Depreciation

Is a deduction allowed for the reasonable wearing out of assets used in business or held for the production of income. ex. machinery,

Capital Improvement

An improvement made to extend the useful life of a property or add to its value. Major repair such as the replacement of a roof are considered to be capital improvement. The cost of capital improvements to business property must be capitalized and may be depreciated.

Capital Gain

The gain from the sale or exchange of a capital assets; such as stock or real estate. The gain is the difference between a selling price exceeds the purchase price of any investment such as property (real estate), stock or bonds, and goodwill.

Basis of Stock

The cost basis of any stock or investment it goes to the original value of an asset purchased, If the stock is received as a gift, basis is generally from the previous owner or the fair market value when received. See also in publication 551 

Adjustment to Income

An expense which may be deducted even if the taxpayer does not itemize deductions. Adjustment to income are subtracted from gross income to arrive at adjusted gross income.

Taxpayer Child

Includes the taxpayer's natural child, step-child, or a child placed for legal adoption regardless of when the child came to live with the taxpayer; also, any other child whom the taxpayer cared for as his own child for the entire year unless the child's natural or adoptive parents provided over half of the child support.

Support

The total amount provided on behalf of an individual. Support includes food, lodging, and other necessities as well as recreation and other nonessential expenditures. Support is not limited to necessities and can be as lavish as the taxpayer can afford.

Recovery of Cost

The amount that was paid for income received, usually a factor only in income from sale of items purchased for resale, income from sales of property, and income from pensions or annuities. The portion of income that represents recovery of cost is not taxable.

Principal Place of Abode

(Principal Residence) The place that an individual considered to be his permanent home. A person's abode does not change when he is temporarily absent due to illness, school, military services, etc., as long as his living area is maintained and he can reasonably expected to return home after the temporary absence.

Physical Custody

The taxpayer with whom a child lives is considered to have physical custody.

Noncustodial Parent

The parent who does not have physical custody of the child.

Full Time Student

An individual who is enrolled in a school for the number of hours or courses considered by the school to be full-time. School includes elementary and secondary schools, post-secondary colleges, and technical and trade schools. It does includes on the job training, correspondence schools, or night school. However, a student will not be disqualified by night classes that are part of a full-time course of study.

Foster Child

For the tax purposes, a child other than a natural or adopted child, who live with the taxpayer for the entire year and whom the taxpayer cared for as his own child. The term foster child does not include a child place with the taxpayer by a child placing agency that makes payments to the taxpayer as a foster parent.

Exemption

An amount (3,800 for 2012) allowed by laws as a reduction of income that would otherwise be taxed. there are two kinds of exemptions; Personal, and dependency. see Form Instruction 1040 

Dependent

An individual who qualifies to be claimed as a dependent on another person's income tax return. To be claimed as a dependent, a person must meet five tests.

Custodian Parent

The parents with whom a child lives for more than 6 months. A custodial parent is also considered the primary care parent.

What is Tax Supplement?

Local tax imposed be a lower government unit (such as a municipality) on the same tax base over which a higher governmental unit (state or federal government) has already imposed a similar tax.

What is Tax Sheltered Income?

Tax-deferred or tax-exempt earnings.

What is Tax Sink?

Jurisdiction in which no income tax is imposed.

What is Tax Waiver?

A state issued document that specifies the tax department will transfer stock as indicated. Tax waivers are often used to transfer ownership of property.

What is Tax Write off?

Offsetting depreciation, expenses, and losses against tax payer's income.

What is Taxable Equivalent Yield?

Restatement of total income earned from an investment portfolio (including income from tax exempt securities such as municipal bonds) in terms of taxable, for comparing its yield with those of the other investment portfolios.

What is Taxable Estate?

An amount calculated as the adjusted gross estate minus any marital deduction property and any charitable deductions.

What is Taxable Value?

Percentage of property value used to determine how much the property owner pays in taxes.

What is Taxable Income?

Taxable Income - The amount of income that is used to calculate an individuals or a company's income tax due. Taxable income is generally described as gross income or adjusted gross income minus any deductions exemptions or other adjustments that are allowable in that tax year.
Taxable income is also generated from appreciated assets that have been sold or capitalized during the year and from dividends and interest income. Income from these sources is generally taxed at a different rate and calculated separately by the tax entity.

What is Tax Year?

Standard 12 month period (such as a calendar year or a fiscal year) used for computing a tax payer's tax liability.

What is Taxable year?

Twelve-month period used as the basis for computing tax on income received during that period. Also called tax year.

What is Taxation?

A means by which governments finance their expenditure by imposing charges on citizens and corporate entities. Governments use taxation to encourage or discourage certain economic decisions. For example, reduction in taxable personal (or household) income by the amount paid as interest on home mortgage loans results in greater construction activity, and generates more jobs. see also taxation principles.

Ownership

Ownership of income is determined by state law. The laws regarding the ownership of income and property in most states are based on British common law. These states are called separate property states. In separate property states, income belongs to the person who earned it or who owns the property that produced the income.

Gross Income

Gross income is total worldwide income received in the form of money, property, or services that is subject to the tax. There are two types of gross income:

• Earned income is received for services performed. Some examples are wages, commissions, tips, and generally, farming and other business income.
• Unearned income is taxable income that does not meet the definition of earned income. It includes money received for the investment of money or other property, such as interest, dividends, and royalties. It also includes pension, alimony, unemployment compensation, and other income that is not from performing service.

