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CCH Federal Taxation Comprehensive Topics Chapter 9 Tax Credits, Prepayments, and Special Methods

CCH Federal Taxation Comprehensive Topics Chapter 9 Tax Credits, Prepayments, and Special Methods. ©2006 , CCH, a Wolters Kluwer business 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 www.CCHGroup.com. Chapter 9 Exhibits. 1. Household and Dependent Care Credit

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CCH Federal Taxation Comprehensive Topics Chapter 9 Tax Credits, Prepayments, and Special Methods

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  1. CCH Federal TaxationComprehensive TopicsChapter 9Tax Credits, Prepayments, and Special Methods ©2006, CCH, a Wolters Kluwer business 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 www.CCHGroup.com

  2. Chapter 9 Exhibits 1. Household and Dependent Care Credit 2. Elderly and Disabled Persons Credit 3. Adoption Assistance Credit 4. Child Tax Credit 5. Hope and Lifetime Learning Credits—Overview 6. Hope and Lifetime Learning Credits—Phaseout Rules 7. Hope and Lifetime Learning Credits—Examples 8. General Business Credits—Overall Limit 9. Earned Income Credit—Overview 10. Earned Income Credit—Computations 11. Obtaining Credit for Excess Withholdings 12. Estimated Tax Payments—Overview 13. Estimating Taxes—Example 14. Alternative Minimum Tax—History 15. Nonrefundable Credits Chapter 9, Exhibit Contents CCH Federal Taxation Comprehensive Topics

  3. Household and Dependent Care Credit Qualifying individual. A qualifying individual can be a child under age 13, or a mentally or physically handicapped dependent or spouse. “Gainful employment” expenses.Gainful employment expenses include household services such as babysitting, housekeeping, and nursing. Outside services, such as daycare facilities, must be in qualified facilities. These expenses must be incurred to enable the taxpayer to be employed or to seek employment. Chapter 9, Exhibit 1a CCH Federal Taxation Comprehensive Topics

  4. Household and Dependent Care Credit The formula for computing qualifying expensesis as follows: 35% x the lesser of (a), (b), or (c)Where: a = actual gainful employment expenses b = $3,000 per qualifying individual, not to exceed $6,000c = earned income (if married, use income of the spouse with the lower income) Chapter 9, Exhibit 1b CCH Federal Taxation Comprehensive Topics

  5. Household and Dependent Care Credit The maximum expenses eligible for the credit must be reduced by amounts excludable from income under an employer-provided dependent care assistance program. Credit percentage. The credit percentage is the greater of • 35%, reduced by 1 percentage point for each $2,000 of adjusted gross income, or fraction thereof, above $15,000 or • 20% Chapter 9, Exhibit 1c CCH Federal Taxation Comprehensive Topics

  6. FACTS: Billy and Lynda are married taxpayers filing a joint return with three dependents ages 2, 5, and 14. They incurred employment-related childcare expenses in the amounts of $2,000, $5,000 and $14,000 respectively. Lynda worked part time and had earnings of $3,000. Billy had earnings of $97,000. QUESTION: How much of the dependent care credit may be applied against their tax liability? SOLUTION: Credit allowed is $600 ($3,000 qualified expenses x 20% credit percentage) Qualifying expenses of $3,000 are the lesser of: a = $7,000 actual gainful employment expenses ($2,000 + $5,000) b = $6,000 (i.e., $3,000 each for the 2- and 5-year-old) c = $3,000 earned income of the spouse with the lower income Credit percentage is the greater of: (a) 0% = 35% – [($100,000 AGI – $15,000 threshold amount) $2,000], expressed as a % (b) 20% (minimum credit percentage) Household and Dependent Care Credit—Example Chapter 9, Exhibit 1d CCH Federal Taxation Comprehensive Topics

  7. Elderly and Disabled Persons Credit Eligible taxpayers. Eligible taxpayers must meet one of the following two conditions: 1. Reach age 65 before the end of the tax year 2. Retire under age 65 before the end of the tax year due to total, permanent disability. Married taxpayers. Married taxpayers must file jointly unless they have lived apart for the entire year. Chapter 9, Exhibit 2a CCH Federal Taxation Comprehensive Topics

  8. Elderly and Disabled Persons Credit The formula for computing the creditis as follows:   15% x [(a) – (b) – (c)]  Where: a = Base amount of $5,000 (or $7,500 for married filing joint return with both spouses age 65 or older) b = Tax-exempt pension benefits such as tax-exempt Social Security benefits c = Income level adjustment: 50% x (AGI – $10,000) for married persons filing jointly 50% x (AGI – $ 7,500) for single persons 50% x (AGI – $5,000) for married persons filing separately Chapter 9, Exhibit 2b CCH Federal Taxation Comprehensive Topics

