 of the sailboat debt generates personal non-deductible interest.m
mExample: Jack Michaels purchased his home for $80,000. His debt remaining on his original mortgage used to acquire the house is $70,000. The 2011 fair market value of the house is $95,000. Jack
used a home equity line of credit in 2010 to borrow $15,000 to purchase a new car. All of the interest
paid in 2014 on the original mortgage (acquisition debt) and on the $15,000 car loan (home equity
debt) are deductible as qualified home mortgage interest.m
Under the mortgage interest rules, all debt incurred before October 14, 1987, and secured by a main
or second residence is treated as acquisition debt. Such debt is not subject to the $1 million cap, but
it does reduce the $1 million and $100,000 limits if any additional debt is incurred on the residence
after October 13, 1987.
mExample: Mabel Warrens principal residence is worth $3.2 million. In 2014, she had $2 million
outstanding debt on the residence, all incurred prior to October 14, 1987. For 2014, she may deduct in
full the interest she pays on the $2 million debt. If she now borrows any more money, even for a home
improvement, the interest is nondeductible personal interest because she has already surpassed the
$1 million acquisition debt limit and the $100,000 home equity debt limit.m
Recall that the interest paid on home equity debt is deductible up to the lesser of the following:
$100,000.
The difference between the fair market value (FMV) of the home and the remaining acquisition
debt.
Consider the following example.
mExample: Joe Matthews purchased his home in 2008 for $155,000, incurring $147,250 acquisition
debt (his original mortgage). In January 2014, he took out a home equity loan to consolidate his other
debts at a lower interest rate. The lender, the Cash Market, allowed him to borrow up to 110% of
the fair market value of his home. His remaining mortgage principal at the time was $138,600, and
the fair market value of his home was $165,000 [$165,000 2 110% = $181,500 limit]. Joe borrowed
$42,900, the maximum amount allowed [$181,500 limit $138,600 existing mortgage = $42,900].
In 2014, the interest Joe paid on his home equity loan is not fully deductible. Why? Because the home
equity debt limit has been exceeded. The difference between the FMV of the home and the remaining
acquisition debt is $26,400 [$165,000 $138,600 = $26,400], which is less than $100,000. Joe borrowed $42,900; therefore, the interest on $16,500 [$42,900 $26,400 = $16,500] of his home equity
debt is not deductible.m
The computation of such mortgage interest limitations can get rather involved, requiring multiple
worksheets. We do not ask you to complete the worksheets, but it is important to be aware of the
deduction limitations, because these types of home equity loans are rather popular. If you encounter
a similar situation, you may wish to consult IRS Publication 936, Home Mortgage Interest Deduction.
ax tip: In recent years, many mortgage lenders have made special offers
allowing taxpayers to take out home equity loans or lines of credit exceeding the fair market values of their homes. They follow these offers with the
caveat, The interest is usually tax-deductible. Ask your tax advisor. How would
you advise a homeowner in this situation?
Prepaid Interest
Interest paid in advance (for a period extending beyond the current tax year) generally is deductible
in the tax years to which the payments apply. The taxpayer may deduct in each year only the interest
for that year.
Points
Points (also called loan origination fees, maximum loan charges, or loan discounts) are mortgage
interest paid up front, when the mortgage is granted. One point equals 1% of the mortgage loan
amount.
To be deductible as mortgage interest, points must be paid solely for the use of money. Fees paid to
cover services, such as the lenders appraisal fee, notary fees, or the preparation of the mortgage note,
are not deductible.
Because points represent interest paid in advance, they generally must be deducted over the life of the
loan. However, points incurred to finance the purchase or improvement of the taxpayers main home
may qualify to be deducted in full in the year they were paid.
Deducting points in the year paid. Points are fully deductible in the current year if the mortgage
loan was secured by the taxpayers residence and the charging of points is an established business
practice in the area. The deduction may not exceed the number of points usually charged in the area.
Further, funds obtained from the lender cannot be used to pay the points. If the taxpayer is buying the
home, he must provide funds at the time of closing at least equal to the points charged. If any of these
conditions are not met, the points must be deducted over the life of the loan. The flowchart on page
156 of IRS Publication 17 can help you determine whether points are fully deductible in the year paid.
Note that even if a taxpayer qualifies to deduct the full amount of points when paid, a taxpayer who
does not benefit from itemizing deductions for the first year of the mortgage may deduct the points
over the life of the loan.
mExample: Sandy Briggs, a taxpayer filing as head of household, purchased her first home in
November 2014. She paid three points ($3,000) to acquire her 30-year $100,000 mortgage. Her first
mortgage payment was made on January 1, 2015.
For 2014, her itemized deductions, including points paid, totaled only $5,700, far less than her $8,950
standard deduction. Sandy should choose to deduct her points over the life of the mortgage loan.
Because she will have paid a full years worth of mortgage interest and real estate taxes in 2015, she
will be more likely to benefit from itemizing.m
Deducting Points Over the Life of the Loan. Points paid to refinance a home mortgage (often
referred to as a re-fi) or to purchase a second home must be deducted over the life of the loan.
Generally, points deducted over the life of the loan must be amortized using the original issue discount (OID) rules. These rules are rather complex, and we do not cover them in this course. However,
cash-method taxpayers may use a simplified method and deduct the points ratably (equally) over the
life of the loan if all of the following tests are met:
The loan is secured by a home.

The duration of the loan is not more than 30 years. For loans of more than ten years, the terms
of the loan must be the same as other loans offered in the taxpayers area for the same period or
longer.
Either the loan amount is $250,000 or less, or not more than four points were paid for a loan of 15
years or less (not more than six points for a loan of more than 15 years).
Points paid to refinance a loan are not reportable on Form 1098, unless it is to refinance a construction
loan. Points paid to refinance other loans should be obtained from the refinance statement.
mExample: Sandy Briggs, from the preceding example, may deduct $100 of her points [$3,000 3 360
monthly payments 2 12 payments per year = $100] each year from 2014 through 2043.m
Loan Ends Early. If points are being deducted over the life of a loan and the mortgage is paid off
early, any remaining points can be deducted when the loan is paid off. In cases where the mortgage is
refinanced with a new lender, the remaining points on the original loan are deducted when the loan
is paid off. However, if the mortgage is refinanced with the same lender, the remaining points must
be deducted over the life of the new loan.
mExample: Amanda Probst refinanced her original home mortgage during 2014. The original 30-year
loan, made in July 2006, was for $125,000. Amanda paid 2 points to obtain the loan, a total of
$3,125 [$125,000 2 2.5% = $3,125]. Her first payment was made on September 1, 2006. She has been
deducting the points over the life of the loan at $8.68 per month [$3,125 3 360 monthly payments =
$8.68]. From September 2006 through December 2013. Prior to 2014, she has deducted $764 [$8.68
per month 2 88 = $764]. Amanda made her last payment on the original loan on February 1, 2014.
The re-fi loan is a 15-year, $110,000 loan made on February 20, 2014, with a new lender. Amanda
paid two points to obtain this loan [$110,000 2 2% = $2,200]. The first payment was made on April
1, 2014. She must deduct the points on the re-fi over the life of the loan [$2,200 3 180 monthly payments = $12.22 per month].
Amandas 2014 deduction for points is $2,471 [$3,125 points on original loan $764 deducted prior to
2014 + ($12.22 monthly points on new loan 2 9 months) = $2,471].
Hypothetical: If Amandas original loan had been refinanced with the same lender, the points
remaining from the original loan would have to be deducted over the life of the new loan. Because
Amanda made two payments prior to refinancing the loan, her remaining point balance from the original loan is $2,344 [$3,125 $764 prior to 2014 $8.68 January 2014 $8.68 February 2014 = $2,344].
After Amanda refinanced the loan, she would deduct $13.02 per month for the remaining point balance of the original loan [$2,344 remaining points 180 months = $13.02 per month]. Thus, her 2014
deduction for points would have been $245 [($8.68 2 2) + ($13.02 2 9) + ($12.22 2 9) = $245].
Important: Any deduction for points is in addition to the deduction for the normal monthly interest
payments she made on both loans.m
Seller-Paid Points. Points paid by the seller in connection with a loan to the buyer are usually considered for tax purposes to be paid by the buyer and are deductible by the buyer. The taxpayer must
reduce the basis of the home by the amount of points paid by the seller.

Illustration 14.4
Reporting Home Mortgage Interest on Schedule A

Financial institutions must report, to the borrower and the IRS, mortgage interest of $600 or more
received during the year. Form 1098 (a copy of the standard form is shown in Illustration 4) is used
for this purpose. Box 1 shows the interest received from the payer, exclusive of deductible points. Box
2 shows points received for the purchase of the taxpayers main home, only for the year acquired.
Box 3 shows any refund of interest made because the taxpayer overpaid the amount actually owed.
Entries in this box are fairly rare. If you are interested, you may find more information about taxable
recoveries of previously deducted amounts in Chapter 12 of IRS Publication 17.
Box 5 can show various information, such as the address of the property financed or amounts paid out
of escrow, including real estate taxes and insurance premiums.
On Schedule A, line 10, enter deductible interest and points reported on Form 1098. Keep in mind
that the amounts shown on Form 1098 may or may not be deductible, depending on how they fit the
guidelines discussed earlier.
Deductible home mortgage interest and points paid by the taxpayer not reported to him on Form
1098 are entered on Schedule A, lines 11 and 12, respectively. If the recipient of the interest is an
individual, enter the recipients name, address, and identifying number (usually SSN) on the dotted
lines below line 11.
Qualified Mortgage Insurance Premiums

Taxpayers who were required to purchase mortgage insurance for a mortgage issued after 2006 can
deduct the premiums they paid if the mortgage was secured by their first or second home. The amount
of premiums paid for this insurance can usually be found in box 4 of Form 1098, and it should be
entered on line 13 of Schedule A.
There is a phaseout range for deducting mortgage insurance premiums. You must use the worksheet
for line 13 of Schedule A (not shown) to figure the deduction for taxpayers whose adjusted gross
income is more than $100,000 ($50,000 if married filing separately). See IRS Publication 936, Home
Mortgage Interest Deduction, for a detailed explanation of mortgage insurance premiums.
Investment Interest
Investment interest is interest paid on money borrowed to buy investment property, such as stocks
and bonds. Investment interest is deductible only to the extent of the taxpayers net investment
income (investment income minus expenses other than interest expense). Any amount disallowed
under this rule may be carried forward to future years.
mExample: Patrick Hamill had net investment income of $900 and investment interest expenses of
$1,000. Patrick is only allowed a current deduction of $900. The remaining $100 is carried forward to
future years and deducted when he has sufficient net investment income to absorb it.m
The deductible interest amount is computed on Form 4952, which we do not cover in this course.
However, if the taxpayer meets all of the following criteria, he may dispense with Form 4952 and
enter his deductible investment interest directly on Schedule A, line 14:
The taxpayers investment interest expenses are not more than his investment income from interest and ordinary dividends (minus qualified dividends).
The taxpayer had no other deductible investment expenses.
The taxpayer has no carryover of investment interest expenses from the previous year.
mExample: Bertha Fieldings only investment income for the year was ordinary (nonqualified) dividends of $500. Her investment interest expense for the year was $200, she incurred no other deductible expenses associated with her dividends, and she had no carryover of investment interest from the
previous year. Bertha should enter $200 on Schedule A, line 14. She does not need to file Form 4952.m
One final note on investment interest: To be deductible, the interest must be incurred to purchase
taxable investments. Therefore, interest on a loan used to purchase municipal bonds, for example, is
not deductible. This is true even if the loan is a home equity loan. Additional information regarding
investment interest can be found in IRS Publication 550, Investment Income and Expenses (including
Capital Gains and Losses).
Nondeductible Interest
Personal interest is not deductible. Personal interest is interest paid on loans for personal purposes, as
opposed to business, investment, passive activity, or home mortgage purposes. Examples of personal
interest are car loan interest, personal loan interest, and credit card finance charges. Also, as mentioned in the section dealing with investment interest, interest on loans used to purchase nontaxable
investments (municipal bonds and life insurance, for example) is not deductible.
CHARITABLE CONTRIBUTIONS
The amount of money contributed and the value or cost of property donated to qualified U.S. charities are deductible. Donations must be made voluntarily and without receiving (or the expectation of
receiving) anything of equal or greater value in return.
To be deductible, a charitable contribution must be made to a qualified organization. Qualified organizations generally are nonprofit groups that are charitable, religious, educational, scientific, or literary
in purpose, or that work to prevent cruelty to children or animals. Certain organizations that foster
national or international amateur sports competition also qualify.
Examples of qualified organizations include:
Religious organizations, such as churches, mosques, temples, and synagogues.
Most nonprofit charitable organizations, schools, museums, hospitals, medical research organizations, volunteer fire companies, civil defense organizations, and war veterans groups.
The United States government, governments of U.S. states and possessions and political subdivisions thereof (counties, municipalities, etc.), the District of Columbia, and Native American tribal
governments that perform governmental functions.
Certain nonprofit cemeteries and fraternal organizations.
The chart on page 22 lists some of the most popular charities. Most organizations, other than religious
organizations and governments, must apply to the IRS to become qualified organizations. If you do
not know whether an organization qualifies, you can check with the organization or with the IRS. A
complete list is available online at <www.irs.gov>.
Contributions to fraternal lodge societies (such as Elks, Lions, Masons, and Moose) are deductible if
they are used for qualified charitable purposes. They may not be used for sickness or burial expenses
of its members. Dues paid to fraternal lodge societies are not deductible.
Amounts contributed to a nonprofit cemetery are deductible if the funds are irrevocably dedicated to
the perpetual care of the cemetery as a whole and not for a particular lot or crypt.
To be deductible, contributions must actually be paid in cash or property during the year, regardless
of when pledged. A donation paid by credit card is considered to be paid on the date the charge slip
is written.

Illustration 14.5
American Cancer Society
POPULAR U.S. CHARITIES

Habitat for Humanity
American Childrens Fund
March of Dimes
American Heart Association
Muscular Dystrophy Association
American Lung Association
National Easter Seal Society
American Red Cross
Planned Parenthood
Boy Scouts and Girl Scouts
Salvation Army
Catholic Charities
Shriners Hospitals
Disabled American Veterans
United Way
Goodwill Industries
YMCA and YWCA
Cash Donations
If the taxpayer contributes cash, the deduction is usually the amount of cash contributed. However,
sometimes amounts that appear at first glance to be charitable contributions do not qualify as deductions. A few examples follow:
Amounts paid to charitable organizations primarily for personal benefit, such as educational or
club activities for the taxpayers child, are not deductible.
Amounts paid to a charitable organization for raffle tickets or to play games of chance, such as
bingo, are not deductible as contributions. (However, they may be deductible as gambling losses,
discussed in Tax Essentials, Itemized Deductions II.)
Contributions made for the benefit of an individual; to Chambers of Commerce and other business,
civic, political, and social clubs or organizations; and to foreign and international organizations
(except certain Canadian, Israeli, and Mexican charitable organizations) are not deductible.
If amounts paid to a qualified organization for merchandise, goods, or services are more than the
fair market value, the amount you pay that is more than the value of the item can be a charitable
contribution. For the excess amount to qualify, there must be an intent to make a charitable contribution.
You cannot deduct a cash contribution, regardless of the amount, unless you keep a record of the
contribution. An example would be a bank record (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. The written communication must include the name of the charity,
the date, and the amount of the contribution.
Contributions of $250 or more made at any one time to a qualified charitable organization are deductible only if the taxpayer obtains written substantiation from the donee organization. Canceled checks
do not suffice to document such donations. Written substantiation is required for both cash and
property donations. It must be obtained from the qualified organization by the earlier of the date the
taxpayer files his return or the due date of the return (including extensions).
mExample: Maria Cora donated $300 to the Red Cross on January 4. She must have written substantiation of the contribution from the Red Cross in order to deduct it. However, if Maria had given two
gifts at separate times of $150 each, her canceled checks or other written documentation would suffice
to document the deduction.m
For contributions of more than $75 for which the taxpayer receives goods or services, the donee organization must specify that the contribution is only partly deductible and must furnish the taxpayer
with a good-faith estimate of the value of the goods or services. A detailed discussion of records to keep
can be found in IRS Publication 526, Charitable Contributions.
Volunteer Work
Out-of-pocket expenses incurred in rendering volunteer services to charitable organizations are
deductible. The cost and upkeep of uniforms, equipment, and supplies used when performing services
for a charitable organization are deductible.
The cost of transportation to perform volunteer work is deductible. If the volunteer uses his car, he
may deduct the cost of parking, tolls, gas, and oil. Alternatively, the taxpayer may deduct 14 per mile
for miles driven in 2014, plus parking and tolls. If the taxpayer uses public transportation, that cost
may be deducted. Qualified transportation includes going to and from home to the locations where
volunteer work is performed.
A chosen representative attending a convention of a qualified organization and others whose volunteer work takes them away from home overnight may deduct food, lodging, and other unreimbursed
expenses directly related to the volunteer services. Recent tax law changes have attempted to eliminate deductions for charitable trips that are really disguised vacations. Thus, expenses for volunteer
travel are deductible only if there is no significant element of personal pleasure, recreation, or vacation involved. This does not mean that the volunteer is forbidden to enjoy himself while performing
the volunteer service, but it does mean that volunteer service must be the main motivation for the
trip.
mExample: Lee Martin accompanies a group of Boy Scouts on a camping trip. During the trip, he is
on duty as a supervisor of the scouts in a real and substantive sense most of the time. Lee may deduct
his travel expenses for this excursion. The fact that he enjoys this type of activity does not disqualify
his deduction.m
The value of the volunteers time and work is not deductible.
mExample: Linda Jamison is an attorney. Without charge, she drew up a trust agreement for her
church. The work took her five hours. She normally charges $200 per hour for such work. Linda may
take no charitable deduction because the value of her time is not deductible.m
The cost of transportation to attend meetings of charitable organizations as a member or observer
(rather than to perform volunteer services) is not deductible. The cost of driving one or several people
to an activity is not deductible unless the driving is volunteer service to a charitable organization and
the volunteer would not otherwise attend the activity.
A taxpayer may deduct up to $50 per school month of the actual amounts spent for the well-being of a
student who is living in his home under a written agreement with a qualified charitable organization.
The student may not be a dependent or relative of the taxpayer and must be a full-time student in the
12th grade or lower at a school in the United States. A school month for purposes of this deduction is
15 days or more in a calendar month during which the student lived with the taxpayer and attended
school. This deduction is used mostly by those who take foreign exchange students into their homes.
However, the costs of a foreign student living in the taxpayers home under a mutual exchange program whereby the taxpayers child lives with a family in a foreign country are not deductible.
Contributions of Property
You cannot take a deduction for clothing or household items you donate after August 17, 2006, unless
the clothing or household items are in good used condition or better.
Generally, the fair market value (FMV) of property at the time it is donated to a charitable organization is deductible. Fair market value is the price at which property would be sold in a transaction
between a willing buyer and a willing seller, both of whom have full knowledge of the relevant facts.
In every case in which the FMV of donated property is less than the cost of the property, the allowable deduction is FMV. A common example is a donation of clothes, home furnishings, or automobiles made to various charitable organizations or thrift shops operated by such organizations. The
FMV of these items is generally less than the cost; therefore, the deduction usually is the FMV.
a taxpayer donates a car worth more than $500 to a qualified orgaTnizationIfafter
December 31, 2004, and the organization sells the car, the taxax tip:
payers deduction is limited to the gross proceeds of the sale or the cars FMV,
whichever is less. However, if the organization improves the car or makes significant use of it before selling it, the taxpayer may deduct the fair market value
at the time of the donation.
Appreciated property. If donated property has appreciated in value (FMV is more than cost), the
allowable deduction is the FMV minus the amount of the value that would have been ordinary income
if the property was sold. In most cases, if the property donated was owned by the donor for personal
or investment purposes, this means that:
If the taxpayer owned the property one year or less, the deduction is the cost of the property.
If the taxpayer owned the property for more than one year, the deduction is the FMV of the
propertythere are some exceptions, so do some research in IRS Publication 526, Charitable
Contributions, if you encounter this type of donation.
mExample: In 2010, Linda Atwell purchased 100 shares of ABC stock for $1,000. In 2014, when
she gave the stock to her synagogue, the stock was worth $2,000. Linda may deduct the full $2,000
because she held the stock for more than one year.m
mExample: In January 2014, Jerry Cloud purchased 100 shares of XYZ stock for $1,000. In November,
when he gave the stock to his church, it was worth $2,000. Jerry may deduct only $1,000 because he
did not own the property more than one year.m
When total property contributions of more than $500 are deducted, Form 8283, Noncash Charitable
Contributions, must be completed. Page 1 is used if the value of the property totals between $501
and $5,000 and is used for certain publicly traded securities of any value over $500. The name and
address of the charitable organization, when and how the property was acquired, and the method used
to value the property must be reported.
If a single item of donated property (or aggregate of similar items) has a value of more than $5,000,
Form 8283, page 2, must be completed. The recipient organization is required to sign this page. The
taxpayer must obtain a written appraisal (except for nonpublicly traded stock of $10,000 or less and
securities for which market quotations are readily available). The appraisal should not generally be
attached to the return. A separate Form 8283, page 2, is required for each different type of property
given and for each separate recipient organization.
For donated art with an aggregate value of $20,000 or more, the donor must attach to his return a
complete copy of the qualified appraisal. The taxpayer must also be able to provide upon IRS request
an 8210-inch color photograph or transparency of any individual objects valued at $20,000 or more.
For purposes of these rules, art includes paintings, sculptures, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia, and similar objects.
Note: There is no deduction allowed for a donation of the use of property.
mExample: A taxpayer allows a scout camp to use his property as a parking lot, but retains title to
the land. No deduction is allowed.m
The taxpayer must keep a record of each cash or property contribution he makes. Records of property
donations should include a description of the property, its cost and fair market value, the date of the
contribution, and the name and location of the charity.
There are limitations on deductions for charitable contributions. The majority of contributions by taxpayers are given to qualified charitable organizations. Donations to most of these organizations are
deductible up to 50% of AGI. However, the value of gifts to veterans organizations, fraternal societies,
and nonprofit cemeteries may not exceed 30% of AGI. Gifts of certain types of property may be further
limited. The majority of taxpayers do not approach these limits. If you are interested, you may find
a discussion of these limits and carryover provisions in the section titled Limits on Deductions in
Chapter 24 of IRS Publication 17.
CHAPTER SUMMARY
Generally, taxpayers may deduct the larger of their total itemized deductions or their standard
deduction.
Most medical and dental expenses are deductible to the extent they exceed 10% (7% if either the
taxpayer or their spouse is age 65 or older) of the taxpayers adjusted gross income.
Transportation for medical purposes is deductible. In lieu of actual gas and oil expenses, taxpayers
may choose the standard mileage rate, 23.5 for 2014.
A taxpayer may deduct the following taxes:
State and local taxes (income or general sales).
Real property tax.
Personal property tax.
Foreign income taxes.
A taxpayer may deduct interest paid on qualified home mortgages and on money borrowed to buy
investment property. However, personal interest is not deductible.
Cash and property donated to qualified U.S. charities is deductible. A taxpayer must voluntarily
make the donation and not receive anything of equal or greater value in return.
Suggested Reading
For further information on the topics discussed in this chapter, you may wish to read the following in
IRS Publication 17:
Chapter 21, Medical and Dental Expenses.
Chapter 22, Taxes.
Chapter 23, Interest.
Chapter 24, Contributions.
15
Itemized Deductions II
OVERVIEW
The Tax Code allows certain personal expenses to be deducted from gross income. Some of the expenses a taxpayer may deduct depend on the taxpayers adjusted gross income (AGI). In other words,
before a taxpayer will see any tax benefits from these types of deductions, they will have to cross a
threshold amount. The dollar amount of the threshold is different for every taxpayer, but the percentages (2%, 7%, and 10%) of AGI are the same. It is not uncommon for a taxpayer to have several
thousand dollars of one type of expense, but see no tax benefit from it. Other types of deductions may
be deducted regardless of AGI.
OBJECTIVES
At the conclusion of this book, you will be able to:
Identify a casualty or theft loss of personal-use or investment-use property and compute a deductible loss of personal-use property on Form 4684.
Determine if an employee may deduct transportation expenses using the standard mileage rate,
and compute the deduction using Form 2106-EZ.
Determine deductible gambling losses and enter them on Schedule A.
Identify other miscellaneous itemized deductions, and make the appropriate entries on Schedule A.
Explain the Alternative Minimum Tax.
Determine if a recovery (refund) of a previously deducted item is taxable.
TAX TERMS
Adjusted basis.
Casualty loss.
Itemized deductions.
Qualified charitable organization.
15.1
CASUALTY AND THEFT LOSSES

A casualty is the complete or partial destruction of property resulting from an identifiable event of a
sudden, unexpected, or unusual nature. It must be due to an external cause, rather than to a defect in
the product itself. A theft is the unlawful taking of property. To claim a casualty or theft loss, the taxpayer must own or be buying the damaged property or be responsible for damages to leased property.
Casualty and theft losses include, but are not limited to:
Damage from a hurricane, tornado, earthquake, tidal wave, volcanic eruption, flood, storm, fire, or
sonic boom.
Damage from an accident, if it was not caused by a willful act or willful negligence on the part of
the taxpayer.
A loss from vandalism or theft.
Damage or loss from a terrorist attack.
Losses that are not deductible include:
Paying for personal injuries or damage to property owned by another person.
Property broken through ordinary use or by wearing out over time.
Loss of trees or other plants caused by a fungus, a disease, insects, worms, or similar pests. (Note:
Sudden destruction of trees or plants caused by an unexpected or unusual infestation of beetles or
other insects may qualify.)
Termite or moth damage.
Accidental loss or disappearance of property if it was not the result of damage from a sudden,
unexpected, unusual, and identifiable event.
Loss caused by a defect in the product.
Loss of market value because the property is near a casualty area.
mExample: The gradual wearing out of a roof is not a casualty. On the other hand, damage to a roof
caused by a severe storm is a casualty.m
mExample: Damage to a car caused by the owner losing control and accidentally running into someone
elses tree is a casualty assuming it was not a willful act or willful negligence. However, the car owner
cannot claim as a casualty any damages he paid for the tree.m
Proof of Loss
In order to deduct a casualty or theft loss, the taxpayer should be able to substantiate:
The nature of the casualty or theft and when it occurred or was discovered.
The loss was the direct result of the casualty or theft.
The taxpayer was the owner of the property or responsible for damages to leased property.
The adjusted basis of the property (usually its cost).
The fair market value of the property before and after the loss.
The amount of insurance or other compensation received or expected to be received.
Tax Essentials Itemized Deductions II 15.3
A casualty or theft loss of property held for personal use is deductible on Schedule A only after completing Form 4684, Casualties and Thefts. The loss must be reduced by:
Any insurance reimbursement the taxpayer receives (or is eligible to receive, even if a claim is not
filed).
$100 per incident.
10% of adjusted gross income after combining all casualties and thefts for the year.
A business casualty loss or theft will not be discussed in this course. Such losses or thefts would be
listed on Section B, Form 4684 (not shown), and then transferred to the appropriate business form.
Unreimbursed losses of investment property, such as notes, bonds, or collectibles held for potential
increase in value, are deductible on Schedule A, but such losses are not reduced by the $100 floor or
10% of AGI. An unreimbursed casualty or theft of notes or bonds is uncommon, because most would
be difficult to cash and would be replaced if stolen or destroyed.
Amount of the Casualty or Theft Loss

Before the amount of a casualty loss can be computed, we must determine the adjusted basis of the
property and the propertys fair market value (FMV) before and after the casualty or theft.
The adjusted basis of property is usually the original cost plus the cost of capital improvements and
the cost of restoring the property after any previous casualty, minus any reimbursement or deduction
of previous casualty losses and depreciation taken (if the property had ever been used for the production of income).
An appraisal fee incurred in ascertaining the amount of loss is deductible as a miscellaneous itemized
deduction subject to the 2%-of-AGI floor, which you will study in this course, and not as part of the
casualty or theft loss.
The cost of cleaning up, repairing, or replacing the property after a casualty is not deductible.
However, it may be used as a measure of the decrease in FMV if:
The repairs are necessary to restore the property to the same condition as before the casualty.
The amount spent for repairs is not excessive.
The repairs only rectify the damage.
The value of the property does not increase beyond the FMV of the property prior to the casualty.
Amounts spent to improve the structure of the property in order to protect against future casualties
are not deductible but may be added to the basis of the property. Expenses incidental to the casualty,
such as moving expenses and rental of temporary quarters, are not part of the casualty loss.
Real property (such as the taxpayers main home, vacation home, or cabin). The amount of casualty
loss is determined for the entire property as a single item. The entire property includes the buildings,
land, landscaping, and other improvements. The loss is the lesser of the adjusted basis of the entire
property or the decrease in FMV of the entire property, minus any insurance reimbursement.
mExample: Pat Land owns a cabin in the mountains. The FMV of the cabin and the land on which it
stands was $95,000 before the uninsured cabin was damaged by a small fire. Its FMV after the fire
was $87,000. The adjusted basis of the property prior to the casualty was $81,000. Pats casualty loss
(before applying the required reductions) is $8,000 [$95,000 $87,000].m
Personal-type property (such as vehicles, furnishings, jewelry, and sporting equipment). The
amount of casualty loss is determined separately for each item. The amount of the loss is the lesser of
the adjusted basis or the decrease in fair market value of each item of personal property, reduced by
any insurance reimbursement or other recovery.
If multiple assets are destroyed or damaged by the same casualty, the amount of the loss for each
asset is determined as stated, then totaled and reduced by $100. The $100 floor reduces the total loss
from each separate casualty or theft that might occur during the year. The 10%-of-AGI reduction
applies only to the total of all casualty losses incurred during the year. The requirement to reduce
the casualty amount by the $100 floor and 10% of AGI applies to personal-use property but not to
investment property.
Insurance policies can vary greatly and may cover less than (or more than) the entire loss. If the policy
has a deductible clause (the policy holder pays the first specified dollar amount of each covered loss)
or otherwise covers less than the entire loss, only the out-of-pocket expenses are deductible. It does
not matter how much the asset will cost to replace. An insurance reimbursement also may result in a
taxable gain, which we will discuss later in this chapter.
mExample: Kathy Schmitts car was totaled in an accident in 2014. The car was worth $4,000 before
the accident and $300 afterward. Her auto policy had a $250 deductible, so the insurance company
paid her $3,450 [$3,700 loss $250 deductible]. Her deductible loss before limitations is only $250. It
does not matter how much it would cost to buy a replacement car.m
When to Deduct a Loss

In general, a loss is deductible only for the year the casualty occurred or the theft was discovered.
If the taxpayer expects to be reimbursed in a later year, only the part of the casualty only the portion
of the casualty or theft that will not be reimbursed is deductible. If the taxpayer recovers less than
he expected, the difference may be deducted in the year in which no more reimbursement or recovery
can reasonably be expected. If a reimbursement is later received for a casualty or theft previously
deducted, the reimbursement must be included in income for the year in which it is received, to the
extent the deduction reduced the previous years income subject to tax.
Federally declared disaster area. A casualty loss from a disaster that occurred in an area the
President of the United States declares to warrant federal assistance may be deducted either on the
return for the year in which the casualty occurred or on the return for the immediately preceding tax
year. For example, a disaster loss in 2014 may be deducted on either the 2014 or the 2013 tax return.
The purpose of this provision is to allow taxpayers who have been victims of a disaster to receive some
money quickly by filing an amended return for the preceding year, thereby obtaining a refund.
A taxpayer has until the due date of the return for the year of the loss to make this election. The
election to claim the deduction on a prior years return becomes irrevocable 90 days after being made.
The choice should be based on which year the claim will result in the greater reduction of tax and on
how quickly the taxpayer needs the money.
mExample: Brendas car was destroyed by a tornado in September 2014. Due to the severe damage
caused by several tornadoes, her county was declared a disaster area by the president. She may wait
until she files her 2014 return and deduct the loss in the usual way, or she may elect to file an amended 2013 return and deduct it there. She must make the election by April 15, 2015, the due date for
2014 returns.
If she files an amended 2013 return on October 15, 2014, she has 90 days to revoke the election by
filing another amended return and paying back the refund. She may then claim the loss on her 2014,
the due date of the 2014 return (the year in which the disaster area was declared). m
Net Operating Losses

Casualty or theft losses of personal-use property that exceed the taxpayers AGI may possibly be used
to reduce income in prior or future years. If you encounter this situation, you will need to do some
research on the subject of net operating losses. IRS Publication 536, Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts, provides an excellent starting place if you need to learn more about
net operating losses.
FORM 4684 CASUALTIES AND THEFTS

When a person suffers a casualty or theft, in most cases, a loss occurs. In some instances, however,
when insurance or other reimbursement is more than the adjusted basis of the property, the result
can be a gain.
mExample: Suppose that Kathy Schmitt (from the earlier example) had an insurance policy that paid
the replacement cost for her car. She paid $8,500 when she bought the car in 2009, and her insurance
paid $10,000 when the car was totaled. She has a $1,500 gain from the casualty.m
Form 4684, Casualties and Thefts, is used to compute taxable gain or deductible loss from a casualty or theft. Section A is used for personal-use property, and Section B is used for business and
income-producing property. In this book, you will complete only Section A. Study Form 4684, Section
A, in Illustration 15.1.
mExample: Lisa Ogilves car was severely damaged in a hailstorm on September 3, 2014. She was not
insured against such damage. She purchased the car on March 7, 2012, for $11,500. She did not live
in a declared disaster area. Lisa will claim itemized deductions on her return.
Immediately before the storm, the fair market value of the car was $9,750, and after the storm, the
FMV was $6,930. Lisa spent $2,820 to repair the dents and replace the broken glass. Her AGI is
$21,300.
Lisas Form 4684 is shown in Illustration 15.1. The figure on line 6 was computed by subtracting the
cost of restoring the car to its previous condition from its FMV before the storm.m
A separate Section A must be completed for each separate casualty or theft. Each item lost, destroyed,
or damaged in the same casualty or theft is listed separately on line 1. Computations necessary for
each item are done in the appropriate columns A through D.
If more than four items are involved in the same casualty or theft, or if the taxpayer suffers more than
one casualty or theft during the year, some special calculations are necessary. Those are explained in
the IRS instructions for Form 4684.
When Form 4684 is completed correctly, with the line-by-line directions on the form followed carefully, any gain to be reported on Schedule D will appear on Form 4684, line 15. Any deductible loss to be
reported on line 20 of Schedule A will appear on Form 4684, line 18. The rules concerning FMV, basis,
the $100 floor per casualty or theft, and the 10%-of-AGI reduction are all taken into account. (Note:
If any of the losses were in a declared disaster area, you will have to do further research.)

Illustration 15.1
A special note about Form 4684, line 15, is in order here. If there is a net gain, combine the short-term
gains and losses, and enter the net short-term gain or loss on Schedule D, line 4. Combine the longterm gains and losses, and enter the net long-term gain or loss on Schedule D, line 11.
Further special provisions apply to taxpayers who realize a gain from the destruction of their main
homes or contents in a federally declared disaster area. You can read about this in the IRS instructions for Form 4684 or seek assistance if you encounter a casualty gain situation.
MISCELLANEOUS DEDUCTIONS
Miscellaneous itemized deductions generally encompass expenses necessary for the production of
income. Thus, unreimbursed ordinary and necessary employment expenses, gambling losses to the
extent of gambling winnings, hobby losses to the extent of hobby income, tax advice and preparation
fees, investment expenses, and similar expenses are deductible as miscellaneous itemized deductions.
Recall how medical expenses are generally deductible only to the extent they exceed 10%-of-AGI (7.5%
for taxpayers age 65 and over). The total of some miscellaneous itemized deductions is subject to a
similar 2%-of-AGI limitation. Examine lines 21 through 27 of Schedule A, shown in Illustration 15.2,
to see where deductions subject to this limitation are entered.
Next, look carefully at Schedule A, lines 21, 22, and 23. Line 21 is for unreimbursed employee expenses and calls for the attachment of Form 2106 or 2106-EZ in some cases. Line 22 is for tax preparation fees. Line 23 is for other expenses. Other expenses are miscellaneous deductions that are not
employment-related: for example, fees paid for investment advice or the rent paid for a safe deposit
box in which stock certificates are stored.
Form 2106 or 2106-EZ is required to report a number of employee business expenses. These include
transportation, travel, meals, and entertainment expenses, and any reimbursements received from
the employer and not included in box 1 of Form W-2. In this book, you will learn to use Form 2106-EZ
to report only unreimbursed transportation expenses using the standard mileage rate. Other types
of expenses requiring the use of Form 2106 can be studied in the H&R Block Intermediate Vehicle
Expense and Advanced Employee Business Expense courses.
Taxpayers who have unreimbursed employment-related expenses other than those previously listed
need not file Form 2106 or Form 2106-EZ. Simply enter the description of the expense(s) and the
amount(s) on Schedule A on the dotted line to the left of line 21, and enter the total on line 21.
Expenses Subject to the 2% Limitation

The miscellaneous itemized deductions discussed in the remainder of this section are, when totaled,
subject to the 2%-of-AGI limitation. We will not be discussing all miscellaneous deductions available
in this course because sales and home-office expenses and those that require Form 2106 are treated
extensively in the H&R Block intermediate and advanced courses.

Illustration 15.2
Transportation Expenses
Employees (except statutory employees) who claim a deduction for using an automobile in connection
with their employment must file Form 2106 or Form 2106-EZ. We will focus exclusively on Form
2106-EZ.
People in business for themselves and statutory employees may also claim a deduction for business
transportation. While the rules you will learn in this book generally apply to all taxpayers who have
deductible transportation expenses, independent business persons and statutory employees will claim
their deductions on Schedule C (or Schedule C-EZ). Transportation expenses to care for rental property are deducted from rental income on Schedule E. These forms will be introduced later in this course.
Deductible transportation expenses are those that involve the use of a motor vehicle for business
purposes (other than commuting, discussed below). Outside salespersons and individuals who provide
on-site repair, maintenance, construction, or remodeling services will generally have transportation
expenses, unless the employer provides the vehicle and pays all the expenses. Independent delivery
persons and over-the-road truck drivers will have transportation expenses.
It is possible for many different types of workers to have such expenses occasionally. For example, an
employee who works at the employers place of business and is required to use their car to take deposits to the bank or mail to the post office may have transportation expenses. A taxpayer who works at
two locations for the same employer in one day may deduct the cost of driving from one place to the
other. In addition, taxpayers who work at two separate jobs in the same day may deduct the cost of
driving from one place of employment to the other.
Commuting. It is important to distinguish between deductible business mileage and nondeductible
commuting mileage. A taxpayer cannot deduct transportation expenses for driving from their home
to their regular place of business (a specific building or location) and back home. This is commuting
mileage.
mExample: Carl Anderson, a married taxpayer, is an insurance adjuster. His office is located at his
employers corporate headquarters, five miles from Carls home. Transportation between his home
and the office and back home is a nondeductible commuting expense.m
Driving between work locations. If the taxpayer must drive from the regular location or the first
business location to other business locations, that mileage is deductible. The same is true of running
errands for the employer.
mExample: In the course of his work, Carl (from the preceding example) often drives his own car from
the office to various client-related locations during the workday. He drove 3,340 miles and paid $16 in
tolls while making these visits during 2014. The mileage from the office to client locations and back
to the office produces a deduction. The related tolls are also deductible.m
Temporary work location. An employee who works in a temporary job location for their current
employer may deduct the cost of round-trip transportation from their home to the temporary location,
even if it is within the same general area of the employees regular place of business.
mExample: In addition to the client visits, Carls employer required him to work in one of the companys other offices for two weeks (ten working business days). The other office is 14 miles from his
home. Even though the temporary assignment may be considered to be in the same general area as
his regular place of work, the cost of round-trip transportation between his home and the other office
generates a deductible business expense.m
Short-term workers. The situation is different if a person has no regular place of work, but rather
works at different locations on a short-term basis in the area where they live. Such a taxpayer may
not deduct the cost of transportation from home to work and return. Such a taxpayer will, however,
generate a deduction if they work at more than one work site during the day.
mExample: Rhonda Wallace is employed as a house painter. Her work takes her to different locations
within the general area in which she lives. Her transportation from her home to her work site and
return each day is a nondeductible commuting expense.
If Rhonda works at two or more locations during the same day, her transportation between work sites
is deductible. However, her commute from home to the first work site and from the last work site back
home is not deductible.m
There are two methods for computing allowable transportation expenses: the regular method (using
the actual expenses incurred) and the optional method (using a standard rate per mile of business
use). In this book, we will discuss the optional method only.
Optional method. To qualify to use the optional method with the standard mileage rate, a taxpayer
must do all of the following:
Own or lease the vehicle.
Not have more than four vehicles in simultaneous business use at any time during the year.
Use the optional method the first year the car or truck is placed in service.
mExample: In 2014, Paula Booth began working for a messenger service that does not reimburse for
mileage. She used her 2011 Honda Civic to make deliveries in the metropolitan area in which she
lives. She also owns a 2006 Chevrolet Cavalier, which she uses for personal purposes. She has not
used either car for business in the past. Paula may use the standard mileage rate for the Honda. If
she decides to use the Chevy for business in a future year, she may use the standard mileage rate for
it too.m
The standard mileage rate is a deductible amount that is computed on Form 2106-EZ, on line 1. For
2014, the rate is 56 per mile.
On line 2, enter parking and tolls paid for employee business purposes. No other actual vehicle
expenses may be added to this amount. Since we will not discuss other expenses, the sum of lines 1
and 2 will be our total expenses.
Any allowable personal property tax paid on an employees vehicle is deductible as usual on Schedule
A. Finance charges (interest) paid on a loan used to finance the vehicle are not deductible by employees. This treatment is slightly different for self-employed taxpayers.
Taxpayer records for substantiation of transportation expenses should be written and kept in a timely
manner as the expenses occur. A record book should contain information showing dates, times, mileage, business purpose, and any other pertinent information.
mExample: Lets go back to Carl Anderson. He started using his car for business purposes on May 1,
2013, claiming the standard mileage rate for that year. He worked at his regular job location 230 days
during 2014. He used his trip odometer to keep track of his business mileage and kept written records.
His records show that the mileage was 3,620 from January 1 through December 31. He received no
reimbursements from his employer. Carl did not know he needed his total mileage for the year, but
he estimates 10,000 miles. His wife also owns a car.
Carls Form 2106-EZ is shown in Illustration 15.3. His business mileage is 3,620 miles [3,340 + (10
days 2 28 miles round trip)]. His commuting mileage is 2,300 miles [10 miles round trip 2 230 days].
His other (personal) mileage was computed by subtracting these two figures from 10,000 miles.m
ax Tip: It is common for the IRS to audit taxpayers with unreimbursed

business expenses. To substantiate the amount of unreimbursed business
expenses reported on Form 2106 or 2106-EZ, the taxpayer should keep a copy
of the employers business expense reimbursement policy as well as documentation that shows the amounts of business expenses reimbursed by the employer.
Education Expenses
The cost of education that maintains or improves the skills required by the taxpayers present job, or
that meets the requirements of the law or the employer for maintaining the taxpayers present salary
or position, is deductible as an employment expense. This is true even if the taxpayer receives a degree
through their course of study.
Expenses are not deductible if the education is required to meet the minimum educational requirements in effect when the taxpayer first obtained the job or if it qualifies them for a new trade or
business.
mExample: Karyn Piccone, a convenience store clerk, took the H&R Block Income Tax Course in 2014
in the hope of becoming a Tax Professional. Because the course would qualify her to work in a new
business, the cost of the course is not deductible.m
In the H&R Block Income Tax Course, you learned about education tax benefits, such as the lifetime
learning credit, the American Opportunity Credit (AOC), and the tuition and fees deduction. As
you will see, with the lifetime learning credit and the tuition and fees deduction, qualified expenses
include amounts paid for tuition and other course-related fees. However, certain expenses that do not
qualify for those tax breaks may be deductible on Schedule A. For example, fees for courses taken
at locations other than qualified institutions (colleges) are deductible. Also the cost of all books and
qualified transportation expenses are deductible.
mExample: Dave Wolfe, an H&R Block Tax Professional, took H&R Blocks Advanced Disposition of
Business Assets course in 2014 to improve his job skills. Daves tuition is deductible.
The classes were held at an H&R Block tax office. Because the tax office is not a qualified institution
for purposes of the lifetime learning credit and the tuition and fees deduction, Dave may not claim
either of those benefits for taking the tax course. He may, however, take a deduction for the course
on Schedule A.m
Remember, the taxpayer may not claim more than one tax benefit for the same expenses. If an
expense qualifies for the American Opportunity Credit, the lifetime learning credit, the tuition and
fees deduction, or a Schedule A deduction, the one that provides the greatest tax benefit is the one
the taxpayer should use. Some of the factors to consider are the income limitations, the taxpayers
marginal tax rate, and whether their deductible expenses exceed the 2%-of-AGI floor.

Illustration 15.3
Job-Seeking Expenses
Unreimbursed expenses incurred in seeking new employment in the same occupation are deductible.
The same expenses are not deductible if the taxpayer is seeking employment for the first time or
employment in a new occupation. The occupation of a taxpayer, who is unemployed, is the work they
were engaged in during their most recent employment. An individual who has been unemployed for a
long period of time before beginning to look for a job may not deduct their expenses.
mExample: Carol Tashahito was a bank teller. In 2004, she decided to stay at home and raise her
children. In 2014, Carol sought work again as a bank teller. Because of the long period of time between
Carols paid jobs, she cannot deduct her job-seeking expenses.m
Deductible expenses include employment agency fees, the cost of preparing and mailing resumes, and
telephone expenses. Transportation and travel expenses incurred in seeking qualified new employment away from the general area of the present job are also deductible. Qualified job-seeking expenses
are deducted directly on Schedule A, line 21, or on 2106-EZ if transportation or travel expenses are
involved.
It is important to note that qualified job-seeking expenses are deductible even if they do not result in
securing employment.
Other Employment-Related Deductions

The following work-related expenses are listed directly on Schedule A, line 21, unless 2106-EZ is
otherwise used:
Subscriptions to professional or trade publications related to the taxpayers work.
Union dues, initiation fees, and assessments for benefit payments to unemployed union members
are deductible. (However, assessments that provide funds for sickness, accident, or death benefits
are not deductible.)
Dues paid to a professional society by a lawyer, teacher, accountant, doctor, or other professional.
Business liability insurance.
Cost of a physical examination required by an employer. (This may be deducted instead as a medical expense if that is more advantageous.)
Cost of small tools, supplies, and licenses required in the taxpayers employment.
Cost of teaching aids, supplies, and equipment. (Include only amounts in excess of those deducted
as an adjustment to income, discussed in the H&R Block Income Tax Course.)
Cost of safety equipment and protective clothing, such as safety glasses or shoes, hard hats, and
other items to protect the workers physical well-being.
The cost of specialized clothes and uniforms is deductible if such clothing is specifically required by
an employer and is not adaptable to general wear. (Both qualifications must be met.) The cost of
cleaning and maintaining qualified clothing is also deductible. The cost of theatrical costumes and
accessories worn by musicians and other entertainers is deductible if the items are not suitable for
everyday wear.
Tools (or equipment) that are expected to be used in the taxpayers employment for more than one
year must be depreciatedthat is, the cost is deducted over a period of time.
Tax Preparation Fees

If the taxpayer paid someone to prepare and/or electronically file their income tax return(s), the
fees are deductible. These amounts are entered on Schedule A, line 22. Also, include the cost of tax
preparation software and publications. Bank fees or finance charges paid to financial institutions in
connection with applying for or obtaining refund anticipation loans or checks or similar products are
not deductible.
If the taxpayer is self-employed or owns rental property, the portion of tax preparation fees directly
associated with the business or rental property should be deducted on the appropriate form (Schedules
C, E, or F or Form 4835) and the remainder deducted on Schedule A, line 22.
The fees are deducted in the year paid. Thus, the amount entered on the 2014 return will usually
reflect the preparation of the 2013 return(s).
Investment Expenses
Investment expenses, which are deductible as itemized deductions on Schedule A, line 23, include:
Amounts paid to a broker or similar agent to collect income.
Legal expenses necessary to produce or collect taxable income.*
Appraisal fees to determine the value of property donated to a charity or to establish the amount
of a casualty loss.
Fees paid for investment advice.
Safe-deposit box rental fee if the box is used to keep potentially taxable investment-related papers
and documents, such as stocks or bonds.
Custodial fees in connection with property held for the production of income.
Amounts actually paid for clerical help or renting an office used in taking care of investments (but
no deduction can be claimed for the value of the taxpayers time, other unpaid help, or space in the
taxpayers home).
The taxpayers share of investment expenses of a regulated investment company.
Certain losses on nonfederally insured deposits in an insolvent or bankrupt financial institution.
Deduction for repayment of amounts under a claim of right if $3,000 or less.
* Certain attorney fees and court costs incurred after October 22, 2004, for cases involving unlawful
discrimination may be deducted as an adjustment to income.
Expenses to attend shareholders meetings are usually not deductible. Neither are expenses to produce nontaxable income, such as municipal bond interest.
Note: Casualty and theft losses from property used in performing services as an employee are also
deducted on Schedule A, line 23. These amounts are carried from Form 4684, Section B, and are not
discussed in this course. For more information, see IRS Publication 529, Miscellaneous Deductions.
Hobby Expenses
A hobby, for tax purposes, is an activity not carried on to make a profit.
mExample: George Conway collects stamps for his own enjoyment. Occasionally, he sells a stamp
when he has a duplicate. George has a hobby, not a business.m
Hobby expenses are deductible up to the amount of hobby income reported on the current-year tax
return. The following expenses attributable to hobby income are deductible, in the following order:
1. State and local property taxes and casualty losses (that is, deductions that are allowable as personal itemized deductions) are fully deductible.
2. All other expenses of the hobby, such as craft supplies and sales expenses, may be deducted only to
the extent that gross income from the activity exceeds the deductions described in 1 above.
3. Depreciation may be deducted only to the extent gross income from the activity exceeds the expenses described in 1 and 2 above. (Equipment with a useful life of more than one year that is used to
produce hobby income is a depreciable asset. That is, the cost is divided and a portion is deducted
each year for a number of years, instead of deducting the entire cost in the year of purchase.)
The hobby expenses in items 2 and 3 above may be deducted only as itemized deductions on Schedule
A, line 23. Hobby income is reported on the return as other income on Form 1040, line 21.
Nondeductible Expenses
The IRSspecifically states that certain expenses are not deductible on the Schedule A. Some examples
of nondeductible expenses include:
Funeral expenses.
Repairs and improvements to a personal residence.
The cost of personal-use property (vehicles, furniture, and appliances, for example).
Homeowners or renters insurance.
Nonbusiness license fees (driver, pet, hunting, and fishing, for example).
Fines and penalties (for traffic violations, for example).
Personal legal expenses, except those paid to obtain taxable income.
mExample: Betty Dawson paid her lawyer the following amounts during 2014:
$5,000
650
2,200
Representation during her divorce

Preparation of a new will
Assistance in obtaining alimony
Betty may deduct the $2,200 because she spent it attempting to secure taxable income. The remaining
expenses are not deductible.m
For more information on nondeductible expenses, see IRS Publication 529, Miscellaneous Deductions.
OTHER MISCELLANEOUS DEDUCTIONS

Two kinds of miscellaneous deductions are available on Schedule A, those subject to the 2%-of-AGI
floor and those not subject to the 2%-of-AGI floor. Lets now look at those miscellaneous itemized
deductions not subject to the 2%-of-AGI floor. Expenses that fall into this category include:
Gambling losses to the extent of winnings included on Form 1040, line 21. Gambling losses include
amounts paid to charitable organizations for lottery and raffle tickets, bingo, and other games of
chance, as well as amounts lost in other forms of gambling.
Impairment-related work expenses for handicapped individuals.
Federal estate tax on income in respect of a decedent.
Unrecovered cost of a decedents pension or annuity.
Repayments of certain types of income more than $3,000 under a claim of right.
Casualty and theft losses from income-producing property from Form 4684, Section B.
Amortizable bond premiums on bonds acquired prior to October 23, 1986.
Miscellaneous itemized deductions not subject to the 2%-of-AGI floor are identified and entered on
Schedule A, line 28. In this course, only gambling losses are discussed. If you encounter any of the
other itemized deductions discussed, you will need to do additional research. A good place to start
would be IRS Publication 529, Miscellaneous Deductions.
Gambling Losses to the Extent of Winnings

The taxpayer is required to report the full amount of their gambling winnings as income on Form
1040, line 21, and the taxpayer can claim their losses (up to the amount of their winnings) as an
itemized deduction on Schedule A. It is ever appropriate to net winnings with losses. Taxpayers who
deduct gambling losses should be advised to keep an accurate diary or similar record of their losses
and winnings. The diary should contain at least the following information:
The date and type of 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 amounts the taxpayer won and lost.
In addition to a diary, the taxpayer should also have other documentation. The taxpayer can generally prove their winnings and losses through Forms W-2G, wagering tickets, canceled checks, credit
records, bank withdrawals, and statements of actual winnings or payment slips provided by the gambling establishment.
The taxpayer would not need to present all of this documentation to the Tax Professional to prove
their deductions, but as a Tax Professional, you should inform the taxpayer that the IRS requires
extensive documentation to substantiate the taxpayers gambling losses.
ITEMIZED DEDUCTION PHASEOUT

Under the American Taxpayer Refund Act of 2012 (ATRA), itemized deductions are subject to an overall limit based on the taxpayers adjusted gross income(AGI). For 2014, the phaseout amounts are:
$305,050 Married filing jointly and qualifying widow.
$254,200 Single.
For taxpayers who exceed these thresholds, their itemized deductions are reduced by the lesser of:
3% of the excess of their AGIover their threshold amount.
80% of the amount of their total itemized deductions before considering the overall limit, and
excluding itemized deductions that are not subject to the itemized deduction phaseout.
The itemized deductions that are not subject to the itemized deduction phaseout include the following:
Medical expenses.
Investment interest.
Casualty and theft losses.
Gambling losses.
To calculate the itemized deduction phaseout, the taxpayer would complete the Itemized Deduction
Worksheet Line 29 found in the Schedule A instructions.
ALTERNATIVE MINIMUM TAX

Deductions can add up, and as you will see, certain large deductions can cause the Alternative
Minimum Tax (AMT) to apply to the taxpayer. Therefore, we will briefly discuss the AMT, so you are
aware that large itemized deductions can trigger AMT and you will be able to explain this to your
clients.
The purpose of the AMT is to ensure that taxpayers with higher income levels cannot entirely avoid
income taxes by claiming certain deductions and credits. Taxpayers subject to the AMT must calculate
both the regular tax and the AMT, then pay whichever amount is greater. Form 6251, Alternative
Minimum Tax Individuals, is completed to support any amount reported as AMT on Form 1040, line
45. See Illustrations 15.4 and 15.5.
Taxpayers may be subject to the AMT if their taxable income for regular tax purposes, combined with
certain credits and deductions, is more than:
$82,100 if filing status is married filing jointly (or qualifying widow(er) with dependent child).
$52,800 if filing status is single or head of household.
$41,050 if filing status is married filing separately.
The following common scenarios may trigger the AMT (this list is not all-inclusive):
A large number of exemptions are claimed on the return.
Itemized deductions with a large deduction for taxes (very common in areas with high state or local
taxes).
Itemized deductions with large deductions for miscellaneous deductions subject to the 2%-of-AGI
limitation (very common on returns claiming large amounts for unreimbursed employee business
expenses).
Credit for Prior-Year Minimum Tax

A credit for a prior years AMT may be claimed against regular tax in future years if the taxpayer
qualifies. Form 8801, Credit for Prior Year Minimum Tax Individuals, Estates, and Trusts, is used
to support this credit when it is claimed on line 53, Form 1040.
The Alternative Minimum Tax is an advanced topic. You will not be required to complete a Form
6251 or 8801 for any exercises, quizzes, or exams.
ax Tip Knowing that a credit might be claimed for having paid AMT in a
prior year is another reason why it is important for new clients to bring in
last years return.
RECOVERY OF A PRIOR YEARS ITEMIZED DEDUCTION

Generally, if a taxpayer recovered all or part of an amount of an item deducted or took a credit for it
in a prior year, all or part of the amount recovered may be taxable income in the year received. The
most common recoveries are refunds, reimbursements, and rebates of itemized deductions.
State and local income taxes, medical expenses, and casualty or theft losses are all examples of itemized deductions that might be deducted in one year and recovered, in part or in full, in a later year.
State income tax refunds are, by far, the most common recovery.
The IRS states that a taxpayer must include a recovery in their income in the year the taxpayer
received the recovery, up to the amount by which the deduction or credit the taxpayer took for the
recovered amount reduced their tax in the earlier year.
If the taxpayer took itemized deductions in the year in which the itemized deduction recovery applies,
the recovery generally is taxable (or partially taxable) based on the amount of the tax the recovery
reduced in the prior year. This makes sense, because the deducted amount, reported on Schedule A,
reduced taxable income for the year deductions were itemized; so when some of the deducted amount
is refunded to the taxpayer, the recovery increases taxable income because it reduced taxable income
in the prior year.
The IRS Recoveries of Itemized Deductions Worksheet, in Illustration 15.7, will assist you in computing the taxability of itemized deduction recoveries. This worksheet is located in IRS Publication 525,
Taxable and Nontaxable Income.

Illustration 15.4

Illustration 15.5
Partially Taxable
A state income tax refund (or any other itemized deduction that is recovered in a later year) is taxable only to the extent that the deduction reduced taxable income in the earlier year. The taxpayer
may receive a Form 1099-G showing the amount of the state income tax refund. An example of Form
1099-G is shown in Illustration 15.6. However, being a recipient of a 1099-G is not an indication of
whether the refund is taxable. The major clue to when a recovered amount is taxable is whether or
not the taxpayer claimed the expense as an itemized deduction in a prior year, but there are other
circumstances that may apply. For more information on those situations, you may want to read about
recoveries on page 90 of IRS Publication 17.
If the taxpayer did not itemize deductions for the year in which the refund applies, the amount is not
taxable.
To help determine the taxability of state income tax refunds, BlockWorks produces a State and Local
Income Tax Refund Worksheet. This worksheet is shown in Illustration 15.8. This worksheet will only
calculate the portion of 2013 state tax refunds received in 2014. If the taxpayer receives state income
tax refunds for other tax years, the taxpayer should prepare the IRS Recoveries of Itemized Deductions
Worksheet.
In most states, a taxpayer has the option to deduct either:
State and local income tax.
State and local sales tax.
mExample: Omar Kahlil is single. His 2013 federal itemized deductions totaled $6,225, of which he
claimed $1,230 of state income taxes paid in 2013. Omar lives in a state that does not have state or
local sales tax. He filed his tax returns on February 26, 2015, and on March 14, he received his $275
state income tax refund. His Form 1099-G is shown in Illustration 15.6.
The single standard deduction for 2013 was $6,100. By itemizing deductions on his federal return,
Omar reduced his taxable income by $125 [$6,225 $6,100 = $125]. Therefore, only $125 of his $275
state income tax refund is taxable in 2014. Omars BlockWorks State and Local Income Tax Refund
Worksheet is shown in Illustration 15.8.m
Taxable refunds of state and local income taxes from a prior year are entered on Form 1040, line 10.
Taxable recoveries of other prior-year itemized deductions are entered on Form 1040, line 21.
If a taxpayer receives a state tax refund and chooses to deduct state and local income taxes as an itemized deduction in the prior year, then the refund is taxable only to the limit of the excess of the tax the
taxpayer chooses to deduct for the prior year over the tax they did not choose to deduct for that year.
mExample: Irene Cavanaugh filed head of household. Her 2013 federal itemized deductions totaled
$9,400, of which $850 was state income tax. Her available sales tax deduction was $675. She filed her
tax returns on March 1, 2014. On March 22, she received her $700 state income tax refund.
The head of household standard deduction for 2013 was $8,950. By itemizing on her federal return,
Irene reduced her taxable income by $450 [$9,400 $8,950]. Therefore, only $450 of her $700 state
income tax refund is taxable in 2014.
However, Irene could have chosen to deduct her sales tax instead of her state income tax, and her
itemized deductions would have totaled $9,225 [$9,400 $850 + $675 = $9,225], and her state income
tax refund would be nontaxable. Therefore, the maximum refund Irene will include in income is $175
[$850 state income tax $675 state sales tax = $175].m
When a taxpayer chooses to deduct state and local income taxes as an itemized deduction in the prior
year and then receives a state income tax refund, the taxpayer may end up deferring their federal
income tax to the next year.
Illustration 15.6
mExample: Jeff, who is in the 25% federal tax bracket, had $1,000 state income tax withheld during
2013. He made no other payments. His available sales tax deduction from the Schedule A instructions
is $800. At first glance, it would appear that the state income tax deduction will save him $50 more
in tax than if he claimed the state sales tax deduction [$1,000 $800 = $200 2 25% = $50].
However, after completing his state return, Jeff finds that he will receive a $300 state refund, all or
part of which may be taxable in 2014 if he deducts state income tax in 2013. Thus, if he is again in
the 25% bracket in 2014, the state refund could increase his federal tax by $50. So by Jeff claiming the
state income tax in 2013, he pays $50 less in federal tax in 2013. However, he may end up deferring
the $50 of 2013 federal income tax to 2014. If Jeff uses the state sales tax in 2013, he pays $50 in
federal tax in 2013 and will not have to include his refund in income for 2014.m
Another factor to consider is how your state treats the sales tax deduction. Some states do not allow
taxpayers to include their state and local income taxes as part of the states itemized deduction, but
will allow the taxpayer to include the sales tax deduction in the states itemized deductions.
mExample: Jim had $1,000 state income tax withheld from his pay during 2013. He made no other
payments. His available sales tax deduction from the Schedule A instructions is $850. He is in the
15% federal tax bracket and the 5% state tax bracket.
If he chooses to deduct the state and local income taxes, he would have a savings of $150, all on his
federal return since the income tax paid cannot be used on the state return. If he chooses the $850
general sales tax, he would have a savings of $127.50 [$850 2 15% = $127.50] on his federal return
and $42.50 [$850 2 5% = $42.50] on the state return for a total savings of $170. The savings of $170
is the greater, so he should choose to use the general state and local sales tax on his tax return.m
Your instructor will provide specific information regarding your state. Once again, it is important to
examine all the options.

Illustration 15.7

Illustration 15.8
SUMMARY
In this book, you learned:
Unreimbursed casualty and theft losses on personal-use property are deductible, subject to reductions of $100 per incident and 10% of AGI for all losses during the year. Form 4684 is used to report
casualty and theft losses.
Miscellaneous itemized deductions subject to the 2%-of-AGI limitation include most employee business expenses, fees for financial and tax advice, tax preparation and electronic filing fees, investment expenses, safe-deposit box fees if the box contains items held for investment, and qualified
job-seeking expenses.
Work-related transportation expenses may be deducted using Form 2106 (or 2106-EZ). For 2014,
the standard mileage rate is 56 per mile.
The cost of education that maintains or improves the skills required by the taxpayers present job
or meets the requirements of the law or the employer for maintaining the taxpayers present salary
or position is deductible.
Job-seeking expenses are deductible if they were incurred while attempting to obtain a new job in
the taxpayers current occupation.
Gambling losses to the extent of gambling winnings are deductible.
Higher income taxpayers can be impacted by the Alternative Minimum Tax.
Refunds of amounts previously deducted from taxable income are generally taxable in the year
received.
Suggested Reading
For further information on the topics discussed in this book, you may wish to read the following chapters in IRS Publication 17, plus the other IRS publications listed below:
Chapter 25, Nonbusiness Casualty and Theft Losses.
Chapter 26, Car Expenses and Other Employee Business Expenses.
Chapter 28, Miscellaneous Deductions.
IRS Publication 525, Taxable and Nontaxable Income.
IRSPublication 529, Miscellaneous Deductions.
16
OVERVIEW
This entire chapter is devoted to the BlockWorks Practice Session 2. This practice session will help
you to become familiar with the preparation of taxpayers income tax returns in the BlockWorks software as well as develop your tax interview skills at the tax desk. The practice case studies are set up
as roleplays to give you the experience of interviewing a client. This will help you start thinking of
ways you will ask questions to conduct a thorough tax interview that results in an accurate tax return.
INSTRUCTIONS
To complete the BlockWorks Practice Session 2, you will spend the first hour of class discussing state
chapter material. Your instructor will provide you with guidance as to which state chapters your class
will be discussing.
Next, you will spend one hour completing ITC chapter case study returns in the BlockWorks software. Your instructor will provide you with guidance as to which chapter case studies you enter into
BlockWorks.
Last, you will complete case studies 16.1 and 16.2 in the BlockWorks software. The case study return
information can be found in your workbook starting on page W16.1. The case studies are set up in
your workbook as an interview with a taxpayer at the tax desk. To complete these case studies, you
will need to partner with another participant in class. One individual will play the role of the Tax
Professional, and the other individual will play the role of the taxpayer. Each case study in your workbook is set as two scripts, the Tax Professional and the taxpayer. Use the script associated to your role
to ask or answer questions and complete the case study returns in the BlockWorks software.
16.1
17
Self-Employment Income
OVERVIEW
In this course, you learn how to prepare tax returns for self-employed people. You will use Schedule C,
Profit or Loss From Business, to determine the net profit or loss from a business. Here we concentrate
on the more detailed Schedule C, though the less detailed Schedule C-EZ may be used in some cases.
Schedule C is based on a simple formula: gross receipts (the money taken into a business) minus
expenses equals net profit or loss.
Also, in this course, you learn about Schedule SE, the form used by sole proprietors to compute their
self-employment tax.
OBJECTIVES
Determine business income.
Determine business expenses.
Complete Schedule C to determine net business profit or loss and carry the appropriate entries to
Form 1040 and Schedule SE.
Complete Schedule SE to determine the self-employment tax and the corresponding adjustment to
income and enter both the tax and the adjustment on Form 1040.
Identify when self-employment income requires Schedule F.
Explain the tax treatment of a sole proprietors own health insurance premium payments.
Determine if a taxpayer has qualified home-office expenses.
TAX TERMS
The following definitions may be helpful to you as you work through this course:
At-risk rules. Special rules limiting the taxpayers deductible business, partnership, S corporation,
or real estate loss to cash invested plus debt he is legally obligated to pay and the adjusted basis of
any property contributed.
Cost method of inventory valuation. Valuing inventory purchased during the year at cost; that
is, the invoice price less any discounts plus transportation or other costs incurred in acquiring the
merchandise.
17.1
Cost of goods sold. Beginning inventory plus direct purchases, direct labor costs, and overhead costs
less withdrawals for personal use and ending inventory. Sole proprietors compute their cost of goods
sold in Part III of Schedule C (Form 1040).
FICA. FICA (Federal Insurance Contributions Act) The law that provides for social security and
medicare benefits. This program is financed by payroll taxes imposed equally on the employer and
employee. For 2014, the employer is required to withhold 1.45% from each employees gross wages for
medicare tax and 6.2% of each employees wages up to $117,000 for social security tax.
Hybrid method of accounting. A combination of accounting methods, usually of the cash and
accrual methods.
Independent contractor. A taxpayer who contracts to do work according to his own methods and
who is not subject to control except as to the results of such work. An employee, by contrast, is subject
to the control of the employer as to the methods to be used to obtain the desired results.
Inventory. A list of articles of property. For income tax purposes, inventory refers only to a list of
articles comprising stock in tradearticles held for sale to customers in the regular course of a trade
or business. The cost of goods sold during the year is determined by adding to the inventory at the
beginning of the year the purchases during the year, and subtracting from this sum the inventory at
the close of the year.
Lower of cost or market method of inventory valuation. Inventory valuation considering the
actual cost or the replacement cost of merchandise on the inventory date. The lower value is used,
creating a reduced gross profit for the period in which the decline occurred and an approximately
normal gross profit is realized during the period in which the item is sold.
Partnership. A form of business in which two or more persons join their money and skills in conducting the business as co-owners. Partnerships are treated as a conduit and are not subject to taxation.
Various items of partnership income, expenses, gains, and losses flow through to the individual partners and are reported on their personal income tax returns.
Proprietorship. A business controlled and operated by one person.
Self-employed individuals. Taxpayers who work for themselves. They decide when, how, and
where to work, obtain their own jobs or sales, pay their own expenses, and receive social security and
medicare coverage through payment of self-employment tax.
Statutory Employee. A worker who is treated as an employee for social security and medicare tax
purposes and as self-employed for income tax purposes. The Statutory employee box on such a workers Form W2 should be marked.
THE SOLE PROPRIETOR

Self-employed individuals are their own bosses. They decide when, how, and where to work, obtain
their own jobs or sales, pay their own expenses, and receive social security and medicare coverage
through payment of self-employment tax.
In this course, we discuss in detail the sole proprietorship, which is a business owned by one individual, who files Form 1040 that reports net profit or loss from Schedule C. Schedule C (or C-EZ) is
completed by all sole proprietors, except farmers. Schedule F is used exclusively by farm proprietors.
Farmers have a separate schedule because of their specialized income and expenses. A separate
Tax Essentials Self-Employment Income 17.3
Schedule C (or C-EZ) must be completed for each business. An individual may have more than one
business, or each spouse may have their own business.
If a taxpayer and spouse own and operate a business, even if there is no formal partnership agreement
between them, a partnership exists and Schedule C may not be used. Instead, the partnership must
file Form 1065, U.S. Return of Partnership Income. There are two exceptions to this rule:
If a taxpayer and spouse wholly own an unincorporated business as community property under the
laws of a community property state, the business may be treated as a sole proprietorship.
If the taxpayer and spouse materially participate (see Schedule C, line G, on page 1.5) as the only
members of a jointly owned and operated business and they file a joint return, they can make a
joint election to be taxed as a qualified joint venture. A Schedule C (or C-EZ) must be prepared for
each spouse, reporting their respective amounts of income, loss, and deductions.
A proprietor does not receive a salary, and therefore cannot issue a Form W-2 or withhold and pay
payroll taxes on amounts they withdraw from the business for their own use. This is true even if they
think of certain amounts as wages. Net profit or loss is the correct term to describe the results of
each business activity.
A proprietor who employs their own workers must withhold payroll taxes and remit them to the
taxing agencies as well as prepare Forms W-2 and furnish them to their employees and to the taxing
agencies.
A proprietor files a Form 1040-ES, Estimated Tax, to pay their own estimated income and self-employment (SE) tax liability.
ACCOUNTING PERIODS
When a self-employed taxpayer prepares a statement of income and expenses, generally their income
tax return, they must use their books and records for a specific interval of time called an accounting
period. The annual accounting period for a taxpayers income tax return is called a tax year. The
taxpayer is allowed to use of one of the following tax years when preparing their income tax return.
Calendar tax year.
Fiscal tax year.
Unless the IRS or income tax regulationsrequire a taxpayer to use a specific tax year, the taxpayer
will adopt their tax year by filing their first income tax return using the tax year they desire.
Calendar tax year is an annual accounting period made up of 12 consecutive months beginning
January 1 and ending December 31.
Taxpayers are required to adopt a calendar year if any of the following circumstances apply to the
taxpayer:
The taxpayer does not keep books.
The taxpayer has no annual accounting period.
The present tax year the taxpayer is using does not qualify as a fiscal year.
The taxpayer is required by the IRSor income tax regulations to use a calender year.
Fiscal tax year is an annual accounting period that consists of either 12 consecutive months ending
on the last day of any month except December or a 5253-week tax year that varies from 52 to 53
weeks, but does not have to end on a last day of a month.
If the taxpayer makes the fiscal tax year election, they are required to maintain their books and
records as well as report their income and expenses based on the fiscal year adopted. For more information on a fiscal tax year, including a 5253-week tax year, see IRSPublication 538, Accounting
Periods and Methods.
Change in tax year. Once a taxpayer has chosen their tax year, generally they are required to
seek IRSapproval before they are allowed to change their tax year. Generally, a taxpayer must file
Form 1128, Application To Adopt, Change, or Retain a Tax Year, along with a user fee to request
IRSapproval to change their tax year. The IRSdoes provide specific exceptions in which a taxpayer
may change their accounting period without filing Form 1128. For more information about these
exceptions available, see the instructions for Form 1128.
SCHEDULE C, THE HEADING

Refer to Schedule C, shown in Illustrations 17.117.2, as we examine Schedule C. The heading
requests information about the business. The following explanations will help you complete this portion of the form.
Principal business or profession is the business or professional activity that provided the principal source of income. Give the general field or activity and type of product sold or produced or client
served. Examples are retail sales of household products and preparation of tax returns for individuals.
Business code is a number taken from the IRS list, reproduced at the end of the textbook.
Business name and address. Use the actual name of the business, or, if there is no business name,
leave line C blank. The business address on line E is the address from which the business is conducted. Enter the street address (including suite or room number), city, state, and ZIP, not a post office
box number. Line E may be left blank if the taxpayer conducted the business from their home and
that address is the address shown on Form 1040.
Employer ID number (EIN). Many self-employed taxpayers are not required to obtain an EIN. A
sole proprietor needs an EIN if they have employees, a qualified retirement plan or are required to file
employment, excise, alcohol, tobacco, or firearms returns, or are a payer of gambling winnings. The
proprietor may obtain an identification number by filing Form SS-4, which is available from the IRS.
Accounting method. The most common methods of accounting are the cash and accrual methods.
Under the accrual method of reporting income, total sales and total charges for services in the tax
year are included in income, even though payment may be received in another tax year. Under the
cash method, only income actually or constructively received during the tax year is included.
Sole proprietors who produce, purchase, or sell merchandise in their businesses generally must use
the accrual method of accounting for their inventories and gross receipts. They may use the cash
method for their operating expenses. This mixed use of accounting methods is called a hybrid method. Qualified taxpayers may choose to use the cash method of accounting for every aspect of their
businesses.