What is Income

Generally speaking, income is financial gain derived from labor (work), capital (money) or a combination of the two. Unless specifically exempt or excluded by law, all income is subject to income tax and is reported on the tax return.

Fiscal Year

Instead of the calendar year, a few tax-payers report their income using a fiscal year. A fiscal year may end on the last day of any month except December.

Hybrid Method of Accounting

Hybrid Method of Accounting
A hybrid accounting method is a combination of methods, usually of the accrual and cash methods. Business often use a hybrid method because the accrual method is required on tax returns for inventory accounting, but the cash method is more convenient for operating expenses.

Accrual Method of Accounting

When the accrual method of accounting is used, income is reported in the tax year earned, whether or not received. Deductions are claimed in the tax year incurred, whether or not paid.

Calendar Year

The calendar year is January 1 through December 31.The normal due date for filing a calendar-year tax return (including the final return of a taxpayer who died during the tax year) is April 15 following the end of the tax year. Taxpayers may receive an automatic extension until August 15 filing Form 4868 by April 15. If April 15 falls on a Saturday, Sunday, or legal holiday, the due date is extended to the next business day.

Cash Method of Accounting

When the cash method of accounting is used, income is reported in the tax year it is constructively or actually received, and deductions are claimed in the tax year paid. Constructively received means that the income is available to the taxpayer, regardless of whether it is actually in his possession. Constructively received income includes income credited to an account, income and reinvested by an agent of the taxpayer, a check or other payment received before the end of the year even if not deposited or converted to cash, and income for which the date of receipt is controlled by the taxpayer (for example, income due and payable from an activity owned or controlled by the tax payer who elects to defer receipt).

Unearned Income

Unearned Income -An individual's income derived from means other than the provision of personal efforts (Salaries), such as that derived as dividend, interest, or rent. Pensions and royalties, however, are not considered unearned income.

Examples of unearned income include interest from a saving account, bond interest, tips, alimony, and dividends from stock. As long as this income is "realized" then it is taxable.

Gambling Winnings

The gross amount of a taxpayer's gambling winning is taxable. Gambling losses may not be "netted out" of the gross winnings. Gambling losses may be deducted only as an itemized deduction on schedule A and only to the extent of winnings.

Withholding of income tax from certain gambling winnings is required. If a taxpayer had gambling winnings from which tax was withheld, he will have a Form W-2g which should be attached to, and filed with, Form 1040. Winnings are reported on line 21, Form 1040. The tax withheld is included with taxes withheld from Form W-2 on line 57, Form 1040.

Scholarship and Fellowships

Some scholarships are nontaxable. But first, we'll those scholarships that are taxable.

A degree candidate will follow this same procedure of reporting any scholarship income spent for, or designated for, room and board. However, he does not need to report scholarship money spent for tuition, fees, and course-required books, supplies, and equipment. These amounts are excludable from gross income. The recipient is responsible for determining whether the grant from gross income. The recipient is responsible for determining whether the grant was used for qualified tuition and related expenses.

Hobby Income

Gross income from a hobby is taxable and is reported on line 21, Form 1040. Expenses to the extent of hobby income, are deductible as a miscellaneous itemized deduction on Schedule A.

Gambling Winings

The gross amount of a taxpayer's gambling winning is taxable. Gambling losses may not be "netted out" of the gross winnings. Gambling losses may be deducted only as an itemized deduction on schedule A and only to the extent of winnings.

Withholding of income tax from certain gambling winnings is required. If a taxpayer had gambling winnings from which tax was withheld, he will have a Form W-2g which should be attached to, and filed with, Form 1040. Winnings are reported on line 21, Form 1040. The tax withheld is included with taxes withheld from Form W-2 on line 57, Form 1040.

Miscellaneous Income

Miscellaneous income includes various types of income that do not have specific lines of entry on Form 1040. Such income is generally reported on line 21, Form 1040, as "other income" Form 1040A or 1040EZ can not be used to report these types of income. Some common examples are gambling winnings, prizes, awards, jury duty fees, fees paid to election judges, and fees paid to nonprofessional executors of trusts and estates.

Some employers require their employees to surrender any jury duty pay they receive in exchange for their regular wages. Always ask a taxpayer imposes this requirement on its employees.

Employees in this situation must report their jury duty pay as income on line 21, Form 1040, in the usual manner. They may then back it out as a write-in adjustment to income on line 32, Form 1040.

Nontaxable Income

Only income that is specifically exempt from tax is nontaxable. Income that is specifically exempt includes welfare benefits, gifts, most bequests and inheritances, workers compensation, and most veterans' benefits.

Barter Income

Barter income (the value of property or services a taxpayer receives in exchange for property or services rendered) and kickbacks (amounts received for referrals) are taxable miscellaneous income or may be self-employment income.

Child Support

Payments that are specifically designated in the decree or agreement as support for minor children are child support and not alimony. These payments are neither deductible by the payer nor taxable to the recipient.

Sometimes amounts not specifically stated in the decree to be child support will nonetheless be treated as child support. This happens when payments are reduced or eliminated upon the occurrence of a contingency relating to the child, or at a time that is clearly associated with the contingency.

