1. © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Essentials of Taxation 1 Chapter 10 Individuals: Income, Deductions, and Credits

2. 2 The Big Picture (slide 1 of 4) Donna and David Steele recently married and have come to you for tax advice. –They both are employed, and they expect to have combined wages of $70,000 during the year. Donna recently completed an internship with a CPA firm. –The firm was pleased with her work and gave her a $1,500 bonus to help with her graduate school expenses at State University. Because of Donna’s excellent academic record, the university awarded her a graduate assistantship that waived her tuition of $6,000 per semester and paid her $400 per month. –In exchange, Donna was required to teach a principles of accounting course each semester. –Donna used the $400 per month for books and incidental fees.

3. 3 The Big Picture (slide 2 of 4) Donna paid $400 of interest on student loans from her undergraduate years. Donna and David also received a wedding gift of $10,000 from her grandmother. –The couple earned $250 of interest on a savings account they opened with the money. David sold stock for $1,000 that was purchased two years ago for $5,000.

4. 4 The Big Picture (slide 3 of 4) Late in the year, Donna was hit by a delivery van. The driver had a blood alcohol level of.12. Donna suffered a severe injury to her right arm that required her to miss work for a month or so. The delivery company’s insurance company settled the case by paying damages, itemized as follows: Compensatory damages: Medical expenses $ 30,000 Injury to Donna’s right arm 100,000 Pain and suffering 50,000 Loss of income 10,000 Legal fees 25,000 Punitive damages 160,000 $375,000

5. 5 The Big Picture (slide 4 of 4) This is David’s second marriage, and he pays alimony to his ex-wife. –He has custody of his 15-year-old son, Stephen, who lives with Donna and David for nine months each year. The Steeles rent their home, paid $3,500 of state income taxes, paid an $812 motor vehicle registration tax on their personal car, incurred additional medical expenses of $25,000, and made $2,500 of charitable contributions. Without calculating Donna and David’s tax liability, what are the tax implications of the transactions noted above? –Are there other tax deductions or credits for which they may qualify or other tax issues about which they should be made aware? Read the chapter and formulate your response.

6. 6 Specific Inclusions Applicable To Individuals The following provisions applicable to individuals are covered in this chapter: – Alimony and separate maintenance payments –Prizes and awards –Unemployment compensation –Social Security benefits

7. 7 Alimony and Separate Maintenance Payments (slide 1 of 3) Alimony is: –Deductible by payor –Includible in gross income of recipient

8. 8 Alimony and Separate Maintenance Payments (slide 2 of 3) Property settlements –Transfer of property to former spouse –No deduction or recognized gain or loss for transferor –No gross income and carryover of transferor’s basis for transferee

9. 9 Alimony and Separate Maintenance Payments (slide 3 of 3) Child support payments –Payments made to satisfy legal obligation to support child of taxpayer –Nondeductible by payor and not taxed to recipient (or child) May be difficult to determine whether an amount received is alimony or child support –If amount of payment would be reduced due to some future event related to the child (e.g., child reaches age 21), such reduction is deemed child support

10. 10 Alimony and Separate Maintenance Payments (slide 3 of 3) Child support payments –Payments made to satisfy legal obligation to support child of taxpayer –Nondeductible by payor and not taxed to recipient (or child) May be difficult to determine whether an amount received is alimony or child support –If amount of payment would be reduced due to some future event related to the child (e.g., child reaches age 21), such reduction is deemed child support

11. 11 Prizes and Awards General rule: FMV of item is included in income Exceptions: Taxpayer designates qualified organization to receive prize or award (subject to other requirements) Employee achievement awards of tangible personal property made in recognition of length of service or safety achievement (limits apply)

12. 12 Prizes and Awards General rule: FMV of item is included in income Exceptions: Taxpayer designates qualified organization to receive prize or award (subject to other requirements) Employee achievement awards of tangible personal property made in recognition of length of service or safety achievement (limits apply)

