ACCT 504 Exam 2

Individual income tax formula (overall)

Gross income − deductions for AGI = AGI; then subtract the greater of the standard deduction or itemized deductions plus any other allowed from-AGI deductions to get taxable income; taxable income × tax rates = income tax liability; add other taxes, subtract credits and prepayments, to get tax due or refund.

Adjusted gross income (AGI) formula

AGI = Gross income − deductions for AGI (above-the-line deductions).

Taxable income formula

Taxable income = AGI − applicable deductions from AGI, generally including the greater of the standard deduction or itemized deductions plus other allowed from-AGI deductions.

Tax due or refund formula

Income tax liability + other taxes = total tax; total tax − credits − prepayments = tax due (or refund if the result is negative).

All-inclusive income concept

All realized income is included in gross income unless a tax rule specifically excludes or defers it.

Realized income

Income associated with a measurable change in property rights; realized income is generally included unless excluded or deferred.

Recognized income

Realized income that is actually reported on the tax return.

Excluded income

Income that is never included in taxable income; examples in the slides include municipal bond interest and qualifying gain on the sale of a personal residence.

Deferred income

Realized income not taxed in the current year but recognized in a later year; examples include installment sales and like-kind exchanges.

Character of income or loss

The classification that determines the tax rate or treatment applied to income or loss, such as tax-exempt, tax-deferred, ordinary, qualified dividend, or capital.

Ordinary income

Income taxed using the ordinary income tax rate schedule.

Qualified dividends

Dividends taxed at preferential rates of 0%, 15%, or 20%, depending on the taxpayer’s income level.

Capital gain or loss

Gain or loss from selling a capital asset; treatment depends on whether the holding period is short-term or long-term.

Long-term vs. short-term capital gain/loss

A capital asset held more than one year produces a long-term gain or loss; otherwise it is short-term.

Capital asset holding-period counting rule

Count the day of disposition but not the day of acquisition when determining how long a capital asset was held.

Net capital gain

Net long-term capital gains in excess of net short-term capital losses; generally taxed at preferential 0%, 15%, or 20% rates depending on taxable income.

Capital asset

Generally an asset held by the taxpayer, except items such as accounts receivable, inventory, and assets or supplies used in a trade or business.

Net capital loss

Capital losses in excess of capital gains for the year.

Net capital loss deduction limit

Up to $3,000 of net capital loss can be deducted against ordinary income for the year, reducing AGI; excess losses carry forward indefinitely.

Deduction for AGI

An above-the-line deduction used to determine AGI; the slides state that it reduces taxable income dollar for dollar.

Common deductions for AGI

Examples include qualifying pre-2019 alimony paid, rental and royalty expenses, and contributions to qualified retirement accounts.

Deduction from AGI

A below-the-line deduction subtracted from AGI to determine taxable income.

Standard deduction vs. itemized deductions

A taxpayer generally deducts whichever is greater: the standard deduction or total itemized deductions.

Common itemized deductions

Examples include home mortgage interest, state income taxes, and charitable contributions.

Deduction for seniors

From-AGI deduction of $6,000 for a taxpayer at least age 65 at year-end; subject to an AGI-based phaseout.

Qualified car loan interest deduction

From-AGI deduction of up to $10,000 of qualified car loan interest; subject to an AGI-based phaseout.

Charitable deduction for nonitemizers

From-AGI deduction for cash contributions of up to $1,000, or $2,000 for married filing jointly, for taxpayers who do not itemize.

Qualified tip income deduction

From-AGI deduction of up to $25,000 of qualified tip income; subject to an AGI-based phaseout.

Qualified overtime deduction

Up to $12,500 ($25,000 MFJ), with a phase-out beginning above a modified AGI of $150,000 ($300,000 MFJ).

Qualified business income (QBI) deduction

A from-AGI deduction generally equal to 20% of qualified business income, subject to additional limitations

2026 basic standard deduction: MFJ

$32,200.

2026 basic standard deduction: qualifying surviving spouse

$32,200.

2026 basic standard deduction: head of household

$24,150.

