gstti.com · table of contents section 1 - federal income taxes lesson 1

FEDERAL TAX CONTINUING EDUCATION COURSE

15 HOURS

GOLDEN STATE TAX TRAINING INSTITUTE, INC.

2012

15 HOURS FEDERAL CONTINUING EDUCATION COURSE

IRS Course Number: P619F-T00001-12-S

GOLDEN STATE TAX TRAINING INSTITUTE, INC.

P. O. BOX 930

Prospect Heights, IL, 60070 Voice: 877-674-9290 Fax: 877-674-9290 www.GSTTI.com

http://www.gstti.com/

California Tax Education Council (CTEC)

Provider Number: 2040

2012

GOLDEN STATE TAX

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Copyright © 2012 Golden State Tax Training Institute, Inc. All Rights Reserved.

Table of Contents

SECTION 1 - FEDERAL INCOME TAXES LESSON 1 .............................................................................................................. 1-1

2012 FEDERAL TAX LEGISLATION, CONTINUING CHANGES, TAXABLE INCOME, PERSONAL EXEMPTIONS, FILING STATUS ................................... 1-1

LESSON 2 .............................................................................................................. 2-1

COMPENSATION, DIVIDENDS, INTEREST, OTHER INCOME, and SOCIAL SECURITY/MEDICARE ...................................................................................... 2-1

LESSON 3 .............................................................................................................. 3-1

EXCLUSIONS, OTHER EMPLOYEE COMPENSATION, DEDUCTIONS FOR ADJUSTED GROSS INCOME, IRAs .................................................................. 3-1

LESSON 4 .............................................................................................................. 4-1

STANDARD DEDUCTION, ITEMIZED DEDUCTIONS ....................................... 4-1

LESSON 5 .............................................................................................................. 5-1

CREDITS ............................................................................................................ 5-1

LESSON 6 .............................................................................................................. 6-1

CAPITAL GAINS AND LOSSES, SALE OF PERSONAL RESIDENCES, ALTERNATIVE MINIMUM TAX ........................................................................... 6-1

LESSON 7 .............................................................................................................. 7-1

SMALL BUSINESS TAXATION, BUSINESS USE OF YOUR HOME, HOUSEHOLD EMPLOYMENT TAXES, FARMING TAXATION, RENTS AND ROYALTIES, and DEPRECIATION 7-1

LESSON 8 .............................................................................................................. 8-1

TAX FORMS, TAX COMPUTATION WORKSHEET, FILING DATES, ELECTRONIC FILING, ADMINISTRATION, AND PENALTIES .......................... 8-1

LESSON 9 .............................................................................................................. 9-1

TAX PREPARER’S ETHICS, MAIN PENALTIES, ADMINISTRATION OF TAX . 9-1

INDEX ........................................................................................................................ 1

© 2012 Golden State Tax Training Institute 1-1

SECTION I FEDERAL INCOME TAXES

LESSON 1

2012 FEDERAL TAX LEGISLATION, CONTINUING CHANGES, TAXABLE INCOME, PERSONAL EXEMPTIONS, FILING STATUS

Section I of this course is a review of the important tax laws, regulations and rulings you need to prepare Federal income tax returns for individuals.

IMPORTANT Update on Tax Preparer Requirements

IRS Continuing Education Initiative

The IRS has announced plans requiring tax preparers in all states to complete 15 hrs of annual federal continuing education. These 15 hours of continuing education must include 2 hours of ethics, 3 hours of federal tax law updates and 10 hours of other federal tax law. The continuing education requirements for Registered Tax Return Preparers do not apply to attorneys, certified public accountants, and enrolled individuals, certain supervised preparers, and individuals who do not prepare Form 1040 series returns. Golden State Tax Training, Inc. is an approved education provider for the IRS.

Tax Return Preparers Must Use IRS e-File A new law requires paid tax return preparers to electronically file federal income tax returns prepared and filed for individuals, trusts, and estates starting Jan. 1, 2011. The e-file requirement will be phased in over two years starting in 2011. As a result of the new rules, preparers will be required to start using IRS e-file beginning:

January 1, 2011— for preparers who anticipate filing 100 or more Forms 1040, 1040A, 1040EZ and 1041 during the year; or

January 1, 2012— for preparers who anticipate filing 11 or more 1040, 1040A, 1040EZ and 1041 during the year.

The rules require members of firms to compute the number of returns in the aggregate that they reasonably expect to file as a firm. If that number is 11 or more in calendar year 2012 and thereafter, then all members of the firm must e-file the returns they prepare and file. This is true even if a member prepares and files fewer than the threshold on an individual basis. Clients may independently choose to file on paper.


Tax Preparers Must have a Preparer Tax Identification Number

New regulations require all paid tax return preparers (including attorneys, CPAs, and enrolled agents) to apply for a Preparer Tax Identification Number (PTIN) — even if you already have one — before preparing any federal tax returns in 2012.

Due Date of 2011 Tax Return File Form 1040 by April 17, 2012. The due date is April 17, instead of April 15, because April 15th falls on Sunday and April 16th falls on Emancipation Day in the District of Columbia — even if you do not live in the District of Columbia.

2011 FEDERAL TAX LEGISLATION Reporting capital gains and losses on new Form 8949 In most cases, you must report your capital gains and losses on new Form 8949. Then you report certain totals from that form on Schedule D (Form 1040). Standard mileage rates. The 2011 rate for business use of your car is 51 cents a mile for miles driven before July 1, 2011, and 55 ½ cents a mile for miles driven after June 30, 2011. The 2011 rate for use of your car to get medical care is 19 cents a mile for miles driven before July 1, 2011, and 23 ½ cents a mile for miles driven after June 30, 2011. The 2011 rate for use of your car to move is 19 cents a mile for miles driven before July 1, 2011, and 23 ½ cents a mile for miles driven after June 30, 2011. Standard deduction increased. The standard deduction for some taxpayers who do not itemize their deductions on Schedule A of Form 1040 is higher in 2011 than it was in 2010. The amount depends on your filing status. Exemption amount The amount you can deduct for each exemption has increased. It was $3,650 for 2010. It is $3,700 for 2011. Self-employed health insurance deduction This deduction is no longer allowed on Schedule SE (Form 1040). However, you can still take it on Form 1040, line 29. Alternative minimum tax (AMT) exemption amount increased The AMT exemption amount has increased to $48,450 ($74,450 if married filing jointly or a qualifying widow(er); $37,225 if married filing separately). Health savings accounts (HSAs) and Archer MSAs For distributions after 2010, the additional tax on distributions from HSAs and Archer MSAs not used for qualified medical expenses has increased to 20%.Also beginning in 2011, amounts paid for medicine or a drug are qualified medical expenses only if the medicine or drug is a prescribed drug or is insulin.


Roth IRAs If you converted or rolled over an amount to a Roth IRA in 2010 and did not elect to report the taxable amount on your 2010 return, you generally must report half of it on your 2011 return and the rest on your 2012 return. Designated Roth accounts If you rolled over an amount from a 401(k) or 403(b) plan to a designated Roth account in 2010 and did not elect to report the taxable amount on your 2010 return, you generally must report half of it on your 2011 return and the rest on your 2012 return. Alternative motor vehicle credit You cannot claim the alternative motor vehicle credit for a vehicle you bought in 2011, unless the vehicle is a new fuel cell motor vehicle. First-time homebuyer credit To claim the first-time homebuyer credit for 2011, you (or your spouse if married) must have been a member of the uniformed services or Foreign Service or an employee of the intelligence community on qualified official extended duty outside the United States for at least 90 days during the period beginning after December 31, 2008, and ending before May 1, 2010. Repayment of first-time homebuyer credit If you have to repay the credit, you may be able to do so without attaching Form 5405. Non-business energy property credit This credit is figured differently for 2011 than it was for 2010. Health coverage tax credit This credit has been extended, and the amount has changed. Foreign financial assets If you had foreign financial assets in 2011, you may have to file new Form 8938 with your return. Schedule L Schedule L is no longer in use. You do not need it to figure your 2011 standard deduction. Making work pay credit The making work pay credit has expired. You cannot claim it on your 2011 return. Schedule M is no longer in use. Child Tax Credit For 2011 tax year, the child tax credit stays at $1000.


