Chapter 8 Income Taxation of Individuals. Exemptions Chapter 8 Income Taxation of Individuals. Exemptions. Itemized Deductions, Credits Howard Godfrey, Ph.D., CPA UNC Charlotte Copyright © 2014, Dr. Howard Godfrey Edited October 7, 2014.

Part 1. Introduction Part 2. Exemptions – Personal, Dependency Part 3. Filing Status – Joint, Separate, Single, Head of Household Part 4. Deductions From AGI – Std. Deduction, Itemized deduction Part 5. Limits – High income taxpayers’ deductions, Part 6. Standard deduction for children, Kiddie tax Part 7. Tax Credits – Child Credit, Earned income credit, Dependent care, Higher Education Part 8. Filing requirements

Mr. and Ms. Jones have combined salaries of $60,000. Their only expenditures affecting the tax return are state income taxes of $6,000, mortgage interest of $7,000 and real estate taxes amounting to $1,000. They have two small children whom they support, and file a joint return. What is their taxable income for 2014?

Exemptions- Sec. 151, 152 Each taxpayer (who is not a dependent) is entitled to one personal exemption Exemption deduction is $3,950 for 2014 Additional exemptions allowed for each person who is considered a dependent Anyone who is claimed as a dependent cannot claim a personal exemption For purposes of the dependency exemption, a dependent is a qualifying child or qualifying relative

Requirements – all dependents. Sec. 152(b) Must meet these tests You may not claim an exemption for yourself, if you are the dependent of another taxpayer Citizenship test – U.S. or contiguous country Joint Return. Married individual who files a joint return generally is not a dependent of another person

Qualifying Child. Sec. 152(c) Must meet these tests Residency test - live with taxpayer more than 6 months Relationship test – child of taxpayer- or descendent of such child - brother, sister, stepbrother or stepsister of taxpayer, or descendant (of any of these relatives) Age test - under 19 (or under 24 if full-time student) Disabled individual has no age test. Support test - child cannot provide more than half his own support.

Qualifying Relative- Sec. 152(d) These tests must be met: Relationship test - must either be a qualifying relative of the taxpayer or a resident in the taxpayer’s household for the entire year Gross income test - the qualifying relative's gross income from taxable sources must be less than the exemption amount ($3,950 for 2014) Support test (provided by taxpayer) Not a qualifying child for any taxpayer

Qualifying Relative Support Test Taxpayer must provide more than 50% of the dependent's total support Support includes amounts spent for food, clothing, shelter, medical care, education and capital expenditures such as a car Value of services and scholarship funds are omitted in determining support received by a student Dependent’s nontaxable income used for support must be included in support determination

Dependency Exemptions-Joseph-1 Joseph provides $12,000 of support for his mother, Miriam, who lives in his house. Miriam is a U.S. citizen and single. Miriam’s only income is Social Security of $5,000 and taxable pension income of $4,000. Miriam uses the Social Security income for support but puts all of the pension income into her savings account.

Dependency Exemptions-Joseph-2 Joseph also provides $6,000 of support for his 22-year-old son, Mike, who is a full-time student attending college on a basketball scholarship. The balance of Mike’s support comes from a scholarship that pays Mike's $10,000 tuition and fees for the year. How many dependents can Joseph claim on his tax return?

Dependency Exemptions-Joseph-3 One Dependency Exemptions-Joseph-3 One. Miriam is not a child of Joe-she cannot be a qualifying child. Her gross income ($4,000) is above the $3,950 limit so she does meet the gross income test. Tax-free income not in gross inc. Mike is a qualifying child so he qualifies as a dependent.

Multiple Support Agreement Multiple support agreements allow one member of group of support providers to claim the exemption when Together the group meets support test All other dependency tests are met Member who claims exemption must provide more than 10% of the total support and other members providing more than 10% support agree to exemption

Phaseout of Exemptions Personal and dependency exemptions are phased out at a rate of 2% (for each $2,500 (or fraction thereof) ($1,250 for MFS)of AGI above thresholds: $254,200 if single $279,650 if head of household $305,050 if married filing jointly or surviving spouse $152,525 if married filing separately

Exemption Phaseout (AGI – threshold AGI)/$2,500 = Phase-out Factor (always round up to next whole number) Phase-out Factor x 2 = Phase-out Percentage Exemption Amount – Exemption Reduction = Allowable Exemption Deduction

Phaseout of Exemptions What is the total deduction for personal and dependency exemptions for the following taxpayers? Married filing jointly with two dependents and AGI of $400,000

Filing Status Taxpayer’s filing status determines standard deduction and tax rate schedule Marital status determined on the last day of the tax year Separated spouses are considered married until divorce becomes final.

