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Wiley Tax Preparer ebook

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Whether you're already a tax preparer or you'relooking to become one, you need a firm grasp of the tax concepts onwhich individual taxation is based. We created the Wiley TaxPreparer as a refresher for the experienced tax preparer, and as areadable guide for the less-experienced tax preparer. This timely guide is an essential tax resource providing youwith useful information on tax principles and filing requirementsthat a preparer must know to complete a 1040 series return andassociated schedules. You'll refer to it time and again, forinformation about: Practices and Procedures * Penalties to be assessed by the IRS against a preparer fordisregard of the rules and regulations * Furnishing a copy of a return to a taxpayer * Safeguarding taxpayer information Treatment of Income and Assets * Taxability of wages, salaries, tips, and other earnings * Reporting requirements of Social Security benefits * Determination of basis of assets Deductions and Credits * Medical and dental expenses * Types of interest and tax payments * Child and dependent care credit Other Taxes * Alternative Minimum Tax * Self-Employment Tax Preliminary Work and Collection of Taxpayer Data * Collecting a taxpayer's filing information anddetermining their status * Determine filing requirements, including extensions and amendedreturns * Personal exemptions and dependents Completion of the Filing Process * Check return for completeness and accuracy * Tax withholding, payment and refund options, and estimated taxpayments * Explaining and reviewing the tax return Ethics and Circular 230 * Preparer's due diligence for accuracy of representationsmade to clients and the IRS * Sanctions that may be imposed under Circular 230 * Rules governing authority to practice before the IRS If you're looking for a practical guide to the principlesbehind Form 1040, look no further. The Wiley Tax Preparer is themost accessible guide to understanding how complex tax laws affectindividual taxpayers.

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Contents

Cover

Title Page

Copyright

Part 1: The Income Tax Return

Chapter 1: Filing Information

Personal Information

Filing Requirements and Thresholds

Deadlines, Extensions, and Penalties

Which Version of Form 1040 to Use

Special Filing Rules for Aliens

Chapter 2: Filing Status

Five Filing Statuses

Determining Marital Status

Making Changes in Filing Status

Chapter 3: Personal and Dependency Exemptions

Personal Exemptions

Dependency Exemptions

Special Rules for Parents Who Are Divorced, Separated, or Not Married

Taxpayer Identification Numbers

Part 2: Income and Assets

Chapter 4: Wages, Salaries, and Other Earnings

Employee Compensation

Special Topics

Employee or Independent Contractor

Chapter 5: Interest Income

Taxable Interest Income

Original Issue Discount

Taxable Bond Interest

State and Municipal Bonds

Reporting Interest on the Return

Foreign Account Reporting

Chapter 6: Dividends and Other Corporate Distributions

Ordinary versus Qualified Dividends

Capital Gain Distributions

Other Distributions

Chapter 7: Rental Income and Expenses

Rental Income

Rental Expenses

Deducting Rental Expenses—Special Rules

Passive Loss Limitations

Special Rules for Real Estate Professionals

At-Risk Limitations

Reporting Rental Income and Expenses

Chapter 8: Retirement Plans, Pensions, and Annuities

Qualified Retirement Plans

IRA Distributions

Rollovers

Conversions

Special Additional Taxes

Commercial Annuities

Life Insurance

Chapter 9: Social Security and Equivalent Railroad Retirement Benefits

Social Security Benefits

Railroad Retirement Benefits

Social Security Disability Benefits

Chapter 10: Other Types of Income

Scholarships and Grants

Taxable Recoveries

Alimony

S Corporation and Partnership Income

Royalties

Unemployment Compensation

Damages

Cancellation of Debt Income

Gambling Winnings

Jury Duty Pay

Barter

Other Types of Income

Chapter 11: Self-Employment Activities

Who Files Schedule C (or Schedule C-EZ)?

Reporting Income

Business Expenses

Farmers

Self-Employment Tax

Hobby Loss Limitation

Benefits

Recordkeeping

Chapter 12: Basis of Property

What Is Basis?

