Income Tax

Cited from the book "Tax Made Simple: Income Taxes Explained in 100 Pages or Less"

Chapter 1 Basics

1. The filing status is based on the marital and family status on the last day of the tax year.
2. Marginal tax rate: the tax rate you would pay on one additional dollar of income.
3. Effective tax rate: the total amount of income tax divided by the taxable income. 

 Chapter 2 Exemptions, Deductions and Credits

1. Deductions and exemptions both reduce the taxable income. 
2. Credit reduces tax.
3. Deductions generally arise from expenses.
4. Total income (sum of all income) - Above the line deductions =  Adjusted Gross Income (the line)
5. Adjusted gross income - Standard deduction or itemized deductions (below the line deductions) - Exemptions = Taxable income
6. Above the line deductions: IRA, health saving account (HSA), and interest paid on student loans.
7. Itemized deductions: charitable contributions, the interest on a home mortgage, and medical/dental expenses.
8. After determining the total amount of tax owed, the dollar value of credits are subtracted.
9. Credits are generally associated with a taxpayer doing something that Congress had decided is beneficial to the community.
10. Credits: qualified education expenses for oneself, the spouse or one of the dependents. 

Chapter 3 Calculating Your Refund

1. Total federal income tax for the year (after subtracting deductions and exemptions) - the amount withhold for the federal income tax throughout the year = refund or repay
2. The amount of withholding is abased upon the estimate of a taxpayer's income and how many exemptions a taxpayer will be claiming.
3. The employer withholds for federal income tax, Social Security tax, Medicare tax, and state income tax.
4. The Social Security tax and the Medicare tax are calculated as 6.2% and 1.45% of the earnings, respectively. Before paying the income taxes, 7.65% of the income has been withheld.

Chapter 4 Taxable Income

1. The taxable income could include any of the following types of income, each of which has its own unique tax treatment: 
   • Earned income (salary, wages, earnings from self-employment, etc)
   • Interest income
   • Dividend income
   • Passive income (rental income) 
   • Capital gains (the sale of stock)
2.  Earning from self-employment is subject to the same income tax rate as the employed and additionally the self-employment tax (2 times of Social Security and Medicare taxes combined),  but is not subject to Social Security and Medicare payroll taxes.
3.  Instead of W2, 1099-MISC is used to report income and taxes for self-employment, if income is more than $600.
4. Most interest income is subject to the income tax(es), but is not subject to Social Security and Medicare taxes. It is reported in 1099-INT. Exceptions:
   
   • Interest income from bonds issued by the government and municipalities is not subject to federal income tax, but often subject to state/local income tax. 
   • Interest income from U.S. treasure bills or bonds is subject to federal income tax at the ordinary rate, but not subject to the state/local income tax.
5. Like interest income, income from dividend -- distribution of a corporation's profits to shareholders is subject to the income tax but exempt from Social Security and Medicare taxes.
6. Dividend income is often subject to lower tax rate. If a dividend meets certain requirements, it is called "qualified dividend".
   • Any qualified dividend income that falls in the 39.6%, 25-35%, 10 or 15% tax brackets will be taxed at a rate of 20%, 15% or not taxable at all, respectively.
7. Generally, dividends you receive for shares of stocks held for at least 60 days will be qualified dividends.
8. Passive income includes all income from trades and business that one does not materially participate, and rental income (even if you materially participate in the activity except one is a real estate professional).
9. Like interest income, passive income is subject to the regular income tax but exempt from payroll tax or self-employment tax.
10. Passive income is different from other sources of income in that losses from passive activities can only used to offset income from passive activities.
11. An exception to this rule: if one or one's spouse actively participate in a rental activity, up to $25,000 of loss from that activity can be used to offset one's nonpassive income each year However, this $25,000 amount is reduced by 50% of the amount by which your modified adjusted gross income exceeds $100,000.
12. Making decisions about the lease terms, property repairs, which tenant(s) to rent to qualifies as active participation. 

Chapter 5 Capital Gains and Losses

1. Proceed received from the sale - "cost basis" in that asset = Capital gains or losses
2. Long-term capital gains (asset held for more than 1 year; LTCG) vs short-term capital gains (asset held for 1 year or less; STCG)
3. STCGs are taxed at the normal income tax rate, and LTCGs are taxed the same rate as qualified dividend income. 
4. Mutual funds are a large collection of other investments (thousands of different stocks, bonds or option contracts).
5. Each year, a mutual fund is accountable on the tax on the net capital gains, but it is the mutual fund's share holders pay for the tax on one's share of the related gains (reported in 1099-DIV, sent by the brokerage firm or the mutual fund). 
6. Selling homes for a profit usually results in long-term capital gain tax, unless exemptions apply.
7. Three requirements for exemptions of capital gains ($250,000 for singles or $500,000 for married couple filing jointly) from selling homes
   • For the two years prior to the date of sale, one did not benefit from capital gain exemption from selling another home;
   • During the five years prior to the date of sale, one owned the home for at least 2 years;
   • During the five years prior to the date of sale, one lived in the home for as the primary residence, which does not need to be concurrent in time with point two. 
8. For the 2nd and 3rd requirements, the 2-year period does not have be continuous.
9. For married couples, both spouses need to be meet the 1st and 3rd requirements, and at least one spouse meet the 2nd requirement.
10. Each year, short/long-term net capital change = short/long-term capital gains - short/long-term capital losses, and if the difference is positives, this is subject to short/long-term capital gain tax. If it is negative, $3,000 can be deducted from one's ordinary income, with the remainder carried forward for the following years, till it is used up its entirety. If one of the short-term and long-term net capital change is positive and the other is negative, the difference between these two is taxed at its short/long-term nature. 

  Chapter 6 Saving for Retirement: IRAs and 401(k)s

1. IRAs are investment accounts with benefits and restrictions attached.
2. When money is withdrawn from traditional IRAs, it is taxable as income. 
3. Traditional IRAs are tax deferred, owing to 'tax-deduction-now'  and 'taxable-withdrawals-later'.
4. The income limit for receiving the full deduction of traditional IRAs is influenced by whether one or one's spouse is covered by retirement plan at work.
5. IRA withdrawal (IRA distributions) is subject to a 10% tax in additional to the normal income tax, if withdrawn before age 59.5, with some exceptions.

Chapter 7 Other Important Deductions

1. In order to qualify for contributing to a Health Savings Account (HSA), one must be enrolled in a "high deductible health plan" (HDHP).