CH 12: Tax Credits and Payments

Refundable Credits

-Taxes withheld on wages -Earned income credit -Affordable Care Act premium tax credit

An additional 0.9 percent Medicare tax is imposed on wages received in excess of $250,000 for married taxpayers filing a joint return ($125,000 if married filing separately) and $200,000 for all other taxpayers.43 Unlike the general 1.45 percent Medicare tax on wages, the additional tax on a joint return is computed on the combined wages of the employee and the employee's spouse. As a result, the Medicare tax rate is:

1. 1.45 percent on the first $200,000 of wages ($125,000 on a married filing separate return; $250,000 of combined wages on a married filing joint return), and 2. 2.35 percent (1.45% 1 0.9%) on wages in excess of $200,000 ($125,000 on a married filing separate return; $250,000 of combined wages on a married filing joint return).

The additional Medicare tax also applies to self-employed individuals; net earnings from self-employment are used for the threshold computations. As a result, the tax rate for the Medicare tax on self-employment income is:

1. 2.9 percent on the first $200,000 of net earnings from self-employment ($125,000 on a married filing separate return; $250,000 on a married filing joint return), and 2. 3.8 percent (2.9% + 0.9%) on net earnings from self-employment in excess of $200,000 ($125,000 on a married filing separate return; $250,000 on a married filing joint return).

Additional Medicare Tax on Unearned Income (Net Investment Income Tax or NIIT) An additional 3.8 percent Medicare tax is imposed on the unearned income of individuals, estates, and trusts.44 For individuals, the tax is 3.8 percent of the lesser of:

1. Net investment income, or 2. The excess of modified adjusted gross income over $250,000 for married taxpayers filing a joint return ($125,000 if married filing separately) and $200,000 for all other taxpayers.45 In general, "net investment income" includes interest, dividends, annuities, royalties, rents, income from passive activities, and net gains from the sale of investment property less deductions allowed in generating that income.46

Qualified expenditures are eligible for the 20 percent credit, and they can be deducted in the year incurred.13 The taxpayer chooses among three options.

1.Use the full credit and reduce the expense deduction for research expenses by 100 percent of the credit, or 2.Retain the full expense deduction and reduce the credit by the product of the full credit times the Federal corporate income tax rate (21 percent), or 3.Use the full credit, capitalize the research expenses, and amortize them over 60 months or more.

Foreign tax credit (FTC)

A U.S. citizen or resident who incurs or pays income taxes to a foreign country on income subject to U.S. tax may be able to claim some of these taxes as a credit against the U.S. income tax. §§ 27 and 901-905.

Rehabilitation expenditures credit

A credit that is based on expenditures incurred to rehabilitate industrial and commercial buildings and certified historic structures. The credit is intended to discourage businesses from moving from older, economically distressed areas to newer locations and to encourage the preservation of historic structures. § 47.

Nonrefundable credits

A credit that is not paid if it exceeds the taxpayer's tax liability. Some nonrefundable credits qualify for carryback and carryover treatment.

Refundable credits

A credit that is paid to the taxpayer even if the amount of the credit (or credits) exceeds the taxpayer's tax liability.

Credit for small employer pension plan startup costs

A nonrefundable credit available to small businesses based on administrative costs associated with establishing and maintaining certain qualified plans. While such qualifying costs generally are deductible as ordinary and necessary business expenses, the availability of the credit is intended to lower the costs of starting a qualified retirement program and therefore encourage qualifying businesses to establish retirement plans for their employees. The credit is available for eligible employers at the rate of 50 percent of qualified startup costs. The maximum credit is $500 (based on a maximum $1,000 of qualifying expenses). § 45E.

Credit for certain retirement plan contributions

A nonrefundable credit is available based on eligible contributions of up to $2,000 to certain qualified retirement plans, such as traditional and Roth IRAs and § 401(k) plans. The benefit provided by this credit is in addition to any deduction or exclusion that otherwise is available resulting from the qualifying contribution. The amount of the credit depends on the taxpayer's AGI and filing status. § 25B.

Credit for employer-provided family and medical leave

A nonrefundable credit is available to employers who pay wages to employees while they are on family and medical leave. The credit is equal to 12.5 percent of wages paid to qualifying employees (limited to 12 weeks per employee per year). Employers must pay a minimum of 50 percent of the wages normally paid; if wages paid during the leave exceed 50 percent of normal wages, the credit is increased by 0.25 percent for each percentage point above 50 percent to a maximum of 25 percent of wages paid. The credit does not apply to wages paid in taxable years beginning after 2020. § 45S.

Child tax credit

A tax credit based solely on the number of qualifying children under age 17. The maximum credit available is $2,000 per qualifying child. (In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children.) A qualifying child must be claimed as a dependent on a parent's tax return and have a Social Security number to qualify for the credit. Taxpayers who qualify for the child tax credit may also qualify for a supplemental credit. The supplemental credit is treated as a component of the earned income credit and is therefore refundable. The credit is phased out for higher-income taxpayers. § 24. See also dependent tax credit.

Disabled access credit

A tax credit designed to encourage small businesses to make their facilities more accessible to disabled individuals. The credit is equal to 50 percent of the eligible expenditures that exceed $250 but do not exceed $10,250. Thus, the maximum amount for the credit is $5,000. The adjusted basis for depreciation is reduced by the amount of the credit. To qualify, the facility must have been placed in service before November 6, 1990. § 44.

Earned income credit

A tax credit designed to provide assistance to certain low-income individuals who generally have a qualifying child. This is a refundable credit. To receive the most beneficial treatment, the taxpayer must have qualifying children. However, it is possible to qualify for the credit without having a child. See the text chapter on credits for the computation procedure required in order to determine the amount of the credit allowed.

Lifetime learning credit

A tax credit for qualifying expenses for taxpayers pursuing education beyond the first two years of postsecondary education. Individuals who are completing their last two years of undergraduate studies, pursuing graduate or professional degrees, or otherwise seeking new job skills or maintaining existing job skills are all eligible for the credit. Eligible individuals include the taxpayer, taxpayer's spouse, and taxpayer's dependents. The maximum credit is 20 percent of the first $10,000 of qualifying expenses and is computed per taxpayer. The credit is phased out for higher-income taxpayers. § 25A.

Credit for child and dependent care expenses

A tax credit ranging from 20 percent to 35 percent of employment-related expenses (child and dependent care expenses) for amounts of up to $6,000 is available to individuals who are employed (or deemed to be employed) and maintain a household for a dependent child under age 13, disabled spouse, or disabled dependent. § 21.

