Individual Income Taxes C13-1 Chapter 13 Tax Credits and Payment Procedures Copyright ©2009 Cengage Learning Individual Income Taxes

C13-2 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 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

Individual Income Taxes C13-3 Refundable vs Nonrefundable Credits (slide 1 of 2) Refundable credits –Paid even if the tax liability is less than amount of credit Refundable credits –Paid even if the tax liability is less than amount of credit

Individual Income Taxes C13-4 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 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

Individual Income Taxes C13-5 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 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

Individual Income Taxes C13-6 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 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

Individual Income Taxes C13-7 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 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

Individual Income Taxes C13-8 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 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

Individual Income Taxes C13-9 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 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

Individual Income Taxes C13-10 Disabled Access Credit –Credit available for eligible access expenditures made by small businesses –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 –Credit available for eligible access expenditures made by small businesses –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

Individual Income Taxes C13-11 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 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

Individual Income Taxes C13-12 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 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

Individual Income Taxes C13-13 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 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

Individual Income Taxes C13-14 Earned Income Credit (slide 1 of 3) General qualifications for credit –Must have earned income from being an employee or self-employed, and –Must have a qualifying child Exception: credit is available for some taxpayers having no children Qualifying child generally has the same meaning as it does for purposes of determining who qualifies as a dependent General qualifications for credit –Must have earned income from being an employee or self-employed, and –Must have a qualifying child Exception: credit is available for some taxpayers having no children Qualifying child generally has the same meaning as it does for purposes of determining who qualifies as a dependent

Individual Income Taxes C13-15 Earned Income Credit (slide 2 of 3) Credit amount (2008 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 $18,740 for MFJ with qualifying child ($15,740 for other taxpayers) Use IRS tables to calculate exact credit amount Credit amount (2008 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 $18,740 for MFJ with qualifying child ($15,740 for other taxpayers) Use IRS tables to calculate exact credit amount

Individual Income Taxes C13-16 Earned Income Credit (slide 3 of 3) Credit for taxpayers having no children –Taxpayers aged 25 through 64 Credit amount for couple filing jointly with no qualifying children (2008 tax year) –7.65% × earned income (up to $5,720) –Phase-out of credit begins when earned income (or AGI) exceeds $10,160 for MFJ ($7,160 for others) Credit for taxpayers having no children –Taxpayers aged 25 through 64 Credit amount for couple filing jointly with no qualifying children (2008 tax year) –7.65% × earned income (up to $5,720) –Phase-out of credit begins when earned income (or AGI) exceeds $10,160 for MFJ ($7,160 for others)

Individual Income Taxes C13-17 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 General qualifications –Age 65 or older, or –Under age 65 and permanently and totally disabled

Individual Income Taxes C13-18 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 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

Individual Income Taxes C13-19 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 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

Individual Income Taxes C13-20 Foreign Tax Credit (slide 2 of 2) 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 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

Individual Income Taxes C13-21 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 $11,650 (in 2008) –Credit is phased-out ratably for modified AGI between $174,730 and $214,730 Credit for qualified adoption expenses incurred in adoption of eligible child –Examples of expenses: adoption fees, court costs, attorney fees Maximum credit is $11,650 (in 2008) –Credit is phased-out ratably for modified AGI between $174,730 and $214,730

Individual Income Taxes C13-22 Adoption Expenses Credit (slide 2 of 2) Eligible child is one that is –Less than 18 years of age, or –Physically or mentally handicapped Nonrefundable credit –Excess may be carried forward for five years Married taxpayers must file jointly to claim Eligible child is one that is –Less than 18 years of age, or –Physically or mentally handicapped Nonrefundable credit –Excess may be carried forward for five years Married taxpayers must file jointly to claim

Individual Income Taxes C13-23 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 Credit amount is $1,000 per child Eligible children are: –Under age 17, –US citizen, and –Claimed as dependent on taxpayer’s tax return

Individual Income Taxes C13-24 Child Tax Credit (slide 2 of 2) Credit is phased out by $50 for each $1,000 of AGI above specified levels –$110,000 for joint filers –$55,000 for married filing separately –$75,000 for single Credit is phased out by $50 for each $1,000 of AGI above specified levels –$110,000 for joint filers –$55,000 for married filing separately –$75,000 for single