Illustration 17.1

Illustration 17.2
Line G. A proprietor materially participates when they are involved in the business in a substantial
way on a regular basis. The answer to this question is important because if the proprietor does not
materially participate, any loss from the business is considered a passive loss and, generally, can only
be deducted currently against passive income. A full discussion of material participation can be found
in IRS Publication 925, Passive Activity and At-Risk Rules.
Line H. Mark this box if the business was started or acquired during the tax year, or if the business
is reopening after a temporary close and no Schedule C (or C-EZ) was filed the previous tax year.
Lines I and J. The boxes on both lines refer to whether the proprietor made any payments related
to the business that would require filing Form 1099.
SCHEDULE C, PART I, INCOME

Gross receipts include the gross amount of cash and credit receipts and the fair market value of any
property and services the proprietor receives in exchange for the goods or services they sell. Depending
upon the type of business, the proprietor may receive one or more Forms 1099MISC, reporting some
or all of the income they have made from self-employment. This income should be included as part of
their gross receipts.
mExample: Roberta Stanton delivers newspapers as an independent contractor for the Your City
Daily News. She receives her share of the profits directly from the newspaper, which handles all subscription and billing activities. Robertas Form 1099-MISC is shown in Illustration 17.3. Roberta will
report the income shown in box 7 on line 1 of her Schedule C.m
Roberta will have expenses to deduct from her income, the largest of which probably will be her automobile expenses. We discuss deductible transportation expenses in a later course.
Do not include retail sales taxes imposed on the buyer that are collected by the proprietor and passed
onto state or local taxing authorities. Also, do not include these sales taxes as a tax expense. Certain
taxes may, however, need to be entered on other lines of Schedule C, as you will soon discover.
Keep in mind that if the accrual method is being used for gross receipts, accounts receivable must
be included in income, even if they are not collected by the end of the year.

Illustration 17.3
Returns and allowances are amounts included in gross receipts that were refunded to customers who returned merchandise for refund or who were given a partial refund because they received
damaged merchandise or for other similar reasons. These amounts are subtracted from gross
receipts.
Cost of goods sold. If the taxpayer produces, purchases, or sells merchandise to produce income for
the business, the taxpayer must complete Part III on page 2 of Schedule C to compute their cost of
goods sold or manufactured.
Gross profit, in Part I, is gross receipts minus returns and allowances and cost of goods sold.
Other income includes income from sales of scrap, interest received on customer accounts receivable,
and other kinds of miscellaneous income received by the trade or business. If the taxpayer is permitted to retain a portion of state or local sales taxes collected, that amount is entered here.
Note: Certain small business taxpayers who produce, purchase, or sell merchandise in their businesses may use the cash method of accounting for every aspect of their businesses, including their inventories. The main advantage to this method is that these businesses do not need to include accounts
receivable in income until they are collected. But even with the new rules, the taxpayer may only
deduct the cost of goods sold. A proprietor cannot stock up on merchandise that remains unsold and
deduct the cost at the end of the year.
In this course, we will use the hybrid method of accounting (accrual for inventory and receipts, cash for
expenses) for all business taxpayers with inventories. If you want more information about using the
cash method for inventories, obtain a copy of IRS Publication 538, Accounting Periods and Methods.
Schedule C, Part III

Method(s) used to value closing inventory. The two most common methods of valuing inventory
are cost and lower of cost or market.
The cost method is different, depending on if the proprietor is a merchant or a manufacturer. For
merchants, the cost method usually involves pricing merchandise, at the time of purchase, at the
invoice price less appropriate discounts plus transportation or other charges incurred in acquiring the
goods. To value merchandise on hand at the beginning of the tax year, the cost is the ending inventory
price of the goods from the preceding tax year. For merchandise purchased during the year, the cost
is the invoice price less any discounts plus transportation and other charges (specific cost identification method). For manufacturers who produce merchandise during the year, the cost method is equal
to all the direct and indirect costs associated with the creation of the item. The manufacturer would
include the total cost of raw materials, on hand and purchased during the year, that are used to create
the product, plus the total cost of merchandise in work in process, and the total cost of finished goods
sitting in storage and waiting to be sold.
In using the lower of cost or market method, a comparison is made, at inventory time, of the market
value of each merchandise item and its cost. The lower of the two is used as its inventory valuation.
Taxpayers who use the cash method of accounting must use the cost method to value their inventory.
Beginning inventory is usually the same as the ending inventory from the preceding tax year. Any
difference should be explained. The beginning inventory for a manufacturer includes the total value
of raw materials, work in process, finished goods, and materials and supplies used in manufacturing
the goods. For merchants, the beginning inventory consists of the cost of merchandise held for sale.
Purchases for manufacturers include the cost of raw materials and parts purchased for manufacture into finished products. Purchases for merchants are all merchandise bought for resale. The cost
of purchases is the total amount actually spent; that is, the stated price minus any quantity and
prompt-payment discounts. Note that, if the accrual method is used, purchases are an expense for the
year incurred, even if paid in a later year (e.g., taxpayer purchases merchandise on account).
The cost of merchandise from current-year purchases that is withdrawn for personal or family use is
subtracted from the cost of purchases in Part III, line 36.
Labor costs are usually included in the cost of goods sold only for manufacturing or mining businesses. Merchants usually do not incur labor costs that can properly be charged to cost of goods sold. Labor
costs included here involve the necessary work to make the final product saleable.
Materials and supplies are such things as hardware and chemicals used in the manufacturing
process.
Other costs include amounts spent for containers and packages that are an integral part of the product being manufactured, freight-in for raw materials, supplies used in production, and merchandise
purchased for sale. If an expense incurred is related to both the cost of goods sold and an operating
expense, it should be prorated, and the portion of the expense is properly claimed for each category.
Ending inventory is the inventory on hand at the end of the year. A physical inventory count should
be taken at the end of each accounting period.
Cost of goods sold is the beginning inventory plus purchases and other direct cost of goods minus
the ending inventory.
SCHEDULE C, PART II, EXPENSES

Operating expenses are the ordinary and necessary expenses of conducting a business, trade, or profession. These expenses are deducted on Schedule C, Part II. We will discuss them in the order they
appear on the form.
When self-employed taxpayers are determining deductible operatTing expenses,
they should maintain records to substantiate business use
ax Tip:
of assets that have both business and personal use. Common assets that have
both business and personal use include, but are not limited to, cars and trucks,
computers, and cellular phones.
Advertising. These are expenses to promote the business, including newspaper ads, flyers (including
the cost of distributing them), television and radio promotions, Internet banners, and business cards.
Car and truck expenses. Actual car and truck expenses are deducted on line 9 (except depreciation,
which goes on line 13, and lease payments, which go on line 20a). Alternatively, the standard mileage
rate allowance may be claimed on line 9 if the taxpayer meets certain qualifications. If the taxpayer
used the standard mileage rate for the first year the vehicle was placed into service, either method
may be used in subsequent years. But if the actual expense method was used in the first year, it must
be used for all years that the vehicle remains in service. Part IV on the second page of Schedule C
requests information about the vehicle used in the business.
Commissions and fees. Amounts paid to other individuals or businesses for services and not included on any other line of Schedule C are deducted here. Do not enter wages or benefits paid to the taxpayers employees or any amounts paid to independent contractors or subcontractors who worked for
the taxpayer.
Contract labor. These payments are the compensation paid to independent contractors and subcontractors (non-employees) for services rendered. The proprietor should provide a Form 1099-MISC to
any independent contractor who worked for him and earned $600 or more. The distinction between
an independent contractor and an employee is an important one, because the proprietor is required
to withhold various payroll taxes for an employee. We do not cover all the factors that go into making
this determination in this course, but IRS Publication 15-A provides considerable information on this
topic.
Depletion. The only properties subject to depletion are oil or gas wells, exhaustible natural deposits,
and timber.
Depreciation. Depreciation is the annual deduction allowed to recover the cost or other basis of business property with a useful life of more than one year. If, for example, a proprietor buys a computer
for use in their business, they generally do not deduct its full cost in the year of purchase. Rather,
they deduct a portion of the cost every year for a number of years. The process is called depreciation.
Depreciation is discussed in the Tax Essentials: Depreciation course.
Employee benefit programs. Amounts contributed by an employer to employee fringe benefit programs are deductible. Contributions to employee benefit programs include those to education, recreation, health, dependent care, and adoption assistance programs.
Insurance (other than health). Premiums paid to protect the business against losses are deductible as an operating expense. Regardless of whether the cash or accrual method of accounting is used,
advance payments may be deducted only in the year to which they apply. Types of insurance for which
premiums are deductible include fire, theft, flood, merchandise and inventory, credit, workers compensation, business interruption, errors and omissions, disability (for employees), malpractice, and
product liability. Vehicle insurance, if the standard mileage allowance is not claimed, is deducted on
line 9 along with other car and truck expenses.
Mortgage interest (paid to banks, etc.). Use this line to deduct the interest portion of mortgage
payments made to financial institutions on real property used in the business and for which the taxpayer received a Form 1098. However, if the business is located in the taxpayers home, the qualified
business portions of mortgage interest, real estate taxes, rent, and utilities are entered on line 30 after
they are computed on Form 8829, Expenses for Business Use of Your Home.
Other interest. This category includes interest on business indebtedness other than mortgage interest reported on line 16a. Include finance charges on business loans and credit card purchases.
Any interest, including mortgage interest, that is paid in advance must be deducted only in the year
to which it applies.
Legal and professional services. These expenses include attorney, accounting, and other professional fees that are ordinary and necessary to conduct business and expenses for the preparation of
tax forms related to the business.
mExample: Glenn Ippolito opened a new business in 2014. On April 6, 2015, he had H&R Block
prepare his 2014 tax return, which included Schedules C and SE. The fees for those schedules will
be deductible on line 17 of his 2015 Schedule C. The remainder of his tax preparation fees may be
deducted in the usual manner on Schedule A, if he itemizes.m
Office expense. This category includes consumable office supplies such as pads, pens, pencils, order
books, receipt books; supplies for computers, printers, calculators, cash registers, and copy machines;
stamps, express delivery charges, registered or certified mail expenses, and the rental of a postage
meter and post office box; and so on.
Pension and profit-sharing plans. Amounts paid as contributions to pension, profit-sharing, or
annuity plans for employees are deducted here. If the plan includes the sole proprietor, the amount
contributed for the proprietor can be deducted only as an adjustment on Form 1040, line 28.
Rent or lease. Amounts paid are deducted as an operating expense in the tax year for which the
rent is due. Lease payments for assets used in the business are deductible as rent. Enter rent or lease
payments for vehicles, machinery, and equipment on line 20a and all other rent or lease payments,
including that for real property, on line 20b.
Repairs and maintenance. Amounts necessary to maintain business property in an ordinary,
efficient operating condition are deductible. The cost of repairs includes labor, supplies, the annual
portion of the cost of service contracts, and other items incidental to the repair. The cost of repairs
deductible on line 21 do not add value or appreciably prolong the life of the property. The value of
the proprietors labor and the value of unpaid labor of friends and relatives is not deductible. It is
important to distinguish between expenditures for repairs and those for improvements because an
expenditure for an improvement (that is, a capital expenditure) must be added to the basis of the
property and depreciated. A capital expenditure is incurred to increase the value of the asset, increase
the productivity of the asset, prolong the assets useful life, or adapt it to a different use.
tax years before 2014, the determination of whether an expense
Nwas Ina repair
or an improvement was determined by an analysis of facts
ew:
and circumstances, and sometimes resulted in different interpretations by tax

preparers and the IRS. Consistency in this area is important because an item
classified as a repair can be deducted right away, but an item classified as an
improvement cannot be deducted until the property is sold (though it may be
depreciated.
Beginning in 2014, the IRS issued tangible property regulations (TPRs) to provide framework for how to treat costs incurred to acquire, produce, or improve
tangible property. To comply with the regulations, taxpayers may have to make
certain elections with their tax return or file Form 3115, Application for Change
in Accounting Method.
Supplies. Any supplies not included in Part III that are necessary to the proprietors business are
deductible. The taxpayer can deduct the cost of books, professional instruments, equipment, etc., if
they are normally used in the business and have a useful life of less than one year.
Taxes and licenses. Only those taxes that are directly attributable to the trade or business are
deductible. Such taxes may include:
Real estate and personal property taxes imposed on business assets.
State and local taxes imposed on gross income (as distinguished from net income).
Compensating use taxes that are generally imposed on the use, storage, or consumption of an item
brought in from another taxing jurisdiction.
Payroll taxes (see below).
Federal highway use tax.
Sales taxes imposed on the seller of goods or services. (If the proprietor passes these taxes onto the
buyer, however, these taxes should be included here and in gross receipts on line 1.)
Payroll taxes are the taxes that a business must pay on behalf of its employees. They include social
security tax of 6.2% for wages up to $117,000 (for 2014), medicare tax of 1.45% on all wages, and
FUTA (Federal Unemployment Tax Act) tax ranging from 0.8% to 6.0% on each employees wages up
to $7,000. The employer must also withhold a 0.9% Additional Medicare Tax from wages and compensation paid to employees in excess of the following threshold amounts.
MFJ
$250,000
S/HOH/QW
$200,000
MFS
$125,000
Taxes and other amounts withheld from employees wages are not separately deductible because gross
wages, which include amounts withheld from employees, are deducted under wages on line 26. For
clarity, many taxpayers list the employers portion of payroll taxes in the space provided for other
expenses in Part V on page 2 of Schedule C.
Licenses (such as occupational, chauffeur, or building) and regulatory fees paid annually to state and
local governments in connection with the trade or business are also deducted on this line.
Travel, meals, and entertainment. These expenses for a self-employed person are subject to the
same limitations and requirements as those for an employee. Note that generally a 50% limitation
applies to business meals or entertainment expenses. Also, taxpayers who deduct travel, meals, and
entertainment must substantiate these expenses. Records may be maintained in a book of account,
diary, statement of expense, or similar record along with the documentary evidence that supports
each element of the expense. Documentary evidence includes, but is not limited to, such items as
receipts, canceled checks, and invoices marked paid. For more information, see IRSPublication 463,
Travel, Entertainment, Gift, and Car Expenses.
Utilities. This item includes the cost of heat, lights, power, telephone, and Internet access. The taxpayer must allocate between the business-use portion and personal-use portion of such expenses when
separate utility meters are not installed. If the business is located in the taxpayers home, no portion
of the base rate for the first telephone line into the home is deductible. However, if a second line is
added for business purposes, or if extra services, such as call waiting, are added for business reasons,
the business portion of such charges is deductible. Also, long-distance charges incurred for business
purposes are deductible.
Wages. To be deductible, compensation must be an ordinary and necessary expense of carrying on the
business, reasonable in amount, for personal services actually rendered, and actually paid or incurred
during the tax year. Gross salaries, wages, or other compensation paid to relatives (including the proprietors spouse and children) are deductible, provided the above requirements are met.
The cost of meals and lodging furnished to employees is deductible as compensation paid, regardless of
whether the value is taxable to the employees. This is considered a fringe benefit because the employee received this benefit for their performance of services. The value of meals and lodging furnished for
the employers convenience is not included in the employees Form W-2 gross wages. If furnished as
additional employment incentive, the value of meals and lodging is included in the employees Form
W-2 gross wages.
Employment credits. Several credits are available to employers who hire workers from certain
groups or certain areas of high unemployment. If you ever need more information about these credits,
youll find it in IRS Publication 334, Tax Guide for Small Business.
Other expenses. This category covers all ordinary and necessary business expenses not entered on
the other lines of Part II. Examples include bank service charges (such as check-printing fees, night
deposit fees, etc.), bad debts (see below), dues to professional and trade organizations, the cost of business-related publications, and laundry and cleaning expenses for such things as employee uniforms.
All other expenses must be itemized in Part V on the second page of Schedule C and the total from
line 48 entered on line 27a, Part II.
Personal expenses are never deductible as business expenses. If an expense is partly personal and
partly business, only the business portion is deducted on Schedule C. An example of a part-personal,
part-business expense is the fee paid for tax preparation of the previous years return. The portion of
the fee pertaining to the preparation of Schedule C and any other business-related forms would go on
line 17, Schedule C, as mentioned earlier. The balance of the fee would be an itemized deduction on
line 22, Schedule A, and would be subject to the 2%-of-AGI limitation. State and local income taxes on
the net profit from a business are personal expenses and deductible only on Schedule A.
Bad debts are customer accounts receivable and notes receivable determined to be uncollectible. Such
debts are only deductible if the income was previously included in gross income. Cash-method taxpayers ordinarily are not entitled to claim a deduction for business bad debts because sales are not
included in gross income until payment is received.
mExample 1: David Brooks makes and sells custom skateboards. He sold 12 boards to a sporting
goods store in December 2014 for $700. The terms of the sale specified that the merchandise would be
paid for within 60 days. Because he uses the accrual method of accounting for his inventory and gross
receipts, David included the $700 in his income in 2014.
After the customer failed to pay, David exhausted every legal means attempting to collect the money.
Unfortunately, the customer was now bankrupt. By October 2015, David determined that the debt
was uncollectible. He may deduct $700 for the bad debt on his 2015 return. He may also deduct the
expenses of trying to collect the money.m
mExample 2: Sandra Balderson runs a bookkeeping business. In 2014, she performed $300 worth of
work for a client who left town without paying the bill. Because she uses the cash method of accounting, she did not include the $300 in her income because the client had not yet paid. Thus, even though
her client disappeared without paying, she cannot take a bad debt deduction because the $300 was
never included in income.m
Home-office expenses. If a proprietor uses a portion of their home regularly and exclusively as their
principal place of business or as a place to meet customers, they may deduct the expenses of operating
the home office. Such expenses are calculated on Form 8829, Expenses for Business Use of Your Home,
and entered on line 30, Schedule C.
Fringe benefits. If the proprietor provides their employees extra benefits that help to supplement
the employees salary, the proprietor may be able to include the cost of the fringe benefit provided on
their Schedule C in the category in which the cost falls. Examples of fringe benefits include groupterm life insurance coverage, cafeteria plan, employee use of the business car, tickets to entertainment or sporting events, education assistance, etc. Depending on the type of fringe benefit provided
to the employee, the employer may or may not be required to include these costs of fringe benefits in
the employees wages. For more information on fringe benefits, see IRSPublication 334, Tax Guide for
Small Business, and IRSPublication 15-B, Employers Tax Guide to Fringe Benefits.
OTHER SELF-EMPLOYMENT-RELATED TOPICS

While it is important for you to be aware of the topics of direct sellers, at-risk limitation, and net operating loss, these topics will be covered in other intermediate and advanced courses.
Direct Sellers
Direct sellers are individuals who sell consumer products to others on a person-to-person basis other
than at an established retail location. They may sell door to door, through a sales party plan, or by
appointment in customers homes.
Direct sellers and other salespeople often have complex tax situations, to the extent that we cannot
cover them in detail in this course. IRS Publication 334, Tax Guide for Small Business, contains more
information to help you determine which taxpayers qualify as direct sellers and to assist you in the
preparation of their tax returns.
At-Risk Limitation
Read Schedule C, line 32. A net loss is allowed as a subtraction from other income and as a net operating loss (discussed shortly) only up to the amount the taxpayer has at risk. At-risk amounts are
the actual cash invested in the business by the taxpayer and the adjusted basis of other property contributed by the taxpayer to the activity. In addition, the taxpayer is at risk for amounts they borrow
for use in the activity if they are personally liable for the repayment or if they have pledged property
(other than property used in the business) as collateral. This limitation prevents a taxpayer who has
borrowed money through a nonrecourse loan (a loan for which the taxpayer is not personally liable
for the repayment) from deducting from income losses greater than the amount actually invested in
the business activity. If the taxpayer has amounts for which they are not at risk in the activity, Form
6198, At-Risk Limitations, must be completed to determine the allowable loss on Schedule C. Form
6198 is not covered in this course.
Net Operating Loss

Net loss from self-employment that exceeds all other income for the year may create a net operating
loss (NOL). An NOL may be carried back and/or forward to reduce the income in other years. This
would reduce the income tax in those years and result in a refund or reduced income tax liability.
An NOL cannot be used to reduce the amount of self-employment tax owed. If a taxpayer appears
to have an NOL, additional research may be required. For more information on NOL, see both IRS
Publication 334, Tax Guide for Small Business, and IRS Publication 536, Net Operating Losses (NOLs)
for Individuals, Estates, and Trusts.
It is important to note that IRShas safe harbor rules, also called hobby loss rules, for determining if a
taxpayer maintains a business for profit or as a hobby. For the taxpayer to meet the IRS safe harbor
rule, their business generally must produce a profit for three of five consecutive years. If the taxpayer
cannot meet this rule, their business is considered a hobby and they are only allowed to deduct business expenses up to the amount of hobby income. When determining if the taxpayers business is for
profit or a hobby, it is the tax preparers responsibility to apply the hobby loss rules. For information
about the IRShobby loss rules, see IRS Publication 535, Business Expenses.

Illustration 17.4

Illustration 17.5
SELF-EMPLOYMENT TAX
Schedule SE, shown in Illustrations 17.4 and 17.5, is the form used to determine the sole proprietors
social security and medicare taxes. Schedule SE is a two-page form, but we will only be discussing
Section A on page 1 in this course. A flowchart useful for determining which taxpayers must use
Section B is shown just above Section A on the first page of the form. Generally, self-employed taxpayers with net earnings of $400 or more must pay SE tax. Self-employed taxpayers pay SE tax at
the rate of 15.3% on the first $117,000 of self-employment income. Then, the self-employed taxpayer
is subject to the 2.9% medicare tax on wage amounts greater than $117,000. The SE tax computed on
Schedule SE is then reported on Form 1040, line 57. Self-employed taxpayers are allowed to deduct
one-half of their SEtax on Form 1040, line 27. Thus, Schedule SE is unique in that it gives rise to a
tax liability and an adjustment simultaneously. Because the Schedule SEis prepared after the close
of the taxpayers business fiscal year, the self-employed taxpayer may be required to pay estimated
tax payments during the year to avoid an underpayment penalty.
mExample: James S. Dalony has a full-time job at which he earns $30,000. He is also a self-employed
chimney sweep on evenings and weekends. His net self-employment income on his Schedule C (line
31) is $4,216. James is subject to $596 of self-employment tax, but he also receives a one-half self-employment tax deduction of $298. His Schedule SE, page 1, is shown in Illustration 17.4.m
Lines 1a and 1b. Net income or loss from farm operations go on these lines. Farms are not covered
in depth in this course.
Line 2. Net income from self-employment from nonfarm businesses goes here. Net losses also go here
and are enclosed in parentheses. If the taxpayer has more than one business, combine the amounts
from all the taxpayers Schedules C. For example, if a taxpayer had two businesses, one with a net
gain of $10,000 and one with a net loss of $2,000, you would enter $8,000 on line 2. James has just
the one business, so line 2 shows his net profit from line 31, Schedule C.
Line 3. Combine lines 1a, 1b, and 2.
Line 4. Self-employed taxpayers generally pay SE tax at the rate of 15.3% (line 5). Similarly, an
employee and his employer each pay a percentage of the employees gross wages for social security
and medicare taxesthe employee pays 6.2%, and the employer pays 7.65%, for 2014. In an effort to
be more equitable, self-employed taxpayers are allowed to reduce their net income by 7.65% on line
4 before computing their SE tax. The form accomplishes what would otherwise be a two-step process
(multiplying SE income by 7.65% (0.0765), then subtracting the result from SE income) in one step
by instructing us to multiply the SE income on line 3 by 92.35% (0.9235) [100% 7.65% = 92.35%].
If line 4 turns out to be less than $400, the taxpayer is not required to pay SE tax, and they should
not file Schedule SE. As a practical matter, this means there is no need to begin the form if net SE
income is less than $433 [$433 2 .9235 = $399.88]. Of course, any amount of self-employment income
is still entered on line 12 of Form 1040.
Line 5. Follow the appropriate arithmetical directions, depending on the amount shown on line 4.
Jamess amount on line 4 is $117,000 or less, so they multiplied line 4 by 15.3%. The amount on line
5 is carried to line 56, Form 1040.
Line 6. Line 6 is the deduction for the employer-equivalent portion of self-employment tax. It is calculated by multiplying line 5 by 50% (.50). This amount on line 6 is carried to line 27, Form 1040, as
an adjustment to income.
SELF-EMPLOYED HEALTH INSURANCE DEDUCTION

Sole proprietors may deduct on Schedule C the cost of health insurance benefits for their employees.
However, the cost of such insurance coverage for themselves and their families is not considered a
business expense and may not be deducted on Schedule C. Rather, self-employed taxpayers may be
eligible to deduct amounts they pay for medical insurance for themselves and for their families as
an adjustment to personal income on Form 1040, line 29. In order for the taxpayer to qualify for this
deduction, the following requirements must be met:
The taxpayer may not be eligible for coverage under the medical plan of their employer (assuming
they have a job in addition to their self-employment) or their spouses employer.
The plan must be a qualified health plan meeting the benefit and cost sharing standards established under the Affordable Care Act. The taxpayer may either purchase a plan through the
Marketplace, or they may obtain private coverage that meets these requirements. The policy can
either be in the taxpayers name or in the business name.
The self-employed health insurance deduction may not exceed the net income from the self-employment activity under which the plan was established, minus any amounts on Form 1040, lines 27
and 28, that are attributable to the activity.
Note that if the deduction is limited, any remainder may be deducted on Schedule A if the taxpayer
itemizes. However, any amount deducted on line 29 may not be deducted again on Schedule A.
mExample: Ruth Riddie is self-employed and uses the head of household filing status. Her net income
on Schedule C is $3,000. She does not contribute to a retirement plan. She does hold another, parttime job, but she is not eligible for coverage under her employers medical plan. The deduction for the
employer-equivalent portion of her self-employment tax is $212 [$3,000 92.35% 15.3% 50%].
This calculation has to be completed as if Form 1040, line 29, is zero, since that is the amount we are
determining.
During 2014, Ruth paid $300 per month for qualified health insurance to cover herself and her dependent. Her self-employed health insurance deduction is limited to $2,788: the lesser of her net self-employment income $2,788 [$3,000 $212] or her total health insurance premiums of $3,600 [300 12
months]. The amount of $2,788 is entered on Form 1040, line 29, and Ruth may deduct the remaining
$812 [$3,600 $2,788] as a medical expense on Schedule A if she itemizes deductions.m
Self-employed taxpayers may claim the premium tax credit and
Tthe self-employed
health insurance deduction in the same year. However,
ax Tip:
a circular calculation must first be resolved to arrive at both amounts. Why?

Because the self-employed health insurance deduction affects modified adjusted
gross income, which affects the premium tax credit calculation. This, in turn,
affects the self-employed health insurance deduction (because premiums cannot
be used for both tax benefits). This calculation is beyond the scope of this class,
but IRS Publication 974, Premium Tax Credit, includes a series of worksheets
that can be used to arrive at the optimal amounts and resolve the calculation.

Illustration 17.6
HOME-OFFICE EXPENSES
In this section, we will examine the rules for deducting all home-office expenses for the self-employed.
You must be able to recognize when a taxpayer may be able to deduct such expenses before you can
assist them in deducting such expenses.
Who Can Deduct Home-Office Expenses?

Many taxpayers do part of their work at home, but only certain taxpayers are allowed to deduct part
of the operating expenses of their homes as a business expense. The flowchart in Illustration 17.6
will help you determine if a taxpayer is eligible to deduct home-office expenses. There are several key
points outlined on the following page.
1. Is the office used exclusively for business?
Aside from two exceptions mentioned in the next paragraph, all deductible home offices must be used
exclusively for business. This standard is strict, and the taxpayer should make no personal use of the
office at any time. The office may be an entire room or other separately identifiable space, but the
office area does not need to be marked off by permanent partitions. It is recommended that the office
area is furnished with only office furniture or equipment used in the business. It is better not to have
sofas, easy chairs, or televisions in the office, even though such furniture is common in office buildings.
The following are the two exceptions to the exclusive-use test:
The taxpayer uses part of their home for storage of inventory or product samples.
The taxpayer uses part of their home as a daycare facility.
These two exceptions are discussed in more detail in IRSPublication 587, Business Use of Your Home.
2. Is the office used regularly for business?
This standard is less rigid than the exclusive-use test, and common sense should prevail when interpreting it. Generally, the taxpayer must spend substantial amounts of time working in the office on
a periodic basis to meet the test. Usually, this test is easily met if the taxpayer meets the other tests
as described in Illustration 17.6.
Is the taxpayer an employee?
Employees, as opposed to the self-employed, cannot deduct home-office expenses unless the office is
for the employers convenience.
Is the office for the employers convenience?
Many employees bring work home. Even if the place where this work is done is used regularly and
exclusively for this purpose, it does not qualify for the deduction. Only if such work is for the employers convenience, as opposed to the employees convenience, would it qualify. Usually, this means that
the employer does not provide a place where the employee can perform their required duties.
Does the taxpayer meet clients in the office in the normal course of business?
If the taxpayer meets clients, patients, or customers in their home office in the normal course of business, the office qualifies the taxpayer for a deduction. Notice, if the taxpayer meets this test, their
home office does not need to be their principal place of business.

Illustration 17.7
Is the office in a separate structure?

If the office is located on the taxpayers property but is not physically attached to the taxpayers
residence, the office qualifies for deduction if all other tests are met. Having a separate structure for
a home office eliminates the need to demonstrate that the office is the taxpayers principal place of
business.
Is the office the principal place of business?
Each trade or business in which the taxpayer engages can have a principal place of business.
The definition of principal place of business is similar to the definition of tax homethe place where
the taxpayer earns most of their income or spends most of their income-producing hours. However,
if the taxpayer uses their home office to perform necessary administrative or management activities
(such as billing and recordkeeping), then the home office qualifies as the taxpayers principal place of
business. This applies if there is no other fixed location at which they perform these tasks.
Figuring the Deduction

After the taxpayer has determined that they meet the tests to deduct the business use of the home,
the taxpayer has two methods available for determining the deduction: the simplified method and the
actual expenses method.
The simplified method is an alternative to the calculation, allocation, and substantiation of actual
expenses. The taxpayer is allowed to choose each year which method they wish to figure their business
use of the home deduction.
Using the Simplified Method

Under the simplified method, the taxpayer would determine their business use of the home deduction
by multiplying $5, the prescribed rate, by the area of their home used for qualified business use. The
area used to figure the deduction is limited to 300 square feet (sqft).
Note that if the taxpayer uses the simplified method to figure their deduction for the business use of a
home, their mortgage interest, qualified mortgage insurance premiums, real estate taxes, or casualty
losses, subject to limitations, are treated as personal expenses and deducted on Schedule A, if the taxpayer itemizes deductions. No part of any of these expenses can be deducted as a business expense on
Schedule C. The amount of the deductions under the simplified method is limited to the gross income
from the activity minus all other expenses related to the activity, excluding all expenses relating to
business use of the home.
If the taxpayer uses their home for their trade or business and files Schedule C, they will use the
Simplified Method Worksheet, shown in Illustration 17.7, which can be found in the instructions for
Schedule C.
mExample: On January 1, 2014, Johnny Appleton started a painting business that he runs out of
his home. He uses 240 square feet of his home strictly for his business. For 2014, Johnnys tentative
profit reported on Schedule C, line 29, is $9,000. Under the simplified method, Johnny is allowed to
deduct $1,200 for business use of the home office on Schedule C, line 30. Johnnys Simplified Method
Worksheet is shown in Illustration 17.7.m
When determining the simplified method, special rules apply to taxpayers who have part-year use of
their home office or change the area of their home office during the year. For more information on the
simplified method, see IRSPublication 587, Business Use of Your Home.

Illustration 17.8
What Expenses Are Deductible under the Actual Expenses Method?

Deductible home-office expenses, allowed under the actual expenses method, include depreciation of
the home, rent paid, dwelling insurance, utilities, maintenance, and repairs. Expenses for landscaping, lawn care, and the like are not deductible unless a business purpose can be shown, such as use
as a display to potential clients of a lawn-care business.
The home-office deduction for sole proprietors and statutory employees does include qualified home
mortgage interest, real estate tax, and casualty loss. The business portion of these expenses is allowed
as a home-office expense (even if there is a loss on Schedule C). The personal portion of these expenses
is deductible on Schedule A.
Sole proprietors and statutory employees filing Schedule C compute their home-office deduction on
IRS Form 8829 and carry the deduction to Schedule C, line 30.
On Form 8829, you will be computing a limitation that applies to rent, dwelling insurance, utilities,
maintenance, repairs, and other expenses. These deductions are limited to the gross income from the
activity minus all other expenses related to the activity, including the business portion of qualified
mortgage interest, real estate taxes, and casualty losses that we discussed above. This limitation is
computed on Form 8829, lines 815. A second limitation applies to depreciation. This limitation is
computed on Form 8829, lines 1627. Any expenses that cannot be deducted due to the limitations
may be carried over to future years and deducted when the business or employment creates enough
income to absorb them.
FORM 8829
Form 8829 is the form used by sole proprietors who are not farmers and by statutory employees to
determine their home-office deductions. Illustration 17.6 is a flowchart that will help you understand
the business-use-of home deduction.
mExample: Jason Hoyburg is a self-employed writer who uses one room of his home regularly and
exclusively as his writing studio. His Form 8829 is shown in Illustration 17.8.m
we do not include depreciation in this course, it is importTant thatAlthough
you know that because a portion of the taxpayers home is used for
ax Tip:
business, the depreciation table used for Form 8829 is the table for nonresidential real property, not the table for residential rental real property.
Lines 1 through 3. These lines determine the percentage of business use of the home. All businesses
except daycare businesses enter the line 3 percentage on line 7, as Jason did. If the home were used
for business purposes only part of the year, the business percentage would be prorated in the manner
described in the Form 8829 instructions.
Lines 4 through 7. Generally, a portion of the home must be used regularly and exclusively for business if the taxpayer is to qualify for a home-office deduction.
Note: There is an exception to the exclusive-use test for daycare businesses. The portions of the home
used for daycare must still be used regularly for business purposes to qualify for the deduction, but
they need not be used exclusively for business. Lines 4 through 7 are for prorating the use of the home
by hours of daycare use.
mExample: Carol Gordon runs a child-care business in her home. For ten hours per day (220 days
during 2014), the kids she watched had the run of the downstairs portion of the house (50% of the
total area of the home). In the evenings and on weekends, of course, she and her family used the entire
home for personal purposes.
Carol can deduct home-office expenses for the downstairs portion of the house, prorated for the hours
of business use. Note that if Carols business were other than day care, she would have no deductible
home-office expense, because she would fail the exclusive-use test.m
Line 8. Enter the amount from Schedule C, line 29. Line 29 represents tentative income from the
business after all other expenses have been subtracted.
Lines 9 through 15. These are for entering various other expenses that are deductible in the proportion they pertain to the home office. The limitation alluded to on line 10 is the million-dollar limitation
on the deductibility of home mortgage acquisition debt. Jasons expenses are shown and are entered
in the indirect column because they pertained to the whole residence.
Columns A and BDirect and Indirect Expenses. Many lines on the form are divided into columns for direct expenses and indirect expenses. Direct expenses are those that are fully chargeable to
the home office. For example, the cost of painting the interior of the home office and the expense for
electricity if the home office is separately metered and billed are direct expenses. Indirect expenses,
on the other hand, are expenses that cover the entire home and must be prorated to determine the
portion attributable to the home office. For example, real estate tax paid on the whole property would
be entered in the indirect expense column because part of the tax is for the business portion of the
home and part is for the personal portion.
Lines 16 through 21. These involve following the line directions. Jason has a total of $3,000 listed on
lines 16 through 21, and 10% is apportioned to his home office. This $300 will become part of Jasons
home-office deduction. Another limitation comes into play at this point. Depreciation can only be
deducted currently to the extent that it does not exceed the income from the business, less all other
expenses, including the operating expenses shown on lines 16 through 21. Therefore, line 27 shows
the maximum depreciation that could be currently deducted for this home office. In Jasons case, the
limit is so high they do not come close, because his depreciation on line 31 is only $256, compared to
the $44,300 limitation. Any depreciation that might be disallowed by the limitation is carried to the
next year.
Lines 22 through 27. Follow the instructions for each line on the form.
Line 28. Casualty losses in excess of the amount on line 9 are multiplied by the business percentage
of those losses (line 7).
Note: The following lines deal with depreciation, which you will study in the next course. For a basic
awareness, depreciation is a deduction allowed for the reasonable wearing out of an asset.
Line 29. The depreciation for the home is taken from Part III of the form. Part III has most of the
same information as the depreciation worksheet; it is just presented in a different format. If this is
the first year for depreciating the home, Form 4562 is also necessary.
Lines 30 through 32. Follow the instructions for each line on the form.
Lines 36 through 41. The depreciable basis of property converted from personal use to business use
is the lesser of its adjusted basis (generally, the purchase price plus the cost of improvements) or the
fair market value of the property on the date first used for business.
Lines 42 and 43. Follow the instructions for each line on the form.
FARMING INCOME
Determining the profit or loss from a farm is the same formula as that used by a non-farm proprietor:
gross receipts (the money taken into a business) minus expenses equals net profit or loss. However,
because farm returns require the use of some special vocabulary, Schedule F, rather than Schedule C,
is used to calculate the profit or loss of a sole proprietor farmer. Schedule F is shown in Illustrations
17.9 and 17.10.
Farming includes cultivating land; operating dairy farms, fruit farms, nurseries, orchards, poultry
farms, fish farms, plantations, ranches, stock farms, and truck farms; and breeding and raising
fur-bearing animals or laboratory animals. It does not include breeding, raising, or caring for dogs,
cats, or other pets.
While many income and expense items are unique to the business of farming and will require some
explanation, the basic formula is the same as for other businesses: Gross income minus expenses
equals net profit or loss. Schedule F is used to determine the profit or loss from farming.
Schedule F is a two-page form. Part I is used by cash-basis farmers to determine their gross farm
income, and Part II is used by all farmers to report expenses. Part III on the second page is used by
accrual-basis farmers to determine their gross farm income.
Taxpayers who are engaged in a farming business may have the opportunity to calculate the tax on
their farming income by using an averaging method. The taxpayer may be able to average all or some
of their farm income by using tax rates from the three prior years (base years) to calculate the tax on
their farming income. This may give the taxpayer a lower tax rate if their current-year income is high
and their taxable income, which includes income from farming from one or more of the three prior
years, was low. The taxpayer would file Schedule J, Income Averaging for Farmers and Fisherman, to
elect to figure their farming income by averaging and figure their amount of tax. For more information
of income averaging for farmers, see IRSPublication 225, Farmers Tax Guide.
COURSE SUMMARY
In this course, you learned how to:
Determine business income and expenses.
Complete Schedule C to determine net business profit or loss and carry the appropriate entries to
Form 1040 and Schedule SE.
Complete Schedule SE to determine the self-employment tax and the corresponding adjustment to
income and enter both the tax and the adjustment on Form 1040.
Identify when self-employment income requires Schedule F.
Explain the deduction available to sole proprietors who provide health insurance coverage for their
employees.
Determine if a taxpayer has qualified home-office expenses.
Suggested Reading
For further information on the topics discussed in this course, you may wish to read the following
IRSPublication:
IRS Publication 334, Tax Guide for Small Business.
IRSPublication 463, Travel, Entertainment, Gift, and Car Expenses.
IRSPublication 538, Accounting Periods and Methods.
IRSPublication 587, Business Use of Your Home.
IRS Publication 925, Passive Activity and At-Risk Rules.

Illustration 17.9

Illustration 17.10

Illustration 17.11

Illustration 17.12
18
Depreciation
OVERVIEW
Depreciation is an annual deduction that allows the taxpayer to recover the cost or other basis for the
reasonable wearing out of durable assets used in business or held for the production of income. When
an asset, such as a piece of equipment or a building, is purchased for use in business for the production of income, generally the full purchase price is not allowed to be deducted in the year of purchase.
Rather, the taxpayer is allowed to deduct a portion of the propertys cost or other basis over a period
of several years.
OBJECTIVES
Describe the concept of depreciation.
Describe the two systems of depreciation under the Modified Accelerated Cost Recovery System
(MACRS): General Depreciation System (GDS) and Alternative Depreciation System (ADS) method.
Determine when the mid-month, mid-quarter, and half-year conventions apply and which MACRS
depreciation table applies.
Compute depreciation of business-use property using the MACRS GDS method.
Determine which types of assets are listed property and compute depreciation for listed property
using the MACRS ADS method.
Determine which types of assets qualify for a 179 expense deduction, compute the allowable
deduction, and enter it on the tax return.
Determine which types of assets qualify for a special (bonus) depreciation allowance, compute the
allowable deduction, and enter it on the tax return.
Complete Form 4562, when necessary, and enter the depreciation deduction on the associated tax
forms or schedules.
Determine what events trigger depreciation recapture.
18.1
TAX TERMS

Accelerated Cost Recovery System (ACRS).

Adjusted basis.
Alternative straight-line depreciation system (ADS).
Asset.
Business assets.
Business-use property.
Depreciation.
Disposition.
Estimated (useful) life.
General depreciation system (GDS).
General straight-line depreciation system.
Listed property.
Modified Accelerated Cost Recovery System (MACRS).
Personal property.
Real property.
Section 179 expense deduction.
Straight-line depreciation method.
Unadjusted basis.
DEPRECIATION
Depreciation is a deduction that allows the taxpayer to recover a portion of the cost or other basis of
business property or income-producing property each year because the property is subject to deterioration, wear and tear, and obsolescence.
It is important to understand which assets may be depreciated and which may not. Generally, business-use property with a useful life of more than one year is depreciable.
To be depreciable, the property generally must be owned by the taxpayer, and:
Be used in their business or be income-producing.
Have a determinable useful life.
Be expected to last longer than one year.
Properties that are not depreciable include:
Property placed in service and disposed of in the same year.
Personal-use assets, such as a snowblower used only to clear the family driveway.
Equipment used to build capital improvements. (Generally, the cost of equipment is added to the
basis on the property being improved.)
Tax Essentials Depreciation 18.3
Assets with an unlimited or indeterminable life, such as landeven if used in business.

Intangible assets (e.g., patents, copyrights, trademarks, etc.).
Inventory or stock in trade, such as the cars sold on an auto dealership lot.
mExample: In 2014, Marilyn Cole purchased a refrigerator for use in her floral business. Marilyn
will not deduct the full cost of the refrigerator in the year she purchases it. Rather, she will deduct a
portion of the cost of the refrigerator as an expense against her business income each year for several
years. In 2014, Marilyn also purchased a new freezer for personal use in her home. Marilyn may not
claim a depreciation deduction for her new freezer because it is personal-use property.m
Let us take a moment to explain some terminology as it applies to depreciation. Property can be
divided into two types: real and personal. Real property refers to land and buildings. Personal type
property is all property other than real property. Examples of personal property include automobiles,
furniture, tools, machinery, and livestock. Property is also divided into categories of usage: personal-use, investment-use, business-use, or stock-in-trade (inventory).
is important to understand the difference between personal type
TpropertyItand
personal-use property. Personal type property is one of the two
ax Tip:
classifications of property, real or personal. Sometimes this type of property is

commonly referred to as tangible personal property. Personal-use property is all
property (real or personal type) that is used by the taxpayer for personal purposes. It is important to understand that personal-use property is not depreciable because the taxpayer used the property for non-income producing purposes.
When we refer to personal property in the context of depreciation, we mean
personal type property.
Property owned. Generally, the taxpayer owns the property if they have legal title to the property;
have a legal obligation to pay for the property; are liable for property taxes, maintenance, and operating expenses; and the taxpayer has a risk of loss if the property is damaged, destroyed, or condemned.
With regards to leased property, generally the owner (the lessor) can depreciate property they lease
to someone else (the lessee). Depending on how the lease agreement is executed, the lessee may be
able to depreciate the leased property or lease-hold improvements made to the property. If you are
preparing a return for a taxpayer who leases property, additional research may be required. For more
information about depreciating leased property, see IRSPublication 946, How To Depreciate Property.
Useful life. Depreciable property must have a useful life greater than one year. This means that the
property will eventually wear out, decay, become obsolete, or lose its value over time. If the property
has a useful life of less than one year, the cost of the property may be deducted in the year purchased.
Partial business- and investment-use. Depending on the type of asset, the taxpayer may use the
asset for both business or investment purposes as well as personal-use. Two common assets that fall
into this category include motor vehicles and computers. When determining the depreciation deduction for assets used for business/investment purposes and personal purposes, the taxpayer is only
allowed to deduct depreciation based on business- or investment-use. The taxpayer is not allowed
to deduct depreciation for personal activities. Certain assets that may be used for both personal and
business use are called listed property. Listed property is a special class of property and subject to
separate set of tax rules. Listed property will be discussed in more detail later in the course.
For a taxpayer to properly calculate the depreciation deduction for their property, the taxpayer must
answer the following questions:

What is the depreciable basis of the property?

What is the depreciation method for the property?
Is the property considered listed property?
Does the property qualify for the special (bonus) depreciation deduction?
Does the property qualify for the 179 depreciation deduction?
DEPRECIABLE BASIS
As discussed earlier, the depreciation deduction allows the taxpayer to recover a portion of the cost
or other basis in the business property or income-producing property over several years. The taxpayer starts depreciating the property in the year the property is placed in service. The taxpayer stops
depreciating the property either when the taxpayer has fully recovered their cost or other basis in
the property or when the taxpayer retires the property from service, whichever comes first. With that
said, it is essential for the taxpayer to know the depreciable basis of the property so they can correctly
calculate the propertys depreciation deduction and fully recover their basis.
Cost basis. Depreciable basis is the amount the taxpayer has invested in the property. The cost basis
is generally the cost of the property. The cost basis includes the amount of cash paid, debt obligations
incurred or assumed, and/or the fair market value (FMV) of other property or services provided plus
additional costs incurred in acquiring the property. Additional costs may include sales tax, freight
charges, and installation. Note that if a taxpayer purchased property that has an existing debt obligation and they assume the debt, their basis in the property includes the amount paid plus the debt
obligation assumed.
Other basis. Other basis is the basis for property that is received by a taxpayer through a direct
exchange of the same property (like-kind exchange), through payments for services rendered, received
as a gift or inherited, and is calculated based on the method by which the property was received. If you
are preparing a return for a taxpayer who received property as a gift, inheritance, like-kind exchange,
or for services rendered, additional research is required. For more information about determining the
propertys basis, see IRSPublication 551, Basis of Assets.
Adjusted basis. Once the taxpayer has determined the propertys basis, they may have to increase
or decrease the basis based on events that occurred since the time the property was acquired and the
time the property was placed in service. The taxpayer is required to increase their basis in the property for capital improvements, certain taxes, and legal fees. The taxpayer is required to decrease their
basis in the property for casualty or theft losses, certain credits and deductions received with respect
to the property, and rebates.
When determining adjusted basis, the taxpayer must reduce their basis by the greater of the amount
of depreciation allowed or allowable. Depreciation allowed is the amount of depreciation actually
taken. The amount of depreciation allowable is the total amount of depreciation the taxpayer was
entitled to deduct, regardless of how much was actually taken. So, if the taxpayer was entitled to a
depreciation deduction under tax law and did not take the deduction, they are still required to reduce
their basis by the amount of the deduction that could have been deducted.
Repairs vs. improvements. When a taxpayer repairs business property, they are making necessary
maintenance on the property to keep it in good operating condition. Repairs do not materially add
value to the property or substantially prolong its life. The taxpayer is generally allowed to deduct
repair costs in the year incurred. Improvements, on the other hand, are additions or partial replacement of property that adds value and lengthens the life of the property. The taxpayer is required to
add the cost of the improvement to the basis of the property and depreciate the improvements as
separate depreciable property.
FORM 4562
Generally, the taxpayer will use Form 4562 to calculate and report depreciation and amortization
deductions. The taxpayer would attach Form 4562, shown in Illustrations 18.1 and 18.2, to their tax
return in the current tax year when claiming depreciation or amortization on any one of the following
items:
179 depreciation deduction for the current year or carryover from prior years (discussed later in
the course).
Depreciation for property placed in service during the current year.
Depreciation on any vehicle or listed property (regardless of when placed in service).
Vehicle deductions reported on a form other than Form 1040, Schedule C, and Schedule CEZ.
Amortization of costs that begin in the current year.
Depreciation or amortization on any corporate asset reported on a corporate return (other than
Form 1120S).
The taxpayer is required to submit a separate Form 4562 for each business activity reported on their
return. The completion of this form will be discussed in more detail later in the course.

Illustration 18.1

Illustration 18.2
AMORTIZING
Generally, a taxpayer cannot depreciate new business start-up costs, goodwill, or other intangible
assets such as patents, copyrights, or computer software. Instead, the taxpayer is required to amortize these costs. Amortization is similar to depreciation in that it allows the taxpayer to recover
certain costs over a fixed time period. Generally, the amortization deduction is calculated using the
straight-line method of depreciation. For amortization beginning in the current year, the taxpayer
would complete Part VI of Form 4562 and attach it to their return. If the taxpayer is reporting amortization costs that began before 2014 and they are not required to file Form 4562, the taxpayer would
report the amortization deduction directly on the Other Deductions or Other Expenses line of their
business form or schedule. For more information about amortization, see the H&R Block Intermediate
Depreciation course.
METHODS USED TO DEPRECIATE PROPERTY

The most common method used to depreciate property is the Modified Accelerated Cost Recovery
System (MACRS). This method is generally used to depreciate property placed in service after 1986.
For depreciable property placed in service before 1987, the general method used is the Accelerated
Cost Recovery System (ACRS). In this chapter, we will be focusing on MACRS and will not be discussing ACRS. For more information about ACRS, see IRS Publication 534, Depreciating Property Placed
in Service Before 1987.
MACRS
As noted above, MACRS is the depreciation method generally used for most business and investment
property placed in service after 1986. This system is made up of two depreciation systems: the General
Depreciation System (GDS) and the Alternative Depreciation System (ADS). Both systems provide
different methods and recovery periods to figure depreciation deductions. MACRS provides three
depreciation methods under GDS and one depreciation method under ADS, which are listed below:
The 200% declining balance method (200DB) over a GDS recovery period.
The 150% declining balance method (150DB) over a GDS recovery period.
The straight-line method (S/L) over a GDS recovery period.
The straight-line method (S/L) over an ADS recovery period.
Straight-line method. The straight-line depreciation method is a method of depreciation that takes
the basis of the property less the propertys salvage value or land value divided by the propertys useful life or GDS/ADSrecovery period. The straight-line method allows you to take the same amount of
depreciation each year. This depreciation method is the basis for how the 200% and 150% declining
balance methods are calculated. This is regular MACRS recovery method for residential and nonresidential real property.
200% declining balance method. The 200% declining balance method, also called the double declining balance method, is an accelerated depreciation method that is twice the rate of the straight-line
method. This is regular MACRS depreciation method for 3-, 5-, 7-, and 10-year non-farm property.
150% declining balance method. The 150% declining balance method is an accelerated depreciation method that is one and a half times the rate of the straight-line method. This is regular MACRS
depreciation method for farm property, except real property, and most 15- and 20-year property.
Note: Both the 200% and 150% declining balance methods will yield larger depreciation deductions
in the earlier years of the depreciable propertys life compared to the straight-line method, and then
these two methods will convert to the straight-line method in later years.
GENERAL DEPRECIATION SYSTEM (GDS)

Generally, property is depreciated using GDS, unless the taxpayer elects or is required by the IRS to
use ADS. This course will first cover GDS and will then discuss ADS.
Computing the MACRS GDS Depreciation Deduction

To compute the MACRS depreciation deduction for an asset, you need to use two sets of tables:
Table of Asset Class Lives and Recovery Periods (most often needed).
Modified Accelerated Cost Recovery System Percentage Tables.
For GDS, all depreciable personal property and certain depreciable real property (except residential
rental property and nonresidential real property, which you will learn about later in this course) is
classified by the recovery period assigned to it. There are nine property classifications under MACRS
GDS property. Each class covers different types of property:
3-year property.
5-year property.
7-year property.
10-year property.
15-year property.
20-year property.
25-year property.
Residential rental property.
Nonresidential real property.
To determine which GDSclass a particular asset belongs to and its recovery period, you will use the
IRS table in the appendix labeled Table of Asset Class Lives and Recovery Periods. This table is often
referred to as the CLADR (often pronounced as cladder) table. You can find the CLADR table on
pages A18.5A18.14 in the appendix, as well as in IRSPublication 946, How To Depreciate Property.
For a quick reference, Table B-1 of the IRSTable of Asset Class Lives and Recovery Periods is shown
in Illustration 18.3. To help you understand how the table works, lets study the columns in Table B-1
of the IRSTable of Asset Class Lives and Recovery Periods.

Illustration 18.3
Asset class. Notice that to the left of the descriptions of the various kinds of property is a column of
numbers labeled Asset class. You will not use this information for anything, but you may notice that
the assets are listed in roughly numerical order.
Notice that after the descriptions of the various kinds of property are three columns of numbers.
Class life (in years). The first column shows the official IRS class life of the property. It has no practical application for purposes of this course.
Recovery periods (in years). The recovery period for property is the number of years over which
the taxpayer would recover the cost or other basis of the property based on the depreciation system
used, GDSor ADS.
General Depreciation System (GDS). This column provides the GDS class to which the property
belongs and the recovery period over which it will be depreciated.
Alternative Depreciation System (ADS). This column provides the propertys recovery period over
which ADS is computed. Generally, the recovery period for most property is longer under ADS than
under GDS. ADS will be discussed in more detail later in the course.
HALF-YEAR, MID-QUARTER, AND MID-MONTH CONVENTIONS

After determining the recovery period for the depreciable property, the next step is to determine
which convention applies. A convention refers to the time period the property was placed in service.
The convention the taxpayer uses determines the number of months for which the taxpayer can claim
depreciation in the year the property is placed in service and in the year the taxpayer disposes of the
property. This affects the amount of depreciation deduction. The taxpayer has three types of conventions available: the half-year convention, the mid-quarter convention, and the mid-month convention.
Half-Year Convention
Generally, the taxpayer would use the half-year convention for depreciable personal type property
placed in service during the year. The half-year convention treats all property placed in service or
disposed of at the midpoint or middle of the year. This means the taxpayer receives one-half year
depreciation deduction for property placed in service or disposed of during the year. The taxpayer
would indicate the half-year convention by entering HY on Form 4562, Part III, column (e).
Mid-Quarter Convention
Generally, the taxpayer is required to use the mid-quarter convention on all depreciable personal type
property placed in service during the tax year if more than 40% of the basis of all personal type property placed in service during the year occurred in the last three months. This means that if you add
up the total basis of all personal type property placed in service during the year and 40% of the total
basis was placed in service during the last three months, then generally all the personal type property
placed in service during the year must use the mid-quarter convention. When determining the 40%
rule, the propertys basis is first reduced by the 179 depreciation deduction as well as the percentage
time the taxpayer used the property for personal use. Note that the total basis is not reduced by special (or bonus) depreciation claimed during the year.
Under the mid-quarter conventions, the taxpayer treats the property as being placed in service or
disposed of at the midpoint of the quarter. This means the taxpayer receives 1 months of depreciation in the quarter the property was placed in service. The taxpayer would indicate the mid-quarter
convention by entering MQ on Form 4562, Part III, column (e).
Mid-Month Convention
Generally, the taxpayer would use the mid-month convention for nonresidential real property and
residential rental property. Under this convention, the taxpayer treats the property as being placed
in service or disposed of at the midpoint of the month. The taxpayer would indicate the mid-month
convention by entering MM on Form 4562, Part III, column (e).
MACRS PERCENTAGE TABLES

After determining the recovery period and the convention for property, the next step is to determine
the percentage by which you will multiply the depreciable basis of the asset (usually its cost, unadjusted for previous depreciation deductions) to arrive at the current years depreciation. Illustration 18.4
shows MACRS Table A1, the table for the GDS, Half-Year Convention. This table is one of the most
commonly used MACRS GDS tables for personal property. This table, along with other GDS and ADS
percentage tables, is provided in the appendix on pages A18.17A18.41 as well as in IRSPublication
946, How To Depreciate Property.
Looking at Illustration 18.4, you will notice that across the top of the table there are columns labeled
with the recovery periods3-year, 5-year, 7-year, and so on. Find the assets appropriate recovery
period column and then the recovery year in the far left-hand column. For example, if an asset is
placed into service in 2014, then 2014 is recovery year 1, 2015 is year 2, 2016 is year 3, and so on.
Multiply the unadjusted basis of the property by the percentage in the appropriate column on the line
corresponding to the recovery year.

Illustration 18.4
mExample: In March 2014, Larry Valentine purchased and placed in service a used desk (asset class
00.11) costing $500 for use exclusively in his business. Under the general depreciation system, desks
have a recovery period of seven years. Therefore, his depreciation deduction for the desk in 2014 was
$71 [$500 2 14.29%, the percentage from the table in Illustration 18.4 for year 1 of 7-year property,
half-year convention]. For 2015, depreciation on the desk is $122 [$500 2 24.49% for year 2 of 7-year
property]; for 2016, it is $87 [$500 2 17.49% for year 3]; and so on.m
mExample: In June 2014, Penny Scott purchased and placed in service a special glass manufacturing tool (asset class 30.21) costing $3,000. This special tool has a three-year recovery period under
MACRS GDS and Penny will use the 3-year column, half-year convention in Illustration 18.4. The
depreciation deduction for each year is computed as follows.
2014
(year 1)
$3,000 2 33.33%
$1,000
2015
(year 2)
3,000 2 44.45%
1,334
2016
(year 3)
3,000 2 14.81%
444
2017
(year 4)
3,000 2
7.41%
222
Total
$3,000
Notice that it actually takes four tax years to fully depreciate property in the three-year class. This
is because of the half-year convention, meaning that the taxpayer is only granted half the otherwise
allowable depreciation in the year the property is placed in service. So, in the case of three-year property, the taxpayer gets a half year of depreciation, then two full years, then another half year.
To help you determine the correct MACRS GDS and ADS depreciation percentage table to use, the
IRS has provided a MACRS Percentage Table Guide. This guide is shown in Illustration 18.5 and
is also provided in the appendix on page A.15 as well as in IRSPublication 946, How To Depreciate
Property.
COMPUTING MACRS GDS DEPRECIATION DEDUCTION FOR REAL

PROPERTY
Real property, as you will recall, consists of land and buildings. The first thing to learn about depreciating real property is that land is not depreciable. That is because depreciation is a deduction allowed
for the wearing out of an asset. Because land does not wear out, it is not depreciable. Buildings, however, are another story. If used for business or the production of income, buildings are depreciable.
The value of land is always subtracted from the value of the property before calculating depreciation.
Residential Rental Real Property
Residential rental real property (such as rental houses and apartment buildings) placed in service
after 1986 is depreciated using a straight-line method over 27 years. You may recall that the
straight-line method means an equal amount of depreciation is claimed each full year the asset is
depreciated.
Illustration 18.6 shows the MACRS GDS Table A-6. This table is used when depreciating residential
rental real property. Notice that the percentages for the year placed in service vary by the month
the property is placed in service. That is because real property under MACRS is required to use the
mid-month convention. The mid-month convention treats the property as being placed in service at
the mid-point of the month during which it was actually placed in service.
mExample: During March 2014, Wanda Trobridge purchased and placed in service a rental house
costing $90,000, which included $10,000 for the land. After subtracting the value of land, her basis
for depreciation is $80,000. Her depreciation deduction for 2014 is $2,303 [$80,000 2 2.879%, the
percentage from the table in Illustration 18.6 under column 3 (March), row #1 (year 1)]. For 2015, her
depreciation deduction will be $2,909 [$80,000 2 3.636%].m

Illustration 18.5

Illustration 18.6
Nonresidential Real Property

Nonresidential real property (such as office buildings, factories, and workshops) placed in service on
or after May 13, 1993, is depreciated using the straight-line method over 39 years. Generally, nonresidential real property placed in service after 1986 and before May 13, 1993, is depreciated over
31 years, again using the straight-line method. As with residential rental real property, the first
years percentage depends on the month the property was placed in service because of the mid-month
convention. Illustration 18.7 shows Table A-7a. This MACRS GDS table is used to depreciate nonresidential real property over 39 years using the straight-line method. For nonresidential real property
subject to 31.5 years straight-line, the taxpayer would use the MACRS GDS Table A-7.
mExample: In May 2014, Daniel Corey purchased and placed in service a workshop costing $110,000,
including $20,000 for the land. After subtracting the value of land, his basis for depreciation is
$90,000. His depreciation deduction for 2014 is $1,445 [$90,000 2 1.605%, the percentage from the
table in Illustration 18.7 under column 5 (May), row #1 (year 1)]. For 2015, his depreciation deduction
will be $2,308 [$90,000 2 2.564%].m

Illustration 18.7
mExample: In December 2006, Walter Cross placed in service a retail store. Because 2014 is recovery
year 9 for the store, Walter will multiply his unadjusted basis (basis minus land value) by 2.564%.
column 12 (December), row #2-39.m
REPORTING MACRS DEPRECIATION ON THE TAX FORMS

When a taxpayer takes a depreciation deduction, entries must generally be made on up to three different forms:
1. The Depreciation Worksheet.
2. Form 4562, Depreciation and Amortization, if required.
3. The appropriate schedule:
Schedule C if the property is used in a non-farm business.
Schedule F if the property is used in the business of farming.
Schedule E if the property is rental real estate or connected therewith.
Schedule A if the property is used for investment or employee business purposes.
Depreciation Worksheet
The Depreciation Worksheet is a useful document to help the taxpayer track depreciation on their
depreciable assets from the time the taxpayer places the asset in service until the time the assets
basis has been fully recovered and/or disposed of. To help taxpayers calculate current-year depreciation, H&RBlock has created a Depreciation Worksheet shown in Illustration 18.8. A blank copy of the
Depreciation Worksheet is provided in the appendix on page A18.3.
mExample: Britney Kleen opened a womens jewelry store in 2014. She placed the following assets in
service on April 29, 2014:
Store and land (land is valued at $25,000) (39Y)
Glass display case (5Y)*
$200,000
$7,000
Desk (7Y)
$600
Cash register (5Y)
$500
Office chair (7Y)
$350
*Assets used in a retail business to display products of inventory for sale fall under 57.0 Asset class
and have a useful life of five years.
Her 2014 Depreciation Worksheet and Form 4562, page 1, are both shown in Illustrations 18.818.9.
Study Britneys Depreciation Worksheet while you read the following explanations.m
The top portion of the Depreciation Worksheet is used to enter basic information about the asset and
establish the basis for each asset. The lower part is used to make the necessary depreciation computations. Up to eight assets can be listed on each worksheet.
Some of the data on the worksheet includes items you have not read about yet, but do not worryyou
will. For now, let us review those with which you are somewhat familiar.
Manner/date acquired. Most of the assets you will encounter will have been purchased.
Date placed in service. The first date on which this asset was used in business or to produce income.
System and class/life. As we mentioned, MACRS is the predominant system and the one that
Britney is using. For MACRS personal property, enter the recovery period found in the center column
of the CLADR table.
Column A. Enter the cost or other basis, as appropriate. The basis of a purchased item is usually its
cost.
Column B. Sometimes the basis of an asset needs to be adjusted. One example is real estate, because,
as we discussed earlier, land is not depreciable. Thus, the land value must be subtracted before depreciation is computed. Also, certain credits will reduce the depreciable basis of an asset. Enter such
basis adjustments in column B.
Column C. Subtract column B from column A.
Column D. If the asset is used only partially for business or investment purposes, enter the business-use/investment-use percentage here. This may be measured by comparing time, space, or mileage that an asset is used for business or investment to its total use. We will discuss this in more detail
as we go along.
Column E. Multiply the amount in column C by the percentage in column D.
Column F. This column is where the taxpayer would report the 179 depreciation deduction. We will
discuss the 179 deduction later. You may assume that Britney either did not qualify for it or elected
not to take advantage of it.

Illustration 18.8

Illustration 18.9
X.X
Column H. This column is where the taxpayer would report special (bonus) depreciation. We will
discuss special (bonus) depreciation later. You may assume that Britney either did not qualify for it
or elected not to take advantage of it.
Columns G and I. These are simple subtractions.
Column J. For most MACRS assets, the recovery period will be the same recovery period found in
the center column of the CLADR table.
Column K. First, enter the method used for depreciating the item in question. For 3-, 5-, 7-, and
10-year personal property, we generally use the 200% declining balance method of depreciation,
which is abbreviated as 200DB on the worksheet. For 15- and 20-year property, enter 150DB,
which stands for 150% declining balance. You will not encounter 25- or 50-year property on individual
returns. For real property, the method used is straight-line and is abbreviated as S/L.
Then, enter the convention used for the depreciation. In the case of personal property, we generally
use the half-year convention, meaning that half the otherwise allowable depreciation is allowed the
year the asset is placed in service. The half-year convention is denoted by the letters HY. In the case
of real property, we use the mid-month convention, meaning the property is considered to be placed
in service at the midpoint of the month it was placed in service. The mid-month convention is abbreviated MM. There is also a mid-quarter convention, abbreviated MQ. The mid-month convention
will be discussed in more detail later in the course.
Column L. One Depreciation Worksheet may not last for the entire depreciable life, because the
document provides space for only three years of depreciation computations. Britneys building, for
example, will require several worksheets to depreciate it over its entire 39-year recovery period. If the
worksheet you are completing is an overflow worksheet (this one is not), you will enter in this column
the total depreciation claimed prior to the first year entered on the new worksheet.
Column M. If the asset was disposed of or withdrawn from service, enter the date of disposition here.
You will learn more about depreciation in the year of disposition later.
Column N. Each depreciation year is divided into three columns. Above the three columns, enter the
calendar year. In the Rec. Year column, enter the assets recovery year. For example, on Britneys
worksheet, 2014 is year 1 of depreciation, so we have entered 1; 2015 is year 2, etc. In the % column,
you will enter the appropriate percentage from the MACRS percentage table. Finally, in the Depr.
column, you will multiply the depreciable amount from column I by the appropriate percentage.
For each year the asset remains depreciable, another column-N entry is completed. Normally, this is
done year by year.
Notice that there is not enough room to fully depreciate all of Britneys assets. For Tax Year 2017,
when this worksheet is full, the data will be transferred to an overflow worksheet. The depreciation
deductions taken prior to 2017 will be totaled and entered in column L of the new worksheet.
Beneath each row on the bottom of the worksheet is a row labeled AMT. This row is used for alternative minimum tax depreciation, which is often different from that used for regular tax. We will not
delve into that topic in this course.
preparing a BlockWorks return for a taxpayer who
Bhas depreciable When
assets, BlockWorks will produce a simplified version of
lockWorks Tip:
the Depreciation Worksheet previously discussed. A copy of Britney Kleens

BlockWorks Depreciation Worksheet is shown in Illustration 18.10.
Reporting Depreciation on Form 4562

As discussed earlier, the taxpayer may be required to complete and file Form 4562, Depreciation and
Amortization, with the tax return. The form is generally required, for example, when a taxpayer takes
a 179 deduction, when depreciated property is first placed in service, or when depreciation on a vehicle is claimed. When required, the form should be completed after the Depreciation Worksheet. Key
information from the worksheet is transferred to the form. Study Britney Kleens Form 4562, shown
in Illustration 18.9, as you read the following information.
For property placed in service during 2014, the taxpayer would report depreciation by completing
Form 4562, Part III. If the taxpayer placed property in service before 2014, they would report depreciation on Form 4562, Part III, line 17.
The heading calls for the taxpayers name, SSN, and a brief description of the business to which the
deduction relates. Part I of the form deals with the 179 expense deduction, which you will learn
about later in this course. Part II includes the special depreciation allowance, which you will also
learn about later in this course.
Part III is used to report the depreciation deduction for assets placed in service during 2014. Notice
how there are lines for the different MACRS classes. On lines 19a19g, all assets in each class placed
in service in 2014 are combined in columns (c) and (g). Column (c) represents the total depreciable
basis from column I of the worksheet, and column (g) is the depreciation deduction from column N.
Columns (d), (e), and (f) show the recovery periods, conventions, and depreciation methods used for
each classification of property.
If a taxpayer has not placed any assets into service in the current tax year and is merely continuing
the depreciation of assets he placed in service in a prior year, Form 4562 generally is not required
(unless the taxpayer has listed property, which you will learn about later). When Form 4562 is not
required, the depreciation amount from the worksheet can be entered directly on the appropriate
business schedule. If Form 4562 is required, the continued depreciation amount of any MACRS assets
placed in service in a prior year would be entered on line 17 of Form 4562.

