Taxation 101: A Complete Manual for the Free Online Tax Training Course

Tax Basics for Beginners (Taxes 101)

The 3 Sources of Federal Tax Law in the U.S.

The Different Types of Business Entities in the U.S.

Comparing Business Entity Types

Sole Proprietorships | Advantages and Disadvantages

C Corporations | Advantages and Disadvantages

S Corporations | Advantages and Disadvantages

LLCs | Advantages and Disadvantages

Partnership Tax in the U.S.

How to Calculate Outside Basis of a Partner

Inside Basis vs Outside Basis | Partnership

Tax Rules for S Corporations in the US

Qualifying for S Corporation Status

Making the Election to be an S Corporation

How to Allocate Income and Losses for S Corporations

Distributions to Shareholders of S Corporations

S Corporation Property Distribution

How to Calculate Basis for S Corporation Stock

S Corporation Indebtedness and Shareholder Basis

Section 351 Transaction (U.S. Corporate Tax)

Section 351 Transaction with the Transfer of Services (U.S. Corporate Tax)

Section 351 Transaction with Boot (U.S. Corporate Tax)

Section 351 transaction with Section 357 liabilities (U.S. Corporate Tax)

How to Calculate Transferor’s Basis– Section 351 (U.S. Corporate Tax)

How to Allocate Basis to Multiple Classes of Stock– Section 351 (U.S. Corporate Tax

How to Determine Holding Period of Stock in a Section 351 Transaction (U.S. Corporate Tax)

How to Calculate Corporation’s Basis in a Section 351 Transaction (U.S. Corporate Tax)

The 3 Accounting Methods for Corporate Tax Returns (U.S. Corporate Tax)

3 Tax Advantages of Debt (U.S. Corporate Tax)

4 Tax Advantages of Using Equity (U.S. Corporate Tax)

After-tax Cost of Debt vs. Equity (U.S. Corporate Tax)

The 5 Factors of Section 385 for Classifying as Debt or Equity (U.S. Corporate Tax)

Earnings Stripping (U.S. Corporate Tax)

Section 1244 Stock (U.S. Corporate Tax)

Junk Bonds and Taxes: The AHYDO Rules (U.S. Corporate Tax)

E&P Earnings and Profits (U.S. Corporate Tax)

Current E&P vs. Accumulated E&P (U.S. Corporate Tax)

Course Notes and Summary

Module 1: Introduction to Taxation

Lesson 1.1: What Are Taxes?

Taxes are compulsory contributions levied by a government on its citizens to fund public services and infrastructure. This lesson will introduce you to the different types of taxes and their roles in society.

Types of Taxes

Income Tax: This tax is levied on both individuals and corporations based on their income. It is one of the largest sources of revenue for governments.
- Personal Income Tax: Individuals pay this based on their earnings from work, business, or investments.
- Corporate Tax: Businesses are taxed on their profits, which contributes to government revenue.
Sales Tax: Levied at the point of sale, this tax is typically a percentage of the total purchase price of goods and services.
- Varies by state and municipality, with some areas having no sales tax at all.
- Collected by businesses and remitted to the government.
Property Tax: Paid by property owners based on the value of their real estate. These taxes are used primarily to fund local services such as schools, police, and fire departments.
Other Taxes:
- Capital Gains Tax: Charged on the profit made from selling an asset like real estate or stocks.
- Estate Tax: Taxed on the transfer of a deceased person’s estate.
- Excise Tax: Applied to specific goods like alcohol, cigarettes, and gasoline.

Why Taxes Are Essential

Taxes play a crucial role in the following:

Funding Public Services: Education, healthcare, public safety, and infrastructure projects are all funded by taxes.
Economic Stability: Governments use taxes to stabilize the economy by adjusting spending and tax rates according to economic conditions (known as fiscal policy).
Redistribution of Wealth: Progressive tax systems aim to reduce income inequality by taxing higher-income individuals at higher rates.

