Banking Academy City University of Seattle

TAXATION

PERSONAL INCOME TAX

IN THE UNITED STATE

Group’s member:

Nguyễn Như Nam (C)

Phan Thu An

Nguyễn Thùy Dung

Hoàng Bá Sơn

Ngô Thị Ánh Tuyết

Date: 15/12/2014

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Table of Contents

PART 1. The review on the tax system in the United States....21. The tax administration system in United States...........22. The tax policy system in United States...................3

PART 2. The review of the main content of the tax laws.......5I. The scope of application................................51. Taxable incomes......................................52. Non-taxable..........................................73. Payers...............................................7

II. The taxation bases.....................................9III. The tax calculation method...........................101. Gross Income........................................102. Adjusted gross income...............................173. Tax Credits.........................................174. Tax Rates...........................................205. Deductions and exemptions...........................22

IV. Tax declaration, submission and refund................321. Declaration.........................................322. Submission..........................................333. Refund..............................................34

REFERENCES..................................................36

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PART 1. The review on the tax system in the United

States

Taxation is an important for each country. Taxation provides a

material to distribute economic resources towards those with

low incomes or special needs. Taxes provide the revenue needed

for critical public services such as social security, health

care, national defense, and education.

1. The tax administration system in United States

The U.S. system of tax administration is based on the

principle of self-assessment. In a self-assessment system,

taxpayers calculate and pay their own taxes without the

intervention of a tax official. If this is not done

appropriately and within the prescribed timeframes, the tax

administration detects this failure and takes appropriate

enforcement action, including applying the penalties provided

for in the law. Tax administrations generally accept tax

returns at face value at the time of filing, at which time the

tax due is paid. Under an administrative assessment system,

the responsibility is on the tax administration to examine tax

returns and financial statements, calculate the amount of tax

payable, and notify the taxpayers of the tax liability for key

features of the administrative assessment system (Okello,

2014).

Box 1. Key features of the administrative assessment system

Taxpayers report on their activities on an annual basis.

Reporting consists of completion of a tax return and filing

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financial statements, and other supporting information to the

tax administration.

Tax returns and the supporting financial statements are

reviewed and verified by tax officials.

The tax administration makes the decision on the tax

liability and informs the taxpayer of what to pay, typically

through a notice of assessment.

Taxpayers pay the tax due or object to the assessment.

The tax administration reconciles assessment notices and

payments.

In the United States, tax law originates with the United

States Congress. However, most of the detailed tax rules are

actually enacted by the Department of the Treasury, which is

an agency of the United States government, and its sub

agency, the Internal Revenue Service (IRS). Regulations

issued by the Department of the Treasury must conform both to

the Tax Code, which is the law enacted by Congress and to any

constitutional requirements; otherwise, the regulation may be

voided by the courts. Because the amount of taxes that must

be paid depends on transactions, especially the receipt of

income, tax authorities depend heavily on self reporting by

those who are taxed, that may be subject to review by the IRS

through audits (William, 2014).

United States divided into federal and state, so organization

of federal, state and local tax administrations varies

widely. Every state maintains a tax administration. A few

states administer some local taxes in whole or part. 4

The federal taxes are administered by the IRS, which is part

of the Department of the Treasury. Alcohol, tobacco, and

firearms taxes are administered by the Alcohol and Tobacco Tax

and Trade Bureau (TTB). Taxes on imports (customs duties) are

administered by U.S. Customs and Border Patrol. TTB is part of

the Department of Justice and CBP belongs to the Department of

Homeland Security.

Every state in the United States has its own tax

administration, subject to the rules of that state's law and

regulations. These are referred to in most states as the

Department of Revenue or Department of Taxation. The powers of

the state taxing authorities vary widely. Most enforce all

state level taxes but not most local taxes. However, many

states have unified state-level sales tax administration,

including for local sales taxes. State tax returns are filed

separately with those tax administrations, not with the

federal tax administrations. Each state has its own procedural

rules, which vary widely.

Most localities within the United States administer most of

their own taxes. In many cases, there are multiple local

taxing jurisdictions with respect to a particular taxpayer or

property. For property taxes, the taxing jurisdiction is

typically represented by a tax assessor/collector whose

offices are located at the taxing jurisdiction's facilities.

2. The tax policy system in United States

Tax Policy develops and implements tax policies and programs;

reviews regulations and rulings to administer the Internal

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Revenue Code, negotiates tax treaties, provides economic and

legal policy analysis for domestic and international tax

policy decisions. It also provides estimates for the

President's budget, fiscal policy decisions, and cash

management decisions (Roach, 2010).

Tax policy affect to economic consequences, both for the

national economy and for particular groups in the economy. Tax

policies are made with the intention of stimulating economic

growth. Tax policy clearly reflects the expression of power in

the U.S. Those without power or favor are left paying more in

taxes while others reach the benefits of lower taxes because

of their political influence. Tax policy has clearly been used

to promote political, as well as economic, agendas (Roach,

2010).

To know clearly about tax policy, we have to look at tax

policy objectives. The following tax policy objectives have

been deemed desirable by their prevalence in the literature,

by the prevalence of their citations, and because they are

commonsensible.

According to Adam Smith in Tax policy objectives (William,

2014), in his Wealth of Nations, listed what he called the

cannons of taxation, which still has validity today:

Ability to Pay. The taxpayer should pay an amount based on

his ability to pay, which is dependent on his income.

Certainty. A desirable tax structure should be predictable

and consistent, meaning that the taxpayer should know when,

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where, and how the tax will be levied, so that individuals

and businesses, and other organizations can readily ascertain

the tax consequences of any endeavor or transaction. Of

course, this is a desirable characteristic of any law.

Good Timing. Taxes should be assessed when the taxpayer is

most able to pay. This principle was particularly apt in Adam

Smith's day, when most people were farmers and made most of

their money at particular times of the year. Nowadays, with

most economies being highly diversified, good timing has much

less relevance. However, modern economies did adopt Adam

Smith's maxim that taxes are easier to pay if they are paid

in portions periodically, which most nations impose on its

taxpayers by requiring employers to withhold taxes from the

pay of employees and by requiring self-employed individuals

to make estimated tax payments.

Economy. Collection costs by the government and compliance

costs by the taxpayer should be minimized. Minimizing

collection costs leaves more money for the government to

carry out its functions. Minimizing compliance costs leaves

more time and money for the taxpayer.

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PART 2. The review of the main content of the tax

laws

I. The scope of application

1. Taxable incomes

The Internal Revenue Code states that "gross income means all

income from whatever source derived," and gives specific

examples”. Gross income is not limited to cash received. "It

includes income realized in any form, whether money, property,

or services. Gross income includes wages and tips, fees for

performing services, gain from sale of inventory or other

property, interest, dividends, rents, royalties, pensions,

alimony, and many other types of income. Items must be

included in income when received or accrued. The amount

included is the amount the taxpayer is entitled to receive.

Gains on property are the gross proceeds less amounts

returned, cost of goods sold, or tax basis of property sold.”

Certain types of income are subject to tax exemption. Among

the more common types of exempt income are interest on

municipal bonds, a portion of Social Security benefits, life

insurance proceeds, gifts or inheritances, and the value of

many employee benefits.

Taxable income can encompass more than just your annual

salary.  Taxable income can include profits from stocks or

real estate sales, winnings from the lottery, betting the dogs

or horses, and winnings from any casino (domestic or abroad).

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Even the cash value of bartered items is considered taxable

income.

Income that may be part of your gross income but is not

identified as taxable income would include child support,

proceeds from life insurance policies, inheritances, workers

compensation payments, welfare benefits, compensation awarded

as a result of physical injury, education scholarships or

grants, and income paid to your retirement account (either a

401k or IRA, up to a certain amount).

