Pope Phft2012 Ind Sm 14

7/29/2019 Pope Phft2012 Ind Sm 14

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© 2012 Pearson Education, Inc. publishing as Prentice Hall

I:14-1

Chapter I:14

Special Tax Computation Methods, Tax Credits

and Payment of Tax

Discussion Questions

I:14-1 Most taxpayers are not subject to the alternative minimum tax (AMT) because they do nothave substantial tax preferences and AMT adjustments and because there is a liberal exemptionamount to reduce the tax base on which the AMT is calculated. However, more and more taxpayersin recent years are being subjected to the AMT. p. I:14-2.

I:14-2 No, the alternative minimum tax does not apply if an individual's tentative minimum taxunder the AMT rules is less than his regular tax liability. It applies only if the tentative minimumtax exceeds the regular tax liability. p. I:14-3.

I:14-3 b. only. Only excess depreciation for real property placed in service before 1987 is a tax preference item. For tax years prior to 1987, net long-term capital gains were a tax preference item(i.e., the 60% long-term capital gain deduction) and for taxable years prior to 1993 the appreciatedelement related to charitable contributions of capital gain real property was a tax preference item. p.I:14-4.

I:14-4 a, b, c only. Itemized deductions that are not allowed in computing AMTI, excessdepreciation on real property placed in service after 1986, and excess MACRS depreciation for personal property placed in service after 1986, are all AMT adjustments. Tax-exempt interest is not

an AMT adjustment but may be a tax preference item if the bonds are private activity bonds. pp.I:14-4 through I:14-6.

I:14-5 a and b only. Charitable contributions and mortgage interest on a personal residence aredeductible when computing AMT. Mortgage interest is subject to the restrictions pertaining toqualified housing interest. Other interest is deductible up to the amount of qualified net investmentincome and since the individual has no investment income, the other interest (investment interest) isnot deductible. Medical expenses are deductible only for amounts in excess of 10% of AGI andstate and local taxes are not deductible for AMT purposes. pp. I:14-4 and I:14-5.

I:14-6 Most people are not subject to the self-employment tax because they are classified as

employees for tax purposes. Employees make FICA employee contributions, which must bematched by their employers. p. I:14-8.

I:14-7 Tony will have to make social security tax payments in the form of self-employment taxes if

he continues to operate his consulting business as a sole proprietor. If Tony continues to beemployed, he will not be subject to the OASDI portion of the self-employment tax on the first$106,800 (2010) of total earnings. However, any income (i.e., salary or consulting) above thisamount will be subject to the hospital insurance (HI) premium portion of the FICA tax

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(1.45% for employment related income and 2.9% for his self-employment earnings). If he retiresfrom his salaried job, Tony's consulting income will all be subject to the 15.3% self-employment rateon the first $106,800 and 2.9% on income in excess of $106,800. Tony will then receive a for AGIdeduction for one-half of self-employment taxes paid. pp. I:14-8 and I:14-9. For 2010 only, the first$106,800 will be subject to self-employment tax at a reduced rate of 13.3%, reflecting the payroll tax

holiday enacted in the TRUIRJCA of 2010.

I:14-8 If the engagement is set up as a consulting arrangement rather than an employment contract,then the consulting firm will be able to avoid making matching FICA contributions for Theresa. Inaddition, the consulting firm will not be required to withhold the employee's share of FICA tax.Thus, if the compensation paid to Theresa would be the same whether she was an employee or independent consultant, the cost paying for Theresa’s services would be less if she were a consultantrather than an employee. Theresa, however, will be subject to the self-employment tax. If her income as an employee (e.g., college professor) is in excess of the ceiling amount of $106,800(2009) for the OASDI portion of self-employment income, she will not be subject to the 12.4% portion of the tax. She will however, be subject to the 2.9% HI portion on her self-employment

income. Thus, because of self-employment taxes, receiving compensation as a consultant is moreexpensive to Theresa. p. I:14-8.

I:14-9 a. Ted’s taxable base is $20,000, the lesser of (1) $20,000 self-employment income or (2) $72,000 ($106,800 ceiling - $34,800 FICA wages). Ted's net earnings from self-employment are$18,470 ($20,000 x 0.9235); thus Ted’s self-employment tax is $2,826 ($18,470 x 0.1530).

Tina’s taxable base is $10,000, the lesser of (1) $10,000 self-employment income or (2) the$106,800 ceiling). Tina's net earnings from self-employment are $9,235 ($10,000 x .9235); thusTina’s self-employment tax is $1,413 (0.1530 x $9,235). Combined self-employment tax on the joint return is $4,239 ($2,826 + $1,413).

b. Ted and Tina are entitled to a business deduction on their 2009 income tax return equal to

one-half of self-employment taxes paid. If they file a joint return, the deduction is $2,119 (0.50 x$4,239). pp. I:14-8 and I:14-9.

I:14-10 a. Foreign tax credits are provided to mitigate the effect of double taxation on foreign sourceincome.

b. The research credit is given to encourage (reduce the cost of) research and developmentactivities.

c. Business energy credits are incentives to encourage energy conservation measures and the

use of fuel other than petroleum.d. The work opportunity credit encourages employers to hire individuals from economically

and socially challenged groups.

e. The child and dependent care credit was enacted to reduce the cost of quality child care for parents and other individuals who are employed and who must incur expenses for household anddependent care services.