Illustration 18.10
On lines 19h and 19i, each piece of real property placed in service during 2014 is listed separately.
Britneys building is nonresidential real property; therefore, it is entered on line 19i. Column (b)
shows the month and year the property was placed in service, and column (c) shows the depreciable
basis (exclusive of land value) for the building. The information in columns (d) through (f) is preprinted on the form, except for column (d) in the second row of line 19i.
In Part IV, line 22, is for the total depreciation claimed for 2014. The amount from line 22 is carried
to the appropriate schedule. In Britneys case, the appropriate schedule is Schedule C because she is
a sole proprietor.
ALTERNATIVE DEPRECIATION SYSTEM (ADS)

As discussed earlier, MACRS is made up of two depreciation systems, the General Depreciation
System (GDS) and the Alternative Depreciation System (ADS). Under ADS, the taxpayer depreciates
property using the straight-line method over the ADS recovery period. Generally, the recovery period
is longer under ADS than under GDS. The taxpayer may elect to use ADS instead of GDS, but they
are required to use ADS to depreciate the following property:

Listed property with qualified business use of 50% or less.

Tangible property used predominantly outside the U.S. during the year.
Tax-exempt property.
Property financed with tax-exempt bonds.
Farming business property that has been placed in service in the year an election not to apply the
uniform capitalization rules is in effect.
Property imported from a U.S. trade restricted foreign country.
Table A-8, partially shown in Illustration 18.11, is used to compute MACRS ADS under the half-year
convention.
Electing ADS. If the taxpayer elects to use ADS instead of GDS, generally, the election requires that
the taxpayer uses ADS to depreciate all assets in the same property class placed in service during
the year. However, the taxpayer is allowed to make the ADS election for residential rental property
and nonresidential real property on a property-by-property basis. Once the taxpayer has made the
election, it cannot be revoked. To make the election, the taxpayer would complete Form 4562, Part
III, line 20.

Illustration 18.11
LISTED PROPERTY
Listed property is property that commonly has both personal and business use. A list of these assets
can be found in IRC 280F(d)(4) and are subject to depreciation restrictions under certain circumstances.
Listed property includes:
Most passenger automobiles weighing 6,000 pounds or less and any other property used for transportation, unless it meets a specific exception.
Property generally used for entertainment, recreation, or amusement, including photographic,
phonographic, communication, and video-recording equipment.
Computers and related peripheral equipment, unless used exclusively at a regular business establishment and owned or leased by the person operating the business.
For tax years beginning after 2009, cellular telephones and similar telecommunication equipment
have been removed from the definition of listed property.
Restrictions
If listed property is used 50% or less for business purposes in the year it is placed in service, the
property does not qualify for the 179 depreciation deduction or special depreciation allowance.
Furthermore, if business use of these assets falls to 50% or less, any bonus depreciation previously
taken is subject to recapture, and the asset must be depreciated using the ADS straight-line method.
When depreciating listed property, check the box in the top section of the Depreciation Worksheet,
noting that the asset is listed property. After completing the worksheet, transfer the appropriate
information to page 2 of Form 4562. From there, the depreciation deduction is carried to line 21 on
page 1 of Form 4562, then to the appropriate schedule.
mExample: On March 8, 2014, James T. Omar purchased and placed in service a computer costing
$3,500. He uses the computer 40% to keep records for his home repair business and 60% for personal
purposes. James keeps written records of the use of the computer, which is located in his home.
The computer is listed property because it is not used exclusively in a place of business. Thus, it must
be reported on page 2 of Form 4562. Because it is used 50% or less for business, the computer is subject
to the restrictions described earlier, and James must use the ADS straight-line depreciation method.
Illustrations 18.1218.14 show James Form 4562 and Depreciation Worksheet for his computer.m
Notice the following about the forms:
Listed property is reported on the second page of Form 4562, whether or not it is subject to the
restrictions concerning its business-use percentage. Automobiles are always listed property and
will be reported there (unless the taxpayer qualifies to report them directly on another form, such
as Schedule C, as you learned earlier in the course).
Recreational equipment and computers are sometimes listed property and sometimes not. If they
are used exclusively at a regular place of business, including a qualified home office (and in the
case of computers, owned or leased by the operator of the business), they are not listed property.
Otherwise, they are listed property subject to the restrictions. James computer is listed property
because he does not use it exclusively in a place of business. It is subject to the restrictions because
he uses it 50% or less for business.
Be sure to answer the questions about evidence for the business-use percentage on lines 24a and
24b on page 2 of Form 4562.
179 DEPRECIATION DEDUCTION

For 2014, a taxpayer generally may elect to expense (deduct) up to $500,000 of the cost of certain property in the year the property is placed in service, instead of recovering that amount under MACRS.
This special depreciation deduction is called the 179 depreciation deduction, and it is named after
IRC 179. Simply put, this special deduction enables taxpayers to deduct the full price, up to $500,000,
of qualifying business property in the year the property was purchased. This enables taxpayers to
take an immediate deduction rather than having to spread out the expense over several years. The
deduction is called the 179 depreciation deduction. Married taxpayers filing separately may elect to
allocate the $500,000 limitation in any manner they choose; each spouse is not limited to a $250,000
deduction. If no allocation is made, each spouse may expense up to $250,000 of eligible property.
For property to be eligible for the 179 depreciation deduction, the taxpayer must purchase the property for use in the taxpayers trade or business. Property acquired through a gift or inheritance does
not qualify. Generally, this includes new or used tangible personal property (usually equipment or
office furniture) purchased and placed in service for use in a trade or business.

Illustration 18.12

Illustration 18.13
X.X

Illustration 18.14
A taxpayer may elect to treat certain qualified real property placed in service during the 2014 tax
year as 179 property. If the election is made, it only includes certain real property that is defined in
the instructions for IRS Form 4562. The maximum 179 expense deduction that may be expensed for
qualified 179 real property is $250,000 of the total cost of all 179 property placed in service in 2014.
This course will not deal with this special election other than to make you aware of the possibility of
making such an election.
mExample: On May 19, 2014, Jim Birmingham purchased a machine for use in his business for
$100,000. He may, if he wishes, claim the 179 depreciation deduction for the whole cost in the year
of purchase, or he may depreciate it using MACRS. He may even split it, expensing part and using
MACRS for the rest if he likes but to do this, he must opt out of the bonus depreciation, which he
could claim in addition to the 179 deduction. Bonus depreciation will be discussed in greater detail
later in this chapter.
Jeff decides to claim the 179 depreciation deduction for the whole cost in the year of purchase. His
Depreciation Worksheet and Form 4562 are shown in Illustrations 18.1518.16.m
Certain depreciable property is not eligible for the 179 depreciation deduction. Such nonqualified
property includes:
Property held for investment.
Real property leased to others.
Real property and furnishings used predominantly to furnish lodging.
Heating and air conditioning units.
Certain property used predominantly outside the United States.
Certain property used by certain tax-exempt, government, and foreign organizations and entities.
A more detailed list of nonqualified 179 depreciation deduction property can be found in IRS
Publication 946, How to Depreciate Property.
If an asset is first used by the taxpayer for any purpose for which depreciation is not allowed (such
as the personal use of a car), the 179 expense deduction will never be available to that taxpayer for
that asset. However, depreciation deductions may be allowed at a later date if the asset is converted
to business use.
mExample: Rosalyn Sanford purchased a computer for personal use in 2011. In 2014, she started
using it for business purposes. She may not claim a 179 expense deduction for the computer, but she
may begin depreciating it using MACRS. However, the computer is still subject to the usual limitations for listed property (discussed earlier).m
The 179 expense deduction may be claimed or revoked on an original return or on an amended return
for any open tax year. If the election is revoked, the taxpayer cannot change their mind again.

Illustration 18.15

Illustration 18.16
X.X
Property acquired in any of the following ways may not be expensed under 179:
Property acquired from a person whose relationship to the taxpayer would result in the disallowance of losses under the rules for sales to related taxpayers and 50% owned partnerships. For this
purpose, the family of the taxpayer includes a spouse, ancestors, and lineal descendants only.
Property acquired by one member of a controlled group from another member of that controlled
group.
Property acquired by inheritance or in a transaction in which the basis of the acquired property is
determined with respect to the basis of the property in the hands of the person from whom it was
acquired (a gift, for example).
Other 179 Restrictions

$2,000,000 limitation. If the cost of all property eligible for the deduction during the year exceeds
$2,000,000, the deduction is reduced dollar for dollar by the amount in excess of $2,000,000. Include
in this calculation the cost of any eligible 179 property placed in service during the year by the taxpayers spouse, even if the couple files separately. Thus, if the taxpayer (and spouse) placed $2,500,000
worth of eligible property or more in service in 2014, neither of them could claim a 179 deduction.
Business income limitation. The total cost a taxpayer may deduct each year after they apply the
dollar limit is limited to the taxable income from the active conduct of any trade or business during
the year. Generally, they are considered to actively conduct a trade or business if they meaningfully
participate in the management or operations of the trade or business. The total amount expensed
cannot exceed the taxpayers business income from all trades or businesses.
The business income limitation is calculated by combining income from self-employment, wages,
salaries, tips, and other compensation the taxpayer earned as an employee. Do not subtract any
deductions for self-employment tax, any net operating loss, or any unreimbursed employee business
expenses. On a joint return, combine the amounts for both spouses.
Listed property limitation. The 179 depreciation deduction is not allowed for listed property
used 50% or less in a trade or business. Also, if property for which the expense deduction is taken
is converted to personal use (defined as 50% or less business use) at any time before the end of its
MACRS recovery period, a prorated portion of the amount expensed must be recaptured (added back
into income).
mExample: Amy Wolfman, a sales representative, purchased a car in 2011. She used the car 75% for
business purposes each year until 2014, when she purchased a new car, converting the old one to personal use. Her business use of the old car was only 20% in 2014. Because the car had not reached the
end of its MACRS recovery period, she will have to recapture as ordinary income (pay tax on) part of
the 179 deduction. Depreciation recapture is discussed in more detail later in the course.m
SPECIAL DEPRECIATION ALLOWANCE

The taxpayer is allowed to take a special, also called bonus, depreciation allowance of, generally, 50%
the cost of qualified property placed in service during the tax year. The allowance is only available for
the first year the taxpayer places the qualified property in service. The special depreciation allowance
is taken after the taxpayer applies any 179 depreciation deduction and before they figure regular
depreciation under MACRS for the first year the taxpayer placed the property in service. Please note
that the special depreciation allowance is optional and the taxpayer may choose to not claim the
allowance.
In this course, we will limit our discussion of qualified property to tangible personal property depreciated under MACRS with a recovery period of 20 years or less. It is important to note that for this
property to qualify, it must be purchased after December 31, 2007, and placed in service before
January 1, 2015. The property must also meet the original use test, which generally means the taxpayer purchased the property new and was the first person to use the property.
Special depreciation has been constantly changing for the last few years in an effort to stimulate the
economy. The last change was made in 2010. For the 2010 tax year, special depreciation allows a
depreciation deduction of 100% for certain qualified property acquired after September 8, 2010, and
placed in service prior to January 1, 2012. Generally, the requirements for the 100% allowance are the
same as the requirements for the 50% allowance for qualified property acquired after December 31,
2007, and placed in service before January 1, 2015. While the current, special depreciation allowance
expired at the end of 2014, Congress could decide to extend it for Tax Year 2015.
This course will inform you of many of the changes. However, understanding and implementing
the changes requires a deeper dive into depreciation more than this course discusses. To continue
your study, a good starting point would be the H&R Block Intermediate Depreciation course. If you
encounter situations where you are not confident about how to calculate bonus depreciation, you are
encouraged to turn to a senior Tax Professional for assistance. For those who want to study more, two
good resources are IRSPublication 946, How to Depreciate Property, and the instructions for Form
4562. In all cases for the problems in this course, you will be informed as to whether or not special
depreciation will be used.

Illustration 18.17

Illustration 18.18
mExample: On March 6, 2014, Megan Rustaford purchased a new safe for use in her business office.
The safe is seven-year property and cost $3,500. She claimed a 50% special depreciation allowance
[$3,500 2 50% = $1,750], leaving $1,750 to depreciate normally. The normal depreciation deduction
for each year is computed as follows.
2014
(year 1)
$1,750 2 14.29%
$250
2015
(year 2)
1,750 2 24.49%
429
2016
(year 3)
1,750 2 17.49%
306
2017
(year 4)
1,750 2 12.49%
219
2018
(year 5)
1,750 2
8.93%
156
2019
(year 6)
1,750 2
8.92%
156
2020
(year 7)
1,750 2
8.93%
156
2021
(year 8)
1,750 2
4.46%
78
Total
$1,750
Megans 2014 Form 4562, page 1 and Depreciation Worksheet are shown in Illustrations 18.1718.18.m
MID-QUARTER CONVENTION
Recall the three types of conventions discussed earlier in the chapter and the 40% rule for mid-quarter convention. The 40% rule states that the mid-quarter convention generally must be used for all
personal property placed in service during the year if the total depreciable basis of MACRS personal
property placed in service during the final three months of the year exceeds 40% of the total depreciable basis of MACRS personal property placed in service during the entire year. The mid-quarter
convention requires that property be considered placed in service halfway through the quarter in
which it was actually placed in service.
Turn to pages A.17A.19 in the appendix and find the MACRS tables labeled Table A-2, A-3, A-4, and
A-5. These tables are the MACRS GDS Mid-Quarter Convention tables. Notice that there is a table
for each quarter of the year. Once you begin using one of the mid-quarter tables, you will continue to
use the same table for each subsequent year of depreciation.

Illustration 18.19
X.X

Illustration 18.20
mExample: Emilio Brockman placed the following new business-use assets in service during 2014:
January 17a $3,000 machine (7-year property)
July 7a $1,000 desk (7-year property)
November 10a $5,000 computer (5-year property)
Because the basis of the computer exceeds 40% of the combined basis of the assets placed in service
this year, Emilio is required to use the mid-quarter convention to depreciate all three assets. (There is
a little twist to this equation, but we will look at that in a moment.) Refer to the mid-quarter MACRS
tables in the appendix as you read how each asset is depreciated for 2014.
The machine was placed in service during the first quarter of the year, so we use the First Quarter
Property table. The depreciation percentage for the machine is 25%.
The desk was placed in service during the third quarter of the year, so we use the Third Quarter
Property table. The depreciation percentage for the desk is 10.71%.
The computer was placed in service during the final quarter of the year, so we use the Fourth Quarter
Property table. The depreciation percentage for the computer is 5%.
Illustrations 18.1918.20 shows Emilios Form 4562, page 1, and Depreciation Worksheet for the
assets he placed in service during the year.m
Which Assets to Include

When figuring the depreciable basis of assets for purposes of the mid-quarter convention, reduce all
basis by any 179 deduction. Also, do not include any property placed in service and withdrawn in
the same year, as it is not depreciable. Finally, do not include residential rental or nonresidential real
property.
mExample: Lisa Quinn purchased two new machines, each costing $50,000, for use in her business.
She purchased machine 1 on August 16, 2014, and machine 2 on October 7, 2014. Both machines are
seven-year property. She placed no other assets in service during 2014.
Because the depreciable basis of personal property placed in service in the last quarter exceeds 40%
(in this case, it is 50%) of the depreciable basis of all personal property placed in service during the
year, the mid-quarter convention applies.
However, Lisa could claim a $25,000 179 deduction on machine 2. Now, the depreciable basis of
assets placed in service in the fourth quarter is not more than 40% of the total basis of assets placed
in service during the year [$25,000 for machine 2 3 $75,000 total = 33.33%], so then she would not
be required to use the mid-quarter convention.m
When entering the mid-quarter convention on the forms, use the same procedure you have learned
for personal-type property up to this point. The only difference is that you use the designation MQ to
indicate you are using the mid-quarter convention, rather than the half-year convention.
DEPRECIATION RECAPTURE
When a taxpayer receives a gain from the sale or disposal of business property that has been depreciated using MACRS, the taxpayer may be required to include all or part of the gain as ordinary
income. This situation is called depreciation recapture. Generally, the taxpayer is subject to depreciation recapture because they were able to take a depreciation deduction that reduced their business
income in prior years. So, when the taxpayer sells the business asset and receives a gain from the sale,
the taxpayer is required to recapture as ordinary income up to the amount of depreciation allowed or
allowable for the property. If a gain remains after the depreciation recapture, the gain is generally
taxed at the taxpayers capital gains tax rate, assuming the gain is long-term.
mExample: Tom Jankins places a piece of equipment in service worth $3,000. Over a couple years, he
claimed accumulated depreciation deductions of $1,500, which in turn reduced his income. He later
sold the equipment for $3,300 and received a $1,800 long-term gain [$3,300 sales prices ($3,000 cost
$1,500 accumulated depreciation) = $1,800]. Because Tom received a gain of $1,800, he is subject to
a depreciation recapture of $1,500, which he is required to include in ordinary income. The remaining
$300 long-term gain is taxed at Toms applicable long-term capital gain tax rate.m
When the taxpayer sells business property, they will report the sale on Form 4797, Sales of Business
Property. The taxpayer will first complete Form 4797, Parts I and II, to calculate the gain or loss
from the sale of the business property. If the taxpayer receives a gain from the sale, the taxpayer will
complete Form 4797, Part III, to calculate the amount of the gain subject to depreciation recapture.
More information on depreciation recapture can be found in IRSPublication 946, How to Depreciate
Property.
TANGIBLE PROPERTY REGULATIONS (TPRS)

The IRS has recently finalized tangible property regulations (TPRs) that govern how taxpayers report
costs they incurred during the year to acquire, produce, repair, maintain, or improve depreciable tangible property. These regulations require that taxpayers adopt several changes in the treatment of
tangible property used in the taxpayers business activity. Taxpayers who file Schedules C, Schedules
E, Schedules F, or an entity-level return, such as an 1120 or 1120S, will be impacted by the finalized
TPRs. Some taxpayers will have to file Form 3115, Application for Change in Accounting Method. This
topic is beyond the scope of this course, but is covered extensively in H&R Block 2015 Tax Update
WBT as well as H&R Block Change in Accounting Method: Form 3115 WBT.
CHAPTER SUMMARY
In this chapter you learned to:
Describe the concept of depreciation.
Describe the two systems of depreciation under the Modified Accelerated Cost Recovery System
(MACRS): General Depreciation System (GDS) and Alternative Depreciation System (ADS) method.
Determine when the mid-month, mid-quarter, and half-year conventions apply and which MACRS
depreciation table applies.
Compute depreciation of business-use property using the MACRS GDS method.
Determine which types of assets are listed property and compute depreciation for listed property
using the MACRS ADS method.
Determine which types of assets qualify for a 179 expense deduction, compute the allowable
deduction, and enter it on the tax return.
Determine which types of assets qualify for a special (bonus) depreciation allowance, compute the
allowable deduction, and enter it on the tax return.
Complete Form 4562, when necessary, and enter the depreciation deduction on the associated tax
forms or schedules.
Determine what events trigger depreciation recapture.
Suggested Reading
For further information on the topics discussed in this chapter, you may wish to read IRS Publication
946, How to Depreciate Property.
19
Passive Income
OVERVIEW
This chapter is devoted to the study of passive income. This will not be an in-depth study of the topic,
but rather an introduction to various concepts relating to passive income. H&R Block offers a wide
variety of intermediate-level courses, which will be available to you after your first year of tax preparation experience. We highly recommend the Intermediate Rental Income course as the next step in
your learning about passive income.
OBJECTIVES
Explain how to report rental income and some expenses on Schedule E and how to calculate net
rental income or loss when given the income and expenses.
Share basic knowledge related to the new tangible property regulations (TPRs).
Explain how to report royalty income and expenses on Schedule E and how to calculate net royalty
income or loss when given the income and depletion.
Identify income from partnerships, S corporations, estates, or trusts reported on Schedules K-1.
Identify income and losses as passive, active, or portfolio.
Explain the passive loss rules as they apply to active-participation rental property.
TAX TERMS
Active income and losses.
Partnership.
Passive income and losses.
Portfolio income and losses.
Rental income.
Royalty.
S corporation.
Trust.
Vacation home.
19.1
PASSIVE INCOME
Passive income is income derived from a passive activity. There are two types of passive activities.
The first is a trade or business activity in which the taxpayer does not materially participate during
the year. Generally, a taxpayer is not considered to materially participate if they are not involved in
the business operation. The second is rental activities, including the rental of real estate, regardless of
whether a taxpayer materially participates or not. However, if a taxpayer is a real estate professional,
income derived from rental activities is nonpassive.
Real Estate Professional

A taxpayer may qualify as a real estate professional if the following two requirements are met:
More than half of the personal services performed by the taxpayer in all trades or businesses
during the tax year were performed in real property trades or businesses in which the taxpayer
materially participated.
The taxpayer performed more than 750 hours of service during the year in real property trades or
businesses in which the taxpayer materially participated.
For more information on qualifying as a real estate professional, see IRS Publication 527, Residential
Rental Property (Including Rental of Vacation Home), and IRS Publication 925, Passive Activity and
At-Risk Rules.
The precise definition of material participation is an involved proTcess. If you
need to determine whether a taxpayer materially participated
ax Tip:
in an activity, please partner with a Tax Professional experienced in this area.

IRS Publication 925, Passive Activity and At-Risk Rules, is also an excellent
resource to help guide you in this area.
Trade or Business Activities

A trade or business activity is any activity that:
Involves the conduct of a trade or business (that is, deductions would be allowable under IRS Code
162 if other limitations, such as the passive activity rules, did not apply).
Is conducted in anticipation of starting a trade or business.
Involves research or experimental expenditures that are deductible under IRS Code 174 (or that
would be deductible if the taxpayer chose to deduct rather than capitalize them).
Tax Essentials Passive Income 19.3
Nonpassive Income
Nonpassive income is income derived from activities that are not passive. Nonpassive income includes
the following:
Portfolio income. This includes income from interest, dividends, annuities, and royalties not
derived in the ordinary course of business. Gain or loss from the disposition of property that produces these types of income or that is held for investment is also included. Portfolio income does
not include self-charged interest treated as passive activity income.
Personal service income. Salaries, wages, commissions, self-employment income from trade
or business in which the taxpayer materially participates, deferred compensation, taxable social
security and other retirement benefits, and payments from partnerships to partners for personal
services are all included.
Other income. Other income that is not passive activity income includes state and local refunds,
income from intangible property if the taxpayer contributed to the creation of the property, income
or gain from investments of working capital, Alaska Permanent Fund dividends, and income from
a hobby or from gambling.
Note: Portfolio income cannot offset passive activity losses and is entered on the usual forms and
schedules (for example, interest and dividend income on Schedule B).
The IRS may, from time to time, issue regulations to include or exclude specific types of income or
activities from the passive classification. The purpose of this authority is to prevent taxpayer manipulation of the rules that would allow passive losses against nonpassive income disguised as passive.
For more information about the distinction between passive and nonpassive income, see IRS
Publication 925, Passive Activity and At-Risk Rules.
mExample: Edgar Price is the landlord of three single-family homes. All three houses were rented for
most of 2014. Edgar is also a partner in Capital Resources lending corporation. Finally, Edgars family has established a family trust that distributes interest income annually. A copy of Edgars Schedule
E is shown in Illustrations 19.119.2. m
tax years before 2014, the determination of whether an expense
Nwas Ina repair
or an improvement was determined by an analysis of facts
ew:
and circumstances and sometimes resulted in different interpretations by tax

preparers and the IRS. Consistency in this area is important because an item
classified as a repair can be written off right away, but an item classified as an
improvement generally must be depreciated.
Beginning in 2014, the IRS issued tangible property regulations (TPRs) to provide framework for how to treat costs incurred to acquire, produce, or improve
tangible property. To comply with the regulations, taxpayers may have to make
certain elections with their tax return or file Form 3115, Application for Change
in Accounting Method.

Illustration 19.1

Illustration 19.2
RENTAL INCOME AND EXPENSES

Rent is income received for the use of property. Net rental income is determined in the same manner
as net business incomenet rental income equals gross rent received minus related expenses, including depreciation. Generally, rental income and expenses are reported on Schedule E.
Rent is generally considered to be unearned income. This means, among other things, that rental
income does not qualify a taxpayer for the Earned Income Tax Credit, the Additional Child Tax
Credit, or an IRA. For rent to be earned income, services must be provided with the use of the property. Thus, income from a bed and breakfast or motel operated by the property owner is business income
and is reported on Schedules C and SE, rather than on Schedule E.
Rent received for the use of personal-type property (cars, for example) is also Schedules C and SE
income if the rental of the personal property is conducted as a business. If personal property rental is
for profit (but not as a business activity), then:
Rent received is entered on Form 1040, line 21.
Expenses are entered as a write-in entry on line 36 with the marginal notation PPR.
Rent received for the use of farmland is generally passive rental income, not farm income, and reported on Schedule E. However, if the taxpayer materially participates in the farming operations on the
land, then the rent received from the farmland is considered farm income and reported on Schedule
F or Form 4835, Farm Rental Income and Expenses.
Gross Rent
Gross rent must be reported on the return and includes advance payments, late payments, and
current payments received during the year. Rent that is due but not paid is not included in income.
Because unpaid rent is not included in income, no deduction is allowed for uncollectible past-due rent.
Lease cancellation payments received are rental income in the year received. Refundable security
deposits forfeited by the tenant are rental income to the landlord in the year forfeited. Nonrefundable
security deposits are rental income in the year received. Generally, tenant payments made for taxes,
mortgage interest, insurance, or repairs on the rental property are considered rental income. The
value of services rendered or the value of property improvements made by a tenant in exchange for
reduced rent or rent-free property use is also rental income.
Rental Expenses
Maintenance costs and repairs that do not appreciably add to the value or useful life of the property
are deducted as current expenses. Deductible maintenance and repairs include:
Grounds care.
Pest control.
Cleaning of common areas.
Painting.
Wallpapering.
Repairing, but generally not replacing, the:

Roof.
Electrical system.
Plumbing.
Heating and air conditioning unit.
The TPRs allow the immediate deduction of routine maintenance under the Routine Maintenance
Safe Harbor. Maintenance for a building is generally routine if the taxpayer expects the activities
to be performed more than once during the ten-year period beginning at the time the building upon
which the routine maintenance is performed is placed in service. Maintenance for property other than
buildings is considered routine only if the taxpayer expects to perform the activities more than once
during the appropriate class life of the particular property.
The TPRs added several tests to make the determination of how to treat repairs easier. In general,
repair expenses are deductible if they are not otherwise required to be capitalized. Repairs keep the
property in good operating condition and do not materially add to the value of the property or substantially prolong its life.
Other expenditures necessary for income production that are deductible from gross rent include:
Real estate taxes.
Management fees.
Mortgage interest, points, and other interest.
Utilities:
Electricity.
Water.
Gas.
Telephone.
Wages paid to a caretaker.
Transportation expenses to look after the property (actual expenses or the standard mileage rate
may be claimed).
Legal expenses incurred for evicting tenants or in an effort to collect rent.
Advertising.
Commissions.
Trash hauling.
Preparation of tax forms related to the property.
The value of the owners labor or the unpaid labor of friends and relatives is not deductible. Prepaid
expenses are deductible in the applicable year.
Insurance premiums are often prepaid for a period of one to three years. Such premiums are prorated and claimed for the number of months of coverage during the year. Generally, unless rental use of
the property began or ended during the year, 12 months of premiums are claimed. The yearly amount
could change if the policy was renewed at a different rate during the year.
mExample: Harvey Kittleson paid $1,000 for a two-year hazard insurance policy. The insurance covers his rental house from September 1, 2013, to August 31, 2015. He will claim insurance expenses
on his tax return as follows:

2013 insurance
4/24 2 $1,000 = $167
2014 insurance
12/24 2 $1,000 = $500
2015 insurance
8/24 2 $1,000 = $333m
Points paid to obtain a mortgage when purchasing or refinancing a rental property must be amortized over the life of the loan. When amortizing points connected with an investment property, the
original issue discount (OID) rules apply. These rules are quite complex, so we will not go into them in
this course. For more information about points, see IRS Publication 527, Residential Rental Property
(Including Rental of Vacation Home).
Depreciation
The taxpayer is allowed to depreciate their rental property if they meet all the following requirements:
They own the property.
They use the property in their business or income-producing activity (i.e., rental property).
The property has a determinable useful life.
The property is expected to last more than one year.
A rental propertys depreciable basis is generally the propertys cost minus land value, times the rental use percentage. The propertys cost is generally the amount paid in cash, debt obligation, FMV of
property exchanged, or FMVof services rendered. Major remodeling and improvements that increase
the property value are depreciated. Furnishings and appliances provided with the rental unit are also
depreciated.
mExample: Harry buys a building with land for $150,000 cash and assumes a mortgage of $175,000.
The land is valued at $25,000. Harrys basis in the building is $300,000 [$150,000 cash + $175,000
mortgage = $325,000 $25,000 land = $300,000].m
All residential rental property placed in service after 1986 is depreciated under MACRS using the
straight-line method over 27 years. Nonresidential MACRS real property is depreciated over 39
years (31 years if placed in service before May 13, 1993).
MACRS (and ACRS) deductions for real property are prorated in the acquisition and disposition years
according to the number of months the property was used during the year. Tables are used to make
this adjustment for the acquisition year. You must make the adjustment for the disposition year if the
property is disposed of before the end of its recovery period, as discussed in H&R Blocks Intermediate
Depreciation course.
Most furniture and appliances are five-year MACRS property. A 179 deduction cannot be taken on
any Schedule E rental property. First-year bonus depreciation allowance, also referred to as special
depreciation allowance, may be allowed for taxpayers to recover part of the cost of qualifying business
property placed in service during the year. For 2014, the taxpayer may take a 50% bonus depreciation
allowance on qualified rental property, with a class life of less than 20 years, purchased and placed
in service in 2014.
Note:This is a very brief review of depreciation. Depreciation is covered more extensively in Chapter
18 of this textbook.
When completing Schedule E (see Illustrations 19.119.2), enter a description of the property and its
location on line 1a (for example, rental house, 308 Dismal Dr., Your City, YS). Then, on line 1b, enter
the appropriate number associated with the type of property entered on line 1a and the number of
fair rental and personal use days associated with the property. Last, check the QJV box only if the
taxpayer meets the requirements to file a qualified joint venture.
Gross rental income received is entered on line 3 and rental expenses on lines 5 through 19.
Depreciation is entered on line 18. The form then calculates the amount of rental and royalty income
or loss made during the year.
Personal and Rental Use of Property

If the taxpayer rents a portion of their property, the taxpayer is required to divide the expenses
between the part of the property used for rental purposes and the part of the property used for personal purposes. A common situation is a duplex where the taxpayer lives in one unit and rents out the
other unit or a house where the taxpayer rents out a room to a tenant. The taxpayer is allowed to use a
reasonable method for dividing the costs of some household expenses (for example, utilities) based on
the number of people using them. The two most common methods for dividing expenses are based on:
The number of rooms in the house.
The square footage of the house.
Only the rental portion of these expenses is deducted from rental income.
mExample: June rents out a room in her house that is 15 2 16 feet, or 240 square feet. Her house has
2,000 square feet of floor space. As part of the rent, the utilities are included. If Junes total water bill
for the year is $1,200, June can deduct $144 as a rental expense [$1,200 2 (240 square feet 3 2,000
square feet) = $144].m
If a taxpayer has any personal use of a dwelling unit, including a vacation home, that they rent, the
taxpayer is required to divide their expenses between rental use and personal use. For rental property where the entire property is leased on a day-to-day basis, the taxpayer would prorate the total
expenses based on the total number of days actually rented at FMV to the total number of days the
dwelling unit is used for personal and rental use.
The personal portions of real estate taxes, mortgage interest, and casualty losses are deducted on
Schedule A if the taxpayer itemizes. The personal portion of other expenses is not deductible.
Vacation Homes
A vacation home is a dwelling unit and may be a house, apartment, condominium, mobile home, boat,
or any other property that provides normal living accommodations.
Prorate expenses if:
A vacation home or any dwelling unit is used as a residence part of the time.
It is also rented at fair rental value for 15 days or more during the year.
Generally, expenses are allocated to rental use by:
The ratio of the number of days the dwelling unit is rented at fair rental value to the total number
of days the unit is used for both personal and rental purposes during the year.
However, mortgage interest, real estate taxes, and casualty losses may be allocated using a method
upheld by the Tax Court.
The ratio used in that case is the number of days a dwelling unit is rented at fair rental value (the
numerator) to the total number of days owned during the year(the denominator).
365 (or 366 in a leap year).
Used as a residence means a dwelling unit is used for personal purposes during the year for whichever is the greater:
More than 14 days.
More than 10% of the days the house is rented at fair rental value.
mExample: James and Eleanor Best rented their vacation home to tenants for 184 days during the
year. They used the vacation home themselves for 30 days during the year. The vacation home rules
apply.m
Personal use includes use by any of the following:
The taxpayer, family member, or any person who has a financial interest in the dwelling unit or a
member of that other persons family. Family members include:
Brothers.
Sisters.
Spouse.
Grandparents.
Parents.
Children.
Grandchildren.
Any individual who uses the home under an arrangement that enables the taxpayer to use another
dwelling unit, regardless of whether the use is a rent-free exchange or for payment.
Any individual (other than an employee who is using the home as lodging for the employers convenience) to whom the dwelling unit is being rented at less than fair rental value.
These rules do not apply to:
A dwelling unit that is rented to a relative at fair rental value.
A main home rented at fair rental value for at least 12 consecutive months or for a period of less
than 12 months ending with the sale or exchange of the home.
mExample: Ted Becker bought a new home. He was not able to sell his old home right away, so he
rented it until he was able to sell it, a period of seven months. The vacation home rules did not apply
to Ted.m
When a taxpayer uses a dwelling unit for personal purposes in addition to renting the property, how
the taxpayer reports the rental income and expenses depends on whether the taxpayer used the dwelling unit as a home. If the taxpayer used a dwelling unit for personal purposes, but not as a home, the
taxpayer must report all the rental income and divide the expenses between rental use and personal
use. The rental expenses can be greater than the gross rental income, creating a loss, and the personal
use expenses are not deductible.
If the dwelling unit is used as a home and is rented fewer than 15 days during the year, no income
from the rental is included in gross income. No expenses are deductible, except those deductible on
Schedule A, regardless of type of use; that is, taxes, interest, and casualty losses.
mExample: Jackie and Bill Goodtime live in New Orleans. Every year, they rent out part of their home
for seven days to out-of-towners during Mardi Gras. The Goodtimes do not report the income on their
tax return and cannot deduct rental expenses. They are not required to file a Schedule E.m
Rental Use
If the dwelling unit is used as a home and is rented for 15 days or more during the year, the taxpayer must report all the rental income and divide the expenses between rental use and personal use.
If gross rental income less rental expenses creates a net profit, then the total rental expenses are
deductible. However, if there is a loss, then rental expenses are deductible only to the extent of rental
income, and nondeductible rental expenses may be carried forward. The taxpayer is required to complete the IRS Worksheet for Figuring Rental Deduction for Dwelling Unit Used as Home to figure their
deductible rental expenses and nondeductible rental expenses. This worksheet, shown in Illustrations
19.319.4, can be found in IRSPublication 527, Residential Rental Property (Including Rental of
Vacation Home). The expenses are entered on the IRS Worksheet for Figuring Rental Deduction for
Dwelling Unit Used as Home and are deducted on Schedule E in the following order:
1. The rental portion of interest, taxes, and casualty losses computed. These items are deductible
in full, but only the rental portion reduces rental income. The personal portion is deducted on
Schedule A, if the taxpayer itemizes deductions.
2. Rental expenses not directly related to the dwelling unit itself are fully deductible. Such expenses
include:
Advertising.
Travel and transportation expenses related to the property.
Commissions and fees.
Office supplies and postage.
3. Operating expenses directly related to the dwelling unit. Such expenses include:
Cleaning.
Repairs.
Insurance.
Pest control.
Lawn care.
4. Depreciation.
If the expenses in (1) and (2) exceed the gross rent, a rental loss may be claimed. But, operating
expenses and depreciation may not create a loss. If these expenses are greater than the gross income
minus the expenses in (1) and (2), they must be carried forward to next year.
The IRS Worksheet for Figuring Rental Deduction for Dwelling Unit Used as Home is designed to help
Tax Professionals apply the vacation-home rules. You will not be asked to compute vacation-home
income and deductions on tests, quizzes, or graded reviews during this course. However, you should
know these rules exist and understand how they affect the returns of taxpayers with vacation homes.
A copy of the worksheet is shown in Illustration 19.3.

Illustration 19.3

Illustration 19.4
Rental Not for Profit

If a taxpayer is not engaged in a rental real estate activity with an intent to make a profit, the taxpayer is
allowed to deduct rental expenses only up to the amount of their rental income. The taxpayer is not
allowed to deduct a loss or carry forward any nondeductible rental expenses to the next year.
Gross income received from a not-for-profit rental is reported on Form 1040, line 21, the line for other
income. Deductible expenses, to the extent allowed under the rules above, are deducted as miscellaneous itemized deductions on Schedule A, line 23, subject to the 2%-of-AGI limitation.
Expenses and depreciation are deductible only on Schedule A in the following order:
1. Interest, taxes, and casualties are deductible in full, subject to the usual item limitations.
2. The following expenses are deductible up to the amount of income minus the total expense for
items in (1):
Advertising.
Transportation expenses.
Other expenses not related to the dwelling unit itself.
All operating expenses related to the dwelling unit.
3. Depreciation up to the income amount minus the total expense for items in (1) and (2).
ROYALTIES
Payments received for the right to copyrights, patents, and extraction of natural resources from the
taxpayers property are called royalties and are taxable as ordinary income. Royalties are usually
paid on the basis of units extracted or sold (for example, barrels of oil, board feet of timber, tons of
ore, number of books, or tickets to performances). Generally, royalties and the related expenses are
reported on Schedule E. This topic is presented as an awareness topic only. You will not be expected
to complete returns in a tax office without assistance, and more information about royalties can be
found in IRSPublication 17, page 92.
If a taxpayer holds an operating interest in gas, oil, or mineral properties or is in business as a
self-employed writer, inventor, or originator of other creative works, royalties and expenses are
reported on Schedule C.
Royalties of $10 or more for the year are reported to the taxpayer on Form 1099-MISC. A copy is
shown in Illustration 19.5. Royalties are generally shown in box 2. However, royalties from working
interests in gas and oil properties are shown in box 7.

Illustration 19.5
Heres where to report royalties shown on Form 1099-MISC:

For self-employed writers, inventors, and originators of other creative works, enter box 2 amounts
on Schedule C.
For other writers, inventors, and originators of creative works who are not in the business of doing
this sort of work (but who have a profit motive in mind), the box 2 amount goes on Schedule E, line
4. If the creative activity is a hobby, the box 2 amount goes on Form 1040, line 21.
For owners of nonoperating interests in mineral rights, the box 2 amount goes on Schedule E, line
4. A nonoperating interest bears none of the cost or responsibilities of operating the property. The
only expenses that may be deducted from such income are depletion and state production taxes.
For owners of working interests in gas and oil properties, the box 7 amount is entered on Schedule
C. There would not be a box-2 entry.
DEPLETION
Depletion is the using up of natural resources by mining, drilling, quarrying stone, or cutting timber.
Taxpayers who own economic interests in mineral deposits, geothermal deposits, oil or gas wells, or
standing timber recover their cost through deductions for depletion over the economic life of the property. An economic interest is one acquired by investment, the return on which is dependent upon the
extraction of the natural deposit or the cutting of timber.
There are two methods of computing depletion: cost depletion and percentage depletion. If cost depletion results in a greater deduction than percentage depletion, the depletion deduction is computed
using the cost method.
Cost Depletion
To determine cost depletion, the taxpayer must first determine three items:
The propertys basis for depletion.
The total recoverable units in the propertys natural deposit.
The number of units of minerals sold during the tax year.
Note: Cost depletion cannot be claimed in excess of the basis of the mineral or timber property; that
is, if the basis is $0, cost depletion is $0.
The basis for depletion is:
The original cost of the mineral or timber property rights less:
Amounts recoverable.
Residual value of land and improvements at year end.
Cost or value of land acquired for purposes other than mineral production.
Plus any additional expenditures.
Minus the total depletion (cost and/or percentage) allowed or allowable in all previous years.
The basis may not be less than $0.
The total recoverable units is the sum of the number of units of minerals remaining at year end and
the number of units of minerals sold during the tax year. The taxpayer is required to use the most
current industry method and the most accurate and reliable information obtainable when determining these numbers.
The number of units sold during the year is determined based on the taxpayers accounting method.
For the cash method, the number of units sold is based on the payments received during the year. For
the accrual method, the number of units sold is based on the taxpayers inventory method.
To determine the cost depletion deduction, first divide the propertys basis for depletion by the total
recoverable units. The result of this computation is the unit rate. Next, multiply the unit rate by the
number of units sold during the year.
The timber depletion deduction must be computed using the cost method. Percentage depletion is not
allowed. Timber depletion is computed on the basis of the timber only; no portion of the land basis
is considered when the depletion deduction is computed. If there is no timber basis, the allowable
depletion deduction is $0. The depletion deduction is based on the amount cut during the year. Timber
is considered cut on the date on which the quantity of felled timber is first determined during the
ordinary course of business. The price of timber is generally stated per thousand board feet, which is
written as MBF. If timber depletion is claimed, Form T (not covered in this course) must be completed
and attached to the return.
mExample: Tim Jefferson uses the cash method for the sale of his timber. He received gross receipts
of $20,000 from the sale of his timber. The tree farm, containing 2,000 MBF of timber, was purchased
this year for $60,000, of which $20,000 was for the land. Tims basis in the tree farm is $40,000
[$60,000 $20,000 = $40,000]. During the year, 400 MBF were cut. Tims rate per unit is $20 per MBF
[$40,000 basis 3 2,000 MBF = $20 per MBF]. Tims cost of depletion is $8,000 [$20 rate per unit 2
400 MBF = $8,000].m
Note:This is a very brief review of cost depletion. The cost depletion method is covered in more detail
in IRSPublication 535, Business Expenses.
Percentage Depletion
To determine depletion using the percentage method, multiply the gross royalties from the mineral
interest by the percentage specified for that mineral in the Tax Code. A listing of these percentages
is in IRS Publication 535, Business Expenses, and many other reference books. Allowable percentage
depletion may be claimed even if the property basis is $0.
mExample: Tom Devlin invested in a silver mine. The depletion percentage for silver is 15%. Over the
years, he has owned the investment, Tom has fully recovered his purchase price through depletion
deductions. Thus, his basis is $0. In 2014, the silver mine paid him royalties of $1,000. Despite the fact
that his basis is $0, Tom may nonetheless deduct $150 depletion [$1,000 2 15% = $150]. Note that if
Tom were using cost depletion, he would have no 2014 depletion deduction.m
The deduction for percentage depletion generally may not exceed 50% (100% for oil and gas property) of the taxable property income (computed without regard to the depletion allowance). Percentage
depletion for oil and gas properties is also subject to other limitations. See IRS Publication 535,
Business Expenses, and partner with a Tax Professional experienced in dealing with depletion if you
ever encounter a taxpayer with oil or gas property.
OTHER SCHEDULE E INCOME

Taxpayers may receive income from estates or trusts, partnerships, or small business corporations.
Each of these entities pass their income and losses (and in some cases, deductions and credits) to
taxpayers who hold interests in the activities. The pertinent information is provided to individual taxpayers on one of several Schedules K-1. Most taxpayers report the ordinary income (or the deductible
portion of the ordinary loss) on Schedule E, page 2, shown in Illustration 19.2.
A complete discussion of Schedules K-1 is not included in this course. However, as an introduction
to the passive loss rules, we will present some basic information about each type of entity. For an
in-depth discussion of Schedules K-1, see the H&R Block course Advanced Schedules K-1.
Estates and Trusts

Estates and trusts must file tax returns. Instead of Form 1040, estates and trusts file Form 1041.
A Schedule K-1, shown in Illustration 19.6, should be provided to each beneficiary listing the share
of income and allowable deductions and credits. The appropriate information is then entered on the
beneficiarys individual tax return.
Partnerships
Partnerships do not pay income taxes but are required to file information returns using Form 1065
(or Form 1065-B). They must also provide each partner with a Schedule K-1, shown in Illustration
19.7, listing the partners share of income, loss, deductions, and credits. The appropriate information
is then entered on the partners individual tax return.
Notice items G through I in Part II of the Schedule K-1 in Illustration 19.7. These terms are significant in our discussion of passive activities, so some clarification is warranted.
A general partner is one who is personally responsible for partnership debts. They often participate in
the day-to-day operation of the partnerships business activities. As such, they are subject to self-employment tax on any guaranteed payments and ordinary income attributable to the partnerships
trade or business.
A limited partner is a partner in a partnership organized under a states limited partnership law,
whose personal liability for partnership debts is limited to their investment in the partnership. They
generally do not participate in the partnerships business activities and are not subject to self-employment tax on partnership income.
A limited liability company (LLC) is a business entity formed under state law by filing articles of
organization as a limited liability company. An LLC with two or more owners is generally treated as
a partnership, unless it elects to be treated as a corporation. In an LLC that is treated as a partnership, none of the members are legally liable for the partnerships debts. However, an LLC member
who actively participates in the business (an LLC member-manager in item G on Schedule K-1, Form
1065) is treated for tax purposes the same as a general partner described above.
A business activity in which the taxpayer does not participate is called a passive activity. Limited
partners and LLC members who do not participate in the business activities of the partnership are
subject to limitations when deducting their passive activity losses. There will be more about passive
activities in the next section.
Subchapter S Corporations
Generally, a corporation files a tax return, Form 1120, and pays taxes on its net profits. However,
certain small corporations may elect to be subchapter S corporations, sometimes referred to as S
corps, or similarly abbreviated. Subchapter S refers to the Tax Code portion that allows qualified
corporations to elect this treatment.
S corps are taxed in a manner similar to the way partnerships are taxed. That is, they pay no tax
themselves, but pass the income, losses, deductions, and credits through to the shareholders. The
appropriate information is reported on a Schedule K-1 (see Illustration 19.8), where the shareholders
share of income, loss, deductions, and credits are entered on the shareholders individual tax return.
S corp shareholders, who do not materially participate in the S corp, generally are not subject to
self-employment tax, but are subject to the passive activity rules.
S corps may issue other documents in addition to Schedule K1 (Form 1120S) to their shareholders.
For example, a shareholder who receives ordinary dividends from the corporation will receive a Form
1099-DIV, and a shareholder who is employed by the corporation may receive a Form W-2.
PASSIVE LOSS RULES

In order to understand the rules concerning passive activities and the limitations on passive losses,
we must begin to classify income and losses. Income and losses are categorized as passive, active, or
portfolio.
Passive income and losses are produced by passive activities. A passive activity, as we mentioned
earlier, is a business activity in which the taxpayer does not materially participate. That is, they are
generally not involved in the business operation. The precise definition of material participation is
rather involved. If you need to determine whether a taxpayer materially participated in an activity,
see IRS Publication 925, Passive Activity and At-Risk Rules.
Passive activities also include, by law, most rental real estate activities, whether the taxpayer participates in the operation or not. Landlords, however, are subject to a more liberal set of limitations
than those involved in other passive activities, and certain real estate professionals who materially
participate in rental activities are not subject to the passive activity rules.
Active (non-passive) income and losses are income produced as a result of the taxpayers efforts.
Salaries, bonuses, commissions, and income and losses from business and farm activities in which the
taxpayer materially participates are examples.
Portfolio income and losses are those from such sources as interest, dividends, capital gains and
losses, and royalties.
Illustration 19.9 summarizes the classes of income discussed previously.
Losses from passive activities (other than rental activities discussed below) may be used only to offset income in the current year from other passive activities. Any losses not deducted in the current
year may be deducted against future passive income or deducted in full the year when the taxpayer
disposes of the passive activity.
mExample: In 2014, Hilda Jorgenson invested in a real estate limited partnership. The limited partnership is her only passive activity. In 2014, her share of the partnerships losses was $300. Hilda may
not deduct her loss from her other income in 2014. She may, however, suspend her loss and deduct it
from future passive income. If she still has suspended losses when she sells her limited partnership
investment, she may deduct all of the suspended losses then.m
Active-Participation Rental Activities

The most common passive loss situations involve rental activities similar to those of Albert Hawking
in Exercise 19.2. However, the news is not all bad. There is a provision in the law that allows qualifying taxpayers who are engaged in rental real estate activities to deduct $25,000 of rental losses in the
year incurred. This special allowance is an exception to the general rule disallowing losses in excess
of income from passive activities.
To qualify, the taxpayer must actively participate in a rental real estate activity (by collecting rent
or making management decisions, for example), and they may, in most cases, deduct up to $25,000 of
rental losses against any other kind of income.
mExample: Joseph Benrus owns a rental house in which he actively participates in the rental activity.
On Schedule E, his 2014 loss for the rental house is $1,300. In most cases, Joseph would be allowed
to deduct his full loss from his other income.m
To actively participate in the rental activity, the taxpayer (and taxpayers spouse) must own at least
10% of the rental property and make management decisions or arrange for others to provide services,
like repairs and maintenance on the rental property, in a significant and bona fide sense. Active participation in management decisions may include:
Approve new tenants.
Determine and set rental terms.
Approve rental property expenditures.
However, there is a limit on the $25,000 annual rental loss deduction against other income. If the
taxpayers modified AGI exceeds $100,000, the $25,000 cap on net rental losses is reduced by half the
amount by which the modified AGI exceeds $100,000.
Phaseout rule. The maximum special allowance of $25,000 ($12,500 for married individuals filing
separate returns and living apart at all times during the year) is reduced by 50% of the amount of
the taxpayers modified adjusted gross income that is more than $100,000($50,000 if the taxpayer is
married filing separately). If the modified adjusted gross income is $150,000 or more ($75,000 or more
married filing separately), the taxpayer generally cannot use the special allowance.
Modified AGI, for purposes of passive loss limitations, consists of the taxpayers adjusted gross
income without taking into account:
Taxable social security and/or tier 1 railroad retirement benefits.
Deductible IRA contributions or certain other qualified retirement plans.
Excluded U.S. savings bond interest used for qualified education expenses.
Excludible adoption benefits.
Passive activity income or loss on Form 8582.
Rental real estate losses allowed under the special rule for real estate professionals.
Overall losses from publicly traded partnerships.
Deduction for one-half of self-employment tax.
Student loan interest deduction.
Tuition and fees deduction.

Deduction for domestic production activities.
Form 8582, Passive Activity Loss Limitations, and its worksheets are used to compute the necessary
limitations. You will not be required to complete Form 8582 in this course.
Working Interest in Oil and Gas Properties
A taxpayers holdings in working interests in oil and gas property are exempt from the passive loss
rules, whether or not the taxpayer materially participates in the activity, unless liability is limited.
CHAPTER SUMMARY
How to report rental income and some expenses on Schedule E and how to calculate net rental
income or loss when given the income and expenses.
Basic knowledge related to the new tangible property regulations (TPRs).
How to report royalty income and expenses on Schedule E and how to calculate net royalty income
or loss when given income and depletion.
How to identify income from partnerships, S corporations, estates, or trusts reported on Schedules
K-1.
Generally, passive losses may be deducted currently only against passive income. Rental income is
passive by definition, but an exception to the passive loss rules allows most ordinary taxpayers to
deduct rental real estate losses against non-passive income.
Suggested Reading
sections in IRS Publication 17, plus the other IRSpublications:
Chapter 9, Rental Income and Expenses.
Chapter 12, Other Income.
IRSPublication 527, Residential Rental Property (Including Rental of Vacation Home).
IRSPublication 535, Business Expenses.
IRSPublication 925, Passive Activity and At-Risk Rules.
clients father recently

Tpassed away. His mother has stayed in the houseOurthat
theyve owned and
he Tax Institute at H&R Block Tax Question:
lived in for about 30 years, but she thinks she would like to downsize and live in
an apartment. Our client agrees that it is a good idea, but he is also concerned
that she might change her mind and want to move back into her house. He
would like to explore the tax consequences of renting out the house for a few
years instead of selling it outright.
Would she lose her exclusion if she rents the house? How does she determine
her basis if she sells the house or if she rents it and claims depreciation? He
estimates that his parents spent about $20,000 to buy the house and have made
about $10,000 worth of improvements over the years, including a recently added
deck and a new roof. They think they could get about $160,000 for the house if
they sold it now.
nswer: Your clients mother would not immediately lose the 121 exclusion
of gain on the sale of a principal residence if she converts the house to a
rental, but there are time limits. Although it doesnt appear that she would need
the higher 121 exclusion that applies to joint filers, if the house is sold no later
than two years after his fathers death and his mother has not remarried, she
would qualify for the full $500,000 exclusion.
If she remarries, or she sells the house after the two-year point, she would qualify for the $250,000 exclusion. The exclusion will run out altogether three years
after she moves out of the housethat is, at the point where the two-out-of-five
year use requirement for the exclusion is no longer met. The exclusion is also
affected if she rents out the home and then moves back into it, so that there is a
period of nonqualified use.
Basis in the home for sale purposes is partly the original cost of the home
plus improvements and partly step-up basis. She is treated as inheriting her
husbands half of the home, and basis in that half is stepped-up to fair market
value on the date of his death. Additional improvements made to the home from
now on will also increase her basis in the home.

Illustration 19.6

Illustration 19.7

Illustration 19.8

Illustration 19.9
20
OVERVIEW
This entire chapter is devoted to the BlockWorks Practice Session 3. This practice session will help you
to become familiar with the preparation of taxpayers income tax returns in the BlockWorks software
as well as develop your tax interview skills at the tax desk. The case studies are set up as role-playing
exercises to give you the experience of interviewing a client. This will help you start thinking of the
kinds of questions you will ask to ensure a thorough tax interview, resulting in an accurate tax return.
INSTRUCTIONS
To complete the BlockWorks Practice Session 3, you will spend the first hour of class discussing state
chapter material. Your instructor will provide you with guidance as to which state chapters your class
will be discussing.
Next, you will spend one hour completing ITC chapter case study returns in the BlockWorks software.
Your instructor will provide you with guidance as to which chapter case studies you should enter into
BlockWorks.
Last, you will complete Case Studies 20.1 and 20.2 in the BlockWorks software. The case study
return information can be found in your workbook starting on page W20.1. The case studies are set
up in your workbook as an interview with a taxpayer at the tax desk. To complete these case studies,
you will need to partner with another participant in class. One individual will play the role of the
Tax Professional and the other individual will play the role of the taxpayer. Each case study in your
workbook is set as two scripts, the Tax Professional and the taxpayer. Use the script associated with
your role to ask or answer questions and complete the case study return in the BlockWorks software.
20.1
21
Penalties and Amended Returns

OVERVIEW
This self-study chapter begins with information on how the IRS assesses penalties for late filing, late
payment, negligence, and substantial underpayment. Next, you will learn the procedures for changing
a return that has already been accepted by the IRS. Form 1040X, Amended U.S. Individual Income
Tax Return, is filed to change information on a previously filed return.
OBJECTIVES
Define the different penalties associated with filing a return and paying the tax due.
Determine when it is advantageous or necessary to amend an individual income tax return.
Complete Form 1040X, Amended U.S. Individual Income Tax Return.
State basic details of household employment taxes.
TAX TERMS
You may use the following definitions to help you with this topic:
Amended return. A tax return filed on Form 1040X after the original return has been filed. An
amended return is used to correct an error or to claim a more advantageous way of filing the original
return. An amended return can also be used to carry back an unused credit or net operating loss.
Closed year. A tax year for which the statute of limitations has expired. The taxpayer cannot claim
a refund and the IRS cannot collect additional taxes (with certain uncommon exceptions).
Open year. A taxable year for which the statute of limitations has not yet expired.
OTHER TAX PENALTIES

Taxpayers are subject to penalties if they fail to file their tax return by the filing deadline. See the
chart in Illustration 21.1 for a description of the various types of penalties a taxpayer may face for
failing to file or adequately pay any tax due in a timely manner.
21.1

Illustration 21.1
SITUATION
Failure to File
DESCRIPTION
PENALTY AMOUNT
Taxpayer fails to file the return 5% of the unpaid taxes for each
by the due date, and there is a month or part of a month that
balance due.
the return is late, but not more
than 25%.
Failure to Pay
Taxpayer fails to pay the tax

owed by the due date.
0.50% of the unpaid taxes for

each month or part of a month
after the due date, but not
more than 25%.
Negligence or Intentional
Disregard
Taxpayer shows negligence or

disregard of the rules or regulations, causing an underpayment.
20% of the underpayment.
Substantial Understatement
Taxpayer understates their tax 20% of the underpayment

by the larger of $5,000 or 10%
of the correct tax.
Failure-to-File Penalty
If the tax return is not filed by the due date (including extensions), the penalty is generally 5% for
each month or part of a month the return is late, but not more than 25%. The penalty is based on tax
not paid by the due date (without regard to extensions). However, if the failure-to-file is due to fraud,
the penalty is 15% for each month or part of a month that the return is late, up to a maximum of 75%.
who are due a refund but did not file by the due date
T,must fileTaxpayers
their return within three years from the date the return was due
ax Tip:
(including extensions) to get their refund.
Failure-to-Pay Penalty
If the taxpayer fails to pay their tax on time, the failure-to-pay penalty is one half of 1% (0.50%) of
the unpaid taxes for each month or part of a month after the due date that the tax is not paid. This
penalty does not apply during the automatic six-month extension of time to file period if at least 90%
of the actual tax liability on the return is paid on or before the due date of the return and the balance
is paid when the return is filed.
Combined Penalties
If a taxpayer is subject to both the failure-to-file penalty and the failure-to-pay penalty, the 5% (or
15%) failure-to-file penalty is reduced by the failure-to-pay penalty. Returns that are more than 60
days late are assessed a minimum penalty that is the smaller of $135 or 100% of the unpaid tax.
Tax Essentials Penalties and Amended Returns 21.3
Penalty Exceptions
Failure-to-File
Taxpayers do not have to pay a failure-to-file penalty if they can show that the delay was due to reasonable cause rather than willful neglect.
Failure-to-Pay
Taxpayers do not have to pay a failure-to-pay penalty if they can show that they acted in good faith
and there was reasonable cause for the treatment of any item on the return. Lack of funds is not reasonable cause for failing to pay any tax due.
AMENDED RETURNS
Form 1040X, Amended U.S. Individual Income Tax Return, is used to correct errors or omissions on
the original return. The correction may result in the taxpayer receiving an additional refund or owing
additional taxes. You will find a copy of Form 1040X, pages 21.1 and 21.2, in Illustrations 21.2 and
21.3.
mExample: In June 2014, Darla Eide discovered that she had failed to include in her income the $500
fair market value of a dishwasher she had won on a television show in 2013. She should file Form
1040X for 2013 to include the $500 value in her income.m
A return may also be amended if a more advantageous way of preparing the return is available.
mExample: Darla had originally filed Form 1040A. When she found that she had not reported all of
her income, she also discovered that itemizing deductions would reduce her tax liability. She may
claim her itemized deductions on Form 1040X. Schedule A must be completed and attached.m
Any form, schedule, or statement that changed or would have been required had the original return
been filed using the current method must be attached to Form 1040X.
Due Date for Filing Form 1040X

Generally, an amended return must be filed within three years of the date the original return was
filed, or within two years of the date the tax was paid, whichever is later. If a return is filed on or
before the filing deadline, April 15 is considered the filing date.
If an extension was granted, the date of filing is the actual date the return was filed within the extension period, or April 15 if the return was filed after the extension period expired.
mExample: Charles Dounelis wants to amend his 2011 income tax return. The original return was
due April 16, 2012. Charles filed his return April 2, 2012. An amended return must be filed no later
than April 15, 2015.m
Form 1040X
Return Year: Identify the calendar or fiscal year of the return that is being amended. A fiscal year
is an accounting year ending on the last day of any month except December. Fiscal year returns are
most commonly seen in business returns, not individual returns.
The amended return must be prepared according to the tax law, rules, rates, and schedules applicable
to the tax year being amended.
Name/Address: Complete the heading with the taxpayers current name, current address, and social
security number.
When amending a joint return:
List the names and social security numbers in the same order as shown on the original return.
If the taxpayers are changing from separate returns to a joint return and one of them has not filed
an original return, the name of the taxpayer who has filed should be listed first.
Filing status: The filing status should correspond to the filing status of the amended return, not the
original return. Recall that married couples may not change their filing status from married filing
jointly to married filing separately after the due date of the return.
Filing status considerations:
Changing from separate to a joint return. The taxpayers should understand that they will
both be responsible for the tax and any interest and penalties due on the return now or that may
become due later.
Changing to head of household filing status. If the taxpayer is using the head of household
filing status on the amended return, and the qualifying person is a child who is not the taxpayers
dependent, enter the childs name and QND in Part III, Explanation of changes. The QND
notation indicates a qualifying nondependent.
cannot be e-filed. IRS personnel process Forms 1040X
Tmanually.FormBe 1040X
sure your explanations are clear and precise and that the
ax Tip:
amendment is complete with all applicable forms and schedules.
Changing Amounts
Since Form 1040X can be used for many purposes, it is sometimes difficult to know which part(s) of
the form to fill out. A thorough interview is critical in determining when a taxpayer might be eligible
for credits and deductions that were not available to them on the original return. Unless there are
instructions in Instructions for Form 1040X (Rev. December 2014) that tell the taxpayer otherwise,
they should follow the steps below:
Always complete the top of page 21.1 through Amended return filing status.
Complete:
Lines 123 for changes in filing status, income, adjustments to income, or itemized or standard
deductions.
Lines 130 for changes in exemptions.
Lines 623 for changes in tax before credits.

Lines 723 for changes in nonrefundable credits or other taxes.
Lines 1223 for changes in payments and refundable credits.
If the taxpayer is only sending in additional information to the IRS
Tand no dollar
amounts are changing, complete:
ax Tip:
Heading.
Presidential Election Campaign Fund, if applicable.

Explanation of Changes.
Signature.
Income and Deductions
Follow along on the form in Illustrations 21.2 and 21.3 as you read the line descriptions. It is important that you understand the flow of Form 1040X.
Line 1 Adjusted Gross Income. Recall that adjusted gross income is the total of all taxable
income, minus any adjustments. All forms and schedules that pertain to the change to income and
adjustments must be attached to Form 1040X. Remember, any change in AGI can cause changes in:
Miscellaneous itemized deductions.
Credit for child and dependent care expenses.
Child Tax Credit.
Education credits.
Retirement savings contributions credit.
Allowable charitable contributions.
Taxable amount of social security.
Total itemized deductions.
Deductions for exemptions.
Line 2 Itemized Deductions or Standard Deduction. A change to or from itemized deductions
or the standard deduction must be accompanied by a Schedule A. If there is a change to income, there
will likely be a change to categories in which a percent-of-AGI floor affects the computation of itemized
deductions.
Line 3. Computation line, AGI minus deductions.
Line 4 Exemptions. Any change to exemptions claimed must be detailed in the Exemptions section
on page 21.2. Line 4 can also be affected by a change to AGI. Recall that higher income taxpayers prior
to may not be able to claim the full amount for exemptions. Likewise, a decrease in income might now
allow the full deduction.
Line 5. Computation line for taxable income.
Tax Liability
Line 6 Tax. A change to the tax on taxable income will also reflect the method used to compute the
tax (noted to the left of the dollar amount). Tax computation methods are listed in the chart below.
TAX COMPUTED WITH
LINE 6:
Tax Table
Table
Tax Computation Worksheet
TCW
Schedule D Tax Worksheet
Sch D
Qualified Dividends and Capital Gain Tax

Worksheet
QDCGTW
Schedule J (Form 1040)
Sch J
Foreign Earned Income Tax Worksheet
FEITW
Form 8615, Tax for Certain Children Who Have

Unearned Income
F8615
Line 7 Credits. Any change to nonrefundable credits must be accompanied by the applicable supporting forms. As previously discussed, a thorough interview might uncover credits that the taxpayer
might not have needed or qualified for on the original return.
Line 8. Computation line, taxable income minus refundable credits.
Line 9 Health Care: individual responsibility. Any change to the ACA individual responsibility
payment will be entered on this line.
Line 10 Other Taxes. Changes to the income and deductions section of Form 1040X could affect
any of the taxes listed in the Other Taxes section of Form 1040.
Line 11. Computation line, adding other taxes.
Payments
Unless Form 1040X is being filed for informational purposes only, the payments section should always
be filled out. This section reports all payments and credits that will apply to the new dollar amounts.
See the line numbers below for support that is required when an amount is changing.
Line 12 Withholding. Any change to withholding must be supported with the additional or corrected forms. Such forms might include Form W-2, Form 1099R, and Form 1099G.
Line 13 Estimated Tax Payments. Include all estimated tax payments and prior-year refunds
that were applied to the tax year being amended.
Line 14 Earned Income Credit. A change to EIC should include Schedule EIC if the taxpayer has
a qualifying child. If an EIC claim was previously reduced or disallowed, Form 8862, Information to
Claim Earned Income Credit After Disallowance, might be required. A more detailed explanation can
be found in the Instructions for Form 1040X (Rev. December 2014).
Line 15 Refundable Credits. Attach the appropriate forms to support a change to any refundable
credit.
Line 16 Amount Paid with Extension or Tax Return. Include any amounts paid with extension
requests, the original return, or electronic funds withdrawal.
Line 17 Total Payments. Computation line, payments.