Example: Peter Yosores's divorce decree states he will pay his ex-wife $500 per month until their son reaches age 21. Although the divorce decree does not specifically state that the $500 per month is child support, it will be so treated because it will cease upon the contingency of the son's 21st birthday.

When the divorce decree does not set a specific amount for child support, and no child-related contingencies are involved, the entire payment is alimony.

Example: Gary and Gina Villanueva are divorced. Gina has custody of the couple's two children. Their divorce decree states only that Gary will pay Gina $1,500 per month. Because the decree does not stipulate a specific amount as child support, and no child-related contingencies are involved, the entire amount is considered alimony.

When alimony and child support payments are both required by a decree, child support is always considered to be paid first.

Example: A taxpayer is required to make payments of $900 per month until the death or remarriage of his spouse. The decreed designates $600 pf this amount as alimony and $300 as child support. The taxpayer sends only $9,000 in total payments for the year. The alimony deduction for that year is $5,400 because the $3,600 designated as child support by the decree is considered to be paid first.

On occasion, alimony may include the payment of expenses of a personal residence, such as real estate taxes, insurance, interest, and utilities. The facts in each situation determine the amount deductible by one spouse and taxable to the other spouse.

Community Property States

In community property states, payments to a separated spouse (as opposed to a divorced spouse) are deductible only when the amount exceeds the spouse's share of the community property income; for example, if the spouse's share of community property income is $20,000, and the alimony received and the remaining $20,000 is reported as other gross income. Only $2,000 is deductible by the spouse paying the alimony.

Payments That Are Not Alimony

The term alimony may be used in a decree to describe payments that do not meet the tax deductible requirements of alimony. Property settlements, payments not required by the decree or agreements, and payments not arising from the marital relationship (for example, a bona fide loan from one spouse to the other spouse)

Alimony

Alimony is a payment made to a person by court decree as a result of divorce or separation. If the taxpayer is receiving taxable alimony, it's included in income on line 11, Form 1040. Payment of taxable alimony is deducted by the payer as an adjustment to income on line 31a, Form 1040. Enter the recipient's social security number in the space provided next to line 31a.

Qualifications
If alimony is deductible by the person who pays it, it is taxable income to the person who receives it. The rules governing whether alimony is deductible by the payer and taxable to the recipient depend on when the divorce or separation agreement was established. The rules discussed here apply to divorce and separation agreements established after 1984. If you ever need to know the rules for agreements established prior to 1985, you'll need to do some research.

Capital Gain Tax Computation

Capital gain distributions (those found in Box 2a, Form 1099-DIV) are treated as long-term capital gains regardless of the period of time the shareholder owned an interest in the fund. Long-term capital gains are generally taxed at different rates than short-term gains and other ordinary income, and the several types of capital gain (such as those found in Boxes 2b, 2c, and 2d on Form 1099-DIV) are themselves taxed at different tax rates.

Nontaxable Distributions

Nontaxable distributions are a return of the shareholder's capital (original investment), generally made because an excess amount of capital has been accumulated by the corporation. Nontaxable distributions may be received in cash or reinvested at the shareholder's request to acquire additional shares. The basis (usually the cost) of the stock must be reduced by the amount of the distribution. Amounts received are not taxable until the remaining basis is reduced to zero.

Capital Gain Distributions

Capital gain distributions are paid by mutual funds, regulated investment companies, and real estate investment trusts. They represent the shareholder's portion of gain from the sale of securities owned by these investment companies. There are two treatments of capital gain distributions. Both types of capital gain distributions are taxable for the year constructively received.

• Distributed capital gains are paid in cash to the shareholders or reinvested in additional shares at the shareholders' request.
• Undistributed capital gains are retained by the investment company, which pays the tax on them. These gains are reinvested automatically in additional shares and reported to the taxpayer of Form 2439 rather than on Form 1099-DIV. An individual who receives Form 2439 may have a credit to be entered on line 63, Form 1040, for tax paid by the investment company.

Ordinary Dividends

Ordinary dividends are the most common type of distribution and are the portion of a corporation's profits paid to the shareholders. Ordinary dividends are fully taxable.

Dividends

DIVIDENDS
Dividends are paid to shareholders (people who own stock) of corporations. They represent the shareholder's portion of the corporation's profits. In this section you'll learn about the various kinds of dividends shareholder may receive, and their tax treatment.

Note: Certain distributions commonly referred to as dividends are actually interest. These so-called "dividends" must be reported as interest. The most common example is "dividends" paid by credit unions.

Payers of dividends of $10 or more to any one person during the year required to report such payments to the IRS and furnish the recipient with a statement of total dividends receives for the tax year. Form 1099-DIV

The three most common types of distributions are:

1. Ordinary dividends (Box 1);
2. Capital gain distributions (Box 2a); and
3. Nontaxable distributions (Box 3).

Form 1099-INT-Interest Income

Form 1099-INT-Interest Income

RECIPIENTS identification number is the social security number of the owner of the account.

Box 1. This box includes amounts that are paid or credited to the taxpayer's account by savings and loan associations, building and loan associations, cooperative banks, homestead associations, credit unions, and similar organizations.

It includes interest on bank deposits, corporate bonds, debentures, notes, certificate, stockholder's accounts, and any interest paid in the course of trade or business totaling $600 or more to any one individual.


