Module 28 Individual Tax Computation, Credits, and Alternative Minimum Tax

Menu n n Filing requirements n n Computation of regular tax liability n n Tax credits of individuals n n Estimated tax payments n n Alternative minimum tax

Filing Requirements Key Learning Objectives n Determination of filing status n Who must file a return n Which return should be filed

Filing Status n n Married, joint n n Married, separate n n Head of household n n Single n n Dependent on another's return

Head of Household Rules n n Be relative from “short list” n n Provide > 50% of cost of household n n Relative must u (a) Be a qualifying dependent or u (b) Live in same household n n If child need (b) but not (a) n n If parent need (a) but not (b) n n Other qualifying relative need (a) & (b)

In Class Exercise (1) Determining Filing Status n n The taxpayer (single, 52, with good sight) n n 20-year-old son lives with him n n Son does not pay room and board n n Son is a full-time graduate student and earns $8,000 as a TA n n What information is missing to determine dependency question? n n On facts, what is father’s filing status?

Solution: In Class Exercise (1) Determining Filing Status n n What information is missing to determine dependency question? n n Son is <24 and full time student, so GI not issue n n You need to know if father paid >50% of support u Did Son or anyone else spend money on Son’s support? u If yes, Dad must spend at least $1 more

Solution: In Class Exercise (1) Determining Filing Status (con’t) n n On facts, what is father’s filing status? n n Head of Household u Father pays 100% of cost to run home u Son must live with father u Son need not be dependent, so missing information is not needed

In Class Exercise (2) Determining Filing Status n n Lucy is single, 67 years of age n n She provides more than one-half the support for Ethel, who is Lucy's best friend n n Ethel is 70 years old, single, and lives legally in Lucy's home for the entire year n n Ethel is a citizen of the United States and has income from Social Security of $6,000 n n What is Lucy's total standard deduction and how many exemptions can she claim?

Solution: In Class Exercise (2) Determining Filing Status n n What is Lucy's total standard deduction ? n n Filing status = single n n Ethyl is not a relative so Head of Household is not available n n $ of SD = 4, ,100* = 5,500 u * Increase for age > 65 n n How many exemptions can she claim? n n Two, one for herself and one for Ethyl

Gross Income (GI) Test for Filing n n Must file if GI exceeds n n Sum of personal exemptions only standard deduction (SD), and add on for age only n n If dependent no PE but get add-on for blindness and age

Must File to Pay Self-Employment Taxes n n Need to file even if GI test not met if n n SE (Sch. C) income >$400 n n Remember SE tax rate can be as high as 15.3% of each dollar

Which Form to File n 1040 EZ n 1040A n 1040

Computation of Regular Tax Liability Key Learning Objectives (1) n n Calculating tax using u Tax tables u Tax rate schedules n n Marriage penalty n n Special tax calculation for a child < age 14

Tax rates--Determined by Filing Status n n If taxable income <$100,000 use tables n n Otherwise, use tax rate schedules n n Special rules for dependents under 14 years of age

In Class Exercise Determining Tax Liability-- n n Marge has $102,000 of taxable income n n Marge is not married n n Her 12-year-old daughter lives with Marge's former husband n n He signed Form 8332 releasing exemption, so Marge gets to claim the daughter n n Excerpt from 2000 Tax Table on next slide

Excerpt from 2000 Tax Table

Solution: In Class Exercise Determining Tax Liability n Tax liability = $26,301 n Marge must file as single since child does not live with her, even though she gets the exemption n Information given was taxable income, so no adjustment was needed for deductions from AGI

In Class Exercise Determining Tax Liability n Use the tax rate schedules on previous slide to calculate tax liabilities for the following taxpayers: n Single, TI = 128,228 n Married, joint, TI = 139,100 n Head of Household, TI = 145,104

Solution: In Class Exercise Single, Tax Liability n TI 128,228 n TAX 34,432 n (128, ,550) *

Solution: In Class Exercise Married Joint, Tax Liability n TI 139,100 n TAX 34,242 n (139, ,950) *

Solution: In Class Exercise Head, Tax Liability n TI 145,104 n TAX 37,689 n (145, ,800) *

Taxation if Claimed on Another's Return n n Calculate taxable income n n Determine if subject to “Kiddie Tax” n n Calculate tax liability

If Claimed By Another Calculate Taxable Income n n For all dependent filers calculate taxable income using this rule AGI - SD** = TI n n **SD = standard deduction u Assumes taxpayer does not itemize n n No personal exemption allowed

If Claimed By Another Calculate Taxable Income n n SD will be between $700 & $4,400 (2000) n n SD > $700 is a function of u u earned income u u plus $250 n n SD limited in total to $4,400 plus u u any increases for age or blindness

If Claimed By Another Determine if Kiddie Tax Applies n n <13 years old AND n n Unearned income >$1,400** n n Then must use Kiddie Tax (KT) rules n n * * Twice the dependent SD u $700 in 2000 u If dependent filer itemizes, amount could be different