Illustration 21.2

Illustration 21.3
Refund or Amount You Owe

Line 18 Overpayment. Enter the overpayment amount from the original return. Also, if the IRS
changed the original return and increased the overpayment, include that amount.
Line 19 Computation. Application of previous overpayments.
Line 20 Amount You Owe. Computation line, balance due.
Line 21. Computation line, overpayment.
Line 22 Overpayment Received as Refund. Enter the amount the taxpayer would like to receive
in a check. The IRS does not offer direct deposit on refunds from amended returns. The IRS will calculate any interest due. All refunds are subject to any past due federal or state debts.
Line 23 Overpayment Applied to Estimated Tax. Enter the amount the taxpayer would like
applied to a future tax year and indicate which tax year. No interest will be paid on this amount. This
election cannot be changed.
Exemptions
The exemptions section should only have entries if there are changes to the exemptions (personal and
dependents) that were reported on the original return. Lines 2430 should include all exemptions that
will be claimed on the amended return. This includes:
Listing exemptions that were claimed on the original return that are still being claimed on this
return.
Adding exemptions that were not listed on the original return.
Part III, Explanation of changes, should include a thorough explanation of the changes to exemptions.
Line 30 Dependents. List all dependents claimed on the amended return. This includes:
Dependents claimed on the original return who are still being claimed on this return.
Dependents not claimed on the original return who are being added to this return.
Presidential Election Campaign Fund
Taxpayers who did not designate $3 to the Presidential Election Campaign Fund on their original
return may do so on Form 1040X within 201/2 months of the original due date for filing the return.
For 2014 returns, the time to make this designation ends on January 3, 2017. Previous designations
cannot be changed.
Explanation of Changes
An explanation is necessary for each item changed from the original return. For example, the explanation section for Darla Eide (the taxpayer in the examples on page 21.3) may read:
Did not include fair market value of prize, $500. The $500 is now being added in Column B, line 1.
The standard deduction was claimed on the original return. Column B, line 2, is a result of the taxpayer now claiming itemized deductions.
Change to IRA deduction. IRA deduction should be used to explain any increase or decrease to
an IRA contribution. Form 8606, Nondeductible IRAs, should be attached if the taxpayer is changing
from a deductible to a nondeductible IRA.
Nontaxable combat pay election. Enter nontaxable combat pay and the amount when EIC is
being amended based on the election.
If the taxpayer is filing an amended return based on a particular court case, revenue procedure, regulation, or revenue ruling, it should be cited in the explanation.
Signature
Recall that Form 1040X cannot be e-filed. As such, electronic signatures are not an option. Form
1040X requires an original signature by all taxpayers and Tax Professionals.
Interest on Refunds
The IRS guidelines on paying interest on refunds:
If the taxpayers refund is made within 45 days after the due date of the return, no interest is paid.
If the taxpayer files their return after the due date (including extensions), no interest will be paid
if the refund is made within 45 days after the date the taxpayer filed.
If the refund is not made within this 45-day period, interest will be paid from the due date of the
return or from the date the taxpayer filed, whichever is later.
AMENDED RETURNS IN BLOCKWORKS

Here, we will walk through preparing an amended return in BlockWorks so that you have the information you need use this tool to prepare a Form 1040X. We will use the following example for this
walk-through.
mExample: Ira Showthem, unmarried with no dependents, prepared and filed his own 2014 tax return
on February 14, 2015. His income consisted of one Form W-2 and one Form 1099-DIV. On February
17, 2015, he was going through some old mail and found a Form 1099-INT that he did not report on
his return. He thought he knew enough to file his Form 1040A, but has no idea how to amend his
return, so he went straight to an H&R Block office for help. His Tax Professional reviewed his documents and asked enough questions to determine that Ira needs to amend his return to include the
Form 1099-INT and correct the tax calculation because Ira calculated his tax due without using the
Qualified Dividends and Capital Gain Tax Worksheet.m
In the example above, the taxpayer prepared his own original return. A similar scenario is possible if
a taxpayer came to H&R Block to have their return prepared and, after the return was filed, found an
income document that was not reported on the original return. In the second case, the original return
is already in BlockWorks. Either way, the process to amend the return is nearly the same.
Demonstration Information, included in original return
Demonstration Information, original return
Demonstration Information, original return
Demonstration information, form to be reported on amended return

Illustration 21.4

Illustration 21.5

Illustration 21.6

Illustration 21.7
The Process
1. Access the Form 1040X screen in BlockWorks by entering 1040X in the search field.
2. On the 1040X screen, make entries in all fields that had entries on the original return. Enter the
same values that were reported on the original return. See Illustration 21.4.
3. If the original return was prepared in BlockWorks, all you need to do is add or amend the information already in the system. For example, add a missing income document or delete a dependent
that should have been claimed by another taxpayer.
4. If the original return was not prepared in BlockWorks, you need to input all the information necessary to show a completed return. This includes all income documents, credits, adjustments, etc.
The completed Form 1040X for Ira Showthem is shown in Illustrations 21.521.6. Illustration 21.7 is
shown for informational purposes only. It is not required to file with the return. Note the QDCGTW
printed next to line 6 on Ira Showthems Form 1040X. This is an indication to the IRS that the
Qualified Dividends and Capital Gain Tax Worksheet was used to calculate the tax on the return.
HOUSEHOLD EMPLOYMENT TAXES

A household employee is an individual who performs nonbusiness services in a taxpayers home. Such
services include child care (hence the informal name nanny tax) as well as cleaning, cooking, yard
maintenance, etc. Individuals who employ such employees must report and pay the payroll taxes on
their individual income tax returns. Payroll taxes include social security tax, medicare tax, and federal unemployment tax.
Taxpayers who employ household workers must pay social security and medicare tax for most household employees to whom they pay cash wages of $1,900 or more during the year. They must pay
federal unemployment tax for household employees if they pay cash wages totaling $1,000 or more
to all household employees during any calendar quarter of the tax year or the previous tax year. The
taxpayer is not required to withhold income tax, but may do so if the employee requests withholding
and the taxpayer agrees.
The above rules generally do not apply to employees under age 18, the taxpayers child under age 21,
the taxpayers spouse, or the taxpayers parent.
Schedule H is used to compute the tax to be entered on Form 1040, line 60a. An employer identification number (EIN) must be obtained by all household employers. It may be obtained by filing Form
SS-4. This is an awareness-level explanation. Schedule H completion is not included in this course.
COURSE SUMMARY
In this course, you learned:
There are different penalties associated with filing a return and paying the tax due.
Form 1040X, Amended U.S. Individual Income Tax Return, is used to correct errors or omissions
on previous years tax returns.
Generally, an amended return must be filed within three years of the date the original return was
filed, or within two years of the date the tax was paid, whichever is later.
When amending a tax return, you must use the law that applied for the year of the return being
amended.
Schedule H is used to compute household employment taxes.
Suggested Reading
Chapter 1, The Income Tax Return, the section titled, What if I Made a Mistake?
Chapter 30, How to Figure Your Tax.
Research Question
How long should taxpayers keep copies of their income tax returns?
Answer __________ found on page __________, IRS Publication 17.
22
Tax Planning
OVERVIEW
In this chapter, you will learn that whether a taxpayer owes additional taxes or receives a refund is
well within the taxpayers control. With a good understanding of the Tax Code and careful planning,
a taxpayer can plan for a refund or an amount due. You will be introduced to the concept of tax
planning or the ability to project an amount due or tax refund with relative certainty and to the
consequences of failing to do so.
OBJECTIVES
Determine when a change in withholding or estimated payments will help a taxpayer meet current
tax and financial goals.
Complete Form W-4, Employees Withholding Allowance Certificate.
Explain the Education Savings Bond Program and Coverdell Education Savings Account to taxpayers who are planning to save for their childrens education.
Advise taxpayers regarding the need to make estimated tax payments.
State the procedure for requesting an automatic extension to file a return.
State the options a taxpayer has when they want to directly deposit their refund into more than
one account.
State the procedure for requesting an installment agreement from the IRS.
TAX TERMS
Estimated tax. The amount of tax a taxpayer expects to owe for the year after subtracting expected
amounts withheld and certain refundable credits.
Estimated tax voucher. A statement by an individual of (1) the amount of income tax he estimates
he will incur during the current taxable year on income that is not subject to withholding, (2) the
excess amount over that withheld on income which is subject to withholding, and (3) his estimated
self-employment tax. Advance payment of tax may be required (on as many as four payment dates)
unless estimated tax due after withholding and credits is less than $1,000.
22.1
Exemption from withholding. Status claimed on Form W4 directing the employer not to withhold federal income taxes from the employee. An employee who had no tax liability and received a
full refund of any federal income tax withheld in the preceding tax year, and who expects the same
conditions to apply in the current tax year, may claim exemption from withholding.
Underpayment penalty. If a taxpayer did not pay enough tax on a timely basis during the year, he
may be required to pay an underpayment penalty. The penalty, if any, is computed on Form 2210.
Withholding allowances. A means of determining how much federal income tax is withheld from a
paycheck. The more allowances a taxpayer claims, the less income tax is withheld from each paycheck.
PAY AS YOU GO
The U.S. federal income tax system is a pay-as-you-go arrangement. Taxpayers must pay the tax
as they earn or receive income over the course of the year. There are two ways for a taxpayer to pay
as they go:
Withholding.
Estimated tax payments.
We will cover each method in detail in the next sections of this course.
The pay-as-you-go system creates some confusion for many taxpayers. It is very easy to think of
income taxes as an event that happens once a year. However, it is important to remember that, while
filing a return is the annual event, payment of income taxes is supposed to happen throughout the
entire year. For employees, their employer is generally required by law to withhold income tax on
the employees wages when the employee earns the money and then submit tax withholding to the
IRS. Self-employed individuals and contractors are required to make periodic estimated income tax
payments throughout the year.
Planning tax withholding and refunds can be an important element
Tof an overall
financial plan. Large tax refunds are nice, but it is crucial to
ax tip:
have enough of the paycheck left to pay the bills throughout the year. Proper
planning can help to ensure that both goals are met.
WITHHOLDING
If you are an employee, your employer probably withholds income tax from your paychecks. The tax
money withheld each pay period is sent to the IRS throughout the year. When you file your tax return
for the year, you report all of your income and all of your withholding and other payments. If you paid
more income tax during the year than you had to, as many taxpayers do, you will receive a refund
of the overpayment. If you did not pay enough income tax during the year, you will have to pay the
balance due before the deadline.
Tax Essentials Tax Planning 22.3
Form W-4
An employee tells their employer how much income tax to withhold from their taxable wages by completing Form W-4, Employees Withholding Allowance Certificate, and giving it to the employer. This
form is shown at the bottom of Illustration 22.1.
Withholding is computed on taxable wages. Taxable wages consist of the employees gross pay reduced
by any pre-tax contributions made to retirement plans (such as 401(k) plans or cafeteria plans.)
mExample: David Sawyer (36) holds one job, which pays $900 per week gross. He contributes $50
per week to his 401(k) plan. Thus, his taxable wages are $850 per week.m
Notice that Form W-4 does not actually show the amount of tax to be withheld; rather, it shows how
many withholding allowances the employee is claiming. The employee may determine their allowances using the IRS worksheet provided with Form W-4. The Personal Allowances Worksheet is included
in Illustration 22.2.
Withholding allowances are often confused with the number of exemptions an employee expects to
claim on their tax return. Additional withholding allowances are often granted for reasons other than
anticipated exemptions. The worksheet allows the employee to compute their allowances more accurately than they would by simply counting up their anticipated exemptions.
Understand that it is the goal of the IRS (hence, of the worksheet) to have the taxpayer come close to
breaking even on their tax return. Using the worksheet instructions often results in a small balance
due. Because many taxpayers prefer to receive a refund when they file their tax return, an employee
may choose not to claim all of the withholding allowances to which they may be entitled. A taxpayer
may even choose to claim zero allowances on their Form W-4, which will cause the employer to withhold the maximum amount of income tax based on the wages earned by the taxpayer.
mExample: David Sawyer (from the preceding example) is unmarried and plans to file his 2015
return using the head of household filing status. His total taxable wages from this job for 2015 will be
$44,200 [$850 2 52 weeks + $44,200]. He will have no other income and no adjustments, and he will
not itemize deductions in 2015. David will claim one dependent child (age 10) for whom he will pay
$3,000 in child care expenses. He will claim the Child Care Credit and the Child Tax Credit.
In December 2014, while David gathered the information needed to complete his 2014 tax return, he
decided to start planning for 2015.
David would like to receive a refund of about $600. For the moment, however, let us assume that
David will claim all of the withholding allowances to which he is entitledno more and no less.m
An explanation of each line may prove helpful as you examine Davids worksheet and Form W-4 in
Illustration 22.2.
Line A. The employee may claim one allowance for themselves, unless someone else will claim them
as a dependent.
Line B. The taxpayer may take an additional allowance if the job for which this Form W-4 applies
is their only job, if they are filing a joint return and their spouse does not work, or if the income from
any other jobs they and their spouse holds totals $1,500 or less.
Line C. The employee may add one allowance for their spouse but may choose not to do so if they have
a second job or if their spouse works.

Illustration 22.1

Illustration 22.2
Line D. One additional allowance may be added for each dependent the taxpayer will claim on their
tax return. They may choose not to claim all such allowances if they prefer to have additional tax
withheld.
Line E. An additional allowance may be claimed if the taxpayer will file using the head of household
filing status.
Line F. The employee may claim an additional allowance if they have paid at least $2,000 for child
and dependent care expenses for which they will be claiming a credit.
Line G. Depending upon their expected income, the employee may claim up to two additional allowances for each eligible child for whom they plan to claim a Child Tax Credit on their 2015 return.
Notice that only the Child and Dependent Care and Child Tax Credits are taken into account on lines
F and G. Other nonrefundable credits are not, nor is the Earned Income Credit.
Line H. Add lines A through G. In our example, this number is indeed different from the number of
exemptions David will claim on his return. Although he will be claiming only two exemptions on his
tax return, he is entitled to seven withholding allowances.
Under certain circumstances, additional worksheets may be completed to further fine tune the
number of withholding allowances. We will look at some of them later. Only one worksheet (or set of
worksheets) should be completed by married taxpayers or when multiple jobs are involved.
Examine the Form W-4 withholding allowance certificate.
Lines 1 and 2 show the employees name, address, and social security number.
Line 3. Enter the employees marital status. David is single.
Notice the third option on this line, Married, but withhold at higher Single rate. This is slightly
misleading because the tax rates for married taxpayers and single taxpayers are the same rates; it
is the income level at which the rates change that differs. There is also a difference in the standard
deduction amount.
A married employee may choose to have the employer use the withholding tables that incorporate the
standard deduction and tax rates for single taxpayers, if they prefer to have additional tax withheld.
Line 4. If the employees last name does not match the name on their social security card, checking
this box will alert the IRS to this fact, pending the employees correcting of the situation. This will
happen most often in cases of marriage, divorce, or adoption. The employee must notify the Social
Security Administration as soon as possible to correct their name.
Line 5. Here, the employee may enter the number from line H of the Personal Allowances Worksheet.
If the Deductions and Adjustments Worksheet and/or the Two-Earners/Multiple Jobs Worksheet
(shown in Illustration 22.3) is used, enter the appropriate figure from the last worksheet used.
The Appendix, on pages A.1A.20, contains the wage bracket tables from IRS Publication 15, (Circular
E), Employers Tax Guide. These wage bracket tables, in IRS Publication 15, tell the employer how
much federal income tax to withhold from an employees pay, based on the employees marital status
and number of withholding allowances.
mExample: Recall that David Sawyers taxable wages are $850 per week and he is claiming seven
withholding allowances. Checking the table labeled SINGLE PersonsWEEKLY Payroll Period in
the Appendix on page A.2, you will find that he will have $32 federal income tax withheld from each
paycheck, a total of $1,664 for the year [$32 2 52 = $1,664].
Will this withholding help David to meet his goal of a $600 refund? To find out, simply compute
Davids hypothetical 2015 tax return by performing appropriate calculations. You can do this, even
without a form, using the 2015 tax information found below.
Total income
$44,200
Less adjustments to income
Adjusted gross income
$44,200
Less standard deduction (HH) 9,250

Less two exemptions @ $4,000 8,000
Taxable income
$26,950
To compute the tax from the 2015 tax rate schedules:

1. Find the taxpayers 2015 filing status.
2. Find the line on the schedule that contains his 2015 taxable income.
3. Multiply the taxable amount by the tax rate.
4. Subtract the amount in the right-hand column. The result is the taxpayers expected 2015 tax.
Filing status
HH
Taxable income
$26,950.00
Rate
.15
$ 4,042.50
Less amount
657.50
Tax
$ 3,385.00
Finally, subtract any credits and add any other taxes.

Tax
$3,385
Less Child Care Credit

($3,000 2 20%)
600
Less Child Tax Credit
1,000
Tax after credits
$1,785
Plus other taxes
Tax liability
$1,785
2015 STANDARD DEDUCTION AMOUNTS
Single/MFS
MFJ/QW
Head of Household
Dependent
or earned income
65/older or blind, unmarried
65/older or blind, married
$ 6,300
12,600
9,250
1,050
+ 350
+ 1,550
+ 1,250
2015 EXEMPTION AMOUNT = $4,000

2015 TAX RATE SCHEDULES
$ Taxable Income
Rate
2015 TAX RATE SCHEDULES
= $ Amount
SINGLE
$ Taxable Income
Rate
= $ Amount
HEAD OF HOUSEHOLD
0 9,225
0.10
0.00
0 13,150
0.10
0.00
9,225 37,450
0.15
461.25
13,150 50,200
0.15
657.50
37,450 90,750
0.25
4,206.25
50,200 129,600
0.25
5,677.50
90,750 189,300
0.28
6,928.75
129,600 209,850
0.28
9,565.50
189,300 411,500
0.33
16,393.75
209,850 411,500
0.33
20,058.00
411,500 413,200
0.35
24,623.75
411,500 439,000
0.35
28,288.00
413,200 Over
0.396
43,630.95
439,000 Over
0.396
48,482.00
0.10
0.00
MFJ/QW
MFS
0 18,450
0.10
0.00
0 9,225
18,450 74,900
0.15
922.50
9,225 37,450
0.15
461.25
74,900 151,200
0.25
8,322.50
37,450 75,600
0.25
4,206.25
151,200 230,450
0.28
12,858.50
75,600 115,225
0.28
6,474.25
230,450 411,500
0.33
24,381.00
115,225 205,750
0.33
12,235.50
411,500 464,850
0.35
32,611.00
205,750 232,425
0.35
16,350.50
464,850 Over
0.396
53,994.10
232,425 Over
0.396
27,042.05
Thus, claiming seven withholding allowances would leave David with a balance due of $121 [$1,785
$1,664 = $121], much less than the $600 refund he had in mind. But, he has a few options:
He can claim seven withholding allowances and settle for the $121 balance due.
He may decrease his withholding allowances. For example, if he claims only six allowances (see
the table on page A.2 in the Appendix), his federal withholding would be $44 ($12 more) per week.
This would make his refund approximately $503 [$2,288 withholding $1,785 tax liability = $503].
He can fine-tune his withholding by having a specific additional dollar amount withheld from each
paycheck. See the next example for more details.m
lockWorks tip: When changing the taxpayers Form W-4 allowances to

zero in BlockWorks, you will need to enter a -1, instead of 0, on line 5
(override the calculated number of allowances claimed) of the Form W-4 input
screen.
Line 6. An employee who wishes to have additional tax withheld from each paycheck by specifying
an additional dollar amount may enter that amount on line 6. By using the worksheets as instructed
and entering a specific additional dollar amount to be withheld from each paycheck, the employee can
estimate their refund amount fairly closely.
mExample: If David decreases his withholding allowances to 6, he would receive a $503 refund. If he
is satisfied with the $503 refund, he is done and would complete his Form W-4 with six allowances.
However, if he would like to get closer to $600, he could use seven allowances and have his employer
withhold an additional $14 per paycheck. This would put him on track for a $607 refund, provided
nothing changes about his situation. Davids Form W-4 has been completed with seven allowances
and an additional $14 per paycheck withheld.m
Line 7. An employee may claim exemption from withholding for 2015 only if both of the following
conditions apply:
1. For 2014, the employee had no federal income tax liability and had a right to a full refund of all
federal income tax withheld.
2. For 2015, the employee expects to have no tax liability and would expect a full refund of any federal
income tax withheld.
mExample: Peter Hinwood (16) is a high school student. He expects to earn approximately $3,000
working for a fast-food chain during the summer of 2015. He will have no other income. Peter has
never before filed an income tax return.
Peter may claim exemption from withholding because he meets both conditions above. He will have no
tax liability in 2015 because his standard deduction will equal his earned income plus $300, leaving
him $0 taxable income.m
Contrary to popular belief, being a full-time student alone does not automatically exempt an employee
from withholding. Furthermore, claiming exemption from withholding without a reasonable basis for
such a claim may result in a $500 penalty.
mExample: Assume that Peter (from the preceding example) is a 21-year-old, full-time college student, and that he expects to earn $7,000 during 2015. Peter still lives at home, and his parents continue to claim him as a dependent.
Peter may not claim exemption from withholding because he will have a tax liability, and his taxable
income for 2015 is not expected to be $0.m
a great client experience means that we give taxpayers
Tchoices.Providing
To achieve their desired refund amount, some taxpayers might want
ax Tip:
to keep the number of allowances the same and have an additional amount
withheld from their paychecks and others prefer reducing their allowances so
that their withholding increases. Furthermore, since their circumstances may
change during the year, it is best practice to remind them that they can visit the
tax office any time to update their Form W-4.
Page 2 Worksheets
If the taxpayer plans to itemize deductions or claim certain adjustments to income or credits on
their tax return, they should complete the Deductions and Adjustments Worksheet provided at the
top of page 2 of Form W-4. This worksheet contains references to additional worksheets, which are
contained in IRS Publication 505, Tax Withholding and Estimated Tax. Because we have not yet discussed many of the tax topics involved, we will not go into detail at this time. The worksheets from
IRS Publication 505 are available on the IRS website at <www.irs.gov>.
When the employee or their spouse has another job, they should complete the Two-Earners/Multiple
Jobs Worksheet on the bottom of page 2 of Form W-4. On lines 13 of that worksheet, some withholding allowances may be subtracted from the previously-calculated total to avoid an underwithholding
situation caused by the second job. In some cases, withholding allowances may be reduced to zero and
additional withholding may be required. Those computations are made on lines 49 of the worksheet.
Remember, only one set of worksheets is completed when multiple jobs are involved. Withholding will
be most accurate when all computed allowances are claimed on the withholding allowance certificate
for the highest paying job and zero exemptions are claimed on all other jobs.
mExample: Sheila Watson is single with no dependents. She has two jobsone that pays $75,000 per
year and a side job that pays $17,500 per year. Paychecks from both jobs are issued every two weeks.
Sheilas Two-Earners/Multiple Jobs Worksheet is shown in Illustration 22.3.m
Line 1. Sheilas Personal Allowances Worksheet shows one withholding allowance, which is also
entered here.
Line 2. On Table 1 (in the All Others column), we find that, if the wages from the lowest paying job
are $17,001$26,000, two allowances will be entered here.
Line 3. Because line 1 is less than line 2, leave line 3 blank and continue to line 4. Also, enter zero
on line 5 of Sheilas Form W-4.
Lines 4 and 5 reflect the amounts on lines 2 and 1, respectively.
Line 6. Subtract line 5 from line 4.

Illustration 22.3
Line 7. On Table 2, find the appropriate dollar amount for the highest wages ($75,000). Sheila is not
married filing jointly, so under All Others we find $1,000.
Line 8. Multiply line 7 by line 6.
Line 9. Divide line 8 by the number of pay periods. Sheila is paid biweekly, so there are 26 pay periods
during the year. If this worksheet was being computed after the year had already started, you would
divide by the number of remaining pay periods. You could round dollar amounts in the usual manner,
but we recommend rounding up in all cases to avoid a small balance due [$1,000 3 26 = $38].
Form W-4 for Sheilas lower-paying job should show zero withholding allowances.
Supplemental Wages
An employer may withhold income tax from supplemental wages, such as commissions, tips, bonuses, and other earnings not based on time worked, using the same withholding method used for the
employees regular wages and the same number of withholding allowances claimed on the employees
Form W-4. Alternatively, the employer may withhold federal income tax from these payments at a flat
rate of 25%. If the supplemental wages exceed $1 million, the withholding rate is a mandatory 39.6%.
Other Withholding Forms

Tax may be (but generally is not required to be) withheld from certain income other than wages.
Such income includes pensions, sick pay, certain gambling winnings, unemployment compensation,
social security or railroad retirement benefits, and certain other federal payments. The forms used to
request withholding from these types of income are not shown here, but the information is provided
for your awareness.
Pensions
Withholding from pension or annuity payments is figured in the same way as withholding from salaries and wages. To tell the payer of the pension or annuity how much to withhold, the recipient must
complete Form W4P.
The main differences in the withholding rules for pensions and annuities compared to those for salaries and wages are:
If the recipient does not fill out a withholding certificate (Form W4P), tax will be withheld as if
they were married and claiming three withholding allowances. This means that tax will be withheld for 2015 only if the pension or annuity is at least $1,720 per month (or $20,640 per year).
By checking the box on line 1, the recipient can choose not to have tax withheld, regardless of how
much tax they owed last year or expect to owe this year. In other words, the taxpayer does not have
to qualify for exemption from withholding; they simply choose it.
Sick Pay
Sick pay is a payment made to an employee to replace their regular wages while they are temporarily
absent from work due to sickness or personal injury. To qualify as sick pay, the payments must be
paid under a plan to which the taxpayers employer is a party.
If an employee receives sick pay from their employer or an agent of their employer, income tax must
be withheld just as it is from regular pay. However, if the sick pay is received from a third party who
is not acting as an agent of the employer, such as an insurance company, income tax will be withheld
only if the recipient chooses to have it withheld.
A taxpayer who chooses to have tax withheld from third-party sick pay must fill out Form W-4S. The
instructions contain a worksheet used to figure the amount of tax to be withheld. Form W-4S remains
in effect until the taxpayer changes or cancels it or stops receiving payments.
Gambling Winnings
Gambling winnings of more than $5,000 from the following sources are subject to income tax withholding:
Any sweepstakes, wagering pool, or lottery.
Any other wager (other than keno, bingo, and slot machines) if the proceeds are at least 300 times
the amount of the bet.
The amount withheld generally is 25% of the proceeds. It does not matter whether the winnings are
paid in cash, in property, or as an annuity. Winnings not in money are taken into account at their
fair market value.
Unemployment Compensation
A taxpayer may choose to have income tax withheld from any unemployment compensation they
receive. To make this choice, the taxpayer must complete Form W-4V and give it to the payer. The
amount withheld will be 10% of each payment.
Social Security Benefits
A taxpayer may choose to have income tax withheld from their social security benefits or equivalent
Tier 1 railroad retirement benefits. To make this choice, the taxpayer must complete Form W-4V and
give it to the payer. The recipient can choose to have 7%, 10%, 15%, or 25% of each payment withheld.
Form W-4V is also used to request voluntary withholding from certain agricultural payments. Such
payments will not be discussed in this course.
EDUCATION TAX PLANNING

For taxpayers who wish to save for their beneficiarys education, a few savings vehicles may be available to enable taxpayers to grow funds tax-free if the earnings are used to pay qualified education
expenses. Two of these savings vehicles are:
Education Savings Bond Program.
Coverdell Education Savings Account (ESA).
Education Savings Bond Program
Taxpayers may be able to exclude from income all or part of the interest they received on the redemption of qualified U.S. savings bonds during the year if they paid qualified higher education expenses
during the same year. This exclusion is known as the Education Savings Bond Program. This exclusion
is not available to taxpayers who use the married filing separately filing status. Form 8815, Exclusion
of Interest From Series EE and I U.S. Savings Bonds Issued After 1989, shown in Illustration 22.4, is
used to figure the exclusion.
A qualified U.S. savings bond is a Series EE bond issued after 1989 or a Series I bond. The bond must
be issued in the name of either the taxpayer or their spouse. The owner of the bond must be at least
24 years old before the bond issue date.
mExample: A bond purchased by a parent and issued in the name of their child who is under age 24
does not qualify for the exclusion by the parent or child.m
Qualified higher education expenses are tuition and fees required for the taxpayer, spouse, or dependent to attend an eligible educational institution. This includes any contribution made to a qualified
tuition program or to a Coverdell Education Savings Account.
Qualified expenses do not include expenses for room and board or for courses involving sports, games,
or hobbies that are not part of a degree or certificate-granting program.
Eligible educational institutions include most public, private, and nonprofit universities, colleges, and
vocational schools that are accredited and eligible to participate in student aid programs run by the
U.S. Department of Education.
Taxpayers must reduce their qualified higher education expenses by all of the following tax-free benefits:
Tax-free part of scholarships and fellowships.
Expenses used to figure the tax-free portion of distributions from a Coverdell savings account or
qualified tuition program.
Tax-free payments (except gifts or inheritances) received for educational expenses, such as:
Veterans educational assistance benefits.
Qualified tuition reductions.
Employer-provided educational assistance.
Any expense used in figuring the American Opportunity Credit and lifetime learning credit.

Illustration 22.4
ax tip: In figuring the tuition and fees deduction, taxpayers must reduce
the total of qualified education expenses by any qualified education expenses used to figure the exclusion from gross income of interest received under an
education savings bond program.
Under the Education Savings Bond Program, the exclusion is limited to the amount of educational
expenses paid. Any interest received that exceeds educational expenses is taxable.
As with most tax benefits, there are income phase-out limits. The interest exclusion is limited to taxpayers with the following 2014 modified AGI:
$76,000$91,000 for taxpayers filing single or head of household ($77,200$92,200 for 2015).
$113,950$143,950 for married taxpayers filing jointly or qualified widow(er) with a dependent
child ($115,750$145,750 for 2015).
Taxpayers whose modified AGI is equal to or exceeds the upper dollar amounts of the phaseout range
do not qualify for the exclusion.
Coverdell Education Savings Account (ESA)
A Coverdell Education Savings Account (ESA) is a savings account that is set up to pay qualified education expenses for the designated beneficiary, generally the taxpayers child. The taxpayer does not
receive a deduction for the contributions they make to the Coverdell ESA, but the contributions grow
tax-free until distributed. Also, in the year of the distribution, if the beneficiarys qualified education
expenses are greater than the Coverdell ESA distribution, the beneficiary may not owe tax on the
distribution.
For purposes of Coverdell ESA accounts, qualified education expenses include both qualified higher
education expenses and qualified elementary and secondary education expenses.
Qualified higher education expenses include the following:
Tuition, fees, books, supplies, and equipment required for enrollment or attendance, and expenses
for special needs services in the case of a special needs beneficiary that are incurred in connection
with enrollment or attendance at an eligible educational institution.
Qualified higher education expenses also include the reasonable costs of room and board for a beneficiary who is at least a half-time student to the extent the costs are not more than the greater of:
The allowance for room and board, as determined by the eligible educational institution for a
particular academic period.
The amount charged if the student is residing in housing owned or operated by the eligible educational institution.
Qualified elementary and secondary education expenses include:

Tuition, fees, academic tutoring, special needs services, books, supplies, and other equipment
incurred in connection with enrollment or attendance at a public, private, or religious school.
Expenses for room and board, uniforms, transportation, and supplementary items and services
(like extended day programs) that are required or provided by a public, private, or religious school
in connection with attendance or enrollment.
Expenses for the purchase of computer technology, equipment or Internet access if it is to be used
by the beneficiary and beneficiarys family during the years the beneficiary is in school. Computer
technology does not include software designed for sports, games, or hobbies, unless it is predominantly educational in nature.
Eligible postsecondary educational institutions include most public, private, and nonprofit universities, colleges, and vocational schools that are accredited and eligible to participate in student aid programs run by the U.S. Department of Education. Eligible elementary or secondary schools include any
public, private, and religious school that provides elementary or secondary education (kindergarten
through grade 12), as determined by state law.
For 2014, the total of all contributions to all Coverdell ESAs set up for the benefit of any one designated beneficiary cannot be more than $2,000. This includes contributions (other than rollovers) to all
the beneficiarys Coverdell ESAs from all sources. However, the taxpayer can contribute up to $2,000
for each designated beneficiary for 2014. This amount does not change for 2015.
There are income phaseout limits that limit the amount the taxpayer can contribute to their beneficiarys Coverdell ESA account. The taxpayers contribution (for 2014 or 2015) is limited if their modified
AGI is between:
$95,000$110,000 for taxpayers filing single or head of household.
$190,000$220,000 for married taxpayers filing jointly or qualified widow(er) with a dependent
child.
Taxpayers whose modified AGI is equal to or exceeds the upper dollar amounts of the phaseout range
do not qualify to make a contribution.
For more information on Coverdell ESAs, see IRSPublication 970, Tax Benefits for Education.
ESTIMATED TAX
Tax law requires that the tax on each taxpayers taxable income be paid at or near the time the income
is received. The taxpayers tax liability for the current tax year must be paid during the course of the
year through withholding or payment of estimated taxes, or both.
Because the Tax Code has established requirements for estimated tax payments, it also imposes a
penalty on taxpayers who fail to satisfy the requirements. The payment of penalty can be avoided by
some planning.
Taxpayers who need to file estimated taxes are usually those with considerable amounts of taxable
income from which there is no withholding. Common examples of such income are self-employment
income, interest income, dividends, rental income, and capital gains.
During the discussion of estimated taxes, you will be learning the fundamentals of estimated taxes
and how to establish the taxpayers expected liability for 2015 income taxes. This process should be
completed at the conclusion of the 2014 income tax return preparation, when necessary.
Estimated tax is the total amount of tax a taxpayer expects to owe for the year after subtracting nonrefundable credits, amounts to be withheld, and certain refundable credits.
mExample: Gail Singler expects to have a 2015 tax liability of $7,000. She will have $5,000 withheld
from her wages, and she knows that she will not be eligible for any available 2015 tax credits. Her
estimated tax is $2,000 [$7,000 $5,000 = $2,000].m
mExample: Arlene Drake expects to have a 2015 tax liability of $8,000. She will have $3,000 withheld
from her wages, and she will be eligible for a Child Tax Credit of $1,000. Her estimated tax is $4,000
[$8,000 $3,000 withholding $1,000 Child Tax Credit = $4,000].m
Generally, individuals who will owe estimated tax of $1,000 or more in 2015 may be required to file
Form 1040-ES and submit their own payments for estimated income tax and/or self-employment tax.
Form 1040-ES should be filed for 2015 if estimated tax is $1,000 or more and it appears that the total
amount withheld from the taxpayers 2015 income plus expected credits will be less than the lesser
of the following:
90% of the tax to be shown on the taxpayers 2015 return.
100% of the tax shown on the taxpayers 2014 return (assuming the return covers a full year).
If a taxpayers estimated withholding and credits equal or exceed either of these two conditions, they
need not make estimated payments, even if the estimated tax is $1,000 or more.
Higher-income taxpayers. If the taxpayers AGI for 2014 was more than $150,000 (or more than
$75,000 if their 2014 filing status was MFS), they must prepay 110% of their 2015 tax, rather than
100%, to meet that requirement.
Qualified farmers and fishermen. If at least two-thirds of the taxpayers 2014 or 2015 gross income
comes from farming or fishing, they are required to prepay only two-thirds of their 2015 tax, rather
than 90%. We do not focus on this exception during this discussion, but you should be aware of it.
An employee who is required to pay estimated tax may instead direct their employer to withhold extra
income tax from their wages by providing the employer with a new Form W-4.
Computation of Estimated Tax

H&R Block uses the Estimated Tax Worksheet to compute a taxpayers estimated tax. A copy of the
worksheet is shown in Illustration 22.4. All available facts affecting income, deductions, and credits
are considered in the calculations. Some of these items involve tax concepts to which you have not yet
been exposed, but may be learned with a little research. It may be helpful to use the previous years
tax return as a guide when completing the worksheet.
The income tax (line 6 of the worksheet) on the estimated taxable income (line 5) is computed using
the 2015 Tax Rate Schedules.
The additional taxes entered on line 7 of the worksheet are those normally entered on Form 1040,
line 45.
The taxpayer may estimate the credits they believe they will be eligible to claim on next years tax
return (those found on Form 1040, lines 48 through 54) and enter them on line 9 of the worksheet.
When computing these credits, be sure to take income limitations into account.
mExample: Wilhelm and Wilma Burgdorf expect their 2015 AGI to be $132,000 with no modifications.
They have two qualifying children for the Child Tax Credit.
The Burgdorfs Child Tax Credit will be reduced from $2,000 to $900 because their MAGI will exceed
$110,000 (lines 48 of the Child Tax Credit Worksheet).m
Self-employment tax must also be computed when determining estimated tax and is figured on line
11 of the worksheet.
The taxes entered on line 12 include most (but not all) of those entered on Form 1040, lines 5762.
The taxpayer may also reduce their estimated tax liability by the payments, including certain refundable credits, that they estimate will be available during the tax year.
The credits entered on line 13b are those entered on Form 1040, lines 66a (Earned Income Tax
Credit), 67 (Additional Child Tax Credit), 68 (American Opportunity Credit), and 73 (Fuel tax credit).
Expected federal income tax withholding is entered on line 15 of the worksheet.
After all applicable entries are made on the worksheet, we arrive at estimated tax. If this estimate is
$1,000 or more, and the amount withheld will not cover either 90% of the 2015 tax liability or 100% of
the 2014 tax liability (110%, if applicable), the taxpayer should fill out and send to the IRS payment
vouchers with the required payments by the due dates discussed below.
Examine lines 14a, 14b, and 14c of the worksheet. If the taxpayer wishes to make the smallest amount
of estimated payments possible to avoid the penalty and pay the remainder of their balance due when
they file their return, enter the smaller of 90% of line 13c (line 14a) or 100% (or 110%) of the 2014 tax
(line 14b) on line 14c.
Many taxpayers, on the other hand, prefer to prepay their entire tax liabilities so that they need not
worry about a balance due when they file their returns. For those taxpayers, enter the entire amount
from line 13c on line 14c.

Illustration 22.5
When to Pay Estimated Tax

A payment voucher for estimated taxes, Form 1040-ES, should be filed on the first estimated tax due
date after the receipt of income not subject to withholding. If income is received in essentially equal
amounts throughout the year, the first declaration should be filed on or before April 15.
Period Requirement First Met
Due Date* of Declaration
Maximum Number of
Installments
Between January 1 and March 31
April 15
Between April 1 and May 31
June 15
Between June 1 and August 31
September 15
After August 31
January 15
*These dates are extended to the next regular business day if the due date falls on a Saturday, a
Sunday, or a legal holiday.
A voucher may first be required on a due date after April 15 if the taxpayer has an increase in taxable
income after March 31 from such things as:
Realizing a taxable gain from the sale of property.
Winning a prize.
Starting a business.
An increase in profits of an existing business.
A change of filing status.
The loss of an expected dependent exemption.
The full amount of the estimated tax may be paid when the first Form 1040-ES voucher is filed. Or, if
the first voucher is due April 15, one-fourth the total payment may be made at that time; if the first
voucher is due June 15, one-half of the total must be paid then; if the first voucher is due September
15, three-fourths of the total must be paid then.
mExample: Harry Smiths first voucher is due September 15, 2015. His total estimated tax is $1,804.
He should pay $1,353 [$1,804 2 = $1,353] with his first estimated payment voucher.m
If equal installments are to be paid, you should always round up when calculating each estimated tax
payment. This little extra could mean the difference between owing and not owing a penalty.
mExample: Jane Garrs first voucher is due April 15, 2015. Her estimated tax is $1,458 [$1,458 3 4
payments = $364.50]. It would be a good idea to round each of her payments to $365, for a total of
$1,460. If she only pays $364 each installment, her total payments will be only $1,456, and she could
end up owing a small balance due when she files her income tax return.m
The taxpayer is not required to pay the final installment if they file their tax return and pay the entire
balance due on or before January 31 of the next year.
Qualified farmers and fishermen may elect to wait until January 15 of the following year to file Form
1040-ES and pay their entire estimated tax at that time. Or, if they file Form 1040 and pay their
entire tax on or before March 1, they are not required to file Form 1040-ES or pay estimated tax.
The taxpayer can receive their estimated tax vouchers from their Tax Professional, or they can go
online and get them from <www.irs.gov>.
On or before the due date of each installment, the taxpayer should mail the voucher for that date
and a check or money order to the appropriate IRS address. If a Form 1040-ES is filed at the same
time as the Form 1040, the taxpayer must pay the estimated tax and any balance due on Form
1040 with separate checks or money orders and mail each in a separate envelope to separate places.
The taxpayer should write their social security number and what the payment is for (for example,
2014 Form 1040 or 2015 Form 1040-ES) on every check or money order sent to the IRS. Checks
and money orders should be made payable to United States Treasury.
lockWorks tip: When an overpayment is applied to the estimated tax for

next year, the payment will be entered on the Estimates input screen. The
2014 estimated tax payments are also entered on the Estimates input screen by
voucher due date.
All or part of an overpayment of tax on the 2014 tax return may be applied to the 2015 estimated
tax rather than being refunded, if the taxpayer so chooses. The overpayment may be divided equally
among the required installments or applied in full against the first installment and any remainder to
succeeding installments until used up, or applied in some other way that fits the taxpayers situation.
The overpayment applied from 2014 is not shown on the voucher; only the actual amount paid should
be shown.
Changes in income, exemptions, deductions, and credits during the year may increase or decrease the
estimated tax. An increase in estimated tax should be paid on or before the next installment due date
or in appropriate amounts on or before each remaining due date. If there is a decrease in estimated
tax, remaining installments may be reduced or even eliminated.
Underpayment of Estimated Tax

Some taxpayers may use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and
Trusts, to determine the amount of penalty they must pay when they have not prepaid an adequate
amount of estimated tax. In most cases, however, a taxpayer subject to penalty is not required to prepare Form 2210the IRS will compute the penalty and send the taxpayer a bill.
Note: In certain circumstances, there are ways to reduce or eliminate the penalty by completing Form
2210 as a worksheet. Also, there are times when Form 2210 must be completed and filed. Those times
are described in Part II, lines A through F, on page 1 of Form 2210, shown in Illustration 22.6. The
three most common are:
The taxpayer uses the annualized income installment method of computing the penalty. This is
a fairly complex procedure under which the taxpayer determines just when during the year they
received income and incurred deductions and earned credits. The information is then annualized
for each quarter and may, in some cases, reduce or eliminate the penalty. Schedule AI on page 4
of Form 2210 (not shown in this text) is used for this purpose.
The IRS treats withholding as being withheld in even amounts throughout the year, regardless of
when it was actually withheld. However, if it is beneficial in the penalty computations, the taxpayer can treat it as withheld when it was actually withheld.
The taxpayer based their required annual payment on the preceding years tax and filed a joint
return for one of the years (current or preceding), but not both.
If none of the conditions apply, Form 2210 may be used as a worksheet to compute the taxpayers
penalty (but should not be filed) if:
The amount on Form 1040, line 63, minus lines 6473, is $1,000 or more.
The amount on line 78 is more than 10% of the amount on line 63.
Form 2210 may also be used to compute the penalty if the taxpayer did not make estimated tax payments when required. As we discussed earlier, tax payments are required when income is received.
These payments are made through withholding or estimated tax payments. If the taxpayer failed to
make adequate payments at the time required, a penalty may be due on the underpayment of estimated tax.
Completing Form 2210

Examine a copy of the pages 1 and 2 of Form 2210 (see Illustrations 22.6 and 22.7). Any taxpayer
using the form will complete Part I to determine their required annual payment. Then, the taxpayer
can determine the amount of their penalty (if any) using either Part III, the short method on page
2 of the form, or Part IV, the regular method on page 3 (not shown), or the Annualized Income
Installment Method on page 4 (also not shown). We will just show you the short method. If you need
more information on the regular method or annualized income installment method, see the IRS
instructions for Form 2210.
Follow Form 2210 as you read the following line descriptions. The references used in the descriptions
are from Form 1040. Keep in mind that Form 2210 also may be used by Form 1040A filers, but the
line references to the tax form would be different.
Line 1. Enter the amount from Form 1040, line 56.
Line 2. Enter on this line most of the taxes included in the Other Taxes section (lines 5762) of
Form 1040.
Note: Do not include any amount on line 58. If there are any amounts on Form 1040, lines 58 or 59,
or any write-in taxes on line 62, some special computations may be required. If this is the case, you
will want to get a copy of the IRS instructions for Form 2210.
Line 3. Enter as a negative number the sum of any refundable credits, such as the Additional Child
Tax Credit and the Earned Income Tax Credit, from Form 1040. (The parentheses are pre-printed on
the form.)
Line 4. Combine lines 1, 2, and 3.
Line 5. Multiply line 4 by 90% (0.90).
Line 6. Amounts withheld plus excess social security tax go here (from Form 1040, lines 64 and 71).
Line 7. Subtract line 6 from line 4. If the result is less than $1,000, the rest of the form is not completed and the taxpayer owes no penalty.
Line 8. This is based upon the taxpayers tax liability from the preceding year. A taxpayer can avoid
penalty for 2014 if they prepaid enough tax to cover 100% (or 110% if AGI was more than $150,000,
or $75,000 if married filing separately) of their 2013 tax liability. If the taxpayer had no tax liability
for 2013, was a U.S. citizen or resident all year, and their return (if required to file) was for a full 12
months, they do not need to complete Form 2210 or pay a penalty.
Line 9. Enter the smaller of line 5 or line 8. Notice that if line 6 (the amount the taxpayer had withheld during the year) is equal to or greater than line 9, the taxpayer owes no penalty and need not
complete the remainder of the form.
Computing the Penalty

Recall that there are two basic methods for computing the penalty on Form 2210the short method
in Part III and the regular method in Part IV.
A taxpayer may use the short method if both are true:
They made no estimated tax payments at all during the year (or if made, the estimated payments
were paid in four equal amounts by the due date for each period).
Neither Box C nor Box D is checked in Part II.
Lines 10 through 17 involve following the line instructions. Notice that on line 16, the penalty can
be reduced by early payment (before April 15) of the tax plus penalty.
Lines 15 and 16. Compute the amounts on these lines to the penny, but round the entry on line 17
to the nearest dollar.
Line 17. This amount is entered on Form 1040, line 79, and added to the balance due to be entered
on line 78.

Illustration 22.6

Illustration 22.7
EXTENSIONS
Taxpayers have options to file their income tax return past the traditional April 15 due date if they
request an extension or meet certain criteria. An extension of time to file an income tax return is not
always an extension of time to pay any tax due.
Automatic Extension
Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return,
can be filed to request an additional six months to file a return. This extension does not extend the
time to pay any tax due. However, there is no failure-to-pay penalty if the taxpayer pays at least 90%
of the actual tax liability on or before the due date and then pays the balance when the return is filed.
To get an extension, taxpayers must:
Estimate their tax liability for the tax year they are requesting the extension.
Enter their tax liability on Form 4868.
File Form 4868 (see Illustration 22.8) by April 15 or due date. Fiscal-year taxpayers must file by
the regular due date of their return.
Form 4868 can be e-filed or mailed in. Fiscal-year taxpayers must file a paper form.
Illustration 22.8
Outside the United States

An automatic two-month extension of time to file a return and pay any tax due is an option for taxpayers who are U.S. citizens or residents and, on the due date of the return, are either:
Living outside the United States and Puerto Rico, and their main place of business or post of duty
is outside the United States or Puerto Rico.
In military or naval service on duty outside the United States or Puerto Rico.
This extension is requested by attaching a statement to the return that explains the qualifying situation.
If the return cannot be filed within the two-month time period, an additional four months may be
requested by filing Form 4868 and checking the box on line 8. The additional four-month extension
does not apply to payment.
Taxpayers who file jointly need only one spouse to qualify for the automatic two-month extension. If
a married couple files separate returns, the extension applies only to the spouse who qualifies. The
same is true for the combat zone extension (below), with some exceptions. See IRS Publication 3,
Armed Forces Tax Guide, for more information.
Serving in Combat Zone

The deadline for filing a tax return, paying any tax due, or filing a claim for a refund is automatically
extended 180 days for taxpayers who are serving in a combat zone. This includes:
Members of the Armed Forces.
Merchant marines serving aboard vessels under the operational control of the Department of
Defense.
Red Cross personnel.
Accredited correspondents and civilians under the direction of the Armed Forces in support of the
Armed Forces.
The deadline for taxpayers who are serving in a combat zone is extended for at least 180 days after
the later of:
The last day they served in a combat zone or the last day the area qualifies as a combat zone.
The last day of any continuous qualified hospitalization for injury from service in the combat zone.
In addition to the 180 days, the deadline is also extended by the number of days the taxpayer had left
to take action with the IRS when they entered the combat zone.
mExample: John was deployed to a combat zone on March 15, 2015. There were 32 days left for him
to file his 2014 return, due April 15, 2015. His service in the combat zone ended on October 15, 2015.
Johns extension is a total of 214 days. His extended due date is May 14, 2016.m
DIRECT DEPOSIT OF REFUND TO MORE THAN ONE ACCOUNT

Form 8888, Allocation of Refund (Including Savings Bond Purchases) (see Illustration 22.1), gives taxpayers the option to directly deposit their refund into two or three different accounts. Taxpayers can
divide the refund into any of the following accounts: checking, savings, individual retirement arrangement (IRA), health savings account (HSA), Archer MSA, Coverdell Education Savings Account (ESA),
or TreasuryDirect online account. Taxpayers can also opt to purchase Series I savings bonds with a
portion of their refund.
All accounts must be established through the financial institution before direct deposit is requested.
IRAs
Taxpayers are responsible for notifying the trustee or custodian of the year to which they want their
deposit applied. They are also responsible for verifying that the deposit was made according to their
directions by the due date of the return on which they are claiming the contribution.
TreasuryDirect Account
TreasuryDirect is the only financial services website that lets account holders purchase and sell
securities directly from the U.S. Department of the Treasury. More information can be found at the
TreasuryDirect website, <www.treasurydirect.gov>.
U.S. Series I Savings Bonds

Purchased in multiples of $50, taxpayers can request a portion of their refund to buy up to $5,000 in
U.S. Series I savings bonds. A taxpayer may request up to three different savings bond registrations.
However, each registration must be a multiple of $50, and the total of lines 4, 5a, and 6a cannot be
more than $5,000 (or the taxpayers refund amount, whichever is smaller).
January 2015, the IRS has limited the number of
Nrefunds that Effective
can be electronically deposited into a single financial account
ew for 2015:
or pre-paid debit card. The fourth and subsequent refunds automatically will
convert to a paper refund check and be mailed to the taxpayer. This procedure
has been enacted by the IRS in an effort to combat fraud and identity theft.
INSTALLMENT AGREEMENT REQUEST

Taxpayers who cannot pay the full amount on a balance due return have the option of requesting a
monthly installment plan by filing Form 9465, Installment Agreement Request (see Illustration 22.9).
Requests for an installment agreement will not be denied if the balance due is not more than $10,000
and all three of the following apply:
All tax returns for the past five years have been filed in a timely manner with any tax due paid,
and there are no previous installment agreements.
The IRS determines that the taxpayer is unable to pay the tax due, and the taxpayer gives the IRS
the information to make that determination.
The taxpayer agrees to pay the full amount within three years and comply with all tax laws.
ax tip: For taxpayers who are able to pay the full amount of their balance
due within 120 days, the taxpayer should not request an installment plan.
Instead, the taxpayer is required to contact the IRS by calling 1-800-829-1040.
Payment Methods
Taxpayers may choose their payment method. Fees to initiate the installment agreement vary according to payment method. An installment agreement payment by check, money order, or credit card
and a payroll deduction installment agreement all have a $120 fee. An installment agreement with a
direct debit payment method has a $52 fee.
Interest and penalties will continue to be assessed until the balance is paid in full.
If a taxpayer does not make their payments on time or does not pay any balance due on a return they
file later, they will be in default on their agreement, and the IRS may take enforcement actions, such
as the filing of Notice of Federal Lien or an IRS levy action, to collect the entire amount the taxpayer
owes.

Illustration 22.9
CHAPTER SUMMARY
The federal income tax is a pay-as-you-go system. Thus, tax must be paid as income is received.
An employee determines how much income tax to withhold from their taxable wages by completing
Form W-4, which tells the employer how many withholding allowances they are claiming.
Education Savings Bond Program and Coverdell Education Savings Account can help taxpayers
save for their childrens education.
Taxpayers are required to pay tax at or near the time income is received. Taxpayers should file
Form 1040-ES if their estimated tax is $1,000 or more and it appears the total amount withheld
from the taxpayers income plus expected credits will be less than the lesser of the following:
90% of the tax to be shown on the taxpayers return.
100% (110%, if applicable) of the tax shown on the taxpayers previous years return.
Form 2210 is used to compute the penalty if the taxpayer did not make estimated tax payments
when required. If the taxpayer does not use Form 2210 to compute the penalty, the IRS will, in
most cases, compute the penalty for the taxpayer and send the taxpayer a bill.
The procedure for requesting an automatic extension to file a return.
The options a taxpayer has when they want to directly deposit their refund into more than one
account.
The procedure for requesting an installment agreement from the IRS.
Suggested Reading
Chapter 4, Tax Withholding and Estimated Tax.
Chapter 30, How to Figure Your Tax.
23
Capital Assets
OVERVIEW
In this chapter, you will learn how the classification of property interacts with capital assets. You will
discuss the sale of assets and how gain and/or loss is determined and if the gain or loss is taxable.
OBJECTIVES

Describe the types and uses of property.

Determine what property is a capital asset.
Determine the basis of assets acquired by purchase.
Determine the holding period of an asset.
Recognize taxable sales of capital assets.
Report a simple stock sale on Schedule D.
Explain when and how to report the sale of a taxpayers main home.
TAX TERMS

Adjusted basis.
Business assets.
Depreciation.
Expenses of sale.
Holding period.
Installment method.
Section 1231 gains and losses.
Short sale.
Stock split.
23.1
INTRODUCTION TO PROPERTY
The specific tax consequences of property ownership usually depend on two factors:
The type of property.
The purpose for which the property is used.
Types of Property
There are two types of property: real and personal. Real property (also called real estate) includes
land, buildings, and their structural components.
All property that is not real property is personal property. Personal property may be categorized as
either tangible or intangible.
Tangible personal property has a physical existence and its value is intrinsic. That is, the property
has value in and of itself. Examples include livestock, machinery, vehicles, furniture, and the textbook
you are now reading.
Intangible personal property has no intrinsic value. Rather, its value is in the rights the property
conveys. A good example is a $100 bill. The piece of paper, in and of itself, is virtually worthless. Yet,
the property has value because it conveys the right to purchase goods and services. Other examples
of intangible personal property include insurance, corporate stock, goodwill, and the copyright on the
textbook you are now reading.
Uses of Property
There are four use classifications of property. Each type of property can be in any use class.
Personal-use property is owned for personal well-being and enjoyment and includes homes, vehicles, furniture, jewelry, clothes, pets, sports equipment, hobby equipment, etc.
Investment-use property is owned primarily for potential increase in value, even though some
income may be generated. This classification includes land, works of art, collections such as coins or
stamps, capital stock, bonds, etc.
Business-use property is used for the production of income. This includes rental houses, factory and
office buildings, land, machinery, equipment, vehicles, furnishings, livestock, etc.
Stock-in-trade (also called inventory) is property held for sale to customers.
A sale or exchange of property usually results in a gain or loss, which creates a tax consequence for the
seller. A sale is the transfer of property for money. An exchange is the transfer of property for property.
Sales and exchanges of property are reported on Schedule D, Capital Gains and Losses. Any taxable
gain or deductible loss is then entered on Form 1040.
Tax Essentials Capital Assets 23.3
CAPITAL ASSETS
Generally, everything you own or use for either personal purposes or investment purposes is a capital asset.
The Tax Code defines capital assets in negative terms. In fact, under the Internal Revenue Code, all
property is considered a capital asset except for the following types of property.
The following assets are not capital assets:
Property held mainly for sale to customers or property that will physically become part of merchandise for sale to customers. This includes stock-in-trade, inventory, and other property you hold
mainly for sale to your customers in your trade or business.
Accounts or notes receivable acquired in the ordinary course of a trade or business for services
rendered or from the sale of any properties described above.
Depreciable property used in a trade or business or as a rental property, even if the property is
fully depreciated (or amortized).
Real property used in a trade or business or as rental property, even if the property is fully depreciated.
Copyrights, literary, musical, or artistic property created by personal efforts and prepared or produced for (or, under certain circumstances, acquired by) the taxpayer.
U.S. government publications received from the government for free or for less than the normal
sales price.
Certain commodities and derivative financial instruments which you will seldom encounter.
(Derivative financial instruments are financial contracts whose value depends on and is derived
from the value of an underlying asset, reference rate, or index).
Certain hedging transactions that are entered into in the normal course of a trade or business,
which you will seldom encounter. (A hedging transaction is any transaction entered into primarily
to manage risk of price changes or risk of interest rate or currency fluctuations.)
Supplies of a type regularly used or consumed in the ordinary course of your trade or business.
Properties in the following use classes are capital assets:
Personal-use, including personal residences, vacation dwellings, cars, furniture, jewelry, hobby and
recreational equipment, collections, etc.
Investment-use, including land, stock, municipal and corporate bonds, collectibles, antiques, etc.
Business-use, including only certain intangible personal type property, such as goodwill or a franchise, plus any net 1231 gain from the sale of business-use assets.
Section 1231 transactions are not covered in this course. If you see sales of business-use property, you
will need to do further research. For a more detailed discussion, see Publication 544, Sales and Other
Dispositions of Assets.
BASIS
Basis is a measure of the taxpayers investment in property for tax purposes. One tax purpose for
which basis of property is used is to determine taxable gain or deductible loss on Schedule D when
the property is sold or exchanged.
For purchased property, which is the way most investment-use and personal-use property is acquired,
the basis of the property is its cost.
Cost includes the cash paid, the fair market value of services rendered, and the fair market value
of property traded in exchange for the property. Also, certain closing costs are added to the basis of
property. Such closing costs include commissions paid by the purchaser, legal fees, recording fees, and
state transfer taxes on real estate.
mExample: Nancy Lewis purchased a rare stamp for $800. Her basis in the stamp is $800. She also
purchased a house for $213,000 plus $3,000 in legal fees and recording fees. Her basis in the house
is $216,000.m
During the period the taxpayer owns the property, various events may occur that affect the taxpayers
investment in the property. As a result, the taxpayer must adjust their basis of the property before
gain or loss can be established. This adjustment to basis becomes the taxpayers adjusted basis in the
property. To calculate adjusted basis, take your original basis in the property and:
Increase the basis by:
The cost of capital improvements (which have a useful life of more than one year).
The cost of restoration after a casualty.
Assessments for local improvements.
Certain legal fees and zoning costs.
Decrease the basis by:
Any discount, rebate, or reimbursement of any portion of the purchase price.
Insurance reimbursements for property damages.
The amount of casualty or other losses deducted on the return for any year.
Depletion or depreciation allowed or allowable, including 179 deduction and special bonus
depreciation.
Any gain that is not reported in the year realized.
Any tax credits received through ownership of the asset.
This adjusted basis calculation is a great starting point for determining the taxpayers adjusted basis.
However, this calculation can become very complex, depending on the tax credits or depreciation
deduction claimed associated with the asset. For further information about determining the taxpayers adjusted basis in their asset, see IRS Publication 551, Basis of Assets.
HOLDING PERIOD
Holding period is the length of time an asset has been owned (held). In general, assets owned longer
than one year have been held long term. Assets owned one year or less have been held short term.
Ownership is counted by months, not days. One day plus twelve months after the purchase date is
the first day that the holding period is considered long term.
For property acquired by inheritance, generally the inherited property is considered to have been held
long-term, regardless of the actual holding period of the beneficiary and/or the decedent. If the property is inherited from a decedent who died in 2010, use Publication 4895, Tax Treatment of Property
Acquired From a Decedent Dying in 2010, to determine the holding period.
Sales and exchanges generally are reported in the year the proceeds are received. However, an exception occurs for stock traded on a recognized securities exchange because the trade date (rather than
the settlement or payment date) shown on the sell slip is used as the sale date. The purchase date is
the trade date shown on the buy slip. Settlement dates are ignored for tax purposes.
mExample: Lynette Blum sold 100 shares of publicly traded XYZ stock on December 30, 2014. She
received payment for her stock on January 4, 2015. The stock is considered sold in 2014, and Lynette
must report the sale on her 2014 tax return.m
GAIN OR LOSS
Gain or loss from the sale or exchange of a capital asset is the difference between the gross sales price
and the adjusted basis plus any expenses of the sale. If the gross sales price is greater than the adjusted basis plus any expenses of the sale, the result is a gain. If the adjusted basis plus any expenses of
the sale is greater than the gross sales price, the result is a loss.
mExample: Peter Weiss owned a house for which he paid $200,000. He added a patio at a cost of
$4,000, making his adjusted basis $204,000. He later sold the house for $215,000 and paid a $5,000
sales commission. Thus, his total adjusted basis plus the expenses of the sale were $209,000 [$200,000
cost + $4,000 patio + $5,000 commission = $209,000]. To determine gain or loss, Peter must deduct his
adjusted basis plus the expenses of the sale from the gross sales price. In this case, Peter has a $6,000
gain [$215,000 sales price $209,000 adjusted basis = $6,000].m
Gains realized on most sales or exchanges of personal-use, investment-use, and business-use assets
are taxable. Losses on the sale or exchange of investment-use and business-use assets are deductible.
Losses on the sale or exchange of personal-use assets are not deductible. Losses on sales and exchanges of investment-use or business-use assets between related taxpayers (controlled businesses, broth-
ers, sisters, ancestors, lineal descendants, and spouses) are not deductible, but instead it generally
increases the related taxpayers basis in the asset.
whose income exceed a specific threshold amount based
Ton theirTaxpayers
filing status and have net gains from the disposition of nonbusiax Tip:
ness-use property may be subject to an additional Net Investment Income Tax

(NIIT) of 3.8%. The NIIT is reported on Form 8960.
We have already discussed how to determine the adjusted basis of an asset. Before you can compute
the gain or loss from the sale or exchange of an asset, you also need to know the amount realized from
the sale or exchange and the expenses of the sale.
The amount realized or the gross sales price is the amount of cash received by the seller from the
buyer plus:
The fair market value of any obligations, property, or services received.
The face value of any of the sellers liabilities (e.g., mortgage) the purchaser assumes as part of the
transaction.
Expenses of sale (closing costs) include the costs of transferring the property (for example, commissions and legal fees).
Sales and exchanges of capital assets are generally reported first on Form 8949, Sales and Other
Dispositions of Capital Assets (shown in Illustrations 23.2 and 23.3). Short-term transactions are
reported on Form 8949, Part I, and long-term transactions are reported on Form 8949, Part II. The
transactions from Form 8949 are then carried to Schedule D (shown in Illustrations 23.4 and 23.5) in
the following manner:
Short-term transactions are entered in Part I.
Long-term transactions are entered in Part II.
A summary of capital transactions from Parts I and II is entered in Part III.
Capital gain distributions from mutual funds and regulated investment companies are always treated
as long-term capital gains. As such, they are entered in Part II of Schedule D when it is used, specifically on line 13.
A taxpayer may use as many copies of Form 8949 as required to show all of his reportable transactions.
Form 1099-B (shown in Illustration 23.1) or a similar statement is the means used by brokers to
report sales of stocks, commodities, future contracts, foreign currency contracts, debt instruments,
options, etc. A similar form, Form 1099S (shown in Illustration 23.17), is used to report certain real
estate transactions. The broker or real estate agent sends a copy of Form 1099-B or 1099-S to the IRS
and another copy to the taxpayer.
Please note that many brokers will enter in box 2a of Form 1099-B the gross proceeds minus sales
commissions for sales of securities. In such cases, the sales commission should not be added to the
basis. The appropriate box should be checked in box 2a of Form 1099-B.
A taxpayer may be able to report sale of capital assets directly

Ton Schedule
D and Form 8949 may not be required. This option applies
ax Tip:
to transactions (other than sales of collectibles) for which the following two
requirements are met:
1. The taxpayer received a Form 1099-B that shows basis was reported to the
IRS and does not show a nondeductible wash sale loss in box 5.
2. The taxpayer did not need to make any adjustments to the basis or type of
gain or loss (short-term or long-term) reported on Form 1099-B (or substitute
statement) or to the gain or loss calculated.
mExample: Emily Smith is single. On August 28, 2014, she noticed that FOX stock was selling for
$71 per share, so she decided to sell the 100 shares she owned. She had purchased them on October
7, 2011, for $50 per share. She paid a $100 commission when she sold it. This was her only sale of
capital assets.
Emilys basis is $5,100 [(100 shares 2 $50 per share) + $100 commissions = $5,100]. The gross sales
price, which the broker entered in box 2a of Form 1099-B (shown in Illustration 23.1), is $7,100 [100
shares 2$71 per share = $7,100], so her capital gain is $2,000 [$7,100 sales price $5,100 adjusted
basis = $2,000 gain]. Emily maintained her FOXstock for more than 12 months, so her $2,000 capital
gain is long-term. Emilys sale of FOX stock is reported on Form 8949, page 2, and pages 1 and 2 of
her Schedule D. These forms are shown in Illustrations 23.2 through 23.5.m
Illustration 23.1

Illustration 23.2

Illustration 23.3
X.X

Illustration 23.4

Illustration 23.5
FORM 1099-B
In most cases, if a taxpayer sells stocks or bonds through a broker, they will receive Form 1099-B or
similar statement. Examine the copy of Form 1099-B in Illustration 23.1. Identifying information for
both the broker and taxpayer is shown on the left side of the form.
Recipients identification number is usually the taxpayers social security number.
Box 1a, Description of Property, provides the stock ticker symbol and the number of shares that
were exchanged. This box may also provide the class of stock exchanged. For example, C for common
stock or P for preferred.
Box 1b, Date Acquired, shows the acquisition date, which may be entered on Form 8949, column
(b).
Box 1c, Date Sold or Disposed, shows the sale or exchange date (trade date for broker transactions), which is entered on Form 8949, column (c).
Box 1d, Proceeds, shows the proceeds from sales of stocks, bonds, other debt obligations, or commodities, which may be entered on Form 8949, column (d).This figure may represent either the gross
proceeds from the sale or net proceeds, which is the gross proceeds minus sales commissions and
option premiums. The broker will indicate if gross proceeds or net proceeds were reported in box 1d
by marking the appropriate box in box 6, Reported to IRS.
In either case, the box 1d amount may be reported on Form 8949, column (d). If box 1d represents
gross proceeds, add any sales commissions and option premiums to the basis reported in box 1e. If box
1d represents net proceeds, do not add commissions and option premiums to the basis reported in box
1e because the proceeds have already been reduced by these amounts.
Box 1e, Cost of Other Basis, shows the cost, or adjusted basis, of the securities sold, which may be
entered on Form 8949, column (e).
Box 1f, Code if Any, shows codes for specific transactions. If the code is W, then the transaction is
a wash sale. If the code is C, then the transaction is the sale of a collectible. If the code is D, then
the transaction is the sale of a bond at market discount.
Box 1g, Adjustment, shows the amounts of disallowed wash sale losses.
Box 2, Type of Gain or Loss, distinguishes the gain or loss as either short-term or long-term.
Box 2b indicates whether the taxpayer cannot take a loss due to gross proceeds from a reportable
change in control or capital structure reported in box 2a.
Box 3, Check if Basis Reported to IRS, indicates if the basis reported in box 3 has been reported
to the IRS.
Box 4, Federal Income Tax Withheld, shows the amount of federal taxes withheld from the proceeds in box 2. Usually, this box will be blank, but if an amount is entered, it is included on Form
1040, line 64.
Box 5, If checked, noncovered security, indicates a noncovered security. Noncovered securities

will not be covered in this course.
Box 6, Reported to IRS, indicates the amount in box 1d, Proceeds, that was reported to the IRS
was gross proceeds or net proceeds. Net proceeds equals gross proceeds minus sales commissions and
option premiums.
Box 7, If checked, loss is not allowed based on amount in 1d, indicates that the loss cannot be
taken on the return because the gross proceeds in box 1d are based on a reportable change in control
or capital structure. This type of transaction will not be covered in this course.
Boxes 811 deal with regulated futures contracts and disallowed losses, topics not covered here. You
will need to do additional research if you encounter a Form 1099-B with entries in these boxes. IRS
Publication 550, Investment Income and Expenses, is a good place to start.
Box 13, Bartering, shows cash or the fair market value of property or services received through a
bartered exchange. Barter exchanges will not be covered in this course.
Boxes 1416 show amounts of state income tax withheld.
Form 1099-B also provides the CUSIP (Committee on Uniform Security Identification Procedures)
number, when applicable. This number is not entered on the return.
The Form 1099-B shown in Illustration 23.1 is the official IRS form. Many brokers use their own
version of this form, which may bear little resemblance to the IRS form. However, it is required to
contain the same information.
brokers now use a consolidated form that combines Forms
T1099-B,Many
1099-DIV, and 1099-INT. Beginning in 2008, these consolidatax Tip:
ed forms are required to be mailed to clients no later than February 15. This
means many taxpayers will not have all of their information documents until
after this date.
CAPITAL GAINS TAX RATES

Generally, tax is determined from the Tax Table, or you can compute it from the Tax Computation
Worksheet. However, as you learned in ITC, qualified dividends and capital gain distributions receive
preferential tax treatment.
The tax rates applied to gains resulting from the sale of capital assets held long term depend upon:
The type of assets sold.
When they were sold (or, in cases of installment sales, when the payments were received).
Which tax bracket the taxpayer is in (i.e., what is the taxpayers marginal tax rate).
The Qualified Dividends and Capital Gain Tax Worksheet can be used by most taxpayers who have
capital gains from the sale of capital assets or qualified dividends. However, taxpayers must use the
Schedule D Tax Worksheet if they have any of the following:
Gains from the sale of collectibles.
Unrecaptured 1250 gain (a topic we do not cover in this course).
Gain from the sale of certain 1202 stock (another topic not covered in this course).
A copy of the Schedule D Tax Worksheet can be found in Illustrations 23.10 and 23.11. A copy of Form
1099DIV in Illustration 23.6 will show how qualified dividends are reported to the taxpayer and the
IRS.
Tax liability is determined in Part III on page 2 of Schedule D through a series of questions that lead
to the correct tax computation method. Take a minute to read through Part III, which youll find in
Illustration 23.4.
Normal Capital Gains

Short-term capital gains generally are treated as ordinary income and taxed at the taxpayers marginal rate. Long-term capital gains generally are taxed at a rate of 15%. However, if the taxpayers marginal tax rate is 39.6%, then their long-term capital gains are taxed at the maximum rate of 20%. See
the table in Illustration 23.7 for a breakdown of capital gain tax rates per taxpayers marginal rate.
mExample: Emily Smith (from the preceding example) has taxable income of $55,000. If capital gains
were taxed at her marginal rate, Emily would pay $500 in tax on her capital gain of $2,000 [$2,000
gain 2 25% marginal tax rate = $500 tax on capital gain]. However, because the tax rate on her
long-term capital gain is 15%, Emily pays only $300 tax on the gain [$2,000 gain 2 15% capital gain
rate = $300 tax on capital gain]. Emilys Qualified Dividends Capital Gain Tax Worksheet is shown
in Illustration 23.8.m
For taxpayers in the 10% and 15% marginal tax brackets, the long-term capital gains tax rate is 0%.
mExample: Suppose that Emily instead had taxable income of $24,000. Now, shes in the 15% bracket, so her long-term capital gain is taxed at 0%. Emily will pay no tax on the gain. Emilys Qualified
Dividends Capital Gain Tax Worksheet is shown in Illustration 23.9.m
28% Gain
Certain long-term gains are taxed at a maximum rate of 28%. The 28% maximum rate applies to:
Long-term gain from the sale of collectibles (see Form 1099-DIV, box 2d).
Certain gain from the sale of 1202 stock, also called qualified small business stock (QSBS).
The topic of QSBS is not discussed in this course. If you ever encounter a Form 1099-DIV with an
entry in box 2c, you will need to perform additional research.
A collectible is defined as any work of art, rug, antique, metal, gem, stamp, coin, alcoholic beverage, or
other tangible property specified by the Secretary of the Treasury. However, certain U.S. gold, silver,
and platinum coins, and platinum and palladium bullion are not considered collectibles.

Illustration 23.6
Illustration 23.7
CAPITAL GAINS AND INVESTMENT TAX RATES

Long-Term Capital Gains
20132015
Taxpayer Marginal Rate:
20102012
Applicable LTCG Rate
39.6%
20%
N/A
25%, 28%, 33%, or 35%
15%
15%
10% or 15%
0%
0%
Short-Term Capital Gains
Taxed as ordinary income at the taxpayers marginal rate.
Collectibles Gain
Maximum Rate of 28%
Unexcluded 1202 QSBS Gain
Maximum Rate of 28%
Unrecaptured 1250 Gain
Maximum Rate of 25%
Net Investment Income Tax
3.8%
N/A

Illustration 23.8

Illustration 23.9
mExample: In 2009, Michael Angelo, a single taxpayer, purchased a painting for $30,000. In 2014, he
sold the painting for $50,000 for a gain of $20,000. Michaels taxable income is $187,000.
If his capital gains were taxed at his marginal rate, Michael would pay $6,600 tax on his capital gain
[$20,000 2 33% = $6,600]. However, because the maximum tax rate on the gain is 28%, Michael
pays only $5,600 tax on the gain [$20,000 2 28% = $5,600]. The tax on Micheals gain is computed on
Schedule D Tax Worksheet, which can be found in Illustrations 23.10 and 23.11.m
There is yet another maximum capital gains tax rate, 25%, which applies to unrecaptured 1250
gains, primarily those from the sale of certain real estate used in business. Any such gain distributed by a mutual fund will be shown in Form 1099-DIV, box 2b. You can learn more about 1250 in
H&RBlocks Advanced Disposition of Business Assets.
Important: The above discussed rates are maximum rates. If the taxpayers marginal tax rate is less
than the maximum rate for each type of gain, the gains will be taxed at the marginal rate.
mExample: If Michael Angelo (from the preceding example) was in the 25% bracket, his tax on the
gain from the sale of the painting would have been $5,000 [$20,000 2 25% = $5,000].m
mExample: Doria Juarez, a head of household, has net long-term capital gains totaling $850, but her
taxable income on line 43, Form 1040, is $0. She will pay no tax on her capital gains.m
TAXABLE GAIN OR DEDUCTIBLE LOSS

The amount of capital gain included in income on Form 1040 or the amount of capital loss allowed as
a reduction of income, is determined by combining short-term and long-term gains and losses.
Net short-term gain or loss from Part I, line 7, is combined with net long-term gain or loss from Part
II, line 15. The result is entered on line 16, Part III, of Schedule D. This represents the taxpayers net
capital gain or loss for the year.
Once we have completed line 16 of Schedule D, we then need to proceed carefully through the rest of
the form. When we do that, the form will tell us:
If we need to complete any worksheets.
Which method to use to determine the tax.
Where to enter what amounts on Form 1040.

Illustration 23.10

Illustration 23.11
CAPITAL LOSS CARRYOVER

When a taxpayer has a large net capital loss, they may not be able to deduct the whole loss in the year
it occurs because of this limitation. The amount the taxpayer may not deduct in the current year must
generally be carried over to the following year.
When completing a Schedule D, if the amount on Schedule D, line 16, is a loss, skip lines 1720 and
complete line 21. Line 21 is completed by entering the smaller of the loss on line 16 or $3,000 ($1,500
MFS), the annual limit for capital loss deductions. The line 21 amount is then carried as a negative
entry to Form 1040, line 13.
For most taxpayers, the amount of the carryover is the amount by which the loss exceeds the $3,000
limit. However, even if the loss on Schedule D, line 21, is less than $3,000, there could be a carryover
whenever the taxpayers deductions on Form 1040, line 40, exceed the AGI on line 38. This would
cause line 41 to be a negative amount. In that case, the taxpayer may not be getting full use of the
Schedule D loss to reduce the current-year tax liability. The amount not used is computed and carried
over.
H&R Blocks Capital Loss Carryover Worksheet (shown in Illustration 23.16):
Takes all the limitations and carryover provisions into account.
Allocates the currently deductible loss as called for by the Tax Code:
First to short-term carryover losses.
Then to long-term carryover losses.
mExample: Sandra Collins, filing as head of household in 2014, sustained net short-term capital losses
(Schedule D, line 7) of $2,000 and net long-term capital losses (Schedule D, line 15) of $5,000. This
means her Schedule D, line 21, would be ($3,000). Illustrations 23.12 through 23.16 show Sandras
Form 1040, Schedule D, and her 2014 Capital Loss Carryover Worksheet. Her capital loss carryover,
which she will enter on her 2015 Schedule D, line 14 (unless the line numbers change), is $4,000 (from
her 2014 Capital Loss Carryover Worksheet, line 13).m
There are a few items in Illustrations 23.12 through 23.16 that may require a little explanation:
Sandras Tax Professional completed Part III of Schedule D and entered ($3,000) on Form 1040,
line 13. Then, they completed Form 1040 through line 41 (AGI minus standard or itemized deductions).
Enter the amount from Form 1040, line 41, on line 1 of the worksheet. If it is less than zero,
enclose the amount in parentheses. Notice that the worksheet is completed whenever the loss on
Schedule D, line 16, is more than $3,000 ($1,500 MFS) or whenever Form 1040, line 41, is negative.
If Sandras line 41 had been negative, the carryover amounts computed on lines 10 and 15 of the
worksheet would be different than the amounts shown. You will seldom encounter such a situation,
but if you do, you will want to do some research on net operating losses.
Sandras capital loss carryover is $4,000. She had a $7,000 loss; $3,000 is allowed this year, and
the rest is carried to future years. By going through the worksheet computations, we allocate the
$4,000 carryover to the proper long- and short-term categories. In this particular case, it is all long
term.