  9. Elderly and Disabled Persons Credit–Example Chapter 9, Exhibit 2c CCH Federal Taxation Comprehensive Topics

  10. Adoption Assistance Credit Taxpayers who adopt an eligible adoptee may claim a tax credit for qualified adoption expenses of up to $10,960 for each eligible adoptee. If adoption expenses are paid through a nondiscriminatory employer adoption assistance program, which may be part of a cafeteria plan, the expenses paid by the employer may be excluded up to the limits stated above. Chapter 9, Exhibit 3a CCH Federal Taxation Comprehensive Topics

  11. Adoption Assistance Credit Qualifying adoptee. The adoptee must be a child under age 18 or a child with special needs. Special needs adoptee. A special needs adoptee is a child who, according to a state determination, could not be returned to the home of his or her birth parents because of a specific condition (e.g., a medical condition, a physical or emotional handicap). Chapter 9, Exhibit 3b CCH Federal Taxation Comprehensive Topics

  12. Adoption Assistance Credit Qualified expenses. These include adoption fees, court costs, attorney fees, and other expense related to the legal adoption of an eligible child. Expenses incurred in carrying out any surrogate parenting arrangement do not qualify. Chapter 9, Exhibit 3c CCH Federal Taxation Comprehensive Topics

  13. Adoption Assistance Credit Phaseout of credits and exclusions. For all filing statuses, the adoption assistance credit phases out at the following modified AGI (i.e., AGI figured without certain foreign and possessions income exclusions). • Ceiling of $204,410 modified AGI • Floor of $164,410 modified AGI • Phaseout range of $40,000 (ceiling minus floor) Chapter 9, Exhibit 3d CCH Federal Taxation Comprehensive Topics

  14. FACTS: A married couple incurs $20,000 in adoption expenses for a child under the age of 18. Their modified AGI is $174,450. QUESTION: How much of the $10,960 adoption assistance credit may be applied against their tax liability? SOLUTION: $8,209 = $10,960 – $2,751 phaseout amount Where: $2,751 = $10,960 x [($174,450 – $164,410)  $40,000] Adoption Assistance Credit—Example Chapter 9, Exhibit 3e CCH Federal Taxation Comprehensive Topics

  15. Child Tax Credit Taxpayers with one or more “qualifying children” are allowed a credit of $1,000 per child. Qualifying child. The “qualifying child” must be • A son or daughter for whom the taxpayer may claim a dependency exemption (i.e., natural, step, adopted, or foster pending adoption) and • Less than 17 years old at the close of the tax year. Chapter 9, Exhibit 4a CCH Federal Taxation Comprehensive Topics

  16. Child Tax Credit Chapter 9, Exhibit 4b CCH Federal Taxation Comprehensive Topics

  17. Child Tax Credit Chapter 9, Exhibit 4c CCH Federal Taxation Comprehensive Topics

  18. Hope and Lifetime Learning Credits—Overview Hope Scholarship Credit. The Hope Scholarship Credit provides a maximum nonrefundable tax credit of $1,650 perstudent for the first two completed years of postsecondary (i.e., undergraduate) education. The $1,650 per student limitation is computed as follows: a + b Where: a = 100% of the first $1,100 of qualified expenses b = 50% of the next $1,100 of qualified expenses. Chapter 9, Exhibit 5a CCH Federal Taxation Comprehensive Topics

  19. Hope and Lifetime Learning Credits—Overview Lifetime Learning Credit. The Lifetime Learning Credit allows a maximum nonrefundable tax credit of $2,000 pertaxpayer for an unlimited number of years if qualified tuition expenses are paid • after June 30, 1998, and • in a year in which the Hope Scholarship Credit is not claimed for a given student. The $2,000 limitation is computed as follows: 20% of the first $10,000 of qualified expenses ($5,000 before 2003). Chapter 9, Exhibit 5b CCH Federal Taxation Comprehensive Topics

  20. Hope and Lifetime Learning Credits—Overview Qualified Students.Qualified students consist of the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependents. Hope Scholarship Credit. To qualify, a student must carry at least one-half the normal full-time workload for the course of study the student is pursuing. Lifetime Learning Credit. A student qualifies even if he or she carries less than one-half the normal full-time workload. Also, the Lifetime Learning Credit, but NOT the Hope Scholarship Credit, is available even if students have completed their first two years of undergraduate education. The Hope credit is denied if a student has been convicted of a federal or state felony drug offense. Chapter 9, Exhibit 5c CCH Federal Taxation Comprehensive Topics

  21. Hope and Lifetime Learning Credits—Overview Qualified expenses.Qualified expenses include tuition and fees but NOT books, room and board, student activity fees, insurance expenses, or athletic fees. Qualified programs. The Hope Scholarship Credit is not allowed for the expenses of any graduate or advanced degree programs. However, the Lifetime Learning Credit is allowed for the expenses of any undergraduate, graduate, or vocational program. Chapter 9, Exhibit 5d CCH Federal Taxation Comprehensive Topics

  22. Hope and Lifetime Learning Credits—Overview Qualified time frame.The Hope Scholarship Credit is allowed for a tax year if the student has not completed (before the beginning of the tax year) the first two years of postsecondary education at an eligible educational institution. Chapter 9, Exhibit 5e CCH Federal Taxation Comprehensive Topics

  23. Hope and Lifetime Learning Credits—Phaseout Rules Chapter 9, Exhibit 6 CCH Federal Taxation Comprehensive Topics

  24. Hope and Lifetime Learning Credits—Example 1 Chapter 9, Exhibit 7a CCH Federal Taxation Comprehensive Topics

  25. Hope and Lifetime Learning Credits—Example 2 Chapter 9, Exhibit 7b CCH Federal Taxation Comprehensive Topics

  26. Hope and Lifetime Learning Credits—Example 2 Chapter 9, Exhibit 7c CCH Federal Taxation Comprehensive Topics

  27. General Business Credits—Overall Limit General business credits (GBCs) are a set of several credits commonly available to business. The GBCs include credits for investment, research, targeted jobs, and disabled access.Overall limit.General business credits are limited to: Net income tax – the greater of (a) or (b) Where: a = The tentative minimum tax b = 25% of net regular tax over $25,000 Chapter 9, Exhibit 8a CCH Federal Taxation Comprehensive Topics

  28. General Business Credits—Overall Limit Net income tax. The sum of regular income tax and alternative minimum tax liability reduced by nonrefundable credits other than GBCs. Tentative minimum tax. An amount used in computing the alternative minimum tax. Net regular tax. The taxpayer’s income tax liability reduced by nonrefundable credits other than GBCs, but without regard to the alternative minimum tax. Chapter 9, Exhibit 8b CCH Federal Taxation Comprehensive Topics

  29. General Business Credits—Overall Limit Individual business credit limits. The dollars that can be claimed under each of the individual business credits comprising the GBCs must be determined separately under each credit’s own rules. Chapter 9, Exhibit 8c CCH Federal Taxation Comprehensive Topics

  30. Earned Income Credit—Overview A refundable tax credit is provided for low-income workers with or without qualifying children. Chapter 9, Exhibit 9a CCH Federal Taxation Comprehensive Topics

  31. Earned Income Credit—Overview Eligible taxpayers without qualifying children. Any taxpayer without qualifying children must meet the following requirements: • Principal residence requirement. The taxpayer has a principal residence in the U.S. for over half the tax year. • Age requirement. The individual or his/her spouse (if married) is at least age 25 but not over age 64 by the end of the tax year. • Nondependent requirement. The taxpayer cannot be claimed as a dependent for the tax year in which the credit is claimed. • Limits on earned income. Phaseout ranges apply. Chapter 9, Exhibit 9b CCH Federal Taxation Comprehensive Topics

  32. Earned Income Credit—Overview Eligible taxpayers with qualifying children. Any taxpayer with qualifying children must meet the following requirements: • Principal abode of child. The taxpayer must maintain a household in the U.S. that is the principal abode for over half a year of a dependent child under age 19 or a student, dependent disabled child, or married child for whom the taxpayer may claim a dependency exemption. Foster children must occupy the taxpayer’sabode for the entire year. • Head of household or surviving spouse taxpayers. For individuals qualifying as head of household or surviving spouse, a child who is under age 19 or a student need not be a dependent. • Married taxpayers. Married taxpayers must file jointly to receive the credit. • Limits on earned and unearned income. Phaseout ranges apply. Chapter 9, Exhibit 9c CCH Federal Taxation Comprehensive Topics

  33. Earned Income Credit—Overview Earned income defined.Earned income includes wages, salaries, tips, net earnings from self-employment, and nontaxable compensation (e.g., military allowance).Excluded from earned income are interest, dividends, welfare benefits, veteran’s benefits, pensions, annuities, unemployment compensation, and scholarships. Chapter 9, Exhibit 9d CCH Federal Taxation Comprehensive Topics

