RUSHMORE TAX   RAPID TAX CLASS

2015

 

Lesson 1
Filing Requirements
Lesson 2
Personal & Dependent Exemptions
Lesson 3
Filing Status
Lesson 4
Sources of income
Lesson 5
Standard Deduction
Lesson 6
Earned Income Credit
Lesson 7
Child and Dependent Care Credit
Lesson 8
Child Tax Credit and Additional Child Tax Credit
Lesson 9
Education Tax Credits, Retirement Savings Contribution Credit
Lesson 10
Adjustments to Income and Itemized Deductions
Lesson 11
Self Employment
Lesson 12
Rental Income
 

Lesson One Filing Requirements

FILING REQUIREMENTS

Who is required to file a tax return?

The following table summarizes the filing requirements for most taxpayers. To use the table, the taxpayer must find his/her marital status at the end of 2015 and then read across the line that shows the filing status and age at the end of 2015. The taxpayer must file a return if the gross income was at least the amount shown in the last column.

Gross income includes all income the taxpayer received in the form of money, goods, property, and services that is not exempt from tax. It also includes income from sources outside the United States (even if all or part of it can be excluded).

Filing requirements are shown in charts prepared by IRS. When using the chart, do not include social security benefits as gross income unless the taxpayer is married filing a separate return and lived with his/her spouse at any time in 2015.

Generally, whether the taxpayer must file a return depends on the gross income, filing status and age.

If the taxpayer is age 65 or older and/or blind, the filing requirements are generally higher than that of other taxpayers. If the taxpayer turned 65 on January 1, 2014, he/she is considered to be age 65 at the end of 2015.

Even if a taxpayer is not required to file, a tax return should be filed if any federal income tax was withheld or the taxpayer is qualified to receive the earned income credit and/or the additional child tax credit. Earned income credit and additional child tax credit are covered later.

Most taxpayers must file their tax return by April 15, unless the 15th falls on a Saturday, Sunday or legal holiday. If the return is filed after the due date, the taxpayer may have to pay interest and penalties.

Classwork 1:


Using the “Filing Requirement for Most Taxpayers” chart to determine who must file. Circle “Y” or “N.”

Y or N (1) Ed’s filing status is single and in 2015 he was 54 years old. His gross income was $8,100.
 

Y or N (2) Dick and Sally’s filing status is married, filing a joint return. Dick was 68 and Sally was 61 years old in 2015. Their gross income was $18,000.

Y or N (3) Sam’s filing status is head of household. He was 29 years old in 2015 and his gross income was $11,600.

Y or N (4) Jackie (age 29) was married in 2015 but chose to file married filing separately. In 2015, she had a gross income of $3,510.

 


IF your filing status is...

AND at the end of 2015 you were...*

THEN file a return if your gross income was at least...**

single

under 65

$10,300

 

65 or older

$11,500

married filing jointly***

under 65 (both spouses)

$20,000

 

65 or older (one spouse)

$21,200

65 or older (both spouses)

$22,400

married filing separately

any age

$3,900

head of household

under 65

$12,850

 

65 or older

$14,350

qualifying widow(er) with dependent child

under 65

$16,100

65 or older

$17,300

*

If you were born on January 1, 1949, you are considered to be age 65 at the end of 2015.

**

Gross income means all income you received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States or from the sale of your main home (even if you can exclude part or all of it). Do not include any social security benefits unless (a) you are married filing a separate return and you lived with your spouse at any time during 2015 or (b) one-half of your social security benefits plus your other gross income and any tax-exempt interest is more than $25,000 ($32,000 if married filing jointly). If (a) or (b) applies, see the Instructions for Form 1040 or 1040A or Publication 915 to figure the taxable part of social security benefits you must include in gross income. Gross income includes gains, but not losses, reported on Form 8949 or Schedule D. Gross income from a business means, for example, the amount on Schedule C, line 7, or Schedule F, line 9. But, in figuring gross income, do not reduce your income by any losses, including any loss on Schedule C, line 7, or Schedule F, line 9.

***

If you did not live with your spouse at the end of 2015 (or on the date your spouse died) and your gross income was at least $3,900, you must file a return regardless of your age.

FILING REQUIREMENTS FOR DEPENDENTS
 

Single dependents—Were you either age 65 or older or blind?

No.

You must file a return if any of the following apply.

 

• Your unearned income was more than $1,000.

• Your earned income was more than $6,300.

• Your gross income was more than the larger of:


 

• $1,000, or

• Your earned income (up to $5,750) plus $350.


 

Yes.

You must file a return if any of the following apply.

 

• Your unearned income was more than $2,500 ($4,000 if 65 or older and blind).
• Your earned income was more than $7,600 ($9,100 if 65 or older and blind).
• Your gross income was more than the larger of:

 

• $2,500 ($4,000 if 65 or older and blind), or
• Your earned income (up to $5,750) plus $1,850 ($3,350 if 65 or older and blind).

Married dependents—Were you either age 65 or older or blind?

No.

You must file a return if any of the following apply.

 

• Your unearned income was more than $1,000.
• Your earned income was more than $6,100.
• Your gross income was at least $5 and your spouse files a separate return and itemizes deductions.
• Your gross income was more than the larger of:

 

• $1,000, or
• Your earned income (up to $5,750) plus $350.

Yes.

You must file a return if any of the following apply.

 

• Your unearned income was more than $2,200 ($3,400 if 65 or older and blind).
• Your earned income was more than $7,300 ($8,500 if 65 or older and blind).
• Your gross income was at least $5 and your spouse files a separate return and itemizes deductions.
• Your gross income was more than the larger of:
• $2,200 ($3,400 if 65 or older and blind), or
• Your earned income (up to $5,750) plus $1,550 ($2,750 if 65 or older and blind).

You must file a return if any of the four conditions below apply for 2015.

1.

 

You owe any special taxes, including any of the following.

a. Alternative minimum tax.

b. Additional tax on a qualified plan, including an individual retirement arrangement (IRA), or other tax-favored account. But if you are filing a return only because you owe this tax, you can file Form 5329 by itself.

c. Household employment taxes. But if you are filing a return only because you owe this tax, you can file Schedule H by itself.

d. Social security and Medicare tax on tips you did not report to your employer or on wages you received from an employer who did not withhold these taxes.

e. Recapture of first-time home buyer credit.

f. Write-in taxes, including uncollected social security and Medicare or RRTA tax on tips you reported to your employer or on group-term life insurance and additional taxes on health savings accounts.

g. Recapture taxes.

2.


 

You (or your spouse, if filing jointly) received HSA, Archer MSA, or Medicare Advantage MSA distributions.

3.

You had net earnings from self-employment of at least $400.

4.

You had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer social security and Medicare taxes.

OTHER SITUATIONS WHEN YOU MUST FILE A TAX RETURN

WHO SHOULD FILE

Even if you do not have to file, you should file a federal income tax return to get money back if any of the following conditions apply.

  1. You had federal income tax withheld or made estimated tax payments.

  2. You qualify for the earned income credit.

  3. You qualify for the additional child tax credit.

  4. You qualify for the health coverage tax credit.

  5. You qualify for the American opportunity credit.

  6. You qualify for the credit for federal tax on fuels.


Classwork 2:

Using either the “Filing Requirements for Children and Other Dependents” or the “Other Situations When You Must File” information above, determine who has to file. Circle “Y” or “N.”

Y or N (5) Sonia (age 67 in 2015) is single, received nontaxable social security of $9,000 and made $750 net from selling Christmas ornaments at craft shows.

Y or N (6) Terry (single, age 17 in 2015) is claimed as a dependent by her parents. Her earned income was $4,910 and she had no other income.



Lesson Two Personal Exemptions and Dependent Exemptions

Exemptions reduce the taxable income. Generally, in 2015, $3,500 can be deducted for each exemption claimed. There are two types of exemptions: personal and dependent.

PERSONAL EXEMPTIONS

One exemption is allowed for the taxpayer and, if married, one for the spouse. These are called personal exemptions. A spouse is never considered the taxpayer’s dependent.

EXEMPTION FOR DEPENDENTS

One exemption is allowed for each person claimed as a dependent. If the taxpayer is eligible to be claimed as a dependent on another person’s return, the taxpayer cannot claim his/her own personal exemption. The taxpayer cannot claim the exemption even if the other taxpayer does not actually claim the person as a dependent.

A dependent exemption can only be claimed for a qualifying child or qualifying relative. These three tests must be met:

* Dependent taxpayer test

* Joint return test

* Citizen or resident test


Dependent Taxpayer Test

A person claimed as a dependent cannot claim any dependents during any year that the person, or spouse if filing jointly, was claimed as a dependent.

Example: In 2015, Grace claims her son, George, as a dependent. George cannot claim his own exemption NOR any dependents on his return for 2015.

Joint Return Test

Generally, a married person cannot be claimed as a dependent if he/she files a joint return.

Example: Bitsy supported her 18-year-old daughter who lived with her all year while her daughter’s husband was in the Army stationed overseas. The couple will file a joint return. Even though her daughter is her qualifying child, Bitsy cannot take an exemption for her.

The joint return test does not apply if a joint return is filed by the dependent and his/her spouse merely as a claim for refund and no tax liability would exist for either spouse on separate returns.

Example: Connie’s son and his wife each had $3,000 of wages and no unearned income. Neither is required to file a tax return. Taxes were taken out of their pay, so they filed a joint return to get a refund. Connie is not disqualified from claiming their exemptions just because they filed a joint return.

Citizen or Resident Test

Generally, a person cannot be claimed as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national or a resident of Canada or Mexico for some part of the year.

If the taxpayer legally adopts a child who is not a U.S. citizen, U.S resident alien, or U.S. national, the Citizen or Resident Test is met if the child lived as a member of their household all year. This also applies if the child was lawfully placed for legal adoption.

A U.S. national is an individual who, although not a U.S. citizen, owes his/her allegiance to the United States. U.S. nationals include American Samoans and Northern Mariana Islanders who choose to become U.S. nationals instead of U.S.citizens.

QUALIFYING CHILD OR QUALIFYING RELATIVE

A person cannot be claimed as a dependent unless that person is a “qualifying child” or a “qualifying relative.”

QUALIFYING CHILD

A qualifying child must meet the following five tests:

* Relationship test

* Age test

* Residency test

* Support test

* Special test for qualifying child of more than one person


Relationship Test for a Qualifying Child

A qualifying child must be the taxpayer’s son, daughter, stepchild, eligible foster child or a descendant of any of them (for example, a grandchild), or the taxpayer’s brother, sister, half brother, half sister, stepbrother, stepsister or a descendant of any of them (for example, niece or nephew).

Example: Barbara’s son, her grandson, her sister, her nephew, her stepbrother and her stepbrother’s daughter all live in her home. All of these people satisfy the relationship test for Barbara.

An eligible foster child is an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any competent jurisdiction.

An adopted child is always treated as the taxpayer’s own child.

Age Test for a Qualifying Child

To meet this test, a child must be:

* Under age 19 at the end of the year,

* A full-time student during five calendar months of the year and under age 24 at the end of the year, or

* Permanently and totally disabled at any time during the year, regardless of age.

A child is permanently and totally disabled if he/she cannot engage in any substantial gainful activity because of a physical or mental condition and a doctor determines the condition has lasted or can be expected to last continuously for at least a year, or can lead to death.

Residency Test for a Qualifying Child

A qualifying child must have the same principal residence as the taxpayer for more than half of the year. Exceptions apply for children of divorced or separated parents, kidnapped children, temporary absences, and for children who were born and died during the year.

The taxpayer and another person live together even if one of them is temporarily absent due to special circumstances including illness, education, business, vacation, or military service.

A person is considered to have lived with the taxpayer for all of 2015 if the person was born or died in 2015 and the taxpayer’s home was this person’s home for the entire time he/she was alive.

An exemption can be claimed for a child who was born alive during the year, even if the child lived only for a moment. State or local law must treat the child as having been born alive. There must be proof of a live birth shown by an official document, such as a birth certificate.

Children of divorced or separated parents.

The custodial parent is the parent having custody of the child for the greater portion of 2015. The other parent is the noncustodial parent.

If the parents divorced or separated 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 part of the rest of the year.

Example: Cindy’s child lived with her for 10 months of the year. The child lived with her former spouse for the other 2 months. Cindy is considered the custodial parent.


 

A child will be treated as the qualifying child of his/her noncustodial parent if certain conditions apply.

• The parents are divorced or legally separated under a decree of divorce or separate maintenance, or

separated under a written separation agreement, or lived apart at all times during the last 6 months of 2015,

• One or both parents provide more than half of the child’s total support for 2015,

• One or both parents have custody of the child for more than half of 2015,

• A decree of divorce or separate maintenance or written separation agreement that applies to 2015 provides that the noncustodial parent can claim the child as a dependent, or the custodial parent signs a written declaration that he/she will not claim the exemption for the child in 2015.

This allows a noncustodial parent to claim the child as a qualifying child but only for purposes of the child tax credit and dependency.

Written declaration. The custodial parent should use Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, or a similar statement to make the written declaration to release the exemption to the noncustodial parent. The noncustodial parent must attach the form or statement to his or her tax return.

The exemption can be released for a single year, for a number of specified years (for example, alternate years) or for all future years, as specified in the declaration. If the exemption is released for more than one year, the original release must be attached to the return of the noncustodial parent for the first year, and a copy must be attached for each later year.

Parents who never married.

This special rule for divorced or separated parents also applies to parents who never married.

Support Test for a Qualifying Child
A qualifying child must not have provided more than one-half of his/her own support during the year. This test is different from the support test to be a qualifying relative, covered later.

Special Test for Qualifying Child of More Than One Person
Sometimes, a child meets the relationship, age, residency, and support test to be a qualifying child of more than one person.

If the taxpayer and another person have the same qualifying child, the taxpayer and the other person can decide which person can treat the child as a qualifying child.

That person can take all of the following tax benefits (providing the person is eligible for each benefit) based on the qualifying child:

• Dependency exemption

• Head of household

• Child tax credit

• Earned income credit (EIC)

• Child and dependent care credit

EIC, child tax credit and credit for child and dependent care expenses will be covered later.

The other person cannot take any of these benefits based on the qualifying child. The benefits cannot be divided between the taxpayer and the other person.

If the taxpayer and the other person cannot agree on who will claim the child, and more than one person files a return claiming the same child, the IRS will use the tiebreaker rule. See chart on the next page for the Tie-Breaker Rule. If only one of the taxpayers is the child’s parent, the child is a qualifying child for that parent.

Example: Child lived with parent and grandparent. Mira and her 4-year-old son, Ethan, lived with Mira’s mother all year. Mira is 25 years old and earned $10,000 in 2015. Mira’s mother is not her dependent. Ethan is a qualifying child of both Mira and her mother because he meets the relationship, age, residency, and support tests for Mira and her mother. However, only one of them can claim Ethan. Mira agrees to let her mother claim Ethan. This means that her mother can claim Ethan as a dependent and can claim him as a qualifying child for the child tax credit, head of household filing status, credit for child and dependent care credit, and the earned income credit, if she qualifies for each of those benefits (and if Mira does not claim Ethan as a dependent or as a qualifying child for any of those tax benefits.

Assume, instead, that Mira and her mother both claim Ethan as a dependent and claim him as a qualifying child for the child tax credit and earned income credit. As the child’s parent Mira will be the only one allowed to claim Ethan as a dependent, claim him as her qualifying child for the child tax credit and the earned income credit.

Mira’s mother will have to amend her return to remove Ethan as a qualifying child. They cannot agree to divide these tax benefits between themselves. If two taxpayers are the child’s parents and they do not file a joint return together, then the child is a qualifying child for the parent with whom the child lived for the longest period of time.

If the time was equal, the parent with the higher AGI can claim the child. If none of the taxpayers is the child’s parent, the child is a qualifying child for the taxpayer with the highest AGI. A child who is not a “qualifying child” because he/she does not meet one of the tests may still qualify as a dependent under “qualifying relative” as long as he/she is not a qualifying child of another taxpayer.


When More Than One Person Files a Return

Claiming the Same Qualifying Child (Tie-Breaker Rule)

Caution.

If a child is treated as the qualifying child of the noncustodial parent under the rules for children of divorced or separated parents, see Applying this special test to divorced or separated parents

IF more than one person files a return claiming the same qualifying child and .

THEN the child will be treated as the qualifying child of the. . .

only one of the persons is the child's parent,

parent.

two of the persons are parents of the child and they do not file a joint return together,

parent with whom the child lived for the longer period of time during the year.

two of the persons are parents of the child, they do not file a joint return together, and the child lived with each parent the same amount of time during the year,

parent with the higher adjusted gross income (AGI).
 

none of the persons are the child's parent,

person with the highest AGI.

Applying this special test to divorced or separated parents.

If a child is treated as the qualifying child of the noncustodial parent under these rules, the noncustodial parent can claim an exemption and the child tax credit for the child but cannot ever claim the child as a qualifying child for head of household filing status, the credit for child and dependent care expenses, or the earned income credit. Gross Income. For a qualifying child, there is no gross income test. (Income over $3,900 does not disqualify a qualifying child.)


QUALIFYING RELATIVE

A qualifying relative for purposes of the dependency exemption can include children who do not meet the qualifying child age test, other relatives (i.e., parents, grandparents, uncles, aunts, and in-laws) and unrelated members of the household. Unlike a qualifying child, a qualifying relative can be any age.

There is no age test for a qualifying relative. A person is a qualifying relative for dependency if the following four tests are met.

* Not a qualifying child test

* Relationship or member of household test

* Gross income test

* Support test

Not a Qualifying Child Test for Qualifying Relative

A qualifying relative cannot be the taxpayer’s qualifying child or the qualifying child of any other taxpayer.

Example 1: Bea’s 22-year-old daughter, who is a full-time student, lives with her and meets all of the tests to be her qualifying child. She cannot be Bea’s qualifying relative.


Example 2: John’s 2-year-old son lives with John’s parents and meets all of the tests to be their qualifying child. He cannot be John’s qualifying relative.


Example 3: Harold’s son lives with him but is not his qualifying child because he is 30 years old and does not meet the age test. He may be Harold’s qualifying relative if the gross income test and the support test are met.


An individual is not a qualifying child of “any other taxpayer” if the individual’s parent (or other person who could claim the individual as a qualifying child):

• Is not required to, and does not, file an income tax return, or

• Files an income tax return solely to obtain a refund of withheld income taxes.

Example 1: Jack is single and supports, as members of his household, his girlfriend Mary and Mary’s 3-year-old daughter. Mary and her daughter lived all year with Jack. Mary has no gross income and she is not required to file an income tax return. Because Mary does not have a filing requirement and did not file an income tax return, Mary’s daughter is not treated as a qualifying child of Mary nor of any other taxpayer. Jack may claim the child as his qualifying relative, provided all other requirements are met.

Example 2: Stuart is single and he lived all year with his girlfriend, Mavis, and her two-year-old child Arthur. Stuart provides over half of the support for Mavis and Arthur. Mavis received $9,200 in wages and she has no other income. She has not signed a Form 8332 to allow Arthur’s noncustodial parent to claim him. Mavis will file a tax return but she will not claim Arthur. Arthur cannot be Stuart’s qualifying child (not related) nor can he be claimed as Stuart’s qualifying relative because Arthur is the qualifying child of another taxpayer (Mavis)


Relationship or Member of Household Test for Qualifying Relative

To meet this test, a person must be related or live with the taxpayer for the entire year as a member of his/her household. If at any time during the year the person was the spouse, that person cannot be a dependent. The taxpayer and another person are considered to live together even if one of them is temporarily absent due to special circumstances including illness, education, business, vacation, or military service. A person who died during the year, but was a member of the household until death, will meet the member of household test. The same is true for a child who was born during the year and was a member of the household for the rest of the year. The test is also met if a child would have been in the home except for any required hospital stay following birth.


Local law violated.

A person does not meet the member of household test if at any time during the tax year the relationship between the taxpayer and that person violates local law.

Relatives who do not have to live in the home. A person related in any of the following ways does not have to live with

the taxpayer for the entire year as a member of the household to meet this test.

