Training Manual

2010
Copyright 2009-12. IBSN Inc All rights reserved. No portion of this material may be copied, screened, viewed, printed, read, written, memorized or orally explained to any third party without the express or written permission of IBSN. User of this information may not also perform any act that may be previewed by IBSN as being copied but not specifically mentioned hereto.
CHAPTER INDEX
Sl. No. CHAPTER NAME
USA TOPOGRAPHY TYPES OF VISAS, EAD & I-140 SOCIAL SECURITY NUMBER (SSN) INDIVIDUAL TAXPAYER IDENTIFICATION NUMBER (ITIN) FILING STATUS AND METHODS ACCOUNTING PERIODS TAX RATES SCHEDULES 2010 TAX CALENDER FEDERAL INCOME TAX RETURNS RESIDENTIAL STATUS INCOME OF ALIENS STUDENTS, BUSINESS APPRENTICES AND EXCHANGE VISITORS FROM INDIA EXEMPTIONS WAGE INCOME INTEREST INCOME DIVIDEND INCOME SALE OF HOUSE PROPERTY FORM 1099-G PARTNERSHIP INCOME S-CORPORATION INCOME INDIVIDUAL RETIREMENT ARRANGEMENTS SCHEDULE E CAPITAL GAINS AND LOSSES STOCK OPTIONS ALTERNATIVE MINIMUM TAX STANDARD DEDUCTION ITEMIZED DEDUCTIONS MOVING EXPENSES CHILD TAX CREDIT TAX BENEFITS FOR EDUCATION EARNED INCOME CREDIT HEALTH SAVINGS ACCOUNT DEDUCTION AMENDED RETURN CHILD AND DEPENDENT CARE EXPENSES CREDIT FOREIGN TAX CREDIT
PAGE
1 2 3 4 5 6
7.1 7.2 8 9.1 9.2 9.3 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32
IBSN In-House Training Manual 2010
CHAPTER 1: USA TOPOGRAPHY
IBSN
AK AL AR AZ -
Alaska Alabama Arkansas Arizona
LA - Louisiana MA MD ME MI MN Massachusetts Maryland Maine Michigan Minnesota
PA - Pennsylvania RI Rhode Island
CA - California CO - Colorado CT - Connecticut DE - Delaware FL - Florida
SC - South Carolina SD - South Dakota TN - Tennessee TX - Texas UT - Utah VA - Virginia
MO - Missouri MS - Mississippi MT - Montana NC - North Carolina ND - North Dakota
GA - Georgia
NE - Nebraska
VT - Vermont
HI IA ID IL IN KS KY -
Hawaii Iowa Idaho Illinois Indiana Kansas Kentucky
NH NJ NM NV NY OK OR OH -
New Hampshire New Jersey New Mexico Nevada New York Oklahoma Oregon Ohio
WA WI WV WY
Washington Wisconsin West Virginia Wyoming
A. TAX FREE STATES AK FL NH NV SD TN TX WA WY Alaska Florida New Hampshire Nevada South Dakota Tennessee Texas Washington Wyoming B. STATES SUBJECT TO CITY TAXES MI NY PA OH KY Michigan New York Pennsylvania Ohio Kentucky C. STATES SUBJECT TO COUNTY TAXES IN MD Indiana Maryland
IA
Iowa
D. SALES TAX RATES & STATE WEBSITES State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Dist. of Columbia Florida Georgia Guam Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Sales Tax Rates 4% -5.6% 6% 6% 2.9% 6% -5.75% 6% 4% 4% 4% 6% 6.25% 6% 5% 5.3% 6% Department of Revenue WebPages www.ador.state.al.us/ www.tax.state.ak.us/ www.revenue.state.az.us/ www.state.ar.us/dfa/ www.boe.ca.gov/ www.revenue.state.co.us/main/home.asp www.ct.gov/drs www.state.de.us/revenue www.dccfo.com sun6.dms.state.fl.us/dor/taxes/ www.etax.dor.ga.gov/ www.admin.gov.gu/revtax/ www.state.hi.us/tax/tax.html www.tax.idaho.gov www.revenue.state.il.us www.ai.org/dor/ www.state.ia.us/government/drf/index.html www.ink.org/public/kdor www.state.ky.us/agencies/revenue/
Louisiana Maine Maryland Massachusetts Mariana Islands Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Virgin Islands Washington West Virginia Wisconsin Wyoming
4% 5% 5% 5% -6% 6.5% 7% 4.225% -5.5% 6.5% -7% 5% 4% 4.5% 5% 5.5% 4.5% -6% 7% 6% 4% 7% 6.25% 4.75% 6% 4% 4% 6.5% 6% 5% 4%
www.rev.state.la.us www.state.me.us/revenue/ www.comp.state.md.us/ www.state.ma.us/dor/ www.saipan.com/gov/ www.michigan.gov/treasury www.taxes.state.mn.us www.mstc.state.ms.us/ www.dor.state.mo.us/ www.state.mt.us/revenue/ www.nol.org/home/NDR/ www.tax.state.nv.us/ www.state.nh.us/revenue/ www.state.nj.us/treasury/taxation www.state.nm.us/tax www.tax.state.ny.us/ www.dor.state.nc.us www.state.nd.us/taxdpt www.tax.ohio.gov/ www.oktax.state.ok.us www.dor.state.or.us www.revenue.state.pa.us www.info.state.ri.us/admin.htm www.sctax.org/ www.state.sd.us/drr2/revenue.html www.state.tn.us/revenue www.cpa.state.tx.us/taxinfo/salestax.html www.tax.utah.gov/ www.state.vt.us/tax/ www.tax.virginia.gov/ www.usvi.org/finance/ www.dor.wa.gov/ www.state.wv.us/taxdiv/ www.dor.state.wi.us/ www.revenue.state.wy.us
Note: For latest Sales Tax Rates and State Revenue Department Web Address, please use the following link: http://thestc.com/ta.cgi?STRates
CHAPTER 2: TYPES OF VISAS
IBSN
US Visas
Immigrant Visas For those intending to reside permanently in the United States. (Whether or not they intend to work.)
Non-Immigrant Visas Visa for visiting United States temporarily. Tourist or Medical treatment, Business purpose, Students, Participants in exchange programs, Temporary workers, Performing artists, Professional journalists and Government representatives, etc.
Types of Visas: The following are the various types of visas which we mostly come across in our tax preparation process: 1. 2. 3. 4. 5. Green Cards Employment Visas Visitor Visas Student Visas Family Visas
1. Green Cards EB-1 Category Multinational Executives, Professors, Researchers, Extraordinary Ability. EB-2 Category Professionals holding advanced degrees or aliens of exceptional ability EB-3 Category Skilled workers, professionals, other workers, and Labor Certifications EB-4 Category Reacquisition of Citizenship, Religious Workers, Foreign Medical Grads... EB-5 Category Employment Creation or Investor Visa with Million Dollar Investment. Family Based Green Cards for Family Members and Fiances of US Citizens.
2. Employment Visas H1B Visa For Professionals with a minimum equivalent of a U.S. Bachelor Degree. H-2 Visa Non-agricultural positions for which qualified U.S. workers are unavailable H-3 Visa For Temporary Trainee Transfer's to receive training from an employer L-1 Visa Open a US Corporation or transfer an employee to the United States E Visa Investor and Treaty Trader Visas for single investors and multinational companies J-1 Visa Exchange Trainee Visas to gain work experience and training in his or her field Visa People of extraordinary ability in the arts, athletics, sciences, education, & Business P Visa Athlete or Entertainment groups internationally recognized for their level of performance NAFTA Mexican and Canadian Professional Workers under NAFTA (E.g.: TN Visa-Refer FAQs) Religious Workers Religious Worker Visas H1B1 Visa A new class of non-immigrant work visas for Singaporean citizens, which allows them to live and work in United States. DOS (Dept. of State) does not require Special Fees for Chile/Singapore H-1B1s. E3 Treaty Professional The United States E-3 Treaty Professional Visa for Australian Nationals.
3. Visitor Visas
Visitor visas are nonimmigrant visas, for persons desiring to enter the United States temporarily: For Business purpose B1 visa For pleasure or Tourist purpose B2 visa. For Medical treatment (B-2). (These visas are for a specifically limited period.)
4. Student Visas There are three types of student visas: Academic Studies (F visa): For people who have been accepted into a program to study or conduct research at an accredited U.S. college or university. Non-Academic or Vocational Studies (M Visa) : For people who have been accepted into a program to study or train at a non-academic institution in the U.S. Academic Studies as an Exchange Visitor (J Visas) : For people who have been accepted into a program through a designated sponsoring organization to participate in an exchange visitor program in the U.S. The "J" visa is for educational and cultural exchange programs. 5. Family Visas H-4 Visa Dependent family members of H1 visa holders can obtain H4 visa. Immediate family members like spouse and children under 21 years can qualify for this visa. L-2 Visa L2 is a dependent visa for L1 family members. PART I EAD: EMPLOYMENT AUTHORIZATION DOCUMENT 1. What is EAD? U.S. employers must check to make sure all employees, regardless of citizenship or national origin, are allowed to work in the United States. If the taxpayer is not a citizen or a lawful permanent resident, he may need to apply for an Employment Authorization Document (EAD) to prove he may work in the U.S. 2. When should the taxpayer apply for EAD? To prove that the taxpayer is entitled to work in US Though the taxpayer is not a citizen or a lawful permanent resident of US 3. Who can apply? Asylum seekers Students seeking particular types of employment (E.g. F1) Applicants seeking permanent residence status (E.g. H1/H1B) Fiances of American citizens Dependents of Foreign Government officials Those listed in Form I-765 4. How long does it take to get an EAD? (Normally 90 days) but (150 days or 180 days for asylum applicants)
5. Who issues EAD? USCIS (United States Citizenship & Immigration Services) 6. How many categories of EADs are there? Original EAD Renewal EAD (to be applied before 6 months the original EAD expires) Replacement EAD (if original EAD is lost, stolen or mutilated or has incorrect/misspelled data) Interim EAD (if no response even after 90 days of filing application) 7. Which form to use to make an EAD application? I-765 (there is a huge list of people(available on http://www.uscis.gov) who can apply for an EAD to be able to work in the US) 8. How to apply? Taxpayer may apply electronically through Form I-765 or Manually with the USCIS Regional Service Center in the area the taxpayer lives. 9. Filing Requirements? Identity Documents, the taxpayers latest photo and requisite fees. 10. Can the taxpayer appeal if he did not receive EAD? No but he can submit a motion to reopen (or) motion to reconsider with the concerned USCIS office where he filed his EAD application. PART II I-140: IMMIGRATION PETITION FOR ALIEN WORKER 11. What is I-140? It is a Immigration Visa based on Employment is Immigration Petition for Alien Worker 12. Who can file this petition/I-140? An outstanding professor or researcher with at least 3 years of experience in teaching or research An alien who, in 3 years preceding the filing of this petition, was employed for at least 1 year by a firm/corporation/other legal entity and who seeks to enter the US to continue to render services to the same employer or to a subsidiary or affiliate in the capacity of manager or executive. An alien with exceptional ability in the sciences, arts or business who will substantially benefit the national economy, cultural or educational interests, or welfare of the US. A member of the profession holding an advanced degree A Skilled worker (with at least 2 years of specialized training or experience in the skill) to perform labor for which qualified workers are not available in the US An Unskilled worker (with at least 2 years of specialized training or experience in the skill)
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to perform labor for which qualified workers are not available in the US. 13. Do they charge any fee? $195 payable through checks and money orders.
CHAPTER 3: SOCIAL SECURITY NUMBER
IBSN
PART I GENERAL 1. Why is a Social Security Number (SSN) needed? SSN is needed if the taxpayer needs to get a job, collect social security benefits and receive some other government services. Even other businesses, banks and credit companies may ask for SSN. SSN is used to report the taxpayers wages to the government and to determine eligibility for social security benefits. It is extremely important that each person has and uses their correct SSN. Otherwise it may be cumbersome to file their tax returns and/or consequently delay the processing of their tax refunds. 2. Who can apply for SSN? If the taxpayer is temporarily in the US to work, his employer will ask for his SSN. SSN can also be assigned to foreign workers who are authorized to work in the US. 3. Which form to use? The Application for a Social Security Card (Form SS-5-FS) is the form to be completed if the taxpayer has never had a number before or needs a duplicate or corrected SSN Card.
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Taxpayer can use this form even if he (or the child on whose behalf he is applying) is living outside the US. The SSA can assign a number or issue a duplicate or corrected card if he (or the child) is either: a US citizen or a non-citizen with current lawful, work-authorized immigration status. 4. Where to send the form? The taxpayer should either take or mail the completed form with the required original documents or copies certified by the custodian of the record to the nearest US Social Security Office, US Embassy or consulate. Note: Original documents should not be mailed to the Social Security Administration in Baltimore, Maryland. 5. What are the different types of SSN Cards? SSA issues three types of Social Security Cards. All cards show the taxpayers name and his SSN. Type A: The first type of card shows the taxpayers name and SSN and lets him work without restriction. It is issued to US Citizens and people lawfully admitted to the US on a permanent basis. Type B: The second type of card shows the taxpayers name and number and says, VALID FOR WORK ONLY WITH DHS AUTHORIZATION. It is issued to people lawfully admitted to the US on a temporary basis who have DHS authorization to work. Type C: The third type of card shows the taxpayers name and number and says, NOT VALID FOR EMPLOYMENT. It is issued to people from other countries: 1. Who are lawfully admitted to the US without work authorization from DHS or 2. Who need a number because of a federal law requiring SSN to get a benefit or service? PART II-SSN FOR NONCITIZENS/TEMPORARY WORKERS 6. How to apply? Generally speaking, only those non-citizens who have permission to work from the Department of Homeland Security (DHS) can apply for SSN. Applying for an SSN and card is free. To apply for an SSN, the taxpayer needs to do the following: Step 1: Complete Form SS-5; Step 2: Show original documents to SSA which can prove his Immigration Status, Work Eligibility, Age and Identity; Step 3: Take or mail the completed application form along with the original documents to the nearest local social security office.
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Note: All documents must be either originals or copies certified by the issuing agency. SSA does not accept photocopies or notarized copies of original documents. It does not even accept a receipt showing that the taxpayer has applied for the original document. 7. How does the taxpayer prove his immigration status / identity to SSA? To prove his US immigration status, the taxpayer must show the current US immigration document (I-94: Arrival/Departure Record) issued to him when he arrived in the US or Form I-551 ( i.e. machine readable immigrant visa with his unexpired foreign passport) If the taxpayer is on F-1 or M-1 student visa, he must also show his I-20: Certificate of Eligibility for Non-immigrant Student Status. If the taxpayer is on J-1 or J-2 exchange visitor visa, he must show his DS-2019: Certificate of Eligibility for Exchange Visitor Status. To prove the taxpayers identity, all the above documents must be UNEXPIRED showing his name, address and a recent photograph. If the taxpayer does not have the above documents, he can furnish any of the following: 1. Employee ID Card 2. School ID Card 3. Marriage Document 4. Health Insurance Card/Life Insurance Policy 5. US Military ID Card 6. Adoption decree 8. How does the taxpayer prove his work eligibility? For most foreign workers, SSA needs only I-94. Some foreign workers may be required to show their work permits from DHS. International students must present further documentation. 9. Will the taxpayers employer need SSN? The IRS requires employers to report wages using a SSN. If the taxpayer has applied for SSN and is waiting for the same to be issued, then his employer can use a letter from the SSA stating that he has applied for the same. Taxpayers employer can use even his DHS documents as proof of his authorization to work in the US. 10. How does the taxpayer prove his Age? Birth certificate needs to be presented. If that is not available, passport or a document issued by DHS would suffice. 11. When will the taxpayer get his SSN Card? SSA will mail the number and card as soon as it verifies his documents with the DHS. 12. Should the taxpayer apply for SSN if he needs a number for tax purposes? If the taxpayer needs a number for tax purposes and he is NOT AUTHORISED TO WORK IN US, he can apply for an ITIN from the IRS.
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13. For what purposes the taxpayer does not need an SSN/ITIN? The taxpayer does not need a number to: Purchase savings bonds, Conduct business with banks, Register for school or Apply for educational tests, Obtain private health insurance, Apply for school lunch programs or Apply for subsidized housing.
PART III FAQs 1. How does a taxpayer get an SSN for his newborn baby? The taxpayer can apply for an SSN for his baby when he applies for his babys birth certificate or can apply at any SSA office later. 2. The taxpayer did not apply for his childs SSN at the time of her birth. Now she is 14 years old. Can he still apply for her SSN? Anyone aged 12 years or more requesting an original SSN card must appear for an interview at any Social Security office, even though the parent or guardian signs the application on behalf of the child. Hence, the taxpayer can apply. 3. The taxpayer is a divorcee. Due to divorce there is a change in his name. Can he apply for a new SSN card? If the taxpayer legally changes his name because of marriage, divorce, court order or any other reason, he needs to inform that he needs a replacement card to both SSA and also his EMPLOYER, if he is working. Otherwise, his tax refund may be delayed or his social security benefits may be lowered. For this, SSA may need any of the following documents with a recent photograph confirming the taxpayers name change: Marriage document Divorce decree Certification of Naturalization or
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Court order The new card will have the same number as the previous card, but will show the new name/changed name. Note: SSA may require the same documents (supra) even if there is any change in the immigration status or citizenship. 4. The taxpayer lost his SSN card. What should he do? The taxpayer can replace his card or his childs card for FREE if it is lost or stolen. However, it is limited to only THREE replacement cards IN A YEAR and TEN during his LIFETIME. Note: These limits do not apply to legal name changes and other exceptions as in FAQ #3. 5. What should the taxpayer do to get a replacement card? To get a replacement card, the taxpayer needs to do the following: Complete Form SS-5 Any recent identity proof document Evidence of his US Citizenship if he was born outside the US and did not show proof of his citizenship when he got his original card, and Evidence of his current lawful noncitizen status if he is not a US Citizen The replacement card will have the same name and number as the previous card.
CHAPTER 4: INDIVIDUAL TAXPAYER IDENTIFICATION NUMBER (ITIN)
IBSN
1. What is an ITIN? An Individual Taxpayer Identification Number (ITIN) is a tax processing number issued by the Internal Revenue Service for certain resident and nonresident aliens, their spouses, and their dependents. It is a nine-digit number that always begins with the number 9 and has a 7 or 8 in the fourth digit, example 9XX-7X-XXXX. IRS issues ITINs to individuals who are required to have a U.S. taxpayer identification number but who do not have, and are not eligible to obtain a Social Security Number (SSN) from the Social Security Administration (SSA). ITINs are issued regardless of immigration status because both resident and nonresident aliens may have U.S. tax return and payment responsibilities under the Internal Revenue Code. Individuals must have a filing requirement and file a valid federal income tax return to receive an ITIN, unless they meet an exception.
2. When is an ITIN needed? If the taxpayer does not have an SSN and is not eligible to obtain an SSN, but he has a
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requirement to furnish a federal tax identification number or file a federal income tax return or he is listed on a tax return as a spouse or dependent, he must apply for an ITIN. By law, an alien individual cannot have both an ITIN and an SSN. If the taxpayer is eligible for an SSN, he must apply for one.
3. How is ITIN useful? ITINs are for federal tax reporting only, and are not intended to serve any other purpose. An ITIN does not authorize work in the U.S. or provide eligibility for Social Security benefits or the Earned Income Tax Credit or does not establish immigration status. ITINs are not valid identification outside the tax system.
4. Which Form to use? Each ITIN applicant must now: Apply using the revised Form W-7/W-7SP, Application for IRS Individual Taxpayer Identification Number ; and Attach a federal income tax return to the Form W-7 (Form 1040, 1040A, 1040EZ, 1040NR, 1040NR-EZ) along with the taxpayers original or certified proof of identity documents unless he qualifies for an exception.
5. Who needs an ITIN? IRS issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for an SSN, who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty, needs an ITIN.
Examples of individuals who need ITINs include:
Non-Resident Alien
Others
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A nonresident alien individual eligible to obtain the benefit of reduced withholding under an income tax treaty. A nonresident alien individual, not eligible for SSN who is required to file a U.S. tax return or who is filing a U.S. tax return only to claim a refund. A nonresident alien individual not eligible for an SSN who elects to file a joint U.S. tax return with a spouse who is a U.S. citizen or resident A nonresident alien student, professor, or researcher who is required to file a United States tax return but who is not eligible for an SSN.
A U.S. resident alien (based on the substantial presence test) who files a U.S. tax return but who is not eligible for an SSN. An alien spouse, claimed as an exemption on a U.S. tax return, who is not eligible to obtain an SSN. An alien individual eligible to be claimed as a dependent on a U.S. tax return but who is not eligible to obtain an SSN. A dependent/spouse of a nonresident visa holder who is not eligible for an SSN
6. What are the exceptions to the requirement to attach to a U.S. tax
return?
If any of the exceptions listed below apply to the taxpayer, he will not need to attach a tax return to his W-7/W-7SP. I. Passive Income-Treaty Benefits or Third Party Withholdings: Information reporting and withholding requirements apply to third parties (frequently banks and other financial institutions), who will request an ITIN from the taxpayer to enable them to file information reports required by law. Example: Form 1099-INT, Form 1042-S, etc.
II.
Other Incomes-Wages, Salaries, Compensation-Treaty Benefits or Foreign Students Receiving Scholarship or Fellowship Income: If the taxpayer is a foreign scholar, professor, or researcher, or an individual receiving pay for personal services, his Form W-7/W-7SP will be processed if he provides proof that his application for an SSN (Form SS-5) was rejected by the SSA and include a Form 8233.Note: Applicants with a visa that is valid for employment should first apply for an SSN with the SSA. Taxpayers are not eligible for an ITIN if they are eligible to obtain an SSN.
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III.
Third Party Reporting-Mortgage Interest: To obtain an ITIN under this exception, the taxpayer must include documentation with the Form W-7/W-7SP showing evidence of a home mortgage loan. This documentation could include: a loan commitment letter from the financial institution. a brokers listing agreement or similar documentation.
IV.
Disposition by Foreign Person of US Real Property Interest: A withholding obligation is generally imposed on a buyer or other transferee (withholding agent) when a United States real property interest is acquired from a foreign person. This withholding serves to collect the tax that may be owed by the foreign person. In some instances, the foreign person may apply for a withholding certificate to reduce or eliminate withholding on the disposition of the real property.
7. What identity documents are needed to be attached? An original, or a certified or notarized copy, of an UNEXPIRED passport is the only document that is accepted for both identity and foreign status.
8. What if the taxpayer does not have a passport? If the taxpayer does not have a passport, he must provide a combination (two or three) of the current documents that contain expiration dates and which shows his name and photograph so as to support his claim of foreign status. IRS will accept certified or notarized copies of a combination (two or more) of the following documents, in lieu of a passport: 1. National identification card (must show photo, name, current address, date of birth, and expiration date) 2. U.S. driver's license / Civil Birth Certificate 3. Foreign driver's license 4. U.S. state identification card 5. Foreign voter's registration card 6. U.S. military identification card 7. Foreign military identification card 8. Visa 9. U.S. Citizenship and Immigration Services (USCIS) photo identification 10. Medical records (dependents - under 14 years old - only) 11. School records (dependents and/or students - under 25 years old - only) Note: ITINs do not prove identity outside the tax system, and should not be offered or accepted as identification for non-tax purposes. ITINs are only for federal income tax purposes. If the taxpayer filing for an Extension of Time to File United States Income Tax Return (Form 4868 or Form 2688) or making an estimated payment with these forms or Form 1040-ES (Estimated Tax for Individuals) or Form 1040-ES (NR), (Estimated Tax for Nonresident Aliens), do not file the Form W-7/W-7SP with these forms.
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9. Where to apply? The federal income tax return, Form W-7 and proof of identity documents to be sent to the address listed in the Form W-7 instructions: Internal Revenue Service, ITIN Operations, P.O Box 149342, Austin, TX, 78714-9342. 10. When to apply? 1. The taxpayer can apply for an ITIN any time during the year; however, if the tax return he attaches to Form W-7 is filed after the return's due date, he may owe interest and/or penalties. 2. The taxpayer should file his current year return by the April 15 deadline to avoid this. 11. When can the taxpayer expect the ITIN? If the taxpayer qualifies for an ITIN and his application is complete, he will receive a letter from the IRS assigning his tax identification number, usually within four to six weeks. If he has not received his ITIN or other correspondence six weeks after applying, he may call the IRS to find out the status of his application. He may call the IRS toll-free at 1-800-829-1040 for information and help in completing his Form W-7 and his tax return, or to check on the status of his application six weeks after submitting Form W-7. However, international applicants (say, the client is currently in India) may call 215-5162000 (not a toll free number) for assistance. This number is not available for residents of the U.S.
12. What information must be included on Form W-7/W-7SP? Form W-7/W-7SP must include the following information: a. b. c. d. e. f. g. Reason for applying Applicants full name (and birth name if different) Applicants foreign address Applicants country of citizenship Mailing address, if different from foreign address Applicants date and place of birth The signature of the applicant, or if the applicant is a minor, the signature of the parent, court-appointed guardian or Power of Attorney.
CHAPTER 5: FILING STATUS AND METHODS

PART-I: FILING STATUS 1.) Why to determine the filing status? The determination of the filing status is necessary for: Filing requirements. Determining the Standard deduction.
IBSN
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Figuring out the correct tax, using the tax computation worksheets or tax tables as prescribed by IRS.
2.) How to determine the filing status? Generally, marital status on the last day of the year determines taxpayers entire year. 3.) What are the different types of filing status? There are five types of filing status. They are as follows: a. b. c. d. e. Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er) With Dependent Child. status for the
4.) When can filing status be Single? Filing status is Single, if on the last day of the year: Taxpayer is unmarried or legally separated from his spouse under a divorce or separate decree. He does not qualify for any other filing status. st His filing status may also be single, if he was widowed before 1 of January and st remained unmarried until the year end i.e. 31 December. This is applicable only for 2 years.
5.) When can filing status be MFJ? Taxpayer can choose married filing jointly as his filing status if he is married and his spouse agree to file a joint return. 6.) What are the benefits of filing a Joint return? The benefits of filing a MFJ return are as follows: On a joint return, taxpayer and his spouse can report their combined income and xdeduct their combined allowable expenses. A joint return can be filed even though only one has income and deductions. In this case, tax payable may be lower than any other filing status. His standard deduction may be higher, and he may qualify for tax benefits that do not apply to other filing status. and both he
7.) When can filing status be MFS? Filing status can be married filing separately, if taxpayer and his spouse do not agree to file a joint return. This will benefit only if: Taxpayer wants to be responsible for his own tax, (or)
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The tax has resulted in less tax when compared to a joint return.
8.) What are the shortcomings of filing a MFS return? If taxpayer chooses married filing separately as his filing status, the following special rules apply. Because of these special rules, he will usually pay more tax on a separate return than if he used another filing status that he qualify for. Tax rate generally will be higher than it would be on a joint return. Exemption amount for figuring the alternative minimum tax will be half that allowed to a joint return filer. Taxpayer cannot take the credit for child and dependent care expenses in most cases, and the amount that he can exclude from income under an employer's dependent care assistance program is limited to $2,500 (instead of $5,000 if he filed a joint return). He cannot take the earned income credit. He cannot take the exclusion or credit for adoption expenses in most cases. He cannot take the education credits (the hope credit and the lifetime learning credit), the deduction for student loan interest, or the tuition and fees deduction. He cannot exclude any interest income from qualified U.S. savings bonds that he used for higher education expenses. His capital loss deduction limit is $1,500 (instead of $3,000 if he filed a joint return). If his spouse itemizes deductions, he cannot claim the standard deduction. If he can claim the standard deduction, his basic standard deduction is half the amount allowed on a joint return. If he lived with his spouse at any time during the tax year: He cannot claim the credit for the elderly or the disabled. He will have to include in income more (up to 85%) of any social security or equivalent railroad retirement benefits he received, and He cannot roll over amounts from a traditional IRA into a Roth IRA. The following credits and deductions are reduced at income levels that are half of those for a joint return: The child tax credit, The retirement savings contributions credit, Itemized deductions, and The deduction for personal exemptions.
9.) When can filing status be Head of household? The following requirements are to be met to file a return under head of household status: Taxpayer is unmarried or considered unmarried (See Question 10) on the last day of the year. He paid more than half the cost of keeping up his home for that tax year. A qualifying person (refer table below) lived with him in his home for more than 6 months. If the qualifying person is his dependent parent, he or she does not have to live with
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him. IF the person is . . . AND . . . he or she is single THEN that person is . . A qualifying person, whether or not he can claim an exemption for the person.
qualifying child (such as a son, daughter, or grandchild who lived with he or she is married and taxpayer the taxpayer more than half the year can claim an exemption for him or A qualifying person. her and meets certain other tests) he or she is married and taxpayer cannot claim an exemption for him Not a qualifying person. or her qualifying relative who is taxpayers father or mother
taxpayer can claim an exemption A qualifying person. for him or her taxpayer cannot claim an Not a qualifying person. exemption for him or her he or she lived with the taxpayer more than half the year, and he can a qualifying person. qualifying relative other than claim an exemption for him or her the taxpayers father or mother (such he or she did not live with the as a grandparent, brother, or sister not a qualifying person. taxpayer more than half the year who meets certain tests) taxpayer cannot claim an not a qualifying person. exemption for him or her Note #1: A person cannot qualify more than one taxpayer to use the head of household filing status for the year. Note #2: The terms qualifying child and qualifying relative are of same meaning as defined under Publication 501. Note #3: A person who is a qualifying relative only because he or she lived with the taxpayer all the year as a member of his household is not a qualifying person. Note #4: If taxpayer can claim an exemption for a person only because of a multiple support agreement, that person is not a qualifying person. Multiple Support Agreement: Sometimes one person does not provide more than half of the support for a person. Instead, two or more persons together provide more than half of the person's support. When this happens, taxpayer can agree that any one , who individually provides more than 10% of the person's support, can claim an exemption for that person as a qualifying relative. Each of the others must sign a statement agreeing not to claim the exemption for that year. The person who claims the exemption must keep these signed statements for his or her records. A multiple support declaration obtained from each of the others who agreed not to claim the exemption must be attached to the return of the person claiming the exemption. Form 2120-Multiple Support Declaration can be used for this purpose.
10.) When is the taxpayer considered unmarried? Taxpayer is considered unmarried on the last day of the tax year if he meets ALL of the
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following tests: a. He files a separate return b. He paid more than half the cost of keeping up his home for the tax year. c. His spouse did not live in his home during the last 6 months of the tax year. His spouse is considered to live in his home even if he or she is temporarily absent due to special circumstances (illness, strikes, lockouts, natural disasters, education, military, vacation, etc.) d. His home was the main home of his child, stepchild, or eligible foster child for more than half the year. 11.) When can filing status be qualifying widow(er) with dependent child? Taxpayer is eligible to file as qualifying widow(er) with dependent child for two years following the year his spouse died. For example: If his spouse died in 2010 and he has not remarried, he may be able to use this filing status for 2010. He is eligible to file his 2010 return as a qualifying widow(er) with dependent child if he meets ALL of the following tests: a. He was entitled to file a joint return with his spouse for the year his spouse died. It does not matter whether he actually filed a joint return. b. His spouse died in 2008 or 2009 and he did not remarry before the end of 2010. c. He has a child or stepchild for whom he can claim an exemption. This does not include a foster child. d. He paid more than half of the cost of keeping up a home that was the main home for him and that child for the entire year, except for temporary absences.
Miscellaneous Topics:
12.) What if the taxpayers spouse died during the tax year? If taxpayers spouse died during the year, he is considered married for the whole year and can choose married filing jointly as his filing status. 13.) What filing status can be used by divorcees? If taxpayer is divorced under a final decree by the last day of the year, he is considered unmarried for the whole year and he cannot choose married filing jointly as his filing status. 14.) What is the treatment in case of the annulled marriages? If taxpayer obtains a court decree of annulment, which holds that no valid marriage ever existed, he is considered unmarried even if he filed joint returns for earlier years. He must file amended returns (Form 1040X) claiming single or head of household status for ALL tax years affected by the annulment.
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15.) What if more than one filing status applies to the taxpayer? If more than one filing status applies to the taxpayer, then he may choose to file as per that status for which he is entitled to pay less tax and reap more benefit.
Part-II: Filing Methods

