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Chapter 12

Chapter 12. Tax Credits and Payments. The Big Picture. Tom and Jennifer Snyder have two dependent children in college. Lora is a freshman Her tuition and required fees in 2013 total $14,000.

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Chapter 12

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  1. Chapter 12 Tax Credits and Payments

  2. The Big Picture Tom and Jennifer Snyder have two dependent children in college. Lora is a freshman Her tuition and required fees in 2013 total $14,000. She has a scholarship amounting to $6,500, and the Snyders paid the balance of her tuition ($7,500), plus room and board of $8,500. Sam is a junior, and the Snyders paid $8,100 for his tuition plus $7,200 for his room and board. The Snyders have AGI of $158,000. They would like to know what tax options are available to them related to these educational expenses. They have heard about education tax credits, but they believe that their income is too high for them to get any benefit. Are they correct? Read the chapter and formulate your response. 2

  3. Tax Credit VS. Tax Deduction Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer Tax benefit received from a tax credit is not affected by the taxpayer’s marginal tax rate Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates MTR 0%15%35% Tax benefit if a 25% credit is allowed $250 $250 $250 Tax benefit if tax deduction is allowed –0– $150 $350 3

  4. Refundable vs Nonrefundable Credits (slide 1 of 2) • Refundable credits • Paid even if the tax liability is less than amount of credit

  5. Refundable vs Nonrefundable Credits (slide 2 of 2) • Nonrefundable credits • Credit can only be used to offset tax liability • If credit exceeds tax liability, excess is lost • Exception: some nonrefundable credits have carryover provisions for excess

  6. General Business Credit (slide 1 of 2) • Comprised of a number of business credits combined into one amount • Limited to net income tax reduced by greater of: • Tentative minimum tax • 25% of net regular tax liability that exceeds $25,000 • Unused credit is carried back 1 year, then forward 20 years

  7. General Business Credit (slide 2 of 2) • Includes the following: • Tax credit for rehabilitation expenditures • Work opportunity tax credit • Research activities credit • Low-income housing credit • Disabled access credit • Credit for small employer pension plan startup costs • Credit for employer-provided child care

  8. Rehabilitation Expenditure Credit (slide 1 of 3) • Credit is a percentage of expenditures made to substantially rehabilitate industrial and commercial buildings and certified historic structures • Credit rate • 20% for nonresidential and residential certified historic structures • 10% for other structures originally placed into service before 1936

  9. Rehabilitation Expenditure Credit (slide 2 of 3) • To qualify for credit, building must be substantially rehabilitated meaning qualified rehab expenditures exceed the greater of: • The adjusted basis of the property before the rehab expenditures, or • $5,000 • Qualified rehab expenditures do not include the cost of the building and related facilities or cost of enlarging existing building

  10. Rehabilitation Expenditure Credit (slide 3 of 3) • Basis in structure is reduced by the credit amount • Subject to recapture if rehabilitated property held less than 5 years or ceases to be qualifying property

  11. Work Opportunity Tax Credit(slide 1 of 2) Applies to first 12 months of wages paid to individuals falling within target groups Credit limited to a percentage of first $6,000 wages paid per eligible employee 40% if employee has completed at least 400 hours of service to employer 25% if at least 120 hours of service Deduction for wages is reduced by credit amount 11

  12. Work Opportunity Tax Credit(slide 2 of 2) • Targeted individuals generally subject to high rates of unemployment, including • Qualified ex-felons, high-risk youths, food stamp recipients, veterans, summer youth employees, and long-term family assistance recipients • Summer youth employees: Only first $3,000 of wages paid for work during 90-day period between May 1 and September 15 qualify for credit

  13. Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 1 of 2) • Applies to first 24 months of wages paid to individuals who have been long-term recipients of family assistance welfare benefits • Long-term is at least an 18 month period ending on hiring date

  14. Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 2 of 2) • Maximum credit is a percentage of first $10,000 qualified wages paid in first and second year of employment • 40% in first year • 50% in second year • Maximum credit per qualified employee is $9,000 • Deduction for wages is reduced by credit amount

  15. Research Activities Credit (slide 1 of 5) • Comprised of three parts • Incremental research activities credit • Basic research credit • Energy research credit

  16. Research Activities Credit (slide 2 of 5) • Incremental research activities credit • Credit amount = 20% × (qualified expenditures – base amount) • Expenditures qualify if research relates to discovery of technological info intended for use in developing a new or improved business component for taxpayer • Expenditures qualify fully if research done in-house • Only 65% qualifies if research conducted by outside party (under contract)

