Income Tax Fundamentals,

2022

Chapter 1: The Individual Income Tax

Return

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 Icebreaker

• Pair up with another student, introduce yourself, and consider the following
questions:
• What do you think the current goals of the income tax system are?
• What do you think the goals of the system should be?
• How well do you think current income tax system meets its goals? Does
it meet the goals you envision for it?
• Introduce your student partner to the rest of the class.

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 Learning Objectives
(1 of 2)

By the end of this chapter, you should be able to:

1. Explain the history and objectives of U.S. tax law.
2. Describe the different entities subject to tax and reporting
requirements.
3. Apply the tax formula for individuals.
4. Identify individuals who must file tax returns.
5. Determine filing status and understand the calculation of tax
according to filing status.

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accessible website, in whole or in part.
 Learning Objectives
(2 of 2)

6. Define qualifying dependents.

7. Determine the tax impact of the economic impact payment and
the recovery rebate credit.
8. Calculate the correct standard or itemized deduction amount for
taxpayers.
9. Compute basic capital gains and losses.
10. Access and use various Internet tax resources.
11. Describe the basics of electronic filing (e-filing).

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 History and Objectives of the Tax System

Tax Law History and Objectives

• Since 1913, when the Sixteenth Amendment was passed, the constitutionality of
the income tax has not been questioned by the federal courts.
• The income tax serves a multitude of purposes, such as:
• To raise revenue
• To stimulate the economy (economic goals)
• Reduce unemployment
• Expand investment in productive (capital) assets
• Control inflation
• Encourage certain business activities and industries
• To encourage taxpayers to undertake activities that benefit themselves and
society (social goals)
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 Poll 1

Which of the following do you think is the most important goal of the income
tax system?
a. Raising revenue to operate the government
b. Providing incentives for certain business and economic goals, such as
higher employment rates, through business-favorable tax provisions
c. Providing incentives for certain social goals, such as charitable giving, by
allowing tax deductions, exclusions, or credits for selected activities

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 Reporting and Taxable Entities
(1 of 4)

The Individual
• Most individual taxpayers file Form 10 40, which contains three possible
schedules:
• Schedule 1
• Additional forms of income and many deductions for adjusted gross
income
• Schedule 2
• Additional taxes (such as alternative minimum tax)
• Schedule 3
• Credits and payments other than withholding

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 Reporting and Taxable Entities
(2 of 4)

• In addition to Schedules 1–3, six schedules identify certain types of income

and deductions that must be reported:
• Schedule A
• To itemize deductions
• Schedule B
• To report dividend income and interest income greater than $1,500
• Schedule C
• To report trade or business income

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 Reporting and Taxable Entities
(3 of 4)

• Schedule D
• To report capital gains and losses
• Schedule E
• To report rental and royalty income or pass-through income
• Schedule F
• To report farm and ranch income

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 Reporting and Taxable Entities
(4 of 4)

The Corporation
• Taxed at a flat rate of 21 percent
• Need to file Form 11 20
• Form 11 20 S is used by corporations that elect S corporation status.
• Does not generally pay regular corporate income taxes; instead, passes
through items of income or loss to shareholders
The Partnership
• Reporting entity, not taxable entity
• Form 10 65 reports partnership income or loss and allocation to partners.
• Passes through items of income or loss to partners

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 Knowledge Check 1

Which is/are the most appropriate form(s) and/or schedule(s) for a taxpayer
who receives dividends of $2,000 and does not itemize deductions? Choose
all that apply.
a. Form 10 40
b. Form 11 20
c. Schedule B
d. Schedule C

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 The Tax Formula for Individuals
(1 of 5)

• This tax formula for individuals follows Form 10 40:

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 The Tax Formula for Individuals
(2 of 5)

Gross Income
• Gross income from all of the following are reported directly on Form 10 40:
• Wages
• Interest
• Dividends
• Pensions
• Social Security
• Capital gains and losses

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 The Tax Formula for Individuals
(3 of 5)

Deductions for Adjusted Gross Income

• Deductions for adjusted gross income include:
• Certain trade or business expenses
• Certain reimbursed employee business expenses paid under an accountable plan
• Pre-2019 alimony payments
• Student loan interest
• The penalty on early withdrawal from savings
• Contributions to qualified retirement plans
• Certain educator expenses
Adjusted Gross Income (A G I)
• Sometimes referred to as the “magic line,” since it is the basis for several deduction
limitations

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 The Tax Formula for Individuals
(4 of 5)