13. 13 Prizes and Awards General rule: FMV of item is included in income Exceptions: Taxpayer designates qualified organization to receive prize or award (subject to other requirements) Employee achievement awards of tangible personal property made in recognition of length of service or safety achievement (limits apply)

14. 14 Unemployment Compensation Unemployment compensation is taxable in full

15. 15 Social Security Benefits If taxpayer’s income exceeds a specified base amount, up to 85% of benefits may be taxable Two formulas for computing taxable benefits

16. 16 Specific Exclusions Applicable To Individuals Certain items are specifically excluded from an individual’s income, including: –Gifts and Inheritances –Scholarships –Certain damages –Workers’ Compensation –Accident and Health Insurance Benefits –Interest on Educational Savings Bonds

17. 17 Gifts and Inheritances (slide 1 of 3) Gifts are nontaxable to donee if: –Transfer is voluntary without adequate consideration, and –Made out of affection, respect, admiration, charity, or donative intent

18. 18 Gifts and Inheritances (slide 2 of 3) Inheritances are nontaxable to beneficiary Income earned on gifts or inheritances is taxable under normal rules –Example: Father gifts corporate bond to daughter. Gift is excluded from daughter’s gross income, but interest income earned after gift date is taxable to her.

19. 19 Gifts and Inheritances (slide 3 of 3) Transfers by employers to employees do not qualify as excludible gifts –May be excludible under other provisions, e.g., employee achievement awards

20. 20 The Big Picture - Example 4 Gifts to Employees Return to the facts of The Big Picture on p. 10-1. The $1,500 bonus paid to Donna by the CPA firm was compensation for services rather than a gift. – The payment was most likely not motivated by the employer’s generosity, but as a result of business considerations. –Even if the payment had been made out of generosity, because the payment was received from her employer, Donna could not exclude the “gift.”

21. 21 Scholarships and Fellowships An amount paid to or for the benefit of a student to aid in pursuing a degree at an educational institution –Nontaxable to extent of tuition and related expenses (e.g., fees, books, supplies, and equipment required for courses) Amounts received for room and board are taxable

22. 22 Scholarships and Fellowships An amount paid to or for the benefit of a student to aid in pursuing a degree at an educational institution –Nontaxable to extent of tuition and related expenses (e.g., fees, books, supplies, and equipment required for courses) Amounts received for room and board are taxable

23. 23 The Big Picture - Example 5 Scholarships Return to the facts of The Big Picture on p. 10-1. State University waives tuition for all graduate teaching assistants. –The tuition waived is intended as compensation for services and is included in gross income. –Therefore, the $6,000 tuition waiver Donna received each semester is compensation for her services. The $400 she received each month also is compensation for services. –The fact that she used the funds for educational expenses does not change the tax treatment of the compensation.

24. 24 Damages (slide 1 of 3) Tax consequences of receipt of damages –Depends on type of harm taxpayer experienced –The taxpayer may seek damages for: Loss of income Expenses incurred Property destroyed Personal injury

25. 25 Damages (slide 2 of 3) Tax treatment of damages received for: –Loss of income Generally, taxed the same as the income replaced –Exceptions exist related to personal injury –Reimbursement for expenses incurred Not income, unless the expense was deducted –Damages that are a recovery of the taxpayer’s previously deducted expenses are generally taxable under the tax benefit rule

26. 26 Damages (slide 3 of 3) Tax treatment of damages received for: –Property damaged or destroyed Treated as an amount received in a sale or exchange of the property – Thus, taxpayer has realized gain if damage payments exceed property’s basis –Personal injury Receives special treatment

27. 27 Compensation for Injuries and Sickness (slide 1 of 3) Personal injury damages –Compensatory damages received on account of physical personal injury or physical illness are excludible Includes amounts received for loss of income associated with the physical personal injury or physical sickness –All other personal injury damages are taxable Compensatory damages for nonphysical injury All punitive damages

28. 28 The Big Picture - Example 9 Damages Return to the facts of The Big Picture on p. 10-1. The damages Donna received were awarded as a result of a physical personal injury. –Therefore, all of the compensatory damages can be excluded. –Even the compensation for the loss of income of $10,000 can be excluded. The punitive damages Donna received, however, must be included in her gross income.