  • Child, stepchild, eligible foster child, grandchild, great grandchild, etc. (A legally adopted child qualifies.)

  • Brother, sister, half brother, half sister, stepbrother, or stepsister

  • Parent, grandparent, or other direct ancestor, but not foster parent

  • Stepfather or stepmother

  • A brother or sister of the taxpayer’s father or mother

  • A son or daughter of a brother or sister

  • Father-in-law, mother-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law

Any of these relationships that were established by marriage are not ended by death or divorce.

Example: Hector and Madge have supported Madge’s widowed father Sam for the last few year. Madge died in 2012. In spite of her death, Sam continues to meet this test and Hector can claim him as a qualifying relative if he meets the other test, including the gross income test and support test.

Eligible foster child.

A foster child is any child placed with the taxpayer by an authorized agency or by judgment, decree, or other order of any court of competent jurisdiction.

Adoption.

An adopted child is always treated as the taxpayer’s child. The term adopted child includes a child who was lawfully placed with the taxpayer for adoption.

Cousin.

An exemption for a cousin can only be claimed if he/she lives with the taxpayer as a member of the household for the entire year. A cousin is a descendant of a brother or sister of the taxpayer’s father or mother and does not qualify under the relationship test.

Gross Income Test for a Qualifying Relative

Generally, the taxpayer cannot take an exemption for a dependent if that person had gross income of $3,500 or more for the year. All income in the form of money, property, and services that is not exempt from tax is gross income. Gross income also includes all unemployment compensation. Tax-exempt income, such as certain social security payments, is not included in gross income.

Disabled dependents working at sheltered workshop.

For the gross income test, gross income does not include income received by a permanently and totally disabled individual at a sheltered workshop. The availability of medical care must be the main reason the individual is at the workshop. A sheltered workshop is a school that provides special instruction or training designed to alleviate the disability of the individual.

Support Test for a Qualifying Relative

The taxpayer must generally provide more than half of the person’s total support during the calendar year to meet the support test. Figure whether the taxpayer has provided more than half by comparing the amount the taxpayer contributed to

the person’s support with the entire amount of support the person received from all sources. This amount includes the person’s own funds used for support. A person’s own funds such as savings are not support unless they are actually spent for support.

Example: Wilma’s mother Betty received $2,400 in social security benefits and $300 in interest. Betty paid $2,000 for lodging and $400 for recreation. Even though Betty received a total of $2,700, she spent only $2,400 for her own support. If Wilma spent more than $2,400 for Betty’s support and no other support was received, Wilma would have provided more than half of her mother’s support

Tax-exempt income.

In figuring a person’s total support, include tax-exempt income, savings, and borrowed amounts actually used to support that person. Tax-exempt income includes certain social security benefits, welfare benefits, nontaxable life insurance proceeds, Armed Forces dependency allotments, nontaxable pensions, and tax-exempt interest.

Example: Wesley provides $4,000 toward his mother’s support during the year. She had earned income of $600, nontaxable social security benefit payments of $4,800, and tax-exempt interest of $200. She uses all of these amounts for her support. Wesley cannot claim an exemption for his mother because the $4,000 he provided is not more than half of her total support of $9,600.

Social security benefits.

If a child receives social security benefits and uses them toward his/her own support, the payments are considered as provided by the child.

Support provided by the state (food stamps, housing, etc.).Benefits provided by the state to a needy person generally are considered to be used for support.

Total support. To figure if the taxpayer provided more than half of the support of a person, the taxpayer must first determine the total support provided for that person. Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation and similar necessities. (See worksheet on page 18.)

Expenses that are not directly related to any one member of a household, such as the cost of food for the household, must be divided among the members of the household.

Fair rental value defined.

This is the amount the taxpayer could reasonably expect to receive from a stranger for the same kind of lodging. It is used in place of rent or taxes, interest, depreciation, paint, insurance, utilities, cost of furniture and appliances, etc. In some cases, fair rental value may be equal to the rent paid. Person living in his or her own home. The total fair rental value of a person’s home that he or she owns is considered support contributed by that person.

Capital expenses.

Capital items, such as furniture, appliances, and cars that are bought for a person during the year can be included in total support under certain circumstances.


Do NOT Include in Total Support

The following items are not included in total support.

  • Federal, state, and local income taxes paid by persons from their own income.

  • Social security and Medicare taxes paid by persons from their own income.

  • Life insurance premiums.

  • Funeral expenses.

  • Scholarships received by the child if the child is a full-time student.

  • Survivors’ and Dependents’ Educational Assistance payment used for support of the child who receives them.


Support Test for Child of Divorced or Separated Parents.

In most cases, a child of divorced or separated parents will be a qualifying child of one of the parents. However, if the child does not meet the requirements to be a qualifying child of either parent, the child may be a qualifying relative of one of the parents.

A child will be treated as being the qualifying relative of his/her noncustodial parent if all of the following apply:

• The parents are divorced or legally separated under a decree of divorce or separate maintenance, or separated under a written separation agreement, or lived apart at all times during the last 6 months of 2015.

• One or both parents provide more than half of the child’s total support for 2015.

• One or both parents have custody of the child for more than half of 2015.

• A decree of divorce or separate maintenance or written separation agreement that applies to 2015 provides that the noncustodial parent can claim the child as a dependent, or the custodial parent signs a written declaration that he/she will not claim the exemption for the child in 2015. If the divorce or separation agreement went into effect before 1985, this requirement will be met if the noncustodial parent provides at least $600 for the child’s support in 2015.

The custodial parent is the parent with whom the child lived for the greater part of the year. The other parent is the non-custodial parent. If the parents divorced or separated 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 part of the rest of the year. Written declaration. The custodial parent should use Form 8332

Release of Claim to Exemption for Child of Divorced or Separated Parents, or a similar statement to make the written declaration to release the exemption to the noncustodial parent. The exemption can be released for a single year, for a number of specific years (for example, alternate years) or for all future years, as specified in the declaration. This declaration must be attached to each return when the noncustodial parent claims the child’s exemption.

Parents who never married.

This special rule for divorced or separated parents also applies to parents who never married.

Classwork 2

  1. Susan has three children who can be claimed as her dependents. In addition, in 2015, Susan gave birth to a boy who lived for only 3 months. Can Susan claim this child as a dependent on her 2015 tax return?

    Explain your answer________________________________________________________________________

    ________________________________________________________________________________________

     

  2. Joseph has $300 of tax-exempt income that he uses to support himself while away at college. Should Joseph’s parents use this income in calculating his total support? Explain your answer

    ________________________________________________________________________________________

    ________________________________________________________________________________________


     

  3. A married couple lives together with their two children who are under age 16. The wife does not have any income. They will file a joint return. Can the father claim his wife and his two children as dependents? Explain your answer.

    ________________________________________________________________________________________

    ________________________________________________________________________________________

     

  4. Pedro’s wife and child (age 2) lived in Mexico for nine months and in the United States for the rest of 2015. He pays all of their support. Pedro and his son are U.S. citizens. Can he claim his son as a dependent on his tax return?

    ________________________________________________________________________________________

    ________________________________________________________________________________________


     

  5. William and his 8-month-old son live with William’s mother, Sadie. Sadie earns more money than William. Sadie provides more than half of the support of William and his son. William files his tax return and wants to claim his son as his dependent. Can he do this? Explain your answer

    ________________________________________________________________________________________

    ________________________________________________________________________________________


     

  6. Rich, who is single, had five children living in his home. Three of the children (ages 7, 9, and 10) are his own and the other two are his cousins. The oldest cousin (age 15) lived with him for 7 months, while the youngest cousin (age 11) lived with him for the full year. None of the children had any income. Rich wants to claim the five children as dependents because he provided more than half of their support. How many total exemptions can he claim?

    A) 5     B) 3     C) 4     D) 6

  1. Fred lives with his girlfriend, Sue, and her six-year-old child Amy. Fred provides over half of the support for Amy and both Sue and Amy have lived all year with Fred. Sue has no income and she has not signed a Form 8332 allowing the noncustodial parent to claim Amy. Can Amy be Fred’s qualifying child? ________

    If not, explain why she can or cannot be claimed as Fred’s qualifying relative?

    ____________________________________________________________________________________________

     

  2. The Potterbells want help in determining which of the members of their household can be claimed as dependents. They provided more than half the support for each of the following individuals:
    • Single daughter, Marissa (age 25), who was a full-time student in 2015. Marissa earned $3,500 while at school and used it for her support.
    • Single son, Michael (age 17), who was a full-time student for 4 months. Michael lived with his parents all year. He earned $4,800 that was spent on his entertainment.
    • Their granddaughter, Alise (age 5), who lived with them from March until the end of 2015.
    • Mr. Potterbell’s father (age 69) whose only income was social security benefits of $4,300 which he used for his support. Which of these persons can the Potterbells claim as dependents? Explain your answer.

    ____________________________________________________________________________________________

     

  3. Joanne’s daughter, Adrienne, earned $3,550 in 2015. Adrienne is 20 years old and not in school. Can Joanne claim Adrienne as a dependent?_______ Explain your answer ____

    ____________________________________________________________________________________________

     

  4. Phil’s son, Tony, earned $3,600 in 2015. Tony is 21 years old and started college in September 2015. Is the age test for a qualifying child met? ________________________

     

  5. Tracey spent $3,200 for food, shelter, and clothing for her four-year-old daughter. She received $2,800 from welfare for her daughter. Is the support test met for a qualifying child? ______ Explain your answer

    ____________________________________________________________________________________________

     

  6. Curly provided all of the support of his father, Larry, who lived with him all year. Larry’s only income is $3,500 of interest a nd social security of $1,200. Can Curly claim Larry as a dependent? ___

    Explain your answer____________________________________________________________________________


Lesson Three   Filing Status

The filing status is used to determine the taxpayer’s filing requirements, standard deduction, and correct tax. It is also used in determining whether or not the taxpayer is eligible to claim certain other deductions and credits. Filing status is determined on the last day of the taxpayer’s tax year (December 31st for most people). Generally, filing status depends on whether a taxpayer is considered married or unmarried.

A taxpayer is considered to be unmarried for the whole year if, on the last day of the tax year, he/she is unmarried or legally separated from the spouse by a divorce or a separate maintenance decree. There are five filing statuses:

1. Single (S)
2. Married Filing Jointly (MFJ)
3. Married Filing Separately (MFS)
4. Head of Household (HH)
5. Qualifying Widow(er) with Dependent Child (QW)

Single (S)

A taxpayer’s filing status is single if unmarried or separated from his/her spouse by a divorce or separate maintenance decree, and does not qualify for another filing status. If the taxpayer is widowed before January 1, 2015 and does not remarry in 2015, the filing status is single.
 

Example: Joan’s husband died August 8, 2012. Joan lives alone and has not remarried. Her filing status is single. However, if there is a dependent child, he/she may qualify for another filing status that will give a lower tax. See Head of Household and Qualifying Widow(er) with Dependent Child to see if the taxpayer qualifies.


Married Filing Jointly (MFJ)

A marriage means only a legal union between a man and a woman as husband and wife. A taxpayer can file married filing
jointly if married and the spouse agrees to file a joint return. On a joint return the taxpayers combine their income and deduct
their combined expenses. A joint return can be filed even if one spouse has no income. Married filing jointly usually results in a lower tax.

Example: Mark and Jennifer were married on December 31, 2015. Their filing status can be married filing jointly or they may choose to file married filing separately. A married person who dies during the year is considered married for that tax year. If the spouse does not remarry during that tax year, the surviving spouse can file married filing jointly. If the spouse does remarry, he/she may file married filing jointly with the new spouse, but the deceased spouse must be filed as married filing separately.

Example: Brad and Kathy were married on June 21, 2015. Brad was in an accident and was killed on November 3, 2015. Kathy did not remarry. Kathy can file married filing jointly with Brad for 2015. If the taxpayer is divorced under a final decree by the last day of the year, he/she is considered unmarried for the whole year and cannot choose the status of married filing jointly. If taxpayers file married filing jointly, both spouses may be held responsible, either jointly and individually, for the tax and any interest or penalty due. One spouse may be held responsible even if the other spouse earned all the income.

When a joint return is filed and only one spouse owes past-due child or spousal support or a federal debt, the other spouse can be considered an injured spouse. An injured spouse can get a refund for his /her share of the overpayment that would otherwise be used to pay the past-due amount on the joint return. To be considered an injured spouse, the taxpayer:

• Must file a joint return,

• Must have reported income (wages, etc.),

• Must have made tax payments (such as federal income tax withheld from wages or estimated tax payments), or claim the earned income credit or other refundable credits, and

• Must have an overpayment on the return, all or part of which may be applied against the past-due amount. If qualified as an injured spouse, the taxpayer can obtain his/her portion of the joint refund by completing Form 8379, Injured Spouse Allocation.

Married Filing Separately (MFS)

A married couple can choose married filing separately as their filing status. This method may benefit them if each wants to be responsible for only his/her own tax, or if this method results in less tax than a joint return. They can also use this filing status if they cannot agree to file a joint return. The couple’s tax can be figured using both married filing jointly and married filing separately. The filing status that is more beneficial to the taxpayers can be used. Generally, the taxpayers will pay more combined tax on separate returns than on a joint return because the tax rate is higher for married persons filing separately.

On a separate return, the taxpayer generally reports only his/her own income, exemption(s), credits, and deductions. If a married taxpayer lives apart from the spouse and meets certain tests, he/she may be “considered unmarried” and may be able to file as head of household. This can apply even if they are not divorced or legally separated. If qualified to file as head of household instead of married filing separately, the tax may be lower, the earned income credit and certain other credits may be allowed and the standard deduction will be higher. The head of household filing status allows the taxpayer to choose the standard deduction even if the spouse chooses to itemize deductions.

Head of Household will be discussed later.

Special rules apply if the taxpayer files a separate return in a community property state.

If the taxpayer lives in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin and files separately, his/her income may be considered separate income or community income for income tax purposes.

Community income means property in a marriage is considered jointly owned. More information can be found in Publication 555, Community Property. If a separate return is filed, the taxpayer:
* Cannot claim the standard deduction if the spouse itemizes his/her deductions. If the standard deduction is claimed, it is half the amount allowed on a joint return.

* Cannot take the credit for child and dependent care expenses.

* Cannot take the earned income credit.

* Cannot (in most cases) take the credit or exclusion for adoption expenses.

* Cannot take the education credits (Hope and lifetime learning).

* Cannot deduct interest paid on a qualified student loan.

* Cannot exclude interest income from qualified U.S. savings bonds used for higher education expenses.

* Cannot take the credit for the elderly or the disabled unless he/she lived apart from the spouse for the entire year.

* Cannot take the tuition and fees deduction.

* May have to include, as taxable income, more of his/her social security benefits (or any equivalent railroad retirement benefits) than would be included on a joint return.

* Cannot roll over amounts from a traditional IRA to a Roth IRA.


When a married taxpayer files separately, the taxpayer must show his/her spouse’s social security number in the label section. Also, the spouse’s full name must be entered on line 3 in the space provided opposite the married filing separately check box.

Joint Returns after Separate Returns. The taxpayer can change filing status by filing an amended return using Form 1040X, Amended U. S. Individual Income Tax Return. If the couple files separate returns, a change to a joint return can be made any time within 3 years from the due date of the separate return or returns. This does not include any extensions. A separate return includes a return filed by the taxpayer or spouse claiming married filing separately, single, or head of household filing statuses.

Separate Returns After Joint Return. Once the taxpayer has filed a joint return, he/she cannot choose to file separate returns for that year after the due date of that return.

Head of Household (HOH)

A taxpayer may be able to file as head of household if he/she is not married or is “considered unmarried” on the last day of the year. In addition, the taxpayer must have paid more than half the cost of keeping up a home for the year and a qualifying person must have lived with him/her in that home for more than half the year. However, see Special Rule for Parent, later. The head of household filing status usually has a lower tax rate than single or married filing separately statuses as well as having a higher standard deduction.

Temporary Absences. The taxpayer and the qualifying person are considered to live together even if one or both are temporarily absent from the taxpayer’s household due to special circumstances such as illness, education, business, vacation, or military service. It must be reasonable to assume that the absent person will return to the household after the temporary absence. The taxpayer must continue to keep up the home during the absence.

Death or Birth of Qualifying Person. The taxpayer may still be eligible to file as head of household if the individual who qualifies him/her for this filing status is born or dies during the year. The taxpayer must have provided more than half of the home maintenance costs for the year, or if less, the period during which the individual lived.

Special Rule for Parent.Even if the parent for whom the taxpayer can claim an exemption does not live with him or her, the single taxpayer may be eligible to file as head of household. The taxpayer must pay more than half of the cost of keeping up a home that was the main home of his/her parent(s) for the entire year or pay over half the cost of keeping a parent(s) in a rest home or home for the elderly.

Distant relatives and non-relatives (roommates, boyfriends, girlfriends, etc.) cannot qualify the taxpayer for head of household filing status.

Example: Melissa and her boyfriend Skip live together. Skip has been unemployed for nine months and Melissa paid for all the rent, food, and utilities. Melissa cannot file as head of household because Skip is not a qualifying person. Even if the child of a boyfriend or girlfriend can be claimed as a dependent under the qualifying relative rules, he/she is not a qualifying person for head of household purposes.


Example: Jack is single and supports, as members of his household, his girlfriend Mar, and Mary’s 3-year-old daughter. Mary and her daughter lived all year with Jack. Mary has $3,800 of unemployment income and no other income. She is not required to file an income tax return nor did she. Mary’s daughter is NOT treated as a qualifying child of Mary or any other taxpayer so Jack may claim the child as his qualifying relative, provided all other requirements are met. Jack cannot claim H/H because Mary’s daughter is not a qualifying person for head of household purposes.

Qualifying Child or Qualifying Relative.

A “child” includes the taxpayer’s child or stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of one of these. A “relative” includes a child who is not a qualifying child, parent, grandparent, brother, sister, stepbrother, stepsister, half brother, half sister, stepmother, stepfather, mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law, uncle, aunt, nephew or niece. “Relative” does not include cousins and more distant relatives.

Qualifying Person

The following table shows who is a qualifying person. Anyone not described in the table is not a qualifying person.

Considered Unmarried for Head of Household Status.

To qualify for head of household status, the taxpayer must be either unmarried or considered unmarried.

Some married taxpayers who live apart from their spouses may be considered unmarried for tax purposes.

A taxpayer can be “considered unmarried”

on the last day of the tax year if he/she meets all of the following tests.

* Files a separate return.

* Paid more than half the cost of keeping up the home for the tax year.

* Spouse did not live in home during the last six months of the tax year. A spouse is considered to live with the taxpayer if he or she is temporarily absent due to special circumstances. See Temporary absences earlier.

* Taxpayer’s home was the main home of his/her child, stepchild, or eligible foster child for over six months of the tax year. These are the only persons who can qualify the taxpayer for considered unmarried head of household.

* Must be able to claim an exemption for the child. This test can still be met if the taxpayer cannot claim the exemption only because the noncustodial parent is allowed to claim the exemption for the child.

Example: Jennifer and her two children lived in their own apartment for all of 2015. She paid for all the rent, utilities, and food for the three of them. She hasn’t seen her husband Jack for two years. Jennifer meets all of the tests and can file as head of household.

Taxpayers must enter the name of the person who qualifies them for the head of household status. If the person is a dependent, enter the dependent’s name on line 6c of the exemption section of the tax return. If the qualifying person is not claimed as a dependent, enter the name of the non-dependent person on line 4 in the filing status section of the tax return.

Who Is a Qualifying Person Qualifying You To File as Head of Household?