Box 2. The early withdrawal penalty is the interest penalty due to an early withdrawal of time deposits. It is entered on line 30, Form 1040. It does not affect the entry of interest income from Box 1.

Box 3. Interest from U.S. Savings Bonds and Treasury obligations is entered here Generally, this income is taxable on the federal return, but nontaxable on state returns. Box-3 amounts are entered on the federal return in the same manner as Box-1 amounts.

Box 4. Usually, tax isn't withheld from interest payments. However, if the taxpayer has failed to provide the payer with this social security or other identifying number, the payer is required to withhold 31 percent of the interest paid. Any amount withheld is entered in Box 4.

Box 5. Any amount shown in this box is the taxpayer's share of investment expenses from a real estate mortgage investment conduit (REMIC). A REMIC is a corporation similar to a mutual fund that invests in mortgage. If the taxpayer itemizes, he may deduct this amount as an itemized deduction.

Box 6. Foreign tax paid is any foreign tax withheld from the interest income. The taxpayer mat take a dollar-for-dollar credit for this tax, or deduct it from his taxable income as an itemized deduction.

Box 7. Foreign country or U.S. possession is the country or possession to which  the foreign tax was paid.

Interest Penalty on Early Withdrawal of Savings

Interest Penalty on Early Withdrawal of Savings

If money in a time savings (such as a certificate of deposit) is withdrawn before maturity, interest may revert to a lower rate for the year of withdrawal and there may also be a period when no interest is paid. The difference (the amount of interest forfeited) will be reported as an early withdrawal penalty in Box 2 on Form 1099-INT or similar statement. It's possible that the penalty could be more than the gross amount of interest reported in Box 1.

The interest penalty is entered on line 30, Form 1040, ans is subtracted from total income. Form 1040A cannot be used. The interest reported on Form 1099-INT is the amount that was received for the tax year up to the date of withdrawal.

Tax-exempt Interest

Tax-exempt interest is reported on Forms 1040A and 1040, but must be kept separate from taxable interest so it is not included in taxable income. Tax-exempt interest is reported on line 8b, Form 1040A or Form 1040.

If the taxpayer received a Form 1099-INT for ta-exempt interest, include the tax-exempt interest with other interest items.

Municipal Bonds

Municipal bonds are generally issued by state and local government to fund capital improvement projects. Local government include countries, cities, school district, and other administrative divisions of the states that have been granted the authority to issue bonds. The federal government does not tax municipal bond interest.

Some state and local governments do not tax interest from any municipal bonds. Others tax interest from municipal bonds issued by state or local governments other than their own. Other states tax interest from all municipal bonds, including their own.

Modified Adjusted Gross Income

Modified adjusted gross income is an employee's adjusted gross income for a tax year, plus any tax exempt interest they have earned.The taxpayer's adjusted gross income, and is then modified for each individual purpose.

MAGI, for purposes of the U.S. Savings Bonds exclusion, is usually computed in the same manner as the regular AGI. However, the amount of interest included in MAGI is the amount before any qualified bond exclusion has been subtracted. Any student loan interest deduction shown Form 1040, must be added back, and any employer-provided adoption benefits which were excluded from income must be added in. Also, certain taxpayers must add back the foreign earned income exclusion, the foreign housing exclusion or deduction, the exclusion for income from certain U.S. possessions, and the exclusion for income from sources within Puerto Rico.

Education Saving Bond Program

EDUCATION SAVING BOND PROGRAM

Some taxpayers can avoid paying tax on certain bond interest when they use the funds to pay for college expenses. If a taxpayer cashes qualified Series EE or Series I bonds and uses the money, or an equivalent amount from other sources, to pay qualified higher education costs for himself, his spouse, or his dependents, the interest will escape taxation, provided the taxpayer's income doesn't exceed certain levels. The exclusion is phased out for higher-income taxpayers. Qualified tuition and fees must be reduced by the amount of any nontaxable scholarships or fellowships used by the student.

To qualify for the exclusion, the bonds must be issued after 1989 and must have been purchased by an individual who was at least 24 years old on or before the bond's issue date. Gift bonds, however, don't qualify. For example, if the taxpayer purchases the bonds and puts them in his child's name, the exclusion is lost even if the child later redeems the bonds to pay college tuition. The same is true if the child's grandparents, for example, purchase the bonds and give them to the child's parents.

Example: Adriano Yosores, a grandfather, purchased Series EE bonds and gave them to her daughter on the condition that the proceeds of the bonds be used for her granddaughter college education. These bonds would not qualify for the exclusion. Adriano would be wiser to give the money to her daughter and have her daughter purchase the bonds, thus making them eligible for the exclusion when the granddaughter goes to college, assuming all other qualifications are met. Note: Adriano's granddaughter may, if she owns the bonds and if she qualifies, elect to report the interest income annually, as discussed earlier. This strategy may reduce or eliminate his overall tax burden regarding bonds.

Exclusion - Specific condition, circumstance, or situation usually listed in a contract as being not covered. All contracts (including insurance policies and construction contracts) contain exclusions, expressly or by implication.