Itemized deductions that can minimize your taxable income

include medical expenses and health insurance, as well as the

cost of prescriptions, and the mileage to/from your doctors

appointments.  Itemized deductions also include mortgage

interest paid on a home loan, personal losses due to theft or

accident, state and local income or sales taxes, property

taxes (on real estate as well as personal property),

charitable contributions to churches and other qualified

nonprofit organizations, gambling losses  (provided they are

offset by gambling winnings), and home office expenses.

The standard deduction to reduce your taxable income will be

based on your filing status and changes from year to year,

depending on inflation. There is a higher standard deduction

for individuals who are blind, and those aged 65 or older.  In

addition to the standard deduction, you may claim deductions

for real estate taxes, (net) loss sustained as a result of a

Federally Declared Disaster, and taxes on federally-sponsored

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programs (which may include energy-efficient vehicle

purchases, appliances, etc.).

In summary, taxable income is that portion of your gross

income which is subject to taxation by the governing

authority, less any allowable itemized or standardized

deductions.

Types of Income Subject to Tax

The following categories represent types of income, which may

be subject to Federal/State income tax, as set forth by the

IRS:

Wages and salaries

Tip income

Interest received

Dividends

Business income

Capital gains and losses

Pensions and annuities

Lump-sum distributions

Rollovers from retirement plans

Rental income and expenses

Farming and fishing income

Earning for Clergy

Unemployment compensation

Gambling income and losses

Bartering income

Scholarship and Fellowship grants

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Social Security and equivalent Railroad Retirement

Benefits

401(k) plans

Passive activities (losses and credits)

Stock options

Exchange of Policyholder Interest for stock

Canceled debt

Alimony and child support

For a complete list of the types of income subject to tax, see

the IRS Publication 525 (Taxable and Nontaxable Income).

2. Non-taxable

The Internal Revenue Service (IRS) defines income as any

money, property or services you receive. The government says

that all types of income are taxable unless specifically

excluded by law. (F. Amy, 2013)

Disability insurance payments.

Employer-Provided Insurance.

Gift Giving of Up-to $13,000; Gift Receipt of Any Amount.

Life Insurance Payouts.

Sale of Principal Residence.

Life insurance payouts.

Sale of principal residence.

Up to $3000 of income offset by capital losses.

Income earned in nine States.

Corporate income earned in five States.

Inheritance.

Municipal bond interest.

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Child support payments

Meals and Lodging for the convenience of your employer

Compensatory Damages awarded for physical injury or

physical sickness

Welfare Benefits

Cash Rebates from a dealer or manufacturer

3. Payers.

U.S. citizens and resident aliens are subject to tax on their

worldwide income, regardless of source. U.S. citizens and

resident aliens may exclude, However, it up to $97,600

(for 2013) of their foreign earned income plus certain

housing expenses if they meet specified qualifying tests and

if they file U.S. tax returns to claim the exclusion.

A non-resident alien is subject to U.S. tax on income that is

effectively connected with a U.S. trade or business and on

U.S.-source fixed or determinable, annual or periodic

gains, profits and income (generally investment income,

including dividends, royalties and rental income). U.S.

–source investment income is taxed on a gross basis at a flat

rate of 30%. (The worldwide persona tax guild 2013-2014)

Residence status for tax purposes

Residence for income tax purposes generally has no bearing on

an individual’s immigration status.

Generally, foreign nationals may be considered resident aliens

if they are lawful permanent residents (“green card”

holders) or if their physical presence in the United

States lasts long enough under a substantial presence12

test. Under the substantial presence test, a foreign national

is deemed to be a U.S. resident if the individual fulfils both

of the following conditions:

• The individual is present in the United States for at least

31 days during the current year.

• The individual is considered to have been present for at

least 183 days during a consecutive 3-year test period that

includes the current year, using a formula weighted with the

following percentages:

• Current year – 100%

• 1st preceding year – 33.33%

• 2nd preceding year – 16.67%

Among several exceptions to the substantial presence test are

the following:

• Days present as a qualified student, teacher or trainee, or

if a medical condition prevented departure, are not counted.

• An individual might claim to be a non-resident of the

United States by virtue of having a closer connection (such as

a tax home) to a foreign country.

• Bilateral income tax treaties may override domestic U.S.

tax rules for dual residents.

In certain circumstances, it may be beneficial for an

individual to be considered a resident of the

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United States for income tax purposes. An individual may make

what is known as a first-year election to be treated as a

resident in the year of arrival if certain conditions are met.

II. The taxation bases

The individual income tax is based on earnings individuals

accrue from a variety of sources. Included in the individual

income tax base are wages, salaries, tips, taxable interest

and dividend income, business and farm income, realized net

capital gains, income from rents, royalties, trusts, estates,

partnerships, taxable pension and annuity income, and alimony

received.

The tax base is reduced by adjustments to income, including

contributions to Keogh and traditional IRAs, some interest

paid on student loans and higher education expenses,

contributions to health savings accounts, and alimony payments

made by the taxpayer. This step of the process produces

adjusted gross income (AGI), which is the basic measure of

income under the federal income tax. Deductions from the

income tax base that result in an individual’s AGI are also

known as “above the line” deductions. These deductions are

available to all taxpayers, whether the taxpayer chooses to

take the standard deduction or itemize deductions.

The tax base is further reduced by either the standard

deduction or individuals’ itemized deductions. Itemized

deductions are allowed for home mortgage interest payments,

state and local income taxes, state and local property taxes,

charitable contributions, medical expenses in excess of 10% of

AGI, and for a variety of other items. For taxable years 200414

through 2013, at the election of the taxpayer, state and local

sales taxes can be deducted as an alternative to state and

local income taxes.

The tax base is reduced further by subtracting personal and

dependent exemptions. Exemptions are a fixed amount to be

subtracted from AGI. Exemptions are allowed for the taxpayer,

the taxpayer’s spouse, and each dependent. In 2014, the

exemption amount per person is $3,950. If a taxpayer was

married and had one child being claimed as a dependent, the

exemption would be $11,850 (= $3,950 * 3). For taxpayers with

high levels of AGI, the personal and dependent exemptions are

phased out. Federal income taxes are assessed on a taxpayer’s

taxable income. Taxable income equals AGI reduced by either

the standard deductions or itemized deductions and personal

and dependent exemptions.

The tax liability depends on the filing status of the

taxpayer. There are four main filing categories: married

filing jointly, married filing separately, head of household

and single individual. The computation of a taxpayer’s tax

liability depends on their filing status.

The income tax system is designed to be progressive, with

marginal tax rates increasing as income increases. At a

particular marginal tax rate, all individuals, regardless of

their level of earnings, pay the same tax rate on their first

dollar of taxable income. Once a taxpayer’s income surpasses a

threshold level placing them in a higher marginal tax bracket,

the higher marginal tax rate is only applied on income that

exceeds that threshold value. Currently, the individual income

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tax system has seven marginal income tax rates: 10%, 15%, 25%,

28%, 33%, 35%, and 39.6%. These marginal income tax rates are

applied against taxable income to arrive at a taxpayer’s gross

income tax liability.

After a taxpayer’s tax liability has been calculated, tax

credits are subtracted from gross tax liability to arrive at a

final tax liability. Major tax credits include the earned

income tax credit, the child tax credit, education tax

credits, and the credit for child and dependent care expenses.

Not all income is subject to the marginal income tax rates

noted above. Long-term capital gains— that is, gain on the

sale of assets held more than 12 months—and qualified dividend

incomes are taxed at lower tax rates. Net investment income is

also subject to an additional tax for taxpayers above certain

income thresholds (Internal Revenue Service, 2014).

III. The tax calculation method

This is the formula to calculate federal personal income tax:

Gross income - above the line deductions = Adjusted gross

income (AIG)

Adjusted gross income – standard or itemized Deduction -

exemptions = Taxable income.