IF the person is your. . . AND. . . THEN that person is. . .

qualifying child (such as a son, daughter, or grandchild who lived with you more than half the year and meets certain other tests) 2

he or she is single

a qualifying person, whether or not you can claim an exemption for the person.

he or she is married and you can claim an exemption for him or her

a qualifying person

he or she is married and you cannot claim an exemption for him or her

not a qualifying person. 3

qualifying relative 4 who is your father or mother
 

you can claim an exemption for him or her 5

a qualifying person. 6

you cannot claim an exemption for him or her

not a qualifying person.

qualifying relative 4 other than your father or mother (such as a

grandparent, brother, or sister who meets certain tests) 7

he or she lived with you more than half the year, and he or she is related to you in one of the ways listed under Relatives who do not have to live with you and you can claim an exemption for him or her 5

a qualifying person

he or she did not live with you more than half the year

not a qualifying person

he or she is not related to you in one of the ways listed under Relatives who do not have to live with you and is your qualifying relative only because he or she lived with you all year as a member of your household

not a qualifying person

you cannot claim an exemption for him or her

not a qualifying person

1 A person cannot qualify more than one taxpayer to use the head of household filing status for the year.

2 The term “qualifying child” is defined under Exemptions for Dependents. Note. If you are a noncustodial parent, the term “qualifying child” for head of household filing status does not include a child who is your qualifying child for exemption purposes only because of the rules described under Children of divorced or separated parents under Qualifying Child. If you are the custodial parent and those rules apply, the child generally is your qualifying child for head of household filing status even though the child is not a qualifying child for whom you can claim an exemption.

3 This person is a qualifying person if the only reason you cannot claim the exemption is that you can be claimed as a dependent on another return.

4 The term “qualifying relative” is defined under Exemptions for Dependents.

5 If you can claim an exemption for a person only because of a multiple support agreement, that person is not a qualifying person..

6 See Special rule for parent for an additional requirement.

A person who is a qualifying relative only because he/she lived with the taxpayer all year as a member of the household is not a qualifying person.


Example: Sidney’s girlfriend, Elaine, lived with him all year in a state where cohabitation is not against the law. Sidney provided all of the support for Elaine who had no income. He can claim her as a dependent (qualifying relative) because the relationship does not violate local law. However, just because she qualifies under the member of household test does not make her a qualifying person for head of household purposes.

Qualifying Widow(er) with Dependent Child (QW)

If the taxpayer’s spouse died in 2015, the taxpayer can use married filing jointly as the filing status for the 2015 tax year if otherwise qualified to use that status. The year of death is the last year in which a taxpayer can file married filing jointly with the deceased spouse. The taxpayer may be eligible to use qualifying widow(er) with dependent child as his/her filing status for the two tax years following the year of death.

For example, if the taxpayer’s spouse died in 2015 and the taxpayer does not remarry, he/she may be able to use this filing status for 2014 and 2015. The qualifying widow(er) with dependent child filing status entitles the taxpayer to use joint return tax rates and the higher standard deduction amount (if the taxpayer does not itemize deductions). This status does not entitle the taxpayer to file a joint return. If a taxpayer files as qualifying widow(er) with dependent child, either Form 1040A or Form 1040 can be used. The Married filing jointly column of the Tax Table is used to figure the tax.

Eligibility Rules:

• The taxpayer was entitled to file a joint return with the spouse for the year the spouse died (2011 or 2012).

It does not matter whether a joint return was actually filed.

• The taxpayer did not remarry before the end of 2015.
• The taxpayer has a child or stepchild for whom an exemption can be claimed. This does not include a foster child.
• The taxpayer paid more than half the cost of keeping up a home that is the main home for himself/herself and that child for the entire year.
• The child lived in the home for all of 2015.


Example: Juan’s wife died in 2015. Juan has not remarried. During 2015, he has continued to keep up a home for himself and his child for whom he can claim an exemption.


For 2015, he was entitled to file a joint return for himself and his deceased wife.

For 2015, he can file as a qualifying widower with a dependent child. If he qualifies for 2014, he can also file as qualifying widower for that year. After 2014, he can file as head of household if he qualifies.

Classwork 3

1. What are the five filing statuses?

________________________________________________________________________
 

________________________________________________________________________



2. Jennifer and Joe were married on December 30, 2015. What filing status(es) could they use for tax year 2015?

______________________________________________

 

3. Michelle is a single parent with two children. They lived with her all year. She provides all of their support and all of the cost of maintaining the home. What is Michelle’s filing status?

__________________________________________


 

4. Jerry and Kim are married and have no children. They lived together until June of 2015 when Jerry moved out of the home. Can Kim use the head of household filing status for herself in 2015?

______


Circle the correct filing status for questions 5-16.
 

5. David and Sarah are married and have two children. Sarah left David in May of 2015 and he hasn’t any idea where she is. Their children still live with David. He provides all of their support and over half of the cost of keeping up the home. Which filing status should David use?

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child.


6. Same situation as above, but what is Sarah’s filing status?


A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child.

Assuming Sarah contacted David and they both agreed, could David and Sarah file married filing jointly? Yes/No


7. Janet’s unmarried stepsister, Lia, moved in with her in March of 2015. Janet paid all the expenses of the household and all of Lia’s support because her stepsister didn’t work and had no other income. What is Janet’s filing status?

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child


8. Maggie’s husband died in 2012 and she hasn’t remarried. They had no children and Maggie has no other dependents. What filing status should Maggie use in 2015?

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child


9. Carla and her husband Rob separated in January 2015. They have no children. Which filing status would generally result in the lowest tax liability?


A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child

10. Dana’s husband died in September of 2015. Dana’s son (age 9) lived with her all year. Dana hasn’t remarried. What filing status should she use?
 

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child


11. In 2015, Roger, who is divorced, maintained a home for himself and his daughter (age 6). She cannot be claimed as Roger’s dependent because their divorce decree gives his former wife the right to can claim the child. What is Roger’s filing status?

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household

E) Qualifying Widow(er) with Dependent Child


12. Slick and Betsy are married and lived together until March 2015 when Slick moved out of the home and Betsy does not know how to locate him. Betsy continued to live in the home and, in June 2015, her mother Wilma came to live with her. Wilma’s only income is a taxable pension of $1,000 and social security benefits of $2,200. Betsy provided over half of Wilma’s support and over half of the cost of keeping up the home. No one else lived in the home. What is Betsy’s filing status?

A) Single

B) Married Filing Jointly

C) Married Filing Separately

D) Head of Household


13. Dakota is single and provides a home for his girlfriend, Clara, and her 6-year-old son Lance. Clara worked as a dancer and earned $3,000 and she has no other income. Clara and Lance lived with Dakota all year and he provided all of their support. What is Dakota’s filing status?

A) Single

B) Head of Household


14. What filing status could a custodial parent use even though her son cannot be claimed as her dependent because, according to their divorce decree, the other parent can claim their son as a dependent?

A) Single

B) Head of Household

C) Married Filing Separately

D) Married Filing Jointly


15. Jason and Maria, a childless married couple, lived apart for all of 2015. On December 31, 2015, they were legally separated under a divorce decree. What are the filing status choices available to them in 2015?

A) Married Filing Jointly

B) Married Filing Separately

C) Single

D) Head of Household



16. Sheila has not lived with her husband since 2006. She has legal custody of their son and pays more than half of his support. Her son lives with her for 9 months out of the year under the custody agreement. How should Sheila file her tax return if the divorce decree does not specifically state who claims her son as a dependent?

A) Head of Household with one dependent
B) Single with one dependent
C) Married Filing Jointly with one dependent
D) Head of Household without a dependent


For questions 1-6, determine the filing status and number of exemptions (personal and dependent) that can be claimed by the following taxpayers.
(All persons are U.S. citizens.)



1. Bob and Jane were married on July 1, 2000. They have 2 sons (ages 4 and 10). Jane died on December 31, 2015. Bob did not remarry and his sons lived with him all year. What is Bob’s filing status and number of exemptions?


_______________________________________________________________

 

2. Mike and his unmarried son, Mike Jr. (age 18), lived together until September of 2015 when Mike Jr. moved into his college dorm. Mike provided all of the support for his son for the year. What isMike’s filing status and number of exemptions?

_____________________________________________________



3. Jennifer (25) and her unmarried cousin Susan (16) lived together all year. Susan is unemployed and had no income. Jennifer provided over half of her support for the year. Jennifer also paid over half of the cost to support her widowed mother who lived in a nursing home. Her mother had no income. What is Jennifer’s filing status and number of exemptions?
 

________________________________________________________________



4. Ronald is single and his mother lived with him all year. He provided all of his mother’s support. She is unmarried and received $3,558 interest from her savings account, which was her only income. What is Ronald’s filing status and number of exemptions?

____________________________________________________



5. John and Mary were married on December 9, 2015. Mary had wages of $2,500 and she lived with her parents all year. John was in the Navy, stationed in Guam, and he earned $12,000. John and Mary will file a joint return. Mary’s parents have 2 other children (ages 13 and 15) who lived with them all year. Mary’s parents paid all of the support for Mary and their other children.

(a) What is the number of exemptions that John and Mary can claim? ______

(b) How many exemptions can Mary’s parents claim? ___________________


6. Angelina lived all year with her boyfriend, Boyd, and her son Juan (age 5). Juan is not Boyd’s son. Angelina has not signed over her son’s exemption to Juan’s father. Boyd made $15,000 working as a security guard and he has no other income. He pays all of the cost of their home and all of the support for Angelina and Boyd. Angelina has no income.

 

(a) Can Boyd claim Angelina and Juan as dependents? ___________________

(b) Is either Angelina or Juan a qualifying person for head of household status for Boyd?

_____________________________________________________________________


Lesson Four  Sources of Income

 

Taxable income is any income that is subject to tax. It must be reported on a tax return unless the amount is so small that the taxpayer is not required to file a return.

Taxable income includes earned income such as wages and self-employment income and unearned income such as interest, dividends, unemployment compensation, and pension income.

The following types of income are taxable:
 

• Wages, salaries, bonuses and commissions
• Tips and other compensation for personal services
• Interest*
• Dividends
• Refunds of state and local taxes**
• Business income
• Pensions and annuities (part or all may be nontaxable)
• IRA distributions (part or all may be nontaxable)
• Unemployment compensation
• Social security benefits (part may be taxable)
* Some interest, such as interest on certain state and local bonds, is not taxable.
** Refunds of state and local taxes are taxable only if the taxpayer itemized deductions for the tax year the taxes were paid and if the taxpayer’s tax liability was
reduced because of the deduction

Other Taxable Income includes:


• Alaska Permanent Fund Dividend income
• Alimony
• Allowances and reimbursements
• Court awards and damages
• Credit card insurance payments
• Estate and trust income
• Gambling winnings
• Hobby income
• Illegal income
• Jury duty pay
• Prizes and awards
• Canceled debts
• Recoveries
• Rental of personal property
• Repayments

Form W-2
The IRS requires that all income be reported whether it is from a business entity or an individual. Wages, salaries, and tips that are earned as an employee are the most familiar types of income received for services performed. Wages and salaries are compensation received. Tips are money and goods received as a gratuity by food servers, maids, bartenders, etc.

If the taxpayer is an employee, he/she should receive a Form W-2, Wage and Tax Statement, from the employer showing the wages received and any withholding. The

taxpayer should have a Form W-2 from each employer he/she worked for in 2015. An individual or a couple filing jointly might have one or more Forms W-2 from
various employers. Add the amounts from box 1 of each Form W-2 and report the total amount on the return. If the taxpayer does not receive a Form W-2 by February 2, 2015, he/she should first contact the employer and find out if or when the Form W-2 was mailed. If, after a reasonable amount of time, the Form W-2 still has not
 been received, the taxpayer should contact the IRS, but not before February 15, 2015. If the taxpayer does not receive Form W-2, he/she shoul file Form 4852,Substitute for Form W-2, Wage and Tax Statement or Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Income may also be reported on Form W-2c, Corrected Wage and Tax Statement.

All tip income is taxable.
Tips that are reported to employers are included with wages on Form W-2, box 1. Tips of $20 or more in a month from any one job that are

not reported to the employer must be shown on Form 4137,  Social Security and Medicare Tax on Unreported Tip Income. Tips of less than $20 per month are not
subject to social security and Medicare taxes. However, this tip income is subject to federal income taxes and must be reported on line 7 of Form 1040 or Form 1040A, or line 1 of Form 1040EZ. If the employer allocated tips to the taxpayer, they are shown separately in box 8 of Form W-2. They are not included in box 1 with the wages and reported tips. Allocated tips are tips that the employer assigned to the taxpayer in addition to the tips reported to the employer. The taxpayer may have allocated tips if he/she worked in a restaurant, cocktail lounge, or similar business that must allocate tips to employees. Unless the taxpayer has records to prove that the allocated tips are incorrect, the allocated tips in box 8 of Form W-2 are added to the amount in box 1 and reported as wages on line 7 of Form 1040. Because social security
and Medicare taxes have not been withheld from the allocated tips, Form 4137 must be completed to report these taxes. All wages, salary and tip income must be
reported on the return, even if the employee did not receive a Form W-2 for these.

Form 1099-INT
Taxable interest includes interest received from bank accounts, savings bonds and other sources. Most interest income is taxable. Interest income is reported in box 1 of Form 1099-INT,  Interest Income. Even if no Form 1099-INT is received, all interest income received must be reported on the tax return. Certain distributions commonly called dividends (for example, from a credit union) are actually interest. If funds are withdrawn from a deferred interest account before maturity, the taxpayer may have to pay a penalty. The total amount of interest paid or credited to

the account must be reported. Any penalty reported in box 2 of Form 1099-INT can be deducted as an adjustment on Form 1040 (covered later). Tax-Exempt Interest
. Certain types of interest are exempt from federal income tax. Interest on a bond used to finance government operations generally is not taxable if the bond is issued by the state, the District of Columbia, a possession of the U.S., or any of their political subdivisions (county or city). Tax-exempt interest is shown in box 8 of Form 1099-INT and reported on line 8b of Form 1040.

Form 1099-DIV
Dividends are distributions of money, stock, or other property paid to the taxpayer by a corporation. Dividends are reported on Form 1099-DIV, Dividends and Distributions . Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a corporation and are ordinary income to you. This means they are not capital gains. Ordinary dividends are reported to on Form 1099-DIV, box 1a. Qualified dividends are those ordinary dividends which are subject to the same 0% or 15% maximum tax rate that applies to net capital gain. Qualified dividends should be shown in box 1b of Form 1099-DIV. Capital gain distributions are reported in box 2a of Form 1099-DIV. Capital gain distributions are reported directly on line 13 of Form 1040 if a Schedule D, Capital Gains and Losses, is not required. Substitute Forms Many times interest and dividends may be reported on a combined

Substitute Form 1099.
The information is the same as on Forms 1099-INT and 1099-DIV but the substitute form may look more like a list with box numbers showing the income type.

Form 1099-G
Certain government payments such as unemployment compensation (box 1) and state and local tax refunds (box 2) are reported to the taxpayer on Form 1099-G, Certain Government Payments . Unemployment compensation generally includes any amount received under the unemployment compensation law of the U. S. or of a state. All unemployment compensation is includible in income. Taxpayers who receive a refund of state or local income taxes may receive a Form 1099-G with an amount in box 2. None of the state refund is taxable if in that year he/she either did not itemize deductions or elected to deduct state and local general sales taxes instead of state and local income tax. However, if the taxpayer itemized deductions in 2012 and received a state or local income tax refund, the taxpayer may have to include part or all of the refund in taxable income in 2015.

Form W-2G
Taxpayers must include gambling winnings as income on their returns. An accurate diary or similar record must be kept of the winnings and the losses. Winnings from lotteries and raffles are gambling winnings. Form W-2G, Certain Gambling Winnings , shows the amount of winnings in box 1 and any tax withheld in box 2. If the taxpayers itemize their deductions on Schedule A, they can deduct the gambling losses they had during the year, but only up to the amount of their winnings . Itemized deductions are covered later. Form SSA-1099 Taxpayers who receive social security payments will receive

Form SSA-1099,
Social Security Benefit Statement . Social security benefits include monthly survivor and disability benefits. They do not include supplemental social security income (SSI) payments which are not taxable. If filing a joint return, include the net benefits from Form SSA-1099 for both spouses. Depending on the other income and filing status, up to 85% of these payments may be taxable.

Do not include a dependent’s Form SSA-1099 received in the dependent’s name on the return of the parent(s). If the dependent is otherwise required to file a return, the amount is entered on the dependent’s return. The worksheet should be used to see if any of the income is taxable. A railroad employee’s equivalent of social security benefits is reported on an RRB-1099, Payments By the Railroad Retirement Board , and the benefits are reported in the return in the same way as social security.

Form 1099-R
Generally, pensions and annuities provide payments to the taxpayer after he/she retires. Pensions and annuities may be either partially taxable or fu lly taxable, depending on the amount of contribution to the plan. Generally, if the taxpayer did not pay any part of the cost of an employee pension or annuity and the employer did not withhold part of the cost from the taxpayer’s pay, the amount received each year is fully taxable. If the taxpayer paid part of the cost of the annuity, the part of the annuity that represents a return of cost is not taxed. Taxpayers who have distributions from pensions, annuities, retirement plans and IRAs will receive a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc . Box 1 identifies the total amount of the distribution. Box 2a shows the part of the distribution that is generally taxable.

Disability Pensions
If the taxpayer retired on disability the amount reported on Form 1099-R, with a code 3 in box 7, is considered wages (line 7 of Form 1040 or Form 1040A) if the taxpayer has not reached the employer’s minimum retirement age. Minimum retirement age generally is the age at which the taxpayer can first receive a pension or annuity if they are not considered disabled.

Employee Pensions and Annuities.
If the taxpayer paid part of the cost of the pension or annuity, the part of the annuity he/she receives that represents the return of that cost is not taxable. Generally, the simplified method is used to figure the taxable amount if the payer did not show the taxable amount in box 2a of Form 1099-R. IRAs. An individual retirement arrangement (IRA) is a personal savings plan that offers the taxpayer tax advantages to set aside money for retirement. An IRA may be either a traditional IRA or a Roth IRA.

Traditional IRAs
The traditional IRA is usually funded by deductible contributions, making all distributions taxable. When distributed, the payer is generally not required to compute the taxable amount. Therefore, most of the time the amounts in boxes 1 and 2a will be the same. If the taxpayer is at least age 70 ½, he/she must take minimum distributions from the traditional IRA. If the taxpayer does not, he/she may be subject to a 50% excise tax on the amount that should have been distributed.

Roth IRAs
Generally the payer is not required to compute the taxable amount. of distributions from a Roth IRA. The taxpayer must compute any taxable amount on Form 8606, Nondeductible IRAs . If certain requirements are met qualified distributions are tax-free.


Form W-2 Wage and Tax Statement
Employers use Form W-2 to report wages paid to an employee as well as any other employee deductions and taxes withheld from the wages paid. Enter the information and amounts as they are shown on the taxpayer’s Form W-2.

Box a The employee’s social security number (SSN)
Box b The employer’s identification number (EIN)
Box c The employer’s name and address
Boxes e and f The employee’s name and address
Box 1 Wages are reported on the wages line of Form 1040EZ, Form 1040A, or Form 1040.
Box 2 Federal income tax withheld is different for everyone because it is based on the amount of withholding allowances claimed on Form W-4. This withholding amount is reported as federal income tax withheld on Form 1040EZ, Form 1040A or Form 1040.
Box 3 Social security wages are shown here. Social  security wages may differ from wages in box 1 because of deductions in box 12.
Box 4 The social security tax withheld is 6.2% of the box 3 wages.
Box 5 Medicare wages and tips will generally be the same amount as box 1 except when there is a deduction amount in box 12.
Box 6 Medicare tax withheld is 1.45% of the box 5 wages
Box 7 Shows the tips that were reported to the employer and are not included in box 3.
Box 8 These tips are notincluded in boxes 1, 3, 5 or 7 and generally must be reported on the wages line of Form 1040. Social security and Medicare taxes must
also be paid on these tips using Form 4137.
Box 9 Advance earned income credit must be entered on the advance payments line of Form 1040A or Form 1040.
Box 12 Amounts reported here may be from the employee’s 401(k) plan, deferred compensation plan or other nontaxable benefit plans.
Box 13 Indicates if the employee is a statutory employee, covered by a retirement plan or received third-party sick pay.
Box 14 of Form W-2 is generally only for additional information.
Boxes 15 through 20 are the state and local wages and any state and local tax withheld.

