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THE TAX COLLEGE

Volume

1

Educational Series

Federal Income Tax Course 2013

E D UC ATI ON AL S ERI ES - VO L UME 1

Federal Income Tax Course 2013

WorldWideWeb Tax, Inc. 1000 West McNab Rd. Pompano Beach, FL 33069

The Tax College is a Division of WorldWideWeb Tax, Inc.

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i

Table of Contents

How To Use Our Income Tax Course

xxiii

Key Tax Numbers

xxiv

Lesson 1

- Our Federal Tax System

1

The Revolutionary War Period

2

The Post-Revolutionary War Period

4

The Civil War Period

4

The

Post-Civil War Period

5

The 16th Amendment

7

The 1920’s

13

The 1930’s

18

The Social Security Act

 

20

The World War II Period

23

The Post-World War II Period

24

The 1960’s

25

Medicare

 

27

The Economic Recovery Tax Act of 1981

28

The Tax Reform Act of 1986

28

The IRS Restructuring and Reform Act of 1998

30

The Economic Growth and Tax Relief Reconciliation Act of 2001 30

 

The Jobs and Growth Tax Relief Reconciliation Act of 2003

32

The Patient Protection and Affordable Care Act of 2010

32

The Health Care and Education Reconciliation Act of 2010

34

The American Taxpayer Relief Act of 2012

34

The Modern Income Tax

35

What are the different types of taxes?

38

Income Tax

 

38

Sales Tax

39

Use Tax

39

Excise Tax

39

Real Estate Tax

40

Personal Property Tax

40

Tolls and Permits

40

Estate, Gift and Inheritance Taxes

41

Tariffs

41

Value Added Tax (VAT)

41

ii

Lesson 2 - The Tax Return Preparation Process

43

History of the Tax Preparation Industry

44

The Return Preparation Process

46

The Client Organizer/Checklist

48

Tax

Estimator

48

The Three Stages

48

Welcoming the Taxpayer

48

Establishing Rapport

49

Be an Active Listener

49

Asking Questions Effectively

50

Dealing with Communication Barriers

50

Completing the Tax Return

51

Complex Tax Returns

51

Frequently Asked Questions

54

E-filing

54

What If a Taxpayer or Dependent Does Not Have a Social Security Number?

55

What if a Taxpayer Moves?

55

Which Address Should Taxpayers Use: Their Street Address or Their PO Box? .55

How Long Should Taxpayers Keep Their Tax Returns and Documentation?

56

Recordkeeping Review

57

Lesson Summary

62

Lesson 3 - Taxpayer Identification Numbers

 

65

Social Security Number Verification

67

Individual Taxpayer Identification Numbers

67

Who Needs an ITIN?

 

67

The Procedure for Acquiring an ITIN

68

Form W9 and Backup Withholding

70

Community Property States

72

Community

or Separate Property and Income

72

Community

Property

72

Community Income

 

73

Separate Property

73

Separate

Income

73

Lesson Summary

77

Lesson 4 - Aliens

80

Determining Alien Status

81

The Three Statuses

 

81

Resident Status

81

iii

Nonresident Status

83

Dual-Status Aliens

86

Undocumentated Aliens

86

Children Born Abroad - Obtaining a Social Security Number

88

Questions Commonly Asked by or About Aliens

89

Lesson Summary

97

Questions Taxpayers Ask…

98

Lesson 5 - Filing Statuses and Who Should File a Tax Return

100

Single Taxpayers

102

Married Filing Jointly

102

Innocent and Injured Spouses

105

Married Filing Separately

106

Head of Household

110

Keeping Up a Home

 

110

Qualifying Criteria

111

Married and Living Apart with Dependent Child

114

Table for Determining Status:

 

115

Reporting

116

Qualifying Widow(er) With Dependent Child

117

Qualifying Criteria

 

117

After the Spouse's Death

119

Who Must File Versus Who Should File

121

Dependents Who Must or Should File a Return

122

People Age 65 or Older or Blind

123

Other Situations When You Must File

123

Who Should File

124

Who Should Not File

125

Which Form to Use

125

Form 1040EZ

 

125

Form 1040A

125

Form 1040

126

Lesson Summary

126

Lesson 6 - Personal and Dependency Exemptions

 

129

Overview of the Dependency Exemption Rules:

130

The

Taxpayer

133

The Spouse

133

Dependency Exemptions

134

Tests for all Dependents

135

iv

The Four Tests

135

Relationship Test

136

Support Test

136

Residency Test

137

Age Test

137

Tie Breaker Rules

137

Qualifying Relative Tests

138

Dependency Tests

138

Citizen or Resident Test

139

Joint Return Test

139

The Member of Household or Relationship Test

139

The Qualifying Child of another Taxpayer Test

141

The Gross Income Test

141

The Support Test

142

Multiple Support

143

How do you determine who should claim the exemption?

