Professional Documents
Culture Documents
International Report
International Report
Volume
Federal Income
Tax Course 2015
H O W TO U S E O U R I N C O M E TA X C O U R S E
QUESTIONS, COMMENTS, AND NOTES:
Our course is intentionally designed with a wide left margin to allow space for your
questions, comments, and notes.
ICON AND COLOR KEY:
The following icon and color coding is used in our Side Bars and Tips:
ICON
TYPE
DESCRIPTION
TAX QUOTE
SIDE BAR
TAX TIP
TAX PLANNING
TIP
TAX PRACTICE
TIP
ii
$13,190
Up to $13,190
$82,100
$41,050
$52,800
26%
28%
0%
15%
20%
25%
28%
9%
Maximum EITC
$496
$3,305
$5,460
$6,143
$496
$3,305
$5,460
$6,143
$2,500
$2,000
$2,000
$2,500
$4,000
$2,000
$17,500
$17,500
$5,500
$12,000
$2,500
$250 per month
$250 per month
$20 per month
$3,950
$600
$300
$100
$254,200
$305,050
$152,525
$279,650
THEN you
should file a
AND at the end of 2014
return if your
you were
gross income
was at least
Under 65
$10,150
65 or older
$11,700
Under 65 (both spouses)
$20,300
65 or older (one spouse)
$21,500
65 or older (both
$22,700
spouses)
Any age
$3,950
Under 65
$13,050
65 or older
$14,600
Under 65
$16,350
65 or older
$17,550
Single
$99,200
Gift Tax
Exclusion
Spouse
Non-U.S. Citizen Spouse
Health Savings Accounts (HSAs)
Maximum Annual Contribution Limits
Self-Only Coverage
Family Coverage
Additional Over Age 55
Minimum Deductible
Self-Only Coverage
Family Coverage
Maximum Out of Pocket
Self-Only Coverage
Family Coverage
IRA Contributions
Traditional
Age 50 or Older
Roth
Age 50 or Older
Kiddie Tax
Age Limit
Unearned Income Limitation
Long Term Care Premiums (deductible)
Age 40 or Under
Age 41 to 50
Age 51 to 60
Age 61 to 70
Age 71 and Over
Medical Savings Accounts (MSAs)
Premium for High Deductible
Self Coverage
Family Coverage
Maximum Out of Pocket
Self Coverage
Family Coverage
Mileage Rates
$14,000
Unlimited
$145,000
$3,300
$6,550
$1,000
$1,250
$2,500
$6,350
$12,700
$5,500
$6,500
$5,500
$6,500
18
$2,000
$370
$700
$1,400
$3,720
$4,660
$2,200-$3,250
$4,350-$6,550
$4,350
$8,000
v
Business
Medical and Moving
Charitable
$0.56
$0.235
$0.14
$500,000
No limit on earnings
$1 of benefits will be deducted for each $2
earned above $15,480
$1 of benefits will be deducted for each $3
earned above $41,400
$117,000
$7,254
Base Amount
$6,200
$12,400
$6,200
$9,100
$12,400
$1,000 or Earned
Income + $350
Single
Married Filing Jointly
Married Filing Separately
Head of Household
Qualifying Widow(er)
Dependent of Another
vi
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Lesson
1
Lesson 1 - Our Federal Tax System
In this lesson you'll learn about the history of our federal tax system and how
it works today. The following topics are discussed in this lesson:
The Revolutionary War
Period
The Post-Revolutionary War
Period
The Civil War Period
The Post-Civil War Period
The 16th Amendment
The 1920s
The 1930s
The Social Security Act
The World War II Period
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the power to levy a tax on personal income. Other changes were more
gradual, responding to changes in society, the economy, and in the role of
the federal government. For most of our country's history, individuals rarely
had any contact with the federal government as most of the government's
tax revenues were derived from excise taxes, tariffs, and customs duties.
In 1765, the English Parliament needing funds to pay for its war against
France, passed the Stamp Act, the first tax imposed directly on the American
colonies. Colonists lacked representation in the English Parliament. This led
to the rallying cry of the American Revolution "taxation without
representation is tyranny" and established a persistent wariness regarding
taxation.
On December 16, 1773 a group of Americans disguised as Indians board a
ship and throw 342 chests filled with tea into Boston Harbor to protest
Englands tax on tea. The Boston Tea Party is perhaps the most famous
event in U.S. tax history.
Before the Revolutionary War, the federal government had only a limited
need for revenue, while each of the colonies had greater responsibilities and
revenue needs, which were met with different types of taxes. The south
taxed primarily imports and exports, the middle colonies imposed a
property tax and a "head" or poll tax levied on each adult male, and the
northern colonies taxed real estate, had excises taxes, and taxes based on
occupation.
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Article I, Section 9 requires that, "No Capitation, or other direct, tax shall be
laid, unless in Proportion to the Census or enumeration herein before
directed to be taken." Therefore, any taxes imposed had to be uniform
throughout the United States. The Constitution limited Congress' ability to
impose direct taxes, by requiring it to distribute taxes in proportion to each
state's population.
The table below shows how long it took the average American to prepare
his or her tax return last year.
Average
Cost
$200
69%
16
$260
1040A
19%
$80
1040EZ
12%
$40
Type of Taxpayer:
Nonbusiness *
68%
$110
Business *
24
13
$410
32%
* Taxpayers are considered business filers if they file one or more of the following with
Form 1040: Schedule C, C-EZ, E, F, Form 2106 or 2106-EZ. Taxpayers are considered
nonbusiness filers if they did not file any of those schedules or forms with Form 1040 or
if they file Form 1040A or 1040EZ.
Source: Internal Revenue Service
Table: Time it takes to prepare return
Tax Quote
"It would be thought a hard government that should tax its people one
tenth part."
Benjamin Franklin (1706-1790) Founding Father of the United States
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Tax Quote
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and the right to enforce the tax laws through seizure of property and
through prosecution.
By 1866, tax collections had reached their highest point in history. The
federal government collected more than $310 million. In 1867, heeding
public opposition to the income tax, Congress cut the tax rate. The need for
federal revenue declined sharply after the war and the personal income tax
was abolished in 1872.
LESSON
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The table below shows how long Americans work each year to pay their
taxes:
Number of Days Per
Year Spent Working
All Taxes as a
Year
to Pay Taxes
Percentage of Income
1900
22
5.9%
1910
19
5.0%
1920
44
12.0%
1930
43
11.7%
1940
55
17.9%
1950
91
24.6%
1960
102
27.7%
1970
110
29.6%
1980
112
30.7%
1990
113
30.8%
1997
119
32.5%
1998
122
33.2%
1999
122
33.3%
2000
125
34.0%
2001
121
33.0%
2002
111
30.3%
2003
108
29.5%
2004
109
29.7%
2005
116
31.5%
2006
118
32.3%
2007
120
32.7%
2008
113
30.8%
2009
103
28.2%
2010
99
26.9%
2011
102
27.7%
2012
107
29.2%
Source: www.taxfoundation.org
Table: Total Effective Tax Rates
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To view the entire 1913 Form 1040 see Appendix A or click here.
Before the income tax most citizens were able to pursue their financial
affairs without any knowledge by the federal government. Individuals
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earned their money and wealth was accumulated and dispensed with little
or no interaction with the federal government.
Side Bar
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10
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SIDE BAR
The United States entry into World War I greatly increased the need for
revenue. One problem with the income tax law was how to define
"lawful" income. Congress responded by passing the 1916 Revenue Act.
It deleted the word "lawful" from the definition of income.
Consequently, all income, regardless of how it was obtained, became
subject to tax. The Supreme Court would subsequently rule the Fifth
Amendment could not be used by bootleggers and others who earned
income through illegal activities to avoid paying income taxes. As a
result, many who broke various laws and were able to escape
prosecution for those crimes were convicted on tax evasion charges.
12
LESSON
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The 1916 Act raised the lowest tax rate from 1% to 2% and raised the top
rate to 15% on taxpayers with incomes in excess of $1.5 million. The 1916
Act also imposed taxes on estates and excess business profits.
The income tax fundamentally changed the relationship between the
citizens and the federal government by giving the federal government the
right and the need to know all about an individuals or business's financial
life. Consequently, in 1916 Congress required that information from income
tax returns be kept confidential.