There are multiple copies of Form W-2. Copy A is sent by the employer to the Social Security Administration. Copy D is for the em ployer to keep and Copy 1 is se nt to the state or local tax department. The taxpayer receives Copy B which is sent to IRS with a paper return, Copy C to keep with the taxpayer’s records, and Copy 2 which may be require d for the state return. It is important to understand the information shown in the various boxes of Form W-2. Enter the wages, salaries, and tips shown in box 1 of Fo rm W-2 on line 7 of Form 1040. Some amounts in other boxes may also go on Form 1040, line 7. Certain other box amounts may need to be entered elsewhere on the tax return. Some boxes of Form W-2 give information about amounts that are included in box 1. Generally do not enter the amounts in these boxes on Form 1040. Use this additional information to figure adjustments, deductions, and credits. For example, box 14 may show state disability in surance taxes withheld or union dues that may be deductible on other forms of the tax return.

Some Common W-2 Box 12 Codes

A   Uncollected social security tax or RRTA tax on tips
B   Uncollected Medicare tax on tips
C   Taxable cost of group-term life insurance over $50,000 (included in box 1, 3 and 5)
D   Elective deferrals to a 401(k) cash or deferred arrangement. Also, includes deferral under a SIMPLE retirement account that is part of a section 401(k) arrangement. G   Elective deferrals and employer contributions (including non-elective deferrals) to a section 457(b) deferred compensation plan (state and local government and tax-exempt employers)
H   Elective deferrals to a 501(c)(1 8)(D) tax-exempt organization plan
J   Nontaxable sick pay (not included in boxes 1, 3, and 5)
L   Substantiated employee business expense reimbursements (nontaxable)
M   Uncollected social security tax on group-term life insurance coverage over $50,000
N   Uncollected Medicare or RRTA tax on group-term life insurance coverage over $50,000
P   Excludable moving expense reimbursements paid directly to employee (not included in boxes 1, 3, or 5)
Q   Nontaxable combat pay
T   Adoption benefits (not included in box 1)
V   Income from exercise of non-statutory stock option(s) (included in boxes 1, 3 (up to social security base amount) and 5)

Code D. Deferred compensation is the part of pay which an employee contributes to a qualified retirement arrangement set up by an employer such as a 401(k) plan. It is treated as an employer contribution to a qualified plan and is not taxable until it is withdraw n. The amount of deferred compensation is shown in box 12 of Form W-2 with the code letter D. Deferred compensation is not included in Form W-2, box 1 because it is not subject to income tax. However, this compensation is subject to social security and Medicare taxes. Because of this, the social security and Medicare wages shown in boxes 3 and 5 of Form W-2 will be different from the wages shown in box 1. Anytime there is a difference between the amounts in boxes 1, 3, and 5, look in box 12 of Form W-2 to see if the reason can be determined.

 

Form 1099-INT Interest Income

A taxpayer receives a Form 1099-INT for interest income. Generally, this interest income is from a bank account. Instead of receiving this form, the taxpayer may receive a substitute Form 1099-INT that reports the interest income.

Box 1 Interest income is reported on Schedule B, Interest and Ordinary Dividends (for Form 1040) or Schedule 1 (for Form 1040A) and/or on line 8a of Form 1040 or Form 1040A.
Box 2 Shows interest or principal forfeited because of early withdrawal of time savings. Early withdrawal penalty is deducted as an adjustment to income on Form 1040.
Box 3 Interest on U.S. Savings Bonds, Treasury bills, Treasury bonds and Treasury notes is reported on Schedule B or Schedule 1 and/or on line 8a of Form 1040 or Form 1040A. This interest is not included in box 1 and is exempt from state and local taxes.
Box 4 Shows backup withholding and is included on the tax return as federal tax withheld.
Box 8 Shows tax-exempt interest, including exempt-interest dividends from a mutual fund or other regulated investment company, paid to the taxpayer during the year. Report this amount on line 8b of Form 1040A or Form 1040.

The interest income amounts in boxes 1 and 3 are reported on Schedule B (or Schedule 1 for Form 1040A) unless the combined total of all interest is $1,500 or less. If the interest income is $1,500 or less, the total interest in come can be reported directly on line 8a of Form 1040 or Form 1040A or line 2 of Form 1040EZ.


Form 1099-DIV Dividends and Distributions
A taxpayer receives a Form 1099-DIV for dividend income or long-term capital gain distributions from corporations. This may be from mutual funds or stocks owned by the taxpayer. Instead of receiving this form, the taxpayer may receive a substitute Form 1099-DIV that reports the same kind of income.

1099 div

Box 1a Ordinary dividends are reported on Schedule B, Interest and Ordinary Dividends (for Form 1040) or Schedule 1 (for Form 1040A) and/or on line 9a of Form 1040 or Form 1040A.
Box 1b Shows the portion of the amount in box 1a that may be eligible for the 15% or zero capital gains tax rate.
Box 2a Shows total capital gain distribution. Report the amounts in box 2a in Part II of Schedule D, Capital Gains and Losses . If no amount is reported in boxes 2c – 2d and the only capital gains and losses are capital gain distributions, enter the amounts shown in boxes 2a directly on line 10 of Form 1040A or line 13 of Form 1040. Also check the box next to line 13 on Form 1040 that Schedule D is not required.
Box 3 Shows the part of the distribution that is nontaxable because it is a return of cost. Is not shown on the tax return.
Box 4 Shows backup withholding which is included on the tax return as federal income tax withheld.
Box 6 Shows the foreign tax eligible for a credit or deduction. The ordinary dividends in box 1a are reported on Schedule B (or Schedule 1 of Form 1040A) unless the combined total of all ordinary dividends is $1,500 or less. If the ordinary dividend income is $1,500 or less, the total ordinary dividend income can be reported directly on line 9a of Form 1040 or Form 1040A. The total qualified dividends in box 1b are generally reported on line 9b of Form 1040 or Form 1040A

Form 1099-G Certain Government Payments
A taxpayer receives a Form 1099-G for unemployment compensation. A Form 1099-G may also be received for a state or local tax refund from a prior year. If the taxpayer itemized deductions in that prior year, the amount may be partially or fully taxable.

Box 1 Shows the total unemployment compensation paid in 2015. This amount is reported on line 3 of Form 1040EZ, line 13 of Form 1040A or line 19 of Form 1040.
Box 2 Shows refunds, credits, or offsets of state or local income tax received. This amount is reported on line 10 of Form 1040 only if the taxpayer deducted the state or local income tax paid as an itemized deduction on Schedule A in the prior year. Even if the taxpayer did not receive the amount shown because it was credited to the state or local estimated tax, or recaptured to pay some other debt it is still taxable if it was deducted.
Box 3 Shows the tax year for which the box 2 amount was made. If there is no entry in this box, the refund is for 2012 taxes .
Box 4 Shows backup withholding or withholding requested on unemployment compensation.

Form W-2G Certain Gambling Winnings
A taxpayer receives a W-2G to report gambling winnings and any federal income tax withheld. The requirements for reporting and withholding depend on the type of gambling, the amount of the gambling winnings, and generally the ratio of the winnings to the wager.

 

Box 1. The payer must furnish a Form W- 2G to you if you if you receive:
1. $600 or more in gambling winnings and the payout is at least 300 times the amount of the wager (except winnings from bingo, keno, and slot machine);
2. $1,200 or more in gambling winnings from bingo or slot machines;
3. $1,500 or more in proceeds (the amount of winnings less the amount of the wager from keno; or
4. Any gambling winnings subject to federal income tax withholding.
Generally, report all gambling winnings on the “Other income” line of Form 1040. You can deduct gambling losses as an itemized deduction, but you cannot deduct more than your winnings. Keep an accurate record of your winnings and losses, and be able to prove those amounts with receipts, tickets, statements, or similar items that you have saved.
Box 2. Any federal income tax withheld on these winnings is show n in this box. Federal income tax must be withheld at the rate of 25% on certain winnings less the wager. If you did not provide your federal identification number to the payer, the amount in this box may be subject to backup withholding at a 28% rate. Include the amount shown in box 2 on your Form 1040 as federal income tax withheld.
Other winners. Prepare Form 5754, Statement by Person(s) Receiving Gambling Winnings , if another person is entitled to any part of these winnings. Give Form 5754 to the payer.

Form SSA-1099 Social Security Benefit Statement
Each taxpayer who receives social security benefits will receive a Form SSA-1099. Depending on the amount of other income, up to 85% of the net benefits received in 2015 may be taxable.

Box 1 Recipient’s Name
Box 2 Recipient’s SSN
Box 3 Total benefits paid in 2015
Box 4 Shows any benefit checks returned to SSA for 2015 and any adjustments for other types of repayments. The amounts listed include all amounts repaid in 2015, no matter when the benefits were received. If there are no repayments, the word “none” will be shown.
Box 5 Shows the net benefits received for 2015 (box 3 minus box 4).This amount is used to determine how much, if any, of the social security benefits are taxable.
Box 6 Shows the amount of federal income tax withheld. This amount is included on the tax return as tax withheld. The Social Security Benefits Worksheet is used to determine if any of the benefits are taxable. The taxable amount is reported on line 14b of Form 1040A or line 20b of Form 1040

Form 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
A taxpayer receives a Form 1099-R when there is a distribution from a pension, annuity, retirement or profit-sharing plan, or from an IRA or insurance contract.

Box 1 Shows the total amount received in 2015. The amount may have been a direct rollover, a transfer or conversion to a Roth IRA, a re-characterized IRA contribution; or it may have been received as periodic payments, non-periodic payments, or as a total distribution. Report this amount on Form 1040 or 1040A on the line for “IRA distributions” or “Pensions and annuities” (or the line for “Taxable amount”), and on Form 8606, whichever applies. If the taxpayer retired on disability (code 3 in box 7 of Form 1099-R) and has not reached the minimum retirement age, report this amount as wages on line 7 of Form 1040A or Form 1040.
Box 2a This part of the distribution is generally taxable. 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 should be marked.
Box 2b If the first checkbox is marked, the payer was unable to determine the taxable amount, and box 2a should be blank unless this is a traditional IRA, SEP, or SIMPLE distribution. If the second checkbox is marked, the distribution was a total distribution that closed out that account. Box 2a is not reduced by the amount a qualified public safety officer used to purchase certain insurance premiums.
Box 4 This is the amount of federal income tax withheld. Include this on the tax return as tax withheld, and if box 4 shows an amount other than zero, attach copy B of the Form 1099-R to the tax return.
Box 5 Generally, this shows the employee’s investment in the contract (after-tax contributions), if any, recovered tax-free this year, the part of the premiums paid on commercial annuities or insurance contracts recovered tax free. This box does not show contributions to an IRA.
Box 7 These numeric codes identify some common types of distribution received:
1— Early distribution, no known exception (in most cases, under age 59 ½).
2— Early distribution, exception applies
3— Disability
4— Death
7— Normal distribution

Some of the Common Letter Codes for Box 7 of 1099-R
G— Direct rollover to a qualified plan, tax- sheltered annuity, governmental 457(b) plan or an IRA.
J— Early distribution from Roth IRA, no known exception (generally used when under age 59 ½)
Q— Roth IRA qualified distribution. Taxpayer is age 59 ½ or over and meets the 5-year holding period for a Roth IRA.
T— Roth IRA distribution, exception applies. Taxpayer is either age 59 ½ or an exception (code 3 or 4) applies.
Box 9a If a total distribution was made to more than one person, the percentage received is shown.
Box 9b For a life annuity from a qualified plan or from a tax-sheltered annuity (with after-tax contributions), the amount shown is the employee’s total investment in the distributions. It is used to compute the taxable part of the distribution.
Boxes 10-15 If state or local income tax was withheld from the distribution, these boxes may be completed. Boxes 12 and 15 may show the part of the distribution subject to state and/or local tax.

Taxable Income
All taxable income must be reported even if no form was received. This class will help you determine what income is reported on what form(s) and where it is reported on the tax return.

Nontaxable Income
Nontaxable income is income that is exempt from federal tax. If a return must be filed, some types of nontaxable income will be shown on the return but will not be added into the amount of income subject to tax.

Income NOT taxed includes:
• Child support payments
• Life insurance proceeds
• Welfare benefits/public assistance*
• Workers’ compensation
• Veterans’ benefits
• Gifts, bequests and inheritances
• Accident and health insurance proceeds • Supplemental security income (SSI)
• Federal income tax refunds
• Interest on state or local government obligations (municipal bonds)
• Military allowances • Moving expense reimbursements
• Compensatory damages awarded for physical injury or sickness * Certain TANF (Temporary Assistance for Needy Families) payments


FORM 1040EZ, FORM 1040A & FORM 1040

On the following pages, Forms 1040EZ, 1040A and 1040 show the lines where the forms discussed in this chapter will be reported.

Form 1040EZ
Form 1040EZ can be used if:
• the filing status is single or married filing jointly
• no dependents are claimed • the only tax credits claimed are the earned income credit and/or the recovery rebate credit (covered later)
• the taxpayer (and spouse if filing a joint return) were under 65 and not blind • the taxable income is less than $100,000
• only wages, tips, unemployment compensation, and taxable interest and the taxable interest was not over $1,500
• the taxpayer has no adjustments to income.

Form 1040A
Form 1040A can be used for:
• wages, tips, interest, tax-exempt interest, dividends, certain capital gain distributions, IRA distributions, pensions and annuities, unemployment compensation, social security benefits and railroad retirement benefits, jury duty pay
• the taxable income is less than $100,000
• adjustments to income such as penalty on early withdrawal of savings, educator expenses, IRA deduction, student loan interest and tuition and fees deduction.
• the standard deduction is claimed
• the only credits claimed are the child tax credit, additional child tax credit, education credits, earned income credit, credit for child and dependent care expenses, credit for the elderly or, disabled, the retirement savings contributions credit, or the recovery rebate credit Form 1040 If you cannot use Form 1040EZ or Form 1040A, you must use

Form 1040.
You can use Form 1040 to report all types of income, deductions, and credits.

 

 

 

 

 


Lesson Five  Standard Deduction

What's New

 

Standard deduction increased. The standard deduction for some taxpayers who don't itemize their deductions on Schedule A (Form 1040) is higher for 2015 than it was for 2014. The amount depends on your filing status. You can use the 2015 Standard Deduction Tables in this chapter to figure your standard deduction.

Introduction

 

This chapter discusses the following topics.

  • How to figure the amount of your standard deduction.

  • The standard deduction for dependents.

  • Who should itemize deductions.

 

Most taxpayers have a choice of either taking a standard deduction or itemizing their deductions. If you have a choice, you can use the method that gives you the lower tax.

The standard deduction is a dollar amount that reduces your taxable income. It is a benefit that eliminates the need for many taxpayers to itemize actual deductions, such as medical expenses, charitable contributions, and taxes, on Schedule A (Form 1040). The standard deduction is higher for taxpayers who:

  • Are 65 or older, or

  • Are blind.

You benefit from the standard deduction if your standard deduction is more than the total of your allowable itemized deductions.

 

Persons not eligible for the standard deduction.   Your standard deduction is zero and you should itemize any deductions you have if:
  • Your filing status is married filing separately, and your spouse itemizes deductions on his or her return,

  • You are filing a tax return for a short tax year because of a change in your annual accounting period, or

  • You are a nonresident or dual-status alien during the year. You are considered a dual-status alien if you were both a nonresident and resident alien during the year.

    If you are a nonresident alien who is married to a U.S. citizen or resident alien at the end of the year, you can choose to be treated as a U.S. resident. (See Pub. 519, U.S. Tax Guide for Aliens.) If you make this choice, you can take the standard deduction.

If an exemption for you can be claimed on another person's return (such as your parents' return), your standard deduction may be limited. See Standard Deduction for Dependents, later.

 

Standard Deduction Amount

 

The standard deduction amount depends on your filing status, whether you are 65 or older or blind, and whether another taxpayer can claim an exemption for you. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amounts for most people are shown in Table 20-1.

Decedent's final return.   The standard deduction for a decedent's final tax return is the same as it would have been had the decedent continued to live. However, if the decedent wasn't 65 or older at the time of death, the higher standard deduction for age can't be claimed.

 

Higher Standard Deduction for Age (65 or Older)

 

If you are age 65 or older on the last day of the year and don't itemize deductions, you are entitled to a higher standard deduction. You are considered 65 on the day before your 65th birthday. Therefore, you can take a higher standard deduction for 2015 if you were born before January 2, 1951.

Death of a taxpayer.   If you are preparing a return for someone who died in 2015, see Death of taxpayer in Pub. 501 before using Table 20-2or Table 20-3.

Higher Standard Deduction for Blindness

 

If you are blind on the last day of the year and you don't itemize deductions, you are entitled to a higher standard deduction.

Not totally blind.   If you aren't totally blind, you must get a certified statement from an eye doctor (ophthalmologist or optometrist) that:
  • You can't see better than 20/200 in the better eye with glasses or contact lenses, or

  • Your field of vision is 20 degrees or less.

  If your eye condition isn't likely to improve beyond these limits, the statement should include this fact. Keep the statement in your records.

  If your vision can be corrected beyond these limits only by contact lenses that you can wear only briefly because of pain, infection, or ulcers, you can take the higher standard deduction for blindness if you otherwise qualify.

Spouse 65 or Older or Blind

 

You can take the higher standard deduction if your spouse is age 65 or older or blind and:

  • You file a joint return, or

  • You file a separate return and can claim an exemption for your spouse because your spouse had no gross income and can't be claimed as a dependent by another taxpayer.

 

Death of a spouse.    If your spouse died in 2015 before reaching age 65, you can't take a higher standard deduction because of your spouse. Even if your spouse was born before January 2, 1951, he or she isn't considered 65 or older at the end of 2015 unless he or she was 65 or older at the time of death.

 

A person is considered to reach age 65 on the day before his or her 65th birthday.

 

Example.

Your spouse was born on February 14, 1950, and died on February 13, 2015. Your spouse is considered age 65 at the time of death. However, if your spouse died on February 12, 2015, your spouse isn't considered age 65 at the time of death and isn't 65 or older at the end of 2015.

You can't claim the higher standard deduction for an individual other than yourself and your spouse.

 

Examples

 

The following examples illustrate how to determine your standard deduction using Tables 20-1 and 20-2.

Example 1.

Larry, 46, and Donna, 33, are filing a joint return for 2015. Neither is blind, and neither can be claimed as a dependent. They decide not to itemize their deductions. They use Table 20-1. Their standard deduction is $12,600.

Example 2.

The facts are the same as in Example 1 except that Larry is blind at the end of 2015. Larry and Donna use Table 20-2. Their standard deduction is $13,850.

Example 3.

Bill and Lisa are filing a joint return for 2015. Both are over age 65. Neither is blind, and neither can be claimed as a dependent. If they don't itemize deductions, they use Table 20-2. Their standard deduction is $15,100.

Standard Deduction for Dependents

 

The standard deduction for an individual who can be claimed as a dependent on another person's tax return is generally limited to the greater of:

  • $1,050, or

  • The individual's earned income for the year plus $350 (but not more than the regular standard deduction amount, generally $6,300).

 

However, if the individual is 65 or older or blind, the standard deduction may be higher.

If you (or your spouse, if filing jointly) can be claimed as a dependent on someone else's return, use Table 20-3 to determine your standard deduction.

Earned income defined.   Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work you actually perform.

 

   For purposes of the standard deduction, earned income also includes any part of a taxable scholarship or fellowship grant. See Scholarships and fellowships in chapter 12 for more information on what qualifies as a scholarship or fellowship grant.

 

Example 1.

Michael is 16 years old and single. His parents can claim an exemption for him on their 2015 tax return. He has interest income of $780 and wages of $150. He has no itemized deductions. Michael uses Table 20-3 to find his standard deduction. He enters $150 (his earned income) on line 1, $500 ($150 + $350) on line 3, $1,050 (the larger of $500 and $1,050) on line 5, and $6,300 on line 6. His standard deduction, on line 7a, is $1,050 (the smaller of $1,050 and $6,300).