16.) What are the different methods of filing a return? The two different methods of filing a return are:a. Paper Filing, or b. E-filing. 17.) What if tax return is e-filed? E-filing is the most convenient and fastest way to file the returns. The benefits of E-filing are as follows: Free-file options by IRS. Fast and direct deposit of refunds into the taxpayers bank account. Privacy and security assured. Enables electronic signatures. Proof of receipt provided. E-filing can be done to federal and state returns. Convenient, safe and secure electronic payment options are available.
18.) Whether to e-file or paper file? E-filing and paper filing options vary from one return to another. Many factors are involved in determining whether to e-file or paper file an individual tax return.
CHAPTER 6: ACCOUNTING PERIODS
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PART I: ACCOUNTING PERIODS 1. What is an accounting period? In terms of taxation, it is the 12-month period a taxpayer uses to determine his or her income
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tax. 2. What is a tax year? Each taxpayer must figure taxable income on an annual accounting period called tax year. The annual accounting period for which taxpayer keeps records and reports his income and expenditure is called Tax Year. Tax Year can be either a Calendar Year or Fiscal Year or Short Tax Year. 3. What is a calendar year? A calendar year is 12 consecutive months beginning January 1 and ending December 31. If taxpayer adopts the calendar year, he must maintain his books and records and report his income and expenses from January 1 through December 31 of each year. Generally, anyone can adopt the calendar year. However, he must adopt the calendar year if any of the following apply: He keeps no books. He has no annual accounting period. His present tax year does not qualify as a fiscal year. He is required to use a calendar year by a provision of the Internal Revenue Code or the Income Tax Regulations.
4. What is a fiscal year? A fiscal year is 12 consecutive months ending on the last day of any month except December. If taxpayer adopts a fiscal year, he must maintain his books and records and report his income and expenses using the same tax year. 5. What is a short tax year? A short tax year is a tax year of less than 12 months. A short period tax return may be required when taxpayer (as a taxable entity): Are not in existence for an entire tax year, or Change his accounting period.
PART II: ACCOUNTING METHODS 6. What is meant by accounting method? Each taxpayer must use a consistent accounting method, which is a set of rules for determining when to report income and expenses.
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7. What are the different types of accounting methods used? The most commonly used accounting methods are:o the cash method and o the accrual method. 8. What is a cash method? Under the cash method, taxpayer generally report income in the tax year he receives it and deduct expenses in the tax year he pays them. CASH METHOD can be further divided into:1. Actual Receipt When taxpayer actually receives it. 2. Constructive Receipt Where in a third party gets involved and receives the payment. Taxpayer does not need to have physical possession of it. The following are some of the examples: Garnisheed Wages If the employer uses taxpayers wages to pay his debts Brokerage and other accounts Profits from a brokerage account, or similar account, are fully taxable in the year taxpayer earns them. Debts paid for the taxpayer If another person cancels or pays his debts (but not as a gift or loan) Payment to third party If a third party is paid income from property taxpayer owns Payment to agent Income an agent receives for the taxpayer Check received or available A check that was made available to taxpayer but not cashed or deposited. 9. What is an accrual method? Under the accrual method, taxpayer generally report income in the tax year he earns it, regardless of when payment is received, and deduct expenses in the tax year he incurs them, regardless of when payment is made.
CHAPTER 7.1: TAX RATES SCHEDULES-2010
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The following tax rate schedules are used to compute the taxpayers Federal estimated income tax for 2010: Schedule X Single
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If taxable income is over-- But not over-$0 $8,351 $33,951 $82,251 $171,551 $372,951 $8,350 $33,950 $82,250 $171,550 $372,950 no limit
The tax is: 10% of the amount over $0 $835.00 plus 15% of the amount over $8,350 $4,675.00 plus 25% of the amount over $33,950 $16,750.00 plus 28% of the amount over $82,250 $41,754.00 plus 33% of the amount over $171,550 $108,216.00 plus 35% of the amount over $372,950
Schedule Y-1 Married Filing Jointly or Qualifying Widow(er) If taxable income is over-- But not over-$0 $16,701 $67.901 $137,051 $208,851 $372,951 $16,700 $67,900 $137,050 $208,850 $372,950 no limit The tax is: 10% of the amount over $0 $1,670.00 plus 15% of the amount over $16,700 $9,350.00 plus 25% of the amount over $67,900 $26,637.50 plus 28% of the amount over $137,050 $46,741.50 plus 33% of the amount over $208,850 $100,894.50 plus 35% of the amount over $372,950
Schedule Y-2 Married Filing Separately If taxable income is over-- But not over-$0 $8,351 $33,951 $68,526 $104,426 $186,476 $8,350 $33,950 $68,525 $104,425 $186,475 no limit The tax is: 10% of the amount over $0 $835.00 plus 15% of the amount over $8,350 $4,675.00 plus 25% of the amount over $33,950 $13,318.75 plus 28% of the amount over $68,525 $23,370.75 plus 33% of the amount over $104,425 $50,447.25 plus 35% of the amount over $186,475
Schedule Z Head of Household If taxable income is over-- But not over-The tax is:
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If taxable income is over-- But not over-$0 $11,951 $45,501 $117,451 $190,201 $372,951 AMT Tax Rates: For Taxable Income up to $1,75,000 For Taxable Income beyond $1,75,000 $11,950 $45,500 $117,450 $190,200 $372,950 no limit
The tax is: 10% of the amount over $0 $1,195.00 plus 15% of the amount over $11,950 $6,227.50 plus 25% of the amount over $45,500 $24,215.00 plus 28% of the amount over $117,450 $44,585.00 plus 33% of the amount over $190,200 $104,892.50 plus 35% of the amount over $372,950
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Capital Gain Tax Rates: The following tax rate schedules are used to compute the Capital Gains for 2010: Type of Capital Asset Short-term capital gains (STCG) Long-term capital gains (LTCG) Holding Period One year or less More than one year Tax Rate Ordinary income tax rates up to 35% 5% for taxpayers in the 10% and 15% tax brackets 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets
CHAPTER 7.2: TAX CALENDAR IBSN In-House Training Manual 2010
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Part I - Introduction
1. What is a Tax Calendar? A tax calendar is a 12-month calendar divided into quarters. The calendar gives specific due dates for the following: Filing tax forms. Paying taxes. Taking other actions required by federal tax law.
2. What is a General Tax Calendar? This tax calendar has the due dates for 2010 that most taxpayers will need. Employers and persons who pay excise taxes should use the Employer's Tax Calendar and the Excise Tax Calendar. Part II Tax Calendar 2010 Important Dates Applicable to Individuals January 1 Start of tax season. Make the fourth payment of 2010 estimated tax if taxpayer is not paying his income tax for the year through withholding (or he does not pay enough tax in that way). Use Form 1040-ES. Taxpayer doesnt need to make this payment if he files his 2010 return and pays any tax due by January 31, 2010. If the taxpayer did not pay his last installment of estimated tax by January 16, he may choose (but are not required) to file his income tax return (Form 1040) for 2010 by January 31. Filing his return and paying any tax due by January 31 prevents any penalty for late payment of the last installment. January 31 If he cannot file and pay his tax by January 31, then he can file and pay his taxes by April 18. W-2s are due from the employer. Forms 1099 are due from payers of interest, dividends and other specified types of income. February 15 If taxpayer was exempt from income tax withholding for 2007, he must file a new Form W-4 by this date to continue his exemption for 2010. Next year, tax day falls on Sunday, April 15, so tax day will be Monday, April 16, not the 17th. April 16 Get an automatic six-month extension to file the return. Taxpayer can download Form 4868, Application for Automatic Extension of Time To File. This form must
January 16
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be postmarked on or before April 15, 2010. With the extension, his new deadline for filing his return will be October 15, 2010. This is also the last day to set up an IRA or make 2007 IRA contributions even if he gets an extension. The first payment of his 2010 estimated tax has to be made if he is not paying his income tax for the year through withholding (or will not pay enough in tax that way). Use Form 1040-ES. If taxpayer is a U.S. citizen or resident alien living and working (or on military duty) outside the United States and Puerto Rico, file Form 1040 and pay any tax, interest, and penalties due. If taxpayer wants additional time to file his return, file Form 4868 to obtain four additional months to file. However, if he is a member of the armed forces serving in a combat zone he may be able to further extend the filing deadline. The second payment of his 2010 estimated tax has to be made if he is not paying his income tax for the year through withholding (or will not pay enough tax in that way). Use Form 1040-ES. The third payment of his 2010 estimated tax has to be made if he is not paying his income tax for the year through withholding (or will not pay enough tax in that way). Use Form 1040-ES. Deadline for establishing a SIMPLE IRA. If taxpayer filed Form 4868 extending the due date of his return, the files 2007 tax return by this day and pays any tax, interest, and penalties due. October 16 Last day for recharacterizing an IRA contribution for 2010 if taxpayer filed his 2007 return on time. Last day for making many elections that ordinarily were required to be made by the due date of the 2010 return if taxpayer filed his 2010 return on time.
June 15
September 17 October 2
CHAPTER 8: FEDERAL INCOME TAX RETURNS

An Overview:
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Federal Income Tax Returns
Form 1040 EZ
Form 1040 A
Form 1040
Form 1040 NR Form 1040 NR-EZ
The three forms used for filing individual federal income tax returns are: 1. Form 1040EZ 2. Form 1040A, and 3. Form 1040. If taxpayer was a nonresident alien during the tax year and he was married to a U.S. citizen or resident alien, he may use any one of these three forms, based on the circumstances, only if he elects to file a joint return with his spouse. Other nonresident aliens may have to file Form 1040NR or Form 1040NR-EZ.
Form 1040 EZ
Form 1040EZ is the most simplest of all the forms. Taxpayer may use Form 1040EZ if he meets all of the following conditions: 1. Filing Status must be Single/MFJ 2. No Dependents must be claimed 3. Tax Payer and Spouse if filing MFJ return, must be under 65 years of age as on January 1, and not blind at the end of the year 4. Taxable income is less than $1,00,000 5. Income is only from: Wages, salaries, tips Taxable scholarships and fellowship grants Qualified State Tuition program earnings Taxable Interest of $1500 or less Unemployment Compensation Alaska Permanent Fund Dividends
6. There are no following adjustments to income: Educator Expenses Deductions for contributions to Traditional IRAs Student loan interest deduction Tuition and Fees deduction
7. No earned income credit payments have been received in advance.
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8. Taxpayer does not claim any of the following Credits: Education Credit Retirement Savings Contributions Credit Health Coverage Tax Credit
9. Taxpayer does not owe anything towards household employment taxes on wages he paid to a household employee. NOTE: If taxpayer files Form 1040EZ, he cannot itemize deductions or claim any adjustments to income or tax credits (other than the earned income credit.)
Form 1040A
If taxpayer cannot use Form 1040EZ, he may be able to use Form 1040A if: 1. His income is only from wages, salaries, tips, taxable scholarships and fellowships, interest, ordinary dividends, capital gain distributions, pensions, annuities, IRAs, unemployment compensation, taxable social security or railroad retirement benefits and Alaska Permanent Fund dividends,
2. His taxable income is less than $100,000, 3. He does not itemize deductions, and 4. His only adjustments to income are: the IRA deduction, the student loan interest deduction, the educator expenses and the tuition and fees deduction He can claim only following credits: the credit for child and dependent care expenses, the earned income credit, the adoption credit, the credit for the elderly or the disabled, the education credits, the child tax credit, the additional child tax credit, and the retirement savings contribution credit.
Form 1040
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Finally, taxpayer must use Form 1040 under certain circumstances, such as: 1. His taxable income is $100,000 or more, 2. He has certain types of income such as unreported tips, certain nontaxable distributions, selfemployment earnings, or income received as a partner, income received as a shareholder in an "S" Corp., or income received as a beneficiary of an estate or trust.
3. He itemizes deductions or claims certain tax credits or adjustments to income, or 4. He owes household employment taxes. NOTE: A complete list of conditions outlining when Form 1040 must be used is in the instructions for Form 1040A.
Form 1040 NR-EZ

