Special Tax Computation Methods, Tax Credits, and Payment of Tax Chapter 14 Special Tax Computation Methods, Tax Credits, and Payment of Tax 1

Learning Objectives Calculate the Alternative Minimum Tax Describe what constitutes self-employment income and compute the self-employment tax Describe the various business and personal tax credits Understand the mechanics of the federal withholding tax system and the requirements for making estimated payments 2

Alternative Minimum Tax COMPUTATIONAL ASPECTS TAXABLE INCOME PLUS+: TAX PREFERENCE ITEMS PLUS+: PERSONAL AND DEPENDENCY EXEMPTION PLUS+ OR MINUS: ADJUSTMENTS REQUIRED EQUALS =: ALTERNATIVE MINIMUM TAXABLE INCOME MINUS: EXEMPTION AMOUNT ($45,000 MFJ & SS, $33,750 single, & $22,500 MFS) EQUALS =: ALTERNATIVE TAX BASE TIMES x: TAX RATE (26% of first $175,000; 28% amounts in excess of $175,000) EQUALS =: TENTATIVE MINIMUM TAX MINUS: REGULAR TAX EQUALS =: THE ALTERNATIVE MINIMUM TAX 3

Alternative Minimum Tax Tax preference items Include excess depreciation over S\L depreciation Tax-exempt interest on certain activity bonds Exclusion of gain on the sale of certain small business stock under Sec. 1202 4

Alternative Minimum Tax AMT adjustments For most taxpayer AMTI adjustments represent itemized deductions that are not allowed in computing AMTI Only certain itemized deductions allowed for AMT purposes Casualty and theft loss in excess of 10% of AGI Charitable contributions Medical expenses in excess of 10% of AGI Qualified housing interest 5

Alternative Minimum Tax AMT adjustments due to timing differences For real property placed in service after 1986, difference between MACRS and ADS 6

Alternative Minimum Tax AMT adjustments due to timing differences For personal property placed in service after 1986, difference between MACRS deduction and the amount determined by using 150% DB method 7

Self-employment Tax Distinction between independent contractor and an employee is important Self-employed individuals are subject to self-employment tax on the amount of net earnings from the self-employment Employees who have a small business in addition to regular employment may also be subject to the self-employment tax 8

Self-employment Tax Computing the tax Individuals having net earnings from self-employment of $400 or more are subject to the self-employment tax The self-employment tax is 15.3%. This consist of 12.4% for OASDI and 2.9% for Medicare. The limit for 2004 on OASDI is $87,900 and there is no limit on the Medicare portion of the self-employment tax 9

Self-employment Tax Computing amount subject to the self-employment tax To compute the amount that is subject to self-employment tax. Multiply self-employment income by 92.35% (100%-7.65%) this equals the net earnings from self-employment 10

Self-employment Tax One-half of self-employment tax imposed is allowed as a for AGI deduction 11

Self-employment Tax What constitutes self-employment Net earnings from a sole proprietorship Director’s fees Taxable research grant Distributive share of partnership income plus guaranteed payments The self-employment tax is computed on Schedule SE 12

Overview Of Tax Credits Use and importance of tax credits Tax credits may be used to implement tax policy objectives Example: provide tax relief for low income taxpayer - earned income credit 13

Overview Of Tax Credits Value of credit versus a deduction The value of a deduction is dependent on taxpayer’s marginal rate A tax credit reduces tax liability dollar for dollar 14

Overview Of Credits Classification of credits Refundable Nonrefundable 15

Overview Of Tax Credits Non-refundable Personal tax credits Child tax credit Child and dependent care credit Tax credit for the elderly & disabled Adoption credit Hope scholarship credit Lifetime learning credit Qualified Retirement Savings Contribution Credit 16

Overview Of Tax Credits Non-refundable Miscellaneous credits Foreign tax credit General business credits Credit for increasing research Work opportunity credit Empowerment zone employment Disabled access credit Rehabilitation expenditures Business energy credit Welfare to Work 17

Refundable Credits Earned Income Credit Eligibility rules: Earned income and AGI thresholds met Principal place of abode in the US for more than ½ of the tax year. The individual is at least 25 years old and not more than 64 at the end of the year. The individual is not a dependent of another taxpayer for the tax year

Payment Of Taxes Withholding of taxes Employers are required to withhold federal income taxes and FICA tax from employee compensation Special rules are provided for more than one employer during the same year Exemptions for certain employment activities such as ministers and domestic servants 18

Payment Of Taxes Withholding allowances and methods Every employee must file an Employee’s Withholding Allowance Certificate (Form W-4) 19

Payments Of Taxes Estimated tax payments Calendar year taxpayers quarterly payments are due April 15, June 15, Sept 15 of the current year, and January 15 of the following year 20

Tax Planning Considerations Avoiding the Alternative Minimum Tax Avoiding the underpayment penalty for estimated tax Cash-flow considerations Use of credits 21

Compliance And Procedural Considerations Alternative minimum tax filing procedures Form 6251 or 4626 Withholding and estimated payments Form W-2 and 1040ES General Business Credit Form 3800 Personal tax credits Form 2441 Schedule R Schedule EIC Form 1116 Form 8863 22