Research activities credit

A tax credit whose purpose is to encourage research and development. It consists of three components: the incremental research activities credit, the basic research credit, and the energy credit. The incremental research activities credit is equal to 20 percent of the excess qualified research expenditures over the base amount. The basic research credit is equal to 20 percent of the excess of basic research payments over the base amount. § 41.

Self-employment tax

A tax of 12.4 percent is levied on individuals with net earnings from self-employment (up to $137,700 in 2020) to provide Social Security benefits (i.e., the old age, survivors, and disability insurance portion) for such individuals. In addition, a tax of 2.9 percent is levied on individuals with net earnings from self-employment (with no statutory ceiling) to provide Medicare benefits (i.e., the hospital insurance portion) for such individuals. If a self-employed individual also receives wages from an employer that are subject to FICA, the self-employment tax will be reduced. A partial deduction is allowed in calculating the self-employment tax. Individuals with net earnings of $400 or more from self-employment are subject to this tax. §§ 1401 and 1402.

Tax credits

Amounts that directly reduce a taxpayer's tax liability. The tax benefit received from a tax credit is not dependent on the taxpayer's marginal tax rate, whereas the benefit of a tax deduction or exclusion is dependent on the taxpayer's tax bracket.

For 2020, the maximum earned income credit is $3,584 ($10,540 × 34%) for a taxpayer with one qualifying child, $5,920 ($14,800 × 40%) for a taxpayer with two qualifying children, and $6,660 ($14,800 × 45%) for a taxpayer with three or more qualifying children.

A taxpayer with no qualifying children can qualify for an earned income credit up to a maximum of $538.

When the AMT tax base is computed, an annual exemption is allowed, and a two-bracket tax schedule is used (26 percent and 28 percent).

AMT liabilities must be included in the taxpayer's estimated tax payments. Form 6251 is used by individuals to report the tax.

For 2020, the lifetime learning credit amount is phased out, beginning when the taxpayer's AGI (modified for this purpose) reaches $59,000 ($118,000 for married taxpayers filing jointly).

After the phaseout, the credit equals zero when AGI reaches $69,000 (or $138,000).

Example 7

Alesia's general business credit for the current year is $70,000. Her net income tax is $150,000, the tentative minimum tax is $130,000, and Alesia's net regular tax liability is $150,000. She generates no other tax credits. Alesia's general business credit allowed for the tax year is computed as follows. Net income tax$ 150,000 Less: The greater of • $130,000 (tentative minimum tax) • $31,250 [25% × ($150,000 − $25,000)](130,000) Amount of general business credit allowed for tax year$ 20,000 Alesia now has $50,000 ($70,000 −$20,000) of unused general business credits that may be carried back or forward to other tax years as discussed below.

Small businesses are entitled to a nonrefundable credit for administrative costs associated with establishing and maintaining certain qualified retirement plans (primarily, plans for non-highly compensated employees).

Although such costs (e.g., payroll system changes, retirement-related education programs, consulting fees)19 generally are deductible as ordinary and necessary business expenses, the credit lowers the after-tax cost of establishing a qualified retirement program and thereby encourages qualifying businesses to offer retirement plans for their employees.

The credit is capped at 25 percent of wages paid (this would be allowed if the employer paid 100 percent of the employee's wages during the leave). The credit is limited to 12 weeks of leave per employee during any taxable year.

An employer must have a written policy in place that allows all qualifying full-time employees no less than two weeks of annual paid family and medical leave (non-full-time employees must be offered leave on a pro rata basis). Wages paid as vacation leave, personal leave, or other medical or sick leave are not considered to be family and medical leave. The credit applies to wages paid in taxable years 2018 through 2020.

In general, one-fourth of this required annual payment is due on each of April 15, June 15, and September 15 of the tax year and January 15 of the following year.

An equal part of withholding is deemed paid on each due date. Thus, the estimated tax due on each date is the quarterly installment of the required annual payment, reduced by the quarter's share of the year's withholdings for the individual. Payments are accompanied by the payment voucher, Form 1040-ES.

Example 41:

Andre, a calendar year and cash basis taxpayer, spent $3,000 by December 1 on qualifying child care expenses for his dependent 11-year-old son. The $250 that is due the care provider for child care services rendered in December does not generate a tax credit benefit if the amount is paid in the current year because the $3,000 ceiling has been reached. However, if the payment can be delayed until the next year, the total credit over the two-year period for which Andre is eligible may be increased. A similar shifting of expenditures to a subsequent year may be wise if this nonrefundable credit otherwise generated would exceed the tax liability available to absorb the credit.

Example 20: During the year, Tan Company constructed a child care facility for $400,000 to be used by its employees who have preschool-aged children in need of child care services while their parents are at work. In addition, Tan incurred salaries for child care workers and other administrative costs associated with the facility of $100,000.

As a result, Tan's credit for employer-provided child care is $125,000 [($400,000 + $100,000) × 25%]. Correspondingly, the basis of the facility is reduced to $300,000 ($400,000 − $100,000), and Tan's deduction for salaries and administrative costs is reduced to $75,000 ($100,000 − $25,000).

Taxpayers are prohibited from receiving a double tax benefit associated with qualifying educational expenses.

As a result, taxpayers who claim an education credit may not deduct the expenses, nor may they claim the credit for amounts that are otherwise excluded from gross income (e.g., scholarships, employer-paid educational assistance).

The AMT works as a "shadow" tax system, such that all taxpayers are required to compute both the regular tax and the AMT, and then to pay whichever liability is higher.

As most taxpayers now complete their income tax filings by using tax software and/or a tax professional, this typically does not present a compliance burden for the individual. However, additional record keeping is required.

Some nonrefundable credits, such as the foreign tax credit, can be "carried over" to another tax year if they exceed the credit allowed for a given year. Other nonrefundable credits, such as the credit for the elderly (refer to Example 5), are not subject to carryover provisions and are lost to the extent that they exceed the limitations.

Because some credits are refundable and others are not, and because some credits are subject to carryover provisions while others are not, the order in which credits are offset against the tax liability is important.

Low-income housing credit

Beneficial treatment to owners of low-income housing is provided in the form of a tax credit. The calculated credit is claimed in the year the building is placed in service and in the following nine years. § 42.

The American Opportunity credit and the lifetime learning credit 33 are available to help qualifying low- and middle-income individuals defray the cost of higher education. The credits are available for qualifying tuition and related expenses incurred by students pursuing undergraduate or graduate degrees or vocational training.

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.

Qualified child care expenses include the costs of acquiring, constructing, rehabilitating, expanding, and operating a child care facility.

