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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

About the Author

Norma Wahnon integrated her accounting and taxation background and experience to produce the “1040 Exam Prep” e-Book Series to help tax return preparers pass the IRS competency exam and become Registered Tax Return Preparers. Wahnon was raised in Argentina and after graduating with an Accounting degree from National University of Misiones, in 1989, and running her accounting practice for 10 years she moved to the Canary Islands, Spain, for one year, to complete a MBA program. From 2000 to 2006, she lived in the capital of Cape Verde, the city of Praia (Africa). She became a resident of the United States in 2006 and a citizen in June 2010. In November 2010 she successfully completed all sections of the Uniform Certified Public Accountant Exams in few months. After working in the tax return preparation industry for several years, she created and owns TaxBiz Solution, an accounting and tax practice service located in Silver Spring, MD, USA. Lastly, she earned the RTRP credential by passing the competency exam in September 2012.

Norma Wahnon Author

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

RTRP EXAM PREP e-BOOKLETS

DOMAIN 1 PRELIMINARY WORK AND COLLECTING TAXPAYERS DATA The Form 1040 Formula and Basic Tax Concepts

By Norma Wahnon

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Point to Ponder Before taking the first step to prepare for the RTRP exam, be clear on how the RTRP credential will help your career. The rewards you will get from becoming a RTRP should be your top motivation to prepare for and pass the exam.

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

PRELIMINARY WORK AND COLLECTING TAXPAYERS DATA ___________________________________________________ INTRODUCTION In preparing income tax returns, practitioners are required to do some preliminary work to collect, analyze, and review information provided by the taxpayer. Domain 1 of the IRS Tax Return Preparer Test Specification Outline is about the preliminary work tax preparers must do to analyze information provided by taxpayers before beginning to effectively prepare a return. Part of the preliminary work is to familiarize taxpayers with the overall structure of the individual income tax return contained in Form 1040, its schedules and complementary forms, as well as the tax preparer obligations and regulation demands on tax practitioner. This e-booklet covers income tax concepts contained in Domain 1 of the IRS Test Specification Outline such as understanding the Form 1040 formula, filing information, filing status, personal and dependent exemptions, among others. Topics covered in the e-booklets offered by 1040ExamPrep are based on the IRS Test Specification Outline. The e-booklets are designed to help RTRP candidates meet the preparation requirements to pass the competency exam. Credit for Prior Year Minimum Tax—Individuals, Estates, and Trusts

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

PART I - PRELIMINARY WORK Taxpayers have the obligation to file a tax return every year. Taxpayers also have primary responsibility for the information contained in the return they file. However, if a paid tax practitioner prepares the taxpayer’s return the practitioner also has inherent responsibilities and obligations established in the IRS regulations. As preliminary work leading up to the preparation and filing of a tax return, practitioners are required to collect taxpayers’ data and perform the following not all-inclusive tasks: 

Review of prior years’ Individual Form 1040 returns, for comparison as well as for compliance, accuracy, and completeness;

Collect taxpayers’ biographical information such as date of birth, marital and dependent status, Immigration status and/or citizenship (i.e., citizenship status, visas and green card statuses, and the resident alien or non-resident alien status);

Determine taxpayer’s filing status (i.e., single, married filing jointly, married filing separately, widow(er), and head of household);

Determine sources of all incomes, whether from interest, wages, business, sale of property, dividends, interest, rental income, etc;

Determine applicability of adjustments to gross income from retirement plans, health savings accounts, alimony, health insurance, moving expenses, self-employment tax, etc.;

Determine applicable deductions, whether itemized or standard;

Identify sources of applicable credits such as credits for education, filed tax, retirement, energy, child care, etc;

Identify tax payments such as withholdings from wages, estimated tax payments, and, using appropriate methods, determine whether individuals and/or business entities are involved;

Identify items that affect future returns such as carryovers, operating losses, net operating losses, Schedule D, Form 8801, Credit for Prior Year Minimum Tax—Individuals, Estates, and Trusts;

Identify all required taxes filed (i.e., employment, gift, estimated tax);

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA 

Identify special filing requirements for gifts, foreign income, presidentially declared disaster areas, etc.;

Others, as applicable.

Collecting complete and accurate data helps the tax professional profile the taxpayer accurately, and meets an ethical responsibility requirement for both. The tax professional must make clear to the taxpayer that all pertinent information requested should be provided if a tax return is to be prepared accurately. An “organizer form set", is a very useful tool tax return preparers can use to help taxpayers visualize the documents they need to gather, and information they must provide, before their return can be prepared. A completely filled out “organizer-form set” signed by the taxpayer is also valuable in the event the IRS calls an audit on a return, and instrumental to maintain a healthy relationship between the taxpayer and the tax professional. The input and output of the tax return preparation process is the mutual responsibility of both the taxpayer and the tax return preparer. The new regulations being implemented by the IRS increase the professional responsibility of tax return preparers, and non-compliance with the rules may result in punitive action including revocation of authorization to work as a tax professional. Successful taxpayer data collection and correct processing of such data requires the work of a competent tax return preparer. The Registered Tax Return Preparer examination is all about assuring competency.