Who May Take the Exclusion

You may take the exclusion if all four of the following apply:

1. You cashed qualified U.S. savings bonds in 1999 that were issued after 1989
2. You paid qualified higher education expenses in 1999 for yourself, your spouse, or your dependents.
3. Your filing status is any status except married filing separately.
4. Your modified AGI (adjusted gross income) is less tha: $68,100 if single or head of household; $109,650 if married filing jointly or qualifying widow(er).

Note: The amount above subject to change (that is only example for 1999 tax year).It depend the amount of current year.

U.S. Savings Bonds That Qualify for Exclusion

To qualify for the exclusion, the bonds must be series EE or I U.S. savings bonds issued after 1989 in your name, or, if you are married, they may be issued in your name and your spouse's name. Also, you must have been age 24 or older before the bonds were issued. A bond bought by a parent and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.

Record-keeping Requirements

Keep the following to verify the amount of interest you excluded.

• Bill, receipts, canceled checks, or other documents showing you paid qualified higher education expenses in 1999.
• A written record of each post-1989 series EE or I bond that you cash. Your record must include the serial number, issued date, face exceeds these levels. It also isn't available for taxpayers using the married filing separately status. 

Treasury Bills

Treasury Bills, notes and bonds are direct obligations of the Treasury. Treasury Bills mature in one year or less, and are taxed at maturity . Most other treasury obligations are taxed as the interest is earned.

If a Treasury obligation is redeemed before maturity, the taxpayer may be forced to forfeit some of the interest earned.

By federal law, interest from U.S. Treasury obligations is never subject to state or local income taxes.

Interest

Interest is money paid or received for the use of money. Banks pay interest on money their customers deposit; governments and corporations pay interest on bonds they issue; insurance companies pay interest on money left on deposit. The sources of interest income are almost unlimited. Most of the interest we received is taxable, but some is not. See  Form 1099-INT.

Filing Requirement

Common Law Marriage
A taxpayer is considered married if, at the end of the tax year, he is in a common law marriage that is recognized in the state where the couple is residing, or was at the time recognized by the state where the common law marriage began.

AGE
Taxpayers are considered to be age 65 on the day before 65th birthdays.

Example:
Jacob Martin's 65th birthday is January 1, 2007; for tax purposes, he is considered age 65 for the 2006 tax year.

The age of a person who dies during the year is determined as of the date of death.

For federal income tax purposes, there are five filing statuses:

1. Single;
2. Married filing jointly;
3. Married filing separately;
4. Head of household; and
5. Qualifying widow(er)

Retirement

Everyone wants a financially secure retirement, and most people take some steps to provide for their later years. Almost all employed and self-employed Americans are required to contribute to the social security system. In addition, many people belong to retirement plans where they work, contribute to individual retirement arrangements (IRAs), or buy annuities.

SOCIAL SECURITY AND EQUIVALENT RAILROAD RETIREMENT BENEFITS
Many taxpayers who are retired, disabled, or whose spouses or parents are deceased may receive social security or equivalent tier 1 rail road retirement benefits. The maximum benefit amount for 1999 is $1,373 per month. Some of these benefits may be taxable, depending upon the taxpayer's circumstances. Taxpayers above a certain income level will pay tax on a portion  of their social security income, while lower income taxpayers will enjoy tax-free social security benefits.

Note: For purposes of this section, the term "benefits" applies only to those payments made under the Old-Age, Survivors, and Disability Insurance program (OASDI), which is funded through the social security payroll tax and based on prior earnings. Social security benefits do not include SSI (Suplemental Security Income), which is federally funded program of income assistance based on financial need for the aged, blind, and disabled. The Social Security Administration administers both programs, but SSI benefits are not taxable.

For 1999, up to 85 percent of a taxpayer's social security and equivalent tier 1 railroad retirement benefits may be taxable. Generally, however, if these benefits are the only source of a taxpayer's income, they won't be taxable. This also holds true if the taxpayer's other income is small.

Forms SSA-1099 (for social security) and RBB-1099 (for railroad retirement) are used to notify the taxpayer of total benefits received during the year. Also indicated is the amount of repayment of benefits the taxpayer made, if any.

Each individual recipient of social security and tier 1 railroad retirement of social security and tier 1 railroad retirement receives Form SSA-1099 or RRB-1099. For example, if a widowed parent receives one monthly benefits check that includes benefits for that parent as well as two minor children, each of them will receive a separate Form 1099 reporting his share of the year's benefits.

Computing Taxable Benefits
The amount of a taxpayer's social security or tier 1 railroad retirement benefits that is subject to federal income tax varies from zero to 85 percent of the taxpayer's benefits, depending on the taxpayer's income level and filing status. None of the benefits are taxable unless the taxpayer's modified adjusted gross income (defined below) plus half the taxpayer's benefits exceeds $32,000 (MFJ), $25,000 (S.HH, QW, or MFS and the taxpayer didn't live with his spouse at any time during the year), or $0 (MFS and the taxpayer lived with his spouse at any time during the year).


Note: the above amount is subject to change.(The amount it depend of current year stated)

Social security and equivalent railroad retirement benefits may be nontaxable or partially taxable, depending on the taxpayer's other income and filing status.

PENSION AND ANNUITIES

Contribution - When a person puts money into retirement plan.
Distribution -When a person takes or receives money from a retirement plan.

When a taxpayer receives a distribution from a pension or annuity, he must sometimes determine how much of the amount he receives is taxable and how much is not.