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f. The earned income credit is designed to encourage low-income individuals to becomegainfully employed or to continue to work despite low earnings.

g. The purpose of the American Opportunity tax credit is to reduce the cost of postsecondaryeducation for low and middle income taxpayers.

h. The disabled access credit is designed to reduce the cost of adding disabled access to

existing business facilities.i. The adoption credit is designed to reduce the financial burdens associated with adopting

children. p. I:14-27.

I:14-11 To a taxpayer in the 15% marginal tax bracket, a $200 deduction is worth $30 in tax savingsand is therefore worth less than a $40 credit. To a taxpayer in the 25% marginal tax bracket, thededuction is worth $50 in tax savings, more than a $40 credit. Thus, for all taxpayers with amarginal tax rate of 25% or more, the deduction is more advantageous than the credit. p. I:14-10.

I:14-12 The general business credit includes the rehabilitation expenditures credit, work opportunitycredit, research credit, business energy credits, and the disabled access credit. pp. I:14-19 through

I:14-25.

I:14-13 a. The general business credit may not exceed the "net income tax" minus the greater of (1)the tentative minimum tax or (2) 25% of the "net regular tax liability" in excess of $25,000.

b. The general business credit is a nonrefundable credit and has a lower priority than personaltax credits. An individual must use personal tax credits as well as the foreign tax credit to offset taxliability before the general business credit is used. Since the credit is nonrefundable, if the taxliability has already been eliminated by credits with a higher priority than the general businesscredit, the taxpayer will only be able to carryback or carryforward the unused general businesscredit.

c. For tax years beginning after December 31, 1997, the general business tax credit may be

carried back 1 year and any remaining credit may be carried forward 20 years. Credits arising from prior years (commencing with the earliest carryover years) are first carried back or forward beforecredits arising from the current year may be used. p. I:14-24.

I:14-14 a. The foreign tax credit is equal to the income tax paid or accrued to a foreign country, butlimited to the taxpayer's U.S. tax liability times the ratio of foreign source taxable income toworldwide taxable income. This limitation restricts the use of foreign tax credits when the effectiveforeign tax rate exceeds the effective U.S. tax rate. In this case the effective foreign tax rate is lower than the effective U.S. tax rate and the foreign tax credit would be $24,000 ($120,000 x 0.20).

b. In this case Sarah would be better off choosing the earned income exclusion since $92,900(2011) of her income could be excluded from U.S. taxation. Computations for each alternative:

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1. If Sarah elects the foreign-earned income exclusion, his total tax would be:U. S. taxable income after exclusion

($120,000 - $92,900)$27,100

x 0.30U.S. tax $ 8,130

Foreign tax paid ($120,000 x 20%) 24,000Total tax before FTC $32,130Foreign tax credit ($27,100 x 20%) (5,420)Total taxes paid $26,710

Sarah is eligible for a foreign tax credit on the $27,100 of income subject to U.S. tax.

2. If Sarah elects the foreign tax credit , her total tax would be:

U. S. tax on worldwide taxableincome ($120,000 x 0.30)

$36,000

Foreign tax credit ($120,000 x 0.20) ( 24,000) Net U.S. tax liability $12,000Plus: Foreign tax paid 24,000Total taxes paid $36,000

Ultimately, Sarah pays the higher tax rate (30%) on the $120,000 income: 20% to the foreigncountry and 10% (after FTC) to the U.S.

pp. I:14-18 and I:14-19.

I:14-15 The work opportunity tax credit is 40% of up to $6,000 of qualified first-year wages for

each qualified employee hired. Second-year wages are eligible for the credit only for employees incategory 11. In this case, the work opportunity tax credit for King Corporation is $9,600 (4 qualifiedemployees x first $6,000 of wages x 40% credit). pp. I:14-21.

I:14-16 Queen Corporation is eligible for the disabled access credit as an eligible small business.Though the company had $1 million or more of gross receipts in the preceding year, it meets the test because it had fewer than 30 employees (24). The credit is $5,000 (0.50 x $10,000). Only $10,000of the $15,000 expenditure qualifies for the credit (expenditures over $250 but not exceeding$10,250, or $10,000 maximum). The depreciable basis of the property is reduced by the $5,000allowable credit. p. I:14-22 and I:14-23.

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I:14-17 a. The credit applies to expenditures for the rehabilitation of older industrial and commercial buildings and certified historic structures. Expenditures may not be for residential real estate unlessthe structure is a certified historic structure.

b. A rate of 10% applies to expenditures on structures placed in service before 1936 and arate of 20% to expenditures on certified historic structures.

c. Depreciation of qualifying expenditures must be computed using the straight-linedepreciation method.

d. For the purpose of depreciation, the basis of the property must be reduced by the fullamount of the credit taken.

e. The rehabilitation credit must be recaptured at a rate of 20% per year in the event of anearly disposition of the property. p. I:14-20.

I:14-18 Solar energy property and geothermal energy property qualify for the business energy credit.Solar energy property is eligible for an increased credit of 30% of basis in 2006-2016. p. I:14-20.

I:14-19 Many personal tax credits are motivated by both economic and social policy objectives. For

example, the dependent care credit makes it profitable for more parents to work and provideadequate child care. p. I:14-10.

I:14-20 A refundable tax credit resembles a direct subsidy. It is a type of negative income tax. If thecredit exceeds the tax liability the government pays the taxpayer the excess credit. A nonrefundabletax credit may only be used to offset the taxpayer’s tax liability; therefore, if the credit exceeds thetax liability the taxpayer receives no payment and at best can only carryback or carryforward theexcess credit. The earned income credit, the first-time homebuyers’ credit, and the Making Work Pay credit are refundable tax credits. Child and dependent care credits, tax credits for the elderlyand the general business credit are examples of nonrefundable credits. p. I:14-25.

