2015 EDITION ESSENTIALS OF FEDERAL INCOME TAXATION FOR INDIVIDUALS AND BUSINESS LINDA M. JOHNSON, Ph.D., CPA Handy Tax Facts 2014 Tax Rate Schedules Single Married Filing Separately Schedule X Schedule Y-2 If taxable But not Tax is: of the If taxable But not Tax is: of the income over— amount income over— amount is over— over— is over— over— $0 $9,075 ….10% $0 $0 $9,075 ….10% $0 9,075 36,900 $907.50 + 15% 9,075 9,075 36,900 $907.50 + 15% 9,075 36,900 89,350 5,081.25 + 25% 36,900 36,900 74,425 5,081.25 + 25% 36,900 89,350 186,350 18,193.75 + 28% 89,350 74,425 113,425 14,462.50 + 28% 74,425 186,350 405,100 45,353.75 + 33% 186,350 113,425 202,550 25,382.50 + 33% 113,425 405,100 406,750 117,541.25 + 35% 405,100 202,550 228,800 54,793.75 + 35% 202,550 406,750 …. 118,118.75 + 39.6% 406,750 228,800 …. 63,981.25 + 39.6% 228,800 Married Filing Jointly or Qualifying Widow(er) Head of Household Schedule Y-1 Schedule Z If taxable But not Tax is: of the If taxable But not Tax is: of the income over— amount income over— amount is over— over— is over— over— $0 $18,150 ….10% $0 $0 $12,950 ….10% $0 18,150 73,800 $1,815.00 + 15% 18,150 12,950 49,400 $1,295.00 + 15% 12,950 73,800 148,850 10,162.50 + 25% 73,800 49,400 127,550 6,762.50 + 25% 49,400 148,850 226,850 28,925.00 + 28% 148,850 127,550 206,600 26,300.00 + 28% 127,550 226,850 405,100 50,765.00 + 33% 226,850 206,600 405,100 48,434.00 + 33% 206,600 405,100 457,600 109,587.50 + 35% 405,100 405,100 432,200 113,939.00 + 35% 405,100 457,600 …. 127,962.50 + 39.6% 457,600 432,200 …. 123,424.00 + 39.6% 432,200 2014 and 2015* Standard Deductions Basic Standard Deduction Additional Standard Deduction Elderly/Blind 2014 2015 2014 2015 Married, fi ling jointly (MFJ) $12,400 $12,600 $1,200 $1,250 Qualifying widow(er) 12,400 12,600 1,200 1,250 Head of household 9,100 9,250 1,550 1,550 Single 6,200 6,300 1,550 1,550 Married, fi ling separately (MFS) 6,200 6,300 1,200 1,250 Dependents—The 2014 basic standard (i) $1,000 or (ii) earned income + $350, but cannot exceed the basic standard deduction for deduction is limited to the greater of dependent’s fi ling status. 2014 and 2015* Exemption Amounts 2014 2015 $3,950 $4,000 2014 and 2015* OASDI Rate and Base 2014 Rate 2014 Limit 2015 Rate 2015 Limit 6.2% $117,000 6.20% $118,500 2014 Standard Mileage Rates Business Charitable Medical/ Moving $.56/mile $.14/mile $.235/mile * 2015 amounts are based on the best estimates available from November 1, 2014. 2014 Amounts, Thresholds, and Phase-Out Ranges Reduction of the Exemption Deduction and Itemized Deductions: AGI Thresholds MFJ and qualifying widow(er): $305,050 Head of household: $279,650 MFS: $152,525 Single: $254,200 American Opportunity Credit: AGI Phase-Out Range MFJ: $160,000 − $180,000 All others except MFS: $80,000 − $90,000 Lifetime Learning Credit: AGI Phase-Out Range MFJ: $108,000 − $128,000 All others except MFS: $54,000 − $64,000 Child Tax Credit: AGI Thresholds MFJ: $110,000 MFS: $55,000 All others: $75,000 Adoption Credit / Exclusion Amount and Modifi ed AGI Phase-Out Range For all taxpayers: $13,190 maximum credit/exclusion $197,880 − $237,880 Net Investment Income (NII) Tax: Modifi ed AGI Threshold MFJ and qualifying widow(er): $250,000 MFS: $125,000 Single and head of household: $200,000 Series I and EE Exclusion: Modifi ed AGI Phase-Out Range MFJ: $113,950 − $143,950 All others except MFS: $76,000 − $91,000 Roth IRA Contributions: AGI Phase-Out Range MFJ and qualifying widow(er): $181,000 − $191,000 Single and head of household: $114,000 − $129,000 MFS, lived with spouse: $0 − $10,000 MFS, did not live with spouse: $114,000 − $129,000 Coverdell Education Savings Account Contributions: Modifi ed AGI Phase-Out Range MFJ: $180,000 − $220,000 All others: $95,000 − $110,000 Traditional IRA Deduction: Modifi ed AGI Phase-Out Range for Active Participants Single, head of household, and MFS living apart from spouse the entire year $60,000 − $70,000 MFJ and qualifying widow(er) $96,000 − $116,000 MFS and living with spouse at some point during the year $0 − $10,000 Nonparticipating spouse fi ling MFJ with active participant spouse $181,000 − $191,000 Student Loan Interest Deduction: Modifi ed AGI Phase-Out Range MFJ: $130,000 − $160,000 All others: $65,000 − $80,000 Alternative Minimum Tax Exemption Amount and AMTI Phase-Out Range MFJ and qualifying widow(er): ($82,100 exemption) $156,500 − $484,900 MFS: ($41,050 exemption) $78,250 − $242,450 Single and head of household: ($52,800 exemption) $117,300 − $328,500 Additional .9% Medicare Tax: Earned Income Threshold MFJ: $250,000 MFS: $125,000 All others: $200,000 2015 EDITION Essentials of FEDERAL INCOME TAXATION For Individuals