Taxpayer can use Form 1040 NR-EZ if all of the following conditions are satisfied: 1. His income from U.S. Sources is only from: Wages, Salaries, Tips Taxable refunds of state and local income taxes, and Scholarship or fellowship grants
Note: If he has taxable interest or dividend income, he cannot use this form. 2. 3. 4. 5. 6. He does not claim exemption for his spouse (or) any dependents. He is not claimed as a dependent on someone elses US tax return. His taxable income is less than $1,00,000 He does not claim any itemized deductions in his federal tax return. He does not claim any adjustments to income other than: student loan interest deduction scholarship and fellowship grants
7. He does not claim any tax credits. 8. He owes no taxes other than: income tax social security and medicare tax on tip income not reported to his employer If he does not meet all of the above conditions, he must file Form 1040 NR.
Form 1040 NR IBSN In-House Training Manual 2010 33
Taxpayer must file Form 1040 NR if any of the following four conditions applies to him: 1. He was a nonresident alien engaged in a trade or business in the United States during the tax year. He must file even if: None of his income came from a trade or business conducted in the US, He has no income from U.S. sources, or His income is exempt from U.S. tax.
He must also file if he wants to: Claim a refund of over withheld or overpaid tax Claim the benefit of any deductions or credits.
However, if taxpayer was a nonresident alien student, teacher, or trainee who was temporarily present in the US under an F, J, M, or Q visa, he must file Form 1040 NR (or Form 1040 NR-EZ) only if he has income that is subject to tax under Section 871. Note: Section 871 income includes income items listed in: Lines 8 to 21 on Page 1 of Form 1040 NR & Lines 75a to 84 on Page 4 of Form 1040 NR.
2. If the taxpayer was a nonresident alien not engaged in a trade or business in the US during tax year and: he received income from US sources that is reportable on lines 75a to 84 of Page 4 of Form 1040 NR & his federal taxes were not totally withheld.
3. He represents a deceased person who has to file Form 1040 NR. 4. He represents an estate or trust that has to file Form 1040 NR. In short, he must satisfy all of the following conditions to file Form 1040 NR: He must be a nonresident alien He must not engaged in a trade or business in the US at any time He had no income that was effectively connected with the conduct of a US trade or business His federal income taxes were withheld in full He is filing Form 1040NR solely to claim a refund of US tax withheld at source.
Taxpayer has to file Form 1040 NR-EZ and Form 1040 NR only at: Internal Revenue Service Center, Austin, TX 73301-0215, U.S.A
CHAPTER 9.1: RESIDENTIAL STATUS IBSN In-House Training Manual 2010
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Introduction: For tax purposes, an alien is an individual who is not a US Citizen. Aliens are classified into Resident Aliens and Nonresident Aliens. However, if the taxpayer are both a Nonresident and Resident in the same year, he is treated a Dual Status Alien. Resident Aliens are generally treated the same as US Citizens and thus both are by and large taxed on their worldwide income, whereas Nonresident Aliens are taxed only on their: Income from sources within the US and Certain income connected with the conduct of a trade/business in the US. 1. Who are Nonresident Aliens and Resident Aliens? If taxpayer is an alien (not a US Citizen), he is considered a Nonresident Alien unless he meets one of the two tests discussed herein. He is a Resident Alien of the US for tax purposes if he meets either the Green Card Test (Question 2) or the Substantial Presence Test (Question 3) for the Calendar Year. Even if he does not meet either of these tests, he may be able to choose to be treated as a US Resident for part of the year if he satisfies the First Year Choice Test (Question 9). 2. What is Green Card Test? Taxpayer is a Resident for tax purposes if he is a lawful permanent resident of the US at anytime during the calendar year. This is known as Green Card Test. He is lawful permanent resident of the US at any time if he has been given the privilege, according to the immigrations laws, of residing permanently in the US as an immigrant He generally has this status if the USCIS has issued him an alien registration card, also known as Green Card. He continues to have Resident status under this test unless the status: o is taken away from him, or o is administratively or judicially determined to have been abandoned. If he terminates his residency after June 3, 2004, he will still be considered a US Resident for tax purposes until he: o Notify the Secretary of Homeland Security, and o File Form 8854: Initial and Annual Expatriation Information Statement. 3. What is Substantial Presence Test? Taxpayer is considered a US Resident for tax purposes if he meets the Substantial Presence Test for the calendar year. To meet this test, he must be physically present in the US on at least: a) 31 days during the current year, and b) 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counted as under: 1. Step 1: Enter the no. of days he was present in the current year (say 2010) 2. Step 2: Enter the no. of days he was present in the first year before the current year (say 2008) times 1/3. 3. Step 3: Enter the no. of days he was present in the second year before the current year (say 2009) times 1/6. 4. Step 4 = Total of Steps 1 to 3 If Step 4 is at least 183 days, then (b) is satisfied Otherwise, (b) is not satisfied
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If both (a) and (b) are satisfied, taxpayer is considered a US Resident under Substantial Presence Test. And please note that in (a), 31 days of presence during the current year need not be in a row. 4. When is taxpayer treated as not present in the US? Taxpayer is treated as present in the US on any day he was physically present in the US at any time during the day. However, there are some exceptions to this rule which have been listed here under. Do not count the following as days of presence in the US for Substantial Presence Test: 1. Days he was in the US for less than 24 hours when he was in transit between two places outside the US 2. Days he was unable to leave the US because of a medical condition that arose while he was in the US. Days he intended to leave the US, but could not leave because of a medical condition or problem that arose while he was in the US. 3. Days he was an exempt individual. 5. Can the taxpayer be treated as a Nonresident Alien even if he meets Substantial Presence Test? Yes.Even if the taxpayer meets the Substantial Presence Test, he can be treated as Nonresident Alien if: Taxpayer was present in the US for less than 183 days during the current year Maintains a Tax Home in a foreign country during the current year Have a closer connection to one foreign country in which he has a tax home than to US. 6. Closer Connection to a Foreign Country For determining whether taxpayer has a closer connection to a foreign country, his tax home must be: In existence for the entire current year, and Located in the same foreign country to which he is claiming to have a closer connection. He cannot claim that he has a closer connection to a foreign country if either of the following applies: He personally applied, or took any steps, to change his status to that of a permanent resident during the current year, or He had an application pending for adjustment of status during the current year. 7. What is a Tax Home? Possibility 1: Main place of Business, Employment, or Post of duty Tax home is general area of taxpayers main place of business, employment, or post of duty, regardless of where he maintains his family home. Possibility 2: Place where taxpayer permanently or indefinitely works Tax home is the place where he permanently or indefinitely works as an employee or a selfemployed individual. Possibility 3: Place where taxpayer lives If taxpayer does not have a regular or main place of business because of the nature of his
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work, then his tax home is the place where he regularly lives. Possibility 4: Place wherever taxpayer works If taxpayer does not fall into any of the above categories, he is considered an itinerant and his tax home is wherever he works. 8. What is First Year Choice Test? If taxpayer does not meet either the Green Card Test or the Substantial Presence Test for 2010 or 2011 and he did not choose to be treated as a Resident for part of 2010, but he meets the Substantial Presence Test for 2011, he can choose to be treated as a US Resident for part of 2010. To make this choice, he must: Be present in the US for at least 31 days in a row in 2010, and Be present in the US for at least 75% of the number of days o Beginning with the first day of the 31-day period, and o Ending with the last day of 2010. For purposes of this 75% requirement, he can treat up to 5 days of absence from the US as days of presence in the US. If taxpayer makes the First Year Choice, his residency starting date for 2010 is the first day of the earliest 31-day period that he uses to qualify for the choice. He cannot file Form 1040 or the statement until he meets the Substantial Presence Test for 2009. He must attach a statement to Form 1040 to make the First Year Choice and the statement must contain his name and address and specify the following: That he is making the First Year Choice That he was not a Resident in 2007 That he is a Resident in 2010 under the Substantial Presence Test The number of days of presence in the US during 2010 The date or dates of his 31-day period of presence in US during 2010 The period of continuous presence in the US during 2010 The date or dates of absence from the US during 2010 that he was treating as day of presence
Note: Taxpayer does not have to be married to make this choice. Example: Mr. Krish is a citizen of India. He came to the US for the first time on November 1, 2010 and was here on 31 consecutive days from (November 1 through December 1, 2010). Mr. Krish returned to India on December 1 and came back to the US on December 17, 2010. He stayed in the US for the rest of the year. Answer: Mr. Krish is a Resident of the US under the Substantial Presence Test and can make the First Year Choice for 2010 because: He was in the US in 2010 for a period of 31 days in a row, and He was present for at least 75% from the date he first came to US till December 31 computed as under: o No. of days from November 1 to December 31 = 61 days o No. of days actually present in US From November 1 to December 1 = 31 days From December 17 to December 31 = 15 days Total days actually present in US = 46 days o Percentage = 46 days / 61 days X 100 = 75.41%
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Say in the above example, Mr. Krish was absent for the last 5 days in 2010, still he qualifies as a Resident under the First Year Choice Test because for purposes of 75% requirement, up to 5 days of absence are considered days of presence. Note: Taxpayer cannot file Form 1040 or the statement until he meets the substantial presence test for 2009. 9. Who are Dual-Status Aliens? If taxpayer is both a nonresident alien and a resident alien during the same tax year, then he is termed Dual-Status Alien. This usually occurs in the year he arrives in or departs from the US. 10. Can a Dual Status Alien be treated as a US Resident? If the taxpayer is a dual-status alien, he can choose to be treated as a US Resident for the entire year if all of the following apply: He was a Nonresident Alien at the beginning of the year He was a Resident Alien at the end of the year He was married to a US Citizen or Resident Alien at the end of the year If the taxpayers spouse joins in making the first-year choice
This is possible even if both the taxpayer and his spouse were Nonresident Aliens at the beginning of the tax year and Resident Aliens at the end of the tax year. Note: The taxpayer cannot make this choice if he is SINGLE at the end of the year. If he makes this choice, the following rules apply: The taxpayer and his spouse are treated as US Residents for the entire year for income tax purposes The taxpayer and his spouse are taxed on worldwide income The taxpayer and his spouse must file a joint return for the year of choice Neither the taxpayer nor his spouse can make this choice for any later tax year, even if they are separated, divorced or remarried. Statement of Joint Declaration: The taxpayer should attach a statement signed by both himself and his spouse to their joint return for the year of choice. The statement must contain the following information: A declaration that they both qualify to make the choice and that they choose to be treated as US Residents for the entire tax year The name, address, and TIN (SSN/ITIN) of each spouse 11. Can a Nonresident Spouse be treated as a Resident? If at the end of the tax year, one spouse is a US Citizen or Resident Alien and the other spouse is a Nonresident Alien, the resident spouse can choose to treat the Nonresident spouse as a US Resident, unmindful of whether he was Resident or Nonresident at the beginning of the year. If the taxpayer makes this choice, the following rules apply: The taxpayer and his spouse are treated as US Residents for the entire year for income tax purposes
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Taxpayer and his spouse are taxed on worldwide income Taxpayer and his spouse must file a joint return for the year of choice Neither the taxpayer nor his spouse can claim not to be a US Resident under any tax treaty. Statement of Joint Declaration: The taxpayer should attach a statement signed by both himself and his spouse to their joint return for the year of choice. The statement must contain the following information: A declaration that they both qualify to make the choice and that they choose to be treated as US Residents for the entire tax year The name, address, and TIN (SSN/ITIN) of each spouse. 12. What is the taxpayers Residency Starting Date under Substantial Presence Test? If the taxpayer meets the Substantial Presence Test for a calendar year, his residency starting date is generally the first day he is present in the US during that calendar year. However, do not count up to 10 days of actual presence in the US if on those days: Taxpayer had a closer connection to a foreign country than to the US, and His tax home was in that foreign country. Taxpayer must file a statement with the IRS if he is excluding up to 10 days of presence in the US for purposes of his residency starting date. This statement must contain information as specified in Publication 519. Example: Mr. First is a citizen of India. He came to the US for the first time on January 6, 2010, to attend a business meeting and returned to India on January 10, 2010. His tax home remained in India. On March 1, 2010, he moved to the US and resided here for the rest of the year. Answer: In this case, Mr. First is able to establish a closer connection to India for the period January 6-10. Thus, his residency starting date is March 1 and not January 6. 13. What information should the taxpayer report as a Dual-Resident Taxpayer? If the taxpayer is a dual-resident taxpayer and he claims treaty benefits, then: He must file a return by the due date (including extensions) using Form 1040NR or 1040NR-EZ, and Compute his tax as a Nonresident Alien He must also attach a fully completed Form 8833 if he determines his residency under a tax treaty and receive payments or income items totaling more than $100,000. 14. Which form to file? The U.S. income tax return the taxpayer must file as a dual-status alien depends on whether he is a resident alien or a nonresident alien at the end of the tax year. If Resident at the end of tax year: The taxpayer must file Form 1040 if he is a dual-status taxpayer, who becomes a resident during the year and who is a U.S. resident on the last day of the tax year. Write Dual-Status Return across the top of the return. Attach a statement to the taxpayers return to show the income for the part of the year he
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is a nonresident. He can use Form 1040NR or Form 1040NR-EZ as the statement, but be sure to mark Dual-Status Statement across the top. If Nonresident at the end of tax year: The taxpayer must file Form 1040NR or Form 1040NR-EZ if he is a dual-status taxpayer who gives up residence in the United States during the year and who is not a U.S. resident on the last day of the tax year. Write Dual-Status Return across the top of the return. Attach a statement to the taxpayers return to show the income for the part of the year he is a resident. He can use Form 1040 as the statement, but be sure to mark Dual-Status Statement across the top. Note: In either case, e-filing is not possible.
CHAPTER 9.2: INCOME OF ALIENS IBSN In-House Training Manual 2010
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1. How are Resident Aliens taxed? Resident Aliens are generally taxed in the same way as US Citizens. This means that their worldwide income is subject to US tax and must be reported on their US tax return. 2. How are Nonresident Aliens taxed? Nonresident Aliens are taxed based on the source of their income and whether or not their income is effectively connected with a US trade or business. A Nonresident Aliens income that is subject to US income tax must be divided into two categories: Income that is effectively connected with a trade or business in the US, and Income that is not effectively connected with a trade or business in the US. The difference between two categories is that effectively connected income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to US Citizens and Residents. Income that is not effectively connected is taxed at a flat 30% (or lower treaty) rate. 3. What are incomes effectively connected / not effectively connected with a trade or business in the US? Refer Page 4 of Form 1040NR: US Nonresident Alien Income Tax Return 4. How are Social Security Benefits taxed? A Nonresident Alien must include 85% of any US Social Security Benefits in the US source fixed or determinable annual or periodic income. This income is exempt under some tax treaties that exempt US Social Security Benefits from US tax.
CHAPTER 9.3: STUDENTS, BUSINESS APPRENTICES AND EXCHANGE VISITORS FROM INDIA IBSN In-House Training Manual 2010
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Part I - Students and Business Apprentices from India 1. Rules Applicable: Students and Business Apprentices who are eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty may be able to claim exemptions for their spouse. The taxpayer can claim an exemption for his spouse if he or she had no gross income during the year and cannot be claimed as a dependent on another US taxpayers return. The taxpayer cannot claim exemptions for each of his dependents not admitted to the US on F-2, J-2 or M-2 visas unless they meet the same rules that apply to US Citizens. List the taxpayers spouse and dependents on Line 7c of Form 1040NR. 2. Withholding on Scholarships and Fellowship Grants There is no withholding on a qualified scholarship received by a candidate for a degree. If the taxpayer is a nonresident student or grantee with an F, J, M, or Q visa and he receives a US source grant or scholarship that is not fully exempt, then the withholding agent (usually the payer of scholarship) withholds tax at 14% (or lower treaty rate) of the taxable part of the grant or scholarship that is not a payment for services. However, if the taxpayer is not a candidate for a degree and the grant does not meet certain requirements, tax will be withheld at the 30% (or lower treaty rate). 3. Social Security or Medicare Taxes Withholding: Generally, services performed by the taxpayer as a nonresident alien temporarily in the United States as a nonimmigrant under subparagraph (F), (J), (M), or (Q) of section 101(a) (15) of the Immigration and Nationality Act are not covered under the social security program if the services are performed to carry out the purpose for which he was admitted to the United States. This means that there will be no withholding of Social Security or Medicare Taxes from the pay the taxpayer receives for these services. These types of services are very limited, and generally include only on-campus work, practical training, and economic hardship employment. Social security and Medicare taxes will be withheld from his pay for these services if he is considered a resident alien, even though his nonimmigrant classification (F, J, M, or Q) remains the same. Services performed by a spouse or minor child of nonimmigrant aliens with the classification of F-2, J-2, M-2, and Q-3 are covered under social security.
4. Nonresident Alien Students:
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If the taxpayer is a nonresident alien temporarily admitted to the United States as a student, he generally is not permitted to work for a wage or salary or to engage in business while he is in the United States. In some cases, a student admitted to the United States in F-1, M-1, or J-1 status is granted permission to work. Social security and Medicare taxes are not withheld from pay for the work unless the student is considered a resident alien. The U.S. Citizenship and Immigration Services (USCIS) permits on-campus work for students in F-1 status. On-campus work means work performed in the school's premises. Oncampus work includes work performed at an off-campus location that is educationally affiliated with the school. On-campus work under the terms of a scholarship, fellowship, or assistantship is considered part of the academic program of a student taking a full course of study and is permitted by the USCIS. Students in F-1 status may be permitted to participate in a curricular practical training program that is an integral part of an established curriculum. Curricular practical training includes work/study programs, internships, and cooperative education programs. Employment due to severe economic necessity and for optional practical training is sometimes permitted for students in F-1 status. Students may be granted permission to work due to severe economic necessity or for optional practical training by the USCIS. Students in M-1 status who have completed a course of study can accept employment for practical training for up to 6 months and must have been authorized by the USCIS. Note: In all the above cases, Social security and Medicare taxes are not withheld from pay for this work unless the student is considered a resident alien. In all other cases, any services performed by a nonresident alien student are not considered as performed to carry out the purpose for which the student was admitted to the United States. Social security and Medicare taxes will be withheld from pay for the services unless the pay is exempt under the Internal Revenue Code.
CHAPTER 10: EXEMPTIONS
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PART- I: INTRODUCTION 1. What is an Exemption? A deduction allowed by law to reduce the amount of income that would otherwise be taxed is an Exemption. Exemptions reduce the taxpayers taxable income. Generally, the taxpayer can deduct $3,650 for each exemption he claims in 2010. The taxpayer usually can claim exemptions for himself, his spouse, and for each person whom he can claim as dependent. 2. What are the different types of exemptions available? There are two types of exemptions: o o Personal Exemptions and Dependent Exemptions.
3. How to claim exemptions? Claiming an exemption on the tax return depends on which form is being filed. Exemption For Form 1040EZ filers Form 1040A filers Form 1040 filers U.S. citizen or Resident Aliens Where To Report Exemption? line 5 includes both standard deduction and personal exemption line 26 = line 6d * $3650 line 42 = line 6d * $3650 Qualify for any of the exemptions Generally exemption is available only for the taxpayer. However, special provisions apply for Students and Business Apprentices from India.
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PART- II: PERSONAL EXEMPTION 1. What is a Personal Exemption? Amount of money a person can exclude from personal income in calculating federal and state income tax is Personal Exemption. The taxpayer is generally allowed one exemption for himself and, if he is married, one exemption for his spouse. Taxpayers can claim one exemption for every person in their household. Taxpayers can also claim additional exemptions for each dependent parent living with them, if the dependent is blind, or over age 65. But the taxpayer may lose the benefit of part or all of his exemptions if his adjusted gross income is above a certain amount. Phase out of Exemptions: The taxpayer loses part of the benefit of his exemptions if his adjusted gross income is above
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a certain amount. The amount at which the phase out begins depends on his filing status. For 2010, the phase out begins at: $117,300 for married persons filing separately, $156,400 for single individuals, $195,500 for heads of household, and $234,600 for married persons filing jointly or qualifying widow(er) s.
2. Who cannot claim a personal exemption? If the taxpayer is entitled to claim an exemption for a dependent (such as his child), that dependent cannot claim a personal exemption on his or her own tax return. 3. What about Spouse Exemption? The taxpayers spouse is never considered his dependent. Filing Status / Situation MFJ Is Spouse Qualified For Exemptions? Taxpayer can claim one exemption for himself and one for his spouse. Taxpayer can claim the exemption for his spouse only if his spouse: has no gross income, is not filing a return, and is not the dependent of another taxpayer. As the taxpayer is considered unmarried, he cannot claim spouse exemption. However, he can claim exemption for his spouse only if his spouse has no gross income, is not filing a return, and is not the dependent of another taxpayer.
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Head of household.
Death of spouse
If taxpayers spouse died during the year, he can claim one exemption for himself and one for his spouse.
Divorced or separated spouse.
If the taxpayer obtained a final decree of divorce or separate maintenance by the end of the year, he cannot take his former spouses exemption even if he provided all of his former spouses support.
PART- III: DEPENDENT EXEMPTIONS
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1. Who is a Dependent? The term dependent means: A qualifying child, or A qualifying relative.
2. What are the different tests that must be met for a child to be a qualifying child? a. Relationship Test:The child must be the taxpayers son, daughter, stepchild, eligible foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them. b. Age Test: The child must be: Under age 19 at the end of the year, or Under age 24 at the end of the year if a full-time student, or No age limits apply if permanently and totally disabled. c. Residency Test: The child must have lived with the taxpayer for more than half of the year. d. Support Test: The child must not have provided more than half of his or her own support expenditure for the year. e. Special Test: If the child meets the rules to be a qualifying child of more than one person, the taxpayer must be the person entitled to claim the child as a qualifying child. 3. What are the different tests that must be met for a person to be a qualifying relative? a) Not a Qualifying Child Test: The person cannot be the taxpayers qualifying child or the qualifying child of anyone else. b) Relationship Test: The person either: Must be related to the taxpayer in one of the ways listed under relatives who do not have to live with the taxpayer, or Must live with the taxpayer all year as a member of his household. c) Gross Income Test: The persons gross income for the year must be less than $3,650. d) Support Test: The taxpayer must provide more than half of the persons total support expenditure for the year. 4. Who can claim dependent exemption? The taxpayer supporting the dependent(s) is allowed to claim dependent exemption(s). He is allowed one exemption for each person he can claim as a dependent He cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico, for some part of the year.
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However, special provisions apply for Students and Business Apprentices from India. 5. What are the different tests that must be met for a person to claim exemptions for dependents? The taxpayer can claim an exemption for a qualifying child or qualifying relative only if these three tests are met: a. Dependent taxpayer test. b. Joint return test. c. Citizen or resident test. a. Dependent Taxpayer Test: If the taxpayer could be claimed as a dependent by another person, he cannot claim anyone else as a dependent. Even if he has a qualifying child or qualifying relative, he cannot claim that person as a dependent. If he is filing a joint return and his spouse could be claimed as a dependent by someone else, he and his spouse cannot claim any dependents on their joint return.
b. Joint Return Test: Taxpayer generally cannot claim a married person as a dependent if he or she files a joint return. However, Joint Return Test does not apply if a joint return is filed by the dependent and his or her spouse merely as a claim for refund and no tax liability would exist for either spouse on separate returns.
C. Citizen or Resident Test o Taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico, for some part of the year. However, special provisions apply for Students and Business Apprentices from India. However, there is an exception for certain adopted children. If the taxpayer is a U.S. citizen who has legally adopted a child who is not a U.S. citizen, U.S. resident, or U.S. national, this test is met if the child lived with him as a member of his household all year. This also applies if the child was lawfully placed with him for legal adoption.
6. What are the special provisions that apply for Students and Business Apprentices from India? Generally a Nonresident Alien, whether single or married, may claim only one personal exemption for himself, as long as he may not be claimed as a dependent on any other US tax return. However, students and business apprentices covered by Article 21(2) of the United States-India Income Tax Treaty may claim an additional exemption for their spouse if the spouse has no gross income for the year, and is not claimed as dependent by another taxpayer. They may also claim additional exemptions for children who reside with them in the
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United States at any time during the year, but only if the dependents are U.S. citizens or nationals or residents of the United States, and the dependents pass all of the five dependency tests described earlier. In other words, a Nonresident Alien Indian Student cannot claim a dependency exemption for his child unless the child is a US Citizen / Resident Alien. They may not claim exemptions for dependents who are admitted to the United States on "F-2," "J-2," or "M-2" visas unless such dependents have become resident aliens. Note: A Dual Status Alien may claim all the same personal exemptions which are allowed to a US Citizen for that portion of the year in which he is a Resident Alien, but he may claim only the exemptions allowed to Nonresident Aliens as explained above for that portion of the year in which he is a Nonresident Alien.
CHAPTER 11: WAGE INCOME IBSN In-House Training Manual 2010
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1.) What are the contents of Form W-2? Form W-2 consists of the following components listed below: Box#1: Wages, tips, other compensation Box#2: Federal Income Tax Withheld Box#3: Social Security Wages Box#4: Social Security Taxes Withheld Box#5: Medicare Wages and Taxes Box#6: Medicare Tax Withheld Box#7: Social Security Tips Box#8: Allocated Tips Box#9: Advance EIC Payment Box#10: Dependent Care Benefits Box#11: Nonqualified Plans Box#12: Instructions Apply Box#13: Statutory Employee, Retirement Employee or Third Party Box#14: Others Box#15: State & Employers State ID Number Box#16: State Wages, tips, etc. Box#17: State Income Tax Box#18: Local Wages, tips, etc. Box#19: Local Income Tax Box#20: Locality Name 2.) What are the different copies of Form W-2 and how are they dealt with? Employer: Sends Copy A of Form W-2 with Form W-3 to the Social Security Administration (SSA). Retains Copy D for own Records. Sends Copy 1 for State, City or Local Tax Department. Employee: Sends Copy B to be filed with Employees Federal Income Tax Return to the Internal Revenue Service (IRS), if paper filing. Retains Copy C for Own Records. Sends Copy 2 to be filed with the Employees State, City or Local Income Tax Return, if paper filing. 3.) What is to be done if the employer does not provide the taxpayer with Form W-2? In general, employers/payers must provide employees with Form W-2: Wage and Tax Statement or Form 1099-MISC: Miscellaneous Income, by January 31 of the current year for the income earned/received in last tax year. Employers/payers have the option of making the information available on a website. However, if the taxpayer leaves his employer before the end of the calendar year, and request his Form W-2 or Form 1099- MISC at that time, his employer must provide him his form within 30 days of his request. Even if he does not receive Form W2 or Form 1099- MISC, the taxpayer must still file his return on time.
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6.) What if the employer does not issue the Form W-2 to the taxpayer even after January
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31 2009? After January 31 of the current year (i.e. 2010), if the taxpayer has not received Form W2 or Form 1099MISC, or received an incorrect form or information, he needs to contact his employer/payer for issue of Form W-2 or Form 1099-Misc or Corrected W-2. He may not have received his form because of an incorrect or incomplete address. He needs to be sure to verify the address used if already mailed. 7.) What is the difference between a Form W-2 and a Form 1099-MISC? Both of these forms are called information returns. The differences between the two have been tabulated as under: Form W-2 Form 1099-MISC The Form W-2 is used by employers to Form 1099-MISC is used to report payments report wages, tips and other compensation made in the course of a trade or business to paid to an employee. another person or business who is not an employee. The form also reports the employee's income tax and social security taxes withheld and any advanced earned income credit payments. The Form W-2 is provided by the employer to the employee and the Social Security Administration. The form is required among other things, when payments are of $10 or more in gross royalties or $600 or more in rents or compensation are paid. The form is provided by the payer to the IRS and the person or business that received the payment.
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BOX 1 of Form W2 (Federal Wages): Federal Wages = Gross Wages, Prizes, Awards, Non-cash Compensation, Non-qualified Expenses, Automobile Expenses + Other Compensation Employee contributions to FSA, 403(b) Retirement plans or University Health Insurance and transit deductions if any. BOX 2 of Form W2 (Federal Tax W/H): Amount of Federal Tax on Box 1 would be the Federal Tax Withheld. BOX 3 of Form W2 (Social Security Wages): Social security wages include monthly survivor and disability benefits. They do not include supplemental security income (SSI) payments, which are not taxable. The maximum Social Security Wage base for TY 2010 is $106,800. BOX 4 of Form W2 (Social Security Tax W/H): The maximum amount of Social Security Tax would be @6.2% of Social Security Wages. BOX 5 of Form W2 (Medicare Wages): Medicare wages are also a part of Social Security Benefits that are provided by an employer to his Employee which covers the health related issues of his employees. The maximum Medicare Wage base for TY 2010 is $106,800. BOX 6 of Form W2 (Medicare Tax W/H): The maximum Medicare Tax would be @1.45% of Medicare Wages.
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NOTE: In case of more than one Employer: If the taxpayer works as an employee in the United States, he must pay social security and Medicare taxes in most cases. His payments of these taxes will contribute to his coverage under the U.S. social security system. The taxpayer can claim a credit for Excess Social Security Tax paid on his income tax return if he has more than one employer. If any Employer has deducted more than the limit specified, he cant claim the credit but he can ask the employer to refund the excess amount paid. BOX 10 of Form W2 (Dependent Care Benefits): Amounts paid directly to either by the Taxpayer or by the Care Provider for the care of his Qualifying Person while he works, and The Fair Market Value for taking care of the Qualifying Person provided or sponsored by his employer. 8.) Should the taxpayer amend his return if he receives his Form-W2 or Form W2C later? If the taxpayer receives a Form W-2, Form W-2c, or Form 1099-R, after his return is filed with Form 4852, and the information differs from the information reported on his return, he must amend his return by filing Form 1040X, Amended U.S. Individual Income Tax Return. 9.) When is Form W2C required to be filed? Form W2C is used to make corrections on W2s already issued. The form is used to make any and all corrections on previously issued W2s from current or past years. Form W2C is prepared by entering both the previously erroneous information and the correct information. That data which is not required to be corrected should not be included in the Form W2C (only data which is corrected should be included). 10.) When is the Form W2C used? Unlike Form W2, Form W2C is issued on as-needed basis. After W2s are issued and reported to the SSA, W2C is used to make any and all changes to the original W2. There is no specific deadline for filing W2C. However, the recipient (employee) will want it corrected so that he or she can file the tax return without questions from the IRS.
CHAPTER 15: SELF EMPLOYMENT INCOME AND TAXES IBSN In-House Training Manual 2010
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Part-I: Self Employment Income 1.) Who is considered Self Employed? The Taxpayer is self-employed if he: a) b) c) d) Carries on a trade or business as a sole proprietor, Is an independent contractor, Is a member of a partnership, or Is in business for himself in any other way.
2.) Is Identification number required for a Self-employed? The Taxpayer must have a taxpayer identification number to operate his business. This is generally his social security number, or an individual taxpayer number. However if he has employees, he will need an Employer Identification Number.
3.) What is the main difference between an Employee and a Self-employed? Employers direct or control the work of employees. Self-employed workers are their own bosses; they control their own work. 4.) Who are Independent contractors? Do they fall under the category of Self-employed? An Independent contractor (may be carpenters, artists, and consultants) is the person who performs services for others. The recipients of the services do not direct or control the means or methods by which the independent contractors accomplish their work. The recipients do control the results of the work; they decide whether the work is acceptable to them or not. They may receive Form 1099-MISC-Miscellaneous Income, from the recipient of the services. Form 1099-MISC reports payments made to the self-employed worker. 5.) Can a person be both an Employee as well as a Self-employed Independent contractor? An individual can be an employee as well as a self-employed independent contractor. Example: Ms. Blue works full-time as a teacher (employee). On the weekends she works in her own business as a graphic artist (self-employed). 6.) How are the payments made to an Independent contractor reported? Payments made to independent contractors are reported on the Form 1099-MISC. 7.) What is meant by Self-employment profit and loss? Self-employment profit is self-employment income minus self-employment expenses i.e. resulted when self-employment income is greater than self-employment expenses. Self-employment loss is self-employment income minus self-employment expenses i.e. resulted when self-employment income is less than self-employment expenses. 8.) How is Self-employed income reported?
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Self-employed income is reported separately from wages, salaries, and tip income. For a business owned by just one person, self-employment income and expenses are reported on Schedule C-Profit or Loss from Business. Some businesses can use Schedule C-EZ, which is a simplified way to report selfemployment profit. 9.) What are Self-employment expenses? Self-employment expenses may include: advertising car and truck expenses commissions paid insurance interest legal and professional services office expenses rent or lease expenses repairs and maintenance supplies taxes business travel business meals and entertainment Utilities, including telephone expenses. depreciation on assets and vehicles Part-II: Self-Employment Tax 10.) What do you mean by Self-employment Tax? The self-employment tax is similar to the social security tax and Medicare tax for employees. The self-employment tax is calculated on Schedule SE Self-Employment Tax. 11.) What is the tax rate applicable for self employed? The self-employment tax is paid on self-employment profit. The self-employment tax rate is 15.3 percent of net earnings from self-employment. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). Taxpayers pay self-employment tax on 92.35 percent of their self-employment profit up to net earnings of $90,000. The self-employment tax increases the total tax on Form 1040. One-half of the self-employment tax decreases the income that is subject to income tax.
12.) Who must pay Self employment tax? The Taxpayer must pay SE tax and file Schedule SE (Form 1040) if either of the following applies:
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His net earnings from self-employment (excluding church employee income) were $400 or more. He had church employee income of $108.28 or more.
13.) If the Taxpayer has run a small business in the past, but this year there is no income or expenses, is it necessary to file a Schedule C? If the Taxpayers sole proprietorship business is inactive during the full year, it is not necessary to file Schedule C for that year. 14.) The Taxpayer received a Form 1099-MISC instead of a Form W-2. He is not selfemployed; He does not have a business. How does he report this income? If payment for services he provided is listed in box 7 of Form 1099-MISC, he is being treated as a self-employed worker, also referred to as an independent contractor. He does not necessarily have to "have a business," but simply perform services as a non employee to have his compensation treated this way. The payer has determined that an employer-employee relationship does not exist in his case. Thus, report it as self-employment income in his tax return.
15.) The Taxpayer is self-employed. How does he report his income and how does he pay Medicare and social security taxes? As a self-employed person, he pays his Medicare and social security taxes the same way he pays his income taxes. If he expects to owe less than $1,000 in total taxes, he can pay them when he files his income tax return. If he expects to owe $1,000 or more in total taxes, he will need to make estimated tax payments.
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CHAPTER 17: INTEREST INCOME