General Information Tax rate brackets 2011

Top bracket 35% Fifth bracket 33% Fourth bracket 28% Third bracket 25% Second bracket 15% Initial bracket 10%

Child tax credit $1000 IRA contributions age 50 under $5,000 IRA contributions age 50 over $6,000 SIMPLE contributions $11,500 Elective deferrals $16,500 Elective catch-ups

SIMPLEs $2,500 401(k), 403(b), 457 plans $5,500

Alternative Minimum Tax (AMT) single $48,450 married filing jointly $74,450

WHO IS SUBJECT TO THE TAX Every citizen of the U.S. and every resident alien is subject to the income tax. All citizens must pay the tax even if they are residents of a foreign country. A limited exclusion applies to income earned from foreign sources. The tax is also levied on citizens of foreign countries who are residents of the U.S., and on citizens of foreign countries who earn income in the U.S. The rates and procedures for nonresident aliens are different from those for citizens and resident aliens. In addition, the U.S. has tax treaties with many countries that exempt certain items of income from taxation or decrease the rates. Age, occupation, and mental or physical conditions have no influence on who is subject to the tax. A minor must pay the tax on his or her income just like any adult, including the President of the United States. Persons institutionalized because of mental incapacity are still subject to the tax. However, not every person has to file an annual tax return with the Internal Revenue Service (IRS). Taxpayers have to file a tax return only if their gross income exceeds the total of their standard deduction plus their allowable personal exemptions. The amount varies depending on the taxpayer's filing status and, for tax year 2011, the amounts are:

2011 Single individual $9,500 Single individual 65 or older 10,950 Married couple, filing jointly 19,000 Married couple, one spouse 65 or older 20,150 Married couple, both 65 or older 21,300 Married individual, filing separate return 3,700 Head of household 12,200 Head of household 65 or over 13,650


Surviving spouse 15,300 Surviving spouse 65 or older 16,450 Self-employed individual 400

TAXABLE INCOME

The Federal income tax is an annual tax determined by applying the applicable tax rate to the net taxable income. There are a variety of rates that apply to different taxpayers and many detailed rules that are used to determine the amount of net taxable income.

GROSS INCOME

Gross income is income from all sources, except for items specifically excluded by the Internal Revenue Code. Income on an individual's annual income tax return typically is the sum of wages and other items of income less the exclusions. The precise amount of gross income is important in order to determine whether the taxpayer must file a return.

ADJUSTMENTS TO GROSS INCOME The following are major items, within limits, allowed by law to be subtracted from your Gross Income. These are:

1. Educator expenses 2. Certain business expenses of reservists, performing artists, and fee-basis

government officials 3. Archer MSA and Health savings account deduction 4. Moving expenses 5. One-half of self-employment tax 6. Self-employed SEP, SIMPLE, and qualified plans 7. Self-employed health insurance deduction 8. Penalty on early withdrawal of savings 9. Alimony paid 10. IRA deduction 11. Student loan interest deduction 12. Tuition and Fees Deductions

ADJUSTED GROSS INCOME (AGI)

Adjusted gross income is the remainder of gross income after subtraction of allowed adjustments above. This intermediate amount is important because it is used for computing deductions, tax credits, and other tax benefits that are based on or limited by income. The deductions for medical expenses, contributions, casualty losses and miscellaneous itemized deductions are all based on or limited by the amount of adjusted gross income.

DEDUCTIONS FROM ADJUSTED GROSS INCOME Some deductions are allowed for expenses of a personal nature. These are divided into five categories:


1. Uninsured Medical and Dental Expenses 2. Paid interest and taxes on your home 3. Gifts to Charity 4. Casualty and Theft Losses 5. Job Expenses and Certain Miscellaneous Deductions, including union dues, tax

preparation fees, safe deposit box fees, and un-reimbursed employee business expenses.

Deductions from adjusted gross income are sometimes referred to as personal deductions; however, this can result in confusion. Most personal expenses, such as food, clothing, shelter, entertainment, and the like, are not deductible. A more appropriate designation is itemized deductions.

STANDARD DEDUCTION Itemized Deductions should be used only when they exceed the flat Standard Deduction amounts provided by law. The Standard Deduction amounts are:

2011 Married filing jointly $11,600 Married filing separate returns 5,800 Single filers 5,800 Head of household filers 8,500 Dependent(Minimum) 950

PERSONAL EXEMPTIONS

The last subtraction from income to be considered is the deduction for personal exemptions. Throughout the history of the income tax, Congress has recognized that some minimal amount is needed by everyone for the basic necessities, and has excluded this amount from taxation. The basic amount for tax year 2011 is $3,700 per person. Thus in tax year 2011, the first $3,700 earned by an unmarried individual who has not reached sixty-five years of age and who has no obligations to others dependent on him is not subject to the tax. No exemption is allowed when the taxpayer is a dependent of another taxpayer. Amount of Deduction: The total deduction for tax year 2011 for personal exemptions is the sum of the following:

1. $3,700 for the taxpayer. Every individual is entitled to an exemption for himself, and therefore a $3,700 deduction, unless a dependent of another as indicated above.

2. $3,700 for the taxpayer's spouse (husband or wife) if a joint return is filed. A taxpayer may get a deduction for his (or her) spouse on a separate return if the spouse has no income and is not claimed as the dependent of another. A joint return is one in which the husband and wife combine their income and deductions.

3. $3,700 for each dependent. What constitutes a dependent is explained in detail later.


Personal exemptions will have no phase-out limits for tax years 2011 or 2012.

NET TAXABLE INCOME The final remainder is the net taxable income. This amount is the base for the tax; the rates are applied to this amount to determine the gross tax liability. The 2011 Federal Tax Table, the 2011 Tax Rate Schedules, and the 2011 Tax Computation Worksheet are in the Appendix.

FILING STATUS The tax law divides taxpayers into four status categories based on their family responsibilities. This is referred to as the taxpayer's filing status. Because the tax rates differ for each filing status, separate tax rate schedules and tax tables are prepared by the Internal Revenue Service. The filing status categories include: Single --A taxpayer’s filing status is single if the person never married or if, on the last day of the year, the person is unmarried or legally separated under a divorce or separate maintenance decree. Married, filing a joint return -- A joint return may be filed under the following conditions:

1. If the individuals are married as of the last day of the taxable year. A couple could be married at 11:59.59 p.m. on December 31 of the taxable year and still file a joint return for the entire year.

2. If one spouse dies during the taxable year, provided that the surviving spouse has not remarried during the year. If remarried, the taxpayer may file jointly with his/her new spouse.

3. If the individuals are not divorced or legally separated before the end of the taxable year under a final decree.

4. If both spouses agree to file a joint return. 5. If a non-resident alien is married to a citizen of the United States and they both

elect to be taxed on their worldwide income. 6. If the tax years of both spouses begin on the same date.

Qualifying Widow(er) With Dependent Child Surviving spouses with a dependent child may also use the same tax tables and tax rate schedules as used by joint filers (up to 2 years after year of death). A surviving spouse is a widow or widower whose spouse died not earlier than the second preceding taxable year and who has a dependent child, stepchild, adopted child, or foster child living with him/her for the entire year. To illustrate, a taxpayer's husband died in July, 2011. The taxpayer has a dependent son who lives with her. For 2011, she may file a joint return because she was still married on the date of her spouse's death. For 2012 and 2013, she qualifies as a surviving spouse. For 2014 and later years, she is not a surviving spouse because her husband died earlier than the second preceding taxable year. Married Taxpayers filing separately -- Taxpayers who are married but elect to file


separate returns must use a rate schedule which provides for the highest tax of all the classes. Normally, it will not be advantageous for married taxpayers to make this election. One consideration, however, which might lead a married person to file separate return in certain circumstances is the joint liability for the tax on a joint return; that is, if one spouse fails to pay the tax, the other will have to. There are other disadvantages which are detailed later in this course. Unmarried Head of Household -- To qualify as a head of household, a taxpayer must meet the following four conditions:

1. The taxpayer is (a) unmarried and (b) provides a home for a certain other person(s).

2. The taxpayer provided over half the cost of keeping up a home that was the main home for the entire tax year for the taxpayer’s parent(s) whom the taxpayer can claim as a dependent(s). The parent(s) did not have to reside in the taxpayer’s home.