If Claimed By Another Calculate Tax n n If KT n/a use normal rules n n If KT applies (1) Am't taxed at parent's rates is Unearned - $1,400 (2) Remainder taxed at lowest rates for dependent’s filing status (3) Total tax = sum of 1 & 2

In Class Exercise 1: Dependent Filer Tax Calculation n n Taxpayer is claimed on another's return and has the following income: n n Salary = 3,750 n n Taxable Interest = 5,000 AGI = 8,750 PE = 0 SD (salary + 250) = (4,000) TI = 4,750

Solution In Class Exercise 1: Dependent Filer Tax Calculation n n If filer is >13 the tax = $716 (Table) n n If filer <13 use KT rules Unearned income (5, ,400) = 3,600 Remaining T/I = (4, ,600)= 1,150 TI 4,750 Parents 's MTR = 31% TL = 3,600 x.31 +1,150 (table) 1, = $1,290

In Class Exercise 2: Dependent Filer Tax Calculation n n Taxpayer is claimed on another's return and has the following income: n n Salary = -0- n n Taxable Interest = 9,000 AGI = 9,000 PE = 0 SD = (700) TI = 8,300

In Class Exercise 2: Dependent Filer Tax Calculation n n If filer is >13 the tax = $1,249 (Table) n n If filer <13 use KT rules Unearned income (9, ,400) = 7,600 Remaining TI (8, ,600)= 700 TI 8,300 Parent's MTR is 28% TL = 7,600 x (per table) 2, = 2,235

In Class Exercise 3: Dependent Filer Tax Calculation n n Taxpayer is claimed on another's return and has the following income: n n Salary = 5,000 n n Taxable Interest = 9,000 AGI = 14,000 PE = 0 SD = (4,400) TI = 9,600

In Class Exercise 3: Dependent Filer Tax Calculation n n If filer is >13 the tax = $1,444 (Table) n n If filer <13 use KT rules Unearned income (9, ,400) = 7,600 Remaining TI (9, ,600)= 2,000 TI 9,600 Parent's MTR is 28% TL = 7,600 x ,000 (per table) 2, = 2,430

In Class Exercise 4: Dependent Filer Standard Add-on n n Taxpayer is LEGALLY BLIND, claimed on another's return and has following income: n n Salary = -0- n n Taxable Interest = 9,000 AGI = 9,000 PE = 0 SD = (1,800) * TI = 7,200 *Calculate SD using limits, THEN add bump for age/blindness

In Class Exercise 4: Dependent Filer Tax Calculation n n If filer is >13 the tax = $1,084 (Table) n n If filer <13 use KT rules BUT here taxable income (7,200) is less than unearned (9,000) so all income is taxed at parents’ MTR Parent's MTR is 36% TL = 7,200 x (per table) 2, = 2,592

Computation of Regular Tax Liability Key Learning Objectives (2) n Self employment tax n Domestic service employment tax

Tax Credits of Individuals Key Learning Objectives (1) n n Refundable vs. nonrefundable credits n n Taxes withheld n n Social security tax overpayments n n Earned income credit n n Child and dependent care credit

Tax Credits of Individuals Key Learning Objectives (2) n Mortgage certificate credit n Elderly and disabled person credit n Foreign tax credit

Estimated Tax Payments Key Learning Objectives n n Who must pay n n Regular installment method n n High income installment method n n Annualized installment method

Estimated Tax Payments & Withholding n n All taxpayers must pay "as you go" n n Withholding automatic if W2 income n n All other income u Pay by voucher u Pay quarterly

Due Dates & Extensions n n Individual returns generally due u April 15 n n Must file written request to extend

Penalties & Interest n n File return, even if no money n n Contact IRS for payment schedules n n Ignoring is never good strategy n n Penalties sometimes abated for cause n n Interest only abated if IRS is grossly late

Alternative Minimum Tax of Individuals Key Learning Objectives n Calculation formula n AMT preferences and adjustments n Exemptions n Tax rates n AMT credit n Carryover of credit

AMT Background n Policy reason n History of individual provisions n Compliance burden

AMT Concepts n Parallel tax system u AMT is a separate tax system u Differences will exist between regular taxable income and AMTI n Prepayment system u AMT accelerates income and defers deductions u Minimum tax credit available for future years

Individual AMT Formula AMT Tax Base Taxable income + NOL deduction + NOL deduction + Tax preferences + Tax preferences +/- Adjustments +/- Adjustments Tentative AMTI - AMT NOL (90% limit) - AMT NOL (90% limit)AMTI - Exemption - Exemption AMT Base

Individual AMT Formula AMT Tax Calculation ATM Base x 26 / 28% Tentative minimum tax before FTC Minus AMT FTC (90% limit) Tentative minimum tax Minus regular tax (after FTC) AMT (if positive)

Common Adjustments: Deductions From AGI n Exemptions** u ** Tax form does this by picking up taxable income before exemptions are deducted n Standard deduction OR n Lessor of medical or 2.5% of AGI n 100% of taxes paid u Also delete refund included in income

Common Adjustments: Deductions From AGI (con’t) n Equity interest on home n Difference between regular and AMT investment interest expense n 100% of remaining misc. 2% deductions