I:14-21 If an individual is unemployed and has no earned income, it is generally not possible toreceive a child and dependent care credit, because the intention of the credit is to help a person whomust pay for dependents to enable the individual to work. One exception to this rule is a spouse whois either a full-time student or is incapacitated. Such individuals are deemed to have earned incomeof $250 per month (one qualifying dependent) or $500 (two or more qualifying dependents). pp.I:14-11 and I:14-12.

I:14-22 There are several significant differences between the American Opportunity Tax Credit(AOTC) and the Lifetime Learning Credit. First, the AOTC only applies during a student’s first four years of post-secondary education, whereas the Lifetime Learning Credit applies to undergraduate,

graduate, and professional education. Second, the AOTC applies per student (maximum $2,500 per student) whereas the Lifetime Learning Credit is based on the dollars spent on qualified tuition andrelated expenses by the taxpayer. Finally, the AOTC and Lifetime Learning credits have different phaseout rules.

Low- and middleincome taxpayers are most likely to qualify for both credits. pp. I:14-14through I:14-16.

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I:14-23 The maximum amount of child and dependent care expenses that qualify for the credit for ataxpayer with two or more qualifying individuals is $6,000. Therefore, a taxpayer who has $8,000of eligible expenses may claim a maximum credit of $2,100 ($6,000 x 0.35). The credit ratedecreases to a minimum of 20% as the taxpayer’s AGI increases from $15,000 to $43,000. If thetaxpayer’s AGI exceeds $43,000, the maximum credit is $1,200 ($6,000 x 0.20). p. I:14-11 and

I:14-12.

I:14-24 Vivian's child and dependent care expenses are initially limited to the $6,000 ceilingamount, which is then reduced by the $4,000 employer reimbursement. The maximum allowablecredit is thus $600 (0.30 x $2,000). Her rate is 30% because her AGI of $24,500 exceeds the baseAGI of $15,000 by $9,500. Thus, the basic 35% credit is reduced to 30% ($9,500/$2,000 = 4.75,rounded to 5 percentage points). pp. I:14-11 and I:14-12.

I:14-25 a. The adoption credit allowed is the amount of qualified adoption expenses incurred to amaximum of $13,170 (2010). The credit is allowable in the year following the year the expenseswere paid unless the expenses are paid in the year the adoption becomes final. This rule is intended

to prevent taking a credit for adoption expenses where the adoption is not finalized. Finally, there isa phase-out of the credit based on the taxpayer's AGI. For taxpayers with AGI above $182,250(2010), the credit is ratably phased-out and is fully phased-out when AGI reaches $222,250.

b. As with other phase-outs in the tax law, Congress does not intend this credit for higher-income taxpayers. pp. I:14-13 and I:14-14.

I:14-26 Alice is eligible for the earned income credit (EIC) since she has qualifying children and hasearned income which does not exceed the phase-out limitation amounts. Her initial credit amountfor 2011 is $5,112 (0.40 x $12,780). Because her AGI exceeds $16,690, her EIC is subject to phaseout. The phase-out amount is $1,034 [($21,600 – 16,690) x 0.2106)], so her net EIC for 2011is 4,078. Alice can obtain advance payment of the credit by filing a Form W-5 with her employer.

Her employer will increase her pay by the amount of the credit. pp. I:14-25 and I:14-26.

I:14-27 Most elderly people are unable to qualify for the credit because they receive Social Security benefits which exceed the ceiling limitation, or they have AGI in excess of the limitation, or both,

which eliminates the credit. p. I:14-13.

I:14-28 Penalties are imposed if an employer fails to withhold federal income tax and pay this tax tothe IRS. Corporate officers, directors, and other officials may also be held personally liable for payment of the tax. p. I:14-27.

I:14-29a. Though there already are favorable tax benefits in connection with the contribution of

amounts to qualified retirement plans, given the budget constraints of lower and middle incomehouseholds, Congress wanted to further encourage saving for retirement. Further, Congressacknowledged that the United States has a low savings rate, especially among lower and middleincome households.

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b. The credit is computed by multiplying qualifying contributions (maximum $2,000 per taxpayer per year) by an applicable percentage. The applicable percentage depends on the taxpayer’sadjusted gross income and filing status, and ranges from 10-50%. Therefore, the maximum annualcredit would be $1,000 ($2,000 x 0.50). pp. I:14-17 and I:14-18.

I:14-30 a. The two components of the credit for employer-provided childcare are (1) qualifiedchildcare expenses, which include expenses paid to acquire, construct, rehabilitate, expand, andoperate a qualified childcare facility, and (2) qualified child care resource and referral expenditures,which are expenses paid to provide child care resource and referral services for employees.

b. The credit is 25% of qualified childcare expenses plus 10% of qualified childcare resourcesand referral expenditures. The total credit for an employer is limited to $150,000 for any given taxyear. Finally, if an employer ceases its childcare operations within the first three years, 100% of thecredit is recaptured. p. I:14-22.

I:14-31 The research credit is allowed for increasing research expenditures. The credit is 20% of theexcess of qualified research expenses for the taxable year over an established base amount. pp.

I:14-23 and I:14-24.

