Roger Philipp, CPA presents:
THE ROADMAP TO “INDIVIDUAL TAXATION”

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Welcome, welcome. We are going to be talking about individual taxation. Which I know is an exciting area and some of you are familiar with this, you’ve done your own tax returns and so on, some of you do a 1040EZ which unfortunately they’re not going to… They don’t say, “Please prepare a five line 1040EZ “and have a lovely day, become a CPA.” No, generally it’s much more detailed.

This is the first area of tax, we’re going to be going through tax first. So we’re going to sixty percent, so we’re going to cover individual, corporate, S-corps, partnerships, estates, trust, gift, exempt organizations, property transactions, depreciation, AMT and all that.

Then we’ll move onto professional responsibilities and ethics, ‘cause those areas alone are about twenty percent. Then business law used to be back in my day its own exam, so it was its own three and a half hour exam back when I was your age many moons ago pre-grey hair.

So they have a lot, three and a half hours of information which is part, it’s 20 percent of a three hour exam. So you can see that there’s a lot of material for law even though it’s only 20 percent because they’ve kind of pared it down. So you need a little bit about a lot. Especially when it comes to business law.

Now starting out with individual taxation. You do not need to memorize things like the tax code, right. The IRC or Internal Revenue Code you will use for research but you don’t need to memorize that. You don’t need to memorize necessarily cost of living adjusted information because again, these numbers change every year.

For example, bankruptcy every three years they update the numbers, those we need to know. But numbers like your standard deduction, personal exemptions, you don’t need to know those. Why not? Because they change every year.

The AICPA cannot afford to update every single question every single year for those numbers. So those are things you don’t need to know. You do need to know the schedules.

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What is schedule A? Schedule A itemized deductions. Schedule B interest and dividends. Schedule C profit or loss from a trade or business. Schedule D capital gains and losses. Schedule E flow-through entities, rental, royalty, S-corps, partnership, K-1 income flows through. Schedule F farm income. Those are things you will need to know.

You will need to know certain thresholds. For example, medical expenses is 10 percent. Used to be seven and a half, it’s 10 percent unless you’re 65 or older than it’s still seven and a half percent. But you do need to know things like that, medical deductions.

You do need to know, for example, two percent miscellaneous deductions. So that’s business, investment, tax preparation and so on. So those are things you will need to know. As we go through the questions you’ll see, very important.

Now one of the things I want to point out is when you’re preparing for the exam, taxes are always changing. The thing is, there’s at least a six month window between laws changing and it hits the exam.

That means that, let’s say you’re taking the exam in the first part of 2014, that’s 2013 law. The second half of 14 would be 2014 law. The first part of 2015 would be 14 law. The second part of 15 would be 15 law.

So I want you to realize that the first two windows of the year are always the previous year’s tax rules. And then the second part would be that current years. Because they gave you six months for those things to change.

But that’s why again there’s that overlap. That’s why they’re not going to test you on the specific things as far as standard deductions, things that change, but rules like the 10 percent, that’s not gonna necessarily change, those are the numbers that they’re gonna like to test you on. So that’s important before we even jump in. So you understand what’s happening.

Now, you’ll see here, and I love memory aids and mnemonics, I’m Mr. Mnemonic, woohoo right? I love these things because they help you, once you understand it, to then be able to recall it. That’s the purpose of it.

What we’re going to be looking at here is our basic 1040 tax return. And the 1040 we’ve got our schedules A B C D and so on. With your tax return it starts out with your filing status. Filing status means what are you as of December 31st?

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So if you’re sitting at home alone watching TV and watching the ball drop with ah, whatever Ryan Seacrest or Dick Clark, I think he’s died now, but anyway, you watch the ball drop you’re single. Because you’re home alone and crying. Alright that’s single.

Married filing joint, married filing separate, head of household, we’ll have to learn what all the distinctions are between those categories.

Exemptions, what’s an exemption? Myself, I’m alive, woohoo, I get a certain amount of money. I’m married, filing joint, so I have myself, my personal exemption, my spouse would also be a personal exemption so the two of us, we would get a certain amount of money. Let’s just say roughly $4,000. And again it changes every year, 39, 39, 50, 4,000 and so on. You don’t need to memorize it but in your notes you will have the current number just in case you wanted it. So that is it.