Example 2.

Joe, a 22-year-old full-time college student, can be claimed as a dependent on his parents' 2015 tax return. Joe is married and files a separate return. His wife doesn't itemize deductions on her separate return. Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe finds his standard deduction by using Table 20-3. He enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,150 on line 3. On line 5, he enters $4,150, the larger of lines 3 and 4. Because Joe is married filing a separate return, he enters $6,300 on line 6. On line 7a he enters $4,150 as his standard deduction because it is smaller than $6,300, the amount on line 6.

Example 3.

Amy, who is single, can be claimed as a dependent on her parents' 2015 tax return. She is 18 years old and blind. She has interest income of $1,300 and wages of $2,900. She has no itemized deductions. Amy uses Table 20-3 to find her standard deduction. She enters her wages of $2,900 on line 1. She adds lines 1 and 2 and enters $3,250 ($2,900 + $350) on line 3. On line 5, she enters $3,250, the larger of lines 3 and 4. Because she is single, Amy enters $6,300 on line 6. She enters $3,250 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked the box in the top part of the worksheet, indicating she is blind, she enters $1,550 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $4,800 on line 7c.

Example 4.

Ed is 18 years old and single. His parents can claim an exemption for him on their 2015 tax return. He has wages of $7,000, interest income of $500, and a business loss of $3,000. He has no itemized deductions. Ed uses Table 20-3 to figure his standard deduction. He enters $4,000 ($7,000 - $3,000) on line 1. He adds lines 1 and 2 and enters $4,350 on line 3. On line 5 he enters $4,350, the larger of lines 3 and 4. Because he is single, Ed enters $6,300 on line 6. On line 7a he enters $4,350 as his standard deduction because it is smaller than $6,300, the amount on line 6.

Who Should Itemize

 

You should itemize deductions if your total deductions are more than the standard deduction amount. Also, you should itemize if you don't qualify for the standard deduction, as discussed earlier under Persons not eligible for the standard deduction .

You should first figure your itemized deductions and compare that amount to your standard deduction to make sure you are using the method that gives you the greater benefit.

You may be subject to a limit on some of your itemized deductions if your adjusted gross income is more than: $258,250 if single ($284,050 if head of household; $309,900 if married filing jointly or qualifying widow(er); or $154,950 if married filing separately).

 

When to itemize.   You may benefit from itemizing your deductions on Schedule A (Form 1040) if you:
  • Don't qualify for the standard deduction, or the amount you can claim is limited,

  • Had large uninsured medical and dental expenses during the year,

  • Paid interest and taxes on your home,

  • Had large unreimbursed employee business expenses or other miscellaneous deductions,

  • Had large uninsured casualty or theft losses,

  • Made large contributions to qualified charities, or

  • Have total itemized deductions that are more than the standard deduction to which you otherwise are entitled.

These deductions are explained in chapters 21–28.

 

   If you decide to itemize your deductions, complete Schedule A and attach it to your Form 1040. Enter the amount from Schedule A, line 29, on Form 1040, line 40.

 

Electing to itemize for state tax or other purposes.   Even if your itemized deductions are less than your standard deduction, you can elect to itemize deductions on your federal return rather than take the standard deduction. You may want to do this if, for example, the tax benefit of itemizing your deductions on your state tax return is greater than the tax benefit you lose on your federal return by not taking the standard deduction. To make this election, you must check the box on line 30 of Schedule A.

 

Changing your mind.   If you don't itemize your deductions and later find that you should have itemized — or if you itemize your deductions and later find you shouldn't have — you can change your return by filing Form 1040X, Amended U.S. Individual Income Tax Return.

 

Married persons who filed separate returns.   You can change methods of taking deductions only if you and your spouse both make the same changes. Both of you must file a consent to assessment for any additional tax either one may owe as a result of the change.

 

   You and your spouse can use the method that gives you the lower total tax, even though one of you may pay more tax than you would have paid by using the other method. You both must use the same method of claiming deductions. If one itemizes deductions, the other should itemize because he or she won't qualify for the standard deduction. See Persons not eligible for the standard deduction , earlier.

 

2015 Standard Deduction Tables

 

 

Caution
If you are married filing a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you can't take the standard deduction even if you were born before January 2, 1951, or are blind.

 

Table 20-1.Standard Deduction Chart for Most People*

If your filing status is... Your standard deduction is:
Single or Married filing separately $ 6,300
Married filing jointly or Qualifying widow(er) with dependent child 12,600
Head of household 9,250
*Don't use this chart if you were born before January 2, 1951, are blind, or if someone else can claim you (or your spouse if filing jointly) as a dependent. Use Table 20-2 or 20-3 instead.

 

Table 20-2.Standard Deduction Chart for People Born Before January 2, 1951, or Who are Blind*

Check the correct number of boxes below. Then go to the chart.
You: Born before January 2, 1951 □ Blind □
Your spouse, if claiming spouse's exemption: Born before January 2, 1951 □ Blind □
Total number of boxes checked
Box
 
IF  
your filing status is...
AND 
the number in the box above is...
THEN 
your standard deduction is...
Single 1 $  7,850
  2   9,400
Married filing jointly 1 $13,850
or Qualifying 2   15,100
widow(er) with 3   16,350
dependent child 4   17,600
Married filing 1 $  7,550
separately 2   8,800
  3   10,050
  4   11,300
Head of household 1 $10,800
  2   12,350
*If someone else can claim you (or your spouse if filing jointly) as a dependent, use Table 20-3 instead.

 

Table 20-3.Standard Deduction Worksheet for Dependents Use this worksheet only if someone else can claim you (or your spouse if filing jointly) as a dependent.

Check the correct number of boxes below. Then go to the worksheet.
You:   Born before January 2, 1951 □ Blind □
Your spouse, if claiming spouse's exemption: Born before January 2, 1951 □ Blind □
Total number of boxes checked
Box
1. Enter your earned income (defined below). If none, enter -0-. 1.  
2. Additional amount. 2. $350
3. Add lines 1 and 2. 3.  
4. Minimum standard deduction. 4. $1,050
5. Enter the larger of line 3 or line 4. 5.  
6. Enter the amount shown below for your filing status.
  • Single or Married filing separately—$6,300

  • Married filing jointly—$12,600

  • Head of household—$9,250

6.  
7. Standard deduction.      
  a. Enter the smaller of line 5 or line 6. If born after January 1, 1951, and not blind, stop here. This is your standard deduction. Otherwise, go on to line 7b. 7a.  
  b. If born before January 2, 1951, or blind, multiply $1,550 ($1,250 if married) by the number in the box above. 7b.  
  c. Add lines 7a and 7b. This is your standard deduction for 2015. 7c.  
Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services you performed. It also includes any taxable scholarship or fellowship grant.


 

Classwork

1. What form is used to report the wages paid to the taxpayer for the year?

____________________________________________________________________

2. What form is used to report pension, retirement or IRA distributions to the taxpayer?

____________________________________________________________________

3. How would unemployment compensation be reported to the taxpayer?

_________________________________________________________________________________

4. What form is used to report gambling winnings? ____________________________________________________________________

5. Britton received the following income in 2015: wages, tips, interest, child support, alimony, an inheritance, worker’s compensation and gambling winnings. Which of these must Britton include as income on his 2015 tax return?

____________________________________________________________________

____________________________________________________________________

6. T or F   Interest income must be reported even if no Form 1099-INT is received.

7. T or F   Most taxable compensation a taxpayer receive s as an employee is shown in box 1 of Form W-2.

8. T or F   If a taxpayer receives a state refund in 2015 and he itemized his deductions in 2012, all or part of the state refund may be taxable.

9. T or F   Unemployment compensation is not taxable.

10. T or F Child support payments are taxable to the person who receives them.

11. T or F A pension is fully taxable if the taxpayer did not contribute to the pension plan.

12. T or F Depending on the amount of the social security benefits and the other income, all of the taxpayer’s social security benefits may be taxable.

13. T or F Tips totaling $20 in any month do not have to be reported to the employer.

14. T or F A taxpayer who is married filing separately cannot use the standard deduction if his/her spouse itemizes deductions

 


Nonrefundable and Refundable Credits

A tax deduction reduces the income subject to tax.

 tax credit is a dollar-for-dollar reduction of the tax itself and may result in a refund even if there is no federal income tax withheld.

There Are Two Types of Credits.

A nonrefundable credit is subtracted directly from the tax. These credits may reduce the tax to zero. However, if these credits are more than the tax, the taxpayer cannot receive a refund of the excess.

The child and dependent care credit, child tax credit, Hope and lifetime learning credits, and the retirement savings contributions credit are examples of nonrefundable credits.

Example 1:
Tax liability is $ 678
Child tax credit is limited to $ 678
The credit cannot be more than the amount of the tax.

Example 2:
Tax liability is $0
Child tax credit is $0

If there is no tax owed, there is no credit. A refundable credit is treated as a payment and is added to the federal income tax withheld (if any). If these total payments are more than the tax, the excess will be received as a refund . A refundable credit usually means more money in the taxpayer’s pocket. The earned income credit, additional child tax credit, and the first-time homebuyer’s credit are examples of refundable credits.

Example:
Tax liability is $ 678
Federal income tax withholding is $ 0
Earned income credit is $2,134
---------
Refund $1,456


The taxpayer can receive a refund even if he/she has no federal income tax withheld .


Lesson Six  Earned Income Credit (EIC)

What is the Earned Income Credit?

The earned income credit (EIC), also called EITC, is a tax credit for certain people who work and have earned income under $41,646 . The credit depends upon the taxpayer’s earned income, AGI, filing status and whether or not the taxpayer(s) have one child, two children or no qualifying child. The earned income credit is a refundable credit . It reduces the am ount of tax owed. EIC may give the taxpayer a refund even if no taxes were withheld.

Claiming EIC

To claim EIC the earned income and the AGI must be less than:

  • $46,227 ($51,567 married filing jointly) with three or more qualifying children
  • $43,038 ($48,378 married filing jointly) with two qualifying children
  • $37,870 ($43,210 married filing jointly) with one qualifying child
  • $14,340 ($19,680 married filing jointly) with no qualifying children

Tax Year 2015 maximum credit:

  • $6,044 with three or more qualifying children
  • $5,372 with two qualifying children
  • $3,250 with one qualifying child
  • $487 with no qualifying children

Requirements for Claiming EIC
General requirements must be met for anyone who qualifies for EIC. Additional rules will apply depending on whether the taxpayer has a qualifying child or not.

The rules for everyone are:

* Have a valid social security number for the taxpayer and taxpayer’s spouse (if married filing jointly)
* Not be married filing separately
* Must be a U.S. citizen or resident alien for all of the year
* Investment income must be less than $3,300
* Have earned income, which includes wages, salaries, tips, other taxable employee pay and net earnings from self-employment.
* Unemployment compensation, social security and railroad retirement benefits, interest, dividends, child support, alimony, pension income (not certain disability pensions), workers’ compensation, veteran’s benefits, and welfare benefits are not considered earned income.
* Not be filing Form 2555 or Form 2555-EZ (relating to foreign income)

Additional rules apply if there is a qualifying child. The taxpayer’s qualifying child(ren) must:

* Not be used as a qualifying child of another person,
* Meet the relationship, age, and residency tests,
* Have a valid social security number,
* Not be used by more than one person to claim EIC. If there is no qualifying child , the taxpayer (and spouse, if filing a joint return) must:
* Be at least 25, but under age 65 (If married filing a joint return, only one needs to meet this test.),
* Not be the dependent of another person
* Have lived in the U.S. for more than half the year


Who is a Qualifying Child?
The definition of a qualifying child for purposes of the earned income credit is generally the same as the uniform definition of a child that is contained in the
dependency exemption rules.

A qualifying child must meet all three tests (relationship, age and residency).

• Under the relationship test, a qualifying child is a son, daughter, stepchild, grandchild or foster child (placed by an authorized agency or by judgment, decree, or other order of any court of competent jurisdiction). A brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of the
taxpayer’s brother, sister, etc. (for example, a niece or nephew) can also be a qualifying child.
• Under the age test, the qualifying child must be (at the end of 2015) under age 19 or under age 24 and a full-time student, orany age and permanently and totally disabled at any time during the year. A child is permanently and totally disabled if he/she cannot engage in any substantial gainful activity because
of a physical or mental condition, and a doctor determines the condition has lasted or can be expected to last continuously for at least a year, or can lead to death.
• Under the residency test, a qualifying child must have lived with the taxpayer in the U.S. for more than half of the year. A taxpayer does not need a home to claim the EIC. For example, if the taxpayer and his/her child(ren) lived together for more than half the year in one or more homeless shelters, the child meets the residency test.
 
The taxpayer’s child does not have to be a dependent to be a qualifying child unless he/she is married.
A Qualifying Child Cannot be Used by More Than One Person to Claim EIC. Sometimes a child meets the rules to be a qualifying child of more than one person. However, only one person can treat that child as a qualifying child and claim EIC using that child. If the child meets the conditions to be a qualifying child of more than one person, the taxpayer and the other person can decide who will claim the credit using that child. If no agreement is reached, the tie-breaker rule applies.
 
The tie-breaker rule is:

* If only one of the persons is the child’s parent, the child will be treated as the qualifying child of the parent.
* If both persons are the child’s parents, the child will be treated as the qualifying child of the parent with whom the child lived for the longer period of time during 2015.
* If the child lived with each parent for the same amount of time, the child will be treated as the qualifying child of the parent who had the higher AGI for 2015.
* If none of the persons is the child’s parent, the child will be treated as the qualifying child of the person who had the highest AGI for 2015.

 

Example 1: Astrid and her son, Irving (age 6), lived with her mother all year. Astrid is 25 years old and her only income was $9,300 from a part-time job. Her mother’s only income was $15,000 from her job. Irving is a qualifying child of both Astrid and her mother. Only one of them can use Irving to claim the EIC. Astrid and her mother may choose which one will treat Irving as a qualifying child to claim EIC. However, if they disagree, since Astrid is the child’s parent, she will be the only one allowed to claim the credit using Irving.

Example 2: Trish and her boyfriend Kaleb have never married but they shared a household for the entire year. They have a daughter, Wendy (age 2), who lived with them. Trish earned $8,000 and Kaleb earned $15,000. They both had no other income. Wendy is a qualifying child for both Trish and Kaleb. Trish and Kaleb may choose which one will treat Wendy as a qualifying child to claim EIC. If they cannot agree, however, Kaleb will be the one allowed to claim the credit using Wendy because he has a higher AGI than Trish.

Example 3: Malcolm (age 16) lived all year with his two brothers, Josh and Jerome. Josh had wages of $20,000 (his only income) and Jerome had wages of $18,500 (his only income). Malcolm is a qualifying child of both Josh and Jerome. Josh and Jerome may choose which one will treat Malcolm as a qualifying child to claim EIC. However, if they disagree, because Josh has a higher AGI than Jerome, Josh is the one that will be allowed to claim the credit using

Malcolm. If the taxpayer’s qualifying child is treated under the tie-breaker rule as the qualifying child of another person for 2015, the taxpayer cannot take the EIC for persons who do not have a qualifying child, but may take the EIC based on a different qualifying child, if there is one. Schedule EIC must be completed if there is a qualifying child(ren) and the credit is claimed on Form 1040A or Form 1040. Improper Claim Made in Prior Year. For any year after 1996, if EIC was denied or reduced for any reason other than a mathematical or clerical error, a completed Form 8862 Information to Claim Earned Income Credit After Disallowance, must be attached to the next return on which EIC is claimed.

If EIC was denied for any year after 1996 and it was determined that the error was due to reckless or intentional disregard of the EIC rules, then EIC cannot be claimed for the next two years. If the error was due to fraud, EIC cannot be claimed for the next ten years.


Due Diligence.
Tax preparers are subject to a penalty if they do not exercise due diligence in determining eligibility for EIC. The penalty is $100 for each failure to meet
the requirements. Due diligence requires the preparer to:
• Complete the EIC Qualification Checklist for Form 8867, Paid Preparer’s Earned Income Credit Checklist. The information must be provided by the taxpayer or obtained in another reasonable manner. It is important to ensure that the questions are asked. A copy should be included in the taxpayer’s file.
If there is a suspicion that the information is incorrect, inconsistent, or incomplete, the preparer must request more information and ask more questions until he/she is satisfied with the information. The preparer must evaluate the information received and make reasonable inquiries.
• The preparer may not ignore any implications of the information furnished to, or known by, the preparer. The preparer must document the additional inquiries
and the client’s responses.

To comply with the knowledge requirement, preparers should:
• Apply a common sense standard to the provided information;

• Evaluate whether the information appears to be complete and identify missing facts;
• Determine whether the information is consistent; recognize contradictory statements or statements that are inconsistent with what the preparer knows to be true;
• Conduct an interview with the taxpayer every year;
• Ask enough questions to ensure the return is correct and complete. If there is an isolated and inadvertent lapse resulting in an erroneous claim for EIC, the
IRS will not assess the penalty if the preparer can demonstrate that considering all the facts and circumstances, the normal office procedures are reasonably designed and routinely followed to ensure compliance with the due diligence requirements.

 

Classwork 1

 

1. Bo (age 26) is single, live s alone, and earned $9,789 working  as a bouncer in a club. He has  interest income of $201 and his AGI is $9,990. He cannot be claimed as a dependent on another person’s return. Can Bo claim the earned income credit? Yes/No

2. Peter and Jane are married and have two qualifying children (ages 10 and 17). In 2015, Peter had wages of $21,775 and Jane had wages of $3,425. Jane also received unemployment compensation of $3,240. They have no other income. Is their earned income for purposes of the earned income credit $25,200? Yes/No

3. Sabrina (age 32) is married and lived with her husband, Darren, and their son (age 13) until August 2015, when Darren moved out of their apartment. Their son continued to live with Sabrina. She had wages of $23,240 and no other income. Is Sabrina eligible for the earned income credit? Yes/No

4. Roxanne (age 39) is divorced and lives with her daughter (age 2). Her former husband will claim the child as a dependent on his return. Roxanne had wages

of $18,250 and she received $4,000 of child support in 2015. She has no other income. Is Roxanne eligible for the earned income credit? Yes/No
Will Roxanne have $22,250 of earned income for purposes of the earned income credit? Yes/No

5. Raven (age 32) is single and lives with her daughter Dove (age 8). Raven’s only income is unemployment, social security disability and alimony. Her AGI is $15,250. Is Raven eligible for the earned income credit? Yes/No

6. Lionel (age 29) is married but he and his wife, Tina, did not live together in 2015 and he will file married filing separately. Lionel lives alone and his wages were $10,000. He has no other income. Is Lionel eligible for the earned income credit? Yes/No

7. Ben (age 30) and Louise (age 32) were married and lived together until May 2015, when they divorced. They have two children Joey (age 7) and Richie (age 5). The children lived with both of the parents until May, and then they lived with their mother. Ben’s earned income and AGI is $25,000. He also paid $5,000 in child support. Louise’s earned income is $17,500 and her AGI is $19,500. Can Ben claim the earned income credit? Yes/No.

