Understanding Special Tax Methods and Tax Credits for Effective Tax Planning

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

2. 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

3. 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 =: THEALTERNATIVE MINIMUM TAX

4. 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

5. 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

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

7. 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

8. 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

9. 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

10. 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

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

12. 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

13. 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

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

15. Overview Of Credits • Classification of credits • Refundable • Nonrefundable

16. Overview Of Tax CreditsNon-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

17. Overview Of Tax CreditsNon-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

18. 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

19. 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

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

21. 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

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

23. 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