  17. Research Activities Credit (slide 3 of 5) • Tax treatment of R&E expenditures • Full credit and reduce expense deduction by credit amount • Full expense deduction and reduce credit by (100% × credit × max. corp. tax rate) • Full credit and capitalize research expenses and amortize over 60 months or more • Amount capitalized is reduced by full amount of credit only if the credit exceeds the amount allowable as a deduction

  18. Research Activities Credit (slide 4 of 5) • Basic research credit • Additional 20% credit is allowed on basic research payments in excess of a base amount • Basic research payments - amounts paid in cash to a qualified basic research organization, such as a college or university or a tax-exempt organization operated primarily to conduct scientific research • Basic research is any original investigation for the advancement of scientific knowledge not having a specific commercial objective • The definition excludes basic research conducted outside the United States and basic research in the social sciences, arts, or humanities

  19. Research Activities Credit (slide 5 of 5) • Energy Research Credit – • This credit is intended to stimulate additional energy research • Credit amount = 20% of amounts paid or incurred by a taxpayer to an energy research consortium for energy research

  20. Low-income Housing Credit • Credit is issued on a nationwide allocation program • Credit amount • Based on qualified basis of the property which is dependent on the number of units rented to low-income tenants • Credit is allowed over a 10-year period • Subject to potential recapture

  21. Disabled Access Credit • Credit available for eligible access expenditures made by small businesses • Includes amounts paid to remove barriers that would otherwise make a business inaccessible to disabled and handicapped individuals • Facility qualifies if placed in service before November 6, 1990 • Credit amount • 50% × expenditures that exceed $250 but not in excess of $10,250 • Thus, max. credit is $5,000 • Basis in asset is reduced by credit amount

  22. Credit For Pension Plan Startup Costs • Small businesses can claim nonrefundable tax credit for admin costs of establishing and maintaining a qualified retirement plan • Small business has < 100 employees who have earned at least $5,000 of compensation • Credit amount = 50% of qualified startup costs limited to max credit of $500 per year for 3 years • Deduction for startup costs is reduced by amount of credit

  23. Credit For Employer-Provided Child Care (slide 1 of 2) • Employers can claim a credit for providing child care facilities to their employees during normal working hours • Limited to $150,000 per year • Credit amount: • 25% of qualified child care expenses • 10% of qualified child care resource and referral services

  24. Credit For Employer-Provided Child Care (slide 2 of 2) • Deductible qualifying expenses must be reduced by the credit amount • Basis of qualifying property must be reduced by credit amount • Credit may be subject to recapture if child care facility ceases to be used for qualifying purpose within 10 years of being placed in service

  25. Earned Income Credit (slide 1 of 3) • 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

  26. Earned Income Credit (slide 2 of 3) • Credit amount (2013 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 $22,870 for MFJ with qualifying child ($17,530 for other taxpayers) • Use IRS tables to calculate exact credit amount

  27. Earned Income Credit (slide 3 of 3) • Credit for taxpayers having no children • Available to taxpayers aged 25 through 64 • Credit amount for couple filing jointly with no qualifying children (2013 tax year) • 7.65% × earned income (up to $6,370) • Phase-out of credit begins when earned income (or AGI) exceeds $13,310 for MFJ ($7,970 for others)

  28. Credit for Elderly or Disabled Taxpayers (slide 1 of 2) • General qualifications • Age 65 or older, or • Under age 65 and permanently and totally disabled

  29. Credit for Elderly or Disabled Taxpayers (slide 2 of 2) • Credit amount • Maximum credit = $1,125 • Amount reduced for taxpayers with Social Security benefits or AGI in excess of specified amounts • IRS will calculate credit for taxpayer if necessary

  30. Foreign Tax Credit(slide 1 of 2) • The purpose of the foreign tax credit (FTC) is to mitigate double taxation since income earned in a foreign country is subject to both U.S. and foreign taxes • Credit applies to both individuals and corporations that pay foreign income taxes • Instead of claiming a credit, a deduction may be claimed for the taxes paid

  31. Amount of the credit allowed is the lesser of: The foreign taxes imposed, or The overall limitation determined using the following formula: Foreign-source TI ×U.S. tax before credit Worldwide TI = Overall FTC limitation For individual taxpayers, worldwide taxable income is determined before personal and dependency exemptions Unused FTCs can be carried back 1 year and forward 10 years Foreign Tax Credit(slide 2 of 2)

