© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Individual Income Taxes
1
Chapter 13
Tax Credits and Payment Procedures
2
The Big Picture
• Tom and Jennifer Snyder have two dependent children in college. – Lora is a freshman
• Her tuition and required fees in 2012 total $14,000. • She has a scholarship amounting to $6,500, and the Snyders paid the
balance of her tuition ($7,500), plus room and board of $8,500. – Sam is a junior, and the Snyders paid $8,100 for his tuition plus $7,200
for his room and board. • The Snyders have AGI of $158,000. • They would like to know what tax options are available to
them related to these educational expenses. – They have heard about education tax credits, but they believe that their
income is too high for them to get any benefit. – Are they correct?
• Read the chapter and formulate your response.
3
Tax Credit VS. Tax Deduction
• Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer– Tax benefit received from a tax credit is not affected by the
taxpayer’s marginal tax rate
• Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates
MTR 0% 15% 35%
Tax benefit if a 25% credit is allowed $250 $250 $250
Tax benefit if tax deduction is allowed –0– $150 $350
4
Refundable vs Nonrefundable Credits (slide 1 of 2)
• Refundable credits– Paid even if the tax liability is less than amount of
credit
5
Refundable vs Nonrefundable Credits (slide 2 of 2)
• Nonrefundable credits– Credit can only be used to offset tax liability– If credit exceeds tax liability, excess is lost
• Exception: some nonrefundable credits have carryover provisions for excess
6
General Business Credit (slide 1 of 2)
• Comprised of a number of business credits combined into one amount
• Limited to net income tax reduced by greater of:– Tentative minimum tax– 25% of net regular tax liability that exceeds
$25,000
• Unused credit is carried back 1 year, then forward 20 years
7
General Business Credit (slide 2 of 2)
• Includes the following:– Tax credit for rehabilitation expenditures– Work opportunity tax credit– Research activities credit– Low-income housing credit– Disabled access credit– Credit for small employer pension plan startup
costs– Credit for employer-provided child care
8
Rehabilitation Expenditure Credit (slide 1 of 3)
• Credit is a percentage of expenditures made to substantially rehabilitate industrial and commercial buildings and certified historic structures
• Credit rate– 20% for nonresidential and residential certified
historic structures– 10% for other structures originally placed into
service before 1936
9
Rehabilitation Expenditure Credit (slide 2 of 3)
• To qualify for credit, building must be substantially rehabilitated meaning qualified rehab expenditures exceed the greater of:– The adjusted basis of the property before the rehab
expenditures, or– $5,000
• Qualified rehab expenditures do not include the cost of the building and related facilities or cost of enlarging existing building
10
Rehabilitation Expenditure Credit (slide 3 of 3)
• Basis in structure is reduced by the credit amount
• Subject to recapture if rehabilitated property held less than 5 years or ceases to be qualifying property
11
Work Opportunity Tax Credit(slide 1 of 2)
• Applies to first 12 months of wages paid to individuals falling within target groups – Credit limited to a percentage of first $6,000
wages paid per eligible employee• 40% if employee has completed at least 400 hours of
service to employer
• 25% if at least 120 hours of service
– Deduction for wages is reduced by credit amount
12
Work Opportunity Tax Credit(slide 2 of 2)
• Targeted individuals generally subject to high rates of unemployment, including– Qualified ex-felons, high-risk youths, food stamp
recipients, veterans, summer youth employees, and long-term family assistance recipients
• Summer youth employees: Only first $3,000 of wages paid for work during 90-day period between May 1 and September 15 qualify for credit
13
Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 1 of 2)
• Applies to first 24 months of wages paid to individuals who have been long-term recipients of family assistance welfare benefits– Long-term is at least an 18 month period ending on
hiring date
14
Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 2 of 2)
• Maximum credit is a percentage of first $10,000 qualified wages paid in first and second year of employment– 40% in first year– 50% in second year
• Maximum credit per qualified employee is $9,000– Deduction for wages is reduced by credit amount
15
Research Activities Credit (slide 1 of 5)
• Comprised of three parts– Incremental research activities credit– Basic research credit– Energy research credit
16
Research Activities Credit (slide 2 of 5)
• Incremental research activities credit– Credit amount = 20% × (qualified expenditures – base
amount)
• Expenditures qualify if research relates to discovery of technological info intended for use in developing a new or improved business component for taxpayer– Expenditures qualify fully if research done in-house
– Only 65% qualifies if research conducted by outside party (under contract)
17
Research Activities Credit (slide 3 of 5)
