Understanding Taxes PDF

What is Income? Economic benefit in the form of money or other assets. The common category of income identified by the IRS are: 1. Dividend income from stocks 2. Earned income from a paycheck 3. Rental income from real estate 4. Royalty income intellectual property, inventions, etc. 5...

What is Income? Economic benefit in the form of money or other assets. The common category of income identified by the IRS are: 1. Dividend income from stocks 2. Earned income from a paycheck 3. Rental income from real estate 4. Royalty income intellectual property, inventions, etc. 5. Capital gains from selling assets that have appreciated in value 6. Profits from a business 7. Interest from savings, bonds, or lending activities Understanding Taxes Wages Wages, salaries, and other forms of employee compensation are included in income. The employer reports annual employee compensation to employees on Form W-2. The employee should attach copy B of Form W-2 to their tax return when filing a paper return. Dividend Income Ordinary Dividends ► Ordinary (taxable) dividends are the most common type of distribution from a corporation. ► The corporation pays ordinary dividends out of its earnings and profits, and the shareholders must report such payments as ordinary income. Qualified Dividends ► Qualified dividends are subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. ► To qualify for the maximum rate, the following must be true: The dividends must be paid by a U.S. corporation or a qualified foreign corporation. The taxpayer must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. 1099-DIV Interest Income ► A taxpayer must generally report taxable interest from Form 1099-INT (or Schedule K-1 for partnerships, S corporations, estates, and trusts). Bank, savings, and loan, or credit union accounts Certificates of deposit U.S. Treasury bills, notes, and bonds (exempt from all state and local income taxes) Loans made to others Gifts more than $10 for opening financial accounts ($20 if the account is more than $5,000) Interest received on tax refunds 1099-INT Childcare Providers When taxpayers provide childcare, regardless of location, the payments received must be included in gross income. Taxpayers who are not employees must include payments for services on Schedule C and complete Schedule 1. Similar rules apply for persons babysitting, even if only periodically and/or just for relatives. Household employees are required to file a Schedule H and have their employee withhold payroll taxes Other Earnings and Additional Income ► Foreign Income ► Back Pay and Severance Pay ► Sick Pay and Disability Income ► Fringe Benefits ► Tip Income ► Rental Income ► Business Income Foreign Income U.S. citizens and resident aliens must report income from sources outside the United States (foreign income) on their tax return unless it is exempt by U.S. law. Foreign income can be earned or unearned income; including wages, interest, dividends, and capital gains. Back Pay and Severance Pay Back Pay ► Amounts awarded in a settlement or judgment for back pay should be included in income. ► These include payments made to a person for damages, unpaid life insurance premiums, and unpaid health insurance premiums. Employers should report on Form W-2. Severance Pay Severance pay and any payment received due to the cancellation of an employment contract must be included in income amounts. Sick Pay and Disability Income Sick Pay Pay received from an employer while sick or injured is part of salary or wages. In addition, employees must include sick pay benefits received from: ► A welfare fund ► A state sickness or disability fund ► An association of employers or employees ► An insurance company, if the employer paid for the plan Disability Income Generally, employees must report as income any amount received for personal injury or sickness through an accident or health plan when the employer pays plan premiums. Fringe Benefits Fringe benefits received in connection with the performance of services are included in income as compensation unless the employee paid fair market value for the benefits, or the benefit is specifically excluded by law. Tip Income All tips received directly, charged tips paid by an employer, and any tips received under a tip-splitting or tip-pooling arrangement are included in income. The IRS also considers non-cash tips, such as tickets, passes, or other items of value, as income, and are included in income based on their value. *May be gone with the next set of tax law changes in 2025-2026 Rental Income Taxpayers are entitled to rental income from investment property. Taxpayers file for their individual tax return (Schedule E) and their business (Form 8825). ► Short-Term Rentals- Airbnbs ► Long-Term Rentals- Renting a home to a tenant as their home. ► Limited Partners- Invested in a real estate fund. Mortgage Interest Statement (Form 1098) Schedule E Schedule E Form 8825 Active vs. Passive Income Active vs Passive Income Active Income requires continuous time and effort to generate income Passive Income requires one event to occur to generate income. It is possible to repeat this event to compound the income gains. Is it Active or Passive? 1. Dividend income from stocks 2. Earned income from a paycheck 3. Rental income from real estate 4. Royalty income intellectual property, inventions, etc. 5. Capital gains from selling assets that have appreciated in value 6. Profits from a business 7. Interest from savings, bonds, or lending activities Active vs Passive Income Active Income requires continuous time and effort to generate income Passive Income requires one event to occur to generate income. It is possible to repeat this event to compound the income gains. Is it Active or Passive? 1. Dividend income from stocks (Passive) 2. Earned income from a paycheck (Active) 3. Rental income from real estate (Passive) 4. Royalty income intellectual property, inventions, etc. (Passive) 5. Capital gains from selling assets that have appreciated in value (Passive) 6. Profits from a business (Active) 7. Interest from savings, bonds, or lending activities (Passive) Case Study Time Let’s review all the sources of income Business Income–S-Corp Items are separately stated because different shareholders may treat be able to treat these items differently on their own individual tax returns, depending on their individual situations. ► Charitable contributions ► Interest income ► Capital gains and losses ► Dividend income ► Royalty income ► Net rental real estate income (loss) ► Other net rental income (loss) ► Section 179 deduction ► Foreign transactions ► Alternative minimum tax item ► Items affecting shareholder basis Deductions A deduction is an amount you subtract from your income when you file so you pay less pay taxes. By lowering your taxable income, a taxpayer will have a lower amount they will have a liability for once tax