If the taxpayer made no contribution to the pension plan or annuity (for example, his employer paid all the costs), or if the taxpayer made only pre-tax contributions to a plan such as a 401(K) plan, the entire amount received during the year is taxable.

If the taxpayer did make after-tax contributions to the pension plan or to the cost of the annuity, part of the amount received is a return of his cost (investment) and is nontaxable. The balance represents a return of his employer's cost and and amounts earned from the investment of the pension plan's funds.

Simplified Method
The simplified method may be used to compute the taxable portion of a pension or annuity with a starting date after July1, 1986. The pension or annuity must meet the following three conditions:

• The payments are for either the annuitant's life or the joint lives of the annuitant and a beneficiary;
• The payments must be from a qualified pension, profit-sharing, or stock bonus plan; a qualified employee annuity plan; or a tax-sheltered annuity; and
• The annuitant must be under 75 years of age when the payments begin, or if 75 or older, there must be fewer than five years of guaranteed payments.

Pension and annuity income is fully taxable if the taxpayer did not contribute after-tax money to the cost of the pension or annuity or, in some cases, if the taxpayer has recovered his entire cost  in previous years. Use of the simplified method for computing the taxable portion of a pension or annuity is generally mandatory for pensions starting after November 18, 1996.

SPECIAL AVERAGING METHODS

When a taxpayer receives a lump-sum distribution he has some choices to make. He may choose to roll over all or part of the distribution into a traditional IRA or other eligible retirement plan within 60 days. Any amount the taxpayer rolls over isn't currently taxable.


Ten-Year Averaging
Ten-year averaging may be used to compute the tax on a lump-sum distribution only if the emplyee or self-employed person

1. Was born before January 1, 1936, and
2. Was an active participant in a qualified plan for at least five full years (except in the case of death) before the year of the distribution. If the distribution was made due to the death of the plan participant, the beneficiary may use special 10-year averaging if the distribution otherwise qualifies.

Qualified higher education expenses
The expenses must be paid for the taxpayer, his spouse, or the child or grandchild of the taxpayer or spouse.

Qualified first-time home-buying expenses

For the purpose of exception 9, are any costs of acquiring or construction a principal residence for a firs-time homebuyer. The term first-time homebuyer is misleading; what it really means is someone who has not owned a home during the two-year period prior to the acquisition of the home to which this exception applies.

The distribution must be used to pay qualified expenses within 120 days of the date of distribution. The expenses must be paid for the taxpayer, his spouse, child, or grandchild, or parent or grandparent.

SIMPLE Distributions

Early withdrawals from a SIMPLE IRA are generally subject to the usual 10-percent penalty, but a 25  percent penalty applies to withdrawals made during the first two years in which an employee participates in the plan.

Rollovers can be made from one SIMPLE IRA to another. Rollovers to traditional IRAs are permitted at the end of two years of participation in the plan.

See: Self-employment income

CREDIT FOR THE ELDERLY OR THE DISABLED

The credit for the elderly or the disabled is a nonrefundable credit available to low-income taxpayers who are age 65 or older or who are permanently and totally disabled at the end of the tax year. This credit has not been adjusted for inflation since 1983. Due to the numbers involved, nowadays it is a fairly rare occurrence when a taxpayer actually gets the credits, but we'll discuss it briefly for your awareness.

To be eligible for the credit, a taxpayer must be:

• A qualified individual (define below);
• A U.S. citizen or resident for the entire year (or a nonresident alien who is married to and filing a joint return with a U.S. citizen or resident); and
• Filing a joint return if married at the end of the tax year, unless the taxpayer and his spouse did not live together at any time during the tax year or the taxpayer qualifies to be considered unmarried.

A qualified individual is one who is 65 or older; or, if under age 65

1. is retired because of permanent and total disability,
2. had not reached the mandatory retirement age for his employer's retirement program at the beginning of the tax year, and
3. has received taxable disability benefits during the year.

 Disability Pensions

If a taxpayer under 65 is retired because of a disability and received a taxable disability pension due to this disability during the year from an employer-funded disability plan or a disability provision of a retirement plan, he is eligible to claim the credit for the elderly or disabled if he was permanently and totally disabled at the time he retired and is still permanently and totally disabled.

Permanent and Total Disability
To be considered permanently and totally disabled, a taxpayer must be unable to engage in any substantial gainful activity because of a medically determined physical or mental impairment that is expected to result in death, or that has lasted or is expected to last for a continuous period of at least 12 months.

Substantial gainful activity means performing significant physical or mental work for pay or profit (or intended for profit). Part-time work may constitute substantial activity. The fact that the work activity may pay less than the one in which the taxpayer was engaged prior to the disability is immaterial.

The following nontaxable income must be taken into account and will reduce the maximum amount on which the credit is computed:

• Nontaxable social security and equivalent tier 1 railroad retirement benefits;
• Nontaxable veterans' pensions; and
• Any other pension, annuity, or disability benefits excluded from gross income (but not the cost recovery portion of a pension or annuity).

Unearned Income

Unearned Income -An individual's income derived from means other than the provision of personal efforts (Salaries), such as that derived as dividend, interest, or rent. Pensions and royalties, however, are not considered unearned income.