and Business LINDA M. JOHNSON, Ph.D., CPA Accounting Professor (retired), and CEO, LNV Services Inc. EDITORIAL STAFF List of acronyms used: Production: Jennifer Schencker AAA—Accumulated Adjustments Account Cover Design: Laila Gaidulis ACA —(Patient Protection and) Affordable Care Act Interior Design: Kathie Luzod ACRS—Accelerated Cost Recovery System ACV—Amortized Carrying Value ADS—Alternate Depreciation System AFR—Applicable Federal Rate AGI—Adjusted Gross Income This publication is designed to provide accurate and authoritative AMT—Alternative Minimum Tax information in regard to the subject matter covered. It is sold with the AMTI—Alternative Minimum Tax Income understanding that the publisher is not engaged in rendering, legal, AVD—Alternative Valuation Date accounting, or other professional service, and that the authors are not CD—Certificate of Deposit offering such advice in this publication. If legal advice or other expert CDE—Community Development Entity assistance is required, the services of a competent professional person CPA— Certified Public Accountant should be sought. CPE—Continuing Professional Education CPI—Consumer Price Index CTC—Child Tax Credit DB—Declining Balance DOMA—Defense of Marriage Act ©2014 CCH Incorporated. All Rights Reserved. DRD—Dividend Received Deduction 4025 W. Peterson Ave. E&P—Earnings and Profits Chicago, IL 60646-6085 EIC—Earned Income Credit 800 248 3248 EFTPS—Electronic Funds Tax Payment System CCHGroup.com EIN—Employer Identification Number FICA—Federal Insurance Contributions Act No claim is made to original government works: however, within this FMV—Fair Market Value Product or Publication, the following are subject to CCH Incorporated’s FSA—Flexible Spending Account copyright: (1) the gathering, compilation, and arrangement of such FTE—Full-time Equivalent government materials; (2) the magnetic translation and digital conver- FUTA—Federal Unemployment Tax Act sion of data, if applicable; (3) the historical, statutory and other notes HI—Hospital Insurance and references; and (4) the commentary and other materials. HOH—Head of Household HSA—Health Savings Account IRA—Individual Retirement Arrangement IRS—Internal Revenue Service LLC—Limited Liability Company LLP—Limited Liability Partnership MACRS—Modified Accelerated Cost Recovery System MFJ—Married Filing Jointly MFS—Married Filing Separately NII—Net Investment Income NOL—Net Operating Loss OASDI—Old Age, Survivors, and Disability Insurance OID—Original Issue Discount PMI—Private Mortgage Insurance PSC—Personal Service Corporation PTIN—Preparer Tax Identification Number QPAI—Qualified Production Activity Income SEP—Simplified Employee Pension SIMPLE—Savings Incentive Match Plan for Employees SL—Straight-line SSN—Social Security Number TI—Taxable Income TIN—Taxpayer Identification Number WOTC—Work Opportunity Tax Credit Preface iii Preface WHY STUDY FEDERAL INCOME TAXATION? Essentials of Federal Income Taxation for Individuals and Business, 2015 Edition, covers the taxation of individuals for the 2014 tax year. It provides complete coverage in an easy-to-read and easy- to-understand format for your first course in taxation. This practical text helps you understand the tax laws and improve the reporting quality of your tax returns. The coverage does not assume that you have had an introductory accounting course. If you are interested in learning how to prepare tax returns, including your own, studying this text and mastering its content will help you solve actual tax problems and succeed in preparing your own tax returns. At press time, the 2015 Edition contains the latest information and tax forms available for the 2014 tax year. It also contains the latest information for the 2015 tax planning process. LOADED WITH OUTSTANDING FEATURES Many outstanding features make the new 2015 Edition the main reference for completing 2014 federal income tax returns. Before you start reading Essentials of Federal Income Taxation for Individuals and Business, 2015 Edition, you are encouraged to spend a little time looking over the next few pages. The 2015 Edition benefits from the helpful comments and suggestions con- tributed by instructors and students who have taught and learned federal income taxation from previous editions. BUSINESS ENTITY OPTION While this text focuses on the income taxation of individuals, it is also makes available an optional course of study that examines the taxation of income earned by corporations and partnerships, as well as sole proprietorships. This option is included in response to the growing number of instructors who believe that an introductory tax course should compare and contrast the tax challenges facing the different forms of business organizations. Those who choose to place more attention on the taxation of business entities are encouraged to study the chapters in the following sequence: 1, 2, 14, 15, 16, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, and 13. Chapters 1 and 2 cover the basic tax structure for individuals. Chapters 14, 15 and 16 introduce the students to the taxation of C corporations, S corporations, and partnerships. All subsequent chapters (3–13) include at least one special business entity problem. These problems require students to relate material covered in the chapter to the different forms of business. The business entity problems are located near the end of each chapter’s QUESTIONS AND PROBLEMS. The solutions to the business entity problems generally require information from Chapters 14, 15 and 16. Consequently, students will be reviewing these chapters on a regular ba- sis throughout the course. The business entity problems are indicated by the business folder icon (shown here in the left margin). OTHER SPECIAL FEATURES The information icon (shown here in the left margin) next to a shaded box, highlights tax tips, planning opportunities, general observations and fun facts designed to enrich the learn- ing experience. The computer mouse icon (shown here in the left margin) indicates homework problems suitable for completion using tax preparation software. iv Essentials of Federal Income Taxation Since the last edition of Essentials of Federal Income Taxation for Individuals and Businesses, several tax provisions were allowed to expire at the end of 2013. At the time this textbook was sent to the printer in October, 2014, efforts to extend these provisions had not been successful. However, many believe that Congress will pass tax legislation late in 2014 or early in 2015 that will retroactively reinstate most, if not all, of these provisions. The potential changes to the tax law that may affect the 2014 tax year are discussed in shaded boxes and are identified with the new developments icon shown here in the left margin. Feature: This textbook presents the tax laws that will assist you in preparing tax returns for the 2014 tax year. Additional information about possible tax legislation that may affect the current tax year is discussed separately in a legislative developments box identified with the icon shown here to the left of the shaded box. Benefit: Although there is never any way of knowing for certain what the tax laws will be from year to year, some of the provisions presented in the textbook are expected to change in the near future. The material presented in the legislative developments box will provide you with that information, which, in turn, will assist you in tax planning for the current and future tax years. Line-by-line instructions describing how to complete tax forms and schedules are illustrated throughout the chapters. These illustrations are found next to the filled-in forms icon shown here in the left margin. Feature: Each filled-in tax form is supported by information provided from the taxpayer’s records and receipts. References to specific line numbers where the taxpayer’s information is entered has been provided for each filled-in form and schedule presented in the chapter. The line number references shown in the textbook correspond to the line numbers on the tax forms and schedules included in the textbook, including draft versions of the 2014 tax forms or the final 2013 version of the form, when necessary. Benefit: This concise presentation makes it easier for you to relate tax data to the tax form. The format presents information supplied by the taxpayer highlighted in bold. Once this data has been entered on the apropriate line(s) of the tax form, the rest of the lines on the form can be completed by following the instructions provided on the form. This approach helps you see how information is used to complete each tax form and schedule introduced in the chapter. COMPREHENSIVE PROBLEMS are included in most chapters; many include two versions of the problem. Feature: These problems incorporate many concepts introduced in the chapter. Many of these involve completing a tax return or portions of a tax return. Benefit: This learning application integrates and summarizes the concepts covered in the chapter. Completing the comprehensive problems will help you see how the concepts from the chapter are reported on the tax return. By including multiple versions of the problem, students have more opportunities to solve real-world tax problems, as well as complete real-world tax returns. Eleven CUMULATIVE PROBLEMS are included in this textbook. Feature: Comprehensive problems focus primarily on the concepts introduced in the chapter. Cumulative problems, on the other hand, not only incorporate the concepts from the current chapter, but also include concepts studied in prior chapters. Many of these involve using the taxpayer’s information to complete the entire income tax return. Benefit: These learning applications integrate and summarize concepts from multiple chapters to give students the opportunity to step back and see the big picture. Also, by completing the Cumulative Problems presented at the end-of-chapter homework materials for Chapters 2, 4, 6, 7, 9, and 12, you will gain a greater sense of what all is involved in preparing a real-world income tax return. Preface v Tax questions and problems requiring use of the IRS website are included at the end of the chapter. These problems are identified by the icon shown to the left here. Feature: The answers to these questions and problems are found in the information contained in IRS tax forms and schedules, the instructions to IRS forms and schedules, or IRS publications. Benefit: You will learn how to find answers to tax questions from IRS publications available on the Internet. You will also learn how to find needed tax forms, fill them out while on the Internet, and print out copies of the completed forms. These learning applications provide you the opportunity to obtain knowledge about tax law using information outside of the textbook. HELPFUL INFORMATION INCLUDED IN THE 2015 EDITION!! Frequently used tax facts are provided. Feature: Handy Tax Facts appear on the inside front cover. Included are the 2014 tax rate schedules and standard mileage rates; standard deduction and exemption deduction amounts for 2014 and 2015; and OASDI base amounts for 2014 and 2015. Benefit: This helpful page provides a quick and easy reference source for frequently used tax facts. Commonly used AGI threshold amounts and phaseout ranges are provided. Feature: These amounts and ranges appear on the inside back cover. Benefit: This helpful page provides a quick and easy reference to some of the more commonly- used AGI thresholds and phase-out ranges. Paragraph referencing system. Feature: All major headings and subheadings in the chapter have been referenced using a paragraph referencing system. Benefit: Paragraph references provide an additional method of indexing the material in each chapter. When referring to information in a chapter, students and instructors can refer to either the page number on the page or the paragraph number where the material can be found. Paragraph references also are used throughout the chapters to cross-reference material discussed elsewhere in the textbook. Learning objectives provided at the beginning of each chapter. Feature: The major learning objectives for each chapter have been provided and referenced in the homework problems. Benefit: Each homework problem is linked to a learning objective. This helps students make sure that they have mastered all major learning objectives before proceeding to the next chapter. Numerous examples are provided. Feature: Every chapter includes numerous easy-to-follow examples. Benefit: These examples show you how the tax laws are applied to a variety of real-life situations. Self-study questions are included at the end of each chapter. Feature: Twenty self-study questions (10 true/false; 10 multiple choice) are included at the end of the reading material for each chapter (immediately before the QUESTIONS AND PROBLEMS). These questions are designed to allow you to gauge your understanding of the concepts introduced in the chapter. They are intended to be answered prior to attempting the QUESTIONS AND PROBLEMS. Benefit: Answering these study questions after reading the chapter material will help you understand which topics from the chapter you may want to review before working through the QUESTIONS AND PROBLEMS at the end of each chapter. The answers to the self- study questions can be found in Appendix C at the back of the textbook. vi Essentials of Federal Income Taxation Step-by-step instructions on how to access IRS forms and publications from the IRS website is given. Feature: Information on how to obtain forms and publications from the IRS through the Internet appears in Appendix A after Chapter 16. Benefit: This information will help you access the most up-to-date forms, instructions to forms, and IRS publications referenced in the text. Appendix of commonly-used blank tax forms. Feature: Blank copies of selected tax forms and schedules are provided in Appendix B. Benefit: The selected forms and schedules provided are some of the more commonly-used forms and schedules. Having these forms and schedules in one place will help students visualize the flow of tax information on the tax return. The tax forms and schedules included in Appendix B are the most recent ones available at the time the 2015 Edition was sent to the printer. OTHER SUCCESSFUL FEATURES OF ESSENTIALS OF FEDERAL INCOME TAXATION FOR INDIVIDUALS AND BUSINESS, 2015 EDITION Comprehensive coverage of self-employed taxpayers (Chapter 7) Detailed coverage of business entities, including C corporations, partnerships, and S corporations Almost 50 filled-in forms, schedules, and worksheets are illustrated, each including details regard- ing the line numbers where data is initially entered by the taxpayer or tax preparer Multiple versions (a./b.) for many comprehensive problems, allowing students the opportunity to work two different problems using the same tax forms A table referencing the filled-in tax forms, schedules, and worksheets follows the Table of Contents A detailed Table of Contents of headings and subheadings for each chapter is located at the end of this Preface Tax tips are provided throughout the textbook to assist with tax planning and tax reduction Problems at end of chapters designated for tax software solution Assignments that provide actual application and check students’ understanding Acronym list on copyright page (that precedes this Preface) provides actual words to the ac- ronyms used in this textbook Preface vii SPECIAL NOTE REGARDING FINAL TAX FORMS AND SCHEDULES FOR THE 2014 TAX YEAR One of the user-friendly features of Essentials of Federal Taxation for Individuals and Business, is the filled-in forms that follow the discussion of the tax topic. To illustrate how the relevant tax form is completed, the information needed to complete the form is provided. Line number refer- ences and calculations are then provided to help you see how to prepare the form. This technique enhances your learning experience, and gives you the tools necessary to prepare the real-world tax return problems found at the end of the chapter. To this end, the 2015 Edition includes the most up-to-date tax forms and schedules available at the time the textbook was sent to the printer in October, 2014. When final forms were not available, draft versions of the form were included in the textbook. When a draft version of the current year’s tax form had not been released, the final version of the prior year’s form was used. Usually, the use of draft forms or the prior year’s tax forms does not pose much of a problem, as many tax forms do not change much from year to year. When completing tax return problems at the end of the chapters, it is recommended that the final version of each form and schedule be used. However, please keep in mind that the line number references might change should the final version of the form differ in any way from the form that appears in the textbook. Final tax forms and schedules can be downloaded from the IRS website. Appendix A includes step-by-step instructions on how to use the IRS website to download tax forms and IRS Publications. CURRENT LEGISLATIVE DEVELOPMENTS For well over a decade, several tax provisions have been allowed to expire time and again, only to be temporarily extended at a later date. Often these provisions are renewed retroactively. Most recently, several tax “extenders” expired at the end of 2013. At the time this textbook was sent to the printer, Congress (comprised of the House of Representatives and the Senate) had not been able to agree on which provisions to extend, and for how long to extend them. For example, in September, 2014, the House of Representatives passed legislation to permanently extend many of these expired tax provisions. The Senate, on the other hand, has introduced (but yet to vote on) legislation that would extend these same provisions, but only for two years (through 2015). Although many feel that some sort of tax legislation will be passed by Congress late in 2014 or early in 2015, there is no way of knowing with any certainty what that final tax bill will include. With that in mind, the 2015 Edition contains all of the current tax law in effect as of the time this textbook was sent to the printer in October, 2014. It also includes a discussion of possible (retroactive) changes to the tax laws in shaded text (next to the New Developments icon). In the event that Congress passes tax legislation late in 2014 or early in 2015 that affects the 2014 tax year, a summary of the tax bill can be found at: CCHGroup.com/Legislation. For the latest developments and updates please visit CCHGroup.com/Resources.