Cost Basis

Adjusted Basis

Basis Other than Cost

Chapter 13: Sale of Property

Sales, Exchanges, and Transfers

Reporting Sales on the Tax Return

Gains and Losses on Business Assets

Chapter 14: Sale of Home

Determining Basis

Figuring Gain or Loss

Home Sale Exclusion

Abandonments, Foreclosures, and Repossessions

Reporting Home Sales

Recapture

Chapter 15: IRA and HSA Contributions

Traditional IRAs

Roth IRAs

Other IRAs

Health Savings Accounts

Chapter 16: Education-Related Adjustments

Tuition and Fees Deduction

Educator Expenses Deduction

Student Loan Interest Deduction

Chapter 17: Business-Related Adjustments

Deduction for a Portion of Self-Employment Tax

Self-Employed Health Insurance Deduction

Moving Expenses

Other Business Adjustments

Chapter 18: Alimony

Payments that Are Alimony

Payments that Are Not Treated as Alimony

Alimony Deduction

Alimony Income

Alimony Recapture

Part 3: Deductions and Credits

Chapter 19: Standard and Itemized Deductions

Standard Deduction

Overview of Itemized Deductions

Chapter 20: Medical and Dental Expenses

Itemized Deduction

Qualified Medical Expenses

Deducting Medical Expenses

Special Situations

Chapter 21: Tax Payments

Tests for Deducting Taxes

State and Local Taxes

Real Estate Taxes

Personal Property Taxes

Chapter 22: Interest Payments

Home Mortgage Interest

Points

Mortgage Insurance Premiums

Investment Interest

Chapter 23: Charitable Contributions

Qualifying Organizations

Deductible Contributions

Contributions of Property

Nondeductible Contributions

Recordkeeping and Substantiation

When to Deduct Contributions

Limits on Deductions

Chapter 24: Nonbusiness Casualty and Theft Losses

What Is a Casualty?

What Is a Theft?

Loss on Deposits

Figuring the Loss

Insurance and Other Reimbursements

Deduction Limits

Figuring a Gain

When to Report Gains and Losses

Chapter 25: Miscellaneous Itemized Deductions

Miscellaneous Itemized Deductions Subject to the 2% Limit

Deductions Not Subject to the 2% Limit

Nondeductible Expenses

How to Deduct Miscellaneous Itemized Expenses

Chapter 26: Employee Business Expenses

Overview of Employee Business Expenses

Travel Away from Home

Entertainment Expenses

Business Gifts

Local Transportation Expenses

Work-Related Education Expenses

Other Work-Related Expenses

Recordkeeping and Substantiation

Reimbursements

Reporting Employee Business Expenses

Chapter 27: Earned Income Credit

Overview of the Earned Income Credit

Who Can Claim the Credit? Rules that Apply to Everyone

Taxpayers with a Qualifying Child

Taxpayers with No Qualifying Child

Who Cannot Claim the Credit?

Figuring the Credit

Claiming the Credit on the Return

Paid Preparer Responsibilities

Chapter 28: Child and Dependent Care Credit

Overview of the Child and Dependent Care Credit

Filing Status Requirement

Qualifying Child or Other Person

Earned Income

Work-Related Expenses

Figuring the Credit

Reporting the Credit

Chapter 29: Child Tax Credit

Qualifying Child

Amount of the Credit

Claiming the Credit

Additional Child Tax Credit

Chapter 30: Education Credits

Requirements for Education Credits

American Opportunity Tax Credit

Lifetime Learning Credit

Credit Recapture

Chapter 31: Other Tax Credits

Credit for Qualified Retirement Savings Contributions (Saver's Credit)

