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THE TAX INSTITUTE AT H&R BLOCKTHE TAX INSTITUTE AT H&R BLOCKTHE TAX INSTITUTE AT H&R BLOCK
Wiley Registered Tax Return Preparer Exam Review 2012
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Wiley Registered Tax Return Preparer Exam Review 2012
John Wiley & Sons, Inc.
THE TAX INSTITUTE AT H&R BLOCKTHE TAX INSTITUTE AT H&R BLOCKTHE TAX INSTITUTE AT H&R BLOCK
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This book is printed on acid-free paper.
Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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Printed in the United States of America
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Contents
Introduction viiStrategies for Success on the Registered Tax Return Preparer Exam xi
Part 1 � e Income Tax Return 1
Chapter 1 Filing Information 3 Chapter 2 Filing Status 13 Chapter 3 Personal and Dependency Exemptions 25
Part 2 Income and Assets 39
Chapter 4 Wages, Salaries, and Other Earnings 41 Chapter 5 Interest Income 53 Chapter 6 Dividends and Other Corporate Distributions 65 Chapter 7 Rental Income and Expenses 73 Chapter 8 Retirement Plans, Pensions, and Annuities 85 Chapter 9 Social Security and Equivalent Railroad
Retirement Benefi ts 101Chapter 10 Other Types of Income 109Chapter 11 Self-Employment Activities 121Chapter 12 Basis of Property 141Chapter 13 Sale of Property 151Chapter 14 Sale of Home 169Chapter 15 IRA and HSA Contributions 181Chapter 16 Education-Related Adjustments 191Chapter 17 Business-Related Adjustments 199Chapter 18 Alimony 209
Part 3 Deductions and Credits 217
Chapter 19 Standard and Itemized Deductions 219Chapter 20 Medical and Dental Expenses 225Chapter 21 Tax Payments 235Chapter 22 Interest Payments 243Chapter 23 Charitable Contributions 255
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vi Contents
Chapter 24 Nonbusiness Casualty and Theft Losses 269Chapter 25 Miscellaneous Itemized Deductions 279Chapter 26 Employee Business Expenses 289Chapter 27 Earned Income Credit 305Chapter 28 Child and Dependent Care Credit 317Chapter 29 Child Tax Credit 325Chapter 30 Education Credits 331Chapter 31 Other Tax Credits 339
Part 4 Other Taxes 357
Chapter 32 Figuring the Regular Tax 359Chapter 33 The Alternative Minimum Tax 369Chapter 34 The Kiddie Tax 377Chapter 35 Other Taxes 387
Part 5 Completion of the Filing Process 397
Chapter 36 Tax Payments and Refund Options 399Chapter 37 Completing and Filing the Return 413
Part 6 Practices and Procedures 423
Chapter 38 Preparer Responsibilities and Penalties 425
Part 7 Ethics and Circular 230 437
Chapter 39 Rules Governing Authority to Practice before the IRS 439
Chapter 40 Duties and Restrictions Relating to Practice before the IRS 447
Chapter 41 Sanctions for Violating Circular 230 459
Answers to Review Questions 469Appendix: IRS Resources 507Index 509
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Introduction
Tax preparers are required to pass the Registered Tax Return Preparer (RTRP) exam unless they are specifi cally exempt from the exam. Exempt individuals include attorneys, certifi ed public accountants (CPAs), enrolled agents (EAs), supervised preparers, and individuals who do not prepare Form 1040 series tax returns.
If you prepare Form 1040 series tax returns for compensation and you are not an attorney, CPA, or EA, and you don’t fall into any other exempt category, you will need to pass the RTRP exam.
Th is book, together with the Exam Bank, will help you do just that.
Exam StructureTh e exam, which was designed to test for “basic competency,” was fi rst made available in November 2011. Th e 2½-hour exam contains a combination of 120 multiple-choice and true/false questions and covers seven areas of taxation, referred to as “domains.”
Th ese seven domains are:
1. Preliminary Work and Collection of Taxpayer Data
2. Treatment of Income and Assets
3. Deductions and Credits
4. Other Taxes
5. Completion of the Filing Process
6. Practices and Procedures
7. Ethics and Circular 230 (Subparts A, B, and C)
For more detail about each of these domains, see the Candidate Information Bulletin at www.irs.gov/pub/irs-utl/rtrpcandidateinfobulletin.pdf. Th e exam includes questions drawn from a variety of sources (see IR-2011-89, September
DEFINITION: Supervised preparers are individuals who do not sign and are not required to sign the tax return but are super-vised by an attorney, CPA, or EA who signs the tax return. In order to qualify, the business must be owned at least 80% by attorneys, CPAs, or EAs.