I:14-32 a. Yes, a person may claim fewer allowances than she is entitled to. b. An individual might claim fewer allowances to increase the amount withheld, if she

anticipates that taxes will be owed at the end of the year and she does not wish to make quarterlyestimated tax payments.

c. Virginia can claim more than five withholding allowances in a tax year if she has larger than average deductible expenses (for example, mortgage interest expenses on a new house that aresubstantially larger than the average for a family of Virginia’s income amount). pp. I:14-28 and I:14-29.

I:14-33 a. Mario should file exempt status on a Form W-4 to avoid having amounts withheld. b. Mario would receive a smaller paycheck each period due to withholding. Since he owes

no taxes, he would be entitled to a refund of all withholding amounts. In effect, Mario would beloaning the government the withholding amount interest-free. p. I:14-28.

I:14-34 Backup withholding was implemented to prevent abusive noncompliance with tax provisions. Backup withholding provides for withholding of taxes from pension income, interest,dividends, and royalties under certain circumstances (e.g., where the taxpayer fails to provide the payor with his tax identification number, or fails to report this type of income on his return). p. I:14-28.

I:14-35 a. Vincent is not required to make tax payments in 2011 since he had more withheld in 2011($9,000) than 100% of his tax liability in 2010 ($8,000) and his 2010 AGI was less than $150,000.

b. No. Since Vincent has paid withholding tax in excess of 100% of his tax liability for the previous year he will not be subject to an underpayment penalty.

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c. No, for the same reason cited in part (b) above. If Vincent's AGI for the prior year exceeded $150,000, the 110% of prior year's tax exception would also have been met because the$9,000 withheld is greater than the $8,800 (1.10 x $8,000) minimum estimated tax paymentrequired. pp. I:14-29 and I:14-30.

I:14-36 To avoid the estimated tax underpayment penalty, the taxpayer should make combinedestimated payments and withholdings equal to the required percentage of the preceding year’s taxliability. In 2011, for example, a taxpayer must pay in 100% of the preceding year’s tax liability if his AGI in 2010 was $150,000 or less. If the taxpayer’s AGI exceeded $150,000 in 2010, thetaxpayer would be required to pay 110% of his 2010 tax liability in 2011. p. I:14-32.

I:14-37 It is preferable to have an underpayment of the tax liability because the IRS does not payinterest on overpayments if it refunds the overpayment within 45 days from the later of the due dateof the return or its filing date. Overpaying has the effect of making an interest free loan to the IRS. p. I:14-33.

I:14-38 Many people overpay their taxes in the form of additional withholding to be sure that theywill not have to pay a lump-sum tax payment at the filing date (using the withholding system as a"forced savings" program). As mentioned previously, the disadvantage with this forced savings isthat no interest is earned on such savings. p. I:14-33.

Issue Identification Questions

I:14-39 The primary issue is the tax effect of paying self-employment taxes directly versuscontinuing to pay FICA taxes via withholding from his employment income. In addition, Darylshould consider the effect of the change on his marginal tax rate and the taxation of his pension benefits. He should also consider the loss of tax-free employee fringe benefits, such as employer

contributions to accident and health insurance. pp. I:14-29 and I:14-30.

I:14-40 The primary issue is whether Jennifer should make quarterly estimated tax payments toavoid an underpayment penalty. She needs to consider whether she can avoid the underpayment penalty by meeting one of the exceptions. A secondary issue is the tax treatment accorded the property settlement and the tax basis of the securities. While the securities are not subject to incometaxation pursuant to the divorce, they do have a carryover basis. Since the basis may be low, it is possible for Jennifer to recognize a sizeable gain if she sells the securities. Estimated taxes must be paid on such a gain to avoid underpayment penalties. pp. I:14-30.

I:14-41 Coastal must obtain certification that the intended hires are members of a targeted group.

Coastal should also evaluate the amount of tax benefit that accrues after the deduction for wages isreduced by the amount of the credit. The net tax benefit should be compared to the additional jobtraining expenses. pp. I:14-21 and I:14-22.

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Problems

I:14-42 a. Taxable income $ 70,000Plus: Personal and dependency exemptions ($3,700 x 2) 7,400

Tax preference items 20,000

Adjustment related to itemized deductions 15,000AMTI $112,400Minus: Exemption (no phaseout) ( 74,450)Alternative minimum tax base amount $ 37,950Times: Rate x 0.26Tentative minimum tax $ 9,867

Minus: Regular tax ( 9,750)Alternative minimum tax $ 117

b. Taxable income $ 70,000Plus: Personal and dependency exemptions ($3,650 x 1) 3,700

Tax preference items 20,000Adjustment related to itemized deductions 15,000

AMTI $108,700Minus: Exemption (no phaseout) ( 48,450)

Alternative minimum tax base amount $ 60,250Times: Rate x 0.26Tentative minimum tax $ 15,665Minus: Regular tax ( 13,625)Alternative minimum tax $ 2,040

pp. I:14-2 through I:14-7.

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I:14-43 Taxable income $160,000Personal exemption 3,700AMT adjustments 30,000AMT preferences 10,000AMTI 203,700

Minus: Exemption (using 2009 patch): ( 25,650)$48,450 - 0.25($203,700 - $112,500)

AMT tax base $178,050

Tax on first $175,000: (175,000 x 0.26) $ 45,500Tax on amounts in excess:($178,050 - $175,000) x 0.28 854

Tentative minimum tax $ 46,354Minus: Regular tax ( 38,417)Jose’s alternative minimum tax $ 7,937

pp. I:14-3 and I:14-4.