8. Rocky (age 40) is single and lived all year with his girlfriend Betty (age 25) and Betty’s son, Mario (age 6). Rocky’s earned income is $30,000 and his AGI is $31,000. Betty does not work and she has no other income except unemployment of $4,000. Rocky can claim Mario as a dependent since Betty does not

work and is not required to file a tax return. Can Rocky claim the earned income credit? Yes/No

9. Donna (age 22) is single and was a full-time college student in 2015. She earned $5,000 and had no other income. She and her 2-year-old son lived with Donna’s mother for the entire year. Donna meets all the relationship, age, and residency tests and therefore is a qualifying child for her mother. Her mother’s 2015 investment income of over $3,000 is too high to allow her mother to claim the earned income credit. Can Donna claim the earned income credit? Yes/No

10. Edna (age 23) is single and lived all year with her son Eddie (age 4). No one else lived in the home. Edna is divorced and she has agreed in writing that Eddie’s father can claim Eddie as a dependent. Edna’s earned income is $20,000 and she has no other income. Can Edna claim the earned income credit? Yes/No

11. Amy (age 43) is single and lived all year with her son Jarred (age 25). No one else lived in the home. Jarred is totally and permanently disabled. Amy’s earned income is $29,000 and her AGI is $31,000. Can Amy claim the earned income credit? Yes/No

12. Witt (age 32) lived all year with his son Roy (age 7) and Roy’s mother Gabby (age 29). Witt and Gabby are not married. Witt’s earned income is $18,000 and Gabby’s earned income is $15,000. Neither of them had any other income. They both want to use Roy to claim EIC. If they cannot agree, can Witt claim the earned income credit? Yes/No
Can Gabby claim the earned income credit? Yes/No


Lesson Seven   Child and Dependent Care Credit

 
If the taxpayer pays someone to care for a dependent who is under age 13 or for a spouse or dependent who is not able to care for himself/herself, a credit of up to 35% of the expenses may be allowed. To qualify, the taxpayer (and spouse, if married filing jointly) must pay these expenses in order to work or look for work. This is a nonrefundable credit.

Dollar Limit.

The dollar limit on the amount of work-related expenses that can be used to figure the credit is $3,000 for one qualifying person or $6,000 for two or more
qualifying persons.

Claiming the Credit

To figure the credit, the taxpayer uses Schedule 2, Child and Dependent Care Expenses for Form 1040A Filers or Form 2441, Child and Dependent Care Expenses (Form 1040) and must meet all of the following tests.
 

* The care must be for one or more qualifying persons who are identified on the form the taxpayer uses to claim the credit.
* The qualifying individual must live with the taxpayer (and spouse, if married filing jointly) for more than one-half of the year, even if the taxpayer does not provide more than one-half of the cost of maintaining the household.
* The taxpayer (and spouse, if married filing jointly) must have earned income during the year. (However, see Student-spouse or spouse not able to care for self,later.)
* Child and dependent care expenses must be paid so the taxpayer (and spouse, if married filing jointly) can work or look for work.
* Payments for child and dependent care expenses must be made to someone who cannot be claimed as a dependent. If payments are made to his/her child, the child cannot be a dependent and must be age 19 or older by the end of the year.
* The filing status must be single, head of household, qualifying widow(er), or married filing jointly.
* The care provider must be identified on the tax return. The taxpayer’s child and dependent care expenses must be for the care of one or more members of the home who are qualifying persons.

A qualifying child is:

• The taxpayer’s dependent child including a son, daughter, adopted child, stepson, stepdaughter, eligible foster child (who must have been placed with the taxpayer by an authorized placement agency or an order of a court), brother, sister, stepbrother, stepsister, or a descendant of one of these listed
relatives (including a grandchild, niece or nephew).
• A child who was under age 13 when the care was provided and for whom an exemption can be claimed (See exception under Child of Divorced or Separated Parents, later) or any age if permanently and totally disabled.
• Be a U.S. citizen, national, or resident
• Have lived with the taxpayer for more than half of 2015. A child who was born or died in 2015 and whose only residence was with the taxpayer meets this requirement.

A qualifying person is

• A spouse who was physically or mentally not able to care for himself/ herself, or
• A dependent who was physically or mentally not able to care for himself/ herself and for whom an exemption can be claimed (or could be claimed except the person had $3,500 or more of gross income). Person qualifying for part of the year. A person’s qualifying status is determined each day. For example, if the person for whom the child and dependent care expenses are paid no longer qualifies on September 16, count only those expenses through September 15.
Child of Divorced or Separated Parents. To be a qualifying person, the child usually must be a dependent for whom an exemption can be claimed. But an exception may apply if the taxpayer is divorced or separated. Under the exception, if the taxpayer is the custodial parent, then the child is treated as a
qualifying person even if the child is not claimed as a dependent. If the taxpayer is the noncustodial parent, he/she cannot treat the child as a qualifying
person even if the child’s exemption can be claimed.

The Child and Dependent Care Credit can help offset some of the costs you pay for the care of your child, a dependent or a spouse.
Here are 10 facts the IRS wants you to know about the tax credit for child and dependent care expenses.

    1. If you paid someone to care for your child, dependent or spouse last year, you may qualify for the child and dependent care credit. You claim the credit when you file your federal income tax return.

       
    2. You can claim the Child and Dependent Care Credit for “qualifying individuals.” A qualifying individual includes your child under age 13. It also includes your spouse or dependent who lived with you for more than half the year who was physically or mentally incapable of self-care.

       
    3. The care must have been provided so you – and your spouse if you are married filing jointly – could work or look for work.

       
    4. You, and your spouse if you file jointly, must have earned income, such as income from a job. A special rule applies for a spouse who is a student or not able to care for himself or herself.

       
    5. Payments for care cannot go to your spouse, the parent of your qualifying person or to someone you can claim as a dependent on your return. Payments can also not go to your child who is under age 19, even if the child is not your dependent.

       
    6. This credit can be worth up to 35 percent of your qualifying costs for care, depending upon your income. When figuring the amount of your credit, you can claim up to $3,000 of your total costs if you have one qualifying individual. If you have two or more qualifying individuals you can claim up to $6,000 of your costs.

       
    7. If your employer provides dependent care benefits, special rules apply. See Form 2441, Child and Dependent Care Expenses for how the rules apply to you.

       
    8. You must include the Social Security number on your tax return for each qualifying individual.

       
    9. You must also include on your tax return the name, address and Social Security number (individuals) or Employer Identification Number (businesses) of your care provider.

       
    10. To claim the credit, attach Form 2441 to your tax return. If you use IRS e-file to prepare and file your return, the software will do this for you.

Example: Sasha is divorced and has custody of her 8-year-old child. She signed Form 8332 to allow her ex-spouse to claim the child’s exemption. Sasha pays child care expenses so that she can work. The child is a qualifying person and Sasha, the custodial parent, can claim the credit for those expenses even though her ex-spouse claims an exemption for the child.

Earned Income

To claim the credit, the taxpayer (and spouse, if married filing jointly) must have earned income during the year. Earned income includes wages, salaries, tips, other taxable employee compensation and net earnings from self-employment. A net loss from self-employment reduces earned income. Earned income also includes strike benefits and any disability pay that is reported as wages. Earned income does not include pensions or annuities, social security payments, workers’ compensation, interest, dividends or unemployment compensation. Generally, only taxable compensation is considered earned income. However, the taxpayer can elect to include nontaxable combat pay in earned income. If filing a joint return and both the taxpayer and spouse received nontaxable combat pay, they can each make their own election. Student-spouse or Spouse Not Able to Care for Self.

The spouse is treated as having earned income for any month that he/she is:

* A full-time student, or
* Physically or mentally not able to care for himself or herself. The earned income for each month is considered to be at least $250 if there is one
qualifying person in the home or at least $500 if there are two or more. This applies to only one spouse for any one month. If, in the same month, both the taxpayer and spouse do not work and are either full-time students or physically or mentally not able to care for themselves, only one can be treated as having earned income in that month. Full-time Student. A full-time student is one that is enrolled at and attends a school for the number of hours or classes that the
school considers full-time. To qualify he/she must have been a student for some part of each of 5 calendar months during the year. The months need not be consecutive.A school does not include on-the-job training courses, correspondence school, or school offering courses only through the internet.

Expenses

Child and dependent care expenses must be work related to qualify for the credit. Expenses are considered work related only if both of the following are true.
• Allows the taxpayer (and spouse, if married filing jointly) to work or look for work.
• Are for a qualifying person’s care. Example: The cost of a sitter to go out to eat is not a qualifying expense. Unpaid volunteer work or volunteer work for a
nominal salary is not considered work.

Camp.
The cost of sending the child to an overnight camp is not considered a qualified expense.

Working or looking for work.
To be work related, the expenses must allow the taxpayer to work or look for work. If the taxpayer is married, generally both must work or look for work. However, if no job is found and there is no earned income for the year, the credit cannot be taken.

Example: Andy lived all year with his 4-year-old son, Jeb. In 2015, Andy’s only income was unemployment. While Andy looked for work he paid Kid’s Cove $650 to care for Jeb. Andy has no earned income so he cannot claim the child and dependent care credit. Earned Income Limit The amount of expenses used to figure the credit cannot be more than:

1. The earned income for the year, if single at the end of the year, or

2. The smaller of the earned income or spouse’s earned income for the year, if married at the end of the year.

Community property laws.

Community property laws should be disregarded when figuring earned income for this credit. The child care provider must give the following information to the taxpayer for claiming the child and dependent care credit:
• Name,
• Address, and
• Taxpayer identification number, SSN or EIN.


Lesson Eight   Child Tax Credit and Additional Child Tax Credit

 

The Child Tax Credit is an important tax credit that may be worth as much as $1,000 per qualifying child depending upon your income.

  1. Amount - With the Child Tax Credit, you may be able to reduce your federal income tax by up to $1,000 for each qualifying child under the age of 17.

     
  2. Qualification - A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.

     
  3. Age Test - To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2015.

     
  4. Relationship Test - To claim a child for purposes of the Child Tax Credit, they must either be your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes your grandchild, niece or nephew. An adopted child is always treated as your own child. An adopted child includes a child lawfully placed with you for legal adoption.

     
  5. Support Test - In order to claim a child for this credit, the child must not have provided more than half of their own support.

     
  6. Dependent Test - You must claim the child as a dependent on your federal tax return.

     
  7. Citizenship Test - To meet the citizenship test, the child must be a U.S. citizen, U.S. national, or U.S. resident alien.

     
  8. Residence Test - The child must have lived with you for more than half of 2015. There are some exceptions to the residence test, which can be found in IRS Publication 972, Child Tax Credit.

     
  9. Limitations - The credit is limited if your modified adjusted gross income is above a certain amount. The amount at which this phase-out begins varies depending on your filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax you owe as well as any alternative minimum tax you owe.

     
  10. Additional Child Tax Credit - If the amount of your Child Tax Credit is greater than the amount of income tax you owe, you may be able to claim the Additional Child Tax Credit.
NOTE: An eligible foster child must be placed with the taxpayer by an authorized agency, or by judgment, decree, or other order of any court of competent jurisdiction.

Children of Divorced or Separated or Never Married Parents.
A child will be treated as being the qualifying child or qualifying relative of his/her noncustodial parent (the parent with whom the child lived for the lesser part of 2015) if all of the following apply:
* The parents are divorced, legally separated, separated under a written separation agreement, or lived apart at all times during the last 6 months of 2015.
* The child received over half of his/her support for 2015 from the parents. Support of a child received from a parent’s spouse is treated as provided by the parent.
* The child is in the custody of one or both of the parents for more than half of 2015.
* Either of the following applies:
a. The custodial parent signs Form 8332 or a substantially similar document that he/she will not claim the child as a dependent for 2015. The noncustodial
parent attaches the form or statement to his/her return.
b. A decree of divorce or separate maintenance or written separation agreement between the parents that applies to 2015 provides that the noncustodial
parent can claim the child as a dependent.
If the rules above apply and the child would otherwise be the qualifying child of more than one person, then Only the noncustodial parent can claim the child for purposes of the dependency exemption, the child tax credit, and the additional child tax credit.
 
For head of household filing status, the credit for child and dependent care expenses and the earned income credit, only the custodial parent can claim these three benefits.

No other person can claim any of these three benefits unless he/she has a different qualifying child. If the taxpayer and any other person claim the child as a qualifying child, the IRS will apply the rules under Qualifying Child of More than One Person, covered later.

Example: Ira and Sheena were divorced in 2005. They have one child together, Amy (age 10), who lives with Sheena. Ira and Sheena provide all of Amy’s support. The divorce decree does not state who can claim the child. Sheena earned income is $29,000 and her AGI is $31,000 and Ira’s earned income and AGI is $32,000. If Sheena signs Form 8332, the dependency exemption, the child tax credit, and the additional child tax credit is given to Ira, the noncustodial parent. However, Sheena can still claim head of household, the earned income credit, and child and dependent care credit based on Amy,
assuming she otherwise qualifies for them.
 
Qualifying Child of More Than One Person.
If the child is the qualifying child of more than one person, only one person can claim the child as a qualifying child for all of the following tax benefits, unless the rules for children of divorced, separated, or never-married parents apply:
• Head of household filing status
• Dependency exemption
• Credit for child and dependent care expenses
• Child tax credit
• Additional child tax credit
• Earned income credit No other person can claim any of the tax benefits listed unless he/she has a different qualifying child. If the taxpayer and any other person claim the child as a qualifying child, the IRS will apply the rules for the Special Test for Qualifying Child of More Than One Person

 

Additional Child Tax Credit
If the taxpayer receives less than the full amount of the child tax credit because the tax is less than the allowable child tax credit, part of the credit may be refundable. or
taxpayers with one or more qualifying children, the additional child tax credit is the smaller of:
• The amount of the child tax credit remaining after reducing the regular tax, or
• 15 percent of the taxpayer’s taxable earned income (usually wages on line 7 of Form 1040A or Form 1040)
.
Nontaxable combat pay is included as income when figuring the taxable earned income. Counting combat pay as income does not change the exclusion of combat pay from taxable income. This is a refundable credit and the taxpayer could get a refund of the credit even if no tax is owed. This credit is figured on
Form 8812


Lesson Nine   Education Tax Credits, Retirement Savings Contribution Credit

 

Education Credits

The American Opportunity Credit and the Lifetime Learning Credit may help you pay for the costs of higher education. If you pay tuition and fees for yourself, your spouse or your dependent you may qualify for these credits.

Here are some facts the IRS wants you to know about these important credits:

The American Opportunity Credit

  • The AOTC is worth up to $2,500 per eligible student.

     
  • The credit is available for the first four years of higher education at an eligible college, university or vocational school.

     
  • The credit lowers your taxes and is partially refundable. This means you could get a refund of up to $1,000 even if you owe zero tax.

     
  • An eligible student must be working toward a degree, certificate or other recognized credential.

     
  • The student must be enrolled at least half time for at least one academic period that began during the year.

     
  • You generally can claim the costs of tuition and required fees, books and other required course materials. Other expenses, such as room and board, do not qualify.

The Lifetime Learning Credit

  • The credit is worth up to $2,000 per tax return per year. The yearly limit applies no matter how many students are eligible for the credit.

     
  • The credit is nonrefundable. This means the amount you can claim is limited to the amount of tax you owe.

     
  • The credit is available for all years of higher education. This includes courses taken to acquire or improve job skills.

     
  • You can claim the costs of tuition and fees required for enrollment or attendance. This includes amounts you were required to pay to the institution for course-related books, supplies and equipment.

You cannot claim either of these credits if someone else claims you as a dependent on his or her tax return. Both credits are subject to income limitations and may be reduced or eliminated depending on your income.

Keep in mind that you can’t claim both credits for the same student in the same year. You may not claim both credits for the same expense. Parents or students claiming either credit should receive a Form 1098-T, Tuition Statement, from their educational institution. You should make sure it is complete and correct.

Retirement Savings Contribution Credit

You may be able to take a tax credit for making eligible contributions to your IRA or employer-sponsored retirement plan.

Who's eligible for the credit?

You're eligible for the credit if you're:

  1. Age 18 or older;
  2. Not a full-time student; and
  3. Not claimed as a dependent on another person’s return.

Amount of the credit

The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (reported on your Form 1040 or 1040A). Use the chart below to calculate your credit.

2015 Saver's Credit
Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $35,500 AGI not more than $26,625 AGI not more than $17,750
20% of your contribution $35,501 - $38,500 $26,626 - $28,875 $17,751 - $19,250
10% of your contribution $38,501-$59,000 $28,876 - $44,250 $19,251 - $29,500
0% of your contribution more than $59,000 more than $44,250 more than $29,500

*Single, married filing separately, or qualifying widow(er)

2014 Saver's Credit
Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $36,000 AGI not more than $27,000 AGI not more than $18,000
20% of your contribution $36,001 - $39,000 $27,001 - $29,250 $18,001 - $19,500
10% of your contribution $39,001-$60,000 $29,251 - $45,000 $19,501 - $30,000
0% of your contribution more than $60,000 more than $45,000 more than $30,000

Retirement savings eligible for the credit

The Saver’s Credit can be taken for your contributions to a traditional or Roth IRA; your 401(k), SIMPLE IRA, SAR SEP, 403(b), 501(c)(18) or governmental 457(b) plan; and your voluntary after-tax employee contributions to your qualified retirement and 403(b) plans.

Rollover contributions aren’t eligible for the Saver’s Credit. Also, your eligible contributions may be reduced by any recent distributions you received from a retirement plan or IRA.

Example: Jill, who works at a retail store, is married and earned $30,000 in 2015. Jill’s husband was unemployed in 2015 and didn’t have any earnings. Jill contributed $1,000 to her IRA in 2015. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $29,000. Jill may claim a 50% credit, $500, for her $1,000 IRA contribution.

Classwork 1

1. Explain the difference between a refundable and a nonrefundable credit

________________________________________________________________________________________


2. Jon and Andrea (AGI $79,000) have three teenage children. Laura, a senior at a private high school; Carrie, a freshman in college; and Martin, a senior in college. Andrea took a computer class at the local community college which cost $500. Jon and Andrea paid the following educational expenses for their dependent children:
 
Laura $2,500
Carrie 5,000
Martin 5,000

What education credits do they qualify for and why?

________________________________________________________________________________________


3. John and Karen file jointly with 2 dependent children (ages 2 and 4). John works as a schoolteacher earning $25,000 a year. Karen does not work outside the home. They pay $400 to a day care center so Karen can take swimming lessons. Can John and Karen claim the child and dependent care credit? Explain why or why not.

________________________________________________________________________________________
 

4. Susan and Peter both work and have two children in day care. Susan works part-time as a nurse and earned $25,000 and Peter is a computer programmer earning $42,000 a year. They have no other income. While they are working the children are in day care. Their oldest child, Catherine, is 9 and is in day care after school which costs $3,150 a year. Their youngest child, Kyle is 2 years old and is in a day care center where they paid $3,650 for the year. Do Susan and Peter qualify for the child and dependent care credit? If yes, what is the maximum amount of child and dependent care expenses they can use to figure the credit?

________________________________________________________________________________________
 


5. Jane is a single mother with a 5-year-old son, Matthew. Jane is Matthew’s custodial parent, but she has signed a Form 8332 allowing her ex-husband to claim the dependent exemption. Jane earned $25,000 in 2015 and paid $2,600 in day care expenses for Matthew. Can Jane qualify for the child care credit? If yes, what is the maximum amount of child and dependent care expenses she can use to figure the credit?

________________________________________________________________________________________
 

Classwork 2

1) T or F    The earned income credit can be claimed when the taxpayer’s only income is from interest.

2) T or F    For EIC purposes, the taxpayer’s niece or nephew can be a qualifying child.

3) T or F    The taxpayer must have earned income to claim the earned income credit.

4) T or F    The earned income credit can be taken for a niece who lived with the taxpayer for nine months of the tax year.

5) T or F    The child and dependent care credit can be claimed for expenses paid for the entire year even though the child’s 13th birthday was Oct 2015.

6) T or F    The taxpayer must claim a child as a dependent to qualify for the earned income credit.

7)T or F     A taxpayer can claim the earned income credit for a cousin (age 10) who lived in the home for 8 months.

8) T or F    The additional child tax credit may be refundable when the credit is more than the taxpayer’s tax.

9) T or F    The retirement savings contributions credit is a refundable credit.

10) T or F   The child must be under age 17 to be a qualifying child for the child tax credit.

11) T or F   The lifetime learning credit is only for a dependent that is in the first two academic years of postsecondary education.

12) T or F   The American Opportunity credit can be taken for any two years of education at an eligible education institution


Lesson Ten   Adjustments to Income and Itemized Deductions

The total of all income earned by a taxpayer (and spouse, if married filing jointly) is shown on line 15 of Form 1040A or line 22 of Form 1040.