Taxable income * proportion of taxable income (ordinary, capital

gain, ATM) = Gross Tax

Gross Tax – tax credit - withholding – quarterly estimated

payment = Tax owed (refund due)

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1. Gross Income

According to the IRS, the gross income of an individual is all

income that is received in the form of money, goods, property

and services that is not exempt from tax. In general, gross

income must be segregated into the following three separate

baskets: earned income, portfolio income, and passive income.

There are a number of forms of what would broadly be defined

as income that are excluded from taxable income in practice.

For example, wage income of employees is taxed, although most

contributions to employee pension and health insurance plans

and certain other employee benefits are not included in wages

subject to income tax. Employer contributions to Social

Security are also excluded from wages. When pensions are

received, they are included in income to the extent that they

represent contributions originally excluded. If the taxpayer

has the same tax rate when contributions are made and when

pensions are received, this treatment is equivalent to

eliminating tax on the earnings of pension plans. Some Social

Security benefits are also subject to tax.

1.1 Earned income

Earned income is any income that is generated by working. Your

salary or money made from hourly employment (regardless of

whether that salary or hourly income came from working for

someone else or from your own “consulting”) is considered

earned income. Some activities that generate earned income

include: Working a job, owning a small business, consulting,

gambling and any other activity that pays based on time or17

effort spent. Examples of earned income are: wages; salaries;

tips; and other taxable employee compensation. Earned income

also includes net earnings from self-employment. Earned income

does not include amounts such as pensions and annuities,

welfare benefits, unemployment compensation, worker's

compensation benefits, or social security benefits.

While earned income is the most common mechanism for making

money, its obvious downside is that once you stop working, you

stop making money. Additionally, because the amount of money

that is made through earned income is directly proportional to

the time and effort you spend working, it’s difficult for

someone to make more earned income without either learning a

new (or more valuable) skill or working longer hours.

Additionally, earned income is taxed at a higher rate than any

other type of income.

One huge benefit of earned income over the other income types

is that you generally don’t need any startup capital in order

to make earned income, which explains why most people rely on

earned income from the start of their working life. In fact,

earned income is a great way to start your investing career,

as it allows you to save up cash that will help you generate

the other two types of income…

Employment income

In addition to cash payments, taxable salary generally

includes all employer-paid items, except qualifying moving

expenses, medical insurance premiums, pension contributions to

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a U.S. qualified plan and, for individuals on short-term

assignments of one year or less, meals and temporary housing

expenses.

Education allowances

Education allowances provided by employers to their employees’

children are taxable for income and social security tax

purposes. In general, a nonresident alien who performs

personal services as an employee in the United States at any

time during the tax year is considered to be engaged in a U.S.

trade or business. An exception to this rule applies to a non-

resident alien performing service in the United States if all

of the following conditions apply:

The services are performed for a foreign employer.

The employee is present no more than 90 days during the

tax year.

Compensation for the services does not exceed $3,000.

These conditions are similar to those contained in many income

tax treaties, although the treaties often expand the time

limit to 183 days and increase or eliminate the maximum dollar

amount of compensation. If an employee does not fall under the

above statutory exception or under a treaty exception, all

U.S.-source compensation received in that year is considered

effectively connected income (not just the amount exceeding

the $3,000 limitation or the dollar limitation under a

treaty). This income includes wages, bonuses and

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reimbursements for certain living expenses paid to, or on

behalf of, the employee. (Earn and Young, 2014)

Compensation

Compensation is considered to be from a U.S. source if it is

paid for services performed in the United States. The place

where the income is paid or received is irrelevant in

determining its source. If income is paid for services

performed partly in the United States and partly in a foreign

country, and if the amount of income attributable to services

performed in the United States cannot be accurately

determined, the U.S. portion is determined on a workday ratio

basis. Fringe benefits that meet certain requirements are

sourced to the person’s principal place of work. These

benefits include moving expenses, housing, primary and

secondary education for dependents and local transportation.

Effectively connected income retains its character even if

received before or after a U.S. trade or business ceases

operations. Consequently, wages for services performed in the

United States, but received during a year in which a

nonresident alien reports no U.S. workdays, are taxed at the

graduated rates instead of the flat 30% rate.

States often follow the federal tax treatment in determining

if a nonresident alien’s income is subject to state taxation;

however, certain states tax income of a nonresident regardless

of federal tax treatment or treaty relief. (Earn and Young,

2014)

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Self-employment income

In general, a nonresident alien who performs independent

personal services in the United States at any time during the

tax year is considered to be engaged in a U.S. trade or

business.

Although subject to tax at the graduated rates, compensation

paid to a nonresident alien for performing independent

personal services in the United States is subject to a 30%

withholding tax. A nonresident alien must file a U.S. tax

return to claim a refund or to pay any additional tax due. If

compensation is exempt from U.S. tax under an income tax

treaty or if the amount paid is not greater than the personal

exemption amount ($3,900 in 2013), a nonresident alien may

request exemption from withholding by preparing Form 8233,

Exemption from Withholding on Compensation for Independent

Personal Services of a Nonresident Alien Individual, and then

giving it to the withholding agent (payer). In addition, many

U.S. income tax treaties contain separate provisions affecting

the taxation of independent personal services income.

Income from operating a business through a proprietorship,

partnership, or small business corporation that elects to be

treated similarly to a partnership or through rental property

(which reflects returns to both investment and effort) is also

subject to tax. This income is the net of gross receipts

reduced by such deductible costs as payments to labor,

depreciation, costs of goods acquired for resale and other

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inputs, interest, and taxes. Some investment income of small

businesses is subject to favorable treatment through

provisions that allow costs of capital equipment to be

expensed. Other income, such as miscellaneous income, gambling

winnings, and royalties, is also included in the tax base.

(Earn and Young, 2014)

Directors’ fees

In general, directors’ fees are considered to be earnings from

self-employment.

Deferred compensation and participation in foreign pension plans

The United States has very complex rules regarding the

taxation of deferred compensation. If a plan of deferral does

not meet the requirements of the law, significant penalties

and interest may be charged. Complex rules apply to the

taxation related to participation in a non-U.S. retirement

plan. In many cases, continued participation in the home

country plan may result in income that is taxable in the

United States. Certain newer income tax treaties attempt to

address this issue.

1.2 Portfolio incomePortfolio income certain come from investments, dividends,

interest, royalties and capital gains. Various types of

portfolio income are taxed differently. For example, capital

gains on investments held for longer than 12 months are taxed

at a rate of 10% to 20%, and those held for less than 12

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months are taxed as regular income. However, portfolio income

is not subject to social security and Medicare taxes.

One of the major benefits of capital gains is that it can be

offset by losses on other investments. Therefore, if one stock

earns $10,000 and another loses $9,000, your capital gain

based on that information alone would only be $1,000. ( IRS,

2014).

Qualified stock option plans

Under incentive stock option (ISO) rules, options provided to

employees under qualified stock option plans are not subject

to tax at the time the option is granted or at the time the

employee exercises the option and buys the stock. However, at

the time of exercise, the difference between the exercise

price and the fair market value of the stock at the date of

exercise is considered a tax preference item for AMT purposes

Tax is levied at capital gains tax rates when the employee

sells the stock. The employee’s basis in the stock is the

amount paid for the stock at the time the option is exercised.

Consequently, the employee recognizes a capital gain or loss

in the amount of the difference between the sale price and the

grant price. For purposes of determining whether the capital

gain is long-term or short-term, the holding period begins on

the date after the option is exercised, not on the date the

option is granted. Stock purchased under an incentive stock

option may not be sold within two years from the grant date

and within one year from the exercise date. If the stock is

sold before the expiration of the required holding period, any

gain on the sale is treated as ordinary income.