Child care resource and referral services include amounts paid or incurred under a contract to provide child care resource and referral services to an employee.

Major Tax Credit: Certain retirement plan contributions (§ 25B)

Computation: Calculation is based on amount of contribution multiplied by a percentage that depends on the taxpayer's filing status and AGI. Comments: Nonrefundable credit. Purpose is to encourage contributions to qualified retirement plans by low- and middle-income taxpayers.

Major Tax Credit: Child and dependent (§ 24)

Computation: Credit is based on number of qualifying children under age 17 and dependents. Maximum credit is $2,000 per child and $500 per dependent. Credits are phased out for higher-income taxpayers. Comments: Child tax credit is partially refundable (up to $1,400), but limited to 15% of earned income in excess of $2,500. Dependent tax credit is not refundable. Purpose is to assist families with children or dependents.

Major Tax Credit: Low-income housing (§ 42)

Computation: Appropriate rate times eligible basis (portion of project attributable to low-income units). Credit is available each year for 10 years. Recapture may apply. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage construction of housing for low-income individuals.

Major Tax Credit: Work opportunity (§ 51)

Computation: Credit is limited to 40% of the first $6,000 of wages paid to each eligible employee. Comments: Nonrefundable credit. Part of the general business credit and therefore subject to the same carryback, carryover, and FIFO rules. Purpose is to encourage employment of individuals in specified groups.

Major Tax Credit: Foreign taxes paid (§ 27)

Computation: Foreign-source taxable income/total worldwide taxable income × U.S. tax = overall limitation. Lesser of foreign taxes imposed or overall limitation. Comments: Nonrefundable credit. Unused credits may be carried back 1 year and forward 10 years. Purpose is to prevent double taxation of offshore income.

Major Tax Credit: Education (§ 25A)

Computation: American Opportunity credit is available for qualifying education expenses of students in first four years of postsecondary education. Maximum credit is $2,500 per year per eligible student. Credit is phased out for higher-income taxpayers. Lifetime learning credit permits a credit of 20% of qualifying expenses (up to $10,000 per year) provided American Opportunity credit is not claimed with respect to those expenses. Credit is calculated per taxpayer, not per student, and is phased out for higher-income taxpayers. Comments: (American Opportunity Credit) Credit is designed to help low- to middle-income families defray costs of the first four years of higher education. The credit is partially refundable. (Lifetime Learning Credit) Nonrefundable credit. Credit is designed to help low- to middle-income taxpayers defray costs of higher education beyond the first four years.

Major Tax Credit: Disabled access (§ 44)

Computation: Credit is 50% of eligible access expenditures that exceed $250 but do not exceed $10,250. Maximum credit is $5,000. Available only to eligible small businesses. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage small businesses to become more accessible to disabled individuals.

Major Tax Credit: Credit for employer-provided family and medical leave (§ 45S)

Computation: Credit is equal to 12.5% of wages paid to qualifying employees while they are on family and medical leave (limited to 12 weeks per employee per year). Employers must pay a minimum of 50% of the wages normally paid; if wages paid during the leave exceed 50% of normal wages, the credit is increased by 0.25% for each percentage point above 50% to a maximum credit of 25%. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage employers to provide leave to their employees for family and medical purposes (e.g,, birth of a child; care for a sick child, spouse, or parent).

Major Tax Credit: Employer-provided child care (§ 45F)

Computation: Credit is equal to 25% of qualified child care expenses plus 10% of qualified expenses for child care resource and referral services. Maximum credit is $150,000. Deduction for related expenses or basis must be reduced by the amount of the credit. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage employers to provide child care for their employees' children during normal working hours.

Major Tax Credit: Credit for increasing research activities (§ 41)

Computation: Incremental credit is 20% of excess of computation year expenditures over the base amount. Basic research credit is allowed to certain corporations for 20% of cash payments to qualified organizations that exceed a specially calculated base amount. An energy research credit is allowed for 20% of qualifying payments made to an energy research consortium. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage high-tech and energy research in the United States.

Major Tax Credit: General business (§ 38)

Computation: May not exceed net income tax minus the greater of tentative minimum tax or 25% of net regular tax liability that exceeds $25,000. Comments: Nonrefundable credit. Components include 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, and credit for employer-provided child care. Unused credit may be carried back 1 year and forward 20 years. FIFO method applies to carrybacks, carryovers, and credits earned during current year.

Major Tax Credit: Rehabilitation expenditures (§ 47)

Computation: Qualifying expenditures times 20%. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to discourage businesses from moving from economically distressed areas to newer locations.

Major Tax Credit: Energy Credits

Computation: Various items to encourage individuals and businesses to "go green." Comments: The credits are subject to various expiration dates.

Major Tax Credit: Earned income (§ 32)

Computation: Amount is determined by reference to Earned Income Credit Table published by IRS. Comments: Refundable credit. A form of negative income tax to assist low-income taxpayers. Earned income and AGI must be less than certain threshold amounts. Generally, one or more qualifying children must reside with the taxpayer.

Major Tax Credit: Tax withheld on wages (§ 31)

Computation: Amount is reported to employee on Form W-2. Comments: Refundable Credit

Major Tax Credit: Small employer pension plan startup costs (§ 45E)

Computation: Credit equals 50% of qualified startup costs incurred by eligible employers. Maximum annual credit is $500. Deduction for related expenses is reduced by the amount of the credit. Comments: Nonrefundable credit. Part of general business credit and therefore subject to same carryback, carryover, and FIFO rules. Purpose is to encourage small employers to establish qualified retirement plans for their employees.

Major Tax Credit: Child and dependent care (§ 21)

Computation: Rate ranges from 20% to 35% depending on AGI. Maximum base for credit is $3,000 for one qualifying individual, $6,000 for two or more. Comments: Nonrefundable personal credit. No carryback or carryforward. Benefits taxpayers who incur employment-related child or dependent care expenses in order to work or seek employment. Eligible taxpayers must have a dependent under age 13 or a dependent (any age) or spouse who is physically or mentally incapacitated.

Major Tax Credit: Adoption expenses (§ 23)

Computation: Up to $14,300 of costs incurred to adopt an eligible child qualify for the credit. Taxpayer claims the credit in the year qualified expenses were paid or incurred if they were paid or incurred during or after year in which adoption was finalized. For expenses paid or incurred in a year prior to when adoption was finalized, credit must be claimed in tax year following the tax year during which the expenses are paid or incurred. Comments: Nonrefundable credit subject to a phaseout. Unused credit may be carried forward five years. Purpose is to assist taxpayers who incur nonrecurring costs associated with the adoption process.

