Tax Accounting - Chapter 8
Exceptions to the basic tax computation Taxpayers should perform to additional computations to determine their tax liability if
1. When they recognize: a) long-term capital gains (0, 15, 20 percent) b) received dividends that are taxed at preferential (lower) rates (0, 15, 20 percent) 2. When the taxpayer is a child and the child's unearned is taxed using trusts and estates tax rates.
Tax brackets or marginal tax rates on ordinary income:
10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent
Net Investment Income Tax
3.8 percent tax imposed on lesser of: • Net investment income (e.g., interest, dividends, annuities, royalties, rents, passive activity income, net gains from disposing of property, less related allowed deductions) or • Excess of modified AGI over $250,000 (MFJ), $125,000 (MFS), and $200,000 (all others).
American Opportunity Tax Credit Example (2) How much AOTC would Courtney have been allowed to claim on her 2020 tax return if she were married and filed a joint return with her husband (assuming the couple's AGI is $162,000)?
Answer: $1,867
Tax Computation Example Assume that Courtney's taxable income is $479,050, including $15,000 of qualifying dividends taxed at the preferential rate. What would be Courtney's tax liability under these circumstances?
Answer: $138,521 *Courtney had $15,000 of preferentially taxed income. $10,000 of her dividends fall in the 20 percent preferential tax bracket ($479,050 taxable income − $469,050 end of 20 percent preferential tax bracket; see preferential tax rate schedule for head of household). The remaining $5,000 is taxed at 15 percent (15 percent bracket for preferentially tax income extends from $53,601 to $469,050 for head of household).
American Opportunity Tax Credit Example (1) Courtney paid $2,000 of tuition and $300 for books for Ellen to attend the University of Missouri-Kansas City during the summer following the end of her first year. What is the maximum American opportunity tax credit (AOTC) (before phase-out) Courtney may claim for these expenses?
Answer: $2,075 Because the cost of tuition and books is an eligible expense, Courtney may claim a maximum AOTC before phase-out of $2,075 [($2,000 × 100%) + ($2,300 − $2,000) × 25%].
Due dates
April 15-Extend filing up to six months (May not extend due date for paying taxes.)
Kiddie Tax Example: Suppose that during 2020, Deron received $5,200 in interest from an IBM bond, and he received another $2,100 in interest income from a money market account that his parents have been contributing to over the years. What is Deron's taxable income? (Deron's mother Courtney is subject to a 24% marginal tax rate.)
Because Deron is younger than 18 years of age at the end of the year and his net unearned income exceeds $2,200, he is potentially subject to the kiddie tax. Deron's taxable income is $6,200.
Marriage penalty or benefit, who is likely to have a penalty?
Both spouses receive income.
Regular tax computation dependent upon:
Filing status • Married filing jointly • Qualifying widow or widower (also called surviving spouse) • Married filing separately • Head of household • Single
Filing Requirements
Individual taxpayers are required to file a tax return only if their gross income exceeds certain thresholds, which vary based on the taxpayer's filing status and age.
Nonrefundable Personal
Lifetime learning credit -Eligible expenses (tuition) for any course of instruction to acquire or improve taxpayer's job skills -Includes professional or graduate school -Includes continuing education • Applied per taxpayer -MFJ return is one taxpayer. •20 percent of up to $10,000 of eligible expenses (maximum of $2,000) -Phase-out based on AGI
Kiddie Tax
Net unearned income taxed at parents' marginal rate. Net unearned income = unearned income in excess of $2,200
If net earnings from self-employment < $400 then
No self-employment tax.
Marriage penalty or benefit, who is likely to have a benefit?
One spouse receives income.
Determining whether taxpayer is employee or independent contractor
Primary question: who has control over how, when, where work is performed?
Underpayment Penalties
Safe-harbor provisions - 90 percent of current tax liability or - 100 percent of previous-year tax liability (110 percent for individuals with AGI greater than $150,000) • Applied on a quarterly basis - 90%/4 = 22.5% of current-year liability must be paid in by deadline, or - 100%/4 = 25% of previous year's liability must be paid in by deadline (110% for taxpayers with AGI > $150,000). • Penalty based on amount of underpayment at each quarter × federal short-term rate + 3%.
Kiddie Tax Example: Suppose that during 2020, Deron received $5,200 in interest from an IBM bond, and he received another $2,100 in interest income from a money market account that his parents have been contributing to over the years. What is Deron's tax liability? (Deron's mother Courtney is subject to a 24% marginal tax rate.)