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Nonqualified stock option plans

A stock option provided to an employee under a nonqualified

plan is taxed when it is granted if the option has a readily

ascertainable fair market value at that time. An option that

is not actively traded on an established market has a readily

ascertainable fair market value only if all of the following

conditions are met:

The option is transferable.

The option is exercisable immediately and in full when it

is granted.

No conditions or restrictions are placed on the option

that would have a significant effect on its fair market

value.

The fair market value of the option privilege must be

readily ascertainable.

The above conditions are seldom satisfied. Consequently, most

nonqualified options that are not traded on an established

market do not have a readily ascertainable fair market value

and are not taxable at the date of grant.

The exercise of a nonqualified stock option triggers a taxable

event. An employee recognizes ordinary income in the amount of

the value of the stock purchased, less any amount paid for the

stock or the option. When the stock is sold, the difference

between the sale price and the fair market value of the stock

at the date of exercise, if any, is taxed as a capital gain.

(Earn and Young, 2014)

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Capital gains and losses

Net capital gain income is taxed at ordinary rates, except

that the maximum rate for long-term gains is limited to the

following:

0% for individuals in the 10% or 15% bracket

20% for individuals in the 39.6% bracket

15% for individuals in all other brackets

Net capital gain is equal to the difference between net long-

term capital gains over net short-term capital losses. Long-

term refers to assets held longer than 12 months. Short-term

capital gains are taxed as ordinary income at the rates set

forth in Rates.

Investors who hold qualified small business stock for longer

than five years may be entitled to exclude up to 100% of the

gain realized on disposition of the stock.

Once every two years, U.S. taxpayers, including resident

aliens, may exclude up to $250,000 ($500,000 for married

taxpayers filing jointly) of gain derived from the sale of a

principal residence. To be eligible for the exclusion, the

taxpayer must generally have owned the residence and used it

as a principal residence for at least two of the five years

immediately preceding the sale. However, if a taxpayer moves

due to a change in place of employment, for health reasons or

as a result of unforeseen circumstances, a fraction of the

maximum exclusion amount is allowed in determining whether any

taxable gain must be reported. The numerator of the fraction25

is the length of time the home is used as a principal

residence, and the denominator is two years. The repayment of

a foreign currency mortgage obligation may result in a taxable

exchange-rate gain, regardless of any economic gain or loss on

the sale of the principal residence. For sales occurring after

2008, part of the gain on the sale of a principal residence

may not be eligible for exclusion. To the extent the taxpayer

has “nonqualified use” of the property (after 2008), that

portion of the gain (determined on a time basis over the total

holding period of the property) is not eligible for exclusion

from income. A complex set of rules applies to determine

whether a particular use of the property, such as renting out

the property or leaving it vacant, is considered a

“nonqualified use.”

Capital losses are fully deductible against capital gains.

However, net capital losses are deductible against other

income only up to an annual limit of $3,000. Unused capital

losses may be carried forward indefinitely. Losses

attributable to personal assets (for example, a personal

residence or an automobile) are not deductible (Earn and

Young, 2014).

Dividends

Dividends received by individuals from domestic corporations

and “qualified foreign corporations” are taxed at the same

special rates as those applicable to net capital gains, for

both the regular tax and the alternative minimum tax.

Consequently, dividends are taxed at the following rates:26

0% for individuals in the 10% or 15% bracket

20% for individuals in the 39.6% bracket

15% for individuals in all other brackets

To qualify for the 15% (or 0% or 20%) tax rate, the

shareholder must hold a share of stock for more than 60 days

during the 120-day period beginning 60 days before the ex-

dividend date. Other dividends are taxed at ordinary rates.

1.3 Passive capital income

Passive income is money you get from assets you have purchased

or created. For example, if you were to buy a house and rent

it out for more money than it costs you to pay your mortgage

and other expenses, the profit you make would be considered

passive income. Some activities that generate passive income

include:

Rental Income or Note Income from Real Estate

Business Income (assuming it’s not earned based on

amount of time/effort spent — that would be Earned

Income)

Creating and Selling Intellectual Property — Books,

Patents, Internet Content, etc.

Affiliate or Multi-Level Marketing

Special rules regarding passive activity losses were enacted

in 1986 to limit the amount you could reduce your tax

liability from passive income. However, you can still reduce

your non-passive income up to $25,000 if your income is below

27

$150,000 and you actively participate in passive rental real

estate activities. This amount is phased out between $100,000

and $150,000. Other than this exception, you may only claim

losses up the amount of income from the activity. Losses that

cannot be claimed are carried forward until the property is

disposed of or there is adequate income to offset the loss.

Real property and other types of investments, if they qualify,

may also be used in a 1031 exchange to avoid paying taxes on

the income from the sale of the property. This only applies if

the proceeds from the sell are used to purchase a similar

investment (Internal Revenue Service, 2014).

2. Adjusted gross income

An individual’s adjusted gross income (“AGI”) is determined by

subtracting certain “above-the-line” deductions from gross

income. . As was mentioned in the formula, deductions and

exemptions are subtracted from AGI to determine taxable

income. These deductions include, among other things, trade or

business expenses, losses from the sale or exchange of

property, deductions attributable to rents and royalties,

contributions to pensions and other retirement plans, certain

moving expenses, and alimony payments.

3. Tax Credits

Tax credits offset tax liability on a dollar-for-dollar basis.

Over time, tax credits have become an increasingly popular

method of providing tax relief and social benefits. There are

two different types of tax credits: those that are refundable

and those that are non-refundable. If a tax credit is28

refundable, and the credit amount exceeds tax liability, a

taxpayer receives a payment from the government. The earned

income credit is refundable, and the child tax credit is

refundable for all but very low-income families. If credits

are not refundable, then the credit is limited to the amount

of tax liability. In some cases, unused credits can be carried

forward to offset tax liability in future tax years. Non-

refundable credits provide limited benefits to many middle-

and lower income individuals who have little or no tax

liability. Many credits are phased out as income rises and

thus do not benefit higher income individuals. These phase out

points vary considerably across different credits. Tax credits

are available for a wide variety of purposes. The major

individual income tax credits are described below.

Child Tax Credit

The child tax credit allows qualifying taxpayers to receive a

credit of up to $1,000 per qualifying child. The credit for

taxpayers with children under 17 was adopted in 1997, and was

originally set at $400 for each qualifying child. Subsequent

legislation in 2001, 2003, and 2004 increased the credit to

$1,000 and made the credit partially refundable. Legislation

in 2008, 2009, and 2010 temporarily expanded eligibility for

the refundable portion of the credit. The American Taxpayer

Relief Act made permanent the $1,000 per qualifying child

credit, and extended provisions allowing for greater refund

ability through 2017. Through 2017, the credit is at least

partially refundable for taxpayers with at least $3,000 in

earnings (after 2017, earnings must exceed $10,000, adjusted

29

for inflation, for the credit to be refundable). This credit

is phased out for higher income families.

Dependent Care Credit

This credit is provided for the costs of paid care for

dependents, mostly children. The maximum credit rate is 35% of

costs. The value of the credit is capped at $3,000 for one

dependent and $6,000 for two or more dependents. The credit

rate is reduced when the taxpayer’s adjusted gross income

(AGI) exceeds $15,000, but is no less than 20% for higher-

income taxpayers. The credit is nonrefundable. The current

credit amounts were first set under EGTRRA and made permanent

under ATRA.

Earned Income Tax Credit

The earned income tax credit (EITC) supplements wages for

lower-income families and individuals. Since the 1990s, the

EITC has been a major component of the federal government’s

poverty reduction strategy and is currently the largest anti-

poverty cash entitlement program. For 2014, the maximum credit

amount for taxpayers with three or more children is $6,143.