I:14-44 a. Harry and Mary’s regular tax and AMT is computed as follows:

Regular Tax

Salary $100,000Interest and dividends 8,000AGI 108,000Standard deduction $11,600Personal exemptions (14 x $3,700) 51,800 (63,400)Taxable income

Regular income taxChild tax credit ($1,000 x 6) Net regular tax

$ 44,600

$5,840(6,000)$ -0-

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Alternative Minimum Tax:

Taxable income (above) $ 44,600Personal exemptionsStandard deduction

51,80011,600

AMTI $108,000

Minus exemption (no phaseout) (74,450)AMT base 33,550

Pre-credit tentative minimum taxChild tax credit

x 0.26$8,723(6,000)

Tentative minimum tax 2,723 Net regular tax ($ -0-)Alternative minimum tax $ 2,723

b. The imposition of an AMT levy on Harry and Mary likely is not what Congressintended when the AMT was enacted. However, the law clearly imposes an additional tax of

$2,723 in the form of the AMT. pp. I:14-3 through I:14-7.

I:14-45 a. AMT adjustments:Medical expenses [($4,375 ($10,000 - $5,625) for regular tax

- $2,500 ($10,000 - $7,500) for AMT)] $ 1,875Real estate taxes 8,000State income taxes 5,000Total adjustments $14,875

b. Taxable income $48,000Plus: Tax preferences 20,000

Personal Exemption 3,700Adjustments related to itemized deductions 14,875AMTI $86,575Minus: Exemption (no phaseout) ( 48,450)Alternative minimum tax base $38,125Times: Rate x 0.26Tentative minimum tax $9,913Minus: Regular tax liability ( 8,125)Alternative minimum tax $ 1,788

pp. I:14-3 through I:14-7.

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I:14-46 a. Tax base and liability for OASDI portion:lesser of: $64,645 ($70,000 x 0.9235) self-employment earnings or $61,800 ($106,800 - $45,000) ceiling reduced by FICA wages$61,800 x 0.104 = 6,427

Tax base and liability for HI portion:

$64,645 x 0.029 = $1,875Total self-employment tax = ($6,427 + $1,875) = $8,302Amelia may deduct one-half of the self-employment taxes paid as a for AGI deduction.This amount is $4.768[($6,427 x 0.596) + ($1,875 x 0.50)]

b. Tax base for OASDI portion:lesser of: $64,645 ($70,000 x .9235) self-employment earnings, or $0 ($106,800 - $110,000) ceiling reduced by FICA wages

OASDI portion of self-employment tax is $0 because Amelia’s FICA wages exceeded theceiling amount.

Tax base for HI portion:

$64,645 x 0.029 = $1,875Total self-employment tax = $1,875.

As in part a. above, Amelia may deduct one-half of the self-employment taxes paid as a for AGI deduction in the amount of $938 ($1,875 x 0.50). pp. I:14-8 and I:14-9.

b. Tax base and liability for OASDI portion:lesser of: $64,645 ($70,000 x 0.9235) self-employment earnings or $61,800 ($106,800 - $45,000) ceiling reduced by FICA wages$61,800 x 0.124 = $7,663

Tax base and liability for HI portion:$64,645 x 0.029 = $1,875

Total self-employment tax = ($7,663 + $1,875) = $9,538Amelia may deduct one-half of the self-employment taxes paid as a for AGI deduction.This amount is $4.769 (.050 x $9,538).

I:14-47 Arnie: A partner’s income from a partnership is considered self-employment income.Arnie’s self-employment tax is computed as follows:

Net earnings from self-employment: ($75,000 x 0.9235) = $69,263OASDI portion: $69,263 x 0.104 $ 7,203HI portion $69,263 x 0.029 2,009Total self-employment tax $9,212

Note: Though Arnie and Angela are married, their self-employment taxes are computed separately.

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Angela: Net earnings from self-employment noneSelf-employment tax none

Angela is not self-employed and is therefore, not subject to the SE tax. She pays FICA (Social

Security and Medicare) via wage withholding, and her employer must match these two tax levies.

pp. I:14-8 and I:14-9.

I:14-48 a. Net earnings from self-employment: $ 4,618($11,000 + $9,000 - $15,000) x 0.9235

Times: Rate (OASDI 0.104 + HI 0.029) x 0.133Self-employment tax $ 614

Taxpayers may deduct losses from self-employment activities against self-employment income.Anita incurred a $6,000 loss from her consulting practice and this amount is offset against her

$11,000 of director’s fees.

b. Anita would be subject to the HI portion of the self-employment tax, but not to OASDI.Since her salary is greater than the maximum OASDI amount of $106,800, none of her self-employment income is subject to OASDI. The HI portion is $134 ($4,618 x 0.029). Thus, Anita’stotal SE tax is $134. pp. I:14-8 and I:14-9.

I:14-49 a. The allowable personal tax credit is $1,200 (child and dependent care). b. Total business tax credits are $15,600 ($1,000 + $14,000 + $600). The allowable amount

of the credit is $12,600 ($13,800 tax - $1,200 of personal tax credits).c. Unused business tax credits of $3,000 ($15,600 - $12,600) may be carried back one year

and carried forward 20 years. pp. I:14-10 through I:14-24.

