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 Federal Income Taxes
Corporations and Individuals

          Income Taxes
 Cliche - “There are only two things
  certain in life - death and taxes.”
 This is one of most written about and
  discussed topics in American life.
 There are many thousands of books,
  articles, jokes and cartoons on the

Income Taxes

                   Income Taxes
The difference between the short and long income tax forms is
simple. If you use the short form, the government gets your
money. If you use the long form, the accountant gets your money.

A nervous taxpayer was unhappily conversing with the IRS
auditor who had come to review his records. At one point the
auditor exclaimed, Mr. Carr, we feel it is a great privilege to be
allowed to live and work in the USA. As a citizen you have an
obligation to pay taxes, and we expect you to eagerly pay them
with a smile. Thank God, returned Mr. Carr. I thought you were
going to want cash.

     Even worse accounting jokes are available on the Web.

              Income Taxes
 The tax handout gives a broad overview
  of corporate and individual taxes.
 Loyola offers three tax courses
     One at undergraduate level
     Two in MBA program

   Masters in Taxation is available in
     Business Schools (MS)
     Law Schools (LLM)

                 Income Taxes
   Tax law vs. GAAP
       Who makes tax law?

        a. IRS
        b. Congress
        c. Supreme Court
        d. FASB

                Income Taxes
   Tax law vs. GAAP
     Who makes tax law?
     Who makes GAAP?

     Two sets of books

   CPAs and taxes
        We are all experts in this field - NOT!
   Tax avoidance vs. tax evasion
        Which is illegal?
   Where do you get copies of tax forms?

Who Pays And Who Does Not
    Pay Income Taxes?
   Pays
     Corporations
     Individuals

   Does not pay
       Not-for-profit organizations
         e.g., Loyola College
       Proprietorships and Partnerships
         • They file informational returns only.
         • Then, how is the income taxed?
               On the owners’ personal returns

                Corporate Taxes
 “Income Before Taxes” is a line on an
  Income Statement prepared using GAAP.
 “Taxable Income” is a line on a tax return.
     i.e., the amount on which the corp. pays tax.
   Reasons why above amounts may differ
    Certain corporate revenues and expenses
     are excluded in computing taxable income.
         These are known as “permanent” differences.
    Timing of recognition of revenues and
     expenses may differ.
         Known as “temporary” differences.

         Corporate Taxes
                   Tax Rates
 Technically, corporate tax rates are not
  a flat rate; they are graduated as with
  individual’s rates.
 However, for corporations with taxable
  incomes exceeding a relatively small
  amount ($335,000 in 1991), the tax is flat.
      Therefore, the effect is a flat tax
      for most corporations.
   Tax rates will be provided
    on the test if needed.

            Corporate Taxes
    Loss Carrybacks and Carryforwards
      Current year tax losses can be carried
       back 3 years and forward 15 years.
      If the loss is not “used up” by the end of
       the 15th year, what happens?
 A loss carryback results in a tax refund
  in the current year for taxes paid in
  past year(s).
 A loss carryforward is applied against
  taxable income in future years.
 3                                        15

           Corporate Taxes
   Depreciation Methods           Depreciate me
     Methods used for tax
      purposes are quite different from those
      used for financial statement purposes
     Therein lies a major reason for most
      corporations keeping “two sets of books”
   Key to understanding tax depreciation
    “The depreciable period or useful life used
      for tax purposes is based on law and has
      no relationship to the actual useful life of
      the asset; thus, no attempt is made to
      match revenues and expenses.”

            Corporate Taxes
   Tax depreciation is based on MACRS
     Modified Accelerated Cost Recovery System
     It is an accelerated method similar to the
      double-declining-balance and sum-of-the-
      years digits methods.
 Straight-line depreciation can
  also be used for tax purposes.
 You are not responsible for
  any depreciation calculations

           Corporate Taxes
   Income Tax Allocation (pp. 21-24)
     This is how to account for taxes under
      GAAP, not how to calculate taxes owed.
     Congress vs. FASB

   Two reasons for differences in Taxable
    Income (from tax return) and “Book”
    Income (from income statement)
     Permanent differences               Statement

     Temporary (or timing) differences

              Corporate Taxes
            Permanent Differences
   As previously mentioned, certain
    corporate revenues and expenses
    are excluded in computing taxable
        i.e., they are never shown on the
        tax return
   Permanent differences include
     Nontaxable revenues
     Nondeductible expenses

            Corporate Taxes
          Permanent Differences
   Nontaxable revenue examples
     Life insurance proceeds on death of
      key employee
     Interest received from state and local
   Nondeductible expense examples
     Premiums paid on life insurance
      policies for key-employees
     Lobbying expenses

    Corporate Taxes
  Temporary Differences
These are differences between
   taxable income and book
 income caused by items that
  affect both, but in different
  Therefore, they are also called
        timing differences.

           Corporate Taxes
         Temporary Differences
Temporary/timing differences include:
     Revenues reported earlier on the tax
      return than on the books
        e.g., Revenue received in advance
     Expenses reported later on the tax
      return than on the books
        e.g., Expenses based on estimates such as
        uncollectible accounts expense
     Expenses reported earlier on the tax
      return than on the books
        e.g., when different depreciation methods
        are used for book and tax purposes.