Standard Deduction or Itemized Deductions

• The following table gives the standard deduction amounts for 2021:

Filing Status Standard Deduction

Single $12,550
Married, filing jointly 25,100
Married, filing separately 12,550
Head of household 18,800
Qualifying widow(er) 25,100

Additional amounts for blindness or over age 65:

• $1,700 for unmarried taxpayers
• $1,350 for married taxpayers and surviving spouses
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 The Tax Formula for Individuals
(5 of 5)

Exemptions
• Prior to the T C J A, taxpayers received a deduction called an exemption
for themselves, spouse (if married filing jointly), and dependents.
• Exemptions were suspended starting in 2018 to the end of 2025.

The Gross Tax Liability

• Obtained by reference to the tax table or by use of a tax rate schedule

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 Who Must File
(1 of 4)

And at the end of 2021 you Then file a return if your gross
If filing status is ... were*... income** was at least...
Single under 65 $12,550
65 or older $14,250
Married filing jointly*** under 65 (both spouses) $25,100
65 or older (one spouse) $26,450
65 or older (both spouses) $27,800
Married filing separately any age $5
Head of household under 65 $18,800
65 or older $20,500
Qualifying widow(er) under 65 $25,100
65 or older $26,450

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 Who Must File
(2 of 4)

If a parent or someone else can claim you as a dependent, you still may have to file a return.
For example, a single dependent who is not age 65 or older or blind must file a return if any
of the following apply:
• Your unearned income was over $2,800 ($4,500 if 65 or older and blind).
• Your earned income was over $14,250 ($15,9500 if 65 or older and blind).
• Your gross income was more than the larger of—
• $2,800 ($4,500 if 65 or older and blind), or
• Your earned income (up to $12,200) plus $2,050 ($3,750 if 65 or older and blind).
There are several other conditions that exist when determining whether a dependent must
file, based on age, earned/unearned income level, married or single, and if the dependent is
blind.

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 Who Must File
(3 of 4)

Other situations when you must file include:

• You owe any special taxes, such as Social Security and Medicare tax on tips.
• You have to pay alternative minimum tax, tax on an individual retirement account,
or recapture of taxes or the first-time homebuyer credit.
• You (or your spouse if filing jointly) received health savings account, Archer MSA,
or Medicare Advantage MSA distributions.
• You had net earnings of $400 or more from self-employment.
• 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.
• Advance payments of the premium tax credit or health coverage tax credit were
made for you.
• You are required to include amounts in income under Section 965.

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 Who Must File
(4 of 4)

• Must file hard copy at I R S Campus Processing Site or e-file

• Generally, due 15th day of 4th month of year following close of tax year
• If 15th falls on weekend, returns are due next business day
• Two exceptions:
• In Maine and Massachusetts, Patriots’ Day may fall on April 15;
thus, returns are not due until April 16.
• In the District of Columbia, Emancipation Day is observed on April
16; if that falls on a Saturday, it is observed on April 15, and filing
day is extended.

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 Discussion 1

Describe a situation in which you would not have to file taxes if you are a
single person.
When two people are the same age and have the same earned income and
marital status, is it possible that one is required to file and one is not?

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 Discussion 1 Debrief

Describe a situation in which you would not have to file taxes if you are a
single person.
When two people are the same age and have the same earned income and
marital status, is it possible that one is required to file and one is not?
• A single person would not have to file taxes if his or her gross income was
beneath $12,550, assuming the requirements for dependents also apply.
• Two people of the same age, earned income, and marital status could have a
different filing status based on a number of factors. The primary factor is
what their gross income is. For example, one individual may have more
unearned income, which raises the gross income over the minimum limit. Another
factor could be if either person is a dependent. Another factor
is if the person is blind.
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 Filing Status and Tax Computation
(1 of 4)

Single Filing Status

• Unmarried or legally separated as of December 31
• Not qualified as married filing separately, head of household, or qualifying
widow(er)
Married Filing Jointly
• If married on December 31, even if didn’t live together entire year
• If spouse dies during year, file as married filing jointly in current year
Married Filing Separately
• Each file separate returns
• Must compute taxes the same way; both itemize or both use standard
• If living in community property state, must follow state law
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 Filing Status and Tax Computation
(2 of 4)

Head of Household
• Tax tables have lower rates for single or married filing separately status.
• Unmarried or abandoned as of December 31
• Paid more than 50 percent of cost of keeping up home that was principal
place of residence of dependent child or other qualifying dependent
relative
• There is one exception to principal residence requirement: If
dependent is taxpayer’s parent, he or she does not need not to live
with taxpayer.