Adoption Credit

Residential Energy Credits

Foreign Tax Credit

Alternative Motor Vehicle Credit

Credit for the Elderly or Disabled

Mortgage Interest Credit

First-Time Homebuyer Credit

Health Coverage Tax Credit

Credit for Excess Social Security or Railroad Retirement Tax

Part 4: Other Taxes

Chapter 32: Figuring the Regular Tax

Taxable Income

Regular Tax Computation Options

Tax Liability

Chapter 33: The Alternative Minimum Tax

Overview of the AMT

Figure AMTI

Figure AMT

Reporting AMT

Minimum Tax Credit

Chapter 34: The Kiddie Tax

General Rules of the Kiddie Tax

Tax Treatment of a Child's Income

Figuring the Tax on the Child's Return

Parents' Election to Report Child's Interest and Dividends

Chapter 35: Other Taxes

Self-Employment Tax

Additional Taxes on Qualified Retirement Plans, IRAs, and Qualified Health Plans

Additional Tax on Qualified Health Plans (HSAs and MSAs)

Education Credit and Adjustment Recapture

Household Employment Taxes

Allocated Tips

Uncollected Social Security and Medicare Tax on Wages

First-Time Homebuyer Credit Repayment

Part 5: Completion of the Filing Process

Chapter 36: Tax Payments and Refund Options

Tax Payment and Withholding Information

Paying a Balance Due

Obtaining a Refund

Interest and Penalties

Chapter 37: Completing and Filing the Return

Completing the Return

Discuss the Significance of Signing a Return

e-filing

Part 6: Practices and Procedures

Chapter 38: Preparer Responsibilities and Penalties

Compliance with e-file Procedures

Authorization for Tax Representation

Safeguarding Taxpayer Information

Penalties Related to Return Preparation

Part 7: Ethics and Circular 230

Chapter 39: Rules Governing Authority to Practice before the IRS

What Is Circular 230?

What Does “Practice before the IRS” Mean?

Who May Practice Before the IRS?

What Is the Application Process to Become an EA?

How Do EAs Renew Their Status?

Preparer Tax Identification Numbers

Chapter 40: Duties and Restrictions Relating to Practice before the IRS

Information to Be Furnished to the IRS—Section 10.20

Knowledge of Client's Omission—Section 10.21

Diligence as to Accuracy—Section 10.22

Prompt Disposition of Pending Matters—Section 10.23

Assistance from or to a Disbarred or Suspended Person—Section 10.24

Practice by Former Government Employees—Section 10.25

Notaries—Section 10.26

Fees—Section 10.27

Return of Client's Records—Section 10.28

Conflicting Interests—Section 10.29

Solicitation (Including Advertising)— Section 10.30

Negotiating Checks—Section 10.31

Practice of Law—Section 10.32

Best Practices—Section 10.33

Standards for Tax Returns and Other Documents—Section 10.34

Covered Opinions—Section 10.35

Procedures to Ensure Compliance— Section 10.36

Requirements for Other Written Advice—Section 10.37

Chapter 41: Sanctions for Violating Circular 230

Sanctions—Section 10.50

Incompetence and Disreputable Conduct—Section 10.51

Violations Subject to Sanction—Section 10.52

Receipt of Information—Section 10.53

Scenarios of Disciplinary Actions

Answers to Review Questions

Appendix: IRS Resources

Index

Copyright © 2013 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data

Wiley tax preparer : a guide to Form 1040. p. cm. ISBN 978-1-118-07262-2 (pbk.); ISBN 978-1-118-41608-2 (ebk); ISBN 978-1-118-41898-7 (ebk); ISBN 978-1-118-61587-4 (ebk) 1. Income tax—Law and legislation—United States—Examinations—Study guides. 2. Tax returns—United States—Examinations—Study guides. I. John Wiley & Sons. KF6369.85.W58 2013 343.7305′2044—dc23 2013005222

PART 1

The Income Tax Return

CHAPTER 1 FILING INFORMATION

CHAPTER 2 FILING STATUS

CHAPTER 3 PERSONAL AND DEPENDENCY EXEMPTIONS

CHAPTER 2

Filing Status

One of the first and most important determinations you will make as you begin to prepare a tax return is the taxpayer's filing status.