I:14-50 a. The limitation on qualifying expenses is $6,000. Since AGI is greater than $43,000, thecredit rate is 20% and the credit equals $1,200 ($6,000 x 0.20).

b. The credit is still $1,200. Payments to relatives are qualified payments as long as therelative is not a dependent or a child (under age 19) of the taxpayer.

c. Qualifying expenses are limited to $2,000 ($3,000 - $1,000) since one child is older than12 and $1,000 was excluded from Bruce's gross income under Sec. 129. AGI is greater than$15,000; so the credit rate is 29%. The credit rate is reduced from 35% by 1% for every $2,000 [or fraction thereof] that AGI exceeds $15,000). The credit is $580 (0.29 x $2,000).

d. The qualifying expense is limited to $4,000. (The lower earned income of Candice). The

credit rate is 20%, and the credit is $800 (0.20 x $4,000).e. The limitation on qualifying expenses is generally limited to the earned income of the

lesser earning spouse. Ben has no earned income during the year. However, since he is a full-timestudent, he is treated as earning $500 per month, or $5,000 (10 months x $500). Therefore, thecredit is $1,000 ($5,000 x 20%). pp. I:14-11 and I:14-12.

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I:14-14

I:14-51a. Valerie and Brad's qualified adoption expenses are:2010 2011

Agency fees $5,000 $4,000Travel expenses 1,500 400Publications 300 0

Legal fees 1,000 0Court costs ____0 1,500TOTAL $7,800 $5,900

The agency fees, travel expenses, and legal fees are qualified adoption expenses. The publicationsqualify if they are directly related to, and have the principal purpose of the legal adoption of aneligible child. [Sec. 23(d)]. The kennel fees for the dog and the cost of nursery furniture are notqualified expenses. Since the qualified adoption expenses were paid in the year prior to the year theadoption was finalized, the expenses are not eligible for the credit until the year the adoption isfinalized. So, no credit is allowable in 2010.

b. The maximum credit is $13,360, which may be taken in 2011. Sec. 23 provides that thecredit is allowed in the tax year following the tax year in which such expenses were paid or incurred.However, in the year the adoption becomes final, expenses paid in that tax year are currentlydeductible. Thus, in Brad and Valerie's situation, the expenses in 2010 and 2011 would be eligible

for the credit in 2011. They incurred a total of $13,700 ($7,800 + $5,900) of qualified expenses, butthe credit is limited to $13,360.

c. No difference; the credit would still be $13,360. Tax law provides $13,360 is themaximum even for a child with special needs. However, the law also provides that an adoptioncredit of $13,360 is allowed for a child with special needs regardless of whether the taxpayer hasqualified adoption expenses. pp. I:14-13 and I:14-14.

I:14-52 a. The Norths can claim education credits in 2011 as follows:

• American Opportunity tax credit (AOTC) for Phil in Spring 2011 and Jaciin Spring and Fall 2011, because it applies to a full four years of undergraduate education. Qualified tuition and related expenses (QTRE)include the tuition, lab fees, and books (student activity fees and roomand board are not QTRE.) The maximum credit is $2,500 (100% of thefirst $2,000 of qualified expenses plus 25% of the next $2,000.) per student. Computation of the North’s tentative credit:

Phil: QTRE total $8,400, so tentative credit is the maximum $2,500. Jaci: QTRE total $3,900, so tentative credit is $2,475 [(100% x

$2,000) + (25% x $1,900)].

The Norths are not subject to phaseout of the AOTC because their modified AGI of $112,000 is less than the MFJ phaseout start point of $160,000.Thus, their total AOTC is $4,975.

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I:14-15

• Lifetime Learning (LL) tax credit for Phil in Fall 2011 semester, because

it applies to both undergraduate and graduate education. The maximumcredit is $2,000 (20% of the first $10,000 of qualified expenses) per taxpayer who pays for the education (not per student.) Computation of the North’s tentative credit:

Phil: QTRE total $8,950, so tentative credit is $1,790 (20% x$8,950.)

The Norths are subject to phaseout of the LL credit because their modifiedAGI exceeds the MFJ phaseout start point of $102,000. The phaseout is $1,895,which is their tentative credit of $1,790 x [($112,000 - $102,000) ÷ $20,000].Thus, their allowable LL credit is $895.

b. Phil’s QTRE for both the AOTC and the LL credits must be reduced bythe amount of the excluded scholarship. In Spring semester, Phil’s QTRE will

be $5,400 in Spring semester, which still allows the maximum AOTC of $2,500.His QTRE will be $5,950 in Fall semester, which allows a tentative LL credit of $1,190 (20% x $5,950).

If modified AGI is $175,000, the North’s AOTC phaseout will be $3,731, whichis their tentative credit of $4,975 x [($175,000 - $160,000) ÷ $20,000]. Thus,their allowable AOTC is $1,244.

If Phil had been a junior in Spring semester and a senior in Fall semester, hewould have qualified for the AOTC and not the LL credit. His QTRE total$17,350 ($8,400 + $8,950). The North’s tentative AOTC relative to Phil would

be the maximum of $2,500, and they will not be subject to phaseout because their modified AGI is $160,000.

pp. I:14-14 through I:14-16.

I:14-53 a. Tentative Tax credit:

Initial ceiling amountMinus: Nontaxable social security benefitsMinus: One-half of AGI in excess of $7,500 (0.50 x [$8,500 - $7,500])Credit base

Times: RateTotal credit

$3,000

500

$5,000

(3,500)$1,500

x 0.15$ 225

b. All of Caroline’s $225 tentative tax credit is allowed since it does not exceed her pre-

credit tax liability. p. I:14-13.