           Corporate Taxes
         Temporary Differences
A reconciliation must be used to explain
   why book and taxable income differ.
Reconciliation of Book Income to Taxable Income (p. 22)

              per tax return

       Corporate Taxes
      Temporary Differences
All temporary differences require the
     use of interperiod income tax
    Tax on the item causing the difference
 will be reported in the period in which the
 item is reported for accounting purposes,
   regardless of when it is reported for tax
  purposes. (i.e., there must be a “normal”
     relationship between Pretax Income
       and Income Tax Expense on the
              Income Statement.)

                Corporate Taxes
             Temporary Differences
Page 23
                                             [Per Tax Return]

          * Note normal 15% relationship each year. This
          would not be the case if the amount of tax paid
          (i.e., amount on tax return) were reported as the
          income tax expense on the income statement.

                                             [Per Income Statement


      Personal Income Tax
. .
. .
. .    Joe P.            Taxpayer              123 45 6789
       Sally L.          Taxpayer              987 65 4321
       123 Main Street
       Anywhere, USA 55555-5555



       Kenny Taxpayer               Son
       Posh    Taxpayer             Daughter
       Tinkie Winky Taxpayer        ???


    Personal Income Tax
Whether an individual needs to file a
tax return depends on whether their
    income exceeds the sum of:
 Their standard deduction amount, plus
 Their exemption amount
    e.g., using 1998 rates, a single person would
    not file unless their gross income
    were greater than $6,950.

    Personal Income Tax
         Four Filing Statuses
 Single
 Married filing jointly

 Married filing separately

 Head of household
    Congress in it’s wisdom has seen fit to set
    different tax rates for each.

         Personal Income Tax
                 Taxable Income
                   Examples of Excluded Income
           Gifts, inheritances, interest on state of Taxable
Flow Chart for Determination bonds,
                  certain Social Security benefits.
               for These items are not deducted!
  Income(NOTE:Individual Taxpayer (p. 25)
                   They are just never included.)
Also includes illegal gambling income and other illegal income.
                 Know the model!
                   Gross (Total) Income
   Includes all income from whatever source derived
   except for a few specifically excluded items.
   Includes such items as wages, dividends, interest,
   proprietorship earnings, taxpayer’s share of
   partnership earnings, net rents.

     Personal Income Tax
             Taxable Income
    Examples: Individual Retirement Accounts (IRA)
                  and Keogh plans.

         Deductions From Gross Income
Consists of business expenses, payments to an
individual retirement arrangement, and a few other
minor items.

              Adjusted Gross Income


        Personal Income Tax
                 Taxable Income
Standard Deduction - A specified amount that is permitted by
tax law to be deducted in lieu of itemized deductions. It
         each year because it is Personal inflation.
changesStandard or Itemized indexed to Deductions

  Deduct the higher of the standard deduction or
  itemized personal deductions. Itemized deductions
  consist of contributions, mortgage interest, certain
  taxes levied directly against the taxpayer, limited
  casualty and theft losses, limited medical
  expenses and certain “nonbusiness” expenses.
  The standard deduction for a single taxpayer for
  1998 was $4,250.

     Personal Income Tax
             Taxable Income

One fixed amount (e.g., $2,700 for 1998)
for taxpayer, one for spouse and one for each
dependent. At certain levels of Adjusted Gross
Income, personal exemptions are phased out.


                 Taxable Income

    Personal Income Tax

    Types of Itemized Deductions
 Certain taxes including real estate and
  state income tax
 Interest on principal residence and any
  second residence
    No longer deductible on consumer loans
 Charitable contributions to approved
 educational, religious and other not-for-
 profit organizations

    Personal Income Tax

    Types of Itemized Deductions
 Medical expenses to the extent they
  exceed 7.5% of Adjusted Gross Income
 Casualty losses subject to certain
  complicated guidelines
    (Which you do not need to know)
 Certain other deductions to the extent
 that they exceed 2% of Adjusted Gross
    e.g., professional journals, union dues, tax
    return preparation, business entertainment

          Personal Income Tax
 Exemption - A reduction in taxable
  income because you “are” (i.e., you be).
 Exemptions are also available for
 Dependents must meet 4 criteria.
     Close relative or effectively a family member
     Had income < $2,150
        The law makes exceptions for children under age
        19 or full-time college students under age 24.
     Got > half of support from taxpayer
     Did not file a joint return with a spouse

          Personal Income Tax
   Your taxable income is
  understated. You cannot
claim Babe as an exemption!

     Personal Income Tax
Marginal Tax Rate - The rate applied to
the next dollar of taxable income.
 This relates to the fact that personal tax
  rates are graduated.
 It means that while a single taxpayer with
  taxable income of $50,000 is in the “31%
  bracket”, he or she is taxed at that rate on
  only $700. (See Rate Schedule on p. 29)
 It also means that the person who says “I
  don’t want more income this year because
  it will throw me into a higher tax bracket”
  doesn’t have a clue!

     Personal Income Tax
Effective Tax Rate - The average rate of
taxation on a given amount of taxable
   Effective   =     Total Taxes Paid
   Tax Rate        Total Taxable Income

       Personal Income Tax
               Rates Example
 Assume that a Tom (a single taxpayer) has
 taxable income of $63,000. Using the rate
  schedule in the handout, his tax liability,
marginal tax rate and average tax rate would
         be determined as follows:
Tax on income up to $49,300                 $11,158
Tax on income above $49,300
  (31% x $13,700 [$63,000 - $49,300])         4,247
Tax Liability                         $15,405

              Marginal tax rate = 31%
     Average tax rate = $15,405/$63,000 = 24.5%


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