Filing status affects many areas of the tax return, such as whether the taxpayer is eligible for certain tax benefits, the amount of the standard deduction, the tax table and rates used to determine tax liability, and other tax rules. Filing status also affects the version of Form 1040, U.S. Individual Income Tax Return, that can be filed, as noted in Chapter 1. You must be consistent and use the same filing status for all purposes on a return.

Filing status may sound simple, and in most cases you will be able to easily select the correct filing status. However, in some cases, a taxpayer may qualify for more than one filing status, and you may need to determine which is the most advantageous status for the taxpayer. Also, be aware that filing status is one of the most misunderstood areas of the tax law, and many errors are caused when taxpayers claim a status they do not qualify to use.

Five Filing Statuses

Taxpayers may use only one of five filing statuses shown in Figure 2.1.

Figure 2.1 Filing Status on Form 1040

On Form 1040, and Form 1040A, select filing status by checking the appropriate box on the tax return after determining the filing status for which the taxpayer qualifies.

Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents, can be used only by those taxpayers who use either the single or married filing jointly filing status. On Form 1040EZ, shown in Figure 2.2, filing status is indicated simply by including personal information for either one or two people.

Figure 2.2 Filing Status on Form 1040EZ

ALERT: The filing status used on the prior year's return may not be the same as that on the current return. Circumstances change: a person can get married or divorced, lose a spouse, be abandoned, or experience some other change affecting filing status. Determine filing status for the tax return each year.

Single

The taxpayer's filing status is single if, on the last day of the tax year, the taxpayer was unmarried, widowed, divorced, or legally separated from his or her spouse and does not qualify for another filing status.

A widow(er) is single if the spouse died prior to the current tax year and he or she does not qualify to file under the head of household or qualifying widow(er) status rules.

Example
Ellen's husband died last year, and she has not remarried. For the current year, Ellen is single (unless she qualifies for either the head of household or qualifying widow(er) statuses).

Married Filing Jointly

Married filing jointly (MFJ) is the filing status used by most married couples. A married couple can file a joint income tax return if they both agree to do so. This means that a couple's combined income and combined deductions are taken into account in figuring the couple's combined tax liability. A married couple can file jointly even if one spouse has no income.

A married couple can file a joint return even if:

They live apart for part or all of the year.One spouse died during the year and the surviving spouse did not remarry during the year.One spouse is incapacitated or in a combat zone and cannot sign the joint return; the other spouse may sign on his or her behalf. Signing a joint return is discussed in Chapter 37.

A married person cannot file a joint return if:

His or her spouse files a return using the married filing separately status.His or her spouse is a nonresident alien or dual-resident alien at any time during the year, and they do not elect to file jointly. (Filing jointly means including the worldwide income of both spouses on the return.)

The tax law in some instances penalizes married couples in comparison to unmarried couples; in other words, the tax liability for a married couple may be higher than the combined tax liabilities if the couple had not married and each taxpayer were to file as single. The 2001 Tax Act introduced temporary marriage penalty relief: (1) The MFJ 15% income tax bracket was expanded to exactly twice the size of the single income tax bracket, and (2) the MFJ standard deduction was increased to exactly twice the single deduction. Under the relief provisions, MFS amounts are exactly one-half the MFJ amounts, so MFS filers benefit too. The American Taxpayer Relief Act of 2012 made the marriage relief penalty permanent.

Married Filing Separately

Married filing separately (MFS) is the filing status with the least favorable tax rules.

A married person can choose to use this filing status even though he or she is eligible to use the MFJ status. Why would someone want to file separately if the least favorable tax rates apply? Filing separately may be advisable in two situations:

1. To avoid joint and several tax liability on the joint return. Each spouse is “jointly and severally liable” for the tax on the joint return, which means the IRS can look to either spouse for the full amount owed on the joint return, regardless of which spouse is responsible for the income or any omissions on the return.
2. To save the couple income taxes (in special situations). For example, if one spouse has lower income and higher medical deductions, casualty or theft losses, and/or miscellaneous itemized deductions, filing separately allows for greater deductions because these three itemized deductions all have an income threshold that must be exceeded. The income threshold is easier to meet for the taxpayer with lower income.
Example
The Longstreets' adjusted gross income is $105,000 ($90,000 attributable to Mr. Longstreet and $15,000 to Mrs . Longstreet). She had medical expenses of $10,000. If they file jointly, they can deduct only $2,125 of these costs ($10,000 – [$105,000 × 7.5%]) (see Chapter 20 for more details on deducting medical costs). If they file separately and itemize deductions, Mrs. Longstreet can deduct $8,875 ($10,000 – [$15,000 × 7.5%]), or $6,750 more than had the Longstreets filed jointly.