Tax Liability of $1,334
Progressive tax rates
Tax rate schedules with tax rates ranging from 10 percent to 37 percent.
How does the $137,700 Social Security earnings limit apply when receiving both wages and self-employment earnings in the same year?
Wages use up limit first—favorable or unfavorable for taxpayer? Why?
Late Filing Penalty
• 5 percent of tax owed per month up to 25 percent if not fraudulent; 15 percent of tax owed per month up to 75 percent if fraudulent. • No penalty if no tax is owed as of the due date.• •If don't pay entire tax owed by due date of return - .5 percent of the tax owed for each month (or fraction of a month) that the tax is not paid • Combined late filing and late payment penalties may not exceed maximum amounts for either one.
Kiddie Tax Applies if
• Child is under age 18 at year-end • Child is 18 at year-end but earned income not greater than half of child's support, or • Child is over age 18 but under age 24 at year-end, is a full-time student during the year, and child's earned income not greater than half of child's support (excluding scholarships).
Child and Dependent Care Credit
• Dependent under age of 13 (or disabled dependent) • Amount of credit is based on amount of taxpayer's expenditures to provide care for one or more qualifying persons • Percentage qualifying expenditures -Maximum qualifying expenditures: $3,000 for one qualifying person, $6,000 for two or more -Credit Care percentage depends on AGI
American opportunity tax credit (AOTC)
• For the first four years of postsecondary education •For eligible expenses and institutions only • Applied per student -Taxpayer, taxpayer's dependents, third parties on behalf of taxpayer's dependents -Amounts paid by dependents treated as paid by taxpayer. • 100 percent of first $2,000 of eligible expenses and 25% of next $2,000 (maximum credit is $2,500) • Phase-out based on AGI • 40 percent of credit is refundable (subject to restrictions).
Education credits
• If deduct for AGI education expenses for someone, no education credit allowed for that person -Could take American opportunity tax credit for one dependent and for AGI deduction for another
Preferential Tax Rates for Capital Gains and Dividends
• Long-term capital gains (net capital gains) - Generally 0, 15, or 20 percent, but can be as high as 28 percent - Two different tax rates on one gain is possible. • Dividends - Qualified dividends generally taxed at 0, 15, or 20 percent. - Two different tax rates on one dividend is possible.
Earned Income Credit (Refundable Personal)
• Negative income tax • Must have earned income • Must have at least one qualifying child or must be at least 25 years old and less than 65 and not a dependent of another
Business Tax Credits (Tax Credits)
• Promote certain behaviors • If the credit exceeds gross tax, carry back one year and carry forward 20 years. • Foreign Tax Credit -Nonrefundable; carry back one year and carry forward up to 10 years.
Prepayments and Filing Requirements
• Taxes must be paid as you go. • Withholdings - Treated as made equally throughout the year • Estimated tax payments - Due on April 15, June 15, and September 15 of the current year and January 15 of the following year
Nonrefundable Personal - Child Tax Credit
•$2,000 for each qualifying child under age 17 at end of year who is claimed as taxpayer's dependent (Partially refundable) •$500 for each other qualifying dependent •Phase-out amount, not percentage
Tax differences
•Amount of FICA or self-employment taxes payable •Deductibility of expenses -For AGI -From AGI -Employer portion of self-employment taxes
Employment FICA Taxes (Employee)
•Must pay FICA taxes on compensation from employer (6.2 percent Social Security tax rate; 1.45 percent Medicare tax rate; .9 percent additional Medicare tax rate on salary or wages in excess of $200,000 [$125,000 for married filing separately; $250,000 married filing jointly]) •$137,700 limit applies to Social Security portion. •Multiple employers during year•
Employment FICA Taxes (Employer)
•Pays FICA tax on employee's compensation (6.2 percent Social Security tax rate; 1.45 percent Medicare tax rate) •Withholds FICA tax from employee's paycheck
Tax Credits
•Reduce tax liability dollar-for-dollar •Consist of three categories -Nonrefundable personal -Refundable personal -Business
Self-employed taxpayers
•Responsible for entire FICA tax (employee and employer share and additional Medicare tax) •Tax base is net earnings from self-employment (generally, net Schedule C income and multiply by .9235 -> 92.35%). •Same $137,700 limit applies to Social Security portion.