143

Special Rules for Children of Divorced or Separated Parents

144

Determining the Number of Exemptions to Claim

145

Completing the Exemptions Section of the Return

146

Lesson Summary

148

Lesson 7 - Income - Part I

150

Nontaxable Income

154

Medical Reimbursements

159

Where to Report Income

159

Earned Income - Wages, Salaries, and Tips

161

Form W-2

161

Household Employees

169

Household Employers Checklist

171

Incorrect Form W-2

172

Missing Form W-2

172

Form 4852

173

Fraudulent Form W-2

174

How Do You Report Suspected Tax Fraud Activity?

175

Earned Income

175

Form 1099-MISC

176

Tip Income

177

Allocated Tips

178

Tip Income Requiring Form 1040

179

v

Scholarships and Fellowships

180

Interest Income

181

Seller-Financed Mortgages

183

U.S. Savings Bonds - Series EE and Series I

184

U.S. Savings Bonds - Series HH Bonds and Other U.S. Obligations185 Co-owners

185

Deferred Interest Accounts

186

One Year or Less

186

More Than One Year

186

Original Issue Discount (OID)

187

Lesson Summary

194

Lesson 8 - Income - Part II

197

Coverdell ESA's

199

Tax-Exempt Interest

202

Tax Free Interest Rate Equivalents

203

Form 1099-INT

203

Reporting Interest

210

Form 1040EZ

210

Forms 1040 and 1040A

210

Form 1040

211

Foreign Investment Accounts and Trusts

212

Dividends and Corporate Distributions

214

How to Report Ordinary Dividends

216

Spouses

218

How to Report Capital Gain Distributions

218

Sick Pay

219

Qualified Long-term Care Insurance

221

State and Local Refunds

221

Alimony

223

Specific Rules Regarding Alimony Payments

224

225

Specific Rules Regarding Property Transferred Pursuant To Divorce

Unemployment Compensation

227

Supplemental Unemployment Benefits

230

Union Benefits

231

Veterans Benefits

233

Royalty Income

233

REMIC Income

233

Other Income

235

vi

Lesson Summary

237

Lesson 9 - Self Employment Income

240

The Role of Small Business

241

Types of Business Organizations

242

Starting a Business

248

Employee or Independent Contractor?

250

Who is an Independent Contractor?

251

How should payments made to Independent Contractors be reported?

254

Who is a Common-Law Employee?

254

Who is a Statutory Employee?

254

Who is a Statutory Nonemployee?

255

Misclassification of Employees

255

Due Dates for Small Business Tax Returns

256

Accounting Periods and Methods

257

Calendar Year

260

Income and Expenses

260

Income

260

Expenses

262

Cost of Goods Sold

265

Capital Expenses

267

Going into Business

268

Partially Deductible Expenses

269

Payments in Kind

269

Who May Use Schedule C-EZ

272

Schedule C-EZ

272

Total Expenses

273

Leasing vs. Buying Equipment

279

Conditional Sales Contracts

280

Capitalizing Rent Expenses

280

Business and Personal Use

280

Business Travel Expenses

282

Car Expenses

284

Standard Mileage Rate Method

285

Actual Car Expense Method

288

Net Profit

290

Limits on Losses

290

Part III: Information on Your Vehicle

291

Schedule SE

292

vii

Who Must File Schedule SE

296

Reporting the Self-Employment Tax

296

Deduction of Self-Employment Tax

297

Home Office Deductions

298

Safe-Harbor Rules

299

Principal Place of Business

302

How to Apportion Total Annual Expenses for New Businesses?

305

Depreciation

305

Listed Property

307

Basis

313

Adjusted Basis

313

MACRS Method of Depreciation

314

Placed in Service Date

315

Property Classes and Recovery Periods

316

Applying Recovery Periods

317

First Year Expensing (Section 179)