rates are applied. Standard Deduction: Automatic tax deduction applied to taxpayers. Itemized Deductions: Select deductions the client can claim in place of the standard deduction. These include: ► Medical and dental expenses ► Certain taxes paid (Personal property taxes and state and local taxes) ► Home mortgage interest ► Gifts to charity ► Casualty and theft losses (only losses derived from federally declared disaster areas are allowed) ► Certain miscellaneous deductions Do you Really Want to Leave the Standard Deduction? Credits A credit is an amount you subtract from the tax you owe. This can lower your tax payment or increase your refund. Some credits are refundable — they can give you money back even if you don't owe any tax. Refundable Tax Credits: ► Earned Income Tax Credit (EITC): A refundable credit for low- to moderate-income workers, varying based on income and number of qualifying children. ► Premium Tax Credit: Assists eligible individuals and families in covering premiums for health insurance purchased through the Health Insurance Marketplace. Partially Refundable Tax Credits: ► American Opportunity Tax Credit (AOTC): Provides up to $2,500 per eligible student for the first four years of higher education, with up to $1,000 being refundable. ► Child Tax Credit (CTC): Offers up to $2,000 per qualifying child under age 17, with up to $1,400 being refundable through the Additional Child Tax Credit (ACTC). Nonrefundable Tax Credits: ► Child and Dependent Care Credit: Helps offset costs of care for dependents under 13 or a spouse/dependent incapable of self-care, allowing the taxpayer to work or seek employment. Credits Individual Decision Economic Benefit Tax Credits Invest in Retirement Place money towards the money Retirement Savings Credit markets Clean Energy Investing towards lowering the long-term Clean Vehicle Tax Credit US carbon emissions; reduces Residential Clean Energy Credit international penalties Energy-Efficient Commercial Building Credit Higher Education Investing towards your skill and American Opportunity Tax Credit knowledge to contribute more value in Lifetime Learning Credit the labor market Invest in Health Insurance Maintain health and longevity to work Premium Tax Credit and contribute to GDP longer Being a parent Being fruitful and multiply the workforce Child Tax Credit Adoption Tax Credit Child and Dependent Care Credit Deductions vs. Credits Deductions = Lower your taxable INCOME Credits = Lowers your tax BALANCE Pass-Through Entities Items are separately stated because different shareholders may treat be able to treat these items differently on their own individual tax returns, depending on their individual situations. ► Charitable contributions ► Interest income ► Capital gains and losses ► Dividend income ► Royalty income ► Net rental real estate income (loss) ► Other net rental income (loss) ► Section 179 deduction ► Foreign transactions ► Alternative minimum tax item ► Items affecting shareholder basis Failure to File Penalty ► The failure to pay penalty applies if you don’t pay the tax when due. ► The penalty you must pay is a percentage of the taxes you didn’t pay. ► We calculate the failure to pay penalty based on how long your overdue taxes remain unpaid. Unpaid tax is the total tax required to be shown on your return minus amounts paid through withholding, estimated tax payments and allowed refundable credits. ► The failure to pay penalty will not exceed 25% of your unpaid taxes. Failure to File Penalty Calculations ► The Failure to File penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty won't exceed 25% of your unpaid taxes. ► If both a Failure to File and a Failure to Pay penalty are applied in the same month, the Failure to File penalty is reduced by the amount of the Failure to Pay penalty for that month, for a combined penalty of 5% for each month or part of a month that your return was late. ► If after 5 months you still haven't paid, the Failure to File penalty will max out, but the Failure to Pay penalty continues until the tax is paid, up to its maximum of 25% of the unpaid tax as of the due date. ► If the return is more than 60 days late, the minimum Failure to File penalty is the amount shown below or 100% of the underpayment, whichever is less: Failure to Pay Penalty ► The failure to pay penalty applies if you don’t pay the tax when due. ► The penalty you must pay is a percentage of the taxes you didn’t pay. ► We calculate the failure to pay penalty based on how long your overdue taxes remain unpaid. Unpaid tax is the total tax required to be shown on your return minus amounts paid through withholding, estimated tax payments and allowed refundable credits. ► The failure to pay penalty will not exceed 25% of your unpaid taxes. ► Plus interest Failure to Pay Penalty Calculations The failure to pay penalty is 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. The penalty won’t exceed 25% of your unpaid taxes. If both a failure to pay and a failure to file penalty are applied in the same month, the failure to file penalty will be reduced by the amount of the failure to pay penalty applied in that month. For example, instead of a 5% failure to file penalty for the month, we would apply a 4.5% failure to file penalty and a 0.5% failure to pay penalty. If you filed your tax return on time as an individual and you have an approved payment plan, the failure to pay penalty is reduced to 0.25% per month (or partial month) during your approved payment plan. If you don’t pay your tax in 10 days after getting a notice from us with our intent to levy, the failure to pay penalty is 1% per month or partial month. We apply full monthly charges, even if you pay your tax in full before the month ends. Levy ► An IRS levy permits the legal seizure of your property to satisfy a tax debt. It can garnish wages, take money in your bank or other financial account, seize and sell your vehicle(s), real estate and other personal property. Liens ► A federal tax lien is the government’s legal claim against your property when you neglect or fail to pay a tax debt. The lien protects the government’s interest in all your property, including real estate, personal property and financial assets. ► A lien is not a levy. A lien secures the government’s interest in your property when you don’t pay your tax debt. A levy actually takes the property to pay the tax debt. If you don’t pay or make arrangements to settle your tax debt, the IRS can levy, seize and sell any type of real or personal property that you own or have an interest in. Criminal vs Civil Penalty Payment Plans & Installment Agreements Extensions The deadline to file an extension is the same as the original filing deadline ► March 15th for Partnerships and S-Corp ► April 15th for Individuals and C-Corps ► September 15th for Partnerships and S-Corp ► October 15th for Individuals and C-Corps Paperwork, Paperwork, Paperwork