29. 29 Compensation for Injuries and Sickness (slide 2 of 3) Workers’ compensation –Although may be payment for loss of wages, workers’ compensation is specifically excluded from gross income

30. 30 Compensation for Injuries and Sickness (slide 3 of 3) Accident and health insurance benefits –Benefits received under policy purchased by taxpayer are excludible Even if benefits are substitute for income –Different rules apply if the accident and health insurance protection was purchased by the individual’s employer

31. 31 Compensation for Injuries and Sickness (slide 3 of 3) Accident and health insurance benefits –Benefits received under policy purchased by taxpayer are excludible Even if benefits are substitute for income –Different rules apply if the accident and health insurance protection was purchased by the individual’s employer

32. 32 Educational Savings Bonds Interest on Series EE U.S. Savings Bonds may be excluded from income if: –Proceeds used to pay for qualified higher educational expenses –Bonds issued after 12/31/89, and –Bonds issued to person at least 24 years old Exclusion is phased-out once modified AGI exceeds threshold amount

33. 33 Itemized Deductions (slide 1 of 2) Personal expenditures that are deductible from AGI as itemized deductions include: –Medical expenses –Certain taxes –Mortgage and investment interest –Charitable Contributions –Miscellaneous itemized deductions

34. 34 Itemized Deductions (slide 2 of 2) Itemized deductions provide a tax benefit only to extent that, in total, they exceed the standard deduction amount for the taxpayer

35. 35 Medical Expenses (slide 1 of 6) Medical expenses are deductible to the extent unreimbursed medical expenses, in total, exceed 10% of AGI –For taxpayers age 65 and older, the threshold is 7.5% of AGI until 2017, when it increases to 10% –Prior to 2013, the percentage threshold for regular income tax purposes was 7.5% of AGI for all taxpayers

36. 36 Medical Expenses (slide 2 of 6) Example of medical expense deduction limitation: –Amy, age 24, has AGI of $10,000 and medical expenses of $1,500 –Amy’s medical expense deduction = $500 [$1,500 – ($10,000 × 10%)]

37. 37 Medical Expenses (slide 3 of 6) Example of medical expense deduction limitation: –Bob, age 67, has AGI of $4,000 and medical expenses of $1,000 –Bob’s medical expense deduction = $700 [$1,000 – ($4,000 × 7.5%)]

38. 38 Medical Expenses (slide 4 of 6) Expenditures for: –The diagnosis, cure, mitigation, treatment, prevention of disease, or –The purpose of affecting any structure or function of the body of the taxpayer, spouse, or dependents –Includes prescription drugs and insulin

39. 39 Medical Expenses (slide 5 of 6) Does not include the cost of items such as : –Unnecessary cosmetic surgery –General health items –Nonprescription drugs If cosmetic surgery is deemed necessary, it is deductible as a medical expense – Cosmetic surgery is necessary when it ameliorates A deformity arising from a congenital abnormality A personal injury, or A disfiguring disease

40. 40 Medical Expenses (slide 6 of 6) Medical expenditures are deductible in year paid –Includes payment by check or credit card

41. 41 The Big Picture - Example 13 Medical Expenses Return to the facts of The Big Picture on p. 10-1. The medical expenses associated with Donna’s accident were later reimbursed by the delivery company’s insurance company. –The Steeles had other qualifying medical expenses. Assuming that their AGI for the year is $200,000. –They will need to itemize their deductions and have more than $20,000 ($200,000 X 10%) in unreimbursed medical expenses to receive a tax benefit from those expenses.