317

Hobby Income and Losses

321

Sale of Business Property

322

Recapture of Depreciation Deductions

323

Net Operating Losses

329

Form 1045 - Schedule A

330

How to Carry an NOL Back or Forward

330

"Going Out of Business" Checklist

335

Causes of Small Business failures

335

Summary of Employment Taxes and Forms

337

General Business Credits

338

How to Claim the Credit

338

Business Tax Return Due Dates

342

Lesson Summary

343

Lesson 10 - Sale of Investment Property

346

Stock Fundamentals

349

Capital Assets

349

Capital Gain Distributions

350

Where to Report Gains and Losses

353

When Do You Need To File Form 8949 and Schedule D

354

Basis of Stock

354

Adjusted Basis

354

Holding Period - Long-Term or Short-Term

356

viii

Blocks of Stock

357

Tax-Free Stock Dividends and Stock Splits

357

Taxable Dividends

358

Demutualization

358

Wash Sales

359

Form 1099-B

359

Determining the Basis of Stock

360

Reporting Form 1099-B Information - Where the Data Goes

361

1099 Consolidated Statements

364

Schedule D - Outline of the Three Parts

365

Reporting Stock Gains or Losses

366

Reporting Other Gains

367

Capital Loss Carryovers

368

Divorced and MFS Taxpayers

369

Deducting Worthless Securities

369

Like-Kind Exchanges

371

Like-Kind Property

372

Like Class

372

Lesson Summary

378

Lesson 11 - Sale of Home

380

Eligibility Requirements for the Exclusion

380

Reporting the Exclusion

382

Definition of Main Home

383

More than One Home

383

Ownership and Use Test - Period of Ownership and Use

384

Married Homeowners

385

Exclusion of Gain on Sale of Principal Residence by a Surviving Spouse

386

Reduced Exclusion

386

Unforeseen Circumstances

386

Gain on Sale of Main Home

387

Selling Price

387

Amount Realized

387

Basis

387

Adjusted Basis

388

Repairs

390

Figuring the Gain

390

Form 1099-S

391

Home Foreclosures

391

ix

Step 1

392

Step 2

393

The Mortgage Forgiveness Debt Relief Act of 2007

393

Installment Sales

396

Installment Sale Interest

396

Lesson Summary

397

Questions Taxpayers Ask…

399

Lesson 12 - Pension Income

402

Disability Pensions

406

406

407

408

417

418

418

420

421

421

422

422

424

427

429

431

432

Annuities

Individual Retirement Accounts (IRAs)

Social Security Benefits

Railroad Retirement Benefits (RRB's)

Other Types of Pension Plans

Form 1099-R

Form SSA-1099

Form RRB-1099 and Form RRB-1099R

Tier 1 Railroad Retirement Benefits

Pensions with Taxable Amount Determined

Pensions in General

"Before-Tax" vs. "After-Tax" Contributions

423

Partially Taxable Pensions and Annuities Other than IRAs

423

General Rule

423

Simplified Method

423

Taxation of Individual Retirement Accounts

Traditional IRA

425

Savings Incentive Match Plans for Employees (SIMPLE) IRA

425

Simplified Employee Pension (SEP) IRA

425

Roth IRAs

425

Taxation of Social Security Benefits

What is the Social Security Lump Sum Election?

428

Disability Pension Income

Reporting Pension Income

429

Disability Income Reporting

429

Reporting Social Security Benefits

Repayment of benefits

431

Reporting IRA Distributions

Traditional IRA, SIMPLE IRA, or SEP IRA

432

x

Premature Distributions

433

Lump-Sum Distributions

434

Taxpayers born before January 2, 1936

436

Minimum Distributions

437

Lump-Sum Benefit Payments

438

Withdrawal of Excess IRA Contributions

439

Pension Withholding and Estimated Tax Payments

440

Lesson Summary

445

Questions Taxpayers Ask…

446

Lesson 13 - Rental Income and Expenses

447

Rental Income

448

Rental Expenses

449

Mortgage Interest and Property Taxes

450

Deduction of Property Taxes

450

Other Deductible Rental Expenses

451

Auto and Travel Expenses

451

Repairs vs. Improvements

452

Advance Insurance Premiums

453

Special Allocations

453

Rental vs. Personal Use

453

Days Used for Repairs and Maintenance

453

Deductibility Limitations

454

Rental Losses

455

Passive Activity vs. Active Participation

455

Passive Activity Losses

456

Active Participation

457

Phase-Out of Offset

457

Reporting Rental Losses

458

Self-Employment Tax

459

Lesson Summary

460

Lesson 14 - Foreign Earned Income Exclusion

462

Eligibility Requirements

464

Married Couples

464

Qualifying Tax Home

464

Military Personnel

464

Choosing the Exclusion

465

Revoking the Exclusion

465

Determining the Tax Home

465

xi

Period of Stay

467

Bona Fide Residence Test

467

Physical Presence Test

467

Figuring the 12-month Period

467

Waiver of Time Requirements

468

Qualifying Income

468

Form 2555

472

Form 2555-EZ

472

Deductions Allocable to Excluded Income

473

Self-Employment Tax

473

Itemized Deductions

474

Moving Expenses

475

Net Exclusion

475

Tax Guide for U.S. Citizens and Resident Aliens Abroad

475

Lesson Summary

476

Questions Taxpayers Ask

477

Lesson 15 - Adjustments to Income - Part I

478

Archer Medical Savings Accounts (MSA)

479

Archer MSA Contributions of Self Employed Persons

479

Archer MSA Contributions of or for Employees

480

Archer MSA Distributions

481

Certain business expenses of reservists, performing artists, and fee-basis

government officials

481

Health Savings Accounts (HSAs)

482

What are the benefits of an HSA?