2026 basic standard deduction: single

$16,100.

2026 basic standard deduction: married filing separately

$16,100.

Progressive tax rate schedule

The U.S. individual income tax uses progressive rates; the slides list rates from 10% through 37%.

Preferentially taxed income

Net capital gains and qualified dividends are taxed separately from ordinary income and may receive preferential rates.

Examples of other taxes

Alternative minimum tax, self-employment tax, 3.8% net investment income tax, and 0.9% additional Medicare tax.

Tax credit

A tax benefit that reduces tax liability dollar for dollar.

Child tax credit amount

$2,200 for a qualifying child under age 17 at year-end.

Credit for other qualifying dependents

$500 for a qualifying dependent who does not meet the requirements for the higher child tax credit amount.

Tax prepayments

Payments already made toward tax liability, including wage withholding, estimated tax payments, and prior-year overpayments applied to the current year.

When does a taxpayer receive a refund?

When prepayments exceed tax liability after credits.

General dependency requirements

The person must be a U.S. citizen or a resident of the U.S., Canada, or Mexico; generally must not file a joint return with a spouse (subject to the no-tax-liability exception); and must be either a qualifying child or qualifying relative.

Qualifying child tests

Relationship test, age test, residence test, and support test.

Qualifying child relationship test

Includes the taxpayer’s son, daughter, stepchild, eligible foster child, brother, sister, half-sibling, step-sibling, or a descendant of any of these relatives.

Qualifying child age test

The child must be younger than the person claiming the child and be under 19 at year-end, under 24 and a full-time student, or permanently and totally disabled.

Qualifying child residence test

The child must have the same residence as the taxpayer for more than half the year; temporary absences such as education are allowed.

Qualifying child support test

The child must not provide more than half of his or her own support.

Scholarship treatment for qualifying-child support test

A scholarship received by the taxpayer’s actual child is excluded from the child’s support computation.

Qualifying child tiebreaker: parent vs. nonparent

A parent has priority over a nonparent.

Qualifying child tiebreaker: two parents

The parent with whom the child lived the longest during the year has priority; if equal, the parent with the higher AGI has priority.

Qualifying child tiebreaker: nonparents

If competing claimants are nonparents, the person with the highest AGI has priority.

Qualifying relative tests

Relationship test, support test, and gross income test.

Qualifying relative relationship test

Includes descendants or ancestors, siblings and step-siblings, nieces/nephews, aunts/uncles, specified in-laws, or an unrelated person who lives in the taxpayer’s home for the entire year.

Qualifying relative support test

The taxpayer must pay more than half of the person’s living expenses/support.

2026 qualifying relative gross income test

The person’s gross income must be less than $5,300.

Five filing statuses

Married filing jointly, married filing separately, qualifying surviving spouse, single, and head of household.

Married filing jointly (MFJ)

Taxpayers generally must be married on the last day of the year; if one spouse dies during the year, the survivor is generally treated as married to the deceased spouse at year-end unless the survivor remarries.

Joint and several liability

On a joint return, both spouses are responsible for the tax liability.

Married filing separately (MFS)

Married taxpayers file separate returns; the status is often less favorable for tax rates/benefits but avoids joint and several liability and may be chosen for nontax reasons.

Abandoned spouse / married person treated as unmarried

A married person can be treated as unmarried if the person does not file jointly, pays more than half the cost of maintaining a household that is the principal home of a qualifying child for more than half the year, and lived apart from the spouse for the last six months of the year.

Qualifying surviving spouse

Available for the two years after the year of the spouse’s death if the survivor does not remarry and maintains a household for a dependent child.

Single filing status

Generally applies to an unmarried taxpayer who does not qualify for head of household or qualifying surviving spouse status.

Head of household (HOH): general requirements

Taxpayer is unmarried or considered unmarried at year-end, is not a qualifying surviving spouse, pays more than half the cost of maintaining a home, and generally lives with a qualifying person for more than half the year.

HOH qualifying person: qualifying child

A qualifying child can be a qualifying person for head of household status.