42. 42 Nursing Home Expenditures If primary reason for being in nursing home is medical, costs (including meals and lodging) qualify If primary purpose of placement in home is personal, only specific medical costs qualify (no meals or lodging)

43. 43 Capital Medical Expenditures May include a pool, air conditioners if they do not become permanent improvements, dust elimination systems, elevators, etc. Must be medical necessity, advised by a physician, used primarily by patient, and expense is reasonable Full amount of cost is medical expense in year paid Maintenance on capital expenditures also medical expense

44. 44 Capital Improvement to Home Deductible medical expense only to extent cost exceeds increase in value of home –Appraisal costs related to capital improvements are also deductible, but not as medical expenses Exception: removal of structural barriers to home of handicapped are deemed to add no value to home –Thus, full amount is a medical expense

45. 45 Medical Care of Spouse and Dependents Taxpayer may deduct cost of medical care for spouse and dependents –Dependents need not meet gross income or joint return tests –Medical expenses of children of divorced parents can be deducted by non-custodial parent even though child is claimed as dependent of custodial parent

46. 46 Medical Transportation and Lodging Transportation costs to and from medical care are deductible –Mileage allowance of 23.5 cents per mile (in 2014) may be used instead of actual out-of-pocket automobile expenses Lodging while away from home for medical care –Allowable amount is $50 per person per night If parent and/or aide needs to accompany patient, their expenses are also deductible

47. 47 Medical Transportation and Lodging Transportation costs to and from medical care are deductible –Mileage allowance of 23 cents per mile (in 2015) may be used instead of actual out-of-pocket automobile expenses Lodging while away from home for medical care –Allowable amount is $50 per person per night If parent and/or aide needs to accompany patient, their expenses are also deductible

48. 48 Medical Insurance Premiums (slide 1 of 2) Premiums paid for medical care insurance are deductible medical expenses –If employer pays all or part of taxpayer’s medical insurance premiums the amount paid by employer is Not included in gross income by employee Not deductible by the employee as medical expense

49. 49 Medical Insurance Premiums (slide 2 of 2) For self-employed, 100% of insurance premiums are deductible for AGI –Includes amounts paid for taxpayer’s spouse and dependents –Not allowed if taxpayer is eligible to participate in a subsidized health plan maintained by any employer of the taxpayer or the taxpayer’s spouse Premiums paid for qualified long-term care insurance are deductible medical expenses –Subject to limitations based on age of the insured

50. 50 Health Savings Accounts Used in conjunction with a high deductible medical insurance policy –Employee contributions to HSA are deductible for AGI and earnings on funds in account are not taxable –Deductible contributions are limited to the sum of the monthly limitations. The monthly deductible amount is limited to the lesser of one twelfth of: The annual deductible under a high deductible plan or $3,350 for self-only ($6,650 for family coverage) in 2015 –Withdrawals from HSA are excludible to the extent used for qualified medical expenses

51. 51 Taxes (slide 1 of 4) State, local, and foreign income and real property taxes are deductible in the year paid –Real property taxes do not include taxes assessed for local benefits e.g., Special assessments for streets, sidewalks, curbing, and other similar improvements State and local personal property taxes based on value (ad valorem) are deductible in the year paid

52. 52 Taxes (slide 2 of 4) Other taxes such as FICA, excise, etc., are not deductible –May be deductible if incurred in business or production of income activity Fees are not deductible as tax

53. 53 Taxes (slide 3 of 4) Real estate taxes for year property is sold must be apportioned between the buyer and the seller –Failure to correctly apportion requires offsetting adjustments to seller’s amount realized and buyer’s adjusted basis

54. 54 Taxes (slide 4 of 4) Can elect to deduct either state & local income taxes or sales/use taxes –For state and local income taxes, deduct amounts paid during year: Amounts withheld Estimated tax payments Amounts paid in current year for prior year’s liability –For sales/use taxes, deduct either: Actual sales/use tax payments or Amount from an IRS table –Table amount may be increased by sales tax paid on certain specific items (e.g., Purchase of motor vehicles, boats, etc.)

55. 55 The Big Picture - Example 17 Deductible Property Taxes Return to the facts of The Big Picture on p. 10-1. In Donna and David Steele’s state, the motor vehicle registration tax is 2% of the value of the vehicle plus 40 cents per hundredweight. –The Steele’s car is valued at $20,000 and weighs 3,000 lbs. –Their annual registration tax is $412. $400 (2% of $20,000) is deductible as a personal property tax if they itemize. The remaining $12, based on the weight of the car, is not deductible.