Examples of unearned income include interest from a saving account, bond interest, tips, alimony, and dividends from stock. As long as this income is "realized" then it is taxable.

INTEREST
Interest is money paid or received for the use of money. Banks pay interest on money their customers deposit; governments and corporations pay interest on bonds they issue; insurance companies pay interest on money left on deposit. The sources of interest income are almost unlimited. Most of the interest we received is taxable, but some is not. See  Form 1099-INT.

Payers of interest of $10 or more to any one person during the year generally required to report such payments to the IRS and furnish the recipient with a statement of total interest received for the tax year. If less than $10 interest was received from any payer, that interest is also taxable to the taxpayer, even though a reporting form is not required from the payer. In some cases, especially with loans or contracts, the taxpayer must determine the amount received from his own records (for example, from an amortization schedule).

When the taxpayer receives taxable interest totaling more than $400, it must be listed on either Form 1040A, Schedule 1, or Form 1040, Schedule B. Interest totaling $400 or less can be listed in the Interest Income section of the Income Compilation Worksheet.

If a taxpayer sells his home to a buyer who uses the home as his residence, and the seller finances part or all of the mortgage, the seller must report the interest he receives each year on Schedule B, Form 1040, or Schedule 1, Form 1040A. Additionally, the seller must report the buyer's name, address, and social security number on Schedule B or Schedule 1. The seller is also required to provide the buyer with his name, address, and social security number.

Taxation Principle

Basic concepts by which a government is meant to be guided in designing and implementing an equitable taxation regime. These include:

1. Adequacy: taxes should be just-enough to generate revenue required for provision of essential public services. 
2. Broad Basting: taxes should be spread over as wide as possible section of the population, or sectors of economy, to minimize the individual tax burden.
3. Compatibility: taxes should be coordinated to ensure tax neutrality and overall objectives of good governance. 
4. Convenience: taxes should be enforced in a manner that facilitates voluntary compliance to the maximum extent possible.
5. Earmarking: tax revenue from a specific source should be dedicated to a specific purpose only when there is a direct cost-and-benefit link between the tax source and the expenditure, such as use of motor fuel tax for road maintenance.
6. Efficiency: tax collection efforts should not cost an inordinately high percentage of tax revenues.
7. Equity: taxes should equally burden all individuals or entities in similar economic circumstances.
8. Neutrality: taxes should not favor any one group or sector over another, and should not be designed to interfere-with or influence individual decisions making.
9. Predictability: collection of taxes should reinforce their inevitability and regularity.
10. Restricted exemptions: tax exemptions must only be for specific purposes (such as to encourage investment) and for a limited period.
11. Simplicity: tax assessment and determination should be easy to understand by an average taxpayer.

Components of Tax Practice

Tax practice is a rapidly growing field that provides substantial opportunities for tax specialists in public accounting, law, and industry. The tasks performed by a tax professional may range from the preparation of a simple Form 1040 for an individual to the conduct of the tax research and planning for highly complex business situations. Tax practice consists of the following activities:

Describe the components of a tax practice and understand the importance of computer applications in taxation

• Tax compliance and procedure (i.e., tax return preparation and representation of a client in administrative proceedings before the IRS)
• Tax research
• Tax planning and consulting
• Financial planning

Tax Compliance and Procedure
Preparation of tax returns is a significant component of tax practice. Tax practitioners often prepare federal, state, and local tax return preparation (i.e., compliance) function usually is performed by a company's internal tax department staff. In such a case, a CPA or other tax practitioner may assist the client with the tax research and planning aspects of their tax practice, and may even review their return before it is filed.

Typical Misconception

Many people believe that a tax practitioner should serve in the capacity of a neutral, unbiased expert. They tend to forget that tax practitioners are being paid to represent their clients' interests. A tax practitioner may sometimes recommend a position that is defensible, but where the weight of authority is on the side of the IRS.

An important part of tax practice consists of assisting the client if an administrative appeal is contemplated with the IRS's  Appellate Division. In most instances, an attorney is retained if litigation is being considered.

Tax Research
Tax research is the search of the best possible defensibly correct solution to a problem involving either a completed transaction (e.g, a sale of property) or a proposed transaction (e.g. , a proposed merger of two corporations). Research involves each of the following steps:

• Determine the facts.
• Identify the issue(s).
• Identify and analyze the tax law sources (i.e., code provision, Treasury Regulations, administrative rulings, and court cases).
• Evaluate nontax (e.g, business) implications.
• Solve the problem.
• Communicate the findings to the client.

Tax research may be conducted in connection with tax return preparation, tax planning, or procedural activities.

What Does Business Income Mean?

What Does Business Income Mean?
Any income that is realized as a result of business activity. Business income is a type of earned income, and is classified as ordinary income for tax purposes.

Business income can be offset with business expenses and business losses. It can be either positive or negative in a given year.

Many Americans do not work for someone else-they earn their livings by running their own business. In this course you will learn how to prepare tax returns for self-employed people, except for farmers. You will use Schedule C. Profit or Loss From Business. Certain small business owners may qualify to use Schedule C.

While Schedule C may look a bit complicated at first glance, keep in mind that it is based on a simple formula: gross receipt (the money taken into a business) minus expenses equals net profit or loss.