Interest Income (Form 1099-INT) 1. What is taxable interest?
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Taxable interest includes interest which the taxpayer received from bank accounts, loans which he makes to others and other sources. 2. What are the common sources of Taxpayer? A. Dividends that are actually interest: Certain distributions commonly called dividends are actually interest. The Taxpayer must report as interest so-called dividends even if he receives dividends on deposits or on share accounts in: Cooperative banks, Credit unions, Domestic building and loan associations, Domestic savings and loan associations, Federal savings and loan associations, and Mutual savings banks. B. Money market funds: Amounts received from money market funds should be reported as dividends, not as interest. C. Certificates of deposit and other deferred interest accounts: If the Taxpayer opens any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. He generally must include this interest in his income when he actually receives it or are entitled to receive it without paying a substantial penalty. Note: 1. If the Taxpayer withdraws funds from a deferred interest account before maturity, he may have to pay a penalty. He must report the total amount of interest paid or credited to his account during the year, without subtracting the penalty. 2. The interest he pays on money borrowed from a bank or savings institution to invest in certificate of deposit and the interest he earns on the certificate are two separate items. a. The Taxpayer must report the total interest he earns on the certificate of deposit in his income. b. If the taxpayer itemizes deductions, he can deduct the interest he pays as investment interest, up to the amount of his net investment income. D. Gift for opening account: If the Taxpayer receives non-cash gifts or services for making deposits or for opening an account in a savings institution, he may have to report the value as interest. For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest.
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E. U.S. obligations: Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is subject to federal income tax, but is exempt from all state and local income taxes. The Taxpayer should receive Form 1099-INT showing the amount of interest in box (3) that was paid to him for the year. The difference between the discounted price he pays for the bills and the face value he receives at maturity is interest income. Generally, he reports this interest income when the bill is paid at maturity.
F. Interest on tax refunds: Interest he receives on tax refunds is taxable income. G. U.S. Savings Bonds: It explains how to report the interest income on these bonds and how to treat transfers of these bonds. Accrual method taxpayers: If the taxpayer uses an accrual method of accounting, he must report interest on U.S. savings bonds each year as it accrues. He cannot postpone reporting interest until he receives it or until the bonds mature. Cash method taxpayers: If the taxpayer uses the cash method of accounting, he should report the interest on U.S. savings bonds when he receives it.
3. Which form is used to report Interest income? Interest income is generally reported to the taxpayer on Form 1099-INT, or a similar statement, by banks, savings and loans, and other payers of interest. This form shows the taxpayer the interest he received during the year. He does not have to attach it to his tax return. Report on his tax return the total amount of interest income that he receives for the tax year. Even if the taxpayer does not receive Form 1099-INT, he must still report all of his taxable interest income. If someone receives interest as a nominee for the taxpayer, that person will give the taxpayer a Form 1099-INT showing the interest received on his behalf. 4. What if taxpayer received incorrect income? If the taxpayer receives a Form 1099-INT that shows an incorrect amount (or other incorrect information), he should ask the issuer for a corrected form. The new Form 1099-INT he receives will be marked Corrected. 5. How about exempt-interest dividends? Exempt-interest dividends are not shown on Form 1099- INT or Form 1099- DIV as they are not included in the taxpayers taxable income. For exempt-interest dividends received from a regulated investment company (mutual fund) the taxpayer will receive a notice from the mutual fund stating the amount of exempt-interest dividends that he received. 6. What about interest received on IRAs? Interest on a Roth IRA generally is not taxable. Interest on a Traditional IRA is tax deferred. The taxpayer generally does not include it in his income until he makes withdrawals from the IRA.
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7. When to report interest income? Reporting of interest income depends on whether the taxpayer uses the cash method or an accrual method of accounting. Cash method. If the taxpayer uses this method, he should report his interest income in the year in which he has actually or constructively received it. Note: The taxpayer constructively receives income when it is credited to his account or made available to him. He does not need to have physical possession of it. Accrual method. If the taxpayer uses an accrual method, he should report his interest income when he earns it, whether or not he has received it.
8. How to report interest income? If the taxpayer uses Form 1040, then report interest income on Line 8a If the taxpayer uses Form 1040A, then report interest income on Line 8a If the taxpayer uses Form 1040EZ, then report interest income on Line 2 Note: The taxpayer cannot use Form 1040EZ if his interest income is more than $1,500. Instead, he must use Form 1040A or Form 1040. 9. What is backup withholding? When the taxpayer opens a new account, makes an investment, or begins to receive payments reported on Form 1099, the bank or other business will give him Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form to fill in his TIN. The taxpayer must show his TIN in the form and, if his account or investment will earn interest or dividends, he also must certify (under penalties of perjury) that his TIN is correct and that he is not subject to backup withholding. Backup withholding may also be attracted if IRS has determined that he has under reported his interest or dividend income. Under backup withholding, the payer of interest must withhold, as income tax, 28% of the amount he is paid as interest. 10. How to report backup withholding? If backup withholding is deducted from the taxpayers interest income, the payer must give him a Form 1099-INT for the year that indicates the amount withheld. The Form 1099-INT will show any backup withholding as Federal income tax withheld.
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CHAPTER 18: DIVIDEND INCOME
INTRODUCTION: A cash payment financed by profits that is designated by a company's board of directors to be distributed among stockholders may be termed Dividend. A portion of the principal, or profits, divided among several owners of a thing may be termed Dividend. The term is usually applied to the division of the profits arising out of bank or other stocks; or to the division among the creditors, of the elects of an insolvent estate.
1. What is Dividend? Dividends are payments made by a company to its shareholders. When a company earns a profit, some of it is reinvested in the business and called retained earnings, and some of it can be paid to its shareholders as a dividend. The Board of Directors of a company decides if it will declare a dividend, how often it will declare it, and the dates associated with the dividend. Quarterly payment of dividends is very common, annually or semiannually are less common, and many companies don't pay dividends at all. Other companies from time to time will declare an extra or special dividend. Mutual funds sometimes declare a year-end dividend and maybe one or more other dividends. The frequency of these varies by country. In the United States dividends are usually declared quarterly by the board of directors. In other countries dividends are paid biannually, as an interim dividend shortly after the company announces its interim results and a final dividend typically following its annual general meeting. In other countries, the board of directors will propose the payment of a dividend to shareholders at the annual meeting who will then vote on the proposal.
2. How dividends are paid? Mostly dividends are paid in three forms: a) Cash b) Stock or scrip dividends c) Property or dividends in specie a) Cash (most common) are those paid out in form of "real cash". It is a form of investment interest/income and is taxable to the recipient in the year they are paid. It is the most common method of sharing corporate profits. b) Stock or Scrip dividends (common) are those paid out in form of additional stock shares of the issuing corporation, or other corporation (e.g., its subsidiary corporation). They are usually issued in proportion to shares owned (e.g., for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). This is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization. c) Property or dividends in specie (Latin for "in kind") (rare) are those paid out in form of assets from the issuing corporation, or other corporation (e.g., its subsidiary corporation). Property dividends are usually paid in the form of products or services provided by the corporation. When paying property dividends, the corporation will often use securities of
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other companies owned by the issuer. 3. What are different important dates regarding Dividends? Dividends must be declared or approved by a companys Board of Directors each time they are paid. There are four important dates to remember regarding dividends. I. Declaration date: The declaration date is the day the Board of Directors announces their intention to pay a dividend. On this day, the company creates a liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date. II. Date of record: Shareholders who properly registered their ownership on or before this date will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date. III. Ex dividend date: Is set by the exchange where the stock is traded, several days (usually two) before the date of record, so that all trades made on previous dates can be properly settled and the shareholder list on the date of record will accurately reflect the current owners. Purchasers buying before the ex-dividend date will receive the dividend. The stock is said to trade cum dividend on these dates. Purchasers buying on or after the ex-dividend date will not receive the dividend. The stock trades ex-dividend on these dates. IV. Payment date: The date when the dividend checks will actually be mailed to the shareholders of a company. 4. Is dividend income subject to backup withholding? The Taxpayers dividend income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the payer of dividends must withhold, as income tax, 28% of the amount he is paid. Backup withholding may also be required if the Internal Revenue Service (IRS) has determined that the taxpayer underreported his interest or dividend income.
5. What are the different kinds of distributions available? The most common kinds of distributions are: A. B. C. D. Ordinary dividends (Qn.6), Qualified dividends (Qn.7), Capital gain distributions (Qn.11), and Nondividend distributions (Qn.12)
6. Explain Ordinary Dividends. Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a corporation and are ordinary income to the taxpayer. This means they are not capital gains. The taxpayer can assume that any dividend he receives on common or preferred stock is an ordinary dividend unless the paying corporation tells him otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV he receives.
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7. Explain Qualified Dividends. Qualified dividends are the ordinary dividends that are subject to the same 5% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV the taxpayer receives. Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 5% rate.
To qualify for the 5% or 15% maximum rate, all of the following requirements must be met: a. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. b. The dividends are not of the type listed later under Dividends that are not qualified dividends. c. The Taxpayer meets the holding period. 8. What are the dividends that are not qualified dividends? The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV. Capital gain distributions. Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions. (Report these amounts as interest income.) Dividends from a corporation that is a tax-exempt organization or farmers cooperative during the corporations tax year in which the dividends were paid or during the corporations previous tax year. Dividends paid by a corporation on employer securities which are held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation. Dividends on any share of stock to the extent that the taxpayer is obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property. Payments in lieu of dividends, but only if the taxpayer knows or has reason to know that the payments are not qualified dividends. Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent the taxpayer knows or has reason to know the payments are not qualified dividends.
9. What is holding period? The taxpayer must have held the stock for more than 60 days during the 121-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 he disposed the stock, but not the day he acquired it.
10. What is Preferred stock? Preferred stock is the stock that the taxpayer has held for more than 90 days during the 181day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the previous question applies.
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11. What are Capital Gain Distributions? Capital gain distributions (also called capital gain dividends) are paid to the taxpayer or credited to his account by regulated investment companies (commonly called mutual funds) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV the taxpayer receives from the mutual fund or REIT. Report capital gain distributions as long-term capital gains, regardless of how long the taxpayer owned his shares in the mutual fund or REIT.
12. What are Nondividend Distributions? A nondividend distribution is a distribution that is not paid out of the earnings and profits of a corporation. A Nondividend distribution reduces the basis of the taxpayers stock. It is not taxed until his basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of his investment in the stock of the company. The taxpayer should receive a Form 1099-DIV or other statement from the corporation showing him the non-dividend distribution. On Form 1099-DIV, a nondividend distribution will be shown in box 3. If the taxpayer does not receive such a statement, he reports the distribution as an ordinary dividend.
13. How to report dividend income? Generally, the taxpayer can use either Form 1040 or Form 1040A to report his dividend income as under: Total Ordinary Dividends are reported on line 9a of Form 1040 or Form 1040A. Total Qualified Dividends are reported on line 9b of Form 1040. If the taxpayer receives Capital Gain Distributions, he may be able to use Form 1040A or he may have to use Form 1040. If the taxpayer receives Non-dividend Distributions required to be reported as capital gains, he must use Form 1040. NOTE: The taxpayer cannot use Form 1040EZ if he receives any dividend income.
14. Which Form is used to report dividend income? If the taxpayer owned stock on which he received $10 or more in dividends and other distributions, he should receive a Form 1099-DIV. Even if the taxpayer does not receive Form 1099-DIV, he must still report all of his taxable dividend income. For example, the taxpayer may receive distributive shares of dividends from partnerships or S corporations. These dividends are reported to him on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S).
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CHAPTER 19: SALE OF HOUSE PROPERTY
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1. Sale of Main Home If the taxpayer sells his residence then he may be able to exclude from income any gain up to a limit of $250,000 ($500,000 on a joint return in most cases). To exclude the gain from the income, the Tax Payer has to satisfy the following conditions. 1. Ownership Test ( The home should be owned by the Tax Payer at least for 2 years), and 2. Use Test ( The Tax Payer should have lived in the home as his main home at least for 2 years) Period of Ownership and Use The required 2 years of ownership and use during the 5-year period ending on the date of the sale do not have to be continuous. The taxpayer meets the tests if he can show that he owned and lived in the property as his main home for either 24 full months or 730 days (365 2) during the 5-year period ending on the date of sale. Temporary absence: Short temporary absences for vacations or other seasonal absences, even if he rents out the property during the absences, are counted as periods of use. Example 1: David Johnson, who is single, bought and moved into his home on February 1, 2005. Each year during 2006 and 2007, David left his home for a 2-month summer vacation. David sold the house on March 1, 2010. Although the total time David used his home is less than 2 years (21 months), he may exclude any gain up to $250,000. The 2-month vacations are short temporary absences and are counted as periods of use in determining whether David used the home for the required 2 years. Example 2: Professor Paul Beard, who is single, bought and moved into a house on August 28, 2006. He lived in it as his main home continuously until January 5, 2010, when he went abroad for a 1-year sabbatical leave. On February 6, 2009, 1 month after returning from the leave, Paul sold the house at a gain. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test. He cannot exclude any part of his gain, because he did not use the residence for the required 2 years. 2. Exceptions to the 2 out of 5 Year Rule: If the taxpayer lived in his home less than 24 months, he may be able to exclude a portion of the gain. Exceptions are allowed if he sold his house because the location of his job changed, because of health concerns, or for some other unforeseen circumstance. a) Change in the Location of his Job If the taxpayer lived in his house for less than two years, he can exclude a part of his gain on the sale of his house if his work location has changed. This exception would apply if he started a new job, or if he is moved to a new location with his employer.
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b) Health Concerns If the taxpayer is selling his house for medical or health reasons, he needs to document those reasons with a letter from his physician. Such a letter does not need to be filed with his tax return. Instead, keep the documentation in his personal records just in case the IRS wants further information. c) Unforeseen Circumstances If the taxpayer is selling his house because of unforeseen circumstances, he needs to document what those reasons are. IRS Publication 523 defines an unforeseen circumstance as "the occurrence of an event that he could not reasonably have anticipated before buying and occupying his main home." The IRS has given specific examples of unforeseen circumstances: natural disasters, acts of war, acts of terrorism, change in employment or unemployment that left him unable to meet basic living expenses, death, divorce, separation, or Multiple births from the same pregnancy.
3. Partial Exclusion The taxpayer can exclude a portion of his gain if he is selling his home and lived there less than 2 years and he meets one of the three exceptions. He calculates his partial exclusion based on the amount of time he actually lived in his home. Count the number of months he actually lived in his home. Then divide that number by 24. Then multiply this ratio by $250,000 (if unmarried) or by $500,000 (if married). The result is the amount of gain he can exclude from his taxable income. For example: The taxpayer lived in his home for 12 months, and then sold the home because his employer asked him to relocate to a different office. He is an unmarried person. He calculates his partial exclusion: 12 months divided by 24 months (for a ratio of .50) times his maximum exclusion of $250,000. The result: he can exclude up to $125,000 in gain. If his gain is more than $125,000, he includes only the amount over $125,000 as taxable income. If his gain is less than $125,000, then his gain can be excluded from his taxable income. 4. Reporting the Gain on the Sale of Home Gain on the sale of home is reported on Schedule D as a capital gain. If the taxpayer owned his home for one year or less, the gain is reported as a short-term capital gain. If he owned his home for more than one year, the gain is reported as a long-term capital gain. Loss on the Sale of a Home The taxpayer cannot deduct a loss from the sale of his main home 5. Calculating Cost Basis and Capital Gain Just like calculating capital gains, the formula for calculating the gain or loss involves subtracting the cost basis from the selling price. The formula for calculating cost basis on the main home is as follows:
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Purchase price + Purchase costs (title & escrow fees, real estate agent commissions, etc.) + Improvements (replacing the roof, new furnace, etc.) + Selling costs (title & escrow fees, real estate agent commissions, etc.) - Accumulated depreciation (for example, if the taxpayer ever took the office in the home deduction) = Cost Basis
And then calculating the profit or loss would be: Selling price - Cost Basis = Gain or Loss
If the resulting number is positive, the taxpayer made a profit when he sold his home. If the resulting number is negative, he incurred a loss. Finally, calculate the taxable gain: Gain - Maximum or Partial Exclusion = Taxable Gain
Limit on itemized deductions: Certain itemized deductions (including taxes and home mortgage interest) are limited if the adjusted gross income is more than $150,500 ($75,250 if the filing status is married filing separately). FIRST TIME HOME OWNERS 1. What Can and cannot be Deducted? 1. To deduct expenses of owning a home, the taxpayer must file Form 1040 and itemize his deductions on Schedule A (Form 1040) 2. If the Taxpayer took out a mortgage (loan) to finance the purchase of his home, he probably has to make monthly house payments. His house payment may include several costs of owning a home. The only costs he can deduct are real estate taxes actually paid to the taxing authority and Interest that qualifies as home mortgage interest. Here are some expenses, which may be included in his house payment that cannot be deducted. Fire or homeowner's insurance premiums. FHA or other mortgage insurance premiums. The amount applied to reduce the principal of the mortgage.
2. Real Estate Taxes: Enter the amount of his deductible real estate taxes on Schedule A (Form 1040), line 6. Taxpayer can deduct real estate taxes imposed on him. He must have paid them either at settlement or closing or to a taxing authority (either directly or through an escrow account) during the year.
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Real estate taxes are generally divided so that taxpayer and the seller each pay taxes for the part of the property tax year he owned the home. His share of these taxes is fully deductible, if he itemizes his deductions.
Items that cannot be deducted as Real Estate Taxes The following items are not deductible as real estate taxes. 1. Charges for services: An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. Taxpayer cannot deduct the charge as a real estate tax if it is: A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water he uses), A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or A flat fee charged for a single service provided by the local government (such as a $30 charge for mowing the lawn because it had grown higher than permitted under a local ordinance).
2. Assessments for local benefits: The taxpayer cannot deduct amounts he pays for local benefits that tend to increase the value of his property. Local benefits include the construction of streets, sidewalks, or water and sewer systems. He must add these amounts to the basis of his property. He can, however, deduct assessments (or taxes) for local benefits if they are for maintenance, repair, or interest charges related to those benefits. An example is a charge to repair an existing sidewalk and any interest included in that charge. If only a part of the assessment is for maintenance, repair, or interest charges, he must be able to show the amount of that part to claim the deduction. If he cannot show what part of the assessment is for maintenance, repair, or interest charges, he cannot deduct any of it. 3. Transfer taxes (or stamp taxes): Taxpayer cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home. If he is the buyer and he pays them, include them in the cost basis of the property. If he is the seller and he pays them, they are expenses of the sale and reduce the amount realized on the sale. 4. Homeowners association assessments: Taxpayer cannot deduct these assessments because the homeowners association, rather than a state or local government, imposes them. 3. Sales Taxes Generally, Taxpayer can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). Deductible sales taxes may include sales taxes paid on his home (including mobile and prefabricated), or home building materials if the tax rate was the same as the general sales tax rate. 4. Home Mortgage Interest Usually, Taxpayer can deduct the entire part of his payment that is for mortgage interest, if he
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itemizes his deductions on Schedule A (Form 1040). However, his deduction may be limited if: His total mortgage balance is more than $1 million ($500,000 if married filing separately), or He took out a mortgage for reasons other than to buy, build, or improve his home.
Refund of home mortgage interest. If Taxpayer receives a refund of home mortgage interest that he deducted in an earlier year and that reduced his tax, he generally must include the refund in income in the year he receives it. Deductible Mortgage Interest Prepaid interest. If taxpayer pays interest in advance for a period that goes beyond the end of the tax year, he must spread this interest over the tax years to which it applies. He can deduct in each year only the interest that qualifies as home mortgage interest for that year. Late payment charge on mortgage payment. He can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with his mortgage loan. Mortgage prepayment penalty. If he pays off his home mortgage early, he may have to pay a penalty. He can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with his mortgage loan. Ground rent. In some states (such as Maryland), he may buy his home subject to a ground rent. A ground rent is an obligation he assumes to pay a fixed amount per year on the property. Under this arrangement, he is leasing (rather than buying) the land on which his home is located.
Redeemable ground rents. If the taxpayer makes annual or periodic rental payments on a redeemable ground rent, he can deduct the payments as mortgage interest. The ground rent is a redeemable ground rent only if all of the following are true. His lease, including renewal periods, is for more than 15 years. He can freely assign the lease. He has a present or future right (under state or local law) to end the lease and buy the lessor's entire interest in the land by paying a specified amount. The lessor's interest in the land is primarily a security interest to protect the rental payments to which he or she is entitled.
Payments made to end the lease and buy the lessor's entire interest in the land are not redeemable ground rents. He cannot deduct them. Non-redeemable ground rents: Payments on non-redeemable ground rents are not mortgage interest. He can deduct them as rent only if they are a business expense or if they are for rental property. Refund of cooperative's mortgage interest: The taxpayer must reduce his mortgage interest deduction by his share of any cash portion of a patronage dividend that the cooperative receives. The patronage dividend is a partial refund to the cooperative housing corporation of mortgage interest it paid in a prior year. If he receives a Form 1098 from the cooperative housing corporation, the form should show only the amount he can deduct.
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Points The term points is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points also may be called loan origination fees, maximum loan charges, loan discount, or discount points. Note. If taxpayer meets all of the tests listed below and he itemizes his deductions in the year he gets the loan, he can either deduct the full amount of points in the year paid or deduct them over the life of the loan, beginning in the year he gets the loan. If he does not itemize his deductions in the year he gets the loan, he can spread the points over the life of the loan and deduct the appropriate amount in each future year, if any, when he does itemize his deductions. 5. Mortgage Interest Credit The mortgage interest credit is intended to help lower-income individuals afford home ownership. If the taxpayer qualifies, he can claim the credit each year for part of the home mortgage interest he pays. Who qualifies? Taxpayer may be eligible for the credit if he was issued a mortgage credit certificate (MCC) from his state or local government. Generally, an MCC is issued only in connection with a new mortgage for the purchase of his main home. Where to Deduct Interest and Taxes Paid on Home IF the taxpayer is eligible to deduct . . . real estate taxes home mortgage interest and points reported on Form 1098 home mortgage interest not reported on Form 1098 points not reported on Form 1098 How to claim the credit? To claim the credit, complete Form 8396 and attach it to the taxpayers Form 1040. Include the credit in his total for Form 1040, line 54 Mortgage not more than certified indebtedness: If mortgage loan amount is equal to (or smaller than) the certified indebtedness amount shown on his MCC, enter on Form 8396, line 1, all the interest paid on his mortgage during the year. Mortgage more than certified indebtedness: If mortgage loan amount is larger than the certified indebtedness amount shown on MCC, the taxpayer can figure the credit on only part of the interest he paid. To find the amount to enter on line 1, multiply the total interest he paid during the year on his mortgage by the following fraction. THEN report the amount on Schedule A (Form 1040) . . . Line 6. Line 10. Line 11. Line 12.
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Certified Indebtedness amount on MCC ------------------------------------------------------Original amount of Mortgage The fraction will not change as long as the taxpayer is entitled to take the mortgage interest credit. Limits: Two limits may apply to the credit. A limit based on the credit rate, and A limit based on his tax.
Limit based on credit rate. If the certificate credit rate is higher than 20%, the credit the taxpayer is allowed cannot be more than $2,000. Limit based on tax. The credit (after applying the limit based on the credit rate) generally cannot be more than his regular tax liability on Form 1040, line 44, plus any alternative minimum tax on Form 1040, line 45, minus certain other credits. Use Form 8396 to figure this limit. Dividing the Credit If two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person. Effect of Refinancing on the Credit IF the taxpayer gets a new (reissued) MCC and the amount THEN the interest he claim on Form 8396, line 1, is* ... of his new mortgage is ... smaller than or equal to the certified indebtedness amount on All the interest paid during the year on the new mortgage. the new MCC Interest paid during the year on his new mortgage multiplied by the following fraction. Certified Indebtedness amount on MCC ------------------------------------------------------Original amount of Mortgage
larger than the certified indebtedness amount on the new MCC
*The credit using the new MCC cannot be more than the credit using the old MCC. Basis Basis is the starting point for figuring a gain or loss if the taxpayer later sells his home, or for figuring depreciation if he later uses part of his home for business purposes or for rent.
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While he owns his home, he may add certain items to his basis. He may subtract certain other items from his basis. These items are called adjustments to basis If the taxpayer elects to deduct the sales taxes on the purchase or construction of his home as an itemized deduction on Schedule A (Form 1040), he cannot include the sales taxes as part of his cost basis in the home. Purchase: The basis of a home he bought is the amount he paid for it. This usually includes his down payment and any debt he assumed Construction: If the taxpayer contracted to have his home built on land that he owns, his basis in the home is his basis in the land plus the amount he paid to have the home built. This includes the cost of labor and materials, the amount he paid the contractor, any architect's fees, building permit charges, utility meter and connection charges, and legal fees that are directly connected with building his home. If he built all or part of his home himself, his basis is the total amount it cost him to build it. He cannot include the value of his own labor or any other labor for which he did not pay. Adjusted Basis: This table lists examples of some items that generally will increase or decrease the basis in the home. It is not intended to be all-inclusive. Increases to Basis Improvements: Putting an addition on home Replacing an entire roof Paving driveway Installing central air conditioning Rewiring the home Decreases to Basis
Assessments for local improvements (see Assessments for local benefits, under What Can and Cannot be Deducted)
Insurance or other reimbursement for casualty losses Deductible casualty loss not covered by insurance Payments received for easement or right-of-way granted Depreciation allowed or allowable if home is used for business or rental purposes Value of subsidy for energy conservation measure excluded from income.
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CHAPTER 20: FORM 1099-G

1. When should Form 1099-G be filed?
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Form 1099-G: Certain Government Payments should be filed, if as a unit of a federal, state, or local government, the taxpayer made payments of: Unemployment compensation; State or local income tax refunds, credits, or offsets; Alternative trade adjustment assistance (ATAA) payments; Taxable grants; or Agricultural payments.
The officer or employee of the government unit having control of the payments (or the designated officer or employee) must file Form 1099-G. 2. What are the main constituents of Form 1099-G? The main constituents of Form 1099-G are as follows: Unemployment compensation. State or Local Income Tax Refunds. Taxable Grants. ATAA Payments. Agricultural Payments.
3. What is Unemployment Compensation? Unemployment compensation for U.S. workers was established by the federal Social Security Act of 1935. Unemployment compensation is provided: For workers who have lost their job through no fault of their own with monetary payments for a given period of time, or Until they find a new job.
This compensation is designed to give an unemployed worker time to find a new job equivalent to the one lost without major financial distress. 4. How to disclose the unemployment compensation in Form 1099-G? Enter payments of $10 or more in unemployment compensation including Railroad Retirement Board payments for unemployment. Enter the total amount before any income tax was withheld. If the taxpayer withheld federal income tax at the request of the recipient, enter it in box 4. 5. Are State Tax Refunds taxable? If the taxpayer itemized tax deductions on his tax return for 2010 or a prior tax year and deducted state tax or local tax paid in that year, and received a tax refund of some or all of the state tax or local tax in 2010, he should include the tax refund as taxable income on his 2010 tax return. This is reported in Box-2 of the Form 1099-G of that tax year.
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6. Where is voluntary withholding of Federal Income Tax Withheld reported? Enter in Box-4, any voluntary federal withholding on unemployment compensation, Commodity Credit Corporation loans, and certain crop disaster payments. Note: The taxpayer is not required to report state withholding to the IRS. 7. What are ATAA payments and how are they treated? Payments of $600 or more that the taxpayer paid to eligible individuals under the Demonstration Project for Alternative Trade Adjustment Assistance for Older Workers. It is reported in Box-5 of Form 1099-G. 8. What is a Taxable Grant and where is it reported? Any amount administered by a federal, state, or local program to provide subsidized energy financing or grants for projects may be termed a Grant. They must have been designed to conserve or produce energy, but only with respect to energy property or a dwelling unit located in the United States. Also, enter any amount of a taxable grant administered by an Indian tribal government. Taxable Grants > $600 must be reported in Box-6.
9. How are the agricultural payments dealt with? Enter agricultural subsidy payments made during the year in Box-7. If the taxpayer is a nominee who received subsidy payments for another person, file Form 1099-G. 10. Does Backup Withholding apply to Form 1099-G too? Yes. Backup withholding at a 28% rate on payments apply to Form 1099-G too. For example, if a recipient does not furnish its/his/her taxpayer identification number (TIN) to the payer, the later must backup withhold.
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CHAPTER 23: PARTNERSHIP INCOME
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1.) How to define Partnership? An unincorporated organization with two or more members who carry on a trade, business, financial operation, or venture and divide its profits is called partnership for federal tax purposes. A joint undertaking merely to share expenses is not a partnership. There can also be family partnerships subject to compliance of required conditions.
2.) Does any special rule apply for the Organizations formed after 1996? An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following: An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. An insurance company. Certain banks. An organization wholly owned by a state or local government. An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). A tax-exempt organization. A real estate investment trust. Any other organization that elects to be classified as a corporation by filing Form 8832.
3.) Is Partnership a Taxable entity? A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items. 4.) What are the contents and purpose of Form 1065? Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. The partnership return must show the names and addresses of each partner and each partners distributive share of taxable income. The return must be signed by a general partner.
5.) When is a Partnership not required to file Form 1065? A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes.
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6.) How is individual partners share of income and deductions reported in Form 1065? A partnership itself generally does not pay income tax to the IRS. A partnership files an annual information tax return with the IRS, Form 1065, stating all items of taxable income and tax deductions. Included is Schedule K-1 which details each partner's share of taxable income and tax deductions. If the taxpayer is a member of a partnership that carries on a trade or business, his distributive share of partnership income or loss is taxable to him on his tax return.
7.) How to report the contents of Schedule K-1 in individual income tax return? Report the partnership income (as indicated on Schedule K-1 of Form 1065) on Form 1040. The net earnings from self employment are shown on Schedule K-1 of Form 1065. Figure the self employment tax on Schedule SE.
Note: Do not attach Form 1065 or it's Schedule K-1 to any personal tax return filed. 8.) When to file a Partnership return? A domestic partnership must file Form 1065 by the 15th day of the 4th month following the date its tax year ended as shown at the top of Form 1065. Example: If the tax year of a domestic partnership ended on 12/31/2010, then it must file its Form 1065 by 04/15/2011. For partnerships that keep their records and books of account outside the United States th and Puerto Rico, an extension of time to file and pay is granted to the 15th day of the 6 month following the close of the tax year. Example: If the tax year of a domestic partnership ended on 12/31/2010, then it must file its Form 1065 by 06/15/2011. Do not file Form 7004 if the partnership is taking this 2-month extension of time to file and pay. If the partnership is unable to file its return within the 2-month period, use Form 7004 to request an additional 4-month extension. Example: If the tax year of a domestic partnership ended on 12/31/2010, and has sought 2-months extension to file its Form 1065 by 04/15/2011, but has failed to do so for any reason, then it must file its Form 1065 by 10/15/2011. If the due date falls on a Saturday, Sunday, or legal holiday, file by the next business day.
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CHAPTER 24: S-CORPORATION INCOME

1.) Define an S-Corporation?
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It is a form of corporation, allowed by the IRS for most companies with 100 or fewer shareholders, which enables the company to enjoy the benefits of incorporation but be taxed as if it were a partnership, is called S Corporation. S-Corporations must meet specific eligibility criteria, and they must notify the IRS of their choice to be taxed as an S-Corporation within a certain period of time. 2.) What are the requirements to be met by a Corporation to be treated as an S-Corporation? In order to qualify as an S-Corporation the requirements to be met are: Must be an eligible entity (a domestic corporation, a partnership or a single- member or multiple members limited Liability Company). Must not have more than 100 shareholders. Shareholders must be U.S. citizens or residents, and must be natural persons, so corporate shareholders must be excluded. Must have only one class of stock. Profits and losses must be allocated to shareholders proportionately to each ones interest in the business. Each shareholder consents to the S-Corporation election. An S corporation election must be made with the IRS by the 15th day of the third month of the tax year, to which the election is to apply by filing IRS Form 2553 - Election by a Small Business Corporation. All shareholders must sign this form. Once the election is made, it continues until either the corporation is no longer eligible or the corporation elects to revoke such election by shareholders holding a majority of shares outstanding on the date of revocation. 3.) Is S-Corporation subject to tax? An S-Corporation is not subject to corporate tax rates. According to the Internal Revenue Service, an S-Corporation is exempt from federal income tax other than tax on certain capital gains and passive income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share. 4.) What are the filing requirements to be complied by an S-Corporation? An S corporation must file a return on Form 1120S. U.S. Income Tax Return for an S Corporation, and send Schedule K-1 (Form 1120S) to each shareholder. Please note that Schedule K-1 (Form 1120S) is for the shareholders own records, it should not be attached to the shareholders Form 1040(US Individual Tax Return). 5.) When and why is Schedule K-1 prepared? Once the S-Corporation's Form 1120S is prepared, then the process of preparing Schedule K-1 for each shareholder begins. Schedule K-1 of Form 1120S is used to report each shareholder's pro-rated share of net income or loss from an S-Corporation, along with various separately stated income and deduction items. Schedule K-1 can also be used to summarize a shareholder's beginning and ending stock basis for the year.
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6.) What is the deadline for S-Corporations to issue Schedule K-1 to its shareholders? S-Corporations are required to issue a Schedule K-1 to shareholders by March 15th (the deadline for Form 1120S), or by the extended deadline (September 15th). 7.) What is the deadline for filing Form 1120S? The deadline for filing Form 1120S is March 15th, or the 15th day of the third month following the end of the corporation's tax year. The corporation can request an automatic 6month extension using IRS Form 7004. The extended deadline for corporate returns is September 15th. 8.) What are the benefits that can be availed by filing as an S-Corporation when compared to that of a Partnership, Sole-proprietorship, or a C Corporation? The benefits an S-Corporation could avail are as follows: S-Corporation losses can be used as Tax Savings on the shareholders personal income tax returns. S-Corporation is not taxed on the S-Corporation profits by the Federal government. It enables for the Pay-roll tax savings. Schedule K1 - Shareholder's Share of Income, Deductions, Credits, etc. Generally, there is no tax at the corporation level (subject to certain exceptions); all earnings are passed through to shareholders. Shareholders in an S Corporation must include on their personal income tax return, their distributive share of each separate pass-thru item. Shareholders are taxed on these items, regardless of whether or not the items have been distributed (withdrawn) to them during the year. Please note that even though Form1040 is based on Cash Method of Accounting for an individual, the Tax System here is recommending to adopt Accrual system. Each shareholder of a corporation gets a Schedule K-1. Pass-through of income and/or loss (to shareholder/K-1) Net income or loss is passed-through to shareholders as follows: 1) S corporations report both separately and non-separately stated items of income and/or loss. Separately stated income items include dividends, interest, capital gains and losses, Section 1231 gains and losses (IRS Pub 544). Separately stated deductions include charitable contributions, Section 179 expenses etc. 2) Allocations to shareholders are made on a per-share, per-day basis. 3) Losses are limited to a shareholders adjusted basis in S corporation stock plus direct shareholder loans to the corporation. Shareholder guarantees do not increase basis. Any losses disallowed may be carried forward indefinitely and will be deductible as the shareholders basis is increased. 4) The following S corporation items flow through to the shareholder in a manner similar to a partnership (See Schedule K-1 for complete list): a) Ordinary income (not subject to FICA) b) Rental income/loss c) Portfolio income (including interest, dividends, royalties and all capital gains and losses) d) Tax-exempt interest e) Percentage depletion f) Foreign income tax g) Section 1231 gains and losses h) Charitable contributions i) Expense deduction for recovery property (Section 179 kind of Depreciation)
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Part II Income or Loss from Partnerships and S Corporations If you are preparing this schedule for a shareholder in an S corporation, use Part II to report his share of the S corporation income (even if not received) or loss. Shareholder should receive a Schedule K-1 from the S corporation. He should also receive a copy of the Shareholder's Instructions for Schedule K-1. His copy of Schedule K-1 and its instructions will tell you where on his return to report his share of the items. If he did not receive these instructions with his Schedule K-1, see the Instructions for Form 1040 or the Instructions for Form 1040NR for how to get a copy. Do not attach Schedules K-1 to the shareholders return. They should be retained by the shareholder for his own records. If you are treating items on the shareholders tax return differently from the way the S corporation reported them on its return, then Form 8082 has to be filed. Purpose of Schedule K1: The corporations use Schedule-K1 to report the shareholders share of corporations income (reduced by any tax the corporation paid on the income) deductions, credits etc. Filing of Schedule-K1 along with the tax return is not required as the corporation has filed a copy with IRS. Key Points to be considered while entering the contents of Schedule K-1 into the Form 1040 (US Individual Income Tax Return): Report income in the proper location on individual returns as instructed on Schedule K-1, page 2, and in the instructions. Avoid netting or combining income against separately stated losses or expenses. Refer to Form 8582, Passive Activity Loss Limitation, for instructions on properly deducting passive activity losses. Ordinary business income should be reported separately from other related deductions, such as un-reimbursed partnership expenses or Section 179 expenses. Refer to the Schedule E instructions for information on properly accounting for deductions related to Schedule K-1 income. Report deductible At Risk or Basis Limitation losses carried forward from prior years on a separate line from current year transactions. Do not combine (net) them with any current year amounts. Identify estimated K-1 income. When the Schedule K-1 has not been received at the time the Form 1040 is filed, the income should be estimated. Form 8082, Notice of Inconsistent Treatment or Amended Return, generally should be used to identify estimated K-1 income or when the investor disagrees with the amounts reported on the K-1.
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CHAPTER 25: INDIVIDUAL RETIREMENT ARRANGEMENTS
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PART I TRADITIONAL IRA 1. Define IRA An IRA (Individual Retirement Arrangement) is a personal savings plan that offers tax advantages to individuals who set aside money for retirement. An IRA can be set up with: most banks and similar saving institutions, mutual funds stock brokerage firms and insurance companies The primary advantages of IRA are: Deductibility of contributions Tax exemption of IRA earnings until they are distributed
Generally, an IRA is prohibited from investing in collectibles. However, an IRA may hold platinum coins as well as gold, silver, or platinum bullion. 2. What are the different kinds of IRAs? There are 5 kinds of IRAs: a. b. c. d. e. Individual Retirement Account Individual Retirement Annuity Employer and Employee Association Trust Accounts Simplified Employee Pension (SEP) Savings Incentive Match Plan for Employees (SIMPLE)
Pub.590 also lists Individual Retirement Bonds, but not Individual Savings Bonds, as a permitted IRA. 3. Who can set up an IRA? Any individual who receives taxable compensation during the tax year and is not 70 years of age by the end of the year may set up an IRA at anytime during the year. He/she may also set up a spousal IRA for a spouse provided a joint return is filed. An IRA must be fully vested at all times and no part of the trust funds can be used to purchase life insurance contracts. 4. When to make contributions? Once an IRA is set up, the contributions can be made each year in which they are qualified. To qualify to make contributions, a taxpayer must not have attained 70 years of age during the tax year and must have received taxable compensation. However, contributions need not be made every year. Contributions must be made by the
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due date of the return (not including extensions). 5. What is taxable compensation? Compensation is defined as income earned from working. INCLUDES Wages, salaries, tips, bonuses Professional fees Commissions Any amount received for providing personal service e. Self-employment Income f. Partnership income of an active partner providing services to the partnership g. Alimony and separate maintenance payments h. Scholarships and Fellowships (only if shown in Box 1 of W2) a. b. c. d. 6. What is the maximum contribution to IRA? Whether Traditional IRA or Roth IRA, the maximum the taxpayer can contribute is the least of: a. Taxable compensation received, or b. $5000* *$6000 if individuals age is 50 years or more. Spousal IRA Limit: If a joint return is filed and a taxpayer makes less than his/her spouse, the taxpayer may still contribute the least of: a. The sum of his/her taxable compensation and the taxable compensation of spouse, reduced by the amount of his/her IRA deduction, or b. $5000 Note: The total combined contributions to an IRA and a spouses IRA can be as much as $ 8000 per year (plus an additional $ 500 for each spouse aged 50 years or more). If the taxpayer has more than one IRA, the limit applies to the total contributions made to the IRAs for the year. 7. What about Inherited IRAs? A person may deduct contributions made to an inherited IRA only if the IRA was inherited from a spouse. Contributions made to an IRA inherited from someone who died after December 31, 1983 and who was not a spouse are not deductible. When an IRA is inherited from a person other than a spouse, the IRA cannot be treated as owned by the taxpayer who inherited the IRA. In addition, the taxpayer cannot contribute more to the IRA or roll over the IRA into a Roth IRA. a. b. c. d. e. f. g. h. EXCLUDES Rental Income Interest Income Dividend Income Pension / Annuity Income Share of S-Corporation Income Foreign Earned Income Deferred Compensation Exempted Income
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8. Deductible Contributions: Generally, a deduction is allowed for contributions that are made to an IRA. a. If neither spouse was covered for any part of the year by an Employer Retirement Plan (ERP), the entire contribution may be deducted. b. If a taxpayer is not covered by an ERP at work but the taxpayers spouse is, then the taxpayer may still deduct the full amount of the contribution. However, the deduction is reduced if the MAGI on the joint return is $156000 but less than $166000. The deduction is not available if MAGI is more than $166000. c. If a taxpayer is covered by an ERP at work, the IRA deduction will be phased out or eliminated if the taxpayers MAGI is between specified income limits.
d. For an individual whose MAGI falls within one of the phase out ranges, the amount that must be reduced from IRA deduction is determined by the following equation: Modified AGI Applicable Minimum Phase out Amount X $4000 Maximum Phase out Amount Minimum Phase out Amount This amount is again subtracted from the maximum allowable deduction to arrive at the allowable deduction amount. Round it up to the next highest multiple of $10 to enter the allowable deduction amount. However, deduction cannot exceed the actual contribution made. 9. Deductible Contribution Limits: (A) Deduction if the taxpayer is covered by Retirement Plan at Work If the taxpayer is covered by a retirement plan at work, use this table to determine if his modified AGI affects the amount of his deduction. (2010) Filing Status Modified AGI (MAGI) Single $53,000 or less more than $52,000 but less than $62,000 or $63,000 or more head of household Married filing $85,000 or less jointly more than $85,000 but less than $105,000 $105,000 or more or qualifying widow(er) Married filing less than $10,000 separately* $10,000 or more Deduction FULL PARTIAL NIL
FULL PARTIAL NIL
PARTIAL NIL
* If the taxpayer did not live with his spouse at any time during the year, his filing status is considered Single for this purpose (therefore, his IRA deduction is determined under the Single column). Note: If he is not certain whether he was covered by his employers retirement plan, he
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should ask his employer. (B) Deduction if the taxpayer is Not Covered by Retirement Plan at Work If the taxpayer is not covered by a retirement plan at work, use this table to determine if his modified AGI affects the amount of his deduction. Filing Status Single or Head of household, or Qualifying widow(er) Married filing jointly or separately with a spouse who is not covered by a plan at work Modified AGI (MAGI) Deduction
Any Amount
Full
Any Amount
Full
$159,000 or less Married filing jointly with a spouse who is covered by a plan at work more than $159,000 but less than $169,000 $169000 or more Married filing separately with a spouse who is covered by a plan at work less than $10,000 $10,000 or more
Full Partial
Full Partial Nil
**The taxpayer is entitled to the full deduction even if he did not live with his spouse at any time during the year. 10. What are prohibited transactions with a Traditional IRA? A taxpayer may not engage in the following transactions with a Traditional IRA: a. Sell property to it, b. Buy property for the personal use, or c. Use it as security for a loan, 11. What are Nondeductible Contributions? The difference between the taxpayers Total Permitted Contributions and his IRA Deduction, if any, is his Nondeductible Contribution. To designate contributions as nondeductible, he must file Form 8606.
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He must file Form 8606 to report Nondeductible Contributions even if he does not file a tax return for the year.
12. Where to report deductible contributions? If the taxpayer files Form 1040, enter his IRA deduction on Line 32. If he files Form 1040A, enter his IRA deduction on Line 17. He cannot deduct IRA contributions on Form 1040EZ. Part II Rollovers 13. What about Rollovers? Generally, a rollover is a tax-free distribution of cash or other assets from one retirement plan to another retirement plan. A rollover must be from one qualified plan to another qualified plan. If the taxpayer does not make a direct transfer of assets from one retirement plan to another, but instead withdraws assets from the plan, the taxpayer must deposit the assets into another qualified plan within 60 days of the withdrawal in order to avoid taxes and penalties. A rollover cannot be deducted.
14. What are not Qualified Distributions for the purpose of Rollover? The following are the distributions that are not qualified distributions: a. b. c. d. e. f. g. h. Required minimum distributions Hardship distributions Any series of substantially periodic distributions Corrective distributions due to excess contributions A loan treated as a distribution Dividends on employee securities Cost of life insurance coverage Distribution to the plan participants beneficiary
15. What if only part of IRA is rolled over? If a taxpayer withdraws assets from an IRA, rolls over tax-free part of it, and keeps the rest, a gain must be recognized, and he/she may be subject to 10% tax on premature distributions. 16. What if Inherited IRAs? If an individual inherits a Traditional IRA from anyone (other than a deceased spouse) and makes direct contributions, the person is not permitted to treat the inherited IRA as his or her own IRA. The inherited IRA will generally not be subject to tax until distributions are received on the IRA assets. When transferring an IRA account to a spouse, taxes and penalties may be avoided by: a. Changing the name on the IRA account or b. Transferring the IRA assets into another qualified plan.
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Part III Penalties 17. What if Excess Contributions made? Generally, an excess contribution is the amount contributed to an IRA that is more than the least of: a. Compensation received, or b. $5000 ($6000 for a taxpayer 50 years of age or more) An excess contribution could be on account of: a. Taxpayers contribution, b. Spouses contribution, c. Employers contribution, or d. An Improper Rollover Contribution A 6% excise tax is imposed each year on excess amounts that remain in an IRA at the end of the each tax year. 18. How to avoid 6% excise tax on excess contributions? The 6% excise tax can be avoided if the excess contribution and the interests earned on it are withdrawn before the due date (including extensions) of the tax return. The interest earned on the excess contributions qualifies as a premature distribution and is subject to an additional tax of 10% on that distribution. 19. Can excess contributions made in previous year be treated as current year contributions? Yes. The taxpayer may treat the unused/excess contributions from a previous year as having been made in the current year restricted to the extent of maximum contribution limit. 20. What are Premature Distributions? Premature distributions are amounts withdrawn from an IRA or Annuity before a taxpayer reaches 59 years of age. These distributions are subject to an additional tax @ 10% on the premature distributions that must be included in gross income. This additional tax is in addition to any regular income tax that is due. 21. When does 10% additional tax does not apply? The following are the exceptions where the 10% additional tax does not apply to IRA distributions even if they are made before a taxpayer reaches 59 years of age: a. b. c. d. Death Disability Annuity payments based on life expectancy Distributions made to an employee after he/she separates from service after attaining 55 years of age e. Medical expenses in excess of 7.5% of AGI f. Qualified Higher Education Expenses g. Qualified First-time Homebuyer Distribution h. Unemployed Health Insurance Premium i. Payments made under a Qualified Domestic Relations Order
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22. What if taxpayer borrows money against an IRA? If a taxpayer borrows money against an IRA, the FMV of the IRA as on the first day of the tax year must be included in the gross income. The taxpayer may also be subject to 10% penalty tax. 23. What if Excess Accumulations? Generally, a taxpayer must begin receiving distributions by April 1 of the year following the year in which he/she reaches 70 years of age. If distributions are less than the required minimum distribution for the year, a 50% excise tax will be imposed on the amount not distributed. 24. How to avoid 50% excise tax? The 50% excise tax may be avoided if the excess accumulation is due to reasonable error, and the taxpayer is taking steps to remedy the insufficient distribution. To make a waiver request, a taxpayer must: a. File Form 5329, b. Pay 50% excise tax owed, and c. Attach a written explanation showing when excess accumulation was renewed or what he/she has done to have it withdrawn. Any tax paid will be refunded if the waiver is granted. Part IV Roth IRA 25. What about Roth IRAs? Roth IRAs (also referred to as tax-free IRAs) have the following characteristics: a. Contributions to the Roth IRA are nondeductible, but income can be accumulated tax-free. b. To be treated as a Roth IRA, the account must be designated as such when it is established. c. Roth IRAs are subject to income limits. The contribution amount is the same as the amount for a deductible IRA, and the total contribution to both deductible and nondeductible IRAs cannot exceed $5000 per taxpayer ($6000 if 50 years of age or more). Unlike traditional IRAs, individuals are allowed to make contributions to Roth IRA even after reaching 70 years of age. 26. What if contributions are made to both Traditional IRA and Roth IRA? If contributions are made to both Traditional and Roth IRAs, the taxpayers contribution limit is the least of the following amounts: a. $5000 ($6000 if 50 years of age or more) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA) for the year other than Roth IRAs. b. His taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA) for the year other than Roth IRAs.
st
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However, if his MAGI is above a certain amount, his contribution limit may be reduced as explained later in Question 28. 27. Contribution Limits to a Roth IRA: If the taxpayer has Taxable Compensation and his Filing Status is MAGI is Then he can contribute
less than Up to $5,000 ($6,000 if the taxpayer is 50 or $159,000 older) married filing jointly, or at least $159,000 qualifying widow(er) but less than Reduced amount $169,000 $169,000 or more Nothing zero (-0-) Up to $5,000 ($6,000 if he is 50 or older) married filing more than zero (separately and he lived 0-) Reduced amount with his spouse at any but less than time during the year $10,000 $10,000 or more Nothing less than $95,000 Up to $5,000 ($6,000 if he is 50 or older) single, head of household, or at least married filing $1,01,000 Reduced amount separately and he did but less than not live with his spouse at $1,16,000 any time during the year $116,000 or more Nothing
28. How to compute reduced amount of contribution to Roth IRA? If the taxpayers MAGI is above a certain amount, his contribution limit may be reduced. However, a reduced contribution amount is computed as under: 29. How to treat distributions from a Roth IRA? Qualified distributions from a Roth IRA are: Not included in the taxpayers gross income and Not subject to the additional 10% early withdrawal tax. To be a Qualified Distribution, the distribution must: Satisfy a 5-year holding period and Meet one of the four additional requirements: 5-year Holding Period: Roth IRA distribution may not be made before the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA The 5-year holding period begins to run with the tax year to which the contribution relates, not the year in which the contribution was actually made. Thus, a contribution made on 04/12/2002, if designated as a 2001 contribution, may be withdrawn tax free in 2006. One of the four additional requirements: The distribution must be Made on or after the date on which the individual attain 59 year of age Made to a beneficiary (or the individuals estate) on or after the individuals death
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Made because the taxpayer is disabled Made to pay up to $10,000 of certain Qualified First-time Homebuyer Expenses
If they are not qualified distributions from a Roth IRA, then they are: To be included in the taxpayers gross income and Subject to even the additional 10% early withdrawal tax. No portion of a distribution is treated as includible in gross income until the total of all distributions from the Roth IRA exceed the amount of contributions. 30. Can distributions from one Roth IRA be rolled over (or) converted into another Roth IRA? Yes. Distributions from one Roth IRA can be rolled over (or) converted tax-free into another Roth IRA. 31. Can the amounts from an ordinary IRA be rolled over (or) converted into a Roth IRA? Yes, if the following requirements are met: a. The taxpayers AGI for the tax year is not more than $1,00,000, and b. The taxpayers filing status is not MFS If a taxpayer has both deductible and nondeductible IRAs and only a portion of IRAs are converted into a Roth IRA, any amount rolled into a Roth IRA will be considered to have been drawn proportionately from both deductible and nondeductible IRAs and will be taxed accordingly. Once a taxpayer has begun periodic distributions of a traditional IRA, he/she is able to convert his/her traditional IRA into Roth IRA and resume the periodic payments. In addition, the 10% early withdrawal penalty will not apply to nonqualified distributions.
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CHAPTER 33: CAPITAL GAINS AND LOSSES