Limitations

However, if taxpayers choose to file separate returns merely to avoid liability for the taxes on a joint return, they probably will pay higher taxes overall. This is because of the limitations on certain favorable tax rules. By filing using the MFS status:

A spouse cannot claim the earned income credit, adoption credit, American Opportunity credit, or child and dependent care credit.The income levels for determining the child tax credit and retirement saving contribution credit are half of those for joint filers.A spouse cannot claim exclusions for employer-paid adoption expenses or interest on U.S. savings bonds redeemed for higher education purposes.A spouse cannot claim the deductions for student loan interest or tuition and fees.Half the capital loss deduction applies against ordinary income ($1,500 instead of the $3,000 for other filers).If one spouse itemizes deductions, the other spouse cannot use the standard deduction; instead, he or she must itemize as well. If one spouse uses the standard deduction and the other spouse wants to use it too, the amount is limited to half of that for joint filers.Half the alternative minimum tax (AMT) exemption amount applies for purposes of the AMT.If a spouse lived with the other spouse for any portion of the year, then 85% of Social Security benefits are taxable, regardless of other income; and such spouse cannot claim the credit for the elderly and disabled.If the taxpayers lived apart for the entire year, they can claim only one-half of the special rental loss allowance (up to $12,500 rather than $25,000). If the spouses lived together for any portion of the year and file separately, the spouses cannot claim any rental loss allowance.

A spouse must file a separate return (and cannot file a joint return) if the other spouse files as married filing separately or if either spouse is a nonresident alien or dual-resident alien at any time during the year and they do not elect to file jointly.

Community Property Rules

If taxpayers file separately and are domiciled in a community property state—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin—their income must be characterized as either separate or community income. (Special rules apply to reporting community income and expenses on separate returns. See IRS Pub. 555, Community Property, for details.)

Example
Frank lives in California with his spouse, Gretchen, who works, while he does not. Gretchen files a separate return. Under state community property rules, half of Gretchen's wages are treated as Frank's income. Frank must report half of the wages on his separate return. Gretchen will report only half of the wages she earned on her return.

Head of Household

Head of household is a filing status that is more beneficial in many ways than the single status. As head of household, a taxpayer may use tax rates that are better than those for single or married persons filing separate returns, and the standard deduction is higher. To qualify for head of household status, a taxpayer must meet three conditions, discussed next.

I. Unmarried or Considered Unmarried

A taxpayer must be unmarried (single) or considered to be unmarried on the last day of the year.

Even though married, a taxpayer is considered unmarried on the last day of the tax year if all these tests are met.

ALERT: If the qualifying person was born or died during the year, a different rule applies. Previously, IRS guidance indicated that a taxpayer may file as head of household as long as he or she provided more than half the cost of keeping up the home that was the qualifying person's main home for more than half the year, or if less, the entire period the person was alive. The IRS was considering a change to this rule when this edition went to print. Check IRS Pub. 501, Exemptions, Standard Deduction, and Filing Information, and the Form 1040 Instructions to verify current IRS guidance for situations when a qualifying person was born or died during the year.
1. The taxpayer files a separate return.
2. The taxpayer paid more than half the cost of keeping up the home for the tax year.
3. Taxpayer's spouse did not live in the home during the last six months of the tax year. The taxpayer's spouse is considered to live in the home even if he or she is temporarily absent due to special circumstances.
4. The taxpayer's home was the main home of the taxpayer's child, stepchild, or eligible foster child for more than half the year. A “child” for this purpose is a son or daughter (including an adopted son or daughter). Grandchildren, parents, siblings, and others who may meet the relationship test for other purposes are not qualifying people for the “considered unmarried” test.
5. The taxpayer must be able to claim an exemption for the child. However, this test is met if the taxpayer cannot claim the exemption only because the noncustodial parent can claim the child using the rules for children of divorced or separated parents or parents who live apart. (The exemption rules are explained in Chapter 3.)