Then I’ve got these wonderful little rugrats running around. My kids. So the question is hmmm, is that a qualified child? Or is it a qualified relative dependent? We’ll have to see.

Because if you count, then I get another 4,000 for you, 4,000 for you, 4,000 for you, so I get 4,000 for me, 4,000 for my wife, 4,000 for my kid, my other kid, the other kid, what about a cousin who lives with me? Hmm I don’t know, let’s see. Are they a relative? We’ll learn that later on. So I get all those exemptions. I got five of them at 4,000. That’s another 20 grand.

Then I’ve got income. So we’ll go through the detail of the income, but one of the things that I want you to see is the flow of the 1040. And the flow is as follows.

You got your 1040, incidentally when is your 1040 due? It is due how many months after year end? It’s due what April 15th? Which is how many months after year end? And you are allowed to bring your fingers to the exam. Right, they don’t make you cut them…

So January, February, March, April, that’s January, February, March, April 15th, that’s four and a half months after year end. No, what is that, three and a half? January, February, March, no. March 15th, yeah. Three and a half. No, four and a half. Four and a half months after year end. January, February, March, all of April, no half of April, three and a half months. Okay, so, that’s 4/15.

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Now, think about a corporation. Corporations are these big sophisticated entities. They have an internal accounting department. Therefore we give you one less month. So corporations instead of 4/15 would be 3/15. Which is January, February, half of March, which is two and a half months after year end. This is three and a half months after year end. Very good.

Then you go to my favorite place where I buy all my clothes and jewelry, the Goodwill. Now when you go to the Goodwill, you ever notice I go, “Hey can I see that?” And everybody walks really slowly. Well these are called tax exempt organizations.

They are tax exempt so what does that saying? The government gives them one extra month. So they’re due not 4/15 but 5/15 which is four and a half months after year end.

So you’ve got 3/15 for corporations, 4/15 for individuals, 5/15 for exempt organizations like 990’s. So we’ll talk about that but that’s just kind of a nice starting point of what and when it is due.

You’ve got your gross income, that’s your worldwide income, all of our income and we’re going to talk about what is income. Wages. So I’m an employee, I get a W2. I’m an independent contractor I get a 1099 but then I’m responsible for keeping track of my expenses and all that.

I’ve got taxable refunds, so I got a refund the question is is it taxable. Alimony received, capital gains, IRA distributions, pensions, rental, farm, unemployment compensation.

So unemployment is income? Mmmhmm, it’s a wage substitute therefore it’s taxable income. That is called unemployment. What about worker’s comp? You’re injured? No. So we’ll talk about that later.

Then you’ve got other income. And that’s just a line other income, you could write stuff in there like jury duty fee received, that would go there as well.

Then you’ve got all these other adjustments and expenses. We talk about like if you put money into your IRA, deductible part of self-employment tax, alimony that you pay, so we’ll learn that alimony is taxable and if I’m the one paying it tax deductible.

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So all these adjustments are these. And I always, like I said, I love memories and mnemonics. This is I embraced education health and farm. So I embraced. So that’s going to be I E M B R A C E D E H F. So that’s going to be… And this is what? This flows to the face of your 1040.

Now on the bottom line of the 1040, that bottom line number is a really important number, it is called A G I. What is that? Adjusted gross income. A lot of times certain thresholds are based on AGI.

They may say for example, “Hey, you can only deduct “medical expenses above and beyond 10 percent of AGI.” What does that mean? If my AGI’s 100 grand, I had a good year made a lot of money, 100 G’s, 100 grand, guess what? I cannot deduct $1 of medical expenses until I hit 10 percent of that or 10 grand.

That’s why in the real world unless you have an uninsured catastrophic injury, most of us have insurance good old Obamacare, the point is that we have this insurance so what it says is, “You know what? “It’s gotta be uninsured over 10 grand.”

So in reality you probably won’t have any. For the exam of course we’re gonna always have everything so we’ll have to include that.