Needing still more tax revenue, the War Revenue Act of 1917 lowered
exemptions and greatly increased income tax rates. Tax revenues increased
from $809 million in 1917 to $3.6 billion in 1918.
The Revenue Act of 1918, passed to raise even greater sums for the World
War I effort, increased income tax rates once again, this time raising the
lowest rate to 6%. The top rate of income tax rose to 77%. The Revenue Act
of 1918 codified all existing tax laws and pushed the filing deadline forward
to March 15th where it remained until 1954 when it was moved ahead to
April 15th. In 1918, 5% of the U.S. population paid income taxes, as
compared to just 1% five years earlier. By 1939 that number would rise to
6%, and six years later by the end of World War II it would stand at 75%.
Today the federal income tax affects 90% of all Americans.
The 1920s
The Prohibition Unit was established to enforce the National Prohibition Act
of 1919, commonly known as the Volstead Act, which, under the 18th
Amendment to the Constitution prohibited the manufacture, sale, and
transportation of alcoholic beverages. When it was first established in 1920,
the Prohibition Unit was a division of the Bureau of Internal Revenue. On
April 1, 1927 it became an independent entity within the Department of the
Treasury, changing its name from the Prohibition Unit to the Bureau of
Prohibition.
The tax rates dropped sharply after World War I. During the 1920s, with a
booming economy, Congress cut taxes five times returning the lowest tax
rate to 1% and lowering the highest rate to 25%. As tax rates and tax
collections declined, the economy got even stronger.
13
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14
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This strategy worked for a few days but the panic broke out again the
following Tuesday, October 29, 1929, and there was no stopping it. The
stock market crashed. Within three months the stock market lost 40% of its
value. $26 billion of wealth disappeared. AT&T lost one-third of its value.
General Electric lost one-half of its value. RCA's stock fell by three-quarters
within a matter of months. It would take 25 years for the stock market to
return to its pre-crash level.
The Great Depression began and over the next few years:
Side Bar
LESSON
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SYSTEM
low-income people tend to put more money into the economy because
these taxpayers are more likely to spend their extra cash right away, on
purchases or renovations they have been putting off. Cuts for highincome taxpayers tend not to have the same effect, because this group
already has enough money to buy everything they need. High-income
taxpayers tend to save their extra money, so cuts for these taxpayers end
up being used for investments and savings. Cuts for high-income
taxpayers improve the outlook on Wall Street. Cuts in corporate and
business taxes give businesses more money to spend, often creating jobs
and boosting the bottom line.
In 1932, the federal government collected only $1.9 billion in taxes,
compared to $6.6 billion in taxes in 1920. In the face of rising budget
deficits which reached $2.7 billion in 1931, Congress followed the prevailing
economic wisdom of the time and passed the Tax Act of 1932 which
dramatically increased tax rates. This further improved the government's
finances while further weakening the economy. In retrospect, Congress
should have lowered tax rates instead of raising them. By 1936 the lowest
personal income tax rate had risen to 4% and the highest tax rate had risen
to 79%.
Side Bar
16
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SYSTEM
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Side Bar
The 1930s
During a routine warehouse raid in Chicago
in 1931 by the Treasury Departments
Bureau of Prohibition, agents Eliot Ness and
The Untouchables discovered what was
clearly a crudely coded set of accounts in a
desk drawer. They, and Frank Wilson, an
undercover agent in the Bureau of Internal
Revenues
Intelligence
Unit,
then
concentrated on gathering evidence and
pursuing Public Enemy No. 1, Al Capone, for
Figure 1-3: Alphonse Gabriel
his failure to pay income tax on this
Capone a.k.a. "Scarface Al"
substantial illegal income.
Capone had always done his business through front men and it was
previously believed he had no books or accounting records in his own
name. Even his mansion was in his wife's name.
Capone was tried in federal court in 1931. Capone was found guilty on five
of 22 counts of tax evasion for the years 1925, 1926, and 1927, and willful
failure to file tax returns for 1928 and 1929. Capone's legal team offered to
pay all outstanding income taxes plus interest and told their client to expect
a severe fine. On October 17, 1931 the judge sentenced Capone to eleven
years in a federal prison and one year in the county jail, as well as an earlier
six-month contempt of court sentence. He ultimately served only six and a
half years because of time off for good behavior. He also had to pay fines
and court costs totaling $80,000. Capones isolation from his associates and
the repeal of Prohibition ended his criminal career.
18
LESSON
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TAX
SYSTEM
On October 10, 1973, Spiro T. Agnew, the 39th Vice President of the
United States, resigned and then pleaded nolo contendere (no
contest) to criminal charges of tax evasion and money laundering;
Soviet spy Aldrich Ames earned more than $2 million for his
espionage and was also charged with tax evasion as none of the
money was reported on his income tax returns. Ames attempted to
have the tax evasion charge dismissed on the grounds his espionage
profits were illegal, but the charges stood. The $2 million remains to
this day in an undisclosed bank account. Russian intelligence has
refused to disclose this bank account information in order for the
United States to seize it, arguing that that money was rightfully
earned by Ames;
Leona Helmsley the billionaire New York City hotel operator and real
estate investor nicknamed "The Queen of Mean." She was convicted
of federal income tax evasion in 1989 and served 19 months in
prison, after receiving an initial sentence of 16 years;
Side Bar
LESSON
OUR
FEDERAL
TAX
SYSTEM
income tax guide. Its first publication in 1939 sold 23,000 copies and hit
the best sellers list. Mr. Lasser became an adjunct professor at New York
University in 1942 and served as the Institute on Taxations chairman until
his death. Mr. Lasser revised the tax guide each year and by 1946 seven
million copies were sold. His books on taxation were used as texts in
more than 160 colleges and universities. He died from a heart attack at
the age of 57 in 1954. His best selling tax guide, J.K. Lassers Your Income
Tax is in its 76th year of continuous publication and today is published by
John Wiley & Sons, Inc.
We strongly recommend that you purchase a copy of J.K. Lassers Your
Income Tax each year. You can do so from Lesson 30 on the Homework
Page. The Tax College is not affiliated with the J.K. Lasser Institute.
Tax Quote
"Anyone may arrange his affairs so that his taxes shall be as low as
possible; he is not bound to choose that pattern which best pays the
treasury. There is not even a patriotic duty to increase one's taxes. Over and
over again the Courts have said that there is nothing sinister in so
arranging affairs as to keep taxes as low as possible. Everyone does it, rich
and poor alike and all do right, for nobody owes any public duty to pay
more than the law demands."
Judge Learned Hand - (1872-1961), Judge, U. S. Court of Appeals for the
2nd Circuit Gregory v. Helvering 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293
U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935)
The Social Security Act
In 1935 Congress passed the Social Security Act.
President Franklin D. Roosevelt signed the program
into law on Aug. 14, 1935. This law provides
payments to the aged, the needy, the handicapped,
and to certain minors. These programs were initially
financed by a 2% tax, one-half of which was
withheld directly from an employee's paycheck and
one-half of which was collected from employers.
The tax was levied on the first $3,000 of the
20
LESSON
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TAX
SYSTEM
During his one day of participation in the program, a nickel was withheld
from Mr. Ackermans pay for Social Security, and, upon retiring, he received
a lump-sum payment of 17 cents. The average lump-sum payment during
this period was $58.06. The smallest payment ever made was for 5 cents.
Ida May Fuller of Ludlow, Vermont filed her retirement claim on November
4, 1939. While running an errand she dropped by the Rutland, VT Social
Security office to ask about possible benefits. She would later say: "It wasn't
that I expected anything, mind you, but I knew I'd been paying for
something called Social Security and I wanted to ask the people in Rutland
about it."
Her claim was taken by Claims Clerk Elizabeth Corcoran Burke and
transmitted to the Claims Division in Washington, D.C. for adjudication. The
case was reviewed and sent to the Treasury Department for payment. In
those days claims were grouped in batches of 1,000 and a Certification List
for each batch was sent to the Treasury Department. Miss Fuller's claim was
the first one on the first Certification List.