  32. 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 $12,970 (in 2013) • Credit is phased-out ratably for modified AGI between $194,580 and $234,580 (in 2013)

  33. 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

  34. 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

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

  36. 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

  37. 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

  38. 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

  39. 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

  40. 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

  41. 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 2013) • Cannot be claimed in same year the American Opportunity credit is claimed

  42. 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

  43. Education Tax Credits(slide 4 of 5) • Both education credits are subject to income limitations, which differ for 2009 through 2012 • 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)

  44. Education Tax Credits(slide 5 of 5) • The lifetime learning credit amount is phased out when modified AGI reaches $53,000 ($107,000 for MFJ) • The credit is completely eliminated when AGI reaches $63,000 ($127,000 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

  45. The Big Picture - Example 32American Opportunity Credit Return to the facts of The Big Picture on p. 12-1. Recall that Tom and Jennifer Snyder are married, file a joint tax return, have modified AGI of $158,000. Both Lora (a freshman) and Sam (a junior) are full-time students and are Tom and Jennifer’s dependents. The Snyders paid the following education expenses. $7,500 of tuition and $8,500 for room and board for Lora, and $8,100 of tuition plus $7,200 for room and board for Sam. Lora’s and Sam’s tuition are qualified expenses for the American Opportunity credit. For 2013, Tom and Jennifer may claim a $2,500 American Opportunity credit [(100% $2,000) + (25% $2,000)] for both Lora’s and Sam’s expenses. In total, a $5,000 American Opportunity credit. 45

  46. The Big Picture - Example 33American Opportunity Credit Phaseout Return to the facts of The Big Picture on p. 12-1. Now assume that Tom and Jennifer’s modified AGI for 2013 is $172,000 instead of $158,000. Tom and Jennifer are eligible to claim a $2,000 American Opportunity credit for 2013. Their $5,000 available American Opportunity credit must be reduced because their AGI exceeds the $160,000 limit for married taxpayers. The percentage reduction is computed as the amount by which modified AGI exceeds the limit, expressed as a percentage of the phaseout range, or ($172,000 - $160,000)/$20,000) = 60% reduction. Therefore, the maximum available credit for 2013 is $2,000. $5,000 X 40% allowable portion. 46

  47. The Big Picture - Example 34Lifetime Learning Credit Return to the facts of The Big Picture on p. 12-1. Assume that Tom and Jennifer’s modified AGI is $121,000 and that Tom is going to school part-time to complete a graduate degree He pays qualifying tuition and fees of $4,000 during 2013. As Tom and Jennifer’s modified AGI is below $160,000, a $5,000 American Opportunity credit is available to them for Lora and Sam’s tuition . In addition, Tom’s qualifying expenses are eligible for the lifetime learning credit. The available lifetime learning credit of $800 ($4,000 X 20%) must be reduced because their modified AGI exceeds the $107,000 limit for married taxpayers. As their modified AGI exceeds the $107,000 limit by $14,000 and the phaseout range is $20,000, their lifetime learning credit is reduced by 70%. Therefore, their lifetime learning credit for 2013 is $240 ($800 X 30%) Their total education credits amount to $5,240 $5,000 American Opportunity credit and $240 lifetime learning credit. 47

  48. Credit For Certain Retirement Plan Contributions • Credit was enacted to encourage low and middle income taxpayers to contribute to qualified retirement plans • Eligible contributions of up to $2,000 qualify • Credit rate depends on level of AGI and filing status • Maximum credit is $1,000 ($2,000 × 50%) • To qualify, must be at least 18 years old and not a dependent of another taxpayer or a full-time student

  49. Small Employer Health Insurance Credit • Health Care Act of 2010 provides a tax credit for a qualified small employer for nonelective contributions to purchase health insurance for its employees beginning in 2010 • To qualify for credit, employer must • Have no more than 25 full-time equivalent employees whose annual full-time wages average no more than $50,000 • Pay at least half the cost of the health insurance premiums • The credit is 35% of the health insurance premiums paid in 2010 through 2013 • 50% in years after 2013 • It is subject to a phaseout if the employer has more than 10 full-time equivalent employees and/or has annual full-time wages that average more than $25,000

  50. Payment Procedures(slide 1 of 8) Employer is responsible for withholding income taxes and employees’ share of FICA employment taxes (Social Security and Medicare) Also, employer must match FICA and pay full cost of FUTA (unemployment taxes) 50

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