I:14-54 a. Net Income Tax Net Regular Tax

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I:14-16

Regular tax before credits $37,500

Alternative minimum tax 0Foreign tax credit (4,500)Other nonrefundable credits (6,100)

Net income tax (NIT): $27,400

Net regular tax (NRT):

$37,500

n/a(4,500)(6,100)

$ 27,400

The general business cannot exceed the greater of 1. (NIT - tentative minimum tax) = $27,400 - $20,200 = $7,2002. [NIT – 0.25 x (NRT - $25,000)] = $29,600 - $600 = $29,000

b. Mark’s allowable 2011 credit will be $29,000. This will consist of $3,000 from thecarryforward credit and $26,000 from the credit earned in 2011.

c. Mark will carry $4,000 forward to 2012. p. I:14-24.

I:14-55 Laser's foreign tax credit is limited to $62,900 [($185,000/$505,000) x $171,700], since theeffective foreign tax rate (40%) exceeds the effective U.S. tax rate (34%). The $11,100 ($74,000 -$62,900) unused foreign tax credit is carried back one year and forward for ten years. pp. I:14-18and I:14-19.

I:14-56 a. The tentative work opportunity credit is $2,400 for each youth hired (0.40 x $6,000), or $4,800 total.

b. Total general business credits for the current year are $39,800 ($35,000 + $4,800). Langmay use $30,000 [$40,000 minus the greater of the tentative minimum tax of $10,000 or 0.25($40,000 - $25,000)] in the current year. Lang may carryforward or carryback $9,800 ($39,800 -

$30,000).c. Lang can deduct $11,200 of the salaries and wages paid to the two youths ($16,000 -

$4,800 = $11,200). Lang’s total deduction for salaries and wages is $61,200 ($50,000 + $11,200). p. I:14-21.

I:14-57a. The rehabilitation tax credit is $8,000 (0.20 x $40,000). b. The basis is $52,000 ($20,000 building costs + $40,000 renovation costs - $8,000 tax

credit). p. I:14-20.c. Straight-line depreciation must be used. The regular MACRS depreciation rules apply to

the $20,000 basis that is not eligible for the credit. Nonresidential real estate must be depreciatedover 39 years using the straight-line method. $52,000 / 39 years x 4.5/12 = $500

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I:14-17

I:14-58 Pharm, Inc. may claim a credit for research activities in 2011 as follows:

Regular Research Credit:

Salaries $180,000Supplies and materials 162,000

Depreciation 30,000Total qualified research expenses $372,000Base amount:

Average gross receipts for past four years: $5,000,000Fixed base-period percentage x 0.03 ( 150,000)

Excess $ 222,000Credit percentage x 0.20Regular research credit $ 44,400

Pharm, Inc. would also be entitled to a research and experimentation deduction of $391,600 under Sec. 174, computed as follows:

Research expenses for the regular research credit $372,000Less amount of research credit ( 44,400)Deduction allowed for 2010 $327,600

pp. I:14-23 and I:14-24.

I:14-59 a. Carolyn’s tentative earned income credit (EIC) is $3,094 (0.34 x $9,100).

b. Carolyn’s earned income credit is partially phased out because her AGI of $18,000 exceeds the $16,690 phaseout floor. The phaseout is $209 [0.1598 x

($18,000 - $16,680)] and her allowable EIC is $2,855.

c. Yes. The EIC is refundable.

d. If Carolyn is married filing a joint return with three qualifying children, her tentative EIC is $5,751 (045 x $12,780). There will be no phaseout becauseneither AGI ($18,000) nor earned income ($12,000) exceeds the phaseout floor of $21,770.

pp. I:14-25 and I:14-26.

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I:14-18

I:14-60 a. $464 (0.0765 x $6,070) b. $433 [$464 - 0.0765($8,000 - $7,590)].c. Yes, because the earned income credit is refundable.d. Yes. Jose would not be entitled to the earned income credit because his investment

income exceeds $3,150. pp. I:14-25 and I:14-26.

I:14-61 a. The Wilsons can take a first-time homebuyers’ credit (FTHC) of $8,000 in 2010.The credit is the lesser of 10% of the purchase price of the residence ($22,500)or $8,000. No phaseout applies because modified AGI is less than $225,000.

b. The credit is refundable, so the Wilsons will receive a $2,000 refund in 2010.

c. If Loren and Sally sell the house within 36 months of the purchase date of April 1,2010, the full credit must be recaptured.

d. Because their modified AGI exceeds $225,000, the $8,000 credit would be

reduced as follows:

Tentative credit $8,000Phaseout: [($236,000 - $225,000) ÷ $20,000] x $8,000 (4,400)Allowable credit $3,600

pp. I:14-26 and I:14-27.

I:14-62 a. 1. Latisha’s taxable income is $5,500 ($22,400 - $5,800 - $11,100).Regular tax before credits is $550 ($5,500 x 0.10).

2. The tentative EIC is $5,112 (0.40 x $12,780), but the phaseout is $1,203

($22,400 - $16,690) x 0.2106, so the allowable credit is $3,909.3. Latisha will receive a refund of $3,359 ($3,909 - $550).

b. 1. The FTHC is $8,000 (lesser of 10% of cost or $8,000).2. Marcus will be subject to recapture of the credit if he sells the home within 36months of purchase.

pp. I:14-27 and I:14-28.

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I:14-19

I:14-63 a. It is vital that the corporation forward FICA and withholding payments to the IRS.Penalties must be imposed if Lake fails to pay these amounts to the IRS.

b. The liability for payment can extend beyond the corporation. Responsible individualssuch as the treasurer, in this case, can be held personally liable for payment of the tax.

p. I:14-29.