Introduction:
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Almost everything the taxpayer owns and uses for personal or investment purposes is a capital asset. Examples are his home, household furnishings, and stocks or bonds held in his personal account. When he sells a capital asset, the difference between the amounts he sells it for and the basis, which is usually what he paid for it, is a capital gain or a capital loss. If he received the asset as a gift or inheritance, the basis may be either cost or the FMV of that asset. He has a capital gain if he sells the asset for more than the basis. He has a capital loss if he sells the asset for less than the basis. While he must report all capital gains, he may deduct only capital losses on investment property, not personal property. Thus, losses from the sale of personaluse property, such as his home or car, are not deductible. Part I - Basics Investors receive two types of income: ordinary income and capital gains. Ordinary income includes dividends and interest taxpayer receives. He has capital gain when he sells a capital asset for a profit. Any asset he holds as an investment (stocks, bonds, real estate, for example) is a capital asset. Of course, he can also lose money when he sells a capital asset: a capital loss. Advantages of Capital Gains Capital gains are better than ordinary income for two reasons: First, taxpayer doesnt pay tax on a capital gain until he sells the asset. Normally he can choose whether to sell sooner or later, so the taxpayer controls the timing of his gain or loss. For example, he can decide to sell late in December or early in January, depending on which year he wants to report his gain or loss. Generally speaking, he doesnt have that kind of choice with ordinary income, such as interest and dividends. Capital gains have another big advantage over ordinary income: they're taxed at special rates. To qualify for these rates taxpayer must have long-term capital gains. Short-term capital gain is taxed at the same rates as ordinary income. Measuring Capital Gain Capital gain from a sale is measured by the difference between: The amount realized in the sale and Basis in the asset sold.
Roughly speaking, the amount realized is what taxpayer received on the sale usually measured by the sale price minus the brokerage commission. Basis is based on the cost (usually the purchase price plus the brokerage commission) but may
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be adjusted as a result of various events. For example, if the stock splits while taxpayer owns it, the basis also splits accordingly. Example: 1. Taxpayer buys 100 shares of XYZ at $35, paying $3,500 plus a brokerage commission of $40. His basis is $3,540. 2. Later, he sells when the stock is at $39. He receives $3,900 minus a brokerage commission of $40, so the amount realized is $3,860. 3. His capital gain is $3,860 (net realization) minus $3,540 (basis) = $320. 4. If his basis is greater than the amount realized, he has a capital loss. What about Capital Losses? Capital losses are used first to offset capital gains. If there are no capital gains, or if the capital losses are larger than the capital gains, taxpayer can deduct the capital loss against his other income up to a limit of $3,000 in one year. If his overall capital loss is more than $3,000, the excess carries over to the next year. In other words, he can treat the extra portion as if it was an additional capital loss in the following year Note: If taxpayer has capital gain from selling his home, he can use a capital loss from a stock investment to reduce or eliminate that gain. Example: In 2002 Ted had a $4,000 capital gain, and a capital loss of $11,400. He used $4,000 of the capital loss to offset the capital gain: that left a net capital loss of $7,400. He claimed $3,000 of the loss on his 2002 return. The effect was to reduce his taxable income by $3,000. Ted was in the 30% bracket, so the loss decreased his 2002 income tax by $900. The remaining $4,400 of capital loss will be carried over to be claimed on his 2003 income tax return. In 2003 he had a $500 capital gain and no capital losses except for the carryover. So he used $500 of the $4,400 carryover to offset the gain, leaving a capital loss of $3,900. Once again, Ted deducts $3,000 of the loss against the other income and carries over the remaining $900 to 2004. Where to report? Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040. Set-off and Carry forward of Capital Losses:
If taxpayers capital losses exceed his capital gains, the amount of the excess loss that can be claimed is limited to $3,000 or $1,500 if he is filing married filing separately. If the net capital loss is more than this limit, he can carry the loss forward to later years.
The Wash Sale Rule The tax law contains rules designed to prevent taxpayers from creating artificial capital losses.
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One rule taxpayer should be familiar with is the wash sale rule. This rule says taxpayer can't claim a loss from sale of a security (such as stock) if he buys the identical security as a replacement within the period beginning 30 days before the sale and ending 30 days after the sale. So if taxpayer sells XYZ for a loss on December 30 and buy the same stock on January 5 of the next year, he won't get a loss deduction for the sale on December 30. He needs to wait at least 31 days to repurchase the stock if he wants to claim the loss. Part II Types of Gains Short-Term Gain If the trade date of the sale is one year or less after the trade date of the purchase, taxpayer has a short-term capital gain. For example, if he bought on May 12, 2003 and sold on May 12, 2004 he has a short-term gain, because he must hold for more than one year to have a long-term gain. Short-term capital gain is taxed at the same rate as ordinary income (like wages and interest income), unless he has a capital loss that eliminates it. If the gain isn't short-term, then it's long-term. Long-Term Gain If the trade date of the sale is more than one year after the trade date of the purchase, taxpayer has a long-term capital gain. He pays 5% tax on this category of gain if it falls into the 10% or 15% tax bracket; otherwise he pays 15%. Net Capital Gains If taxpayer has a net capital gain, that gain may be taxed at a lower tax rate. The term "net capital gain" means the amount by which his net longterm capital gain for the year is more than his net shortterm capital loss. The highest tax rate on a net capital gain is generally 15% (or 5%, if it would otherwise be taxed at 15% or less). There are 3 exceptions: 1. The taxable part of a gain from qualified small business stock is taxed at a maximum 28% rate. 2. Net capital gain from selling collectibles such as coins or art is taxed at a maximum 28% rate. 3. The part of any net capital gain from selling Section 1250 real property that is due to recapture of straight-line depreciation is taxed at a maximum 25% rate. If he has taxable capital gain, he may be required to make estimated tax payments. Part III Tax Rates Currently, capital gains may be taxed at 5 percent, 15 percent, 25 percent or 28 percent or a combination of rates. These tax levels are known as long-term capital gains and apply to assets that taxpayer holds for at least 366 days (more than one year). The long-term capital gain tax is, generally, much lower than what he pays on his regular income. Now capital gains and qualified
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dividends will continue to be taxed at 15 percent (or 5 percent for lower-income taxpayers) through 2010. In fact, it is a taxpayer's income level that generally determines which capital gains rate is owed. If taxpayers profit pushes him into a higher bracket, he could possibly be taxed at a combination of rates. And he could face yet another rate depending upon the type of property he sells. 5% Tax Rate This capital gains rate applies to taxpayers in the 10-percent or 15-percent income tax brackets. They will pay a maximum 5-percent long term gains rate on property held for more than a year. Lower-income investors get an even better investment sale deal in 2010. That year, these filers will pay no tax on sales of long-term holdings. The 5-percent rate still applies to a portion of Taxpayers gains even if his asset sale pushes him into a higher bracket. For example, if, as a single filer, Taxpayers taxable income was $25,000 but he netted another $7,000 from a long-term stock sale, some of that gain would still be taxed at the lower 5 percent capital gains rate even though technically he was bumped into the 25percent tax bracket. In this case, $31,850 (the 2007 income ceiling for the 15-percent bracket) minus his ordinary income of $25,000 gives him a $6,850 capital gains cushion at the 5-percent level. Only the remaining $150 of gain would be taxed at the 15-percent rate applicable to his new, higher tax bracket. 15% Tax Rate This most widely paid capital gains tax rate applies to long-term investments by individuals in the 25-percent or higher tax brackets. When taxpayer hears "lower capital gains rate", it generally means this level, because there are few investors with incomes low enough to qualify solely for the 5-percent rate. Note: For now, the 5-percent and 15-percent rates are in effect through 2010. But they are still considered "temporary." 25% Tax Rate This rate applies to part of the gain from selling real estate that depreciated. Basically, this keeps taxpayer from getting a double tax break. The Internal Revenue Service first wants to recapture some of the tax breaks he has been getting via depreciation throughout the years. He will have to complete the work sheet in the instructions for Schedule D to figure his gain (and tax rate) for this asset, known as Section 1250 property. 28% Tax Rate Two categories of capital gains are subject to this rate: small business stock and collectibles. If taxpayer realized a gain from qualified small business stock that he held more than five years, he generally can exclude one-half of his gain from income. The remainder is taxed at a 28percent rate. If his gains came from collectibles rather than a business sale, he will still pay the 28-percent rate.
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This includes proceeds from the sale of a work of art, antiques, gems, stamps, coins, precious metals and even pricey wine or brandy collections. Part IV Planning Tips Avoid Short-Term Gains Here's another reason for patience: if the stocks are held long enough then the gains will be taxed at a lower rate. Taxpayer needs to hold an asset more than a year to qualify for the 15% rate (5% for gain that falls in the 10% or 15% bracket). So he has to keep track of the purchase dates and avoid selling stock with gains before he qualifies for the lower rate. Avoid Long-Term Losses This tax advice goes against the grain of the buy-and-hold theory. In some cases taxpayer is better off if he sells his losers before they turn long-term. Generally this is true only if he has both long-term and short-term capital gains. Soak Up Big Capital Losses If the taxpayer has large capital losses and capital gains, it can be helpful if they fall in the same year. That way he doesnt have a big hit of income and tax in one year. Especially if the taxpayer wants to avoid having large losses fall in a year after his large gains, because losses are carry forward but not carried back. Remember that he can only deduct $3,000 of capital loss in excess of capital gain against other income. Example 1: During 2003 taxpayer has $20,000 of capital gain and no capital loss, so he has to pay tax on the entire capital gain of $20,000. During 2004 he has $20,000 of capital loss but no capital gain. He can only deduct $3,000 of the capital loss. The rest gets carried forward to the next year. Depending on his future capital gains, it may take several years before he can use the entire $20,000 capital loss. If the loss fell in 2003 when he had the big gain, he would have received the entire benefit of $20000 immediately. Example 2: During 2003 taxpayer has $3,000 of capital loss (it doesn't matter whether it's shortterm or long-term). He also has a $3,000 long-term gain he can take in 2003 or hold until 2004. If he postpones the gain until 2004, his 2003 loss will reduce his tax on ordinary income (wages, interest or dividends, for example), and his gain will be taxed the following year at the favorable rate for long-term capital gain. But if he takes his capital gain in 2003 it will swallow up the capital loss and he won't get the benefit of the favorable capital gain rate. Part VI Nonresident Aliens and US Holdings A person is considered non-resident in the years when that person is in the US fewer than 183 days; the actual rule is a little more complex, and takes prior years into account (as detailed in IRS publication 519). Anyhow, in the years when a non-US citizen is considered a non-resident for tax purposes, that person files the US tax return on form 1040 NR, instead of regular 1040 / 1040EZ / 1040A, and pays tax on investment income according to the following special rules: No tax withholdings on capital gains. This means that a brokerage or a mutual fund should withhold nothing when selling shares. With respect to mutual funds, long-term capital gain distributions are exempt as
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well. But, they are taxable. No tax withholdings on bank interest. This means regular accounts with credit unions, savings and loans, etc. But, the incomes are taxable. 30% flat-rate tax on dividends. Generally this includes dividend and short-term capital gain distributions by mutual funds. This rate may be reduced by a tax treaty with the country of residence. 30% flat-rate tax on Interest 30% flat-rate tax on Interest that neither is paid by a bank nor qualifies as "portfolio interest." This rate may be reduced by a tax treaty with the person's country of residence. No personal exemption or deductions No personal exemptions or deductions can be applied against investment income which is, "income not effectively connected with taxpayers US trade or business". Further, according to the IRS, "if his sole U.S. business activity is trading securities through a U.S. resident broker or other agent, he is not engaged in a trade or business in the United States" so the income is not effectively connected with a US trade or business. If the alien is a non-resident for the tax purposes in a given year, but spends 183 days or more in the country, any capital gains are also subject to the 30% flat tax. This is a fairly rare but possible situation. But, most common approach is to treat him/her as Resident Alien (if stays for 183 days or more) and tax accordingly (5%, 15%, 25%, or 28%).
Tax treaties are very important. If the individual's country of residence has an agreement (tax treaty) with the US government, those rules pretty much supersede the standard rules set by the Internal Revenue Code. In particular, they often reduce the tax rate on interest and dividend income. Nonresident alien students, scholars, alien employees of foreign governments and international organizations who, at the time of their arrival in the United States, intend to reside in the United States for longer than one year, are subject to the 30% taxation on their U.S. source capital gains during any tax year, if during such tax year (usually calendar year), they are present in the United States for 183 days or more, unless a tax treaty provides for a lesser rate of taxation. This assumes that such capital gains are not effectively connected with the conduct of a United States trade or business. These capital gains would be reported on Page 4 (not Page 1) of Form 1040NR, and would not be reported on a Schedule D, because they are being taxed at a flat rate of 30%, or at a reduced flat rate under a tax treaty.
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CHAPTER 34: STOCK OPTIONS
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INTRODUCTION: GRANT DATE It is the date on which the board of directors or the stock option committee completes the corporate action which constitutes an offer of stock, rather than the date on which the option agreement is prepared. EXERCISE DATE It is the date on which the corporation receives notice of the exercise of the option and payment for the stock, rather than the date the shares of stock are actually transferred.
If taxpayer receives a non-statutory option to buy or sell - stock or other property as payment for his services, he usually will have income: When he receives the option When he exercises the option (use it to buy or sell the stock or other property) When he sells or otherwise disposes of the option. However, if he receives a statutory option, he will not have any income until he sells or exchanges his stock. His employer can tell him which kind of option he holds. PART I NONSTATUTORY STOCK OPTIONS: If taxpayer is granted a non statutory stock option, the amount of income to include and the time to include it depend on whether the FMV of the option can be readily determined. The FMV of an option can be readily determined if it is actively traded on an established market. The FMV of an option that is not traded on an established market can be readily determined only if all of the following conditions exist: 1. The option is transferable 2. The option is exercisable immediately in full by the taxpayer 3. The option or the property subject to option is not subject to any restriction or condition which has a significant effect upon the FMV of the option, and 4. The FMV of the option privilege is readily ascertainable. The option privilege for an option to buy is the opportunity to benefit during the options exercise period from any increase in the value of property subject to the option without risking any capital. For example, if during the exercise period the FMV of the stock subject to an option is greater than the option exercise price, a profit may be realized by exercising the option and immediately selling the stock at its higher value. The option privilege for an option to sell is the opportunity to benefit during the exercise period from a decrease in the value of property subject to the option.
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OPTION WITH AND WITHOUT READILY DETERMINED VALUE: If the taxpayer receives a non-statutory stock option that has a readily determined FMV at the time it is granted to him, the option is treated like other property received as Compensation. If the FMV of the option is not readily determined as the time it is granted to him (even if it is determined later), he does not have income until he transfers or exercises the option. When he exercises this kind of option, the restricted property rules apply to the property received. The amount to include in his income is the difference between the amount he pays for the property and its FMV when it becomes substantially vested. If he receives compensation from employer-provided non statutory stock options, it is reported in Box 1 of Form W-2. It is also reported in Box 12 using Code V. PART II STATUTORY STOCK OPTIONS: There are two kinds of statutory stock options: 1. Incentive Stock Options (ISOs), and 2. Options granted under Employee Stock Purchase Plans (ESPP) For either kind of option, taxpayer must be an employee of the company granting the option at all times beginning with the date the option is granted, until 3 months before he exercises the option. Also, the option must be nontransferable except at death. If he does not meet the employment requirements, or he receives a transferable option, he option is a non statutory stock option. If he receives a statutory stock option, do not include any amount in his income either when the option is granted or when he exercises it. He has taxable income or a deductive loss when he sells the stock that he bought by exercising the option. His income or loss is the difference between the amount he paid for the stock (the option price) and the amount he receives when he sells it. He generally treats this amount as Capital Gain or Loss and reports it on Schedule D (Form 1040) for the year of sale. However, he may have ordinary income for the year that he sells or otherwise dispose of the stock in either of the following situations: 1. He does not meet the holding requirement. This situation generally applies if he sells the stock: Within 1 year after it has been transferred to him (or) Within 2 years after the option was granted. For example, the employer granted him an incentive stock option on April 1, 1999, and he exercised the option on October 1, 1999, he must not sell the stock until April 1, 2001, to obtain favorable tax treatment (the later of two years from the date of the grant or one year from the date of exercise). 2. He meets the conditions described under Option granted at a discount. 3. Report the ordinary income as Wages on Form 1040, Line 7 for the year of sale.
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INCENTIVE STOCK OPTIONS (ISOs): If the taxpayer sells stock acquired by exercising an ISO and meets the holding period requirement, his gain or loss from the sale is Capital Gain or Loss. If he does not meet the holding period requirement and has a gain from sale, the gain is Ordinary Income up to the amount by which the FMV of stock when he exercised the option exceeded the Option Price. And any excess gain is Capital Gain. If he has a loss from sale, it is a Capital Loss and he does not have any Ordinary Income. Example 1: Taxpayer is granted 100 shares by his employer on 3/11/2003 at $10 per share, its FMV at that time. He exercised the option on 1/14/2004, when the stock was selling on the open market for $12 per share. On 1/24/2005, he sold the stock for $15 per share. Here see the computation: WN1: Computation of amount to be reported as Wages: FMV on the Exercise Date Less: Purchase Price Amount to be reported as Wages Per Share $12 $10 $2
WN2: Computation of amount to be reported as Capital Gain: Sale Price Less: Purchase Price Gain Less: Amount to be reported as Wages (WN1) Amount to be reported as Capital Gain
Per Share $15 $10 $5 $2 $3
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ALTERNATIVE MINIMUM TAX (AMT): When the rights in the stock are transferable or no longer subject to a substantial risk of forfeiture, he must include as an adjustment in figuring Alternative Minimum Taxable Income the amount by which the FMV of the stock exceeds the Option Price. This must be included as an adjustment on Form 6251, Line 13. However, no adjustment is required if he disposes of the stock in the same year he exercises the option. Example 2: The facts are the same as in Example 1. On 1/18/2005, when the stock was selling on the open market for $14 per share, taxpayers rights to the stock first became transferable. In such case he must include as adjustment on Line 13 of Form 6251 - $400 computed as under: FMV of the stock on the date his rights became transferable Less: Purchase Price Alternative Minimum Taxable Income Total AMT Income = $4 X 100 Shares EMPLOYEE STOCK PURCHASE PLAN (ESPP): If taxpayer sold stock acquired by exercising an option granted under an ESPP, determine his Ordinary Income and his Capital Gain or Loss as follows: OPTION GRANTED AT A DISCOUNT: If at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the FMV of the share, and taxpayer disposes the share after meeting the holding period requirement, or he dies while owning the share, he must include in his income as Compensation, the least of: The amount by which the FMV of the share at the time the option was granted exceeded the price paid under the option, or The amount by which the FMV of the share at the time of disposition or death exceeded the price paid under the option. For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is figured as if the option had been exercised at the time it was granted. Any excess gain is Capital Gain. If the taxpayer has a Loss from the sale, it is a Capital Loss, and he does not have any ordinary income. Example 3: Taxpayer is granted by his employer an option under ESPP to buy 100 shares of stock for $20 per share on 1/1/2003. On which date its FMV was $22 per share. On 1/7/2004, he exercised the option when its FMV was $23 per share. On 1/8/2005, he sold his stock for $30 per share. Here see the computation: WN1: Computation of amount to be reported as Wages: Per Share $14 $10 $4 $400
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FMV on the Grant Date Less: Purchase Price Amount to be reported as Wages WN2: Computation of amount to be reported as Capital Gain: Sale Price Less: Purchase Price Gain Less: Amount to be reported as Wages (WN1) Amount to be reported as Capital Gain Note:
$22 $20 $2 Per Share $30 $20 $10 $2 $8
Since FMV of the share was determined on the Grant Date itself, FMV on Exercise Date is not considered in WN1.
DIVIDENDS RECEIVED ON RESTRICTED STOCK: Dividends received on restricted stock are treated as Compensation and not as Dividend Income. Employer should include these payments on the taxpayers Form W-2. If they are also reported on Form 1099-DIV, then he should list them on Schedule B or Schedule 1, with a statement that he has included them as Wages. Do not include them in the Total Dividends Received. Taxpayer can choose to include these dividends as Total Dividends Received in the year he transferred the restricted stock. For this he must have Form 1099-DIV and he must not include them as Wages in his tax return, an example of restricted stock. Taxpayer must perform substantial services over a period of time and must resell the stock to the company at predetermined price (regardless of its value on resale date); if he does not perform the services, his rights to the stock are subject to a substantial risk of forfeiture, etc. INTERNAL REVENUE BULLETIN: 2004-16 Income Tax Treatment of Stock Options Generally In general, the income tax consequences associated with an option arise when the option is exercised. When an employee exercises a compensatory stock option (commonly known as non statutory option), both Section 83 of the Internal Revenue Code and long-standing judicial authority require that the difference between the FMV of the stock and the option Exercise Price be included in employees Gross Income as Compensation. In the case of a stock purchased under an incentive stock option (or a statutory option), Section 56 provides that the difference between the FMV of the stock and the Option Exercise Price must
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be included in the employees Gross Income for the purposes of computing AMT. Statutory stock options are not subject to tax on the date of grant. Non statutory stock options rarely are subject to tax on the date of grant, and taxation at grant date typically occurs only if an option is actively traded on an established securities market on that date or, if not so traded, it has a readily ascertainable FMV. A non-publicly traded non statutory stock option is considered to have a readily ascertainable FMV on the grant date only if, on that date, it satisfies the following four conditions: 1. The option is transferable 2. The option is exercisable immediately in full by the optionee. 3. The option or the property subject to option is not subject to any restriction or condition which has a significant effect upon the FMV of the option, and 4. The FMV of the option privilege is readily ascertainable.
INCENTIVE STOCK OPTIONS TREATMENT: To obtain favorable tax treatment, the stock acquired under an incentive stock option qualifies for favorable long-term capital gain tax treatment only if it is not disposed of before the later of two years from the date of the grant of the option, or one year from the date of the exercise of the option. If this holding period is not satisfied, the portion of the gain equal to the difference between the fair market value (FMV) of the stock at the time of exercise and the option price is taxed as compensation income rather than capital gain. In this case, taxpayer may be subject to the higher rate of income imposed on ordinary income. SUMMARY: ---Excerpts from IBSN Newsletter
(a) It is taxable as Compensation if it is disposed of: Before 2 years from the date of grant of option or Before 1 year from the date of exercise of option Or (b) It is taxable as Long Term Capital Gains if it is disposed of: After 2 years from the date of grant of option or After 1 year from the date of exercise of option PART III EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) 1. What Is An ESOP? An ESOP is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It is equity based deferred compensation plan. 2. What are special features of ESOP? Only an ESOP is required by law to invest primarily in the securities of the sponsoring employer. An ESOP is unique among qualified employee benefit plans in its ability to borrow money.
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3. How does ESOP work? The ESOP operates through a trust, set up by the company, which accepts tax deductible contributions from the company to purchase company stock. The contributions made by the company are distributed to individual employee accounts within the trust. The amount of stock each individual receives may vary according to pre-established formulas based on salary, service, or position. The employees may cash out after vesting in the program or when they leave the company. The amount they may cash out may depend on the vesting requirements. When an ESOP employee who has at least 10 years of participation in the ESOP reaches age 55, he or she must be given the option of diversifying his/her ESOP account up to 25% of the value. This option continues until age 60, at which time the employee has a one-time option to diversify up to 50% of his/her account. This requirement is applicable to ESOP shares allocated to employees accounts after December 31, 1986. Employees receive the vested portion of their accounts at termination, disability, death, or retirement. These distributions may be made in a lump sum or in installments over a period of years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP accounts right away. 4. What are the advantages? Capital Appreciation: Companies sell some or all of their equity to employees and by doing so they convert corporate and personal taxes into tax-free capital appreciation. This allows the owner to sell 100% of his or her share in the company, get money out tax-free and still maintain control on the company. Retirement Based Incentive It provides a cost-effective plan to motivate employees. Tax Advantages Enables tax advantaged purchasing of stock or a retiring company owner. With this purpose, a company owner may sell their shares to the ESOP and incur no taxable gain on the sale. A company owner can sell all or some of the shares to the employees cost free. Owners who sell 30% or more of their share to an ESOP are allowed to roll-over the proceeds into other securities and defer taxation on the gain. Reduced Tax Liability A company can reduce its corporate income taxes and increase its cash flow and net worth by simply issuing treasury stock or newly issued stock to its ESOP. 5. What are the disadvantages? Dilution: If the ESOP is used to finance the companys growth, the cash flow benefits must be weighed against the rate of dilution.
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Fiduciary Liability: The plan committee members who administer the plan are deemed to be fiduciaries, and can be held liable if they knowingly participate in improper transactions. Liquidity: If the value of the stock appreciates substantially, the ESOP and/or the company may not have sufficient funds to repurchase stock, upon employees retirement.
Stock Performance: If the value of the company does not increase, the employees may feel that the ESOP is less attractive than a profit sharing plan. In an extreme case, if the company fails, the employees will lose their benefits to the extent that the ESOP is not diversified in other investments. 6. What are the alternatives to ESOP? Employee Stock Options An Employee Stock Option Plan is when the company offers its shares to the employees. It is an option to buy the companys share at a certain price. This could either be at the market price or at a preferential price lower than the current market price. Profit Sharing Plan An ESOP differs from a Profit Sharing Plan in that an ESOP is required to invest primarily in employer securities, while a Profit Sharing Plan is usually prohibited from investing primarily in employer securities.
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CHAPTER 35: ALTERNATIVE MINIMUM TAX
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PART I-ALTERNATIVE MINIMUM TAX (AMT) 1. What is AMT? The alternative minimum tax (or AMT) is an extra tax some people have to pay on top of the regular income tax. The original idea behind this tax was to prevent people with very high incomes from using special tax benefits to pay little or no tax. The alternative minimum tax is a separately figured tax that eliminates many deductions and credits, thus increasing tax liability for an individual who would otherwise pay less tax. The tentative minimum tax rates on ordinary income are percentages set by law. 2. What is the need for AMT? The tax laws give preferential treatment to certain kinds of income and allow special deductions and credits for certain kinds of expenses. The alternative minimum tax attempts to ensure that anyone who benefits from these tax advantages pays at least a minimum amount of tax. 3. How does the taxpayer figure is AMT? First, taxpayer figures the amount of tax he would owe under a different set of rules. The three different rules are as follows: a. Various tax benefits that are available under the regular tax are reduced or eliminated. b. He gets a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income. This deduction phases out when his income reaches higher levels, a fact that causes significant problems under the alternative minimum tax. c. He calculates the tax using AMT rates, which start at 26% and move to 28% at higher income levels. By comparison, the regular tax rates start at 10% and then move through a series of steps to a high of 35%. The result of this calculation is the amount of income tax he would owe under this "alternative" system of tax. Then he compares this tax with his regular tax. If the regular tax is higher, he doesn't owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT he has to pay. Example 1: Taxpayers regular income tax is $47,000. When he calculates his tax using the AMT rules, he comes up with $39,000. That's lower than the regular tax, so he doesn't pay any AMT.
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4. What are the different items that are subject to AMT? The following items are subject to the alternative minimum tax. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. accelerated depreciation in excess of straight line depreciation; circulation expenses; depletion; foreign tax credit; income from long term contracts computed under the percentage of income method; income from the exercise of incentive stock options; intangible drilling costs; installment sale income (certain types); interest on home equity debt used for non-residential purposes; investment expenses; itemized tax deductions for tax, medical expenses, and miscellaneous expenses; mining exploration and development costs; net operating loss tax deductions; passive income or loss tax deductions; personal tax exemptions; pollution control facility amortization; research and experimental expenses; small business stock gains that qualify for the 50% tax exclusion; standard tax deduction; tax exempt interest from private activity bonds; Tax shelter farm income or loss.
5. What are the basic things that cause AMT Liability? There are many things that affect the AMT liability. But, the most important and the basic things are reported as follows: i. ii. iii. iv. v. vi. vii. viii. ix. x. Exemptions. Standard Deduction. State & Local Taxes. Interest on Second Mortgages. Medical Expenses. Miscellaneous Itemized Deductions. Incentive Stock Options. Various Credits. Long term Capital Gains. Tax-Exempt interest.
6. Where does the taxpayer report the AMT and what is the purpose of that? AMT is reported in Form-6251. The purpose of such reporting is as under: It is used to figure the amount, if any, of taxpayers alternative minimum tax (AMT). The AMT applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions, under the tax law.
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These tax benefits can significantly reduce the regular tax of some taxpayers with higher economic incomes. The AMT sets a limit on the amount these benefits can be used to reduce total tax. PART-II: AMT CREDIT
7. When can taxpayer claim AMT Credit? Certain items under the alternative minimum tax (AMT) give rise to a credit taxpayer can claim in a later year. He doesn't get to claim AMT credit if he paid AMT because he had a large number of exemptions, or a large itemized deduction for state and local taxes. Yet he may be able to claim AMT credit if he paid AMT because he exercised an incentive stock option. The credit can also apply when AMT arises from certain other "timing items," such as an AMT adjustment relating to accelerated depreciation. 8. How is Credit figured? If taxpayer has some AMT credit available from a prior year, he has to determine how much of the credit he can use in the current year. He can only use the AMT credit in a year when he is not paying alternative minimum tax. The amount of credit he can use is based on the difference between his regular tax and the tax calculated under the AMT rules. Example: Suppose Taxpayer has $8,000 of AMT credit available from 2003. In 2004 his regular tax is $37,000. His tax calculated under the AMT rules is $32,000. He doesnt have to pay AMT because his regular tax is higher than the tax calculated under the AMT rules. Better still, he is allowed to claim $5,000 of AMT credit, reducing his regular tax to $32,000. In this example, he would still have $3,000 of AMT credit he hasnt used. That amount will be carried forward to be availed in 2005. 9. How to report AMT Credit? To calculate and report AMT credit taxpayer needs to fill out Form 8801 Credit for Prior Year Minimum Tax Individuals, Estates, and Trusts.
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CHAPTER 37: STANDARD DEDUCTION
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1. What is Standard Deduction? The standard deduction is a dollar amount that reduces the amount of income on which taxpayer is taxed. The standard deduction is a benefit that eliminates the need for many taxpayers to itemize actual deductions, such as medical expenses, charitable contributions, and taxes, on Schedule A of Form 1040. The standard deduction is higher for taxpayers who are 65 or older or blind or both. 2. When to claim Standard Deduction? Taxpayer claim standard deduction: If he/she does not qualify to claim itemized deductions If his/her standard deduction is higher than the total of itemized deductions. 3. Who are eligible to claim Standard Deduction? The following persons are eligible to claim standard deduction: Any individual who is filing an income tax return. Non-Resident married to US Citizen, Nation or Resident. Non-Residents who are students or business apprentices from India can claim standard deduction because of US-India tax treaty agreement and Article 21(2). Even Dual Status Aliens who are students or business apprentices from India can claim standard deduction because of the US-India tax treaty agreement and Article 21(2). 4. Who are not eligible to claim Standard Deduction? The following persons not eligible for the standard deduction:
If the taxpayer is married and filing a separate return and his spouse itemizes
deductions If the taxpayer is filing a tax return for a short tax year because of a change in his annual accounting period, or If the taxpayer is a nonresident or dual-status alien during the year (not student or business apprentice from India). He is considered a dual-status alien if he was both a nonresident and resident alien during the year.
5. How to figure the amount of standard deduction? The standard deduction amount depends on: The taxpayers filing status, whether he is 65 or older, or blind, and Whether an exemption can be claimed for him by another taxpayer. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amounts for most taxpayers for 2010 are shown in Table below:
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IF filing status is... Single or separately Married filing
THEN the Standard deduction is... $ XXXXX $XXXXX $XXXX
Married filing jointly or Qualifying widow(er) with dependent child Head of household
NOTE: Taxpayer is entitled to an additional standard deduction of: $1050 - If he is age 65 or older/Blind and Married $1350 - If he is age 65 or older/Blind and Unmarried
6. Can a dependent claim standard deduction? The standard deduction for an individual for whom an exemption can be claimed on another person's tax return is generally limited to the greater of: a) $900, or b) The individual's earned income for the year plus $300 (but not more than the regular standard deduction amount, generally $5,450). For purposes of standard deduction, earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work taxpayer actually performs. Earned income also includes any part of a scholarship or fellowship grant that he must include in his gross income.
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CHAPTER 38.1: ITEMIZED DEDUCTION