UNDERSTANDING THE FORM 1040 FORMULA Taxable income is the part of a taxpayer’s income subject to a federal income tax rate. To determine the taxable income it is necessary to work with the formula imprinted in the Form 1040 series. A thorough understanding of the formula is necessary, to compute the taxable income. To determine the taxable income one must understand and follow the Form 1040 Formula. The Formula may look simple, but its application can become cumbersome because of allowed exclusions and allowable deductions. Figure 1 provides details of the Form 1040 Formula.

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Figure 1 – Form 1040 Formula

Figure 2 shows the Formula in simplified form:

Figure 2 – The Form 1040 Formula in Simplified Form

THE COMPONENTS OF THE FORM 1040 FORMULA The components of the Form 1040 Formula are: Income: Taxable and non–taxable; 

Gross Income;

Deductions “For AGI” or “Above the Line”;

Adjusted Gross Income (AGI);

Itemized Deductions and Standard Deductions (nondeductible expenditures);

Preliminary Work and Collecting Taxpayer Data: Domain 1 - IRS Test Specification Series www 1040examprep.com (C) Copyrighted 2012. All Rights Reserved

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

REVIEW QUESTIONS 3. Which of the following taxpayers MUST file an income tax return? a. Alex, 19, full–time college student and earned $7,500 wages during 2011. He is claimed as dependent by his parents. b. John, 10, had unearned income (dividend) of $1,500 during the year. He is claimed as dependent by his parents. c. Mary, 15, and earned wages $5,400 and interest $ 800 during the year. She is claimed by her parents. d. Steve, 68, retired, single, Social Security benefit of $12,000, interest $200. He lives with his son who claims him as dependent. e. Leo, 16, earned interest $250 in the year. Leo is claimed as dependent by his parents. Leo also earned $3,200 from his online business during the summer. f. Esther, 67, blind, lives w/ her retired husband, 70, in their daughter’s home. The couple is claimed as dependents by their daughter. Both receive Social Security of $15,000 and $22,000 respectively. Esther received $3,800 interest income for the year. g. Alex, 23, full–time college student and earned $3,500 wages during 2011. He is claimed as dependent by his parents. h. John, 12, and earned ordinary dividend $500 and interest $300 during the year. He is claimed as dependent for his parent. i. Louis, 18, and received unemployment compensation of $1,500 and interest $300 during the year. He is claimed as dependent for his parent. j. Steve, 48, blind, single, social security benefit $22,000, interest $1,200. He lives with his son who claimed him as dependent. 4. Determine for the following independent situations, the filling status of taxpayer Dorothy. a. Dorothy lives alone and supports her married daughter, Ellen’s (20), household. Ellen and her husband had no income during the year. Dorothy claims both as qualified relatives. b. Same situation as (a) but Ellen is single and does not qualify as dependent. c. Same situation as (a) but Ellen files with her husband and claims only taxes withheld. Dorothy claims both as qualified relatives. d. Dorothy lives alone and she supports her parents’ household. Her mother was a qualified dependent but her father did not qualify as dependent. e. Dorothy lives alone and her husband died this year. She supports her parent household. Her mother and father are qualified dependents.

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

ANSWERS TO REVIEW QUESTIONS 3. Which of the following taxpayers MUST file an income tax return? Use Table I from the Annex to answer questions in this section Yes. Alex earned more than $5,800 Yes. John has unearned income higher than $950 Yes, Mary applied the gross income analysis. Her gross income $6,200 ($5,400+$ 800) is larger than the gross income limit, $5,500, plus $300. No. Steve has unearned income lower than $2,400. The $12,000 Social Security is not taxable. It may be taxable if individual incomes from all sources exceed a specified amount (MAGI); as much as 85% of the total amount of Social Security benefits received may be taxable and must be included in gross income. No. Leo unearned income is lower than the $950 limit and his earned income $3,200 plus $300 ($3,500) don’t reach $5,800 limit. Yes, Esther must file return because her unearned income is higher than $3,250 limit for married taxpayer age 65 older. No. Alex earned income is not higher than the $5,800 for earned income. No. John unearned income is $800 which is lower than the larger of $950 limit for unearned income. Yes. Louis received $1,800 of unearned income which is higher than the $950 limit. No. Limit amount of unearned income of single taxpayers under age 65 is $2,400 (for age 65 or older is $3,850). Steve is blind; his $1,200 of unearned income is lower than $2,400 6. Which of the following individuals may be or not be claimed as a dependent, assuming they meet the income tests? Use Table III, IV and V from the section to answer these questions a. Yes, can be claimed as dependent (qualified relative) b. Yes, can be claimed as dependent (qualified relative) c. Yes, can be claimed if the taxpayer is divorced from the former spouse for more than 2 years and the residence, support and income test are met.

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

ANNEX Use these tables as help to solve the review questions of this domain. Table I:

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Table II

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Table III

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Table IV

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Table V

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DOMAIN 1 - PRELIMINARY WORK AND COLLECTING TAXPAYERS’ DATA

Table VI

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Domain I of IRS Test Specification for the RTRP Exam  

Domain I: Preliminary Work and Collection of Taxpayer’s Data –The Form 1040 formula and Basic Tax Concepts

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