The EITC is refundable (otherwise, it could not fulfill its

function). Since the EITC is designed to supplement wages, it

phases in for lower-income taxpayers. The tax credit phases

out as incomes exceed certain thresholds. In 2014, for married

taxpayers with three or more children, the EITC begins to

phase out once income reaches $23,260 and is fully phased out

once income reaches $52,427.

Higher Education Credits

30

The Hope credit and the Lifetime Learning credit were added to

the code in 1997. The Hope credit has been temporarily

replaced by the American Opportunity Tax Credit (AOTC) for

2009 through 2017. The maximum value of the AOTC credit is

$2,500 per student annually for the first four years of

college. Prior to 2009, the maximum value of the Hope credit

was $1,800, limited to the first two years of college. The

Hope credit is scheduled to remain available after the AOTC

expires at the end of 2017. The AOTC is partially refundable.

Both the Hope credit and the AOTC phase out for higher-income

individuals.

Additionally, qualified expenditures on tuition and related

expenses may qualify taxpayers for the Lifetime Learning

credit. The Lifetime Learning credit rate is 20% of costs up

to $10,000 for qualified tuition and related expenses. The

credit is capped at $2,000. The Lifetime Learning credit is

nonrefundable and phases out for higher-income individuals.

Alternative Minimum Tax

Individuals may also pay tax under the alternative minimum tax

(AMT). Under current law, to calculate the AMT, an individual

first adds back various tax items, including personal

exemptions and certain itemized deductions, to regular taxable

income. This grossed up amount becomes the income base for the

AMT. Next, for 2014, an exemption of $82,100 for joint returns

and $52,800 for single returns is subtracted from this income

base to obtain AMT taxable income. These exemption levels are

indexed for inflation. The basic exemptions are phased out for

taxpayers with high levels of AMT income. A two-tiered rate

31

structure of 26% and 28% is then assessed against AMT taxable

income. The taxpayer compares his AMT tax liability to his

regular tax liability and pays the greater of the two.

Most nonrefundable personal tax credits are allowed against

the AMT .Temporary provisions, first enacted in 1998, allowed

individuals to use all personal tax credits against both their

regular and AMT tax liabilities. The American Taxpayer Relief

Act made permanent provisions that allow most nonrefundable

personal tax credits against the AMT (Internal Revenue

Service, 2014).

4. Tax Rates

Tax rate schedules for individuals include joint returns for

married couples, single returns, and head of household returns

for single individuals with dependents. Married couples can

file separate returns; the brackets in these schedules are

half as wide as brackets in the joint return, so there is no

tax rate advantage in filing such a return. Current tax rate

schedules were set as part of the American Taxpayer Relief

Act. As was noted above, income earned from long-term capital

gains and dividends is taxed at lower rates. The maximum rate

on long-term capital gains and dividends is 20%. This 20% rate

applies to taxpayers in the 39.6% bracket (single filers with

taxable income above $406,750; married filers with taxable

income above $432,200). Taxpayers in the 25%, 28%, 33%, and

35% tax brackets face a 15% tax rate on long-term capital

gains and dividends. The tax rate on capital gains and

dividends is 0% for taxpayers in the 10% and 15% tax brackets.

32

The individual income tax rate schedules for 2014 which have

sources from IRS are shown in the under:

Single taxpayer:

Married Filing Jointly and Surviving Spouses:

Head of household

Married Filing

Separately:

Given the

complexities of the tax code, most taxpayers do not pay the

marginal tax rates associated with their tax bracket. Various

tax provisions are available to individuals depending on their

level of income. For example, the earned income tax credit

(EITC) phases in as income increases, reducing a taxpayer’s

marginal tax rate. At higher income levels, as the credit

phases out, the taxpayer faces a higher marginal tax rate

during that phase out range. Higher-income individuals with a33

high ratio of exemptions and deductions to income may be

subject to the alternative minimum tax (AMT). There are two

marginal tax rates under the AMT, 26% and 28%, that are

applied to an expanded base (Internal Revenue Service, 2014).

5. Deductions and exemptions

5.1 What are Tax Deduction?Simply stated, deductions reduce taxable income. Each

deduction reduces tax liability by the amount of deduction

times the tax filer’s marginal tax rate. In contrast, a tax

credit reduces tax liability on a dollar-for-dollar basis

because it would be applied after the marginal tax rate

schedule. First, they can account for large, unusual, and

necessary personal expenditures, such as the deduction for

extraordinary medical expenses. Second, they are used to

encourage certain types of activities, such as homeownership

and charitable contributions. Third, they account for and ease

the burden the burden of paying for non-federal forms of

taxes, such as state and local taxes. Fourth, deductions

adjust for the expenses of earning income, such as deductions

for work-related employee expenses.

As previously discussed, tax filers have the option to claim

either a standard deduction or the sum of their itemized

deductions. Whichever deduction the tax filer claims—standard

or itemized— the deduction amount is subtracted from AGI to

arrive at final tax liability

34

5.2 How does it work?Individual tax payers are allowed a choice when preparing

their income tax returns. They canitemize their

deductions from a list of allowable items and subtract those

itemized deductions and their personal exemption

deductions from their AGI to get their Taxable Income. Or they

can choose to subtract the standard deduction and

their personal exemptions. The choice between standard and

itemized deduction depends on:

A comparison between both types of deductions: whatchoice gives more money to subtract?

Do you have kept records of the items you want tosubtract? - you need them as prove.

If you are filing as 'Married', Filing separately', andyour spouse itemizes, you have to do that to.

5.3 Standard Deduction AmountsThe standard deduction is a fixed amount, based on filing

status, available to all taxpayers. s. In contrast to those

itemizing their deductions, tax filers do not have to provide

additional documentation in order to claim the standard

deduction.

The standard deduction was introduced into the federal tax

code with the passage of the Individual Income Tax Act of 1944

(P.L. 78-315) primarily to simplify tax administration and

compliance. At the time of passage, it was noted that

taxpayers generally had little idea about what deductions were

allowable and few taxpayers kept accurate records. Thus, the

enactment of the standard deduction reduced excessive

unsupportable claims of deductions, although at the same time35

it permitted many taxpayers to take a deduction in excess of

what they would have been allowed if they had been required to

itemized their deductions

The standard deduction amount varies depending on the filing

status of the tax unit (i.e., single, married filing jointly,

married filing separately, or head of household), whether the

tax filer is over the age of 65, and whether the tax filer is

blind.

Five filing statuses

Tax filer must determine their filing status before

determining whether they must file a tax return, their

standard deduction (discussed later), and their tax. Tax

filers also use their filing status to determine whether they

are eligible to claim certain other deductions and credits.

There are five filing statuses:

Single,

Married Filing Jointly,

Married Filing Separately,

Head of Household, and

Qualifying Widow(er) With Dependent Child.

If more than one filing status applies to tax filers, they

should choose the one that will give them the lowest tax. Your

filing status is single if you are considered unmarried and

you do not qualify for another filing status.

With married people, if tax filer and his/her spouse each have

income, they may want to figure your tax both on a joint

return and on separate returns (using the filing status of

married filing separately).They can choose the method that36

gives both the lower combined tax - married filing jointly status is

considered for the married and both tax filer and his/her

spouse agree to file a joint return. On a joint return, tax

filer and his/her spouse report their combined income and

deduct their combined allowable expenses. They can file a

joint return even if one of them had no income or deductions.

If tax filer and his/her spouse decide to file a joint return,

his/her tax may be lower than his/her combined tax for the

other filing statuses. Also, his/her standard deduction (if

he/she does not itemize deductions) may be higher, and he/she

may qualify for tax benefits that do not apply to other filing

statuses. If his/her spouse died during the year, he/she are

considered married for the whole year and can choose married

filing jointly as his/her filing status. If they divorced

under a final decree by the last day of the year, they are

considered unmarried for the whole year and they cannot choose

married filing jointly as his/her filing status.

With married filing separately, a tax filer can choose married

filing separately as his/her filing status if they are

married. This filing status may benefit him/her if he/she

wants to be responsible only for his/her own tax or if it

results in less tax than filing a joint return. If the tax

filer and his/her spouse do not agree to file a joint return,

he/she must use this filing status unless he/she qualify for

head of household status

A tax filer may be able to choose head of household filing

status if he/she are considered unmarried because he/she live

apart from his/her spouse and meet certain tests .This can

37

apply to him/her even if they are not divorced or legally

separated. If he/she qualifies to file as head of household,

instead of as married filing separately, his/her tax may be

lower, he/she may be able to claim the earned income credit

and certain other credits, and his/her standard deduction will

be higher. The head of household filing status allows a tax

filer to choose the standard deduction even if his/her spouse

chooses to itemize deductions. A tax filer may be able to

file as head of household if he/she meets all the following

requirements.

He/she is unmarried or considered unmarried on the last

day of the year. He/she paid more than half the cost of

keeping up a home for the year.

A qualifying person lived with him/her in the home for

more than half the year (except for temporary absences,

such as school). However, if the qualifying person is

his/her dependent parent, he or she does not have to live

with her/him

If a person qualifies to file as head of household, hi/her tax

rate usually will be lower than the rates for single or

married filing separately. He/she will also receive a higher

standard deduction than if he/she files as single or married

filing separately.

Furthermore, a person was filed as qualifying widow(er) with

dependent child unless he/she satisfies the following factors

If he/she and his/her spouse died in 2013, you can use

married filing jointly as his/her filing status for 2013

if he/she otherwise qualifies to use that status. The

38

year of death is the last year for which he/she can file

jointly with his/her deceased spouse.

He/she may be eligible to use qualifying widow(er) with

dependent child as your filing status for 2 years

following the year his/her spouse died. For example, if

his/her spouse died in 2012 and he/she have not

remarried, he/she may be able to use this filing status

for 2013 and 2014. The rules for using this filing status

are explained in detail here.

This filing status entitles the tax filer to use joint

return tax rates and the highest standard deduction

amount (if he/she does not itemize deductions). It does

not entitle him/her to file a joint return.

Current Year 2014 Standard Deduction Table

2014

Personal Filing Threshold

http://www.paywizard.org/main/salary/incometax/2014

39

Filing Status Standard Deduction

Single $6,200

Head of Household $9,100

Married Filing Separately $6,200

Married Filing Jointly $12,400

Qualifying Widow(er) $12,400

5.4 Itemizing

5.4.1 Itemized deductions

Alternatively, tax filers claiming itemized deductions must

list each item separately on their tax return and be able to

provide documentation (i.e., in the event of an IRS audit)

that the expenditures have been made. Only individuals with

aggregate itemized deductions greater than the standard

deduction find it worthwhile to itemize. Itemized deductions

are claimed on the IRS Schedule A form. Itemizing deductions

would generally be more advantageous if the sum of all

itemizable expenses works out to be greater than the standard

deduction for the corresponding filing status. The following

set of expenses can, in general, be itemized:

Interest payments to service a mortgage on primary

residence

State and local property taxes

State and local income taxes or, if living in a state

that does not levy income tax, state and local sales tax.

Charitable contributions

Casualty & theft losses

Gambling losses (to the extent that they exceed the gains

from gambling)

Medical expenses to the extent that they are greater than

7.5% of Adjusted Gross Income (AGI)

The itemized deduction amount is subtracted from adjusted

gross income (AGI) in the process of determining taxable

income. Some itemized deductions can only be claimed if they

meet or exceed minimum threshold amounts (also known as a

40

floor) to simplify tax administration and compliance. Floors

usually come in the form of a limit based on a percentage of

AGI. For example, eligible extraordinary medical and dental

expenses must amount to 10% of AGI in order to claim an

itemized deduction in 2014; total expenses less than this

floor are not eligible for an itemized deduction. This floor

makes it simpler for a tax filer to choose whether he or she

would be better off itemizing the deductions or choosing to

claim the standard deduction, and it helps to ensure that the

IRS is only reviewing documentation of fewer, larger events

rather than many, smaller events. Any restriction placed upon

an itemized deduction generally applies prior to the 2% AGI

floor

In addition, some itemized deductions are subject to a cap

(also known as a ceiling) in benefits or eligibility. Caps are

meant to reduce the extent that tax provisions can distort

economic behavior, limit revenue losses, or reduce the

availability of the deduction to higher-income tax filers. For

example, the itemized deduction for home mortgage interest can

only be claimed for the value of interest payments made on the

first $1 million of mortgage debt.Which Itemized Deductions Contribute Most to Revenue

Loss?

Some itemized deductions are classified as tax expenditures,

or losses in federal tax revenue. Tax expenditures are defined

under the Congressional Budget and Impoundment Control Act of

1974 (P.L. 93-344) as “revenue losses attributable to

provisions of the Federal tax laws which allow a special

exclusion, exemption, or deduction from gross income or which41

provide a special credit, a preferential rate of tax, or a

deferral of tax liability.” The top five itemized deductions

that contribute most to tax expenditures in FY2014 are

estimated to account for 18.8% ($208.1 billion) of the

approximately $1.11 trillion in individual tax expenditures,

including mortgage interest deduction, state & local income or

sales taxes, charitable gifts, real estate taxes, medical

expenses.

http://www.fas.org/sgp/crs/misc/R43012.pdf

In addition, there are some limitation on itemized deductions,

as mentioned below

Limits on itemized deductions

Medicalexpenses

Amount exceeding 10 percent of your adjusted grossincome is deductible. The threshold for taxpayersolder than 65 remains at 7.5 percent through the 2016tax year.

Mortgageloaninterest

Generally, fully deductible for loans totaling $1million or less ($500,000 if married filingseparately) on your primary residence or second home.

Home equityloaninterest

Generally, deductible for loans up to $100,000($50,000 if married filing separately) that aresecured by your home.

42

Charitablecontribution

Most are fully deductible as long as the gift amountdoes not exceed 50 percent of AGI.

Casualtylosses

Deductible after subtracting insurancereimbursements, 10 percent of your AGI and $100.

Miscellaneous expenses

Amount exceeding 2 percent of AGI is deductible.

http://www.bankrate.com/finance/taxes/standard-tax-deduction-

amounts.aspx

5.5 Exemption

An exemption is similar to a tax deduction because it lowers

your taxable income. The amount of your exemption is reduced

if your AGI (adjusted gross income) is above a certain level,

based on your Federal filing status. 

There are two types of exemptions you may be able to take:

Personal exemptions for yourself (and your spouse, if

applicable)

Exemptions for dependents (dependency exemptions).

Firstly, about personal exemptions, a tax filer generally

allowed one exemption for himself. If he/she is married,

he/she may be allowed one exemption for your spouse. These are

called personal exemptions, including individual’s exemption

and spouse's exemption. With individual’s exemption the tax

filer can take one exemption for yourself unless you can be

claimed as a dependent by another taxpayer. If another

taxpayer is entitled to claim you as a dependent, you cannot

take an exemption for yourself even if the other taxpayer does

not actually claim you as a dependent. With spouse's

exemption, because a person’s spouse is never considered as

43

dependent, some term should be considered below. About joint

return - on a joint return, a tax filer can claim one

exemption for himself/herself and one for his/him spouse.

About separate return - if you file a separate return, you can

claim an exemption for your spouse only if your spouse had no

gross income, is not filing a return, and was not the

dependent of another taxpayer. This is true even if the other

taxpayer does not actually claim your spouse as a dependent.

You can claim an exemption for your spouse even if he or she

is a nonresident alien; in that case, your spouse must have no

gross income for U.S. tax purposes and satisfy the other

conditions listed above. With head of household - If a tax filer

qualifies for head of household filing status because he/she

is considered unmarried, he/she can claim an exemption for

his/her spouse if the conditions described in the preceding

paragraph are satisfied. With death of spouse - If his/her

spouse died during the year and he/she file a joint return for

himself and his deceased spouse, he/she generally can claim

his/her spouse's exemption under the rules just explained

in Joint return . If he/she files a separate return for the year,

he/she may be able to claim your spouse's exemption under the

rules just described in Separate return. If he/she remarried

during the year, he/she cannot take an exemption for his/her

deceased spouse. If he/she is a surviving spouse without gross

income and he/she remarry in the year his/her spouse died,

he/she can be claimed as an exemption on both the final

separate return of his/her deceased spouse and the separate

return of his/her new spouse for that year. If he/she files a

44

joint return with his/her new spouse, she/he can be claimed as

an exemption only on that return. With divorced or separated

spouse - If a tax filer obtained a final decree of divorce or

separate maintenance during the year, he/she cannot take your

former spouse's exemption. This rule applies even if he/she

provided all of your former spouse's support.

Secondly, about exemptions for dependents, a tax filer is

allowed one exemption for each person he/she can claim as a

dependent. He/she can claim an exemption for a dependent even

if his/her dependent files a return.

The term “dependent” means:

A qualifying child, or

A qualifying relative.

The terms “qualifying child ” and “qualifying relative ” are

defined later.

A tax filer can claim an exemption for a qualifying child or

qualifying relative only if these three tests are met: test,

joint and citizen or resident test.

More specifically, a qualifying child must satisfy the

following five tests are: relationship, age, residency,

support, and joint return. Sometimes, a child meets the

relationship, age, residency, support, and joint return tests

to be a qualifying child of more than one person. Although the

child is a qualifying child of each of these persons, only one

person can actually treat the child as a qualifying child to

take all of the following tax benefits (provided the person is

eligible for each benefit): the exemption for the child, the

child tax credit, head of household filing status, the credit

45

for child and dependent care expenses and the exclusion from

income for dependent care benefits, the earned income credit.

A qualifying relative must meet the following four tests are:

not a qualifying child test, member of household or

relationship test, gross income test, and support test.About

the dependent taxpayer test-If a person can be claimed as a

dependent by another person, he/she cannot claim anyone else

as a dependent. Even if he/she have a qualifying child or

qualifying relative, he/she cannot claim that person as a

dependent. If he/she are filing a joint return and his/her

spouse can be claimed as a dependent by someone else, he/she

and his/her spouse cannot claim any dependents on his/her

joint return. About joint return test- a person generally

cannot claim a married person as a dependent if he or she

files a joint return. He/she can claim an exemption for a

person who files a joint return if that person and his or her

spouse file the joint return only to claim a refund of income

tax withheld or estimated tax paid. About citizen or resident

test- A person generally cannot claim a person as a dependent

unless that person is a U.S. citizen, U.S. resident alien,

U.S. national, or a resident of Canada or Mexico. However,

there is an exception for certain adopted children. About the

exception for adopted child, if a person is a U.S. citizen or

U.S. national and he/she has legally adopted a child who is

not a U.S. citizen, U.S. resident alien, or U.S. national,

this test is met if the child lived with him/her as a member

of his/her household all year. This exception also applies if

the child was lawfully placed with him/her for legal adoption.

46

About child's place of residence- children usually are

citizens or residents of the country of their parents. If a

person was a U.S. citizen when his/her child was born, the

child may be a U.S. citizen and meet this test even if the

other parent was a nonresident alien and the child was born in

a foreign country.About foreign students' place of residence-

foreign students brought to this country under a qualified

international education exchange program and placed in

American homes for a temporary period generally are not U.S.

residents and do not meet this test. An individual cannot

claim an exemption for them. However, if he/she provided a

home for a foreign student, he/she may be able to take a

charitable contribution deduction. With U.S. national- A U.S.

national is an individual who, although not a U.S. citizen,

owes his or her allegiance to the United States. U.S.

nationals include American Samoans and Northern Mariana

Islanders who chose to become U.S. nationals instead of U.S.

citizens (IRS, 2014).

Recently The personal exemption amount is indexed annually for

inflation. For taxable years beginning in 2014, the personal

exemption amount is $3,950. But beginning in 2014, the

personal exemption is subject to a phase-out that begins with

adjusted gross incomes of:

W $305,050 (Married filing jointly and surviving spouses)

W $279,650 (Heads of households)

W $254,200 (Single (other than surviving spouses and heads of

households))

W $152,525 (Married filing separately)

47

The personal exemption phases out completely with adjusted

gross incomes of:

W $427,550 (Married filing jointly and surviving spouses)

W $402,150 (Heads of households)

W $376,700 (Single (other than surviving spouses and heads of

households))

W $213,775 (Married filing separately)

Personal exemptions are subject to phase-out limits, called

the personal exemption phase-out (or PEP).The personal

exemption phases out, or gradually reduces, by 2 percent for

each $2,500 (or fractional portion of $2,500) by which a

person's adjusted gross income for the year exceeds a

threshold amount. For people who use the married filing

separately status, the personal exemption phases out by 2

percent for each $1,250 of adjusted gross income over the

threshold.

You can take an exemption for yourself - the personal

exemption - or for your dependents, but you cannot do that if

you can be claimed as a dependent by another taxpayer - even

if this taxpayer doesn't actually claim you as a dependent. If

you are married you can claim an exemption for your spouse

filing Jointly or Separately - only if another taxpayer

doesn't claim your spouse as a dependent. You cannot claim a

person dependent unless that person is your Qualifying Child

or qualifying relative. You must always list the social

security number (SSN) of any dependent for whom you claim an

exemption. If you don't list the SSN the exemption could be

denied (William Perez)

48

Threshold with number of Blind/Elderly Exemptions

http://www.paywizard.org/main/salary/incometax/2014

Earned Income Credit (EITC)

http://www.paywizard.org/main/salary/incometax/2014

Above-vs.-Below-the-Line Deductions

To arrive at final tax liability, all taxpayers may be able to

claim above-the-line deductions whether they claim itemized

deductions or the standard deduction. Each of these deductions

has a specific line on the Form 1040 (e.g., line 34 for the

deduction of student loan interest)

These deductions are commonly referred to as above-the-line

deductions, because they reduce a tax filer’s AGI (the line).

Above-the-line deductions are sometimes also called

adjustments to income, because they generally represent costs

49

incurred to earn income. In contrast, itemized and standard

deductions are sometimes referred to below-the-line

deductions, because they are applied after AGI is calculated

to arrive at taxable income.

Above-the-line deductions may provide additional benefits to

some tax filers seeking to claim certain tax preferences. A

number of tax provisions have a phaseout of benefits as income

increases. The higher the AGI, the less likely the tax filer

will be able to claim a larger value of the tax preference.

Tax deductions that lower AGI increase the likelihood that the

tax filer will be able to claim a larger value of the tax

preference.

IV. Tax declaration, submission and refund

1. Declaration

With almost United States citizen, they will need to file

personal income tax every year to determine how much they have

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to pay for it. Each individuals will be provided a secret

private tax code and it will be used for all item of incomes

(). People who have enough qualify & responsibility are

required for making and filing their return at the end of

calendar year or fiscal year. To help them easier in

declaring, below are some important steps they should take to

file their federal income tax return.

1.1 Find out if you are required to file a federal income tax return

While the majority of people are required to file and pay

income taxes, there are certain low-income earners who are

exempt such as children, poor people, and dependents. You

should check the U.S Internal Revenue Service (IRS)

requirements before you proceed.