Introduction:
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Generally, taxpayer must decide whether to itemize deductions or to use the standard deduction. He should itemize deductions if his allowable itemized deductions are more than his standard deduction. Some taxpayers must itemize deductions because they do not qualify for the standard deduction. Those taxpayers not eligible to use the standard deduction include nonresident aliens, dual status aliens, and individuals who file returns for periods of less than 12 months. However, students and business apprentices from India can claim either Standard Deduction or Itemized Deduction under Article 21(2) of the US-India Tax Treaty Agreement. When a married couple files separate returns and one spouse itemizes deductions, the other spouse must also itemize deductions. Heads of Itemized Deductions: Itemized deductions are certain expenses that taxpayer can use to lower his taxes. The categories of itemized deductions are: 1. 2. 3. 4. 5. 6. 7. 8. Medical and dental expenses, State and local income taxes, or sales tax, Real estate and personal property taxes, Home mortgage and investment interest, Charitable contributions, Casualty and theft losses, Job expenses, and Miscellaneous deductions.
Limits on Itemized Deductions: Taxpayer may be subject to a limit on some of his itemized deductions based on his adjusted gross income. This limit applies to all itemized deductions except medical and dental expenses, casualty and theft losses, gambling losses, and investment interest. In 2010, an individual whos AGI exceeds $159,950 ($79,975 if MFS) must reduce the aggregate of itemized deductions by the lesser of: a. 3% of the amount by which his AGI exceeds $159,950 ($79,975 if MFS), or b. 80% of his itemized deductions that are affected by the limit.
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PART I MEDICAL EXPENSES 1. When can taxpayer deduct Medical and Dental expenses in Schedule A? They are allowed as deduction only if medical and dental expenses are more than 7.5% of AGI.
2. What are the different Medical and Dental Reimbursements? Any payments received from Insurance or Health Reimbursement Arrangement (HRA) or Any other sources Excess reimbursements.
3. Whose Medical and Dental expenses can taxpayer include in his return? Taxpayer, Spouse, Dependents, Student Living with Taxpayer.
4. What is Cafeteria Plan and how to treat it? Cafeteria Plan refers to a qualified benefit that does not defer compensation and is excludable from an employees gross income under a specific provision of the Code. Qualified benefits include health care, vision and dental care, group-term life insurance, disability, adoption assistance and certain other benefits. Treatment: It is included in Box-1 of W2 and is reflected in Line-1 of Sch-A. 5. What is the treatment of expenses towards Meals and Lodging, Transportation? The expenses mentioned below can be claimed as deduction: Taxpayer can include in medical expenses the cost of meals at a hospital or similar institution if a principal reason for being there is to get medical care. If any one in the taxpayers family met with an accident and he/she is shifted to a hospital for treatment, then those miles can be claimed. Car Expenses, if out of pocket, for medical purposes can be claimed but not depreciation, repair or maintenance expenses Use Standard Mileage Rate if actual expenses not claimed: Parking & toll fees. PART IITAXES YOU PAID 1. What are Deductible Taxes? State and local income taxes. Foreign income taxes. Employee contributions to state funds listed under Contributions to state benefit funds.
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One-half of self-employment tax paid. State and local general sales taxes. State and local real estate taxes. Foreign real estate taxes. Tenants share of real estate taxes paid by cooperative Housing Corporation. State and local personal property taxes. Taxes that are expenses of taxpayers trade or business or of producing income. Taxes on property producing rent or royalty income. Occupational taxes. Fees and charges that are expenses of taxpayers trade or business or of producing income.
2. What are the tests involved to deduct any taxes? The following two tests must be met for any tax to be deductible: a. The tax must be imposed. b. The tax must be paid during the tax year. a. The tax must be imposed: Generally, taxpayer can deduct only taxes that are imposed on him. Generally, he can deduct property taxes only if he is the property owner. If his spouse owns property and pays real estate taxes on it, the taxes are deductible on his spouses separate return or on his joint return. b. The tax must be paid during the tax year: If taxpayer is a cash basis taxpayer, he can deduct only those taxes actually paid during the tax year. If he pays his taxes by check, the day he mails or delivers the check is the date of payment, provided the check is honored by the financial institution. If he uses a pay-by-phone account, the date reported on the statement of the financial institution showing when payment was made is the date of payment. If he contest a tax liability and are a cash basis taxpayer, he can deduct the tax only in the year in which it is actually paid. 3.When to deduct State and local income taxes or general sales taxes? a. Taxpayer can elect to deduct either state and local general sales taxes or state and local income taxes. b. Exception: he cannot deduct state and local income taxes he pays on income that is exempt from federal income tax, unless the exempt income is interest income. For example, he cannot deduct the part of a states income tax that is on a cost-of-living allowance that is exempt from federal income tax.
4. What to deduct in State and local income taxes? The deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows: Withheld taxes. Taxpayer can deduct state and local income taxes withheld from his salary in the year they are withheld.
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For 2010, these taxes will be shown in boxes 17 and 19 of his Form W-2. He may also have state or local income tax withheld on Form W-2G (box 14), Form 1099-MISC (box 16), or Form 1099-R (boxes 10 and 13).
Estimated tax payments. Taxpayer can deduct estimated tax payments he made during the year to a state or local government. However, he must have a reasonable basis for making the estimated tax payments. Any estimated state or local tax payments he makes that are not reasonably determined in good faith at the time of payment are not deductible. For example, taxpayer made an estimated state income tax payment. However, the estimate of his state tax liability shows that he will get a refund of the full amount of his estimated payment. Taxpayer had no reasonable basis to believe he had any additional liability for state income taxes and he cannot deduct the estimated tax payment. Refund applied to taxes. Taxpayer can deduct any part of a refund of prior-year state or local income taxes that he chose to have credited to his 2010 estimated state or local income taxes. Do not reduce the deduction by either of the following items. Any state or local income tax refund (or credit) he expects to receive for 2010. Any refund of (or credit for) prior year state and local income taxes he actually received in 2010.However, part or all of this refund (or credit) may be taxable. Separate federal returns. If the taxpayer and his spouse file separate state, local, and federal income tax returns, he can deduct on his federal return only the amount of his own state and local income tax. Joint state and local returns. If taxpayer and his spouse file joint state and local returns and separate federal returns, each of them can deduct on their separate federal return part of the state and local income taxes. Taxpayer can deduct only the amount of the total taxes that is proportionate to his gross income compared to the combined gross income of his and his spouse. However, he cannot deduct more than the amount he actually paid during the year. He can avoid this calculation if he and his spouse are jointly and individually liable for the full amount of the state and local income taxes. If so, he and his spouse can deduct on their separate federal returns the amount each actually paid. Joint federal return. If taxpayer files a joint federal return, he can deduct the total of the state and local income taxes both he and his spouse have paid.
6. When to deduct Foreign Income Taxes? Generally, taxpayer can take either a deduction or a credit for income taxes imposed on him by a foreign country or a U.S. possession. However, he cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion.
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7. When to deduct State and local general sales taxes? Taxpayer can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction on Schedule A (Form 1040), line 5. Generally, he can use either his actual expenses or the state and local sales tax tables to figure his state and local general sales tax deduction. 8. When to deduct Real Estate Taxes? Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare. Taxpayer can deduct these taxes only if they are based on the assessed value of the real property and charged uniformly against all property under the jurisdiction of the taxing authority. Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property. They also do not include itemized charges for services (such as trash collection) to specific property or people, even if the charge is paid to the taxing authority. 9. When to deduct Personal Property Taxes? Personal property tax is deductible if it is a state or local tax that is: Charged on personal property, Based only on the value of the personal property, and Charged on a yearly basis, even if it is collected more or less than once a year. A tax that meets the above requirements can be considered charged on personal property even if it is for the exercise of a privilege: For example, a yearly tax based on value qualifies as a personal property tax even if it is called a registration fee and is for the privilege of registering motor vehicles or using them on the highways. If the tax is partly based on value and partly based on other criteria, it may qualify in part. Note: For the TY2010, Property Taxes can be deducted even if Standard Deduction is claimed on the Tax Return. The amount of Property Taxes can be added to the Standard Deduction amount. 10. What are the Real estate items that cannot be deducted? Payments for the following items generally are not deductible as real estate taxes: A. Taxes for local benefits. B. Itemized charges for services (such as trash and garbage pickup fees). C. Transfer taxes (or stamp taxes). D. Rent increases due to higher real estate taxes. E. Homeowners association charges. 11. Where to deduct the taxes? Taxpayer can deduct taxes on the following schedules. a. State and local income taxes: These taxes are deducted on Schedule A (Form 1040), line 5, even if his only source of income is from business, rents, or royalties. He must check box a on line 5. If he deducts these taxes, he cannot elect to deduct general sales taxes.
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b. General sales tax deduction: These taxes are deducted on Schedule A (Form 1040), line 5. He must check box b on line 5. If he elects to deduct these taxes, he cannot deduct state and local income taxes. c. Foreign income taxes: Generally, income taxes he pays to a foreign country or U.S. possession can be claimed as an itemized deduction on Schedule A (Form 1040), line 8, or as a credit against his U.S. income tax on Form 1040, line 47. To claim the credit, he may have to complete and attach Form 1116. d. Real estate taxes and personal property taxes: These taxes are deducted on Schedule A (Form 1040), lines 6 and 7, unless they are paid on property used in his business in which case they are deducted on Schedule C, Schedule C-EZ, or Schedule F (Form 1040). Taxes on property that produces rent or royalty income are deducted on Schedule E (Form 1040). e. Self-employment tax: Deduct one-half of the self-employment tax on Form 1040, line 27. f. Other taxes: All other deductible taxes are deducted on Schedule A (Form 1040), line 8
PART III- INTEREST YOU PAID 1. What are the different types of Interest? There are 5 types of Interest: I. II. III. IV. V. Home Mortgage Loan Interest. Investment Interest. Business interest. Personal interest Student Loan interest.
2. What is Home Mortgage Interest? Any interest paid on a loan secured by home (Main home or a Second home). 3. Differentiate between Main Home and a Second Home. Main Home: Taxpayer can have only one main home at any one time. This is the home where he ordinarily lives most of the time. Second Home: A second home is a home that he chooses to treat as his second home.
4. When can taxpayer deduct HMI? Taxpayer can deduct his HMI if all the following conditions are satisfied: The mortgage must be secured by his qualified home. He must be legally liable for the loan. There must be a true debtor and creditor relationship. He must file Sch-A &Form 1040, 1040NR.
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He cannot deduct the payment for some one else who is not legally liable. 6. Is the HMI amount fully deductible? If all of taxpayers mortgages fit into one or more of the following three categories at all times during the year, he can deduct all of the interest on those mortgages. The three categories are as follows: a. Mortgages he took out on or before October 13, 1987 (called grandfathered debt). b. Mortgages he took out after October 13, 1987, to buy, build, or improve his home (called home acquisition debt), but only if throughout 2007 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately). c. Mortgages he took out after October 13, 1987, other than to buy, build, or improve his home (called home equity debt), but only if throughout 2007 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of his home reduced by (a) and (b). 7. How to report the HMI paid? Deduct the home mortgage interest and points reported to him on Form 1098 on Schedule A (Form 1040), line 10. If he paid more deductible interest to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Attach a statement explaining the difference and print See attached next to line 10. Deduct home mortgage interest that was not reported to him on Form 1098 on Schedule A (Form 1040), line 11. He can take a deduction for points that were not reported to him on Form 1098, deduct those points on Schedule A (Form 1040), line 12.
8. What if there is more than one borrower? If the taxpayer and at least one other person (other than his spouse if he files a joint return) were liable for and paid interest on a mortgage that was for his home, and the other person receives a Form 1098 showing the interest that was paid during the year, attach a statement to his return explaining this. Show how much of the interest each of them paid, and give the name and address of the person who received the form. Deduct taxpayers share of the interest on Schedule A (Form 1040), line 11, and print See attached next to the line.
9. State the limits on deduction of HMI. #1: Home acquisition debt limit The total amount taxpayer can treat as home acquisition debt at any time on his main home and second home cannot be more than $1 million ($500,000 if married filing separately). This limit is reduced (but not below zero) by the amount of his grandfathered debt. Debt over this limit may qualify as home equity debt.
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#2: Home equity debt limit There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on taxpayers main home and second home is limited to the smaller of: a. $100,000 ($50,000 if married filing separately), or b. The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home. 10. What is the treatment of certain special items? a. Late payment charge on mortgage payment: Taxpayer can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with his mortgage loan. b. Mortgage prepayment penalty: If the taxpayer pays off his home mortgage early, he may have to pay a penalty. He can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with his mortgage loan. c. Sale of home: If the taxpayer sells his home, he can deduct his home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale.
d. Prepaid interest: If the taxpayer pays interest in advance for a period that goes beyond the end of the tax year, he must spread this interest over the tax years to which it applies. He can deduct in each year only the interest that qualifies as home mortgage interest for that year. PART IVGIFTS TO CHARITIES 1. What are qualified organizations? Qualified Organizations include non-profit groups (religious, charitable, educational, scientific, literacy or something that prevents cruelty to animal / children). Other organizations must apply to IRS to treat them as qualified organization. 2. What are the filling requirements? To deduct a charitable contribution taxpayer must file Form 1040 and itemize deductions on Schedule-A. For the non cash contributions file Form 8283. 3. What are the different organizations that qualify to receive deductible contributions? a. b. c. d. e. Non profit groups War-veteran organizations Non-profit companies or corporations Religious places Federal / state / local government (only if it is for public benefit)
4. List some Contributions which are deductible: Money / Property given to:
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Temples, Churches, Mosques or any other religious organization Federal / state / local tax government (only for general public benefit) Non-profit schools & organization Public parks & recreation facilities Salvation array, Red Cross etc. War-veteran organizations Expenses paid for a student living with the taxpayer (because of an agreement between him & qualified organization) Out-of-pocket expenses to a qualified organization
5. List some Contributions which are non-deductible: Money / Property given to: Clubs / Unions / Chambers / Leagues Foreign organizations Individuals Profit groups Political groups Lottery tickets Value of his time & services Value of blood donated to a blood bank. 6. When is a written statement needed in addition to a receipt? If taxpayer contributes to any charitable organization (other than a qualified organization) more than $75 in cash or towards goods & services the Tax Payer must obtain a written statement from charitable organization. No written statement is required if he contributes to any of those five types of organizations, a receipt will suffice. 8. Who is considered to be a student living with the taxpayer? Student can be foreign / American who: a. Lives with the taxpayer in his house because of a written agreement between him & a qualified organization to provide educational opportunities for the student. b. Is not his relative or dependent, and th c. Is a Full time student (12 or any lower grade) at a school in US. 9. What is the deduction on the expenses taxpayer paid for a student living with him? Deduction is limited to $ 50 per month for the number of months student lived with the taxpayer (15 days or more is treated a month). However, the total deduction cannot exceed 30% of AGI. Qualifying expenses: Food, clothing, transportation Cost of books, Medical expenses, Entertainment & other expenses actually spent for the well-being of the student Non-qualifying expenses: Depreciation on taxpayer house General house hold expenses Taxes, insurance, repairs etc. Reimbursed expenses.
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11. What if taxpayer receives daily allowances? If taxpayer provide services to charitable organizations and receive daily allowance to cover reasonable travel expenses (including meals & lodging) he can claim deduction only if his stay is away from home OVERNIGHT, then include in his income the amount of allowance in excess of the deductible travel expenses. 12. What are deductible travel expenses? Air, rail & bus transportation Out of expenses for the taxpayers car Taxi fares or other transportation Lodging costs Cost of meals
13. What if the taxpayer had contributed cars, boats or airplanes to a qualified organization? Case-1: Contributed car sold for > $500 by Qualified Organization The deduction is limited to the least of: o Gross proceeds from the sale of car by the qualified organization or o FMV on the date of contribution. Attach Form 1098-C issued by qualified organization which reflects the gross proceeds of the car. No deduction if no Form 1098-C. This Form 1098-C must be obtained within 30 days from the date his car is sold by qualified organization.
Case-2: Contributed car sold for $500 or less by Qualified Organization Deduction is limited to the least of: o $500 or o FMV on the date of contribution No Form 1098-C applies If FMV of the car is $250 or more, obtain a written statement from the qualified organization acknowledging his donation.
Case-3: Contribution of used clothes and other personal things or household goods FMV is usually lower than the actual price There are no fixed formulas or methods to determined this value Certificate is not mandatory a receipt will do Deduction is the value on the receipt or certificate from the qualified organization.
Case-4: Contribution of food & inventory or book inventory (Same as Case-3) 14. What are Carryovers? If amount donated is greater than maximum deduction than the amount can be carry forward.
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15. What are the Deduction limits for charitable contributions: Case 1: Limited to 50% of AGI It applies to total of all contributions made during the year to only 50% organizations Deduction is limited to: o Amount contributed, or o 50% of AGI whichever is less. 50% limit does not apply to qualified contribution defined in publication 4492.
Case 2: Limited to 30% of AGI It applies to total of all contributions made to any qualified organization (other than 50% limit organization) and qualifying expenses of a student living with the taxpayer. Deduction is limited to the least of: o Amount contributed and qualifying expenses, or o 30% of AGI
Case 3: Special 30% limit for capital gain period It applies if capital gain property is gifted to 50% limit organization Case 4: Limited to 20% deduction It applies if capital gain property is gifted to any qualified organization other than a 50% limit organization.
Note: All charitable contributions must not be more than 50% of AGI. 16. What are cash contributions? Cash, check, credit card, pay roll deductions from wages, out of pocket expenses etc. If cash contributions are: < $250 Receipt necessary > $250 Receipt mandatory 17. What are Non cash contributions? Any contribution which is not a cash contribution is a non-cash contribution. It includes: Food inventory Capital gain property Cars
The additional information necessary depends upon the amount contributed which is as follows: $0 - $250 Receipt necessary $250 500 Acknowledgment necessary $501 5000 Acknowledgment & written records mandatory $5001 & Above (Qualified written appraisal from qualified appraiser mandatory).
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PART VCASUALTY & THEFT LOSS
Introduction: If taxpayers property is destroyed, damaged, or stolen due to casualty or theft, he may be entitled to a tax deduction. A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, and unusual. A theft is the taking and removing of property or money with the intent to deprive the owner of it. Lost or mislaid property is not considered a theft; he cannot deduct the loss. Casualty losses are generally deductible only in the year the casualty occurred. However, if he has a deductible loss from a disaster in a presidential declared disaster area, he can choose to deduct that loss on his tax return for the year immediately preceding the year of the casualty. If he has already filed his return for the preceding year, the loss may be claimed in the preceding year by filing an amended return (Form 1040X) for Individuals or Form 1120X for Corporations. Generally, he must make the choice to use the preceding year, by the due date of the current year's return, without extensions. 1. What if property is covered by insurance? If the property is covered by insurance, a timely insurance claim for reimbursement of the loss has to be filed. Otherwise he cannot deduct this loss as a casualty or theft. This does not apply to the portion of the loss not covered by insurance. 2. What in case of Business or Income-Producing Property? If business or incomeproducing property, such as rental property, is stolen or completely destroyed or lost because of a casualty, the amount of loss is adjusted basis in the property minus any salvage value and insurance or other reimbursement that taxpayer receives or expects to receive. Adjusted basis is usually the cost, increased or decreased by various events such as improvements or depreciation. 3. What in case of Personal-Use Property or Personal-Use Business of Income-Producing Property? To determine the amount of a casualty or theft loss of personaluse property, or of the personal-use portion of business or incomeproducing property that is used partly for personal purposes, taxpayer must know the FMV of his property before and after the
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casualty. Fair Market Value (FMV) is the price for which he could have sold the property to a willing buyer if neither the seller nor the buyer had to sell or buy and both knew all relevant facts. The amount of his loss is the lesser of: 1. The decrease in fair market value as a result of the casualty; or 2. The adjusted basis in the property before the casualty or theft. 4. How to compute this loss? Step 1: Reduce Reimbursements Taxpayer must reduce his loss by any reimbursement he receives or expects to receive, such as an insurance recovery. Step 2: Increase Adjusted Basis He must increase the adjusted basis by amounts he spends on repairs after a casualty that substantially prolong the life of the property, increase its value, or adapt it to a different use. Step 3: $100 Reduction To determine how much of the loss is deductible, if the property was held by taxpayer for personal use, or partly for personal use, he further reduces his loss by $100. This $100 reduction for personal use property applies to each casualty or theft event that occurred during the year, regardless of how many items of property are involved. Step 4: 10% AGI Reduction The total of all the casualty and theft losses of personal use property for the year must then be reduced by 10% of his adjusted gross income. Step 5: Deductible Casualty or Theft Loss The balance that remains after making these reductions is the amount of his deductible casualty or theft loss on personal-use property. 5. Which form to use? To claim a casualty or theft loss, he must complete Form 4684: Casualties and Thefts, and attach it to his return. He may claim casualty or theft loss of personal use property only if he itemizes deductions on Schedule A.
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PART VIMISCELLANEOUS DEDUCTIONS 1. What are the deductions subject to 2% limits? It applies only to items in Lines 20, 21 and 22 of Sch-A. 2. How are the deductions subject to 2% limit categorized? Deductions subject to the 2% limit are discussed in the three categories in which the taxpayer reports them on Schedule A: Un-reimbursed employee expenses (line 20). Tax preparation fees (line 21). Other expenses (line 22).
3. Who are not subject to this 2% limit? The following are certain class of employees whose expenses are not subject to the 2% limit: Armed Forces Reservists. Educators. Impairment-related work expenses. Performing artist. State and Local Government Officials.
4. What are Un-reimbursed Employee Business Expenses? Taxpayer may be able to deduct the following items as unreimbursed employee expenses which are reported in Line 20 of Sch-A: Work related education expenses Legal fees related to his job Licenses and regulatory fees Medical examinations required by his employer Occupational taxes Passport for a business trip (including visa stamping) Subscriptions to professional journals and trade magazines related to his work Travel, transportation, entertainment and gift expenses (as in Pub.463) Business liability insurance premiums paid for protection against personal liability for wrongful acts on job. (ref Question#5) Damages for Breach of Employment Contract Depreciation on Computers or Cellular Telephones Dues to Chambers of Commerce and Professional Societies Job search expenses-Conditions: i. Taxpayer is not looking for a job for the first time ii. He is looking for a job in the same occupation iii. There is no substantial break between his last job and the new one Employment and outplacement agency fees Research expenses of a College Professor Tools used in his work Union membership fees not related to political activities Work clothes and uniforms-Conditions: i. His employment demands he must wear them, and
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ii. The clothes are not suitable for everyday wear. Example: Nurse, Doctor, Lawyers, etc. Protective Clothing E.g.: Coal Mines, Cement Factory, Medical/Pharmaceuticals Company.
5. What is meant by Business Liability Insurance? The Insurance plan for which taxpayer deducts insurance premiums he paid for protection against personal liability for wrongful acts on the job. 6. What is Tax Preparation Fees? Where is it Reported in Sch-A? It includes: Regular TY Fees, Amendment Fees E-filing fees Preparation of Schedules C/E/F
It is reported in Line 21 of Sch-A. 7. What are the other expenses? Where to report them? They include expenses paid to: Produce or collect income that must be included in the taxpayers Gross Income Manage, conserve or maintain property held for producing such income E.g.: Bungalow Maintenance charges Determine, contest, pay or claim a refund of any tax.
Examples: a. Appraisal Fees paid to determine FMV of donated property b. Certain casualty and theft losses E.g.: Cell phone/Laptop lost etc. through Form 4684 c. Fees paid to a broker, bank, trust or similar agent to collect taxable bond interest or dividends on shares. Exceptions: i. Fees paid to a broker to buy investment property add this to the cost of property. ii. Fees paid to a broker to sell the securities Enter in Schedule D to figure gain/loss. d. Deduct hobby expenses only if there is hobby income e. Investment Fees and Expenses f. Legal Expenses if: i. Related to keeping or doing his job ii. For tax advice related to a divorce iii. To collect taxable alimony g. Safe Deposit Box Rent
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i. Condition: Only if used to store taxable income-producing stocks, bonds or investment-related papers and documents. ii. Exception: Not deductible for jewelry, tax-exempt securities or other personal items. h. Service charges on dividend reinvestment plans. 8. What are the Deductions that are not subject to 2% limits? Expenses which are not subject to 2% limits are reported in Line 27 of Sch-A Examples: Casualty and theft losses if it was an income-producing property (stocks, bonds, gold, silver, art works etc.) Gambling losses only up to the amount of gambling winnings Show winnings on Line 21 of Form 1040 and claim losses on Line 27 of Schedule A Schedule K-1 (Box 2) Loss from other activities
9. List some Nondeductible Expenses. Taxpayer cannot deduct the following expenses: Burial or funeral expenses Car Licenses, Marriage licenses and dog tags Home repairs, insurance and rent Losses from sale of his home, furniture, personal car etc. Personal disability insurance premiums Personal, living or family expenses Child adoption expenses Fines or penalties Home Security Expenses Investment related seminars, conventions, meetings Life insurance premiums Lost or mislaid cash or property Meals while working late Personal legal expenses Political contributions Residential Telephone Service Tax-exempt income expenses Travel expenses for another individual (other than business associate/expert) like spouse, dependent who accompanies him on business travel Wrist watches.
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CHAPTER 40: MOVING EXPENSES
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1. Where can the taxpayer deduct Moving Expenses? Moving expenses are figured on Form 3903 and deducted as an adjustment to income on Form 1040. Taxpayer cannot deduct any moving expenses that were reimbursed by his employer He cannot deduct moving expenses on Form 1040EZ or Form 1040A. 2. Who can deduct Moving Expenses? Taxpayer can deduct his moving expenses if he meets all the following requirements: a. He move is closely related to the start of work. b. He meets the distance test. c. He meets the time test. a. Move is closely related to the start of work - The employee's move must be closely related, both in time (generally within 12 months to start date) and place (generally the distance from the employee's new home to the new job location should not be greater than the distance from the employee's old home to the new job location), to the start of work at the new job location. b. Meet the distance test - No moving expenses can be excluded from the employee's income unless the employee's new work site is at least 50 miles farther from his former residence than his old work-site was from his old residence. i. Distance between his old home and new work place ii. Distance between his old home and old work place iii. Difference=(i-ii) iv. Test (whether (iii) is at least 50 miles) v. If Yes Claimable; If No-Not Claimable. c. Meet the Time Test i. If Employee must be employed full time for at least 39 weeks during the first 12 months. ii. If Self-employee must be employed full time for at least 78 weeks during the first 24 months An example of the distance test is given below
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3. What if Time test is not met? Taxpayer can deduct his moving expenses on his 2010 tax return even though he has not met the time test by the date his 2010 return is due. He can do this if he expects to meet the 39-week test in 2009 or the 78-week test in 2009 or 2010. If the taxpayer does not deduct his moving expenses on his 2087 return, and he later meet the time test, he can file an amended return for 2010 to take the deduction. NOTE: If he deduct moving expenses but do not meet the time test in 2009 or 2010, taxpayer must either: 1. Report his moving expense deduction as other income on his Form 1040 for the year he cannot meet the test, or 2. Amend the 2007 tax return using Form 1040X. 4. What moving expenses are deductible? If taxpayer meets the requirements discussed earlier in Question 2 (Who Can Deduct Moving Expenses?), he can deduct the reasonable expenses of: 1. Moving his household goods and personal effects and 2. Traveling (including lodging but not meals) to his new home. Examples of deductible moving expenses: The cost of traveling from his former home to his new one should be by the shortest, most direct route available by conventional transportation. If he uses his car to take himself, members of his household, or his personal effects to his new home, he can figure his expenses by deducting either: 1. The actual expenses, such as gas and oil for his car, if he keeps an accurate record of each expense, or 2. The standard mileage rate (51 cents per mile from January 1 through
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December 31, 2010) Whether he uses actual expenses or the standard mileage rate to figure his expenses, he can deduct parking fees and tolls he pays in moving. 5. What moving expenses are not deductible? Taxpayer cannot deduct the following items as moving expenses: Any part of the purchase price of his new home Car tags / Driver's license Expenses of buying or selling a home (including closing costs, mortgage fees, and points) Expenses of getting or breaking a lease Home improvements to help sell his home Loss on the sale of his home Losses from disposing of memberships in clubs Mortgage penalties Pre-move house hunting expenses Real estate taxes Refitting of carpet and draperies Return trips to his former residence. Security deposits (including any given up due to the move) Storage charges except those incurred in transit and for foreign moves
Examples of non-deductible moving expenses: Taxpayer cannot deduct any expenses for meals during the travel. If during his trip to his new home, he stops over, or make side trips for sightseeing, the additional expenses for his stopover or side trips are not deductible as moving expenses. He cannot deduct any part of general repairs, general maintenance, insurance, or depreciation for his car.
6. When to deduct the moving expenses? If there is no reimbursement, then deduct the expenses in the year he incurred or paid. If there is a reimbursement, then deduct in the year he paid or received. Reimbursements are generally taxable in the year he received if he uses cash method of accounting and he paid the expenses before due date of filing the taxes or before extension for filing the tax return.
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CHAPTER 41: CHILD TAX CREDIT
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INTRODUCTION: This credit is for people who have a qualifying child. With the Child Tax Credit, taxpayer may be able to reduce the federal income tax he owes by up to $1,000 for each qualifying child. It is in addition to the credit for child and dependent care expenses (on Form 1040, line 48 or Form 1040A, line 29) and the earned income credit (on Form 1040, line 66a, or Form 1040A, line 41a). Publication 972 explains child tax credit. 1. Who is a qualifying child? A qualifying child for purposes of the child tax credit is child who: a. Is taxpayers son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, his grandchild), b. Was under age 17 at the end of 2010 c. Did not provide over half of his or her own support for 2010
d. Lived with the taxpayer for more than half of 2010 and e. Was a U.S. citizen, a U.S. national, or a resident of the United States Exceptions to time lived with the taxpayer condition: A child is considered to have lived with the taxpayer for all of 2010 if child was born or died in 2010 and his home was childs home for the entire time he or she was alive. Temporary absences for special circumstances, such as for school, vacation, medical care, military service, or business, count as time lived with him. Kidnapped children and children of divorced or separated parents. NOTE: For each qualifying child taxpayer must either check the box on Form 1040 or Form 1040A, line 6c, column (4), complete Form 8901 (if the child is not his dependent). 2. What about qualifying child of more than one person? A special rule applies if the qualifying child is the qualifying child of more than one person. For details, see table below :
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IF more than one person files a return claiming the same qualifying child and. Only one of the persons is the child's parent Two of the persons are parents of the child and they do not file a joint return together Two of the persons are parents of the child, they do not file a joint return together, and the child lived with each parent the same amount of time during the year, None of the persons are the child's parent,
THEN the child will be treated as the qualifying child of the. . . Parent Parent with whom the child lived for the longer period of time during the year Parent with the highest adjusted gross income (AGI)
Person with the highest AGI.
3. What if qualifying child is not taxpayers dependent? If taxpayer has a qualifying child who is not his dependent, he must complete and file Form 8901: Information on Qualifying Children Who Are Not Dependents, to claim this Child Tax Credit. 4. Can taxpayer claim child tax credit for an adopted child? An adopted child is always treated as his own child. An adopted child includes a child lawfully placed with the taxpayer for legal adoption. If he is a U.S. citizen or U.S. national and his adopted child lived with him all year as a member of his household in 2010, and that child was also a U.S. citizen, a U.S. national, or a resident of the United States for the entire tax year, then he can claim Child Tax Credit even for that adopted child. 5. When do limits apply? If the amount on Form 1040, line 46 or Form 1040A, line 28 is less than the credit. If this amount is zero, taxpayer cannot take this credit because there is no tax to reduce. But he may be able to take the additional child tax credit. If the modified adjusted gross income (AGI) is above the following limits : I. Single, head of household or qualifying widow(er) - $75,000. II. Married filing separately - $55,000. III. Married filing jointly - $110,000. 6. How to compute Modified adjusted gross income? Computation of Modified adjusted gross income: i. ii. iii. iv. AGI on line 38 of Form 1040 or line 22 of Form 1040A Add: Amount on line 43 on Form 1040 and line 38 of Form 2555 Add: Amount on line 18 of Form 2555 - EZ Total MAGI : (i) + (ii) + (iii)
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7. How to claim child tax credit? To claim the child tax credit, taxpayer must file Form 1040 or Form 1040A. He cannot claim the child tax credit on Form 1040EZ. He must provide the name and identification number (usually social security number) on his tax return (Form 8901) for each qualifying child. PART II ADDITIONAL CHILD TAX CREDIT INTRODUCTION:
The additional child tax credit is a credit taxpayer may be able to take if he is not able
to claim the full amount of the child tax credit. credit.
This credit is for certain individuals who get less than the full amount of the child tax The additional child tax credit may give him a refund even if he does not owe any tax.
Summary of Important things to know about the Additional Child Tax Credit: Taxpayers household must have taxable earned income above $11,000 or he will not be eligible. The Additional Child Tax Credit is claimed by filing Form 8812 with his federal tax return.
1. Who can claim Additional child tax credit? If taxpayer has a qualifying child and owe less in tax than the full amount of CTC he may claim additional child tax credit 2. How to claim the Additional child tax credit? To claim the additional child tax credit, follow the steps below: I. Multiply the number of qualifying children x $1000. II. Subtract the amount taxpayer owes in tax from this figure; call this Amount A. III. To be eligible for the Additional Child Tax Credit, Amount A must greater than $0. IV. Take the total taxable earned income and subtract $11,750. V. Take 15% of this amount (i.e., multiply by 0.15), call this Amount B VI. The smaller of Amount A and Amount B is the Additional Child Tax Credit (i.e., what can be refunded to the taxpayer). NOTE: If taxpayer has 3 or more qualifying children there are additional calculations specified on Form 8812 (Additional Child Tax Credit) that need to be made.
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CHAPTER 44: TAX BENEFITS FOR EDUCATION
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Part I: Scholarships, Fellowships, Grants and Tuition Reductions 1. General Notes: a. A Taxable Scholarship or Fellowship is Compensation only if it is shown in Box 1 of Form W-2. b. Taxpayer can set up and make contributions to an IRA if he receives such taxable compensation. 2. What are Scholarships and Fellowships? a. A Scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student can be either an undergraduate or a graduate. b. A Fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. 3. When are Scholarships or Fellowships tax free? a. They are tax free only if: i. Taxpayer is a candidate for a degree at an eligible educational institution, and ii. He uses the scholarship or fellowship to pay qualified education expenses. b. A candidate for degree is one attending: i. A primary or secondary school or ii. A college or university or iii. Any other accredited educational institution. c. Qualified Education Expenses include payments for: i. Tuition and fees to enroll or attend at an eligible educational institution, and ii. Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at such eligible educational institution. d. Qualified Education Expenses do not include payments for: i. Room and board, ii. Travel iii. Research iv. Clerical help v. Other irrelevant expenses e. If any of the amounts in (d) are paid even to the institution itself, as a condition of enrollment or attendance, still these costs are taxable. f. If the amount of scholarship or fellowship is used for any purpose other than towards Qualified Education Expenses, then they are taxable to the extent of such expenditure. g. Even athletic scholarships are tax free if the above requirements are met. If he wins scholarships as a prize in a contest, still they are fully taxable. 4. Reporting Scholarships or Fellowships: a. If the taxpayers only income is a completely tax-free scholarship or fellowship, he does not have to file a tax return and no reporting is necessary. b. If all or part of his scholarship or fellowship is taxable and he is required to file a
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tax return, report the taxable amount whether or not he received a Form W-2. If he received incorrect Form W-2, ask for a corrected one. c. If he files Form 1040 / 1040A, report the taxable amount on Line 7. If Form 1040EZ on Line 1. If the taxable amount was not reported on Form W-2 then enter SCH and the taxable amount in the space to the left of Line 7 (Line 1 in case of 1040 EZ). d. If he received scholarship as pay for his services as an independent contractor and his net earnings are $400 or more, then he will have to pay self-employment tax and figure it through Schedule SE. 5. Other Types of Educational Assistance: a. Fulbright Grants: They are generally treated as scholarship or fellowship and are normally tax free. Only the taxable amount must be reported as in Question 4 (above). b. Pell Grants and Other Title IV Need-Based Education Grants: These needbased grants are treated as scholarships and are tax free to the extent used for Qualified Education Expenses during the period for which the grant is awarded. Only the taxable amount must be reported as in Question 4 (above). 6. Qualified Tuition Reduction: a. It means a tax-free reduction in tuition provided by an eligible educational institution to certain individuals (refer Pub. 970 for more details) for education below the graduate level (including primary and secondary school). b. Tuition reductions for graduate education are also considered tax free if they are provided by an eligible educational institution to a graduate student who performs teaching or research activities for that institution. All other tuition reductions for graduate education are taxable. c. All taxable tuition reductions must be included as wages in Box 1 of Form W-2 and reported on Line 7 of Form 1040/1040A (Line 1 incase of Form 1040EZ).
Tax-Treaty Exemption for Nonresidents: An alien student, trainee, researcher may claim treaty exemption for a scholarship or fellowship by submitting Form W-8BEN to the payer of the grant. However, a scholarship or fellowship recipient who receives both wages and scholarship/fellowship which are exempt from tax from the same institution can claim treaty exemptions on both kinds of income on Form 8233. In such case, the recipient who is claiming treaty exemption must provide taxpayer with his/her ITIN or SSN on Form W-8BEN or Form 8233. Otherwise, he cannot allow the treaty exemption. Under the Internal Revenue Code, a student may become a resident alien for tax purposes if his/her stay in the US exceeds 5 calendar years. Even if he becomes resident still he can claim tax treaty exemption giving Form W-9 to the payer of the grant and attaching an explanation statement.
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Part II: Education Credits 1. Education Credits: They are of two types: a. Hope Credit: b. Lifetime Learning Credit 2. Difference between Hope Credit and Lifetime Learning Credit: Comparison of Education Credits Hope Credit Lifetime Learning Credit Up to $1,800 credit per eligible student Up to $2,500 credit per return Available ONLY until the first 2 years of postsecondary education is completed Available ONLY for 2 years per eligible student Student must be pursuing an undergraduate degree or other recognized education credential Available for all years of postsecondary education and for courses to acquire or improve job skills Available for an unlimited number of years Student does not need to be pursuing a degree or other recognized education credential
Student must be enrolled at least half time Available for one or more courses for at least one academic period beginning during the year No felony drug conviction on student's record Felony drug conviction rule does not apply
3. On Hope Credit: It is a nonrefundable tax credit. It is limited to the amount of the tax. If the credit is more than the tax, then the excess will not be refunded to the taxpayer. Taxpayer cannot take both an education credit and the tuition and fees deduction for the same student in the same year. Taxpayer cannot take the Hope Credit for more than 2 years for the same student. He cannot claim both Hope Credit and Lifetime Learning Credit for the same student in the same year. The taxpayer cannot claim the Hope Credit if he is subject to the phase out because of the amount of your income. The Hope Credit is phased out as modified AGI rises from $90,000 to $110,000 for joint IRS tax return filers ($45,000 to $55,000 for single tax filers). The Hope Credit is nonrefundable and is available for up to 100% of the first $1,100 and 50% of the second $1,100 of qualified tuition and related expenses paid during a taxable year. If either the Lifetime Learning Credit or the education income exclusion for withdrawals from an Education IRA is elected the Hope Credit may not be taken on the taxpayers tax return. In the case of a dependent, if either the Hope Credit or the Lifetime Learning Credit is claimed by a taxpayer other than the student (e.g., a parent), the dependent student may not claim the Hope Credit, and the taxpayer is treated as paying all eligible
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expenses for the tax year for Hope Credit purposes. 4. On Lifetime Learning Credit: Taxpayer may be able to claim up to $2,500 as Lifetime Learning Credit There is no limit on the number of years the Lifetime Learning Credit can be claimed for each student. It is a nonrefundable tax credit. It is limited to the amount of tax. If the credit is more than tax, then the excess will not be refunded to the taxpayer. Taxpayer cannot take both an education credit and the tuition and fees deduction for the same student in the same year. Taxpayer cannot claim both Hope Credit and Lifetime Learning Credit for the same student in the same year. 5. Who can claim the Hope Credit / Lifetime Learning Credit? The taxpayer can claim if all of the following three conditions are met: a. Taxpayer paid Qualified Education Expenses of higher education for an eligible student b. The eligible student can be the taxpayer, his spouse, or a dependent for which the taxpayer claims an exemption on his tax return. c. If the taxpayer claimed exemption for dependent, then, only he can claim the Hope Credit but not the dependent. 6. Who cannot claim the Hope Credit / Lifetime Learning Credit? a. b. c. d. The taxpayers filing status is MFS The taxpayer is claimed as a dependent in some one elses tax return. Taxpayers MAGI is $55000 or more ($110000 or more in case of MFJ). Taxpayer (or his spouse) was a nonresident alien for any part of 2007 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. e. Taxpayer claimed either the other education credit or a Tuition and Fees Deduction for the same student in 2007. f. If the taxpayer deducts higher education expenses as business expense on his tax return. g. If the taxpayer did not claim exemption for dependent on his tax return, then the dependent can claim the Hope Credit / Lifetime Learning Credit not the taxpayer. 7. What expenses qualify for the Hope Credit / Lifetime Learning Credit? All Qualified Education Expenses as defined in Question 4 of Part III qualify for the Hope Credit / Lifetime Learning Credit. 8. Who is an Eligible Student? For the purposes of Hope Credit, the taxpayer is an eligible student if he meets all of the following requirements: a. Taxpayer did not claim Hope Credit in any earlier tax years for 2 years. b. The student had not completed the first 2 years of postsecondary education before 2007. c. For at least one academic period beginning in 2007, the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. d. The student was free of any federal or state felony conviction.
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For the purposes of Lifetime Learning Credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution. 9. Who can claim dependent expenses? If expenses are paid by
Dependent
Taxpayer
Others
If the taxpayer claims exemption for the dependent, treat any expenses paid (or deemed paid) by his dependent as if he paid them and claim Hope Credit / Lifetime Learning Credit, as the case may be.
If the taxpayer claims exemption for the dependent, only he can include any expenses he paid when figuring the Hope Credit. If neither the taxpayer nor his spouse, claim dependent exemption, then only the dependent can claim Hope Credit / Lifetime Learning Credit, as the case may be.
If some one makes a payment directly to the eligible educational institution, then student is treated as receiving the payment from other person and paying the institution. If the taxpayer claims exemption for such student, then he can claim the Hope Credit / Lifetime Learning Credit, as the case may be.
10. How to figure the Hope Credit / Lifetime Learning Credit? The amount of the Hope Credit per eligible student is the sum of: a. 100% of the first $1,100 of Qualified Education Expenses the taxpayer paid for the eligible student, and b. 50% of the next $1,100 of Qualified Education Expenses the taxpayer paid for that student. Note: The maximum amount of Hope Credit you can claim in 2010 is $1650 times the number of eligible students. The amount of the Lifetime Learning Credit is 25% of the first $10,000 of Qualified Education Expenses the taxpayer paid for the eligible student. Note: The maximum amount of Lifetime Learning Credit the taxpayer can claim in 2010 is $2500 (25% of $10000). 11. Which form to use? a. To figure the Hope Credit / Lifetime Learning Credit, the taxpayer should receive st Form 1098-T from the eligible educational institution by 31 of January next tax year. b. The taxpayer must claim the Hope Credit by completing Parts I and III of Form 8863.
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c. The taxpayer must claim the Lifetime Learning Credit by completing Parts II and III of Form 8863. Part III: Tuition and Fees Deduction 1. Who can claim this deduction? If both the conditions are met: a. The taxpayer pays qualified education expenses of higher education for an eligible student b. The eligible student is the taxpayer, his spouse or dependent for whom he claims an exemption on his tax return. 2. Who cannot claim this deduction? If any of the following apply: a. The Taxpayers filing status is MFS b. Taxpayer is claimed as a dependent on someone elses tax return c. Taxpayers MAGI is more than $80000 (or $160000 if MFJ) d. The taxpayer was a nonresident alien for any part of the year and did not elect to be treated as a resident alien for tax purposes. e. The taxpayer or anyone else claims a Hope or Lifetime Learning Credit for the eligible student. 3. When can the taxpayer claim this deduction? Generally, the deduction is allowed for qualified education expenses paid in current tax year (say 2010) in connection with the following: a. Enrollment at an institution of higher education during current tax year (say 2010) b. For an academic period beginning current tax year ( say 2010) or in the first 3 months of the next tax year (say 2009) Here academic period includes a semester, trimester, quarter, or such other period of study as may be determined by the educational institution. Please note that the educational institution must be administered by the U.S. Department of Education. 4. What are Qualified Education Expenses? Any expenses paid are deductible as qualified education expenses only if they are paid to the institution as a condition of enrollment or attendance. They include amount paid towards: a. Student-activity fees b. Expenses for course-related books, supplies and equipment They do not include the amounts paid for (even if paid to the institution as a condition of enrollment or attendance): 1. Insurance 2. Medical Expenses / Student Health Fees 3. Room and Board 4. Transportation 5. Similar personal, living or family expenses The institution will provide the taxpayer with the amount he paid (or were billed) for Qualified Education Expenses on Form 1098-T: Tuition Statement.
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5. Who is an Eligible Student? a. A student who is enrolled in one or more courses at an eligible education institution. b. The student must have either a high school diploma or a General Educational Development credential. 6. Caution: The taxpayer cannot do any of the following: a. Deduct as Qualified Education Expenses if he deducted them under any other provision of law (E.g. as Business Expense). b. Deduct as Qualified Education Expenses paid with tax-free scholarship, grant or employer-provided educational assistance. Only the expenses in excess of such taxfree scholarship, grant or employer-provided educational assistance can be deducted. 7. What is the deduction? a. This deduction can reduce the amount of the taxpayers taxable income by up to $4000 or $2000 or $0, depending on the amount of his MAGI. b. This deduction is taken as an adjustment to income on Form 1040 or 1040A. c. This deduction can be claimed whether the taxpayer itemizes or files standard return. d. To help the taxpayer figure his tuition and fees deduction, he should receive Form st 1098-T from the eligible educational institution by 31 January of next tax year. e. If the taxpayer received any assistance / refund this tax year for the tuition and fees deduction claimed in last tax year, include in his income in the year he received such assistance / refund to the extent he claimed deduction. Part III Student Loan Interest Deduction Background: Generally personal interest is not deductible. However, if the taxpayers MAGI is less than $65,000 (or $135000 in case of MFJ), there is a special deduction allowed for paying interest on a Student Loan (also known as Education Loan) used for higher education. Student Loan Interest Deduction is taken as an adjustment to income on Line 33 of Form 1040. Moreover, the taxpayer can claim this deduction even if he does not itemize deductions on Schedule A. When can the taxpayer claim this deduction? Only when all the following three conditions are satisfied: a. Taxpayers filing status is any status other than MFS b. Taxpayer is not claimed as dependent on someone elses tax return c. Taxpayer paid interest on a qualified student loan When you cannot claim this deduction? a. Taxpayers filing status is MFS b. Taxpayer paid interest on a loan though he is not legally obligated to make such interest payment as per the terms of the loan. c. Taxpayer paid loan origination fees as payments for property or services provided by lender. E.g. Commitment Fees, Processing Costs, etc.
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Exception to general rule for dependents: Here the taxpayer need not necessarily claim an exemption for his dependent on tax return. Taxpayer can have a dependent even if he is the dependent of another taxpayer and can accordingly claim student loan interest deduction for that dependent in his tax return. Taxpayer can have a dependent even if he files a joint return. Taxpayer can have a dependent even if his Gross Income was $3400 or more. Related Persons can be: Taxpayers Spouse Qualifying Child or Qualifying Relative Certain Corporations, Partnerships, Trusts, and Exempt Organizations. Qualified Education Expenses: For the purposes of Student Loan Interest deduction, they include amounts paid for: Tuition and fees Room and board, only as determined by the eligible educational institution Books, supplies, and equipment Other necessary expenses (such as transportation)
Part IV: Employer-Provided Education Assistance 1. Taxability: a. If the taxpayer receives educational assistance benefits from his employer under an Educational Assistance Program, he can exclude up to $5,250 of those benefits each year. b. These benefits must not be included by his employer in Box 1 of Form W-2. c. Thus, these benefits need not be shown on his income tax return. d. But, benefits over $5,250 must be included in Box 1 of Form W-2 by his employer. e. Now, if these benefits over $5,250 also qualify as a working condition fringe benefit, then his employer need not include them in Box 1 of your Form W-2. A working condition fringe benefit is a benefit which the taxpayer can deduct as an employee business expense, if he had paid for it. 2. When is it treated Educational Assistance Program? a. The plan must be written and must meet certain other requirements. b. The taxpayers employer can tell him whether this is qualified program 3. What are educational assistance benefits? a. They include payments for: i.Tuition, fees and similar expenses ii.Books, supplies and equipment. b. They do not include payments for: iii.Meals, lodging, or transportation iv.Courses involving sports, games or hobbies unless it is useful in business or required as a part of a degree program.
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Part V: Business Deduction for Work-Related Education 1. Standard Mileage Rate (car to and from school): a. 2010: 51 miles b. 2009: 50.5 miles 2. When can the taxpayer deduct as Work-related education expenses? a. He must be working b. He must itemize his deduction on Schedule A / C / F c. He has expenses for Qualifying Work-Related Education 3. What are the tax benefits? a. The taxpayer can deduct them as Work-related education expenses on Line 20 of Schedule A b. These work-related education expenses also qualify for other benefits such as i. Tuition and fees deduction and ii. Hope and Life time learning credits 4. How to figure the taxes? a. Method 1: Figure the taxes by treating the taxpayers expenses as tuition and fees deduction b. Method 2: Figure the taxes again using any of the other deductions and credits which the taxpayer qualifies, which ever is beneficial. 5. What is Qualifying Work-Related Education? If it meets any of the following tests: a. Education is required by the taxpayers employer for business purpose or by the law to keep his present salary, status, or job (or) b. Education maintains or improves skills needed in his present work (E.g. refresher courses, academic or vocational courses, etc.) c. However, it is not a Qualifying Work-Related Education: i. If this study is needed to meet the minimum education requirements of his present trade or business / his employer / the laws and regulations he is subject to (or) ii. If this study qualifies him for a new trade or business, though he does not intend to enter that trade or business (E.g. Bar or CPA Review Course). But, change in duties cannot be treated as change to a new business. 6. Temporary absence Vs Indefinite absence: a. Temporary absence: If the taxpayer stops working for a year or less in order to get education to maintain or improve skills needed in his present work and then return to the same general type of work, though not with the same employer, his absence is considered temporary and the education that he gets during this absence is a Qualifying Work-Related Education b. Indefinite absence: If the taxpayer stops working for more than a year, his absence from his job is considered indefinite absence and the education that he gets during this absence is not a
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Qualifying Work-Related Education even though it maintains or improves his skills in the work from which he is absent. 7. Is it a Qualifying Work-Related Education in the following cases: a. Full time engineering student Working as a part time engineer Will be employed as full time engineer after completion: Not QWRE b. Accountant Met minimum education requirements when hired Later employer changed minimum education requirements and required to take additional education: Yes QWRE c. Accountant Employer wants the taxpayer to become a Lawyer at his own expense Taxpayer does not intend to practice as a Lawyer: Not QWRE d. Medical practitioner Attend course to review developments in several specialized medical fields for two weeks: Yes QWRE 8. When are expenses deductible? a. If the taxpayer meets the requirements of Qualifying Work-Related Education, deduct on Line 20 of Schedule A or, Schedule C / C-EZ and b. The expenses are not related to tax-exempt and excluded income. 9. What expenses are deductible? a. Tuition, books, supplies, lab fees and similar items b. Certain transportation and travel (meals and lodging) costs if the taxpayer travels overnight to obtain Qualifying Work-Related Education and the main purpose is to attend a work-related course or seminar. c. Other education expenses, such as costs of research and typing when writing a paper as part of an education. 10. What expenses are nondeductible? a. Personal expenses (E.g. value of time to attend classes) b. Capital expenses c. Expenses of a unclaimed reimbursement 11. Caution: Taxpayer cannot do any of the following a. Deduct work-related education expenses as business expenses on Form 2106 / 2106-EZ if he deducted these expenses under any other provision of law (E.g. as Tuition and Fees deduction on Line 34 of Form 1040) b. Deduct work-related education expenses paid with tax-free scholarship, grant or employer-provided educational assistance. Only the expenses in excess of such tax-free scholarship, grant or employer-provided educational assistance can be deducted. 12. Reimbursements: a. Accountable Plan Employer must not include the reimbursement in Box 1 of Form W-2 The taxpayer can deduct the qualifying expenses only in excess of the reimbursement received b. Non accountable Plan Employer must include the reimbursement in Box 1 of Form W-2 The taxpayer can deduct expenses regardless of whether they are more than, less than, or equal to your reimbursement in Box 1 of Form W-2. Note that reimbursement of nondeductible expenses is treated as reimbursement under a non accountable plan.
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CHAPTER 43: EARNED INCO CHAPTER 45: EARNED INCOME CREDIT
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SECTION - I 1. What is EIC? The EIC is the tax credit for certain people who work and have earned income below the prescribed limit. A tax credit usually reduces the amount of tax the taxpayer owes and may also give him a refund.
2. Who can claim EIC? In order to claim EIC, the taxpayer must meet certain rules. These rules are summarized here under:
#1: Rules for Everyone A. The taxpayers Earned Income & Adjusted Gross Income (AGI) must each be less than: For Tax Year 2006 $36,348 ($38,348 for MFJ) $32,001 ($34,001 for MFJ) $12,120 ($14,120 for MFJ if the taxpayer has more than one qualifying child, if the taxpayer has only one qualifying child if the taxpayer has no qualifying child
Maximum Earned Income Credit Allowed: (all in $) Particulars If the taxpayer has more than one qualifying child, If the taxpayer has only one qualifying child If the taxpayer has no qualifying child B. The taxpayer must have a valid SSN. C. His filing status cannot be MFS. If he is married, he usually must file a joint return to claim the EIC. His filing status cannot be Married filing separately. If he is married and his spouse did not live in his home at any time during the last 6 months of the year, he may be able to file as head of household, instead of married filing separately. In that case, he may be able to claim the EIC. For detailed information about filing as head of household, see Publication 501, Exemptions, Standard Deduction, and Filing Information. D. The taxpayer must be either a: U.S. Citizen or Resident Alien all the year or TY 2005 4300 2604 390 TY 2006 4536 2247 412 TY 2007 4716 2853 428
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Non-Resident Alien married to a U.S. Citizen or Resident Alien and filing a MFJ Return.
Note: He cannot claim the earned income credit if he is a non-resident alien for any part of the year, unless: 1. The taxpayer is married to a U.S. citizen or a resident alien, and 2. He chooses to be treated as a resident for all of 2005 by filing a joint return E. He cannot file Form 2555 or Form 2555-EZ (relating to Foreign Earned Income). F. His Investment Income must be as under: For TY 2005 For TY 2006 For TY 2007 $2700 or less. $2800 or less. $2900 or less.
G. He must have earned Income from Employment or Self-Employment. #2: Rules if the taxpayer has one Qualifying Child. A. The taxpayers Child must meet the relationship, age and residency tests. B. His qualifying child cannot be used by more than one person to claim the EIC. If he and someone else have the same qualifying child, he and the other person(s) can decide which of them, if otherwise eligible, will take all of the tax benefits C. He cannot be a qualifying child of another person. #3: Rules if the taxpayer has no Qualifying Child A. The taxpayer must be at least 25 years of age but not more than 65 years. If he is married filing a joint return, either he or his spouse must be at least age 25 but under age 65 at the end of 2010. It does not matter which spouse meets the age test, as long as one of the spouses does. If neither the taxpayer nor his spouse meets the age test, he cannot claim the EIC. Put No next to line 66a (Form 1040), line 41a (Form 1040A), or line 8a (Form 1040EZ). B. The taxpayer cannot be dependent of another person. If he is not filing a joint return, he meet this rules if: He checked box 6a on Form 1040 or 1040A, or He did not check the You box on line 5 of Form 1040EZ, and he entered $8,200 on that line. If he is filing a joint return, he meet this rules if: He checked both box 6a and box 6b on Form 1040 or 1040A, or He and his spouse did not check either the You box or the Spouse box on line 5 of Form 1040EZ, and he entered $16,400 on that line. C. The taxpayer cannot be a qualifying child of another person. D. The taxpayer must have lived in the US more than half of the year. His home (and his spouses, if filing a joint return) must have been in the United States for more than half the year. If it was not, put No next to line 66a (Form 1040), line 41a
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(Form 1040A), or line 8a (Form 1040EZ). 3. What is adjusted gross income (AGI)? AGI is the amount on Line 4 of Form 1040EZ, Line 22 of Form 1040A, or Line 38 of Form 1040. Note: If the taxpayers AGI is equal to or more than the prescribed limit listed above, he cannot claim the EIC. Example: For Tax Year 2010 the taxpayers AGI is $32,500, he is single, and he has one qualifying child. He cannot claim the EIC because his AGI is not less than $31,030. However, if his filing status was married filing jointly, he might be able to claim the EIC because his AGI is less than $33,030. Section III: Rules If the taxpayer has One Qualifying Child The taxpayer must file Form 1040 or Form 1040A to claim the EIC if he has one qualifying child. (He cannot file Form 1040EZ.) He must also complete Schedule EIC and attach it to his return. 4. Who is eligible as Qualifying Child? The taxpayers child is a qualifying child if he/she meets the following three tests. These three tests are: 1. Relationship, 2. Age, and 3. Residency. Test#1: Relationship Test To be the taxpayers qualifying child, a child must be his: Son, daughter, stepchild, eligible foster child, or a descendant of any of them (for Exercise, your grandchild), or Brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them (for Exercise, his niece or nephew) And
At the end of 2007 the child was: under 19 years of age or under 24 years of age and a student or Permanently and totally disabled at any time during the year, regardless of age And Who lived with the taxpayer in the United States for more than half of 2010. The following definitions clarify the relationship test: Adopted child: An adopted child is always treated as the taxpayers own child. The term adopted child includes a child who was lawfully placed with him for legal adoption.
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Eligible foster child: For the EIC, a person is the taxpayers eligible foster child if the child is placed with him by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. (An authorized placement agency includes a state or local government agency. It also includes a tax-exempt organization licensed by a state. In addition, it includes an Indian tribal government or an organization authorized by an Indian tribal government to place Indian children.) Exercise: Harry, who is 12 years old, was placed in the taxpayers care 2 years ago by an authorized agency responsible for placing children in foster homes. Now, Harry is his eligible foster child. Test#2: Age Test The taxpayers child must be: 1. Under age 19 at the end of 2010, 2. A full-time student under age 24 at the end of 2010, or 3. Permanently and totally disabled at any time during 2010, regardless of age. Important Exercise: The taxpayers son turned 19 years of age on December 10. Unless he was disabled or a fulltime student, he is not a qualifying child because, at the end of the year, he was not under age 19.
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CHAPTER 46: HEALTH SAVINGS ACCOUNT DEDUCTION
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1.) What is a Health Savings Account? Health Savings Accounts (HSA) are tax-deductible saving plans that allow a taxpayer to save pre-tax dollars for future healthcare expenses. HSA are paired with high-deductible health insurance plans. Features: Contributions to an HSA are tax-deductible. Earnings, such as interest and dividends, in the health savings account are tax-exempt. Withdrawals from a health savings account are tax-free if the funds are used for qualified medical expenses. 2.) What are the requirements to be met by an individual to qualify for HSA? To be an eligible individual and qualify for an HSA, the taxpayer must meet the following requirements: He has a high deductible health plan (HDHP), described later, on the first day of the month. He has no other health coverage except what is permitted under other health coverage, later. He is not enrolled in Medicare. He cannot be claimed as a dependent on someone elses 2010 tax return.
3.) What is a High Deductible Health Plan (HDHP)? An HDHP has: A higher annual deductible than typical health plans, and A maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that the taxpayer must pay for covered expenses. Out-of-pocket expenses include co payments and other amounts, but do not include premiums.
4.) What are the benefits of a Health Savings Account? The taxpayer may enjoy several benefits from having an HAS, like: He can claim a tax deduction for contributions he, or someone other than his employer, makes to his HSA even if he does not itemize his deductions on Form 1040. Contributions to his HSA made by his employer (including contributions made through a cafeteria plan) may be excluded from his gross income. The contributions remain in his account from year to year until he uses them. The interest or other earnings on the assets in the account are tax free. Distributions may be tax free if he pays for qualified medical expenses. An HSA is portable so it stays with the taxpayer if he changes employers or leave the work force.
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5.) What are the limits for tax deductions with regard to HSA contributions? For tax year 2010, HSA contributions are limited to: $2,900 for individual coverage, $5,800 for family coverage, and $700 for additional catch-up contributions for people age 55 or older.
6.) What is the deadline to contribute for the HSA? Contributions for the HSA for TY 2010 can be made until 17 April, 2011. 7.) What are the reporting requirements for the contribution towards HSA? Report all contributions to the taxpayers HSA on Form 8889-Health Savings Accounts (HSAs), and file it with his Form 1040. He should include all contributions made for 2010, including those made by April 17, 2011, that is designated for 2010. Contributions made by his employer are also shown on the Form 8889. His employer's contributions also will be shown in box 12 of Form W-2: Wage and Tax Statement, with code W. Report his HSA deduction on Form 1040, line 25. 8.) How are the excess contributions dealt with? The taxpayer will have excess contributions if the contributions to his HSA for the year are greater than the limits discussed earlier. Excess contributions are not deductible. Excess contributions made by his employer are included in his gross income. If the excess contribution is not included in box 1 of Form W-2, he must report the excess as Other Income on his tax return.
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CHAPTER 51: AMENDED RETURN
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1. Why to file an amended return? If the taxpayer made a mistake on a prior-year tax return, an amended return is the way to set things right. Arithmetic errors, missing information, and oversights are all fairly common, and generally there's no reason to fear filing an amended return - whether he owes money to the IRS or vice versa. 2. When do we file an amended return? We do file an amended return if the taxpayer discovers (before the IRS does) that any of the following were reported incorrectly: His filing status His total income His dependents His deductions or credits Certain special situations can also trigger amended returns. For example, if the taxpayer suffers a casualty loss in a presidentially-declared disaster area, he may deduct the loss on his tax return for the year of the disaster, or he may amend the prior-year return and deduct the loss in that year. The best strategy depends on his tax bracket for the years, plus other factors such as the amount of his loss and whether it occurred early or late in the year. Couples who filed separately can also change a return to married filing jointly so they can get some tax breaks not allowed to separate filers. The taxpayer can't, however, do the reverse. Changing from joint to separate filing after a return's deadline is past is not allowed. And there's also a section for adding or subtracting personal exemptions in case there was some confusion as to whether he properly counted someone as a dependent. Be sure the changes he wants to make are valid. The tax laws have changed frequently over the past several years. What was deductible one year might not be deductible the very next year, and the list of items includable in taxable income has also changed from year to year. If, as a result of the changes, the IRS owes to the taxpayer, he will receive a refund with interest. If he owes the IRS, payment should be made with the 1040X. The IRS will bill him for any additional interest. Regardless of the reason for the amended return, be sure to keep good records to substantiate the reasons for the change. 3. When to file? The taxpayer can file an amended return within three years of his original filing date. This includes any filing extensions.
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If the taxpayer is filing more than one amended return, be sure to mail each in a separate envelope to the IRS center for the area in which he lives. And don't forget his state taxes. Changes he made on an old federal filing might affect a previously filed state return. To get this three-year grace period, however, he must have paid all his tax due with the return in question. If he didn't pay in full then, he will only have two years from the time he finally paid his tax bill to make corrections. 4. Which Form to use? Form 1040X ("Amended U.S. Individual Income Tax Return") is the IRS form designed for amended filings, to correct a previously filed Form 1040, 1040A or 1040EZ. It doesn't matter if the taxpayer originally filed a paper return or sent it electronically. However, his amended return must be done on paper. The IRS e-file system does not yet accept electronic 1040X forms. The 1040X asks for his corrected data, the reason for the changes and his originally reported information. If the changes involve another schedule or form, attach it to the 1040X. By sending the IRS a corrected tax return in these cases, he might be able to get more money back. Or, if the mistake he made wasn't so favorable, he should own up to that, too. Either way, it's not a difficult process. Be sure to enter the year of the return he is amending at the top of Form 1040X. If he is amending more than one tax return, use a separate 1040X for each one and mail each return in a separate envelope to the IRS processing center for the area in which he lives. The 1040X instructions list the addresses for the centers. 5. How to fill Form 1040X? The Form 1040X has three columns. Column A is used to show original or adjusted figures from the original return. Column C is used to show the corrected figures. The difference between the figures in Columns A and C is shown in Column B. There is an area on the back of the form where the taxpayer explains the specific changes being made on the return and the reason for each change. If the changes involve another schedule or form, attach it to Form 1040X. Be sure to enter the year of the return he is amending at the top of the form as required. 6. How can the taxpayer check the status of my amended return? The taxpayer will need to contact IRS assistance line at (800) 829-1040 to receive information on the processing of his amended return. Amended/corrected returns are processed as quickly as possible. However, it could take 8 to 12 weeks to process an amended return. 7. Can the taxpayer check the status of the refund for an amended return on the automated tax line or access "Where's my Refund? The taxpayer cannot check the status of a refund for an amended return on the automated tax line or by accessing "Where's my Refund". Amended/corrected returns are processed as quickly as possible. However, it may take 8 to 12 weeks or longer to process the return. If 8 weeks have elapsed and he has not received your refund, he may call (800) 829-0582 (Ext.462) and check his file status.
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CHAPTER 52: CHILD AND DEPENDENT CARE EXPENSES CREDIT