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 Filing Status and Tax Computation
(3 of 4)

Qualifying Widow(er) with Dependent Child

• May continue to benefit from the joint return rates for 2 years after the
death of a spouse
• To qualify to use joint return rates, widow(er) must pay over half the cost
of maintaining household where dependent child, stepchild, adopted
child, or foster child lives

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 Filing Status and Tax Computation
(4 of 4)

Tax Computation
• For 2021, there are seven brackets:
• 10 percent
• 12 percent
• 22 percent
• 24 percent
• 32 percent
• 35 percent
• 37 percent
• Rates based on income level

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 Knowledge Check 2

Ricardo is married and has no dependents. In June, his wife, Katrina, leaves
him and essentially disappears. What should his filing status be?
a. Single
b. Married, filing a joint return
c. Married, filing separate returns
d. Head of household
e. Qualifying widower

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 Qualifying Dependents
(1 of 7)

Dependents
• Prior to the T C J A, exemptions could be taken for self, spouse (if married
filing jointly), and any dependents.
• Those exemptions are no longer available; however, dependents are
important for credits and head of household status.
• A dependent can qualify as either:
• A qualifying child
• A qualifying relative

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 Qualifying Dependents
(2 of 7)

Qualifying Child
• Qualifying child dependency allowed when six tests are met:
• Relationship Test
• Child is taxpayer’s child, stepchild, adopted child, or sibling, half- or stepsibling,
or a descendant of any of these.
• Foster child may also qualify.
• Taxpayer must be older than the child unless the child is permanently disabled.
• Domicile Test
• Child has same principal place of abode as taxpayer for more than half the
year.
• Age Test
• Child is under 19 or a full-time student under 24 (enrolled at least 5 months of
year).

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 Qualifying Dependents
(3 of 7)

• Joint Return Test

• Child does not file a joint return with spouse (unless return is filed merely to
claim refund).
• Citizenship Test
• Child is a U.S. citizen; a resident of the United States, Canada or Mexico;
or an alien child adopted by and living with a U.S. citizen.
• Self-Support Test
• Child who provides more than half his or her own support cannot be
claimed as a dependent of someone else.
• Funds received by students as scholarships are excluded from support test.

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 Qualifying Dependents
(4 of 7)

• What if the child meets the dependency requirement for more than one taxpayer?
• If one of the parties is a parent, he or she can claim child.
• If both parties are a parent, then the parent with whom the child resides longest
can claim child.
• If not ascertainable, parent with highest A G I may claim child.
• If no parents are involved, person with highest A G I may claim child.
• If parents are legally separated or divorced, person with whom child resides
more than 6 months may claim child.
• However, dependency can shift if the custodial parent signs Form 83 32,
and the form is attached to the noncustodial parent’s tax return.

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 Discussion 2

Owen is 12 years old. He lives in the same house with his mother, Leah, and
his aunt, Christina.
Under what circumstances would Christina be able to claim Owen as a
dependent? Why might Leah and Christina want Christina to claim Owen?

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 Discussion 2 Debrief

Owen is 12 years old. He lives in the same house with his mother, Leah, and
his aunt, Christina.
Under what circumstances would Christina be able to claim Owen as a
dependent? Why might Leah and Christina want Christina to claim Owen?
• Since Leah is Owen’s mother, she has the right to claim Owen as a dependent. The tie-
breaking rules are not necessary if the taxpayer who can claim the dependent does not
claim the dependent. Hence, Christina can claim Owen as a dependent if Leah does not
claim him. Depending on the income of each woman, it may be financially
advantageous for Christina, rather than Leah, to claim Owen as a dependent in
order to lower their total tax burden.

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 Qualifying Dependents
(5 of 7)

Qualifying Relative
• Dependency exemption may be granted for a qualifying relative (who is not a
qualifying child) based on the following five tests:
• Relationship or Member of Household Test
• Individual must either be a relative of taxpayer or member of household for
entire year.
• Broad list of qualifying relatives
• Gross Income Test
• Individual may not have gross income equal to or in excess of $4,300.
• Support Test
• Dependent must receive over half of his or her support from taxpayer.

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 Qualifying Dependents
(6 of 7)

• Joint Return Test

• Dependent may not file a joint return unless it is merely to claim refund.
• Citizenship Test
• Child is a U.S. citizen; a resident of the U.S., Canada or Mexico; or an alien
child adopted by and living with a U.S. citizen.
• A taxpayer’s child who does not meet qualifying child tests may meet qualifying
relative tests.

