Credits (Tax course)
Summary
A tax credit is a dollar for dollar reduction of the tax. A credit is usually worth more than a deduction, because a deduction reduces income that is used in calculating the income tax. There are two types of tax credits - refundable and nonrefundable. A refundable credit is similar to withholdings or estimated payments, in that if the total credits exceed the tax, then the excess is refundable to the taxpayer (or applied to next year). A nonrefundable credit can reduce the regular tax to zero, but if the credit exceeds the tax liability, the portion of the credit that exceeds the liability is lost.
Entering Credits in Drake Software
Drake calculates and automatically limits credits based on information entered in Data Entry. Some credits require information to be entered directly into the appropriate credit screen in data entry to calculate. Most credit limitations are based on AGI, MAGI, age, filing status, residency status, relationship, passive limitations, business income, date of purchase, etc.
Child Tax Credit
Exceptions to time lived with you A child is considered to have lived with you for more than half of 2016 if the child was born or died in 2016 and your home was this child's home for more than half the time he or she was alive. Temporary absences by you or the child for special circumstances, such as school, vacation, business, medical care, military service, or detention in a juvenile facility, count as time the child lived with you. There are also exceptions for kidnapped children and children of divorced or separated parents.
Nonrefundable Credits
Nonrefundable credits are listed on page 2 of form 1040, lines 48 through 54. Nonrefundable credits include: foreign tax credit, credit for child and dependent care expenses, education credits (a portion of this may be refundable), retirement savings contribution credit, child tax credit, resident energy credit, and other credits.
Child Tax Credit
Qualifying Child A qualifying child for purposes of the child tax credit is a child who: Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, your grandchild, niece, or nephew), Was under age 17 at the end of 2016, Did not provide over half of his or her own support for 2016, Lived with you for more than half of 2016, (see exceptions on the next slide) Is claimed as a dependent on your return, Does not file a joint return for the year (or files it only as a claim for refund), and Was a U.S. citizen, a U.S. national, or a U.S. resident alien. For more information, see Publication 519, U.S. Tax Guide for Aliens. See adopted children covered later in this unit.
Child Tax Credit
Reduction of the Child Tax Credit You must reduce your child tax credit if either (1) or (2) applies. he amount on Form 1040, line 52; Form 1040A, line 35; or Form 1040NR, line 47, is less than the credit. If this amount is zero, you cannot take this credit because there is no tax to reduce. But you may be able to take the additional child tax credit. See "Additional Child Tax Credit", later. Your modified adjusted gross income (AGI) is more than the amount shown below for your filing status: Married filing jointly - $110,000 Single, head of household, or qualifying widow(er) - $75,000 Married filing separately - $55,000
Refundable Credits
Refundable credits are credits that are not limited by the amount of the taxpayer's tax liability. Therefore, unlike the nonrefundable credit, any excess of the credit over the tax liability is not lost. The refundable credits, with the appropriate 2016 Form 1040 line numbers include: Line Description 66a Earned income credit 67 Additional child tax credit 68 American opportunity credit from Form 8863, line 14 72 Credit for federal tax on fuels. Attach Form 4136 73 Credits from Forms 2439, 8839, 8801, and 8885
Child Tax Credit
Taxpayers can claim a $1,000 deduction for each qualifying child. There is a limit of this credit based on AGI. Also, since this credit is not refundable, there is a limit based on tax liability. The portion of the credit limited by the tax liability is available for the refundable additional child tax credit. The credit limited by AGI is not available for a refund.
Foreign Tax Credit
The taxpayer may claim a credit for foreign taxes paid or accrued to another country on foreign source income, if the related income is taxable in the U.S. The taxpayer may have a choice to claim a credit or an itemized deduction on Schedule A. The most common situation to have paid foreign taxes is from investments in global or international mutual funds. The taxpayer may elect to claim the foreign tax credit without filing Form 1116. This election is available only if the following conditions are met: All foreign source gross income was "passive category income" (which includes most interest and dividends) All the income and any foreign taxes paid were reported on a qualified payee statement (1099-DIV, 1099-INT, K-1) Total creditable foreign taxes are not more than $300 ($600 MFJ) There is not a carryover from a prior year or a carry forward to a future year election
Tax Credits Overview
A tax credit is a dollar for dollar reduction of the tax. Therefore, a credit is usually worth more than a deduction, because a deduction reduces income that is used in calculating the income tax. Two Types of Credits 1. Nonrefundable tax credits: These are credits that can reduce the regular tax to zero, but if the credit exceeds the tax liability, the portion of the tax credit that exceeds the liability is usually lost forever. See page 2 of federal Form 1040, lines 48 through 54, for these credits. 2. Refundable tax credits: These are similar to withholdings or estimated payments, in that if the credits exceed the tax, then the excess is refunded to the taxpayer (or applied to the next year). See page 2 of federal Form 1040, lines 64 through 69, 72, and 73.
