Section 1100 Preliminary Workand Taxpayer Data

1000 Individuals 1100 Preliminary Work and Taxpayer Data 1110 Preliminary Work to Prepare Tax Returns 1110.01 Use of Prior‐Year’s Return for Comparison The preparation of a client’s tax return for the current year normally begins with a review of the client’s prior‐year’s income tax return. Familiarizing oneself with issues on the prior‐year’s tax return allows the tax return preparer to note the issues that may re‐occur on the current year’s return and to have a basis to compare the current year’s transactions with the prior years. In many cases, a tax client’s financial transactions and personal data, such as marital status, number of dependent children, etc., are consistent from year‐to‐year. Sources of income and types of deduction often vary little from one year to the next. Wide divergences in income, expenses, credits, and deductions from one year to the next are unusual and call for investigation on the preparer’s part as to the source of such divergence. 1110.02 In the event that a taxpayer does not have a copy of a prior‐year’s income tax return, he or she can obtain one from the Internal Revenue Service (IRS) by completing Form 4506, Request for Copy or Transcript of Tax Form, and mailing it, along with the required fee, to the IRS center where the return was filed. As an alternative, a transcript, which is a computer printout of a prior‐ year’s return, may be obtained from the IRS, also using Form 4506. Transcripts may be requested online, by phone or by mail. There is no charge for the transcript, which shows most line items from the original return, including accompanying forms and schedules. 1 INDIVIDUALS 1110.03 A tax return transcript shows most line items from an income tax return as it was originally filed, including any accompanying forms and schedules. In most cases, a transcript includes all the information a lender or government agency needs, but it does not show any changes the taxpayer, his or her representative, or the IRS made after it was filed. The tax return transcript is generally available for the current and past three years. 1110.04 The IRS can also provide a tax account transcript, which is also free, and shows basic data from the taxpayer’s income tax return, including marital status, type of return filed, adjusted gross income, and taxable income. A transcript also includes any adjustments the taxpayer or the IRS made after the taxpayer filed his or her income tax return. Like the tax return transcript, the tax account transcript is generally available for the current and past three years. 1110.05 Accuracy of Prior Year’s Return A review of a client’s prior‐year’s tax return could reveal errors or mistakes such as an intentional or accidental omission of income or overstated deductions. The discovery of these mistakes could benefit the client or result in additional tax to the taxpayer because the mistake or omission could result in reporting additional income or reducing a deduction on an amended tax return. In the case of a taxpayer who in a prior year has omitted income or overstated a deduction or credit, the tax return preparer should recommend to the client that he or she should amend his or her return so as to correct mistakes occurring on a prior‐year’s tax return. Circular 230, the guide for tax practitioner ethical conduct, recommends that if the client refuses to file an amended return in such circumstances, the EA (or other tax practitioner) should consider whether he or she should continue to work with and represent this client. Circular 230 does not require the EA to sever professional relations with the client in such circumstances; but he or she could determine that that is the step he or she should take. 2 INDIVIDUALS 1110.06 A review of a prior‐year’s income tax return could reveal beneficial carryovers from a prior year that had not yet been utilized, such as capital loss carryovers, charitable contribution carryovers, alternative minimum tax credit carryforwards, net operating loss carryforwards, and other tax benefits. In some cases, such as with certain energy credits, a tax benefit taken once in a prior year precludes its being taken again, either wholly or partially, in a subsequent year. 1110.07 Many EAs and other professional tax return preparers provide their clients with data organizers in preparation for the upcoming tax filing season. Data organizers are useful for gathering information from clients; though most of the time, the EA or other tax return preparer will find it necessary to follow‐up with additional questions and requests for clarification as few clients complete 100 percent of the organizer; some make no attempt to complete it, others partially complete it or provide incorrect information. 1110.08 Once a taxpayer’s income tax return is complete, a proper review of the completed tax return includes a comparison with the prior‐ year’s tax return. At times, an EA may note discrepancies between the transactions reported in the two years. Since in most cases peoples’ financial lives are consistent from year‐to‐year, major changes in a tax return from one year to the next should prompt the EA to find out why these major differences exist. 1110.09 Just as certain transactions in prior years impact the current‐ year’s income tax return, the current‐year’s income tax return may have an impact on future tax returns. Certain transactions reported in the current year could generate losses that could be carried back to a prior year or forward to later years. In addition, certain decisions relating to expensing and depreciation made in the current year will impact future tax years also. 1110.10 Taxpayer’s Biographical Information The taxpayer must provide the EA with his or her date of birth, age, marital status, and Social Security number in order for the EA to accurately and fully complete the client’s income tax return. Relevant biographical information must also be provided for the taxpayer’s spouse and dependents. If the taxpayer wants his or her refund deposited directly into a bank account, the taxpayer 3 INDIVIDUALS should provide the tax return preparer with his or her bank account number and routing number so the IRS will be able to make a direct deposit of the taxpayer’s refund into the taxpayer’s bank account. The tax preparer must verify and confirm the client’s bank account each year to ensure there were no changes to the banking information. The EA must insert the taxpayer’s Social Security number as well as the Social Security numbers for any dependents on the tax return. If the taxpayer does not have a Social Security number, he or she may have an Individual Taxpayer Identification Number (ITIN), a number which the IRS issues to individuals requiring a United States taxpayer identification number but who are not eligible for a Social Security number. A taxpayer that fails to include his or her Social Security number (SSN) or that of another person where required on a return, statement, or other document is subject to a $60 penalty for each failure and the maximum aggregate penalty cannot be greater than $30,000. The penalty can be waived if the taxpayer can show that the failure was due to reasonable cause and not willful neglect. 1110.11 4 Typically, a client data organizer that the EA sends to a client will ask for the taxpayer’s biographical information that will be needed to prepare the individual’s income tax return, e.g., date of birth, age, marital status, citizenship, dependents, etc. This information is required for purposes of preparing an individual’s tax return and should be retained in the client’s permanent file that a tax return preparer should keep for each client. Since tax return preparers generally use software programs to prepare tax returns, this biographical information can be retained and used to “proforma” the client’s tax return for each year. This means that client information will be automatically inserted onto the succeeding year’s tax forms, and the EA can change it on an exception only basis in subsequent years as the taxpayer’s circumstances change and life events such as births, marriages, deaths, and divorces that impact tax return filing occur. INDIVIDUALS 1110.12 Immigration Status and Citizenship An individual’s status as an alien – resident, nonresident, or dual‐ status ‐ determines whether and how he or she must file a United States federal income tax return. If an individual is a resident alien for the entire year, he or she must file a tax return following the same tax rules that apply to U.S. citizens. If the individual is a nonresident alien, the tax rules and tax forms that apply are different from those that apply to U.S. citizens and resident aliens. If an individual is a resident alien for part of the tax year and a nonresident alien for the rest of the year, he or she is a dual‐ status taxpayer and different tax rules will apply for each part of the year. 1110.13 An alien, a person who is not a U.S. citizen, is considered a nonresident alien unless he or she meets either the green card test or the substantial presence test for the calendar year. Even if the individual does not meet either of these tests, he or she may elect to be treated as a U.S. resident for tax reporting purposes. This sometimes occurs when aliens who are married to United States citizens choose to file a United States tax return with their United States citizen spouse. The effect of such an election would be that all of the alien’s income, wherever in the world it is earned or generated, is taxed by the United States. A resident of the United States or citizen of the United States is taxed on all of his or her world‐wide income, regardless of where such income is earned. a. Green card test ‐ Under the green card test, an individual is a resident of the United States for tax purposes if he or she is a lawful permanent resident of the United States at any time during calendar year. An individual is a lawful permanent resident of the United States at any time if he or she has been given permission, under U.S. immigration laws, to reside permanently in the United States. An individual has this status if the U.S. Citizenship and Immigration Services (U.S.CIS) issues the individual an alien registration card, also known as a “green card.” The individual continues to have resident status under this test unless the green card status is taken away or it is administratively or judicially determined that the individual abandoned his or her green card status. 5 INDIVIDUALS b. Substantial presence test ‐ An individual will be considered a United States resident for tax purposes if he or she meets the substantial presence test for the year. To meet this test, the individual must be physically present in the United States on at least 31 days during the calendar year, and 183 days during the current year and the two preceding years, counting: 1. All the days the individual was present in the current year, and 2. One‐third of the days the individual was present in the year preceding the current year, and 3. One‐sixth of the days the individual was present in the second year preceding the current year. Example: Sam was physically present in the United States on 120 days in each of the years 2021, 2022, and 2023. To determine if Sam meets the substantial presence test for 2022, count the full 120 days of presence in 2023, 40 days in 2022 (1/3 of 120), and 20 days in 2021 (1/6 of 120). Because the total for the three‐year period is 180 days, Sam is not considered a resident of the United States under the substantial presence test for 2023. c. 6 Closer connection to a foreign country ‐ Even if an individual meets the substantial presence test, he or she can be treated as a nonresident alien if he or she: 1. Is present in the United States for less than 183 days during the year, 2. Maintains a tax home in a foreign country during the year, and 3. Has a closer connection during the year to a foreign country in which he or she has a tax home than to the United States. INDIVIDUALS d. Establishing a closer connection A taxpayer will be considered to have a closer connection to a foreign country than the United States if the taxpayer or the IRS establishes that the taxpayer has maintained more significant contacts with the foreign country than with the United States. In making this determination, the following nonexclusive facts and circumstances should be considered taken into account: 1. The country of residence the taxpayer designates on forms and documents. 2. The types of official forms and documents he or she files. 3. The location of: (i) Taxpayer’s permanent home; (ii) His or her family; (iii) His or her personal belongings, such as cars, furniture, clothing, and jewelry; (iv) His or her current social, political, cultural, or religious affiliations; (v) His or her business activities (other than those that constitute the taxpayer’s tax home); (vi) The jurisdiction in which the taxpayer holds a driver’s license; (vii) The jurisdiction in which the taxpayer votes; and (viii) Charitable organizations to which the taxpayer contributes. 7 INDIVIDUALS 1110.14 Filing Deadlines Taxpayers on the calendar year generally have until April 15 of the succeeding tax year to file their income tax returns and pay any taxes due. Taxpayers have extra time when April 15 falls on a weekend or a holiday in the District of Columbia. Filing deadlines that fall on District of Columbia holidays are extended to the next day that is not a Saturday, Sunday, or holiday. Under the so‐called “mailbox rule,” a tax return is considered filed timely if it arrives at the IRS with a proper address and sufficient postage and is postmarked on or before the due date. Thus, a 2023 income return, unless extended, may be mailed on April 15, 2024 (a Monday), and is considered timely filed even if it arrives at the IRS after the due date. A tax return which is electronically filed is considered timely filed if the authorized electronic return transmitter postmarks the electronic transmission of the income tax return by the due date of the tax return. In many cases, the authorized electronic return transmitter is the tax preparation firm that prepared the return. 