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viii Introduction
tronically. Reference materials include IRS Pub. 17, Your Federal Income Tax(www.irs.gov/pub/irs-pdf/p17.pdf ), Form 1040, and Form 1040 instructions (www.irs.gov/pub/irs-pdf/i1040.pdf ). Handheld and onscreen calculators will also be available.
More information about the IRS requirements for becoming a paid tax return preparer is available at http://tinyurl.com/3qpprcy.
A L E R T: The exam will be off ered year-round, except for a black-out period from April 1 through April 15. The exam will be updated dur-ing the black-out period. Before the fi rst scheduled black-out period (from April 1, 2012, through April 15, 2012, the exam will cover 2010 law. After the fi rst black-out period, the exam will cover 2011 tax law.
6, 2011, at http://tinyurl.com/IR-2011-89. Th is Bulletin recommends the pretest study material shown below, information about which is included in this book.
7 Circular 230, Regulations Governing Practice before the Internal Revenue Service
7 Form 1040, U.S. Individual Income Tax Return 7 Form 1040 Instructions 7 Form 2848, Power of Attorney and Declaration of Representative 7 Form 2848 Instructions 7 Form 6251, Alternative Minimum Tax—Individuals 7 Form 6251 Instructions 7 Form 8821, Tax Information Authorization 7 Form 8867, Paid Preparers Earned Income Credit Checklist 7 Form 8879, IRS e-File Signature Authorization 7 Publication 17, Your Federal Income Tax1*
7 Publication 334, Tax Guide for Small Business 7 Publication 596, Earned Income Credit (EIC) 7 Publication 970, Tax Benefi ts for Education 7 Publication 1345, Handbook for Authorized IRS e-File Providers 7 Publication 4600, Safeguarding Taxpayer Information: Quick Reference Guide for Businesses
To register for the exam, you must schedule an appointment through your online preparer tax identifi cation number (PTIN) account (www.irs.gov/ptin) and pay the $116 exam fee. Th e exam may be taken at any one of approximately 260 Prometric testing centers located throughout the United States (see http://tinyurl.com/cysfxvp for locations where the test is off ered; there are no inter-national sites yet).
Exam DayYou should arrive at the exam site approximately 30 minutes before your appointment. You should bring a government-issued photo ID that contains your signature. You will not be allowed to bring any personal items with you to the exam area; all personal items must be stored in a locker. Cell phones and watches are not allowed in the exam area.
After checking in with the test center administrator, you will be guided into the exam area for the exam. Allowable reference materials will be available elec-
* At the time the 2010 version of Publication 17 went to press, there were certain tax benefi ts that had not been fi nalized. Th us, several of these tax benefi ts were subsequently extended.
TIP: See the Appen-dix on how to fi nd these materials on the IRS Web site.
ALERT: This book focuses on tax laws that were in eff ect in 2011. At the time of publication, several tax forms were not available and therefore 2010 forms may appear in illustrations or in links.
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Introduction ix
tronically. Reference materials include IRS Pub. 17, Your Federal Income Tax (www.irs.gov/pub/irs-pdf/p17.pdf ), Form 1040, and Form 1040 instructions (www.irs.gov/pub/irs-pdf/i1040.pdf ). Handheld and onscreen calculators will also be available.
More information about the IRS requirements for becoming a paid tax return preparer is available at http://tinyurl.com/3qpprcy.
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Strategies for Success on the Registered Tax Return Preparer Exam
You will be on your way to passing the Registered Tax Return Preparer (RTRP) exam if you:
Preview the breakdown of the exam.Remember these tips.Educate yourself on unfamiliar topics. Practice exam questions.Adequately prepare.Review reference materials that will be provided with the exam.Excel on the RTRP exam.
Preview the Breakdown of the Exam Th e RTRP exam focuses on basic tax competency related to Form 1040 and its related forms and schedules. Th e exam also covers the ethical responsibilities of federal tax return preparers. Th e exam contains 120 total questions, consisting of multiple-choice and true/false format.
You will have 2½ hours to complete the exam, which equates to an average of a little more than one minute per question. Be mindful of this when you come to a question that you are unsure how to answer. Don’t spend too much time dwelling on a diffi cult question. If you are unsure of the answer, move on, and come back to it later.
Th e exam covers seven major topics, which are referred to as domains by the IRS. Coverage of the domains in the exam are as follows:
Domain 1. Preliminary Work and Collection of Taxpayer Data—15%Domain 2. Treatment of Income and Assets—22%Domain 3. Deductions and Credits—22%Domain 4. Other Taxes—11%
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xii Strategies for Success on the Registered Tax Return Preparer Exam
Domain 5. Completion of the Filing Process—10%Domain 6. Practices and Procedures—5%Domain 7. Ethics—15%
Th e RTRP exam is a test of your knowledge of individual taxation. Use the domain breakdown to help you determine which areas to focus on when studying. Answer the practice questions in the Exam Bank to help identify the domains where you need to focus your study.