Individual Income Taxes C13-25 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 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

Individual Income Taxes C13-26 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 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

Individual Income Taxes C13-27 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, handicapped 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 Eligible care costs defined –Costs for care of qualified individual within taxpayer’s home or outside home If outside home, handicapped 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

Individual Income Taxes C13-28 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 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

Individual Income Taxes C13-29 Education Tax Credits (slide 1 of 4) 2 education tax credits are available –Hope scholarship credit –Lifetime learning credit Both nonrefundable credits are available for qualifying tuition and related expenses –Room, board, and book costs are ineligible for the credits 2 education tax credits are available –Hope scholarship credit –Lifetime learning credit Both nonrefundable credits are available for qualifying tuition and related expenses –Room, board, and book costs are ineligible for the credits

Individual Income Taxes C13-30 Education Tax Credits (slide 2 of 4) Maximum credits –Hope scholarship credit maximum per eligible student is $1,800 per year for first 2 years of postsecondary education in % of first $1,200 of qualifying expenses plus 50% of next $1,200 of qualifying expenses –Lifetime learning credit maximum per taxpayer is 20% of qualifying expenses (up to $10,000 per year in 2008) Cannot be claimed in same year the Hope credit is claimed Maximum credits –Hope scholarship credit maximum per eligible student is $1,800 per year for first 2 years of postsecondary education in % of first $1,200 of qualifying expenses plus 50% of next $1,200 of qualifying expenses –Lifetime learning credit maximum per taxpayer is 20% of qualifying expenses (up to $10,000 per year in 2008) Cannot be claimed in same year the Hope credit is claimed

Individual Income Taxes C13-31 Education Tax Credits (slide 3 of 4) Eligible individuals include: –Taxpayer, –Spouse, and –Taxpayer’s dependent To be eligible for Hope credit, student must take at least 1/2 of full-time course load –No such requirement for lifetime learning credit Eligible individuals include: –Taxpayer, –Spouse, and –Taxpayer’s dependent To be eligible for Hope credit, student must take at least 1/2 of full-time course load –No such requirement for lifetime learning credit

Individual Income Taxes C13-32 Education Tax Credits (slide 4 of 4) Income limitations –Both education credits are combined and phased out for AGI of $96,000 to $116,000 for married filing jointly and $48,000 to $58,000 for others Taxpayers can’t receive a double tax benefit for education expenses –Can’t claim a credit for amounts otherwise excluded from income (e.g., scholarships and employer-paid education assistance) –May claim credit and exclude from gross income amounts distributed from a Coverdell Education Savings Account in same tax year but not for same expenses Income limitations –Both education credits are combined and phased out for AGI of $96,000 to $116,000 for married filing jointly and $48,000 to $58,000 for others Taxpayers can’t receive a double tax benefit for education expenses –Can’t claim a credit for amounts otherwise excluded from income (e.g., scholarships and employer-paid education assistance) –May claim credit and exclude from gross income amounts distributed from a Coverdell Education Savings Account in same tax year but not for same expenses

Individual Income Taxes C13-33 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 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

Individual Income Taxes C13-34 Recovery Rebate Credit (slide 1 of 2) The Economic Stimulus Act of 2008 provides a refundable tax credit for certain taxpayers –The Treasury Department issued rebate checks to taxpayers in the spring of 2008 to help stimulate the economy The credit includes two components—a basic credit and a qualifying child credit The Economic Stimulus Act of 2008 provides a refundable tax credit for certain taxpayers –The Treasury Department issued rebate checks to taxpayers in the spring of 2008 to help stimulate the economy The credit includes two components—a basic credit and a qualifying child credit