1111 Taxpayer Filing Status 1111.01 For income tax filing purposes, there are five tax filing statuses: 1111.02 8 a. Single; b. Married Filing Jointly (MFJ); c. Married Filing Separately (MFS); d. Head of Household (HOH); and e. Qualifying Surviving Spouse with Dependent Child. A taxpayer’s filing status depends on whether they are considered unmarried or married at the end of the tax year. For federal tax purposes for the tax year 2023, a person is considered married if they are legally married to a person of the same sex or the opposite sex, as long as the marriage in question was legal in the state in which it was performed. INDIVIDUALS 1111.03 A person is considered unmarried for the whole year if, on the last day of the tax year, the individual is unmarried or legally separated from his or her spouse under a divorce or separate maintenance decree. State law governs whether an individual is married or legally separated under a divorce or separate maintenance decree. If a person is divorced under a final decree by the last day of the year, for tax purposes he or she is considered unmarried for the whole year. 1111.04 If individuals obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce the individuals intended to, and did, remarry each other in the next tax year, the individuals must file tax returns as married individuals. Married Persons 1111.05 If a taxpayer is considered married for the whole year, he or she and his or her spouse can file a joint return, or each spouse can file his or her own separate income tax return. The choice of whether to file as married filing jointly or married filing separately is entirely up to the taxpayers themselves. A taxpayer is considered married for the whole year if on the last day of the tax year the taxpayer and his or her spouse meet any one of the following tests: a. They are married and living together as husband and wife. b. They are living together in a common law marriage that is recognized in the state where they now live or in the state where the common law marriage began. c. They are married and living apart, but not legally separated under a decree of divorce or separate maintenance. d. They are separated under a temporary decree of divorce. For purposes of filing a joint return, they are not considered divorced. 9 INDIVIDUALS 1111.06 If a taxpayer’s spouse died during the year, the surviving spouse is considered married for the whole year for filing‐status purposes. If the surviving spouse did not remarry before the end of the tax year in which his or her spouse died, he or she can file a joint income tax return for himself or herself and his or her deceased spouse. For the next two years, the taxpayer may be entitled to file as a Qualifying Surviving Spouse with Dependent Child. If the surviving spouse remarried before the end of the tax year, he or she can file a joint return with his or her new spouse. The deceased spouse’s filing status for the year of his or her death will be married filing separately for that same year. Taxpayers “Considered Unmarried” 10 1111.07 If a taxpayer lives apart from his or her spouse and meets certain tests, he or she may be considered unmarried. If the taxpayer is considered unmarried, he or she can file as head of household even though he or she is not divorced or legally separated. If the taxpayer qualifies to file as head of household instead of as married filing separately, the taxpayer’s standard deduction will be higher, his or her tax liability may be lower, and he or she may be able to claim the earned income credit. 1111.08 To qualify for head of household status, a taxpayer must be either unmarried or considered unmarried on the last day of the year. A taxpayer is considered unmarried on the last day of the tax year if he or she meets all the following tests: 1. The taxpayer files a separate return. 2. The taxpayer pays more than half the cost of keeping up his or her home for the tax year. 3. The taxpayer’s spouse did not live in the taxpayer’s home during the last six months of the tax year. A taxpayer’s spouse is considered to live in the taxpayer’s home even if he or she is temporarily absent due to special circumstances. 4. The taxpayer’s home was the main home of his or her child, stepchild, or foster child for more than half the year. 5. The taxpayer must be able to claim an exemption for the child. However, the taxpayer meets this test if he or she INDIVIDUALS cannot claim the exemption only because the noncustodial parent can claim the child. Single 1111.09 A taxpayer’s filing status is single if, on the last day of the year, they are unmarried or legally separated from their spouse under a divorce or separate maintenance decree, and they do not qualify for another filing status. For example, a taxpayer’s filing status may be single for the year 2023 if they were widowed before January 1, 2023 and did not remarry before the end of 2023. Married Filing Jointly 1111.10 A taxpayer can file as married filing jointly as his or her filing status if he or she is married and both the taxpayer and his or her spouse agree to file a joint return. On a joint return, the taxpayers report their combined income and deduct their combined allowable expenses. Both parties can file a joint income tax return even if one of them has no income or deductions. If both spouses file a joint income tax return, their tax liability may be lower than their combined tax for the other filing statuses. Also, their standard deduction (if they do not itemize deductions) may be higher, and they may qualify for tax benefits that do not apply to other filing statuses. On the downside, each party is jointly and severally liable for the entire tax liability, regardless of how much income a party generated. 1111.11 If both spouses have income, they may want to figure their tax both on a joint return and on separate returns using the filing status of married filing separately since they can choose the method that gives them the lower combined tax. Most tax preparation software programs do this comparison automatically. a. Divorced persons – If a taxpayer is divorced under a final decree by the last day of the year, he or she is considered unmarried for the whole year and the taxpayer cannot choose married filing jointly as his or her filing status. b. Spouse died during the year – If a taxpayer’s spouse died during the year, the taxpayer is considered married for the whole year and the surviving spouse can choose to file as married filing jointly as his or her tax filing status. 11 INDIVIDUALS Filing a Joint Return 1111.12 When married taxpayers file a joint return, both the taxpayer and his or her spouse must include all of their income, exemptions, and deductions on their joint return. Both taxpayers must use the same accounting period, but they may use different accounting methods. Both taxpayers may be held responsible, jointly and individually, for the tax and any interest or penalty due on their joint return. Because both spouses are jointly and severally liable for the tax liability, one spouse may be held liable for all the tax due on a joint return even if all the income was earned by the other spouse. A divorced taxpayer may be held jointly and individually responsible for any tax, interest, and penalties due on a joint return filed before his or her divorce even if the divorce decree states that a taxpayer’s former spouse will be responsible for any amounts due on previously filed joint returns. Relief from Joint and Several Liabilities 1111.13 In some cases, one spouse may be relieved of joint liability for tax, interest, and penalties on a joint return for items of the other spouse that were incorrectly reported on the joint return. There are three types of relief available from joint and several liability: (i) innocent spouse relief; (ii) separation of liability; and (iii) equitable relief. (i) 12 Innocent spouse relief ‐‐ To receive “innocent spouse relief” the taxpayer must: • File a joint return that had an “understatement” (not merely an underpayment) of tax due to “erroneous items” of one of the spouses. • Establish that at the time he or she signed the joint return he or she did not know, and had no reason to know, that there was an understatement of tax. • Prove that, considering the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement of tax. • Previously it was required that a taxpayer must request relief no later than two years after IRS collection activity began. The two‐year time limit no longer applies for innocent spouse requests for INDIVIDUALS equitable relief. Rather, the IRS will consider a request for equitable relief if the collection statute of limitations for the tax years involved has not expired, or if the taxpayer is seeking a refund, if the refund statute of limitations has not expired. Many taxpayers that were previously denied equitable relief because of the two‐year limit may now qualify for relief. If it is established that the taxpayer signed a joint return under duress, then a joint return has not been filed. An understatement of tax is generally the difference between the total tax liability that should have been shown on the return and the amount that was actually shown on the return. An underpayment of tax is an amount of tax the taxpayer properly reported on the return but has not paid. For example, a joint 2023 tax return shows that the taxpayer and his spouse owe $5,000. They paid $2,000 with the return. They have an underpayment of $3,000. A taxpayer may qualify for partial relief if, at the time he or she filed her return, he or she knew or had reason to know, that there was an understatement of tax due to his or her spouse’s erroneous items, but he or she did not know how large the understatement was. He or she will be relieved of the understatement to the extent he or she did not know about it and had no reason to know about it. Erroneous items are either of the following: • Any gross income item received by the spouse that was not reported as income; or • Any improper deduction, credit, or property basis claimed on the return. 13 INDIVIDUALS The following are examples of erroneous items: • The expense for which the deduction is taken was never paid or incurred. For example, the non‐ requesting spouse, a cash‐basis taxpayer, deducted $10,000 of advertising expenses on Schedule C (Form 1040), but never paid for any advertising. • The expense does not qualify as a deductible expense. For example, the spouse claimed a business fee deduction of $10,000 that was for the payment of state fines. Fines are not deductible. • No factual argument can be made to support the deductibility of the expense. For example, the non‐ requesting spouse claimed $4,000 for security costs related to a home office, which were actually veterinary and food costs for the family’s two dogs. A spouse has knowledge or reason to know of an understatement if he or she actually knew of the understatement, or if a reasonable person in similar circumstances would have known of the understatement. Facts and circumstances considered in determining whether a requesting spouse had reason to know of an understatement include, but are not limited to: 14 • The nature of the erroneous item and the amount of the erroneous item relative to other items; • The couple’s financial situation; • The requesting spouse’s educational background and business experience; • The extent of the requesting spouse’s participation in the activity that resulted in the erroneous item; • Whether the requesting spouse failed to inquire, at or before the time the return was signed, about items on the return or omitted from the return that a reasonable person would question; and • Whether the erroneous item represented a departure from a recurring pattern reflected in prior year’s returns. INDIVIDUALS (ii) Separation of liability – Under this type of relief, there is an allocation of the understatement of tax (plus interest and penalties) on the joint return between the taxpayer and the spouse (or former spouse). The understatement of tax allocated to the taxpayer is generally the amount he or she is responsible for. Taxpayers may request this type of relief on Form 8857 in addition to innocent spouse relief. To request relief by separation of liability, a taxpayer must have filed a joint return and must meet one of the following requirements at the time he or she files Form 8857: • The taxpayer must no longer be married to, or be legally separated from, the spouse with whom the joint return was filed for which relief is requested (Under this rule, the taxpayer is no longer married if he or she is widowed); or • The taxpayer must not be a member of the same household as the spouse with whom the joint return was filed at any time during the 12‐month period ending on the date he or she files Form 8857 to request separation of liability. Even if the taxpayer meets the requirements above, a request for separation of liability will not be granted in the following situations: • The IRS proves that the taxpayer and spouse transferred assets to third parties as part of a fraudulent scheme; • The IRS proves that at the time the taxpayer signed the joint return, he or she had actual knowledge of any items giving rise to the deficiency that were allocable to the spouse; or • The spouse (or former spouse) transferred property to the taxpayer to avoid tax or the payment of tax. 15 INDIVIDUALS If it is established that the taxpayer signed the joint return under duress, then it is not a joint return, and the taxpayer is not liable for amounts from that return. However, the taxpayer may be required to file a separate return for that tax year. If the spouse transfers property to the taxpayer for the purpose of avoiding tax or payment of tax, the tax liability allocated to the taxpayer will be increased by the value of the property transferred. A transfer will be presumed to have as its main purpose the avoidance of tax or payment of tax if the transfer is made after the date that is one year before the date on which the IRS sent its first letter of proposed deficiency allowing the taxpayer an opportunity for a meeting in the IRS Appeals Office. This presumption will not apply if the transfer was made under a divorce decree, separate maintenance agreement, or a written instrument incident to such an agreement. The presumption will also not apply if the taxpayer establishes that the transfer did not have as its main purpose the avoidance of tax or payment of tax. (iii) Equitable relief ‐‐ If the taxpayer does not qualify for innocent spouse relief or relief by separation of liability, the taxpayer may still be relieved of responsibility for tax, interest, and penalties through the IRS provisions for equitable relief. The taxpayer may qualify for equitable relief if all of the following conditions are met: 16 • The taxpayer is not eligible for innocent spouse relief or relief by separation of liability; • The taxpayer and the spouse did not transfer assets to one another as a part of a fraudulent scheme; • The spouse did not transfer assets to the taxpayer for the main purpose of avoiding tax or the payment of tax; • The taxpayer did not file the return with the intent to commit fraud; and INDIVIDUALS • The taxpayer establishes that, considering all the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement or underpayment of tax. Unlike innocent spouse relief or separation of liability, the taxpayer can get equitable relief from both an understatement of tax or an underpayment of tax. As noted, the two‐year time limit no longer applies for innocent spouse requests for equitable relief. Rather, the IRS will consider a request for equitable relief if the collection statute of limitations for the tax years involved has not expired, or if the taxpayer is seeking a refund, if the refund statute of limitations has not expired. Many taxpayers that were previously denied because of the two‐ year limit may now qualify for relief. 