Major Tax Credit: Elderly or disabled (§ 22)

Computation: Usually taken from an IRS table. Comments: Nonrefundable personal credit. No carryback or carryforward. Provides relief for taxpayers not receiving substantial tax-free retirement benefits.

An eligible small business is one that during the previous year either had gross receipts of $1 million or less or had no more than 30 full-time employees. An eligible business can be a sole proprietorship, a partnership, a C corporation, or an S corporation.

Eligible expenditures include reasonable and necessary amounts that are paid or incurred to make certain changes to older facilities. Qualifying projects include installing ramps, widening doorways, and adding raised markings on elevator control buttons. Improvements also qualify if they assist hearing or visually impaired employees or customers who interact with the business. The tax basis of the asset is reduced by the amount of the credit. Eligible expenditures do not include amounts incurred in connection with any facility that first was placed in service after November 5, 1990.

Work opportunity tax credit

Employers are allowed a tax credit equal to 40 percent of the first $6,000 of wages (per eligible employee) for the first year of employment. Eligible employees include certain hard-to-employ individuals (e.g., qualified ex-felons, high-risk youth, food stamp recipients, and veterans). The employer's deduction for wages is reduced by the amount of the credit taken. For qualified summer youth employees, the 40 percent rate is applied to the first $3,000 of qualified wages. The credit does not apply to any amount paid to an individual who begins work for the employer after 2020. §§ 51 and 52.

Unused general business credits initially are carried back one tax year, to reduce the tax liability during that year. As a result, the taxpayer may receive a tax refund as a result of the carryback. Any remaining unused credits then are carried forward for up to 20 tax years.

FIFO method is applied to the carrybacks, carryovers, and utilization of credits earned during a tax year. By using the oldest credits first, the FIFO method minimizes the potential for loss of a general business credit benefit due to the expiration of credit carryovers.

Estimated tax is the amount of tax (including any AMT and self-employment tax) an individual expects to owe for the year after subtracting tax credits and income tax withheld. Any individual who has estimated tax for the year of $1,000 or more in excess of withholdings must make quarterly estimated tax payments.40 No penalty applies if the taxpayer had a zero tax liability for the preceding tax year and the preceding tax year was a taxable year of 12 months and the taxpayer was a U.S. citizen or resident for the entire preceding tax year.

First, the required annual payment is computed. This is the smaller of: •90 percent of the tax shown on the current year's return. •100 percent of the tax shown on the preceding year's return (the return must cover the full 12 months of the preceding year). If the AGI on the preceding year's return exceeds $150,000 ($75,000 if married filing separately), the 100 percent requirement is increased to 110 percent.

Dependent tax credit

For 2018 through 2025, the TCJA of 2017 replaced the dependency exemption with a $500 non-refundable credit. This credit can be claimed for dependents who are not a qualifying child or under the age of 17. The dependent must be a citizen or resident of the United States.

The work opportunity tax credit generally is equal to 40 percent of the first $6,000 of wages (per eligible employee) for the first 12 months of employment. If the credit is taken, the employer's tax deduction for wages is reduced by the amount of the credit.

For an employer to qualify for the 40 percent credit, the employee must (1) be certified by a designated local agency as being a member of one of the targeted groups and (2) have completed at least 400 hours of service to the employer. If an employee meets the first condition but not the second, the credit rate is reduced to 25 percent provided the employee has completed a minimum of 120 hours of service to the employer.

Although the following discussion largely centers on self-employed taxpayers, estimated tax may be required from some employees. An employee may be required to pay estimated tax for income other than wages that is not subject to withholding (e.g., investment income).

Further, the taxpayer may conduct a second trade or business (e.g., as a sole proprietor), and these profits may require the payment of income and self-employment tax.

Nonrefundable Credits

General business credit, which includes: •Tax credit for rehabilitation expenditures •Work opportunity tax credit •Credit for increasing research activities •Low-income housing credit •Disabled access credit •Credit for small employer pension plan startup costs •Credit for employer-provided child care •Credit for employer-provided family and medical leave -Credit for elderly or disabled -Foreign tax credit -Adoption expenses credit -Child and dependent tax credits* -Credit for child and dependent care expenses -Education tax credits** -Energy credits -Credit for certain retirement plan contributions -Small employer health insurance credit

A spouse employed by another spouse is subject to FICA tax payments.

However, children under the age of 18 who are employed in a parent's trade or business are exempted.

The FTC is designed to mitigate double taxation because income earned in another country by a U.S. person is subject to both U.S. and foreign income taxes.

However, the FTC ceiling still may result in some form of double taxation when the effective foreign tax rates are higher than the applicable U.S. rates. Unused FTCs are carried back 1 year and forward 10 years.

To claim the credit for employer-provided family and medical leave , employers must pay a minimum of 50 percent of the wages normally paid to an employee during the leave.

If the wages paid during the leave exceed 50 percent of normal wages, the credit is increased by 0.25 percentage point for each percentage point above 50 percent. For example, if the employer pays 60 percent of the usual wages, then the credit is 15 percent [12.5 percent + (0.25 × 10)].

Any qualifying expenses otherwise deductible by the taxpayer are reduced by the amount of the credit. In addition, the taxpayer's basis for any property acquired or constructed and used for qualifying purposes is reduced by the amount of the credit.

If, within 10 years of being placed in service, a child care facility ceases to be used in providing child care for employees, the taxpayer must recapture a portion of the credit previously claimed.21 Such a rule, often referred to as a clawback, is an accountability measure to help ensure that tax incentives are used as intended.

Example 31:

In 2020, Keshia earned a salary of $140,000 from her employer. Therefore, FICA taxes withheld from her salary are $8,537.40 ($137,700 × 6.2%) plus $2,030.00 ($140,000 × 1.45%) for a total of $10,567.40. In addition to remitting the amount withheld from Keshia's salary to the Federal government, her employer pays its own tax of $10,567.40 relative to her salary.

Example 10: Work Opportunity Credit Calculation

In January 2020, Green Company hires four individuals who are certified to be members of a qualifying targeted group. Each employee works 800 hours and is paid wages of $8,000 during the year. Green Company's work opportunity credit is $9,600 [($6,000 × 40%) × 4 employees]. If the tax credit is taken, Green must reduce its deduction for wages paid by $9,600. No credit is available for wages paid to these employees after their first year of employment.

Eligibility for the credit depends not only on the taxpayer meeting the earned income and AGI thresholds (shown in IRS tables), but also on whether he or she has a qualifying child. The term qualifying child generally has the same meaning here as it does for purposes of determining who qualifies as a dependent.