Lesson 1.2: Key Tax Terminology

In the world of taxes, understanding the terminology is key to managing and filing your tax returns correctly. Here are some of the most important tax terms you’ll encounter:

Gross Income: The total income earned by an individual or business before any deductions or taxes are applied. It includes wages, dividends, capital gains, rental income, and more.
- For example, if you earn $50,000 from a job and receive $5,000 in interest and dividends, your gross income is $55,000.
Adjusted Gross Income (AGI): This is your gross income after certain adjustments are made (such as contributions to a retirement account, student loan interest, and alimony payments). AGI is important because it determines eligibility for tax credits and deductions.
Deductions: These reduce the amount of income that is subject to tax. Deductions can be standard or itemized, depending on what you qualify for:
- Standard Deduction: A set amount based on your filing status.
- Itemized Deduction: Specific expenses that you can deduct from your income (e.g., medical expenses, mortgage interest).
Tax Credits: These directly reduce your tax liability dollar for dollar. Credits can be refundable (meaning you can receive a refund if your credit exceeds your tax) or non-refundable (which reduces your tax but does not result in a refund).
Exemption: An amount that can be subtracted from gross income to reduce taxable income, often available for dependents (such as children).
Tax Bracket: A range of income that is taxed at a particular rate in a progressive tax system. As income increases, higher amounts of income fall into higher tax brackets.
Tax Liability: The total amount of tax owed to the government based on your income and filing status.

Lesson 1.3: Overview of the U.S. Tax System

The United States operates on a progressive tax system, which means that individuals and businesses pay taxes at different rates based on their income levels.

How the Tax System Works

Federal Taxes: These include income taxes on individuals and corporations, as well as payroll taxes to fund Social Security and Medicare.
State Taxes: Most states impose income and/or sales taxes. Rates vary by state.
Local Taxes: Some local governments collect property taxes and other small taxes, like local sales or use taxes.

The IRS

The Internal Revenue Service (IRS) is the federal agency responsible for collecting taxes and enforcing tax laws. The IRS provides tax guidance, audits returns, and ensures compliance with tax regulations.

Taxpayer Rights

Taxpayers have specific rights when dealing with the IRS, including:

The right to be informed about tax laws and IRS decisions regarding your account.
The right to quality service, including courteous and professional interactions with IRS representatives.
The right to confidentiality, ensuring your tax information is kept private and secure.

Filing Requirements

Taxpayers must file their tax returns by the annual deadline (usually April 15). Failure to file or pay taxes by this deadline can result in penalties and interest. Extensions are available for those who need more time, but taxes must still be paid on time to avoid penalties.

Module 2: Understanding Income and Filing Status

Lesson 2.1: Types of Income

Income comes in many forms, and the IRS taxes different types of income in different ways. In this lesson, we’ll cover the most common types of income you’ll encounter.

Earned Income

This is the income you receive from employment or self-employment activities. Examples include:

Wages: Salary or hourly income earned through employment.
Tips: Income received by workers in certain service industries.
Bonuses: Additional compensation provided by an employer.
Self-Employment Income: Income earned through freelance work or a personal business, reported on a Schedule C.

Unearned Income

This refers to income from investments or passive sources. Examples include:

Interest: Income from savings accounts, bonds, or loans made to others.
Dividends: Payments made to shareholders from corporate profits.
Capital Gains: The profit from selling assets like stocks, bonds, or real estate. Long-term gains (held for over one year) are taxed at lower rates than short-term gains.
Rental Income: Income earned from renting out property.

Other Forms of Income

Alimony: Payments made from one ex-spouse to another after a divorce.
Pension and Social Security Income: Payments received from retirement plans or the Social Security Administration.

Lesson 2.2: Filing Status

Choosing the correct filing status is one of the most important decisions you’ll make when preparing your tax return. Your filing status impacts your tax bracket, eligibility for certain credits and deductions, and your overall tax liability.

Filing Statuses

Single: Applies to individuals who are unmarried, divorced, or legally separated as of the last day of the tax year.
Married Filing Jointly: Couples who are legally married can combine their income and deductions onto one return. This often results in lower taxes compared to filing separately.
Married Filing Separately: Some married couples may choose to file separately, particularly if one spouse has significant medical expenses or deductions that benefit them more than the joint return.
Head of Household: Single taxpayers who have dependents and provide more than half the cost of maintaining a home can qualify for this filing status, which typically offers a lower tax rate than filing as single.
Qualifying Widow(er): Taxpayers whose spouse has passed away may be able to use this status for two years after their spouse’s death if they are caring for a dependent child.

Impact of Filing Status

Standard Deduction: Your filing status determines the amount of your standard deduction.
Tax Brackets: Each filing status has its own tax brackets, affecting how much of your income is taxed at each rate.

Module 3: Tax Deductions and Credits

Lesson 3.1: Understanding Tax Deductions

Tax deductions reduce the amount of your income that is subject to tax, lowering your overall tax liability.

