Income Taxation- Ch 7 Individual Income Tax Computation And Tax Credits

Front 1

When is there a marriage penalty using MFJ rates?

Back 1

Penalty= greater tax liability using MFJ rates, both spouses earn income

Front 2

When is there a marriage benefit using MFJ rates?

Back 2

Benefit=greater tax liability using single rates, one spouse earns income

Front 3

What does the regular tax amount depend on?

Back 3

Filing Status:
- Married filing jointly
- Qualifying widow or widower
- Married filing separately
- Head of Household
- Single

Front 4

What is a capital gain?

Back 4

the gain recognized on the disposition of a capital asset

Front 5

What is a capital asset?

Back 5

any asset other than business assets. Investment or personal use assets

Front 6

What are business assets?

Back 6

accounts receivable, inventory, assets used in the business.

Front 7

What are preferential tax rates for LTCG?

Back 7

- capital assets owned for more than a year
- generally 15% but can be as high as 28% or low as 0%

Front 8

What are preferential tax rates for Qualified Dividends?

Back 8

Generally taxed at 15% but could be taxed as low as 0%

Front 9

What are the two ways tax laws reduce parents' ability to shift unearned income to children?

Back 9

A reduced standard deduction for those who are claimed as a dependent ... AND

Kiddie Tax

Front 10

The Kiddie Tax

Back 10

Reduces parents ability to shift unearned income to children

When it applies, children must pay tax on a certain amount of their unearned income at their parents' marginal tax rate

Front 11

The Kiddie Tax Applies to a child if the child is... (3 options)

Back 11

1. Under 18 at year end
2. 18 at year end but child's earned income does not exceed half of the child's support
3. Over 18 but under 24 at year end, is a full-time student during the year and the child's earned income does not exceed half of the child's support (excluding scholarships)

Front 12

If the Kiddie Tax applies, what is the child's tax base?

Back 12

Tax base is the child's net unearned income

Front 13

If the Kiddie Tax applies, what is the child's net unearned income?

Back 13

Lesser of:
Gross unearned income less $1900 OR taxable income

Front 14

What is Alternative Minimum Tax and when does it apply?

Back 14

AMT is a tax on an alternative tax base meant to more closely reflect economic income.
Taxpayers pay AMT only when the tax on AMT base exceeds the regular tax.

Front 15

Who is likely to have to pay AMT?

Back 15

- live in high income tax state
- have many dependents
- pay high real estate taxes
- have high capital gains

Front 16

What are common items to be added back to compute AMT income?

Back 16

- Personal and dependency exemptions
- standard deduction if it is deducted
- real property taxes
- state income or sales taxes
- home-equity loan interest expense if proceeds not used to improve home)
- misc itemized deductions subject to the 2%

Front 17

Why is AMT become more prevalent?

Back 17

- AMT exemption amount is not indexed for inflation
> as taxpayers' incomes increase over time through inflation, teh exemption amount does not.
> exposes more income to AMT
- individual tax rates have been decreasing while AMT rates have remained constant

Front 18

What are the two components of FICA taxes?

Back 18

1. Social Security tax- 12.4%, wage base limited to $106,800
2. Medicare tax- 2.9%, no wage base limitation

Front 19

How does FICA work when there are multiple employers during the year?

Back 19

- each employer must withhold FICA taxes on an employee's wages until the wage base limit is reached for that employee
- excess withholdings- treated as an additional tax payment (or credit) of employees form 1040
-Employers do not receive refund of excess taxes paid on behalf of employees

Front 20

What are the steps to computing Self-Employment Taxes?

Back 20

Step 1: Compute net income from self-employment
Step 2: Multiply amount of 0.9235 to get net earnings from self-employment
Step 3: Compute Self Employment Taxes

Front 21

What are some Self-Employment Taxes shortcuts?

Back 21

1. If net SE earnings are less than $400, no SE tax
2. If net SE earnings are $106,800 or less, multiply net SE earnings by 15.3%
3. If net SE earnings exceed $106,800, multiply net SE earnings by 2.9% and add $13,243 (106,800*12.4%)

Front 22

How do you calculate Self-Employment Taxes if the person receives both employee wages and self-employment income in the same year?

Back 22

- Total Earnings are subject to FICA taxes
- First determine FICA tax on the employee compensation as if the employee had no SE income
- Then compute SE tax
- Employee wages use up the Social Security wage base limit before determining the Social Security tax on SE income

Front 23

What are independent contractor factors?`

Back 23

- sets own working hours
- works part-time
- works for more than 1 firm
- performs the work outside employer's premises
- uses own tools
- works without frequent oversight

Front 24

What are the two major tax differences between employees and independent contractors?

Back 24

1. Amount of FICA taxes paid- employee pays half, self-employed pays all FICA
2. Deductibility of business expenses- employee puts unreimbursed expenses under misc itemized subject to 2% floor, independent contracts deduct business expenses for AGI AND deduct 1/2 SE taxes for AGI

Front 25

What are nontax differences between employees and independent contractors?

Back 25

Independents don't receive:
- Fringe benefits
- Health Insurance
- Retirement plan benefits
- Workers' compensation
- Unemployment $

Front 26

What are tax credits?

Back 26

- tax credits reduce tax liability dollar for dollar
- tax savings from deductions depend on the taxpayer's marginal tax rate

Front 27

What are the three categories of tax credits?