1. When the taxpayer may be able to claim this credit? The taxpayer may be able to claim the credit if he pays someone to care for: His dependent who is under age 13 His spouse or dependent who is not able to care for himself or herself 2. What is the maximum limit? The credit can be up to 35% of your expenses. You must have paid these expenses so that you can work or look for work.
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3. What about Dependent Care Benefits on Form W-2? If the taxpayer received any dependent care benefits from his employer during the year, he may be able to exclude from his income all or part of them. For this, he must complete Part III of Form 2441 or Schedule 2 (Form 1040A) before he figures the amount of his credit.
4. Should the taxpayer have to pay employment taxes? If the taxpayer pays someone to come to his home and care for his dependent or spouse, he may be a household employer who has to pay employment taxes. He is not a household employer if the person who cares for his dependent or spouse does so at his or her home or place of business.
5. Which form to file to claim this credit? Either Form 1040 or Form 1040A but not Form 1040EZ. 6. What tests are to be satisfied to claim this credit? All of the following tests must be satisfied to claim this credit: a.Qualifying Person Test b.Earned Income Test c. Work-Related Expense Test d.Payment to Relatives Test e.Filing Status Test Single/HOH/QWDC/MFJ f. Provider Identification Test g.Reduced Dollar Limit Test Test 1: Qualifying Person Test: The taxpayers child and dependent care expenses must be for the care of one or more qualifying persons. A qualifying person can be: a. His qualifying child who was under age 13 when the care was provided who has lived with him for more than half the year and
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who is his dependent
b. His spouse or any other person who was physically or mentally not able to care for himself or herself, who lived with him for more than half the year, and was his dependent (can be either qualifying child or qualifying relative). Note: For purposes of this credit, a person is considered a dependent even if his or her: gross income was $3400 or more, or has filed a joint return, or were claimed as a dependent on someone elses tax return. Test 2: Earned Income Test To claim the credit, the taxpayer and his spouse (if married), must have earned income during the year. Here, Earned Income = Form W2 Income + Self-Employment Income Note: A spouse is treated to have earned income if he or she was either: a full time student or physically or mentally not able to care for himself or herself, and has lived with him for more than half the year But this rule applies to any one spouse for any one month. I.e. if both of them meet any of the above conditions, still only one of them is treated as having earned income in that month. Test 3: Work-Related Expense Test The taxpayers expenses are considered work-related only if both of the following conditions are satisfied: They allow him or his spouse (if married) to work or to look for work, and They are incurred for care of a qualifying person. Expenses for care include expenses for a child in nursery school, pre-school, or kindergarten; amounts paid to dependent care center (minimum 6 persons); amounts paid to housekeeper (including meals and lodging) Expenses for care do not include amounts the taxpayer pay for food, clothing, transportation, education and entertainment and amounts paid to attend kindergarten or a higher grade. Note: A spouse is treated to have working if he or she was either: a full time student or physically or mentally not able to care for himself or herself, and has lived with him for more than half the year This rule applies to both of them. But they must have found a job and must have earned income for the year to take this credit, otherwise no credit. Test 4: Payments to Relatives Test The taxpayer can count work-related payments he makes to relatives who are not his dependents, even if they live in his home. However, do not count any amounts paid to: A dependent for whom he or his spouse (if married) can claim an exemption His child who is under age 19
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His spouse
Test 5: Joint Return Test Married couples are eligible to claim these credits whether they file joint return, or separate return, or are legally separated. But the qualifying person, whom the taxpayers supports more than half of expenses, must have lived with him for at least 6 months even though his spouse did not live with him for last 6 months of the year. Test 6: Provider Identification Test The taxpayer must keep the name, address and TIN of all persons or organizations that provide care for his child or dependent. And must complete Part I of Form 2441 or Schedule 2 (Form 1040A) to show this information. He can use Form W-10: Dependent Care Providers Identification and Certification and request the required information from care provider. Test 7: Reduced Dollar Test There is a dollar limit on the amount of the taxpayers work-related expenses he can use to figure the credit. This limit is $3,000 for one qualifying person or $6,000 for two or more qualifying persons. If you paid work-related expenses for the care of two or more qualifying persons, the $6,000 limit does not need to be divided equally among them. For example, if the taxpayers workrelated expenses for the care of one qualifying person are $3,300 and his work-related expenses for another qualifying person are $2,800, he can use the total, $6,000, when figuring the credit. The dollar limit is a yearly limit. The amount of the dollar limit remains the same no matter how long, during the year, he has a qualifying person in his household. Use the $3,000 limit if he paid work-related expenses for the care of one qualifying person at any time during the year. Use $6,000 if he paid work-related expenses for the care of more than one qualifying person at any time during the year. Reduced Dollar Limit If the taxpayer received dependent care benefits that he excludes or deducts from his income, he must subtract that amount from the dollar limit that applies to hi. His reduced dollar limit is figured on lines 28 through 32 of Form 2441 or lines 22 through 26 of Schedule 2 (Form 1040A). Example: George is a widower with one child and earns $24,000 a year. He pays workrelated expenses of $2,900 for the care of his 4-year-old child and qualifies to claim the credit for child and dependent care expenses. His employer pays an additional $1,000 under a dependent care benefit plan. This $1,000 is excluded from George's income. Although the dollar limit for his work-related expenses is $3,000 (one qualifying person), George figures his credit on only $2,000 of the $2,900 work-related expenses he paid. This is because his dollar limit is reduced as shown below:
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Amount of Credit To determine the amount of his credit, multiply his work-related expenses (after applying the earned income and dollar limits) by a percentage. (Here $2000 X appropriate %) This percentage depends on his adjusted gross income shown on Form 1040, line 38, or Form 1040A, line 22. 7. How to figure this credit? This credit is allowed as a percentage of the taxpayers work-related expenses These expenses are subject to earned income limit and the dollar limit. The percentage are based on your AGI 8. How to figure total work-related expenses? To figure the credit for 2010 work-related expenses, count only those expenses the taxpayer paid till 12/31/2010. If he pays for services before they are provided, he can count the expenses paid only in the year the care is received. If he paid 2009 expenses in 2010, then do not count them as expenses in 2010, but he may be able to claim additional credit.
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CHAPTER 53: FOREIGN TAX CREDIT
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1.) Why Foreign Tax Credit? The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived. 2.) What are the different ways to figure the Foreign Taxes paid? The taxpayer can choose to take the amount of any qualified foreign taxes paid or accrued during the year as: a foreign tax credit or An itemized deduction.
To choose the deduction, he must itemize deductions on Form 1040, Schedule A. To choose the foreign tax credit he generally must complete Form 1116 and attach it to his Form 1040. Every year he can change his option whether to claim as a Credit or as a Deduction. Note: If foreign taxes paid are not computed in US currency, then use the exchange rate prevalent on the date he paid the foreign taxes to compute the amount of foreign taxes paid to that foreign country. 3.) Which choice among the above mentioned is beneficial for the Tax Payer? A tax credit reduces the taxpayers US tax liability on a dollar-for-dollar basis, and so is generally more valuable than a deduction which reduces his taxable income. 4.) Who are eligible to claim the Foreign Tax Credit? U.S. citizens, resident aliens, and certain nonresident aliens who paid foreign income tax and are subject to U.S. tax on foreign source income may be able to take a foreign tax credit. They can be any of the following: Individual The taxpayer (and his spouse) Partner Beneficiary of an estate or trust Shareholder in a S Corporation Shareholder of a Mutual Fund Certain Foreign Corporations
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5.) What is the Maximum Allowable Tax Credit? The taxpayers foreign tax credit cannot exceed his US tax liability multiplied by a percentage. The percentage is his total foreign-source income divided by his total worldwide income. He must figure the allowable amount by various categories of income. Examples of income categories include investment income (interest, dividends), royalties and wages. 6.) How is the Tax Credit claimed? The taxpayer can choose to take a credit in one year, and a deduction in the next year. He can even change his choice by amending his tax return within 10 years of the original due date of the tax return. 7.) What Foreign Taxes are qualified for the credit? Generally, the following four tests must be met for any foreign tax to qualify for the credit: 1. The tax must be imposed on the taxpayer. 2. He must have paid or accrued the tax. 3. The tax must be the legal and actual foreign tax liability. 4. The tax must be an income tax (or a tax in lieu of an income tax). Taxes in lieu of Income Taxes: A foreign levy is a tax in lieu of an income tax only if: It is not payment for a specific economic benefit, and The tax is imposed in place of, and not in addition to, an income tax otherwise generally imposed. A tax in lieu of an income tax does not have to be based on realized net income. A foreign tax imposed on gross income, gross receipts or sales, or the number of units produced or exported can also qualify for the credit. 8.) For which foreign taxes the taxpayer cannot claim the credit? The foreign taxes for which the taxpayer cannot take a credit are: Taxes on excluded income, Taxes for which the taxpayer can only take an itemized deduction, Taxes on foreign oil related income, Taxes on foreign mineral income, Taxes from international boycott operations, Taxes of U.S. persons controlling foreign corporations or partnerships
9.) Mention some foreign taxes that are not income taxes. Generally, only foreign income taxes qualify for the foreign tax credit. Other taxes, such as foreign real and personal property taxes, do not qualify. But the taxpayer may be able to deduct these other taxes even if he claims the foreign tax credit for foreign income taxes. He generally can deduct these other taxes only if they are expenses incurred in a trade or business or in the production of income. However, he can deduct foreign real property taxes that are not trade or business expenses as an itemized deduction on Schedule A (Form
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1040). 10.) Define Carry back and Carryover. If, because of the limit on the credit, the taxpayer cannot use the full amount of qualified foreign taxes paid or accrued in the tax year, he may be allowed a 1-year carry back and then a 10-year carryover of the unused foreign taxes. This means that he can treat the unused foreign tax of a tax year as though the tax were paid or accrued in your first preceding and 10 succeeding tax years up to the amount of any excess limit in those years. Note: If the taxpayer deducts foreign taxes in a tax year, he cannot use a carry back or carry over in that year because he cannot take both a deduction and a credit in the same tax year. 11.) How to figure the Foreign Tax Credit? Complete Form 1116 and attach it to Form 1040. Enter the credit on Form 1040, line 47. 12.) What is the exception for filing the Form 1116? The taxpayer does not have to complete Form 1116 to take the credit if all five of the following apply: All of his gross foreign source income was from interest and dividends and all of that income and the foreign tax paid on it were reported to him on Form 1099-INT, Form 1099-DIV, or Schedule K-1 (or substitute statement). If he had dividend income from shares of stock, he held those shares for at least 16 days. The total of his foreign taxes was not more than $300 (not more than $600 if married filing jointly). All of his foreign taxes were Legally owed and not eligible for a refund, and Paid to countries that are recognized by the United States and do not support terrorism. 13.) Is there any limit on the Credit? Unless the taxpayer can elect not to file Form 1116, his foreign tax credit cannot be more than his U.S. tax liability (Form 1040, line 44), multiplied by a fraction. The numerator of the fraction is his taxable income from sources outside the United States. The denominator is his total taxable income from U.S. and foreign sources. 14.) What are the exemptions from the Credit limit? The taxpayer will not be subject to this limit and will be able to claim the credit without using Form 1116 if the following requirements are met: His only foreign source gross income for the tax year is passive income (interest, dividends, rent, royalties, annuities, etc.) However, for purposes of this rule, high taxed income and export financing interest are also passive income. His qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return). All of his gross foreign income and the foreign taxes are reported to him on a payee statement (such as a Form 1099-DIV or 1099-INT). He elects this procedure for the tax year.
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15.)What is General Limitation Income? This is the income from sources outside the US that does not fall into one of the other separate limit categories. It includes wages, salaries, and overseas allowances of an individual as an employee.
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2010