• Tax treatment of R&E expenditures– Full credit and reduce expense deduction by credit
amount– Full expense deduction and reduce credit by
(100% × credit × max. corp. tax rate)– Full credit and capitalize research expenses and
amortize over 60 months or more• Amount capitalized is reduced by full amount of credit
only if the credit exceeds the amount allowable as a deduction
18
Research Activities Credit (slide 4 of 5)
• Basic research credit– Additional 20% credit is allowed on basic research
payments in excess of a base amount• Basic research payments - amounts paid in cash to a qualified basic
research organization, such as a college or university or a tax-exempt organization operated primarily to conduct scientific research
– Basic research is any original investigation for the advancement of scientific knowledge not having a specific commercial objective
• The definition excludes basic research conducted outside the United States and basic research in the social sciences, arts, or humanities
19
Research Activities Credit (slide 5 of 5)
• Energy Research Credit –– This credit is intended to stimulate additional
energy research– Credit amount = 20% of amounts paid or incurred
by a taxpayer to an energy research consortium for energy research
20
Low-income Housing Credit
• Credit is issued on a nationwide allocation program
• Credit amount– Based on qualified basis of the property which is
dependent on the number of units rented to low-income tenants
– Credit is allowed over a 10-year period– Subject to potential recapture
21
Disabled Access Credit
• Credit available for eligible access expenditures made by small businesses– Includes amounts paid to remove barriers that would
otherwise make a business inaccessible to disabled and handicapped individuals
– Facility qualifies if placed in service before November 6, 1990
• Credit amount– 50% × expenditures that exceed $250 but not in excess
of $10,250• Thus, max. credit is $5,000
– Basis in asset is reduced by credit amount
22
Credit For Pension Plan Startup Costs
• Small businesses can claim nonrefundable tax credit for admin costs of establishing and maintaining a qualified retirement plan– Small business has < 100 employees who have earned at
least $5,000 of compensation
• Credit amount = 50% of qualified startup costs limited to max credit of $500 per year for 3 years– Deduction for startup costs is reduced by amount of credit
23
Credit For Employer-Provided Child Care (slide 1 of 2)
• Employers can claim a credit for providing child care facilities to their employees during normal working hours– Limited to $150,000 per year
• Credit amount:– 25% of qualified child care expenses– 10% of qualified child care resource and referral
services
24
Credit For Employer-Provided Child Care (slide 2 of 2)
• Deductible qualifying expenses must be reduced by the credit amount
• Basis of qualifying property must be reduced by credit amount
• Credit may be subject to recapture if child care facility ceases to be used for qualifying purpose within 10 years of being placed in service
25
Earned Income Credit (slide 1 of 3)
• General qualifications for credit– Must have earned income from being an employee
or self-employed – For 2009 and 2010, ARRTA of 2009 increases
• Credit percentage for families with three or more children, and
• Phaseout threshold amounts for married taxpayers filing joint returns
– The Tax Relief Act of 2010 extends this treatment through 2012
26
Earned Income Credit (slide 2 of 3)
• Credit amount (2012 tax year)– Applicable percentage rate × earned income
• Rate and maximum amount of earned income determined by number of qualifying children
• Phase-out of credit begins when earned income (or AGI) exceeds $22,300 for MFJ with qualifying child ($17,090 for other taxpayers)
• Use IRS tables to calculate exact credit amount
27
Earned Income Credit (slide 3 of 3)
• Credit for taxpayers having no children– Available to taxpayers aged 25 through 64
• Credit amount for couple filing jointly with no qualifying children (2012 tax year)– 7.65% × earned income (up to $6,210)– Phase-out of credit begins when earned income (or
AGI) exceeds $12,980 for MFJ ($7,770 for others)
28
Credit for Elderly or Disabled Taxpayers (slide 1 of 2)
• General qualifications– Age 65 or older, or– Under age 65 and permanently and totally disabled
29
Credit for Elderly or Disabled Taxpayers (slide 2 of 2)
• Credit amount– Maximum credit = $1,125
• Amount reduced for taxpayers with Social Security benefits or AGI in excess of specified amounts
– IRS will calculate credit for taxpayer if necessary
30
Foreign Tax Credit(slide 1 of 2)
• The purpose of the foreign tax credit (FTC) is to mitigate double taxation since income earned in a foreign country is subject to both U.S. and foreign taxes– Credit applies to both individuals and corporations
that pay foreign income taxes– Instead of claiming a credit, a deduction may be
claimed for the taxes paid
31
Foreign Tax Credit(slide 2 of 2)
• Amount of the credit allowed is the lesser of:– The foreign taxes imposed, or– The overall limitation determined using the following formula:
Foreign-source TI × U.S. tax before credit
Worldwide TI = Overall FTC limitation
