1. Income Tax Fundamentals 2009 Gerald E. Whittenburg Martha Altus-Buller Student’s Copy

2. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  A credit is a direct reduction in tax liability Credits are used to target certain groups for tax benefit Provide equal benefit to all taxpayers  A deduction is a reduction of taxable income Reduces tax liability in the amount of [deduction x tax rate] Provides more benefit to higher income taxpayers

3. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Illustration of difference between a $1,500 deduction and a $1,500 credit Deduction Credit TI (before)$ 70,000$ 70,000 Deduction (1,500) -0- TI$ 68,500$ 70,000 Tax Liability$ 13,469$ 13,844 Credit -0- (1,500) Tax due$ 13,469$ 12,344 *This is assuming a single taxpayer in the 25% tax bracket – using 2008 tax tables

4. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Provides tax relief through a credit to taxpayers with children Credit for each child under age 17 claimed as a dependent and meeting definition of “qualifying child”  Credit is $1000 per child Credit begins phasing out when  AGI >= $110,000 (MFJ)  AGI >= $ 75,000 (HH, S)  AGI >= $ 55,000 (MFS) For 3 or more kids complex credit calculation applies: see www.irs.gov Phased out $50 for each $1000 [or part thereof] that AGI exceeds threshold

5. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Refundable credit Serves as “negative” income tax Can get refund equal to the amount of the credit  Taxpayer may get EIC even if no kids Taxpayer must be between ages 25 and 65 and not someone else’s dependent “Disqualified income” [certain type of investment income] must be les than $2900  With kids, EIC available if Child meets definition of “qualifying child” Single or married taxpayers [MFJ only] Earned income meets certain guidelines

6. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Gives tax relief to working parents who must provide childcare for dependents Dependent must be under age 13 or Spouse or dependent who cannot care for themselves  If child’s parents are divorced, child need not be dependent of taxpayer claiming credit if lives more than 50% of year with that parent  Multiply qualifying care costs (see next screen) by a percentage that decreases as AGI increases From 35% down to 20% based on AGI Table on p. 6-4

7. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Determine qualifying expenses In-home and out-of-home care Day camps qualify, but not overnight camps  If camp is focused on fun/games, not education  Limited to the lesser of Earned income of lowest earning spouse or $3000 (1 dependent) or $6000 (2+ dependents)  If spouse is fulltime student, count him/her as earning $250/month (1 dependent) or $500/month (2+ dependents)  Must reduce by any amount reimbursed by employer

8. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Provides tax relief for qualified higher education expenses Tuition and fees only  Available for each eligible student in first 2 years of college Eligible students are taxpayer, spouse or eligible dependent Student must be at least 1/2 time for one term during tax year Student must not have felony conviction for possessing or distributing a controlled substance  Credit = 100% of first $1,200 + (50% of the next $1,200) Maximum credit = $1,800 Phased out when AGI > certain levels [see p. 6-6]

9. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Provides tax relief for education expenses; meant to encourage taxpayers to take courses to acquire or improve job skills Tuition and fees only LLC can be used for less than ½ time students  Credit = 20% of first $10,000 Maximum credit = $2,000 per year Subject to same phase outs as HOPE Credit Not limited to first two years - u ndergraduate, graduate or professional courses qualify No limit on number of years you may claim LLC

10. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  US taxpayers are allowed foreign tax credit on income earned in foreign country and subject to income taxes in that country Mostly seen on dividends on foreign stock investments  Provides relief from double taxation on money generated from foreign sources Credit is up to amount paid foreign governments But limited to maximum credit = Net foreign income x US tax liability Total US taxable income before credit Total US taxable income before credit

11. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  IRS provides a credit as relief to taxpayers who pay adoption expenses  Credit is amount spent up to $11,650 per adoption [not an annual amount] Adoption credit phases out when AGI > $174,730 Different rules  If pay expenses over more than one year or  If foreign adoption or special needs child  Qualified adoption expenses include court costs, legal fees, travel, etc.  Unused credits can be carried over for up to five years

12. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Credit for hybrid vehicle purchase Different credit per vehicle based on weight class/fuel economy Credit only applies to first 60,000 sold by manufacturer  Go to irs.gov to get detailed information on available hybrid credits  As of 10/1/07, credits no longer available for Prius  Credit for energy saving improvements to principal residence Lifetime credit up to $500 for energy-efficient expenditures in home  Varying amounts allowed for different qualifying improvements  Credit for alternative energy expenditures 2006-2008: may be claimed on principal and second residence Up to $2000 credit/year for 30% of amount paid for qualified solar water heaters and photovoltaic property 30% credit for fuel cell property – max credit of $500 for each.5 kilowatt of capacity, with no cap on total credit

13. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Tax was originally intended for high income taxpayers with tax shelters It has evolved to impact many middle income people  Separate [parallel] system for calculating taxes If Alternative Minimum Tax (AMT) is higher than regular federal tax liability, must pay AMT amount  AMT Rates 26% up to and equaling $175,000 ($87,500 MFS) AMT base 28% above $175,000 ($87,500 MFS) AMT base Long-term capital gains taxed at preferential rates See following screen for Alternative Minimum Taxable model

14. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Calculation of Alternative Minimum Tax Regular Taxable Income (before exemptions & standard deduction) +/- Adjustments +/- Tax Preferences - AMT Exemption AMT Base x AMT rate(s) Tentative Minimum Tax - Regular Tax = AMT due with tax return [if positive amount]

15. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Provision designed to prevent parents from transferring income-producing assets to children in lower tax brackets Net unearned income [NUI] of child under age 18 is taxed at parent’s highest tax rate Applies to a child with at least one living parent, who is 18 or younger at end of tax year or students with ages 19 through 23 and has NUI NUI = Unearned income Less the greater of $900 or investment expenses Less statutory deduction [$900]