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CHAPTER 6

CHAPTER 6 . Credits and Special Taxes. Income Tax Fundamentals 2008 Gerald E. Whittenburg Martha Altus-Buller Student’s copy. Credits and Deductions. A credit is a direct reduction in tax liability Credits are used to target certain groups for tax benefit

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CHAPTER 6

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  1. CHAPTER 6 Credits and Special Taxes Income Tax Fundamentals 2008 Gerald E. Whittenburg Martha Altus-Buller Student’s copy

  2. Credits and Deductions • 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. Tax Credits Illustration of difference between a $1,500 deduction and a $1,500 credit DeductionCredit TI (before) $ 70,000 $ 70,000 Deduction (1,500) -0- TI $ 68,500$ 70,000 Tax Liability $ 13,683 $ 14,058 Credit -0- (1,500) Tax due $ 13,683$ 12,558 *This is assuming a single taxpayer in the 25% tax bracket – using 2006 tax tables

  4. Child Tax Credit • Provides tax relief through a nonrefundable 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) Phased out $50 for each $1000 [or part thereof] that AGI exceeds threshold

  5. Earned Income Credit [EIC] • 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. Child and Dependent Care Credit • 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. Child and Dependent Care Credit • 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 (for 1 dependent) or • $6000 (for 2 or more dependents) • If spouse is fulltime student, count him/her as earning $250/month (1 child) or $500/month (2+ children) • Must reduce by any amount reimbursed by employer

  8. Education Credits: HOPE Credit • 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 $1,100 + (50% of the next $1,100) • Maximum credit = $1,650 • Phased out when AGI > certain levels [see p. 6-6]

  9. Education Credits: Lifetime Learning Credit (LLC) • 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 - undergraduate, graduate or professional courses qualify • No limit on number of years you may claim LLC

  10. Foreign Tax Credit • 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 xUS tax liability Total US taxable income before credit

  11. Adoption Credit • IRS provides a credit as relief to taxpayers who pay adoption expenses • Credit is amount spent up to $11,390 per adoption [not an annual amount] • Adoption credit phases out when AGI > $170,820 • Different rules • If pay expenses over more than one year or • If foreign adoption or • If 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. Temporary Energy Tax Credits • Credit for hybrid vehicle purchase • Different credit per vehicle based on weight class/fuel economy • Go to irs.gov to get detailed information on available hybrid credits • Credit only applies to first 60,000 sold by manufacturer • As of 10/1/07, no credit available for Prius • Credit for energy saving improvements to principal residence • Lifetime credit up to $500 for energy-efficient expenditures in home • Credit is maximum of $500 for 2006 and 2007 combined • 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. Individual Alternative Minimum Tax • 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. Alternative Minimum Tax 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. Unearned Income of Minor Children • 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 must be taxed at parent’s highest tax rate • Applies to a child with at least one living parent, who is younger than 18 at end of tax year or, beginning in 2008, is a student between 18-24 and has NUI NUI equals Unearned income Less the greater of $850 or investment expenses Less statutory deduction [$850]

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