Certain adjustments can be taken which are then subtracted from the total income to arrive at a number known as Adjusted Gross Income (AGI). The AGI is reported on line 21 of Form 1040A or line 37 of Form 1040. The adjustments that will be covered in the Rapid Class are:

• Educator expenses
• Moving expenses
• Penalty on early withdrawal of savings
• Alimony paid
• IRA deduction
• Student loan interest deduction
• Tuition and fees deduction

Form 1040EZ does not allow for any adjustments to income. Form 1040A allows only educator expenses, IRA deduction, student loan interest deduction and tuition and fees deduction. All other adjustments must be taken on Form 1040.

Educator Expenses
Eligible educators (kindergarten through grade 12) can deduct up to $250 for qualified unreimbursed expenses on Form 1040A or Form 1040, rather than as a miscellaneous itemized deductions (covered later). If the taxpayer and the spouse are both eligible educators and choose to file a joint return, they may deduct up to $500 ($250 each) of qualified expenses.

Eligible educators include:
 
• Teachers
• Counselors
• Instructors
• Principals
• Aides

The educator must have worked for at least 900 hours during a school year in a school that provided elementary or secondary education, as determined under state law.

Qualified Expenses.
Qualified expenses are the unreimbursed expenses paid or incurred for books, supplies, computer equipment (including related software and services),
and other equipment and supplementary materials that the taxpayer uses in his/her classroom.

The educator expense can be claimed on Form 1040, line 23 or Form 1040A, line 16.

Moving Expenses
An adjustment can be taken on Form 1040, line 26, for certain expenses incurred from moving to a new home because of a change in job location. The move must be closely related, both in time and in place, to the start of work at the taxpayer’s new job location.

The new job location must be at least 50 miles farther from the former home than the old job was from the former home. In other words, the commuting distance, if the taxpayer did not move, would have to increase by 50 miles or more.

Example: Cecile’s old job was 3 miles from her old home.
Her new workplace is 54 miles from her old home.
Her old home is at least 50 miles (54 – 3 = 51) farther from her new workplace than from her old workplace.

The location of the new home does not enter into the calculation. The taxpayer does not have to move 50 miles from his/her old home to pass this test.
 

Figure A. Illustration of Distance Test


The taxpayer must also work full time as an employee for at least 39 weeks in the first 12 months after arriving in the new area. A longer working period of time applies to a self-employed taxpayer. A member of the Armed Forces on active duty is allowed to deduct moving expenses for a permanent change of station without meeting the time and distance tests.

Deductible expenses include the cost of moving household goods, travel, and lodging, but not meal expenses. Form 3903, Moving Expenses, is used to report these expenses. The standard mileage rate for moving expenses is 24 cents a mile.

Figure B. Qualifying Moves Within the United States (Non-Military) Footnote: 1: Military persons should see Members of the Armed Forces, later, for special rules that apply to them.

 


Penalty on Early Withdrawal of Savings
If the taxpayer forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT in box 2 and reported on line 30 of Form 1040. The entire penalty is deductible, even if it exceeds the interest income.

Alimony Paid
Alimony is a payment made to a spouse or former spouse under a divorce decree or separation agreement. It can be deducted by the payer and must be included in the recipient’s income. The amount of alimony paid is entered as an adjustment on line 31a of the payer’s Form 1040. The SSN of the recipient of the alimony must be entered on line 31b.



Child support is not the same as alimony or separate maintenance payments. Child support is not taxable to the recipient and cannot be claimed as an adjustment by the payer.

IRA Deduction
An Individual Retirement Arrangement (IRA) is a personal savings plan that offers the taxpayer tax advantages to set aside money for retirement. There are two types of IRAs:

1) Traditional IRA – Contributions may be deductible and distributions may be taxable.

2) Roth IRA – Contributions are not deductible and qualified distributions are not taxable. Contributions to a Roth IRA are not reported on the tax return and no adjustment to income is allowed for a Roth IRA. The Roth IRA will not be covered in the Rapid Class.

Contributions can be made to a traditional IRA if the taxpayer (and/or spouse, if filing a joint return) has taxable compensation. Compensation includes wages, salaries, tips, commissions, self-employment income, taxable alimony and separate maintenance payments. The most that a person can
contribute to a traditional IRA is the smaller of:

1) The compensation included in income for the year, or
2) $5,000 ($6,000 if age 50 or older).

If filing a joint return and only the taxpayer or the spouse works and has taxable compensation, a spousal IRA contribution can be made for the nonworking spouse.

Who can contribute to a traditional IRA?
A taxpayer can make contributions to a traditional IRA if he/she (or spouse, if filing a joint return) received taxable compensation in 2015 and is under 70½
years old. The taxpayer may be able to deduct his/her contributions on Form 1040A, line 17 or Form 1040, line 32, in whole or in part, depending on the modified AGI and whether the taxpayer is covered by an employer retirement plan.

Deduction limits for a traditional IRA.
The deduction for a traditional IRA may be fully or partially reduced if the taxpayer (or spouse, if filing a joint return) was covered by an employer retirement plan at any time during the year for which contributions were made.

Form W-2 has a checkbox used to indicate if covered by a retirement plan for the year. Box 13, “Retirement plan” should be checked if the employee is covered.

If the traditional IRA contribution is reduced or eliminated by the phase out, contributions can still be made up to the $5,000/$6,000 limit. The difference between the total permitted contribution and the IRA deduction is a nondeductible contribution. To designate contributions as nondeductible, file Form 8606, Nondeductible IRAs. Taxpayers may deduct traditional IRA contributions on their 2015 tax return if the contributions are made in 2015 or by the due
date for filing the return, not including extensions.


Student Loan Interest Deduction
Student loan interest is interest paid during the year on a qualified student loan. This is a loan taken out to pay qualified education expenses. These include amounts paid for:

• Tuition and fees
• Room and board
• Books, supplies and equipment
• Other necessary expenses (such as transportation)

Up to $2,500 interest paid on qualified student loans can be claimed on Form 1040A, line 18, or Form 1040, line 33. To qualify, the student must have been enrolled at least half-time in a degree program at an eligible educational institution at the time the loan was taken out and must be the taxpayer, spouse (if married filing jointly) or a dependent. The taxpayer can not be married filing separately.

Interest paid on a student loan for a dependent can be deducted if the taxpayer(s) is legally liable to make the interest payments and actually made the payments.

The amount may be gradually reduced (phased out) or eliminated based on the taxpayer’s filing status and modified adjusted gross income.

Tuition and Fees Deduction
A deduction of up to $4,000 per tax return is allowed for qualified education expenses for the taxpayer, spouse (if married filing jointly) or a dependent for whom an exemption can be claimed.

Qualified education expenses are tuition and certain related expenses required to enroll at or attend an eligible education institution. Student activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.

An eligible education institution, such as a college or university, must furnish Form 1098-T, Tuition Statement, to each enrolled student.

Qualified education expenses do not include room and board, transportation, or similar personal living, or family expenses. Form 8917, Tuition and Fees Deduction, is used to figure the deduction amount.

This deduction is not permitted for a married filing separate return. No deduction is allowed if the same student is claiming the American Opportunity Credit or the lifetime learning credit (covered earlier) for qualified tuition and related expenses in the same year. No credit is allowed on expenses paid with a tax-free scholarship, grant, or employer-provided educational assistance.

The deduction may be limited if the modified AGI exceeds certain limits

Itemized Deductions

Most taxpayers have a choice of taking a standard deduction or itemizing their deductions. If the taxpayer is married and filing a separate return and the spouse itemizes deductions the standard deduction is zero and the taxpayer should itemize any deductions he/she has. If an exemption can be claimed on another person’s return (such as a parent’s return), the taxpayer’s standard deduction may be limited.

If, a taxpayer qualifies for a greater deduction by itemizing certain expenses, the IRS will allow that greater deduction. This is accomplished by filing a Schedule A along with Form 1040. Itemized deductions can only be claimed on Form 1040.

The most common reason for itemizing is home ownership because home mortgage interest and real estate taxes are deductible. It is usually these items that make itemizing on a Schedule A more beneficial than using the standard deduction.

Other itemized deductions are large medical expenses, charitable contributions and unreimbursed employee business expenses.

In some cases, a taxpayer may have many expenses to report on the Schedule A, but the total amount is lower than his/her standard deduction. In this instance, the taxpayer would use the standard deduction because it is higher than the total allowable itemized deductions.

Allowable Medical Deductions
Only the part of the medical and dental expenses that exceeds 7.5% of the AGI can be deducted. Medical expense payments made for the taxpayer, spouse or dependent(s) that have not been reimbursed are deductible. Some examples are:
• Insurance premiums for medical and dental care, including long-term care premiums (limited) and Medicare parts B and D
• Prescription medicines
• Medical service fees from doctors, dentists, surgeons, and other medical practitioners
• Medical examinations and tests
• Medical mileage incurred for doctor’s visits, medical clinic for treatment, to pick up medications, etc. The standard mileage is 24 cents per mile for mile. Parking and tolls are also deductible.
• Other transportation expense such as bus or taxi
• Nurses for in-home care or hospital care
• Medical treatment for alcoholism, drug addiction or stop-smoking programs including the cost of prescription drugs designed to alleviate nicotine withdrawal
• Certain weight-loss programs to treat disease diagnosed by a physician, including obesity
• Medical aids such as eyeglasses, contacts, hearing aids, braces, crutches, wheelchairs, etc.
• Ambulance and emergency service charges

Payments that may NOT be deducted:
• Cosmetic surgery, unless medically necessary
• Life insurance or income protection policies
• Medicare tax on wages
• Nursing care for a healthy baby
• Medicine purchased without a prescription
• Travel the doctor advises for rest or a change
• Teeth whitening
• Any type of funeral or burial costs
• Prescription drugs bought in or ordered from a foreign country

Taxes Paid
The following two tests must be met for any tax to be deductible.
1) The tax must be imposed on the taxpayer.
2) The tax must be paid during the tax year.

Taxpayers cannot deduct:
• A tax that they do not owe but pay for someone else,
• A tax that they owe but someone else pays, or
• A tax that was not paid in 2015.

State and local income or general sales taxes.
This includes state and local taxes withheld from the taxpayer’s salary, pension, etc. in the year they were withheld, estimated payments made in the tax year, and the tax paid in 2015 for a prior year’s state and local income tax.

Mandatory payments made to the state benefit funds of AK, CA, NJ, NY, PA, RI, and WA are also deductible as state income taxes.

The taxpayer can elect to deduct state and local general sales taxes instead of the state and local income taxes. A choice is made on Schedule A to deduct either sales tax or income taxes. For sales tax, use either actual receipts or optional tables to determine the deductible amount. Using the tables means that taxpayers will not need to save receipts throughout the year. Sales taxes paid on motor vehicles and boats may be added to the table amount, but only up to the amount paid at the general sales tax rate.
 

Sample only..



The taxpayer cannot deduct both state and local income taxes and the sales tax paid.

Real estate tax.
These are taxes on real property, such as a house or land that is owned by the taxpayer but not used for business. The taxes must be based on the
assessed value of the property. Real estate taxes are usually shown on Form 1098, Mortgage Interest Statement or a substitute Form 1098.

Personal property tax.
Taxes that state and local governments charge on personal property that are based on the value of the property are deductible. The personal property tax must also be charged on a yearly basis, even if collected more or less than once a year. Personal property tax paid on a car is an example.

Nondeductible Taxes.
Many federal, state, and local government taxes are not deductible. The following taxes are not deductible:
• Federal taxes – income tax, social security (FICA), Medicare, railroad retirement tax, and gift tax
• Hunting licenses and dog licenses
• Water and sewer taxes
• Taxes on alcoholic beverages, cigarettes, and tobacco
• State, local, and federal taxes on gasoline, diesel, and other motor fuels used in a non-business vehicle
• Utility taxes – telephone, gas, electricity, etc.

Mortgage Interest and Points
Interest is the amount that is paid in order to borrow money. Only taxpayers who are legally liable for the debt can deduct the interest in the year it is paid or accrued. A home mortgage is any loan that is secured by the main home or second home. It includes first and second mortgages, home equity loans, and refinanced mortgages.

A home may be a house, condominium, mobile home, boat, or similar property that provides basic living accommodations including sleeping space, toilet, and cooking facilities. Home mortgage interest and points may be shown on Form 1098 or substitute Form 1098.



Generally, points paid to refinance a mortgage are not deductible in full in the year they are paid but must be prorated over the life of the loan.


Charitable Contributions
Charitable contributions can be deducted if donated to a qualified organization. Contributions to specific individuals cannot be deducted.

Example: Dustin’s neighbor Clint has been out of work for 6 months. Dustin gave Clint $200 to help pay some of his expenses. Dustin cannot deduct the $200 as a charitable contribution.

For property contributed to a qualified organization, the amount of the charitable contribution is generally the fair market value (FMV) of the property at the time of the contribution. The fair market value of donated items can be obtained by looking at resale values listed in second hand shops, newspapers, garage sales, etc.

Example: Dawn donated a coat in June, 2015, to the thrift store operated by her church. She paid $300 for the coat 5 years ago. Similar coats in the thrift store or at a garage sale sell for $25. The fair market value of the coat is therefore $25.

Any donations of clothing or household items made to a charity will not be deductible unless the donated items are in “good” or better condition. IRS has not issued any guidance as to what is “good” condition.

The taxpayer needs to be able to prove both the condition and the value of the donation. If the donation of a single item is not in at least good condition but is worth more than $500, it is deductible if the taxpayer gets a qualified appraisal of the property.

Noncash contributions totaling over $500 (including the vehicle donation) must be reported on Form 8283, Noncash Charitable Contributions.


 

Contributions That Benefit Taxpayer.
If a taxpayer receives a benefit in exchange for a charitable contribution, the deduction is reduced by the value of the benefit received.

Example: Craig made a $50 donation to public television and received a CD (FMV $30) of the greatest hits of 1995 in appreciation for his donation. His
deduction is $20.


Recordkeeping.
The taxpayer must keep records to prove the amount of the cash and noncash contributions he/she makes during the year. It is always important to keep a record of the fair market value of donated property along with receipts.

The taxpayer cannot deduct a cash contribution, regardless of the amount, unless the taxpayer keeps as a record of the contribution a bank record (such as a cancelled check, a bank copy of a cancelled 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, date of the contribution, and amount of the contribution.

Donations of autos, boats and planes. Deduction amounts for charitable contributions of autos, boats and planes for which the claimed value exceeds $500 will depend on how the donated asset is used by the recipient charity.

If the organization sells the asset without making any significant use of it, the deduction is limited to the gross sales proceeds received by the charity and the FMV cannot be used.

If the charity intends to make significant use of the donated asset, the charity must estimate the fair market value at the time of the donation. In both cases it will send the taxpayer a written acknowledgement, Form 1098C, Contributions of Motor Vehicles, Boats, and Airplanes, which must be attached to Form 8283 for each donated vehicle reported at over $500 value.


Standard mileage rate for charitable use of a vehicle. The standard mileage rate for charitable use of a vehicle is 14 cents a mile.

Personal Casualty and Theft Losses
A personal casualty loss results from an identifiable event that is sudden, unexpected, or unusual such as a fire, hurricane, storm, flood, vandalism or a
natural disaster. Theft is the unlawful taking and removing of money or property with the intent to deprive the owner of it. Theft does not include the mere disappearance of money or property. Form 4684, Casualties and Thefts, is used to claim the loss.



Addition to the Standard Deduction.
If a taxpayer does not itemize deductions, the standard deduction for 2015 and 2014 is increased by the disaster loss deduction. The box on Form 1040, line 39c must be checked. This is the same box that is checked when adding real estate taxes to the standard deduction.

A casualty or theft may result in a gain if the insurance proceeds or other reimbursement exceed the adjusted basis of destroyed or stolen property.

Nondeductible losses.
These are losses that result from progressive deterioration of property rather than from a sudden event. For example, the weakening of a building due to normal wind and weather conditions, damage caused by termites and moths, and damage to trees and shrubs from drought or from a fungus, insects, worms, or similar pests are not casualty losses and cannot be deducted.

Amount of Loss.
Once it is determined that a casualty or theft was suffered, the amount of loss must be determined. The amount of a casualty or theft loss is the smaller of the following minus any insurance or other reimbursements received or expected to be received:
• The adjusted basis of the property before the casualty or theft, or
• The decrease in fair market value of the property as a result of the casualty or theft.

Adjusted basis is the owner’s basis or investment in the property for tax purposes when adjusted by various items or events. The basis of property when purchased is usually its cost.

The original basis in purchased property is adjusted (increased or decreased) by certain events such as improvements made to the property: the basis increases by the cost of the improvement. If deductions are taken for depreciation or casualty losses, the basis is reduced. Altogether, this is adjusted basis.

The decrease in FMV is the difference between the value of the property immediately before and immediately after the casualty or theft. Cost of cleanup and repairs. The cost of repairing or cleaning up damaged property can be used as a measure of the decrease in
value if:
* The repairs are necessary to bring the property back to its condition before the casualty
* The amount spent for the repairs is not excessive
* The repairs are only to take care of the damage, and
* The repairs do not increase the value of the property to more than its value before the casualty.

Example: Pat and Mary’s living room furniture was damaged in a fire. The furniture was worth $2,300 immediately before the fire. They paid $800 to repair the damage. They can use the $800 figure as the decrease in the FMV as a result of the fire.

Reimbursement.
The amount of the loss must be reduced by any reimbursement received or expected to be received even if the reimbursement is not received until a later tax year. The most common type of reimbursement is an insurance payment for stolen or damaged property but can also include amounts received to restore property from an employer’s emergency disaster fund or from relief agencies.

If the reimbursement received after the deduction is claimed is less than expected, include the difference as a loss on the return in the year in which the taxpayer can reasonably expect no more reimbursement. If reimbursement in the later year is more than expected and the deduction reduced the tax for the earlier year, the excess reimbursement may have to be included as income for the year received.

If taxpayers have insurance coverage for the property, a claim must be filed. Otherwise, the loss cannot be deducted as a casualty or theft loss. However, the portion of the loss that is not covered by insurance can be deducted even if a claim is not filed.

Deduction Limits.
Once the taxpayer figures the amount of the loss, he/she must apply two limits to the loss to determine the deductible amount. The limits are referred to
as the $100 rule and the 10% rule. These limits may prevent the taxpayer from deducting any part of the loss.

The $100 Rule. Each casualty or theft loss caused by a single event must be reduced by $100. It does not matter how many items were damaged by the single event; only a single $100 reduction applies to each event.

Example: A flood damaged Rich’s home and car. He received $58,000 of insurance for the house and he had no insurance on the car. The flood is a single event which caused damage to the two items. Rich figures the loss on the home and car and reduces the total amount by $100. The 10% Rule. After each single event loss is reduced by $100, the total of all casualty and theft losses must be reduced by 10% of the AGI. If casualties from more than one event are reported, the 10% rule has to be applied to the combined losses.

Example: Rich’s house and car were damaged in a flood. The loss was $7,000 for the house and $3,000 for the car. He had an AGI of $32,000. After reducing the $10,000 by $100 he must also reduce the loss by 10 percent ($3,200) of his AGI. His deductible loss from the flood was $6,700 ($10,000 - $100 - $3,200 = $6,700).

When to Deduct a Loss.
Deduct a theft loss in the year the theft is discovered. Generally, deduct a casualty loss only for the tax year in which the casualty occurs. This is true
even if the damaged property is not repaired or replaced until a later year.

However, if the taxpayers have a loss in a federally declared disaster area (formerly called Presidentially declared disaster area), they can choose to deduct the loss on their tax return either for the year the casualty occurred or for the year immediately preceding the casualty year. Deducting it in
the earlier year can bring a quicker refund to help with the casualty repair.

Employee Expenses and Miscellaneous
Expenses Subject to 2% of AGI. These expenses can be deducted to the extent that they exceed 2% of the AGI.

Employee expenses.
Unreimbursed employee business expenses can be deducted on Form 2106, Employee Business Expenses. This form is used to claim any
travel, transportation, meal or entertainment expenses connected with the job and adjust for any reimbursements made by the employer.

To deduct these expenses, they must be ordinary and necessary business-related expenses. An ordinary expense is one that is common and accepted in the field of the trade, business, or profession. A necessary expense is one that is helpful and appropriate for the business.