3. The taxpayer paid over half the cost of keeping up a home in which the taxpayer resides and in which one of the following also resided for more than half of the year:

a. The taxpayer’s unmarried child, adopted child, grandchild, great-grandchild, (etc.), or stepchild. It does not matter what age the child was, and the child does not have to qualify as a dependent of the taxpayer.

b. The taxpayer’s married child; this child must be a dependent of the taxpayer (under most circumstances).

c. The taxpayer’s foster child; this child must be a dependent of the taxpayer.

d. Any other relative the taxpayer can claim as a dependent. 4. A married taxpayer who lives apart from his/her spouse can claim head of

household status if: a. The taxpayer lived apart from his/her spouse for the last six (6) months of

the tax year. b. The taxpayer files a separate tax return from his/her spouse. c. The taxpayer paid over 50% of the cost of maintaining his/her home for

the tax year. d. The taxpayer’s home was the main home of the taxpayer’s child,

adopted child, stepchild, or foster child for more than half of the tax year, and, the taxpayer claims such a child as a dependent.

COMPUTATIONS OF GROSS TAX LIABILITY USING THE TAX TABLE

After determining a taxpayer's taxable income and his tax status, arriving at his gross tax liability is a relatively simple chore. This is accomplished by referring to the correct column on the Tax Table provided by the Internal Revenue Service. The Tax Table is set up based on amounts of taxable income below $100,000. A person having taxable income of $100,000 or more must use the Tax Computation Worksheet (based on the Tax Rate Schedules). A column is provided for each tax status, and the tax is determined by locating the amount shown under the correct column to the right of the taxable income amount. The 2011 Federal Tax Table, the 2011 Tax Rate Schedules, and the 2011 Tax


Computation Worksheet are in the Appendix.

NET TAX LIABILITY The final step in the tax formula is the determination of the net tax liability, the amount of money, which the taxpayer must pay with the filed tax return, or the amount that the tax filer will receive back from the government. To determine this amount, the following must be either added or subtracted:

ALTERNATIVE MINIMUM TAX The Alternative Minimum Tax is figured on Form 6251 and posted to Line 45, Form 1040.

TAX CREDITS The major tax credits are as follows:

Credit for the elderly or the disabled

Education credits

Retirement savings contributions credit

Residential Energy Credits

Adoption credit

Foreign tax credit

Child Tax Credit

Child and dependent care

Electric vehicle credits

Mortgage interest

Prior year minimum tax

Other business-related and other miscellaneous credits

Tax credits do not have the same effect as deductions. Deductions such as IRA deductions and excess itemized deductions reduce the income amount on which the tax is levied. Credits, on the other hand, are subtracted directly from the gross tax liability. If a taxpayer, for example, is in the 15 percent bracket on the applicable tax table, a $100.00 deduction reduces his tax liability by only $15.00. If, on the other hand, he has a tax credit of $100.00, this will reduce his tax liability by a full $100.00.

TAX PAYMENTS

Earned Income Credit

Child tax credit

First-time homebuyer credit

Estimated tax paid

Excess social security and tax withheld

Federal income tax withheld

Health coverage tax credit The most obvious subtraction in this category is the amount of Federal income tax that has been withheld from the employee's pay (reported by employers on Form W-2). Also


included are estimated taxes paid by self-employed individuals, and excess amounts of social security taxes that have been withheld from an employee's pay. Included here is the amount for Earned Income Credit, to be discussed in Lesson 5. Also included here is the additional Child Tax Credit; the amount paid with a request for extension to file; and other payments.

OTHER TAXES The most important other tax that must be reported on an individual’s Federal income tax return is the self-employment tax. This tax must be paid by persons who are not employees and therefore do not have Social Security taxes withheld from their pay. Also in this category are Social Security and Medicare tax on tip income, tax on IRAs, other qualified retirement plans, tax on advanced earned income credit payments, and tax due on household employment.

EXEMPTION FOR DEPENDENT There is no maximum limit on the deduction for dependency exemptions. A taxpayer with any number of dependents is entitled to a $3,700 exemption for each one in tax year 2011. The term dependent, like most other words used in the law, has a specific meaning established by statute. Beginning in tax year 2005, new definitions for a “qualifying child” and “qualifying relative” and tie-breaking rules are applicable for claiming an individual as a dependent. For years beginning after December 31, 2008, the definition of qualifying child is modified to include a new age test and a joint return test. “Qualifying Child” Definition. A child to be considered a “qualifying child” for purposes of the dependency exemption must satisfy five tests: relationship, age, citizenship/residency, principal place of abode and support.

(1) Relationship. The child must bear one of the following relationships to the taxpayer: (a) a son, daughter, stepson, stepdaughter or a descendant of such child or (b) a brother, sister, stepbrother, stepsister or a descendant of such relative.

The relationship test includes foster and adopted children. An eligible foster child is a child who is placed with the taxpayer by an authorized placement agency or by a decree issued by the courts. An eligible adopted child shall include both a legally adopted child and a child legally placed for adoption.

(2) Age. The child must not have attained the age of 19 by the end of the calendar year or must be a student that has not attained the age of 24 by the end of the calendar year. A student is defined as an individual attending on a full-time basis for at least five calendar months in a year at a qualified educational institution or qualified on-farm training program. This requirement is suspended for any individual who is total and permanently disable at any time during the year. For 2010 year and later, the definition of age has been modified to include that the child must be younger than the taxpayer or spouse.

(3) Residency. To meet this test, your child must have lived with you for more than half of the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents

(4) Joint Return. To meet this test, the child cannot file a joint return for the year.


(5) Support. The child must not provide more than one-half their own support for the year.

In the event that a child can be claimed as the qualifying child by two or more individuals, the child is considered the qualifying child of their parent first and, if neither is the parent of the child, then the taxpayer that the child spent the most time with, then the taxpayer with highest adjusted gross income. If the child or individual fails to meet all the requirements to be considered a qualifying child, the individual may still be claimed as a dependent if they meet all the requirements for a “qualifying relative.” “Qualifying Relative” Definition. For individuals who fail to satisfy all the requirements to be considered a “qualifying child,” they may still qualify to be claimed as a dependent if they meet four different tests, to determine whether a taxpayer was entitled to claim an individual as a dependent. The four tests are not a qualifying child, member of household or relationship, gross income, support:.

1. Not a qualifying child. A child is not your qualifying relative if the child is your qualifying child or the qualifying child of any other taxpayer.

2. Relationship. The individual must fall within one of the following relationships: a. son, daughter, stepson, stepdaughter, or a descendant of such child; b. brother, sister, stepbrother or stepsister; c. father, mother or an ancestor of either (i.e., grandmother and/or

grandfather); d. stepfather or stepmother; e. son or daughter of a brother or sister of the taxpayer (i.e., nieces and/or

nephews); f. brother or sister of the father or mother of the taxpayer (i.e., aunts and/or

uncles); g. son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or

sister-in-low; or h. an individual that for the year has the same principal place of abode as the

taxpayer and is a member of the taxpayer’s household. 3. Gross Income. The individual in must have less than $3,650 of gross income.

This gross income test does not apply if the individual is a qualifying child of the taxpayer and either is under age 19 or is a full-time student under age 24 at the end of the calendar year.

4. Support. Over half of the dependent’s total support for the calendar year must have been furnished by the taxpayer (with exceptions relating to multiple support agreements and children of divorced patents.

The definition of a child for qualifying relative purposes is the same as for a qualifying child. Thus, a legally adopted child or a child lawfully placed for adoption is treated as a child or individual related by blood to the taxpayer. If a foster child is lawfully placed with the taxpayer by an authorized agency or decree of the courts, the child or the individual may also be treated as related to the taxpayer. The relationship of affinity, once existing, is not destroyed for income tax purposes by


divorce or by the death of a spouse. (For example, Mr. Goodtaxpayer contributes more than half the support of his wife’s mother. Mrs. Goodtaxpayer divorces Mr. Goodtaxpayer but he continues to contribute more than half the support of his former mother-in-law. Mr. Goodtaxpayer may continue to claim his former mother-in-law as a dependent on his separate return.) Assuming that the support test is met, a full exemption may be claimed for a child born at any time during the tax year, so long as the child lives momentarily and the birth is recognized under state or local law as a “live” birth. Married Dependents. The exception for claiming a dependent that files a joint return with the dependent’s spouse for purposes of claiming a refund has been repealed. The filing of a joint return bars another taxpayer from claiming either individual as a dependent. Multiple-Support Agreements -- In many cases, two or more persons join together to support the same individual. For example, several children may share the cost of supporting a parent. In these situations, one of the groups can claim an exemption, even though no one provides over one-half the support. The group can enter into a multiple-support agreement if the following conditions are met:

