Taxation of Individuals

2020 Edition

Spilker ● Ayers ● Barrick

Outslay ● Robinson ● Weaver ●
Worsham

Chapter 4
Individual Income Tax
Overview, Dependents,
and Filing Status

©2020 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom.  No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
 Learning Objectives
1. Describe the formula for calculating an
individual taxpayer’s taxes due or refund.
2. Explain the requirements for determining
who qualifies as a taxpayer’s dependent.
3. Determine a taxpayer’s filing status.

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 The Individual Income Tax
Formula 1

Gross income.
• Minus: For AGI (above the line) deductions.
• Equals: Adjusted gross income (AGI).
• Minus: From AGI (below the line) deductions:
• Greater of (a) Standard deduction or.
(b) Itemized deductions and.
• Deduction for qualified business income.
• Equals: Taxable income.

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 The Individual Income Tax
Formula 2

Taxable income.
• Times: Tax rates.
• Equals: Income tax liability.
• Plus: Other taxes.
• Equals: Total tax.
• Minus: Credits.
• Minus: Prepayments.
• Equals: Taxes due or (refund).

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 The Individual Income Tax
Formula 3

Individuals report taxable income to the IRS.

• Reported on Form 1040.
U.S. tax laws use all-inclusive income
concept.
• Realized income.
• Measurable change in property rights.
• All realized income included in gross income unless
specifically excluded or deferred.
• Recognized income.
• Reported on tax return.

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 The Individual Income Tax
Formula 4

Excluded and deferred income not included in

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

Deferred income.
• Income included in a subsequent tax year.
• Installment sales.
• Like-kind exchanges.
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 The Individual Income Tax
Formula 5

Character of income or loss.

• Determines rates applicable to income or loss in
current year.
• Tax-exempt—no tax.
• Tax-deferred—no tax in current year (current-
year tax rate is zero).
• Ordinary—ordinary rates from tax rate schedule.
• Qualified dividends taxed at 0 percent, 15
percent, or 20 percent depending on taxpayer’s
income level.

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 The Individual Income Tax
Formula 6

Capital gain or loss—depends on whether

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

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 The Individual Income Tax
Formula 7

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

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 The Individual Income Tax
Formula 8

Capital gains and losses.

• Net long-term capital gains in excess of net
short-term capital losses are generally taxed at
0 percent, 15 percent, or 20 percent depending
on the taxpayer’s taxable income.
• Short-term capital gains taxed at ordinary rates.
• Net capital losses (losses in excess of gains for
year).
• $3,000 deductible against ordinary income for year.
• Losses in excess of $3,000 carried forward.

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 The Individual Income Tax
Formula 9

Deductions for AGI.

• “Deductions above the line.”
• Deducted in determining adjusted gross income.
• Always reduce taxable income dollar for dollar.
• Common for AGI deductions.
• Alimony paid (pre-2019 divorce decree).
• Rental and royalty expenses.
• Contributions to qualified retirement accounts.

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 The Individual Income Tax
Formula 10

Deductions from AGI.

• Deducted from adjusted gross income to
determine taxable income.
• “Deductions below the line.”
• Deduction for qualified business income (not an
itemized deduction).
• Deduction = Qualified business income × 20%.
• Greater of standard deduction or itemized
deductions.
• Common itemized deductions.
• Mortgage interest.
• State income taxes.
• Charitable contributions.
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 The Individual Income Tax
Formula 11

2019 standard deduction amounts.

• $24,400 Married filing jointly.
• $24,400 Qualifying widow or widower.
• $12,200 Married filing separately.
• $18,350 Head of household.
• $12,200 Single.
• Additional standard deduction amounts for age
and eyesight (discuss in Individuals Deductions
chapter).

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 The Individual Income Tax
Formula 12

Tax calculation.
• The United States uses a progressive tax rate
schedule.
• Rates range from 10 percent to 37 percent.
• Some items are taxed at preferential rates.
• Long-term capital gains.
• Qualified dividends.
• Tax on these items is calculated separately from income
taxed at ordinary rates.