• For individual taxpayers, worldwide taxable income is determined before personal and dependency exemptions
• Unused FTCs can be carried back 1 year and forward 10 years
32
Adoption Expenses Credit (slide 1 of 2)
• Credit for qualified adoption expenses incurred in adoption of eligible child– Examples of expenses: adoption fees, court costs,
attorney fees
• Maximum credit is $12,650 (in 2012) – Credit is phased-out ratably for modified AGI
between $189,710 and $229,710
33
Adoption Expenses Credit (slide 2 of 2)
• Eligible child is one that is – Less than 18 years of age, or– Physically or mentally incapable of taking care of
himself or herself
• Nonrefundable credit– Excess may be carried forward for five years
• Married taxpayers must file jointly to claim
34
Child Tax Credit (slide 1 of 2)
• Credit amount is $1,000 per child
• Eligible children are:– Under age 17,– US citizen, and– Claimed as dependent on taxpayer’s tax return
35
Child Tax Credit (slide 2 of 2)
• Credit is phased out by $50 for each $1,000 (or part thereof) of AGI above specified levels– $110,000 for joint filers– $55,000 for married filing separately– $75,000 for single
36
Child and Dependent Care Credit (slide 1 of 4)
• General qualifications for credit– Must have employment related care costs for a
• Dependent under age 13, or
• Dependent or spouse who is physically or mentally incapacitated and who lives with the taxpayer for more than one-half of the year
37
Child and Dependent Care Credit (slide 2 of 4)
• Credit amount– Eligible care costs × applicable percentage– Applicable percentage ranges from 20% to 35%
depending on AGI
• Married taxpayers must file a joint return to obtain credit
38
Child and Dependent Care Credit (slide 3 of 4)
• Eligible care costs defined– Costs for care of qualified individual within
taxpayer’s home or outside home• If outside home, physically or mentally incapacitated
dependent or spouse must spend at least 8 hours a day within taxpayer’s home
– Amount of costs that qualify is the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individuals
39
Child and Dependent Care Credit (slide 4 of 4)
• Earned income limitation– Amount of eligible care costs cannot exceed lower
of taxpayer’s or spouse’s earned income– Full-time student or disabled taxpayer or spouse
are deemed to have earned income up to maximum per month limits
40
Education Tax Credits(slide 1 of 5)
• 2 education tax credits are available– American Opportunity credit (previously known as the
Hope scholarship credit)
– Lifetime learning credit
• Both credits are available for qualifying tuition and related expenses– Books and other course materials are eligible for the
American Opportunity credit (but not the lifetime learning credit)
– Room and board are ineligible for both credits
41
Education Tax Credits(slide 2 of 5)
• Maximum credits– American Opportunity credit maximum per
eligible student is $2,500 per year for first 4 years of postsecondary education
• 100% of the first $2,000 of tuition expenses plus 25% of the next $2,000 of tuition expenses
– Lifetime learning credit maximum per taxpayer is 20% of qualifying expenses (up to $10,000 per year in 2012)
• Cannot be claimed in same year the American Opportunity credit is claimed
42
Education Tax Credits(slide 3 of 5)
• Eligible individuals include taxpayer, spouse, and taxpayer’s dependents
• To be eligible for American Opportunity credit, student must take at least 1/2 of full-time course load– No such requirement for lifetime learning credit
43
Education Tax Credits(slide 4 of 5)
• Both education credits are subject to income limitations, which differ for 2009 through 2012– In addition, 40% of the American Opportunity credit is
refundable and the entire credit allowed may be used to offset a taxpayer’s AMT liability
• The lifetime learning credit is neither refundable nor an AMT liability offset
• The American Opportunity credit is phased out, beginning when the taxpayer’s modified AGI reaches $80,000 ($160,000 for MFJ)– The credit is completely eliminated when modified AGI
reaches $90,000 ($180,000 for MFJ)
44
Education Tax Credits(slide 5 of 5)
• The lifetime learning credit amount is phased out when modified AGI reaches $52,000 ($104,000 for MFJ)– The credit is completely eliminated when AGI reaches
$62,000($124,000 for MFJ)
• Taxpayers are prohibited from receiving a double tax benefit associated with qualifying educational expenses– Can’t claim education credit and deduct the same expenses– Can’t claim the credit for amounts that are excluded from income
• e.g., scholarships, employer-paid educational assistance
– May claim an education tax credit and exclude from gross income amounts distributed from a Coverdell Education Savings Account as long as the distribution is not used for the same expenses for which the credit is claimed
45
The Big Picture - Example 32
American Opportunity Credit• Return to the facts of The Big Picture on p. 13-1. • Recall that Tom and Jennifer Snyder are married, file a joint
tax return, have modified AGI of $158,000.– Both Lora (a freshman) and Sam (a junior) are full-time students and
are Tom and Jennifer’s dependents.• The Snyders paid the following education expenses.
– $7,500 of tuition and $8,500 for room and board for Lora, and – $8,100 of tuition plus $7,200 for room and board for Sam.
• Lora’s and Sam’s tuition are qualified expenses for the American Opportunity credit. – For 2012, Tom and Jennifer may claim a $2,500 American Opportunity
credit [(100% $2,000) + (25% $2,000)] for both Lora’s and Sam’s expenses.
– In total, a $5,000 American Opportunity credit.
46
The Big Picture - Example 33 American Opportunity Credit Phaseout
• Return to the facts of The Big Picture on p. 13-1.
• Now assume that Tom and Jennifer’s modified AGI for 2012 is $172,000 instead of $158,000.
• Tom and Jennifer are eligible to claim a $2,000 American Opportunity credit for 2012. – Their $5,000 available American Opportunity credit must be reduced
because their AGI exceeds the $160,000 limit for married taxpayers. – The percentage reduction is computed as the amount by which
modified AGI exceeds the limit, expressed as a percentage of the phaseout range, or
– ($172,000 - $160,000)/$20,000) = 60% reduction.– Therefore, the maximum available credit for 2012 is $2,000.
• $5,000 X 40% allowable portion.
47
The Big Picture - Example 34
Lifetime Learning Credit• Return to the facts of The Big Picture on p. 13-1. • Assume that Tom and Jennifer’s modified AGI is $118,000 and that Tom is
going to school part-time to complete a graduate degree – He pays qualifying tuition and fees of $4,000 during 2012.
• As Tom and Jennifer’s modified AGI is below $160,000, a $5,000 American Opportunity credit is available to them for Lora and Sam’s tuition .
• In addition, Tom’s qualifying expenses are eligible for the lifetime learning credit. – The available lifetime learning credit of $800($4,000 X 20%) must be reduced
because their modified AGI exceeds the $104,000 limit for married taxpayers.– As their modified AGI exceeds the $104,000 limit by $14,000 and the phaseout
range is $20,000, their lifetime learning credit is reduced by 70%.– Therefore, their lifetime learning credit for 2012 is $240 ($800 X 30%)
• Their total education credits amount to $5,240 – $5,000 American Opportunity credit and $240 lifetime learning credit.
48
Credit For Certain Retirement Plan Contributions
• Credit was enacted to encourage low and middle income taxpayers to contribute to qualified retirement plans
• Eligible contributions of up to $2,000 qualify• Credit rate depends on level of AGI and filing status
– Maximum credit is $1,000 ($2,000 × 50%)
• To qualify, must be at least 18 years old and not a dependent of another taxpayer or a full-time student
49
Small Employer Health Insurance Credit
• Health Care Act of 2010 provides a tax credit for a qualified small employer for nonelective contributions to purchase health insurance for its employees beginning in 2010– To qualify for credit, employer must
• Have no more than 25 full-time equivalent employees whose annual full-time wages average no more than $50,000
• Pay at least half the cost of the health insurance premiums– The credit is 35% of the health insurance premiums paid in
2010 through 2013 • 50% in years after 2013• It is subject to a phaseout if the employer has more than 10 full-
time equivalent employees and/or has annual full-time wages that average more than $25,000
50
Payment Procedures(slide 1 of 8)
• Employer is responsible for withholding income taxes and employees’ share of FICA employment taxes (Social Security and Medicare)
• Also, employer must match FICA and pay full cost of FUTA (unemployment taxes)
51
Payment Procedures(slide 2 of 8)
• Social Security & Medicare– 2012 rates
• Social Security: 4.2% of first $110,100 wages– Legislation reduced the employee’s (but not the employer’s) Social
Security tax rate from 6.2% to 4.2% for 2011 and 2012
• Medicare: 1.45% of all wages
– If employee is overwithheld for Social Security, excess is refundable credit
52
Payment Procedures(slide 3 of 8)
• Federal withholding– Employee files Form W-4 with employer
indicating marital status and withholding allowances
– Form W-2 issued by employer summarizes employee’s wages, income tax withholding, and FICA
• Must be issued to employee by January 31 following year-end
53
Payment Procedures(slide 4 of 8)
• Estimated payments (ES payments)– Any taxpayer (employee or self-employed) who
will owe at least $1,000 in taxes for the year (and meets none of the exceptions) must make ES payments
54
Payment Procedures(slide 5 of 8)