In addition to being available for taxpayers with qualifying children, the earned income credit is available to certain workers without children.24 However, this provision is available only to taxpayers ages 25 through 64 who cannot be claimed as a dependent on another taxpayer's return.

The employer is responsible for withholding the employee's share of FICA (commonly referred to as the Social Security tax) and appropriate amounts for income taxes.

In addition, the employer matches the FICA portion withheld, and it pays the full cost of FUTA. The sum of the employment taxes and the income tax withholdings is paid to the IRS at specified intervals.

The incremental research activities credit is 20 percent of the excess of qualified research expenses for the taxable year over the base amount.

In general, research expenditures qualify if the research relates to discovering technological information that is intended for use in the development of a new or improved business component of the taxpayer. All such expenses qualify if the research is performed in-house (by the taxpayer or employees). If the research is contracted to others outside the taxpayer's business, only 65 percent of the amount paid qualifies for the credit.

The credit for small employer pension plan startup costs is 50 percent of qualified startup costs. An eligible employer is one with fewer than 100 employees who have earned at least $5,000 of compensation.

In general, the maximum credit is the lesser of (1) $5,000 or (2) $250 times the number of non-highly compensated employees. However, the minimum credit is $500. The deduction for the startup costs incurred is reduced by the amount of the credit. The credit can be claimed for qualifying costs incurred in each of the three years beginning with the tax year in which the retirement plan becomes effective.

Example 38: Assume the same facts as in Example 37, except that Xinran records MAGI of $325,000 (including $240,000 of wages and $85,000 of net investment income).

In this case, Xinran also is subject to an additional Medicare tax of $360 ($40,000 × 0.9%, her wages in excess of $200,000). In total, Xinran pays $3,590 in additional Medicare taxes ($3,230 on unearned income and $360 on wages).

The earned income credit provides income tax equity to the working poor. Roughly, the credit has been designed to eliminate the Federal income tax and reimburse the taxpayer for certain other Federal taxes, such as the gasoline and Social Security taxes.

In this way, the credit is intended to encourage economically disadvantaged individuals to become members of the workforce.

A tax credit is much different from an income tax deduction.

Income tax deductions reduce a taxpayer's tax base; tax credits reduce a taxpayer's tax liability. While the tax benefit received from a tax deduction depends on the tax rate, a tax credit is not affected by the tax rate of the taxpayer.

The tax on self-employment income is levied to provide Social Security and Medicare benefits (old age, survivors, and disability insurance and hospital insurance) for self-employed individuals.

Individuals with net earnings of $400 or more from self-employment are subject to the self-employment tax .41 For 2020, the self-employment tax is 12.4 percent of self-employment earnings up to $137,700 (for the Social Security portion) plus 2.9 percent of the total amount of self-employment earnings (the Medicare portion).

Example 32: In 2020, Kelly reported $86,000 of net earnings from a data transfer services business that she owns. During the year, Kelly also received $67,500 in wages as an employee of an accounting firm.

Kelly's self-employment income subject to the Social Security portion (12.4%) is $70,200 ($137,700 − $67,500), not $86,000. This produces a Social Security portion of the self-employment tax of $8,704.80 ($70,200 × 12.4%). All of Kelly's net self-employment earnings are subject to the Medicare portion of the self-employment tax of 2.9%; no income limit applies for that tax.

Example 27: Return to the facts of The Big Picture on p. 12-1. Recall that Tom and Jennifer Snyder are married and file a joint tax return. The Snyders report modified AGI of $158,000. They have two children, Lora and Sam. The Snyders paid $7,500 of tuition and $8,500 for room and board for Lora (a freshman) and $8,100 of tuition plus $7,200 for room and board for Sam (a junior).

Lora and Sam are full-time students and are Tom and Jennifer's dependents. Lora's tuition and Sam's tuition are qualified expenses for the American Opportunity credit. For 2020, Tom and Jennifer may claim a $2,500 American Opportunity credit each for Lora's and Sam's expenses [(100% × $2,000) + (25% × $2,000)]. This totals to a $5,000 American Opportunity credit on the Snyders' return.

Example 26: Nancy, who has two children under age 13, worked full-time while her husband, Raji, was attending college for 10 months during the year. Nancy earned $22,000 and incurred $6,200 of child care expenses. Raji is deemed to have earned $500 for each of the 10 months (or a total of $5,000) that he was in school. Because Nancy and Raji report AGI of $22,000, they are allowed a credit rate of 31%.

Nancy and Raji are limited to $5,000 in qualified child care expenses ($6,000 maximum expenses, limited to Raji's $5,000 earned income). Therefore, the couple is entitled to a tax credit of $1,550 (31% × $5,000) for the year.

Both education credits are available for qualified expenses incurred by a taxpayer, taxpayer's spouse, or taxpayer's dependent. The American Opportunity credit is available for each eligible student, while the lifetime learning credit is calculated per taxpayer. To be eligible for the American Opportunity credit, a student must take at least one-half of the full-time course load for at least one academic term at a qualifying educational institution.

No comparable requirement exists for the lifetime learning credit. Therefore, taxpayers who take graduate training or continuing education are eligible for the lifetime learning credit. Taxpayers who are married must file joint returns to claim either education credit.

The credit rate applied to the eligible contributions depends on the taxpayer's AGI39 and filing status, as shown in Exhibit 12.3. However, the maximum credit allowed to an individual is $1,000 ($2,000 × 50%).

Once AGI exceeds the upper end of the applicable range, no credit is available. To qualify for the credit, the taxpayer must be at least 18 years of age and cannot be a dependent of another taxpayer or a full-time student.

Individuals who are especially vulnerable to the AMT are those who claim large amounts of accelerated cost recovery deductions.

One also might be subject to the AMT in a year when a large volume of profitable incentive stock options is exercised, or when large investments in private activity municipal bonds are made.

The FTC allowed is the lesser of the foreign taxes incurred or the FTC overall limitation, which is equal to the Federal income tax paid on the double-taxed income.

Only income taxes qualify for the credit.30 Thus, value added taxes (VAT), severance taxes, property taxes, and sales taxes do not qualify because they are not regarded as taxes on income. Uncredited taxes still can be deducted by the taxpayer, however.

Several individual tax provisions support the Federal health insurance system, Medicare, with additional taxes on certain high-income individuals.

Other ACA provisions are reviewed in the text's online appendix (Affordable Care Act Provisions).

Eligible expenses include amounts paid for household services and care of a qualifying individual that are incurred to enable the taxpayer to be employed. The care can be provided in the home (e.g., by a nanny) or outside the home (e.g., at a day-care center).