21
LESSON
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The accumulated taxes on her salary during those three years were a total of
$24.75. Her initial monthly check was $22.54. She didnt do too badly under
Social Security - during her remaining thirty-five years she collected a total
of $22,888.92 in Social Security benefits nearly 1,000 times more than she
contributed. Miss Fuller lived to be 100 years old, dying in 1975.
Soon after it was passed in 1935, Social Security morphed from a fully
funded pension system into a pay-as-you-go system where every
generation (except for Ernests and Ida Mays) pays into the system to
support the currently-retired generation and relies on the next generation
to pay its Social Security benefits.
When Ida May Fuller retired, 40 workers were paying taxes to support each
Social Security recipient. In 1960, there were 4.9 workers paying Social
Security taxes for each person receiving benefits. Today, there are 2.8
workers for each beneficiary, a ratio that will drop to 1.9 workers by 2035,
according to projections by the Congressional Budget Office.
In 1940, when the Social Security Administration mailed Ida May Fuller the
first monthly retirement payment, the retirement age was 65. At that time,
workers who survived to age 65 had a remaining life expectancy of 12.7
years for men and 14.7 years for women. By 2011, life expectancy at age 65
was 18.7 years for men and 20.7 years for women, an increase of six full
years for both. In 20 more years, life expectancy at age 65 for men is
expected to be more than 20 years and more than 22 years for women.
In 1940, 220,000 people received Social Security benefits, out of a total
population of 132 million. At that time, .1666 percent of the total population
22
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Side Bar
23
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Figure 1-6: Form W-2 - Statement of Income Tax Withheld on Wages, circa 1943. Payroll
withholdings are reported to the employee and the IRS on Form W-2.
Tax withholding was also introduced in the Tariff Act of 1913, but repealed
by the Income Tax Act of 1916. The Current Tax Payment Act required
employers to withhold taxes from employees' wages and pay them directly
to the government on the workers' behalf quarterly.
In 1944 Congress passed the Individual Income Tax Act, which created the
standard deductions on Form 1040, raised individual income tax rates, and
repealed the Victory Tax. It standardized the value of personal exemptions
at $500 per person. There were about 60 million taxpayers.
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The 1960s
The Revenue Act of 1964 was signed by President Lyndon Johnson on
February 26th, 1964. It reduced individual income tax rates from 91% to
70%, and reduced the top corporate rate from 52% to 48%. A minimum
standard deduction of $300 plus $100 per exemption was created.
Side Bar
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SYSTEM
The rich, who at that time were earning more than $50,000 per year, went
from paying 44% of total income tax revenues to paying 78.4%.
On December 14, 1962 the 35th President of the United States, John F.
Kennedy delivered a speech to the Economic Club of New York in which
he stated: It is increasingly clear that... an economy hampered by
restrictive tax rates will never produce enough revenues to balance our
budget just as it will never produce enough jobs or enough profits... In
short, it is a paradoxical truth that tax rates are too high today and tax
revenues are too low and the soundest way to raise the revenues in the
long run is to cut the rates now. After Presidents Kennedy and Lyndon
Johnson slashed the capital gains tax and cut the top marginal tax rate
from 91% to 70% federal tax revenues rose from $91 billion in 1960 to
$153 billion in 1968. During those years the rich saw their total share of
revenues increase by 57% while the poor's share increased by just 11%.
During President Ronald Reagan's term in office (1981-1989) he cut taxes
but doubled revenue, and decreased unemployment from 7% to 5.4%
and inflation from 13.5% to 4.1%. In the Reagan years, the top 1% of
earners paid 57.2% of taxes, up from 48%.
26
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The table below shows how much money the federal government
collects each year in taxes:
Year
1960
1970
1980
1990
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Total Tax
Collections
$91,774,803,000
$195,722,096,000
$519,375,273,000
$1,056,365,652,000
$2,096,916,925,000
$2,128,831,182,000
$2,016,627,269,000
$1,952,928,045,000
$2,018,502,103,000
$2,268,895,122,000
$2,518,680,230,000
$2,691,537,557,000
$2,745,035,410,000
$2,345,337,177,000
$2,345,055,978,000
$2,414,952,112,000
$2,524,320,134,000
$2,855,059,420,000
$3,064,301,358,000
%
Increase
113%
165%
103%
99%
2%
-5%
-3%
3%
12%
11%
7%
2%
-15%
0%
3%
5%
13%
7%
Total Individual
Individual
Income Tax
%
Tax % of
Collections
Increase
Total
$44,945,711,000
48.97%
$103,651,585,000
131%
52.96%
$287,547,782,000
177%
55.36%
$540,228,408,000
88%
51.14%
$1,137,077,702,000
110%
54.23%
$1,178,209,880,000
4%
55.35%
$1,037,733,908,000
-12%
51.46%
$987,208,878,000
-5%
50.55%
$990,248,760,000
0%
49.06%
$1,107,500,994,000
12%
48.81%
$1,236,259,371,000
12%
49.08%
$1,366,241,437,000
11%
50.76%
$1,425,990,183,000
4%
51.95%
$1,190,382,757,000
-17%
50.76%
$1,175,989,528,000
-1%
50.15%
$1,346,182,227,000
14%
55.74%
$2,172,233,368,000
61%
86.05%
$2,462,201,645,000
13%
86.24%
$2,575,871,018,000
5%
84.06%
Medicare
In 1965 Congress enacted the Medicare program which provides for the
medical needs of persons aged 65 or older. Social Security Amendments
created the Medicaid program which provides medical assistance for
people with low incomes and resources. The expansions of Social
Security and the creation of Medicare and Medicaid required additional
tax revenues. In 1972 benefits were indexed for the cost of living. In
1949 the FICA payroll tax rate was 2%. The expansions in 1965 led to
further rate increases, with the combined payroll tax rate climbing to
15.3 % by 1990. The maximum Social Security tax burden rose from $60
in 1949 to $7,849 by 1990.
27
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Tax Quote
"Government is saying to the average citizen every January 1: 'For the next
five months youll be working for us, for goals we shall determine. Is that
clear? After May 5 you may look after your own needs and ambitions, but
report back to us next January. Now move along.'
If nearly half of what you make is spent by someone else, that means that
half your work time is spent working for someone else. Call me a radical,
but I think that comes dangerously close to being a form of indentured
servitude."
Richard "Dick" Armey (1940 - ) House Majority Leader (1995-2003)
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30
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31
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The table below shows the current federal income tax brackets:
2001
(1)
Rebate
15.0%
27.5%
30.5%
35.5%
39.1%
2002
10.0%
15.0%
27.0%
30.0%
35.0%
38.6%
2003-12
10.0%
15.0%
25.0%
28.0%
33.0%
35.0%
2013+
10.0%
15.0%
25.0%
28.0%
33.0%
35.0% 39.6%
(2)
(1)
In 2001 a new 10% tax bracket was introduced and tax rates were lowered. The
planned tax rates through 2010 were passed as part of the Tax and Economic
Recovery Acts in 2001 and 2003. They were extended in late 2010 through 2012.
They were extended again in January 2013, with a 39.6% rate for high income
earners.
(2)
Taxpayers in this bracket may also be subject to Affordable Care Act surtax of
0.9%.
Table: Individual Income Tax Brackets
LESSON
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FEDERAL
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LESSON
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SYSTEM
Market Sector Fees: The Act imposes annual nondeductible fees on various
health-related industries, such as medical device manufacturers and
importers, health insurance providers and others.
Medical Expense Deduction: The Act raises the threshold for the itemized
medical expense deduction from 7.5% of AGI to 10% of AGI for regular
income tax purposes effective for 2013. However, individuals age 65 and
older (and their spouses) are temporarily exempt from the increase until
2017.
Medicare Part D: The Act eliminates the deduction for the subsidy for
employers that maintain prescription drug coverage for retirees who are
eligible for Medicare Part D.
Tax-Exempt Hospitals: The Act requires Code Sec. 501(c)(3) hospitals to
conduct periodic community health needs assessments and adopt written
financial assistance policies. Individuals who qualify for financial assistance
are billed at the same rates as insured individuals.
Health Insurance Executive Pay: The Act modifies Code Sec. 162(m) as it
applies to compensation paid by health insurance providers to high-level
executives. If at least 25 percent of the insurers premium income does not
meet minimum essential coverage requirements under the Act, no Code
Sec. 162(m) deduction is allowed if compensation exceeds $500,000.