Remember Th ese Tips 1. Try to determine the correct answer fi rst. Th e chance of your answering
the question correctly will increase if you can fi gure out the answer before looking at the choices. In this way, your knowledge guides your selection even in cases when a wrong answer might sound reasonable and mislead you.
2. Eliminate choices that obviously are wrong. Often you can eliminate at least one, and possibly more answers immediately. Look for fl awed grammar or confusing language, such as double negatives that do not fl ow with the question.
3. Go with your instinct. Don’t overthink yourself out of choosing the right answer. Your fi rst instinct is more often right than wrong. Over-thinking or overanalyzing an answer can lead you into changing a correct answer to an incorrect answer.
4. Manage the clock. Do not let time run out before you have had a chance to answer all of the questions. Budget your time and do not rely too heavily on the reference materials. You will not have enough time to look up the answer to every question. Read through the exam and answer fi rst those questions that test topics in which you are most confi dent. Th is strategy can help your confi dence and allow you to better manage your time.
5. Look for logic traps or false generalizations. Be careful when you see answers with statements that use universal words, such as “all,” “none,” “always,” or “never.” In the tax code, rules are usually never just one way; there is almost always an exception to the general rule. Reading the statement carefully will help you to choose the correct response.
6. Know how to select between similar answers. Some questions will off er you two very similar choices. In such cases, compare the two answer choices and determine the diff erence. Th e diff erence is usually a determining factor as to whether the answer is right or wrong. Select the one that is most likely true. However, if two of the choices say the same thing but in diff erent ways, both probably are wrong and both options can be eliminated.
ALERT: The exam allows test takers to move back and forth between questions. If you don’t know the answer you can mark the question for review and come back to it later.
ALERT: Domain 7 (Ethics) contains informa-tion from Circular 230 Sub-parts A, B, and C. Be sure to familiarize yourself with this content, as Circular 230 is not one of the refer-ence materials provided during the exam.
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Strategies for Success on the Registered Tax Return Preparer Exam xiii
7. When you have no idea of the answer, go with the choice that offers more information. Often, the choice with the most information is more likely to be the correct one.
8. In a long question with a lot of numbers and facts, read the last sentence first. Skipping to the last sentence in the paragraph before reading the entire paragraph will help you determine what information is important and what is not. Often, a lengthy question contains information that is not needed to determine the correct answer. Don’t get bogged down with distracting details of the question that are not needed in order to answer it correctly.
9. Guess if necessary. You will not be penalized for answering a question incorrectly, so you should provide an answer for all questions. For questions to which you do not know the answer, try to eliminate one or more of the answer choices given. If you see a choice that does not sound at all familiar, eliminate it. If you have studied the material, you will have a good understanding of the range of possibilities. When in doubt, make an educated guess.
10. Last minute strategies. If you are running out of time, one strategy to quickly answer remaining questions is to choose the same answer for all questions you do not have time to read (there is no penalty for incorrect answers). For example, if you only have 2 minutes left to finish the exam and still have 15 questions left, answer the same letter for all 15 remaining questions. For example, choose all “a” or all “c” instead of randomly choosing a letter for each question.
Educate Yourself on Unfamiliar TopicsAs you prepare for the exam, focus on topics with which you are unfamiliar. A lot of material can be included on the exam. As you study and practice exam questions, take notice of the topics in which you are weak. Go back through your materials and reread those topics until they make sense to you. If some-thing doesn’t make sense to you now, it won’t make sense when you are taking the RTRP exam.
Once you feel that you have a strong grasp of the material, test your knowledge again in the Exam Bank by answering practice questions. Repetition will help solidify the more challenging concepts and help you remember the correct answer when you are taking your exam.
Practice Exam QuestionsThe questions on the exam are mostly multiple choice, with some true/false questions. Three different multiple-choice formats are used, each of which provides four options from which to choose your answer.
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xiv Strategies for Success on the Registered Tax Return Preparer Exam
The functionality of the exam allows test takers to do a final review of questions (time permitting) that have been unanswered or marked for review at the end of the exam. You can then go back and review those questions again before ending the exam.
Format 1: Direct QuestionWhich one of the following is an example of a casualty or theft loss?
a. Storms, including hurricanes and tornadoes
b. Termite damage
c. Misplaced property
d. Property broken through ordinary use
Format 2: Incomplete SentenceThe deduction for a portion of self-employment tax is taken:
a. As a business deduction on Schedule C.
b. As a miscellaneous itemized deduction on Schedule A.
c. As an adjustment to gross income directly on Form 1040.
d. As an adjustment to self-employment tax owed on Schedule SE.