Filing Status - Married Can file jointly if both spouses are US citizens or US residents (or if nonresident alien agrees to be taxed on worldwide income) If the couple files separately, both must itemize deductions or both must use the standard deduction.

Surviving Spouse Marital status is determined at the date of death so a joint return can be filed for the year in which a spouse dies A surviving spouse may continue to use the tax rates and standard deduction for married persons filing jointly for the next 2 years only if a dependent child lives with the taxpayer

Filing Status – Unmarried Unmarried taxpayers file as Head of household - an unmarried person who provides more than half of the cost of maintaining a home in which a qualifying child or other qualifying relative lives for more than half the year Single

Head of Household Claimed if taxpayer is unmarried (and not a surviving spouse) Taxpayer pays more than half the cost of maintaining home which is the principal residence for more than half the year of A qualifying child An individual for whom the taxpayer may claim a dependency exemption A parent is not required to live with taxpayer

Abandoned Spouse A taxpayer who is married but whose spouse did not live with him or her at any time during the last six months of the tax year and who provides more than half the cost of maintaining the home in which a dependent child lives A qualifying abandoned spouse uses head of household tax rates and standard deduction

Standard Deduction Harry and Silvia, a married couple, are both age 67 and legally blind. What is their standard deduction for 2014?

Itemized Deductions Itemized deductions provide tax benefit only to the extent that, in total, they exceed the taxpayer’s standard deduction Taxpayers can maximize use of the standard deduction and itemized deductions by timing certain deductible payments

Medical Expenses-Sec. 213-1 Medical expenses paid for the taxpayer, spouse & dependents, after reduction for insurance reimbursements, are deductible only to the extent they exceed 10% of AGI for the year.

Medical Expenses-2 Qualified medical costs includes prescription drugs and insulin, costs of a hospital, clinic, doctor, dentist, eyeglasses, contract lenses, transportation for medical care and health insurance costs.

Medical Expenses-3 Health insurance premiums for taxpayers and their dependents are deductible only if paid from after-tax income Premiums paid through an employer-sponsored cafeteria plan are not deductible

Medical Expenses-4 Premiums for disability insurance and for loss of life, limb or income are not deductible Premiums for long-term care insurance are deductible, subject to limits based on age

Medical Expense Deduction Daniel's AGI is $90,000 Medical Expense Deduction Daniel's AGI is $90,000. He incurred $14,000 of medical expenses and was reimbursed for $3,000 of these expenses. What is his allowable medical expense deduction if he itemizes?

Taxes – Sec . 164 Deductible taxes include State, local, & foreign real property taxes State & local personal property taxes State, local, & foreign income taxes Other federal, state, local, and foreign taxes incurred in a business or other income-producing activity Can elect to deduct state & local general sales taxes instead of state & local income taxes

Nondeductible Taxes Federal income taxes Employee's share of payroll taxes Federal excise taxes not incurred for business State & local sales taxes on goods for personal use Assessments on property that increase property value

Tax Benefit Rule-1 In 2013, Rebecca and Gregory, a married couple, filed a joint return with AGI of $70,000 and total allowable itemized deductions of $11,000, which included state income taxes paid of $3,100. They received a $900 refund of state income taxes in April 2014. How much of the state income tax refund must they include in income and in which year do they include it?

Tax Benefit Rule-2 Zero. Their itemized deductions of $11,000 did not exceed their standard deduction of $12,200. As there was no tax benefit derived from deducting state income taxes, none of the refund is included in income.

Tax Benefit Rule-3 If their total itemized deductions for 2013 had been $13,000, then $800 ($13,000 - $12,200 standard deduction) of the $900 refund would be included in income in 2014. If their itemized deductions had been $14,000 or more, the entire $900 refund would be included in income in 2014.

Deductible interest includes Interest Expense- Sec. 163 Deductible interest includes Investment interest Home mortgage interest No deduction for most other personal interest such as interest on auto loans, life insurance loans, credit card debt, and delinquent tax payments (except previously mentioned student loan interest)

HW-30 Interest Expense-1 Pablo & Adriana, a married couple (joint return), buy a $190,000 home by paying $38,000 cash down and taking a mortgage for the balance of the purchase price. The mortgage company charges them $3,000 in points for originating the loan that they pay at closing. They pay $7,000 in interest on the mortgage this year. They also purchase a new car this year for $28,000 by taking out a car loan from their credit union. They paid $975 in interest on the car loan this year. How much can Pablo and Adriana deduct for interest expense this year if they itemize their deductions?