Standard Deduction vs. Itemized Deductions

Standard Deduction: A flat amount determined by your filing status that reduces taxable income. For example, in 2023, the standard deduction is $13,850 for single filers and $27,700 for married filing jointly.
Itemized Deductions: If your deductible expenses exceed the standard deduction, you can itemize them on Schedule A of Form 1040. Common itemized deductions include:
- Medical and Dental Expenses: Only expenses that exceed 7.5% of your AGI can be deducted.
- Mortgage Interest: You can deduct the interest paid on up to $750,000 of mortgage debt.
- Charitable Contributions: Contributions made to qualifying charities are deductible.

When to Itemize vs. Take the Standard Deduction

Itemizing is beneficial if your allowable deductions are greater than the standard deduction. However, itemizing can be more complicated and requires keeping detailed records.

Lesson 3.2: Understanding Tax Credits

Tax credits directly reduce the amount of tax you owe. Unlike deductions, which lower your taxable income, credits reduce your tax bill dollar for dollar.

Types of Credits

Refundable Credits: These credits can reduce your tax liability to below zero, meaning you’ll receive a refund. Example: Earned Income Tax Credit (EITC).
Non-refundable Credits: These can reduce your tax liability to zero, but any excess credit is lost. Example: Child Tax Credit (partly refundable).

Popular Tax Credits

Earned Income Tax Credit (EITC): Designed for low-to-moderate-income working individuals and families. The credit amount varies based on income, filing status, and the number of children.
Child Tax Credit: Offers up to $2,000 per qualifying child, with up to $1,400 being refundable.
American Opportunity Tax Credit: Provides a credit of up to $2,500 for education-related expenses, including tuition and fees.

Lesson 3.3: Adjustments to Income

Adjustments are certain expenses that reduce your gross income, allowing you to calculate your AGI. These are sometimes called “above-the-line” deductions, meaning they are available to all taxpayers, even if they don’t itemize deductions.

Common Adjustments to Income

Retirement Contributions: Contributions to traditional IRAs can reduce your taxable income up to the annual limit ($6,500 in 2023, with a catch-up contribution of $1,000 for those over 50).
Student Loan Interest Deduction: You can deduct up to $2,500 in interest paid on qualified student loans, depending on your income.
Educator Expenses: Teachers and eligible educators can deduct up to $300 of unreimbursed expenses for classroom supplies.

Module 4: Filling Out a Basic Tax Return

Lesson 4.1: Overview of Form 1040

Form 1040 is the main tax form used by U.S. taxpayers to file their annual tax return. Understanding the structure of Form 1040 is key to filing taxes accurately.

Main Sections of Form 1040

Personal Information: Includes your name, Social Security Number, and filing status.
Income: Report wages, interest, dividends, capital gains, and other types of income.
Deductions: Choose to take the standard deduction or itemize deductions.
Tax Liability: Calculate the tax owed based on your taxable income.
Payments: Record any federal income tax already withheld from your paychecks or paid through estimated payments.
Refund or Amount Owed: After calculating your credits, deductions, and payments, determine whether you owe additional taxes or are due a refund.

Lesson 4.2: Common Schedules and Forms

In addition to Form 1040, you may need to file additional schedules and forms to report specific types of income, deductions, or credits.

Common Forms and Schedules

Schedule A (Itemized Deductions): Used to report itemized deductions instead of taking the standard deduction.
Schedule B (Interest and Dividend Income): Used if you have taxable interest or dividend income over a certain threshold.
Schedule C (Profit or Loss from Business): Used by sole proprietors and freelancers to report income and expenses from self-employment.
Schedule E (Supplemental Income and Loss): Used to report income or losses from rental real estate, royalties, partnerships, and S-corporations.
Form W-2: Issued by employers to report wages paid and taxes withheld.
Form 1099: Reports various types of income other than wages, salaries, or tips, such as freelance income, interest, and dividends.

Lesson 4.3: Filing Your Taxes

Filing your taxes involves more than just completing the forms. There are several methods available to file your return, and knowing your options can save time and effort.

Ways to File

E-Filing: The most common and efficient method. Most tax preparation software provides an e-filing option, and the IRS offers Free File for those with an AGI below a certain threshold.
Paper Filing: You can still mail a paper return, but it takes longer to process, and refunds are delayed compared to e-filing.
Tax Preparation Software: Tools like TurboTax, H&R Block, and FreeTaxUSA offer user-friendly platforms for completing your tax return. These tools guide you through the process with prompts and calculations.
Hiring a Professional: If your tax situation is complex, such as having multiple sources of income or extensive deductions, it may be beneficial to hire a certified tax preparer, accountant, or enrolled agent.

