income tax acct exam 3 ch 8

marriage penalty/benefit

couple incurs a greater (penalty)/lesser (benefit) tax liability from filing jointly over what would’ve been their total tax liability from filing separately

• if 2 wage earners with low/moderate income = no benefit or penalty

marriage penalty

2 wage earners with high income

marriage benefit

1 breadwinner

exceptions to basic tax computation

• preferential tax rates for capital gains/dividends

• kiddie tax

preferential tax rates for capital gains/dividends

1. split taxable income into portions subject to preferential rates vs ordinary rates

2. compute tax separately according to type of income and their respective rates

3. sum tax liabilities from each type of income, = taxpayer’s regular tax liability

tax table

IRS provided tables to specify tax liabilities for individuals with taxable income in a certain range

kiddie tax

parents can shift unearned income to their kids to be taxed at lower rates

• kiddie tax reduces ability to shift ownership of income producing property to child and get the benefit

• tax = child must pay taxes on unearned income at parent’s marginal rate (unless preferential rate is lower)

• tax base = lesser of: gross unearned income - 2700 OR child’s taxable income

kiddie tax is applied if: either

1. child is under 18 years old at year end

2. child is 18 at year end but earned income < ½ of their support

3. child is 18-24 years old, a full time student, and earned income < ½ of their support

kiddie tax doesn’t apply if: either

1. child is over 24

2. child is 19-23 and isn’t a full time student

3. self supporting

4. child files MFJ or neither parent is alive

5. dependency doesn’t matter

alternative minimum tax (AMT)

tax paid in addition to regular tax for high income earners who take advantage of tax preferential items (exclusions, deferrals, deductions)

• adds certain deductions and preference items back to income to get new tax base

  • tax exempt interest from private activity bonds

  • state and local income taxes deducted for regular tax

  • real property taxes

AMT formula

regular taxable income

+ standard deduction and senior deduction (if any)

± other adjustments

= AMT taxable income

- AMT exemption amount (if any)

= Tax base for AMT

* AMT rate

= tentative minimum tax

- regular tax liability

= AMT

AMT exemptions (note sheet)

filing status - exemption - phase out begins - phase out completes

MFJ - 140200 - 1M - 1280400

MFS - 70100 - 500k - 640200

HOH/Single - 90100 - 500k - 680200

(if AMTI is within phase out range, then reduce 50 cents per dollar and reduce the exemption by that amount)

additional taxes

• net investment income tax

• employment FICA taxes

net investment income tax

3.8% tax on net investment income for higher income taxpayers

• imposed on the lesser of: net investment income OR excess of mod. AGI > 250k MFJ/125k MFS/200k others

net investment income

gross income from total taxable passive/investment income

interest, dividends, annuities, royalties, rent, passive income from trade/business, net gain from disposing of property

FICA taxes

taxes on employment - 6.2% social security, 1.45% medicare taxes (.9% additional taxes on salary/wages > 250k MFJ, 125k MFS, 200k others)

• if combined FICA taxes for multiple employers > 184,500 then a refund is due for employees only

employee/employer portion of FICA

• employee - tax due from employee is withheld by employer on paycheck

• employer - pays tax based on employee compensation

self employment FICA

• responsible for entire FICA tax

• tax base = schedule c net profit * (1-.0765) (deductible by employer portion)

• multiply tax base by 15.30% (7.65+7.65) = FICA taxes

• cap is 184,500 for social security

• limit: if net earnings from self employment < 400 = no tax

employee vs independent contractor

who has control over how, when, where work is performed?

• tax difference → amount of FICA/self employment taxes payable + deductibility of expenses

tax credits

reduces tax liability dollar for dollar - generates tax savings independent of marginal tax rates

3 categories of tax credits

• nonrefundable personal credits

• refundable personal credits

• business credits

nonrefundable personal credits

• can bring gross tax liability to zero - if credits > tax liability then it’s not refunded rather expires or carried forward

• child tax credit

• child and dependent care credit

• american opportunity tax credit (AOTC)

• lifetime learning credit

child tax credit

• 2200 for each qualifying child under 17 who is claimed as dependent

• 500 for qualifying dependents

• up to 1700 is refundable per child / 0 refundable per dependent

• phases out $50 per every $1000 exceeding 400k MFJ/200k others

child and dependent care credit

• help pay cost of providing care for dependents to allow taxpayers to work/look for work

• qualifying person = dependent under 13 years old and lived with for ½ year OR disabled spouse/dependent and lived with ½ year

  • doesn’t qualify if caregiver is a dependent relative or child of taxpayer

• maximum $3000 credit for 1 qualifying person, $6000 for 2+, credit rate 20-50% depending on AGI

  • multiply credit rate by expense (3000/6000 max) to get credits

american opportunity tax credit (AOTC)

• offsets cost of higher education after high school for qualifying students

• max of 2500/year - 100% of first 2000 and 25% of next 2000

• only for eligible expenses (tuition, fees, books, supplies, equipment) and institutions

• applied per student

• phase out - AGI < 80k (160k MFJ) full credit allowed, >90k then completely phased out

• 40% of credit is refundable

lifetime learning credit

• eligible expenses (tuition) for any schooling to improve job skills (professional/graduate school, continuing education)

• per tax return, so if MFJ then it’s only eligible for 1

• 2000 limit per return

• phase out same as AOTC - AGI < 80k (160k MFJ) full credit allowed, >90k then completely phased out

refundable personal credits

• cash refund

• earned income credit

• portion of child tax credits (1700 max per child)

• portion of AOTC (40% of credit is refundable)

• excess FICA withholdings, taxes withheld on wages/tax payments

earned income credit

• offsets effect of employment taxes on compensation to low income taxpayers, incentive to work

• refund for excess of credit > tax after nonrefundable credits

• qualified individuals -

  • 1. have at least one qualifying child

  • no child but lives in US for more than 6 months, 25-65 years old, not dependent of another

• ineligible if investment income > 12200

business tax credits

• incentivizes hiring certain types of individuals/participate in certain activities

• nonrefundable

• if credits > gross tax - is carried back 1 year and carried forward for up to 20 years

foreign tax credit

• reduces double tax on foreign earned income

• nonrefundable, carry back 1 year and carry forward 10 years

order of applied credits

1. nonrefundable personal credits applied first - excess is lost

2. business credits applied second - excess carried back/forward

3. refundable personal credits applied third - excess is refunded

tax prepayments

income tax is paid as you go, prepaid via withholdings from salary and periodic estimated tax payments during the year

tax payment due dates

april 15, june 15, september 15, jan 15 of next year

underpayment penalties

unpredictable income streams are penalized because they’re hard to know accurate tax liability

• safe harbor provisions

safe harbor provisions

• avoid underpayment penalties if withholdings and prepayments >=

  • 90% of current tax liability OR

  • 100% of previous year tax liability (110% for AGI > 150k)

• applied on a quarterly basis-

  • must pay 22.5% by april, 45% by june, 67.5% by september, 90% by january

  • 100/4 = 25% incremental

• penalty on amount of underpayment by quarter * federal short term interest rate + 3%

filing requirements

only required if gross income > certain thresholds (vary on filing status and age)

• april 15 due date, extend 6 months to october for filing

late filing penalty

5% of amount of tax owed for each month that the return is late

• 25% maximum = 5 months

• fraudulent failure to file = 15% of tax of each month, max 75%

late payment penalty

.5% of tax owed each month late

• max is 25% = 50 months

application of both late filing and payment penalty

the filing 5% penalty decreased by .5% paying penalty amounts