Out-of-the-home expenses incurred for an older dependent or spouse who is physically or mentally incapacitated qualify for the credit if that person regularly spends at least eight hours each day in the taxpayer's household. This makes the credit available to taxpayers with handicapped older children and elderly relatives in their home. Out-of-the-home expenses incurred for services provided by a dependent care center qualify only if the center complies with all applicable laws and regulations of a state or unit of local government. Child care payments to a relative are eligible for the credit unless the relative is a child (under age 19) of the taxpayer.

Example 40: Anna's 2020 AMT liability is computed as follows. She is a single individual. She is subject to the AMT for this tax year, as the AMT liability exceeds her regular income tax liability. Anna owes a total of $115,630 consisting of regular tax of $79,795 and $35,835 which is the excess of the AMT liability over the regular tax ($115,630 − $79,795).

Regular taxable income $300,000 "Spread" on an incentive stock option exercised this year 200,000 AMT exemption (72,900) AMT tax base $427,100 Regular tax liability $79,795 AMT liability [($197,900 × 26%) + ($229,200 × 28%)] $115,630

Example 17:

Sarah spends $1,000,000 to build a qualified low-income housing project that is completed on January 1 of the current year. The entire project is rented to low-income families. The credit rate for property placed in service during January is 7.25%.16 Sarah claims a credit of $72,500 ($1,000,000 × 7.25%) in the current year and in each of the following nine years. If Sarah only made 75% of the project's units available to low-income families, her credit would be $54,375 [($1,000,000 × 75%) × 7.25%]. Recapture of a portion of the credit may be required if the number of units set aside for low-income tenants falls below a minimum threshold, or if the taxpayer sells the property.

In addition, employers must withhold a portion of each wage payment that relates to employment taxes , that is, the Social Security and Medicare tax liabilities that relate to the employee's wages for the period.

Self-employed taxpayers (sole proprietors) do not have employers, so no withholding occurs, but income and employment taxes are prepaid nonetheless. Self-employeds are responsible for remitting their own income and employment taxes, in the form of quarterly estimated tax payments.

Net earnings from self-employment includes gross income from a trade or business less allowable trade or business deductions, the distributive share of any partnership income or loss derived from a trade or business activity, and net income from rendering personal services as an independent contractor.

Self-employed taxpayers deduct a portion of the self-employment tax in determining the self-employment tax itself, and in computing AGI (normally, one-half of the self-employment tax liability).

Example 33: Additional Medicare Tax on Wages

Singh, who is single, earns wages of $500,000. Singh pays $2,900 of Medicare taxes on the first $200,000 of her wages ($200,000 × 1.45%) and $7,050 of Medicare taxes on her wages in excess of $200,000 ($300,000 × 2.35%). In total, her Medicare tax is $9,950. Singh's additional Medicare tax totals $2,700.

Qualifying employment-related expenses are limited in amount to an individual's earned income. For married taxpayers, this limitation applies to the spouse with the lesser amount of earned income.

Special rules are provided for taxpayers with nonworking spouses who are disabled or are full-time students. Here, the nonworking spouse is deemed to have earned income of $250 per month if there is one qualifying individual in the household or $500 per month if there are two or more qualifying individuals in the household. In the case of a student-spouse, only months for which the student is enrolled on a full-time basis are counted.

Employment taxes

Taxes that an employer must pay on account of its employees. Employment taxes include FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. Employment taxes are paid to the IRS in addition to income tax withholdings at specified intervals. Such taxes can be levied on the employees, the employer, or both.

Corporations and other taxpayers, including sole proprietors, make quarterly payments to the Treasury of the estimated taxes that relate to their taxable income for the period.

Taxpayers then claim a credit against the tax due for the withholdings and estimated payments that have been prepaid in this manner.

The 3.8 percent additional Medicare tax on unearned income is in addition to the additional 0.9 percent Medicare tax on wages or self-employment income.

Taxpayers who generate both high wages (or self-employment income) and high investment income may be subject to both taxes.

Taxpayers are allowed a tax credit for expenditures incurred to rehabilitate industrial and commercial buildings and certified historic structures. The rehabilitation expenditures credit is intended to discourage businesses from moving from older, economically distressed areas (e.g., inner cities) to newer locations, while encouraging the preservation of historic structures.

The 20 percent credit is taken ratably over a five-year period starting with the year the rehabilitated building is placed in service. When taking the credit, the basis of a rehabilitated building is reduced by the full rehabilitation credit allowed.

A small number of individual taxpayers pay an additional Federal income tax, known as the alternative minimum tax (AMT).47 Congress designed the AMT to assure that all individuals paid a "fair share" into the income tax system; it had appeared that some taxpayers were taking advantage of "too many" of the Code's exclusions, deductions, exemptions, and credits, and that it was possible for some to pay little or no Federal income tax in certain tax years.

The 2017 tax revisions drastically reduced the number of taxpayers who might be subject to the AMT, chiefly by increasing the annual exemption from the tax and eliminating some of the deductions previously available. The 2017 revisions repealed the AMT for C corporations. AMT also applies to trusts and estates (not addressed in this chapter).

Example 39:

The 2020 AMT tax base for Harry, who files as a single individual on his Form 1040, is $680,000. Harry's AMT exemption phased out to the extent of [($680,000 − $518,400) × 25%], or $40,400. Harry's AMT exemption amount is $32,500 ($72,900 exemption − $40,400 reduction).

Alternative minimum tax (AMT)

The AMT is a surtax, calculated as a percentage of alternative minimum taxable income (AMTI). AMTI generally starts with the taxpayer's taxable income, prior to any standard deduction taken. To this amount, the taxpayer (1) adds designated preference items (e.g., tax-exempt interest income on private activity bonds), (2) makes other specified adjustments (e.g., to reflect a slower cost recovery method), (3) adjusts certain AMT itemized deductions for individuals (e.g., interest incurred on housing), and (4) subtracts an exemption amount. The taxpayer must pay the greater of the resulting AMT or the regular income tax (reduced by all allowable tax credits). AMT preferences and adjustments are assigned to partners, LLC members, and S corporation shareholders. The AMT does not apply to C corporations for tax years beginning after 2017.

The education credits are subject to different income limitations. Forty percent of the American Opportunity credit is refundable, and it can offset a taxpayer's alternative minimum tax (AMT) liability. The lifetime learning credit is neither refundable nor an AMT liability offset.