1. No one person contributes over 50 percent of the dependent's support. 2. Every member of the group could claim an exemption, except for the support

test. 3. The group member who claims the exemption provides more than ten percent

of the support. 4. Every group member who provides more than 10 percent of the support files a

consent on Form 2120. In these situations, the exemptions can be rotated from year to year among members of the group who provide over 10 percent of the dependent's support. Better yet, give the exemption to the member who is in the highest tax bracket and pass around the tax savings. Children of Divorced Parents – Generally, the dependency exemption for children of divorced taxpayers will go to the parent who has custody of the child for the greater part of the calendar year. The custodial parent will be determined by the number of nights in which the child resided with the parent. When the child spends an equal amount of time with each parent, the parent with the higher adjusted gross income is allowed to claim the dependency exemption. This rule applies only if the child receives over one-half of his or her support from parents who are divorced, legally separated, or have lived apart for the last six months of the calendar year. In addition, the child must have been in the custody of one or both parents for more than one-half of the calendar year. There are three (3) exceptions to the rule that a custodial parent is entitled to the dependency exemption. The first exception arises when there is a multiple support agreement that allows the child to be claimed as a dependent by a taxpayer other than the custodial parent. The second exception is when the custodial parent releases his or her right to the child’s dependency exemption to the non custodial parent. This release must be executed in writing and attached to the non custodial parent’s tax return for each year the exemption is released. The third exception is when a pre-1985 divorce decree or


separation agreement between the parents grants the exemption to the non custodial parent and the non custodial parent provides at least $600 for the support of the child for the year in question. Unearned Income of Minor Child (“Kiddie Tax”)--The transfer or shifting of income from a parent’s higher tax bracket over to the parent’s child who has a lower tax bracket in order for the parents to save money on their income tax is greatly limited before the child reaches age 14 (prior to 2006 year).The limit was increased to age 18 for the 2006 and subsequent tax years as amended by the Tax Increase Prevention and Reconciliation Act of 2005. Since the Standard Deduction is $950 for tax year 2011, the child’s unearned income between $950 and $1,900 is taxed at the child’s rate; and, the remaining earned income of the child over $1,900 for tax year 2011 is taxed at the parents’ highest tax rate. The tax is computed on Form 8615 called “Tax for Certain Children who have investment income of more than $1,900”. If the child’s parents file their returns as “married filing separately” the parent with the highest marginal tax rate is the rate to be used. However, for tax year 2011, the parent of a child under age 18 may elect to include the gross income of the child in excess of $1,900 into the parents’ income which can be accommodated by filing Form 8814. The age limit increases to age of 19 or the age of 24 provided that the child is a full-time student whose gross income does not exceed half of his or her own support. Dependent's Social Security Numbers - Dependent's social security numbers must be reported on the taxpayer's tax return for all dependents


LESSON 2

COMPENSATION, DIVIDENDS, INTEREST, OTHER INCOME, and SOCIAL SECURITY/MEDICARE

The most common forms of income reported by the average taxpayer are compensation, dividends, and interest. About 95 percent of the adjusted gross income, of individuals, in are from these three sources. Income from compensation alone -- salaries, wages, and all fringe benefits -- accounts for about 85 percent of the total adjusted gross income.

COMPENSATION/WAGES Form W-2 is used to report to employees the annual amount of salaries and withholdings. In some cases, taxable compensation is not subject to withholding of income taxes and the compensation is not reported on Form W-2. When taxable income is not subject to withholdings, the taxpayer must report the amount on Line 21 of Form 1040(see Appendix A1) unless it fits into one of the categories shown on Lines 7 through 20b. If the space on Line 21 is insufficient to state the nature and source, then the taxpayer must attach a supplementary schedule to Form 1040 to explain the amounts reported. The IRS does not provide a printed form for this purpose.

COMPENSATION SUBJECT TO THE TAX All compensation for personal services is subject to the income tax. Compensation means more than just salaries and wages. The term also includes tips, commissions, fees for personal services, overtime pay, vacation pay, and every other payment for personal services. Virtually every payment made by an employer to an employee or by a customer for personal services, is compensation and is taxable income to the employee-recipient. Taxability of a payment is not affected by what the payment is called. For example, bonuses and performance awards are usually taxable as compensation.

DIVIDENDS For many years, millions of people have invested in corporate stocks. For this reason, dividends are a popular source of income. A dividend on stock is similar to an interest payment received on a savings account, note or bond, but with two important differences: (1) unlike interest, the amount of the dividend is not specified by contract. (2) Dividends are not necessarily paid at regular intervals, but depend upon the decision of the corporate directors to make a distribution.

DIVIDENDS SUBJECT TO THE TAX

For tax purposes, a dividend is any distribution of property made by a corporation to its stockholders, provided it is paid out of earnings and profits accumulated since March 1,


1913. When a corporation has no profits prior to a distribution, or when all accumulated profits have already been distributed to the stockholders, a distribution is nothing more than a return of the stockholders' capital investment. Such a distribution amounts to a partial liquidation of the corporation, and these distributions must receive treatment different from that given ordinary dividend. In addition, some distributions from certain corporations are taxed as capital gains. The usual example is the investments company, which distributes the ordinary dividends, received by it and the capital gains realized during the period. The form in which a dividend is received (cash or property) has no effect on its taxation. Most dividends are paid in cash. When a distribution is of some property other than cash, the fair market value of the property at the time of the distribution is the measure of the dividend. Small, closely held corporations frequently make non-cash distributions in order to preserve their working capital.

ORDINARY DIVIDENDS AND QUALIFIED DIVIDENDS Since January 1, 2003, dividends have been split into two types: 1) ordinary dividends, and 2) qualified dividends.

Ordinary dividends received by a taxpayer are included in gross income and continue to be taxed as ordinary income. A taxpayer can assume that any dividend he/she receives on common or preferred stocks is an ordinary dividend, unless the paying corporation on its Form 1099-DIV states otherwise. The dividend tax on these dividends is the same as an investor's personal income tax bracket. If you're in the 25% tax bracket, for instance, you'll pay a 25% dividend tax on ordinary ( also known as non-qualified) dividends. Ordinary dividends are entered on Line 9a, Form 1040(see Appendix A1), and are usually shown in box 1a of the taxpayers’ Form(s) 1099-DIV. If the total ordinary dividends exceed $1,500 all ordinary dividends must be reported on Part II, Schedule B.

Qualified dividends are eligible to be taxed at a lower tax rate than other ordinary income. Generally, qualified dividends are taxed at long-term capital gains rates (see Lesson 6). This means that qualified dividends are taxed at a maximum rate of 15%. For taxpayers who are in the 10% or 15% tax brackets, the tax rate for qualified dividends is 0%. The total of qualified dividends is entered on Line 9b, Form 1040 (see Appendix A1), and are usually found in box 1b of taxpayers’ Form(s) 1099-DIV. To help calculate the tax on qualified dividends (and capital gains) the IRS provides a “Qualified Dividends and Capital Gain Tax Worksheet.” (see Appendix A9) For dividends to qualify for the 0% or 15% maximum rate, all of the following must be met:

1) The dividends must have been paid by a U.S. corporation or a qualified


foreign corporation between January 1, 2003 and December 31, 2011 2) The dividends are not of the type listed later under Dividends that are not

qualified dividends. 3) You meet the holding period as defined below.

Holding period: The taxpayer must have held the stock for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment. Instead, the seller will get the dividend. When counting the number of days the taxpayer held the stock, include the day the taxpayer disposed of the stock, but not the day the taxpayer acquired it. (There are minor exceptions to these requirements)

INTEREST SUBJECT TO THE TAX Interest is rent on money, paid by the borrower to the lender. With few exceptions, interest is fully taxable to the taxpayer receiving it. The major problem connected with interest is the determination of the year when it is included in gross income. To a cash-basis taxpayer, interest is taxable under the doctrine of constructive receipt of income when it is unqualifiedly made subject to the demand of the taxpayer. Under this rule, interest is received when it is credited to the taxpayer's account. Taxable interest income is reported on Line 8a, Form 1040. For 2011, if interest and dividend income exceed $1,500, a listing of all sources and amounts would have to be shown on Part I of Schedule B. Otherwise if the taxpayer had interest income and Dividends of less than $1,500 the total amount may be placed directly on the Form 1040 Line 8a. Interest income is generally reported to taxpayers on Form 1099-INT, "Interest Income," or a similar statement, by banks, savings and loans, and other payers of interest. Form 1099-INT does not have to be attached to the submitted tax return unless it has tax withholding.