1111.14 Injured Spouse An “injured spouse” is a taxpayer who has filed a joint return with his or her spouse and all or part of his or her share of an overpayment was applied against his or her spouse’s past‐due federal tax liability, child or spousal support, federal nontax debt, or state income tax. A taxpayer may file a claim as an injured spouse to request a refund of the amount of offset. For example, if a spouse is in arrears on his or her child support, it is possible that any refund generated by the filing of a joint tax return may be withheld by the IRS and applied toward the arrearage. A spouse who has income and withholdings or estimated tax payments and who files a joint return with an individual who owes past‐due child support must file a request for a refund of his or her allocation of the joint return refund (Form 8379, Injured Spouse Claim and Allocation). The requirements in order to do this include: (i) The taxpayer seeking relief is not required to pay the past due amounts; rather, the spouse in default is responsible for the debt; (ii) The taxpayer reported income such as wages, taxable interest, etc., on the joint return; 17 INDIVIDUALS (iii) The taxpayer made and reported payments such as federal income tax withheld from taxpayer’s wages or estimated tax payments or the taxpayer claimed the Earned Income Tax Credit or other refundable credit; and (iv) Form 8379 is filed. Signing a Joint Return 18 1111.15 For a tax return to be considered a joint tax return, both husband and wife generally must sign the return. If a spouse died before signing the return, the executor or administrator of the deceased spouse’s estate must sign the return for the spouse. If neither the survivor nor anyone else has yet been appointed as executor or administrator, the surviving spouse can sign the return for his or her deceased spouse and should enter “filing as surviving spouse” in the area where the surviving spouse signs the return. If one spouse is away from home, the other spouse should prepare the return, sign it, and send it to the other spouse to sign so that it can be filed on time. 1111.16 If a spouse cannot sign the tax return because of injury or disease and tells the other spouse to sign the tax return on his or her behalf, the other spouse can sign the disabled spouse’s name in the proper space on the return followed by the words “by (taxpayer’s name), husband (or wife).” The signing individual should also sign in the space provided for his or her own signature. The signing spouse should attach a signed, dated statement that should include the form number of the return that he or she is filing, the tax year, the reason the disabled spouse cannot sign, and a statement that the disabled spouse has agreed that the other spouse should sign for him or her. If one spouse is the guardian of his or her spouse who is mentally incompetent, the one spouse can sign the return for his or her spouse as guardian. If a spouse cannot sign the joint return for any other reason other than those just discussed, the other spouse can sign for him or her only if he or she is given a valid power of attorney. INDIVIDUALS Signing Electronic Tax Returns 1111.17 As with an income tax return submitted to the IRS on paper, the taxpayer and paid preparer (if applicable) must sign an electronic income tax return. Taxpayers must sign individual income tax returns electronically. There are currently two methods for signing individual income tax returns electronically. 1111.18 Taxpayers must sign and date the Declaration of Taxpayer to authorize the origination of the electronic submission of the return to the IRS prior to the transmission of the return to IRS. The Declaration of Taxpayer includes the taxpayer’s declaration under penalties of perjury that the return is true, correct, and complete, as well as the taxpayers’ Consent to Disclosure. The Consent to Disclosure authorizes the IRS to disclose information to the taxpayers’ Providers. Taxpayers authorize Intermediate Service Providers, Transmitters, and Electronic Return Originators (EROs) to receive from the IRS an acknowledgement of receipt or reason for rejection of the electronic return, an indication of any refund offset, the reason for any delay in processing the return, or refund and the date of the refund. 1111.19 Taxpayers must sign a new declaration if the electronic return data on individual income tax returns is changed after taxpayers signed the Declaration of Taxpayer and the amounts differ by more than either $50 to “Total income” or “AGI,” or $14 to “Total tax,” “Federal income tax withheld,” “Refund,” or “Amount you owe.” 1111.20 As noted above, there are two methods of signing individual income tax returns with an electronic signature available for use by taxpayers. Both methods allow taxpayers to use a Personal Identification Number (PIN) to sign the return and the Declaration of Taxpayer. 1111.21 One of these methods is Self‐Select PIN. The Self‐Select PIN method requires taxpayers to provide their prior year Adjusted Gross Income (AGI) amount or prior year PIN for use by the IRS to authenticate the taxpayers. EROs should encourage taxpayers who do not have their original prior AGI or PIN to call IRS Tax Help at (800) 829‐1040. 19 INDIVIDUALS 1111.22 This method may be completely paperless if the taxpayers enter their own PINs directly into the electronic return record using keystrokes after reviewing the completed return. Taxpayers may also authorize EROs to enter PINs on their behalf, in which case the taxpayers must review and sign a completed signature authorization form after reviewing the return. 1111.23 The other method is Practitioner PIN. The Practitioner PIN method does not require the taxpayer to provide their prior year AGI amount or prior year PIN. When using the Practitioner PIN method, taxpayers must always appropriately sign a completed signature authorization form. Taxpayers, who use the Practitioner PIN method and enter their own PINs in the electronic return record using keystrokes after reviewing the completed return, must still appropriately sign the signature authorization form. 1111.24 Regardless of the method of electronic signature used, taxpayers may enter their own PINs; EROs may select and enter the taxpayers’ PINs; or the software may generate the taxpayers’ PINs in the electronic return. After reviewing the return, the taxpayers must agree by signing an IRS e‐file signature authorization containing the PIN. The following taxpayers are ineligible to sign individual income tax returns with an electronic signature using the Self‐Select PIN: • Primary taxpayers under age sixteen who have never filed; and • Secondary taxpayers under the age sixteen who did not file the prior tax year. EROs should advise taxpayers to keep a copy of their completed tax return to assist with authentication in the subsequent year. 20 INDIVIDUALS 1111.25 When taxpayers are unable to enter their PIN directly in the electronic return, taxpayers authorize the ERO to enter their PINs in the electronic return record by signing the appropriate completed IRS e‐file signature authorization form. IRS e‐file Signature Authorization Form 8879, IRS e‐file Signature Authorization, authorizes an ERO to enter the taxpayers’ PINs on Individual Income Tax Returns and IRS e‐file Authorization for Application of Extension of Time to File. Form 8878, IRS e‐file Authorization for Form 4868 and Form 2350, authorizes an ERO to enter the taxpayers’ PINs on Forms 4868 and 2350. 1111.26 The ERO may enter the taxpayers’ PINs in the electronic return record before the taxpayers sign Form 8879 or 8878, but the taxpayers must sign and date the appropriate form before the ERO originates the electronic submission of the return. After completing either Form 8879 or Form 8878, the ERO must give it to the taxpayer for review. This can be done in person or by using the U.S. mail, a private delivery service, fax, e‐mail, or an Internet website. The taxpayer must sign and date the Form 8879 or Form 8878 after reviewing the return and ensuring the tax return information on the form matches the information on the return. The taxpayer may return the completed Form 8879 or Form 8878 to the ERO by hand delivery, U.S. mail, private delivery service, fax, e‐mail, or an Internet website. 1111.27 EROs may use an electronic signature pad to have taxpayers sign Forms 8879 and 8878. Taxpayers must be present in the ERO’s office where the electronic signature pad is located to sign using the signature pad. The ERO must retain the forms with the taxpayers’ signatures and provide a copy to the taxpayer upon request. 1111.28 Only taxpayers who provide a completed tax return to an ERO for electronic filing may complete the IRS e‐file Signature Authorization without reviewing the return originated by the ERO. The ERO must enter the line items from the paper return on the applicable Form 8879 or Form 8878 prior to the taxpayers signing and dating the form. The ERO may use these pre‐signed authorizations as authority to input the taxpayer’s PIN only if the information on the electronic version of the tax return agrees with the entries from the paper return. 21 INDIVIDUALS Married Filing Separately 22 1111.29 Married individuals can choose married filing separately as their filing status. This filing status may benefit a spouse if he or she wants to be legally responsible only for his or her own tax or if it results in less tax than filing a joint return. If the spouses do not agree to file a joint return, they must file married filing separately unless one or both of the spouses qualifies for head of household status. 1111.30 A taxpayer may be able to choose head of household filing status if he or she lives apart from his or her spouse, meets certain tests, and is considered unmarried. This can apply to a spouse who is not divorced or legally separated. If a taxpayer qualifies to file as head of household, instead of as married filing separately, his or her tax may be lower, the individual may be able to claim the earned income credit and certain other credits, and his or her standard deduction will be higher. The head of household filing status allows a taxpayer to choose the standard deduction even if his or her spouse chooses to itemize deductions. 1111.31 Generally, married taxpayers will pay more combined tax on separate returns than they would on a joint return, but there are certainly exceptions to this generalization. However, unless a taxpayer is required to file separately, he or she should figure his or her tax both ways (on a joint return and on separate returns). This way the taxpayer can make sure he or she is using the filing status that results in the lower combined tax. When figuring the combined tax of husband and wife, it is important to consider state taxes as well as federal taxes. 1111.32 If a married individual files a separate return, he or she generally reports only his or her own income, exemptions, credits, and deductions on his or her own individual return. A taxpayer can claim an exemption for his or her spouse if the spouse had no gross income and was not the dependent of another person. However, if a taxpayer’s spouse had any gross income or was the dependent of someone else, the spouse cannot claim an exemption for him or her on his or her separate income tax return. INDIVIDUALS a. A taxpayer can change his or her filing status by filing an amended return using Form 1040X. If a taxpayer and/or his or her spouse file separate returns, they can change to filing a joint return any time within three years from the due date of the separate return or returns. This does not include any extensions. A separate return includes a return filed by the taxpayer or his or her spouse claiming married filing separately, single, or head of household filing status. b. Once a married couple files a joint return, they cannot choose to file separate returns for that year after the due date of the return. However, a personal representative for a decedent can change from a joint return elected by the surviving spouse to a separate return for the decedent. The personal representative has one year from the due date (including extensions) of the return to make the change. Head of Household 1111.33 1111.34 A taxpayer may file as head of household if he or she meets all the following requirements: a. He or she is unmarried or “considered unmarried” on the last day of the year; b. He or she paid more than half the cost of keeping up a home for the year; and c. A “qualifying person” lived with the taxpayer in the home for more than half the year (except for temporary absences, such as school). However, if the “qualifying person” is the taxpayer’s dependent parent, the parent does not have to live with the taxpayer. If a taxpayer qualifies to file as head of household, his or her tax usually will be lower than if he or she had filed as single or married filing separately. The taxpayer will also receive a higher standard deduction than if he or she filed as single or married filing separately. a. Considered unmarried – To qualify for head of household status, the taxpayer must be either unmarried or considered unmarried on the last day of the year. An 23 INDIVIDUALS individual is considered unmarried on the last day of the tax year if he or she meets all the following tests: (i) He or she files a separate return; (ii) He or she paid more than half the cost of keeping up his or her home for the tax year; (iii) The taxpayer’s spouse did not live in his or her home during the last six months of the tax year; (iv) The taxpayer’s home was the main home of his or her child, stepchild, or foster child for more than half the year; and (v) The taxpayer must be able to claim an exemption for the child. To qualify for head of household status, the taxpayer must pay more than half of the cost of keeping up a home for the year. A taxpayer can determine whether he or she paid more than half of the cost of keeping up a home by using the following worksheet. Amount Taxpayer Paid Property taxes Total Cost $ $ $ $ Mortgage interest expense Rent Utility charges Repairs/maintenance Property insurance Food consumed on the premises Other household expenses Total Minus total amount taxpayer paid Amount others paid ( $ $ If the total amount the taxpayer paid is more than the amount others paid, he or she meets the requirement of paying more than half the cost of keeping up the home. 24 ) INDIVIDUALS Included in the cost of upkeep expenses are such expenditures as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food eaten in the home. The cost of upkeep expenses such as clothing, education, medical treatment, vacations, life insurance, or transportation are not included nor is the rental value of a home or the value of the taxpayer’s services or those of a member of his or her household. b. Qualifying person for head of household purposes – The following table can be used to determine whether a person is a qualifying person allowing the taxpayer to file as head of household. IF the Person Is the Taxpayer’s: Qualifying child (such as a son, daughter, or grandchild who lived with taxpayer more than half the year and meets certain other tests)2 Qualifying relative who is your father or mother Qualifying relative other than taxpayer’s father or mother (such as a grandparent, brother, or sister who meets certain tests) AND: THEN That Person Is: He or she is single A qualifying person, whether or not taxpayer can claim an exemption for the person. He or she is married, and taxpayer can claim an exemption for him or her A qualifying person. He or she is married, and taxpayer cannot claim an exemption for him or her Not a qualifying person.3 Taxpayer can claim an exemption for him or her5 A qualifying person. Taxpayer cannot claim an exemption for him or her Not a qualifying person. He or she lived with taxpayer more than half the year, and he or she is related to taxpayer in one of the ways listed under Relatives who do not have to live with taxpayer, later, and taxpayer can claim an exemption for him or her4 A qualifying person. He or she did not live with taxpayer more than half the year Not a qualifying person. (continued) 25 INDIVIDUALS IF the Person Is the Taxpayer’s: AND: THEN That Person Is: He or she is not related to taxpayer in one of the ways listed under Relatives who do not have to live with taxpayer, later, and is taxpayer’s qualifying relative only because he or she lived with you all year as a member of taxpayer’s household Not a qualifying person. Taxpayer cannot claim an exemption for him or her Not a qualifying person. 