Cruz_2025Release_PPT_Ch002_Accessible__2__2

Chapter Overview

Title: Chapter 2 Expanded Tax Formula, Form 1040, and Basic Concepts

Company: McGraw Hill LLCImportant notice about reproduction and distribution rights.

Learning Objective 1: The Income Tax Formula and Form 1040

• The Tax Return

  • Basic Form 1040: An essential document for individual income tax filing, Form 1040 is used by U.S. citizens and residents to report their income, claim deductions, and calculate tax liability. Accurate completion of this form is crucial for compliance with tax laws.

  • Schedules for Form 1040: These are supplementary documents that allow detailed declarations and calculations that support figures shown on the main form. They cover various income types, deductions, credits, and other relevant information.

• Adjusted Gross Income (AGI):

  • Definition: It is defined as gross income minus any allowed deductions such as retirement plan contributions, student loan interest, and tuition fees.

  • Importance: Many tax deductions and credits depend on AGI. A higher AGI can reduce eligibility for certain deductions or credits, impacting overall tax liability significantly.

The Expanded Tax Formula

• Formula Breakdown:

  1. Gross Income (GI): Total income before any deductions.

  2. Minus Permitted Deductions: Deductions prescribed by the tax code to lower GI and calculate AGI.

  3. Minus Standard or Itemized Deductions: After determining AGI, taxpayers can take either standard deductions or itemize deductions for greater tax reduction.

  4. Multiply by Appropriate Tax Rates: Calculate tax liability by applying the applicable tax rate to taxable income.

  5. Minus Tax Credits + Other Taxes - Tax Payments and Refundable Credits: This gives the final number that determines if taxpayers owe money or will receive a refund.

Concept Check 2.1

• False: Schedules are often used when preparing a tax return; they offer specific details that can impact individual tax situations.

• True: AGI is crucial for many deductions and credits computations, impacting overall tax efficiency.

Learning Objective 2: Filing Status

• Types of Filing Statuses

  • Single: Taxpayer is unmarried and not in a recognized domestic partnership by the last day of the year.

  • Married Filing Jointly (MFJ): Couples legally married by the end of the tax year can file together, which can maximize deductions and credits.

  • Married Filing Separately (MFS): Couples may file separately, but it's usually less beneficial. Both must choose the same standard deduction option. This filing status can be considered when one spouse has significant medical expenses or miscellaneous itemized deductions.

  • Head of Household: Available to unmarried individuals who pay more than half the costs of maintaining a home for a qualifying person and has specific criteria to meet.

  • Qualifying Widow(er) with Dependent Child: This status allows the surviving spouse to benefit from joint filing tax rates for up to two years after the spouse's death, provided the household is maintained for a dependent child.

Concept Check 2.2

• True: You can file as MFJ even if in the process of divorce, as long as you were legally married on the last day of the year.

• True: MFS requires the inclusion of the spouse's Social Security number on the tax return.

• False: A surviving spouse can file as a qualifying widow(er) for two years without remarrying, ensuring they still meet all eligibility requirements.

Learning Objective 3: Dependents

• Qualifying as a Dependent

  • Dependents must pass certain tests to qualify for tax credits and determine filing status.

• General Tests for Dependents

  • Dependent Taxpayer Test: Cannot be claimed by another taxpayer.

  • Joint Return Test: Cannot file a joint return unless claiming a refund without any tax liability.

  • Citizen or Resident Test: Must be either a U.S. citizen, resident, national, or a resident of Canada or Mexico.

• Qualifying Child Tests

  • Relationship Test: Must be a child, stepchild, foster child, sibling, or descendant thereof.

  • Age Test: Generally must be under 19 or 24 if a full-time student.

  • Residency Test: Child must live with the taxpayer for more than half the year.

  • Support Test: The taxpayer must provide more than half of the child's support.

  • Special Test: Applies when multiple taxpayers claim the same child.

Concept Check 2.3

• Five tests for a qualifying child include: Relationship, Age, Residency, Support, and Special Tests.

• To meet the age test, a child must be under 19 or under 24 if a full-time student.

• Qualifying Relative Tests

  • Not a qualifying child test.

  • Relationship or Member of Household Test: Must be related to the taxpayer or live in the household for the entire year.

  • Gross Income Test: The relative's gross income cannot exceed $5,050 for 2024.

  • Support Test: The taxpayer must provide more than half of the relative's support.

Concept Check 2.4

• False: Dependents must meet specific tests to qualify as qualifying relatives.

• False: A qualifying relative cannot earn more than $5,050 in gross income for the tax year 2024.

Learning Objective 4: Standard Deduction

• Standard Deduction Amounts for 2024

  • Single: $14,600

  • Married Filing Jointly: $29,200

  • Married Filing Separately: $14,600

  • Head of Household: $21,900

  • Qualifying Widow(er): $29,200

• Additional Standard Deductions:

  • An increase applies for taxpayers aged 65 and older or those who are blind.

  • For dependents, their standard deduction is limited to the greater of $1,300 or their earned income plus $450.

• Additional Deductions by Filing Status

  • Single: $1,950

  • Married Filing Jointly: $1,550

  • Married Filing Separately: $1,550

  • Head of Household: $1,950

  • Qualifying Widow(er): $1,550

Concept Check 2.5

• Detailed calculations showcased for standard deduction examples based on various filing statuses.

Learning Objective 5: Tax Due to the IRS

• Tax Liability Components

  • Tax liability is calculated using tax tables or rate schedules based on the taxpayer's income bracket and adjusted for deductions.

  • Reductions in tax liability can arise from tax payments made throughout the year and by applying applicable credits.

• Types of Tax Credits:

  • Nonrefundable Credits: Can reduce tax liability down to zero but not result in a refund.

  • Refundable Credits: Can reduce tax liability below zero, resulting in a refund to the taxpayer.

• Tax Refund or Amount Due:

  • If tax payments exceed the owed tax, the excess is refunded to the taxpayer.

  • If the owed tax exceeds what has been paid, the difference is the amount due to the IRS.

Concept Check 2.6

• Example calculations for determining tax based on specific income brackets.

• Details on FICA maximum limit for the tax year 2024.

Learning Objective 6: Interest and Tax Penalties

• Interest on Assessments

  • Interest is charged at the federal short-term rate, plus an additional 3 percentage points.

  • Rates for specific periods are published by the IRS and updated regularly.

• Penalties

  • Failure to File Penalty: Assessed at 5% per month of the unpaid tax amount, with a cap of 25%.

  • Failure to Pay Penalty: 0.5% per month on unpaid taxes, also capped at 25%.

  • Combined penalties for failure to pay and failure to file cannot exceed the maximum penalty of 25%.

  • Fraud Penalty: A severe penalty of 75% imposed for any understatement of tax due to fraudulent actions.

  • Accuracy-Related Penalty: Imposed at 20% of the underpaid tax due to negligence or significant misstatements.

Concept Check 2.7

• Examines an example scenario detailing the implications of failure to pay penalties.

• True: Engaging in fraud on tax returns can lead to criminal charges and significant legal consequences.