Question

Provide a brief summary of how the federal income tax return is structured. Be sure

to address the relationship of AGI, personal exemptions, standard or itemized deductions, payments

made, balance owed, TI, and Tax. You may want to follow the general format on the federal form 1040

as a guide.

Answer 1

The individual income tax is the major source of federal revenues, followed closely by Social Security and other payroll taxes. As a revenue source, the corporate income tax is a distant third. Estate and gift and excise taxes play only minor roles as revenue sources.

The Structure of the Federal Individual Income Tax:

The individual income tax is based on earnings individuals accrue from a variety of sources.Included in the individual income tax base are wages, salaries, tips, taxable interest and dividend income, business and farm income, realized net capital gains, income from rents, royalties, trusts,estates, partnerships, taxable pension and annuity income, and alimony received.The tax base is reduced by adjustments to income, including contributions to Keogh and traditional IRAs, some interest paid on student loans and higher education expenses, contributions to health savings accounts, and alimony payments made by the taxpayer. This step of the process produces adjusted gross income (AGI), which is the basic measure of income under the federal income tax. Deductions from the income tax base that result in an individual’s AGI are also known as “above the line” deductions. These deductions are available to all taxpayers, whether the taxpayer chooses to take the standard deduction or itemize deductions.

The tax base is further reduced by either the standard deduction or individuals’ itemized deductions.Itemized deductions are allowed for home mortgage interest payments, state and local income taxes, state and local property taxes, charitable contributions, medical expenses in excess of 10% of AGI, and for a variety of other items.

The tax base is reduced further by subtracting personal and dependent exemptions. Exemptions are a fixed amount to be subtracted from AGI. Exemptions are allowed for the taxpayer, the taxpayer’s spouse, and each dependent.

The tax liability depends on the filing status of the taxpayer. There are four main filing categories:married filing jointly, married filing separately, head of household, and single individual. The computation of a taxpayer’s tax liability depends on their filing status .

After a taxpayer’s tax liability has been calculated, tax credits are subtracted from gross tax liability to arrive at a final tax liability. Major tax credits include the earned income tax credit, thechild tax credit, education tax credits, and the credit for child and dependent care expenses.