1. A person cannot qualify more than one taxpayer to use the head of household filing status for the year. 2. The term “qualifying child” is defined under exemptions for dependents, later. Note: If taxpayer is a noncustodial parent, the term “qualifying child” for head of household filing status does not include a child who is taxpayer’s qualifying child for exemption purposes only because of the rules described under children of divorced or separated parents or parents who live apart under qualifying child, later. If taxpayer is the custodial parent and those rules apply, the child generally is taxpayer’s qualifying child for head of household filing status even though the child is not a qualifying child for whom taxpayer can claim an exemption. 3. This person is a qualifying person if the only reason taxpayer cannot claim the exemption is that taxpayer can be claimed as a dependent on someone else’s return. 4. If taxpayer can claim an exemption for a person only because of a multiple support agreement, that person is not a qualifying person. Example 1: Child – Taxpayer’s unmarried son lived with taxpayer all year and was 18 years old at the end of the year. He did not provide more than half of his own support and does not meet the tests to be a qualifying child of anyone else. As a result, he is taxpayer’s qualifying child and, because he is single, is a qualifying person for the taxpayer to claim head of household filing status. Example 2: Child who is not qualifying person – The facts are the same as in Example 1, except the taxpayer’s son was 25 years old at the end of the year and his gross income was $5,000. Because he does not meet the age test, the taxpayer’s son is not his qualifying child. Because he does not meet the gross income test, he is not the taxpayer’s qualifying relative and as a result, he is not the taxpayer’s qualifying person for head of household purposes. 26 INDIVIDUALS Example 3: Girlfriend – Taxpayer’s girlfriend lived with him all year. Even though she may be the taxpayer’s qualifying relative if the gross income and support tests are met, she is not the taxpayer’s qualifying person for head of household purposes because she is not related to the taxpayer in one of the ways listed above in the table. Example 4: Girlfriend’s child – The facts are the same as in Example 3, except the taxpayer’s girlfriend’s 10‐year‐old son also lived with them all year. The 10‐year‐old son is not the taxpayer’s qualifying child and, because he is the girlfriend’s qualifying child, he is not the taxpayer’s qualifying relative. As a result, he is not the taxpayer’s qualifying person for head of household purposes. Home of qualifying person – Generally, the qualifying person must live with the taxpayer for more than half of the year. However, if the taxpayer’s qualifying person is his or her father or mother, the taxpayer may be eligible to file as head of household even if his or her father or mother does not live with the taxpayer. However, the taxpayer must be able to claim an exemption for his or her father or mother. Also, the taxpayer must pay more than half the cost of keeping up a home that was the main home for the entire year for the taxpayer’s father or mother. A taxpayer keeps up a main home for his or her father or mother if he or she pays more than half the cost of keeping the taxpayer’s parent in a rest home or home for the elderly. A taxpayer may be eligible to file as head of household if the individual who qualifies the taxpayer for this filing status is born or dies during the year. The taxpayer must have provided more than half of the cost of keeping up a home that was the individual’s main home for more than half of the year, or, if less, the period during which the individual lived. Example: The taxpayer is unmarried. Taxpayer’s mother, for whom she can claim an exemption, lived in an apartment by herself until she died on September 2 of the current year. The cost of the upkeep of her apartment for the year until her death was $6,000, of which the taxpayer paid $4,000 and her brother paid $2,000. The brother made no other payments towards the mother’s support. The mother had no income. Because the taxpayer paid more than 27 INDIVIDUALS half of the cost of keeping up her mother’s apartment from January 1 until her death, and the taxpayer can claim an exemption for her, the taxpayer can file as a head of household for the current year. c. Temporary absences – The taxpayer and his or her qualifying person are considered to live together even if one or both of these individuals are temporarily absent from home due to special circumstances such as illness, education, business, vacation, or military service. It must be reasonable to assume that the absent person will return to the home after the temporary absence. The taxpayer must continue to keep up the home during the absence. Qualifying Surviving Spouse with Dependent Child 1111.35 If the taxpayer’s spouse died in the current year, he or she can use married filing jointly as his or her filing status for the current year if the taxpayer otherwise qualifies to use that status. The year of death is the last year for which the taxpayer can file jointly with his or her deceased spouse. 1111.36 The taxpayer may be eligible to use qualifying surviving spouse with dependent child as his or her filing status for two years following the year the taxpayer’s spouse died. For example, if the taxpayer’s spouse died in 20X1 and he or she has not remarried, the taxpayer may be able to use this filing status for 20X2 and 20X3. This filing status entitles the taxpayer to use joint return tax rates and the highest standard deduction amount (if the taxpayer does not itemize deductions). This status does not entitle the taxpayer to file a joint return. a. 28 A taxpayer is eligible to file his or her 2023 income tax return as a qualifying surviving spouse with dependent child if the taxpayer meets all the following tests: (i) The taxpayer was entitled to file a joint return with his or her spouse for the year his or her spouse died. It does not matter whether the taxpayer actually filed a joint return; (ii) The taxpayer’s spouse died in 2021 or 2022 and the taxpayer did not remarry before the end of 2023; INDIVIDUALS (iii) The taxpayer has a child or stepchild for whom he or she can claim an exemption; (iv) The child lived in the taxpayer’s home all year, except for temporary absences; and (v) The taxpayer paid more than half the cost of keeping up a home for the child. Example: John Reed’s wife died in 2021. John has not remarried. He has continued during 2022 and 2023 to keep up a home for himself and his child, who lives with him and for whom he can claim an exemption. For 2021, he was entitled to file a joint return for himself and his deceased wife. For 2022 and 2023, he can file as a qualifying surviving spouse with a dependent child. After 2023, he can file as head of household if he qualifies. b. A taxpayer may be eligible to file as a qualifying surviving spouse with dependent child if the child who qualifies the taxpayer for this filing status is born or dies during the year. The taxpayer must have provided more than half of the cost of keeping up a home that was the child’s main home during the entire part of the year he or she was alive. Sources of All Income 1111.37 Part of an EA’s task is to determine all of the taxpayer’s sources of income, and to differentiate the taxpayer’s taxable income from the nontaxable income. As a general rule, all increments to wealth are taxable, regardless of whether the transaction generating the income is reported to the IRS. Many income generating events require a payor to send an information return ‐‐ Form 1099, Form K‐1, Form W‐2 ‐‐ to the recipient and to the IRS. The IRS’s “matching program” matches up income reported on a taxpayer’s tax return with the information returns it receives from the payers. When there is a mismatch, the IRS will notify the taxpayer and inquire about the mismatch and/or make an adjustment to the taxpayer’s tax liability itself. Regardless of whether an income generating event results in the issuance of an information return such as a Form W‐2, 1099, or Schedule K‐1, the recipient taxpayer is required to include the fair market value of property he or she receives in income for purposes of tax return reporting. 29 INDIVIDUALS 1111.38 As noted, one important step in preparing income tax returns is to examine the information returns that the taxpayer reported receiving in the prior tax year. For example, if a client reported income from various Forms W‐2s, 1099s, and Schedules K‐1s in 2022, the chances are he or she will have income from most of those sources of income again in 2023. If he or she does not report such items, the absence of such income should encourage the EA to investigate why income from a certain source reported in the prior year does not appear on the current‐year’s return. The following is a schedule of some common income reporting forms: a. W‐2 forms for taxpayer and his or her spouse; b. 1099‐C forms for cancellation of debt; c. 1099‐G forms for unemployment income, state, or local tax refunds; d. 1099‐NEC forms for taxpayer and his or her spouse (for any independent contractor work); e. 1099‐R, Form 8606 for payments/distributions from IRAs or retirement plans; f. 1099‐S forms for income from sale of a property; g. 1099‐INT, ‐DIV, ‐B, or K‐1s for investment or interest income; h. SSA‐1099 for Social Security benefits received; and i. 1095‐A, Health Insurance Marketplace Statement. Sources of Applicable Adjustments to Gross Income 1111.39 30 Deductions are categorized as either “adjustments to income” (above the line deductions) that are used to reduce gross income to produce adjusted gross income (AGI), or itemized deductions, which reduce AGI to produce taxable income. A taxpayer may take adjustments to income regardless of whether he or she itemizes his or her deductions. The following discussion addresses a number of important above the line deductions. INDIVIDUALS Self‐Employed Health Insurance 1111.40 A taxpayer with self‐employment income can take a deduction for health and long‐term care insurance expenses incurred for the taxpayer, his or her spouse, and his or her dependents on Line 17 of the 2023 Schedule 1. Eligible individuals include self‐employed people reporting income on Schedule F (for farmers) or Schedule C (self‐employed persons), general partners in a partnership, actively participating members in an LLC treated as a partnership who have self‐employed income, and employees of an S‐ corporation who own 2 percent or more of the S corporation’s stock. 1111.41 Before claiming a deduction for self‐employed health insurance, the taxpayer must calculate his or her allowable health insurance deduction by taking his or her self‐employment income and subtracting the 50 percent deduction for self‐employment taxes and any retirement contributions the taxpayer made to a SEP‐IRA, SIMPLE‐IRA, or Keogh plan. The remainder is the taxpayer’s allowable deduction for health insurance expenses. If the taxpayer is reporting a loss from his or her self‐employed activity, then he or she is not eligible to deduct his or her health insurance costs since this particular deduction is limited by the taxpayer’s self‐employment income. The taxpayer can, however, still claim the health insurance expenses as an itemized medical deduction on his or her Schedule A. This Schedule A deduction is limited in 2023 by a 7.5 percent AGI limitation. 1111.42 A self‐employed individual cannot deduct any health insurance costs for any months he or she was eligible to participate in an employer subsidized health insurance plan through his or her spouse’s employer. Example: John, a self‐employed individual operating his own business, paid for 12 months of health insurance coverage for himself and his family. In December of the year in question, he became eligible to participate in his spouse’s group health insurance. He can deduct only 11 months’ worth of insurance premiums. The taxpayer deducts this expenditure on Line 17 of the year 2023 Schedule 1, not on the Schedule C or the Schedule F. This deduction will not reduce the taxpayer’s self‐employment tax. If the taxpayer were to employ his or her spouse and provide health 31 INDIVIDUALS insurance to him or her that included family coverage, the Tax Court has indicated that this deduction could be taken on the Schedule C. It appears the IRS does not agree with this position. Student Loan Interest Deduction and Form 1098‐E 1111.43 1111.44 32 A taxpayer may be able to deduct interest he or she paid on a qualified student loan. Generally, the amount deductible is the lesser of $2,500 or the amount of interest actually paid. The deduction is claimed as an adjustment to income, so the taxpayer does not need to itemize his or her deductions on Schedule A Form 1040. A taxpayer may claim the deduction if all of the following circumstances apply: a. Taxpayer paid interest on a qualified student loan in the tax year; b. Taxpayer is legally obligated to pay interest on a qualified student loan; c. Taxpayer’s filing status is not married filing separately; d. Taxpayer’s modified adjusted gross income is less than a specified amount which is set annually that precludes taking the deduction; and e. Taxpayer and his or her spouse, if filing jointly, cannot be claimed as dependents on someone else’s return. A qualified student loan is a loan the taxpayer took out solely to pay qualified higher education expenses for the taxpayer, his or her spouse, or a person who was the taxpayer’s dependent when he or she took out the loan. The educational expenses must be paid or incurred within a reasonable period of time before or after the taxpayer took out the loan, and the expenses were for education provided during an academic period for an eligible student. Loans from a related person or a qualified employer plan are not qualified student loans. INDIVIDUALS 1111.45 An eligible student is a student who was enrolled at least half‐ time in a program leading to a degree, certificate, or other recognized educational credential. A student was enrolled at least half‐time if the student was taking at least half the normal full‐ time workload for his or her course of study. The standard for what is half of the normal full‐time workload is determined by each eligible educational institution. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items: 1111.46 1111.47 a. Tuition and fees; b. Room and board; c. Books, supplies, and equipment, and d. Other necessary expenses (such as transportation). The cost of room and board qualifies only to the extent that it is not more than the greater of: a. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student; or b. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary postsecondary institutions. 33 INDIVIDUALS 1111.48 To help the taxpayer figure his or her student loan interest deduction, he or she should receive Form 1098‐E. Generally, an institution (such as a bank or governmental agency) that received interest payments of $600 or more during the tax year on one or more qualified student loans must send Form 1098‐E (or acceptable substitute) to each borrower by January 31 of the succeeding tax year. 1111.49 For 2023, the amount of student loan interest deduction is phased out if a taxpayer’s MAGI is between $75,000 and $90,000 ($155,000 and $185,000 for MFJ). A taxpayer cannot take a student loan interest deduction if his or her MAGI was $90,000 or more ($185,000 or more if MFJ). See the chart below illustrating the impact of MAGI on the deduction for 2023: IF taxpayer’s filing status is: Single, head of household, or qualifying surviving spouse Married filing joint return AND MAGI is: THEN the student loan interest deduction is: Not more than $75,000 Not affected by the phase‐out More than $75,000, but less than $90,000 Reduced because of the phase‐ out $90,000 or more Eliminated by the phase‐out Not more than $155,000 Not affected by the phase‐out More than $155,000, but less than $185,000 Reduced because of the phase‐ out $185,000 or more Eliminated by the phase‐out Tuition and Fees Deduction 1111.50 The Taxpayer Certainty and Disaster Tax Relief Act of 2020 repealed the tuition and fees deduction for tax years beginning after 2020. Income limitations for the Lifetime Learning Credit were increased to help filers transition to the Lifetime Learning Credit. Educator Expenses 1111.51 34 An “eligible educator” can deduct as an above the line deduction up to $300 of qualified expenses paid in the current year. If the taxpayer and his or her spouse file jointly and both are eligible educators, the maximum deduction is $600. However, neither spouse can deduct more than $300 of his or her qualified expenses on Schedule 1, line 11. INDIVIDUALS (i) An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide who worked in a school for at least 900 hours during a school year. (ii) Qualified expenses include ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom. An ordinary expense is one that is common and accepted in the taxpayer’s educational field. A necessary expense is one that is helpful and appropriate for the taxpayer’s profession as an educator. An expense does not have to be required to be considered necessary. Qualified expenses do not include expenses for home schooling or for nonathletic supplies for courses in health or physical education. Health Savings Account 1111.52 A health savings account (HSA) is a tax‐exempt trust or custodial account a taxpayer can set up with a qualified HSA trustee to pay or reimburse certain medical expenses the taxpayer incurs. No permission or authorization from the IRS is necessary to establish an HSA. 1111.53 The tax advantages of an HSA are as follows: • A taxpayer can claim a tax deduction for contributions he or she or someone other than his or her employer makes to his or her HSA even if he or she does not itemize his or her deductions. • Contributions to an HSA made by an employer (including contributions made through a Cafeteria plan) may be excluded from gross income. • The contributions remain in the taxpayer’s account from year to year until he or she uses them. • The interest or other earnings on the assets in the account are tax free. • Distributions may be tax free if the taxpayer pays for qualified medical expenses. 35 INDIVIDUALS • An HSA is “portable,” so it stays with the taxpayer if he or she changes employers or leaves the work force. Qualifying for an HSA 1111.54 1111.55 1111.56 36 To be an eligible individual and qualify for an HSA, a taxpayer must meet the following requirements. • The taxpayer must be covered under a high deductible health plan (HDHP) on the first day of the month. • The taxpayer has no other health coverage, except what is permitted. • The taxpayer is not enrolled in Medicare. • The taxpayer cannot be claimed as a dependent on someone else’s current year tax return. A High Deductible Health Plan (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 you must pay for covered expenses. Out‐of‐pocket expenses include copayments and other amounts, but do not include premiums. An HDHP may provide preventive care benefits without a deductible or with a deductible below the minimum annual deductible. Preventive care includes, but is not limited to, the following: 1. Periodic health evaluations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals 2. Routine prenatal and well‐childcare 3. Child and adult immunizations 4. Tobacco cessation programs 5. Obesity weight‐loss programs INDIVIDUALS 6. Screening services. This includes screening services for the following: a. Cancer b. Heart and vascular diseases c. Infectious diseases d. Mental health conditions e. Substance abuse f. Metabolic, nutritional, and endocrine conditions g. Musculoskeletal disorders h. Obstetric and gynecological conditions i. Pediatric conditions j. Vision and hearing disorders Other Health Coverage 1111.57 The taxpayer (and his or her spouse, if he or she has family coverage) generally cannot have any other health coverage that is not an HDHP. However, the taxpayer can still be an eligible individual even if his or her spouse has non‐HDHP coverage provided he or she is not covered by that plan. A taxpayer can have additional insurance that provides benefits only for the following items: • Liabilities incurred under workers’ compensation laws, tort liabilities, or liabilities related to ownership or use of property. • A specific disease or illness. • A fixed amount per day (or other period) of hospitalization. 37 INDIVIDUALS 1111.58 38 A taxpayer can also have coverage (whether provided through insurance or otherwise) for the following items: • Accidents • Disability • Dental care • Vision care • Long‐term care 1111.59 For an employee’s HSA, the employee, the employee’s employer, or both may contribute to the employee’s HSA in the same year. For an HSA established by a self‐employed (or unemployed) individual, the individual can contribute. Family members or any other person may also make contributions to an HSA on behalf of an eligible individual. Contributions to an HSA must be made in cash; contributions of stock or property to an HSA are not allowed. 1111.60 The amount a taxpayer or any other person can contribute to the taxpayer’s HSA depends on the type of high deductible health plan (HDHP) coverage the taxpayer has, his or her age, the date the individual becomes an eligible individual, and the date he or she ceases to be an eligible individual. For 2023, if the taxpayer has only HDHP coverage, he or she can contribute up to $3,850). If the taxpayer has family HDHP coverage, he or she can contribute up to $7,750. Contributions to an HSA are tax‐deductible and earnings, such as interest and dividends, in the HSA are tax‐ exempt at the federal level. Withdrawals from an HSA are tax‐free as long as the funds are used for qualified medical expenses. No HSA contributions or tax deductions are permitted if the taxpayer is enrolled in Medicare Part A or Part B. Catch‐up contributions of $1,000 are allowed for those age 55 and over. INDIVIDUALS Alimony 1111.61 The Tax Cuts and Jobs Act of 2017 changed the treatment of alimony and separate maintenance payments negotiated after December 31, 2018. For agreements on or before December 31, 2018, a taxpayer can deduct alimony paid, whether or not he or she itemizes deductions on his or her return. The taxpayer should enter the amount of alimony paid on line 19a of Schedule 1 of Form 1040 and the payee’s spouse’s Social Security number on Line 19b. If the taxpayer paid alimony to more than one person, the taxpayer should enter the Social Security number of one of the recipients on Line 19b and show the Social Security number and amount paid to each other recipient on an attached statement. The taxpayer should enter his or her total payments on Line 19a. Alimony received should be reported on line 2a of Schedule 1 of Form 1040. For agreements after December 31, 2018, or agreements changed after December 31, 2018 to state that alimony is not included in income, a taxpayer cannot deduct alimony paid (and taxpayers are not required to report alimony received as income). 1112 Sources of Applicable Deductions Standard Deduction versus Itemized Deductions 1112.01 The standard deduction amount depends on the taxpayer’s filing status, whether the taxpayer is 65 or older or blind, whether an exemption can be claimed for the taxpayer by another taxpayer and whether the taxpayer has a net qualified disaster loss from a federally declared disaster. Generally, the standard deduction amounts are adjusted each year for inflation. Higher Standard Deduction for Blindness 1112.02 If a taxpayer is blind on the last day of the year and he or she does not itemize deductions, he or she is entitled to a higher standard deduction. If the taxpayer is not totally blind, he or she must get a certified statement from an ophthalmologist or optometrist that: 39 INDIVIDUALS 1112.03 a. The taxpayer cannot see better than 20/200 in the better eye with glasses or contact lenses; or b. The taxpayer’s field of vision is 20 degrees or less. If the taxpayer’s eye condition is not likely to improve beyond these limits, the statement should include this fact and the statement must be kept in the taxpayer’s records. If the taxpayer’s vision can be corrected beyond these limits only by contact lenses that the taxpayer can wear only briefly because of pain, infection, or ulcers, the taxpayer can take the higher standard deduction for blindness if he or she otherwise qualifies. Standard Deduction for Dependents 1112.04 The standard deduction for an individual who can be claimed as a dependent on another person’s tax return is generally limited to the greater of: a. $1,250 in 2023; or b. The individual’s earned income for the year plus $400 for 2023, but not more than the regular standard deduction amount, $13,850 (single) for 2023. However, if the individual is 65 or older or blind, the standard deduction may be higher. 40 INDIVIDUALS 1112.05 The standard deduction amounts for 2023 are listed on the following chart. Filing Status Married filing jointly $27,700 Single and married individuals filing separately $13,850 Head of household $20,800 Additional standard deduction for blind people and senior citizens for married individuals $1,500 Additional standard deduction for blind people and senior citizens for singles and head of households $1,850 Dependent 1112.06 2023 Greater of (1) $1,250, or (2) the sum of $400 and the individual’s earned income but not more than the regular standard deduction amount The amount of the standard deduction for a decedent’s final tax return is the same as it would have been had the decedent continued to live. However, if the decedent was not 65 or older at the time of death, the higher standard deduction for age cannot be claimed on the decedent’s final tax return. 41 INDIVIDUALS Who Should Itemize? 1112.07 A taxpayer is better off economically if he or she itemizes his or her deductions when his or her total deductions are more than the standard deduction amount. Also, a taxpayer should itemize if he or she does not qualify for the standard deduction. It is important to note that many taxpayers who regularly itemized deductions prior to 2018 may have a greater benefit from the new, higher standard deduction. The taxpayer should first figure his or her itemized deductions and compare that amount to his or her standard deduction to make sure he or she is using the method that gives him or her the greater benefit. A taxpayer may benefit from itemizing his or her deductions if he or she: a. Does not qualify for the standard deduction, or the amount he or she can claim is limited; b. Had large uninsured medical and dental expenses during the year; c. Paid interest and taxes on their home; d. Made large contributions to qualified charities; or e. Have total itemized deductions that are more than the standard deduction to which the taxpayer is otherwise entitled. It is important to note that the deduction for state and local taxes and property taxes or sales taxes are limited to $10,000 per year. Since tax returns are generally prepared electronically, the software is generally programmed to use the option that produces the greater benefit for the taxpayer. 42 INDIVIDUALS Electing to Itemize for State Tax or Other Purposes 1112.08 Even if a taxpayer’s itemized deductions are less than the amount of his or her standard deduction, the taxpayer can elect to itemize deductions on his or her federal return rather than take the standard deduction. A taxpayer may want to do this, for example, if the tax benefit of being able to itemize his or her deductions on his or her state tax return is greater than the tax benefit the taxpayer would lose on his or her federal return by not taking the standard deduction. If married filing separately and one of the spouses itemizes, the other spouse must itemize as well. To make this election, the taxpayer must check the box on Line 18 of Schedule A. 1112.09 If the taxpayer did not itemize his or her deductions and later finds that he or she should have itemized ‐‐ or if he or she itemized deductions and later concluded that he or she should not have ‐‐ the taxpayer can amend his or her tax return by filing Form 1040X and itemize deductions or take the standard deduction. Married Person Who Filed Separate Returns 1112.10 A taxpayer who filed married filing separately can change his or her method of taking deductions only if the taxpayer and his or her spouse both make the same change. Both spouses must file a consent to assessment for any additional tax either spouse may owe as a result of the change. The taxpayer and his or her spouse can use the method that gives them the lower total tax, even though one of the taxpayers may pay more tax than he or she would have paid by using the other method. Both spouses must use the same method of claiming deductions. If one itemizes deductions, the other spouse must also itemize his or her deductions because he or she will not qualify for the standard deduction. 