In Class Exercise: AMT Adjustments From AGI n What is the AMT adjustment relating to the following deductions from AGI? n Exemptions 5,400 n Taxes 15,000 n Interest on home mortgage u Acquisition 13,000 u Equity 4,560 n Charitable contributions 1,300

Solution: In Class Exercise: AMT Adjustments From AGI n n Add back these deductions from AGI: n n Exemptions 5,400** n n Taxes15,000 n n Interest on home mortgage u Equity u Equity 4,560 n n Total adjustment24,960 u **Amount does not show up on tax form

Common Tax Preferences Business Related Items n Difference between regular and AMT investment interest expense n Depreciation adjustments n Gain/loss adjustments on sale of property n Incentive stock options n Excess percentage depletion/IDC

In Class Exercise: AMT Depreciation Adjustments n John is a CPA with a Schedule C n He bought office furniture for $20,000 in June n He elected to expense $18,500 under §179 n The furniture is 7-year property u 200% for MACRS u 150% for ADS n What is John’s AMT depreciation adjustment?

Solution--In Class Exercise: AMT Depreciation Adjustments Cost20,000 Sec. 179 expense18,500* Depreciable basis 1,500 *allowed for both regular tax and AMT MACRS: 1,500 x.1429 = 214 ADS: 1,500 x.1071 = 161 AMT adjustment (+) 53 AMT adjustment (+) 53

AMT Exemption Base Amount n n Determined by filing status Married, joint 45,000 Married, separate 22,500 / Single/Head of household 33,750

AMT Exemption Phase Out n n Determined by filing status n n Phase out starts when AMTI equals / Married, joint150,000 Married, separate 75,000 Single/Head of household112,500 n n Reduced by 25 of excess

In Class Exercise: Calculating the AMT Exemption n John has AMTI of $190,000 n What is his statutory exemption and AMT base if he files Single? Married, separate?

Solution--In Class Exercise: Calculating the AMT Exemption Exemption filing single: 14,375 14,375 =33, x (190, ,500) AMTI 190,000 Exemption 14,375 AMT Base 175,625 Exemption filing married, separate: = 22, x (190, ,000) AMTI 190,000 Exemption AMT Base 190,000

AMT Tax Rates n n Determined by AMTI amount n n 26% on first 754,000 u 87,500 if married, separate n n 28% on amount over 175,000

In Class Exercise: Calculating the AMT Tax n n Calculate tentative AMT tax before credits for a single taxpayer if AMTI is u 95,000 u 295,000

Solution: In Class Exercise: Calculating the AMT Tax 24,700 AMTI = 95,000 Tax rate 26% AMT tax before credits 24,700 79,100 AMTI = 295,000 Tax rate 26% on 175,000 Tax rate 28% on 120,000 AMT tax before credits 79,100 before credits 79,100 45, ,600 45, ,600

Minimum Tax Credit n AMT paid in one year can offset regular tax in a later year n Carry forward only n Not time limit n Cannot offset AMT n Based on adjusted net minimum tax

Minimum Tax Credit Adjusted Net Minimum Tax n Difference between u AMT actually paid AND u AMT calculated using exclusions F See next slide u Reduced by any credit used in past

Adjusted Net Minimum Tax Exclusions n Itemized deductions or standard n Personal exemptions n The following preference items u Percentage depletion u Tax exempt interest n Exemption phaseout is recalculated

In Class Exercise: Calculating The Minimum Tax Credit (1) n AMT Base AMTI Tentative AMT u 128,750 95,000* 24,700 u Regular tax = 13,000 u AMT liability = 11,700 (24, ,000) n * Single, gets full exemption of 33,750 n Calculate the Minimum Tax Credit IF u AMT base using only exclusions would be 70,000 smaller

Solution: In Class Exercise (1) : Calculating Minimum Tax Credit n Revised AMT base128, ,000 n AMT Base AMTI Tentative AMT u 58,750 25,000* 6,600 u Regular tax = 13,000 u AMT liability = 0 (6,600 < 13,000) n * Single, gets full exemption of 33,750 n Credit = 24,700 u Entire AMT liability for year since there is no exclusion alternative minimum tax

In Class Exercise: Calculating The Minimum Tax Credit (2) n AMT Base AMTI Tentative AMT u 295,000295,000* 79,100 u Regular tax = 50,000 u AMT liability = 29,100 (79,100-50,000) n *Single, gets 0 exemption after phaseout n Calculate the Minimum Tax Credit IF u AMT base using only exclusions would be 80,000 smaller

Solution: In Class Exercise (2) : Calculating Minimum Tax Credit n Revised AMT base295, ,000 n AMT Base AMTI Tentative AMT u 215,000206,875* 54,425** u Regular tax = 50,000 u AMT liability = 4,425 (54,425-50,000) n *Single, gets 8,125 exemption after phaseout 33,750 - (215, ,500) x.25 n **Tentative AMT = 54,425 u 175,000 x ,875 x.28

Solution: In Class Exercise (2) : Calculating Minimum Tax Credit n Minimum Tax Credit = 24,700 u 29, ,425