Indoor Tanning Tax: The Act imposed a tax of 10% on qualified indoor
tanning services effective July 1, 2010.
For complete details on The Patient Protection and Affordable Care Act see
the Affordable Care Act (ACA) Tax Preparer Course available for download
at the Lesson 1 Homework section.
LESSON
OUR
FEDERAL
TAX
SYSTEM
Combined, the two new laws include more than $400 billion in revenue
raisers and new taxes on employers and individuals.
a 20% capital gains and dividend tax rate for the aforementioned
taxpayers
For complete details on The American Taxpayer Relief Act of 2012 see the
CCH Tax Briefings available for download at the Lesson 1 Homework
section.
LESSON
OUR
FEDERAL
TAX
SYSTEM
36
LESSON
OUR
FEDERAL
TAX
SYSTEM
Tax Tip
SIDE BAR
37
LESSON
OUR
FEDERAL
TAX
SYSTEM
The table below shows how much money the Federal Government
collects from each type of tax:
Gross Collections in Fiscal
Type of Tax
2014
Percentage of 2014
(1)
Total
$353,141,112
11.52%
$2,575,871,018
84.06%
$8,611,877
0.28%
$5,953,524
0.19%
$29,410,796
0.96%
Estate Tax
$17,572,338
0.57%
Gift Tax
$2,582,617
0.08%
Excise Tax
$71,158,076
2.32%
Grand Total
$3,064,301,358
100.00%
(1)
SIDE BAR
LESSON
OUR
FEDERAL
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39
LESSON
OUR
FEDERAL
TAX
SYSTEM
Use Tax
Similar to sales tax, these taxes are levied for services such as telephone,
electric and other utilities, and for leases and rentals. They are also levied on
"users" of goods purchased "sales tax free" in another state.
Advantage: Use taxes are collected by the vendor, making it easier for
governments to track.
Disadvantage: Use taxes are regressive, meaning that they impact most
heavily on those with the least ability to pay.
Excise Tax
Excise tax, sometimes called "luxury tax," is used by both the state and
federal governments. Some examples of items subject to excise tax are
heavy tires, fishing equipment, airplane tickets, gasoline, beer and liquor,
firearms, and cigarettes.
Advantage: These taxes can sometimes be used to discourage the use of
items such as cigarettes and alcohol, or to reduce demand for items that
may be scarce.
Disadvantage: Excise taxes are regressive, meaning that they impact most
heavily on those with the least ability to pay.
Real Estate Tax
Federal and state governments do not tax real estate. Real estate tax is most
local government's main source of revenue. Most localities tax private
homes, land, and business property based on the property's value (ad
valorem). When real estate is mortgaged, real estate taxes are ordinarily
collected and escrowed monthly by the mortgage lender along with the
mortgages principal and interest payment. The escrowed real estate tax is
then remitted to the taxing authority once a year.
Advantage: This is a progressive tax, which means people with lower
property values pay less in real estate taxes than the wealthy who usually
own property of higher value.
Disadvantage: If re-assessments are not made by the Property Tax Assessor
annually, owners of new homes pay more than those who own older homes
that have appreciated in value over the years.
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LESSON
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LESSON
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SYSTEM
Disadvantage: Tariffs are regressive, meaning that they impact most heavily
on those with the least ability to pay.
Value Added Tax (VAT)
Value Added Tax is similar to a sales tax. However it is a tax on the
estimated market value added to a product or material at each stage of its
manufacture, production or distribution. As with a sales tax, a VAT is
ultimately passed on to the consumer. The consumer is often unaware
exactly how much VAT is built into the price they pay for a product.
Conversely, the consumer can see the amount of sales tax charged on their
sales receipt. VAT allows countries to collect tax from foreign consumers
when they purchase exported products. Of 192 countries, only 62 have an
income tax, yet 132 have a VAT.
VAT is becoming increasingly attractive since there are few other revenue
raising options. Politically however, VAT poses some major obstacles.
Conservatives perceive a VAT as a hidden tax which can be raised without
the knowledge of the consumer. Liberals see a VAT as a highly regressive
tax which hits low and middle income taxpayers more severely.
Advantage: VAT is collected by the business, making it easy for
governments to track and collect.
Disadvantage: VAT is regressive, meaning that it impacts most heavily on
those with the least ability to pay.
IMPORTANT REMINDERS
Take the Quiz - Taking each lesson's quiz promptly after lesson
completion will help you solidify you're understanding of the
most important lesson content, and will also help you pass the
Final Exam.
Do the Homework - While completing the homework is not
mandatory, we strongly recommend that you complete each
lesson's homework assignment. It will expand your knowledge
and understanding of the topics covered in this course.
42
Glossary
10-Year Averaging - a special computation method to determine the tax on a qualified lump-sum
distribution for taxpayers born before 1936.
Accelerated Cost Recovery System (ACRS) - the system of depreciation mainly used for property
placed in service after 1980 and before 1987. The Modified Accelerated Cost Recovery System
(MACRS) replaced ACRS for assets placed into service after 1986.
Accelerated Depreciation method(s) of depreciation that yield larger tax deductions in the earlier
years of the life of an asset and smaller deductions at the end.
Accountable Plan - a plan for reimbursing employees for expenses such as meals, travel, and
transportation incurred for business purposes on behalf of the employer. Reimbursements are not
taxable and expenses are not deductible to the employee.
Accounting Method - a method under which income and expenses are determined for tax purposes.
Most individuals and small businesses use the cash method. Businesses that maintain inventory are
required to use the accrual method.
Accounting Period - the period (normally a calendar year) that a taxpayer uses to determine federal
income tax liability.
Accrual Method of Accounting a method by which income is reported in the tax year earned,
whether or not received, and deductions are claimed in the tax year incurred, whether or not paid.
Acknowledgement (ACK) - an official electronic notice from the IRS or a State tax authority that
evidences an electronically filled tax return was accepted and considered filed or rejected and
considered not filed.
Acquisition Debt - debt incurred to acquire, construct, or improve the taxpayer's principal or second
residence.
Active Participant - a taxpayer who is covered by an employer-maintained qualified retirement plan,
or a qualified self-employed retirement plan.
Active Participation - the level of involvement in the management of residential rental real estate
that allows the owner to deduct up to $25,000 annually of losses from the rental of the property.
Actual Expenses the regular method of deducting automobile expenses based on actual costs
incurred.
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Additional Child Tax Credit an additional credit for taxpayers with three or more qualifying
children who cannot take the full Child Tax Credit.
Adjusted Basis - the cost or other original basis of property reduced by depreciation allowed or
allowable and casualty losses, and increased by the cost of capital improvements, expenses of
purchase, and other adjustments. Used to determine the gain or loss upon the sale of the asset.
Adjustment to Income expenses that are subtracted from gross income to arrive at adjusted gross
income.
Adjusted Gross Income (AGI) - gross income reduced by adjustments to income.
Adoption Credit a nonrefundable credit for qualified adoption expenses incurred for each eligible
child.
Adoption Taxpayer Identification Number (ATIN) - the taxpayer identification number used for a
child while the child's adoption is pending.
Alternative Minimum Tax (AMT) a mandatory alternative method of computing tax which negates
or minimizes the effects of tax preference items and tax loopholes.
Alien - a person who is not a citizen of the country in question.
Amended Return - a tax return filed on Form 1040X used to correct errors or to claim more
advantageous ways of filing the prior original return.
Amortization - a deduction for certain capital expenses over a fixed period of time. Similar to
depreciation.
Amount Due - money that taxpayers must pay to the government when the total tax on their return
is greater than their total withholding and estimated tax payments.
Applicable Federal Rate (AFR) - a minimum interest rate that must be charged on transactions that
involve payments over a number of years. If the parties do not adhere to this rate the IRS imputes it.
At-Risk Rules rules limiting the amount of losses a taxpayer can claim on a business or investment
to the amount he actually has at risk to lose.
Audit - an IRS examination and verification of a taxpayer's return or other transactions.
44
Authorized IRS e-file Provider - a business authorized by the IRS to participate in the IRS e-file
Program.
Average Basis - a method of figuring basis that can be used only for sales of regulated investment
company (including mutual fund) shares.