43 INDIVIDUALS Qualification for Dependency 1112.11 The TCJA (Tax Cuts and Jobs Act of 2017) suspended personal exemptions for years 2018 through 2025 for taxpayers and their dependents; however, there are still many tax credits which are applicable to dependents. The term “dependent” means a qualifying child or a qualifying relative. a. b. c. d. A taxpayer cannot claim any dependents if the taxpayer (or taxpayer’s spouse, if filing jointly) can be claimed as a dependent by another taxpayer. A taxpayer cannot claim a married person who files a joint return as a dependent unless that joint return is filed only to claim a refund of withheld income tax or estimate tax paid. A taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico. A taxpayer cannot claim a person as a dependent unless that person is their qualifying child or qualifying relative. Qualifying Child Tests 1112.12 There are five tests to determine if a child qualifies as a dependent for tax purposes. These tests are: a. The child must be the taxpayer’s son, daughter, stepchild, foster child, brother, sister, half‐brother, half‐sister, stepbrother, stepsister, or a descendant of any of them. b. The child must be: c. 44 (1) Under age 19 at the end of the year and younger than the taxpayer (or taxpayer’s spouse, if filing jointly), (2) Under age 24 at the end of the year, a student, and younger than the taxpayer (or taxpayer’s spouse, if filing jointly), or (3) Any age if permanently disabled. The child must have lived with the taxpayer for more than half of the year. There are exceptions for temporary absences, children who were born or died during the year, INDIVIDUALS children of divorced or separated parents (or parents who live apart), and kidnapped children. d. The child must not have provided for more than half of his or her own support for the year. e. The child must not be filing a joint return for the year (unless that return is filed only to get a refund of income tax withheld or estimated tax paid). If the child meets the rules to be a qualifying child of more than one person, only one person can treat the child as a qualifying child. Qualifying Relative Test 1112.13 There are four tests to determine if a relative qualified as a dependent for tax purposes. These tests are: a. The person cannot be the taxpayer’s qualifying child or the qualifying child of any other taxpayer. b. The person either: 1) Must be related to the taxpayer in one of the following ways: i. The taxpayer’s child, stepchild, foster child, legally adopted child, or a descendant of any of them. ii. The taxpayer’s brother, sister, half‐brother, half‐sister, stepbrother, or stepsister. iii. The taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. iv. The taxpayer’s stepfather or stepmother. v. A son or daughter of the taxpayer’s brother or sister (including half‐brother and half‐ sister). vi. A brother or sister of the taxpayer’s father or mother. 45 INDIVIDUALS vii. 2) The taxpayer’s son‐in‐law, daughter‐in‐law, father‐in‐law, mother‐in‐law, brother‐in‐ law, or sister‐in‐law. Must live with the taxpayer all year as a member of their household. c. The person’s gross income for the year must be less than $4,700 for 2023. d. The taxpayer must provide more than half of the person’s total support for the year. Any of these relationships that were established by marriage are not ended by death or divorce. 46 1113 Sources of Applicable Credits 1113.01 Child tax credit: The Child Tax Credit under the TCJA (Tax Cuts and Jobs Act of 2017) tax reform is worth up to $2,000 per qualifying child. The age cutoff remains at 17. a. Child dependent: For years 2023 and thereafter, the refundable portion of the credit is limited to $1,600. The beginning credit phaseout for the child tax credit in 2023 is $200,000 ($400,000 for joint filers). The child must have a valid Social Security number (SSN) to qualify for the $2,000 child tax credit. b. Other dependents: This new credit, created under the TCJA, allows for a credit worth $500 for each qualifying dependent who does not qualify for the child tax credit discussed in (a) above; the credit is nonrefundable. For 2023, the phaseout begins for taxpayers with AGI of $200,000 ($400,000 for joint filers). This phaseout applies in combination with the new child tax credit. Unlike the child tax credit, the dependent does not require a valid SSN for the taxpayer to claim the credit for other dependents; an ITIN (Individual Taxpayer Identification Number) or ATIN (Adoption Taxpayer Identification Number) will suffice. INDIVIDUALS 1113.02 Saver’s Credit for contributions to qualified retirement plans A nonrefundable tax credit is available for contributions, or deferrals, to retirement savings plans. The credit is claimed by completing and attaching IRS Form 8880, Credit for Qualified Retirement Savings Contributions, to the taxpayer’s return. a. The credit applies to traditional and Roth IRAs and other qualified retirement plans such as 401(k) plans, 403(b) annuities, 457 plans, SIMPLE plans, and SEP plans. b. For tax year 2023, an eligible lower‐income taxpayer can claim a nonrefundable tax credit for the applicable percentage (50%, 20%, or 10%, depending on filing status and AGI) of up to $2,000 of their qualified retirement savings contributions. In other words, the absolute most the credit could be is $1,000. The credit is in addition to any deduction or exclusion relating to the retirement plan contribution. Joint filers with AGI in excess of $73,000 receive no credit. For heads of households, the amount is $54,750, and for all others it is $36,500. c. The contribution eligible for the credit must be reduced by any distributions received from qualified retirement plans. 1. Such distributions include those paid out during (a) the current year, (b) the two preceding tax years, and (c) the period before the due date (including extensions) of the current return. 2. Distributions received by a spouse are considered as distributions to the taxpayer if a joint return is filed. d. Qualifying taxpayers must be at least 18 years old. e. Dependents and full‐time students are not eligible for the credit. 47 INDIVIDUALS 1113.03 1113.04 Adoption credit: A nonrefundable tax credit is available for qualified adoption expenses paid or incurred in the adoption of a qualified child. Expenses paid before the adoption are claimed as a credit in the year the adoption is finalized. The credit is claimed by completing and filing IRS Form 8839, Qualified Adoption Expenses, with the taxpayer’s return. a. Qualified expenses include reasonable and necessary adoption fees, court costs, attorney fees, and other directly related expenses. For 2023, expenses up to $15,950 may be claimed as a credit. Adoption expenses for a child with special needs are considered to be $15,950, even if the expenses are less. b. Qualifying children are those under age 18 or those who are physically or mentally handicapped. c. The credit allowable is phased out ratably as AGI rises from $239,230 to $279,230. d. Unused credits carry forward five years. e. Married taxpayers must file jointly, and the child’s Social Security number must be reported. Education Credits a. 48 Two tax credits available for students pursuing postsecondary college or vocational education are the American Opportunity Tax Credit and the Lifetime Learning Credit. These credits are available for qualified educational expenditures of the taxpayer, spouse, and dependents. If both the Lifetime Learning Credit and the American Opportunity Tax Credit can be claimed for the same student in the same year, only one can be used, not both. Both credits must be supported by an IRS Form 1098‐T from the college or other postsecondary institution showing the amount of qualified expenses that were paid during the tax year. The American Opportunity Tax Credit (AOTC) makes the Hope Credit available to a broader range of taxpayers, including many with higher incomes and those who owe no tax. It also adds required course materials to the list of qualifying expenses and allows the INDIVIDUALS credit to be claimed for four postsecondary education years instead of two. b. 1) The credit is equal to 100% of the first $2,000 and 25% of the next $2,000, not to exceed $4,000. Therefore, the maximum AOTC allowance is $2,500. 2) Students must be enrolled no less than half‐time during at least one semester during the year. 3) The taxpayer claiming the full credit (not necessarily the student) must have modified adjusted gross income (MAGI) of $80,000 or less for a single taxpayer or $160,000 or less if filing jointly. A partial credit may be available up to MAGI of $90,000 and $180,000, respectively. 4) A taxpayer can claim the credit for each qualifying student for whom qualifying expenses are paid. Lifetime Learning Credit: This nonrefundable credit is equal to 20% of up to $10,000 of tuition expenses paid each year by the taxpayer. Expenses for which the American Opportunity Tax Credit is claimed do not qualify for this credit. In contrast to the American Opportunity Tax Credit, this credit: 1) does not vary with the number of students in the household, 2) is available for an unlimited number of years, 3) applies to undergraduate, graduate, and professional degree expenses, (4) applies to any course at an eligible institution that helps individuals acquire or improve their job skills, and 4) does not require half‐time enrollment for one semester. (Thus, CPE credit courses and professional seminars provided by eligible educational institutions may qualify for the credit.) 49 INDIVIDUALS For tax year 2023 the credit is gradually reduced if the tax taxpayer’s modified adjusted gross income in excess of $80,000 and $90,000 ($160,000 and $180,000 for a joint return). The taxpayer cannot claim the credit if their modified adjusted gross income is in excess of $90,000 ($180,000 for a joint return). c. 1113.05 50 Other limitations: 1) Married taxpayers must file jointly to receive these credits. 2) In a given tax year, only one of the following benefits may be claimed with respect to each student: (a) the American Opportunity Tax Credit or (b) the Lifetime Learning Credit. However, the American Opportunity Tax or Lifetime Learning credit can be claimed in the same year as distributions from a Coverdell Education IRA, provided that the proceeds from the distribution are not used to pay for the education costs used in claiming the American Opportunity or Lifetime Learning credit. 3) The credits are not available if the cost of the course may be deducted by the taxpayer as a business expense. Foreign Tax Credit: A taxpayer may apply income taxes paid to a foreign country or U.S. possession as a credit against United States income tax liability or may use such taxes as an itemized deduction. This credit is claimed on IRS Form 1116 for an individual and on IRS Form 1118 for a corporation. a. This treatment is available for taxes paid to a foreign country on income that is taxable in the United States when no foreign income exclusion is taken. b. The election to use the credit or the deduction is made annually. c. The taxpayer cannot split foreign taxes between a credit and a deduction. INDIVIDUALS d. The overall limit for the credit on taxes paid to all foreign countries is restricted to that portion of the U.S. income tax which relates to the taxable income from all foreign countries. Total foreign taxable income ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ Total worldwide taxable income e. 1113.06 = U.S. income tax Excess credits may be carried back 1 year and forward 10 years. Child and dependent care credit: A variety of taxpayers incur child or dependent care expenses. Prior to the American Rescue Plan Act of 2021 (ARPA), the child and dependent care credit was a nonrefundable credit that allowed taxpayers to receive a credit for qualified employment‐related expenses paid for the care of qualifying individuals. Prior to ARPA, to be eligible for the child and dependent care credit, certain criteria had to be met, including: a. b. Qualifying Person Test: A person is a qualifying individual if he or she satisfies any one of three conditions: 1) The person is a dependent of the taxpayer by reason of being a qualifying child of the taxpayer and has not attained age 13. 2) The person is a dependent of the taxpayer, is physically or mentally incapable of caring for themselves, and has the same principal place of abode as the taxpayer for more than one‐half of the taxable year. 3) The person is the spouse of the taxpayer, is physically or mentally incapable of caring for themselves, and has the same place of abode as the taxpayer for more than one‐half of the taxable year. Earned Income Test: The taxpayer(s) must have earned income during the year, such as wages, salaries, tips, and net earnings from self‐employment. The amount of work‐ related expenses that may be taken into account in calculating the credit may not exceed earned income. A 51 INDIVIDUALS taxpayer who is married and files a joint return may take into account work‐related expenses limited to the lesser of their earned income or their spouse’s earned income. c. Work‐Related Expense Test: The child and dependent care expenses must be work‐related in order to qualify for the child and dependent care credit. Expenses meet this test if both of the following statements are true: 1) The expenses allow the taxpayer (and spouse, if filing joint) to work or look for work. If the taxpayers are married and filing a joint return, both must generally work or look for work. 2) The expenses are for a qualifying person’s care. d. Joint Return Test: Married couples must file a joint return (not married filing separately) in order to take the child and dependent care credit, unless they are legally separated or living apart from each other. e. Care Provider Identification Test: The taxpayer must identify all persons or organizations that provide care for the qualifying child or dependent on Form 2441, Child and Dependent Care Expenses. f. Qualifying Expense Test: The total deduction is required to be less than the dollar limitation for qualifying expenses, which is generally $3,000 if one qualifying person is cared for, and $6,000 if two or more qualifying persons are cared for.  52 The credit is equal to 35% of employment‐related expenses for taxpayers whose AGI was $15,000 or less. As such, the maximum credit is $1,050 ($3,000 × 35%) for one qualifying individual and $2,100 ($6,000 × 35%) for two or more qualifying individuals. This 35% amount is decreased by one percentage point for each $2,000 of additional AGI until it is reduced to 20%. Once AGI is in excess of $43,000, the 20% credit applied. INDIVIDUALS Taxpayers may claim the child and dependent care credit by filing Form 2441, Child and Dependent Care Expenses, and filing it with their tax return. On this form, the taxpayer must identify all individuals or organizations that provided care for the dependent, including the provider’s name, address, and TIN (taxpayer identification number). Taxpayers can request this information from the provider by having them complete Form W‐10, Dependent Care Provider’s Identification and Certification. 