The American Opportunity credit amount is phased out, beginning when the taxpayer's AGI (modified for this purpose) reaches $80,000 ($160,000 for married taxpayers filing jointly). The credit is phased out proportionately over a $10,000 ($20,000 for married taxpayers filing jointly) range. As a result, the credit is eliminated completely when modified AGI reaches $90,000 ($180,000 for married taxpayers filing jointly).

Estimated tax

The amount of tax (including alternative minimum tax and self-employment tax) a taxpayer expects to owe for the year after subtracting tax credits and income tax withheld. The estimated tax must be paid in installments at designated intervals (e.g., for a calendar year individual taxpayer, by April 15, June 15, September 15, and January 15 of the following year).

Basic research is any original investigation for the advancement of scientific knowledge not having a specific commercial objective. Basic research conducted outside the United States and basic research in the social sciences, arts, or humanities does not qualify. This reflects the intent of Congress to use the credit to encourage domestic high-tech research.

The basic research credit computation is based on expenditures in excess of a specially defined base amount. The basic research expenditures not in excess of the base amount still could qualify for the credit for incremental research activities.

The child tax credit is $2,000 per child, and the dependent tax credit is $500 per non-child dependent. The child tax credit phases out as AGI exceeds $400,000 (married filing joint) or $200,000 (other taxpayers).

The child tax credit is partially refundable (up to $1,400 per child, but no more than 15 percent of earned income in excess of $2,500). The dependent tax credit is subject to a phaseout and is not refundable.

More than any other credit, the low-income housing credit is influenced by nontax factors. For example, the property must be certified by an appropriate state or local agency. These credits are issued based on a nationwide allocation of congressional funding.

The credit amount depends on the number of units rented to low-income tenants. Occupants are low-income tenants if their income does not exceed a specified percentage of the area median gross income. The credit is determined by multiplying the qualified basis by a credit rate. The credit is claimed over a 10-year period, as long as the property continues to meet the required conditions.

An employer's expenditures incurred to provide for the care of children of employees can be deducted as ordinary and necessary business expenses. Alternatively employers may claim a credit for providing child care facilities to their employees during normal working hours.

The credit for employer-provided child care, limited annually to $150,000, is composed of the aggregate of two components: 25 percent of qualified child care expenses and 10 percent of qualified child care resource and referral services.

The credit is available for a taxpayer who is married filing jointly, is single, or is filing as a head of household.

The credit for those filing a joint return with qualifying children phases out to zero as earned income increases from about $25,000 to about $57,000.25 Amounts in the IRS table are indexed annually for inflation.

In general, the credit is equal to a percentage of unreimbursed employment-related expenses up to $3,000 for one qualifying individual and $6,000 for two or more individuals.

The credit rate varies between 20 percent and 35 percent, depending on the taxpayer's AGI, as indicated in Exhibit 12.2.

Example 30: Earl and Josephine, married taxpayers, each contribute $2,500 to § 401(k) plans. The AGI reported on their joint return is $45,000.

The eligible retirement contributions for purposes of the credit are limited to $2,000 for Earl and $2,000 for Josephine. As a result, Earl and Josephine may claim a credit for their retirement plan contributions of $400 [($2,000 × 2) × 10%]. They would not qualify for the credit if their AGI had exceeded $65,000.

The general business credit is composed of a number of other credits, each of which is computed separately under its own set of rules.

The general business credit combines these credits into one amount to limit the amount of business credits that can be used to offset a taxpayer's income tax liability.

The American Opportunity credit permits a maximum credit of $2,500 per year (100 percent of the first $2,000 of tuition expenses plus 25 percent of the next $2,000 of tuition expenses) for each of the first four years of postsecondary education.

The lifetime learning credit permits a credit of 20 percent of qualifying expenses (up to $10,000 per year) incurred in a year in which the American Opportunity credit is not claimed.35 Generally, the lifetime learning credit is used for individuals who are beyond the first four years of postsecondary education.

The AMT tax base is designed to allow fewer tax deductions and exclusions, and to make some items available in a manner that is slower than applies for the regular tax. Similarly, income items are identified in the AMT base that are included more quickly than is the case for regular tax purposes, and a few additional income items are subject to tax only under the AMT rules.

The result is a form of income tax with lower rates and a broader tax base. In addition, most tax credits are not allowed to reduce AMT.

General business credit

The summation of various non-refundable business credits, including the tax credit for rehabilitation expenditures, business energy credit, work opportunity credit, research activities credit, low-income housing credit, and disabled access credit. The amount of general business credit that can be used to reduce the tax liability is limited to the taxpayer's net income tax reduced by the greater of (1) the tentative minimum tax or (2) 25 percent of the net regular tax liability that exceeds $25,000. Unused general business credits can be carried back one year and forward 20 years. § 38.

The FICA tax has two components: Social Security tax (old age, survivors, and disability insurance; rate 6.2 percent) and Medicare tax (hospital insurance; rate 1.45 percent). Both the employer and the employee pay the tax at these rates.

The tax rates and wage base under FICA have increased substantially over the years. The base amount is adjusted each year for inflation. Withholdings from employees continue until the maximum base amount is reached. For 2020, for example, FICA withholding for the Social Security portion (6.2 percent) ends once the employee has earned FICA wages of $137,700. No wage limit applies for the Medicare portion (1.45 percent) of the tax.

American Opportunity credit

This credit applies for qualifying expenses for the first four years of postsecondary education. Qualified expenses include tuition and related expenses and books and other course materials. Room and board are ineligible for the credit. The maximum credit available per student is $2,500 (100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses). Eligible students include the taxpayer, taxpayer's spouse, and taxpayer's dependents. To qualify for the credit, a student must take at least one-half of the full-time course load for at least one academic term at a qualifying educational institution. The credit is phased out for higher-income taxpayers. § 25A.

The credit for child and dependent care expenses mitigates the inequity felt by working taxpayers who must pay for child care services to work outside the home.

This credit is a specified percentage of expenses incurred to enable the taxpayer to work or to seek employment. The credit is claimed by completing and filing Form 2441, Credit for Child and Dependent Care Expenses.

Corporations (other than S corporations or personal service corporations) are allowed an additional 20 percent credit for basic research payments made in excess of a base amount.

This credit is not available to individual taxpayers. Basic research payments are 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.

Energy Research Credit

This credit was designed to stimulate additional energy research. The credit is 20 percent of the amounts paid to or incurred by a taxpayer for energy research through an energy research consortium.

Taxpayers may claim a nonrefundable credit for certain retirement plan contributions based on eligible contributions of up to $2,000 to certain qualified retirement plans, such as traditional and Roth IRAs and § 401(k) plans.