Backup Withholding - a 28% tax withheld by the payer from investment income, such as interest and
dividends, to ensure that tax is collected on the income.
Bank Denial - a Refund Anticipation Loan (RAL) denial by a bank.
Bank Product - a RAL, Instant Loan, or Preferred Electronic Refund Check (PERC).
Basis - the amount of the taxpayers adjusted cost in an asset from which gain or loss is determined
for income tax purposes when the asset is sold.
Blind - for tax purposes, a taxpayer is blind if his vision with corrective lenses is no better than 20/200
in his best eye, or if he has a visual field not greater than 20 degrees.
Boot - cash or other property used in a sale or exchange to make the values of property traded equal.
Cafeteria Plan an employer plan that allows employees to select from a menu of taxable and
nontaxable benefits.
Capital Asset - an asset owned for investment or personal purposes, such as stocks and bonds.
Capital Expenditure - an expenditure made for an asset, with a useful life of more than one year, that
increases its value or extends its useful life.
Capital Gain - a gain from the sale or exchange of a capital asset.
Capital Gain Distributions ordinarily, amounts paid by a mutual fund resulting from the sale of
capital assets by the fund.
Capital Improvement - an improvement made to extend the useful life or add to the value of a
property.
Capital Loss - a loss from the sale or exchange of a capital asset.
Capital Loss Carryover - the amount of a capital loss not allowed as a deduction against ordinary
income in the current year and carried over to the next year.
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Capitalize - to record an expense as an addition to an asset account and depreciate it, rather than
treating it as a deductible expense in the current year.
Carry Back - to use deductions or credits that cannot be taken in the current year to reduce tax
liability for a prior year(s).
Carry Forward to use deductions or credits that cannot be taken in the current year to reduce tax
liability for a later year(s).
Cash Method of Accounting a method of accounting under which income is reported in the tax
year actually or constructively received and expenses are deducted in the tax year paid.
Casualty Loss - the complete or partial destruction of property resulting from an identifiable event of
a sudden, unexpected, or unusual nature.
Certified Historic Structure - a structure listed on the National Register of Historic Places or located
in a designated historic area. The tax code provides tax incentives for the rehabilitation of such
structures.
Certified Public Accountant (CPA) - a person who has met state requirements for education and
work experience, passed a national exam, and met other licensing requirements.
Change in Accounting Method - a change from one accounting method to another, which ordinarily
requires prior approval from the IRS.
Change in Accounting Period - a change from one accounting period to another.
Charitable Contributions tax deductible money or property donated to a qualified tax-exempt
charitable organization.
Charitable Organization - a tax-exempt organization recognized by the IRS as a charity.
Child Tax Credit - A credit of up to $1,000 per eligible child under age 17 at the end of the tax year.
Child and Dependent Care Credit - a tax credit of 20-35 percent of employment-related child and
dependent care expenses incurred to enable the taxpayer to be gainfully employed.
Citizen or Resident Test - a test that allows taxpayers to claim a dependency exemption for persons
who are U.S. citizens for some part of the year or who live in the United States, Canada, or Mexico for
some part of the year; or an alien child whom you have adopted and who lived with you for the entire
year.
46
Combat Zone - a geographical area designated by the president of the United States from which
members of the armed forces can exclude military pay from their income tax return.
Common-Law State - a state in which the laws governing property rights are based on English
common law under which the property and income of each spouse belongs to him or her separately.
Community Income - income of a married couple in a community property state, that belongs
equally to each spouse, regardless of which spouse earned or received the income. The community
property states are Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and
Wisconsin.
Community Property property of a married couple in a community property state, that belongs
equally to each spouse.
Compulsory Payroll Tax - an automatic tax collected from employers and employees to finance
specific programs.
Constructive Receipt a tax rule that states the taxpayer receives taxable income when it is made
available to him, regardless of whether he actually takes possession of it.
Cost - cash and/or the value of property paid to acquire the property received.
Cost of Goods Sold the cost of obtaining and producing goods sold in a business.
Coverdell Education Savings Account (ESA) - a tax-favored educational savings plan.
Credits tax credits are similar to credits from a retail store, which are subtracted from tax liability.
Crop Method - a form of accounting used by farmers under which they deduct the entire cost of
producing a crop, including the expense of seed and young plants, in the year they realize income
from it.
Declaration Control Number (DCN) - a 14-digit number assigned by 1040 ValuePak to each
electronically filed return, which is used by the IRS or state tax authority to track the return.
Declining Balance Method of Depreciation - an accelerated method of depreciation under which
the depreciable basis for the following year is reduced by the depreciation deduction taken in the
current year.
Deduction - expenses that may be subtracted from taxable income.
47
Deferred Compensation a plan that allows an employee to receive part of a year's pay in a later
year and not be taxed in the year the money was earned.
Deficiency - the difference between the amount reported on a tax return and the amount assessed
by the IRS.
Deficit - the result of a government spending more money than it takes in.
Defined Benefit Plan - an employer-provided retirement plan in which contributions are based on
the retirement benefits to be paid.
Defined Contribution Plan an employer-provided retirement plan in which contributions are based
on a specific percentage of income.
Dependent - a qualifying child or relative, other than the taxpayer or spouse, who entitles the
taxpayer to claim a dependency exemption.
Dependent Exemption the amount a taxpayer can claim for a "qualifying child" or "qualifying
relative".
Depletion - a method similar to depreciation that allows the owner of natural resources to deduct a
portion of the cost of the asset during each year of its presumed productive life.
Deposit Account Number (DAN) - the deposit account number for a checking or savings account.
Depreciable Property - property with a useful life of more than one year that is used for your trade
or business.
Depreciation - the deduction for the reasonable allowance for the wear and tear of assets with a life
of more than one year used in a trade or business or held for the production of income.
Direct Deposit an electronic transfer of a tax refund directly into the taxpayer's bank account.
Disability Pension - a taxable pension from an employer-funded disability plan received by a
taxpayer who retired on disability and has not reached normal retirement age.
Disaster Area Loss - an un-reimbursed loss of property sustained in an area designated as a disaster
area by the President of the United States.
Disposition a sale or other disposal of property that causes a gain or a loss, including like-kind
exchanges and involuntary conversions.
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49
Energy Tax Credit--Residential Property - a tax credit allowed for the purchase of certain qualified
energy efficiency improvements (i.e. insulation, exterior windows, and exterior doors) and residential
energy property costs (i.e. qualified furnaces, water heaters, and heat pumps) and the cost of qualified
photovoltaic property, solar water heating property, and fuel cell property.
Entertainment Expenses - expenses which are deductible by employees and self-employed
taxpayers only if the expenses are directly related to or associated with a trade, business, or
profession.
Estate Tax - a tax based on the fair market value of the decedent's property at death, less his or her
liabilities.
Estimated Tax - quarterly tax payments paid to the IRS on April 15, June 15, September 15, and
January 15 if the total year's taxes will exceed $1,000 and the amount is not covered by withholding.
Excess Accelerated Depreciation - the difference between the total depreciation taken and the
depreciation that would have been taken using the straight-line depreciation method.
Excess Social Security Tax Withheld excess amounts withheld by multiple employers of the
taxpayer.
Excise Tax - a tax on the sale or use of specific products, transactions or property.
Exempt from Withholding to be free from withholding of federal income tax a person must meet
certain income, tax liability, and dependency criteria.
Excludable Amount of Pension - the portion of pension distributions that is not taxable.
Exemption - an deduction taxpayers can claim for themselves, their spouses, and eligible dependents
which reduces income subject to tax.
Expensing a term used when a taxpayer claims the Internal Revenue Code (IRC) Section 179
expense deduction and currently deducts certain expenditures that would ordinarily be required to be
depreciated.
Extension - a allowance of additional time to perform an act required by the tax law or by regulation.
Fair Market Value (FMV) - the amount at which property would change hands between a willing
buyer and a willing seller, neither being under compulsion to buy or sell and both having reasonable
knowledge of the relevant facts.
Federal Income Tax a tax levied on personal and corporate income.
50
Federal Income Tax Withheld - the amount withheld from income and submitted by the payer to
the IRS as an advance payment of the taxpayer's federal income tax.
Federal Insurance Contributions Act (FICA) - a federal law that requires taxpayers to pay Social
Security taxes for Old-Age, Survivors and Disability Insurance (OASDI), and Medicare.
Federal Unemployment Tax Act (FUTA) - a cooperative effort between 53 possessions and states,
and the federal government for the administration of unemployment insurance. The IRS is responsible
for receiving and processing the Employers Annual Federal Unemployment Tax Return (Form 940).
Filing Extension - an additional amount of time to file a tax return.
File a Return - to mail or electronically transmit to an IRS service center the taxpayer's information, in
specified format, about income and tax liability.
Filling Center the computer data center which transmits electronically filed tax returns to the
appropriate IRS Service Center, as well as bank applications to the appropriate RAL bank, and sends
acknowledgements and other reports back to the Electronic Return Originator.
Filing Status - the five filing statuses are: single, married filing a joint return, married filing a separate
return, head of household, and qualifying widow(er) with dependent child.
Final Return for Decedent a tax return filed for the year in which the individual died.
First In, First Out (FIFO) a method of valuing inventory that assumes any inventory sold was from
the first inventory purchased.
First-year Expensing - a term used when a taxpayer claims the Internal Revenue Code (IRC) Section
179 expense deduction and currently deducts certain expenditures that would ordinarily be required
to be depreciated.
Fiscal Year - an accounting year ending on the last day of any month except December.
Fixing-up Expenses - expenses incurred to physically prepare a home for sale.
Flexible Spending Account - a method of paying for benefits under a cafeteria plan through salary
reductions.
Financial Management Service (FMS) - a bureau of the Department of the Treasury that provides
central payment services to federal agencies, operates the federal government's collections and
51
deposit systems, provides government wide accounting and reporting services and manages the
collection of delinquent debt owed to the government.
Foreign Child - a child who is not a U.S. citizen or resident.
Foreign Earned Income Exclusion an amount of income that the taxpayer can exclude from
taxable income if he lived and earned income in a foreign country.
Foreign Housing Exclusion and Deduction - an exclusion or deduction available if the taxpayer lived
and earned income outside the United States and either his employer paid for his housing or he was
self-employed.
Foreign Tax Credit or Deduction - a credit or deduction available to a taxpayer who incurs or pays
income tax to a country other than the U.S., on income that is also subject to U.S. income tax.
Form 8633 the Application to Participate in the IRS e-file Program, which must be filed by anyone
who wants to participate in the IRS Electronic Filing program. Upon IRS acceptance the tax preparer is
assigned an EFIN.
Form 8879 - a form that allows taxpayers and preparers to sign a tax return using an electronic
signature by entering a five-digit PIN.
Form W-2 - the form employers send to workers and the IRS at the end of the year to report annual
wages, taxes withheld and other information.
Form W-4 the Employee's Withholding Allowance Certificate which is completed by the employee
and used by the employer to determine the amount of income tax to withhold from each paycheck.
Forms Method - a method of completing a tax return in 1040 ValuePak by completing the electronic
versions of the IRS forms and schedules.
Foster Child - a child placed with a taxpayer by an authorized placement agency or by court order.
Fringe Benefits - benefits received by an employee in addition to salary.
Full-Time Student - a dependent enrolled in a school for the number of hours or courses considered
by the school to be full-time during some part of at least 5 calendar months during the year.
Gain - the excess of the amount realized from a sale or exchange above the adjusted basis of the
property sold or exchanged.
52
Gain or Loss - the difference between the basis in an asset and the price received upon disposal of
the asset.
Gambling Income and Losses - income and losses from gambling, such as lotteries, bingo and racing.
General Depreciation System - the most commonly used method for computing MACRS
depreciation.
General Rule - the method of determining the taxable part of a pension when the taxpayer is not
eligible to use the simplified method.
Generation-Skipping Transfer Tax - a tax on gifts or death transfers of money or property that
would otherwise escape the once-per-generation transfer taxes that apply to gifts and estates.
Gift Tax a federal excise tax paid by donors on the value of gifts exceeding a specified amount.
Goodwill the value of a trade or business based on expected continued customer patronage due to
its name, reputation, and other factors.
Gross Dividends - the sum of ordinary dividends, capital gains distributions and nontaxable
distributions received during the tax year.
Gross Income total worldwide money, goods, services, and property a person receives that must be
reported on a tax return unless specifically exempt or excluded by law.
Gross Income Test - one of five tests that must be met for a taxpayer to claim someone as his or her
dependent.
Gross Receipts - the total of sales for a business during the year.
Head of Household Filing Status a filing status used by an unmarried taxpayer who pays over half
the cost of maintaining a home that is the principal residence for over half the tax year of his
qualifying child or a qualifying relative.
Hobby Loss - a nondeductible loss arising from a personal hobby which was not pursued for profit.
Holding Period - the period of time property has been owned for income tax purposes.
Home Equity Debt - debt secured by a principal residence or second home that does not include the
original acquisition debt.
Home Office - part of a home or other structure for which the taxpayer qualifies to take a deduction
for its business use.
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Hope Scholarship Credit - a nonrefundable credit for tuition and fees paid for the first two years of
post-secondary education.
Household Employee - an individual who performs non-business services for a taxpayer in or around
the taxpayer's home.
Improvements - the expenses of permanently upgrading property versus maintaining or repairing it.
Imputed Interest - interest the IRS assumes has been paid on a loan if the stated interest is below
the minimum Applicable Federal Rate.
Inclusion Amount the amount a taxpayer must add back to income if the fair market value of his
leased car is above a certain amount.
Income - a gain derived from capital, labor, or a combination of the two.
Income Averaging - a method by which farmers may reduce tax liability by computing their income
tax as if their current farm income had been spread evenly over the preceding three years.
Income in Respect of a Decedent (IRD) - income a decedent earned or was entitled to receive
before death.
Income Taxes - taxes on both earned income (salaries, wages, tips, commissions) and unearned
income (interest, dividends).
Individual Retirement Arrangement (IRA) - a trust account established to receive retirement
contributions of individuals.
Individual Taxpayer Identification Number (ITIN) a taxpayer identification number for persons
(usually aliens) who do not qualify for a Social Security number.
Inflation a simultaneous increase in consumer prices and decrease in the value of money.
Information Returns forms such as Form W-2 and 1099, which report income and property
transactions to the IRS.
Innocent Spouse Rule - an exception to the general rule, under which a spouse may claim to not be
jointly liable if he or she did not know about errors in a tax return and did not benefit from them.
Installment Method - a method enabling a taxpayer to spread the recognition of gain on the sale of
property over the payment period.
54
Instant Loan - an immediate loan made by a RAL bank before the IRS has acknowledged the return,
for a portion of a taxpayers anticipated refund amount.
Interest Expense - the amount paid for borrowing money.
Interest Income - the amount received for lending money.
Internal Revenue Service (IRS) - a division of the U.S. Treasury Department responsible for collecting
taxes.
Inventory - items acquired for sale to customers in the regular course of a taxpayer's trade or
business.
Investment Interest Expense - deductible interest paid on funds borrowed for investment purposes,
which is limited to income generated from the investments.
Investment Income - interest, dividends, capital gains, certain rent and royalty income, and net
passive activity income.
Investment Tax Credit - tax credits which are allowed for rehabilitating a building or investing in
energy property for business purposes.
Involuntary Conversion a forced disposition of property due to a casualty, theft, condemnation or
the threat of condemnation.
IRS e-file - the preparation and transmission of tax return information to the IRS using a computer
and the Internet.
Itemized Deductions - personal expenses allowed by the Internal Revenue Code as deductions from
adjusted gross income.
Joint Return - a return combining the income, exemptions, credits, and deductions of a husband and
wife.
Joint Return Test - one of the five tests a person must pass to qualify as the taxpayers dependent
requiring that the person must not file a joint tax return with his or her spouse for the tax year in
which the taxpayer claims the person as a dependent.
Joint Tenancy a form of joint ownership under which two or more individuals each has an
undivided interest in the entire property.
55
Jointly Owned Property - property held in the name of more than one person.
Keogh Plan - a pension or profit-sharing retirement plan available to self-employed individuals and
their employees.
Kiddie Tax - the popular name for a 1986 law enacted to prevent parents from escaping taxes by
putting money in their children's names.
Last In, First Out (LIFO) a method of valuing inventory that assumes any inventory sold was from
the last inventory purchased.
Legally Separated - married couples living apart under a court order or separate maintenance
agreement.
Lien for Taxes - a lien on the property of a taxpayer who is delinquent in the payment of amounts
owed to the IRS.
Lifetime Learning Credit - a nonrefundable tax credit of a portion of qualified post-secondary higher
education tuition and fees paid on behalf of the taxpayer, his or her spouse, or his or her dependents.
Like-Kind Exchange - a tax-deferred exchange of similar property used in a trade or business or held
for investment, not including securities and other indebtedness or interests such as stocks and bonds.
Listed Property - passenger autos and other property used for transportation, property generally
used for purposes of entertainment, recreation, or amusement, computers, cellular telephones, and
other property specified by the IRS for which special rules apply to depreciation.
Long-Term Capital Gains and Losses - gains and losses on the sale or exchange of capital assets
that have been held for more than 12 months.
Lump-Sum Distribution - the payment of the entire balance in an individual's employer-provided
retirement plan account in one calendar year.
Luxury Automobile Limits - limits on the amount of depreciation that can be taken annually on an
automobile used for business purposes.
Luxury Tax - a tax paid on expensive goods and services considered by the government to be
nonessential.
Marital Deduction - a deduction that allows a taxpayer to transfer assets to his spouse estate and
gift tax free.
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Married Filing Jointly Filing Status - a filing status that can be used by taxpayers who are married at
the end of the tax year.
Married Filing Separately Filing Status - a filing status that can be used by married taxpayers who
choose to declare their individual incomes, deductions, and credits on separate individual tax returns.
Material Participation a test used to determine if the taxpayer worked and was involved in a
business activity on a regular basis or if he was only an investor
Meals and Entertainment - expenses that may be 50% deductible in a business, such as the cost of
taking a client to a restaurant or a sporting event.
Medical Expenses - the reasonable and necessary un-reimbursed expenses relating to health care
(doctors, dentists, hospitals, prescriptions) for the taxpayer and his dependents.
Medical Savings Account (MSA) - a tax-exempt trust or custodial account established to save
money exclusively for future medical expenses that are not covered by health insurance.
Medicare Part A coverage for hospital and nursing home care.
Medicare Part B - coverage for a portion of doctor bills and outpatient services. The premium is
withheld from social security benefits and deductible on Schedule A.
Medicare Tax a tax used to provide medical benefits for workers, retired workers, and the spouses
of workers and retired workers that are eligible to receive Medicare benefits upon reaching age 65.
Medicare Tips - tips reported to an employer by an employee which are subject to Medicare Tax
withholding.
Medicare Wages - wages paid to an employee that are subject to Medicare tax not including
Medicare Tips, which are reported separately.
Miscellaneous Itemized Deductions - deductions reported on Schedule A which are usually jobrelated expenses or investment expenses.
Modified AGI (MAGI) - a figure used to calculate the limit on an exclusion or deduction.
Modified Accelerated Cost Recovery System (MACRS) - the depreciation system used for most
property, other than real estate, placed in service after December 31, 1986.
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Mortgage Interest Credit - a certificate from a state or local government in connection with a new
mortgage for the purchase of a main home entitling taxpayers to claim a credit for a percentage of
their home mortgage interest.
Mortgage Interest Expense - interest paid on a loan secured by a home that is fully deductible up to
certain limits.
Moving Expenses - an adjustment to income permitted to employees and self-employed individuals
who move for work-related reasons, provided certain requirements are met.
Multiple Support Agreement a legal document that states who can claim a person as a dependent
when two or more people provide more than half of a dependent's support.
Net Operating Loss (NOL) a net loss for the year attributable to business or casualty losses
because expense deductions are more than income for the year.
Nominee Dividends - dividends received on behalf of another person.
Nominee Interest - interest received on behalf of another person.
Non-custodial Parent - the parent who does not have physical custody of the child, or who has
custody for the smaller part of the year.
Nonrefundable Credit - a credit that cannot exceed the taxpayer's tax liability.
Nonresident Alien - a person who is not a U.S. citizen and either does not live in the United States, or
lives in the United States and does not have a green card or meet the substantial presence test.
Nontaxable Distributions - stock dividend distributions that are not paid from earnings and are not
taxable - such as a return of capital, stock splits, and/or tax-free distributions.
Nontaxable Income - income that is exempt from tax by law.
Open Year - a tax year for which the statute of limitations has not yet expired.
Ordinary and Necessary Business Expenses - expenses that are fully deductible as current expenses,
as opposed to unnecessary expenses or capital expenditures.
Ordinary Dividends - fully taxable dividends that are distributions of a company's profits.
Ordinary Income - income that does not qualify as a capital gain, such as wages, interest, dividends
and net income from a business.
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Ordinary Loss - a loss that is not a capital loss and that is fully deductible against ordinary income.
Original Issue Discount (OID) a discount that occurs when a bond is issued for a price less than its
face amount or principal amount.
Parsonage Allowance - a housing allowance for clergy, designated by the church or other employer
organization, for the expenses of providing and maintaining a home.
Passive Activity - an activity in which the taxpayer does not materially participate.
Passive Income - income from business activities in which the taxpayer does not materially
participate including most real estate rental activities.
Passive Loss losses from business activities in which the taxpayer does not materially participate.
Payment-in-Kind Wages wages paid to farm employees in the form of farm commodities, such
as livestock or food, instead of cash.
Payroll Tax - a tax based on wages, tips and salaries paid such as Social Security Tax, Medicare Tax,
unemployment compensation, workers compensation insurance and local transit.
Permanent and Total Disability - a disability that prevents an individual from engaging 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 not less
than 12 months.
Personal Exemption exemptions for the taxpayer and his spouse.
Personal Identification Number (PIN) - a five-digit self-selected number which allows taxpayers to
"sign" their tax returns electronically and ensures that electronically submitted tax returns are
authentic.
Physical Presence Test - one of the two residency tests a taxpayer can meet to qualify for the
Foreign Earned Income Exclusion and the Foreign Housing Exclusion and Deduction.
Placed in Service - the date an asset is ready for use for business purposes, which is usually the date
of purchase and which is used as the starting point for depreciation.
Points a loan-origination fee that a borrower may deduct as interest expense under certain
circumstances.
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Portfolio Income - income such as interest, dividends, royalties, and gains or losses from
investments.
Power of Attorney - a legal document authorizing one person to act as another person's attorney or
agent.
Practitioner PIN - allows the Electronic Return Originator to sign a tax return using an electronic
signature by entering a five-digit PIN.
Preferred Electronic Refund Check (PERC) a quick and cost-effective way for taxpayers to receive
their tax refunds - usually in 7 to 14 days without paying any tax preparation fees up front.
Premature Distribution - a withdrawal from a qualified retirement plan before age 59 1/2.
Principal Place of Business - the main place where work is performed or business is transacted,
determined by how much of a taxpayers working time is spent there and the importance of the work
done there.
Principal Residence - generally the home in which a taxpayer lives most of the time, which can be a
house, condominium, cooperative apartment, townhouse, mobile home, or houseboat.
Profit-Sharing Plan a plan for distributing a predetermined percentage of a company's profits to
its employees' accounts.
Progressive Tax - a tax that takes a larger percentage of income from high-income groups than from
low-income groups.
Property Taxes - a tax levied by local governments, based on the value of property owned.
Publication 1345 - Handbook for Electronic Return Originators of Individual Income Tax Returns,
which provides information on electronic filing requirements and restrictions.
Publication 1345A - Filing Season Supplement for Authorized IRS e-file Providers, which is a
supplement to IRS publication 1345 that lists all IRS rejection codes for electronically filed returns.
Qualified Adoption Expenses - reasonable and necessary expenses for adopting a child, including
such expenses as adoption fees, attorney fees, and other expenses, but not including expenses paid
for a surrogate parenting arrangement or expenses paid to adopt a spouse's child.
Qualified Charitable Organization - usually an association or nonprofit corporation designed to
provide some form of public service and specifically approved by the U.S. Treasury as a recipient of
tax deductible charitable contributions.
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Regular Method - a deduction for business use of the taxpayer's vehicle based on actual cost of gas,
oil, repairs, tires, parking, etc. plus depreciation.
Relationship or Member of Household Test - one of the five tests to determine if the taxpayer can
claim someone as a dependent.
Resident Alien a permanent resident, but not a citizen, of the United States.
Return of Capital - a distribution received from an investment that is not income, but rather a return
of a portion of the original investment.
Rollover a tax-free transfer of an employer plan distribution to another employer plan or to a
traditional IRA, or the tax-free transfer from one IRA to another or to an eligible employer plan within
60 days.
Roth IRA a retirement account which features non-deductible contributions on which earnings
grow tax free and qualified withdrawals are also tax free.
Routing Transit Number (RTN) - a unique nine-digit identification number for a bank.
Royalty Income - payments for using of certain kinds of property, such as artistic or literary works
and patents.
S Corporation - a type of small business corporation with no more than 100 shareholders that elects
not to be taxed as a corporation and that generally pays no tax. Instead, shareholders of an S
corporation report their share of the corporation's income, gain, losses, and credits on their individual
returns.
Safe Harbor - tax regulations that allow a simpler method of determining a tax consequence than is
available following the precise language of the Code or regulations.
Salvage Value - the estimated amount an asset could be sold for at the end of its useful life.
Savings Incentive Match Plan for Employees (SIMPLE) - a simplified retirement plan that allows
employees of 100 or fewer employee businesses and self-employed individuals to make salaryreduction contributions to a retirement plan either one similar to a 401(k) plan or one that funds
IRAs for employees.
Schedules - official IRS forms used to report various types of income, deductions, and/or credits.
Section 1231 Gain or Loss - a net section 1231 gain is treated as long-term capital gain and a net
section 1231 loss is treated as an ordinary (fully deductible) loss.
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Section 1231 Property - depreciable assets and real estate used in a trade or business and held for
more than one year, such as equipment, vehicles and rental real estate.
Section 1245 the section of the IRC that requires that when depreciable personal property, such as
business equipment and vehicles, are sold, gain must be recaptured as ordinary income up to the
amount of depreciation claimed.
Section 1250 - the section of the IRC that requires that when real property is sold, gain must be
recaptured as ordinary income up to the amount of depreciation claimed in excess of straight line
depreciation.
Section 179 Expense Deduction - a deduction allowed for up to the entire cost of certain
depreciable business assets, other than real estate, in the year purchased, which can be used as an
alternative to depreciating the asset over its useful life.
Section 457 Plan a deferred-compensation plan for employees of state and local governments and
tax-exempt organizations that allows for tax deferral of salary.
Self-Employment Tax - Social Security and Medicare tax paid by self-employed individuals on the
net income from their trade or business.
Separate Maintenance Payments - amounts paid to one spouse by the other under a court order or
agreement while they live apart.
Series EE Bonds - U.S. Savings Bonds issued after 1979.
Short Tax Year - a tax period less than 12 months, resulting from a business start-up or the transition
to a tax year ending on a different date.
Short Term Gain or Loss - gain or loss on the sale or exchange of a capital asset held one year or
less.
Simplified Employee Pension (SEP) - An retirement plan under which an employer makes
contributions to an employee's Individual Retirement Account (IRA), or a self-employed person
contributes to his own plan.
Simplified Method a method of computing the taxable portion of a pension received from a
qualified employer plan.
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Single Filing Status a filing status used if on the last day of the year, the taxpayer is unmarried or
legally separated from his spouse under a divorce or separate maintenance decree and he does not
qualify for another filing status.
Sin Tax - a tax on goods such as tobacco and alcohol.
Social Security Number (SSN) a taxpayer identification number for most U.S. citizens.
Social Security Tax see Federal Insurance Contributions Act (FICA).
Social Security Tips - the amount of tips reported to an employer by an employee that is subject to
Social Security Tax.
Social Security Wages - wages paid to an employee that are subject to Social Security tax.
Special Needs Child - a child determined by the state to be difficult to adopt due to factors such as
racial or ethnic background, age, a condition that requires special care, mental, physical or emotional
handicaps, or whether the child is a member of a minority or sibling group.
Specific Use - a specific use for a power of attorney that is not recorded in the Centralized
Authorization File (CAF). Because the IRS does not record a power of attorney for specific use, the
person to whom you have given power of attorney must bring a copy of the power of attorney to
each meeting with the IRS.
Spousal IRA - an IRA established by a taxpayer whose spouse has little or no compensation - for the
benefit of that spouse.
Standard Deduction an deductible amount provided by the tax law in lieu of itemized deductions.
Standard Mileage Rate - a deductible fixed rate for each mile of qualified use of an automobile,
which is used instead of keeping track of actual costs, such as gas and maintenance..
State Non-Residents - an individual who temporarily resided and/or worked in a state at any time
during the tax year, although that state was not their state of residence.
State Part Year Residents - an individual who was a resident of a particular state for only part of the
tax year.
Statutory Employee - a worker who is treated as an employee for Social Security and Medicare tax
purposes and as self-employed for income tax purposes.
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Tax Deferral - the postponement of taxes to a later tax year, usually accomplished by recognizing
income or a gain at a later time.
Tax Evasion - a failure to pay or a deliberate underpayment of taxes.
Tax-Exempt Income - income that is not subject to federal income tax by law.
Tax-Exempt Interest Income - interest income that is not subject to federal income tax by law.
Tax Exemption - a part of a taxpayers income on which no tax is imposed.
Tax-Free Exchange - transfers of property specifically exempt from federal income tax consequences
in the current year such as like-kind exchanges.
Tax Home - the taxpayers principal place of work or post of duty.
Tax Liability - the amount of tax the taxpayer must pay after deducting any credits and before taking
into account any advance payments such as withholding or estimated tax payments made by the
taxpayer.
Tax Preference Items - items such as accelerated depreciation, percentage depletion or certain taxexempt income that may result in the imposition of the alternative minimum tax.
Tax Rate Schedules - schedules published by the IRS for taxpayers with taxable income of more than
$100,000 to use to compute their income tax.
Tax Return Preparer - a person paid to prepare, review or assist in the preparation of the taxpayers
income tax return.
Tax Shelter - an investment that is designed to result in tax-favored treatment.
Tax-Sheltered Annuity - a retirement plan for employees of tax-exempt organizations and public
schools, also known as a Section 403(b) plan.
Tax Tables tables published by the IRS for taxpayers with taxable income of $100,000 or less to use
to compute their income tax.
Tax Year - the 12-month reporting period for which taxable income is computed.
Taxpayer Identification Number (TIN) in the case of an individual, the individuals Social Security
number. In the case of a business , the Employer Identification Number (EIN).
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TeleTax - a phone number that taxpayers can call to hear recorded information on more than 100 tax
topics.
Third Party Designee an authorization electronically filed with a tax return that authorizes the IRS
to discuss the tax return with a third party.
Tip Income - gratuities received by the taxpayer for services rendered. Tips of $20 or more from any
one job during a calendar month must be reported to the taxpayer's employer.
Traditional IRA an IRA that is not a SIMPLE IRA or Roth IRA - to which an individual makes annual
contributions that may or may not be deductible depending on the individual's income and whether
the individual actively participates in an employer's retirement plan.
Transaction Taxes - taxes on economic transactions, such as the sale of goods and services.
Transmit - to send a tax return to the IRS electronically.
Transmission - the sending and receiving of tax returns, acknowledgements, and other files using
your computer and Internet connection.
Transportation Expenses - the cost of transportation incurred in the course of business or
employment when the taxpayer is not away from home traveling.
Travel Expenses - ordinary and necessary business expenses such as meals, lodging and
transportation expenses while away from home in the pursuit of a trade or business.
Unadjusted Basis - the basis of property used to figure a gain on the sale of the property, but
without reduction for any depreciation deductions.
Underpayment Penalty - a penalty for not paying enough total estimated tax and withholding.
Unstated Interest - interest the IRS assumes has been paid on a loan if the stated interest rate is
below a minimum, called the Applicable Federal Rate (AFR).
Useful Life - the number of years depreciable business property is expected to be productive and in
use.
Vacation Home - a second home used for recreational purposes that may also be rented out at times
to others.
Voluntary Compliance - a system of compliance that relies on individual citizens to report their
income freely and voluntarily, calculate their tax liability correctly, and file a tax return on time.
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