Then you’ve got your standard deduction. And the government says, “Oh you’re alive?” Let’s just give you a certain amount “and let’s just say it’s about, “I don’t know, 61 62 63 64 hundred dollars.”

So let’s say it’s 6,200 bucks for example, double that would be 12 four so if you’re married filing joint we used to have this marriage penalty which basically said that if you were single you got, let’s say just make it easy six grand, but if you were married instead of getting 12 you got like 11.

It’s like dude we’re better off filing separate in a sense or not being married, because then we each get six. They finally got rid of that penalty. That’s why I didn’t get married until later in life. Because dude, tax reasons. You know, I love you but it’s just not beneficial.

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So then they got rid of that so whatever the single is, let’s say 62, married filing joint would be double 12 four. So that is called standard. Or you can itemize. And your itemization is schedule what? Schedule A. You need to remember that. Schedule A is your itemized deductions.

An itemized deduction, and I’ll show you later but we’re gonna have a memory aid that you’ll have to remember, COMMITT and you should commit this to memory. Why? Because these are your itemized deductions.

In other words either you take 6,200 bucks the government’s giving you, or you say, you know what? It’s gonna be c, charitable contributions, other miscellaneous, miscellaneous two percent, which is business, investment, tax preparation, medical 10 percent, interest, taxes, theft and casualty.

So I could itemize or I could take the standard. It’s one or the other. So you don’t get both you get one or the other.

Then you have your net exemptions, remember I talked about an exemption. We’ll learn a mnemonic or memory aid for exemptions. C the IRS jack you out of your money.

Which means can I take my cousin off as a dependency exemption and get whatever, let’s say get four grand for them. You can if they’re a citizen, they don’t make much income, they’re related to you or live with you the entire year, you support them, and they’re not filing a joint tax return. C the IRS jack you out of your money.

There’s another mnemonic. So that’s how we know if someone is a net exemption. So I get some money there. Taxable income times the tax rate. You don’t need to memorize it, let’s say it’s 39.6, 40 percent. Boom tax liability.

Then you’ve got your credits. A credit is a dollar for dollar reduction. So I have some sort of credit, maybe it’s an educational credit or a child tax credit or an elderly credit, some kind of credit. Earned income credit.

Then I’ve got self-employment tax, so I might have self-employment tax here we’ll talk about. So I’m self-employed and I need to pay that tax, which is say 15.3 percent.

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Then you’ve got AMT. What’s AMT? Alternative minimum tax. Alternative minimum tax was created in order to squeeze a little extra money out of everybody’s pocket. Because what it said is, “Let’s calculate your tax this way, “then we’ll calculate an alternative way, “and whichever one is higher, “that’s what you owe.”

So let’s for example your regular tax is higher they go cool, you’re paying us enough. Let’s say your AMT is higher, they go okay, you’re gonna pay us this. This difference is your alternative minimum tax. It’s like a penalty tax.

So all of these down here, this is gonna be kind of a penalty tax. So the penalty is hey, dude, you made too much money we’re gonna disallow certain itemized deductions. So what happens is some of these things in COMMITT, they start to take away.

So they say, “Well, you took too much for this.” We’re gonna take it away. “You know these exemptions?” That’s not a real out of pocket outlay, “we’re gonna take it away.” So they gonna take stuff away that’s AMT.

Then you’ve got prepayments. Because let’s say for example, I’m retired and I have $100,000 in the bank. Let’s just pretend that interest rates, I could earn 10 percent. Which I used to be able to earn, now I’m getting, you know, less than one.

So let’s say I was earning 10 percent. So I have $10,000 of income, no one’s withholding taxes on that, so I’m gonna have to prepay. I’m gonna have to do some kind of estimated taxes, a 1040 ES estimated tax.

Withholdings would be like your W4, which is when you get a new job and you’re an employee you fill out the form and it says how many dependents you have and this and that and other things you think about your mortgage interest deductions.