Individual Income Taxes C13-35 Recovery Rebate Credit (slide 2 of 2) Eligible individuals received a basic credit equal to the greater of: –The taxpayer’s net income tax liability up to a maximum of $600 ($1,200 in the case of a joint return), or –$300 ($600 for joint returns) if the individual had: At least $3,000 of earned income (plus Social Security benefits), or Net income tax liability of at least $1 and gross income greater than the sum of the applicable basic standard deduction amount and one personal exemption (two personal exemptions for a joint return) If an individual is eligible for any amount of the basic credit, the individual also may have received a qualifying child credit of $300 for each qualifying child (defined in the same manner as for the child tax credit) Eligible individuals received a basic credit equal to the greater of: –The taxpayer’s net income tax liability up to a maximum of $600 ($1,200 in the case of a joint return), or –$300 ($600 for joint returns) if the individual had: At least $3,000 of earned income (plus Social Security benefits), or Net income tax liability of at least $1 and gross income greater than the sum of the applicable basic standard deduction amount and one personal exemption (two personal exemptions for a joint return) If an individual is eligible for any amount of the basic credit, the individual also may have received a qualifying child credit of $300 for each qualifying child (defined in the same manner as for the child tax credit)

Individual Income Taxes C13-36 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) 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)

Individual Income Taxes C13-37 Payment Procedures (slide 2 of 8) Social Security & Medicare –2008 rates Social Security: 6.2% of first $102,000 wages Medicare: 1.45% of all wages Employee and employer both pay at these rates –If employee is overwithheld for Social Security, excess is refundable credit Social Security & Medicare –2008 rates Social Security: 6.2% of first $102,000 wages Medicare: 1.45% of all wages Employee and employer both pay at these rates –If employee is overwithheld for Social Security, excess is refundable credit

Individual Income Taxes C13-38 Payment Procedures (slide 3 of 8) Federal withholding –Employee files Form W-4 with employer indicating marital status and withholding allowances –Form W-2 issued by employer summarizes employee’s wages, income tax withholding, and FICA Must be issued to employee by January 31 following year-end Federal withholding –Employee files Form W-4 with employer indicating marital status and withholding allowances –Form W-2 issued by employer summarizes employee’s wages, income tax withholding, and FICA Must be issued to employee by January 31 following year-end

Individual Income Taxes C13-39 Payment Procedures (slide 4 of 8) Estimated payments (ES payments) –Any taxpayer (employee or self-employed) who will owe at least $1,000 in taxes for the year (and meets none of the exceptions) must make ES payments Estimated payments (ES payments) –Any taxpayer (employee or self-employed) who will owe at least $1,000 in taxes for the year (and meets none of the exceptions) must make ES payments

Individual Income Taxes C13-40 Payment Procedures (slide 5 of 8) ES payments –To avoid penalties for underpayment, must annually pay the smaller of: 90% of the current year’s tax, or 100% of last year’s tax –Exception: Increased to 110% of last year’s tax if AGI last year exceeded $150,000 ($75,000 if married filing separately) ES payments –To avoid penalties for underpayment, must annually pay the smaller of: 90% of the current year’s tax, or 100% of last year’s tax –Exception: Increased to 110% of last year’s tax if AGI last year exceeded $150,000 ($75,000 if married filing separately)

Individual Income Taxes C13-41 Payment Procedures (slide 6 of 8) ES payments –For calendar year individual taxpayer, ES payments of 1/4 of annual amount are due April 15, June 15, and September 15 of the tax year, and January 15 of the following year ES payments –For calendar year individual taxpayer, ES payments of 1/4 of annual amount are due April 15, June 15, and September 15 of the tax year, and January 15 of the following year

Individual Income Taxes C13-42 Payment Procedures (slide 7 of 8) Self-employment tax –Taxpayers with net self-employment earnings of at least $400 must pay self-employment tax 2008 rates –Social Security: 12.4% of first $102,000 net self- employment income –Medicare: 2.9% of all net self-employment income These rates are twice what an employee pays on wages Self-employment tax –Taxpayers with net self-employment earnings of at least $400 must pay self-employment tax 2008 rates –Social Security: 12.4% of first $102,000 net self- employment income –Medicare: 2.9% of all net self-employment income These rates are twice what an employee pays on wages

Individual Income Taxes C13-43 Payment Procedures (slide 8 of 8) Self-employment tax –Taxpayer receives a deduction from net self- employment income of 7.65% for purposes of calculating the actual self-employment tax –Taxpayer receives a FOR AGI deduction for 50% of the self-employment tax paid Self-employment tax –Taxpayer receives a deduction from net self- employment income of 7.65% for purposes of calculating the actual self-employment tax –Taxpayer receives a FOR AGI deduction for 50% of the self-employment tax paid