Format 3: All of the Following ExceptAll of the following taxpayers file Schedule C EXCEPT:
a. An independent contractor.
b. A sole proprietor running a boutique.
c. A sole proprietor running a farm.
d. A statutory employee.
Format 4: True or FalseBeginning in 2011, a paid tax return preparer may be assessed a penalty of $500 per return for failing to comply with EIC due diligence requirements.
True
False
Make sure you read the questions carefully and know what each one is asking. Pay special attention to questions in Format 3 (All of the Following Except), as it is easy to get tricked into choosing one of the three choices that is a correct statement but is not the correct answer to the question being asked. When necessary, take time to reread the question to make sure you are choosing the correct answer based the question that is being asked. Key information in the question may not necessarily be presented in bold or italics.
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Strategies for Success on the Registered Tax Return Preparer Exam xv
Adequately PrepareIn addition to studying the material and reviewing practice questions, here are some additional steps to take to adequately prepare for your exam:
7 Know the scope of the exam. Make sure that you are comfortable with the content that will be tested to ensure your success on the RTRP exam.
▫ Begin preparing on a schedule well in advance of the exam date. 7 Know the format of the questions that will be asked. 7 Familiarize yourself with the location of your testing center prior to the date of the exam.
▫ Arrive at the test center at least 30 minutes before your scheduled exam. 7 Familiarize yourself with the policies of the testing center.
▫ Bring required identification. ▫ Exam takers will not be allowed to bring in their own reference materi-als or calculator. These will be provided at the test center.
7 Relax. ▫ Don’t overstudy the night before the exam. Give yourself a break and let your mind relax.
▫ The night or morning before the exam is a great time to do a light review or final run-through of your notes.
Review Reference Materials that Will Be Provided with the Exam During the exam, you will have access to the following electronic reference materials:
Publication 17, Tax Guide for IndividualsForm 1040, U.S. Individual Income Tax ReturnForm 1040 Instructions
Take advantage of the opportunity to use reference materials on the exam by familiarizing yourself with these materials BEFORE you take the exam. Your chances of answering questions correctly are significantly improved when you can look things up. However, relying too heavily on reference materials while taking the exam will reduce the time you have to spend on other ques-tions. As you take the exam, answer the questions to the best of your ability and use the reference materials only when needed. Making sure you are adequately prepared and have studied the material will give you confidence
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xvi Strategies for Success on the Registered Tax Return Preparer Exam
in your ability to answer the questions correctly and limit the amount of time you need to use in referring to the reference materials.
Excel on the RTRP ExamMaking sure you adequately PREPARE is the key to passing the exam. Following the steps listed here will help you to excel on the RTRP exam. Good luck on your way to becoming a registered tax return preparer!
TIP: Refer to the index in the reference materials when you are unsure of where to fi nd a topic.
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PART 1PART 1PART 1
Th e Income Tax Return
CHAPTER 1 FILING INFORMATION
CHAPTER 2 FILING STATUS
CHAPTER 3 PERSONAL AND DEPENDENCY EXEMPTIONS
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CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1CHAPTER 1
Filing Information
Filing an income tax return is a yearly obligation for most U.S. citizens and residents. However, not everyone is required to fi le a return, and even some who do not have to fi le may want to do so for various reasons. Tax
returns are due by a set date—generally April 15 for most individual taxpayers. It is possible to obtain an automatic six-month extension if action is taken in a timely manner. If not, penalties can apply. Th ere are diff erent versions of Form 1040, U.S. Individual Income Tax Return, for individuals. Th e version to use depends on the taxpayer’s income, deductions, credits, and other factors. Special rules apply to individuals who are not U.S. citizens or residents.
Personal InformationIn order to complete a return, you need to know certain personal information about a taxpayer. You must enter some of the information directly on the tax return; other information is useful to you as a preparer.
Taxpayer’s Name Th e name of the taxpayer and that of his or her spouse (if married and fi ling jointly) must be included on the return. See Chapter 2 for information on fi ling status. Th ere is no requirement that the husband’s name appear fi rst.
Address Usually the address is a street address. However, a post offi ce box number can be used if there is no mail delivery to the home. A foreign address may be used if the taxpayer is located outside of the United States.
Daytime Phone Number Th e phone number is optional information that can be entered at the end of the return. Th e IRS may use this phone number to contact the taxpayer to speed up the processing of the return.
Taxpayer Identifi cation Number Enter the taxpayer’s Social Security Number (SSN) (and the SSN of the taxpayer’s spouse, if the taxpayer is married fi ling jointly). Nonresident and resident aliens who are ineligible for a SSN must include their Individual Taxpayer Identifi cation Number (ITIN).
Date of Birth Th e taxpayer’s date of birth is not entered on the return but is used to determine eligibility for certain tax breaks, such as the additional standard deduction amount for those age 65 and over.
ALERT: If the tax-payer’s name has changed due to marriage or divorce, the taxpayer should report the change to the Social Security Administration before fi ling the return.
ALERT: If the taxpayer plans to move after the return is fi led, the taxpayer should complete Form 8822, Change of Address, at the time of the move. This will ensure that refunds and other IRS communica-tions reach the taxpayer at the new address.
ALERT: An ITIN can be obtained by fi ling Form W-7, Application for IRS Indi-vidual Taxpayer Identifi ca-tion Number. The taxpayer generally submits Form W-7 to the IRS together with the fi rst income tax return he or she fi les. See the form’s instructions for more details.
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4 Wiley Registered Tax Return Preparer Exam Review 2012
Disability Disability information is not entered on the return but may alert you to possible tax breaks, such as an additional standard deduction amount for blindness or exemption from an early distribution penalty for IRA withdrawals before age 59½.
Occupation List occupation information at the end of the return near the sig-nature line.
Filing Requirements and Th resholdsCertain taxpayers must fi le a tax return while others may want to fi le even though they aren’t required to do so.
A person must fi le a tax return if gross income is at least a threshold amount (called the “fi ling threshold”) for the person’s fi ling status (explained in Chapter 2) and age. Th is is so even if the person is a U.S. citizen or resident living outside of the United States.
General Filing Thresholds
Table 1.1 lists the fi ling threshold amounts.
Example
Stan is single, age 45, with interest income of $1,200 and wages of $20,000. He must fi le a return.
TIP: A taxpayer can elect to contribute to the presidential election fund. It does not change the taxpayer’s tax liability in any way. If the taxpayer wants to contribute, this is indicated in a check box. Taxpayers using the married fi ling jointly fi ling status can each make their own decision.
TABLE 1.1 Filing Threshold Amounts
Filing status (see Chapter 2 for details) Age at end of 2011*
2011 Gross income at least
Single Under 6565 or older
$9,500$10,950
Married � ling jointly Both spouses under 65One spouse 65 or olderBoth spouses 65 or older
$19,000$20,150$21,300
Married � ling separately Any age $3,700
Head of household Under 6565 or older
$12,200$13,650
Qualifying widow(er) with dependent child
Under 6565 or older
$15,300$16,450
*Those born on January 1 are treated as age 65 on the previous December 31. Thus, a person born on January 1, 1947, is treated as attaining age 65 in 2011.
DEFINITION: Gross income is all income received that is not spe-cifi cally tax free, including income from sources outside the United States. Examples of gross income include gain on the sale of a principal residence (even though the gain may be all or partially excluded) and the taxable portion of Social Security benefi ts. A portion of Social Security benefi ts are taxable if the taxpayer lived with his or her spouse at any time during the year but fi les separately, or is a single or head-of-household fi ler with gross income, plus one-half of Social Security benefi ts and tax-exempt interest that exceeds $25,000 ($32,000 if married fi ling jointly).
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Filing Information 5
Example
Sarah is single, age 70, with interest income of $1,200 and Social Security benefi ts of $20,000. She does not have to fi le a return. Her Social Security benefi ts are not counted as gross income because they are not taxable.
FYI: Where do these numbers come from? Th e gross income thresholds refl ect the standard deduction amount for each fi ling status and the personal exemption amount.
A person must also fi le a tax return if he or she:
7 Is self-employed and has net earnings from self-employment of at least $400.
7 Had wages of $108.28 or more from a church or church-controlled orga-nization that is exempt from employer Social Security and Medicare taxes.
7 Received advance earned income credit from an employer (advance pay-ment is not available after 2010).
7 Owes any special taxes. Th ese include: ▫ Th e alternative minimum tax (AMT). ▫ Additional tax (penalties) on individual retirement accounts (IRAs) or other tax-favored accounts.
▫ Employment taxes for household employees. ▫ Social Security and Medicare tax on tips not reported to an employer or uncollected Social Security and Medicare or Railroad Retirement Tax Act (RRTA) tax on tips reported to an employer.
▫ Recapture of the fi rst-time homebuyer credit or other credit. ▫ Additional taxes on Health Savings Accounts (HSAs), Archer Medical Savings Accounts, and Coverdell Education Accounts.
Special Rules for Dependents
Th e usual fi ling thresholds discussed above do not apply to a person who is treated as a dependent of another taxpayer. A dependent is an individual whose exemption may be claimed on another person’s income tax return. Th e rules for dependents are discussed in Chapter 3. Filing requirements for dependents turn not only on gross income but also on earned and unearned income.
Table 1.2 shows the fi ling threshold for dependents.
Example
A taxpayer’s dependent child, who is single, age 17, and is not blind, earned $5,500 from a part-time job throughout the year and also received bank interest of $500. A tax return for the child must be fi led because he or she had gross income that exceeded the fi ling threshold.
ALERT: If the only reason for fi ling a return is to report the additional tax on IRAs or other tax-favored accounts, you can fi le Form 5329, Additional Taxes on Qualifi ed Plans (Including IRAs) and Other Tax-Favored Accounts, by itself; no income tax return needs to be fi led. See Chapter 35 for information on Form 5329.
DEFINITIONS: Earned income is income from the performance of personal services. Examples include salary and wages, earnings from self-employment, tips, and taxable scholar-ships and grants.
Unearned income is income from investments and other sources not involv-ing personal services. Examples include taxable interest, ordinary divi-dends, capital gain distri-butions, unemployment benefi ts, taxable Social Security benefi ts, pen-sions and annuities, and distributions of unearned income from trusts.
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6 Wiley Registered Tax Return Preparer Exam Review 2012
Filing a Return Even If Not Required
Even though a return is not required, there are some situations in which fi ling may still be a good idea:
7 Requesting a refund. If the taxpayer overpaid tax (e.g., there was too much withholding from wages), the only way to obtain a refund is to fi le a return.
7 Obtaining refundable credits. Some tax credits are refundable, which means they can be paid to the taxpayer in excess of taxes owed. Refundable credits include the earned income credit, the additional child tax credit, the adoption credit, and the American Opportunity credit. Refundable credits are explained in Chapters 27 through 31.
7 Establishing a capital loss. If a taxpayer had an overall capital loss on investments or other property transactions for the year, he or she should fi le a return, along with Schedule D, Capital Gains and Losses and any other necessary forms or schedules, to show the loss. Doing this enables the taxpayer to establish a capital loss carryforward (explained in Chapter 13).
Deadlines, Extensions, and PenaltiesFiling Deadline
Th e income tax return is due by the fi fteenth day of the fourth month after the close of the tax year, which is April 15. However, this date is extended if
TABLE 1.2: Filing Threshold for Dependents for 2011
Marital status Under 65/not blind 65 or older or blindSingle Unearned income over
$950, orEarned income over $5,800, orGross income more than the larger of (1) $950, or (2) earned income up to $5,500, plus $300
Unearned income over $2,400 ($3,850 if 65 or older and blind), orEarned income over $7,250 ($8,650 if 65 or older and blind), orGross income more than the larger of (1) $2,400 ($3,850 if 65 or older and blind), or (2) earned income up to $5,500, plus $1,750 ($3,200 if 65 or older and blind)
Married Unearned income over $950, orEarned income over $5,800, orGross income of at least $5 and spouse � les a separate return and itemizes deductions, orGross income more than the larger of (1) $950, or (2) earned income up to $5,500, plus $300
Unearned income over $2,100 ($3,250 if 65 or older and blind), orEarned income over $6,950 ($8,100 if 65 or older and blind), orGross income at least $5 and spouse � les a separate return and itemizes deductions, or
Gross income was more than the larger of (1) $2,100 ($3,250 if 65 or older and blind) or (2) earned income up to $5,500, plus $1,450) ($2,600 if 65 or older and blind)
ALERT: If a depend-ent child under age 19 or a full-time student under age 24 at the end of the year has income only from interest, dividends, and capital gain distributions and is subject to kiddie tax (the kiddie tax is a tax imposed on certain children with investment income of $1,900 or more), the child’s parent may be able to elect to report the income on the parent’s return (discussed in Chap-ter 34). In such a case, the child does not have to fi le a return.
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Filing Information 7
April 15 falls on a weekend or national holiday. Emancipation Day is a holiday in Washington, D.C., that is usually observed on April 17, and this occasionally extends the fi ling deadline.
U.S. citizens and resident aliens are allowed an automatic two-month extension of time to fi le (until June 15) if they are living outside the United States or Puerto Rico on the ordinary due date for fi ling the tax return and either: (1) their main place of business is outside the United States or Puerto Rico, or (2) they are on duty on military or naval service outside of the United States or Puerto Rico.
Requesting an Extension
If, for any reason, a taxpayer cannot meet the fi ling deadline, he or she must make an extension request by the fi ling deadline. Th is request provides an auto-matic six-month extension. Th us, anyone who timely requests an extension will not be penalized if their return is fi led by October 15. Th is date is extended if October 15 falls on a weekend.
Filing an extension does not extend the time to pay any balance due.
Request an extension by fi ling Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Form 4868 may be fi led elec-tronically or on paper. Taxpayers who are paying all or part of their taxes due can obtain an extension by paying using a credit or debit card through an IRS-approved processor. Paying by credit or debit card is discussed in Chapter 36.
Penalty for Late Payment
When requesting an extension, estimate the taxes that will be due when the return is fi led. It is advisable for taxpayers to pay as much of the amount expected to be owed in order to minimize or avoid a late-payment penalty. Th e late-payment penalty is usually ½ of 1% of the tax not paid by the due date. It is charged for each month or part of a month that the tax is unpaid; the maximum penalty is 25%.
Example
Edwin obtains a fi ling extension and fi les his return on August 1, 2011. He pays the balance of the taxes he owes, $3,000, when he fi les his return. The late payment penalty is $60 ($3,000 × 0.5% × 4 months).
Penalty for Late Filing
A late fi ling penalty can apply if the return is not fi led on time (postmarked or e-fi led by midnight of the fi ling deadline) and no fi ling extension is obtained. Th e penalty is usually 5% of the amount due for each month or part of a month that the return is late. Th e maximum penalty is 25%. If the return is more than 60 days late, the minimum penalty is $135 or the balance of the tax due on the return, whichever is smaller.
TIP: The IRS can waive the late fi ling pen-alty if there is reasonable cause for fi ling late. Attach a personal statement (there is no IRS form for this) to the late-fi led tax return explaining the reasonable cause. Com-mon reasonable causes are illness of the taxpayer or an immediate family member and incapacity. Whether the cause stated is reasonable is a subjec-tive determination made by the IRS.
ALERT: Individuals serving in a combat zone have an automatic exten-sion of time to fi le. This extension lasts at least 180 days after the later of (1) the last day they are in a combat zone, or (2) the last day they were hospi-talized due to an injury in a combat zone.
TIP: The taxpayer should pay as much of the tax that is expected to be owed as possible by the original due date, usually April 15, in order to avoid or minimize a late pay-ment penalty (explained in Chapter 36).
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8 Wiley Registered Tax Return Preparer Exam Review 2012
Which Version of Form 1040 to UseThere are three different base income tax returns for individuals: Form 1040EZ, Income Tax Return for Single and Joint Filers with No Dependents, Form 1040A, U.S. Individual Income Tax Return, and Form 1040. There is also Form 1040NR, U.S. Nonresident Alien Income Tax Return, for nonresident aliens (discussed later in this chapter). Use the return that will enable a taxpayer to report all the income and claim all the deductions and credits to which he or she is entitled.
Form 1040EZ
Form 1040EZ is the simplest return that can be filed. However, its utility is very limited.
7 Only those who are single or married filing jointly and who are under age 65 and not blind can use this form.
7 It cannot be used to claim dependents. 7 These are the only types of income that can be reported:
▫ Wages and salary ▫ Interest income ▫ Unemployment benefits
7 Taxable income must be less than $100,000. 7 The standard deduction is built into the return; no separate adjustments to gross income or other deductions can be claimed.
7 The only credit that can be claimed is the earned income credit.
Form 1040A
Form 1040A is more extensive than Form 1040EZ but not as broad as Form 1040.
7 It can be used regardless of filing status, and dependents may be claimed. 7 These types of income are reported:
▫ Wages and salary ▫ Interest and ordinary dividends ▫ Capital gain distributions ▫ Unemployment compensation ▫ Income from annuities, pensions, and IRAs ▫ Social Security benefits
7 Taxable income must be less than $100,000. 7 These adjustments from gross income can be claimed:
▫ An IRA deduction ▫ Student loan interest deduction
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Filing Information 9
▫ Tuition and fees deduction ▫ Deduction for educator expenses
No itemized deductions are allowed. 7 Only these credits can be claimed:
▫ Child and dependent care credit ▫ Earned income credit ▫ Credit for the elderly and the disabled ▫ Child tax credit ▫ Adoption credit ▫ Retirement savings contribution credit ▫ Education credits
7 Form 1040A can be used to report estimated tax payments and estimated tax penalties, the advance earned income credit, and the inclusion of a child’s unearned income on a parent’s return (explained in Chapter 34).
Form 1040
Form 1040 is the most comprehensive return. It must be used for anyone who itemizes deductions, reports business income, or has income, deductions, credits, and other taxes not allowed to be reported on either of the other tax return options. Anyone can use Form 1040, even if a simpler return is permissible.
Special Filing Rules for AliensTh e type of tax return to fi le depends on an alien taxpayer’s status. Th ere are three types of aliens: resident aliens, nonresident aliens, and dual-status taxpayers.
See IRS Pub. 519, U.S. Tax Guide for Aliens, for a complete discussion on deter-mining status. Figure 1.1 provides an overview.
Resident Aliens
Resident aliens generally are taxed the same as U.S. citizens. Th ey follow the rules explained earlier in this chapter and can fi le Form 1040EZ, 1040A, or 1040 as appropriate.
Nonresident Aliens
Nonresident aliens with income that must be reported to the United States, including income eff ectively connected with a U.S. trade or business, fi le Form 1040NR, or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents.
ALERT: If a taxpayer fi les an amended return, he or she must use Form 1040X Amended U.S. Indi-vidual Income Tax Return, regardless of whether he or she fi led a 1040EZ, 1040A, 1040, or 1040NR originally.
DEFINITIONS: Resident aliens are non-U.S. citizens who have met either the green card test or the substantial presence test for the calendar year. This is explained in Figure 1.1.
Nonresident aliens are aliens who did not meet the green card test or the substantial presence test at any time during the calendar year.
Dual-status taxpayers are aliens (non-U.S. citizens) who are residents for part of the year.
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10 Wiley Registered Tax Return Preparer Exam Review 2012
FIGURE 1.1 Nonresident Alien or Resident Alien?
Start here to determine your status for 2010
Yes No
Were you a lawful permanent resident of the United States (had a“green card”) at any time during 2010?
Were you physically present in the United States on at least 31days during 2010?3
presence in 2009, and2010, counting all days of presence in 2010,
Were you physically present in the United States on at least 183days during the 3-year period consisting of 2008, 2009, and
1⁄3 the days of1⁄6 the days of presence in 2008?3
Were you physically present in the United States on at least 183days during 2010?
Can you show that for 2010 you have a tax home in a foreigncountry and have a closer connection to that country than to theUnited States?
You are aRESIDENT alien for U.S. tax purposes.
You are aNONRESIDENTalien for U.S.tax purposes.
Yes
Yes
Yes
No
No
No4
No
Yes
Dual-Status Aliens
Dual status occurs most frequently in the year an alien taxpayer arrives or departs from the United States. Dual-status aliens are subject to diff erent rules for the part of the year they are residents and the part of the year they are non-residents. Th e rules for dual-status aliens are complex but are explained more thoroughly in Pub. 519.
Th e base tax form a dual-status alien should fi le depends on residency status at the end of the year. A dual-status alien who is a resident at the end of the year must fi le Form 1040 (dual-status aliens are not allowed to fi le Form 1040A or 1040-EZ) and attach Form 1040NR or 1040NR-EZ as a statement. A dual-status taxpayer who is a nonresident at the end of the year may fi le either Form 1040NR or Form 1040NR-EZ, as appropriate, and attach Form 1040 as a statement.
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Filing Information 11
Special Elections
First-Year Choice. In some cases, a taxpayer who does not meet either the green card test or the substantial presence test in the current year, but who meets the substantial presence test in the following year, may elect to be treated as a resident for part of the current year.
Election for Nonresident Alien or Dual-Status Taxpayer Married to a U.S. Citizen or Resident Alien to Choose Resident Alien Status. Normally, both spouses must be U.S. citizens and/or residents to file a joint U.S. income tax return. However, if married on the last day of the year, the nonresident alien spouse or dual-status taxpayer-spouse can elect to be treated as a resident alien and file a joint return. Doing this requires the nonresident alien/dual-status taxpayer to include his or her worldwide income for the entire year on the joint return. Refer to Pub. 519 for more information.
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12 Wiley Registered Tax Return Preparer Exam Review 2012
1. Sara, who is single, has gross income of $7,000 and self-employment income of $500. Which statement best describes her fi ling situation. Sara:
a. Must fi le a tax return.
b. May fi le a tax return.
c. Is not required to fi le a tax return.
d. Should not fi le a tax return.
2. Carlos, who is required to fi le a tax return, wants to obtain a filing extension. Which of the following actions is required?
a. Paying all of the taxes due.
b. Giving a good reason for wanting the extension.
c. Having a paid preparer submit the extension request.
d. Requesting the extension no later than the fi ling deadline.
3. Harrison, an employee earning $75,000, does not fi le his return on time and does not obtain a fi ling exten-sion. He fi les his return on August 15 and pays his balance due, $4,000 at that time. The $4,000 is 25% of his total tax liability. Harrison is:
a. Subject to a late fi ling penalty.
b. Subject to a late payment penalty.
c. Subject to both a late fi ling penalty and late pay-ment penalty.
d. Not subject to any penalty because the return was fi led and payment made before October 15.
4. Ed is a U.S. citizen who is single, age 70, and has gross income of $65,000 (including Social Security benefi ts of $20,000). He owns his home on which he pays mortgage interest and property taxes. He also makes charitable contributions. Because of these payments, it is benefi cial for him to itemize his deductions. Which tax return should he use?
a. Form 1040EZ
b. Form 1040A
c. Form 1040
d. Form 1040NR
5. Madeline and Owen are U.S. residents who are mar-ried, with one dependent child. They do not have enough deductions to itemize. Based on these facts alone, which is the simplest tax return they can fi le?
a. Form 1040EZ
b. Form 1040A
c. Form 1040
d. Form 1040NR
Review QuestionsReview QuestionsReview Questions
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