56. 56 Interest Expense Deduction of interest expense is limited to: –Interest on qualified student loans –Investment interest –Qualified residence (home mortgage) interest –Business interest Personal interest expense is not deductible

57. 57 Interest on Qualified Student Loans Deductible for AGI, subject to limits –Maximum deduction is $2,500 per year –Deduction is phased out for taxpayers with modified AGI (MAGI) between $65,000 and $80,000 ($130,000 and $160,000 on joint returns) –Not allowed for those claimed as a dependent or for married filing separate returns

58. 58 Investment Interest Investment interest on loans whose proceeds are used to purchase investment property may be deductible –e.g., Investment property may include stock, bonds, and land held for investment Deduction of investment interest expense is limited to net investment income

59. 59 Qualified Residence Interest (slide 1 of 4) Interest on indebtedness secured by the principal residence and one other residence (qualified residences) Interest must be on acquisition indebtedness or home equity loans

60. 60 Qualified Residence Interest (slide 2 of 4) Acquisition indebtedness: amounts incurred to acquire, construct, or substantially improve the qualified residences –Interest paid on aggregate acquisition indebtedness of $1 million or less ($500,000 for married, filing separately) is deductible as qualified residence interest

61. 61 Qualified Residence Interest (slide 3 of 4) Home equity indebtedness: loans secured by qualified residences Interest is deductible only on portion of home equity loan that does not exceed the lesser of: –$100,000 ($50,000 for married, filing separate), or –FMV of home – acquisition indebtedness

62. 62 Qualified Residence Interest (slide 4 of 4) Thus, maximum loans on qualified residences that will produce qualified residence interest is $1.1 million Interest on mortgage debt exceeding $1.1 million or on mortgage debt relating to nonqualified residence (e.g., second vacation home) is nondeductible personal interest

63. 63 Interest Paid For Services (slide 1 of 2) “Points” paid for the use or forbearance of money qualify as deductible interest –Cannot be a service charge if they are to qualify as deductible interest Points generally must be capitalized and amortized over the life of loan

64. 64 Interest Paid For Services (slide 2 of 2) Exception: Points paid in the acquisition or improvement of principal residence –Entire amount of such points are deductible in the year paid –Points paid to refinance an existing home mortgage must be capitalized and amortized over the life of the new loan

65. 65 Mortgage Insurance Payments Mortgage insurance premiums are deductible as interest if they relate to a qualified residence of the taxpayer –The deduction begins to phase out for taxpayers with AGI in excess of $100,000 ($50,000 for married taxpayers filing separately)

66. 66 Classification of Interest Expense Whether interest is deductible for AGI or as an itemized deduction (from AGI) depends on purpose of indebtedness –If related to a business or the production of rent or royalty income Interest is deductible for AGI –If incurred for personal use, such as qualified residence interest Deduction is reported on Schedule A, Form 1040 if taxpayer itemizes However, interest on a student loan is a deduction for AGI –If the taxpayer incurs debt in relation to his or her employment Interest is considered to be personal, or consumer, interest

67. 67 Charitable Contributions (slide 1 of 2) Individuals and corporations may deduct contributions made to qualified domestic organizations Contributor must have donative intent and expect nothing in return –If contributor receives tangible benefit, the FMV of such benefit reduces the amount of the charitable contribution deduction

68. 68 Charitable Contributions (slide 2 of 2) Exception to tangible benefit rule –Allows deduction of 80% of amount paid for the right to purchase athletic tickets from colleges and universities

69. 69 Contribution of Services No deduction is allowed for the contribution of services –Unreimbursed expenses related to the services are deductible –Out-of-pocket transportation costs or a standard mileage rate of 14 cents per mile are deductible –Deductions are also permitted for transportation, reasonable expenses for lodging, and the cost of meals while away from home incurred in performing the donated services