You’re trying to come up with an amount where your withholdings are enough so at the end of the year the goal is to have no refund. Like a lot of people go, “Wow, I got a great big refund.” That’s great.” That ain’t so great. You let the government borrow your money interest free all year. Where if you would’ve taken that money, invested it wisely you could’ve earned a bunch of money on it and then at the end you pay that.

So a lot of people what they do is they go, “You know, I’ll just hope for a refund “because then the government’s saving my money for me.” Yeah but you’re giving it to them like I said an interest free loan. So that’s withholdings and then there’s your tax too.

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So this is the basic flow of your 1040. That is a 1040 called your individual tax return called a 1040. Again it’s due when? 4/15, which I had trouble earlier, is how many months after year end? January, February, March, three and a half months after year end. Thank you very much.

So you’ll see just in starting we’ve got some mnemonics. COMMITT, C the IRS, most importantly I embraced education, health, and farm. So we’ll be going through this but notice this goes here.

Now, very important terms. This gets you to AGI. This is called for or to AGI. These are taken away, these are called from AGI. So they’ve asked questions about is it for AGI or from? For means it gets you for or to adjusted gross income, from says let’s take our bottom line number on the face of our 1040 called AGI, then on the backside you start with AGI and then these are all the things from AGI.

So all of these are on the backside like what? Itemized or standard deduction, exemptions, AMT, alternative minimum tax, here are all of the different credits and so on. So that’s going to be from AGI.

For gets you to, so this is part of for. I embraced is part of for AGI, whereas the other side is from AGI. And that would be on the backside of it. So it’s important again to kind of understand the flow so you can see how all of this is kind of interrelated.

You’ll see on the first page that we included here the basics so you can understand the flow. Again you’ll see gross income, adjustments, and that’s where your schedules flow in. So when we talk about all your different tax schedules we’re gonna talk about schedule B, C, D, E, F, they all flow through here to the face of your 1040 for or to AGI.

On the back side of schedule A from AGI. So A is a from AGI, whereas I embraced education health and farmers goes on the face that’s for.

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So when we go through this you’ll see in detail student loan interest, self-employment tax, moving expenses, business expense schedule C, rental royalty flow-through schedule E, alimony paid, contributions to your retirement 401K, you’ve got early withdrawal penalty, jury duty fees, education, here’s your farm income.

So notice we’ve got schedules B is interest in dividends, C boom, D is capital gains, E flow-through entities, F farm, all of those are here. They flow through to the face of your 1040. So that’s a nice easy way to remember it. Whereas on the back side is schedule A, those are coming from AGI as a reduction of your adjusted gross income.

You’ll see there on the right for AGI, and then it says there I embraced education health and farmers. I put there itemized or your standard deduction, so the number you’ll see there is the current amount for your year, not that you need to know it but that’s the number just so you have an idea.

Whether it’s 62 or 63 or 64 hundred times two would be married filing joint. Net exemptions let’s say about four grand. Plus, then you’ve got your for AGI from AGI.

You’ll see here your kind of penalty taxes in a sense, your self-employment, AMT, withholdings, prepayments, and so on. Going back to schedule A the other box is your schedule A COMMITT. Those are things you want to commit to memory.

Now, if you turn to the back of this I have the lecture notes, behind that I have the tax forms. With the tax forms, again the tax forms you do not need to memorize them. They don’t usually change a lot from year to year.

As far as the printing of your book, whatever the most recent tax forms available, those are in your notes. If you want to see more recent ones go to irs.gov. I R S dot G O V and you can look it up. But from one year, the 2014 to 2015 1040 doesn’t change that much. The concepts, you know again they’re testing you on the general broad concepts.

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But if you look in the back of the lecture notes about page 30, 32, somewhere around there 34, starts your tax forms. And the tax forms are as follows.

Here’s your 1040, the face of the 1040 and we’re gonna talk about a lot of this stuff coming up in the next few minutes. Then on the backside of the 1040 here’s yours from AGI. Then you get down to here you’ve got your payments, other taxes like self-employment tax, schedule SE, self-employment.

And then all the way down, and then you’ve got amount you owe or amount you’re getting refunded. Here is your schedule A. Schedule A the mnemonic or memory aid is going to be schedule A COMMITT, so you can write that at the top of the page. C-O-M-M-I-T-T.