Illustration 23.12

Illustration 23.13

Illustration 23.14

Illustration 23.15

Illustration 23.16
FORM 1099-S
The person responsible for closing certain real estate transactions must report these transactions on
Form 1099-S (shown in Illustration 23.17) to both the IRS and the seller. The purpose, as with all
forms of the 1099 series, is to allow the IRS to match the amount on the 1099 with the amount the
taxpayer reports on their tax return.
Real estate transactions involving the sale of business or rental property or the sale of property using
the installment method are initially reported on forms other than Schedule D. Any other real estate
sale is reported directly on Schedule D in Part I or II, depending on the holding period.
SALE OF TAXPAYERS HOME

If a taxpayer has a gain on the sale of their main home, they may qualify to exclude all or part of the
gain from their income. The taxpayer can exclude up to $250,000 of the gain on the sale of their main
home ($500,000 if MFJ and all qualifications are met) if the taxpayer:
Meets the ownership test.
Meets the use test.
Did not exclude gain from the sale of another home during the two-year period ending on the date
of the sale.
The ownership and use test means that during the five-year period ending on the date of the sale, the
taxpayer must have:
Owned the home for at least two years (the ownership test).
Lived in the home as their main home for at least two years (the use test).
Illustration 23.17
For married taxpayers filing jointly, more research should done. A good place to start would be IRS
Publication 523, Selling Your Home.
Taxpayers should report the sale of their main home only if they have a gain that cannot be excluded, the taxpayer chooses to not exclude the gain, or they received a Form 1099-S. The gain would be
reported on Part I or Part II of Form 8949. When you start using BlockWorks, you will use the Sale
of Home Worksheet screen in Illustration 23.18.
As you can see in the illustration, there are several areas where various information and uses of the
home must be entered or answered. Also, you have to answer (using the taxpayers knowledge) several
questions regarding the qualifications for an exclusion. If you encounter a situation where the taxpayer has sold their main home, you should partner with an experienced Tax Professional.
CHAPTER SUMMARY
The two types of property are real and personal. The four uses of property are business, investment, personal, and stock-in-trade (inventory).
The Tax Code defines capital assets in negative terms. Broadly speaking, capital assets are items
acquired for personal or investment purposes.
For tax purposes, the basis of property is a measure of the taxpayers investment in the property.
The basis of purchased property is generally its cost.
Property held one year or less is considered to be held short term. Property held more than one
year is considered to be held long term.
Gain or loss from the sale or exchange of capital assets is reported on Schedule D. Net long-term
capital gains generally are taxed at lower rates than ordinary income.
A taxpayer can generally deduct a maximum of $3,000 net capital loss in any one year. Any loss
not deducted because of the limitation on capital losses can be carried over to future years.
Forms 1099-B and 1099-S are used to report many capital transactions to the taxpayer and to the
IRS.
Qualified dividends and normal capital gain distributions are taxed as long-term capital gains.
Suggested Reading
Chapter 13, Basis of Property.
Chapter 14, Sale of Property.

Illustration 23.18
24
Ethics
OVERVIEW
The ethical decision is always the fearsome decision. When something matters enough that we are
afraid of the consequencesafraid that even the honorable choice could result in harm or loss or sorrowthats when ethics are involved.
Henry W. Bloch
In this self-study chapter, you will learn that ethical behavior is taking responsibility for personal conduct. Ethical rules and regulations established by the IRS and other agencies provide the guidelines
for Tax Professionals. This chapter will inform you of the basic guidelines and show you how to apply
those guidelines at the tax desk.
You should read this chapter, then do the check-for-understanding questions in your workbook as you
go through the WBT.
OBJECTIVES
Identify how ethical standards protect tax payers, Tax Professionals, and H&R Block.
List the due diligence requirements required in preparing income tax returns.
List standards of confidentiality awareness.
Identify conflicts of interest and ways to deal with them.
Specify best practices for return preparation.
TAX TERMS
Circular 230.
Disclosure.
Due diligence.
Noncompliance.
Privilege.
24.1
DUE DILIGENCE
Due diligence is required by all Tax Professionals to ensure that the Tax Code is correctly applied in
all matters. Taxpayers do not always know tax law. They come to Tax Professionals for guidance and
expertise that helps them comply with their tax obligations. It is up to the Tax Professional to apply
due diligence accordingly.
Specific situations in which Tax Professionals must exercise due diligence include:
Preparing, reviewing, and filing tax returns and other documents related to IRS matters.
Determining the correctness of oral or written representations the Tax Professional makes to the
Department of the Treasury.
Determining the correctness of oral or written representations the Tax Professional makes to taxpayers with reference to any matter administered by the IRS.
Accurate and Complete

Tax Professionals must prepare accurate and complete returns. A tax return is accurate and complete
when all income is included and the taxpayer qualifies for all deductions and credits that are claimed.
It is a primary due diligence responsibility to know the tax law and use sound judgment to determine
eligibility.
Thorough Interview
A thorough interview consists of asking questions whenever information is incomplete or seems inaccurate or inconsistent. The taxpayers answer to one question might often lead a Tax Professional to
ask a follow-up question. It is an interesting fact of tax preparation that each taxpayer brings a unique
set of circumstances. A Tax Professional might ask the same question to several different taxpayers,
but should never expect the same answer. Likewise, similar answers might have different outcomes
based on other factors on the return.
Reasonability Check
A reasonability check is when a Tax Professional considers the taxpayers information before making
any conclusions. A reasonability check should be applied to the taxpayers individual answers and to
their whole tax picture. A Tax Professional should look at all the factors and ask, Does this make
sense?
BlockWorks Notes
Although it is specifically required on all EIC claims, Tax Professionals should always document their
questions and the taxpayers answers if they think the IRS might question any item on the return.
Tax Professionals can use the Notes section located on the Client Card in BlockWorks to include any
explanation or additional information that they think the IRS might question. See Illustration 24.1.
Ethics 24.3
Illustration 24.1
The Note selection, shown below (on the Client Card), should be used for information that does not
pertain to EIC. See Illustration 24.2.
Illustration 24.2
CONFLICT OF INTEREST
Conflicts of interest can arise in many situations. A conflict may be present from the moment a
relationship is initiated with a client, or the conflict may develop well after work has started with a
taxpayer. In either case, Tax Professionals must be diligent in acknowledging that a conflict could or
has occurred and take appropriate actions to resolve the situation.
Examples of situations in which a conflict of interest exists include:
One taxpayer will be adversely affected by representation of another taxpayer.
mExample: A Tax Professional represents former spouses before the IRS and ultimately prepares
separate returns for them. It is possible one spouse could pay a disproportionate share of any joint
tax liability.m
A significant risk that representation of one or more taxpayers will affect the Tax Professionals
responsibility to other taxpayers
mExample: A Tax Professional takes on more taxpayers than they can handle, and some taxpayers
incur penalties for failure to file and pay in a timely manner because the Tax Professional could not
prepare all the returns by the deadline.m
The Tax Professional has a personal interest in the outcome.
mExample: A Tax Professional advertises that they can get the maximum refund for taxpayers and
charges a fee based on a percentage of the refund.m
Exceptions to Conflict of Interest Rules

When a conflict of interest is acknowledged, a Tax Professional may still represent the clients under
any of the following circumstances:
The Tax Professional reasonably believes they can provide competent and diligent representation
to each of the affected taxpayers.
The representation is not prohibited by law.
Each of the affected taxpayers gives informed consent, confirmed in writing, stating that they
waive the conflict.
TAXPAYER CONFIDENTIALITY
It is a requirement that all tax returns and tax return information shall remain confidential.
A tax return, for this purpose, includes:
All types of tax returns.
Tax information forms (for example, Forms W-2, 1099, or 1098).
Declaration of estimated tax.
Supporting schedules, attachments, or lists filed with the IRS.
Tax return information includes:
A taxpayers identity.
The nature, source, and amount of income.
Payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax
withheld, deficiencies, over-assessments, and tax payments.
Any other data received, recorded, prepared, or furnished to the IRS, or furnished or collected by
the IRS.
The fact that a taxpayer is the client of a Tax Professional or tax preparation business is confidential
information that must not be disclosed without the taxpayers express consent.
Ethics 24.5
Privileged Communications
Certain communications between attorneys or authorized Tax Professionals and their clients are
privileged. This means that taxpayers may instruct their Tax Professional to refuse to share specific
communications and information with the government. The scope of privilege depends on the status
of the Tax Professional and their relationship to the taxpayer.
There are two levels of privilege in the field of taxation:
Attorney-client privilege exists between attorneys and their clients. Clients may assert this privilege to protect confidential communications and information. Attorneys are professionally obligated to raise this privilege on behalf of their clients, unless the client instructs otherwise.
I.R.C. 7525 privilege applies to communications and information between certain federally authorized Tax Professionals and their clients. Specifically, for I.R.C. 7525, federally authorized Tax
Professionals are those with one of the following designations:
Attorney.
Certified public accountant (CPA).
Enrolled Agent (EA).
Enrolled Actuary.
Appraiser.
Privilege Under 7525 Is Narrow
The 7525 privilege exists between any federally authorized Tax Professional (listed above) and their
client. This privilege is narrow in scope. It applies only to tax advice, not to tax return preparation. It
also does not apply to state tax matters, criminal tax matters, or corporate tax matters.
Unenrolled Tax Return Preparers

There are two groups of unenrolled tax return preparers:
Annual Filing Season Program Participants.
PTIN Holders.
Annual Filing Season Program Participants
Beginning with Filing Season 2015, unenrolled return preparers could opt to participate in this IRS
program, which was designed to encourage education and filing season readiness. This IRS voluntary program recognizes the efforts of PTIN holders who are generally not attorneys, certified public
accountants, or Enrolled Agents by issuing an Annual Filing Season Program Record of Completion to
qualified return preparers who take an approved Annual Federal Tax Refresher course and complete
a certain number of continuing education hours in preparation for a specific tax year. For 2015:
Take 11 hours of continuing education from IRS-approved CE providers including:
A six-hour Annual Federal Tax Refresher course that covers filing season topics and tax law
updates, as well as a relevant comprehension test administered at the end of the course by the
CE provider.
Three hours of other federal tax topics.
Two hours of ethics.
Consent to adhere to the regulations stipulated in Subpart B and 10.51 of Treasury Department
Circular 230, Regulations Governing Practice before the Internal Revenue Service.
PTIN Holders
Tax return preparers who have an active preparer tax identification number, but no professional
credentials, and do not participate in the annual filing season program are authorized to prepare tax
returns. In 2015, they also have limited representation rights. This is the final year this category will
have limited representation rights. Beginning in 2016, PTIN holders will only be authorized to prepare tax returns and will not have representation rights.
Note: Generally, requests from the IRS are sent directly to the taxpayer rather than to the unenrolled
tax return preparer. Thus, the unenrolled tax return preparer will not know of the request unless the
taxpayer brings it to their attention.
NONCOMPLIANCE
It is generally understood that taxpayers must comply with the revenue laws of the United States
by filing accurate and complete tax returns and related documents. Circular 230 provides guidance
regarding a Tax Professionals responsibilities when they have knowledge that a taxpayer has not
complied with the Tax Code.
Noncompliance issues include:
Refusing to provide records and information lawfully requested by the IRS.
Reporting inaccurate income.
Claiming deductions or credits for which the taxpayer does not qualify.
When a Tax Professional has knowledge that a taxpayer has not complied with any tax law, they
must:
Advise the taxpayer promptly of the fact of the noncompliance, error, or omission.
Advise the taxpayer of the consequences of such noncompliance, error, or omission.
The Tax Professionals duty is complete upon informing the taxpayer of the noncompliance and the
consequences of such actions.
The Tax Professional should not voluntarily inform the IRS of a taxpayers noncompliance. In fact,
doing so is a breach of confidentiality. If a taxpayer insists that the Tax Professional prepare an inaccurate or incomplete tax return, the Tax Professional must refuse to prepare the tax return.
DISREPUTABLE CONDUCT
A Tax Professional shall not commit any act of disreputable conduct. A Tax Professional authorized
to represent taxpayers may be disbarred or suspended from practice before the IRS for disreputable
conduct. Any Tax Professional may be forbidden from providing tax advice or preparing tax returns
for other taxpayers.
Ethics 24.7
Examples of Disreputable Conduct

Examples of disreputable conduct include the following:
Committing any criminal offense under the revenue laws or committing any offense involving dishonesty or breach of trust.
Knowingly giving false or misleading information in connection with federal tax matters or participating in such activity.
Willfully failing to file a tax return, evading or attempting to evade any federal tax or payment, or
participating in such actions.
Misappropriating or failing to properly and promptly remit funds received from taxpayers for payment of taxes.
Directly or indirectly attempting to influence the official action of IRS employees by the use of
threats, false accusations, duress, or coercion or by offering gifts, favors, or any special inducements.
Being disbarred or suspended from practice as an attorney, CPA, public accountant, or actuary by
the District of Columbia or any state, possession, territory, or commonwealth, or any federal court,
or any body or board of any federal agency.
Knowingly aiding and abetting another person to practice before the IRS during a period of suspension, disbarment, or ineligibility.
Note: Maintaining a partnership to allow a disbarred person to continue practice before the IRS is
presumed to be a violation.
Using abusive language, making false accusations and statements known to be false, circulating
or publishing malicious or libelous matter, or engaging in any contemptuous conduct in connection
with practice before the IRS.
Giving a false opinion knowingly, recklessly, or through gross incompetence or following a pattern
of providing incompetent opinions in questions arising under the federal laws.
Note: Tax Professionals who fail to comply with the EIC rules and regulations may incur EIC due
diligence penalties of $500 per return for each violation.
Sanctions Related to Disreputable Conduct

Penalties for a Tax Professionals disreputable conduct can be severe, including possible censure,
suspension, or disbarment from practice before the IRS. Tax Professionals may be prohibited from
providing tax advice or preparing tax returns for any other taxpayers. More egregious behavior could
result in high monetary penalties and even imprisonment.
Penalties may be imposed, after a hearing, if a Tax Professional:
Is shown to be incompetent or disreputable.
Fails to comply with any U.S. tax law or regulation.
Willfully and knowingly misleads or threatens a taxpayer or prospective client with intent to
defraud.
Penalty of $5,000 or 50% (whichever is greater) of the income derived by the preparer if the Tax
Professional:
Willfully understates a taxpayers tax liability.

Recklessly or intentionally disregards a U.S. tax law or regulation.
Penalty of $1,000 or 50% (whichever is greater) of the income derived by the preparer if the Tax
Professional:
Understates a taxpayers tax liability due to a position that does not have a realistic possibility of
being sustained and was not disclosed on the return or is determined to be frivolous.
Terminology
Understating a clients taxpayer liability means:
Understating the net tax liability.
Overstating the net amount creditable or refundable.
Frivolous position is one that is patently (obviously) improper.
clients, husband
Tand wife, would like to file MFS and head of household,Myrespectively.
The
husband has been working in Alaska since May of this year. He has not been
home (New Jersey) since he took the assignment, and he does not expect to
return until early next year. He would like to file MFS because he has large
employee business expenses and will be able to claim a higher deduction if their
incomes are not combined.
In addition to exemptions and Child Tax Credits for their two children, as an
HH filer, the wife could claim the EITC (her income will be within the AGI limitation), the child care credit for their younger child, and the lifetime learning
credit for her own education expenses.
Assuming the couple continues to live apart at all times through the end of the
year, may the wife file as head of household? They are not divorced or legally
separated (and dont intend to be) and will agree to split the rest of their itemized deductions in whatever way yields the best results.
nswer: No, the wife may not file as head of household. For a married individual to be considered unmarried for head of household filing purposes
under 7703(b), the individual:
Must maintain a home that is the principal residence of the individuals child
(son, daughter, stepchild, adopted child, or eligible foster child) for more than
half the year.
Must pay more than half the cost of maintaining the household.
The individuals spouse may not be a member of such household at any time
during the last six months of the year.
Ethics 24.9
It appears that the wife meets the first requirement and

Amay meet the second
one as well. However, the not a member of such
nswer continues:
household requirement involves more than simply a husband and wife living in
different places. Reg. 1.7703-1(b)(5) states:
An individuals spouse will be considered to be a member of the household during
temporary absences from the household due to special circumstances. A non-permanent failure to occupy such household as his abode by reason of illness, education, business, vacation, or military service shall be considered a mere temporary
absence due to special circumstances.
Applying the law and regulations to the information youve given about your
clients situation, the husband plans to return home next year, possibly when
the assignment is complete or he is able to take leave. Even if he has purchased
or rented another residence close to his work, there is no indication on the part
of either spouse to separate permanently. The husband is considered to be temporarily absent for special circumstances and the two spouses are considered to
be members of the same household, rather than separate households. The wife
cannot be treated as unmarried and is thus disqualified from filing as head of
household.
In deciding on the best way to file, your clients may compare MFJ to two MFS
returns but not MFJ to MFS and HH returns.
CHAPTER SUMMARY
In this chapter, you learned to:
Identify how ethical standards protect tax payers, Tax Professionals, and H&R Block.
List the due diligence requirements required in preparing income tax returns.
List standards of confidentiality awareness.
Identify conflicts of interest and ways to deal with them.
Specify best practices for return preparation.
Ethical behavior is a positive choice. Tax Professionals must always strive to conduct their business
relationships to the highest ethical standard. Now that you have read this short chapter, you must go
in to Compass and access the WBT for Chapter 24 where you will read the content and complete the
check-for-understanding questions.
Suggested Reading
For further information on the topics discussed in this chapter, you may wish to read IRS Publication
470, Limited Practice Without Enrollment, or Circular 230, Regulations Governing Practice before the
Internal Revenue Service.
25
State-Specific Training
CALIFORNIA
This is a state-specific chapter. Please refer to your California Income Tax Course (2015) Participants
Guide for more information.
25.1
26
Final Exam Review

OVERVIEW
This entire session is devoted to a review of the class to help you prepare for the Final Exam. Your
instructor will lead the review and use various questions and scenarios to help you prepare. You will
also be expected to complete two tax returns in this review using BlockWorks. The returns are comprehensive returns incorporating many of the concepts you have learned. The review returns are not
intended to replicate the tax returns on the final.
You will have time available to ask any questions you may have. However, this will not be a session
where participant questions dominate the entire time period. Similar to the Midterm Exam, the Final
will consist of three parts:
Part I Ten questions for you to determine a taxpayers:
Eligibility to claim the Earned Income Credit.
Part II Ten multiple-choice questions, which may cover any material presented in the course.
Part III A tax return completed using BlockWorks, printed on the printer, and then specific information entered into the online exam.
INSTRUCTIONS
Your instructor has review questions that may be used to review topics covered during the class. You
will also be given time to complete the tax return and discuss the results in class. The return should
be completed in class using BlockWorks.
You will also be given an opportunity to ask questions that you have discovered you need more clarity
on as you were reviewing for the final.
The final is open-book, and you may also use any notes you have taken during the class. You may find
it helpful to have a copy of the Tax Season 2015 Desk Card and a copy of a 2014 Form 1040 where
they are readily available for viewing. The Desk Card can be found in the appendix on page A.24. You
can see a copy of Form 1040 in Chapter 1 on page 1.16.
26.1
27
Final Exam
OVERVIEW
This entire session will be devoted to the Final Exam. The exam will consist of three parts:
Part I Ten questions for you to determine a taxpayers:
Eligibility to claim the Earned Income Tax Credit.
Part II Ten multiple-choice questions, which may cover any material presented in the course plus
an additional three questions on Ethics.
Part III A final tax return completed using BlockWorks, printed on the printer, and then specific
information entered into the online exam.
INSTRUCTIONS
To complete the Final Exam, you should do the tax return using BlockWorks. Your instructor will
give you directions about completing the return. Once you complete the return to your satisfaction,
print the return as directed by your instructor, enter the online site, as directed by your instructor,
and follow the on-screen directions to complete your Final Exam.
When you access the site, Part I of the exam will appear. Answer those questions, and then you will
see Part II. After entering the answers for both Part I and Part II, Part III will appear. Use the information from the return you just completed to enter the requested information.
The final is open-book, and you may also use any notes you have taken during the class. You may find
it helpful to have a copy of the Tax Season 2015 Desk Card and a copy of 2014 Form 1040 where they
are readily available for viewing. The Desk Card can be found in the appendix on page A.24. You can
see a copy of Form 1040 in Chapter 1, beginning on page 1.16.
27.1
Appendix
TABLE OF CONTENTS
ITEM OR TOPIC
PAGE
2014 Tax Rate Schedules
A.3
2014 Tax Computation Worksheet
A.4
2014 Tax Table
A.5
2014 Earned Income Credit (EIC) Table
A.17
Desk Card
A.24
Poster Tax Computation Process
A.27
Poster Filing Status
A.29
Poster A Dependent Is . . .
A.31
Compliance
A.33
Conversations
A.35
Client Experience
A.36
Interviewing the Client
A.37
A.1
A.2 H&R Block Income Tax Course (2015)
This page is intentionally blank.
Appendix A.3
Illustration X.X
Appendix A.5
Appendix A.7
Appendix A.9
Appendix A.11
Appendix A.13
Appendix A.15
Appendix A.17
Appendix A.19
Appendix A.21
Appendix A.23
Appendix A.25
Appendix A.27
Appendix A.29
Appendix A.31
Appendix A.33
COMPLIANCE
IRS Changes
Every year, the IRS conducts audits of offices and Tax Professionals. These may be random audits or
the result of a complaint. Cases may be forwarded to the Criminal Investigation division for possible
prosecution or fines, and penalties may be assessed against the Tax Professional and/or the Company.
As a Tax Professional, you can help to manage the risk to the Company, to your office, and to yourself.
Managing Risk
Managing risk involves verifying paperwork and information. You should verify client information on
documents such as:
Income information worksheets.
Forms 8453/8879.
Form 1040.
Ensure client understanding of filing status, dependents, income, and deductions. Other issues to
clarify and check include:
Business losses.
Rental property losses.
Child care credits.
EIC returns.
Schedules A/C characteristics that manage to sweeten the pot.
Income sources, such as daycare and cleaning services.
Schedules A/C with round dollar amounts.
Schedule A with no mortgage, but high deductions that include non-documented items.
None of these are definitive indicators of misrepresentation or falsification, but they may cause
increased scrutiny by the IRS and raise questions regarding our responsibility to file an accurate
return.
Record your efforts to obtain appropriate documentation and exercise due diligence by recording those
efforts in BlockWorks. These notes protect you and H&R Block.
Handling Clients
Before clients sign and submit their returns, encourage them to review the return in its entirety.
In high-risk cases, such as those listed above, you should advise your client, This may expose your
return to a higher degree of scrutiny by the IRS. Without excellent documentation, this could be challenged.
If you know the client is not providing accurate information or does not have the documentation
required to verify any claim, you have the right to refuse to complete the return until accurate information is provided, and you should refuse to prepare such a return.
Do not, under any circumstances, accuse a client of attempting to defraud the IRS. Instead, focus
on the clients lack of documentation. Indicate that when the client is able to provide accurate and
sufficient documentation to support the claim, you will be glad to complete the return. Until the documentation is supplied, you should not file the return.
Privacy and Confidentiality

According to the FBI, identity theft is the fastest growing crime in the United States today. As of 2014,
only three states have not enacted legislation regarding the notification of clients if their personal
information is exposed due to computer theft, hacking, or other security breach.
Safeguarding clients and associates personal information is a high priority, and failure to do so is
a violation of law. Whether the data is maintained on paper or electronically, you should take every
precaution to protect the information from loss, misuse, and unauthorized access, disclosure, alteration, and destruction.
Remember to point to numbers, rather than saying them aloud whenever possible. Speak low enough
that others sitting around your desk cannot overhear clients sensitive information. Explain why you
need the information you ask for. Ensure that client information is not on your desk and is securely
stored. Immediately retrieve items from the printer. Verify that all documents that you provide to the
client belong to that client. All clients should be advised that any documents not used are shredded,
and documents that remain at the office are stored in a secure location.
Section 7216 of the Internal Revenue Code

Section 7216 generally requires that you obtain the clients written consent before using their information for purposes other than preparing their return or before you may share their tax return information with affiliates or third parties. There are certain exceptions to this rule, but if you have any
questions, you should seek legal advice.
The Gramm-Leach-Bliley Act (GLB)

Gramm-Leach-Bliley (GLB) is another privacy law that applies to tax return preparers. Under GLB,
you must provide, at least on an annual basis, clear and conspicuous notice of our policies and procedures for protecting customers nonpublic personally identifiable information (NPI).
The Gramm-Leach-Bliley Act of 1999, also known as the Financial Services Modernization Act, is the
umbrella for several consumer financial privacy issues that apply to H&R Block.
First, GLB requires us to:
Disclose to clients the types of information we collect about them.
Disclose to clients our information-sharing practices.
Permit clients to decide, by opt-out or opt-in, whether or not we may share information with third
parties.
Second, GLB requires us to be aggressive in safeguarding clients personal information:
Manage the physical security of our offices, computers, and client records to minimize vulnerability
to information theft and unauthorized access to, or disclosure of, personal client information.
Manage the security and integrity of our computer systems to prevent unauthorized access and
protect the data processed and stored by these systems.
Appendix A.35
CONVERSATIONS
Listening
Listening as a method of taking in information is used far more than reading and writing combined,
yet is the least understood function of all. When we think about listening, we tend to assume it is
basically the same as hearing. As a result, we make little effort to learn or develop listening skills.
Listening involves a more sophisticated mental process than hearing, demanding energy and discipline. Listening is an active, rather than passive, process. Listening is:
Taking in information from the client while remaining nonjudgmental and empathetic.
Acknowledging the client in a way that invites communication to continue.
Providing limited, but encouraging, input to the clients response.
Carrying the clients idea one step forward.
As a listener, you have a responsibility in the communication process for moving your relationship
with the client forward. Listening occurs on three levels:
Spurts.
Hearing sounds and words.
Active listening.
LEVELS
DESCRIPTION
Level 3
Listening in spurts: tuning in and tuning out

to the voices around you, being aware of others
but mainly paying attention to yourself. Halflistening: following the discussion long enough
to get your chance to talk. Passive listening:
listening but not responding, faking attention,
preparing for your turn to speak.
Level 2
Hearing sounds and words, but not really

listening: staying at the surface of communication, not paying attention to the deeper
meaning of whats being said. Hearing what
the client is saying, but not making an effort
to understand the intent.
Level 1
Active listening: not evaluating the words,

looking at things from the clients point
of view. Acknowledging and responding.
Being empathetic to the clients feelings and
thoughts.
To improve your skills at listening to clients:

Find areas of common interest.
Take the initiative to find out what the client knows.
Focus your attention on the clients central ideas in the conversation.
Make meaningful notes.
Hold your response until you have listened to the clients full point.
Ask questions to clarify for understanding.
Summarize the clients statement back to them to ensure full understanding.
Focus on the content of the statement rather than the delivery style.
CLIENT EXPERIENCE
Tax Interview
It is vital that your tax interview engages the clients in a dialogue. Clients do not want to be questioned or interrogated. They want to work with you to achieve the best possible result. During the
tax interview, your clients will be sharing personal information. It is important that your language,
behavior, and attitude demonstrate respect and empathy. The client experience protocol for the tax
interview helps clients feel secure and build confidence:
Engage the clients throughout, explaining what you are doing and why.
Give clients the opportunity to ask questions.
Maintain confidentiality and privacy of all client information.
Demonstrate your proficiency with our tax preparation software while you focus on the clients.
Educate the clients, providing relevant and actionable advice.
Orient the clients to where you are in the process and what remains to be done.
Appendix A.37
INTERVIEWING THE CLIENT

Overview
The way you handle questionsasking and answering themsets the atmosphere of professionalism
and competency.
Types of Questions
Several types of questions can be used during your interview, each with appropriate and inappropriate use. Some question types are:
TYPE AND DEFINITION
APPROPRIATE USE
OpenClients are expected to volunteer the

answer. How soon do you want your refund?
Keep clients alert, involved, and thinking. Bring

an uninvolved client back into the conversation.
ClosedYes or no answers. Did you pay any

student loan interest this year?
Prompted by BlockWorks. Guide the conversation to another topic.
RhetoricalNo answer is expected. What client Compel clients to think but not reply when an
doesnt want to claim every allowable credit?
answer is not required.
Avoid using questions that might embarrass clients.
Posing Questions
Many times a good question may be poorly delivered, causing confusion. The following are common
mistakes that new Tax Professionals make when asking questions.
Pitfalls and Poor Questions
Asking questions only one way, followed by a long pause.
Answering too quickly when asked a question.
Stating rather than askingno inflection at the end of a question.
Asking a question with an obvious answer in mind.
How to Ask Effective Questions

1. Pause slightly to attract attention.
2. Ask the question and:
Make eye contact with the client.
Lift your voice at the end.
3. Pauseuntil you get a reply.
4. Rephrase the question to clarify or suggest the type of answer you desire.
5. Wait for the answer and respond.
Handling Questions and Answers
Client questions are where the interview meets the real worldwhere the focus shifts from theoretical to actual.
Before the Interview
Anticipate questions and prepare answers.
Prepare an answer and rehearse the delivery.
During the Interview
Repeat or rephrase the question for clarity.
Thank the client for asking a good question.
Answer the question and check for understanding.
If You Do Not Know the Answer
Repeat the question (verbatim or paraphrased). It gives you time to formulate the correct answer.
Ask for the question to be repeated (sometimes the clients make it clearer).
Dont bluffadmit that you dont know but will find out.
Remember that no one Tax Professional knows all of the answers. The legal code for taxes is immense,
but you also have an immense volume of references available to you. Your desktop has the catalog
of IRS Publications, BlockWorks has help files, and you have an office full of other Tax Professionals
you can ask.
Appendix A.39
Discussion Can Get Out of Hand

Discussion is absolutely essential. It is a chance for your clients to clarify what they think they heard,
associate it with what they already know, and begin thinking about how they can apply it.
It is also a chance for you to establish a conversation with your clients, rather than just a one-way
information feed. However, too much discussion can result in:
Getting off subject.
Running a subject into the ground.
Allowing one or two clients to dominate your time, angering your other appointments.
Rushing because you are behind time.
Avoid Getting Sidetracked
Heres how to redirect the energy without losing the dynamic.
STEP
ACTION
EXAMPLE
1.
Validate the current digression. Steve, thats an interesting

point you make.
2.
Tease forward to a pertinent

section.
In fact, well be discussing

options to get your refund to
you in a little while.
3.
Empower the client.
That is a good point and I will

be discussing this with you in
more detail later in the interview. Let me make myself a
note to remind me later to discuss this with you.
4.
Redirect to the topic.
Steve, didnt I hear you mention something about going

back to school? Lets see if you
qualify for an education credit.
Glossary
401(k) Plan
Deferred compensation plan available through a
wide range of employers. Contributions to a 401(k)
plan are tax deferred to the employee (income tax
is not charged on the amount of the contribution
at the time it is made). Distributions from the plan
are taxed as ordinary income to the recipient when
received.
403(b) Plan
Deferred compensation plan available to employees of many public educational institutions and
non-profit organizations.
457 Plan
Deferred compensation plan available to employees
of many government entities.
Abatement
The removal or elimination of an assessed penalty.
Accelerated Cost Recovery System (ACRS)
The system of depreciation in effect from 1981
through 1986. The Tax Reform Act of 1986 contained several changes to the rules for property
placed in service after 1986. See also Modified
Accelerated Cost Recovery System (MACRS).
Accelerated Depreciation
Various methods of depreciation that yield larger
deductions in the earlier years of the life of an
asset than does the straight-line method. The
double (or 200%) declining balance method is an
example of an accelerated depreciation method.
Accountable Plan
A plan for reimbursing employees for expenses
such as meals, entertainment, travel, and transportation incurred for business purposes on behalf
of the employer. A plan is an accountable plan if
the employer requires the employee to account for
all business expenses and to return any excess
reimbursements. For employees under an accountable plan, reimbursements are not entered on the
tax return as income, and the expenses are not
deductible.
Accounting Method
The method under which income and expenses
are determined for tax purposes. Major accounting methods are the cash method and the accrual
method, both of which are defined elsewhere in

this glossary.
Accounting Period
The 12-month period which a taxpayer uses to
determine federal income tax liability. Unless a
taxpayer makes a specific choice to the contrary,
his accounting period is the calendar year.
Accrual Method of Accounting
One of the two most common methods of accounting, the other being the cash method defined elsewhere in this glossary. Under the accrual method
of accounting, income is reported in the tax year
earned, whether or not received, and deductions
are claimed in the tax year incurred, whether or
not paid.
Accrued Interest
Interest that has been earned but not yet paid or
credited; for example, interest earned on a bond
since the last interest payment was made.
Acquisition Debt
Debt incurred to acquire, construct, or improve the
taxpayers principal or secondary residence.
Active Income and Losses
For purposes of the passive loss rules, income and
losses must be divided into three categories: active,
passive, and portfolio. Active income and losses are
those for which the taxpayer performs services.
Examples are wages, salaries, tips, bonuses, and
income and losses from business and partnership
activities in which the taxpayer materially participates. See also Passive Income and Losses and
Portfolio Income and Losses.
Active Participant
A taxpayer who is covered by a qualified employer-maintained retirement plan, or a qualified
self-employed retirement plan, if even for only one
day during the year.
Actual Expenses (Regular Method)
The method of deducting automobile expenses
based on actual costs incurred.
Adaptation
A type of improvement that adapts a unit of property (UOP) to a new or different use that is consisG.1
G.2 H&RBlock Income Tax Course (2015)

tent with the taxpayers original intended use when
the UOP was placed in service.
Additional Child Tax Credit
A refundable credit available to taxpayers with
earned income exceeding $3,000 or with three or
more qualifying children and whose regular child
tax credit exceeds tax liabilities minus other nonrefundable credits. The additional child tax credit is
computed on Form 8812. See also Child Tax Credit.
Adjusted Basis
The cost or other original basis of property reduced
by adjustments such as depreciation allowed or
allowable and increased by capital improvements
and other adjustments.
Adjusted Gross Income (AGI)
Adjusted gross income equals gross income less
reductions that are allowable, regardless of whether
personal deductions are itemized.
Adjustment to Income
An expense which may be deducted even if the taxpayer does not itemize deductions. Adjustments to
income are subtracted from gross income to arrive
at adjusted gross income.
Adoption Credit
A nonrefundable credit for qualified adoption
expenses incurred for each eligible child. The credit
cannot exceed $13,190 per child (for 2014). The limit
is a per-child limit, not an annual limit, and can be
carried forward for up to five years or until used.
Advance Earned Income Credit
Payment by an employer based on an employees
claim to entitlement to the earned in
come credit.
Advance earned income credit payments are treated
as additional taxes on the tax return.
Advance of the premium tax credit (APTC)
Also known as the advance payment of the premium
tax credit, or advance(d) premium tax credit. The
amount of the monthly health insurance premium
paid in advance by the federal government in order
to help eligible individuals lower their monthly premium costs.
Affordable Care Act (ACA)
Two separate pieces of legislation, which provides
Americans with better health security by comprehensive health insurance reforms; The Patient Protection
and Affordable Care Act, and The Health Care and
Education Reconciliation Act of 2010.
Alimony Payments
Payments made by one spouse to the other spouse
or former spouse under a written separation or
divorce instrument. Qualified alimony and separate
maintenance payments are included in the gross
income of the recipient and are deductible by the
payer. Child support payments and property settlements are not treated as alimony.
Alternate (Straight-Line) Method
Under this method, the MACRS (or ACRS) deduction is computed using a straight-line percent and,
in some cases, an optional longer recovery period.
Alternative Minimum Tax (AMT)
The alternative minimum tax was designed to prevent higher-income taxpayers from escaping taxation through excessive use of certain tax breaks. A
taxpayer may be subject to this tax if he has certain
minimum tax adjustments or tax preference items
and his alternative minimum taxable income ex
ceeds the exemption allowed for his filing status and
income level. The alternative minimum tax is computed on Form 6251.
Alternative Straight-Line Depreciation System
A MACRS system of depreciation using the straightline method over an alternative (usually longer)
recovery period.
Amended Return
A tax return filed on Form 1040X after the original
return has been filed. An amended return is used
to correct an error or to claim a more advantageous
way of filing the original return. An amended return
can also be used to carry back an unused credit or
net operating loss.
American Opportunity Credit (AOC)
Credit for qualifying education expenses available
for tax years 2009 through 2017. The AOC may be
partially refundable.
Amortization
The deduction of certain capital expenses over a
fixed period of time. Amortization is claimed on
Form 4562. Amortizable expenses include business
start-up expenses, qualified forestation or reforestation costs, goodwill, going-concern value, covenants not to compete, franchises, trademarks, trade
names, and 197 costs.
Amount Realized
The amount received by a taxpayer on the sale or
exchange of property. The amount received is the
sum of the cash and the fair market value of any
property or services plus any of the sellers liabilities
Glossary G.3
assumed by the purchaser. Determining the amount
realized is the starting point for arriving at realized
gain or loss.
Annuitant
A person who receives a pension or an annuity.
Annuity
A fixed sum payable to a person at specified intervals for a specific period of time or for life. Payments
represent a partial return of capital and a return on
the capital investment.
Annuity Starting Date
The first day of the first period for which an amount
is due as an annuity payment under an annuity
contract.
Anti-Churning Rules
Regulations designed to prevent taxpayers from
using a more advantageous depreciation system
when depreciating property converted from personal
use to business use.
Applicable Credit Amount
A credit available to decedents in the amount of tax
on the applicable exclusion amount.
Applicable Exclusion
The amount that can pass estate tax-free for each
person.
Applicable Percentage
A factor used to calculate the amount of the taxpayers share of the applicable benchmark plan based
on the taxpayers income in relation to the federal
poverty level.
Appointee
Another person authorized by the taxpayer to
exchange information with the IRS for the benefit of
the taxpayer.
Archer Medical Savings Account(MSA)
A trust or custodial account created before 2004
exclusively for the purpose of paying the qualified
medical expenses of a high deductible health plan of
the account holder. For 2004 and later years, Archer
MSAs are replaced by Health savings accounts
(HSAs). See also Health Savings Account (HSA).
Asset
An item of useful or valuable property.
At-Risk Rules
Special rules limiting the taxpayers deductible business, partnership, S corporation, or real estate loss
to cash invested plus debt he is legally obligated to
pay and the adjusted basis of any property contributed.

Audit
An IRSexamination and verification of a taxpayers
return or other transactions with tax consequences.
An office audit is an audit by the IRS which is conducted in the agents office. A field audit is conducted
by the IRS on the business premises of the taxpayer
or in the office of the tax practitioner representing
the taxpayer.
Automated Collection System (ACS)
IRS automated system that generates a series of
phone calls and letters to attempt collection of pastdue taxes.
Away From Home Overnight
For purposes of deducting travel expenses, a trip
away from ones tax home for a period longer than
an ordinary workday, during which time one is
released from duty to obtain rest.
Bad Debts
Business accounts receivable that have been included in income in a prior year that are uncollectible,
legally binding debts owed to the taxpayer that are
totally worthless and uncollectible, and debts the
taxpayer must pay that he guaranteed in connection
with his business or for a profit may be deductible
as bad debts.
Basis
The amount assigned to an asset from which gain
or loss is determined for income tax purposes. For
assets acquired by purchase, basis is cost. Special
rules govern the basis of property received by virtue of anothers death or by gift, the basis of stock
received on a transfer of property to a controlled corporation, the basis of the property transferred to the
corporation, and the basis of property received upon
the liquidation of a corporation.
Basis of Stock
If purchased, the amount paid for the stock. If the
stock is received as a gift, basis is generally the
basis of the previous owner or the fair market value
when received. The basis of inherited stock is usually its fair market value on the date of the decedents
death.
Benchmark Premium
Also known as the premium for the applicable second-lowest cost silver plan (SLCSP) offered by the
Marketplace in the taxpayers family size, expressed
as a percentage.

Beneficiary
The owner or recipient of funds in an account, such
as an IRA, or from an insurance policy or will.
Betterment
A type of improvement that a) ameliorates a problem or defect that existed when the UOP was
acquired or, b) is a material addition to the UOP or,
c) increases the UOPs productivity, efficiency, or
strength.
Bequest
A gift by will of personal property. A bequest is
not includable in the income of the recipient. Basis
is usually the value of the property at the date of
death of the decedent. If a bequest of money is to be
paid at intervals, then to the extent that it is paid
out of income from property, it is taxable income to
the recipient.
Bona Fide Residence Test
The qualification for eligibility to claim the foreign
earned income exclusion that is based on intent to
make a home in the foreign country for an indefinite
period of time.
Bond
A note obliging a corporation or governmental unit to
repay, on a specified date, money loaned to it by the
bondholder. The holder receives interest for the life of
the bond. If a bond is backed by collateral, it is called
a mortgage bond. If it is backed only by the good faith
and credit rating of the issuing company, it is called
a debenture.
Boot
Cash or property of a type not included in the definition of a nontaxable exchange. The receipt of boot
will cause an otherwise tax-free transfer to become
taxable to the extent of the lesser of the fair market
value of the boot received or the realized gain on the
transfer. Examples of nontaxable exchanges that
could be partially or completely taxable due to the
receipt of boot include transfers to controlled corporations and like-kind exchanges.
Bronze/Silver/Gold/Platinum plans
These are the four levels of qualified health plans
(QHPs) offered by Marketplaces, based on the value
of the coverage provided.
Business Assets
Assets used in a trade or business or used to produce
rental or royalty income.
Business Gifts
The cost of qualified business gifts is deductible to
a maximum of $25, per year per client or customer.
The $25 limit does not apply to promotional items

costing $4 or less on which the taxpayers name is
clearly imprinted and is one of a number of identical
items you widely distribute.
Business-Use Property
Property used for the production of income.
Examples include rental houses, machinery, factories, office buildings, and similar items.
Cafeteria Plan
A plan wherein an employer offers a choice of nontaxable fringe benefits from which participating
employees may select. The plan may be funded with
employer contributions, employee contributions
(usually through salary reduction agreements) or
a combination of both. It is also often called a 125
plan or a flexible spending account (FSA).
Calendar Year
A year that begins on January 1 and ends on
December 31.
Call
An option to purchase stock at a fixed price within a
specified period of time.
Callable
A bond issue, all or part of which may be redeemed
before maturity by the issuing corporation under
specific conditions. The term also applies to preferred shares of stock, which may be redeemed by
the issuing corporation.
Capital Asset
Broadly speaking, all assets are capital assets
except those specifically excluded by the Tax Code.
Major categories of noncapital assets include property held for resale in the normal course of business
(inventory), trade accounts and notes receivable,
depreciable property, and real estate used in a trade
or business.
Capital Expenditure
An expenditure made for assets with useful lives of
more than one year. Usually capital expenditures
may not be deducted in the year they are paid, even
if they are paid in connection with a trade or business. In other words, they are capitalized and generally may be depreciated or amortized.
Capital Gain
The gain from the sale or exchange of a capital
asset.
Capital Gain Distributions
Amounts paid by mutual funds, regulated investment companies, and real estate investment trusts.
Glossary G.5
These amounts represent the shareholders portion
of gain from the sale of capital assets owned by
these investment companies. Capital gain distributions are taxed in the year constructively received
and are always considered to be held long term.
those mentioned above. Individuals deduct personal

casualty losses as itemized deductions on Schedule
A, subject to a $100 nondeductible amount and a
reduction of the loss by 10% of the taxpayers AGI.
Use of Form 4684 is required.
Capital Gain or Loss Holding Period

The length of time a capital asset is owned by the
taxpayer. Assets owned 12 months or less are held
short term; those owned more than 12 months are
held long term.
Certificate
The actual piece of paper that is evidence of ownership of stock in a corporation.
Capital Improvement
An improvement made to extend the useful life of
a property or add to its value. Major repairs, such
as the replacement of a roof, are considered to be
capital improvements. The costs of capital improvements to business property must be capitalized and
may be depreciated.
Capitalize
To treat the cost of additions and improvements to
property as a capital improvement.
Capital Loss
The loss from the sale or exchange of a capital asset.
Up to $3,000 ($1,500 MFS) of net capital loss is
deductible annually with the excess carried forward
to future years. Losses on personal-use assets are
not deductible.
Capital Stock
Shares of stock which represent ownership of a portion of the corporation.
Carryback/Carryover
Provisions in the Tax Code that allow certain losses
or credits to be used in a tax year other than the tax
year incurred. A carryover is to a future year. A carryback is to a prior year.
Cash Method of Accounting
One of the two most common methods of accounting, the other being the accrual method defined
elsewhere in this glossary. Under the cash method
of accounting, income is reported in the tax year
actually or constructively received and expenses are
deducted in the tax year paid.
Casualty Loss
A casualty is the complete or partial destruction of
property resulting from an identifiable event of a
sudden, unexpected, or unusual nature. Examples
are floods, storms, fires, earthquakes, auto accidents, and terrorist attacks. Individuals may deduct
a casualty loss only if the loss is incurred in a trade
or business, in a transaction entered into for profit,
or is a personal loss arising from a disaster such as
Charitable Contributions
Money or property donated to a qualified charitable organization. Such donations are deductible on
Schedule A as an itemized deduction.
Child and Dependent Care Credit
A nonrefundable tax credit of 2035% of employment-related child and dependent care expenses for
amounts of up to $6,000, available to individuals
who are employed and have a qualifying child or
disabled spouse or dependent. The credit is computed on Form 2441 for Form 1040 and 1040A filers.
Child Support Payments
Payments pursuant to a court order, divorce decree,
or other legal obligation. Payments for child support
do not constitute alimony and are not includable in
gross income by the recipient or deductible as alimony by the payer.
Child Tax Credit
A nonrefundable credit of up to $1,000 per dependent child under age 17 at the end of the tax year.
Circular 230
Regulations governing the practice of attorneys, certified public accountants, enrolled agents, enrolled
actuaries, and appraisers before the IRS.
Civil Penalty
IRS penalty, assessed only when a return has a balance due, a monetary penalty, generally based on
the amount of the understated tax, unpaid tax, or
tax due.
CLADR
See Class Life Asset Depreciation Range.
Claim of Right
A term used in the Tax Code in connection with
money or other property received as income which
the recipient holds, but which he is required to
restore to the payer in whole or in part in a later
year because it develops that he did not have an
unrestricted right to the income.
Class Life Asset Depreciation Range (CLADR)
This system of depreciation was used for assets
placed in service prior to January 1, 1981, and must

continue to be used for assets whose depreciation
was set up under that system. The CLADR system
provided guidelines for depreciation lives for the
assets listed in each guideline class.
Closed Year
A tax year for which the statute of limitations has
expired. The taxpayer cannot claim a refund and
the IRS cannot collect additional taxes (with certain
uncommon exceptions).
Collectibles
A group of capital assets which includes works of
art, rugs, antiques, precious metals, gems, stamps,
coins, and alcoholic beverages, the net gains from
which are taxed at a maximum rate of 28%.
Collection Hold
This IRS determination made when a taxpayer is
currently unable to pay any of an overdue tax liability. It is a temporary remedy during which penalties
and interest continue to accrue.
Combat Pay
Pay received by a service member assigned to a combat zone, which is exempted from income.
Combat Zone
An area designated by an Executive Order as an
area in which the USArmed Forces are engaging or
have engaged in combat.
Commission
(1) The brokers fee for purchasing or selling securities or property for a client. (2) An allowance paid to
a salesperson or agent for services rendered.
Commodity Futures
Contracts to buy or sell some fixed amount of a commodity (wheat or soybeans, for example) for a fixed
price at a future date.
Common-Law Marriage
A marriage established in a state that legally recognizes nonceremonial marriages. The parties must
have the legal capacity and the intent to marry,
and they must live together and present themselves
publicly as husband and wife.
Common Stock
Shares in the ownership of a corporation that are
entitled to residual dividends, after bonds and preferred stock have first received interest and dividends. A common stockholder usually has a vote in
deciding company affairs, including the election of a
corporations board of directors.
Community Income
Income of a married couple, living in a community
property state, that is considered to belong equally

to each spouse, regardless of which spouse receives
the income.
Community Property
Property considered to belong in equal shares to a
husband and wife. This concept of ownership for
property acquired after marriage is followed in
Arizona, California, Idaho, Louisiana, New Mexico,
Nevada, Texas, Washington, and Wisconsin.
Commuting
Traveling from ones residence to ones regular place
of business and back to the residence.
Compensation
Wages, commissions, tips, professional fees, and net
self-employment income from services rendered;
that is, earned income. For IRApurposes, compensation also includes alimony and separate maintenance payments.
Condemnation
The taking of property by a public authority. The
property is condemned as the result of legal action,
and the owner is compensated by the public authority. The power to condemn property is known as the
right of eminent domain.
Conduit IRA
An IRA used to hold temporarily a distribution from
a qualified employer-maintained retirement plan,
until such time as it can be rolled into another qualified employer-maintained retirement plan.
Confidentiality
A set of rules or a promise that limits access or places restrictions on certain types of information. .
Conflict of Interest
A situation that has the potential to undermine the
impartiality of a person because of the possibility of
a clash between the persons self-interest and professional interest or public interest.
Controlled Group
This refers to a controlled group of corporations
that is one or more chains of corporations connected
through stock ownership with a common parent corporation.
Constructive Receipt
A cash-basis taxpayer is taxed on income only as
it is received. But if the income was unreservedly
subject to his demand and he could have received it
but chose not to do so, it is regarded as having been
constructively received by him and is taxable. For
example, interest credited to a savings account is
Glossary G.7
constructively received even if the taxpayer has not
withdrawn it.
Contract Price
An amount payable to the seller and equal to the
gross selling price when no mortgages are involved.
If a mortgage is assumed, the contract price is the
gross selling price minus the amount of the mortgage plus the excess (if any) of the mortgage over
the sellers basis and expenses of sale.
Contribution
(1) Gift to a qualified charitable organizations, generally deductible on Schedule A. (2) Money placed in
a retirement fund, such as an individual retirement
arrangement or an employer-maintained retirement
plan.
Conversion (IRA)
Reclassification of a traditional IRA to a Roth IRA.
This process may or may not involve relocation of
the funds. Any converted amounts are taxed to the
extent they were not taxed previously, but are not
subject to an early distribution penalty.
Convertible
A bond or preferred stock that may, under specified
conditions, be exchanged for common stock or another security, usually of the same corporation.
Copyright
The exclusive legal right to sell, reproduce, or publish a literary, musical, or artistic work.
Cost
(1) Cash and/or the value of property given to
acquire the property received. (2) The purchase
price paid for property, or the value at which property is taken into income (as in services paid for
with property). Cost is the amount that is most
often applied against the amount realized from sale
of property in determining the gain or loss. It is also
the figure most often used in determining the depreciation or cost recovery deduction.
Cost Depletion
A method for recovering the taxpayers investment
in natural resources or timber. The cost is recovered
ratably as the resource is extracted or the timber
harvested. Total cost depletion cannot be claimed
in excess of basis. Percentage depletion, the other
method for computing depletion of natural resources, is defined elsewhere in this glossary.
Cost Method of Inventory Valuation
Valuing inventory purchased during the year at
cost; that is, the invoice price less any discounts
plus transportation or other costs incurred in

acquiring the merchandise.
Cost of Goods Sold
Beginning inventory plus direct purchases, direct
labor costs, and overhead costs less withdrawals
for personal use and ending inventory. Sole proprietors compute their cost of goods sold in Part III of
Schedule C (Form 1040).
Cost of Maintaining a Home
Expenses necessary to maintain a taxpayers residence. These costs include mortgage interest and
real estate taxes (or rent), fire and casualty insurance on the dwelling, upkeep and repairs, utilities,
paid domestic help, and food consumed in the home.
Cost Recovery
The writing off of the capital cost of qualified assets
over a specified time period. See also Accelerated
Cost Recovery System (ACRS) and Modified
Accelerated Cost Recovery System (MACRS).
Coupon Bond
A bond with interest coupons attached. The coupons
are clipped as they come due and are presented by
the bond holder for payment of accrued interest.
Coverage Family
Includes all individuals in tax family who are
enrolled in a qualified health plan, and are not eligible for minimum essential coverage other than
coverage in the individual market.
Coverdell Education Savings Account (ESA)
A tax-favored savings plan under which any number
of taxpayers may contribute up to a total of $2,000
per eligible beneficiary. Contributions are non-deductible. Earnings and withdrawals are tax free and
penalty free if used to pay for qualified higher education expenses.
Credits
Reductions of tax liability allowed for various purposes to taxpayers who meet the qualifications.
Some credits are refundable; that is, the IRS will
send the taxpayer a refund for any amount in excess
of the tax liability. Some credits are nonrefundable;
that is, they can only reduce tax liability to zero.
Some credits may be carried to other tax years.
Criminal Penalty
IRS penalty assessed in cases where the taxpayer
has willfully engaged in criminal conduct. Penalties
may be monetary or incarceration.

Custodial Parent
The parent with whom a child lived for the greater
number of nights during the year.
De Minimis Safe Harbor Election
An annual election that allows a taxpayer to deduct
property costing $500 or less per item or with a useful life of 12 months or less.
Dealer
A person or firm that regularly buys and sells property. A person is classified as a dealer if at the time
of the sale, he held the property primarily for sale to
customers in the ordinary course of business. Gains
from the sale of such property are ordinary gains,
not capital gains.
Deceased Spousal Unused Exclusion
The unused portion of a decedents applicable exclusion amount to the extent that this amount does not
exceed the basic exclusion amount in effect in the
year of the decedents death.
Decedent
A person who has died owning property.
Declaration Control Number (DCN)
A unique 14-digit number assigned by the
Electronic Return Originator (ERO) (or transmitter,
in the case of online filing), to each electronically
filed tax return.
Declining Balance Method of Depreciation
An accelerated method of depreciation. The percent
is determined by the type of property. The depreciable basis for the next year is reduced by the depreciation deduction taken in the current year.
Deductions
Amounts that may be subtracted from income that
is otherwise taxable.
Deferred Compensation
Compensation that will be taxed when received or
upon the removal of certain restrictions on receipt
and not when earned. For example, contributions to
a qualified retirement plan on behalf of an employee
are considered deferred compensation. Such contributions will not be taxed to the employee until
the funds are made available or distributed to the
employee, usually upon retirement.
Deferred Gain
Nonrecognition of realized gain at the time of a
tax-deferred exchange. Deferred gain on the sale of
a principal residence generally applies only to those
sales made before May 7, 1997.
Defined Benefit Plan

An employee benefit plan that provides determinable benefits not based on employer profits. The
most common type of deferred benefit plan is a pension plan.
Defined Contribution Plan
An employee benefit plan that provides a separate
account for each person covered and pays benefits based on account earnings. Examples include
401(k)plans and profit-sharing plans.
Department of Health and Human Services (HHS
and DHHS)
The federal agency that oversees the Centers for
Medicare and Medicaid Services (CMS). CMS
administers programs for protecting the health of
all Americans.
Dependency Exemption
An exemption for an individual who qualifies as the
taxpayers dependent ($3,950 for 2014).
Dependent
An individual whose personal exemption may be
claimed on another persons income tax return. To
be claimed as a dependent, a person must meet certain tests, all of which are discussed in Chapter 4.
Dependent Care Credit
A nonrefundable credit based on expenses paid for
a dependents care. Such care must enable the taxpayer to be gainfully employed or to look for gainful
employment. The credit is computed on Form 2441
for Form 1040 filers and 1040A filers.
Depletion
The process by which the cost or other basis of a
natural resource (for example, an oil and gas interest) is recovered upon extraction and sale of the
resource. The two ways to determine the depletion
allowance are the cost and percentage methods,
both of which are defined elsewhere in this glossary.
Depreciable Asset
Tangible personal property or real property used in
business or held for the production of income with a
determinable useful life of more than one year.
Depreciation
The deduction of a reasonable allowance for the
wear and tear of assets used in a trade or business
or held for the production of income.
Direct Skip
Outright bequest or gift to a skip person.
Disabled
See Permanent and Total Disability.
Glossary G.9
Disability Pension
A taxable pension from an employer-funded disability plan or a disability provision of a retirement plan.
Until the recipient reaches normal retirement age, a
disability pension generally is reported on line 7 of
Forms 1040 or 1040A (or line 1 of Form 1040EZ) and
treated as wages for purposes of the child care, child
tax, and earned income credits.
Disaster Loss
If a casualty is sustained in an area designated as a
disaster area by the President of the United States,
the casualty is designated a disaster loss. A disaster
loss may be treated as having occurred in the taxable year immediately preceding the year in which
the disaster actually occurred. Thus, immediate tax
benefits are provided to victims of the disaster.
Disclosure
The release of tax information by an IRS employee.
Disposition
The act of taking an asset out of service in a trade
or business. A disposition occurs when an asset is
sold, abandoned, exchanged, retired, destroyed, or
converted to personal use.
Distribution
Money or property a taxpayer receives from a
retirement plan such as an individual retirement
arrangement (IRA) or an employer-maintained
retirement plan.
Dividend
A stockholders share of the profits of a corporation.
An insurance dividend is not a true dividend but a
return of premium. Dividends from a savings and
loan association or credit union are interest, not dividends.
Divorce Decree (Final)
A decree issued after a divorce is declared final by
the court. This action dissolves the marriage and
returns the spouses to unmarried status. Alimony
payments made as a result of this decree are deduc
tible by the payer and income to the recipient, if
requirements are met.
Divorce Decree (Interlocutory)
A divorce decree that is not yet final. Alimony paid
under an interlocutory decree is deductible by the
payer and income to the recipient, if requirements
are met.
Domestic Production Activities Deduction
This deduction provides a tax savings against
income attributable to domestic production activities. Qualified production activities include manu-
facturing, producing, growing, and extracting tangible personal property, computer software, sound
recordings, and the construction and substantial
renovation of real property, including infrastructure.
The production of certain films is also a qualifying
activity, as are certain engineering or architectural
services.
Due Diligence
Reasonable steps taken by a Tax Professional in
order to satisfy compliance with the tax law.
Early Distribution
A distribution from a qualified retirement plan or
individual (IRA)retirement arrangement before the
plan participant has reached age 59. Such distributions generally are subject to a 10% penalty tax.
Earned Income
Income from personal services as distinguished
from income generated by property or other sources.
Earned income includes all amounts received as
wages, tips, bonuses, other employee compensation,
and self-employment income, whether in the form of
money, services, or property.
Earned Income Credit (EIC or EITC)
A refundable tax credit for qualified taxpayers based
on earned income, adjusted gross income, and the
number of qualifying children.
Easement
A right held by an individual to use property owned
by someone else for a limited purpose, usually to
gain access. For example, an easement may give
Person A the right to use a path through Person Bs
property to get to his own.
Education Expense Deduction
Employees may deduct education expenses as an
itemized deduction if the expenses are incurred either
to maintain or improve existing job-related skills, or
to meet the express requirements of the employer,
or legal requirements to retain current employment
status. Such expenses are not deductible as an itemized deduction, if the education is required to meet
the minimum educational requirements for the taxpayers job, or if the education qualifies the taxpayer
for a new trade or business. Education expenses may
also qualify the taxpayer for a tuition and fees deduction, an American Opportunity Credit, or a lifetime
learning credit. All of these are defined elsewhere in
this glossary.
Educator Expenses Deduction
An above-the-line deduction of up to $250 for classroom supplies, books, and equipment, and available

to eligible educators of students in kindergarten
through 12th grade.
Electronic Funds Withdrawal
A payment method which allows the taxpayer to
authorize the U.S. Treasury to electronically withdraw funds from their checking or savings account.
Electronic Return Originator (ERO)
An Authorized IRS e-file Provider that originates
the electronic submission of returns to the IRS.
Eligible Educator
Any educator who works at least 900 hours during
a school year as a teacher, instructor, counselor,
principal or aide in a public or private elementary or
secondary school.
Eligible Foster Child
A child, other than the taxpayers biological child,
stepchild, or adopted child, who was placed with the
taxpayer by an authorized placement agency or by a
court order, decree, or judgment.
Eminent Domain
The right of a government authority to take private
property for public use upon paying fair compensation to the owner.
EITC
Earned Income Tax Credit.
Employee
For income tax purposes, an employee is to be distinguished from an independent contractor. This is
important, because the withholding of income taxes
on wages applies only to employees. Also, employee
status will affect the manner and extent of some
deductions and credits. The regulations state that
an employee is one who is subject to the will and
control of the employer not only as to what shall be
done but also as to how it shall be done. See also
Statutory Employee.
Employee Stock Option
An option granted to an employee to purchase the
employers stock. Employee stock options to which
special income tax treatment is accorded are known
as statutory options.
Employer-Maintained Retirement Plan
A qualified retirement plan funded in full or in part
by employer contributions on behalf of employees.
Employment Expenses
Ordinary and necessary expenses required to perform the duties for which the taxpayer was hired.
Enforced Collection Action

IRS process to collect payment of past-due taxes by
levying a taxpayers income or assets, attach a tax
lien to a taxpayers property, or by seizing and selling a taxpayers property.
Enrolled Actuary
An enrolled actuary is any individual who has satisfied the qualifications set forth in the regulations
of the Joint Board for the Enrollment of Actuaries
and who has been approved by the Joint Board
to perform actuarial services under the Employee
Retirement Income Security Act (ERISA) of 1974.
Enrolled Agent (EA)
An enrolled agent is a person who has earned the
privilege of practicing, that is, representing taxpayers, before the Internal Revenue Service. Enrolled
agents, like attorneys and certified public accountants (CPAs), are unrestricted as to which taxpayers
they can represent, what types of tax matters they
can handle, and which IRS offices they can practice
before.
Entertainment Expenses
Such expenses are deductible by employees and
self-employed taxpayers only if the expenses are
directly related to or associated with a trade, business, or profession. To prevent abuses, various
restrictions and documentation requirements have
been imposed on the deductibility of entertainment
expenses. The deduction for qualified business
entertainment is limited to 50% of cost.
Estate
A taxable entity that is established upon the death
of a taxpayer. It consists of all the decedents property and personal effects. The estate exists until the
final distribution of its assets to the heirs and other
beneficiaries. During the period of administration,
the executor must usually file a return.
Estimated Tax
The amount of tax a taxpayer expects to owe for the
year after subtracting expected amounts withheld
and certain refundable credits.
Estimated Tax Voucher
A statement by an individual of (1) the amount of
income tax he estimates he will incur during the
current taxable year on income that is not subject
to withholding, (2) the excess amount over that
withheld on income which is subject to withholding,
and (3) his estimated self-employment tax. Advance
payment of tax may be required (on as many as four
payment dates) unless estimated tax due after withholding and credits is less than $1,000.
Glossary G.11
Estimated (Useful) Life
The period of time over which a depreciable asset will
be used by a particular taxpayer. The estimated useful life is used to determine the annual tax deduction
for pre-1981 depreciation.
Ethics
The application of values to behavior.
Exempt Individuals
Individuals who are not required to maintain minimum essential coverage for any month they qualify
for an exemption.
Excess Advance Premium Tax Credit
An additional tax liability the taxpayer will owe
when the Advance Premium Tax Credit is greater
than the Premium Tax Credit.
Excess Social Security Tax Withheld
If a taxpayer worked for more than one employer
during 2014, and more than $7,254 was withheld for
social security tax, the excess over the maximum is
included in the Payments section of the return. The
excess amount has the same character as withholding tax.
Exchange
A transfer of property for other property or services.
Exchanges of like-kind property are often permitted
with no immediate tax consequence.
Excludable Amount of Pension
The portion of pension distributions that are not
taxable.
Excluded Gain
Generally applies to gains realized on the sale of a
principal residence. A taxpayer may exclude up to
$250,000 ($500,000 MFJ) of gain on the sale if he
owned and occupied the residence for at least two of
the five years prior to the sale.
Exclusion
An amount of income that is not included in gross
income because the Tax Code excludes it.
Exclusion Percentage
Used to compute the excludable amount of a pension
under the general rule. This percentage is determined by dividing the taxpayers total contribution
by the expected return.
Ex-Dividend Date
The date before which a stockholder must purchase
stock to qualify to receive the next dividend payment.
Exemption
An amount ($3,950 for 2014) allowed by law as a re
duction of income that would otherwise be taxed. See
also Personal and Dependency Exemptions.