Meals.
When traveling away from home on business, meals can only be deducted if it is necessary for the taxpayer to stop for substantial sleep or rest to

properly perform his/her duties and the meal is business-related. Generally, only 50% of the meal expense is deductible. Some employee business expenses that do notrequire Form 2106 to be filed are:
• Safety equipment, tools, supplies needed to do the job
• Protective clothing such as safety shoes or boots
• Union and professional dues
• Subscriptions for professional journals or magazines
• Uniforms worn as a condition of employment and notsuitable for everyday wear *
• Cost of cleaning those uniforms * It is not enough that the clothing is distinctive or that the taxpayer does not wear the work clothes away from work. To
be deductible, the clothing must not be suitable for taking the place of regular clothing.

Miscellaneous Expenses

Certain expenses can be deducted as miscellaneous itemized deductions. These include:
• Fees paid for preparing the tax return and the electronic filing of the tax return
• Tax software programs, tax publications and any fee paid to electronically file the tax return
• Safe deposit box rent if the box is used to store taxable income-producing stocks, bonds, or investment-related papers and documents

Miscellaneous Expenses That Are Not Subject to the 2% of AGI.

The full amount of the gambling winnings for the year must be reported on line 21 of Form 1040. The gambling losses for the year (only up to the amount of gambling winnings) can be deducted as a miscellaneous itemized deduction and are not reduced by 2% of the AGI. Gambling losses that are more than the winnings cannot be deducted.

Expenses That May NOT Be Deducted Are:

• Expenses (commuting) of going to and from the regular place of employment
• Meals during regular working hours or while working late
• Travel as a form of education
• The value of wages never received or lost vacation time
• Expense of attending seminars or conventions that are not business related
• Lost or mislaid cash or property
• Losses from the sale of home, furniture, personal car, etc.
• Personal, living or family expenses
• Home repairs, insurance, or rent
• Club dues
• Fees and licenses, such as car and marriage licenses and dog tags
• Personal legal expenses

 

Classwork

1. Joseph (age 45) and Connie (age 35) Warren are filing a joint tax return. They have an AGI of $47,000 and in 2015 they paid the following expenses:
 

• $3,400 medical insurance premiums
• 1,900 doctor bills
• 381 hearing aid batteries
• 3,500 real estate tax
• 5,150 mortgage interest
• 200 commuting expenses
• 150 tax preparation fee for their 2012 tax return
• 1,950 in cash charitable contributions (no contribution over $250)
• 1,750 in state tax withheld
• 500 medical miles

What is the Warrens’ standard deduction? _______________________________

What would their itemized deductions be? _______________________________

Should they itemize their deductions or use the standard deduction? _____________
 

 

2. The Kings (both age 65) are filing a joint tax return. They have an AGI of $42,000 and in 2015 they paid the following expenses:
 
•$1,900 in medical insurance
• 1,300 doctors’ bills
• 500 for eyeglasses
• 175 for nonprescription medicines
• 650 personal property tax
• 7,450 mortgage interest
• 2,850 real estate tax
• 1,650 church contributions (no contribution over $250)
• 350 FMV clothing given to Goodwill ($1,800 original cost)
•250 tax preparation fee for their 2012 tax return
•1,200 for repairs to their home
 
What is the Kings’ standard deduction? ______________________________

What would their itemized deductions be?  _____________________________

Should they itemize their deductions or use the standard deduction? __________________________________


Lesson Eleven   Self Employment

 

Many taxpayers incorrectly report amounts from box 7 (Nonemployee compensation) of Form 1099-MISC, Miscellaneous Income, as wages or as other income. This income should instead be reported on Schedule C, Profit or Loss From Business or Schedule C-EZ, Net profit from Business.

All of the income is reported, along with all of the expenses. The expenses are subtracted from the income to determine if there is a gain (profit) or loss. If the income is reported incorrectly, IRS may later issue a notice of a proposed tax increase for the self-employment tax.

The activity is a business if the primary purpose is to make a profit. An activity is generally presumed to be carried on for profit if it produces a profit in at least three of the last five years, including the current year. If the activity is not carried on for profit, it is considered a hobby and the expenses may be limited and any loss is not allowed. The taxpayer does not have to carry on a regular full-time business activity to be self-employed. Having a part-time business in addition to a regular job or business is generally self-employment. The taxpayer must have records to show the source of the income as well as to support the deductible expenses.

Some examples of the supporting documents would include bank deposit slips, receipt books, invoices, cancelled checks and credit card charge slips. If requested, these records must be made available to IRS. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is common and accepted in that field of business, trade, or profession. A necessary expense is helpful and appropriate for the business, trade, or profession.

If a taxpayer owns and operates more than one business activity, the activities are not combined. File a separate Schedule C for each business. If the taxpayer has more than one Form 1099-MISC with box 7, Nonemployee compensation that he or she received for the same business activity,

combine the amounts on one Schedule C. Example: Chris is a plumber and receives a Form W-2 from his employer. On the weekends he does plumbing work for several other contractors and receives four Forms 1099-MISC with amounts in box 7. Since they are all related to his plumbing business, Chris will file one Schedule C,combine the amounts (including any income not reported on a Form 1099-MISC), and report this total as gross receipts on line 1 of Schedule C. Chris also makes and sells fishing lures at the local flea market. He does this to make money and usually earns about $100 a week and has very few expenses. He did not receive a Form 1099-MISC for these sales. He must report this income on line 1 of a separate Schedule C.

 

Husband and Wife Business
Generally, if more than one individual is an owner, the business is not a sole proprietorship and the Schedule C or Schedule C-EZ cannot be used.
A husband and wife who jointly operate an unincorporated business and who file a joint return can elect to file two Schedule Cs or Schedule C-EZs. Both spouses must materially participate in the business and each spouse would report his or her share of income and expenses. This ensures that when a married couple jointly own and participate in a business, they both get credit for paying social security and Medicare taxes.
 

Who Must File?

The taxpayer must file an income tax return if the net earnings from self-employment are $400 or more. If the net earnings from self-employment are less than $400, the taxpayer must still file an income tax return if other filing requirements are met. The Schedule C or C-EZ is completed and the net profit or loss is entered on line 12 of Form 1040. Combine the profits and losses if there is more than one Schedule C. Self-employment can include work in addition to a regular full-time business activity. This income may be reported in box 7 of Form 1099-MISC. The taxpayer must claim any self-employment income received, even if no Form 1099-MISC was issued. The taxpayer may owe self-employment tax on income reported on Form 1099-MISC, box 7 (and/or on any other income not reported on Form 1099-MISC). Some payers of nonemployee compensation are not required to file Form 1099-MISC if the
amount earned is less than $600. All amounts received muststill be reported on the taxpayer’s return. Whether or not the taxpayer has a Form 1099-MISC, the tax preparer should ask questions about additional sources of self-employment income. Did the taxpayer have any income from a business or side job?

Did the taxpayer work as an independent contractor?

Did the taxpayer get a Form W-2 from all of his/her jobs?
Did the taxpayer receive documents other than Form W-2 that show earnings from work (for example, a check stub)?

Hobby or Business

If a taxpayer engages in an activity that is not conducted as a for-profit business, deductions are limited to the amount of income from the activity. In determining whether an activity is a hobby or business, all facts and circumstances are taken into account. Examples of activities that could be
considered not for profit are breeding dogs, cats, etc., or operating a farm for recreation and pleasure. If the activity is a hobby, the income is reported
on line 21 of Form 1040 and the expenses (up to the amount of the income) are reported on Schedule A, subject to 2% of AGI. If the taxpayer does not
itemize, no expenses can be claimed. Form 1099-MISC If the taxpayer is not an employee but receives money for work done, he or she is probably self-employed and should receive a Form 1099-MISC.

The taxpayer is self-employed if he/she:

• Carries on a trade or business as a sole proprietor
• Is an independent contractor
• Is in business for himself/herself in any other way

 

Form 1099-MISC Miscellaneous Income
Form 1099-MISC should be sent to a taxpayer who is a self-employed independent contractor or is in business for himself/herself in any other way. This income is shown on Form 1099-MISC in box 7, Nonemployee compensation. All self-employment income must be reported on Schedule C or Schedule C-EZ even if no Form 1099-MISC is received.

The payer’s name, address, federal employer identification number and the recipient’s name, address, and SSN appears on the left side of Form 1099-MISC.
Boxes 1 and 2 Rental income and royalty income are reported on Schedule E, Supplemental Income and Loss. These types of income are generally
not subject to self-employment tax.
Box 3 Other income is generally reported on line 21 of Form 1040 and is not subject to self-employment tax.
Box 4 Shows backup withholding and is included on the tax return as tax withheld.
Box 7 An amount in this box (Nonemployee compensation) means the payer considers the recipient to be self-employed. This income is reported on Schedule C, Profit or Loss From Business,or C-EZ, Net Profit from Business. Necessary expenses of the trade or business can be deducted from this
amount on Schedule C or C-EZ to get the net income. Amounts shown in box 7 may be subject to self-employment tax (SE) if the net income
is $400 or more. The taxpayer must file a tax return and compute the SE tax on Schedule SE, Self-Employment Tax.

Schedule C

 

Business Codes.
The codes for the Principal Business or Professional Activity classify sole proprietors by the type of activity in which they are engaged. This facilitates the
administration of the Internal Revenue Code. Select the category that best describes the primary business activity from the list.

Employer Identification Number (EIN)

The taxpayer does not need an EIN unless he or she:
• Pays wages to one or more employees.
• Files pension or excise tax returns.

 

Many self-employed taxpayers do not need an EIN. If an EIN is not required and the taxpayer does not have one, leave this box blank. Do not enter the
taxpayer’s social security number here or do not use the Payer’s EIN listed on Form 1099-MISC.

Cash Method

Many self-employed taxpayers with no inventory use the cash method of accounting. Under the cash method, include in gross income all income actually or constructively received during the tax year. Generally, expenses are deducted in the tax year in which they are paid. Other accounting methods will not be covered in the Rapid Class.

Material Participation

Self-employed taxpayers are generally considered to materially participate in the operation of the business.

Gross Receipts or Sales.

All receipts from a trade or business, including any income reported in box 7 of Form 1099-MISC, is reported as gross receipts on line 1 of Schedule C or Schedule C-EZ. All income actually received or constructively received during the year must be included.

Example: Josh is a construction worker.

His Form 1099-MISC, box 7, shows $14,000 and he also received a cash payment of $300 from another construction company. He will report gross receipts of $14,300 on line 1 of his Schedule C.

Expenses.

Total expenses include the total amount of all deductible business expenses actually paid during the year. Some examples of these expenses include
advertising, legal and professional fees, office expenses, repairs, supplies and taxes. The cost of property that is expected to last more than one year must be depreciated (not covered in the Rapid Class). If the taxpayer uses his or her car or truck for business purposes, the standard mileage rate can be
used. To use the standard mileage rate, the taxpayer must choose to use it in the first year the vehicle is available for use in the business. Business
miles are multiplied by the standard mileage rate (56.5 cents) and this amount is added to any deductible parking fees and tolls.

Example: Josh, a construction worker, was required to occasionally use his truck to go from the job site to the building supply store. He kept a writ

ten log of these miles which showed that he drove 1124 miles for this purpose. The 1124 miles are multiplied by the applicable standard mileage rate and he can claim an expense of $635 on his Schedule C.

Part IV of Schedule C or Part III of Schedule C-EZ should be completed if the taxpayer is claiming car and truck expenses.

The business percentage of the interest and personal property tax paid on a car or truck used in a business can be deducted even if the taxpayer uses the standard mileage rate. The taxpayer can choose to take actual expenses (the business portion of gas, tires, repairs, etc., and depreciation) instead of the
standard mileage rate. The taxpayer cannot use the standard mileage rate and, at the same time, take actual expenses (including depreciation) for the same car or truck. Actual expenses will not be covered in the Rapid Class.

Legal and Professional Fees

Include on this line fees paid for the preparation of the tax forms related to the taxpayer’s business.

Example: Josh, the construction worker, filed a Schedule C in 2012. The cost of preparing his entire tax return was $274. Of the $274, $105was for his Schedule C. Josh can deduct $105 on his 2015 Schedule C, line 17.

Net Profit or Loss.

The expenses are subtracted from the gross income to determine the gain or loss. A gain is added to the other types of income on Form 1040. If there is a loss and the taxpayer is “all at risk,” the loss is subtracted from the other types of income on Form 1040. Most Schedule C taxpayers are all at risk. Be sure to check box 32a if there is a loss or the loss will not go to Form 1040.

Schedule SE.

Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes that are withheld from the pay of most wage earners. The difference is that a self-employed taxpayer pays both parts of the social security
and Medicare taxes. The payments of SE tax contribute to the taxpayer’s coverage under the social security system. Social security coverage provides retirement benefits,disability benefits, survivor benefits and hospital insurance (Medicare) benefits. By not reporting all of the self-employment income, when the taxpayer begins to receive social security benefits, this could cause his or her benefits to be lower. The taxpayer must file Schedule SE if the
net earnings from self-employment are $400 or more. The tax is computed on Schedule SE, transferred to Form 1040, line 57, and then added to any other tax owed. A self-employed taxpayer may claim an adjustment to income of one-half of the social security and Medicare taxes paid. The amount from Schedule SE is deducted on Form 1040, line 27.

Substantiation of Income.

The taxpayer must be able to substantiate that he or she had self-employment income. IRS will disallow an unjustified claim for the earned income credit by a taxpayer who reports self-employment income just to get the earned income credit, but doesn’t actually have any self-employment income. If the
taxpayer is filing a Schedule C or Schedule C-EZ, he or she must claim any expenses that were incurred.

Who Can Use Form Schedule C-EZ

 

What is the difference between a Form W-2 and a Form 1099-MISC?
Form W-2 is used by employers to report wages, tips and other compensation paid to an employee. The form also reports the employee’s income tax and social security taxes withheld.
Form 1099-MISC is used to report payments made in the course of a trade or business to another person or business who is not an employee. The form is required when payments of $600 or more in compensation is paid.
The form is provided by the payer to the IRS and the person or business that received the payment.


Classwork
:

Circle either True or False.

 

T or F   1) An activity is presumed to be carried on for profit if it produces a profit in at least three of the last five years.

T or F   2) On a Schedule C or Schedule C-EZ, a taxpayer can put his or her social security number as the EIN number.

T or F   3) If the taxpayer has net self-employment income of at least $400, he or she must file a tax return.

T or F   4) Clay is a self-employed barber. In 2015 he had income of $7,000 and expenses of $7,800. He materially participates in the business and is

all at risk. Clay can claim a loss of $800 on his 2015 Schedule C-EZ?.

T or F   5) Ross is a self-employed taxpayer who has a loss of $625 on his 2015 Schedule C. Since he is “all at risk,” box 32a must be checked or

the loss will not be allowed and will not be subtracted from his other income on Form 1040.


Lesson Twelve  Rental Income

If your rental income is from property you also use personally or rent to someone at less than a fair rental price, first read the information from the IRS in chapter 5, Personal Use of Dwelling Unit (Including Vacation Home).

Rental Income

In most cases, you must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. In addition to amounts you receive as normal rental payments, there are other amounts that may be rental income.

When To Report

When you report rental income on your tax return generally depends on whether you are a cash basis taxpayer or use an accrual method. Most individual taxpayers use the cash method.


Cash method.
   You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it, regardless of when it was earned. You constructively receive income when it is made available to you, for example, by being credited to your bank account.

 

Accrual method.   If you are an accrual basis taxpayer, you generally report income when you earn it, rather than when you receive it. You generally deduct your expenses when you incur them, rather than when you pay them.

 

More information   See Publication 538, Accounting Periods and Methods, for more information about when you constructively receive income and accrual methods of accounting.

Types of Income

The following are common types of rental income.

Advance rent.   Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.

Example.
On March 18, 2012, you signed a 10-year lease to rent your property. During 2012, you received $9,600 for the first year's rent and $9,600 as rent for the last year of the lease. You must include $19,200 in your rental income in the first year.

 

Canceling a lease.   If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your income in the year you receive it regardless of your method of accounting.

 

Expenses paid by tenant.   If your tenant pays any of your expenses, those payments are rental income. Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses.

Example 1.
Your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment. Under the terms of the lease, your tenant does not have to pay this bill. Include the utility bill paid by the tenant and any amount received as a rent payment in your rental income. You can deduct the utility payment made by your tenant as a rental expense.

Example 2.
While you are out of town, the furnace in your rental property stops working. Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Include the repair bill paid by the tenant and any amount received as a rent payment in your rental income. You can deduct the repair payment made by your tenant as a rental expense.

 

Property or services.  If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income.

 

If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.

Example.
Your tenant is a house painter. He offers to paint your rental property instead of paying 2 months rent. You accept his offer.

Include in your rental income the amount the tenant would have paid for 2 months rent. You can deduct that same amount as a rental expense for painting your property.

Security deposits.   Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.

If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.

Other Sources of Rental Income

Lease with option to buy.  If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price.

 

Part interest.  If you own a part interest in rental property, you must report your part of the rental income from the property.

 

Rental of property also used as your home.   If you rent property that you also use as your home and you rent it less than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040), Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for non-rental property.

Rental Expenses

In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income.

Personal use of rental property.   If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Also, your rental expense deductions may be limited. Personal Use of Dwelling Unit (Including Vacation Home).

 

Part interest   If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership.

Example. Roger owns a one-half undivided interest in a rental house. Last year he paid $968 for necessary repairs on the property. Roger can deduct $484 (50% × $968) as a rental expense. He is entitled to reimbursement for the remaining half from the co-owner.

When To Deduct

You generally deduct your rental expenses in the year you pay them.

If you use the accrual method, see Publication 538 for more information.

Types of Expenses

Listed below are the most common rental expenses.

  • Advertising.

  • Auto and travel expenses.

  • Cleaning and maintenance.

  • Commissions.

  • Depreciation.

  • Insurance.

  • Interest (other).

  • Legal and other professional fees.

  • Local transportation expenses.

  • Management fees.

  • Mortgage interest paid to banks, etc.

  • Points.

  • Rental payments.

  • Repairs.

  • Taxes.

  • Utilities.

Some of these expenses, as well as other less common ones, are discussed below.

Depreciation.   Depreciation is a capital expense. It is the mechanism for recovering your cost in an income producing property and must be taken over the expected life of the property.

 

You can begin to depreciate rental property when it is ready and available for rent.

 

Insurance premiums paid in advance.   If you pay an insurance premium for more than one year in advance, for each year of coverage you can deduct the part of the premium payment that will apply to that year. You cannot deduct the total premium in the year you pay it. See Publication 535, chapter 6, for information on deductible premiums.

 

Interest expense.  You can deduct mortgage interest you pay on your rental property. When you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense. Chapter 4 of Publication 535 explains mortgage interest in detail.

 

Expenses paid to obtain a mortgage.  Certain expenses you pay to obtain a mortgage on your rental property cannot be deducted as interest. These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses that are part of your basis in the property.

 

Form 1098, Mortgage Interest Statement.   If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098 or similar statement showing the interest you paid for the year. If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on, the mortgage, and the other person received the Form 1098, report your share of the interest on Schedule E (Form 1040), line 13. Attach a statement to your return showing the name and address of the other person. On the dotted line next to line 13, enter “See attached.

 

Legal and other professional fees.  You can deduct, as a rental expense, legal and other professional expenses such as tax return preparation fees you paid to prepare Schedule E, Part I. For example, on your 2012 Schedule E you can deduct fees paid in 2012 to prepare Part I of your 2011 Schedule E. You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities.

 

Local benefit taxes. In most cases, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. These charges are non-depreciable capital expenditures and must be added to the basis of your property. However, you can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits.

 

Local transportation expenses   You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Transportation expenses incurred to travel between your home and a rental property generally constitute nondeductible commuting costs unless you use your home as your principal place of business. See Publication 587, Business Use of Your Home, for information on determining if your home office qualifies as a principal place of business.

 

Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. For 2012, the standard mileage rate for business use is 55.5 cents per mile.

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