EXCLUDED INTEREST Interest received on the obligations of a state, a territory, or any political subdivision of a state or territory, such as a city or a county, is excluded fully from Federal income taxation. This exclusion makes an investment in state and local bonds attractive for taxpayers that are in higher tax brackets. However, tax-exempt interest must be reported on Line 8b, page 1, Form 1040 even though it is not taxed.

INDIVIDUAL RETIREMENT ARRANGEMENTS (IRAs) Interest earned on an Individual Retirement Arrangement (IRA) is excluded from income until withdrawals are made from the account. This exclusion also applies to interest earned by Keogh retirement plans and other qualified pension or profit sharing plans.


EDUCATION SAVINGS BOND PROGRAM

Interest income can be excluded on qualified U.S. Savings Bonds that you redeem to pay for qualified higher education expenses. These are expenses for tuition and required fees at an eligible educational institution (such as an accredited college, university or eligible vocational school) or to a Coverdell education savings account for you, your spouse, or your dependent(s). A "qualified" U.S. Savings bond is a Series EE savings bond that was issued after December 31, 1989, to an individual who has reached age 24 before the date of issuance and which was issued at a discount. (Series I or EE bonds). The exclusion is subject to a phase out in the years in which the bonds are cashed and the tuition is paid. The phase out based on the taxpayer’s modified Adjusted Gross Income for 2011 begins at $106,650 for joint returns and $71,000 for other returns, and is complete at modified adjusted gross income of $136,650 or more for joint returns and $86,100 or more for other returns. This exclusion is not available to married individuals who file separate returns. To figure the interest exclusion when the bonds are redeemed, use Form 8815, "Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989"

UNEMPLOYMENT COMPENSATION At present, the law requires that all unemployment compensation received from governmental units must be reported as income. For 2011, unemployment compensation is entered on Line 19, Form 1040.

PRIZES AND AWARDS

Almost all contest awards and prizes are now taxable compensation. They usually represent a payment for services rendered. For example, if the taxpayer wins a photography contest, he must have taken the time and invested in the supplies necessary to produce the winning photograph. Although he must include the prize income, he is entitled to reduce the amount of the prize by direct costs. The winner of a lucky number drawing or other contest of chance must report this income on Line 21, Form 1040. Until 1987, prizes and awards, which were given for charitable, scholarly, scientific or educational achievements for which the recipient did not apply, were excluded from taxation. Now, unless the chosen recipient of the award assigns the right to a qualified charitable organization, he must include the award as income. He may not accept the award and later make a gift to a qualified organization of the same amount, without including the award as income.


GAMBLING INCOME Winning or a gains arising from gambling, betting, and lotteries are includible in gross income. Even winnings or gains arising from illegal transactions (such as bootlegging, extortion, embezzlement, or fraud) are includible in the taxpayer’s gross income. Gambling losses can be deducted to the extent of taxpayer’s winnings. Gambling winnings are reported on Form 1040 line 21. For year 2011, Gambling losses are deducted as an Itemized Deduction on line 28 of Form 1040 Schedule A (see Appendix A3). Only taxpayers that itemize can claim gambling losses.

SEPARATION OR DIVORCE Whenever a husband and wife are legally separated or divorced, property and money may change hands. These exchanges, fall into one of three categories: child support payments, alimony, or property settlements. The difference between the three is more than a matter of legal terminology; they involve distinct tax consequences. Child Support: These payments are nontaxable to the recipient and nondeductible by the taxpayer making the payments. If a taxpayer is in arrears in payments for both alimony and child support, payments are first applied to child support. For tax purposes, one can never pay alimony as long as child support is still owed. A recent law now allows the government to divert income tax refunds of taxpayers in arrears on child support payments. In addition, child support payments may now be withheld from the payer's salary checks by employers who are so ordered by the Courts. Alimony: Child support and alimony differ as to basic objectives. After the divorce or legal separation, the wife (or husband) loses the right to participate in the former spouse’s earnings. If many years of marriage have intervened, he/she may have lost marketable job skills, and advanced age could place such a person at a disadvantage in the labor market. Alimony, then, is in the nature of damages to compensate for the former spouse’s loss of earning power. Consideration of alimony as supplemental compensation is the key to determining its tax treatment. Alimony is taxable to the ex-spouse and deductible by the paying former spouse. The treatment of alimony is the opposite of that for child support. Taxpayers deducting alimony paid must report the amount paid on Line 31a of Form 1040 and, that person's Social Security number on Line 31b of Form 1040. This additional information will make it possible for the Internal Revenue Service to determine that amounts being deducted by an ex-spouse are being reported as income by the recipient former spouse.


SOCIAL SECURITY AND MEDICARE TAXES

For 2011, the tax rate for Social Security is 4.20% for employees, 6.20% for employers and 10.4% for self employed people. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 reduced 2011 Social Security tax rates for employees and self-employed people by two percentage points, from 6.2 percent to 4.2 percent for employees and from 12.4 percent to 10.4 percent for self-employed people. Without further changes in the law, these tax rates will return to 6.2 percent and 12.4 percent, respectively, beginning in 2012. The tax rate for Medicare is 1.45%. The Social Security tax applies only to the first $106,800 of wages, for a maximum of $4,486 for employees, $6,621 for employers, and $11,107 for self employed people. The 1.45% Medicare tax applies to all wages without limitation, and will remain at 1.45% until changed by law. Any excess Social Security tax or Medicare tax withheld over these maximums (usually from having two or more employers), are taken in additional paid-in income taxes and are combined with amounts withheld from wages or paid-in with estimates. If a joint return is filed, these amounts withheld from each spouse cannot be added together to exceed the maximums.

TAXATION OF SOCIAL SECURITY BENEFITS If the only income you received during 2011 was Social Security (or equivalent railroad retirement benefits), these benefits are not taxable and an income tax return probably need not be filed. However, if any portion of the benefits is taxable, file using Form 1040 or Form 1040A; Form 1040EZ cannot be used. How much of the benefits are taxable depends on the total amount of the taxpayer’s benefits and other income. Generally, the higher the income amount, the greater the taxable portion of the taxpayer’s benefits. Maximum Taxable Part – Generally, up to 50% of the taxpayer’s benefits will be taxable. However, up to 85% of the taxpayer’s benefits can be taxable if either of the following applies:

A. The total of one-half of the taxpayer’s benefits plus all other income is more than $25,000 ($32,000 if you are married filing jointly);

B. The taxpayer is married but is filing separately and the taxpayer lived with his/her spouse at any time during the tax year.

Joint Return: If you are married and file a joint return for 2011, you and your spouse must combine your incomes and your benefits when figuring if any of your combined benefits are taxable. Even if your spouse did not receive any benefits, you must add your spouse's income to yours when figuring if any of your benefits are taxable. The IRS provides a "Social Security Benefits Worksheet" upon which you can calculate taxable Social Security benefits.


LESSON 3

EXCLUSIONS, OTHER EMPLOYEE COMPENSATION, DEDUCTIONS FOR ADJUSTED GROSS INCOME, IRAs

EXCLUSIONS

Many items that are commonly thought of as income are excluded from taxation because of Congressional action; they are called exclusions. The distinction between increases in wealth that are not income, such as gifts, and those that are exclusions has no effect on the amount of tax paid by each taxpayer. Both types are subtracted from the taxpayer's total increase in wealth for a taxable year to arrive at the taxpayer's gross income. However, the distinction can be important because some exclusions must be reported on Form 1040 or Form 1040A. For now, keep in mind that excludable and nontaxable mean about the same thing. These exclusions (and exemptions) should not be confused with deductions from Gross Income (such as Moving expenses, Alimony paid, etc.) or from Adjusted Gross Income (such as Standard Deduction or any Itemized Deduction), which must be shown on an individual’s income tax return. An exclusion, generally does not have to be posted on a tax return. It is important to note that most of the exclusions which deal with employer-employee relations are tax-free only if the benefits are offered on a nondiscriminatory basis to all employees. That is, the plans must not favor highly compensated employees or owner-employees. These nondiscrimination rules apply to group term life insurance plans, accident and health plans, legal assistance plans, educational assistance plans, and dependent care assistance plans, to mention only a few.

Exclusions Related to Illness There are four primary groups of exclusions relating to illness: 1. Payments made by an employer on behalf of his employee to provide

health and accident coverage for the employee and his family. This covers not only medical expenses, but also disability insurance.

2. Amounts which are received by an employee under an accident and health plan which reimburse him for amounts spent for medical services.