• ES payments– To avoid penalties for underpayment, must
annually pay the smaller of:• 90% of the current year’s tax, or
• 100% of last year’s tax– Exception: Increased to 110% of last year’s tax if AGI last
year exceeded $150,000 ($75,000 if married filing separately)
55
Payment Procedures(slide 6 of 8)
• ES payments– For calendar year individual taxpayer, ES
payments of 1/4 of annual amount are due• April 15, June 15, and September 15 of the tax year, and
January 15 of the following year
56
Payment Procedures(slide 7 of 8)
• Self-employment tax– Taxpayers with net self-employment earnings of at
least $400 must pay self-employment tax• 2012 rates
– Social Security: 10.4% of first $110,100 net self-employment income
» Normally the rate is 12.4%– Medicare: 2.9% of all net self-employment income
• These rates are twice what an employee pays on wages
57
Payment Procedures(slide 8 of 8)
• Self-employment tax– Taxpayer receives a deduction from net self-employment
income of 7.65% for purposes of calculating the actual self-employment tax
– Normally, the taxpayer receives a for AGI deduction for 50% of the self-employment tax paid
• Due to the 2% Social Security rate reduction in 2012, the income tax deduction is computed at the rate of 59.6% of the Social Security tax paid plus one-half of the Medicare tax paid
58
Additional Medicare Taxes on High-Income Individuals
• The Health Care Act of 2010 and the Health Care Reconciliation Act of 2010 include 2 provisions that increase Medicare taxes for high-income individuals beginning in 2013:– An additional .9% tax on wages received in excess
of specified amounts, and – An additional 3.8% tax on unearned income
59
Additional Tax on Wages
• For tax years beginning after 12/31/2012 an additional .9% Medicare tax will be imposed on wages received in excess of – $250,000 for married taxpayers filing jointly,– $125,000 for married filing separately, and– $200,000 for all other taxpayers
• The additional tax on a joint return is on the combined wages of the employee and the employee’s spouse
• Also applies to self-employed individuals– Net earnings from self-employment is used for the
threshold computations
60
Additional Tax on Unearned Income (slide 1 of 2)
• For tax years beginning after 12/31/2012 an additional 3.8% Medicare tax is imposed on the unearned income of individuals, estates, and trusts– For individuals, the tax is 3.8% of the lesser of:
• Net investment income, or
• The excess of modified adjusted gross income (MAGI) over – $250,000 for married taxpayers filing a joint return
– $125,000 if married filing separately, and
– $200,000 for all other taxpayers
• This is in addition to the additional .9% Medicare tax on wages or self-employment income.
61
Additional Tax on Unearned Income (slide 2 of 2)
• In general, net investment income includes interest, dividends, annuities, royalties, rents, and net gains from the sale of investment property less related deductions
• MAGI = AGI + any foreign earned income exclusion– Thus, for individuals who don’t have any excluded
foreign earned income, MAGI is the same as AGI
62
Refocus On The Big Picture (slide 1 of 2)
• Recent tax legislation made significant changes in education tax credits.
• The American Opportunity tax credit provides some relief for Tom and Jennifer Snyder.– Both Lora and Sam qualify for a $2,500 American Opportunity credit
in 2012. • 100% of the first $2,000 and 25% of the next $2,000 of qualified expenses.
• These credits are phased out for married taxpayers’ as AGI exceeds $160,000. – Since the Snyders’ AGI is only $158,000, the total education credits
available to them on their 2012 income tax return is $5,000.– Further, this credit may be used to offset any AMT liability.– 40% ($2,000) is refundable to the Snyders.
63
Refocus On The Big Picture (slide 2 of 2)
• What If?• What if the Snyders’ AGI is $188,000?
– In 2012, the Snyders would not qualify for any education credits
• Their income exceeds the limits for both the American Opportunity and the lifetime learning credits.
– A deduction for AGI is allowed for qualified tuition and related expenses involving higher education.
• However, their AGI exceeds the $160,000 maximum allowed for a deduction (see Chapter 9 for additional details).
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 64
If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:
Dr. Donald R. Trippeer, CPA [email protected]
SUNY Oneonta