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 The Individual Income Tax
Formula 13

Other taxes include:

• Alternative minimum tax.
• Self-employment taxes.
• 3.8 percent net investment income tax.
• .9 percent additional Medicare tax.
Tax credits.
• Reduce tax liability dollar for dollar.

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 The Individual Income Tax
Formula 14

Tax prepayments.
• Payments already made toward tax liability
including:
• Income taxes withheld from wages by employer.
• Estimated tax payments made during the year.
• Taxes overpaid in prior year and applied toward current
year’s liability.

If prepayments exceed tax liability after

credits, taxpayer receives a refund.

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 Who Qualifies as Taxpayer’s
Dependent
Determining who qualifies as dependent is
relevant for determining:
• Filing status.
• Eligibility for tax benefits such as the child tax
credit and the American opportunity credit.

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 Personal and Dependency
Exemptions 1

Dependency requirements.
• Citizen of United States or resident of United
States, Canada, or Mexico.
• Must not file joint return with spouse.
• Exception—if no tax liability filing jointly or separately.
• Must be qualifying child or qualifying relative
of taxpayer.

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 Personal and Dependency
Exemptions 2

Qualifying child.
• Relationship test.
• Age test.
• Residence test.
• Support test.

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 Qualifying Child 1

Relationship test.
• Taxpayer’s son, daughter, stepchild, an eligible
foster child, brother, sister, half-brother, half-
sister, stepbrother, stepsister, or a descendant of
any of these relatives.

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 Qualifying Child 2

Age test: child must be younger than the

individual claiming the child as a qualifying
child and either:
• Under age 19 at the end of the year,
• Under age 24 at the end of the year and a full-
time student, or.
• Permanently and totally disabled.

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 Qualifying Child 3

Residence test.
• Same residence as taxpayer for more than half
the year.
• Exception for temporary absences such as education.

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

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 Qualifying Child 4

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

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 Qualifying Child Example 1

Rodney and Anita have two children:

Braxton, age 12, who lives at home, and
Tara, age 21, who is a full-time student and
does not live at home. While Tara earned
$9,000 in a summer job, she did not provide
more than half of her own support during
the year. Are Braxton and Tara qualifying
children of Rodney and Anita?

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 Qualifying Child Example Solution 1

Test Braxton Tara

Relationship Yes, son Yes, daughter
Yes, under age 24 at year-
Yes, under age 19 at end
end and full-time student
Age of year (and younger
(and younger than her
than his parents)
parents)
Yes, lived at home entire Yes, temporary absences
Residence
year such as school OK
Yes, parents provide more
Yes, he does not provide
than half of support
Support more than half of own
(scholarship does not count
support
as self-support)

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 Qualifying Child Example 2

Braxton’s uncle Shawn (Rodney’s brother)

lived in the Halls’ home (the same home
Braxton lived in) for more than 11 months
during the year. Does Braxton meet the
requirements to be considered Shawn’s
qualifying child?

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 Qualifying Child Example Solution 2

Test Is Braxton Shawn’s qualifying child?

Relationship Yes, son of Shawn’s brother
Yes, under age 19 at end of year (and
Age
younger than Shawn)
Yes, lived in the same residence as Shawn for
Residence
more than half the year
Yes, does not provide more than half of own
Support
support

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 Qualifying Child Example 3

Braxton is considered to be Rodney and

Anita’s qualifying child and he is considered
to be Shawn’s qualifying child. Under the
tiebreaker rules, who is allowed to claim
Braxton as a dependent for the year?

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 Qualifying Child Example Solution 3

Answer: Rodney and Anita. Under the first

tiebreaking rule, Rodney and Anita are
allowed to claim Braxton as a dependent
because they are Braxton’s parents.

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 Personal and Dependency
Exemptions
Qualifying relative.
• Relationship test.
• Support test.
• Gross income test.