3. Amounts which are received by an employee directly from his employer which reimburse him for amounts spent for medical services.

4. Amounts which represent restitution for a permanent loss of, or loss of use of, a member or function of the body, or for permanent disfigurement of the taxpayer, his spouse, or a dependent.

Compensation received under the following special provisions is also excluded: 1. Workman's compensation. 2. Damages for personal injury, such as for injuries you received in an auto


accident while traveling on personal time. 3. Medical pensions and allowances resulting from injuries or illnesses while in

the armed forces. 4. Payments made to government employees for injuries received during

terrorist attacks outside the U.S.

Exclusions Related to Death The following exclusions relate to the death of the taxpayer: 1. Premiums paid by an employer for "group-term" life insurance, up to

$50,000 face amount for each employee. Policies of this type provide only temporary coverage, and do not have a cash surrender or loan value. When the face amount of the policy is greater than $50,000, then the premium applicable to the excess is taxable income to the employee.

2. Amounts received by beneficiaries of life insurance contracts because of the death of the insured are, with minor exceptions, excluded from income. So are amounts received under a life insurance contract from a terminally ill taxpayer.

Exclusions Related to Age

Our tax laws reflect a continuing concern about the social and economic needs of the aged. Prior to 1983, the entire amount of Social Security benefits and Railroad Retirement benefits received could be excluded. Since then, Social Security payments are only generally excluded from a taxpayer's gross income. However, as discussed earlier in the course, there's an exception to this rule where a substantial percentage of the Social Security benefits received must be included in income.

Annual Gift Tax Exclusion

You can give $13,000 to each person, and to as many individuals as you want, without triggering the gift tax. The amount is indexed each year for inflation. In addition to the annual exclusion, you also can give the following without triggering the gift tax:

Charitable gifts. Gifts to a spouse. Gifts to a political organization for its use. Gifts of educational expenses. These are unlimited as long as you make a

direct payment to the educational institution for tuition only. Books, supplies and living expenses do not qualify.

Gifts of medical expenses. These, too are unlimited as long as they are paid directly to the medical facility.


Exclusions and Intergovernmental Relations The federal tax law specifically excludes interest received from any city, state, territory, or any political subdivision, or the District of Columbia. These rules also exclude amounts received from any possession of the United States. This exclusion is one of the most widely used tax-planning tools at present. Welfare payments by state and other governmental units remain excluded from taxation.

Exclusions Related to Education Institutions for higher learning very often grant scholarships and fellowships to outstanding students, and to good students who need assistance to pursue their program of study. A fellowship or scholarship grant qualifies for an exclusion if the person receiving it is a candidate for a degree, and if the payments are made for tuition, books, fees, supplies and equipment. Amounts received for meals and lodging, or other expenses must be included by the taxpayer as income. The amounts received may not represent compensation for past, present, or future services of any kind. If the student is required to perform duties such as teaching classes or grading papers, and these chores are not required of all candidates for the degree, then the exclusion does not apply.

Exclusion Related to Foreign-Earned Income As mentioned previously, every citizen of the United States is subject to the income tax, even if they are residents of a foreign country receiving income from foreign sources. Special provisions are available, however, so that these taxpayers are not taxed heavier than citizens residing in the United States because of the foreign taxes they must pay and the higher cost of living in the foreign country. To qualify for these provisions, however, U.S. citizens must establish that they are bona fide residents of a foreign country, or resident aliens who are present in a foreign country at least 330 days out of any consecutive twelve month period. Taxpayers meeting the above qualifications may exclude up to $92,900 from income for 2011.

OTHER EMPLOYEE COMPENSATION Bargain Purchases - Employers sometimes try to encourage greater effort by their employees by selling them property for less than its fair market value. For example, an automobile manufacturer might sell cars to employees at a price below their fair market value. Such a transaction is called a bargain purchase. Generally, a bargain purchase results in taxable compensation to the employee to the extent that the fair market value of the property sold to him by his employer exceeds the purchase price of the property. Personal Use of Company Car - One of the fringe benefits which was left untaxed until 1984 was the personal use of a company car. Under current Regulations, there are various methods available for employers to use in determining the amount which must be included in an employee's gross income when he/she uses a company car for personal benefit. However, regardless of the method chosen by the employer, the employee is bound to that method.


Fringe Benefits - The following non-cash benefits qualify for exclusion from an employee's gross income: (1) no-additional-cost services (e.g., free stand-by flights by airlines to their employees); (2) qualified employee discounts (e.g., reduced sales prices of products and services sold by the employer); (3) working condition fringe benefits (e.g., use of company car for business purposes); (4) de minimis fringe benefits (e.g., use of copying machine for personal purposes); (5) qualified transportation fringe benefits (e.g., transportation in a "commuter highway vehicle," transit passes, and qualified parking); (6) qualified moving expense reimbursements, and (7) qualified retirement planning services. Also, the value of any on-premises athletic facilities provided and operated by the employer is a nontaxable fringe benefit. These benefits may be extended to retired and disabled former employees, to widows and widowers of deceased employees, and to spouses and dependent children of employees. Applicable nondiscrimination conditions must be met. Qualified Moving Expense Reimbursement - A qualified moving expense reimbursement is an excludable fringe benefit. This is an amount received (directly or indirectly) by an individual from an employer as a payment for (or a reimbursement of) expenses that would be deductible as moving expenses if directly paid or incurred by the individual. Transportation Fringe Benefits - In tax year 2011, employees may exclude a maximum of $120 per month from gross income for the value of employer-provided transit passes or van pooling in an employer-provided "commuter highway vehicle.” A qualifying vehicle must seat at least six adults (excluding the driver), and at least 80% of its mileage use must be reasonably expected to be for employees' commuting purposes and for trips when the vehicle is at least 1/2 full (excluding the driver). In 2011, employees may exclude up to $230 per month from gross income for the value of employer-provided qualified parking. The parking must be provided on or near the business premises of the employer or on or near a location from which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. The exclusion does not apply to parking on or near property used by the employee for residential purposes.

In 2011, employers may reimburse bicycle commuters up to $20 per month tax free for each month a bicycle is used for transportation between the employee's home and place of employment. Reimbursement may be for reasonable expenses incurred for the purchase of a bicycle, bicycle improvements, repair and storage. Bike commuters who receive any other transportation fringe benefit under Section 132 are not eligible to receive the bike commuter benefit.

The exclusion for these types of transportation fringes also applies if an employer reimburses an employee's expenses for transit passes, van pooling, or qualified parking. Furthermore, employers may offer the employee a choice of one or more qualified transportation benefits or the cash equivalent without loss of the exclusion. The amount is includable if the cash option is chosen. With respect to mass transit


passes, employers must provide vouchers and not make cash reimbursements unless vouchers are not readily available for direct distribution by the employer to its employees.

Employer-Provided Child or Dependent Care Services - The value of child or dependent care services provided by an employer pursuant to a written plan generally is not includable in the employee's gross income. To qualify for dependent care assistance, the dependent must be:

(1) under 13 years old whom you can claim as a dependent. If the child turned 13 during the year, the child is a qualifying person for the part of the year he or she was under 13

(2) a dependent or the spouse of the taxpayer who is physically or mentally incapable of caring for themselves and who resides with the taxpayer in their principle place of abode for more than six months of the year.

The plan generally must not discriminate in favor of employees who are highly compensated. However, if a plan would qualify as a dependent care assistance program except for the fact that it fails to meet discrimination, eligibility, or other requirements, then despite the failure the plan may still be treated as a dependent care assistance program in the case of employees who are not highly compensated. The amount excludable from gross income cannot exceed $5,000 ($2,500 in the case of a separate return by a married individual). The exclusion cannot exceed the earned income of an unmarried employee or the earned income of the lower-earning spouse of married employees. Employer Payment of Employee's Educational Expenses - Payments received by an employee for tuition, fees, books, supplies, etc., under an employer's educational assistance program, may be excluded from gross income up to $5,250. Excludable assistance payments may not cover tools or supplies that the employee retains after completion of the course or the cost of meals, lodging, or transportation. Although the courses covered by the plan need not be job-related, courses involving sports, games, or hobbies may be covered if they involve the employer's business or are required as part of a degree program.

Food and Lodging Provided by Employer - You can exclude the value of lodging you furnish to an employee from the employee's wages if it meets the following tests.

It is furnished on your business premises. It is furnished for your convenience. The employee must accept it as a condition of employment.

