Federal Income Tax Accounting Unit 1 ReviewFederal Income Tax Basics

Key Concepts and Terminology

• Gross income encompasses all income from whatever source derived, unless specifically excluded by law
• Taxable income calculated by subtracting deductions and exemptions from gross income
• Tax liability amount of tax owed to the government based on taxable income and applicable tax rates
• Credits directly reduce tax liability dollar-for-dollar (Child Tax Credit, Earned Income Tax Credit)
• Deductions reduce taxable income before calculating tax liability
  • Standard deduction flat amount based on filing status
  • Itemized deductions specific expenses (mortgage interest, charitable contributions) that exceed the standard deduction
• Progressive tax system tax rates increase as taxable income increases
• Marginal tax rate tax rate applied to the last dollar of taxable income

Tax System Overview

• Federal income tax system administered by the Internal Revenue Service (IRS)
• Tax year typically follows the calendar year (January 1 to December 31)
  • Some businesses may use a fiscal year
• Taxes withheld from paychecks throughout the year (Form W-4)
• Taxpayers file annual tax returns to report income, claim deductions and credits, and calculate tax liability
• Self-employed individuals make estimated tax payments quarterly
• Tax returns due April 15th (or next business day if falls on a weekend or holiday)
  • Extensions available to October 15th
• Refunds issued if taxes withheld or paid exceed tax liability
• Additional taxes owed if tax liability exceeds taxes withheld or paid

Types of Taxpayers and Filing Statuses

• Individuals U.S. citizens and resident aliens required to file based on income thresholds
• Married couples may file jointly combining their income and deductions
  • Qualifying Widow(er) status available for two years after spouse's death
• Married Filing Separately each spouse files their own return, but may lose certain tax benefits
• Head of Household unmarried individual who pays more than half the cost of maintaining a home for a qualifying person (child or dependent parent)
• Trusts and Estates separate legal entities that may be required to file income tax returns
• Partnerships flow-through entities that pass income and deductions to individual partners
• Corporations taxed as separate entities with different tax rates and rules

Income Sources and Recognition

• Wages, salaries, and tips earned from employment
• Interest income earned from savings accounts, CDs, and bonds
• Dividend income earned from investments in stocks or mutual funds
• Capital gains profits from the sale of assets (stocks, real estate)
  • Short-term gains taxed as ordinary income
  • Long-term gains (assets held more than one year) taxed at preferential rates
• Rental income earned from renting out property
• Business income profits from self-employment or operating a business
• Alimony taxable income for agreements executed before 2019
• Unemployment compensation generally taxable at the federal level
• Social Security benefits may be taxable depending on total income

Deductions and Credits

• Standard deduction flat amount based on filing status (Single, Married Filing Jointly, Head of Household)
• Itemized deductions claimed in lieu of standard deduction
  • Medical and dental expenses that exceed 7.5% of Adjusted Gross Income (AGI)
  • State and local taxes (SALT) deduction capped at $10,000
  • Mortgage interest on first $750,000 of mortgage debt
  • Charitable contributions cash donations up to 60% of AGI, non-cash donations up to 30% of AGI
• Above-the-line deductions reduce AGI (student loan interest, educator expenses)
• Refundable credits (Earned Income Tax Credit) can result in a refund even if no taxes are owed
• Non-refundable credits (Child Tax Credit) can reduce tax liability to zero but not below

Tax Calculation Process

• Determine gross income from all taxable sources
• Subtract above-the-line deductions to calculate AGI
• Subtract standard deduction or itemized deductions from AGI to determine taxable income
• Apply tax rates to taxable income to calculate tax liability
  • Tax brackets vary based on filing status
• Subtract tax credits from tax liability
• Compare taxes withheld and estimated tax payments to tax liability
  • Refund issued if payments exceed liability
  • Additional taxes owed if liability exceeds payments
• Report tax liability, payments, and refund/amount owed on tax return

Filing Requirements and Deadlines

• Income thresholds for filing vary based on filing status, age, and type of income
  • Single under 65: $12,950
  • Married Filing Jointly under 65: $25,900
• Self-employed individuals must file if net earnings exceed $400
• April 15th (or next business day) deadline for filing federal income tax returns
  • Automatic 6-month extension to October 15th if Form 4868 filed
• Estimated tax payments due quarterly (April 15, June 15, September 15, January 15)
• Penalties and interest assessed for late filing and late payment
• Amended returns (Form 1040X) filed within 3 years of original return to correct errors or claim additional deductions/credits

Common Tax Forms and Schedules

• Form 1040 main tax return form used to report income, deductions, credits, and calculate tax liability
• Schedule A itemized deductions form
• Schedule B interest and dividend income form
• Schedule C profit or loss from business form (sole proprietorships)
• Schedule D capital gains and losses form
• Schedule E supplemental income and loss form (rental income, partnerships, S corporations)
• Form W-2 wage and tax statement provided by employers
• Form 1098 mortgage interest statement provided by lenders
• Form 1099 information returns for various types of income (interest, dividends, independent contractor payments)