Chapter 1
Overview of the Tax Structure

Income Tax Objectives
It all started with the 16th Amendment
"    Raise money for government operations
"    Economic goals
"    Political goals
"    Social goals
Entity Types & Forms
"    Individuals - Form 1040 & CA Form 540
"    Partnerships - Form 1065 & CA Form 565
o    Flow-through entity
o    General, limited partnership
"    Corporations
o    C - Form 1120 & CA Form 100
o    S - Flow-through entity; Form 1120S & CA Form 100S
o    Exempt - Form 990 & CA Form 199 and 109
"    Limited Liability Company - CA Form 568 & Federal Form 1040, 1065, 1120 or 1120S
"    Estates - Form 706 & CA Form 541
"    Trusts - Form 1041 & CA Form 541
Filing Requirements for Individuals
Current filing requirements depend primarily on:
"    Net earnings from self-employment - $400 minimum
"    Receives tips where social security is not withheld
"    Receive Advanced Earned Income Credit
"    Gross income and filing status
o    Federal - see page 1-27, Figure 1-6
o    California - see 540 instruction book page 3
Filing Requirements for Dependents
"    Federal - See pg 8 & 9 in 1040A instructions
o    Single & Married Dependent under 65 years old
"    Has over $950 in unearned income (interest or dividend income)
"    Has earned income over $5,700
"    Has total earned & unearned income exceeding the greater of
     $950 or
     Earned income up to $5,700 plus additional standard deductions for age & blindness
"    State - When gross income is greater than standard deduction - greater of $950 or earned income + $300 not to
      exceed $3,637 for single; $7274 other than single
Filing Status
"    Single
"    Married Filing Joint
"    Married Filing Separate
"    Qualifying Widow(er)
"    Head of Household
"    Registered Domestic Partner - California only
"    Your status is determined on the last day of the year
"    California has conformed to these rules
Single (S)
"    Not married
"    Legally separated from their spouse under a final decree of divorce or separate maintenance. 
"    If a separate maintenance, taxpayer can file a joint return if both parties agree.
"    Does not qualify for other categories
Married Filing Joint (MJF)
"    Determined under the laws of the state in which they reside
"    Legally separated from their spouse under separate maintenance is NOT considered married.  Can file a joint return if both parties agree.  Otherwise file as single.
"    Spouse died during the year and you did not remarry
"    Spouse died in current year before filing of last year's tax return
Married Filing a Separate Return (MFS)
"    Not usually advantageous
"    Married
o     No separate maintenance agreement
"    When a husband and a wife have separate incomes, they may realize savings by filing separate returns. Taxpayers should test joint and separate return status to see which one yields the least tax liability.
"    Relieves liability for spouse
"    Must look at state laws to determine split of income & expense items.
Surviving Spouse (Qualifying Widow[er] with Dependent Child) (QW)
To qualify for surviving spouse status, a widow(er) must:
"    Qualify to file a joint return with the deceased spouse in the year of death
"    Maintain a home for himself or herself and dependent child - 50% support
"    Live with the qualifying child for the entire year
"    Not remarry before the end of the year
Benefit -
"    Same tax rates as MFJ for 2 years
Head of Household (HOH)
"    Unmarried
o    You paid over ½ the cost of keeping up your home and
o    A qualifying person lives with you for at least ½ of the year
"    Exception - parent
o    Qualifying person - Dependent
"    Caution being able to claim a dependent does not automatically qualify you as HOH
"    Custodial parent may give up dependency exemption but will still be able to claim HOH
Abandoned Spouse Rule
"    Treated as unmarried if
o    File a separate return AND
o    Home is the main home of your child/stepchild/adopted/foster child for more than ½ year AND
o    Claim the child as dependent AND
o    Furnishes more than one-half the cost of maintaining the household AND
o    Does not have the other spouse living in the household during the last six months of the taxable year
"    Can file as Head of Household
California Registered Domestic Partner
"    Started in 2007
"    For California, file as Married Filing Joint or Married Filing Separately
"    Federal purposes - file as Single
Dependents
"    See Dependency Exemption Requirements table
"    California has conformed
"    Must have a Social Security Number for each dependent
Children of Divorced or Separated
"    Who gets to claim the kids?
o    Custodial parent - keep track of "night-overs"
o    Tie-breaker rules - whoever has the higher Adjusted Gross Income (AGI)
o    Form 8332
"    Allows noncustodial parent to claim qualified child
"    Must be signed by custodial parent
"    Must be attached to noncustodial parent's tax return
"    Divorce decree ignored
Multiple Support Agreement
The group member claiming the exemption must pass the following tests:
"    Provide more than 10% of the dependent's support
"    Provide, with the other group members, more than 50% of the dependent's support
"    Meet the other dependency tests, including relative test
"    Group members who do not claim the exemption need to complete and deliver a Form 2120 to the claiming member.
o    Form 2120 is a statement stating that they waive their right to claim the exemption for that year.
