Tax Fundamentals & Filing Status

The U.S. income-tax system is a pay-as-you-go, self-assessment system administered by the Internal Revenue Service (IRS), an agency of the Treasury Department. Every U.S. citizen, resident alien, and many nonresidents with U.S.-source income calculate their own tax liability annually and file a return — most commonly Form 1040.

Tax law is not one document. It flows from a hierarchy: the U.S. Constitution grants Congress the power to tax; Congress enacts statute (the Internal Revenue Code, or IRC, found in Title 26 of the U.S. Code); Treasury issues Regulations (also called Treas. Reg. §) that interpret the Code; and the IRS publishes Revenue Rulings, Revenue Procedures, Notices, and informal Publications that give further guidance.

When authorities conflict, higher-ranked authority wins. Statute beats regulation, regulation beats revenue ruling, and everything beats an IRS Publication (which is not binding law). A good tax preparer always knows which type of authority supports a position before advising a client.

The most common taxpayer is the individual — a natural person who files Form 1040 reporting wages, business income, investment income, and everything else on one return.

A sole proprietor is an individual running an unincorporated business. They file Schedule C attached to their 1040. A single-member LLC is by default a 'disregarded entity' — the IRS ignores the LLC and taxes the owner as a sole prop. Single-member LLCs can elect to be taxed as an S-Corp on Form 2553.

Partnerships (including multi-member LLCs) file Form 1065, an informational return. The partnership itself does not pay income tax; it issues each partner a Schedule K-1 that flows to the partner's 1040. S-Corporations file Form 1120-S and also issue K-1s, but S-corp shareholders who work in the business must be paid reasonable W-2 wages. C-Corporations file Form 1120 and pay tax at the entity level; shareholders pay again on any dividends (this is 'double taxation').

There are exactly five filing statuses. Choosing the correct status is the FIRST decision on any return — it drives the standard deduction, tax brackets, and eligibility for many credits.

1. Single — unmarried on 12/31 and doesn't qualify for HOH.
2. Married Filing Jointly (MFJ) — married on 12/31, both spouses sign; joint liability on the entire tax. Almost always produces the lowest combined tax.
3. Married Filing Separately (MFS) — married but each spouse files their own return. Usually the WORST status: many credits disappear (EIC, education credits, student loan interest, Saver's Credit). Sometimes used for liability protection, IBR student-loan planning, or high medical expenses.
4. Head of Household (HOH) — unmarried (or 'considered unmarried' — living apart from spouse the last 6 months), paid MORE THAN HALF the cost of keeping up a home, and a qualifying person lived with the taxpayer MORE THAN HALF the year (a dependent parent does NOT have to live with the taxpayer).
5. Qualifying Surviving Spouse (QSS) — for the 2 years AFTER the spouse's year of death, if the taxpayer has a qualifying child and hasn't remarried. Uses MFJ brackets and standard deduction.

A dependent is either a Qualifying Child (QC) or a Qualifying Relative (QR). QC opens the door to the Child Tax Credit, EIC with kids, and HOH filing status.

Test 1 — Relationship. Must be the taxpayer's child (including stepchild, foster child, adopted child), sibling, step-sibling, or a descendant of any of them (grandchild, niece, nephew).

Test 2 — Age. Under 19 at year-end, OR under 24 and a full-time student for AT LEAST 5 MONTHS of any part of the year, OR permanently and totally disabled at any age.

Test 3 — Residency. Lived with the taxpayer for MORE THAN HALF the year. Temporary absences (school, military, medical, vacation) count as time lived with the taxpayer.

Test 4 — Support. The child did NOT provide more than half of his or her own support.

Test 5 — Joint Return. The child cannot file a joint return with a spouse EXCEPT solely to claim a refund of tax withheld.

A QR is anyone who is not a QC but the taxpayer supports. Four tests must all be met.

Not a Qualifying Child of the taxpayer or anyone else.

Relationship or Member of Household — either has a listed relationship (parent, sibling, aunt/uncle, niece/nephew, in-law, etc.) OR lived with the taxpayer ALL YEAR as a member of the household. Cousins do NOT count as a relationship — they must live with the taxpayer all year.

Gross Income — dependent's gross income must be under $5,200 (2025 amount). Social Security is generally NOT counted in gross income unless taxable.

Support — the TAXPAYER must provide MORE THAN HALF of the dependent's total support for the year. This is the opposite orientation from QC.

Paid preparers must complete Form 8867 (Paid Preparer's Due Diligence Checklist) for any return claiming: Earned Income Credit (EIC), Child Tax Credit / Additional CTC / Credit for Other Dependents (CTC/ACTC/ODC), American Opportunity Credit (AOTC), or Head of Household filing status.

Due diligence requires four steps: (1) complete Form 8867 truthfully; (2) complete all applicable worksheets and compute the credit; (3) apply the 'knowledge requirement' — if the information looks incomplete, inconsistent, or incorrect, ask the client follow-up questions and document the answers; and (4) retain all records for 3 YEARS from the later of the return due date or the date the return was filed.

The penalty under IRC §6695(g) is $635 (2025) PER FAILURE. A single return claiming EIC + CTC + AOTC + HOH is FOUR credits: 4 × $635 = $2,540 in preparer penalties. The firm can also be jointly liable.

Ana was married on Jan 3, divorced on Dec 28. She lives with her 8-year-old daughter and pays 100% of household expenses.

On Dec 31 Ana is UNMARRIED. She has paid more than half the cost of keeping up a home. Her daughter (QC) lived with her all year. Result: Ana files Head of Household.

Contrast: Same facts but the divorce is not finalized until Feb of the following year. On Dec 31 she is STILL MARRIED. Unless she is 'considered unmarried' (spouse did not live in the home during the last 6 months of the year), she can only file MFJ or MFS. If they lived together the whole year, HOH is not available.