The exclusion does not apply if you allow your employee to choose to receive additional pay instead of lodging. Meals that are excluded from an employee's income will be considered a de minimis fringe benefit, if more than one-half of the employees to whom such meals are provided are furnished the meals for the


convenience of the employer, all such meals are treated as furnished for the convenience of the employer. Therefore, the meals will be fully deductible by the employer, instead of possibly being subject to the 50-percent limit on business meal deductions, and excludable by the employees.

DEDUCTIONS FOR ADJUSTED GROSS INCOME

These adjustments are deductions FOR adjusted gross income, or what many professional tax preparers call "above the line deductions."

Teachers’ Classroom Expenses Eligible educators are permitted an “above-the-line” deduction of up to $250 per year ($500 if married filing joint and both spouses are educators, but not more than $250 each) for unreimbursed expenses incurred in connection with books, supplies (other than nonathletic supplies courses in health or physical education), computer equipment and supplementary materials used in the classroom. An eligible educator is an individual who, for at least 900 hours during a school year, is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide, in a school that provides elementary or secondary education. For tax year 2011, The deduction is claimed on either line 23 of Form 1040 or line 16 of Form 1040A.

Certain Business Expenses of Reservists, Performing Artists and Fee Basis Government Officials

Armed Forces reservists traveling more than 100 miles from home. If a member of a reserve component of the Armed Forces of the United States travels more than 100 miles away from home in connection with the performance of services as a member of the reserves, the reservist can deduct travel expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. The amount of expenses such a taxpayer can deduct as an adjustment to gross income is limited to the federal per diem rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and tolls. Claim this adjustment on Form 1040, Line 24. Expenses of certain performing artists. If a taxpayer is a performing artist, such a taxpayer may qualify to deduct his/her employee business expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. This adjustment is arrived at using Form 2106 or 2106-EZ and is posted on Form 1040, Line 24. To qualify, the performing artist must meet all of the following requirements: 1. During the tax year, he/she performed services in the performing arts as an

employee for at least two employers. 2. Such a taxpayer’s related performing-arts business expenses are more than

10% of the taxpayer’s gross income from the performance of those services. 3. Such a taxpayer’s adjusted gross income is not more than $16,000 before

deducting these business expenses. Officials paid on a fee basis. Certain fee-basis officials can claim their employee


business expenses whether or not they itemize their other deductions on Schedule A (Form 1040). Fee-basis officials are persons who are employed by a state or local government and who are paid in whole or in part on a fee basis. Such taxpayers can deduct their business expenses in performing services in that job as an adjustment to gross income (rather than as a miscellaneous itemized deduction). Claim this adjustment on Form 1040, Line 24.

Individual Retirement Arrangements (IRAs) The main purpose for a taxpayer to set up an Individual Retirement Arrangement (IRA) is to save for future retirement. The main tax advantage for taxpayers is that any earnings on the deposits remain tax-free until distributions are taken from the IRA, and at retirement age the taxpayer would probably be in a lower tax-bracket.

Contributions to Traditional IRAs There are two requirements necessary for setting up a traditional IRA. First, you must have received some taxable compensation income during the year, and, second, you have not reached age 70 ½ by the end of the year. Taxable compensation includes wages, salaries, alimony, tips, commissions and the like. However, the following is NOT considered compensation income for purposes of setting up or contributing to an IRA: 1. Earnings and profits from property, such as rental income, interest income,

and dividend income. 2. Pension or annuity income. 3. Deferred compensation income. 4. Any other income that is an exclusion from gross income. An IRA can be set up either in the name of the taxpayer or the taxpayer and his spouse, in a so called "spousal IRA." Contributions can be made to a spousal IRA even if the spouse has no compensation income. There are specific limitations on the amount that you can contribute to a traditional IRA during the year. The maximum amount of contribution is limited to the smaller of (a) the taxpayer’s compensation income for the tax year, or (b): for tax year 2011, $5,000 if you are under age 50. If you over 50 the “Catch-Up” contribution Limit is $6,000. There are established time frames during which you can make an IRA contribution. An IRA contribution can be made at any time during the tax year or by the due date of the tax return for the year in which you want the contribution to apply, not including any extensions in time to file requests. In other words, this means that most taxpayers can make an IRA contribution for 2011 by April 15, 2011. In fact, you can even claim an IRA contribution and file your tax return before the contribution is actually made, as long as it in fact is made before the due date of the return. Line 32 on Form 1040, under "Adjusted Gross Income," is where you claim a deduction for an IRA contribution for the year. The rules for claiming this deduction have become remarkably complicated over the last several years. Specifically, if either the taxpayer or his spouse is covered by an employer provided retirement plan, the amount of available deduction may be reduced or even eliminated.


Not only is the amount of available IRA deduction dependent on filing status, but it may also be subject to certain income limitations. The amount of available IRA deduction can be determined by using an IRS supplied IRA worksheet.

Deductible Phase-Out Range There was an increase in the "Deductible Phase-Out Range" and a change in the definition of an "Active Participant" effective January 1, 1998: 1. An individual is not considered to be an "Active Participant" in an employer

sponsored retirement plan merely because the individual's spouse is an active participant.

2. The maximum deductible IRA contribution for an individual who is not an active participant, but whose spouse is, is phased-out for taxpayers with AGI between $169,000 and $179,000.

3. The deductible IRA income phase-out limits, for individuals who are active participants, are increased as follows:

Joint Return 2011 $90,000-$110,000 Single Return, or Married Filing Separate, Or Head of Household 2011 $56,000-$66,000 Also, if a taxpayer makes a nondeductible contribution, taxpayer must fill out Form 8606. Penalty-Free Withdrawals from IRAs for Qualified Higher Educational Expenses

Penalty-free distributions from IRAs may be made for qualified educational purposes. The penalty-free withdrawal is available for qualified higher education expenses including tuition, fees, supplies, and equipment required for enrollment or attendance at a post-secondary educational institution. This penalty-free withdrawal (up to the amount of the IRA) is available to the taxpayer, the taxpayer's spouse, or any child or stepchild or grandchild of taxpayer or the taxpayer's spouse.

Penalty-Free Withdrawal from IRAs for First Time Homebuyer Expenses The 10% early distribution penalty will not be charged if the taxpayer uses the money from his/her IRA for qualified expenses associated with buying a principle residence. A maximum of $10,000 during the individual’s lifetime may be withdrawn without a penalty for this purpose. Qualified expenses include acquisition costs, settlement charges and closing costs. The principle residence may be for the individual or the individual’s spouse, child, grandchild or ancestor of the individual or the individual’s spouse. In order to be considered a “first-time homebuyer,” the individual (and spouse, if married) must not have had an ownership interest in a principle residence during the two-year period ending on the date that the new home is acquired.

Penalty-Free Withdrawal from IRAs for Medical Insurance Premiums Certain unemployed persons who make an early distribution to pay for qualifying


medical insurance premiums are not subjects to the 10% penalty. Eligible unemployed individuals are those who have received federal or state unemployment compensation for 12 consecutive weeks. Qualifying premiums are deductible premiums for the medical care of the unemployed individual, spouse and dependents. To be excludable, the distributions must be received in the tax year during which unemployment compensation is received or in the following year. In determining whether the premiums are deductible, the 7.5% medical expense floor is ignored. This exception to the 10% penalty imposed on certain early distribution ceases to apply after the person has been reemployed for 60 days (not necessarily consecutive) after initial unemployment.

Roth IRAs Contributions to a Roth IRA are never deductible. The advantage of the Roth IRA is that the buildup within the IRA (e.g., interest, dividends, and/or price appreciation) may be free from federal income tax when the individual withdraws money from the account. In general, a Roth IRA is subject to the same rules that apply to a traditional IRA. For tax year 2011, the Roth IRA allows individuals to make a maximum annual nondeductible contribution of up to $5,000. However, no more than $5,000 can be contributed to all of an individual's IRAs, whether they are traditional (deductible) or Roth (not deductible). There are many new things included in the Roth IRA: 1. The taxpayer can make contributions after age 70½. 2. Distributions for any of the following purposes are not taxable if: a. 5 year holding period has been met. b. made on or after age 59½. c. made to an individual's beneficiary or estate at death. d. made when the individual becomes disabled. e. made for a qualified purpose, such as first-time home buyer expenses,

subject to a $10,000 lifetime cap. There are several restrictions that you should be aware of. One restriction is that a payment or distribution is not a qualified distribution if it is made less than 5 tax years from the 1st tax year in which the individual made a contribution to a Roth IRA. Another restriction is that a rollover from a deductible IRA to a Roth IRA will be taxable. Finally, for tax year 2011, the maximum contribution that can be made to a Roth IRA is phased-out for a single individual with a modified AGI between $107,000 and $122,000, for joint filers with a modified AGI between $169,000 and $179,000, and for married filing separately with a modified AGI between $0 and $10,000.