II. Cost of Keeping Up the Home

The taxpayer must pay more than half the cost of keeping up a home for the entire year, whether he or she owns or rents the home. As shown in Figure 2.3, costs for keeping up the home include expenses such as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food eaten in the home.

Figure 2.3 Cost of Keeping Up the Home

Payments received under Temporary Assistance for Needy Families (TANF) or other public assistance programs that are used for upkeep do not count as the taxpayer's payment. However, they are included in the total cost of keeping up the home when figuring whether the taxpayer paid half of such cost. The following items are not considered payments for the upkeep of a home: clothing, education, life insurance, medical expenses, transportation, vacations, and the value of the taxpayer's services in maintaining the home.

III. Qualifying Person

The taxpayer must have a qualifying person (someone listed in Figure 2.4) who lived in the home for more than half the year (discounting any temporary absences for attending school, taking a vacation, or other reasons, such as birth or death, during the year).

Figure 2.4 Qualifying Person

If the taxpayer's parent is the dependent, the parent need not live with the taxpayer. However, the taxpayer must pay more than half the cost of keeping up the parent's home. Also, as explained earlier, for purposes of being considered unmarried, qualifying persons are more narrowly defined than in other areas (such as dependency exemptions, discussed in Chapter 3).

Example
Harriet is single and supported her child who lived in her home until the child's death in February. Harriet's child is her qualifying child and she claims a dependent exemption for the child. Harriet qualifies for head of household status because she paid more than half the cost of keeping up the home for her child while the child was alive (since the child was alive less than half the year). The same result would apply if Harriet had a child born in December; even though the child did not live with her for more than half the year, Harriet could still qualify for head of household status.
Example
Jane's 12-year-old child lived with the child's father for eight months of the year. Jane cannot use head of household status, regardless of whether she supported her child, because the child did not live with her for more than half the year.
Example
Cynthia is single and supports herself as well as her elderly parent who lives in a nursing home. Cynthia's parent is her dependent. Cynthia qualifies for head of household status.
Example
The same facts as in the last example except that Cynthia is married, although she has not lived with her husband for most of the year. Cynthia cannot be considered unmarried and therefore cannot file using the head of household filing status because a parent is not a qualifying person for this purpose. Cynthia must use either the MFJ or MFS status.

Qualifying Widow(er) with a Dependent Child

Qualifying widow(er)s use the same tax rates and standard deduction amount as those who are married filing jointly. This filing status applies only to the two years following the year of a spouse's death; it cannot be used for more than two years.

To be a qualifying widow(er), these tests must be met:

1. The taxpayer was eligible to file a joint return for the year of the spouse's death, whether the taxpayer actually did so or not.
2. The taxpayer's spouse died in either of the two prior tax years, and the taxpayer has not remarried.
3. The taxpayer has a child or stepchild who can be claimed as a dependent. A foster child does not count for this purpose. As with being considered unmarried for head of household purposes, children related to the taxpayer in other ways are not qualifying people for this status.
4. The taxpayer's child lived in the home for the full year, except for temporary absences. The taxpayer's child is treated as having lived in the home for the full year, even if the child was born or died during the year, so long as the child lived with the taxpayer the entire portion of the year the child was alive. Kidnapped children must have lived with the taxpayer more than half the portion of the year before the kidnapping.
5. The taxpayer paid more than half the cost of keeping up the home for the year, whether the taxpayer owns or rents the home.
Example
Edna's spouse died on April 20, 2010 and she has not remarried. She supported herself and her child, now ten years old, in the home since the death of the spouse. She qualifies for qualifying widow(er) status in 2011 and 2012.
For 2013, Edna can no longer use qualifying widow(er) status because of the two-year limit on this status. However, if Edna continues to support her child in the home and has not remarried, she may qualify to use the head of household status.