Basic Tax Formula for Individuals
    Income from all sources
-    Exempt income
=    Gross income
-     Deductions for AGI (adjusted gross income)
=    AGI
-     Deductions from AGI
        Greater of Itemized or standard deduction
        Exemptions (personal and dependency)
=    Taxable income
x     Tax Rate
=    Tax liability before:
+    Additions to tax
-     tax credits
=    Final tax due (refund)
Gross Income Overview
  1. Compensation for services, including fees, commissions, fringe benefits, and similar items (Ch 3 & 4)
  2. Gross income from business (Ch 7)
  3. Property transaction gains (Ch 3, 10 & 11)
  4. Interest (Ch 3 & 4)
  5. Rents (Ch 3 & 9)
  6. Royalties (Ch 3 & 9)
  7. Dividends (Ch 3 & 4)
  8. Alimony and separate maintenance payments (Ch 3)
  9. Annuities (Ch 3)
  10. Income from life insurance proceeds (Ch 3)
  11. Pensions (Ch 3)
  12. Income from forgiven debt (Ch 3)
  13. Share of distributive partnership income and S Corporation (Ch 9)
  14. Income in respect of a decedent (Ch 1)
  15. Income from an interest in an estate or trust (Ch 9)
Deductions for Adjusted Gross Income (AGI)
Above the Line Deductions
  1. Trade and business deductions (Ch 7)
  2. Limited losses from property transactions (Ch 3, 10 & 11)
  3. Deductions related to rent and royalty income (Ch 3 & 9)
  4. Certain contributions to retirement plans of self-employed individuals (Ch 7)
  5. Deductions related to Individual Retirement Accounts (IRA's) (Ch 4)
  6. Penalties for early withdrawals from certificates of deposits (Ch 4)
  7. Alimony paid (Ch 3 & 4)
  8. Qualified moving expenses (Ch 4)
  9. One-half self-employment tax (Ch 4 & 7)
  10. Health insurance premiums paid by a self-employed person (Ch 4 & 5)
  11. Individual contributions to a health savings account (Ch 4)
  12. Interest paid on student loans (Ch 4)
  13. Educator Expenses (Ch 4)
  14. Tuition & fees deduction (Ch 4)
  15. Domestic production activities deduction(Ch 4)
  16. Certain expenses of reservists, performing artists, and fee-based government officials (Ch 4)
Deductions from AGI
Below the Line Deductions
"    The larger of
o    Itemized Deductions
"    Medical (Ch 5)
"    Taxes (Ch 5)
"    Interest (Ch 5)
"    Charitable Contributions (Ch 5)
"    Casualty and theft losses (Ch 5)
"    Job expenses and some miscellaneous deductions (Ch 6)
"    Other miscellaneous deductions (Ch 6)
o    Standard Deduction (Ch 1)
Standard Deduction
The standard deduction is based on the taxpayer's filing status
o    Single
o    Head of household
o    Married filing a joint return
o    Married filing a separate return (If one spouse uses itemized deductions then the other must use itemized deductions)
o    Surviving spouse
and consists of two factors:
o    Basic standard deduction
o    Additional standard deduction
Standard Deduction for 2009
            Basic Standard Deduction
                Filing Status                                            Federal                                    California
                Married Filing Joint (MFJ) or                    $11,400                                    $7,274
                    Surviving Spouse (Qual. Widow)
                Head of Household (HOH)                        $8,350                                    $7,274
                Single                                                        $5,700                                     $3,637
                Married Filing Separately (MFS)               $5,700                                     $3,637
                Registered Domestic Partner                        N/A                                       $3,637
                    Filing Separately                                                                                    $7,274
                    Filing Joint
             Additional Standard Deduction - Blind or over 64
                 Filing Status                                      Federal (for each occurrence)        California
                 (MFJ) or Surviving Spouse                       $1,100                                    $0
                 Single or HOH                                         $1,400                                    $0
Addition to Standard Deduction for 2009
Standard Deduction to be increased by
          "    Real Estate Taxes - Maximum $1,000/MFJ  $500 Other
          " Net Disaster Loss
          " State Sales Tax paid after 2/16/2009 on the purchase of any new motor vehicle
New Form - Schedule L
Standard Deduction for Dependents
"    Limited to the greater of $950, or
"    Earned Income + $300
"    But not more than the basic standard deduction ($5,700 Single)
"    Worksheet in IRS instructions, page 32
"    Example - Johnny, 15, has interest income of $300 plus wages of $700 - Std Ded?         Change the wages to $5,800 - Std Ded?         Change the wages to $200 - Std Ded?
"    California has the same calculation
Exemptions - Yourself, Spouse & Dependents
"    FEDERAL
o    $3,600 per exemption
o    Exemption reduced (phased down) by 2% when AGI exceeds higher levels
o    See pg 1-10 to 1-11
o    Reduces Taxable income
"    CALIFORNIA
          o    $196 for MFJ/RDP & QW
o    $98 for S, MFS/RDF & HOH
o    $98 for each Dependent
          o    $98 for Blind (taxpayer)
o    $98 for over 64 years old (taxpayer)
o    Exemption reduced (phased out or down) when Federal AGI exceeded higher levels
o    Reduced Tax
Statutory Limit for Assessing Additional Taxes
Normal Limit
    Three years after the later of the return's due date + extensions or the filing date
Income Omissions
    Six years after the later of the return's due date or the filing date for taxpayer's inadvertent omission of more than 25% of gross income reported on return
Fraudulent Return
    Tax year never closes
Responsibilities of Taxpayers
"    Prepare appropriate tax forms and schedules
"    Determine correct tax liability
"    Pay tax due on time
"    File return on time with proper IRS Regional Service Center and keep evidence of on-time mailing
"    Maintain records and documents to support tax return data
"    Try to minimize tax return errors
Minimize Errors
"    Get appropriate forms, schedules, and instructions
"    Study the instructions and assemble data before preparing the return
"    Enter data on a tax organizer (if available)
"    Review IRS identification label for correct facts
"    Supply all data
"    Check all calculations
"    Look for minor omissions due to carelessness
Capital Assets
Capital assets are defined as all property except:
"    Property held for resale (inventory)
"    Real and depreciable property used in a trade or business
"    Accounts receivable acquired in normal business operations
"    Artistic works created by the taxpayer
"    Taxed at special rates
Tax Planning Principles
"    Acquire working knowledge of tax laws
"    Plan transactions in advance to reduce taxes
"    Maximize unrealized income
"    Keep good records
End of Chapter 1