1. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. CHAPTER 6 Credits and Special Taxes Income Tax Fundamentals 2007 Gerald E. Whittenburg & Martha Altus-Buller

2. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Tax Credits  Illustration of difference between a $1,500 deduction and a $1,500 credit  Deduction Credit  TI (before)$ 70,000$ 70,000  Deduction (1,500) -0-  TI$ 68,500$ 70,000  Tax Liability$ 13,796$ 14,171  Credit -0- (1,500)  Tax due$ 13,796$ 12,671  *This is assuming a single taxpayer in the 25% tax bracket – using 2005 tax tables Illustration of difference between a $1,500 deduction and a $1,500 credit Deduction Credit TI (before)$ 70,000$ 70,000 Deduction (1,500) -0- TI$ 68,500$ 70,000 Tax Liability$ 13,796$ 14,171 Credit -0- (1,500) Tax due$ 13,796$ 12,671 *This is assuming a single taxpayer in the 25% tax bracket – using 2005 tax tables

4. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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)

5. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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 Between ages 25 and 65 and not someone else’s dependent “Disqualified income” [certain type of investment income] must be $2800 or less  With kids, EIC available if Child meets definition of “qualifying child” Single or married taxpayers and file MFJ Earned income meets certain guidelines

6. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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  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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Child and Dependent Care Credit  Determine qualifying expenses In-home and out-of-home care Day camps qualify, but not overnight camps  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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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 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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Education Credits: Lifetime Learning Credit (LLC)  Provides tax relief for higher education expenses; meant to encourage taxpayers to take courses to acquire/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 - u ndergraduate, graduate or professional courses qualify No limit on number of years you may claim LLC

10. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Foreign Tax Credit  US taxpayers are allowed foreign tax credit on income earned in foreign country and subject to income taxes in that country  Provides relief from double taxation on money generated from foreign sources Then take credit up to amount paid foreign governments But limited to maximum credit = Net foreign income x US tax liability Total US taxable income before credit Total US taxable income before credit

11. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Adoption Credit  IRS provides a credit as relief to taxpayers who pay adoption expenses  Credit is amount spent up to $10,960 per adoption [not an annual amount] Adoption credit phases out when AGI > $164,410 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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Temporary Energy Tax Credits  Available tax years 2006-2007  Credit for hybrid vehicle purchase Each model has different credit based on weight class/fuel economy Will phase out for existing hybrids as only applies to first 60,000 sold by manufacturer  Energy saving improvements to home Up to $500 for percentage of energy-efficient expenditures in home combined credit 2006-2007 Improvement must be expected to stay in use for five years  Alternative Energy Expenditures Up to $2000 per year for 30% of amount paid for qualified solar water heaters and photovoltaic property - total $8000 over 2 years 30% credit for fuel cell property – max credit of $500 for each.5 kilowatt, with no cap on total credit

13. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Alternative Minimum Tax Calculation of Alternative Minimum Taxable Taxable Income (from 1040) +/- 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. ©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 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 the parent’s highest tax rate Applies to children who are younger than 18 at end of tax year, have at least one living parent and have NUI  NUI equals  Unearned income  Less the greater of $850 or investment expenses  Less statutory deduction [$850]