Tax Consideration for Individuals

Tax Consideration for IndividualsUnder the Internal Revenue Code, individual taxpayers may exclude certain money received from taxable income. The most common exclusions are:

  • Gifts: A gift is generally not considered taxable income for the recipient. Federal law, however, set an annual limit on how much you may receive as a gift from any donor.
  • Personal injury awards: Personal injury damages that you receive that are for pain and suffering, reimbursed medical expenses, future medical expenses and lost wages are excludable.
  • Sale of main home: Generally, gains from the sale of your home may be excluded from taxable income.
    • The home must have been your principal residence, you must have owned the home for at least two years, and you must have used the property as your principal residence for at least two years. When conducting the use test, the IRS will often look at:
      • Whether the home’s address is used for tax returns, auto and voter registrations, driver’s license and general mail
      • The location of the home relative to your place of employment, banks, clubs and other organizations
      • Whether other family members reside at the home
    • You may not exclude income or capital gains on a home other than your primary residence
    • The amount realized on the gain is limited to $250,000, if you file singly, or $500,000, if you are married and filing a joint return.
    • The gain from the sale of another home has not been excluded within the previous two years.
  • Cancellation of debt: Forgiveness, cancellation or discharge of debt is usually considered taxable income. There are exceptions, though, such as forgiveness of a non-recourse loan, forgiveness in bankruptcy, forgiveness of farm debt , and foreclosure.
  • Flexible spending arrangements: Under these employer-provided benefit plans, contributions employers make to the plan may be excludable from an employee’s taxable income. Essentially, the employee is voluntarily reducing an agreed amount of salary, which the employer then contributes into the plan. When the employee makes distributions from the plan for qualified expenses, the amount covering the expense is usually not taxable income to the employee. If the contributions are not used within a specified amount of time, the employee forfeits any balance in the plan.

Tax Credits

A tax credit is a dollar-for-dollar offset that reduces the amount of tax. Common tax credits include:

  • Child and dependent care expenses: Allows qualifying taxpayers to credit up to $3,000 for one child or up to $6,000 for two or more children when certain conditions are met.
  • Earned-income credit: Designed for low-income families and individuals, this credit can result in a tax refund if the credit amount is greater than the amount of taxes owed.
  • Educational credits: Provided that a taxpayer falls within certain income and tax limits, the Hope Scholarship Credit and the Lifetime Learning Credit may help the taxpayer offset some of the cost for post-secondary educational expenses incurred by the taxpayer, a spouse and dependents claimed on the taxpayer’s return. Both credits may be available if the taxpayer incurred expenses for more than one student during the year, but both may not be taken for the same student in the same year.
    • Hope Scholarship Credit: The Hope Scholarship Credit is available for up to $1,650 per eligible student for the first two years of the student’s post-secondary education. To claim the credit, students must be enrolled at least half time, be seeking an undergraduate degree or similar education credential and have no felony drug convictions on record.
    • Lifetime Learning Credit: The Lifetime Learning Credit is available for up to 20 percent of the first $10,000 incurred in expenses for a maximum of $2,000 per family for each of the years the eligibility requirements are met. Students are not required to pursue a degree in order to qualify for the credit, the credit is available for one or more courses and no felony drug conviction restrictions apply.

Tax Deductions

A tax deduction reduces the amount of income subject to tax. Common deductions include:

  • Mortgage interest: Generally, this deduction is allowable for the interest paid on the taxpayer’s main or second home for a home mortgage, home improvement or home-equity loan.
  • Real estate: Real estate tax that is charged by state and local governments can be deducted provided that the taxing authority uniformly applied the tax in the jurisdiction, based the tax on the assessed real property value, and the tax itself was for the general public welfare.
  • Charitable contributions: Contributions made to qualifying charities may be deducted up to certain limits.

Other Tax Considerations

Employment taxes for household employers: Also known as the “nanny tax,” this tax may apply if a taxpayer pays someone to work in the taxpayer’s home and the individual worker is not self-employed or was not placed there by an agency that exercises control over the person as an employee. If the taxpayer is a household employer, then the taxpayer may be required to pay Social Security, Medicare, federal unemployment tax and federal income tax withholding for that employee.

Alternative Minimum Tax: This alternative tax computation avoids taking deductions to the point where the taxpayer would pay little or no tax.

Tax consequences of divorce: Alimony that meets statutory requirements that a taxpayer pays to a former spouse is deductible for the one paying it and includable income for the one receiving it. Child support, however, is not deductible. If there is a child from the dissolved marriage, only one parent may claim the child as a dependent.

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