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 Qualifying Relative 1

Relationship test.
• A descendant or ancestor of the taxpayer (for
example, child, grandchild, parent, or grandparent),
• A sibling of the taxpayer, including a stepbrother or
stepsister.
• A son or daughter of the taxpayer’s brother or sister
(not cousins).
• A sibling of the taxpayer’s mother or father.
• An in-law (mother-in-law, father-in-law, sister-in-law,
or brother-in-law) of the taxpayer, or.
• An unrelated person who lives in taxpayer’s home
entire year.
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 Qualifying Relative 2

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

Gross income test.

• Gross income < $4,200 in 2019.

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 Dependency Exemption Example
John is a 22-year-old student who has lived
in the dorms for most of the year but spends
the rest of the year living with his parents.
He earned a $5,000 scholarship for the
school year and has worked hard to support
himself through school, earning $6,000 to
pay for his own expenses. His parents have
supported him by paying $7,000 for food,
clothing, and lodging expenses. Are John’s
parents able to claim him as a dependent?

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 Dependency Exemption Example
Solution

Test Qualifying child Qualifying relative

Relationship Yes, child Yes, child

Age Yes, < 24 and full-time student Not applicable

Residence Yes, temporary absences OK Not applicable

Support Yes, he provides < ½ Yes, parents provide > ½

Gross income Not applicable No, gross income > $4,200

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 Filing Status 1

Five different filing statuses.

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

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 Filing Status 2

Married filing jointly.

• Must be married on the last day of the year.
• If one spouse dies, the surviving spouse is considered to
be married to decedent spouse at year-end.
• Exception—The surviving spouse remarries before year’s
end.

• Joint and several liability for tax.

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 Filing Status 3

Married filing separately.

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

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 Filing Status 4

Qualifying widow or widower.

• Available for the two years following the year of
spouse’s death.
• Surviving spouse does not qualify if remarries
during two-year period.
• Surviving spouse must maintain household for
dependent child.
Single.
• Unmarried unless qualifying for head of
household.

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 Filing Status 5

Head of household.
• Unmarried or considered unmarried at end of
year.
• See discussion of married individuals treated as
unmarried (abandoned spouses) below.
• Not a qualifying widow or widower.
• Pay more than half the costs of keeping up a
home during the year.
• Lived in taxpayer’s home with a “qualifying
person” for more than half of the year.
• Exception for parents (see below).
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 Filing Status 6

Married individuals treated as unmarried

(abandoned spouse) if individual:
• Is married at end of year (or is not legally
separated from the other spouse).
• Does not file a joint tax return with the other
spouse.
• Pays > ½ the cost of maintaining a household that
serves as principal abode for a qualifying child for
more than half the year.
• Lived apart from the other spouse for the last six
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 Filing Status 7

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

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 Filing Status 8

Qualifying relative who is not the taxpayer’s

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

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 Filing Status Example 1

Assume that last year Rodney passed away,

and during the current year Anita did not
remarry but maintained a household for
Braxton and Tara, her dependent children.
Under these circumstances, what would
Anita’s filing status be?

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 Filing Status Example Solution 1

Answer: Qualifying widow.

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 Filing Status Example 2

Assume Rodney and Anita divorced last year.

During the current year, Braxton lives with
Anita and Anita pays all the costs of
maintaining the household for herself and
Braxton. Under these circumstances, what is
Anita’s filing status for the current year?

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 Filing Status Example Solution 2

Answer: Head of household.

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 Filing Status Example 3

Assume Shawn (Rodney’s brother) lived with

the Halls, but Shawn paid more than half the
costs of maintaining a separate apartment
that is the principal residence of his mother,
Sharon, whose gross income is $1,500.
Because Shawn provided more than half of
Sharon’s support during the year, and
because Sharon’s gross income was only
$1,500, she qualifies as Shawn’s dependent
(as a qualifying relative). In these
circumstances, what is Shawn’s filing status?
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 Filing Status Example Solution 3

Answer: Head of household. Shawn paid

more than half the costs of maintaining a
separate household that is the principal place
of abode for his mother, and his mother
qualifies as his dependent.

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 End of Presentation

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