Determining Marital Status

For federal income tax purposes, marital status is determined under state law. Marital status depends on whether the taxpayer is married on the last day of the year.

Example
The taxpayer was single on January 1 but got married on December 31. The taxpayer is considered married for the entire year.
Example
The taxpayer was married throughout the year but the divorce was finalized on December 31. The taxpayer is not considered married for the year.

Legal Marriage

A marriage that is recognized by state law is usually recognized as a legal marriage for federal income tax purposes. Also, marriages performed outside the United States are usually recognized as legal marriages for federal income tax purposes. In common-law states, living together, no matter how long, does not create a marriage unless a couple meets all of the state's requirements to be considered a valid marriage under common law. These rules vary from state to state.

ALERT: Oklahoma's current common-law marriage rules differ somewhat from the rules in place before November 1, 1998. More information on this topic is beyond the scope of this book.

These states currently recognize common-law marriage: Alabama, Colorado, Iowa, Kansas, Montana, Oklahoma, Rhode Island, South Carolina, Texas, and the District of Columbia.

ALERT: When this publication went to print, several court cases were challenging the Defense of Marriage Act. While President Obama has directed the U.S. attorney general not to defend the Act in court, the President did instruct federal administrative agencies to continue to enforce the law.

Five states recognize common-law marriages established before a certain date: Georgia (1/1/97), Idaho (1/1/96), Ohio (10/10/91), Oklahoma (11/1/98), and Pennsylvania (1/1/05). Utah recognizes common-law marriages only if they have been validated by a court or administrative order.

Example
A couple in Pennsylvania formed a common-law marriage in that state in 2002, meeting all the state's requirements. The couple can file a joint return because their arrangement is recognized as a legal marriage.
Example
Same facts as the last example except the couple began living together in Pennsylvania in 2008, claiming to be husband and wife. They cannot file a joint return; their arrangement, which was formed in 2008, is not recognized by Pennsylvania because the state only recognizes common-law marriages established before January 1, 2005.

Federal Rules

While state law determines whether a couple is legally married, the federal government recognizes marriages only between a man and a woman (due to the Defense of Marriage Act, a federal law enacted in 1996). Same-sex couples that are recognized as married by a state are not viewed as married under federal law and cannot file joint federal tax returns.

Divorces

Taxpayers who are divorced under a final divorce decree as of December 31 of the tax year cannot file a joint return.

Example
Sue and Juan obtain an interlocutory divorce (a temporary court order) in December 2012, but the divorce will not be finalized until December 2013. Sue and Juan are still considered married in 2012 and can choose to file a joint return. However, because their divorce will be finalized in 2013, they cannot file a joint return for that year (unless they remarry by December 31, 2013).

Annulments

If a marriage is annulled, it is considered to have never existed. If a couple filed a joint return prior to an annulment, each taxpayer must file, for each year they filed as married, an amended return using a filing status other than one available only for married taxpayers.

Example
Julia and George married in 2010. They file joint returns for 2010 and 2011. In 2012, a court annuls their marriage. They cannot file a joint return in 2012. They also must amend their jointly filed tax returns for 2010 and 2011 to claim the filing status that applies as if the marriage had not occurred.

Separation

Spouses who are legally separated under a separate maintenance decree issued by a court are considered unmarried for federal tax purposes. They can file as single or as head of household (if head of household tests described earlier are met); they cannot file a joint return.

Spouses who live apart but are not legally separated can choose to file a joint return. Under certain conditions, they may be treated as unmarried for tax purposes and can file as head of household (if head of household tests are met).