1113.07 Credit for Other Dependents The TCJA provided for a $500 nonrefundable credit for qualifying dependents other than qualifying children or for a qualifying child who has an ITIN or ATIN instead of an SSN. 1113.08 Earned Income Credit The following criteria are required for claiming the Earned Income Credit. a. Age Requirement: Individuals who are at least age 25 but under age 65 were eligible for the credit. b. Qualifying Child Requirement: In order to qualify for the EITC with qualifying children, taxpayers typically have to provide information about the qualifying child, including name, age, and TIN/SSN. c. Joint Return Requirement: Individuals who are married are required to file a joint return in order to be eligible to claim the EITC. For EITC purposes, an individual will not be treated as “married” if the individual: 1) Is considered married per §7703(a). 2) Lives with his or her qualifying child for more than half of the tax year. 3) Does not file a joint return for the tax year. 4) Does not have the same principal place of abode as their spouse during the last six months of the tax year or has a decree, instrument, or agreement with regard to their spouse and is not a member of 53 INDIVIDUALS the same household with their spouse by the end of the tax year. 54 d. Investment Income Requirement: Individuals with certain types of investment over $11,000 in 2023 are unable to claim the EITC. This amount is indexed annually for inflation e. Identification Requirement: A taxpayer is required to provide a qualifying child’s name, age, and taxpayer identification number (TIN) in order to claim the qualifying child when determining the amount of the EITC. If the taxpayer i unable to provide the qualifying child’s name, age, and TIN, they were ineligible to claim the EITC as an eligible individual with no qualifying children. f. No credit is allowed to those with “disqualified income” (i.e., investment income or unearned income) in excess of $11,000 for 2023. g. No credit is allowed for those failing to provide correct Social Security numbers for themselves, spouse, and qualifying child. h. The maximum amount of credit for 2023 is $7,430 with three or more qualifying children, $6,604 with two qualifying children, $3,995 for one qualifying child, and $600 with no qualifying children. i. IRC Section 32(d) provides that a married taxpayer who does not file a joint return is not entitled to an EIC. In Action on Decision (AOD) 2018‐05, the IRS gave notice it would follow a Tax Court decision that the taxpayer’s filing status was married filing separately and that the taxpayer had qualifying children, and therefore the taxpayer was entitled to the EIC. However, there is no mention of IRC Section 32(d) in the court’s opinion; therefore, it appears that the Tax Court overlooked the prohibition disallowing the EIC to married taxpayers filing separately. Accordingly, the IRS stated that it will not follow the court’s opinion in allowing an EIC to a married taxpayer filing separately. INDIVIDUALS j. k. 1113.09 Qualifying children: To be eligible for the earned income credit, parents must have children that can meet the following tests: 1) Relationship: The child must be a “qualifying child.” The child may, however, provide over half of his or her own support. 2) Residency: The child must live in the taxpayer’s residence over half of the year; foster children for the entire tax year. 3) Age: the child must be: i. Under age 19, ii. A full‐time student under age 24, or iii. Permanently and totally disabled. Individuals without qualifying children may be eligible for this credit if: 1) They (or their spouse) are at least 25 years old and 2) They cannot be claimed as a dependent by another taxpayer. Credit for withholding and estimated tax payments: A refundable tax credit is available to the taxpayer for withheld taxes and estimated tax payments. 55 INDIVIDUALS 1114 Tax Payments 1114.01 Employers withhold income tax from the pay of most employees. For purposes of employer tax withholding, employee pay includes regular pay, bonuses, commissions, and vacation allowances and reimbursements and other expense allowances paid under a nonaccountable plan. If a taxpayer’s income is low enough that he or she will not have to pay income tax for the year, the taxpayer may be exempt from employer withholding. The amount of income tax an employer withholds from a taxpayer’s regular pay depends on two factors: 1114.02 1114.03 56 a. The amount the taxpayer earns in each payroll period; and b. The information the taxpayer gives the employer on Form W‐4. Form W‐4 includes four types of information that the employee provides that an employer uses to figure a taxpayer’s withholding: a. Personal information and anticipated filing status. b. If you worked multiple jobs and/or your spouse works. c. Information about number of dependents that will be claimed. d. Information about other adjustments regarding income, deductions or additional withholding. The W‐4 is filled out by the employee and submitted to the employer so that the employer will withhold taxes based on the filing status. For instance, a person who is married can opt to have taxes withheld at rates corresponding to single filers. Withholding allowances are no longer used. When starting a new job, an employee must fill out Form W‐4 and give it to the employer. If a taxpayer is receiving pension or annuity income and begins a new job, he or she will need to file Form W‐4 with his or her new employer and can choose to split withholding allowances between the pension and the job in any manner. INDIVIDUALS 1114.04 During the year changes may occur with respect to a taxpayer’s marital status, exemptions, adjustments, deductions, or credits the taxpayer expects to claim on his or her tax return. When this happens, the employee may give his or her employer a new Form W‐4 to change his or her withholding status or number of allowances. If the taxpayer’s marital status changed from married to single, he or she must give his or her employer a new Form W‐4 within 10 days of the change. An employee can submit a new Form W‐4 whenever he or she wishes to adjust withholding. 1114.05 Completing Form W‐4 and worksheets Form W‐4 has worksheets to help a taxpayer figure how much withholding he/she needs. These worksheets are for the taxpayer’s own records and should not be given to the employer. For those working multiple jobs, option (a) most accurately calculates the additional tax you need to have withheld, while option (b) does so with a little less accuracy. 1114.06 If you (and your spouse) have a total of only two jobs, you may instead check the box in option (c). The box must also be checked on the Form W‐4 for the other job. If the box is checked, the standard deduction and tax brackets will be cut in half for each job to calculate withholding. This option is roughly accurate for jobs with similar pay; otherwise, more tax than necessary may be withheld, and this extra amount will be larger the greater the difference in pay is between the two jobs. 1114.07 The IRS estimates that in most situations, the tax withheld from a taxpayer’s pay will be close to the tax liability he or she figures on his or her return if the taxpayer follows these two rules: 1114.08 1. Accurately complete all the Form W‐4 worksheets that apply; and 2. Give the employer a new Form W‐4 when changes occur. Because the IRS’s worksheets and withholding methods do not account for all possible situations, the taxpayer may not get the right amount of tax withheld. The IRS estimates this under withholding is most likely to happen in the following situations: a. Taxpayer is married and both spouses work. b. Taxpayer has more than one job at a time. 57 INDIVIDUALS 58 c. Taxpayer has nonwage income, such as interest, dividends, alimony, unemployment compensation, or self‐ employment income. d. Taxpayer will owe additional amounts with his/her return, such as self‐employment tax. e. Taxpayer’s withholding is based on obsolete, inaccurate Form W‐4 information for a substantial part of the year. f. Taxpayer’s earnings are more than the amount shown under check taxpayer’s withholding in the instructions at the top of Page 1 of Form W‐4. g. Taxpayer works only part of the year. h. Taxpayer changes the number of his or her withholding allowances during the year. 1114.09 When an employee starts a new job, the employer gives the new employee a Form W‐4 to complete. Beginning with the taxpayer’s first payday, the employer will use the information the taxpayer gave on the form to figure the employee’s withholding. If the employee later fills out a new Form W‐4, the employer can put it into effect immediately; though the deadline for putting it into effect is the start of the first payroll period ending 30 or more days after the employee turns it in. If the employee does not give his or her employer a completed Form W‐4, the employer must withhold at the highest rate, as if the taxpayer were single and claimed no withholding allowances. 1114.10 If a taxpayer finds he or she is having too much tax withheld, the taxpayer should give his or her employer a new Form W‐4. The employer cannot repay any of the tax previously withheld so the taxpayer should claim the full amount withheld when he or she files his or her tax return. If the employer has withheld more than the correct amount of tax for the Form W‐4 the taxpayer had in effect, the taxpayer does not have to fill out a new Form W‐4 to have his or her withholding lowered to the correct amount. The employer can repay the amount that was withheld incorrectly. If the taxpayer is not repaid, the taxpayer’s Form W‐2 will reflect the full amount actually withheld, which the taxpayer would claim when he or she filed his or her tax return. INDIVIDUALS 1114.11 Exemption from withholding If a taxpayer claims exemption from withholding, the employer will not withhold federal income tax from wages. The exemption applies only to income tax, not to Social Security or Medicare tax. A taxpayer can claim exemption from withholding for 2023 only if both of the following situations apply: 1114.12 1. For 2022, the taxpayer the taxpayer had no tax liability; and 2. For 2023, the taxpayer expects to have no tax liability. Estimated tax for 2024 Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self‐ employment; interest; dividends; alimony; rent; and gains from the sale of assets, prizes, and awards. An individual taxpayer may have to pay estimated tax if the amount of income tax being withheld from salary, pension, or other income is not sufficient. Estimated tax is used to pay both income tax and self‐ employment tax, as well as other taxes and amounts reported on the taxpayer’s tax return. If the taxpayer does not pay enough tax, either through withholding or estimated tax, or a combination of both, the taxpayer may have to pay a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if he or she is due a refund when he or she files his or her tax return. 1114.13 If a taxpayer receives salaries or wages, he or she can avoid having to pay estimated tax by asking his or her employer to take more tax out of his or her earnings. To do this, the taxpayer should give a new Form W‐4 to his or her employer. The taxpayer does not have to pay estimated tax for 2024 if he or she meets all three of the following conditions: a. He or she had no tax liability for 2023; b. He or she was a U.S. citizen or resident alien for the whole year; and c. His or her 2023 tax year covered a 12‐month period. 59 INDIVIDUALS 1114.14 A taxpayer had no tax liability for 2023 if his or her total tax was zero or he or she did not have to file an income tax return. If he or she owed additional tax for 2023, he or she may have to pay estimated tax for 2024. In most cases, a taxpayer must pay estimated tax for 2024 if both of the following apply: a. Taxpayer expects to owe at least $1,000 in tax for 2024, after subtracting withholding and refundable credits. b. Taxpayer expects his or her withholding plus his or her refundable credits to be less than the smaller of: (i) 90 percent of the tax to be shown on the 2024 tax return, or (ii) 100 percent of the tax shown on the 2023 tax return. If the 2023 AGI is over $150,000, taxpayer is covered if he or she pays in at least 110 percent of last year’s tax liability. Note: For purposes of the EA examination, the above formula for estimated payments should be memorized. It invariably shows up on the EA examination. 60 INDIVIDUALS 1114.15 Use the following flowchart to determine if an individual must make estimated payments: 1114.16 To figure a taxpayer’s estimated tax, the preparer must figure the taxpayer’s expected adjusted gross income (AGI), taxable income, taxes, deductions, and credits for the year. When figuring 2024 estimated tax, it may be helpful to use the taxpayer’s income, deductions, and credits for 2023 as a starting point. Use the 2023 federal tax return as a guide. The preparer can use Form 1040‐ES to figure estimated tax. The tax preparer must make adjustments both for changes in taxpayer’s own situation and for recent changes in the tax law. Form 1040‐ES includes a worksheet to help figure client’s estimated tax. 1114.17 For estimated tax purposes, the tax year is divided into four payment periods. Each period has a specific payment due date. If a taxpayer does not pay enough tax by the due date of each payment period, they may be charged a penalty even if they are due a refund when they file their income tax return. The payment periods and due dates for estimated tax payments are shown below: 61 INDIVIDUALS For the Period: January 1‐March 31 April 1‐May 31 June 1‐August 31 September 1‐December 31 Due Date: April 15 June 15 September 15 January 15, next year If a taxpayer files their 2023 Form 1040 by January 31, 2024 and pays the rest of the tax they owe, the taxpayer does not need to make the payment due on January 15, 2024. 