Part 1: Individuals
Part 1 of the SEE tests the federal income taxation of individuals: filing requirements and status, income, adjustments, deductions and credits, capital gains, and basis. This chapter reviews the enduring rules an enrolled agent applies when preparing individual returns.
Filing Status and Dependents
A taxpayer's filing status is determined as of the last day of the tax year and affects the standard deduction and tax brackets. The five statuses are single, married filing jointly, married filing separately, head of household, and qualifying surviving spouse. Head of household requires being unmarried (or considered unmarried) and paying more than half the cost of keeping up a home for a qualifying person. A dependent may be a qualifying child or a qualifying relative, each with its own relationship, age, residency, support, and gross-income tests.
Gross Income and Adjustments
Gross income includes all income from whatever source derived unless specifically excluded, such as wages, interest, dividends, business income, and taxable retirement distributions. Certain items are excluded, such as gifts, most inheritances, and qualifying municipal-bond interest. Adjustments to income (above-the-line deductions), such as the deductible part of self-employment tax and certain retirement contributions, reduce gross income to arrive at adjusted gross income (AGI), a figure that drives many limits and phaseouts.
Deductions and Credits
Taxpayers choose the larger of the standard deduction or itemized deductions. Itemized deductions include qualifying medical expenses above a percentage-of-AGI floor, state and local taxes subject to a cap, home mortgage interest, and charitable contributions. Credits are more valuable per dollar than deductions because they reduce tax directly; nonrefundable credits can reduce tax only to zero, while refundable credits, such as the earned income credit, can generate a refund beyond tax owed.
Capital Gains, Losses, and Basis
Gain or loss on the sale of property equals the amount realized minus the adjusted basis. Holding property more than one year yields long-term treatment, generally taxed at favorable capital-gain rates; one year or less is short-term, taxed as ordinary income. Capital losses offset capital gains, and a limited amount of net capital loss may offset ordinary income each year, with the excess carried forward. Basis generally starts at cost and is adjusted for improvements, depreciation, and similar items.