70. 70 Nondeductible Items The following items may not be deducted as charitable contributions: –Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups –Cost of raffle, bingo, or lottery tickets –Cost of tuition –Value of blood given to a blood bank –Donations to homeowners associations –Gifts to individuals –Rental value of property used by a qualified charity

71. 71 Qualified Organizations To be deductible, contributions must be to a qualified domestic nonprofit organization or state or possession of U.S. or any subdivisions thereof –Many (but not all) qualified domestic charities are listed in IRS Publication #78

72. 72 Record-Keeping Requirements No deduction is allowed for charitable contributions unless the taxpayer has appropriate documentation and substantiation –The specific type of documentation required depends on the amount of the contribution and whether the contribution is made in cash or noncash property –Special rules may apply to gifts of certain types of property (e.g., used automobiles) where Congress has noted taxpayer abuse in the past

73. 73 Ordinary Income Property Defined: assets that would produce ordinary income or short-term capital gain if sold Contribution amount –FMV of asset less ordinary income (or STCG) potential; generally the lower of adjusted basis or FMV

74. 74 Capital Gain Property Defined: assets that would produce long-term capital gain or Section 1231 gain if sold Contribution amount –Generally FMV of asset

75. 75 Charitable Contribution Limitations (slide 1 of 4) 50% limit –In no case can the charitable contribution deduction for a year exceed 50% of the taxpayer’s AGI –Contributions of cash, ordinary income property, and certain capital gain property (where the contribution amount is adjusted basis) are subject to the 50% limit (50% assets) –Generally, applies to contributions to public charities e.g., Churches, schools, hospitals, and Federal, state, or local governmental units Also applies to private operating foundations and certain private nonoperating foundations

76. 76 Charitable Contribution Limitations (slide 2 of 4) 30% limit –Charitable contribution deduction for certain assets cannot exceed 30% of the taxpayer’s AGI Applies to 30% assets which are: –Capital gain property for which the contribution amount is FMV –Certain contributions to private nonoperating foundations

77. 77 Charitable Contribution Limitations (slide 3 of 4) 30% limit –Taxpayer can elect to treat capital gain property as 50% assets by limiting the amount of such contributions to their adjusted bases –Referred to as the reduced deduction election Enables the taxpayer to move from the 30% limitation to the 50% limitation

78. 78 Charitable Contribution Limitations (slide 4 of 4) 20% limit –Certain contributions of capital gain property to private nonoperating foundations

79. 79 Charitable Contributions Carryover Contributions that cannot be taken in current year due to limitations may be carried forward for 5 years –Contributions carried forward retain their classification e.g., If the contribution originally involved 30% property, the carryover will continue to be classified as 30% property in the carryover year –When using carryovers, current contributions are used first, then carryovers used on a FIFO basis

80. 80 Example of Charitable Contribution AGI Limits Taxpayer, AGI $100,000, contributed $40,000 cash and long-term stocks with a FMV of $35,000 and a basis of $8,000 to a University 50% limit = $50,000 30% limit = $30,000 –Amount of deduction = $50,000 (40,000 cash + 10,000 stock) –Contribution carryforward = $25,000 stock (as 30% asset)

81. 81 Miscellaneous Itemized Deductions Some expenditures are deductible only to the extent they exceed 2% of AGI Examples include: –Professional dues –Uniforms –Tax return prep fees –Job-hunting costs –Certain investment expenses –Hobby losses –Unreimbursed employee expenses

82. 82 Misc. Itemized Deductions Not Subject to 2% of AGI Floor Examples include: –Gambling losses to the extent of gambling winnings –Impairment-related work expenses of a handicapped person –Deduction for repayment of amounts under a claim of right if more than $3,000 –Unrecovered investment in an annuity contract when annuity ceases by reason of death

83. Itemized Deduction Phaseout (slide 1 of 3) For higher income taxpayers, the otherwise allowable itemized deductions are reduced by 3% of the amount AGI exceeds the applicable threshold amount –The reduction in itemized deductions is limited to 80% of affected itemized deductions 83