Exemption from Withholding
Status claimed on Form W4 directing the employer not to withhold federal income taxes from the
employee. An employee who had no tax liability
and received a full refund of any federal income tax
withheld in the preceding tax year, and who expects
the same conditions to apply in the current tax year,
may claim exemption from withholding.
Expanded/Non-Expanded Medicaid States
This term refers to states that chose either to expand
Medicaid or not. Individuals in the expanded states
may be eligible for Medicaid coverage beginning
January 1, 2014.
Expected Return
The total amount an annuitant expects to receive
under a pension or annuity contract. This is generally determined by multiplying the annual payment
by the annuitants expected life multiple from government actuarial tables.
Expenses
For federal income tax purposes, expenses are divided into four categories: (1) trade or business expenses, (2) expenses in connection with production of
income, in connection with management, conservation, or maintenance of property held for production of income, (3) expenses in connection with the
determination, collection, or refund of any tax, and
(4) personal, family, or living expenses. Expenses in
the first three categories are generally deductible in
determining taxable income. Expenses in the fourth
category are not deductible, except in a few cases
(medical expenses, charitable contributions, etc.) in
which they are specifically allowed by law. Expenses
are to be distinguished from capital expenditures,
defined elsewhere in this glossary.
Expenses of Sale
When paid by the seller, these expenses reduce the
sale price of property. Examples are commissions to
a broker or real estate agent, legal fees, and transfer
taxes.
Expensing
A term used to refer to the 179 expense deduction,
Fair Market Value (FMV)
The amount at which property would change hands
between a willing buyer and a willing seller, neither
being under compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

Fair Rental Value
The amount the owner of property could reasonably
expect to receive from a stranger for the same type
of lodging; generally, the amount at which a home
with its furnishings could be rented to a similar size
family in a similar location.
Family size (tax family)
The number of all the individuals a taxpayer can
claim personal exemptions for on their tax return.
This includes the taxpayer, spouse (if married filing
jointly), and any qualifying children or qualifying
relatives.
Fast Track Mediation
Expedited IRS process that provides a trained mediator who facilitates communication between the IRS
and a taxpayer. The mediators recommendations
are not binding on either party.
Federal Income Tax Withheld
The amount taken out of income by the payer and
submitted to the IRS as an advance payment of the
taxpayers federal income tax.
Federal Poverty Level (FPL)
A measure of income issued annually by the
Department of Health and Human Services and
used to determine eligibility for certain programs
and benefits.
FICA (Federal Insurance Contributions Act)
The law that provides for social security and medicare benefits. This program is financed by payroll
taxes imposed equally on the employer and employee. For 2014, the employer is required to withhold
1.45% from each employees gross wages for medicare tax and 6.2% of each employees wages up to
$117,000 for social security tax.
Fiduciary
One who acts for an estate or trust to manage the
property of the estate or trust.
Finance Charges
Amounts paid for the privilege of making purchases
on a deferred-payment basis.
First In, First Out (FIFO)
An accounting method for determining the cost
of inventories. Under this method, the first items
purchased are treated as being the first items sold.
Ending inventory is valued using the cost of later
purchases, or the lower of cost or market.
Fiscal Year
An accounting year ending on the last day of any
month except December.
Flat Dollar Method/Percentage of Income Method

Methods used to calculate the shared responsibility
penalty payment.
Flexible Spending Account (FSA)
See Cafeteria Plan.
Foreign Tax Credit or Deduction
A credit or deduction available to a U. S. citizen or
resident alien, and in limited circumstances to a U.
S. nonresident alien, who incurs or pays income taxes
to a country other than the United States.
Foster Child
A child, other than the taxpayers biological child,
stepchild, or adopted child, who lived with the taxpayer. See also Eligible Foster Child.
Fraudulent Return
A return filed with the intent to evade taxes known
by the taxpayer to be due. The taxpayers conduct
was intended to conceal, mislead, or otherwise prevent the collection of taxes. The civil fraud penalty is
generally 75% of the entire underpayment.
Frivolous Return
A return that does not contain sufficient information to determine the accuracy of the tax liability,
or a return that contains information indicating the
amount of tax shown on the return is substantially
incorrect. It involves a frivolous position or intent to
delay or impede administration of the tax laws. The
penalty for filing a frivolous return is $5,000 for each
occurrence.
Fringe Benefits
Compensation or other benefits received by an
employee that are not in the form of cash. Some
fringe benefits (for example, accident and health
plans, and group-term life insurance) may be excluded from the employees gross income and, therefore,
are not subject to federal income tax.
Full Retirement Age
The age at which a worker qualifies to receive full
social security benefits; increasing incrementally
from age 62 to age 66.
Full-Time Student
An individual who is enrolled in a school for the number of hours or courses considered by the school to be
full time. School includes elementary and secondary
schools, post-secondary colleges, and technical and
trade schools. It does not include on-the-job training,
correspondence schools, or night school. However, a
student will not be disqualified by night classes that
are part of a full-time course of study.
Glossary G.13
Fully Taxable Pensions
Pensions for which taxpayers contributed none of the
cost or have recovered their cost in previous years.
Gain
The excess of the amount realized from a sale or
exchange over the adjusted basis of the property sold
or exchanged.
General Depreciation System
The most commonly used MACRS system. Personal
property is depreciated using the declining-balance
method (double or 150%, depending on the recovery
class) switching to straight-line when that method
results in the larger deduction. Residential rental
property is depreciated using the straight-line method over 27.5 years, and nonresidential real property
is depreciated using the straight-line method over 39
years (31.5 years for property placed in service before
May 13, 1993).
General Partner
A partner who is personally liable for the partnerships debts.
General Partnership
A partnership composed of general partners only.
General Power of Appointment
The right to direct the distribution of property to an
unrestricted class of beneficiaries, including the person holding the power (the holder), the estate of the
holder, the creditors of the holder, or the creditors of
the estate of the holder.
General Rule
Used to determine the taxable portion of a pension or annuity, generally replaced by the simplified method for periodic payments starting after
November 18, 1996.
General Sales Tax
A general sales tax is a sales tax imposed on retail
sales of a broad range of items at a single rate.
General Straight-Line Depreciation System
A MACRS system of depreciation using the straightline method over the normal MACRS recovery period for the asset.
Gift
A transfer of property from one person or entity to
another without consideration or compensation. For
income tax purposes, the words gift and contribution usually have separate meanings, the latter
word being used in connection with contributions to
charitable, religious, etc., organizations, whereas the
word gift refers to transfers of money or property
to private individuals, needy persons, friends, relatives, etc. The recipient of a gift is not required to
include it in his gross income, and the maker of the
gift is not entitled to deduct it (except for business
gifts to customers of $25 or less per donee per year).
Gift Tax
A graduated federal tax paid by donors on gifts ex
ceeding $14,000 (for 2014) per donee.
Golden Parachute
An agreement entered into by a corporation with its
top executives to make substantial payments to the
executives in the event of a change in corporate control. Such payments are treated as compensation.
Goodwill
The ability of a business to generate income in
excess of a normal rate on assets due to superior
managerial skills, market position, new product
technology, etc. In the purchase of a business, goodwill represents the difference between the purchase
price and the value of the net assets. Goodwill must
be amortized over a 15-year period and is subject to
recapture when the business is sold. Amortization is
computed on Form 4562.
Government Bonds Issued at a Discount
Certain U.S. Government bonds are issued at a discount and do not pay interest during the life of the
bond. Instead, the bonds are redeemable at increasing fixed amounts. Thus, the difference between
the purchase price and the amount received upon
redemption represents interest income to the holder. A cash-basis taxpayer may defer recognition of
taxable income until such bonds are re
deemed or
until the year of final maturity, whichever is earlier.
Alternatively, the taxpayer may elect to include the
annual increase in the value of the bond in gross
income on an annual basis.
Gross Estate
All property owned or considered to be owned by a
decedent at the moment of their death.
Gross Income
Total worldwide income received in the form of
money, property, or services that is subject to tax.
Gross Profit
Gross receipts less the cost of goods sold.
Gross Rents
Total income from rents before expenses or the depreciation or cost recovery deduction.
Group Term Life Insurance
Life insurance coverage purchased by an employer

for a group of employees. Such insurance is renewable on a year-to-year basis and does not accumulate
in value; that is, no cash surrender value is built up.
The premiums paid by the employer on such insurance are usually not taxed to an employee unless
coverage exceeds $50,000.
Guaranteed Return
A specific amount to be paid by an annuity. This may
be a certain payment for a given number of years or a
given amount to be paid regardless of death.
Hardship Withdrawal
A withdrawal from a 401(k), 403(b), or 457 plan that
is permitted when the plan participant has an immediate and heavy financial need and the withdrawal is
necessary to meet that need.
Head of Household
The filing status used by an unmarried taxpayer
who pays more than half of the cost of maintaining a
household for a qualifying child who is a dependent
for more than six months, or for his or her mother or
father for the entire year, and may claim either on
his or her tax return.
Health Savings Account (HSA)
A trust or custodial account created after 2003 exclusively for the purpose of paying the qualified medical
expenses of a high deductible health plan of the
account holder.
Hobby Loss
A nondeductible loss arising from a personal hobby
as contrasted with a loss arising from an activity
engaged in for profit.
Holding Period
The period of time property has been owned for
income tax purposes. The holding period determines
if gain or loss from the sale or exchange of a capital
asset is long or short term.
Home-Office Expenses
Expenses of operating a portion of a residence
used for business or employment-related purposes.
Several restrictions limit the deduction for home-office expenses.
Household Employee
An individual who performs nonbusiness services for
the taxpayer in or around the taxpayers home. Such
services include child and dependent care, house
cleaning, cooking, and yard work.
Household Expenses
A portion of total support; the value of lodging
plus food consumed in the home, utilities paid, and
repairs made. The total is divided equally among all

family members. Each members share of household
expenses is part of his total support.
Household Income
The modified adjusted gross income (MAGI) of the
taxpayer and spouse, plus the MAGI of all dependents that are claimed on the taxpayers tax return
and required to file a tax return of their own.
Household Income as a Percentage of the Federal
Poverty Level
This is the taxpayers household income divided by
the federal poverty level for the taxpayers family
size, expressed as a percentage.
Husband and Wife
A status that, among other things, entitles a couple to file a joint federal income tax return. For the
purpose of joint returns, common-law marriages are
recognized only if the state in which the two persons
reside recognizes such marriages or if the state in
which the marriage began recognizes common-law
marriages. The status as husband and wife on the
last day of the tax year governs the right to file a joint
return. See also Marriage.
Hybrid Method of Accounting
A combination of accounting methods, usually of the
cash and accrual methods.
Identifying Numbers
All taxpayers and dependents must have identifying numbers. Individuals generally use their social
security numbers (SSN). Certain resident and nonresident aliens use individual taxpayer identification
numbers (ITIN). Certain children in the process of
being adopted may receive adoption taxpayer identification numbers (ATIN). Businesses, estates, trusts,
partnerships, and payers of dividends and interest,
use employer identification numbers (EIN).
Improvement
A change to a piece of property that adds to the value
of property, prolongs its useful life, or adapts it to
new uses.
Improvement Safe Harbor for Small Taxpayers
An election to deduct, rather than capitalize, the cost
of improvements to buildings. The cost may not be
more than the lesser of 2% of the unadjusted basis
of the building or $10,000. A qualifying taxpayer has
average annual gross receipts of $10 million or less
for the last three years.
Imputed Interest
In the case of certain long-term sales of property, the
IRS has the authority to convert some of the gain
Glossary G.15
from the sale into interest income if the contract does
not provide for a minimum rate of interest to be paid
by the purchaser. Such converted interest is called
imputed interest.
Income
The word income, in its broad sense, is the gain
derived from capital, labor, or a combination of the
two. It is distinguishable from the capital itself.
Ordinarily, for income tax purposes, the word
income is not used alone. Rather it is used within such descriptive terms as gross income, taxable
income, and adjusted gross income, all of which are
Independent Contractor
A taxpayer who contracts to do work according to
his own methods and who is not subject to control
except as to the results of such work. An employee,
by contrast, is subject to the control of the employer
as to the methods to be used to obtain the desired
results.
Individual Retirement Arrangement (IRA)
A personal savings plan that allows a taxpayer to
accumulate money tax deferred until withdrawal,
usually upon retirement. There are two types of
IRAs: traditional IRAs and Roth IRAs, both of which
are defined elsewhere in this glossary.
Individual shared responsibility provision/individual mandate
The requirement that applicable individuals must
obtain health insurance coverage or potentially be
subject to a penalty in the form of an additional tax.
Inherently Facilitative Costs
Certain amounts paid to acquire property in addition
to the cost of the property itself. These costs may
include transportation and shipping fees, commissions, appraisals, application fees, and regulatory
approval fees.
Inheritance
As distinguished from a bequest, property acquired
through laws of descent and distribution from a person who dies intestate (without leaving a will). Prop
erty so acquired usually takes as its basis the fair
market value at the date of the decedents death. An
inheritance of property is not a taxable event, but the
income produced by an inheritance is taxable.
Installment Method
A method of accounting enabling a taxpayer to
spread the recognition of gain on the sale of property
over the payment period. Under this procedure, the
seller computes the gross profit percent from the sale
(that is, the gain divided by the contract price) and

applies it to each payment received to arrive at the
amount of the gain to be recognized.
Insurance Dividends
Amounts paid to policy holders are not dividends
on capital stock, but are a rebate of a portion of the
premiums paid for the insurance. Such dividends
reduce the cost of the insurance and are not taxable,
unless in excess of the total premiums paid. Interest
paid when the dividends are left with the insurance
company is reported to the taxpayer as interest and
is taxable.
Intangible Personal Property
Property, other than real property, with no intrinsic
value; its value lies in the rights conveyed. Examples
include cash, insurance, stock, goodwill, and patents.
Interest Received
An amount received for the use of money that is to be
repaid in full at a specified time or on demand.
Interlocutory Decree
See Divorce Decree (Interlocutory).
Internal Revenue Service (IRS)
The division of the U.S. Treasury Department responsible for collecting taxes.
Interview
Necessary component of due diligence requirements..
Inventory
A list of articles of property. For income tax purposes, inventory refers only to a list of articles comprising stock in tradearticles held for sale to customers in the regular course of a trade or business. The
cost of goods sold during the year is determined by
adding to the inventory at the beginning of the year
the purchases during the year, and subtracting from
this sum the inventory at the close of the year.
Investigative Costs
Certain costs for investigating or pursuing the
acquisition of real property to determine whether
and which property to purchase.
Investment Income
This term generally includes interest, dividends,
capital gains, and other types of distributions. The
subject can be fully explored in IRSPublication 550,
Investment Income and Expenses (Including Capital
Gains and Losses).

Investment Interest
Interest paid on loans acquired to purchase or hold
investment property. Investment interest is deductible as an itemized deduction to the extent of net
investment income.
Investment Property
Property owned primarily for its potential increased
value. Examples include land, stock, works of art,
and collectibles.
Involuntary Conversion
The receipt of money or other property as reimbursement for the loss or destruction of property
through theft, casualty, or condemnation. Any gain
realized on an involuntary conversion can, at the
taxpayers election, be considered non-recognizable
for federal income tax purposes if the owner reinvests the proceeds within a prescribed period of time
in similar property.
Itemized Deductions
Certain personal expenditures allowed by the Tax
Code as deductions from adjusted gross income.
Examples are certain medical expenses, qualified
interest on home mortgages, and charitable contributions. Itemized deductions are reported on Form
1040, Schedule A. A taxpayer who itemizes deductions may not claim the standard deduction.
Land Value
The value of the land in a sale where the total sale
price includes land as well as any improvements to
the land.
Last In, First Out (LIFO)
An accounting method for valuing inventories for
tax purposes. Under this method, the last items
purchased are treated as being the first items sold.
Ending inventory is valued using the cost of the
items with the earlier purchase dates.
Lawfully Present
Immigration status determines whether individuals who are not U.S. nationals/citizens are lawfully
present.
Legally Blind
Able to see no better than 20/200 in the better eye
with corrective lenses, or having a field of vision not
more than 20 degrees.
Legally Separated
Separated under a decree of separate maintenance
that requires the spouses to live apart.
Leasehold Improvements
An amount paid to improve a unit of leased property
by either the lessor or lessee.
Jointly Owned Property

Property held in the name of more than one person.
Lessee
One who rents property from another. In the case of
real estate, the lessee is also known as the tenant.
Joint Return
A return combining the income, exemptions, credits,
and deductions of a husband and wife.
Lessor
One who rents property to another. In the case of
real estate, the lessor is also known as the landlord.
Joint Tenancy (with Right of Survivorship)

A form of joint ownership. Each tenant has an undivided interest in the entire property. On death of
one of the owners, the survivor becomes the owner
of the whole. A joint tenancy may involve more than
two persons.
Levy
An IRS enforced collection action in which the IRS
confiscates property and sells it to satisfy a tax debt.
Joint Venture
An enterprise participated in by associates acting
together, with a community of interests, each associate having the right to participate in its management. For income tax purposes, a joint venture
is treated as a partnership, not taxable in its own
capacity, but regarded as a taxpayer for the purpose
of computing its taxable income, which is distributable among the associates in the proportions agreed
upon. Such distributive shares are reported by the
associates on their individual income tax returns.
Lifetime Learning Credit

A nonrefundable credit equal to 20% of the first
$10,000 of qualified higher education tuition and
fees paid during the year on behalf of the taxpayer,
his spouse, or his dependents.
Like-Kind Exchange
An exchange of property held for productive use in
a trade or business or for investment (except inventory and stocks and bonds) for property of the same
type. Unless different property is received (called
boot), the exchange is nontaxable in the current
year. Any gain or loss is not recognized until the
property received in the exchange is sold or disposed
of. Like-kind exchanges are reported on Form 8824.
Glossary G.17
Limitation on Premium Tax Credit Repayment
If the advanced premium tax credit is greater than
the premium tax credit, the taxpayers additional
tax liability may be limited. The limit is based on
filing status and household income as a percentage
of the federal poverty line.
Lineal Ancestor
A direct, in-line family predecessor of the taxpayer;
e.g., parent, grandparent, great-grandparent, etc.
Lineal Descendant
A direct, in-line offspring of the taxpayer; e.g., child,
grandchild, great-grandchild, etc.
Liquidation
(1) The process of converting securities or other
property into cash. (2) The dissolution of a corporation with cash (remaining after sale of its assets and
payment of all indebtedness) being distributed to
the shareholders.
Liquidation Distributions
A return of capital received because of the partial
or complete liquidation (going out of business) of a
corporation. The basis of the stock on which liquidation distributions are paid is reduced by the amount
of the distributions. Any amount received in excess
of basis in the stock is taxable. In a liquidation that
results in cancellation of the stock, a loss can be
claimed the year the final distribution is received,
if total distributions are less than the taxpayers
basis. Report liquidation distributions on Schedule
D, Form 1040.
Listed Property
Listed property includes passenger autos and other
property used for transportation, property generally
used for purposes of entertainment, recreation, or
amusement, computers not used exclusively at a
regular business establishment, and other property
to be specified by the IRS. Restrictions apply to the
depreciation of listed property.
Limited Partner
A partner whose personal liability for partnership
debts is limited to the amount of money or property contributed or required to be contributed to the
partnership.
Limited Partnership
A partnership formed under a state-limited partnership law and has at least one general partner and
one or more limited partners.
Lodging
A portion of total support. Lodging includes the
fair rental value of a room, apartment, or house in
which the dependent lives, a reasonable allowance

for the use of furniture and appliances, and all utilities.
Long-Term Capital Gains and Losses
Gains and losses on the sale or exchange of capital
assets that have been held for more than 12 months.
A net long-term capital gain is the excess of longterm gains over long-term losses, or vice versa for a
net long-term capital loss.
Lower of Cost or Market Method of Inventory
Valuation
Inventory valuation considering the actual cost or
the replacement cost of merchandise on the inventory date. The lower value is used, creating a reduced
gross profit for the period in which the decline
occurred and an approximately normal gross profit
is realized during the period in which the item is
sold.
Lump-Sum Distribution
Payment of the entire amount due at one time rather than in installments. Such distributions must
come from qualified employer plans. The recipient of
a lump-sum distribution may be eligible for special
tax treatment of the distribution.
Main Home
See Principal Place of Abode.
Margin
A percentage of the full price of a security that must
be paid as a down payment by an investor buying
on credit. The required margin fluctuates, subject to
federal regulations.
Marketplace
A resource where individuals, families, and small
businesses can learn about their health coverage
options; compare health insurance plans based on
costs, benefits, and other important features; choose
a plan; and enroll in coverage. In some states, the
Marketplace is run by the state, while in others it is
run by the federal government.
Marriage
A legal union between one man and one woman as
husband and wife.
Married Filing Jointly (MFJ)
The filing status used by a man and a woman who
are married at the end of the tax year and not
legally separated under a final decree of divorce or
separate maintenance, and who record total income,
exemptions, and deductions of both spouses on one
tax return.

Married Filing Separately (MFS)
The filing status used by a married couple choosing
to record their respective incomes, exemptions, and
deductions on separate individual tax returns.
Marketplace/Exchange
A Marketplace supervised by a governmental agency or non-profit entity that qualified individuals may
use to purchase a qualified health plan.
Material Participation Income

Active income, as distinguished from passive income,
from employment as well as business and other
for-profit activities in which the taxpayer takes a
significant and active role.
Medicaid expansion
A new Medicaid eligibility group created by the
Affordable Care Act (ACA).
Materials and Supplies

Generally, a unit of property (UOP) with an economic life of 12 months or less or that costs $200 or
less. May also include more expensive UOPs used
for certain types of spare parts. Materials and supplies may be incidental or non-incidental. Incidental
items are those on hand for which no record of consumption or inventory is kept and for which costs
are deducted in the year paid. Otherwise, costs for
non-incidental items are deducted in the year used
or consumed.
Medical Expenses
Qualified medical expenses of an individual, spouse,
and dependents are allowed as an itemized deduction to the extent that such amounts (less reimbursements) exceed 10% of adjusted gross income.
(7.5% of if 65 or older),
Medicare Part A
The medicare tax taken out of an employees wages,
or the same tax paid by a self-employed person on
net self-employment income. The Medicare A tax
rate is 1.45% of gross wages (2.9% for self-employed
individuals).
Medicare Part B
The medicare insurance premium withheld from
the benefits of social security recipients. The basic
premium for 2014 is $104.90 per month ($1,258.80
for the entire year). The premium will be higher if
the annual income is more than $85,000 ($170,000
if MFJ).
Medicare Part D
The medicare insurance premium withheld from the
benefits of social security recipients who choose to
pay for prescriptions through medicare.
Misconduct
Unlawful activity such as filing a false tax return.
Mileage Rate (Optional Method)
The method of deducting automobile expenses based
on business miles driven. The standard business
mileage rate for 2014 is 56 per mile.
Military Spouse Residency Relief Act

An act that prevents a service members income and
property from being subject to taxation in multiple
states under certain circumstances.
Minimum Essential Coverage (MEC)
The type of coverage an individual needs to meet
the individual responsibility requirement under the
Affordable Care Act (ACA). This includes individual market policies, job-based coverage, Medicare,
Medicaid, CHIP, TRICARE and certain other coverage.
Modified Accelerated Cost Recovery System
(MACRS)
The method of depreciation used for most depreciable assets placed in service after 1986. Under
MACRS, costs of qualified property are written off
over predetermined periods.
Modified AGI (MAGI)
Modified adjusted gross income. For purposes of
computing a specific deduction or credit, MAGI
begins with the taxpayers regular adjusted gross
income which is then modified to account for certain types of losses, exclusions, and deductions. For
example, for many tax purposes, MAGI is regular
AGI plus any excluded foreign, U.S. possession, and
Puerto Rican income.
Modified Adjusted Gross Income (MAGI) for
Premium Tax Credit Purposes
For purposes of the Premium Tax Credit , MAGI
is the adjusted gross income plus foreign earned
income, tax-exempt interest, and social security benefits not included in income.
Modified 481(a) Adjustment (Cut-off Method)
The 481(a) adjustment is calculated as of the first
day of the taxpayers taxable year of change and
takes into account only amounts paid or incurred
during the year of change. It does not take into
account similar amounts paid or incurred in years
prior to the change, so the adjustment is zero.
Mortgage Credit Certificate
Qualified taxpayers who receive a mortgage credit
certificate from a state or local government to buy,
rehabilitate, or improve their main homes may
Glossary G.19
claim a credit for a percentage of their home mortgage interest. The itemized deduction for home
mortgage interest must be reduced by the amount
of the credit. The credit is not refundable, but any
portion that is unused because it exceeds tax liability may be carried over to the following three
years, where it can be added to any credit for the
current year. The credit is computed on Form 8396.
Mortgage credit certificates may be subject to a
recapture rule if the home is sold within nine years.
Moving Expenses
An adjustment to income permitted to employees and self-employed individuals who move for
work-related reasons, providing certain requirements are met. Form 3903 is used to compute
deductible moving expenses.
Multiple Support Agreement
If two or more persons who would otherwise be
entitled to an exemption for a qualifying relative,
together furnish more than half the dependents
support (but no one individual provides more than
half), any one of them who furnishes more than 10%
of the support is entitled to the exemption if all the
others who furnished more than 10% of the support
file written declarations that they will not claim an
exemption for the individual for that taxable year.
Form 2120 is used for this purpose.
Mutual Fund
(1) An open-ended investment company that invests
money of its shareholders in a (usually) diversified
group of securities of other corporations. (2) A company that is in the business of buying and selling
stocks and sharing its income with those investing
in it (sometimes called a regulated investment company).
Necessary (Expenses)
An expense that is appropriate and helpful in furthering the taxpayers business or income-producing
activity. See also Ordinary Expenses.
Net Operating Loss (NOL)
A net loss for the year attributable to business or
casualty losses. In order to mitigate the effect of the
annual accounting period concept, the law allows
taxpayers to use an excess loss of one year as a
deduction for certain past or future years.
Net premium tax credit
A refundable credit the taxpayer will receive
when the Premium Tax Credit is greater than the
Advance Premium Tax Credit.
Nonbusiness Bad Debts

A bad debt loss not incurred in connection with a
creditors trade or business. A nonbusiness bad debt
is deductible as a short-term capital loss, and is
allowed only in the year the debt becomes entirely
worthless.
Noncompliance
Failure or refusal to comply with the Tax Code.
Noncustodial Parent
The parent who is not the custodial parent of the
child.
Nonparticipating Spouse
The spouse of an active participant in an employer-maintained retirement plan who is not also an
active participant in such a plan.
Nonrecourse Debt
An obligation for which the endorser is not personally liable.
Nonrecovery Property
Property which does not qualify for a cost recovery
deduction under ACRS or MACRS, or property the
taxpayer elects to exclude from ACRS or MACRS by
choosing a depreciation method not based on a number of years.
Nonrefundable Credit
A credit which cannot exceed the taxpayers tax liability.
Nonresident Alien
A person who is not a U.S. citizen and does not live
in the United States, or lives in the United States
under a nonresident visa, or does not meet the substantial presence test. See IRS Publication 519.
Nonsigning Return Preparer
Any tax return preparer who is not a signing tax
return preparer, but who prepares all or a substantial portion of a return or claim for refund with
respect to events that have occurred at the time the
advice is rendered.
Nontaxable Distributions
A general term applied to stock dividend distributions that are not taxable. These distributions generally take the form of return of capital, stock dividends, stock splits, and/or tax-free distributions.
Nontaxable Exchange
An exchange on which no gain or loss is recognized
in the current year.

Nontaxable Income
Income that is by law exempt from tax.
Offer in compromise (OIC)
This program seeks an agreement between a taxpayer and the IRS that settles a tax liability for less than
the full amount owed.
Open enrollment period
The period during which the taxpayer is authorized to enroll in health insurance through the
Marketplace/Exchange.
Open Year
A taxable year for which the statute of limitations
has not yet expired.
Option
An agreement to buy or sell property on or before
a specified date at an established price. The sale or
exchange of an option to buy or sell property results
in capital gain or loss if the property is a capital
asset.
Ordinary Dividends
Ordinary dividends are the most common type
of distribution from a corporation. They are paid
out of the earnings and profits of the corporation.
Ordinary dividends are taxable as ordinary income
unless they are qualified dividends.
Ordinary Expenses
Common and accepted in the general industry or
type of activity in which the taxpayer is engaged. It
is one of the tests for the deductibility of expenses
incurred or paid in connection with a trade or business; for the production of income; for the management, conservation, or maintenance of property held
for the production of income; or in connection with
the determination, collection, or refund of any tax.
Ordinary Income (Loss)
Income (loss) that is fully includable in (deductible
from) gross income and that does not have the characteristics of capital gain or loss.
Over the Counter
The market for securities issued by companies
usually not listed on any stock exchange. Over the
counter (OTC) trading is the principal market for
U.S. government and municipal bonds.
Partial Asset Disposition Election
An election that allows a taxpayer to recognize gain
or loss on the disposition of components of a unit
of property (UOP). Generally, the election is not
required if the component is sold.
Partly Taxable Pensions

Pensions funded through employer plans to which
both pre-tax money and after-tax money has been
contributed.
Partner
An owner of a partnership,be it an individual, an
estate, a trust, a corporation, or another partnership.
Partnership
A form of business in which two or more persons
join their money and skills in conducting the business as co-owners. Partnerships are treated as a
conduit and are not subject to taxation. Various
items of partnership income, expenses, gains, and
losses flow through to the individual partners and
are reported on their personal income tax returns.
Passive Income and Losses
passive, and portfolio. Passive income and losses are
those from business activities in which the taxpayer
does not materially participate, and all rental activities (except those of qualified real estate professionals). See also Active Income and Losses and Portfolio
Income and Losses.
Patent
The exclusive right of an inventor to make, use, or
sell his invention for a period of years. A patent is
an intangible asset that may be depreciated over its
remaining life. The sale of a patent usually results
in long-term capital gain treatment.
Pension
Payments made periodically of (generally) a definite
amount for a specified period (usually life) from an
employer-maintained plan to workers who have met
the stated requirements. Its primary purpose is to
provide retirement income.
Pension/Annuity Starting Date
The first day of the first period for which an amount
is due as a pension/annuity payment under the contract.
Percentage Depletion
There are two methods of computing depletion of
natural resources. One is cost depletion, defined
elsewhere in this glossary. The other method is percentage depletion, which is a specified percentage
of the gross income from the property. In each year,
the method which results in the greater deduction is
used. Percentage depletion is allowed for nearly all
natural resources, except timber.
Glossary G.21
Permanent and Total Disability
A disability that prevents an individual from engaging in any substantial gainful activity because of a
medically determined physical or mental impairment that is expected to result in death, or that has
lasted or is expected to last for a continuous period
of not less than 12 months.
Personal and Dependency Exemptions
The Tax Code provides a $3,950 exemption (for
2014) for each individual taxpayer and an additional $3,9500 exemption for his or her spouse if a
joint return is filed. An individual may also claim a
$3,950 exemption for each dependent providing certain tests are met. Taxpayers who may be claimed
as a dependent on another taxpayers return may
not claim their own personal exemptions.
Personal Expenses
Expenses of an individual for personal reasons are
not deductible, unless stated to be deductible under
Tax Code.
Personal Property
Generally, all property other than real estate.
Personal Property Tax
An annual tax imposed on certain personal property, such as cars or boats, and based on the value of
the property.
Personal Representative
The person who has, either by judicial decree or by
virtue of being in possession of the property of the
decedent, authority to distribute the property and
responsibility for filing any tax returns of the decedents estate.
Personal Residence
The property in which the taxpayer lives and to
which he returns after temporary absences. A taxpayer may have one or more residences, such as
a main home and a vacation house. A residence is
not limited to a house. Condominiums, cooperative
apartments, townhouses, mobile homes, and houseboats can all qualify as residences.
Personal-Use Property
Property owned for personal well-being and enjoyment. It includes a taxpayers home, vehicles, furniture, clothing, and other property.
Physical Custody
The taxpayer with whom a child lives is considered
to have physical custody, regardless of who has
nominal legal custody.
Physical Presence Test

The qualification for eligibility to claim the foreign
earned income exclusion; it is based on residing in
a foreign country for at least 330 full days during a
12-month period, during which time the taxpayers
tax home is in a foreign country.
Points
A loan-origination fee (one-time charge paid for the
use of money) that a buyer generally may deduct as
interest; fully in the year paid if for the purchase or
improvement of a principal residence or, if not, then
over the term of the loan.
Portfolio Income and Losses
passive, and portfolio. Portfolio income and losses
are those from such sources as dividends, interest,
capital gains and losses, and royalties. See also
Active Income and Losses and Passive Income and
Losses.
Premium Tax Credit
A credit available to eligible taxpayers who enroll,
or whose family members enroll in a qualified
health plan (QHP) through a Marketplace.
Premium Tax Credit Eligibility/Advance
Premium Tax Credit Eligibility
Taxpayers must meet eligibility requirements in
order to claim the premium tax credit or advance
of the premium tax credit. A taxpayer who meets
these requirements is also known as an applicable
taxpayer.
Prepaid Expenses
Cash-basis as well as accrual-basis taxpayers usually are required to capitalize prepayments for
rent, insurance, etc. that cover more than one year.
Deductions are taken for the period during which
the benefits are received.
Prepaid Interest
Interest paid in advance is deductible as an interest
expense only as it accrues. The one exception to this
rule involves the interest element when a cash-basis taxpayer pays points to obtain financing for the
purchase or improvement of a principal residence
if the payment of points is an established business
practice in the area in which the indebtedness is
incurred and the amount involved is not excessive.
Points paid to refinance a principal residence, however, must be deducted over the life of the loan.

Principal Payment
That portion of a loan payment applied to the purchase price (contract price), as opposed to an interest payment.
Principal Place of Abode (Principal Residence)
The place that an individual considers to be his
permanent home. A persons abode does not change
when he is temporarily absent due to illness, school,
military service, etc., as long as his living area is
maintained and he can reasonably be expected to
return home after the temporary absence.
Principal Place of Business
The main place where work is performed or business is transacted, or the only fixed location at
which a taxpayer performs administrative and managerial tasks necessary for business.
Principal Residence
See Principal Place of Abode.
Privilege
Protection from being required to disclose confidential communications between two parties, such as
attorney and client.
Prizes and Awards
The fair market value of a prize or award generally
is includable in gross income. An exception applies
when a qualified recipient of an award for charitable
and the like achievements designates that the prize
is to be transferred by the payer to a governmental
unit or to certain charitable, educational, or religious organizations. Another exception is made for
certain employee achievement awards such as the
traditional gold watch presented upon retirement.
Proprietor
The sole owner of a trade or business.
Proprietorship
A business controlled and operated by one person.
Puts and Calls
These are option contracts. A put gives its holder
the option to sell a particular stock at a fixed price
within a specified period of time. A call gives its
holder the right to buy stock under the same conditions. Put and call contracts can last up to several
months and usually specify a price close to the market value of the stock at the time they are drawn.
Puts are purchased by investors who think the price
of the stock will fall; calls are purchased by investors who think the price will rise.
Qualified Charitable Organization

An entity, usually an association or nonprofit corporation, designed to provide some form of public
charity or service and specifically approved by the
U.S. Treasury as a recipient of deductible charitable
contributions.
Qualified Dividends
Dividends received on shares of common stock held
by the taxpayer for more than 60 days of the 121day period beginning 60 days before the ex-dividend
date (for preferred stock, more than 90 days of the
181-day period beginning 90 days before the ex-dividend date). These dividends qualify for long-term
capital gain treatment.
Qualified Health Plan
An insurance plan that is certified by the Health
Insurance Marketplace and provides minimum
essential coverage. This includes Bronze, Silver,
Gold, and Platinum level plans, but not catstrophic
coverage plans.
Pension or Profit-Sharing Plan
An employer-sponsored plan that meets the requirements of IRS Code 401. If these requirements are
met, none of the employers contributions to the
plan are taxed to the employee until distributed to
him. The employer is allowed a deduction in the
year the contributions are made.
Qualified Tuition Plan
A personal savings plan, defined under 529 of the
Internal Revenue Code, which allows a taxpayer to
accumulate money tax deferred. Contributions are
generally deductible (within limits)for state income
tax purposes. Qualified distributions are tax free for
federal and state income tax purposes when withdrawn.
Qualifying Child (QC)
A child who meets the relationship, age, residency,
support, joint return, and the special test tests with
regard to a taxpayer to determine the taxpayers
eligibility to claim the dependency exemption, child
tax credit, earned income credit, or child and dependent care credit with regard to the child, or to use
the head of household filing status. The tests are
discussed in detail in Chapter 4.
Qualifying Relative (QR)
A person (1)who bears a certain relationship to
the taxpayer, (2), for whom the taxpayer provides
more than one-half support for the year (3), whose
gross income for the year is less than the exemption
Glossary G.23
amount, and (4), who is not claimed as a qualifying
child of any taxpayer.
Qualifying Widow(er) (QW)
The filing status available to a qualified taxpayer
for two tax years following the year of the spouses
death. To qualify, the surviving spouse must have
been entitled to file a joint return for the year of
death, remain unmarried at the end of the current
tax year, and pay over half the cost of maintaining
his or her home which was the principal residence
the entire tax year of his or her dependent child.
Railroad Retirement Tax Act
See RRTA.
Realized Gain or Loss
The difference between the amount received upon
the sale or other disposition of property and the
adjusted basis of the property.
Real Property
Also known as real estate, includes land, buildings,
and their structural components.
Reasonable Cause
An inability to meet tax filing and payment responsibilities that arise despite the taxpayers exercise of
ordinary business care and prudence, and that are
due to circumstances beyond the taxpayers control.
Recapture
The inclusion of a previously deducted or excluded
amount in gross income or tax liability. Recapture
may be applicable to accelerated depreciation, cost
recovery, amortization, and various credits.
Recapture of Depreciation or Cost Recovery
Each year that a depreciable business asset is
owned, depreciation is claimed that theoretically corresponds with the using up of the property
through normal wear, obsolescence, etc. Thus, if
proper depreciation has been claimed, the property
should be worth its adjusted basis. If the property
is sold for more than its adjusted basis, 1245 of the
Tax Code requires that the gain on personal property and certain nonresidential real property (to the
extent of depreciation claimed) be recaptured; that
is, included as ordinary income on the tax return.
The purpose of this recapture is to prevent capital gain treatment of gain resulting from claiming
depreciation. The recapture of depreciation or cost
recovery rules do not apply when the property is
disposed of at a loss.
Recharacterization
Returning a converted Roth IRA back to its original
classification as a traditional IRA within the specified time period allowed.
Recognized Gain or Loss
The portion of realized gain or loss that is subject to
income taxation.
Reconciliation/true up
The process used after the end of the year when
federal income tax returns are filed to determine
if indiviudals/families received the right amount of
Advance Premium Tax Credit (APTC)
Recovery
The amount of a deduction or credit taken in a previous year which is later returned to the taxpayer.
The recovered amount must usually be included in
income in the year it is received, to the extent of the
previous tax benefit.
Recovery of Cost
The amount that was paid for income received
usually a factor only in income from sales of items
purchased for resale, income from sales of property,
and income from pensions or annuities. The portion
of income that represents recovery of cost is not taxable.
Recovery Period
A period of years during which the cost of business
assets is written off under ACRS or MACRS.
Recovery Property
Tangible depreciable property placed in service after
1980 that is not excluded from ACRS or MACRS.
Generally, this is new or used property acquired for
use in a trade or business or property held for the
production of income.
Refundable Credit
A credit for which the IRS will send the taxpayer a
refund for any amount in excess of the taxpayers
tax liability.
Regular MACRS Method
The MACRS deduction computed using the double
declining-balance method with a switch to straightline for most personal property, and the straightline method for most real property.
Regular Method
A deduction for business use of the taxpayers vehicle based on actual cost of gas, oil, repairs, tires,
washing, etc., plus a deduction for depreciation.

Regulated Investment Company (Mutual Fund)
A company or trust that uses its capital to invest
in other companies. The two principal types are
closed-end and open-end mutual funds. Shares in
closed-end mutual funds, some of which are listed
on stock exchanges, are readily transferable on the
open market and are bought and sold like other
shares. Open-end funds sell their own new shares to
investors, stand ready to buy back their old shares,
and are not listed.
Regulations
The IRS Commissioner publishes his interpretation
of the Tax Code in the form of regulations. They do
not have the force and effect of law except in those
cases in which the law on a particular subject calls
for rules on that subject to be expounded through
regulations.
Reinvested Dividends
Earnings of investment companies (mutual funds)
that the shareholder has accepted as additional
shares of the companys stock rather than as cash.
They are taxable in the year constructively received.
Removal Costs
The cost of removing old components, parts, structures, or other assets to make way for an improvement.
Rental Income
Income received by the taxpayer for allowing another persons use of the taxpayers property. Rental
income includes advance rental payments, late payments, and current payments. Payments received
for lease cancellation and forfeited security deposits
are rental income the year received or forfeited.
Rental income is considered passive income for purposes of the passive loss rules, except for qualified
real estate professionals.
Repairs
Current expenditures to restore business-use property to an original condition or maintain the property through minor alterations rather than to extend
its useful life. The cost of repairs normally is deductible annually. Substantial repairs that increase the
value or extend the life of the property are treated
as capital improvements, and must have their cost
recovered over a number of years.
Replacement Period
The time during which a taxpayer must purchase
appropriate replacement property in order to postpone tax on the gain from the property disposed of.
Repossession
Taking possession of property that was earlier
sold on an installment contract because the buyer
defaults on payment of the debt.
Resident Alien
A citizen of another country who lives in the United
States and/or has resident status by law or visa,
or passes the substantial presence test. See IRS
Publication 519.
Restoration
A type of improvement that replaces a component of
a unit of property (UOP) for which the taxpayer has
deducted a loss.
Returns of Capital (Nontaxable Distributions)
A return of a shareholders investment generally
made because an excess amount of capital has been
accumulated. Returns of capital may be received in
cash or reinvested to acquire additional shares at
the shareholders request. Amounts received that
are not in excess of the basis of the stock on which
returns of capital are paid are not taxable. The basis
of the stock on which returns of capital are paid
must be reduced. Amounts received in excess of the
basis of the stock on which returns of capital are
paid are reported on Schedule D, in Part I if stock
has been owned short term, or in Part II if stock has
been owned long term.
Revenue Agent Report (RAR)
A letter of assessment sent to the taxpayer at the
close of the audit.
Right
The opportunity a corporation gives a shareholder to
buy additional shares at a special price for a limited
time. Shareholders who do not use their rights can
sell them to other investors.
Rollover
A qualified transfer of funds from one tax-favored
account to another, usually of the same type. A rollover must take place within 60 days of receiving the
funds.
Rotable Spare Parts
Materials and supplies that can be installed,
removed and re-installed on the same or other property or stored for later installation.
Roth IRA
A type of individual retirement arrangement in
which contributions are not tax deductible, earnings
grow tax deferred, and qualified withdrawals are
tax free.
Glossary G.25
Routine Maintenance
For buildings, activities a taxpayer expects to perform at least twice during a 10-year period to keep
the building, including structural components and
systems, in efficient operating condition. For other
property, activities a taxpayer expect to perform at
least twice during the propertys ADS class life to
keep the property in its ordinarily efficient operation condition.
Routine Maintenance Safe Harbor
A required accounting method change to deduct routine maintenance costs.
Royalty
(1) A payment received for the right to exploit a
taxpayers ownership of natural resources or a taxpayers literary, musical, or artistic creation. (2) An
interest in the oil and gas in place that entitles the
holder to a specified fraction, in kind or in value, of
the total production from the property, free of any
expense of development and operation.
Royalty Interest
An interest in the oil and gas in place that entitles
the holder to a specified fraction, in kind or in value,
of the total production from the property, free of any
expense of development and operation.
RRTA (Railroad Retirement Tax Act)
The law that provides for railroad retirement benefits.
Safe Harbor
Tax regulations that allow a (usually) simpler method of determining a tax consequence than is available following the precise language of the Code.
Salvage Value
The estimated value that will be realized upon the
sale or other disposition of an asset at the end of
its useful life. Salvage value must be taken into
account when determining the depreciable amount
under pre-1981 depreciation, but not under ACRS or
MACRS.
Savers Credit
A nonrefundable credit based on up to $2,000 in
contributions to qualified retirement plans and
traditional and Roth IRAs. The credit is allowed in
addition to any deduction available for the contributions. The credit is completed on Form 8880, Credit
for Qualified Retirement Savings Contributions.
Schedules
Official IRS forms used to report various types of
income, deductions, and/or credits.
Scholarships and Fellowships

Financial aid grants awarded to students for
the purpose of attending a college or performing
research.
S Corporation
A qualified small business corporation that has
elected special tax treatment under subchapter S
of the Internal Revenue Code. Unlike most corporations, which are taxable entities themselves, S
corporations pass income, losses, and deductions
through to shareholders to report on their individual returns.
Section (followed by a number)
The section of the Tax Code in which particular
laws are given.
Section 125 Plan
See Cafeteria Plan.
Section 179 Expense Deduction
An election to treat the cost of certain qualified
property as a currently deductible expense rather
than as a capital expenditure. Generally a maximum total deduction of $500,000 may be claimed
for qualified assets placed in service in 2014. This is
also referred to as expensing.
Section 529 Plan
See Qualified Tuition Plan.
Section 1231 Gains and Losses
If the combined gains and losses from the taxable
dispositions of 1231 assets is a gain, such gains
are treated as long-term capital gains. In arriving
at 1231 gains, however, the depreciation recapture
provisions (for example, 1245 and 1250) are first
applied to produce ordinary income. If the net result
of the combination is a loss, such gains and losses
for 1231 assets are treated as ordinary.
Section 1245
Section 1245 assets are depreciable business use
personal property and certain nonresidential real
property. If the sale of these assets results in a gain,
1245 of the Code requires the gain to be treated
as ordinary income to the extent of depreciation
allowed or allowable. That is, the depreciation must
be recaptured. Any gain in excess of the amount
required to be recaptured is 1231 gain, potentially
taxable as long-term capital gain.
Section 1250
The section that requires that gain on disposition
of real property be treated as ordinary income to
the extent of the depreciation claimed in excess
of straight-line. Depreciation equivalent to the

straight-line portion is called unrecaptured 1250
gain. Any remaining gain is 1231 gain, which is
treated as capital gain.
Self-Employed Individuals
Taxpayers who work for themselves. They decide
when, how, and where to work, obtain their own
jobs or sales, pay their own expenses, and receive
social security and medicare coverage through payment of self-employment tax.
Self-employed individuals are taxed on their net
income from self-employment and are entitled to
social security and medicare benefits through the
payment of self-employment tax.
Self-Employment Tax
For 2014, self-employed persons are subject to
social security tax of 12.4% on net earnings of up
to $117,000 and medicare tax of 2.9% on all net
earnings. If a self-employed individual receives
wages from an employer that are subject to social
security tax, the amount of self-employment income
subject to social security tax may be reduced. Selfemployment tax is computed on Schedule SE.
Separate Maintenance Payments
Amounts paid to one spouse by the other spouse
under a court order or agreement while they live
apart.
Service Business
A business in which income is produced chiefly by
personal services rendered.
Shared Responsibility Payment
The penalty a taxpayer must pay if they do not maintain minimum essential coverage and do not qualify
for an exemption. It is calculated using the flat dollar
method/percentage of income method.
Shareholder
An individual or entity that owns shares of capital
stock.
Short Sale
A sale in which the seller borrows the stock certificates or other property delivered to the buyer. At a
later date, the seller either purchases similar stock
or property necessary to cover the sale, and delivers it to the lender or delivers to the lender stock or
property that he already held but did not wish to
transfer at an earlier date. For income tax purposes, there is no gain or loss on the transaction until
the short sale is covered by purchase and transfer.
Special rules apply in determining whether the gain
or loss on a short sale is a long-term or short-term

capital gain or loss.
Short-Term Gain
Gain on the sale or exchange of a capital asset held
12 months or less.
Signing Return Preparer
The individual tax return preparer that has the
primary responsibility for the overall substantive
accuracy of the preparation of the return or claim
for refund.
SIMPLE Retirement Plan
Small employers may establish a savings incentive match plan for employees retirement plan. A
SIMPLE plan can be either an IRA for each employee or a deferred compensation arrangement, such as
a 401(k) plan.
Simplified Employee Pension (SEP)
An arrangement under which an employer makes
contributions to an employees individual retirement
account (IRA), or a self-employed person contributes
to his own plan.
Simplified Method
The method of computing the taxable and nontaxable portions of a qualified employer plan by which
the cost is recovered over a specified number of periodic payments. The number of payments is determined by finding a factor on a simple table. This
method replaced the general rule, which was considerably more complex, for most pensions.
Single
The filing status used by an unmarried taxpayer
who does not qualify for any other filing status.
Skip Person
A person who is more than one generation below the
decedent or donor.
Social Security Tax Withheld
The employees share of social security tax that was
taken out of the employees pay and submitted along
with the employers share to the IRS by the employer. The employee pays 4.2% and the employer pays
6.2% of the first $117,000 of the employees gross
wages (for 2014).
Social Security Tips
The amount of tips reported to an employer by an
employee that is subject to this tax. Tips are also
subject to medicare tax.
Glossary G.27
Social Security Wages
Total wages paid to an employee that are subject to
this tax. This amount does not include tips. Wages
are also subject to medicare tax.
Special Averaging
A special method available to determine the tax on
a qualified lump-sum distribution for any taxpayer who was born before 1936 and meets the other
requirements. The tax computation is done on Form
4972.
Special Enrollment Period
A taxpayer can enroll in the Marketplace outside of
the open enrollment period if they qualify for a special enrollment period.
Special-Needs Child
For the adoption credit, a child determined by the
state to be difficult to adopt due to factors such as
racial or ethnic background, age, a condition that
requires special care, or whether the child has siblings. A special-needs child must be a U.S. citizen.
Spousal IRA
An IRA set up by a taxpayer whose spouse has
little or no compensation, for the benefit of that
spouse. The designation spousal is significant for
tax purposes only. There is no connection between a
spousal IRA and the other spouses IRA, and no IRA
may be jointly owned.
Standard Deduction
A base amount of income not subject to tax. The regular standard deduction for 2012 is $5,950 for single
taxpayers and married persons filing separately;
$8,700 for heads of household; and $11,900 for married couples filing a joint return and qualifying widow(er)s. Taxpayers who are blind and/or 65 or older
have higher standard deductions. Taxpayers who
may be claimed as dependents on other taxpayers
returns may have reduced standard deductions.
Standard Mileage Rate
An annual deduction based on a set number of cents
per mile for qualified business use of the taxpayers
vehicle. The standard mileage rate for 2014 is 56
per mile.
Standby Emergency Spare Parts
A difficult-to-obtain, special-order replacement part
kept on hand to avoid time loss following failure of a
part to function properly. These items are treated as
materials and supplies.
Statements
Explanations of various types of income, deductions,
and/or credits reported on a schedule or directly on
Form 1040. Statements may or may not be official
IRS forms.
State or Local Income Tax Withheld
The amounts taken out of income by the payer and
submitted to the state or local taxing authority as
an advance payment of the taxpayers state or local
income tax.
Statutory Employee
A worker who is treated as an employee for social
security and medicare tax purposes and as self-employed for income tax purposes. The Statutory
employee box on such a workers Form W2 should
be marked.
Step-Up Basis
The basis of property inherited from a decedent
steps-up to the Fair Market Value of the property
as of the date of the death of the decedent.
Stock Dividend
Additional shares of stock distributed to shareholders at no cost. The number of shares received are
a percentage of the shares owned. The basis of the
original shares is generally apportioned equally to
the total shares owned after the distribution.
Stock in Trade
Property held primarily for sale to customers in the
ordinary course of business; inventory.
Stock Split
Additional shares of stock distributed to shareholders at no cost. The number of shares received are a
ratio of the shares owned. The basis of the original
shares is generally apportioned equally to the total
shares owned after the split.
Straddle
A combination of a call and a put (both of which
are defined elsewhere in this glossary) written at
the same time, on the same number of shares of a
security, at the same price, during the same period
of time. The call and put parts of a straddle are generally bought by different holders.
Straight-Line Depreciation Method
The most commonly used method of depreciation
prior to 1981. Basis less salvage value or land value
divided by useful life equals depreciation deduction.

An adjustment to income (limited to $2,500) for
interest paid during the year on qualified higher-education loans.
SUB Pay
Supplemental unemployment benefits. These benefits are generally received from a company-financed
fund, and are fully taxable as wages.
Substantial Authority Standard
An objective standard involving an analysis of the
law and application of the law to the relevant facts.
Support
The total amount provided on behalf of an individual. Support includes food, lodging, and other necessities, as well as recreation and other nonessential
expenditures. Support is not limited to necessities,
and can be as lavish as the taxpayer can afford.
Tangible Personal Property
Property, other than real property, that has a physical existence and an intrinsic value. Examples are
livestock, machinery, equipment, and vehicles.
Tax Bracket
The rate at which income at a particular level is
taxed.
Tax Court
The only judicial body from which tax relief may be
obtained without payment of tax.
Tax Credit for the Elderly or the Disabled
Eligible taxpayers 65 years old and older, and those
under 65 retired on a permanent and total disability, may claim this credit. The amount of the credit,
if any, is computed on Schedule R, for Forms 1040
and 1040A.
Tax-Exempt Income
Income that, by law, is not subject to income tax.
Tax-Free Exchanges
Transfers of property specifically exempt from federal income tax consequences in the current year.
Examples are a transfer of property to a controlled
corporation and a like-kind exchange.
Tax Home
The business location, post, or station of the taxpayer. If an employee is temporarily reassigned to
a new post for a period of one year or less, the taxpayers tax home is his personal residence, and the
travel expenses are deductible.
Tax Liability
The amount of total tax due the IRS after any credits and before taking into account any advance payments (withholding, estimated payments, etc.) made
by the taxpayer.
Tax Lien
A legal claim to a taxpayers property filed by the
IRS to secure payment of the taxpayers tax debt.
The lien attaches to all the taxpayers property and
all the taxpayers rights to the property.
Tax Preference Items
Tax items that may result in the imposition of the
alternative minimum tax.
Tax Rate Schedules
Tax Rate Schedules, which appear in the appendix, are used by certain taxpayers. Separate rate
schedules are provided for married individuals filing
jointly or qualifying widow(er)s, unmarried heads of
household, single taxpayers, and married individuals filing separate returns.
Tax Table
The Tax Table, appearing in the appendix, is provided for taxpayers with taxable incomes of less than
$100,000. Separate columns are provided for single
taxpayers, married taxpayers filing jointly or qualifying widow(er)s, heads of household, and married
taxpayers filing separately.
Taxable Distribution
A distribution of principal or income to a skip person
from a trust.
Taxable Estate
The gross estate of a decedent, less any expenses,
debts, or deductions.
Taxable Income
Adjusted gross income, less itemized deductions or
the standard deduction, less allowable personal and
dependent exemption amounts. This term is also
used to refer to income that is not exempt or excluded from taxation. For example, Wages are taxable
income, but gifts are not.
Taxable Termination
A distribution of principal or income to a skip person, due to the termination of a trust.
Taxable Year
The calendar year or fiscal year for which the taxable income is computed.
Glossary G.29
Temporary Assignment
A work assignment away from the taxpayers tax
home, generally for a period of one year or less.
Deduction of temporary assignment expenses is
allowed to provide relief to those who have extra
expenses because of their work. To have any deductible expenses, the taxpayer must own, or be renting
or buying, lodging in the general area of the regular
place of employment, and intend to return to that
lodging at the end of the temporary assignment.
Temporary Spare Parts
Spare parts kept on hand for use until a new or
repaired part can be installed. These items are
treated as materials and supplies.
Tenancy by the Entirety
A tenancy in which parties jointly own property.
After the death of one, the survivor takes the whole
estate. Tenancy by the entirety can be terminated
during their lifetime only by joint action of the parties.
Tenancy in Common
Two or more individuals jointly owning property.
Each owns an undivided share of the whole. The
shares remain separate even if one party dies.
Thrift Savings Plan
Defined contribution plan for service members.
Tip Income
Gratuities received by the taxpayer for services rendered. Tips of $20 or more from any one job during
a calendar month must be reported to the taxpayers
employer.
Trade Date
Date on which a capital asset is actually bought or
sold.
Trade or Business Expenses
Deductions from gross income that are attributable
to a taxpayers business or profession.
Traditional IRA
An individual retirement arrangement, contributions to which may or may not be deductible
depending on the taxpayers AGI and whether or
not he is covered under an employer-sponsored
retirement plan. Earnings within a traditional IRA
grow tax-deferred. Distributions from a traditional
IRA are taxable, except to the extent they represent
nondeductible contributions.
Transfer Tax
A tax imposed when real estate is sold or transferred from one person to another.
Transportation expenses for an employee or self-employed taxpayer include only the cost of transportation (taxi fares, auto expenses, etc.) incurred in the
course of business or employment when the taxpayer
is not away from home in a travel status.
Travel Expenses
Travel expenses include meals, lodging, and transportation expenses while away from home in the
pursuit of a trade or business (including that of an
employee).
Trust
A tax entity created by a trust agreement. This entity distributes all or part of its income to beneficiaries as instructed by the trust agreement. This entity is required to pay taxes on undistributed income.
Trustee
A person or institution that manages the assets of
an account (an IRA, for example)for the benefit of
the account owner or a beneficiary.
An above-the-line deduction of up to $4,000 per
tax return for qualified tuition and course-related
expenses. The amount of the deduction is figured on
Form 8917.
Unadjusted Basis
The basis of property for purposes of figuring depreciation under ACRS or MACRS. The unadjusted
basis is the original cost or other basis.
Underpayment Penalty
If a taxpayer did not pay enough tax on a timely
basis during the year, he may be required to pay an
underpayment penalty. The penalty, if any, is computed on Form 2210.
Unearned Income
Taxable income other than that received for services
performed (earned income). Unearned income in
cludes money received for the investment of money
or other property, such as interest, dividends, and
royalties. It also includes pensions, alimony, unemployment compensation, and other income that is
not earned.
Unenrolled Tax Preparer
A tax preparer who is not an attorney, CPA,
enrolled agent, enrolled retirement plan agent, or
enrolled actuary authorized to practice before the
IRS.
Unified Credit
See Applicable Credit Amount.

Uniformed Service Retirement Plan
Defined benefit plan for service members.
Unit of Property (UOP)
For personal property and real property other than
a building, the unit of property (UOP) consists of all
components that are functionally interdependent,
i.e. that depend on each other to function or operate.
For plant property, each machinery component that
performs a discrete and major function or operation may be a UOP. For buildings, the UOP is the
building itself, including its systems and structural
components.
Unrecaptured Section 1250 Gains
Gains from the sale of 1250 property that are
attributable to depreciation, equivalent to the
amount which would have been claimed under a
straight-line method. This gain is subject to a maximum tax rate of 25%.
Unstated Interest
Interest which must be calculated, and the sale price
reduced by this amount when interest is not stated in
an installment agreement or the interest rate used is
less than the applicable rate.
Vacation Home
The Tax Code places restrictions on taxpayers who
rent their residences or vacation homes to others for
part of the tax year. The restrictions may result in
scaling down of expense deductions for such taxpayers.
Vested Benefits
Pension benefits owned by the taxpayer.
Wash Sale
The purchase of substantially similar stock or other
securities within 30 days before or after the sale of
the similar stock or security at a loss. A taxpayer

cannot claim a wash sale loss; instead, the loss is
added to the basis of the most recently purchased
substantially similar securities.
Welfare to Work Credit
A tax credit for employers who hire workers from
welfare rolls. The credit is claimed on Form 8861.
Widow (Widower)
A woman (man)who has not remarried following the
death of her husband (his wife).
Willful Neglect
A voluntary and intentional violation of a known
legal duty, or reckless indifference of a known legal
duty.
Withholding Allowances
An increase by which income tax withholding on
certain income is reduced. That is, each individual
withholding allowance decreases the amount of tax
withheld from the income by the payer.
Work Opportunity Credit
A credit available to employers who hire employees
from specified disadvantaged groups. The credit is
claimed on Form 5884.
Worksheet
A record of compiled information that is generally
not sent to the IRS with a tax return.
Worthless Securities
A loss is allowed for a security that becomes worthless during the year. The loss is deemed to have
occurred on the last day of the year. Special rules
apply to securities of affiliated companies and small
business stock.
English-Spanish
Glossary of Terms: Spanish for
Mexico
English to Spanish Glossary of Terms: Spanish for Mexico
English to Spanish
0-9
1040EZ
1040EZ
A
A location near you
Una ubicacin cercana a usted
A tax
Un impuesto
About
Acerca de
ACA Tax Penalty
Penalidad de impuestos de la
Ley ACA
ACA Tax Penalty Exemption
Exencin de penalidad de
impuestos de la Ley ACA
Accelerated Cost Recovery
System
Sistema acelerado de
recuperacin de costos
Depreciacin acelerada
Accelerated Management Program
(AMP)
Programa acelerado de gestin,
Programa Acelerado de
Administracin
Accept Status
Estatus de aceptacin
Account Administration Fee (AAF)
Tarifa de administracin de
cuenta (TAC)
Account Executive
Ejecutivo de cuenta
Account Manager
Administrador de cuenta
Accountable Plan
Plan de rendicin de cuentas,
Plan de rendicin contable
Accounting Method
Mtodo contable
Accounting Period
Periodo contable
Page 2

Mtodo contable de devengo
Accrued Interest
Inters devengado
Accumulated Adjustments
Account (AAA)
Cuenta de ajustes acumulados
(CAA)
Accumulation Period
Periodo de acumulacin
Acquisition Debt
Deuda de adquisicin,
Adquisicin de Deuda
Action plans
Planes de accin
Active Income
Ingresos activos
Ingresos y prdidas activas
Active Losses
Prdidas activas
Active Participant
Participante activo
Gastos reales (mtodo regular),
Gastos Actuales (Metodo
Regular)
Add more Income
Aadir ms ingresos
Crdito fiscal por hijo adicional,
Credito fiscal adicional por hijo
Adjusted Basis
Base ajustada
Adjusted Current Earnings (ACE)
Percepciones actuales
ajustadas (PAA), Ganancias
Ajustadas Actuales (GAA)
Adjusted Gross Income
Ingresos brutos ajustados,
Ingreso Bruto Ajustado
Ajuste a los ingresos
Adoption Credit
Crdito por adopcin
Crdito fiscal por ingresos
percibidos
Advance Premium Tax Credit
Crdito Tributatio Anticipado por
la Prima (APTC, por sus siglas
en ingls)

Repayments
Reembolsos de Crditos
Tributatios Anticipados por la
Prima
Adverse action letter
Carta de accin adversa, carta
de medida adversa
Advice Statement
Recomendacin
Ley de Atencin Mdica
Asequible (Affordable Care Act
o ACA, por sus siglas en ingls)
AGI
IBA
Alimony Payments
Pagos de pensin alimenticia
Allowable Miscellaneous
Deductions (AMID)
Deducciones varias permisibles
(DVP), Deducciones diversas
Admisibles (DDA)
Allowance
Permiso, Concesin
Mtodo alterno (lnea recta),
Sistema alterno de depreciacin
lineal
Alternative Depreciation System
(ADS)
(SAD)
Alternative Minimum Tax
Impuesto mnimo alterno
Alternative Straight-Line
Depreciation System
en lnea recta
Amended Return
Devolucin modificada,
Declaracin rectificada
AmeriCorps (State and National) /
VISTA / National Civilian
Community Corps Member
AmeriCorps (estatales y
nacionales) / VISTA / Miembro
del Cuerpo Civil Comunitario
Nacional
Amortization
Amortizacin
Amount
Monto

Amount Realized
Monto obtenido
AMT
IMA
An additional fee
Una tarifa adicional
An average of
Un promedio de
Annual Percentage Rate, APR
Tasa de porcentaje anual, TPA
Annualized Income Installment
Method
Mtodo de ingresos anualizados
a plazos
Annuitant
Beneficiario de una anualidad
Annuity
Anualidad
Fecha de inicio de la anualidad
Anti-Churning Rules
Reglas contra la prdida de
clientes
Applicable Federal Rate (AFR)
Tasa federal aplicable (TFA)
Applicable percentage
Porcentaje aplicable
Application for a Refund
Anticipation Check and a
Solicitud de cheque de anticipo
de devolucin y de cuenta para
el depsito de devoluciones,
Solicitud para cheque anticipado
de reembolso
Appointment Manager (AM)
Director de citas (DC),
Administrador de citas (AC)
Approval
Aprobacin
Approve Online
Aprobacin en lnea
Approved Client Take Away
Regalo para clientes aprobados
Approved Reload Networks
Redes de recarga aprobadas,
Redes aprobadas de recarga
Archer Medical Savings Account
Cuenta de ahorros mdicos
Archer
Archer MSA
CAM Archer
As fast as you choose
Tan rpido como escoja
Ask
Pregunte
Ask your bilingual professional

Pregntele a su profesional
bilinge
Assemble (return, documents, etc.)
Rena (devolucin, documentos,
etc.)
Asset
Activo
Assistant District Manager (ADM)
Subdirector de Distrito (SDD),
Subadministrador de Distrito
(SAD)
Assistant Regional Director (ARD)
Subdirector Regional (SDR)
At H&R Block we have 50 years
experience in tax preparation
En H&R Block contamos con 50
aos de experiencia en la
preparacin de impuestos
At participating offices
En las oficinas participantesj, En
oficinas participantes
ATM
Cajero automtico
At-Risk Rules
Reglas de monto a riesgo
Audit
Auditora
Audit assistance
Asistencia en auditora
Audit Representation
Representacin en auditora
Audit Support
Auto Pay
Pago automtico
Automated Teller Machine (ATM)
Cajero automtico (ATM)
Automatic payment
Pago automtico
Availability
Disponibilidad
Average
Promedio
Fuera de casa una noche
B
Background check
Revisin de antecedentes
Bad Debts
Deudas incobrables,
insolvencias
Balance
Saldo
Balance Due
Saldo adeudado, Saldo
Pendiente
Balance Due Loan
Prstamo para saldo por pagar,
Saldo pendiente de prstamo
Bank Account
Cuenta bancaria
Bank Privacy Commitment
Compromiso de privacidad del
banco
Bank products
Productos bancarios
Bankruptcy
Bancarrota
Based on
Con base en
Basic Building Blocks (B) Course
Curso Basic Building Blocks (B)
Basis
Base
Basis of Stock
Base de acciones
Be up-to-date
Estar actualizado, Mantente
actualizado
Benchmark plan
Plan de referencia
Beneficiary
Beneficiario
Benefits
Prestaciones, Beneficios
Benefits for retirees
Prestaciones para jubilados,
Beneficios para jubilados
Bequest
Legado
Bond
Ttulo de deuda
Bottom line
Resultados netos
Bronze plan
Plan de categora Bronce
Build Your Client/Customer Base
Cree su base de clients, Crea tu
base de clients
Business Assets
Activos del negocio, Bienes del
negocio
Page 3

Business Cards
Tarjetas de negocios
Business Day
Da hbil
Business Expenses
Gastos del negocio
Business Income
Ingresos del negocio
Business Interruption
Interrupcin de negocios
Business Related
Relacionados con los negocios
Business Related Expenses
Gastos relacionados con los
negocios
Propiedad para uso del negocio
C
Cafeteria Plan
Plan de prestaciones
personalizado (cafetera)
Calendar Year
Ao calendario, Ao Civil
Cancellation of Health Plan
Cancelacin de plan de salud
Capital Asset
Activo fijo, Activos de capital
Capital Expenditure
Gasto de capital
Capital Gain
Ganancia de capital
Distribuciones de la ganancia de
capital
Capital Gain Tax
Impuesto sobre la ganancia de
capital, Distribuciones de
ganancia de capital, Impuesto
sobre la ganancia capital
Capital Improvement
Mejora del capital, mejoramiento
de capital
Capital Investment
Inversin de capital
Capital Loss
Prdida de capital
Capital Stock
Acciones de capital
Capitalize
Capitalizar
Page 4
Car and Truck Expenses

Gastos de automviles y
camiones
Career
Carrera professional, Carrera
Carryback - net operating loss
carryback (forward)
Traslado a ejercicios anteriores,
Transferencia de perdidas neto
Carryover
Prrroga automtica
Carryover Loss
Prdida de prrroga automtica
Mtodo contable de efectivo
Cash on Delivery (COD)
Contra reembolso (COD),
Reembolso (COD)
Casualty Loss
Prdida por siniestro
CBT
CBT
Certificate
Certificado
Certificate of Deposit (CD)
Certificado de depsito (CD)
Certification
Certificacin
Charged by
Cobrado por
Charitable Contribution
Contribucin de caridad,
Contribucin Caritativa
Contribuciones de caridad,
Contribucines Caritativas
Charitable donation
Donativo de caridad, Donacion
Caritativa
Check
Cheque
Check charge
Cargo por cheque
Check processing fee
Comisin por manejode cheque,
Cuota por proceso de cheque
Checking (review)
Cheques (revisin), Chequeo
(revisin)
Checklist
Lista de verificacin
Crdito por hijos y personas
dependientes, Crdito por
dependientes e hijos
Child Care Credit

Crdito por guardera
para menores, Pagos de
manutencin infantile
Child Tax Credit
Crdito fiscal por hijo
Claim of Right
Reclamacin de derecho
Classic Refund Anticipation Loan
Prstamo clsico en anticipo de
devolucin, Prstamo de
Reembolso Anticipado Clsico
Client
Cliente
Client Income Information
Worksheet
Hoja de trabajo de informacin
sobre los ingresos del cliente,
Hoja de informacin sobre los
ingresos del cliente
Client Service Agreement
Contrato de servicios al cliente,
Acuerdo de Servicio al Cliente
Client support
Atencin a clientes
Client-take-away
Regalo al cliente
Collect on Delivery (COD)
Contra reembolso (COD)
Collectibles
Cobrables
Combine
Combinar
Commission
Comisin
Commodity Futures
Futuros sobre mercancas,
Productos Futuros
Common Stock
Acciones ordinarias, Acciones
Comunes
Common-Law Marriage
Concubinato
Community Income
Ingresos de la comunidad
Community Property
Propiedad de la comunidad
Commuting
Traslado laboral diario, Trayecto
laboral diario
Company-Owned Offices
Oficinas que son propiedad de
la empresa, Oficinas de la
empresa

Compensation
Compensacin
Complex Return
Devolucin compleja
Compliance
Cumplimiento
Condemnation
Condena
Connected, Confident, and
Championed
Conectado, confiado y
defendido
Consent to disclose
Consentimiento para divulgar
Consent to Disclose Information,
7216
Consentimiento para divulgar
informacin, 7216
Consent to Disclose Return Tax
Information
Consentimiento para divulgar la
informacin de la declaracin de
impuestos, Consentimiento para
divulgar informacin de la
declaracin de impuestos
Consent to Use
Consentimiento para usar
Consent to use Tax Return
Information
Consentimiento para usar la
impuestos, Consentimiento para
usar informacin de la
declaracin de impuestos
Recibo constructivo
Consumer Price Index (CPI)
ndice de precios al consumidor
(IPC)
Continue
Continuar
Continuing Education Credit (CEC)
Crdito para educacin continua
(CEC)
Continuous support
Apoyo continuo
Contract for Deed
Contrato de escritura
Contract Holder
Titular del contrato
Contract Price
Precio contractual
Contribution
Contribucin
Convertible
Convertible
Copyright
Derechos de autor
Cost
Costo
Cost Depletion
Disminucin de costos
Cost Method of Inventory
Valuation
Mtodo de costos de valuacin
del inventario, Mtodo de
valoracin de costos del
inventario
Cost of Goods Sold
Costo de los bienes vendidos
Costo de mantener un hogar
Cost Recovery
Recuperacin de costos
Coupon
Cupn
Course(s)
Curso(s)
Coverdell Education Savings
Account (ESA)
Cuenta de ahorros en educacin
(CAE) Coverdell, Cuenta de
ahorros de educacin (CAE)
Coverdell
Credit for Child Care Expenses
Crdito por gastos de guardera
Credit Worthiness
Capacidad crediticia, solvencia
crediticia
Credits
Crditos
Custodial Parent
Progenitor que tiene la custodia,
Progenitor que tiene custodia
Customer Service
Servicio al cliente
Customer Service Agreement
Contrato de servicio al clientej,
Acuerdo de servicio al cliente
D
Data Base Administrator (DBA)
Administrador de bases de
datos (ABD)
Date of birth
Fecha de nacimiento
Dealer (commercial)
Concesionario (comercial)
Dealer (securities)
Corredor (valores)
Death of Close Family Member
Muerte de un familiar cercano
Debit MasterCard
MasterCard de dbito
Nmero de control de la
declaracin (NCD)
Declining Balance Method of
Depreciation
Mtodo de depreciacin de
saldos decrecientes
Deduction
Deduccin
Deductions
Deducciones
Default
Predeterminado
Deferred Compensation Plan
Plan de compensaciones
diferidas
Deferred Income
Ingresos diferidos
Plan de beneficios definido
Plan de contribuciones definido
Delete
Borrar
Delivery Envelope
Sobre de entrega
Department ID (DID)
ID del departamento (IDD)
Exencin por dependencia
Dependent
Persona dependiente,
Dependiente
Crdito por cuidado de personas
dependientes
Dependent Children without
Insurance
Hijos dependientes sin seguro
Depletion
Depreciacin
Depletion Allowance
Permiso de depreciacin
Depreciable Asset
Activo depreciable, Posesin
depreciable
Depreciation
Depreciacin
Page 5

Direct Deposit (DD)
Depsito directo (DD)
Dirty dozen
Docena sucia
Disability Pension
Pensin por discapacidad
Disabled
Discapacitado
Disaster Loss
Prdida por desastre
Disaster Victims
Vctimas de desastres
Disclose
Divulgar
Disclosure Statement For Classic
RAL
Declaracin de divulgacin para
RAL Clsico
Discount
Descuento
Discount offer
Oferta de descuento
Disposition (of property)
Disposicin (de propiedad)
Distribution
Distribucin
Distribution from pensions,
annuities, retirements or profitsharing plans, IRAs, insurance
contracts, etc.
Distribucin de pensiones,
anualidades, planes de
jubilacin o de ganancias
compartidas, CIR, contratos de
seguro, etc.
District
Distrito
District Manager (DM)
Director de distrito (DD),
Gerente de distrito (GD)
District Office Supervisor (DOS)
Supervisor de la oficina distrital
(SOD)
District Support Center (DSC)
Centro de Asistencia Distrital
(CSD)
District Technical Support
Specialist (DTSS)
Especialista en asistencia
tcnica distrital (ESTD)
Dividend
Dividendos, Dividendo
Dividend Income
Ingresos por dividendos
Division
Divisin
Page 6

Sentencia de divorcio (final)
Sentencia de divorcio
(interlocutoria)
Do you plan to file Married Filing
Jointly?
Tiene pensado presentar como
casados que presentan una
declaracin conjunta?
Domestic Production Activities
Deduction
Deduccin de actividades de
produccin nacionales,
produccin domestica
Domestic Violence Victims
Vctimas de violencia domstica
Double check (not product name)
Comprobacin doble (sin
nombre de producto)
Drop-off services
Servicios de entrega
E
Earn extra income preparing taxes
Gane ingresos adicionales
preparando impuestos
Earned Income
Ingresos percibidos
Earned Income Credit (EIC)
Crdito por ingresos percibidos
(CIP)
Earned Income Tax Credit (EITC)
Crdito fiscal por ingresos
percibidos (CFIP)
Earnings Statement E & D
Declaracin de percepciones - P
& D, Declaracin de ganancias
P&D
Easy IRA
CIR fcil
Easy Products
Productos fciles
Easy Savings
Ahorros fciles
EasyPay
Pagos fciles
E-commerce
Comercio electrnico
Edit
Editar
Education credits
Crditos por educacin
Deduccin de gastos de
educacin
Education Savings Account (ESA)
Cuenta de ahorros para
educacin (CAE)
Education tax benefits
Beneficios fiscales por
educacin, Beneficios de
Impuestos por Educacin
Deduccin de gastos del
educador
Effective Date
Fecha de entrada en vigor
Electronic Data Processing (EDP)
Procesamiento electrnico de
datos (PED)
Electronic Federal Tax Payment
System (EFTPS)
Sistema electrnico de pago de
impuestos federales (EFTPS)
Electronic Filing (E-file)
Declaracin electrnica (E-file)
Electronic Funds Transfer (EFT)
Transferencia electrnica de
fondos (TEF)
Electronic news (eNews)
Noticias electrnicas (eNews)
Eligible Educator
Educador apto, Educador
elegible
Menor acogido elegible
E-mail
Correo electrnico
Emerald Advance Application and
Terms and Conditions
Trminos y condiciones de la
solicitud Emerald Advance
Emerald Advance
Emerald Advance
Emerald Card Payroll Direct
Deposit Form
Formulario de depsito directo
de nmina de Emerald Card
Emerald Card
Emerald Card
Emerald Cash Rewards
Recompensas en efectivo
Emerald
Emerald Product Suite
Serie de productos Emerald