Back 27

1. Nonrefundable personal
2. Refundable personal
3. Business

Front 28

Nonrefundable Personal Tax Credits (4)

Back 28

1. Child Tax Credit
2. Child and Dependent Care Credit
3. American Opportunity Credit
4. Lifetime learning credit

Front 29

Refundable Personal Tax Credits

Back 29

1. Making work pay credit
2. Earned income credit

Front 30

Nonrefundable- Child Tax Credit

Back 30

$1000 for each qualifying child under age 17 at the end of year who is claimed as a dependent, phase-out based on AGI

Front 31

Nonrefundable- Child and Dependent Care Credit

Back 31

- dependent under age of 13 or disabled dependent
- maximum eligible expenses: $3000 for 1 qualifying person, $6000 for 2 or more qualifying persons
- multiply eligible expenses by credit % based on AGI (there is a chart)

Front 32

Nonrefundable- American Opportunity Credit

Back 32

- for first 4 years of post secondary education (must be enrolled at least half the time)
-for eligible expenses and institutions only: tuition, fees, books and required materials
- applied per student: can be taxpayer, spouse, taxpayer's dependents
- 100% of the first $2000 of eligible expenses and 25% of next $2000 [MAX credit 2500]
-**40% of credit is refundable

Front 33

Nonrefundable- Lifetime Learning credit

Back 33

- applies to cost of tuition and fees for any course to acquire or improve job skills *does not apply to books
- credit=20% of elgible expenses up to an annual maximum of $10,000 of eligible expenses
- maximum credit is $2000
- credit limit applies to the taxpayer, for example, a married couple filing MFJ may claim only $2000
- phase-out for AGI

Front 34

Nonrefundable- Education Credits General Rules to Apply

Back 34

- if a taxpayer qualifies for both AOC and lifetime learning credit, can only claim one credit
- if deduct for AGI educational expenses for a person, no educational credit is allowed for that person
>*a taxpayer may take the American opportunity credit for one dependent and a for AGI deduction for another dependent

Front 35

Refundable- Making Work Pay Credit

Back 35

-Credit is lesser of: (!) 6.2% of earned income or (2) $400 ($800 if MFJ)
-phase out based on AGI
- *dependents are NOT eligible for Make Work Pay Credit

Front 36

Refundable- Earned Income Credit, what is the purpose?

Back 36

-designed to offset the effect of employment taxes on compensation paid to low-income taxpayers and to encourage low-income taxpayers to seek employment
- because it is refundable it is referred to as a "negative income tax"
- the credit is available for qualified individuals who have earned income for the year

Front 37

Refundable- Who is a qualified individual for the Earned Income Credit

Back 37

- any indivdual who as at least 1 qualifying child
- any individual who does not have at least 1 qualifying child but who lives in teh US for more than half the year, is at least 25 years old but younger than 65 and NOT a dependent of another taxpayer
- taxpayers who have investment income more than $3100 are ineligible

Front 38

Refundable- How do you determine the amount of the credit for the Earned Income Credit?

Back 38

Amount of credit depends on filing status, number of qualifying children who live in the home for more than half the year, amount of earned income
* compute credit by multiplying the credit % times the earned income up to a maximum amount
- phase out is based on AGI

Front 39

Business Tax Credits

Back 39

- are nonrfundable credits
- promote certain behaviors
- if credit exceeds tax, carry back 1 year and carryforward 20 years

Front 40

What are the three ways to treat income taxes when taxpayer pays income taxes to foreign countries?

Back 40

1. Exclude foreign earned income from US tax (no deduction or credit can be taken)
2. Include foreign income in gross income and deduct foreign taxes paid as an itemized deduction
- include foreign income in gross income and claim a foreign tax credit

Front 41

What is the order applied to tax credits?

Back 41

1. Nonrefundable Personal
2. Business
3. Refundable Personal

Front 42

Prepayments

Back 42

-Income Tax must be paid on a pay as you go basis: withholdings, estimated tax payments (april 15, june 15, sept 15, and jan 15 of following year)

Front 43

What are the safe-harbor requirement provisions (safe from underpayment penalties)?

Back 43

If tax payments equal or exceed 1 of the following:
a. 90% of current tax liability
b. 100% of previous year tax liability (110% if AGI>$150,000)

Front 44

Underpayment penalties

Back 44

- are applied on a quarterly basis
- 90%/4= 22.5% of current year liability must be paid in by deadline OR
- 100%/4= 25% of previous year's liability must be paid in by deadline
*Penalty based on amount of underpayment at each quarter x federal short term rate +3%

Front 45

Late Filing Penalty

Back 45

- 5% of tax owed for each month (or fraction) that return is late (maximum penalty is 25%)
- if fraudulent, 15% of tax is owed per month up to 75%
- no penalty if no tax is due

Front 46

Late payment penalty

Back 46

- if you don't pay entire tax owned by due date of return, for each month (or fraction) that tax is not paid the penalty equals: 0.5% of the amount due

Front 47

Filing Requirements

Back 47

-taxpayers must file a tax return if their gross income exceeds the standard deduction + personal exemption amount
- due april 15th
- 6 month automatic extension to file BUT this does not extend the due date for paying the tax