84. Itemized Deduction Phaseout (slide 2 of 3) The limitation applies to the following frequently encountered itemized deductions: –Taxes –Home mortgage interest, including points –Charitable contributions –Unreimbursed employee expenses and all other expenses subject to the 2%-of-AGI floor Certain itemized deductions are not subject to phaseout including: –Medical expenses –Investment interest expense –Wagering losses, and –Casualty and theft losses 84

85. Itemized Deduction Phaseout (slide 3 of 3) The applicable threshold amounts for the itemized deduction phaseout for 2015 are as follows: Filing status AGI Threshold Single$258,250 Married, filing jointly 309,900 Head of household 284,050 Married, filing separately 154,950 These threshold amounts are adjusted for inflation for tax years after 2013 85

86. 86 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 $13,400 (in 2015) –Credit is phased-out ratably for modified AGI between $201,010 and $241,010 (in 2015)

87. 87 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

88. 88 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

89. 89 Child Tax Credit (slide 2 of 2) Credit is phased out by $50 for each $1,000 of AGI above specified levels –$110,000 for joint filers –$55,000 for married filing separately –$75,000 for single

90. 90 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

91. 91 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

92. 92 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

93. 93 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

94. 94 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

95. 95 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 2014) Cannot be claimed in same year the American Opportunity credit is claimed

96. 96 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

97. 97 Education Tax Credits (slide 4 of 5) Both education credits are subject to income limitations –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)

98. 98 Education Tax Credits (slide 5 of 5) The lifetime learning credit amount is phased out when modified AGI reaches $55,000 ($110,000 for MFJ) –The credit is completely eliminated when AGI reaches $65,000 ($130,000 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

99. 99 Earned Income Credit (slide 1 of 2) General qualifications for credit –Must have earned income from being an employee or self-employed –For 2009 through 2017, Congress has increased Credit percentage for families with three or more children, and Phaseout threshold amounts for married taxpayers filing joint returns

100. 100 Earned Income Credit (slide 2 of 2) Credit amount (2015 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 $23,630 for MFJ with qualifying child ($18,110 for other taxpayers) Use IRS tables to calculate exact credit amount

101. 101 Refocus On The Big Picture (slide 1 of 5) The $10,000 gift received from Donna’s grandmother can be excluded from gross income. –However, the $250 of interest earned on the money is taxable. The $1,500 bonus Donna earned at the CPA firm is taxable. The tuition waiver of $6,000 and the related payments of $400 per month are intended as a form of compensation. –Donna must include both of these in her gross income.

102. 102 Refocus On The Big Picture (slide 2 of 5) Compensatory damages awards that relate to personal physical injury or sickness can be excluded from gross. –All the compensatory damages of $215,000 can be excluded from gross income. –The punitive damages of $160,000 must be included in Donna’s gross income.

103. 103 Refocus On The Big Picture (slide 3 of 5) Donna and David have several deductions for adjusted gross income. –The alimony paid by David, –$3,000 of the capital loss from the stock sale, and –Interest on qualified student loans. Donna and David should claim the standard deduction for a married couple as it exceeds their itemized deductions. –Donna and David will claim 3 personal and dependency exemptions—one for each spouse and one for David’s son.

104. 104 Refocus On The Big Picture (slide 4 of 5) They will determine their tax liability using the tax rate schedule for married couples filing a joint return. Donna and David may be eligible for one or more tax credits including –The child tax credit, and –An education tax credit related to the tuition paid by Donna. If Stephen has unearned income in excess of certain thresholds, Donna and David should be made aware of the potential ‘‘kiddie’’ tax problem.

105. 105 Refocus On The Big Picture (slide 5 of 5) What If? What if Donna and David purchase a house in the current year? –What are the likely tax implications of owning a new home? If Donna and David purchase a new home –Mortgage interest and property taxes paid on the home are itemized deductions. Depending on the amount of these deductions, Donna and David’s itemized deductions might then exceed their standard deduction. Congress has recently enacted other provisions that benefit new homeowners, so Donna and David should make sure they consult with you again before they make the big purchase.

106. © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 106 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta