 Income tax 2022-2023, taxable income overview. Let's do some wealth preservation with some tax preparation. Most of this information comes from the Form 1040 Instructions Tax Year 2022, the line instructions you can find at the IRS website, irs.gov, irs.gov. When looking at the income tax equation, we're focused on line one now, that being income. Remember, with the income tax equation, the first half of the formula will in essence be an income statement, this being an income tax, although a strange income statement, but it starts where we would expect, which is the income line, and then we have the expenses, which are reflected here in the form of deductions, the above the line deductions, or adjustments to income, the below the line deductions, or the greater of the standard, or the itemized deductions, to get to the equivalent of, in essence, net income, in this case, the taxable income. The second half of the equation then is going to be focused on the calculation of the tax, and then applying any other taxes, credits, and the payments to get to the tax refund or the amount due. So now we're focused basically up top on, unlike the income statement type of calculation to get down to that taxable income, as we're focusing in on the income line. Now, normally, when you think of an income statement, obviously income is support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources, such as Excel practice problems, PDF files, and more, like QuickBooks backup files, when applicable. So once again, click the link below for a free month membership to our website and all the content on it. It's good expenses, which are the equivalent of deductions are typically bad. But when you're looking at taxes, everything is flipped on its head. Income is actually bad because if I have to include the income on the tax return, that means I'm going to get a higher taxable income. And I'm typically going to be paying taxes on it. And then the expenses or deductions are good because if I'm able to claim the deduction, that's going to lower the amount of net income or taxable income, which will lower the amount of taxes. So then what we would like to be able to have is to actually earn income, which I'm not legally required to report on the income statement to pay taxes on. That's kind of what we would like to be having from a tax standpoint, and we would like to have the expenses that I can incur because I want to incur them for whatever reason to help me to live well and possibly get a deduction for them if I'm legally required or able to to lower the taxable income. So that means that on the income line, it looks pretty straightforward. You can imagine many situations where it is straightforward. If you just are a W2 employee, then obviously you're going to get the income reported on the form W2. Pretty basic, but you can imagine many, many, many scenarios where income gets a lot more gray in terms of, is this something I have to include as taxable income? If I found $100 on the ground, do I have to include it as a taxable income, which could be subject then to taxes? And the general rule from the IRS's standpoint is that anything that you receive, whether it be in cash or in some other format will be included in income unless the IRS says specifically otherwise that it is not included in income. That's kind of the way the definition is set up. Everything is included unless we say otherwise. So that means that all the forms that you get, many people kind of feel like it shouldn't be included in income or I don't have to include it in income unless I get a W2 or a 1099 form. That's not the general rule on the IRS side of things. But because the IRS has become more and more intrusive, meaning the IRS is trying to look at the payer side to force them to give this documentation W2s 1099s not only to you, but also to the IRS. It leads people to kind of come to that type of conclusion. But originally, of course, the income tax is a self reported type of tax system. The government verifying the tax system by doing audits, random types of audits instead of basically actually looking at your financial transactions and putting so much pressure on like the payers to issue the 1099s and the W2s. So just a quick recap on how that works. Remember we have an income tax system. That means the government has an incentive to kind of double check or look over your shoulder as to whether you're reporting the income. They could do that traditionally by having random audits in a similar fashion as you would do if you were like trying to catch people that are speeding. You can give people tickets who are speeding. You're not going to give everyone a ticket. But if you do get a ticket, then it's usually substantial enough to stop people from speeding. Same kind of thing or concept with a traditional audit type of situation. Or you could put more and more pressure on the payer of a business transaction because the payer possibly could get a deduction. If you have two businesses once receiving income in a financial transaction, the other is paying. The one that is paying wants to get a deduction. That's where the government has the leverage. If you want the deduction, then they could say, I want you to give me information about who you paid. If it's an employee, I want you to not only give me information, I want you to give me actually withholding. Take the money from them directly before you give it to them and pay it to the government. If it's a contract, I want you to give me a 1099. So the pressure now is on the payer of the transaction to act as a reporter of the tax and possibly as the tax collector. That's more and more the trend, which is why we have this forms oftentimes the W-2s and the 1099s and whatnot that can act as a guide. But that's the general idea. Now when we look at the income lines, we have the first page of the 1040, which is quite extensive. Note that that's because there's a lot of different categories of income that we can imagine. And also you can imagine when we put this together in like an Excel worksheet or in a formula format, we should have income up top and everything else reported on a different form. That's not the way it really looks