1.2 Determine your tax filing statusThe federal tax filing statuses include: single, married

filing jointly, married filing separately, head of household,

and qualifying widow with dependent child. You may qualify for

more than one filing status, in which case you will have to

make a choice. In that situation, you should choose the filing

status that will result in the lowest tax.

1.3 Calculate your dependents and personal exemptionsThe IRS allows taxpayers to claim personal exemptions for

themselves and their dependents. A personal exemption is

similar to a tax deduction because it reduces your taxable

income. For example, in 2013, the maximum personal exemption

is $3,900 ("2014 Federal Tax Rates, Personal Exemptions, and

Standard Deductions," 2014). Your personal exemption

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information must be totally truth on your tax return because

it affects how much you have to pay for.

1.4 Report your income for the tax yearThere are different types of individual income tax forms. You

must use the tax form that corresponds with your particular

situation and allows you to claim the income, deductions and

credits that apply to you. The most common types of income tax

returns include: Form 1040 (U.S. Individual Income Tax

Return), Form 1040A (U.S. Individual Income Tax Return) and

Form 1040EZ (Income Tax Return for Single and Joint Filers

with No Dependents) ("2014 Federal Tax Rates, Personal

Exemptions, and Standard Deductions," 2014).

1.5 Claim eligible tax credits and deductionsIf you qualify for any tax credits or tax deductions, you will

want to take advantage of them. Tax deductions reduce your

taxable income and tax credits reduce the actual amount of tax

that you owe, both will increase your chance of receiving a

tax refund. All of the documents that you will need to file

your federal income tax return should be available on the IRS

website.

2. Submission

Returns and payments are due in full on or before April 15 of

the following year, even if your return is filed later. Your

return must be postmarked, delivered to, or electronically

received by the Department of Revenue by that date. And for US

residents residing overseas on 15 April there is a 2 month

automatic extension to 15 June. For fiscal year taxpayers,

returns and payments are due on the 15th day of the fourth52

month after the end of the fiscal year. If the 15th falls on a

Saturday, Sunday or holiday, the due date is the next business

day.

For estimated tax purposes, generally the year is divided into

four payment periods. Changes in income, deductions, or

exemptions during 2014 for example, may require you to amend

your original estimate or to begin making estimated tax

payments after April 15, 2014. You must pay at least one-

fourth of the total estimated tax on or before April 15. The

remaining quarterly payments are due June 15, September 15 and

January 15 of the following year. You may pay the total

estimated tax with your first payment, if you wish. If you are

filing on a fiscal year basis, each payment is due by the 15th

day of the 4th, 6th, 9th and 13th months following the

beginning of the fiscal year. And if any due date falls on a

Saturday, Sunday, or legal holiday, your return is due on the

next regular workday. With fisherman and farmer, there is only

one required installment date, January 15, if two-thirds or

more of your federal gross income for taxable year is from

farming or fishing. You must either pay 66⅔% of your

following taxable year tax by January 15, or file your New

York State return by March 2 of the following year, and pay

the total tax due. ("Estimated Taxes,").

You should pay your tax by the due date because if you cannot

complete and file your tax return on time, you have to pay for

penalties and interest. To avoid it, you may estimate your

total tax and pay the amount due by direct debit, by credit or

53

debit card, or by check ("Due Dates for Filing Individual

Income Tax," 2014).

3. Refund

Individual tax refund in the following cases: The amount of

tax paid in excess of the amount of tax payable; the amount of

family allowances actually larger than the provisional

deduction; charity and humanitarian donations are not deducted

from the tax; federal non-tax debts (including student loan

repayments), state income tax debts and state unemployment

compensation debts.

According to the IRS, major of refunds will be issued in less

than 21 days. However, this time frame applies to taxpayers

who e-filed their return. And this statement is not a

guarantee that you will receive your tax refund by the

estimated date. It is possible that the processing of your tax

return may face delays due to mistakes, misinformation, or

high volume at the IRS or U.S. Post Office. If you file a

paper return and send it via the Post Office, the IRS will

usually issue your tax refund within 8 weeks after receiving

your return. If you file your tax return electronically (also

called “e-file”), it will be processed quicker and you can

likely expect to receive your tax refund within 3 weeks.

There are two ways to check the status of tax refund. The

first one is online - The IRS has an online tool appropriately

called “Where’s My Refund?” A second option you can use to

check the status of your Federal tax refund is to call the IRS

Refund Hotline (800-829-1954). You will need to provide your

54

Social Security Number (SSN), filing status, and tax refund

amount (in exact whole dollars).

In general, you have three options when it comes to how you

want to receive your Federal tax refund. You may choose

between Direct Deposit, a paper check, or U.S. Savings Bonds.

Example:

Mary Clark is an employee working for a manufacturing company.

She lives with her 9-year-old son. In 2013, her wages, tips

and other compensation: $28,000. She had to pay for Social

Security tax & Medicare tax.

Calculate her tax payable for 2013?

Answer:

- Deductible expenses:

Herself: $8,950

Her son (dependent): $3,900

Medicare tax withheld = $28,000 x 1.45% = $406

Social Security tax withheld = $28,000 x 6.2% =

$1,736

=> Taxable income = $28,000 – (8,500 + 3,900 + 1,736 + 406) =

$13,458

$13,458 < $17,850, so she has to pay personal income tax

with the tax rate is 10%.

Tax payable = $13,458 * 10% = $1,345.8

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REFERENCES

Lousiana Department of Revenue Retrieved December 13, 2014

http://revenue.louisiana.gov/IndividualIncomeTax

2014 Federal Tax Rates, Personal Exemptions, and Standard

Deductions. (2014). US Tax Centre Retrieved December 12,

2014 http://www.irs.com/articles/2014-federal-tax-rates-

personal-exemptions-and-standard-deductions

Due Dates for Filing Individual Income Tax. (2014). Minnesota

Revenue Retrieved December 13, 2014

http://www.revenue.state.mn.us/individuals/individ_income

/Pages/Due_Dates_for_Filing_Individual_Income_Tax.aspx

Estimated Taxes. Internal Revenue Service Retrieved December

14, 2014 http://www.irs.gov/Businesses/Small-Businesses-

&-Self-Employed/Estimated-Taxes

56

Okello.A (2014) Managing Income Tax Compliance through Self-Assessment.

Retrieved from

http://www.imf.org/external/pubs/ft/wp/2014/wp1441.pdf

Roach.B (2010). Taxes in the United States: History, Fairness, and Current

Political Issues. Retrieved December 12, 2014 from

http://www.ase.tufts.edu/gdae/education_materials/modules

/Taxes_in_the_United_States.pdf

F. Amy, 2013: 10 Sources Of Nontaxable Income

http://www.investopedia.com/articles/tax/10/nontaxable-

invome-sources.asp

The IRS Publication 525: Taxable and Nontaxable Income.

Reached from: http://www.irs.gov/uac/Publication-525,-

Taxable-and-Nontaxable-Income--1

Government of US: The worldwide persona tax guild 2013-2014.

Reached from:

http://www.ey.com/Publication/vwLUAssets/Worldwide_Person

al_Tax_Guide_2013-2014/$File/2013-2014%20Worldwide

%20personal%20tax%20guide.pdf

Bell, K. (2013). Standard tax deduction amounts. Retrieved

from http://www.bankrate.com/finance/taxes/standard-tax-

deduction-amounts.aspx

William Perez. Personal Exemptions. Retrieved from:

http://taxes.about.com/od/preparingyourtaxes/a/personal_e

xempt.htm

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Federal Income Tax 2014. Retrieved fromhttp://www.paywizard.org/main/salary/incometax/2014

Maloneynovotny (2014). Congressional Research Service examines

itemized deductions. Retrieved from

http://www.maloneynovotny.com/news-resources/tax-tips/201

4/tax-alerts-040214.html

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