Deadlines and Penalties

Tax Filing Deadline: Typically April 15 of each year. If the 15th falls on a weekend or holiday, the deadline is extended to the next business day.
Extensions: If you need more time, you can request an extension to October 15. However, this does not extend the time to pay any taxes due.
Penalties: Failure to file or pay taxes on time can result in penalties and interest. The penalty for failure to file is typically 5% of the unpaid taxes for each month your return is late, up to 25%.

Module 5: Self-Employment and Business Taxes

Lesson 5.1: Self-Employment Taxes

Self-employed individuals, including freelancers and independent contractors, are responsible for paying both income tax and self-employment tax, which covers Social Security and Medicare contributions.

Understanding Self-Employment Tax

Self-Employment Tax Rate: The total self-employment tax rate is 15.3%, with 12.4% going to Social Security and 2.9% to Medicare.
Deduction for Self-Employment Tax: You can deduct half of your self-employment tax when calculating your AGI.

Estimated Tax Payments

Self-employed individuals are required to make quarterly estimated tax payments if they expect to owe $1,000 or more in taxes for the year. Payments are due on April 15, June 15, September 15, and January 15.

Reporting Self-Employment Income

Schedule C: This form is used to report income and expenses from self-employment.
Schedule SE: Used to calculate and report self-employment tax.

Lesson 5.2: Business Deductions

Running a small business or working as a freelancer comes with many tax-deductible expenses. Knowing what you can deduct is crucial for reducing your tax bill.

Common Business Deductions

Home Office Deduction: If you use part of your home exclusively for business, you can deduct a portion of your home expenses, such as rent or mortgage interest, utilities, and insurance.
Vehicle Expenses: You can deduct either the actual expenses (gas, maintenance, insurance) or use the standard mileage rate (62.5 cents per mile in 2022).
Supplies and Equipment: Business-related purchases such as computers, software, office supplies, and tools are deductible.
Meals and Entertainment: You can deduct 50% of the cost of meals related to your business. Entertainment expenses are no longer deductible.
Marketing and Advertising: The cost of promoting your business through ads, websites, or events is fully deductible.
Professional Services: Fees paid to accountants, lawyers, or consultants are deductible as business expenses.

Depreciation of Assets

If you purchase significant assets like computers, vehicles, or machinery for your business, you may be able to deduct the cost over several years through depreciation. Alternatively, Section 179 allows businesses to deduct the full cost of some assets in the year they are purchased, up to certain limits.

Lesson 5.3: Sales Tax, Payroll Tax, and Other Taxes

Depending on your business structure and activities, you may be responsible for additional taxes beyond income tax.

Sales Tax

If you sell goods or services, you may need to collect sales tax from your customers and remit it to the state or local government. Sales tax rates and requirements vary by state, and it’s essential to register for a sales tax permit if required.

Payroll Tax

If you have employees, you are responsible for withholding payroll taxes from their wages and paying employer contributions for Social Security, Medicare, and unemployment insurance. Payroll tax filing is typically done quarterly, and you may need to file forms such as:

Form 941: Used to report employment taxes withheld from employees’ paychecks.
Form W-2: Issued to employees at the end of the year to report their annual wages and taxes withheld.

Other Local Taxes

Depending on where your business operates, you may need to pay local business taxes, such as gross receipts taxes or business license fees. It’s important to check with your local government to ensure compliance.

Module 6: Tax Planning and Strategies

Lesson 6.1: Retirement Savings and Tax Deferral

Contributing to retirement accounts is one of the most effective ways to reduce your taxable income while saving for the future.

Retirement Account Options

Traditional IRA: Contributions are tax-deductible, reducing your taxable income for the year. However, withdrawals during retirement are taxed as ordinary income.
Roth IRA: Contributions are made with after-tax dollars, but qualified withdrawals during retirement are tax-free.
401(k) Plans: Employer-sponsored retirement plans that allow employees to contribute pre-tax income. Some employers offer matching contributions, which is essentially free money for your retirement savings.

Contribution Limits

IRA Contribution Limit: In 2023, the annual limit for contributions to a traditional or Roth IRA is $6,500, with an additional $1,000 catch-up contribution allowed for those aged 50 or older.
401(k) Contribution Limit: In 2023, the annual limit for contributions to a 401(k) plan is $22,500, with an additional $7,500 allowed for those aged 50 or older.