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 Qualifying Dependents
(7 of 7)

Credits for Dependents

• Deductions for personal exemptions are not permitted from 2018 through
2025.
• Significant tax credits are available.
• A tax credit differs from a tax deduction.
• A tax deduction serves to lower the taxable income of the taxpayer.
• A tax credit is a dollar-for-dollar reduction of tax liability.
• Thus, a credit is generally more advantageous than a deduction.
• Tax credits are covered in detail in Chapter 7.
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 Economic Impact Payment and Recovery Rebate
Credit
(1 of 2)

One-time actions in response to economic impact of COVID-19 pandemic

• Economic impact payment (E I P) is a direct payment to certain taxpayers
authorized by the CARES Act
• Two payments in 2020, and third EIP in March 2021
• Amount of third EIP is $1,400; $2,800 for married filing jointly; additional
$1,400 for each qualifying child
• Phases out based on a ratio that taxpayer’s A G I exceeds specified amount

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 Economic Impact Payment and Recovery Rebate
Credit
(2 of 2)

• Recovery rebate credit (R R C) applies when E I P is not representative of

taxpayer’s tax position
• Same amount as the E I P
• Same phase out limits as the E I P
• E I P is considered an advance refund of the R R C
• If E I P exceeded the R R C, taxpayer is not required to pay back excess
• If E I P is less than R R C, taxpayer can claim additional refundable credit

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 The Standard Deduction
(1 of 7)

The 2021 standard deduction amounts are presented below:

Filing Status Standard Deduction

Single $12,550
Married, filing jointly 25,100
Married, filing 12,550
separately
Head of household 18,800
Qualifying widow(er) 25,100

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 The Standard Deduction
(2 of 7)

Additional Amounts for Old Age and Blindness

• Additional amounts for blindness or over age 65:
• $1,700 for unmarried taxpayers
• $1,350 for married taxpayers and qualifying widows or widowers
Individuals Not Eligible for the Standard Deduction
• Taxpayer cannot use standard deduction and must itemize if:
• Married filing separately and spouse itemizes
• A nonresident alien
• Filing a short-period tax return

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 The Standard Deduction
(3 of 7)

Special Limitations for Dependents

• The standard deduction is limited for the tax return of a dependent.
• The total standard deduction may not exceed the greater of $1,100 or the
sum of $350 plus the dependent’s earned income up to the basic standard
deduction amount of $12,550.

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 The Standard Deduction
(4 of 7)

Special Limitations for Dependents

• EXAMPLE: As a child model, 8-year-old Penzer earned $17,000 in 2021.
He is claimed as a dependent by his parents. How much is his taxable
income?

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 The Standard Deduction
(5 of 7)

Special Limitations for Dependents

• EXAMPLE: As a child model, 8-year-old Penzer earned $17,000 in 2021. He is
claimed as a dependent by his parents. How much is his taxable income?
• Solution:

Earned income  Standard deduction  Taxable income

$17,000  $12,550  $4,450

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 The Standard Deduction
(6 of 7)

Special Limitations for Dependents

• EXAMPLE: Geoffrey, a 4-year-old, is claimed as a dependent by his
parents. He earned $6,500 in interest income from a large bank account
left to him by his grandmother. How much is his taxable income?

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 The Standard Deduction
(7 of 7)

Special Limitations for Dependents

• EXAMPLE: Geoffrey, a 4-year-old, is claimed as a dependent by his parents. He
earned $6,500 in interest income from a large bank account left to him by his
grandmother. How much is his taxable income?
• Solution:

Interest income  Standard deduction  Taxable income

$6,500  $1,100  $5,400

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 A Brief Overview of Capital Gains and Losses
(1 of 6)

• When a taxpayer sells an asset for a gain or loss, the type of asset determines
tax consequences.
• The formula for calculating the gain or loss can be stated as follows:

Gain (or loss) realized  Amount realized*  Adjusted basis**

*Sales price  Sales expenses

**Cost  Accumulated depreciation
• Most gains and losses realized are also recognized (i.e., included in
taxpayer’s income).
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 A Brief Overview of Capital Gains and Losses
(2 of 6)

Capital Gains and Losses

• A capital asset is any property (either personal or investment) held by a
taxpayer, with certain exceptions as listed in the tax law.
• Examples: Stocks, bonds, land, cars, boats, and other items held as
investments or for personal use

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 A Brief Overview of Capital Gains and Losses
(3 of 6)

• Capital gains and losses receive special tax treatment.