Child Tax Credit
Adopted Children or Qualifying Child of More Than One Person Adopted child — An adopted child is always treated as your own child. An adopted child includes a child lawfully placed with you for legal adoption. If you are a U.S. citizen or U.S. national and your adopted child lived with you all year as a member of your household in 2016, that child meets the condition to be a qualifying child for the child tax credit. Qualifying child of more than one person — A special rule applies if your qualifying child is the qualifying child of more than one person. For details, see the instructions for line 6c in either the Form 1040 or Form 1040A instructions.
Child Tax Credit
Children with an Individual Taxpayer Identification Number (ITIN) If you are claiming a child tax credit or additional child tax credit for a child identified on your tax return with an ITIN, you must complete Part I of Schedule 8812 (Form 1040A or 1040). Although a child may be your dependent, you may only claim a child tax credit or additional child tax credit for a dependent who is a citizen, national, or resident of the United States. To be treated as a resident of the United States, a child generally will need to meet the requirements of the substantial presence test. For more information about the substantial presence test, see Publication 519, U.S. Tax Guide for Aliens.
Form 1040, Lines 70-73
Detailed information about lines 70-73 can be found in the Form 1040 instructions. A discussion of the "Other credits" for Form 1040 is beyond the scope of this tax course.
John invested in a global mutual fund and received dividends from a foreign source of $400 and paid foreign tax of $50. John does not elect to carry forward to a future year or have a carryback from prior years. Which of the following is NOT true?
John does not need to report the foreign source of income on his u.s tax return.
Form 1040, Lines 49-50
Line 49 Child and Dependent Care Credit Child and dependent care credits are explained in another unit. Line 50 Education Credits Education Credits are explained in another unit. Residency test - The child must have lived with the taxpayer in the U.S. for more than half the year.
Retirement Savings Contribution Credit
Line 51 Retirement Savings Contribution Credit Taxpayers can claim a credit for eligible contributions to IRA or retirement plans. The maximum credit is $2,000 ($4,000 MFJ). The maximum credit is fifty percent, but is phased out based on AGI. This credit is not available to a taxpayer who is age 18 or older, is claimed as a dependent on another person's tax return, and is not a full-time student. For the definition of a full-time student refer to the instructions for Form 8880. Eligible contributions include contributions to a traditional or Roth IRA, 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan, and voluntary after-tax employee contributions to a qualified retirement and 403(b) plans. Rollover contributions (money that you moved from another retirement plan or IRA) aren't eligible for the Saver's Credit. Also, your eligible contributions may be reduced by any recent distributions you received from a retirement plan or IRA. The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income.
Residential Energy Credits
Line 52 Residential Energy Credits There are two residential energy credits available to individuals. They are the nonbusiness energy property credit and the residential energy efficient property credit. Use Form 5695 to calculate the credits. The nonbusiness energy property credit is 10% of energy efficiency improvements up to a maximum of $500. The improvements are on the taxpayer's principal residence. A manufacturer's certification that the property qualifies for the credit should be obtained. The residential energy efficient property credit includes solar, wind powered, and geothermal heat pumps. The credit rate is 30% and there is no maximum.
Form 1040, Line 54
Line 54 Other credits (a) 3800 (b) 8801 and (c) Other Form 3800 is the general business credit. Form 8801 is the credit for prior year minimum tax. There are a number of other credits that are reported on line 54. These credits are beyond the scope of this tax course but they are discussed in the instructions for Form 1040. Form 3800 has been revised for tax years after 2010, rather than carrying forward one credit amount. The carry forward amounts are identified by the specific credits that are carrying forward.
Earned Income Credit
Line 66a Earned Income Credit - This credit is covered in depth in Unit 18 of this course.
Additional Child Tax Credit
Line 67 Additional Child Tax Credit The additional child tax credit is a refundable credit based on the child tax credit that was previously discussed in this unit. The additional child tax credit is reported on Schedule 8812 and is carried to line 67 of Form 1040. Drake Software makes this calculation unless combat pay is to be included in the calculation. In this case, you will need to complete screen 8812. Basically, the additional child tax credit is the child tax credit over the tax liability that was not limited as a result of the AGI phase out.
Form 1040, Line 68
Line 68 American Opportunity Credit - This credit is discussed in another unit of this course.
Refundable credits are credits that are not limited by the amount of the taxpayer's tax liability. Which of the following credits is refundable?
additional child tax credit