HOH parent exception

A qualifying mother or father need not live with the taxpayer if the parent is the taxpayer’s dependent and the taxpayer pays more than half the cost of maintaining the parent’s separate household.

HOH qualifying relative other than a parent

The qualifying relative must live with the taxpayer more than half the year, be the taxpayer’s dependent, and be related through a qualifying family relationship.

Unrelated full-year household member and HOH

A person who qualifies as a relative only because he or she lived with the taxpayer for the entire year is not a qualifying person for HOH.

Multiple support agreement and HOH

A dependent claimed under a multiple support agreement is not a qualifying person for head of household status.

Custodial parent HOH rule

The child can remain the custodial parent’s qualifying person for HOH even if the noncustodial parent claims the child as a dependent under a divorce agreement.

Gross income

Income that is realized and recognized for the year; under the slides’ §61 concept, gross income includes income from whatever source derived unless excluded or deferred.

Three conditions for recognizing gross income

The taxpayer receives an economic benefit, realizes the income, and no tax rule excludes or defers it.

Borrowed funds

Borrowed funds are not gross income because they create a liability rather than an economic benefit.

Realization principle

Realization occurs when the taxpayer engages in a transaction with another party that produces a measurable change in property rights.

Recognition

Realized income is presumed recognized unless a specific exclusion or deferral rule applies.

Tax basis

The taxpayer’s cost or investment in an asset.

Return of capital principle

Recovery of tax basis is excluded when calculating realized income because recovery of one’s investment is not an economic benefit.

Gain on disposition of an asset

The amount realized above the taxpayer’s adjusted tax basis is included in realized income.

Tax benefit rule

A refund or reimbursement of an amount deducted in a prior year is included in gross income only to the extent the earlier deduction actually reduced tax.

Tax benefit rule formula

Includible refund = the lesser of the refund received or the excess of prior-year itemized deductions over the prior-year standard deduction.

Individual vs. corporate accounting methods

Individuals generally use the cash method; corporations often use the accrual method.

Constructive receipt

A cash-method taxpayer recognizes income when it is actually or constructively received; constructive receipt occurs when the income is credited or made available to the taxpayer.

Claim of right doctrine

Income is recognized when the taxpayer receives it without restrictions on its use and without an obligation to repay it.

Assignment of income: services

Income from services is taxable to the taxpayer who earned it; merely assigning the payment to someone else does not shift the income.

Assignment of income: property

Income from property is taxable to the owner of the income-producing property; shifting the income requires transferring ownership of the property.

Community property systems

In the nine community-property states, each spouse generally includes half of community service income and half of income from community property; treatment of separate-property income varies by state.

Separate property in a community-property system

Property a spouse brings into the marriage is treated as that spouse’s separate property.

Earned income

Income from services or labor generated by the taxpayer’s efforts.

Unearned/property income

Income from property, including gains or losses from property sales, dividends, interest, rents, royalties, and annuities.

Annuity

An investment that pays a stream of equal payments over time; each payment may contain both taxable income and a nontaxable return of capital.

Annuity exclusion ratio

Original investment ÷ expected value of the annuity; this determines the nontaxable return-of-capital percentage of each payment.

Fixed-term annuity expected value

Number of payments × payment amount.

Taxable portion of an annuity payment

Payment − nontaxable return-of-capital portion determined using the exclusion ratio.

Life annuity expected value

For an annuity paid over the taxpayer’s life, IRS life-expectancy tables are used to determine expected value.

Property disposition formula

Amount realized = sales proceeds − selling expenses; gain or loss on sale = amount realized − adjusted tax basis.

Flow-through entity income

For entities such as partnerships and S corporations, income and deductions flow through to the owners, who report their shares.

Alimony definition for tax purposes

Generally a cash transfer under a written separation agreement or divorce decree, not designated as nonalimony, made while legally separated/divorced spouses are not living together, and ending at the recipient’s death.

Payments that do not qualify as alimony

Property divisions and fixed child support payments.

Alimony under a pre-2019 agreement

For agreements executed before January 1, 2019, alimony is included in the recipient’s gross income and deductible for AGI by the payor.