And you’ll see as you go down you’re gonna have, here it has medical expenses gonna be 10 percent, taxes you paid, interest, charity, casualty, miscellaneous expenses, other miscellaneous. So we’ll have to distinguish between the two categories of miscellaneous because some miscellaneous you get them all. Some of them only those above two percent of adjusted gross income.

You’ve got your schedule B, interest and dividends, you need to fill that out if you’ve got more than about $1,500 of interest and or dividends.

And again the government just wants to know, you know they’re concerned you have overseas accounts that you’re not telling us about. Because as you’ll see you get a foreign tax credit for taxes you pay in another country, but all your worldwide income is taxable.

We want it all, right. The government needs your money, right they dig a hole. We talked about that in B E C for economics it’s called deficit spending. Hey, we don’t have the money? Let’s spend it anyway what the heck.

Schedule C is profit or loss and this is basically like an unincorporated little business, like a little corporation but it’s unincorporated. That’s your profit or loss, that’s if you get a 1099, that would go on your schedule C. So with a schedule C you’ll see here you’ve got your income, then you’ve got all your different expenses. Just like as I teach you corporate tax which is I think the next section, we’ll talk about a C-corp.

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So you’ll see advertising, car or truck expense, depreciation, depletion, insurance, mortgage, legal, office, vehicles, meals and entertainment, travel, can you deduct that for a business? Yes, if you’re an unincorporated business schedule C will put it here.

But then at the end nobody’s withholding FICA, Federal Insurance Contribution Act, social security 6.2 percent. Nobody’s withholding Medicare, 1.45 unless you’re rich it goes up by .9 percent.

So all of these are things that say hey, because no one’s withholding you’ve gotta withhold both which is like the employer employee, you owe 15.3 percent. So if you made $10,000 and you were, you know you made less than your standard deduction personal exemptions combined and so on, so you don’t really owe anything you’re still gonna owe 15.3 percent of that 10 grand.

You still owe 1,500 bucks of your net employment income, self-employment, so you need to come up with expenses to get the net down so that way you’ll pay them less cause that’s self-employment. So that would go right there on schedule C as well.

The backside of it… Capital gains, that’s gonna be short-term long-term capital gains. What are the capital gain rates? If you’re very poor zero percent. If you’re up to 35 percent 15 percent. If you’re richy rich 39.6, it’s up to 20 percent capital gains tax. So we’ll talk about that when we hit that area.

Then we’ve got schedule E, supplementary income. Supplementary income is your flow-through. That would be schedule E things like rental income, royalty income. Flow-through entities would be like if you get a K-1 from an S-corp or a partnership.

Where do you put it? On your schedule E which flows through to where? To your 1040. So it’s a flow-through, it doesn’t file its own tax return, it does for information purposes, but as far as paying the dinero, that comes here on your schedule E. So you’ll see here it says, you know, schedule E, boom boom boom, rental income, royalty income.

Then it has all your expenses, advertising, insurance, commissions, management fees, depreciation, all of that and we’ll talk about that. We’ll also talk about passive activity, losses and so forth.

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Then you’ve got, here on the backside it talks about income or loss from a partnership or S-corp. Here it talks about estates and trusts. Because with an estate and trust they will also issue a K-1. Profit or loss from farming, so that’s farm.

Talk about the cash method or the accrual method. So you’ve got your different methods that we could be using, cash versus accrual. And then it talks about your expenses as well. Then you’ve got your self-employment tax, your schedule SE, that’s where you’re calculating your 15.3 percent that we will owe them.

So those are the basic tax forms. You don’t need to memorize them. Again, you can usually see these, look these up and so on, but you do need to understand the tax forms and how the tax forms flow. So that’s really important as far as getting through.

So that’s your overview of where we’re going with individual tax. In a minute we’ll jump into the details about who has to file a return, how much do you need to make in order to file a return, what are different things like kiddie tax, what’s included as income, what’s not income, where does it go, and how are we doing, alright? But we’ll do that in just a minute.