HS 321 Fundamentals of Income Taxation
The architecture of the return
Follow the return from gross income to tax: gross income, less above-the-line adjustments, equals adjusted gross income; less the standard or itemized deduction and the qualified business income deduction, equals taxable income; tax is computed at ordinary or preferential rates, then credits reduce the liability dollar for dollar.
Basis and capital transactions
Basis starts with cost, is adjusted for improvements and depreciation, and carries over on a gift but is stepped up (or down) at death. Long-term means held more than one year. Net short-term and long-term results, deduct up to $3,000 of net capital loss per year against ordinary income ($1,500 married filing separately), and carry the remainder forward. The wash sale rule disallows a loss when a substantially identical security is repurchased within 30 days before or after the sale.
Commonly tested provisions
Above-the-line items include HSA contributions, deductible traditional IRA contributions, self-employed retirement contributions, and student loan interest. Itemized deductions include the capped state and local tax deduction, home mortgage interest, charitable gifts (including qualified charitable distributions after age 70½), and medical expenses above 7.5% of AGI. Note the 3.8% net investment income tax and the additional 0.9% Medicare tax, both keyed to modified AGI.
Traps
- Confusing a deduction with a credit.
- Applying the marginal rate to all income instead of to the incremental slice.
- Forgetting payroll and self-employment taxes.
- Using taxable income where MAGI governs a threshold.
Worked example
A client has an $8,000 long-term loss and a $2,000 short-term gain. Netting gives a $6,000 long-term loss; $3,000 is deducted this year and $3,000 carries forward.