7.1 7.2 8 9.1 9.2 9.3 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32

IBSN In-House Training Manual 2010

CHAPTER 1: USA TOPOGRAPHY

Alaska Alabama Arkansas Arizona

LA - Louisiana MA MD ME MI MN Massachusetts Maryland Maine Michigan Minnesota

PA - Pennsylvania RI Rhode Island

CA - California CO - Colorado CT - Connecticut DE - Delaware FL - Florida

SC - South Carolina SD - South Dakota TN - Tennessee TX - Texas UT - Utah VA - Virginia

MO - Missouri MS - Mississippi MT - Montana NC - North Carolina ND - North Dakota

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Hawaii Iowa Idaho Illinois Indiana Kansas Kentucky

Washington Wisconsin West Virginia Wyoming

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CHAPTER 2: TYPES OF VISAS

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CHAPTER 3: SOCIAL SECURITY NUMBER

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CHAPTER 4: INDIVIDUAL TAXPAYER IDENTIFICATION NUMBER (ITIN)

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Examples of individuals who need ITINs include:

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6. What are the exceptions to the requirement to attach to a U.S. tax

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CHAPTER 5: FILING STATUS AND METHODS

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Part-II: Filing Methods

CHAPTER 6: ACCOUNTING PERIODS

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CHAPTER 7.1: TAX RATES SCHEDULES-2010

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CHAPTER 7.2: TAX CALENDAR IBSN In-House Training Manual 2010

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CHAPTER 8: FEDERAL INCOME TAX RETURNS

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Federal Income Tax Returns

Form 1040 NR Form 1040 NR-EZ

7. No earned income credit payments have been received in advance.

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Form 1040 NR-EZ

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CHAPTER 9.1: RESIDENTIAL STATUS IBSN In-House Training Manual 2010

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