Emerald Savings Application
Solicitud Emerald Savings
Eminent Domain
Dominio eminente
Employee
Empleado
Employer Identification Number
(EIN)
Nmero de identificacin de
empleado (NIE)
Employer-Maintained Retirement
Plan
Plan de jubilacin mantenido por
el patrn, Plan de jubilacin
mantenido por el empleador
Employment Expenses
Gastos de empleo
Enroll Now
Inscrbase ahora
Gastos de representacin
Estate
Patrimonio
Estimate
Estimacin
Vida (til) estimada
Estimated Income
Ingresos estimados
Estimated Tax
Impuesto estimado
Estimator
Estimador
Every cent counts
Cada centavo cuenta
Every opportunity that might
benefit you
Cada oportunidad que puede
beneficiarlo
Eviction/Foreclosure
Desalojo/Ejecucin hipotecaria
Excess Social Security Tax
Withheld
Retencin excesiva de impuesto
de seguridad social
Exchange
Cambio
Exchange Rate
Tasa de cambio, Tipo de cambio
Excise Taxes
Impuestos sobre consumos
especficos
Excluded Gain
Ganancia excluida
Exclusion
Exclusin
Exclusion of income for bona fide
residents of American Samoa
Exclusin de ingresos para
residentes de buena fe de la
Samoa Estadounidense
Exemption
Exencin
Exemption Certificate Number
Nmero de certificado de
exencin
Exemption From Withholding
Exencin de retencin
Expenses
Gastos
Experience
Experiencia
Experienced Tax Professional
Profesional con experiencia en
impuestos
Expertise
Pericia
Expires
Vence
Express IRA
CIR rpida
Extension
Extensin
F
Facts About Lines of Credit
Datos sobre las lneas de
crdito
Facts About Refund Anticipation
Loans
Datos sobre los prstamos en
anticipo de devolucin
Valor justo en el mercado (VJM)
Fair Rental Value
Valor justo de renta
Farm Business
Negocio agrcola
Farm Operation
Operacin agrcola
Farm Proprietor
Propietario agrcola
Farmer
Agricultor
Farming
Agricultura
Farming Income
Ingresos por agricultura
Fast Money Options
Opciones de dinero rpido
Federal and State Forms
Formularios federal y estatal
Federal Income Tax Return
Declaracin fiscal federal de
ingresos
Retencin fiscal federal de
ingresos
Federal Income Tax Withholding
(FIT)
Retencin fiscal federal de
ingresos (RFF)
Federal Insurance Contributions
Act (FICA)
Ley Federal de Contribuciones
de Seguros (FICA)
Federal Marketplace
Mercado federal
Federal Poverty Level
Nivel de pobreza federal
(Federal Poverty Level)
Federal Refund Anticipation
Check
Cheque federal en anticipo de
devolucin
Federal Return
Declaracin federal
Federal taxes paid
Impuestos federales pagados
Fee/Fees
Tarifa/Tarifas
Feel, Felt, Found
Tcnica de ventas Feel, Felt,
Found
Fellowship
Beca
FICA (Federal Insurance
Contributions Act)
FICA (Ley de contribucin al
seguro federal)
Fiduciary
Fiduciario
File a tax return
Presentar una declaracin fiscal
Filing
Presentacin
Filing deadline
Fecha lmite para la
presentacin
Filing requirements
Requisitos para la presentacin
Page 7

Filing status
Estado de la presentacin
Finance charge
Cargo financiero
Finance Charges
Cargos financieros
Financial Advisor (FA)
Consejero financiero (CF)
Financial Centers
Centros financieros
Financial Information Network (FIN)
Red de informacin financiera
(RIF)
Financial Services
Servicios financieros
Primero en entrar, primero en
salir (FIFO)
Fiscal Planning
Planificacin financiera
Fiscal Year
Ejercicio fiscal
Five-Step Disclosure Process
Proceso de divulgacin de cinco
pasos
Fixed-Rate Mortgage
Hipoteca a tasa fija
Flexible Spending Accounts
Cuentas de gastos flexibles
For an office near you
Para encontrar una oficina cerca
de usted
Foreign earned income exclusion
Exclusin de ingresos
extranjeros percibidos
Foreign income
Ingresos extranjeros
Crdito o deduccin fiscal
extranjera
Form
Formulario
Forms Selection
Seleccin de formularios
Foster Child
Menor acogido, Hijo(a)
Adoptivo(a)
Franchise
Franquicia
Franchise Director (FD)
Director de franquicias (DF)
Franchise District Manager
Director distrital de franquicias
Free Notary Services
Servicios notariales gratuitos
Page 8
Friends and Family Returns

Declaraciones de amigos y
familiares
Fringe Benefits
Prestaciones sociales
complementarias
Front office associates
Asociados de front office,
Asociados de oficina frontal
Full Retirement Age
Edad de jubilacin completa
Full-Time Student
Estudiante de tiempo completo
Pensiones completamente
gravables
Gross Profit
Ganancias brutas
Gross Rent
Renta bruta
Seguro de vida colectivo a
trmino
Guaranteed Issue
Emisin garantizada
Guaranteed Loan Offer (GLO)
Oferta de prstamo garantizado
(OPG)
Guaranteed maximum refund
Devolucin mxima garantizada
H
G
Gain
Ganancia
Gambling
Juegos de azar, Apostar
Sistema general de
depreciacin
General Rule
Regla general
General Sales Tax
Impuesto de ventas general
General Straight-Line Depreciation
System
Sistema general de
depreciacin en lnea recta
Get every penny youre entitled to
Reciba cada centavo al que
tenga derecho
Gift
Regalo
Gift Tax
Impuesto sobre regalos
Golden Parachute
Contrato blindado
Good Neighbor
Buen vecino
Goodwill
Fondo de comercio
Government Bonds Issued at a
Discount
Bonos del gobierno emitidos con
descuento
Gross Income
Ingresos brutos
H&R Block Advantage Report

Reporte H&R Block Advantage
H&R Block Advantage
H&R Block Advantage
H&R Block Advantage Statement
Declaracin H&R Block
Advantage
H&R Block At Home software
(not available in Spanish)
Software H&R Block At Home
(no disponible en espaol)
H&R Block Easy IRA
Easy IRA de H&R Block
H&R Block Easy Products
Productos Easy de H&R Block
H&R Block Easy Savings
Ahorros Easy de H&R Block
H&R Block Emerald Advance
Line of Credit
Lnea de crdito Emerald
Advance de H&R Block
H&R Block Emerald Card
Emerald Card de H&R Block
H&R Block Emerald Prepaid
MasterCard
MasterCard Emerald
prepagada de H&R Block
MasterCard
MasterCard Emerald
prepagada de H&R Block
MasterCard Table Topper
Table Topper H&R Block
Emerald Prepaid MasterCard

H&R Block Emerald Product Suite
Serie de productos H&R Block
Emerald
H&R Block Emerald Savings
Emerald Savings de H&R Block
Emerald Savings de H&R Block
account
Cuenta Emerald Savings de
H&R Block
account
Cuenta Emerald Savings de
H&R Block
Disclosures
Divulgaciones Emerald Savings
de H&R Block
H&R Block Franchise
Franquicia de H&R Block
H&R Block Guarantee
Garanta de H&R Block
H&R Block Income Tax Course
Curso sobre impuestos sobre la
renta de H&R Block
H&R Block offers you many
options
H&R Block le ofrece muchas
opciones
H&R Block Premium Office
Oficina premium de H&R Block
H&R Block Tax Professional
Profesional de impuestos de
H&R Block
Hardship
Dificultades econmicas
Hardship Case
Caso de dificultades
excepcionalmente gravosas,
Hardship exemption
Exencin por dificultades
econmicas
Hardship Withdrawal
Retiro de dificultades
excepcionalmente gravosas,
Retiro de dificultades
HDHP
PSDA
Head of Household
Jefe de familia, Cabeza de
hogar
Head of Household Filing Status

(HH)
Estado de la declaracin del
Jefe de familia (CF), Estado de
declaracin de la cabeza de
hogar (CH)
Health Coverage
Cobertura de salud
Health and Human Services (HHS)
Servicios Humanos y de Salud
(HHS, por sus siglas en ingls)
Health Insurance
Seguro mdico
Cuenta de ahorros mdicos
(CAM)
Healthcare reform law
Ley de reforma de salud
High Deductible Health Plan
Plan de salud con deducible alto
Hobby Loss
Prdida por pasatiempo
Hold
Suspender
Holding Period
Periodo de suspensin
Holiday
Vacaciones, Da festivo
Gastos de oficina en casa
Homelessness
Falta de vivienda
Homeowner
Propietario de vivienda
Hope Credit
Crdito de esperanza
Household Employee
Empleado domstico
Household Expenses
Gastos de la casa
hrblock.com
hrblock.com
HSA
CAM
Human Resources (HR)
Recursos humanos (RH)
Husband and Wife
Marido y mujer
Mtodo contable hbrido
I
I Am Worth It
Yo lo valgo
Identifying Numbers
Nmeros de identificacin,
Numero de identificacion
If you are not satisfied
Si no est satisfecho
Ill, Disabled, or Aging Family
Member
Familiar enfermo, discapacitado
o de edad avanzada
Important tax information
Informacin fiscal importante
Imputed Interest
Inters implcito
In good standing
Al da, En buen estado
Income
Ingresos
Income averaging
Promedio de ingresos
Income Entry
Asiento de ingresos, Entrada de
ingresos
Income tax
Impuesto sobre la renta,
Impuesto de ingresos
Income Tax Course (ITC)
Curso sobre impuesto sobre la
renta (CISR), Curso de
impuestos (CI)
Contratista independiente
Individual Performance Plan
Plan de desempeo individual
Individual Retirement Account
(IRA)
Cuenta de jubilacin individual
(CJI)
[An/your/the] Individual Taxpayer
Identification Number (ITIN)
[Un/su/el] nmero de
identificacin del contribuyente
individual (NICI)
Individual taxpayer identification
number (ITIN)
Nmero de identificacin del
contribuyente individual (NICI)
Page 9

Individual Taxpayer Identification
Number (ITIN) Services
Servicios del nmero de
identificacin del contribuyente
individual (NICI)
Information Document
Documento informativo
Inheritance
Herencia
Initial
Inicial
Installment Method (Annualized
Income)
Mtodo a plazos (ingresos
anualizados)
Instant Money
Dinero instantneo
Instant Money Anticipation Loan
(IMAL)
Prstamos instantneo en
anticipo de dinero (PIAD)
Instant Money RAL
PAD de dinero instantneo
Instant Money RAL Proceeds
Producto de PAD de dinero
instantneo
Instant Money Refund Anticipation
Loan (Instant Money RAL)
Prstamo en anticipo de
devolucin de dinero
instantneo (PAD de dinero
instantneo)
Instant RAL
PAD instantneo
Instant Refund Anticipation Loan
devolucin instantnea
Insurance Dividends
Dividendos de seguros
Insurance Policy
Pliza de seguro
Propiedad personal intangible
Interest income
Ingresos por intereses
Interest rate
Tasa de inters, Tarifa de
inters
Interest Received
Inters recibido
Decreto interlocutorio
Servicio Interno de Ingresos
(IRS)
Page 10
Internet Service Provider (ISP)

Proveedor de servicios de
Internet (PSI)
Internet, the Net
Internet, la red
Interview (infinitive verb)
Entrevistar (verbo en infinitivo)
Interview (noun)
Entrevista (sustantivo)
Inventory
Inventario
Investment
Inversin
Investment Income
Ingresos por inversiones
Investment Interest
Intereses sobre inversiones
Investment Property
Propiedad de inversin
Conversin involuntaria
IPP
IPP
IRA
CIR
IRS
IRS
IRS Check
Revisin IRS
Itemize
Detallar
Itemized Deductions
Deducciones detalladas
ITIN
NICI
ITIN Services
Servicios de NICI
J
Job
Trabajo
Joint Return
Declaracin conjunta
Joint Tenancy
Posesin conjunta
Joint Venture
Joint venture, Empresa conjunta
Propiedad poseda
conjuntamente, Copropiedad
L
Labor Code
Cdigo laboral
Land Value
Valor del terreno
Primero en salir, primero en
entrar (LIFO), Ultimo en entrar,
primero en salir or Ultimas
Entradas, Primeras Salidas
(UEPS)
Late fee
Tarifa por retraso, Cargo por
retraso
Learn to prepare taxes
Aprenda a preparar impuestos
Leave and Earnings Statement,
LES
Declaracin de ausencia y
percepciones, DAPj,
Declaracion de ausencia e
ingresos, DAI
Legally Blind
Legalmente ciego
Legally Separated
Legalmente separados
Lender
Acreedor, Prestador
Lessee
Arrendatario
Lessor
Arrendador
Crdito de aprendizaje a vida,
Credito de aprendizaje de por
vida
Limited
Limitado
link
vnculo, Enlace
Liquidation
Liquidacin
Distribuciones de liquidaciones
Listed Property
Propiedad publicada
Load (as in Emerald Card)
Cargar (como en Emerald Card),
Recargar (como en Emerald
Card)
Load the loan money
Cargar el dinero del prstamo

Loan
Prstamo
Loan Agreement
Contrato de prstamo, Convenio
de prestamo
Loan Application
Solicitud de prstamo
Location near you
Ubicacin cercana a usted
Lodging
Alojamiento
Ganancias de capital a largo
plazo
Lower of Cost or Market Method of
Inventory Valuation
Mtodo del monto menor entre
el costo y el valor comercial
para la valuacin de inventarios
Loyalty
Lealtad
Loyalty Client Rebate Program
Programa de descuentos por
lealtad de los clientes
Distribucin de cantidad nica,
Distribucion de pago unico
M
Mail a payment
Enviar un pago por correo
Main Home
Domicilio principal, Domicilio de
casa
Major Franchise (MF)
Franquicia primaria (FP)
Malpractice
Malas prcticas, Negligencia
Manager, Regional Operations
Support (MROS)
Director de apoyo de
operaciones regionales (DAOR)
Managing Skills Seminars (MSS)
Seminarios de habilidades de
direccin (SHD)
Margin
Margen
Marketing
Mercadotecnia
Marketplace
Mercado
Marketplace Eligibility Appeals

Decision
Decisiones sobre apelaciones
de elegibilidad del mercado
Marketplace Exemption
Application
Aplicacin de exencin de
mercado
Marriage
Matrimonio
Casados que presentan una
declaracin conjunta
Married Filing Separately
Casados que presentan
declaraciones separadas
MasterCard Zero Liability
MasterCard con cero
responsabilidad
mastercard.com/zeroliability
Material Participation
Participacin material
Maximum Refund
Devolucin mxima
Maximum Refund Guarantee
Garanta de devolucin mxima
Maximum refund you are entitled
to
Devolucin mxima a la que
tiene derecho
Maximum Refund, Guaranteed
Devolucin mxima, garantizada
MBTO
MBOF
Medicaid Ineligibility NonExpanded Medicaid States
No elegibilidad para Medicaid
Estados sin expansin de
Medicaid
Medical Expenses
Gastos mdicos
Medical Insurance
Seguro mdico
Medicare Part A
Medicare Parte A
Medicare Part B
Medicare Parte B
Medicare Tax Withheld
Retencin de impuestos para
Medicare
Mileage Allowance
Permiso de kilometraje, Millas
permitidas

Tasa de kilometraje (mtodo
opcional), Tasa de millaje
(mtodo opcional)
Military Return
Devolucin para militares,
Declaracion para militares
Minimum essential coverage
Cobertura esencial mnima
Miscellaneous (MISC)
Diversos (DIVR), Miscelaneos
Miscellaneous deductions
Deducciones varias
Mission Values Participant (MVP)
Program
Programa de participante en los
valores de la misin (PVM)
Modified Accelerated Cost
Recovery System (MACRS)
modificado (MACRS)
Modified AGI (MAGI)
AGI modificado (MAGI)
Money Transfer
Transferencia de dinero
Money with no out-of-pocket costs
Dinero sin costos directos,
Dinero sin costo en efectivo
Money youre entitled to
Dinero al que tiene derecho
Mortgage
Hipoteca
Certificado de crdito
hipotecario
Mortgage Interest
Intereses de la hipoteca
Mortgage Services
Servicios hipotecarios
Moving Expenses
Gastos de mudanza
Contrato de asistencia mltiple,
Acuerdo de asistencia multiple
Mutual Fund
Fondo de inversin
My tax money
Mi dinero de impuestos
My tax refund
Mi declaracin fiscal, Mi
devolucion de impuestos
Page 11

myBlockSM for the Tax Office
(MBTO)
myBlockSM para la oficina fiscal
(MBOF)
myStarting Block
myStarting Block
N
Nearly
Casi
Necessary Expenses
Gastos necesarios
Prdidas operativas netas
Never settle for lessSM
Nunca se conforme con
menosSM
New Client
Cliente nuevo
New clients protocols
Protocolos para clientes nuevos
Deudas incobrables que no son
de negocios
Noncustodial Parent
Progenitor que no tiene la
custodia
Non-Profit Referral Program
Programa de referencias sin
fines de lucro
Crdito no reembolsable
Nonresident Alien
Extranjero no residente
Distribuciones no gravables
Nontaxable Exchange
Cambio no gravable
Nontaxable Income
Ingresos no gravables
Not valid
No vlido
Notary Public
Notario pblico
Notary Services
Servicios notariales
O
Offer
Oferta
Page 12
Office Leader (OL)

Jefe de oficina (JO), Lider de
oficina (LO)
Office Level Satisfaction (OLS)
Satisfaccin a nivel de la oficina
(SNO)
Office Level Survey, OLS
Encuesta a nivel de la oficina
(ENO)
Office Manager (OM)
Gerente de oficina (DO)
Offline
Fuera de lnea, Desconectado
Online
En lnea, Conectado
Online services
Servicios en lnea
Online Tax Preparation (OTP)
Preparacin de impuestos en
lnea (PIL)
Option
Opcin
Ordinary Dividends
Dividendos ordinarios
Ordinary Expenses
Gastos ordinarios
Ingresos (prdidas) ordinarios
origination fees
tarifas por tramitacin
Out-of-pocket expenses
Gastos directos, Gastos en
efectivo
Out-of-state return
Devolucin fuera del estado,
Declaracion fuera del estado
Overpay
Pagar en exceso
Overpayment
Pago en exceso
P
Participating
Participando
Pensiones parcialmente
gravables
Partnership
Sociedad
Passive Income
Ingresos pasivos
Passive income and losses
Ingresos y prdidas pasivas
Passive loss
Prdida pasiva
Past returns
Devoluciones pasadas,
Devoluciones anteriores
Past tax returns
Declaraciones fiscales pasadas,
Declaraciones de impuestos
anteriores
Patent
Patente
Pay
Pagar
Pay down date
Fecha de pago
Pay stub
Taln de pago
Paycheck
Cheque de nmina
Payroll taxes
Impuestos sobre nmina
Peace of Mind
Peace of Mind
Peace of Mind Extended Service
Plan
Plan extendido de servicios
Peace of Mind
Penalty and Interest (P&I)
Sancin e intereses (S&I)
Pension
Pensin
Pension Fund
Fondo de pensin
Pension Plan
Plan de pensin
Fecha de inicio de la
pensin/anualidad
Period
Periodo
Discapacidad permanente y
total
Personal and Dependency
Exemptions
Exenciones personales y por
dependencia
Personal Expenses
Gastos personales
Personal Property
Propiedad personal
Impuesto sobre propiedad
personal

Personal Residence
Residencia personal
Propiedad para uso personal
Phaseout
Eliminacin gradual
Physical Custody
Custodia fsica
Point of Sale (POS)
Punto de venta (PV)
Points
Puntos
Policies and Procedures (P&P)
Polticas y procedimientos (P&P)
Cartera de ingresos y prdidas
Potential ACA Tax Penalty
Posible penalidad de impuestos
de la Ley ACA
Premium Guarantee
Garanta premium
Premium Tax Credit (PTC)
Crdito Tributario por la Prima
(PTC, por sus siglas en ingls)
Prepaid Expenses
Gastos prepagados
Prepaid Interest
Intereses prepagados
Prepare Taxes (to prepare taxes)
Prepare los impuestos (preparar
los impuestos)
Pre-tax / Pretax
Pre-impuesto/preimpuesto
Principal
Principal
Principal Place of Abode (Principal
Residence)
Lugar de residencia principal
(residencia principal)
Lugar de negocios principal
Principal Residence
Residencia principal
Printed (name)
En letra de molde (nombre)
Prior Client
Cliente anterior
Prior Client Calling Program,
PCCP
Programa de llamadas al cliente
anterior, PLCA, Programa de
llamadas a clientes previos,
PLCP
Prizes and Awards
Premios y galardones
Pro forma
Pro forma
Problem Resolution Office (PRO)
Oficina de resolucin de
problemas (ORP)
Professional Tax Service (PTS)
Servicio de impuestos
profesional (SIP)
Prohibited
Prohibido
Promote Your Taxpertise
Promueva su experiencia fiscal
Property Tax
Impuesto sobre propiedad
Proprietorship
Propiedad, Derecho de
propiedad
Put to the test
Poner a prueba
Puts and Calls
Opciones de venta y opciones
de compra
Q
Organizacin de caridad
calificada
Qualified Dividends
Dividendos calificados
Seguro de salud que rene los
requisitos
Qualified Pension or ProfitSharing Plan
Plan de pensin o de ganancias
compartidas calificado
Plan de colegiaturas calificado
Qualifying Child
Hijo con derecho
Qualifying Relative
Familiar con derecho
Qualifying Widower
Viudo con derecho
Quality Performance Review (QPR)
Revisin del desempeo de
calidad (RDC)
Quote (Bid/Ask)
Cotizacin (licitar/pedir)
R
RAC (Second use of term)
CAD (segundo uso del trmino)
(RRTA)
Ley de Impuesto a la Jubilacin
de Ferrocarriles (RRTA)
RAL (Second use of term)
PAD (segundo uso del trmino)
Real Estate
Propiedad inmobiliaria, Bienes
Raices
Real estate taxes
Impuestos sobre propiedad
inmobiliaria, Impuesto sobre
bienes raices
Real Property
Bienes inmuebles
Ganancia o prdida obtenida
Reasonable Allowance
Permiso razonable
Reasonable Expenses
Gastos razonables
Recapture
Recuperacin de beneficio fiscal
Recent Tax Changes
Cambios fiscales recientes
Ganancia o prdida reconocida
Recognized Religious Sect
Organizacin religiosa
reconocida
Reconciliation
Conciliacin
Recovery
Recuperacin
Recovery of Cost
Recuperacin del costo
Recovery Period
Periodo de recuperacin
Refer a Friend
Invite a un amigo
Referral
Invitacin
Referral fee
Tarifa por invitacin, Cargo por
invitacion
Referral form
Formulario para invitacin
Referral program
Programa de invitaciones
Page 13

Refile
Volver a presentar
Refiling fees apply
Se aplicarn tarifas por volver a
presentar
Refinancing
Refinanciamiento
Refund
Devolucin
Refund account fee
Tarifa por cuenta de devolucin,
Cargo por cuenta de devolucion
Refund Anticipation Check
Cheque en anticipo de
devolucin, Cheque de
devolucion anticipada
Refund Anticipation Check (RAC)
devolucin (CAD), Cheque de
devolucion anticipada (CDA)
Refund Anticipation Loan
devolucin, Prestamo de
devolucion anticipada
Refund Anticipation Loan (RAL)
devolucin (PAD), Prestamo de
devolucion anticipada (PDA)
Refund Deposit Account
Cuenta de depsito de
devoluciones
Refund Options
Opciones de devolucin
Refund Planning
Planificacin de devolucin
Refund Transfer, RT
Transferencia de devolucin, TD
Refundable Credit
Crdito no reembolsable,
Credito reembolsable
Regional Accounts Manager (RAM)
Director regional de cuentas
(DRC)
Regional Director (RD)
Director regional (DR)
Regional Financial Analyst (RFA)
Analista financiero regional
(AFR)
Regional Financial Support
Specialist (RFSS)
Especialista de asistencia
financiera regional (ESFR)
Regional Franchise Director (RFD)
Director regional de franquicias
(DRF)
Page 14
Regular Method
Mtodo regular
Regulated Investment Company
(Mutual Fund)
Empresa de inversiones
reguladas (fondo de inversin)
Regulations
Reglamentos, Regulaciones
Dividendos reinvertidos
Reliable Accuracy
Precisin confiable
Reload (as in money on your
Emerald Card)
Recargar (como recargar dinero
en su Emerald Card)
Rent
Renta
Rental Income
Ingresos por alquileres
Repairs
Reparaciones
Repayment limitation
Limitacin de reembolso
Replacement Period
Periodo de reemplazo
Reported income
Ingresos declarados
Repossession
Recuperacin, Reposesion
Reschedule
Volver a programar,
Reprogramar
Resident Alien
Extranjero residente
Rest assured
Sintase seguro, Tenga por
seguro
Results
Resultados
Retail Sales
Ventas de menudeo
Retirement
Jubilacin
Return (noun)
Devolucin (sustantivo)
Return on Investment (ROI)
Retorno de la inversin (RI)
Right
Derecho
Rollover
Refinanciamiento
Roth IRA
CIR Roth
Royalty
Regalas
RRTA
RRTA
S
S Corporation
Sociedad S, Corporacin S
SAF form
Formulario SAF, Rembolso SAF
SAF program
Programa SAF
SAF rebate
Descuento SAF
Safe Harbor
Recinto protegido, Puerto
seguro
Salary
Salario
Salvage Value
Valor de salvamento
Satisfaction Guarantee
Garanta de satisfaccin
Schedules
Calendarios, Formularios
Becas
Scrap Sales
Ventas de merma
Second Look at your taxes
Una segunda opinin sobre sus
impuestos
Second Look Review
Revisin Second Look
Second lowest cost silver plan
Plan de categora Plata de
segundo costo ms bajo
Seccin (seguida de un nmero)
Secured Deposit Account
Cuenta de depsito asegurada
Personas que trabajan por
cuenta propia
Ingresos de trabajo por cuenta
propia
Self-Employment Tax
Impuesto sobre trabajo por
cuenta propia
Send a Friend
Enve a un amigo

SEP
PES
Pagos de manutencin
separados
Service
Servicio
Settlement Options
Opciones de acuerdos
Settlement Products
Productos de acuerdos
Pago por responsabilidad
compartida
Shareholder
Accionista
Shine in 09
Brille en '09
Short term
Corto plazo
Short-term consumer loan
Prstamo a consumidores a
corto plazo
SIMPLE
SIMPLE
Plan de jubilacin SIMPLE
Pensin de empleados
simplificada (PES)
Simplified Method
Mtodo simplificado
Single
Soltero
Skills Learning Center
Centro de aprendizaje de
habilidades
Social Security and Medicare
taxes
Impuestos de seguridad social y
Medicare
Social Security Number (SSN)
Nmero de seguridad social
(NSS)
Impuesto de seguridad social
retenido
Consejos de seguridad social
Salarios de seguridad social
Sole proprietor
nico propietario, Propietario
individual
Sole proprietorship
Propiedad nica, Propiedad
individual
Solid
Slido
Special Averaging
Promedio especial
Special Depreciation Allowance
Permiso de depreciacin
especial, Concesin de
depreciacin especial
Specialized
Especializado
Speed of refund
Velocidad de la devolucin
Spend some. Save some. Borrow
some.
Gaste algo. Ahorre algo. Pida
algo prestado.
Spousal IRA
CIR de cnyuge
Stability
Estabilidad
Standard Deduction
Deduccin estndar
Tasa de kilometraje estndar
Standard or Standard Deduction
(STD)
Estndar o deduccin estndar
(DES)
State Marketplaces
Mercados estatales
State or Local Income Tax
Withheld
Retencin de impuesto sobre la
renta estatal o local
State Refund Anticipation Check
(RAC)
devolucin (CAD) estatal
State Return
Devolucin estatal
Statement
Declaracin
Statements
Declaraciones
Status
Estatus
Statutory Employee
Empleado legal
Stock Dividend
Dividendos de acciones
Stock Option Plan
Plan de opciones de acciones

Mtodo de depreciacin en lnea
recta
Deduccin de intereses sobre
prstamo para estudiantes
Student(s)
Estudiante(s)
Subject to
Sujeto a
Success
xito
Supplement Application
Solicitud de suplemento
Supplement Application for
Solicitud de suplemento para
prstamo en anticipo de
devolucin
Supplement To Information,
Identification And Instructions In
Connection With Application For
Refund Anticipation Check(s) And
A Refund Deposit Account
Suplemento de informacin,
identificacin e instrucciones
relacionadas con la solicitud de
cheque(s) en anticipo de
devolucin y cuenta de depsito
de devolucin
Support
Asistencia
Supporting forms
Formularios para asistencia
T
Table topper
Table Topper
Take the course
Tome el curso
Take the H&R Block Income Tax
Course.
Curso sobre impuestos sobre la
renta de H&R Block, Tome el
curso de impuestos de H&R
Block
Talk to our bilingual tax
professionals
Hable con nuestros
profesionales de impuestos
bilinges
Talk to your tax professional
Hable con su profesional de
impuestos
Page 15

Propiedad personal tangible
Tax (taken out of your check)
Impuesto (tomado de su cheque)
Tax and financial needs
Necesidades fiscales y
financieras
Tax authority
Autoridad fiscal
Tax Benefit
Beneficio fiscal
Tax bill
Proyecto de ley tributaria
Tax Bracket
Seccin fiscal
Tax Consulting
Consultora fiscal
Tax Credit
Crdito fiscal
Tax Deductions and Benefits
Deducciones y beneficios
fiscales
Tax Estimator
Estimador de impuestos,
Estimador de impuestos
Tax estimator
Estimador de impuestos
Tax Experience
Experiencia fiscal
Tax fraud
Fraude fiscal
Tax Home
Inicio fiscal
Tax Household
Unidad familiar a efectos
fiscales
Tax interview
Entrevista fiscal
Tax Knowledge Assessment test
Prueba de evaluacin de
conocimientos fiscales
Tax Laws
Leyes fiscales
Tax Liability
Obligacin fiscal
Tax Money
Dinero de impuestos
Tax Planning
Planificacin fiscal
Tax Preparation (process)
Preparacin de impuestos
(proceso)
Tax Preparation Checklist
Lista de verificacin de la
preparacin de impuestos
Page 16
Tax Preparation Software

Software de preparacin de
impuestos
Tax Pro Finder
Buscador de profesionales
fiscales
Tax Professional
Profesional fiscal
Tax Professional Business Builder
Creador de negocios de
profesionales fiscales
Tax Professional Development
Discussion
Debate sobre el desarrollo de
profesionales fiscales
Tax professional passport
Pasaporte de profesionales
fiscales
Tax Rate
Tasa de impuestos
Tax Rate Schedules
Calendario de tasas de
impuestos, Formularios de tasa
de impuestos
Tax Refund
Devolucin de impuestos
Tax Return (The actual document,
1040, 1040E)
Devolucin de impuestos (el
documento real, 1040, 1040E),
Declaracin de impuestos ( el
documento actual, 1040, 1040E)
Tax returns from the past three
years
Devoluciones de impuestos de
los ltimos tres aos,
Declaracin de impuestos de los
ltimos tres aos
Tax Season
Temporada de impuestos
Tax Table
Mesa de impuestos
Tax talks
Conversaciones de impuestos
Tax Terms
Trminos fiscales
Tax Time
Tiempo de impuestos
Tax Training School (TTS)
Escuelas de capacitacin fiscal
(ECF)
Tax Underpayment
Reimbursement
Reembolso de pago insuficiente
de impuestos, Reembolso de
pago incompleto de declaracin
Tax Year
Ao fiscal
Taxable Income
Impuesto gravable
Taxable Year
Ao gravable
TaxCut software (not available in
Spanish)
Software TaxCut (no disponible
en espaol)
Taxes (taken out of your check)
Impuestos (tomados de su
cheque)
Tax-Exempt Income
Ingresos exentos de impuestos
TaxNet
TaxNet
Taxpayer
Contribuyente
Television and Radio Promotions
Promociones en televisin y
radio
Asignacin temporal
Tenancy in Common
Posesin en comn, Tenencia
en comn
Term of the loan
Trmino del prstamo
Thank you for trusting H&R Block
Gracias por confiar en H&R
Block
The EXPRESSTAX Emerald
Prepaid MasterCard is issued by
H&R Block Bank, a Federal
Savings Bank, member FDIC,
pursuant to a license from
MasterCard International.
La tarjeta MasterCard
prepagada EXPRESSTAX
Emerald es emitida por H&R
Block Bank, un banco federal de
ahorro, miembro de la FDIC,
conforme a una licencia de
The H&R Block Emerald Prepaid
MasterCard is issued by H&R
Block Bank, a Federal Savings
Bank, Member FDIC.
La tarjeta MasterCard
prepagada EXPRESSTAX
Emerald es emitida por H&R
Block Bank, un banco federal de
ahorro, miembro de la FDIC., La
tarjeta MasterCard pre-pagada
EXPRESSTAX Emerald es
emitida por H&R Block Bank, un
banco federal de ahorro,

miembro de la FDIC, en
conformidad con la licencia de
MasterCard Internacional.
The H&R Block Guarantee
La Garanta de H&R Block
Tip Income
Ingresos por propinas
Toss Out Your Bills Instant Win
Game:
Juego de Lance sus facturas,
gane al instante: , Juego de
Tirar sus facturas, gane al
instante
Total federal estimated taxes
Impuestos totales federales
estimados, Impuestos federales
estimados totales
Trade Date
Fecha de la transaccin
Traditional IRA
CIP tradicional
Transfer by phone
Transferencia por telfono
Gastos de transporte
Travel Allowance
Permiso de viaje
Travel Expenses
Gastos de viaje
Trust
Fideicomiso
Trust Experience
Experiencia fiduciaria
Trust Us (to trust us)
Confe en nosotros (confiar en
nosotros)
Trustee
Fiduciario
Truth in Savings Disclosure
Divulgacin de la verdad sobre
los ahorros
Deduccin de colegiaturas y
tarifas
U
Unaffordable coverage
Cobertura inasequible
Sancin por pago insuficiente,
Sancin por pago incompleto
Undocumented Immigrant
Inmigrante indocumentado
Unearned Income
Ingresos no percibidos, Ingreso
no ganado
Compensacin por desempleo
Uninsured
No asegurado
Unpaid Medical Expenses
Gastos mdicos impagos
Unrecaptured Gain
Ganancia no recuperada
Up-to-date
Actualizado
Up-to-date (to be)
Al da (estar)
Utility Shut-Off
Corte de servicio pblico
V
Vacation Home
Residencia de vacaciones
View report onscreen
Ver el informe en la pantalla
Void
Nulo

Crdito de oportunidad laboral
Workers' Compensation
Compensacin para
trabajadores
Working Families Credit
Crdito para familias que
trabajan
Worksheet
Hoja de trabajo
www.hrblock.com
www.hrblock.com
Y
Year-Round Assistance
Asistencia todo el ao
Your Rights As a Taxpayer
Sus derechos como
contribuyente
Your Satisfaction is Guaranteed
Su satisfaccin garantizada
Your Tax Preparation Fee
Tarifa de preparacin de sus
impuestos
Your Tax Preparation is Free
La preparacin de sus
impuestos es gratuita
Your Taxes, Your Way
Sus impuestos, a su modo
W-2
W-2
Warranty Products
Productos de garanta
We Are With You
Estamos con usted
We will assure you
Le daremos seguridad
Web Page
Pgina web
Web Site
Sitio web
Crdito de bienestar social al
trabajo
Where is my money?
Dnde est mi dinero?
Widow (Widower)
Viuda (viudo)
Withholding Allowance
Permiso de retencin
Z
Zero Liability
Cero responsabilidad
Zip Code
Cdigo postal
Page 17
English-Spanish
Glossary of Terms: Spanish for
Puerto Rico
English to Spanish Glossary of Terms: Spanish for Puerto Rico
English to Spanish
0-9
1040EZ
Formulario 1040EZ (Impuestos
federales sencillos)
A
A location near you
Una oficina cerca de ti
A tax
Una contribucin
About
Acerca de
ACA Tax Penalty
Multa contributiva conforme a la
Ley ACA
Exencin de multa fiscal
conforme a la Ley ACA
System
(Accelerated Cost Recovery
System, ACRS)
(AMP)
Programa de gerencia
acelerado
Accept Status
Aceptar estatus
Cargo de administracin de
cuenta
Account Executive
Ejecutivo de cuenta
Account Manager
Gerente de cuenta
Accountable Plan
Plan contable
Accounting Method
Mtodo de contabilidad
Accounting Period
Perodo contable
Page 2

Mtodo contable a base de lo
devengado
Accrued Interest
Intereses devengados
Accumulated Adjustments
Account (AAA)
Accumulation Period
Perodo de acumulacin
Acquisition Debt
Deuda adquirida
Action plans
Planes de accin
Active Income
Ingresos activos
Active Losses
Prdidas activas
Active Participant
Participante activo
Gastos actuales
Add more Income
Aadir ms ingresos
Crdito adicional por
dependiente
Adjusted Basis
Base ajustada
Ingresos actuales ajustados
Ingresos brutos ajustados
(Adjusted Gross Income, AGI)
Adoption Credit
Crdito por adopcin
Crdito por ingresos de trabajo
anticipados
(APTC)
Crdito Contributivo Anticipado
por la Prima (APTC, por sus
siglas en ingls)
Repayments
Reintegros del Crdito
Contributivo Anticipado por la
Prima

Carta de accin adversa
Advice Statement
Declaracin de asesoramiento
Ley de Atencin Mdica
Asequible (Affordable Care Act
o ACA, por sus siglas en ingls)
AGI
AGI
Alimony Payments
Pensin pagada por divorcio o
separacin
Allowable Miscellaneous
Deductions (AMID)
Deducciones miscelneas
permitidas
Allowance
Descuento
Mtodo alterno
Alternative Depreciation System
(ADS)
Sistema de depreciacin
alternativa
Contribucin bsica alterna
Depreciation System
Sistema alternativo de
depreciacin uniforme
Amended Return
Planilla enmendada
VISTA / National Civilian
Community Corps Member
AmeriCorps (estatales y
nacionales) / VISTA / Miembro
del Cuerpo Civil Comunitario
Nacional (NCCC)
Amortization
Amortizacin
Amount
Cantidad
Amount Realized
Cantidad realizada
AMT
Contribucin bsica alterna
(AMT)
An additional fee
Un cargo adicional
An average of
Un promedio de

Tasa porcentual anual (Annual
Percentage Rate, APR)
Method
Mtodo de ingreso anual a
plazos
Annuitant
Pensionista
Annuity
Anualidad/renta vitalicia
Anti-Churning Rules
Reglas de prevencin de
transacciones deliberadas
Tasa federal aplicable
Applicable percentage
Application for a Refund
Anticipation Check and a Refund
Deposit Account
Solicitud de Cheque de
reintegro anticipado y Cuenta de
depsito de reintegro
(Administrador de citas)
Approval
Aprobacin
Approve Online
Approve Online (Aprobacin en
lnea) [first occurrence]; Approve
Online [thereafter].
Material para cliente cualificado
Cuenta Archer MSA de ahorros
mdicos
Archer MSA
Cuenta Archer MSA
Tan rpido como lo elijas / Tan
rpido como escojas
Ask
Pedir/Solicitar/Preguntar
Consulta con tu profesional
bilinge
preparar/agrupar/unir
Asset
Activo

Asistente de gerente de distrito
Asistente de director regional
En H&R Block tenemos 50 aos
de experiencia en la preparacin
de planillas
En oficinas participantes
At-Risk Rules
Reglas sobre el riesgo
ATM
ATH
Audit
Auditora
Audit assistance
Audit Assistance
Asistencia en auditoras
Representacin en auditoras
Audit Services
Servicios de auditora
Auto Pay
Auto Pay (Pago automtico)
[first occurrence]; Auto Pay
[thereafter].
Atomated Teller Machine (ATM)
Cajero automtico (ATH)
Automatic payment
Pago automtico
Availability
Disponibilidad
Average
Promedio
Ausente de la vivienda familiar
por una noche
B
Background check
Verificacin de antecedentes
Bad Debts
Deudas incobrables
Balance
Balance
Balance Due
Balance adeudado
Balance Due Loan

Prstamo de balance adeudado
Bank Account
Cuenta bancaria
banco
Bank products
Productos bancarios
Bankruptcy
Quiebra
Based on
Sobre la base de
Basic Building Blocks (B)
Course
Basis
Base
Basis of Stock
Base de acciones
Be up-to-date
Estar actualizado / Estar al da
Benchmark plan
Plan de referencia
Beneficiary
Beneficiario
Benefits
Beneficios
Bequest
Legado
Block Advantage Statement
Estado de cuenta de la ventaja
de Block
Bond
Ttulo
Bottom line
Ganancias netas
Bronze plan
Plan Bronce
Desarrollar tu base de clientes
Business Assets
Activos comerciales
Business Cards
Tarjetas de presentacin
Business Day
Da laboral
Business Expenses
Gastos de negocio
Business Income
Ingresos de negocios
Page 3

Interrupcin de la actividad de
negocios
Business Related
Relacionado con el trabajo
Gastos relacionados con el
trabajo
Bienes de uso de negocios
C
Cafeteria Plan
Plan de beneficios tipo cafetera
Calendar Year
Ao calendario
Capital Asset
Bienes de capital
Capital Expenditure
Gastos de capital
Capital Gain
Ganancias de capital
Distribuciones de ganancias de
capital
Capital Gain Tax
Contribuciones sobre ganancias
de capital
Capital Improvement
Mejora de capital
Capital Investment
Inversin de capital
Capital Loss
Prdida de capital
Capital Stock
Acciones de capital
Capitalize
Capitalizar
Gastos de automvil y camin
Career
Carrera
carryback (forward)
Prdida neta de operacin
aplicada a aos anteriores
(posteriores)
Carryover
Traslado
Page 4
Carryover Loss
Prdida trasladada al ao
siguiente
Mtodo contable a base de
efectivo
Cobro a la entrega
Casualty Loss
Prdida fortuita
CBT
CBT (Capacitacin basada en
computadora) [first occurrence];
CBT [thereafter].
Certificate
Certificado
Certificado de depsito
Certification
Certificacin
Charged by
Cobrado por
Donativo / Donacin
Donaciones a la caridad /
Donaciones de caridad /
Entidades benficas
Check
Revisar
Check charge
Cargo por cheque
Cargo por procesamiento de
cheque
Checking (review)
Revisin
Checklist
Listado
Crdito por cuido de hijos y
dependientes
Child Care Credit
Crdito por cuidado de hijos
Pensin alimentaria
Child Tax Credit
Crdito federal por
dependientes
Claim of Right
Reclamacin por derecho
Prstamo de Rintegro
Anticipado Clsico (Classic
Refund Anticipation Loan, RAL)
Client
Cliente
Client Income Information
Worksheet
Hoja de cmputos para
informacin sobre ingresos del
cliente
Client support
Asistencia al cliente
Client-take-away
Material para cliente aprobado
Cobro a la entrega
Collectibles
Objetos de coleccin
Combine
Combinar
Commission
Comisin
Commodity Futures
Bienes comercializados en el
mercado de futuros
Common Stock
Acciones ordinarias
Common-Law Marriage
Matrimonio de hecho
Community Income
Ingreso de sociedad conyugal
Community Property
Bienes gananciales / Sociedad
matrimonial
Commuting
Viajar de ida y vuelta al trabajo
Oficinas propias de la compaa
Compensation
Compensacin/remuneracin
Complex Return
Planilla compleja
Compliance
Cumplimiento
Condemnation
Expropiacin
Championed
Conectados, Confiados y
Representados
Consent to disclose
Consentimiento para divulgacin
Consent to Disclose Information,
7216
de informacin, 7216

Consent to Disclose Tax Return
Information
Consentimiento para divulgar la
informacin de la planilla
Consent to Use
Consentimiento de uso
Information
informacin de la planilla de
(Consent to use Tax Return
Information)
Recibo implcito
Continue
Continue (Continuar) (software)
Crdito para la educacin
continua (CEC)
Continuous support
Apoyo continuo
Contract for Deed
Contrato para ttulo
Contract Holder
Poseedor del contrato
Contract Price
Precio contractual
Contribution
Donacin (a la caridad) /
contribucin /aportacin
Convertible
Convertible (bond, currency,
debenture, debt, etc.)
Copyright
Derechos de autor
Cost
Costo
Cost Depletion
Agotamiento del activo
Cost Method of Inventory
Valuation
Mtodo de valuacin de
inventario al costo
Cost of Goods Sold
Costo de mercancas vendidas
Costo de mantenimiento del
hogar
Cost Recovery
Coupon
Cupn
Coupon Bond
Bono al portador
Course(s)
Curso(s)
Coverdell Education Savings
Account (ESA)
Cuentas de ahorro para la
educacin Coverdell (ESA)
Crdito por gastos de cuido
Credit Worthiness
Solvencia crediticia
Credits
Crditos
Custodial Parent
Padre o madre con custodia
Customer Service
Servicio al cliente
D
Administrador de base de datos
Date of birth
Fecha de nacimiento
Dealer (commercial)
Distribuidor/a
Dealer (commercial)
Concesionario/a
Dealer (securities)
Revendedor/a (de valores)
Nmero de control de planilla
Depreciation
Mtodo de depreciacin por
saldos decrecientes
Deduction
Deduccin
Deductions
Deducciones
Default
Opcin por omisin
Plan de compensacin diferida
Deferred Income
Ingresos diferidos
Plan de beneficios definidos

Planes de contribucin definida
Delete
Borrar
Delivery Envelope
Sobre de entrega
Department ID (DID)
Identificacin del departamento
Exencin de dependencia
Dependent
Dependiente
Crdito por cuidado de
dependiente
Insurance
Depletion
Agotamiento
Depletion Allowance
Descuento por agotamiento
Depreciable Asset
Activo depreciable
Depreciation
Depreciacin
Direct Deposit (DD)
Depsito directo
Disaster Victims
Disability Pension
Disabled
Discapacitado
Disaster Loss
Prdida por un desastre
Disclose
Revelar
Disclosure Statement For Classic
RAL
RAL clsico
Discount
Descuento
Discount offer
Oferta de descuentos
Disposicin (de bienes)
Distribution
Distribucin
Page 5

Distribution from pensions,
annuities, retirements or profitsharing plans, IRAs, insurance
contracts, etc.
Distribuciones de pensiones,
anualidades, retiros o planes de
participacin en las ganancias,
cuentas IRA, contratos de
seguros, etc.
District
Distrito
Gerente de distrito
Supervisor de oficina de distrito
Centro de asistencia de distrito
District Technical Support
Specialist (DTSS)
Especialista en asistencia
tcnica de distrito
Dividend
Dividendo
Dividend Income
Ingresos de dividendos
Division
Divisin
Sentencia de divorcio (definitiva)
(interlocutoria)
Jointly?
Do you plan to file Married
Filing Jointly? (Piensa
presentar la declaracin como
casado que radica una
declaracin conjunta?)
Deduction
produccin domstica
Revisar/Verificar
Drop-off services
Servicios de entrega drop-off
Page 6
E
Earn extra income preparing
taxes*
Gana dinero extra preparando
planillas*
Earned Income
Ingresos de trabajo
Crdito contributivo
(Comprobante de ingresos, E &
D)
Easy IRA
Easy IRA
Easy Products
Productos Easy
Easy Savings
Easy Savings
EasyPay
EasyPay (internal use)
E-commerce
Comercio electrnico
Edit
Edit (Modificar) (software)
Education credits
Crditos contributivos por
enseanza superior
(universitaria)
educacin
Cuenta de ahorros para la
educacin
educador
Effective Date
Fecha de vigencia
Procesamiento de datos
electrnicos
System (EFTPS)
Sistema federal de pago
electrnico de contribuciones
Planilla electrnica
Transferencia electrnica de
fondos

Noticias electrnicas
Elementary (school)
(Escuela/estudios) elemental e
intermedio
Eligible Educator
Educador elegible
Hijo de crianza elegible
E-mail
Correo electrnico
Solicitud y Trminos y
Condiciones de la lnea de
crdito Emerald Advance
Emerald Advance
Advance
Emerald Card Payroll Direct
Deposit Form
Formulario de depsito directo
de nmina en la tarjeta
prepagada Emerald Card
Emerald Card
Tarjeta prepagada Emerald
Card [(La) tarjeta]
Recompensas de dinero en
efectivo Emerald Cash Rewards
Tarjeta prepagada Emerald
Prepaid MasterCard [(La)
tarjeta]
Solicitud de apertura de cuenta
de ahorro Emerald Savings
Emerald Savings
Emerald Savings
Emerald Savings account
Cuenta de ahorro Emerald
Savings
Emerald Secured Credit Card
Tarjeta de crdito garantizada
Emerald Secured Credit Card
Eminent Domain
Derecho de expropiacin.
Dominio eminente.
Employee
Empleado
Employer Identification Number
(EIN)
empleador

Plan
Plan de retiro mantenido por el
empleador
Employment Expenses
Gastos de empleo
Enroll Now
Inscrbete ahora
Gastos de entretenimiento
Estate
Patrimonio
Estimate
Estimacin
Vida til estimada
Estimated Income
Ingresos estimados
Estimated Tax
Contribuciones estimadas
Every cent counts
Cada centavo cuenta
Every opportunity that might
benefit you
Todas las oportunidades que te
puedan beneficiar
Desalojo/Ejecucin hiptecaria
Excess Social Security Tax
Withheld
Retencin contributiva de
Seguro Social excedente
Exchange
Cambio
Exchange Rate
Tasa de cambio
Excise Taxes
Impuesto a la venta y uso (IVU)
Excluded Gain
Ganancia excluida
Exclusion
Exclusin
residentes autnticos (bona fide)
de la Samoa Estadounidense
Exemption
Exencin
Nmero de certificado de
exencin
Exencin de la retencin
Expenses
Gastos
Experience
Experiencia
Especialista en planillas
Expertise
Conocimiento especializado
Expires
Vence / Vencimiento
Express IRA
Express IRA
Extension
Extensin
F
Informacin sobre las lneas de
crdito
Loans
Informacin sobre los prstamos
de reintegro anticipado
Valor justo en el mercado
Fair Rental Value
Valor justo de alquiler
Farm Business
Negocio(s) agropecuario(s)
Farm Operation
Trabajos agropecuarios
Farm Proprietor
Empresario agropecuario
Farmer
Trabajador agropecuario
Farming
Actividad(es) agropecuaria(s)
Farming Income
Ingresos provenientes de
actividades agropecuarias
Fast Money Options
Planillas federales y estatales
Planilla federal
Retencin contributiva federal
Federal Income Tax Withholding
(FIT)
Retencin contributiva federal
Federal Insurance Contributions

Act (FICA)
al Seguro (FICA)
Federal Marketplace
Mercado federal
Nivel de pobreza federal
(Federal Poverty Level, FPL)
Federal Refund Anticipation
Check
Cheque de reintegro anticipado
federal (Cheque Federal RAC)
Federal Return
Planilla federal
Federal taxes paid
Federal taxes paid
(Contribuciones federales
pagadas) (software)
Fee/Fees
Tarifa/Tarifas; Cargo/Cargos
Feel, Felt, Found
Sentir
Fellowship
Pensin (beca) para realizar
pesquisas o investigaciones
Contributions Act)
al Seguro (FICA)
Fiduciary
Fiduciario
File a tax return
Radicar la planilla
Filing
Radicacin de la planilla
Filing deadline
Fecha lmite de radicacin de la
planilla
Filing requirements
Requisitos para la radicacin de
la planilla
Filing status
Estado civil para efectos de la
planilla
Finance charge
Cargo de financiamiento
Finance Charges
Cargos de financiamiento
Consejero financiero
Financial Centers
Centros financieros
Page 7

Financial Services
Primeras entradas, primeras
salidas (First In, First Out, FIFO)
Fiscal Planning
Planificacin fiscal
Fiscal Year
Ao fiscal
Proceso de divulgacin en cinco
pasos
Fixed-Rate Mortgage
Hipoteca de tasa fija
Para una oficina cerca de ti
Exclusin de ingresos ganados
en el extranjero
Foreign income
Ingresos ganados en el
extranjero
Deduccin o crdito por
contribuciones extranjeras
Form
Planilla
Forms Selection
Foster Child
Hijo de crianza
Franchise
Franquicia
Gerente de franquicia
Gerente de distrito de franquicia
Servicios de notario gratuitos
Planillas de amigos y familiares
Fringe Benefits
Beneficios marginales
Asistente de oficina
Full Retirement Age
Edad de retiro completo
Full-Time Student
Estudiante a tiempo completo
Pensiones completamente
tributables
Page 8
Gain
Ganancia
Sistema general de
depreciacin
General Rule
Regla general
General Sales Tax
Contribucin sobre venta
System
Sistema general de
depreciacin uniforme
Recibe cada centavo que te
corresponde
Gift
Regalo
Gift Tax
Contribuciones sobre
donaciones
Golden Parachute
Contrato blindado
Good Neighbor
Buen Vecino
Goodwill
Fondo de
comercio/plusvala/buen nombre
Discount
Ttulos del gobierno emitidos
con descuento
Gross Income
Ganancia bruta
Gross Profit
Utilidad bruta
Gross Rent
Renta bruta
Seguro de vida grupal
Guaranteed Issue
Emisin garantizada
Reintegro mximo garantizado

Informe H&R Block Advantage
Report [first occurrence]; H&R
Block Advantage Report
[thereafter].
H&R Block Advantage
H&R Block Advantage
H&R Block Easy IRA
Cuenta H&R Block Easy IRA
Productos H&R Block Easy
Cuenta de ahorro H&R Block
Easy Savings
line of credit
Lnea de crdito H&R Block
Amerald Advance
Tarjeta prepagada H&R Block
MasterCard
Folleto informativo rgido de 4
caras (table topper) de tarjeta
prepagada H&R Block Emerald
Prepaid MasterCard
Emerald
H&R Block Emerald SavingsSM
account
Emerald SavingsSM
H&R Block Emerald SavingsSM
Disclosures
Divulgaciones de la cuenta de
ahorro H&R Block Emerald
SavingsSM
Emerald Savings
account
Emerald Savings

H&R Block Emerald Secured
MasterCard Credit CardSM
Tarjeta de crdito garantizada
H&R Block Emerald Secured
MasterCard Credit CardSM
H&R Block Express IRA
H&R Block Express IRA
H&R Block Financial Advisor
Consejero financiero de H&R
Block
H&R Block Franchise
H&R Block Guarantee
Curso de Preparacin de
Planillas de H&R Block
H&R Block offers you many
options
H&R Block te ofrece muchas
opciones
Oficina Premium de H&R Block
H&R Block Promise
Promesa de H&R Block
Los especialistas en planillas de
H&R Block
Hardship
Problemas econmicos
Hardship Case
Caso de dao indebido
Hardship Exemption
Exencin por problemas
econmicos
Hardship Withdrawal
Retiro por problemas
HDHP
Plan HDHP
Head of Household
Jefe de familia
Head of Household Filing Status
(HH)
Jefe de familia que declara
Impuestos
Departamento de Salud y
Servicios Humanos (HHS, por
sus siglas en ingls)
Health Coverage
Cobertura de salud
Health Insurance
Seguro de salud
Cuenta de ahorros para la salud
(Health Savings Account, HSA)

Plan mdico de deducible alto
(High Deductible Health Plan,
HDHP)
Hobby Loss
Prdidas por juegos
Hold
En espera
Holding Period
Perodo de posesin
Gastos de oficina en la casa
Homelessness
Falta de vivienda
Homeowner
Propietario
Hope Credit
Crdito contributivo "Hope"
Household Employee
Empleado domstico
Household Expenses
Gastos domsticos
hrblock.com
hrblock.com/puertorico
HSA
Cuenta HSA
Recursos Humanos
Husband and Wife
Esposo y esposa
Imputed Interest
intereses impuestos
In good standing
Estar al da
Income
Ingresos
Income averaging
Ingresos promedios
Income Entry
Registro de ingresos
Income tax
Contribucin sobre ingresos
Curso de Preparacin de
Planillas
I
I Am Worth It
I Am Worth It (Yo lo valgo) [First
occurrence (when necessary)]; I
Am Worth It [thereafter]
Identifying Numbers
Nmeros de identificacin
Si no ests satisfecho
Member
Familiar enfermo, discapacitado
o de edad avanzada
Informacin importante sobre
Planillas
Page 9

(Individual Performance Plan,
IPP) [first occurrence]; IPP
[thereafter].
Individual Retirement Account
(IRA)
Cuenta de Retiro Individual
(Individual Retirement Account,
IRA)
Inheritance
Herencia
Initial
Inicial
Income)
Mtodo de ingreso anual a
plazos
Instant money
Dinero al Instante
Instant Money RAL
Prstamo instantneo de
reintegro anticipado
Fondos provenientes del
prstamo instantneo de
Prstamo Instantneo de
Reintegro Anticipado (Prstamo
RAL Instant Money)
Instant RAL
Prstamo instantneo de
Prstamo de Reintegro
Anticipado Instantneo
Insurance Dividends
Insurance policy
Pliza de seguro
Bienes personales intangibles
Interest income
Ingresos de intereses
Interest rate
Tasa de inters
Interest Received
Intereses recibidos
Decreto interlocutorio
Servicio Federal de Rentas
Internas
Page 10

Proveedor de Servicio de
Internet
Internet, the Net
Internet
Entrevistar
Interview (noun)
Entrevista
Inventory
Inventario
Investment
Inversin
Investment Income
Ingresos por
inversiones/inversin
Investment Interest
Intereses de inversin
Investment Property
Bienes de inversin
Conversin involuntaria
IPP
(Individual Performance Plan,
IPP) [first occurrence]; IPP
[thereafter].
IRA
Cuenta IRA
IRS
IRS
IRS Check
Cheque del IRS
Itemize
Detallar
Itemized Deductions
ITIN
El nmero de ITIN
J
Job
Trabajo
Joint Return
Planilla conjunta
Joint Tenancy
Tenencia conjunta
Joint Venture
Empresa conjunta
Bienes mancomunados
K
Kindergarden
Kinder
L
Labor Code
Cdigo de trabajo
Land Value
Valor del terreno
ltimas entradas, primeras
salidas (Last In, First Out, LIFO)
Late fee
cargo por pago atrasado
Aprende a preparar planillas
Leave and Earnings Statement,
LES
Comprobante de licencias y
salarios acumulados (Leave and
Earnings Statement, LES)
Legally Blind
Legalmente ciego
Legally Separated
Separados legalmente
Lender
Prestamista
Lessee
Arrendatario, inquilino
Lessor
Arrendador
Crdito vitalicio por aprendizaje
Limited
Limitado/a
Link
Enlace
Liquidation
Liquidacin
Distribuciones de liquidacin
Listed Property
Propiedades listadas
Cargar (a la tarjeta prepagada
Emerald Card)
Load the loan money
Poner el dinero del prstamo
Loan
Prstamo

Loan Agreement
Acuerdo de prstamo
Loan Application
Location near you
Oficina cerca de ti
Lodging
Alojamiento
Ganancias de capital a largo
plazo
Inventory Valuation
Mtodo de valuacin de
inventario al menor costo o de
mercado
Loyalty
Lealtad
Programa de reembolso para
clientes leales
Distribuciones de una suma
global
M
Mail a payment
Pago por correo
Main Home
Vivienda principal
Franquicia principal
Malpractice
Negligencia profesional
Support (MROS)
Gerente, asistencia regional de
operaciones
Seminarios de Habilidades
Gerenciales
Margin
Margen
Marketing
Mercadeo
Marketplace
Mercado
Decisions
Decisiones sobre apelaciones
de elegibilidad del Mercado
Marketplace Exemption
Application
Aplicacin de exencin del
Mercado
Marriage
Matrimonio
Casado/s que radica/n una
planilla conjunta
Casado/s que radica/n una
planilla por separado
Participacin significativa
Maximum Refund
Mximo reintegro
Garanta de mximo reintegro
Maximum refund you are entitled
to
Mximo reintegro que te
corresponde
Mximo reintegro garantizado
MBTO
MBTO
Sin elegibilidad para Medicaid
Estados sin expansin de
Medicaid
Medical Expenses
Gastos mdicos
Medical Insurance
Seguro mdico
Medicare Part A
Parte A de Medicare
Medicare Part B
Parte B de Medicare
Retencin Contributiva de
Medicare
Mileage Allowance
Concesin por millas
Tasa por milla (Mtodo opcional)
Military Return
Planilla contributiva militar
Miscelneo

Program
Programa Mission Values
Participant (MVP)
Modified Accelerated Cost
Recovery System (MACRS)
modificado (Modified
System, MACRS)
Modified AGI (MAGI)
AGI modificados
Money Transfer
Dinero sin necesidad de invertir
de tu bolsillo
Dinero que te corresponde
Mortgage
Hipoteca
Certificado de crdito
hipotecario
Mortgage Interest
Intereses hipotecarios
Mortgage Services
Moving Expenses
Gastos de mudanza
Acuerdo de manutencin
mltiple
Mutual Fund
Fondos mutuos
My tax refund
El reintegro contributivo
(MBTO)
"myBlockSM para la oficina de
preparacin de planillas (MBTO)
myStarting Block
myStarting Block
N
National Tax Advice Day
Da nacional de asesoramiento
sobre planillas
Nearly
Casi
Necessary Expenses
Gastos Necesarios
Page 11

Prdidas netas de operacin
No te conformes con menosSM
New Client
Cliente nuevo
Deudas incobrables no
relacionadas con el negocio
Noncustodial Parent
Padre o madre no custodio
Programa de recomendaciones
para organizaciones sin fines de
lucro
Nonresident Alien
Distribuciones no tributables
Nontaxable Exchange
Intercambio no tributable
Nontaxable Income
Ingreso no tributable
Not valid
No vlido, Nulo
Notary Services
Servicios de notario
O
Offer
Oferta
Office Leader (OL)
Lder de oficina
Satisfaccin de nivel de oficina
(OLS)
Encuesta de nivel de oficina
(Office Level Survey, OLS)
Office Manager (OM)
Gerente de oficina
Offline
Fuera de lnea / Sin conexin
Online
En lnea o conectado
Online services
Servicios en lnea
Page 12

Preparacin de planillas en lnea
(Currently not available in
Spanish)
Option
Opcin
Ordinary Dividends
Ordinary Expenses
Gastos Ordinarios
Ingresos (prdidas)
ordinarios/as
Out-of-state return
Planilla fuera del estado
Overpay
Pagar de ms
P
Participating
Participando
Pensiones parcialmente
tributables
Partnership
Sociedad
Passive Income
Ingresos pasivos
Passive loss
Prdida pasiva
Past returns
Planillas pasadas
Past tax returns
Planillas pasadas
Patent
Patente
Pay
Pagar
Pay down date
Fecha de pago
Pay stub
Talonario de pago
Payroll taxes
Contribucines sobre la nmina
Peace of Mind
Peace of Mind
Peace of Mind Extended Service
Plan
Plan de servicio extendido
Peace of Mind

Penalidades e intereses
Pension
Pensin
Pension Fund
Fondo de pensin
Pension Plan
Plan de retiro
anualidad/pensin
Period
Perodo
Discapacidad permanente y
total
Personal and Dependency
Exemptions
Exenciones personales y de
dependencia
Personal Expenses
Gastos personales
Personal Property
Bienes muebles
Contribuciones sobre bienes
races
Personal Residence
Residencia personal
Bienes de uso personal
Phaseout
Eliminacin por fases
Physical Custody
Custodia fsica
Point of Sale (POS)
Punto de venta
Points
Puntos
Normas y procedimientos
Ingresos y prdidas de cartera
Posible multa fiscal conforme a
la Ley ACA
Premium Guarantee
Garanta Premium
Crdito Contributivo por la Prima
Prepaid Expenses
Gastos prepagados
Prepaid Interest

Preparar planillas
Pretax
Antes de contribuciones
Pre-tax
Antes de contribuciones
Principal
Principal
Residence)
lugar de residencia principal
Lugar principal de negocios
Principal Residence
Residencia principal
Printed (name)
En letra de molde
Prior Client
Cliente previo (anterior)
Prior Client Calling Program,
PCCP
Programa de llamada a clientes
anteriores (Prior Client Calling
Program, PCCP)
Prizes and Awards
Premios y recompensas
Pro forma
Pro forma
Oficina de resolucin de
problemas
Servicio profesional de
preparacin de planillas
Prohibited
Prohibido
Promueve tu conocimiento
especializado en planillas
Property Tax
Contribuciones sobre la
propiedad
Proprietor
Empresario por cuenta propia
Proprietorship
Empresa por cuenta propia
Put to the test
Poner a prueba
Puts and Calls
Opciones de compra y venta
Q
Organizacin de caridad
calificada
Qualified Dividends
Dividendos cualificados
Seguro de salud cualificado
Qualified Pension or ProfitSharing Plan
Plan cualificado de pensin o de
participacin en las ganancias
Plan cualificado de matrcula
Qualifying Child
Hijo cualificado
Qualifying Relative
Pariente cualificado
Qualifying Widower
Viudo(a) que rene los
requisitos
Revisin de desempeo de
calidad (QPR)
Quote (Bid/Ask)
Cotizar
R
Cheque RAC
(RRTA)
Ley de contribuciones de retiro
ferroviaria (Railroad Retirement
Tax Act, RRTA)
Prstamo RAL
Real Estate
Bienes races
Real Property
Bienes races
Ganancia o prdida realizada
Descuento razonable
Reasonable Expenses
Gastos razonables
Recapture
Recuperacin
Recent Tax Changes

Cambios recientes referentes a
las contribuciones
Recognized religious sect
Secta religiosa reconocida
Reconcialiation
Conciliacin
Recovery
Recuperacin
Recovery of Cost
Recuperacin de costo
Recovery Period
Perodo de recuperacin
Referral
Referido
Referral fee
Pago por referido
Referral form
Formulario de referido
Referral program
Programa de referidos
Refile
Volver a llenar la planilla
Refiling fees apply
Se aplican cargos por volver a
someter la planilla
Refinancing
Refinanciamiento
Refund
Reintegro
Refund account fee
Cargo por cuenta de reintegro
Cheque de Reintegro Anticipado
(Cheque RAC)
Anticipado
Anticipado (Prstamo RAL)
Cuenta de depsito de reintegro
Refund Options
Opciones de reintegro
Refund Planning
Planificacin de reintegro
Refund Transfer, RT
Transferencia de reintegro
(Refund Transfer, RT)
Page 13

Refundable Credit
Crdito reembolsable
Gerente de cuentas regional
Director regional
Regional Financial Support
Specialist (RFSS)
Especialista regional en
asistencia financiera
Director regional de franquicia
Regular Method
Mtodo regular
(Mutual Fund)
Sociedad inversionista
reglamentada (fondo mutuo)
Regulations
Reglamentos
Reliable Accuracy
Exactitud confiable
Reload (as in money on your
Emerald Card)
Poner ms dinero
Rent
Renta
Rental Income
Ingresos por alquiler/es
Repairs
Reparaciones
Limitacin de reintegro
Replacement Period
Perodo de reemplazo
Reported income
ingresos declarados
Repossession
Recuperacin de un bien
Reschedule
Volver a programar
Resident Alien
Rest assured
Quedarte totalmente tranquilo
Results
Results (Resultados) (software)
Retail Sales
Ventas al detal
Retirement
Retiro
Page 14
Return (noun)
Planilla
Rendimiento de la inversin
Right
Derecho
Rollover
Reinversin / transferencia
Roth IRA
Cuenta de retiro individual Roth
/ IRA Roth / Cuenta IRA Roth
Royalty
Regalas
RRTA
RRTA
S
S Corporation
Corporacin S
Safe Harbor
Puerto seguro
Salvage Value
Valor residual, valor de
salvamento o valor recuperable
Satisfaccin garantizada
Schedules
Anexos
Becas (in general terms) Becas
de estudio y de investigacin.
Becas de estudio. Becas de
investigacin.
Scrap Sales
Ventas de desechos
Segunda revisin de tu planilla
Second Look Review
Revisin Second Look
Plan Plata de segundo costo
ms bajo
Seccin
Trabajador por cuenta propia
propia
Self-Employment Tax
Contribuciones sobre el trabajo
por cuenta propia
Send-A-Friend
Enva a un amigo
Send-A-Friend Client Referral
Program
Programa de referidos de
clientes Enva a un amigo
Send-A-Friend Program
Programa Enva a un amigo
SEP
Plan SEP
Pagos de manutencin por
separacin judicial
Service
Servicio
Settlement Options
Opciones para liquidar pagos
Settlement Products
Productos para liquidar pagos
Settlement Products
Productos de pago
compartida
Shareholder
Accionista
Shine in 09
Brillar en el 2009
Short term
Corto plazo, a corto plazo
Prstamo a corto plazo para el
consumidor
SIMPLE
Plan SIMPLE

Plan de incentivo de ahorro con
contribuciones equivalentes del
empleador para empleados
(Savings Incentive Match Plan
for Employees, SIMPLE)
Pensin simplificada para
empleados (Simplified
Employee Pension, SEP)
Simplified Method
Mtodo simplificado
Single
Soltero/no casado/nico
Social Security and Medicare
taxes
Contribuciones de Seguro
Social y de Medicare
Nmero de Seguro Social
Retencin Contributiva de
Seguro Social
Propinas para efectos del
Seguro Social
Salarios para efectos del Seguro
Social
Sole proprietor
Sole proprietorship
Solid
Slido
Special Averaging
Promedio especial
Concesin especial para
depreciacin
Specialized
Especializado
Speed of refund
Velocidad de reintegro
Spend some. Save some. Borrow
some.
Gasta un poco. Ahorra un poco.
Toma prestado un poco.
Spousal IRA
IRA a nombre del cnyuge
Stability
Estabilidad
Standard Deduction
Deduccin estndar
State Marketplaces
Mercados estatales
Tasa estndar por milla
(STD)
Deduccin estndar
State or Local Income Tax
Withheld
Retencin de contribuciones
estatales o locales sobre
ingresos
(RAC)
Estado (Cheque Estado RAC)
State Return
Planilla estatal
Statement
Estado de cuenta
Statements
Estados de cuenta
Status
Estatus
Statutory Employee
Empleado estatutario
Stock Dividend
Dividendos en acciones
Stock Option Plan
Plan de opciones de compra de
acciones
Mtodo de depreciacin
uniforme
Deduccin por intereses de
prstamo estudiantil
Student(s)
Estudiante(s)
Subject to
Sujeto a
Success
xito
Solicitud suplementaria
Supplement Application for
Solicitud suplementaria de
Prstamo de reintegro
anticipado (include English
when necessary)
Refund Anticipation Check(s) And
A Refund Deposit Account
relacionadas con la Solicitud de
Cheque(s) de reintegro
anticipado y Cuenta de depsito
de reintegro
Support
Manutencin
Supporting forms
Formularios suplementarios
T
Table topper
caras (Table Topper) [first
occurrence]; folleto informativo
rgido de 4 caras [thereafter].
Take the course
Toma el curso
Course.
Toma el Curso de Preparacin
de Planillas de H&R Block.
Talk to our bilingual tax
professionals
Consulta con nuestros
especialistas bilinges en
planillas
Consulta con tu especialista en
planillas
Bienes personales tangibles
Contribucin retenida
Necesidades fiscales y
financieras
Tax authority
Autoridad fiscalizadora
Tax Benefit
Beneficio contributivo
Tax Bracket
"Rengln de contribuciones
Tax Consulting
Consultora en planillas
Tax Credit
Crdito contributivo
Page 15