Also you'll find out how self-employed taxpayers obtain social security and medicare coverage by the payment of self-employment tax. For this purpose, you'll use Schedule SE, Self-Employment Tax.

BUSINESS INCOME AND EXPENSES

Self-employed individuals are their own bosses. They decide when, how, and where to work, obtain their own jobs or sales, pay their own expenses, and receive social security and medicare coverage through payment of self-employment tax.

Sole Proprietorship - Which is a business owned by one individual, who files Schedule C with Form 1040.

Partnership - Is a business owned by two or more individuals.

If a married couple operate a business that is not set up as a partnership or corporation, the business is considered to belong to the spouse with the greater investment in labor and/or money.

No part of the "salary" of the proprietor is deducted anywhere on Schedule C. A proprietor cannot issue a Form W-2 or withhold and pay payroll taxes on amounts he withdraws from the business even if these amounts are designated as wages. For employees, payroll taxes should be withheld and remitted to the taxing agencies and Form W-2 must be prepared and furnished to the taxing agencies and the employees. A proprietor will file Form 1040-ES to pay his estimated income and self-employment (SE) tax liability.

SCHEDULE C

Heading
The heading of Schedule C request information about the business. The following explanations will help you complete this portion of the form.

Principal business or profession
Is the business or professional activity that provided the principal source of income. Give the general field or activity and type of product sold or produced or client served. Examples are "retail sales of household products" and "preparation of tax returns for individuals"

Business name and address.
Use the actual name of the business or, if there is no business name, leave line C blank. The business address on line E is the address from which the business is conducted. Enter the street address (including suite or room number), city, state, and ZIP, not a box number. Line E ay be left blank if the taxpayer conducted the business from his home and that address is the shown on Form 1040.

Employer ID number (EIN)
Is required if the business has any employees or is required to file alcohol, firearms, excise, or tobacco tax returns, or if the proprietor has a Keogh retirement plan. The proprietor may obtain an identification number by filing Form SS-4, which is available from any IRS office.

Accounting method.
The most common methods of accounting are the cash and accrual methods. Under the accrual method of reporting income, total sales and total charges for services in the tax year are included in income even though payment may be received in another tax year. Under the cash method, only income actually or constructively received during the year is included.

It is also possible to use a hybrid method. If the production, sale, or purchase of merchandise is an income producing factor, the proprietor must keep an inventory and use the accrual method in computing gross profit.

Line G. A proprietor materially participates when he is involved in the business in a substantial way on a regular basis. The answer to this question is important because if the proprietor does not materially participate, any loss from the business is considered a passive loss and can, generally, only be deducted currently against passive income. You'll learn more about passive income and losses later in the course.

Line H. Mark this box if the business was started or acquired during the tax year, or if the business is re-opening after a temporary close and no Schedule C (or C-EZ) was filed the previous tax year.

Income

Gross receipt include the gross amount of cash receipts and the fair market value of any property and services the proprietor receives in exchange for the goods or services he sells. Depending upon the type of business, the proprietor may receive one or more Forms 1099-MISC, reporting some or all of the income he has made from self-employment. This income should be included as part of his gross receipts.

Example: George Yosores delivers newspapers as an independent contractor for the LA news. He receives his share of the profits directly from the newspaper, which handles all subscription and billing activities. George's  Form 1099-MISC and will report the income on line 1 of his Schedule C.

If a business is required to collect state or local sales taxes, the taxpayer may either report gross receipts minus any sales remitted to the taxing agencies with other deductible taxes on 23, Schedule C.

Note: Keep in mind that if the business involves an inventory, gross receipts and the cost of goods sold must be computed using the accrual accounting method. Thus, accounts receivable for such businesses must be included in gross receipts even if not collected by the end of the year.

Returns and allowances 
Are amounts included in gross receipts that were refunded to customers who returned merchandise for refund or who were given a partial refund because they received damaged merchandise or for other similar reasons. These amounts are subtracted from gross receipts.

Cost of goods sold
If the production, purchase, or sale of merchandise produces income for the business, Schedule C, Part III, on page 2, must be used to compute the cost of good sold or manufactured.

Gross profit
In Part I, is gross receipts minus returns and allowances and cost of goods sold.

Other Income
Includes income from sales of scrap, interest received on customer accounts receivable, and other kinds of miscellaneous income received by the trade or business.

Expenses

Operating expenses are the ordinary and necessary expenses of conducting a business, trade, or profession. These expenses are deducted in Part II, Schedule C. We'll discuss them in the order they appear on the form.

Advertising
These are expenses to promote the business, including newspaper ads, flyers (including the cost of distributing them), television and readio promotions, Internet banners, and business cards.

Bad debts from sales or services
Customers accounts receivable and notes receivable that are definitely known to be worthless are business bad debts and are deductible if the income was included in gross income. Generally, only accrual-method taxpayer is ordinarily not entitled to claim a deduction for business bad debt deduction. A cash-method taxpayer is ordinarily not entitled to claim a deduction for business bad debts because sales are not included in gross income until payment is received.


Example: Adrelyn Yosores runs a bookkeeping business. She performed $500 worth of work for a client who left town without paying the bill. Because she uses the cash method of accounting, she did not inclede the $500 in her income because the client had not yet paid. Thus, even though her client disappeared without paying, she cannot take a deduction on line 9 because the $500 was never included in income.