Investment Int. Expense-1 Investment interest includes interest on loans to acquire or hold investment property and margin account interest paid to a broker.

Investment Interest Expense-2 Investment interest expense is only deductible to the extent of net investment income. Net investment income = excess of investment income over investment expenses. Excess is carried forward (indefinitely) subject to same limit in future years.

Qualified Residence Interest- Sec. 163(h)(3) Interest paid for acquisition debt or home equity debt for up to 2 qualified residences Interest on acquisition debt of up to $1 million principal amount (combined limit for 2 homes) is deductible Acquisition debt includes mortgage to buy, construct, or improve the residence.

Qualified Residence Interest Interest on up to $100,000 principal amount of home equity loan is deductible Loan proceeds can be used for any purpose

Qualified Residence Interest Points (loan origination fees) paid on initial home mortgages are deductible Points paid to refinance an exiting loan must be amortized over life of loan.

Charitable Contributions – Sec. 170 Congress allows individuals, corporations, estates and trusts to deduct contributions to certain qualified organizations. Partnerships & S corps pass the contributions through to partners and shareholders who then claim deductions on their own tax returns.

Charitable Contributions Qualified charitable organizations Gov. units (federal, state and local govt.) and entities formed and operated exclusively for religious, charitable, scientific, literary or educational purposes, including churches, nonprofit hospitals, school and universities, libraries, and social service agencies Direct contributions to needy individuals are not deductible

Charitable Contributions No deduction allowed to the extent that valuable goods or services are received in return for the contribution Exception - contributors to universities who receive preferred rights to purchase tickets for university athletic events may deduct 80% of the amount of their contribution.

Charitable Contributions Individuals can deduct up to 50% of AGI Excess contributions may be carried forward up to 5 years

Charitable Contributions No deduction for contributions of the taxpayer’s services and rent-free use of the taxpayer’s property Out-of-pocket costs incurred for volunteer work for a qualifying charity are deductible Property other than long-term capital gain property is valued at lesser of FMV or basis

Contributions of LTCG Property LTCG property is valued at FMV (which is often greater than adjusted basis) Tangible personalty given to a charity which does not use the property in its tax-exempt activity is valued at the lower adjusted basis

Contributions of LTCG Property Deduction for LTCG property valued at FMV is limited to 30% of AGI 30% limit can be avoided (and 50% AGI limit applied) if taxpayer elects to use lower basis If made, election applies to all LTCG contributions that year

Charitable Contributions Stocks or other income producing property that have declined in value should be sold so that the loss can be claimed with the sale proceeds donated Fees incurred for appraisals of donated property may be deducted as a misc. itemized deductions Deduction for donated vehicles sold by charity limited to gross sales proceeds

Charitable Contributions-1 Arnold, a single individual, has adjusted gross income of $65,000 in the current year. Arnold donates the following items to his favorite qualified charities: $5,000 cash to the athletic department booster club at State University. This contribution gives him the right to purchase preferred seats to all home games. The value of this preferred right is $900.

Charitable Contributions-2 ABC stock acquired six years ago at a cost of $6,000. FMV at date of contribution was $22,000. Personal clothing items purchased two years ago at a cost of $1,000. FMV at the date of contribution was $400. Charitable contribution in the current year?

Miscellaneous Deductions Only excess over 2% of AGI is deductible Unreimbursed employee business expenses Job hunting expenses (in searching for a new job in current line of business) Investment-related expenses Hobby expenses (up to hobby income) Tax preparation and planning advice

Phase-out of Itemized Deductions Total deductions phased out by 3% of AGI in excess of $305,050 (Joint) in 2014 (single $254,200) Exception - deductions not phased out: Medical expenses Investment interest Casualty and theft losses Total deductions are not reduced by more than 80% regardless of type

Dependent’s Standard Deduction Dependent’s standard deduction is limited to the greater of: $1,000 (in 2014) or Earned income + $350 (up to otherwise allowable standard deduction) Earned income includes salary and wages Earned income does not include interest income, dividend income, capital gains, or income as beneficiary of a trust

Dependent’s Taxable Income Scott is 15 years old and qualifies as a dependent on his parents' tax return. In 2014 he earned $2,200 from a part-time job and received $1,200 of dividend income on stock given to him by his aunt. What is Scott’s taxable income?