Example
Ann moved out of the marital home with her young child in November 2012; husband Harry continued to live there. Neither spouse has filed for a legal separation. Ann and Harry can choose to file a joint return, or each may file a married filing separate return. They may not use the single or head of household filing statuses.
Example
Same as the last example except Ann moved out of the marital home in April 2012. Ann and Harry can choose to file a joint return or married filing separate returns. Or, because they each lived apart for the last six months of the year, it is possible that Ann may qualify to file as head of household.

Making Changes in Filing Status

Returns generally can be amended to change entries up to three years from the filing date of the return. The exact rules for time limits on filing amended returns are not discussed in this book but can be found in the Form 1040X instructions.

If an error was made on an original return, it should be corrected by filing an amended return.

In some cases, amended returns may be used to change filing status from one permissible filing status to another permissible filing status after the original return has been filed.

The taxpayer can make these changes in permissible filing statuses:

From married filing separately to married filing jointlyFrom single to head of household or qualifying widow(er) if eligibility conditions are metFrom married filing jointly to unmarried following an annulment of the marriage

However, a taxpayer generally cannot make a change from married filing jointly to married filing separately. Once a joint return has been filed, the status is final with one exception: a taxpayer can change from married filing jointly to married filing separately only if an amended return is filed before the original due date of the return.

Review Questions

1. During the current tax year, Harriet is single from January through October; she marries Charles on November 1. She has no dependents. They each have about the same amount of income and will use the standard deduction. For the current tax year, which filing status is probably best for Harriet (and allowable)?

a. Single

b. Married filing jointly

c. Part single/part married

d. Married filing separately

2. Stan married Inez several years ago after his first wife died but is separated from Inez under a court order of legal separation. They did not live together during the current year. Stan does not have any children or other dependents. Which filing status is the most favorable and allowable?

a. Married filing jointly

b. Single

c. Head of household

d. Qualifying widow(er)

3. Joan and Edwin are married and have no children or other dependents. Joan, a part-time bookkeeper who earns a comparably modest amount, has large medical expenses that were not covered by insurance. Edwin is a successful Wall Street broker with a comfortable six-figure income. Edwin also pays a large amount of home mortgage interest and real estate taxes. Which permissible filing status for Joan is most likely to result in the smallest total tax liability?

a. Married filing jointly

b. Married filing separately

c. Single

d. Head of household

4. Ellie, who is single, supports her elderly mother, who resides in a nursing home. Ellie pays all of the costs for her own household as well as more than half the costs for her mother. Her mother receives $10,000 of Social Security benefits and a $3,000 pension that pays the expenses not covered by Ellie. Which filing status is the most advantageous (and allowable) for Ellie?

a. Single

b. Head of household

c. Qualifying widower(er)

d. Married filing separately

5. Camila has two children who lived with her all year. Her husband, Mark, left the home in August. She has not been able to locate him, and they have not filed for divorce or legal separation. Mark did not work all year, and Camila provided all the support for the home and children. Which filing status can Camila use if she does not wish to file a return together with her husband?

a. Single

b. Head of household

c. Married filing separately

d. Married filing jointly

6. Margaret, a single mother who has never been married, lost her job in May of 2012. Margaret and her ten-year-old daughter, Samantha, moved in with Margaret's sister, Joanne, that same month and lived with her the rest of the year. Joanne provided more than half of the support for the household during the year. What is Margaret's filing status?

a. Single

b. Head of household

c. Married filing jointly

d. Married filing separately

7. Rose's spouse died in 2011 and she has not remarried. She supports and cares for her 12-year old daughter. What is the filing status for 2012 that typically will be most favorable to Rose?

a. Single

b. Head of household

c. Qualifying widow(er)

d. Married filing separately

CHAPTER 3

Personal and Dependency Exemptions

Personal and dependency exemptions reduce the amount of income subject to tax. Individuals are allowed to claim one exemption for themselves, their spouse, and any dependents claimed on the return. Each personal and dependency exemption is worth the same deduction amount. For 2012, each exemption is worth $3,800. While the exemption amount is the same, the rules for when an exemption can be claimed are different for personal and dependency exemptions.

Personal Exemptions