Deducciones y beneficios
contributivos
Tax Estimator
Tax Estimator (Calculadora
contributiva)
Tax Experience
Experiencia en planillas
Tax Home
Domicilio fiscal
Tax Household
Unidad familiar a efectos
fiscales
Tax interview
Entrevista fiscal
Prueba de valoracin del
conocimiento sobre
contribuciones Tax Knowledge
Assessment
Tax Laws
Leyes contributivas
Tax Liability
Responsabilidad contributiva
Tax Money
Dinero de contribuciones
Tax Office
Oficina de H&R Block [Do NOT
use oficina de preparacin de
planillas]
Tax Planning
Planificacin de contribuciones
Preparacin de planillas
Lista de documentacin
necesaria para la preparacin
de planillas
Software para la preparacin de
planillas
Tax Pro Finder
Tax Pro Finder
Tax Professional
Tax professional
Desarrollador de negocios para
el Especialista en Planillas
Discussion
Conversacin sobre desarrollo
del Especialista en Planillas
Page 16

Pasaporte del Especialista en
Planillas
Tax Rate
Tasa de contribucin
Tax Rate Schedules
Tarifas Contributivas
Tax Refund
Reintegro contributivo
1040, 1040E)
Planilla
Tax returns from the past three
years
Planillas de los ltimos tres aos
Tax Season
Temporada de Planillas
Tax Table
Tabla de contribuciones
Tax talks
Charlas sobre Planillas
Tax Terms
Vocabulario contributivo
Tax Time
Tiempo de hacer las Planillas
Tax Underpayment
Reimbursement
Reintegro de pagos incompletos
de Contribuciones
Tax Year
Ao fiscal
Taxable Income
Ingresos tributables
Taxable Year
Ao contributivo
Spanish)
Software TaxCut
Contribuciones
Tax-Exempt Income
Ingresos exentos de
contribuciones
TaxNet
TaxNet
Taxpayer
Contribuyente
Promociones por radio y
televisin
Lugar temporal de trabajo
(context)
Tenancy in Common
Tenencia en comn

Gracias por tu confianza en
H&R Block
H&R Block Bank, a Federal
Savings Bank, member FDIC,
pursuant to a license from
H&R Block Bank, una Entidad
Bancaria Federal de Ahorros
(Federal Savings Bank),
Miembro de la Asociacin de
Seguros de Depsito Federal
(Federal Deposit Insurance
Corporation, FDIC) emite la
tarjeta prepagada
EXPRESSTAX Emerald
Prepaid MasterCard en con
MasterCard is issued by H&R
Block Bank, a Federal Savings
Bank, Member FDIC.
(Federal Savings Bank),
Miembro de la Asociacin de
Seguros de Depsito Federal
(Federal Deposit Insurance
Corporation, FDIC) emite la
tarjeta prepagada H&R Block
Emerald Prepaid MasterCard.
The H&R Block Promise
La Promesa de H&R Block
Tip Income
Total de contribuciones
federales estimadas
Trade Date
Fecha de comercializacin
Traditional IRA
Cuenta IRA tradicional
Transfer by phone
Transferencia telefnica
Travel Allowance
Asignacin para gastos de viaje
Travel Expenses
Gastos de viaje
Trust
Fideicomiso
Trust Experience
Experiencia en fideicomisos

Confiar en nosotros
Trustee
Administrador (de cuenta) fideicomisario
Divulgacin en las cuentas de
ahorro
Deduccin por matrcula y
gastos de educacin
W
W-2
Cobertura incosteable
Multas por pago incompleto
Unearned Income
Ingresos no derivados del
trabajo
Uninsured
No asegurado
Unrecaptured Gain
Up-to-date
Actualizado / Al da
Up-to-date (to be)
Utility Shut-Off
Formulario W-2 (Comprobante

de sueldo)
Warranty Products
We Are With You
Estamos contigo
We will assure you
Te aseguraremos
Web Page
Pgina web
Web Site
Sitio web
Crdito de bienestar social por
trabajo (Welfare-to-Work Credit)
Where is my money?
Dnde est mi reintegro?
Widow (Widower)
Viudo (viuda)
Deduccin en la retencin
Crdito por oportunidad laboral
(Work Opportunity Credit)
Compensacin del seguro
obrero
Crdito para familias
trabajadoras
Worksheet
Hoja de cmputos
www.hrblock.com
www.hrblock.com/puertorico
Vacation Home
Casa de vacaciones
Ver reporte en pantalla
Void
Nulo
Tus derechos como
contribuyente
Tu satisfaccin est garantizada
Cargos por la preparacin de tu
planilla

La preparacin de tus planillas
es gratis
Tu planilla, a tu manera
Z
Zip Code
Cdigo postal
Page 17
English-Spanish
Glossary of Terms: US
English to Spanish Glossary of Terms: US
English to Spanish
0-9
1040EZ
Formulario 1040EZ (Taxes
federales sencillos)
A
A location near you
Una oficina cerca de ti
A tax
Un tax
About
Acerca de
ACA Tax Penalty
Penalidad de impuestos de la Ley
ACA
Exencin de la penalidad de
impuestos de la Ley ACA
Accelerated Cost Recovery System
Sistema acelerado de recuperacin
de costos (Accelerated Cost
Recovery System, ACRS)
(AMP)
Programa de gerencia acelerado
(Accelerated Management Program,
AMP)
Accept Status
Aceptar estatus
Cargo de administracin de cuenta
(Account Administration Fee, AAF)
Account Executive
Ejecutivo de cuenta
Account Manager
Gerente de cuenta
Accountable Plan
Plan contable
Accounting Method
Mtodo de contabilidad
Accounting Period
Perodo contable
Mtodo contable a base de lo
devengado
Page 2
Accrued Interest
Intereses devengados
Accumulated Adjustments Account
(AAA)
Accumulation Period
Perodo de acumulacin
Acquisition Debt
Deuda de adquisicin
Action plans
Planes de accin
Active Income
Ingresos activos
Active Losses
Prdidas activas
Active Participant
Participante activo
Gastos reales (mtodo regular)
Add more Income
Add more Income (Agregar ms
ingresos) (software)
Crdito de taxes por hijo adicional
Adjusted Basis
Base ajustada
Ingresos actuales ajustados
(Adjusted Current Earnings, ACE)
Ingresos brutos ajustados (Adjusted
Gross Income, AGI)
Adoption Credit
Crdito por adopcin
anticipados
Advance Premium Tax Credit (APTC)
Crdito Tributario Anticipado por
la Prima (APTC, por sus siglas en
ingls)
Repayments
Reembolsos de Crditos Tributarios
Anticipados por la Prima
Carta de accin adversa
Advice Statement
Declaracin de asesoramiento

Ley de Atencin Mdica Asequible
(Affordable Care Act o ACA, por
sus siglas en ingls)
AGI
AGI
Alimony Payments
Allowable Miscellaneous Deductions
(AMID)
permitidas (Allowable
Miscellaneous Deductionsm, AMID)
Allowance
Descuentos
Mtodo alternativo (depreciacin
uniforme)
Alternative Depreciation System (ADS)
Sistema de depreciacin alternativa
(Alternative Depreciation System,
ADS)
Tax mnimo alternativo (Alternative
Minimum Tax, AMT)
Depreciation System
Sistema alternativo de depreciacin
uniforme
Amended Return
Declaracin enmendada
VISTA / National Civilian Community
Corps Member
AmeriCorps (estatles y nacionales)
/ VISTA / Miembro del Cuerpo Civil
Comunitario Nacional
Amortization
Amortizacin
Amount
Monto
Amount Realized
Cantidad realizada
AMT
AMT
An additional fee
Un cargo adicional
An average of
Un promedio de
Tasa porcentual anual (Annual
Percentage Rate, APR)
Method
Mtodo de ingreso anual a plazos

Annuitant
Pensionista
Annuity
Anualidad/renta vitalicia
Anti-Churning Rules
Reglas de prevencin de
transacciones deliberadas
Tasa federal aplicable (Applicable
Federal Rate, AFR)
Applicable Percentage
Application for a Refund Anticipation
Check and a Refund Deposit Account
Solicitud de Cheque de reembolso
anticipado y Cuenta de depsito de
reembolso
(Administrador de citas)
Approval
Aprobacin
Approve Online
Approve Online (Aprobacin en
lnea) [first occurrence]; Approve
Online [thereafter].
Material para cliente aprobado
Cuenta Archer MSA de ahorros
mdicos
Archer MSA
Cuenta Archer MSA
Tan rpido como lo elijas
Ask
Pedir/Solicitar/Preguntar
Consulta con tu profesional
bilinge
Preparar
Asset
Activo
Gerente de distrito adjunto
Director regional adjunto

En H&R Block tenemos 50 aos de
experiencia en la preparacin de
taxes
En oficinas participantes
ATM
ATM
Atomated Teller Machine (ATM)
Cajero automtico (ATM)
At-Risk Rules
Reglas sobre el riesgo
Audit
Auditora
Audit assistance
Audit Assistance
Asistencia en auditoras
Representacin en auditoras
Audit Support
Asistencia de auditora
Auto Pay
Auto Pay (Pago automtico) [first
occurrence]; Auto Pay [thereafter].
Automatic payment
Pago automtico
Availability
Disponibilidad
Average
Promedio
Ausente de la vivienda familiar por
una noche
B
Background check
Verificacin de antecedentes
Bad Debts
Deudas incobrables
Balance
Saldo
Balance Due
Saldo adeudado
Balance Due Loan
Prstamo de saldo adeudado
Bank Account
Cuenta bancaria

banco
Bank products
Productos bancarios
Bankruptcy
Bancarrota
Based on
Sobre la base de
Basis
Base
Basis of Stock
Base de acciones
Be up-to-date
Benchmark Plan
Plan de referencia
Beneficiary
Beneficiario
Benefits
Beneficios
Bequest
Legado
Bond
Ttulo
Bottom line
Ganancias netas
Bronze plan
Plan de categora Bronce
Desarrollar tu base de clientes
Business Assets
Activos comerciales
Business Cards
Tarjetas profesionales
Business Day
Da hbil
Business Expenses
Gastos de negocio
Business Income
Ingresos de negocios
Interrupcin de la actividad de
negocios
Business Related
Relacionados con el trabajo
Gastos relacionados con el trabajo
Bienes de uso de negocios
Page 3
C
Cafeteria Plan
Plan de beneficios tipo cafetera
Calendar Year
Ao calendario
Capital Asset
Bienes de capital
Capital Expenditure
Gastos de capital
Capital Gain
Ganancias de capital
Distribuciones de ganancias de
capital
Capital Gain Tax
Tax sobre ganancias de capital
Capital Improvement
Mejora de capital
Capital Investment
Inversin de capital
Capital Loss
Prdida de capital
Capital Stock
Acciones de capital
Capitalize
Capitalizar
Gastos de automvil y camin
Career
Carrera
carryback (forward)
Prdida neta de operacin aplicada
a aos anteriores (posteriores)
Carryover
Traslado
Carryover Loss
Prdida trasladada al ao siguiente
Mtodo contable a base de efectivo
Cobro a la entrega (Cash on
Delivery, COD)
Casualty Loss
Prdida fortuita
CBT
CBT (Capacitacin basada en
computadora) [first occurrence];
CBT [thereafter].
Certificate
Certificado
Page 4

Certificado de depsito
Certification
Certificacin
Charged by
Cobrado por
Donacin a la caridad
Donaciones a la caridad
Charitable donation
Donacin a la caridad
Check
Revisar
Check charge
Cargo por cheque
Cargo por procesamiento de
cheque
Checking (review)
Revisin
Checklist
Lista de verificacin
Crdito por cuidado de hijos y
dependientes
Child Care Credit
Crdito por cuidado de hijos
Pagos de pensin para hijos
menores
Child Tax Credit
Crdito de taxes por hijo
Claim of Right
Reclamacin de derecho
Prstamo de Reembolso Anticipado
Clsico (Classic Refund
Anticipation Loan, RAL)
Client
Cliente
Client Income Information Worksheet
Hoja de cmputos para
informacin sobre ingresos del
cliente
Client support
Asistencia al cliente
Client-take-away
Material para cliente
Cobro a la entrega (Collect on
Delivery, COD)
Collectibles
Objetos coleccionables
Combine
Combinar
Commission
Comisin
Commodity Futures
Bienes comercializados en el
mercado de futuros
Common Stock
Acciones ordinarias
Common-Law Marriage
Matrimonio de hecho
Community Income
Ingresos de la comunidad conyugal
Community Property
Comunidad de bienes
matrimoniales
Commuting
Traslado/s interurbano/s al trabajo
Oficinas propias de la compaa
Compensation
Compensacin/remuneracin
Complex Return
Declaracin compleja de taxes
Compliance
Conformidad
Condemnation
Expropiacin
Championed
Conectados, Confiados y
Representados
Consent to disclose
Consent to Disclose Information, 7216
de informacin,7216
Consent to Disclose Return Tax
Information
de informacin de declaracin de
taxes
Consent to Use
Consentimiento de uso
Information
taxes (Consent to use Tax Return
Information)
Recibo implcito
Continue
Continue (Continuar) (software)

Crdito para la educacin continua
(CEC)
Continuous support
Asistencia continua
Contract for Deed
Contrato para ttulo
Contract Holder
Poseedor del contrato
Contract Price
Precio contractual
Contribution
Donacin (a la caridad) /
contribucin /aportacin
Convertible
Convertible (bond, currency,
debenture, debt, etc.)
Copyright
Derechos de autor
Cost
Costo
Cost Depletion
Agotamiento del activo
Cost Method of Inventory Valuation
Mtodo de valuacin de inventario
al costo
Cost of Goods Sold
Costo de mercancas vendidas
Costo de mantenimiento del hogar
Cost Recovery
Coupon
Cupn
Course(s)
Curso(s)
Coverdell Education Savings Account
(ESA)
Cuentas de ahorros para la
educacin Coverdell (ESA)
Crdito por gastos de cuidado de
nios
Credit Worthiness
Solvencia crediticia
Credits
Crditos
Custodial Parent
Padre o madre con custodia
Customer Service
Servicio al cliente
D
Administrador de base de datos
Date of birth
Fecha de nacimiento
Dealer (commercial)
Distribuidor/a
Dealer (commercial)
Concesionario/a
Dealer (securities)
Revendedor/a (de valores)
Debit MasterCard
Tarjeta de dbito Debit MasterCard
Nmero de control de declaracin
(Declaration Control Number,
DCN)
Depreciation
Mtodo de depreciacin por saldos
decrecientes
Deduction
Deduccin
Deductions
Deducciones
Default
Opcin por omisin
Plan de compensacin diferida
Deferred Income
Ingresos diferidos
Plan de beneficios definidos
Planes de contribucin definida
Delete
Delete (Eliminar) (software)
Delivery Envelope
Sobre de entrega
Department ID (DID)
Identificacin del departamento
Exencin de dependencia
Dependent
Dependiente
Crdito por cuidado de dependiente
Insurance
Depletion
Agotamiento
Depletion Allowance
Descuento por agotamiento
Depreciable Asset
Activo depreciable
Depreciation
Depreciacin
Direct Deposit (DD)
Depsito directo
Dirty dozen
Docena de Estafas Mayores (Dirty
Dozen)
Disability Pension
Disabled
Discapacitado
Disaster Loss
Prdida por un desastre
Disaster Victims
Disclose
Divulgar
Disclosure Statement For Classic RAL
RAL clsico
Discount
Descuento
Discount offer
Oferta de descuentos
Disposicin (de bienes)
Distribution
Distribucin
Distribution from pensions, annuities,
retirements or profit-sharing plans,
IRAs, insurance contracts, etc.
Distribuciones de pensiones,
anualidades, jubilacines o planes
de participacin en las ganancias,
cuentas IRA, contratos de seguros,
etc.
District
Distrito
Gerente de distrito
Supervisor de oficina de distrito
Centro de asistencia de distrito
District Technical Support Specialist
(DTSS)
Especialista en asistencia tcnica
de distrito
Dividend
Dividendo
Page 5

Dividend Income
Ingresos de dividendos
Division
Divisin
Sentencia de divorcio (definitiva)
(interlocutoria)
Jointly?
Jointly? (Piensa presentar la
declaracin como casado que
presenta una declaracin conjunta?)
Deduction
produccin domstica
Revisar/Verificar
Drop-off services
Servicios de entrega drop-off
E
Earn extra income preparing taxes
Gana dinero extra preparando
taxes
Earned Income
Ingresos de trabajo
Crdito de taxes por ingresos de
trabajo
(Comprobante de ingresos, E & D)
Easy IRA
Easy IRA
Easy Products
Productos Easy
Easy Savings
Easy Savings
EasyPay
EasyPay (internal use)
E-commerce
Comercio electrnico
Edit
Edit (Modificar) (software)
Page 6
Education credits
Crditos tributarios por enseanza
superior (universitaria)
Deduccin de gastos de educacin
Cuenta de ahorros para la
educacin
Education tax benefits
Beneficios de taxes por educacin
Deduccin de gastos de educador
Effective Date
Fecha de vigencia
Procesamiento de datos
electrnicos
System (EFTPS)
Sistema federal de pago electrnico
de impuestos ["impuestos" since
IRS terminology]
Declaracin electrnica /
Presentacin electrnica de la
declaracin
Transferencia electrnica de fondos
Noticias electrnicas
Eligible Educator
Educador elegible
Hijo de crianza elegible
E-mail
Correo electrnico
Solicitud y Trminos y Condiciones
de la lnea de crdito Emerald
Advance
Emerald Advance
Advance
Emerald Card Payroll Direct Deposit
Form
Formulario de depsito directo de
nmina en la tarjeta prepagada
Emerald Card
Emerald Card
Tarjeta prepagada Emerald Card
[(La) targeta]
Recompensas de dinero en efectivo

Solicitud de apertura de cuenta de
ahorros Emerald Savings
Eminent Domain
Derecho de expropiacin. Dominio
eminente.
Employee
Empleado
Employer Identification Number (EIN)
empleador
Plan
Plan de jubilacin mantenido por el
empleador
Employment Expenses
Gastos de empleo
Enroll Now
Inscrbete ahora
Gastos de entretenimiento
Estate
Patrimonio
Estimate
Estimacin
Vida til estimada
Estimated Income
Estimated Income (Ingresos
estimados) (software)
Estimated Tax
Tax/taxes estimado/estimados
Estimator
Calculadora
Every cent counts
Cada centavo cuenta
Every opportunity that might benefit
you
Todas las oportunidades que te
puedan beneficiar
Desalojo/Ejecucin hipotecaria
Excess Social Security Tax Withheld
Retencin de taxes de Seguro Social
excedentes
Exchange
Cambio
Exchange Rate
Tasa de cambio
Excise Taxes
Impuestos sobre artculos de uso y
consumo
Excluded Gain
Ganancia excluida
Exclusion
Exclusin

residentes autnticos (bona fide) de
la Samoa Estadounidense
Exemption
Exencin
Nmero de certificado de exencin
Exencin de la retencin
Expenses
Gastos
Experience
Experiencia
Experto en preparacin de taxes
Expertise
Experiencia
Expires
Vence / Vencimiento
Express IRA
Express IRA
Extension
Extensin
F
Informacin sobre las lneas de
crdito
Loans
Informacin sobre los prstamos de
reembolso anticipado
Valor normal en el mercado
Fair Rental Value
Valor justo de alquiler
Farm Business
Negocio(s) agropecuario(s)
Farm Operation
Trabajos agropecuarios
Farm Proprietor
Empresario agropecuario
Farmer
Trabajador agropecuario
Farming
Actividad(es) agropecuaria(s)
Farming Income
Ingresos provenientes de
actividades agropecuarias
Fast Money Options

Formularios federales y estatales
Declaracin de taxes federal
Retencin de taxes federal
Federal Income Tax Withholding (FIT)
Retencin de taxes federal
Federal Insurance Contributions Act
(FICA)
Ley Federal de Contribuciones al
Seguro (FICA)
Federal Marketplace
Mercado federal
Nivel de pobreza federal (Federal
Poverty Level)
Federal Refund Anticipation Check
Cheque de reembolso anticipado
federal (Cheque Federal RAC)
Federal Return
Declaracin de taxes federales
Federal taxes paid
Federal taxes paid (Taxes federales
pagados) (software)
Fee/Fees
Tarifa/Tarifas; Cargo/Cargos
Feel, Felt, Found
Siento, Sintieron, Descubrieron
Fellowship
Pensin (beca) para realizar
pesquisas o investigaciones
Contributions Act)
Ley Federal de Contribuciones al
Seguro (FICA)
Fiduciary
Fiduciario
File a tax return
Presentar una declaracin de taxes
Filing
Presentacin de la declaracin
Filing deadline
Fecha lmite de presentacin
Filing requirements
Requisitos para la presentacin de
la declaracin
Filing status
Estado civil para la presentacin de
la declaracin
Finance charge
Cargo de financiamiento
Finance Charges
Cargos de financiamiento
Consejero financiero
Financial Centers
Centros financieros
Financial Services
Primeras entradas, primeras
salidas (First In, First Out, FIFO)
Fiscal Planning
Planificacin fiscal
Fiscal Year
Ao fiscal
Proceso de divulgacin en cinco
pasos
Fixed-Rate Mortgage
Hipoteca de tasa fija
Para una oficina cerca de ti
Exclusin de ingresos ganados en
el extranjero
Foreign income
Ingresos ganados en el extranjero
Deduccin o crdito por taxes
extranjeros
Form
Formulario
Forms Selection
Foster Child
Hijo de crianza
Franchise
Franquicia
Director de franquicia
Gerente de distrito de franquicia
Servicios de notario gratuitos
Declaraciones de amigos y
familiares
Fringe Benefits
Prestaciones suplementarias
Recepcionista
Full Retirement Age
Edad de jubilacin completa
Full-Time Student
Estudiante de tiempo completo
Page 7

Pensiones totalmente imponibles
H
G
Gain
Ganancia
Gambling
Ganancias de juegos de azar
Sistema general de depreciacin
General Rule
Regla general
General Sales Tax
Tax general sobre ventas
System
Sistema general de depreciacin
uniforme
Recibe cada centavo que te
corresponde
Gift
Donacin
Gift Tax
Taxes sobre donaciones
Golden Parachute
Contrato blindado
Good Neighbor
Good Neighbor
Goodwill
Fondo de comercio/plusvala/buen
nombre
Discount
Ttulos del gobierno emitidos con
descuento
Gross Income
Ingresos brutos
Gross Profit
Utilidad bruta
Gross Rent
Renta bruta
Seguro de vida grupal a trmino
Guaranteed Issue
Emisin garantizada
Reembolso mximo garantizado
Page 8

Informe H&R Block Advantage
Report [first occurrence]; H&R
Block Advantage Report
[thereafter].
H&R Block Advantage
H&R Block Advantage
H&R Block Advantage Statement
Estado de cuenta de H&R Block
Advantage
H&R Block At Home software (not
available in Spanish)
Software H&R Block At Home
H&R Block Easy IRA
Cuenta H&R Block Easy IRA
Productos H&R Block Easy
Cuenta de ahorros H&R Block
Easy Savings
H&R Block Emerald Advance Line
of Credit
Lnea de crdito H&R Block
Amerald Advance
MasterCard
MasterCard
caras (table topper) de tarjeta
prepagada H&R Block Emerald
Prepaid MasterCard
Emerald
Emerald Savings
Emerald Savings
account
Emerald Savings

account
Emerald Savings
Disclosures
Divulgaciones de la cuenta de
ahorros H&R Block Emerald
Savings
H&R Block Franchise
H&R Block Guarantee
Curso de Preparacin de Taxes de
H&R Block
H&R Block offers you many options
H&R Block te ofrece muchas
opciones
Oficina Premium de H&R Block
Los profesionales de taxes de H&R
Block
Hardship
Dificultades
Hardship Case
Hardship exemption
Exencin por dificultades
Hardship Withdrawal
Retiro por dificultades
HDHP
Plan HDHP
Head of Household
Jefe de familia
Head of Household Filing Status (HH)
Estado civil de jefe de familia
Servicios Humanos y de Salud
(HHS, por sus siglas en ingls)
Health coverage
Cobertura de salud
Health Insurance
Seguro de salud
Cuenta de ahorros para la salud
(Health Savings Account, HSA)
Plan mdico de deducible alto
(High Deductible Health Plan,
HDHP)
Hobby Loss
Prdidas por pasatiempos

Hold
Hold (Posponer) (software)
Holding Period
Perodo de posesin
Holiday
Da festivo
Gastos de oficina en la casa
Homelessness
Falta de vivienda
Homeowner
Dueo de casa
Hope Credit
Crdito tributario "Hope"
Household Employee
Empleado domstico
Household Expenses
Gastos domsticos
hrblock.com
hrblock.com/espanol
HSA
Cuenta HSA
Recursos Humanos
Husband and Wife
Esposo y esposa
I
I Am Worth It
I Am Worth It (Yo lo valgo) [First
occurrence (when necessary)]; I
Am Worth It [thereafter]
Identifying Numbers
Nmeros de identificacin
Si no ests satisfecho
Member
Familiar enfermo, discapacitado o
de edad avanzada
Informacin importante sobre taxes
Imputed Interest
Intereses imputados
In good standing
Estar al corriente
Income
Ingresos
Income averaging
Ingresos promediables
Income Entry
Income Entry (Registro de ingresos)
(software)
Income tax
Taxes sobre los ingresos
Curso de Preparacin de Taxes
(use "Taxes" also on the website)
(Individual Performance Plan, IPP)
[first occurrence]; IPP [thereafter].
Individual Retirement Account (IRA)
Cuenta de Jubilacin Individual
(Individual Retirement Account,
IRA)
[An/your/the] Individual Taxpayer
Identification Number (ITIN)
[Un/tu/el] Nmero Individual de
Identificacin para el
Contribuyente (ITIN)
Individual taxpayer identification
number (ITIN)
Nmero de identificacin personal
del contribuyente (Individual
taxpayer identification number,
ITIN)
Individual Taxpayer Identification
Number (ITIN) Services
Servicios de ITIN (Nmero
Individual de Identificacin para el
Contribuyente)
Inheritance
Herencia
Initial
Inicial
Income)
Mtodo de ingreso anual a plazos
Instant Money
Dinero al Instante (Instant Money)
Instant Money Anticipation Loan
(IMAL)
Prstamo Anticipado Dinero al
Instante
Instant Money RAL
Prstamo RAL Instant Money
Ingresos provenientes del Prstamo
RAL Instant Money

Prstamo Instantneo de
Reembolso Anticipado (Prstamo
RAL Instant Money)
Instant RAL
Prstamo instantneo de anticipo
de reembolso
Instantneo
Insurance Dividends
Insurance Policy
Pliza de seguro
Bienes personales intangibles
Interest income
Ingresos de intereses
Interest rate
Tasa de inters
Interest Received
Intereses recibidos
Sentencia interlocutoria
Servicio de Impuestos Internos
(Internal Revenue Service, IRS).
Proveedor de Servicio de Internet
Internet, the Net
Internet
Entrevistar
Interview (noun)
Entrevista
Inventory
Existencias / inventario
Investment
Inversin
Investment Income
Ingresos por inversiones/inversin
Investment Interest
Intereses de inversin
Investment Property
Bienes de inversin
Canjes involuntarios
IPP
(Individual Performance Plan, IPP)
[first occurrence]; IPP [thereafter].
IRA
Cuenta IRA
IRS
IRS
Page 9

IRS Check
Cheque del IRS
Itemize
Detallar
Itemized Deductions
ITIN
(El) Nmero de ITIN
ITIN Services
Servicios de ITIN
J
Job
Trabajo
Joint Return
Declaracin conjunta
Joint Tenancy
Tenencia conjunta
Joint Venture
Negocio en participacin
Bienes mancomunados
L
Labor Code
Cdigo de trabajo
Land Value
Valor del terreno
ltimas entradas, primeras salidas
(Last In, First Out, LIFO)
Late fee
cargo por pago atrasado
Aprende a preparar taxes
Leave and Earnings Statement, LES
Comprobante de licencias y
salarios acumulados (Leave and
Earnings Statement, LES)
Legally Blind
Legalmente ciego
Legally Separated
Separados legalmente
Lender
Prestamista
Lessee
Arrendatario, inquilino
Lessor
Arrendador
Page 10

Crdito vitalicio por aprendizaje
Limited
Limitado/a
Link
Enlace
Liquidation
Liquidacin
Distribuciones de liquidacin
Listed Property
Bienes enumerados
Ponerle dinero
Load the loan money
Poner el dinero del prstamo
Loan
Prstamo
Loan Agreement
Acuerdo de prstamo
Loan Application
Location near you
Oficina cerca de ti
Lodging
Alojamiento
Ganancias de capital a largo plazo
Inventory Valuation
Mtodo de valuacin de inventario
al menor costo o de mercado
Loyalty
Lealtad
Programa de reembolso para
clientes leales
Distribuciones de una suma global
M
Mail a payment
Pago por correo
Main Home
Vivienda principal
Franquicia principal
Malpractice
Negligencia profesional
Support (MROS)
Gerente, asistencia regional de
operaciones

Seminarios de Habilidades
Gerenciales
Margin
Margen
Marketing
Marketing
Marketplace
Mercado
Decisions
Decisiones sobre apelaciones de
elegibilidad del mercado
Marketplace Exemption Application
Aplicacin de exencin de mercado
Marriage
Matrimonio
Casado/s que presenta/n una
declaracin conjunta
Casado/s que presenta/n una
declaracin por separado
MasterCard Zero Liability
MasterCard Cero Responsabilidad
mastercardenespanol.com/ceroresp
onsabilidad
Participacin significativa
Maximum Refund
Mximo reembolso
Garanta de mximo reembolso
Maximum refund you are entitled to
Mximo reembolso que te
corresponde
Mximo reembolso, garantizado
MBTO
MBTO
No elegibilidad para Medicaid
Estados sin expansin de Medicaid
Medical Expenses
Gastos mdicos
Medical Insurance
Seguro mdico
Medicare Part A
Parte A de Medicare
Medicare Part B
Parte B de Medicare
Retencin de taxes de Medicare

Mileage Allowance
Descuento por millas
Tasa por milla (Mtodo opcional)
Military Return
Declaracin de taxes militar
Miscelneo
Miscellaneous deductions
Program
Programa Mission Values
Participant (MVP)
Modified Accelerated Cost Recovery
System (MACRS)
Sistema acelerado de recuperacin
de costos modificado (Modified
Accelerated Cost Recovery System,
MACRS)
Modified AGI (MAGI)
AGI modificados
Money Transfer
Dinero sin gastos de bolsillo
Dinero que te corresponde
Mortgage
Hipoteca
Certificado de crdito hipotecario
Mortgage Interest
Intereses hipotecarios
Mortgage Services
Moving Expenses
Gastos de mudanza
Acuerdo de manutencin mltiple
Mutual Fund
Fondo mutualista
My tax money
El dinero de mis taxes
My tax refund
El reembolso de mis taxes
myBlockSM for the Tax Office (MBTO)
(MBTO)
myStarting Block
myStarting Block
N
Nearly
Casi
Necessary Expenses
Gastos Necesarios
Prdidas netas de operacin
No te conformes con menosSM
New Client
Cliente nuevo
Deudas incobrables no
relacionadas con el negocio
Noncustodial Parent
Padre o madre sin custodia
para organizaciones sin fines de
lucro
Nonresident Alien
Distribuciones no imponibles
Nontaxable Exchange
Intercambio no imponible
Nontaxable Income
Ingresos no imponibles
Not valid
No vlido, Nulo
Notary Public
Notary Public
Notary Services
Servicios de notario
O
Offer
Oferta
Office Leader (OL)
Lder de oficina
Satisfaccin de nivel de oficina
(OLS)
Encuesta de nivel de oficina (Office
Level Survey, OLS)
Office Manager (OM)

Gerente de oficina
Offline
Fuera de lnea / Sin conexin
Online
En lnea o conectado
Online services
Servicios en lnea
Preparacin de taxes en lnea
(Currently not available in Spanish)
Option
Opcin
Ordinary Dividends
Ordinary Expenses
Gastos Ordinarios
Ingresos (prdidas) ordinarios/as
Origination fees
Comisiones de apertura
Out-of-pocket expenses
Gastos de bolsillo
Out-of-state return
Declaracin en otro estado
Overpay
Pago en exceso
Overpayment
Pago en exceso
P
Participating
Participantes
Pensiones parcialmente imponibles
Partnership
Sociedad colectiva
Passive Income
Ingresos pasivos
Passive loss
Prdida pasiva
Past returns
Declaraciones pasadas
Past tax returns
Declaraciones de taxes pasadas
Patent
Patente
Pay
Pagar
Page 11

Pay down date
Fecha de liquidacin
Pay stub
Recibo de sueldo
Paycheck
Cheque de pago
Payroll taxes
Taxes sobre la nmina
Peace of Mind
Peace of Mind
Peace of Mind Extended Service Plan
Plan de servicio prolongado Peace
of Mind
Multa e inters
Pension
Pensin
Pension Fund
Fondo de pensin
Pension Plan
Plan de pensin
anualidad/pensin
Period
Perodo
Discapacidad permanente y total
Personal and Dependency Exemptions
Exenciones personales y de
dependencia
Personal Expenses
Gastos personales
Personal Property
Bienes muebles
Tax sobre bienes personales
Personal Residence
Residencia personal
Bienes de uso personal
Phaseout
Eliminacin por fases
Physical Custody
Custodia fsica
Point of Sale (POS)
Punto de venta
Points
Puntos
Normas y procedimientos
Ingresos y prdidas de cartera
Page 12

Posible penalidad de impuestos de
la Ley ACA
Premium Guarantee
Garanta Premium
Crdito Tributario por la Prima
Prepaid Expenses
Gastos prepagados
Prepaid Interest
Preparar taxes
Pre-tax / Pretax
Antes de taxes
Principal
Capital
Residence)
lugar de residencia principal
Lugar principal de negocios
Principal Residence
Vivienda principal
Printed (name)
En letra de imprenta
Prior Client
Cliente previo (anterior)
Prior Client Calling Program, PCCP
Programa de llamada a clientes
anteriores (Prior Client Calling
Program, PCCP)
Prizes and Awards
Premios y recompensas
Pro forma
Pro forma
Oficina de resolucin de problemas
Servicio profesional de preparacin
de taxes
Prohibited
Prohibido
Promueve tu conocimiento
especializado en taxes
Property Tax
Impuestos sobre la propiedad
Proprietorship
Put to the test
Poner a prueba
Puts and Calls
Opciones de compra y venta
Q
Organizacin de caridad que rene
los requisitos
Qualified Dividends
Dividendos que renen los
requisitos
Seguro de salud que califica
Qualified Pension or Profit-Sharing
Plan
Plan calificado de pensin o de
participacin en las ganancias
Plan de matrcula que rene los
requisitos
Qualifying Child
Hijo que rene los requisitos
Qualifying Relative
Pariente que rene los requisitos
Qualifying Widower
Viudo(a) que rene los requisitos
Revisin de desempeo de calidad
(QPR)
Quote (Bid/Ask)
Cotizar
R
Cheque RAC
Railroad Retirement Tax Act (RRTA)
Ley de taxes de jubilacin
ferroviaria (Railroad Retirement
Tax Act, RRTA)
Prstamo RAL
Real Estate
Bienes races
Real estate taxes
Taxes sobre bienes races
Real Property
Bienes races
Ganancia o prdida realizada
Descuento razonable
Reasonable Expenses
Gastos razonables

Recapture
Recuperacin
Recent Tax Changes
Cambios recientes referentes a los
taxes
Recognized religious sect
Secta religiosa reconocida
Reconciliation
Conciliacin
Recovery
Recuperacin
Recovery of Cost
Recuperacin de costo
Recovery Period
Perodo de recuperacin
Refer a Friend
Recomienda a un amigo
Referral
Recomendacin
Referral fee
Recompensa por recomendacin
Referral form
Formulario de recomendacin
Referral program
Refile
Volver a presentar tu declaracin
de taxes
Refiling fees apply
Se aplican cargos para la nueva
presentacin
Refinancing
Refinanciamiento
Refund
Reembolso
Refund account fee
Cargo por cuenta de reembolso
Cheque de Reembolso Anticipado
(Cheque RAC)
(Prstamo RAL)
Cuenta de depsito de reembolso
Refund Options
Opciones de reembolso
Refund Planning
Planificacin de reembolsos
Refund Transfer, RT
Transferencia de reembolso
(Refund Transfer, RT)
Refundable Credit
Crdito reembolsable
Gerente de cuentas regional
Director regional
Regional Financial Support Specialist
(RFSS)
Especialista regional en asistencia
financiera
Director regional de franquicia
Regular Method
Mtodo regular
(Mutual Fund)
Sociedad inversionista
reglamentada (fondo mutualista)
Regulations
Reglamentos
Reliable Accuracy
Exactitud confiable
Reload (as in money on your Emerald
Card)
Ponerle ms dinero
Rent
Alquiler
Rental Income
Ingresos por alquiler/es
Repairs
Reparaciones
Limitacin de reembolso
Replacement Period
Perodo de reemplazo
Reported income
Ingresos declarados
Repossession
Recuperacin de un bien
Reschedule
Volver a programar
Resident Alien
Rest assured
Quedarte totalmente tranquilo
Results
Results (Resultados) (software)
Retail Sales
Ventas minoristas
Retirement
Jubilacin
Return (noun)
Declaracin
Rendimiento de la inversin
Right
Derecho
Rollover
Reinversin / transferencia
Roth IRA
Cuenta de jubilacin individual
Roth / IRA Roth / Cuenta IRA Roth
Royalty
Regalas
RRTA
RRTA
S
S Corporation
Corporacin S
SAF form
Formulario de SAF (if the name of
the program was mentioned before
[Enva-a-un-amigo])
SAF program
Programa SAF (if the name of the
program was mentioned before
[Enva-a-un-amigo])
SAF rebate
Reembolso de SAF (if the name of
the program was mentioned before
[Enva-a-un-amigo])
Safe Harbor
Puerto seguro
Salary
Sueldo
Salvage Value
Valor residual, valor de salvamento
o valor recuperable
Satisfaccin garantizada
Schedules
Anexos
Becas (in general terms) Becas de
estudio y de investigacin. Becas de
estudio. Becas de investigacin.
Scrap Sales
Ventas de desechos
Page 13

Segunda revisin de tus taxes
Second Look Review
Revisin Second Look
Plan de categora Plata de segundo
costo ms bajo
Seccin
Secured Deposit Account
Cuenta de depsito de garanta
Trabajador por cuenta propia
propia
Self-Employment Tax
Taxes sobre el trabajo por cuenta
propia
Send a Friend
Enva a un amigo
SEP
Plan SEP
Pagos de manutencin por
separacin judicial
Service
Servicio
Settlement Options
Opciones para liquidar pagos
Settlement Products
Productos para liquidar pagos
Settlement Products
Productos de pago
compartida
Shareholder
Accionista
Shine in 09
Brillar en el 2009
Short term
Corto plazo, a corto plazo
Prstamo a corto plazo para el
consumidor
SIMPLE
Plan SIMPLE
Plan de incentivo de ahorros con
contribuciones equivalentes del
empleador para empleados
(Savings Incentive Match Plan for
Employees, SIMPLE)
Page 14

Pensin simplificada para
empleados (Simplified Employee
Pension, SEP)
Simplified Method
Mtodo simplificado
Single
Soltero/no casado/nico
Social Security and Medicare taxes
Taxes de Seguro Social y de
Medicare
Nmero de Seguro Social
Retencin de taxes de Seguro Social
Propinas para efectos del Seguro
Social
Salarios para efectos del Seguro
Social
Sole proprietor
Sole proprietorship
Solid
Slido
Special Averaging
Promedio especial
Descuentos especial para
depreciacin
Specialized
Especializado
Speed of refund
Velocidad de reembolso
Spend some. Save some. Borrow some.
Gasta un poco. Ahorra un poco.
Toma prestado un poco.
Spousal IRA
IRA a nombre del cnyuge
Stability
Estabilidad
Standard Deduction
Deduccin estndar
Tasa estndar por milla
(STD)
Deduccin estndar
State or Local Income Tax Withheld
Retencin de taxes estatales o
locales sobre los ingresos

(RAC)
Estatal (Cheque Estatal RAC)
(RAC)
Cheque de reembolso anticipado
estatal (RAC estatal)
State Marketplaces
Mercados estatales
State Return
Declaracin estatal
Statement
Estado de cuenta
Statements
Estados de cuenta
Status
Estatus
Statutory Employee
Empleado estatutario
Stock Dividend
Dividendos en acciones
Stock Option Plan
Plan de opciones de compra de
acciones
Mtodo de depreciacin uniforme
Deduccin por intereses de
prstamo estudiantil
Student(s)
Estudiante(s)
Subject to
Sujeto a
Success
xito
Solicitud suplementaria
Supplement Application for Refund
Anticipation Loan
Solicitud suplementaria de
Prstamo de reembolso anticipado
(include English when necessary)
Refund Anticipation Check(s) And A
relacionadas con la Solicitud de
Cheque(s) de reembolso anticipado
y Cuenta de depsito de reembolso
Support
Asistencia [alt: apoyo, respaldo]
Supporting forms
Formularios suplementarios
T
Table topper
caras (Table Topper) [first
occurrence]; folleto informativo
rgido de 4 caras [thereafter].
Take the course
Toma el curso
Course.
Toma el Curso de Preparacin de
Taxes de H&R Block.
Talk to our bilingual tax professionals
Consulta con nuestros
profesionales de taxes bilinges
Consulta con tu profesional de
taxes
Bienes personales tangibles
Tax (Un tax)
Necesidades fiscales y financieras
Tax authority
Autoridad de taxes
Tax Benefit
Beneficio de taxes
Tax bill
Factura de taxes
Tax Bracket
Categora impositiva
Tax Consulting
Consultora en taxes
Tax Credit
Crdito de taxes
Deducciones y beneficios de taxes
Tax estimator
Calculadora de taxes
Tax Estimator
Tax Estimator (Calculadora de
taxes ) (software)
Tax Experience
Experiencia en taxes
Tax fraud
Fraude fiscal
Tax Home
Domicilio de taxes
Tax Household
Unidad familiar a efectos fiscales
Tax interview
Entrevista sobre taxes

Prueba de valoracin del
conocimiento sobre taxes Tax
Knowledge Assessment
Tax Laws
Leyes fiscales
Tax Liability
Responsabilidad fiscal
Tax Money
Dinero de taxes
Tax Planning
Planificacin de taxes
Preparacin de taxes
Lista de documentacin necesaria
para la preparacin de taxes
Software para la preparacin de
taxes
Tax Pro Finder
Tax Pro Finder
Tax Professional
Profesional de taxes
Desarrollador de negocios para el
Discussion
Conversacin sobre desarrollo del
Pasaporte del Profesional de taxes
Tax Rate
Tasa de taxes
Tax Rate Schedules
Tarifas de taxes
Tax Refund
Reembolso de taxes
1040, 1040E)
Declaracin de taxes
Tax returns from the past three years
Declaraciones de taxes de los
ltimos tres aos
Tax Season
Temporada de taxes
Tax Table
Tabla de taxes
Tax talks
Charlas sobre taxes
Tax Terms
Vocabulario fiscal
Tax Time
Tiempo de hacer los taxes
Tax Training School (TTS)

Cursos de preparacin de taxes
Tax Underpayment Reimbursement
Reembolso de pagos incompletos de
taxes
Tax Year
Ao fiscal
Taxable Income
Ingresos imponibles
Taxable Year
Ao imponible
Spanish)
Software TaxCut
Taxes
Tax-Exempt Income
Ingresos exentos de taxes
TaxNet
TaxNet
Taxpayer
Contribuyente
Promociones por radio y televisin
Lugar temporal de trabajo (context)
Tenancy in Common
Tenencia en comn
Term of the loan
Plazo del prstamo
Gracias por tu confianza en H&R
Block
H&R Block Bank, a Federal Savings
Bank, member FDIC, pursuant to a
license from MasterCard
International.
(Federal Savings Bank), Miembro
de la Asociacin de Seguros de
Depsito Federal (Federal Deposit
Insurance Corporation, FDIC)
emite la tarjeta prepagada
EXPRESSTAX Emerald Prepaid
MasterCard en conformidad con
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MasterCard is issued by H&R Block
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Member FDIC.
(Federal Savings Bank), Miembro
Page 15

de la Asociacin de Seguros de
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emite la tarjeta prepagada H&R
Block Emerald Prepaid
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Total federal estimated taxes (total
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[software].
Trade Date
Fecha de comercializacin
Traditional IRA
Cuenta IRA tradicional
Transfer by phone
Transferencia telefnica
Travel Allowance
Asignacin para gastos de viaje
Travel Expenses
Gastos de viaje
Trust
Fideicomiso
Trust Experience
Confa en la experiencia /
Experiencia en fideicomisos
Confiar en nosotros
Trustee
Administrador (de cuenta) fideicomisario
Divulgacin de veracidad en los
ahorros
Deduccin por matrcula y gastos
de educacin
U
Cobertura inasequible
Multas por pago incompleto
Page 16
Unearned Income
Ingresos no derivados del trabajo
Uninsured
No asegurado
Unrecaptured Gain
Up-to-date
Actualizado / Al da
Up-to-date (to be)
Utility Shut-Off
V
Vacation Home
Casa de vacaciones
Ver informe en pantalla
Void
Nulo

Crdito por oportunidad laboral
(Work Opportunity Credit)
Compensacin del seguro obrero
Crdito para familias trabajadoras
Worksheet
Hoja de cmputos
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www.hrblock.com/espanol
Y
Tus derechos como contribuyente
Tu satisfaccin est garantizada
Cargos por la preparacin de tus
taxes
La preparacin de tus taxes es
gratis
Tus taxes, a tu manera
W
W-2
Formulario W-2 (Comprobante de
sueldo)
Warranty Products
We Are With You
Estamos contigo
We will assure you
Te aseguraremos
Web Page
Pgina web
Web Site
Sitio web
Crdito de bienestar social por
trabajo (Welfare-to-Work Credit)
Where is my money?
Dnde est mi dinero?
Widow (Widower)
Viudo (viuda)
Descuentos en la retencin
Z
Zero Liability
Cero Responsabilidad
Zip Code
Cdigo postal
Index
SYMBOLS
401(k) 8.5, 10.2, 10.3, 10.4, 10.5, 10.29, 10.39
A
Adjusted gross income 1.35, 1.40, 3.11, 3.14, 4.9,
7.3, 8.7, 9.3, 10.14, 10.24, 10.35
Adjustments 1.35, 9.9, 10.23
Advance premium tax credit 2.12, 8.1
Age 2.2, 2.4, 2.6, 2.11, 3.2, 3.3, 7.7, 9.10, 10.21,
10.30, 10.36
Alimony 1.11, 10.7
American Opportunity Credit 2.12, 9.1, 9.2, 9.24
Annuities 10.3, 10.26, 10.31, 10.38
AOC 2.12, 9.1, 9.2, 9.3, 9.5, 9.6, 9.7, 9.9, 9.10,
9.11, 9.20, 9.24
B
Back pay 1.23
Basis 5.1, 13.16, 18.4, 22, 23.4, 23.5, 23.12, 23.28
Blindness 2.7, 2.8, 2.11
Bonds 1.10, 5.2, 5.3, 5.6, 5.8, 5.9, 5.10, 5.13
Business-use property 18.1, 18.2, 18.42, 23.4
C
Capital assets 23.1, 23.3, 23.6, 23.7, 23.13, 23.14,
23.28
Capital gains 1.35, 5.11, 5.12, 5.13, 5.15
Charitable contributions 1.28
Citizenship 3.8
Combat pay 7.3, 7.12, 7.24, 8.6, 8.7
Commissions 1.10, 1.11, 1.23, 10.7
Compensation 1.9, 1.11, 1.23, 1.27, 1.28, 1.33,
1.40, 7.12, 8.5, 8.15, 10.3, 10.4, 10.5, 10.7, 10.8,
10.9, 10.11, 10.16, 10.36
Conflict of interest 24.3, 24.4
Coverdell Education Savings Account 9.5, 9.25
D
Deductions 1.11, 1.22, 1.30, 1.35, 1.36, 1.40, 2.5,
2.9, 2.11, 2.14, 3.2, 4.8, 5.12, 7.2, 8.2, 9.2, 10.10,
10.28, 24.2, 24.4, 24.6, 24.8
Dependent 1.28, 1.36, 2.4, 2.7, 2.8, 2.9, 2.11,
2.16, 2.17, 3.1, 3.2, 3.4, 3.5, 3.7, 3.8, 3.9, 3.10,
3.11, 3.15, 3.20, 4.2, 4.6, 4.7, 4.8, 4.10, 4.13, 4.14,
7.2, 7.6, 7.7, 7.12, 7.25, 8.3, 8.4, 8.7, 8.10, 8.14,
8.20, 8.24, 9.2, 9.3, 9.9, 9.11, 9.19, 10.17, 10.35,
10.36, 11.1, 12.1
Dependent exemptions 11.1, 12.1
Dependents income 3.10
Dependents support 3.8, 3.9
Depletion 17.10, 15, 16, 17, 23.4
Depreciation 15.3, 17.10, 17.25, 17.26, 18.1, 18.2,
18.3, 18.4, 18.5, 18.8, 18.9, 18.11, 18.12, 18.13,
18.14, 18.16, 18.17, 18.18, 18.21, 18.22, 18.24,
18.25, 18.26, 18.30, 18.33, 18.34, 18.37, 18.40,
18.41, 18.42, 6, 8, 11, 14, 22, 23.4, 23.5
Depreciation restrictions 18.25
Disability 1.11, 3.1, 4.1, 7.1, 8.5, 8.10, 8.15,
10.26, 10.28, 10.35
Disaster relief payments 1.10
Distributions 1.11, 1.28, 2.12, 5.1, 5.10, 5.11,
5.12, 5.13, 5.15, 9.6, 10.1, 10.3, 10.5, 10.11, 10.16,
10.18, 10.26, 10.28, 10.33, 10.35, 10.38, 10.39
Dividends 1.11, 1.35, 2.11, 5.1, 5.3, 5.10, 5.11,
5.12, 5.13, 5.15, 7.9, 10.18
Due diligence 1.7, 5.5, 7.1, 7.7, 7.17, 7.18, 7.24,
24.1, 24.2, 24.7, 24.9
E
Early withdrawal penalty 5.6, 10.8, 10.35, 10.39
Earned income 1.11, 1.35, 2.9, 2.11, 2.16, 3.14,
3.15, 7.3, 7.6, 7.7, 7.9, 7.11, 7.12, 7.24, 8.3, 8.4,
8.5, 8.6, 8.7, 9.3, 9.10, 10.7, 10.24
Earned Income Tax Credit 2.12, 7.1, 7.3, 7.24,
8.1
Education 1.35, 3.8, 3.9, 4.7, 5.3, 8.3, 8.14, 9.1,
9.2, 9.3, 9.5, 9.6, 9.7, 9.9, 9.10, 9.11, 9.20, 9.24,
10.4, 10.24, 10.35, 10.36, 24.5, 24.8, 24.9
Educational assistance payments 1.28
Education benefits 3.9, 9.2
Education credits 9.1, 9.2, 9.3, 9.5, 9.7, 9.9, 9.11,
9.13, 9.15, 9.17, 9.19, 9.21, 9.23
Education expenses 3.8, 5.3, 8.14, 9.2, 9.5, 9.7,
9.9, 9.10, 9.11, 9.24, 10.35, 10.36, 24.8
Eligible student 9.2, 9.6, 9.7, 9.19
Employer identification number 1.40, 8.4
I.1
I.2 H&R Block Income Tax Course (2015)
Estates 15.5, 15.18, 17.15, 17, 22.22

Estimated tax 1.39, 2.11, 2.12, 2.15, 13.2, 13.45,
17.18, 21.6, 22.1, 22.17, 22.18, 22.19, 22.21,
22.22, 22.23, 22.24, 22.32, 24.4
Estimated tax 1.39, 2.11, 2.12, 2.15, 24.4
Ethics 24.1, 24.5
Exemption from withholding 22.2
Exemptions 1.36, 2.8, 2.14, 3.2, 8.20, 8.21, 11.1,
12.1, 24.4, 24.8
F
Failure-to-pay penalty 2.13, 21.2, 21.3, 22.27
Failure-to-pay penalty 2.13
Fellowship 8.5
Filing requirements 2.1, 2.2, 2.9, 2.11, 2.12,
10.36
Form
401(k) 8.5, 10.2, 10.3, 10.4, 10.5, 10.29, 10.39
403(b) 10.2, 10.4, 10.5, 10.29
457 10.2, 10.5, 10.26
Form 1040 1.11, 1.24, 1.28, 1.30, 1.35, 1.40,
1.41, 2.14, 3.11, 4.15, 5.1, 5.2, 5.4, 5.6, 5.7,
5.8, 5.11, 5.12, 5.13, 5.15, 7.3, 8.7, 8.14, 8.20,
8.24, 10.10, 10.29, 10.30, 10.35, 10.38
Form 1040A 1.11, 1.24, 1.27, 1.33, 1.35, 1.36,
1.39, 1.40, 2.7, 2.14, 3.14, 3.15, 5.1, 5.2, 5.4,
5.6, 5.7, 5.8, 5.12, 5.13, 7.2, 7.3, 7.9, 7.11,
7.12, 8.1, 8.6, 8.7, 8.14, 8.24, 9.19, 9.24, 10.8,
10.10, 10.11, 10.19, 10.23, 10.24, 10.27, 10.29,
10.30, 10.33, 11.1
Form 1040EZ 1.1, 1.11, 1.24, 1.27, 1.33, 1.34,
1.35, 1.36, 1.39, 1.40, 2.14, 5.2, 5.6, 5.7, 11.1
Form 1098-T 9.7, 9.9, 9.10
Form 1099-DIV 5.10, 5.11, 5.12, 5.13, 5.15
Form 2120 3.11
Form 8606 10.16, 10.33
Form 8815 10.10
Form W-2 1.1, 1.22, 1.23, 1.24, 1.25, 1.27,
1.28, 1.30, 1.40, 1.41, 4.15, 8.7, 8.10, 8.14,
10.5, 10.7, 10.8, 10.17
Form 2210 22.2, 22.22, 22.23, 22.24, 22.32
Foster care 1.10
Fringe benefits 1.10
G
Gifts 1.10, 5.5
Gross income 1.9, 1.10, 1.11, 1.35, 1.40, 2.1, 2.5,
2.8, 2.9, 2.11, 2.12, 2.16, 3.5, 3.11, 3.14, 3.15, 4.9,
5.9, 7.3, 7.8, 8.7, 9.3, 10.8, 10.14, 10.24, 10.35,
10.36
Gross income filing requirements 2.11, 2.12,

10.36
Gross rent 6, 7, 11
H
Head of household 2.3, 2.13, 2.16, 3.11, 3.14,
3.20, 3.21, 4.1, 4.2, 4.3, 4.6, 4.7, 4.8, 4.14, 4.15,
7.3, 7.9, 7.11, 8.7, 8.10, 8.14, 8.20, 10.19, 24.8,
24.9
Health insurance 1.28, 2.12, 3.8, 3.10, 8.13, 8.14,
8.15, 8.16, 8.21, 10.35
History 1.40, 10.3
Homework 1.2
Hope credit 9.2, 9.6
HSA 2.12, 2.16
I
Income 1.1, 1.2, 1.3, 1.4, 1.6, 1.7, 1.9, 1.10, 1.11,
1.22, 1.23, 1.27, 1.28, 1.30, 1.34, 1.35, 1.36, 1.39,
1.40, 1.41, 2.1, 2.2, 2.5, 2.7, 2.8, 2.9, 2.11, 2.12,
2.14, 2.15, 2.16, 2.17, 3.2, 3.4, 3.5, 3.7, 3.10, 3.11,
3.14, 3.15, 3.20, 3.21, 4.6, 4.8, 4.9, 4.15, 5.1, 5.2,
5.3, 5.5, 5.6, 5.7, 5.8, 5.9, 5.10, 5.12, 5.13, 5.15,
7.1, 7.1, 7.2, 7.3, 7.6, 7.7, 7.8, 7.9, 7.11, 7.12, 7.24,
7.25, 8.2, 8.3, 8.4, 8.5, 8.6, 8.7, 8.10, 8.13, 8.14,
8.16, 8.17, 8.19, 8.20, 8.21, 8.24, 9.2, 9.3, 9.10,
9.19, 9.20, 10.4, 10.7, 10.8, 10.9, 10.10, 10.11,
10.14, 10.16, 10.17, 10.18, 10.21, 10.23, 10.24,
10.26, 10.27, 10.28, 10.35, 10.36, 16.1, 20.1, 24.1,
24.2, 24.4, 24.6, 24.7, 24.8, 24.9
Individual taxpayer identification number 1.33
Inheritances 1.10, 9.3
Insurance proceeds 3.5, 3.10
Interest 1.10, 1.11, 2.11, 2.16, 3.5, 3.10, 4.3, 5.1,
5.2, 5.3, 5.4, 5.5, 5.6, 5.7, 5.8, 5.9, 5.10, 5.13, 5.15,
5.16, 7.9, 7.11, 10.10, 10.11, 10.24, 24.1, 24.3,
24.4, 24.9
Investment income 7.1, 7.11, 10.7
IRA 1.28, 9.24, 10.1, 10.2, 10.7, 10.8, 10.9, 10.10,
10.11, 10.14, 10.16, 10.17, 10.18, 10.19, 10.27,
10.28, 10.29, 10.30, 10.33, 10.35, 10.36, 10.38
IRA distributions 10.1, 10.38
L
Life insurance 1.10, 3.10, 4.3
Listed property 18.1, 18.3, 18.4, 18.5, 18.22,
18.25, 18.26, 18.30, 18.33, 18.42
Long-term 5.11, 5.13, 5.15, 10.8, 13.2, 13.7, 13.8,
13.17, 14.5, 15.7, 18.41, 23.5, 23.6, 23.7, 23.12,
23.14, 23.18, 23.21, 23.28
Index I.3
Long-term capital gain 5.13, 18.41, 23.14

Long-term care 14.5
Loss 5.1, 8.5, 13.17, 13.42, 14.5, 14.6, 15.1, 15.2,
15.3, 15.4, 15.5, 15.7, 15.14, 17.1, 17.2, 17.3, 17.7,
17.14, 17.15, 17.18, 17.25, 17.27, 17.28, 18.3,
18.33, 18.41, 19.1, 3, 9, 10, 11, 14, 17, 18, 19, 20,
21, 21.1, 22.21, 23.1, 23.2, 23.4, 23.5, 23.6, 23.7,
23.12, 23.13, 23.18, 23.21, 23.28, 24.1
M
MACRS 18.1, 18.2, 18.8, 18.9, 18.12, 18.13,
18.14, 18.16, 18.17, 18.18, 18.21, 18.22, 18.24,
18.26, 18.30, 18.33, 18.34, 18.37, 18.40, 18.41,
18.42, 8
Marital status 2.3, 2.9, 2.13, 2.16
Married filing jointly 2.1, 2.3, 3.11, 4.8, 7.6, 7.12
Married filing separately 2.3, 2.5, 2.8, 2.14, 2.15,
3.11, 4.8, 4.12, 7.9, 7.11, 8.14, 10.9, 10.23
Medical and dental expenses 3.8
Medicare tax 1.27, 1.28, 7.3
Medicare wages and tips 1.27
Modified Accelerated Cost Recovery System
18.1, 18.2, 18.8, 18.9, 18.42
Mortgage interest 4.3
Multiple support agreement 3.1, 4.1
N
Noncompliance 24.1, 24.6
Nondeductible contributions 10.33
Nondependent taxpayers 2.16
Nonqualified plan 1.28, 10.3, 10.7
Nonresident aliens 1.11, 4.6, 7.8, 7.11, 8.20
O
Ownership of income 2.5
P
Partially taxable 10.21, 10.28, 10.29, 10.30
Partnership 1.9, 1.10, 2.4, 8.7, 13.5, 17.1, 17.2,
17.3, 18, 19, 24.7
Passive income 19.1, 2, 19
Passive loss rules 19.1, 17, 21
Penalties 1.6, 2.13, 2.14, 2.16, 24.4, 24.7
Penalty exceptions 21.3
Pensions 1.11, 3.5, 7.12, 8.5, 8.10, 10.26, 10.30,
10.31
Personal exemption 1.36, 2.1, 2.2, 2.5, 2.7, 2.8,
2.9, 2.16, 7.25
Portfolio income 19.1, 3, 19
Premium tax credit 2.12, 2.16, 8.1, 8.2, 8.13, 8.24
Privilege 24.1, 24.5

Property 1.10, 1.11, 1.22, 2.1, 2.5, 2.15, 8.21,
10.9, 13.13, 13.15, 13.23, 13.24, 13.34, 13.39,
13.42, 13.44, 14.1, 14.7, 14.10, 14.14, 14.19,
14.20, 14.21, 14.22, 14.24, 14.25, 14.26, 15.1,
15.2, 15.3, 15.4, 15.5, 15.9, 15.10, 15.14, 15.15,
15.16, 15.25, 17.1, 17.2, 17.3, 17.7, 17.10, 17.11,
17.12, 17.15, 17.23, 17.25, 17.26, 17.27, 18.1,
18.2, 18.3, 18.4, 18.5, 18.8, 18.9, 18.11, 18.12,
18.13, 18.14, 18.16, 18.17, 18.18, 18.21, 18.22,
18.24, 18.25, 18.26, 18.30, 18.33, 18.34, 18.37,
18.40, 18.41, 18.42, 19.1, 2, 3, 6, 7, 8, 9, 10, 11,
14, 15, 16, 17, 20, 21, 22.13, 22.21, 23.1, 23.2,
23.3, 23.4, 23.5, 23.6, 23.13, 23.14, 23.27, 23.28
Personal property 13.15, 13.34, 14.14, 15.4,
15.10, 17.12, 18.3, 18.9, 18.12, 18.18, 18.21,
18.26, 18.34, 18.37, 18.40, 6, 23.2
Personal-type property 18.40, 6
Personal-use property 15.1, 15.4, 15.5, 15.15,
15.25, 18.3, 23.4
Q
Qualified education expenses 9.2, 9.5, 9.7, 9.9,
9.10, 9.11
Qualified plan 10.2, 10.3, 10.4, 10.5, 10.8, 10.28,
10.35
Qualified tuition 9.3, 9.5, 9.19, 9.24
Qualified tuition plan 9.5
Qualifying child 2.9, 2.17, 3.1, 3.2, 3.3, 3.4, 3.5,
3.7, 3.11, 3.15, 4.1, 4.2, 4.6, 4.7, 4.9, 4.10, 4.12,
4.13, 4.14, 4.15, 7.2, 7.3, 7.6, 7.7, 7.8, 7.9, 7.11,
7.12, 7.25, 8.3, 8.4, 8.24
Qualifying child of more than one taxpayer 4.13,
7.8, 7.25
Qualifying relative 2.9, 2.17, 3.1, 3.2, 3.4, 3.5,
3.7, 3.8, 3.10, 3.11, 3.15, 4.2, 4.6, 4.7, 4.15
Qualifying widow(er) 2.2, 4.2
R
Railroad retirement 8.5, 10.1, 10.9, 10.19, 10.26,
10.38
Real estate taxes 4.3
Refund 1.6, 1.39, 2.1, 2.12, 2.15, 2.17, 3.4, 3.7,
3.20, 5.10, 7.6, 7.8, 7.18, 7.24, 8.17, 9.6, 10.9, 24.4
rental income 13.13, 13.15, 15.9, 19.1, 6, 9, 10,
11, 14, 21, 22.18
Research 1.1, 1.7, 1.9, 1.40, 2.15, 10.16, 10.28,
10.31
Residency 3.3, 3.4, 3.5, 3.15, 4.14, 7.6, 7.8, 7.11,
7.12, 7.25, 8.16
Resident alien 2.15, 7.6, 7.8, 7.11, 9.3
I.4 H&R Block Income Tax Course (2015)
Retirement Savings Contribution Credit 10.1,

10.38
Roth IRA 9.24, 10.1, 10.2, 10.7, 10.11, 10.14,
10.16, 10.17, 10.18, 10.19, 10.28, 10.36, 10.38
Rounding 1.22
S
Salary reduction 1.28, 8.7
Savers Credit 8.2, 10.17, 10.18, 10.19
Schedule C 1.28, 2.12, 13.13, 13.15, 13.43, 15.9,
17.1, 17.2, 17.3, 17.4, 17.7, 17.8, 17.9, 17.10,
17.11, 17.12, 17.13, 17.14, 17.15, 17.18, 17.19,
17.23, 17.25, 17.26, 17.27, 17.28, 18.5, 18.17,
18.24, 18.26, 14, 15
Schedule D 1.35, 5.13, 15.5, 15.7, 21.6, 23.1,
23.2, 23.4, 23.6, 23.7, 23.14, 23.18, 23.21, 23.27,
23.28
Schedule K-1 13.43, 17, 18
Scholarship 3.10, 9.5
Section 179 18.2
Self-employed 2.2, 17.2, 17.18, 17.19, 22.2
Self-employment 1.41, 2.12, 2.16, 4.15, 7.3, 7.9,
8.5, 10.7, 10.23, 13.5, 13.15, 13.45, 17.1, 17.2,
17.3, 17.7, 17.15, 17.18, 17.19, 17.28, 18.33, 3, 18,
20, 22.1, 22.18
Self-employment tax 13.5, 13.15, 17.1, 17.2,
17.15, 17.18, 17.19, 17.28, 18.33, 18, 20, 22.1,
22.18
Separate property states 2.5
Severance pay 1.23, 1.41, 4.15
Sick pay 1.28
Signing the return 1.39
Single filing status 2.8, 2.11, 2.13
Social security 1.11, 1.24, 1.27, 1.28, 1.33, 1.34,
2.4, 2.12, 2.14, 3.5, 3.10, 3.11, 4.12, 5.6, 5.7,
7.3, 7.8, 8.4, 8.5, 8.6, 8.10, 8.13, 8.20, 10.1, 10.9,
10.19, 10.21, 10.23, 10.24, 10.26, 10.38
Social security benefits 1.11, 1.34, 2.4, 3.5, 3.10,
8.6, 10.21, 10.24, 10.26
Social security wages 1.9, 1.27
Sole proprietor 17.1, 17.4, 17.11, 17.18, 17.27,
18.24
Sole proprietorship 8.7, 17.2, 17.3
Special depreciation allowance 18.22, 18.25,

18.34, 18.37, 8
Standard deduction 1.36, 1.40, 2.1, 2.2, 2.5, 2.7,
2.8, 2.9, 2.11, 2.14, 2.16, 4.8, 7.2, 8.2, 9.2, 10.5,
10.19
State and local bonds 1.10
Statements 1.11, 1.22, 1.23
Statutory employee 1.28
Supplemental wages 22.12
T
Taxable income 1.1, 1.11, 1.35, 1.36, 1.40, 2.9,
3.2, 3.15, 5.7, 5.9, 5.13, 7.2, 8.2, 8.6, 8.7, 8.10, 9.2,
9.3, 10.9
Tax Computation Worksheet 1.35, 1.36
Tax-deferred 5.9, 10.2, 10.4, 10.5
Tax liability 1.1, 2.11, 2.13, 2.14, 2.15, 3.1, 3.2,
4.1, 5.9, 7.1, 7.2, 7.3, 7.6, 7.24, 8.2, 8.6, 8.24, 10.9,
11.1, 24.3, 24.4, 24.8
Taxpayer identification number 1.33
Third-party sick pay 1.28
Traditional IRA 10.2, 10.10
Tuition and fees 9.1, 10.10
Tuition and fees deduction 9.1, 10.10
U
Unearned income 1.9, 1.11
Union dues 1.23, 1.28
V
Vacation home 2, 8, 11, 21
Vacation pay 1.23
W
Wages 1.9, 1.10, 1.11, 1.22, 1.23, 1.24, 1.27, 1.28,
1.30, 1.40, 1.41, 2.12, 3.7, 3.10, 3.14, 4.15, 5.1,
7.3, 8.4, 8.5, 8.7, 8.14, 8.21, 10.7, 10.23, 10.24
Withholding allowance 22.6, 22.10
Worksheets 1.6, 1.22, 1.35, 3.14, 7.11

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Income Tax Course

Income Tax Course (2015)

Income Tax Course (2015)

This publication was written and produced at

HRB Tax Group, Inc. 2015

All Rights Reserved

Printed in the U.S.A. 2015

To recommend a friend, visit

Box 8 Allocated Tips...................................................................................................................... 1.27

DEPENDENT EXEMPTIONS AND SUPPORT

Schedule B............................................................................................................................................... 5.2

Shared Policy Allocation...................................................................................................................... 8.19

Identifying Contributions to a Deferred-Compensation Plan........................................................... 10.5

Employee Treated as an Independent Contractor........................................................................... 13.11

Mortgage Interest Credit................................................................................................................... 13.43

Nondeductible Interest....................................................................................................................... 14.20

Schedule C, Part I, Income...................................................................................................................... 17.7

Which Assets to Include..................................................................................................................... 18.40

Direct Deposit of Refund to More than One Account.......................................................................... 22.29

Disreputable Conduct.............................................................................................................................. 24.6

1.2 H&R Block Income Tax Course (2015)

Introduction to Taxation 1.3

1.4 H&R Block Income Tax Course (2015)

HISTORY AND THEORY OF INCOME TAXES

The Internal Revenue Service

Introduction to Taxation 1.5

WHO MAY PRACTICE BEFORE THE IRS?

1.6 H&R Block Income Tax Course (2015)

Limited Practice for Paid Tax Preparers

LAYOUT OF AN INCOME TAX RETURN

Introduction to Taxation 1.7

Tax Law Authority

1.8 H&R Block Income Tax Course (2015)

Primary reasons to use the IRS website:

Other Tax Information Resources

Introduction to Taxation 1.9

WAGES, INCOME, AND TAXES

1.10 H&R Block Income Tax Course (2015)

SOME ITEMS OF INCOME

SPECIFICALLY EXCLUDED FROM

Life insurance payments, if paid by reason of

Net income derived from business

Gifts and inheritances

Gains derived from dealings in property

Interest on state and local bonds

Compensation for personal injuries

Qualified clergy housing allowances

Federal income tax refunds

Qualified scholarships and fellowships

Alimony and separate maintenance payments

Meals or lodging furnished for the convenience

Disaster relief payments

Certain income from the discharge of indebtedness

Certain income from the discharge of indebtedness

Distributive share of partnership gross income

*Gross income not limited to these items

Introduction to Taxation 1.11

There are two types of gross income:

THE INDIVIDUAL INCOME TAX FORMS

Schedules and Forms

1.12 H&R Block Income Tax Course (2015)

Introduction to Taxation 1.13

1.14 H&R Block Income Tax Course (2015)

Introduction to Taxation 1.15