Lesson 6.2: Tax-Efficient Investments

Tax efficiency is key to maximizing your investment returns while minimizing your tax liability.

Capital Gains Tax

Short-term Capital Gains: Profits from the sale of assets held for one year or less are taxed at ordinary income tax rates.
Long-term Capital Gains: Profits from the sale of assets held for more than one year are taxed at lower rates, ranging from 0% to 20% depending on your income.

Tax-Loss Harvesting

Tax-loss harvesting is a strategy used to offset capital gains by selling investments at a loss. By strategically selling losing investments, you can reduce your taxable gains and potentially lower your tax bill.

Qualified Dividends

Qualified dividends are taxed at long-term capital gains rates rather than ordinary income tax rates. To qualify, dividends must be paid by a U.S. corporation or a qualified foreign corporation, and you must meet specific holding period requirements.

Lesson 6.3: Tax Planning for Life Events

Life changes such as marriage, having children, and buying a home can have significant tax implications. This lesson will cover tax planning strategies for major life events.

Marriage

Getting married can affect your filing status, which may change your tax liability. You may need to decide whether to file jointly or separately, depending on your combined income and deductions.

Children

Having a child can provide several tax benefits, including the Child Tax Credit and dependent care credits. You may also be eligible for the Earned Income Tax Credit if your income qualifies.

Buying a Home

Homeownership offers several tax benefits, including the mortgage interest deduction and property tax deductions. You may also be able to exclude up to $250,000 ($500,000 for married couples) of capital gains when selling your primary residence if you meet certain ownership and use requirements.

Module 7: Dealing with the IRS

Lesson 7.1: Responding to IRS Notices

Receiving a notice from the IRS can be intimidating, but it doesn’t necessarily mean you’re in trouble. Most notices are simply requests for more information or clarification.

Common IRS Notices

Notice of Underpayment: If the IRS determines you owe more taxes than you reported, you may receive a notice of underpayment.
Notice of Math Error: If the IRS finds an error in your calculations, they will adjust your return and send you a notice.
Request for Documentation: Sometimes, the IRS may request additional documentation to verify certain claims, such as charitable contributions or business expenses.

How to Respond

Verify the Notice: Always review the notice carefully to ensure it’s accurate. Compare it with your tax return to identify any discrepancies.
Provide Documentation: If the IRS requests documentation, respond promptly with the requested information. Make sure to keep copies of everything you send.
Appealing a Decision: If you disagree with the IRS’s findings, you have the right to appeal. The IRS offers formal appeal processes where you can present your case.

Lesson 7.2: Payment Plans and Settlements

If you owe taxes and can’t pay the full amount by the deadline, the IRS offers payment plans and settlement options to help you manage your tax debt.

Installment Agreements

Short-Term Payment Plan: Available if you can pay the full amount within 180 days. No setup fee is required.
Long-Term Payment Plan: If you need more than 180 days to pay, you can apply for a monthly installment agreement. Setup fees may apply, but fees can be reduced for low-income taxpayers.

Offer in Compromise

An Offer in Compromise (OIC) allows taxpayers to settle their tax debt for less than the full amount owed if they can demonstrate that paying the full amount would cause financial hardship. To qualify, you must provide detailed financial information, and the IRS will assess your ability to pay.

Penalty Relief

If you’ve been charged penalties for late filing or payment, you may be eligible for penalty relief under certain circumstances, such as reasonable cause or first-time abatement. You can request penalty relief by contacting the IRS or submitting a written request.

Conclusion

Taxes are an integral part of everyday life, and understanding how to manage them effectively can significantly reduce stress and financial burden. Whether you’re preparing your own taxes or planning for major life events, having a solid grasp of tax basics can lead to more informed financial decisions.

This course manual serves as a comprehensive guide through the foundational aspects of taxation, from understanding income types and deductions to dealing with the IRS. As you complete this course, you’ll not only be better equipped to handle your own tax returns but also gain the confidence needed to navigate the complexities of the tax system.

Remember, taxation rules can change over time, so staying informed about current tax laws and seeking professional advice when necessary will help you maintain compliance and minimize your tax liability.

By understanding your rights as a taxpayer, maximizing deductions and credits, and utilizing tax planning strategies, you can take control of your financial future and ensure that you are paying only what you owe—no more, no less.

Good luck, and welcome to the world of taxation!