This credit, sometimes referred to as the "saver's credit," encourages lower- and middle-income taxpayers to contribute to qualified retirement plans. The benefit provided by this credit is in addition to any deduction or exclusion that otherwise is available due to the qualifying contribution.

Example 8

This example illustrates the use of general business credit carryovers. General business credit carryovers 2017$ 4,000 2018 6,000 2019 2,000 Total carryovers $12,000 2020 general business credit $ 40,000 Total credit allowed in 2020 (based on tax liability)$50,000 Less: Utilization of carryovers 2017 (4,000) 2018 (6,000) 2019 (2,000) Remaining credit allowed in 2020 $38,000 Applied against 2020 general business credit (38,000) 2020 unused amount carried forward to 2021$ 2,000

If an individual also receives wages subject to FICA tax, the ceiling amount of the Social Security portion on which the self-employment tax is computed is reduced.

Thus, the self-employment tax may be reduced to zero if a self-e

The child tax credit and dependent tax credit provisions allow individual taxpayers to take a tax credit based solely on the number of their qualifying children and dependents. These credits are two of several "family-friendly" provisions that currently are part of the Federal income tax law.

To be eligible for the child tax credit, the child must be under age 17, a U.S. citizen, and a dependent of the taxpayer. The dependent tax credit is available for each dependent of the taxpayer (other than a qualifying child).

The research activities credit is the sum of three components:

an incremental research activities credit, a basic research credit, and an energy research credit.

Only income taxes qualify for the credit.30 Thus, value added taxes (VAT), severance taxes, property taxes, and sales taxes do not qualify because they are not regarded as taxes on income.

Uncredited taxes still can be deducted by the taxpayer, however.

Taxes generally are remitted to the Treasury with the tax return. Withholdings are required, though, as to wages and a few other income items received by individuals. For example, employers must directly transfer a portion of an employee's pay to the Federal government.

Using a Form W-4, the employee instructs the employer as to how much of the wages should be withheld, so that the taxes on the wages are remitted to the government on a "pay as you go" basis.

Energy tax credits

Various tax credits are available to those who invest in certain energy property. The purpose of the credit is to create incentives for conservation and to develop alternative energy sources.

Example 23 Foreign Tax Credit and Its Limitations: Yellow, based in the United States, sells widgets in Peru. Profits for the year in that country total $2,000,000. Yellow is subject to a 32% U.S. income tax rate, and a 20% marginal income tax rate applies to Yellow in Peru. Thus, attributable income taxes for this double-taxed income are $640,000 for the U.S. tax and $400,000 for the Peru tax.

Yellow pays the full $400,000 tax to Peru. Its U.S. tax on this income is $640,000 minus the $400,000 foreign tax credit (lesser of $400,000 foreign tax paid or $640,000 attributable U.S. tax), or $240,000. The FTC allows a full recovery of the $400,000 tax paid to Peru.

The earned income credit is determined by multiplying a maximum amount of earned income by the appropriate credit percentage. Generally, earned income includes employee compensation and net earnings from self-employment;

it excludes items such as interest, dividends, retirement benefits, nontaxable employee compensation, and alimony/child support.23 If a taxpayer has children, the credit percentage used in the calculation depends on the number of qualifying children.

To be eligible for the credit, an individual must have either of the following.

•A dependent under age 13. •A dependent or spouse who is physically or mentally incapacitated and who lives with the taxpayer for more than one-half of the year. Generally, married taxpayers must file a joint return to claim the credit.

Payments to certain relatives for the care of qualifying dependents and children qualify for the credit if the care provider is not a child (under age 19) of the taxpayer. Thus, if the care provider is in a lower tax bracket than the taxpayer, the following benefits result.

•Income is shifted to a lower-bracket family member. •The taxpayer qualifies for the credit for child and dependent care expenses. In addition, to the extent that child care payments can be shifted to future tax years, the benefit from the credit may be preserved on these excess expenditures.

The Internal Revenue Code contains a variety of credits for businesses and individuals to encourage the conservation of natural resources and the development of energy sources other than oil and gas. The energy tax credits include incentives to:

•Install energy-efficient windows, insulation, and heating and cooling equipment; •Purchase solar and other energy-efficient water heaters; and •Install equipment in a business to produce electricity using solar, wind, or geo-thermal sources. Credit amounts and expiration dates differ for the various provisions.

Here are some examples of items that are treated differently under the AMT rules, in deriving the tax base that is used to compute the AMT.

•Most cost recovery computations allow deductions that are taken over a longer time period. When a depreciable asset is sold, then, the AMT gain typically is smaller than the corresponding regular tax gain, as the AMT basis for the asset is larger. •For an individual who itemizes deductions on the Form 1040, the limited deduction for taxes paid is not allowed for AMT purposes. •For AMT purposes, only the percentage of completion method of accounting can be used for long-term contracts, and not the completed contract method. •The AMT includes in the tax base the "spread" related to an incentive stock option (i.e., the excess of the stock's fair market value over the exercise price on the date of the option's exercise). This affects the AMT gain that is recognized when the shares obtained with the option later are sold in the market. •Percentage depletion deductions can be taken under the AMT only until the basis of the productive property reaches zero. •Municipal bond interest is included in the AMT tax base if the bond proceeds were used to benefit the "private activity" of a commercial business (e.g., in building a factory).

The incremental research credit is not allowed for:

•Research conducted once commercial production begins. •Surveys and studies such as market research, testing, or routine data collection. •Research conducted outside the United States, Puerto Rico, and U.S. possessions. •Research in the social sciences, arts, or humanities. Determining the base amount involves a complex series of computations, meant to approximate historical levels of research activity by the taxpayer. As a result, the credit is allowed only for increases in research expenses.

To qualify for the credit, certified historic structures must be substantially rehabilitated during a 24-month period. A building has been substantially rehabilitated if qualified rehabilitation expenditures exceed the greater of

•The adjusted basis of the property before the rehabilitation expenditures, or •$5,000. Qualified rehabilitation expenditures do not include the cost of acquiring a building, the cost of facilities related to a building (such as a parking lot), and the cost of enlarging an existing building.

Two special rules apply to the general business credit. First, any unused credit must be carried back 1 year, then forward 20 years. Second, for any tax year, the general business credit is limited to the taxpayer's net income tax reduced by the greater of:

•The tentative minimum tax. This amount relates to the alternative minimum tax. See text Section 12-5d. •25 percent of net regular tax liability that exceeds $25,000.3 Net regular tax liability is the regular tax liability reduced by certain nonrefundable credits (e.g., credit for child and dependent care expenses, foreign tax credit).