K is 8 years old and single K is 8 years old and single. She is claimed as a dependent on her parents' return. She had interest income of $2,050. Her parents have taxable income of $150,000. What is her taxable income for 2014?

Credits vs. Deductions Deductions only reduce tax liability by a percentage based on the taxpayer’s marginal tax rate Credits are direct dollar-for-dollar reductions in the gross tax liability Tax credits have the same dollar value to all taxpayers, regardless of their marginal tax brackets

Child Tax Credit-1 $1,000 nonrefundable tax credit for each qualifying child under age 17 Qualifying children include the taxpayer’s son, daughter, stepson, stepdaughter, grandchild, or eligible foster child that the taxpayer claims as a dependent Note: under a separate computation, some of the credit may be refundable.

Child Tax Credit-2 Phased out at rate of $50 for every $1,000 (or part thereof) of AGI in excess of $110,000 if married filing jointly ($55,000 if MFS) $75,000 if single or head of household

Child Tax Credit Cindy files as head of household and has three dependent children ages 12, 14, and 16. Her AGI is $80,000. Cindy child tax credit?

The earned income credit provides tax relief to low-income taxpayers Credit is refundable The taxpayer may receive a refund if the credit exceeds the tax liability

Earned Income Credit Eligibility Requirements Taxpayer or spouse Must live more than half the year in the U.S. Must be older than 24 and younger than 65 Cannot be a dependent of another May not have portfolio or passive income in excess of $3,400 (2014) Married taxpayers must file jointly

Earned Income Credit Amount Amount of the credit depends on The taxpayer’s earned income Phased-out after maximum limit is reached The number of qualifying children living in the taxpayer’s home Child must be less than 19 years old (24 if full-time student) Must be a natural, step, or foster child and reside with taxpayer more than half of the year Amount is determined using an IRS table

Dependent Care Credit. Sec. 21. -1 Nonrefundable credit for taxpayers who pay for child or dependent care so they can work

Dependent Care Credit -2 Credit percentage varies from 20% to 35% of up to $3,000 (1 qualifying child) or $6,000 for 2 or more qualifying children under 13 35% if AGI does not exceed $15,000 Reduced by 1% for each $2,000 (or fraction thereof) AGI exceeds $15,000 Minimum credit rate is 20% if AGI exceeds $43,000 Credit is not refundable

Dependent Care Credit-Jane June is a single individual with AGI of $45,000. June has a five-year-old son who is in day care while she works. a. How much can she claim for the dependent care credit if she spends $5,000 for child care during the year? b. How much can she claim for the dependent care credit if she spends $3,000 for child care during the year?

Education Credits-1 Two elective (possibly refundable) tax credits for college tuition & fees for the taxpayer, spouse, or dependents (AOTC) (old Hope Credit) – 100% of first $2,000 and 25% of second $2,000 tuition and fees for first 4 years of college. (maximum $2,500 per student per year) Lifetime Learning Credit – 20% of up to $10,000 spent for tuition & fees (max. $2,000 per taxpayer (family)) A student who is a dependent cannot claim the credit. Parent, etc. gets the credit for expense paid by child Note: with first credit, if you spend $2,000, you get a credit of $2,000. Now so with the second one.

Education Credits-2 Expenses paid with a Pell Grant, scholarship, or employer-provided educational assistance do not qualify The election is separate for each student, so a parent may choose one credit for one child and a different credit for a second child Both credits phase out is AGI is above threshold. AOTC (previously the Hope Scholarship credit) $80,000 to $90,000, or $160,000 to $180,000 (Joint) LLC (Lifetime Learning Credit) $54,000 - $64,000, or $109,000 - $129,000 (Joint)

Excess FICA What happens when you work for two companies and they each withhold FICA, resulting in excess withholding? [You earned $40,000 for the first company and $84,000 for the second company.]

Payment of Income Tax Estimated quarterly payments are made by persons with large amounts of income from sources not subject to withholding Due on April 15, June 15, September 15 of current year and January 15 of following year If payments are not 90% or more of the total tax owed (or an amount required based on the prior year’s tax), a penalty may be charged, unless balance due is less than $1,000

Filing Requirements Any taxpayer whose gross income is less than the sum of the standard deduction and the personal exemption (but not dependency exemptions) does not have to file a tax return $10,150 in 2014 for a single individual $20,300 in 2014 for married filing jointly Returns should be filed if Net self-employment income is $400 or more A child claimed as a dependent has unearned income only of over $1,000 Any married person filing separately has income over $3,000

The End