“Catch-Up” Contributions A taxpayer who will be at least age 50 by the end of the tax year is able to make an additional contribution to a traditional IRA (or Roth IRA). For tax year 2011, the maximum annual amount of the catch-up contribution is $1,000, so the total contribution maximum is $6,000. In future years, the maximum amount will remain at $1,000.


Rollovers

Federal laws permit tax-free “rollovers” from one tax-qualified retirement plan to another, under specific restrictions, time restraints and conditions. For example, if you leave a company and had a 401K plan there, you must roll it over into and IRA account often referred to as a rollover IRA.

COVERDELL EDUCATION SAVINGS ACCOUNTS Low-and-middle-income taxpayers may open up a Coverdell Education Savings Account (CESA) for qualified higher education as well as elementary and secondary education expenses (i.e., grades kindergarten through 12). The school may be public, private or religious. The maximum annual contribution that could be made to a CESA is $2,000 per beneficiary; and, the annual contribution is phased out for joint filers with modified adjusted gross income at or above $190,000 and less than $220,000 (at or above $95,000 and less than $110,000 for single filers).

A contribution to a CESA is not deductible. Amounts remaining in the account must be distributed within (1) 30 days after the beneficiary reaches age 30 or (2) 30 days after the death of the beneficiary. One way of avoiding taking an unwanted distribution is to take advantage of the rollover provision for Coverdell ESAs. Distributed amounts are not subject to federal income taxes if they are rolled-over to another ESA for the benefit of the same beneficiary or a member of the beneficiary's family that is under the age of 30 including:

A son or daughter or descendant of a son or daughter. Stepsons, stepdaughters, brothers, sisters, stepbrothers, or stepsisters. Father or mother or an ancestor of the father or mother. Stepfather or stepmother. Son or daughter of a brother or sister: nieces and nephews. Brother or sister of father or mother: aunts and uncles. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-

in-law. The spouse of any the individuals listed above. First cousins

The age limit does not apply to beneficiaries with special needs. Tuition and fees deductions are posted on Line 34, Form 1040, or Line 19, Form 1040A. Coordination With Other Educational Benefits. Qualified expenses will first be reduced for tax-exempt scholarships or fellowship grants and any other tax-free educational benefits. Expenses will then be reduced for amounts taken into account in determining the Hope and Lifetime learning credits. Where a student receives distributions from both a CESA and a qualified tuition program that together exceed these remaining expenses, the expenses must be allocated between the distributions.


Generally, contributions to CESAs are treated as gifts to the beneficiaries. Distributions from CESAs are excludable from gross income to the extent that the distribution does not exceed the qualified higher education expenses incurred by the beneficiary during the year in which the distribution is made. Qualified distributions, with the exception of room and board, are tax exempt regardless of whether the beneficiary attends an eligible educational institution on a full-time, half-time, or less than half-time basis. Room and board expenses constitute qualified higher education expenses only if the student is enrolled at an eligible institution on at least a half-time basis. Distributions are deemed paid from both contributions (which are always tax free) and earning (which may be excludable). The amount of contributions distributed is determined by multiplying the distribution by the ratio that the aggregate amount of contributions bears to the total balance of the account at the time the distribution is made. If aggregate distributions exceed expenses during the tax year, qualified education expenses are deemed to be paid from a pro rata share of both principal and interest. To calculate, the portion of earnings excludable from income is based on the ratio that the qualified higher education expenses bear to the total amount of the distribution. The remaining portion of earnings is included in the income of the distributee. The tax imposed on any taxpayer who receives a payment or distribution from a CESA that is includible in gross income will be increased by an additional 10% penalty. Qualified higher education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution fall under the definition of qualified education expenses. The term also, generally includes the room and board expenses. Also, for students residing in housing owned or operated by an eligible educational institution, the term will be expanded to cover, if greater, the actual room and board expenses charged by the institution. Room and board expenses are considered qualified higher education costs only if (1) the designated beneficiary is enrolled in a degree, certificate, or other program leading to a recognized educational credential at an eligible educational institution and (2) the student carries at least one-half the normal full-time work-load for the course of study pursued. Furthermore, funds from a CESA may be used to pay for elementary and secondary education expenses, including tutoring, computer equipment, room and board, uniforms and extended day program costs. An eligible educational institution is generally an accredited postsecondary educational institution offering credit towards a bachelor’s degree, an associate’s degree, a graduate-level or professional degree, or other recognized postsecondary credential. Generally, proprietary and postsecondary vocational institutions are eligible educational institutions.


STUDENT LOAN INTEREST DEDUCTION Interest paid during the tax year on any qualified education loan is deductible from gross income in arriving at adjusted gross income on Form 1040 or Form 1040A. The debt must be incurred by the taxpayer solely to pay qualified higher education expenses. The original loan and all refinancing of the loan are treated as one loan for this purpose. The maximum deductible amount of interest for tax year 2011 is $2,500.

For 2011, the amount of the student loan interest deduction is phased out (gradually reduced) if your filing status is married filing jointly and your modified adjusted gross income (AGI) is between $120,000 and $150,000. You cannot take the deduction if your modified AGI is $150,000 or more.

For all other filing statuses, your student loan interest deduction is phased out if your modified AGI is between $60,000 and $75,000. You cannot take a deduction if your modified AGI is $75,000 or more. The IRS provides a Student Loan Interest Deduction worksheet. For more information, see Publication 970 Tax Benefits for Education. A qualified student loan is any loan an individual took out to pay the qualified higher education expenses for his/her self, for his/her spouse, or any for any person who was the taxpayer’s dependent when the student loan was taken out (usually for a son or daughter). The loan must be for an eligible student and pay for qualified higher education expenses.

An eligible student is a person who:

A.) Was enrolled in a degree, certificate, or other program (including a program of study abroad that was approved for credit by the institution at which the student was enrolled) leading to a recognized educational credential at an eligible educational institution and

B.) Carried at least half the normal full-time workload for the course of study he or she was pursuing.

Qualified higher education expenses generally include tuition, fees, room and board, and related expenses such as books and supplies. The expenses must be for education in a degree, certificate, or similar program at an eligible educational institution. An eligible educational institution includes most colleges, universities, and certain vocational schools. Qualified education expenses must be reduced by certain non-taxable benefits such as employer-provided educational assistance, excludable US Series EE and I savings bond interest (from Form 8815), nontaxable qualified state tuition program earnings, nontaxable earnings from Coverdell education savings accounts, and any scholarship, educational assistance allowance, etc.. Furthermore, a loan is not a qualified student loan if (a) any of the proceeds were used for other purposes or (b) the loan was from either a related person or a person who borrowed the proceeds under a qualified employer plan or a contract purchased under such a plan.


Health Savings Account Deduction

Archer Medical Savings Accounts. Taxpayers who are self-employed or who work for small employers may be able to maintain Archer medical savings accounts (Archer MSA’s) to pay medical expenses, provided that the accounts are used in conjunction with high deductible health insurance. For 2011, a high deductible health insurance plan has the following deductibles and limitations: (1) for individual coverage, the minimum deductible is $2,050, maximum deductible is $3,050 and maximum out-of-pocket limitation is $4,100; and (2) for family coverage, the minimum deductible is $4,100, maximum deductible is $6,150 and maximum out-of-pocket limitation is $7,500. An Archer MSA is used solely to pay the unreimbursed health care expenses of the taxpayer or the taxpayer’s spouse or dependents. Within the limits, contributions to an Archer MSA are deductible if made by an eligible individual, and excludable from income if made by an employer on behalf of an eligible individual (employer contributions must be reported on the employee’s W-2). Annual contributions to an Archer MSA are limited to 75 percent of the deductible of the required health insurance plan (65 percent if a self-only plan). Contributions are also limited by an employee’s compensation or the income earned from a self-employed individual’s business. Distributions from an Archer MSA are tax free when used to pay qualified medical expenses. Other distributions are included in income and subject to an additional 15-percent tax unless made after the participant reaches age 65, dies or becomes disabled. The 15-percent additional tax is not treated as a tax liability for purposes of the alternative

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