  34. Earned Income Credit—Computations Chapter 9, Exhibit 10a CCH Federal Taxation Comprehensive Topics

  35. Earned Income Credit—Computations The maximum earned income credit is subject to the above phaseout amounts. The phaseouts for married filing jointly are $2,000 higher. A phaseout amount is calculated as follows: Applicable phaseout percentage x (AGI [or earned income if greater] – Beginning phase amount) No earned income credit is available when AGI or earned income exceeds the ending phaseout amount. Chapter 9, Exhibit 10b CCH Federal Taxation Comprehensive Topics

  36. Earned Income Credit—Example Chapter 9, Exhibit 10c CCH Federal Taxation Comprehensive Topics

  37. Obtaining Credit for Excess Withholdings Excess federal income tax withholdings. Withholdings from employee wages for income tax are treated as refundable credits reported on page 2 of Form 1040. Chapter 9, Exhibit 11a CCH Federal Taxation Comprehensive Topics

  38. Obtaining Credit for Excess Withholdings Excess FICA withholdings: 2 or more employers. Withholdings from wages for FICA tax are also refundable, but only if the aggregate withheld by two or more employers is in excess of the maximum. The refundable amount is reported as a credit on page 2 of Form 1040. (Employers are not entitled to this same credit.) Chapter 9, Exhibit 11b CCH Federal Taxation Comprehensive Topics

  39. Obtaining Credit for Excess Withholdings Excess FICA withholdings: 1 employer. If the FICA tax withheld by only one employer exceeds the maximum limit, the employee must seek a refund from the employer, not the IRS. Chapter 9, Exhibit 11c CCH Federal Taxation Comprehensive Topics

  40. Estimated Tax Payments—Overview Estimated tax requirements. Generally , taxpayers must make quarterly estimated tax payments if: (a – c)  $1,000; AND (c) is less than the lesser of (d) or (e) Where: a = Actual tax liability for the current year, including self-employment tax (i.e., FICA), the alternative minimum tax, and the “nanny” tax b = Actual tax liability for the prior year c = Amount of taxes withheld by any payor (usually an employer) in the current year plus any other tax credits expected d = 90% of (a) e = 100%* of (b) if prior year AGI  $150,000 ($75,000 if married filing separated) * Change 100% to 110% if prior year AGI > $150,000. Chapter 9, Exhibit 12a CCH Federal Taxation Comprehensive Topics

  41. Estimated Tax Payments—Overview Quarterly estimated tax payments. The regular installment method generally results in lower estimated tax payments if income is received fairly evenly throughout the year. Under this method, minimum estimated tax paid each quarter is based on the following formula: 25% x [(The lesser of (d) or (e)) – (c)] Where: a = Actual tax liability for the current year, including self-employment tax (i.e., FICA), the alternative minimum tax, and the “nanny” tax b = Actual tax liability for the prior year c = Amount of taxes withheld by any payor (usually an employer) in the current year plus any other tax credits expected d = 90% of (a) e = 100%* of (b) if prior year AGI  $150,000 ($75,000 if married filing separated) * Change 100% to 110% if prior year AGI > $150,000. Chapter 9, Exhibit 12b CCH Federal Taxation Comprehensive Topics

  42. Estimated Tax Payments—Overview Quarterly payment due dates.Estimated tax payments are due by April 15, June 15, and September 15 of the current year, and by January 15 of the following year. Note that these quarterly payments are not in 3-month increments, (e.g., April 15 to June 15 is two months, September 15 to January 15 is four months). Chapter 9, Exhibit 12c CCH Federal Taxation Comprehensive Topics

  43. Estimated Tax Payments—Overview Penalties for underpayments. A penalty is imposed for underpayment of estimated tax. The penalty is the amount of the underpayment times the underpayment interest rate prorated for each day of underpayment. The underpayment penalty is applied when an actual quarterly payment is less than the quarterly amount required. No penalty is imposed if the tax liability is less than $1,000. The underpayment interest rate is the monthly applicable federal rate published by the IRS, plus 3%. Chapter 9, Exhibit 12d CCH Federal Taxation Comprehensive Topics

  44. Estimating Taxes—Example Chapter 9, Exhibit 13 CCH Federal Taxation Comprehensive Topics

  45. Alternative Minimum Tax—History Chapter 9, Exhibit 14 CCH Federal Taxation Comprehensive Topics

  46. Nonrefundable Credits Chapter 9, Exhibit 15 CCH Federal Taxation Comprehensive Topics

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