482

Contributions to an HSA

483

Limit on contributions

483

Filing Form 8889

485

Moving Expenses

486

One Half of Self-Employment Tax

490

Simplified Employee Pensions (SEP)

493

Savings Incentive Match Plan for Employees (SIMPLE)

494

SIMPLE Distributions

494

Keogh Plans

494

Self-Employed Health Insurance Deduction

497

Penalty on Early Withdrawal of Savings

498

Alimony Paid

499

Specific Rules Regarding Alimony Payments

501

xii

Specific Rules Regarding Property Transferred Pursuant To Divorce

503

Lesson Summary

504

Lesson 16 - Adjustments to Income - Part II

508

Individual Retirement Accounts (IRAs)

508

Non Tax Deductible IRAs

512

Roth IRAs

513

IRA Distributions

515

Student Loan Interest Deduction

517

Qualified Student Loan Interest

518

Who Can Claim the Deduction?

518

Eligible Educational Institution

519

Eligible Student

519

Reductions to Qualified Expenses

520

Deduction Limits

520

Reporting Student Loan Interest

523

Tuition and Fees Deduction

524

What expenses qualify?

524

What expenses do not qualify?

524

Is there a deduction if the expenses were paid with borrowed funds?

525

What is an "Eligible Educational Institution"?

525

What are "Related Expenses"?

525

Adjustments to Qualified Education Expenses

527

Form 1098-T - Tuition Statement

528

Comprehensive or bundled fees

529

Jury Duty Pay Given to Employer

530

Domestic Production Activities Deduction

531

Other Adjustments to Income

534

Lesson Summary

535

Lesson 17 - Individual Retirement Accounts

538

What is an IRA?

539

Contributions

541

General Contribution Limits

543

Deemed IRAs

543

Spousal Contribution Limits

544

Excess Contributions

544

Additional Taxes and Penalties

545

IRA Rollovers

545

Deductible IRA Contributions

550

xiii

Taxpayers Not Covered by an Employer Retirement Plan

550

Filing Status

551

Modified Adjusted Gross Income (MAGI)

551

Taxpayers Covered by an Employer Retirement Plan

552

When to Deduct Traditional IRA Contributions

554

Reporting the Deduction

555

Non-deductible IRA Contributions

555

Additional Taxes & Penalties

556

Lesson Summary

556

Questions Taxpayers Ask

557

Lesson 18 - Standard and Itemized Deductions - Part I

559

What Are Deductions?

559

Standard and Itemized Deductions

560

The Standard Deduction

561

Criteria for Blindness

562

Personal Exemption on Form 1040EZ

563

Taxable Income on Form 1040EZ

563

Married Filing Separately

563

Medical and Dental Expenses

565

Taxes

572

Interest

575

Investment Interest

576

Home Mortgage Interest

580

Itemized Deduction Reduction

588

For Tax Years 2013 and Later:

588

Lesson Summary

589

Lesson 19 - Standard and Itemized Deductions - Part II

592

Home Mortgage Points

593

Gifts to Charity

598

Deduction Limits

598

Gifts To Reduce The Public Debt

602

Reporting Contributions

603

Restrictions on Charitable Contributions made after August 17, 2006

604

Casualty and Theft Losses

605

Involuntary Conversions

609

Declared Disaster Areas

610

Grants under the Disaster Relief Act of 1974

610

Miscellaneous Deductions

611

xiv

Deductions subject to the 2% limit

 

611

Employee Business Expenses

617

Accountable Plans

 

622

Deductions not subject to the 2% limit

624

Gambling Losses

625

Non-deductible Expenses

626

Lesson Summary

627

Lesson 20 - Alternative Minimum Tax

 

631

Alternative Minimum Tax Credit

634

Lesson Summary

635

Questions Taxpayers Ask

Tax Shelters

639

Lesson 21 - Credit for Child and Dependent Care Expenses

 

644

Five Eligibility Tests

652

Qualifying Person Test

 

652

Earned Income Test

653

Work-Related Expense Test

654

Joint Return Test

655

Provider Identification Test

655

Limit on Expenses

658

General Limit

 

658

Dependent Care Benefit Limit

658

Non-working Spouse

659

Lesson Summary

660

Lesson 22 - Child Tax Issues

662

The Child Tax Credit

663

Qualifying Child

663

Eligible Descendent

 

663

Adopted Child

664

Eligible Foster Child

664

Exceptions for Children of Divorced or Separated Parents

664

Amount of Credit

665

Figuring the Credit

668

Additional Child Tax Credit

668

Child Tax Returns Kiddie Tax

668

Tax Returns for Students

675

Penalties

 

676

Adopting a Child

676

Adoption Credit

 

677

xv

Employer Adoption Assistance Exclusion Lesson Summary

679

678

Lesson 23 - Credit for the Elderly or Disabled

683

Personal Qualifications for the Credit

684

Physician Statements

686

Sheltered Employment

686

Income Limits for the Credit

686

Taking the Credit

688

Medicare

689

What is covered by Medicare?

689

How do taxpayers enroll in Medicare?

690

Medigap Insurance

690

What's does Medigap insurance typically cover?

691

Medicaid

691

Eldercare

695

Lesson Summary

698

Questions Taxpayers Ask

698

Lesson 24 Primer: College Planning

703

How Much Does a College Education Cost?

703

College Savings Requirements Worksheet

705

Financial Aid Calendar

706

How to Improve Your Client's Chances of Getting Financial Aid

707

Key College Planning Websites

710

Lesson 24 - Education Credits and Programs

712

The Credits

713

American Opportunity Credit Eligible Student

715

Eligible Educational Institution

717

Income Requirements

717

Modified Adjusted Gross Income (MAGI)

719

Tuition and Fees

720

Related Expenses

720

Non-qualifying Expenses

720

Non-credit Courses

720

Prepaid Expenses

721

Payments with Borrowed Funds

721

Expenses Paid by Others

721

What Is the American Opportunity Credit?

723

Figuring the Credit

725

xvi

What Is the Lifetime Learning Credit?

726

Differences between the Two Education Credits

728

No Double Benefits

729

Adjustments to Qualified Expenses

729

Refunds

730

Qualified Tuition Programs (QTPs) (Section 529 Plans)

731

Coverdell ESA’s

733

Excludable U.S. Savings Bond Interest

736

Educational Assistance Plans

738

Work Related Education Expenses

738

What is the tax benefit of taking a business deduction for work-related

 

education?

739

Qualifying Work-Related Education

739

Education Required by Employer or by Law

739

Education To Maintain or Improve Skills

740

Maintaining Skills vs. Qualifying for a New Job

740

Temporary Absences

740

Indefinite Absences

740

Education To Meet Minimum Requirements

741

Requirements for Teachers

741

Certification in a New State

741

Education That Qualifies The Taxpayer for a New Trade or Business

742

Teaching and Related Duties

742

What Expenses Can Be Deducted

742

Deductible Expenses

742

Non-deductible Expenses

742

Unclaimed Reimbursement

743

Transportation Expenses

743

Temporary Basis

743

Attendance Not on a Temporary Basis

743

Deductible Transportation Expenses

743

Using His Own Car

744

Travel Expenses

744

Mainly Personal Travel

744

Cruises and Conventions

745

50% Limit on Meals

745

Travel as Education

745

No Double Benefit Allowed

745

xvii

Adjustments to Qualifying Work-Related Education Expenses

745

Tax-free Educational Assistance

746

Amounts That Do Not Reduce Qualifying Work-related Education Expenses 746

How To Treat Reimbursements

 

746

Accountable Plans

747

Accountable Plan Rules Not Met

747

Expenses Equal Reimbursement

747

Excess Expenses

747

Allocating the Taxpayer’s Reimbursements for Meals

747

Non-Accountable Plans

748

Reimbursements for Non-deductible Expenses

748

Self-Employed Persons

748

Employees

748

Form 2106 or 2106-EZ

749

Form 2106 or 2106-EZ Not Required

749

Using Form 2106-EZ

749

Performing Artists and Fee-Basis Officials

750

Impairment-Related Work Expenses

750

Lesson Summary

753

Lesson 25 - The Earned Income Tax Credit

 

755

Filing Requirements

756

Income Requirements

757

Taxpayer Identification Numbers

757

Taxpayers With Qualifying Children

758

Taxpayers Without Qualifying Children

758

Earned Income

758

Income Not Considered Earned Income for EIC

 

759

Household Employee Income

759

Qualifying Child

760

Three Tests for the EIC

 

760

Relationship Test

760

Residency Test

761

Age Test

761

Qualifying Child of More Than One Taxpayer

762

EIC Qualification

Checklist

763

Schedule EIC

763

Disallowed EIC

763

Deficiency Procedures

 

763

xviii

Reasons for Disallowed EIC

764

EIC Certification

764

Earned Income Credit Summary

765

Lesson Summary

771

Lesson 26 - The Foreign Tax Credit

773

Qualifying Taxes

774

No Economic Benefit

775

Country Restrictions

775

Form 1116

776

Types of Income

779

Passive Income

779

High Withholding Tax Interest

779

General Limitation Income

779

Completing Form 1116

780

Foreign Earned Income Exclusion

781

Cash Basis vs. Accrual Basis Taxpayers

781

Lesson Summary

781

Lesson 27 - Miscellaneous Tax Credits

790

Qualified Retirement Savings Contributions

793

Eligible Contributions

795

Married Filing Jointly

796

Residential Energy Efficient Property Credit

797

Alternative Motor Vehicle Credit

798

Plug-in Electric Drive Vehicle Credit

799

Mortgage Interest Credit

799

Health Coverage Tax Credit

800

General Business Credits

801

Lesson Summary

802

Lesson 28 - Electronic Filing and Bank Products

807

Electronic Filing

810

The History of IRS e-file

810

IRS e-file Historical Timeline

810

Security of IRS e-file

812

What is the Self-Select PIN method?

813

State E-file Mandates

814

Refund Options

815

Straight Electronic Filing (Direct Deposit)

815

Straight Electronic Fling (Paper Check)

815

xix

Mail in Return (Direct Deposit)

 

815

Mail in Return (Paper Check)

815

How to Get Started with e-file

815

Bank Products

816

Advent Financial

 

817

Federal Refund Anticipation Loan (RAL)

819

Military RAL Exclusion

820

RAL Product Features & Benefits

820

Federal Electronic Refund Check (ERC)

821

ERC Product Features & Benefits

821

Federal Electronic Refund Direct Deposit (ERDD)

822

State Electronic Refund Check (SERC)

822

SERC Product Features & Benefits

823

Lesson Summary

823

Lesson 29 - Finishing The Tax Return

 

826

Income Tax Withholding

828

Estimated Income Tax Payments

833

Refundable Credits

835

Overpayment or Tax Due

836

Refunds

836

Buying U.S. Series I Savings Bonds

 

836

Direct Deposit

836

Payment by Check or Money Order

837

Electronic Payment

Options

838

Monthly Installment

Options

839

Estimated Tax Penalty

839

Estimated Tax

841

Withheld Taxes

 

841

Taxes Not Withheld

842

Who Must Pay Estimated Tax

843

When to Pay Estimated Tax

846

Option to Apply an Overpayment

847

How to Make Payments

848

Forms W-4, W-4P, W-4V, and W-4S

848

Form W-4

 

848

Form W-4P

849

Form W-4V

849

Form W-4S

850

xx

How Much to Withhold

850

Completing Forms W-4 and W-4P

851

Multiple Incomes

855

Attaching Forms and Schedules

855

Signatures

856

Returns for Children

856

Combat Zone

856

Deceased Taxpayers

857

Claiming the Decedent's Refund

859

Federal Estate Tax

859

Federal Gift Tax

863

State Estate and Inheritance Tax

866

Probate

867

Deceased Spouses

868

Third Party Designee

870

Ending the Interview

871

Checking on Refunds

872

Financial Management Service

872

Lesson Summary

874

Lesson 30 - IRS Audits

877

The taxpayer received a notice from the IRS…

879

The taxpayer received a notice from the IRS that’s

880

What to do if there's Form W-2 or Form 1099 discrepancies

880

What if the taxpayer hasn't filed tax returns for several years?

881

What are the penalties and interest and can they be avoided?

882

Acting on bad advice from the IRS

885

Honest mistakes

885

Disputing assessed tax penalties

885

Taxpayer Advocate Helpline

887

IRS Directory

888

How to avoid an IRS audit

888

The High-Risk Tax Audit Areas

890

High Wages

891

Large Amounts of Itemized Deductions

892

High DIF

892

Unreported Taxable Income

892

Self Employment

893

Home Office Tax Deductions

894

xxi

Unreported Alimony

894

Automobile Logs

895

Self-defense Pays Off

896

How to Prepare for an IRS Audit

896

What is an Offer in Compromise?

899

Spouse Relief

902

Innocent Spouse Relief

903

Separation of Liability Relief

904

Equitable Relief

906

Questions and Answers About Applying for Relief

909

Injured Spouse Relief

911

What are a taxpayer’s appeal rights?

912

How does the Statute of Limitations affect tax collections?

915

Statute of Limitations for Collecting Tax Already Assessed

915

Statute of Limitations on Taxpayer’s to Claim a Tax Refund

917

What is the Taxpayer Bill of Rights?

917

How does the Bankruptcy Code affect tax obligations?

920

Lesson Summary

921

Appendices

926

Appendix A - Form 1040 circa 1913

926

Appendix B - Financial Professional Designations

931

Appendix C - Record Keeping Requirements

937

Appendix D - Taxable vs. Non-Taxable Income

938

Appendix E - Where to Report Certain Items

939

Appendix F - Highlights of Tax Benefits for Education Part I

943

Appendix G - Highlights of Tax Benefits for Education Part II

944

Appendix H - Where to Report Investment Income

945

Appendix I - Comparison of Business Entities

946

Appendix J - IRS Publications for Business

956

Appendix K - IRS Forms

957

Appendix L - Social Security Taxes Paid

961

Appendix M - IRS Publications

963

Appendix N - Retirement Plan Comparisons

965

Appendix O - Traditional IRA and Roth IRA Comparison

969

Appendix P - Medicare Total Taxes Paid

970

Appendix Q - Electronic Filing & Bank Product Process

972

Glossary

974

xxii

HOW TO USE OUR INCOME TAX COURSE

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:

I C O N

T Y P E

D E S C R I P T I O N

 

T A X

Q U O T E

Tax Quotes appear in boxes with a lavender background.

 

S I D E

B AR

Side Bars appear in boxes with a light yellow background.

 

T A X

T I P

Tax Tips appear in boxes with a light blue background.

T

A X

P LA N N I N G

Tax & Financial Planning Tips appear in boxes with a light

 

T

I P

green background.

T

A X

P RA CT I C E

Tax Practice Tips appear in boxes with a light grey

 

T

I P

background.

HOW TO COMPLETE YOUR STUDIES QUICKLY If you are taking our course because you need to obtain your IRS Continuing Education hours quickly to renew your PTIN; or you are starting a job at a tax preparation office and you need to learn the material quickly before the tax season starts; you can skip reading the Tax Quotes, Sidebars, Tax Tips, Tax Planning Tips and Tax Practice Tips. The information discussed in them is not covered on the quizzes or final exam. You can return next summer when you have more time and read them at that time.

However, if you are not in a hurry we strongly recommend that you read all of the above as they will enhance your knowledge of the tax laws and expand your understanding of the topics covered in this course.

xxiii

KEY TAX NUMBERS

Adoption Credit

 
 

Child with special needs

$12,650

Other adoptions, qualified expenses

Up to $12,650

Alternative Minimum Tax

 
 

Exemptions

 
 

Married Filing Jointly

$78,750

Married Filing Separately

$39,375

Single or Head of Household

$50,600

 

Tax Rates

 
 

First $175,000 ($87,500 MFS) of AMTI

26%

Over $175,000 of AMTI

28%

Capital Gains Tax Rate (Long Term)

 
 

10% or 15% Tax Bracket

0%

Greater Than 15% Tax Bracket

15%

Un-recaptured Section 1250 Gain

25%

Collectibles

28%

Dividend Tax Rate

 
 

10% or 15% Tax Bracket

0%

Greater Than 15% Tax Bracket

15%

Domestic Production Activities Deduction

9%

Earned Income Tax Credit

Single, Head of Household, Qualifying Widow

Maximum Earnings

Maximum EITC

 

No Children

$13,980

$475

One Child

$36,920

$3,169

Two Children

$41,952

$5,236

Three Children Married Filing Jointly

$45,060

$5,891

 

No Children

$19,190

$475

One Child

$42,130

$3,169

Two Children

$47,162

$5,236

Three Children

$50,270

$5,891

Education

American Opportunity Credit

$2,500

Coverdell ESA

$2,000

Lifetime Learning Credit

$2,000

xxiv

 

Student Loan Interest Deduction

$2,500

Tuition and Fees Deduction Tier 1

$4,000

Tuition and Fees Deduction Tier 2

$2,000

Elective Deferrals Limits

 
 

401(k), 403(b), 457 plans

$17,500

Salary Reduction SEP

$17,500

 

Additional Contribution Age 50 or Older

$5,500

 

SIMPLE IRA

$12,000

 

Additional Contribution Age 50 or Older

$2,500

Employer Provided Transportation Exclusion

 
 

Transit Passes and Commuter Vehicles

$125 per month

Qualified Parking

$240 per month

 

Qualified Bicycle Commuting

$20 per month

Exemptions

 
 

Personal and Dependent

$3,800

Estate

$600

Simple Trust

$300

Complex Trust

$100

Filing Requirements

IF you're filing status is…

THEN you

AND at the end of 2012 return should if file your a you were…

gross income was at least…

 

Single

Under 65

$9,750

65

or older

$11,200

 

Under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses)

$19,500

$20,650

 

Married Filing Jointly

$21,800

Married Filing Separately

Any age

$3,800

Head of Household

Under 65

$12,500

 

65

or older

$13,950

 

Qualifying Widow(er)

Under 65

$15,700

65

or older

$16,850

Foreign Earned Income Exclusion

 

$95,100

Gift Tax

 
 

Exclusion

$14,000

xxv

 

Spouse

 

Unlimited

Non-U.S. Citizen Spouse

$139,000

Health Savings Accounts (HSA’s)

 
 

Maximum Annual Contribution Limits

 
 

Self-Only Coverage

$3,100

Family Coverage

$6,250

 

Additional Over Age 55

$1,000

 

Minimum Deductible

 
 

Self-Only Coverage

$1,200

 

Family Coverage Maximum Out of Pocket

$2,400

 

Self-Only Coverage

$6,050

Family Coverage

$12,100

IRA Contributions

 
 

Traditional

 

$5,500

 

Age 50 or Older

$6,500

 

Roth

 

$5,500

 

Age 50 or Older

$6,500

Itemized Deduction Reductions (beginning at)

 
 

Married Filing Separately

None for 2012

All Others

 

None for 2012

Kiddie Tax

 
 

Age Limit

 

18

Unearned Income Limitation

$1,900

Long Term Care Premiums (deductible)

 
 

Age 40 or Under

$350

Age 41 to 50

 

$660

Age 51 to 60

 

$1,310

Age 61 to 70

 

$3,500

Age 71 and Over

$4,370

Medical Savings Accounts (MSA’s)

 
 

Premium for High Deductible

 
 

Self Coverage

$2,100-$3,150

 

Family Coverage Maximum Out of Pocket

$4,200-$6,300

 

Self Coverage

$4,200

Family Coverage

$7,650

Mileage Rates

xxvi

 

Business

$0.555

Medical and Moving

$0.23

Charitable

$0.14

Section 179 Expense

$500,000

Social Security Payback

At full retirement age or older

No limit on earnings

Under full retirement age

$1 of benefits will be deducted for each $2 earned above $14,640

In the year full retirement is reached

$1 of benefits will be deducted for each $3 earned above $38,880

Social Security Wage Base

Social Security Wage Base

$110,100

Maximum Social Security Tax

$4,624

Standard Deductions

Base Amount

Add for Blind or > 65

Single

$5,950

$1,450

Married Filing Jointly

$11,900

$1,150

Married Filing Separately

$5,950

$1,150

Head of Household

$8,700

$1,450

Qualifying Widow(er)

$11,900

$1,150

Dependent of Another

$950 or Earned Income + $300

$1,150 or $1,450 if Single or HOH

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L E S S O N

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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 1920’s

The 1930’s

The Social Security Act

The World War II Period

The Post-World War II Period

The 1960’s

Medicare

The Economic Recovery Tax Act of 1981

The Tax Reform Act of 1986

IRSRRA of 1998

EGTRRA of 2001

JGTRRA of 2003

The Modern Income Tax

What are the different types of taxes?

T he federal tax system in the United States has been marked by significant changes over the years in response to the ever changing

role of the government. While the law itself is complex, the concept is relatively simple. Income from all sources is taxed, unless specifically exempted by the law.

The types and amounts of tax collected are completely different than they were 200 years ago. Some of these changes are traceable to specific events, such as a war, or the passage of the 16th Amendment which gave Congress

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L E S S O N

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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 England’s 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.

The Revolutionary War Period

To pay the debts of the Revolutionary War, Congress levied excise taxes on distilled spirits, tobacco and snuff, refined sugar, carriages, property sold at auctions, and various legal documents.

The Articles of Confederation of 1781 reflected the American fear of a strong federal government. The federal government had few responsibilities and no tax. It relied solely on donations from the States. When the Constitution was passed in 1789, it was recognized that no government could function if it relied entirely on other governments for its resources. Therefore, the federal government was granted the authority to raise taxes.

Article I, Section 8, Clause 1 of the U.S. Constitution states Congress shall have the power to impose "Taxes, Duties, Imposts and Excises,". However

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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 in 2012.

Major

All

Taxpayers

Major forms filed:

 

1040

69%

16

8

2

4

1 $270

1040A

19%

7

3

1

3

1 $90

1040EZ

12%

4

1

2

1 $40

Type of Taxpayer:

 

Non-

business *

70%

8

3

1

3

1 $120

Business *

30%

23

13

3

6

1 $420

* 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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