1114.18 A taxpayer does not have to make estimated tax payments until he or she has income on which he or she will owe income tax. If the taxpayer has income subject to estimated tax during the first payment period, he or she must make his or her first payment by the due date for the first payment period. A taxpayer can pay all his or her estimated tax at that time, or he or she can pay it in installments. If a taxpayer chooses to pay in installments, he or she should make the first payment by the due date for the first payment period and make remaining installment payments by the due dates for the later periods. 1114.19 If a taxpayer does not have income subject to estimated tax until a later payment period, they must make their first payment by the due date for that period. The taxpayer can pay their entire estimated tax by the due date for that period or they can pay it in installments by the due date for that period and the due dates for the remaining periods. The following chart shows when to make installment payments. If taxpayer has income on which they must pay estimated tax: Make a payment by: Make later installments by: Before April 1 April 15 June 15 September 15 January 15 next year April 1–May 31 June 15 September 15 January 15 next year June 1–August 31 September 15 January 15 next year After August 31 January 15 next year None A taxpayer should pay enough estimated tax by the due date of each payment period to avoid a penalty for that period. A 62 INDIVIDUALS taxpayer can figure their required payment for each period by using either the regular installment method or the annualized income installment method. 1114.20 Under the regular installment method, if the estimated tax payment for any period is less than one‐fourth of taxpayer’s estimated tax, he or she may be charged a penalty for underpayment of estimated tax for that period when he or she files his or her tax return. Under the annualized income installment method, an individual’s estimated tax payments vary with his or her income, but the amount required must be paid each period. After the taxpayer makes an estimated tax payment, changes in his or her income, adjustments, deductions, credits, or exemptions may make it necessary for him or her to refigure his or her estimated tax. The taxpayer should pay the unpaid balance of his or her amended estimated tax by the next payment due date after the change or in installments by that date and the due dates for the remaining payment periods. A taxpayer does not have to pay estimated tax if his or her withholding in each payment period is at least as much as: a. One‐fourth of his or her required annual payment; or b. His or her required annualized income installment for that period. A taxpayer does not have to pay estimated tax if he or she will pay enough through withholding to keep the amount he or she owns with his or her tax return under $1,000. 1114.21 How to pay estimated tax There are five ways to pay estimated tax. a. Credit an overpayment on taxpayer’s 2023 return to the 2024 estimated tax. b. Send in a payment (check or money order) with a payment voucher from Form 1040‐ES. c. Pay electronically using the Electronic Federal Tax Payment System (EFTPS). d. Pay by electronic funds withdrawal if taxpayer is filing Form 1040 electronically. 63 INDIVIDUALS e. 1114.22 Pay by credit or debit card using a pay‐by‐phone system or the Internet. Credit an overpayment If a taxpayer can show an overpayment of tax after completing Form 1040 for 2023, he or she can apply part or all of it to his or her estimated tax for 2024. On Form 1040, line 36, enter the amount the taxpayer wants credited to his or her estimated tax rather than refunded. The taxpayer will then take the amount the taxpayer has credited into account when figuring his or her estimated tax payments. A taxpayer cannot have any of the amount he or she credited to his or her estimated tax refunded to him or her until he or she files his or her tax return for the following year. The taxpayer also cannot use that overpayment in any other way. 1114.23 Pay by check or money order using the estimated tax payment voucher Each payment of estimated tax by check or money order must be accompanied by a payment voucher from Form 1040‐ES. If the taxpayer made estimated tax payments last year and did not use a paid preparer to file his or her return, he or she should receive a copy of the Form 1040‐ES in the mail. It will contain payment vouchers preprinted with taxpayer’s name, address, and Social Security number. Using the preprinted vouchers will speed processing, reduce the chance of error, and help save processing costs. Use the window envelopes that came with the Form 1040‐ ES package. If a taxpayer uses his or her own envelopes, make sure he or she mails the payment vouchers to the address shown in the Form 1040‐ES instructions for the place where he or she lives. Do not use the address shown in the Form 1040 instructions. 1114.24 Pay electronically If a taxpayer wants to make estimated payments by using the Electronic Federal Tax Payment System (EFTPS), by electronic funds withdrawal, or by credit or debit card, go to www.irs.gov/e‐pay for directions. 64 INDIVIDUALS 1114.25 Credit for withholding and estimated tax for 2023 When a taxpayer files his or her 2023 income tax return, take credit for all the income tax and excess Social Security or railroad retirement tax withheld from his or her salary, wages, pensions, etc. Also take credit for the estimated tax he or she paid for 2023. These credits are subtracted from the taxpayer’s total tax. Because these credits are refundable, he or she should file a return and claim these credits, even if he or she does not owe tax. 1114.26 Underpayment penalty for 2023 If a taxpayer did not pay enough tax, either through withholding or by making timely estimated tax payments, he or she may have an underpayment of estimated tax and he or she may have to pay a penalty. Generally, a taxpayer will not have to pay a penalty for 2023 if any of the following apply: a. The total of the taxpayer’s withholding and estimated tax payments was at least as much as his or her 2022 tax (or 110 percent of the 2022 tax if the taxpayer’s AGI was more than $150,000, $75,000 if his or her 2022 filing status was married filing separately) and the taxpayer paid all required estimated tax payments on time; b. The tax balance due on the 2023 return is no more than 10 percent of the taxpayer’s total 2023 tax, and the taxpayer paid all required estimated tax payments on time; c. The taxpayer’s total 2023 tax minus withholding and refundable credits is less than $1,000; d. The taxpayer did not have a tax liability for 2022 and his or her 2022 tax year was 12 months; and e. The taxpayer did not have any withholding taxes and his or her current‐year tax less any household employment taxes is less than $1,000. 65 INDIVIDUALS 1114.27 Installment payments of taxes owed Those who owe taxes that they are unable to pay can set up an installment plan to make payments over time to pay their liability. An installment plan with the IRS costs the taxpayer more money because the IRS charges interest and penalties on the taxes that are not paid in full before the due date. The IRS encourages taxpayers who cannot pay their tax liability to explore less costly options. In order to enter into an installment agreement with the IRS, the taxpayer must file all required tax returns and determine the largest monthly payment the taxpayer can make ($25 minimum). The IRS will apply future refunds to the taxpayer’s tax debt until it is paid in full. The taxpayer uses Form 9465 to apply for an installment agreement. 1115 Previous IRS Correspondence with Taxpayer In addition to reviewing prior year tax returns before preparing a tax return for a taxpayer, an Enrolled Agent should also review previous correspondence between the IRS and the taxpayer. This correspondence may include changes to a prior year tax return, additional tax or penalties owed, etc. It is important to review this information to determine whether the taxpayer owes tax from a previous year and whether the correspondence affects how the current year’s tax return should be filed. 66 1116 Special Filing Requirements 1116.01 Enrolled agents should always note when special transactions, such as gifts, foreign income, and certain disasters necessitate the preparation of special IRS forms or returns in addition to the normal Form 1040 and its associated schedules. Certain gifts that a taxpayer makes would require filing Form 709 and sometimes paying a transfer tax on the amount of the gifted property. The receipt of foreign income might require special United States as well as foreign tax reporting. INDIVIDUALS 1116.02 Casualty losses Casualty losses are generally deductible in the year the casualty occurred. However, if a taxpayer has a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), the taxpayer can choose to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and the taxpayer can deduct the loss on his/her return or amended return for that preceding tax year. 1116.03 A casualty loss in a federally declared disaster area can result from the damage, destruction, or loss of property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or even volcanic eruption. A casualty does not include normal wear and tear or progressive deterioration. If the property is personal‐use property or is not completely destroyed, the amount of the casualty loss is the lesser of: • The adjusted basis of the property; or • The decrease in fair market value of the property as a result of the casualty. 1116.04 The loss must be reduced by any salvage value and by any insurance or other reimbursement received or expected to be received. The adjusted basis of the property is usually its cost, increased or decreased by certain events such as improvements or depreciation. A taxpayer may determine the decrease in fair market value by appraisal, or if certain conditions are met, by the cost of repairing the property. 1116.05 Individuals are required to claim their casualty losses as an itemized deduction on Form 1040, Schedule A. For property held for personal use, once any salvage value and any insurance or other reimbursement is subtracted, the taxpayer must subtract $100 from each casualty or theft event that occurred during the year. Then, add up all those amounts and subtract 10 percent of the taxpayer’s adjusted gross income from that total to calculate his or her allowable casualty and theft losses for the year. 67 INDIVIDUALS 1116.06 Special requirements for Form 1040‐NR: Form 1040‐NR is the standard IRS form for nonresident aliens: that is, those who are not United States residents and do not primarily live in the country but do have taxable U.S. income. Everyone who is not a U.S. citizen is considered either a resident alien or nonresident alien for tax purposes. A resident alien for 2023 is anyone who either holds a green card or spent at least 31 days in the U.S. during the year and 183 days during the 3‐year period of 2023, 2022, and 2021. All other noncitizens are classified as nonresident aliens, as are those who qualify as resident aliens, but can establish they are more closely connected to another country in which they have a “tax home.” 1116.07 Nonresident aliens must file 1040‐NR if they meet any of four conditions: having engaged in a trade or business during the tax year; having other U.S. income such as dividends of interest; representing a deceased person who would have been eligible for the Form 1040‐NR; or representing an estate or trust eligible for 1040‐NR. 1117 Foreign Account and Asset Reporting (e.g., FBAR, Form 8938) 1117.01 Beginning on September 30, 2013, a taxpayer that has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds is required by the Bank Secrecy Act to report the account yearly to the Internal Revenue Service by filing electronically a Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial Accounts (FBAR). This form is filed electronically with the Financial Crimes Enforcement Network (FinCEN). The FBAR must be received by the Department of the Treasury on or before April 15 of the year immediately following the calendar year being reported. FinCEN will grant filers failing to meet the FBAR annual due date of April 15 an automatic extension to October 15 each year. Accordingly, specific requests for this extension are not required. 68 INDIVIDUALS The following individuals are required to file an FBAR:  a United States person that has a financial interest in or signature authority over at least one financial account located outside of the United States; and  the aggregate value of the foreign financial accounts exceeds $10,000 (not equal to $10,000) at any time during the calendar year. 1117.02 The FinCEN Form 114a, Record of Authorization to Electronically File FBARs, is not submitted with the filing, but instead is maintained with the FBAR records by the filer and the account owner and made available to FinCEN or the IRS on request. 1118 Kiddie Tax 1118.01 Unearned income of minor children (called the “kiddie tax”) is taxed in 2023 at the parents’ marginal tax rate. The child may file their own return, or if the child’s income is more than $1,250 but less than $13,850, it may be included on the parents’ return for 2023. The exemption from the kiddie tax for 2023 is $2,500. 1119 Affordable Care Act (ACA) Net Premium Tax Credit or Repayment 1119.01 Taxpayers who are not eligible for a health insurance plan through their employer can purchase health insurance through a federal or state marketplace. The premium tax credit (PTC) is in place to assist taxpayers who could not otherwise afford insurance. Taxpayers may qualify for the premium tax credit if their gross income is 100%–400% of the current poverty level. The American Rescue Plan Act of 2021 (ARPA) changed the affordability percentages used for premium tax credits to increase credits for individuals eligible for assistance and provide credits for taxpayers with income over 400% of the Federal Poverty Level (FPL). All individuals with premiums in excess of 8.5% of their household income are eligible for the PTC. 69 INDIVIDUALS 70 1119.02 Individuals may qualify for the advanced premium tax credit based on projected income when enrolling in a health insurance plan through the federal or state marketplace. This advanced premium tax credit is paid directly to the health insurance provider in monthly installments during the year, lowering the taxpayer’s required health insurance premium payments. 1119.03 Individuals who received the advanced premium tax credit or who may qualify for the premium tax credit must file Form 8962, Premium Tax Credit (PTC) to figure the premium tax credit and reconcile any advanced premium tax credit received during the year. Taxpayers who have a positive net premium tax credit (premium tax credit minus amount received during the year) can include the net premium tax credit as a refundable credit. Taxpayers who received a greater advanced premium tax credit than allowed must repay the excess.