• The holding period of the asset determines the treatment.
• Short-term (held 12 months or less) capital gains are taxed at
ordinary income rates.
• Long-term (held more than 12 months) capital gains are taxed
depending upon the taxpayer’s bracket.

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 A Brief Overview of Capital Gains and Losses
(4 of 6)

This table summarizes the tax rates on long-term capital gains.

Income level 2021 Long-Term Capital Gain Rate
Married filing jointly
$0–$80,000 0%
$80,001–$501,600 15%
>$501,600 20%

Single
$0–$40,400 0%
$40,401–$445,850 15%
>$445,850 20%

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 A Brief Overview of Capital Gains and Losses
(5 of 6)

This table summarizes the tax rates on long-term capital gains.

Income level 2021 Long-Term Capital Gain Rate
Head of household
$0–$54,100 0%
$54,101–$473,750 15%
>$473,750 20%

Married filing separate

$0–$40,400 0%
$40,401–$250,800 15%
>$250,800 20%

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
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 A Brief Overview of Capital Gains and Losses
(6 of 6)

• Long-term capital losses are only allowed $3,000 per year against ordinary
income.
• May carry forward any unused balance
• Capital gains and losses are covered in detail in Chapter 4.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Tax and the Internet
(1 of 2)

The I R S Website
• The I R S website is one of the most useful websites containing tax
information.
• Allows the user to conduct common tasks, such as check refund status
or make a tax payment
• The Forms and Publications search function allows the user to download
tax forms, instructions, and publications available from the I R S.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Tax and the Internet
(2 of 2)

• The I R S has also launched:

• A YouTube video channel that features numerous educational videos
covering a number of tax-related topics, including how to obtain a
refund or how to file a tax return extension
• A Twitter account, including various news feeds
• Linkedin, Instagram, and Face book pages
• A mobile phone application (I R S 2 GO)
Intuit’s Pro Connect Tax Online
• Intuit offers tax prep products such as Pro Connect Tax, Lacerte, and
Turbo Tax.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Poll 2

Which resource would you go to first for online help or information from the
I R S?
a. I R S website
b. You Tube channel
c. Twitter
d. Instagram
e. Facebook

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Electronic Filing (E-Filing)

• Two methods of e-filing:

• Using a personal computer device and tax preparation software
• Using the services of a paid provider, such as a certified public
accountant or a tax attorney, who employs the I R S tax professional e-
filing program
• More than 94 percent of all individual taxpayers now e-file.
• Mandatory e-filing required for most professional tax return preparers

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Case Study 1

Hakeem, age 23, is a full-time student and is not disabled. He lives with
Jamal and Halema Carson. Hakeem is Jamal’s older brother. Hakeem is
single, a U.S. citizen, and does not provide more than one-half of his own
support. Jamal and Halema are both 21 and file a joint return.
Can Jamal and Halema claim Hakeem as a qualifying child?
Go to the I R S website (www.irs.gov) and review Publication 501. Write a
letter to William and Sheila that explains to the why they are, or are not,
allowed to claim Jerry as a qualifying child.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Case Study 2

Harry and Emily Wells, friends of yours, were married on December 30, 2021.
They know you are studying taxes and have sent you an e-mail with a
question concerning their filing status.
Harry and Emily would each like to file single for tax year 2021. Harry has
prepared their taxes both as single and as married filing jointly, and he has
realized that they will get a larger combined refund if they each file single.
Harry argues “It’s not as if we were married for very long in 2021.”
Prepare an e-mail to respond to Harry and Emily’s inquiry.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Summary
(1 of 2)

Now that the lesson has ended, you should have learned how to:
1. Explain the history and objectives of U.S. tax law.
2. Describe the different entities subject to tax and reporting
requirements.
3. Apply the tax formula for individuals.
4. Identify individuals who must file tax returns.
5. Determine filing status and understand the calculation of tax
according to filing status.

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
 Summary
(2 of 2)

6. Define qualifying dependents.

7. Determine the tax impact of the economic impact payment and the
recovery rebate credit.
8. Calculate the correct standard or itemized deduction amount for
taxpayers.
9. Compute basic capital gains and losses.
10. Access and use various Internet tax resources.
11. Describe the basics of electronic filing (e-filing).

Whittenburg and Gill, Income Tax Fundamentals. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.