for the 1040 on income because historically when we used to have to file more by paper, we didn't have as much electronic filing. They wanted to have like just one page for people to file a basic tax return. And then we had different actual form 1040s that are going to be simpler or more complex. But now because we do it mainly electronically, you would think they would reduce the number of lines on the actual form 1040 and have more schedules for the supporting information. So you can have a basic tax return just having the form 1040 with less schedules. And that seems to be the trend they're kind of going towards, but obviously we still have this whole big section that's just kind of income on the first page of the 1040. And then we've got the schedule one, which is their attempt to do what you would think would be logical in this day and age, which is to put more of the income lines on a separate schedule so that people that have more complex tax returns could just add more schedules. And since it's electronic, you don't have to get the form from the post office or something like that. You can just use software to add and tack on the schedule schedules that are necessary. So that kind of is the trend that I would expect that we would go towards going forward. So income generally, you must report all income except income that is exempt from tax by law. So notice the structure of this, the government isn't listing out all the things that you have to report as income. They're going to list out the things you don't have to report as income, which means that basically everything else is income. You have to argue if you were to argue with them under the law here that there's an exception to the rule of you being able to record it as income if you went to court and argued with them on it. So for detail, see the following instructions and the schedule one instructions, especially the instructions for lines one through seven and schedule one line one through eight Z. Also, you can go to publication five to five for more information. So forgiveness of paycheck protection program, the PPP loans. Now when we got into these, the COVID thing, of course, they had all these special rules that many of which went through the IRS when they're trying when they're trying to deal with this whole COVID situation. One of them were these PPP loans, which was an attempt to give more funding or liquidity to the businesses that they're basically kind of forcing to shut down in some cases and they put some things that the businesses kind of had to do. But the way it was structured was that you give someone a loan and then if they do what you wanted them to do, if they met the requirements, then you actually forgive the loan. Now normally the problem there when we talk about an income standpoint is that when someone forgives a loan, that means you got free money, right? So now the question is, well, if they forgive the loan, do I have to include the income that I got from the loan as income or not? The general rule would be that you would include it as income at that case unless again, there's an exception. So the forgiveness of a PPP loan creates tax exempt income. So although you don't need to report the income from the forgiveness of your PPP loan on form 1040 or 1040 SR, you do need to report certain information related to your PPP loan. So revenue procedure 2021-48, 2021-49 IRB 835 permits taxpayers to treat tax-exempt income resulting from the forgiveness of a PPP loan as received or accrued. One, as and to the extent that eligible expenses are paid or incurred. Two, when you apply for the forgiveness of the PPP loan or three, when forgiveness of the PPP loan is granted. If you have tax-exempt income resulting from the forgiveness of a PPP loan tax exempt, meaning, you know, in essence, you don't have to include it as income because as you're saying it's exempt from taxes. So that would be good if you can have income, which is tax exempt. Attach a statement to your return reporting each taxable year for which you are applying a revenue procedure 2021-48 and which section of revenue procedure 2021-48. You are applying either section 3.01, 1, 2, or 3. Any statement should include the following for each PPP loan. Number one, your name, address, item or social security number. Number two, a statement that you are applying or applied section 3.01, 1, 2 or 3 of revenue procedure 2021-48 and for what tax taxable year. Number three, the amount of tax-exempt income from forgiveness of the PPP loan that you are treating as received or accrued or for what taxable year and for whether forgiveness of the PPP loan has been granted as the date you file your return. So you can write the RP 2021-48 at the top of your attached statement. Again, that's an unusual situation given the changes to the tax law that we're still dealing with through the whole kind of COVID situation. Foreign source income. So you must report unearned income such as interest, dividends, and pension from sources outside the United States unless exempt by law or a tax treaty. You must also report earned income such as wages, tips from sources outside the United States. If you've worked abroad, you may be able to exclude part or all of your foreign income. So then if you have foreign income, then the question is how do you have to be treating the income because now you have two basic countries that could be taxing you. So then you've got to get into the weeds in terms of the rules of including the exemption and having and possibly exclude part of or all of your foreign income. And so that's a whole kind of section in and of itself for details. There you can go to publication 54 and form 2555 and the instructions for that form. Foreign retirement plans. If you are a beneficiary of a foreign retirement plan, you may have to report the undistributed income earned in your plan. However, if you were the beneficiary of a Canadian registered retirement plan, you can see Revenue Procedure 2014-55, 2014-44, IRB 753 available at irs.gov forward slash. I won't go into the detail on that. You can see it here and check it out to find out if you can elect to defer tax on the undistributed income. So report distributions from foreign pension plans on lines 5A and 5B. Another kind of more of the unusual type of situation, but one that could apply here. Foreign accounts and trusts. You must complete part three of Schedule B if you were going to get into Schedule B later. So there's other types of income. We've got obviously the W-2 income, which is fairly straightforward. Then we've got investment type of incomes, which could be dividends and interest, which you will typically get 1099s for. It'll be possibly more complex if you've got foreign accounts and trusts with relation to them. In that case, you must complete part three of Schedule B if you had foreign account or received a distribution from or were a grantor of or a transfer to a foreign trusts. Foreign financial assets. If you had foreign financial assets in 2022, you may have to file form 8-9-3-8. C form 8-9-3-8 and its instructions for more detail there. Chapter 11 bankruptcy cases. So this is another kind of unusual type of situation. Hopefully if you're in a bankruptcy situation. So if you were a debtor in a Chapter 11 bankruptcy case, income taxable to the bankruptcy estate and reported on the estate's income tax return includes earnings from services you performed after the beginning of the case, both wages and self-employment income and income from property distributed in Section 541 of Title 11 of the US Code that you either owned when the case began or that you acquired after the case began before the case was closed, dismissed or converted to a case under a different chapter. So because this income is taxable to the estate, don't include this income on your own individual income tax return. Otherwise, you'd have the income reported in multiple areas. The only exception is for purposes of figuring your self-employment tax. For that purpose, you must take into account all your self-employment income for the year from services performed both before and after the beginning of the case. So you get kind of an unusual situation here because we have a difference between the income where the income is going to be reported and then the calculation of the self-employment tax, which is something that obviously is equivalent to payroll taxes and will dive more into the calculation of it in a future presentation. Also, you or the trustee of one appointed, if one is appointed, must allocate between you and the bankruptcy estate, the wages, salary or other compensation and withheld income tax reported to you on Form W2. A similar allocation is required for income and withheld income tax reported to you on Form 1099. You must also include a statement that indicates you filed a Chapter 11 case and that explains how income and withheld income tax reported to you on Form W2 and 1099 are allocated between you and the estate. For more details, including acceptable allocation methods, you can go to the notice 22006-83 and so on and the details here. Community property states. So we've seen before that we could have some unusual kind of situations or different situations depending on the state law, whether the state is community property or not. This could come into play, for example, if you have a married filing separate situation. So if you're looking up rules for married filing separate, remember the filing status is here. We've got single or non-married statuses, which could be single, head of household or possibly qualified widow, widower or they change the name to, but anyways, a qualified widow, widower or if you're married, you've got married filing joint, married filing separate. When applying the rules for married filing separate, which is a more unusual kind of situation, you might have to take into consideration, you should take into consideration whether you're in a community property state or not because that could change the way you're going to be allocating. So community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. So if you and your spouse lived in a community property state, you must usually follow state law to determine what is community income and what is separate income. So for details there, you can see form 8958 and publication 555, Nevada, Washington and California domestic partners. So a registered domestic partner in Nevada, Washington or California must generally report half the combined community income of the individual and their domestic partner. So you can see form 8958 and publication 555 for more information. Rounding off the whole dollars. So you can round off cents to whole dollars on your return and schedule. So you note when we actually do the calculations in the tax forms, usually we're not adding the pennies, we're doing some rounding to the whole dollars. If you do round to the whole dollars, you must round all amounts. So obviously we're going to be consistent with rounding to whole dollars because these are kind of estimates in terms of taxes being an estimate in general. And the cents being typically in material with regards to the whole calculation, that will typically be a good rule to go by. To round, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, a $1.39 becomes $1, $2.50 becomes $4.08. If you have to add two or more amounts to figure the amount to enter on a line includes cents when adding the amounts and round off only the total. Again, that's probably a fairly small, so for example, if you started adding up the dollars without the pennies versus adding the pennies and then rounding after you come to the total, it's probably going to be a fairly insignificant dollar amount. There's dollars like money of rounding differences, but typically you'll round after you add them up with the pennies. So if you are entering amounts that include cents, make sure to include the decimal point. There's no cents column on the form. So in future presentations, we'll get into a little bit more of the general categories and reporting the general categories. There is W2 income, and then we'll take a look at the interest income, the dividend income, capital gains income, and most of those are often have their own schedules. So that's why we kind of talk about them when we get to their own schedules that will feed into basically the income line.