I:14-64 Wages for domestic servants (a) , independent contractor’s fees (b), and tips under $20 per month (g) are exempt from withholding. Only newspaper carriers (c) under age 18 are exempt. p.I:14-29.

I:14-65 a. Barry may not claim exempt status since he was required to pay taxes last year. b. Barry may not claim more than one exemption. Additional withholding allowances are

only allowed if an individual has an unusually large amount of deductions from adjusted grossincome, alimony deductions or tax credits. p. I:14-29.

I:14-66 a. Bart may claim eight withholding allowances, as follows: Bart, Jane, additional special

withholding allowance (spouse unemployed), two children, and three withholding allowancesconnected with Bart's alimony payments.

b. The monthly withholding is $246.33 per the wage bracket table for the year 2010.c. If Bart claims more than ten withholding allowances, Bart's employer must forward the

Form W-4 to the IRS. p. I:14-30.

I:14-67 a. No, Anna is not subject to the underpayment penalty because her withholding isgreater than 100% of her tax liability for the previous year. The 100% exception applies becauseher AGI for the prior year was not more than $150,000. b. In this case, Anna is subject to the underpayment penalty because her withholdings are lessthan 100% of last year's tax liability ($18,000), and also less than $27,000 (90% of this year's

$30,000 tax liability).c. The underpayment penalty is based on the federal short-term interest rate plus 3%; however,the penalty is not deductible as interest. p. I:14-32.

I:14-68 a. Yes, Jane is subject to the underpayment penalty because her $26,000 total withholdingand estimated tax payments are less than 110% of last year's tax liability of $25,000 (110% x$25,000 = $27,500) and less than 90% of this year's tax liability (0.90 x $30,000 = $27,000). Shemust meet the 110% exception instead of the 100% exception because her 2009 AGI was more than$150,000. pp. I:14-31 and I:14-32.

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I:14-20

I:14-69

Salary $150,000Consulting practice net income $53,000 Novelty business net loss (18,000) 35,000

Interest income 3,000Qualified dividend income 9,000Long-term capital gain 24,000Short-term capital loss ( 4,000) 20,000

½ of self-employment tax (469)a

= AGI $216,531

Personal exemptions (4 x $3,700) with no phaseout (14,800)Itemized deductions:

State and local taxes 14,000Real estate taxes 5,000

Home mortgage interest 10,000Charitable contributions 8,000Total 37,000 No Phaseout for 2011: (37,000)

= Taxable income $164,731

Tax on dividends and net LTCG ($29,000 x 0.15) $ 4,350

Tax on balance of taxable income ($135,731) 26,182b Less nonrefundable credits:

Child tax credit $ 0c

Child and dependent care credit 600d

(600)

29,932Self-employment tax 937a Total taxes $ 30,869Less refundable credits and prepayments:

Tax withholdings 21,000Estimated tax payments 14,000 (35,000)

= Refund due to the Webbs $( 4,131)

a SE Tax: $35,000 x 0.9235 = $32,323 net earnings from self-employment x 0.029 = $937.Only the HI portion of the SE tax is due because Mike’s salary covered the OASDI portion.

b The Webbs are not subject to the AMT.

c The Webbs’ tentative child tax credit is $2,000, but the phaseout is: [($216,531 - $110,000) ÷$1,000 x $50] = $5,327, so they receive no child tax credit.

dThe child and dependent care credit is (0.20 x $3,000 = $600). Only one child qualifies, and

Nancy is deemed to have earned $250 per month, or $3,000 for the year.

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I:14-21

I:14-70 This situation involves two issues: (1) whether F&L should rent or buy, and (2) if it is better to buy, which building is the optimal choice.

Rent or Buy: Given the facts, F&L’s cash flows would be better if they decided to buy rather thanrent. The net out-of-pocket cost of $27,000 ($117,000 mortgage payment - $90,000 rent income) is

significantly less than the rent of $72,000 they are currently paying. Given the expectedappreciation of the buildings, the buy decision is clearly superior.

Building #1 or Building #2: Building #2 is the superior choice. F&L would be eligible for a 20%credit on the $600,000 of rehabilitation expenditures since the building is a certified historicstructure. No credit would be available if F&L buys Building #1.

It should be pointed out that much planning needs to be done with respect to Building #2 to ensurethat the tax credit is allowable. Several technical requirements must be met to take the credit, suchas at least 75% of the external walls and at least 75% of the building’s internal structure must remainin place.

Tax Form/Return Preparation Problems

I:14-71 (See Instructor’s Guide)

I:14-72 (See Instructor’s Guide)

Case Study Problems

I:14-73 The following issues need to be included in the client memo:

1. The IRC contains no specific penalty for failure to file quarterly estimated tax payments. There is an underpayment penalty for not paying income taxes on a

timely basis, but this penalty may be waived by paying taxes either throughwithholding or quarterly estimated payments.

2. An underpayment penalty will be imposed in 2010 because Barbara's 2010withholdings of $1,500 are not equal to the prior year's tax liability of $1,900. Thus,Barbara should make quarterly estimated payments of at least $100 per quarter sothat her total taxes paid in during 2010 equal at least $1,900. The 100% of prior year tax liability (rather than 110%) applies because Barbara's AGI for the prior year (2009) was not in excess of $150,000.

3. From an investment income maximizing perspective, Barbara’s quarterly estimated payments should not be more than $100 per quarter even though she will owe aconsiderable amount of tax when she files her 2010 return. She should invest thealimony payments in marketable securities, earn investment income, then pay thetaxes due in April 2011. No interest or penalties will be imposed.

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I:14-22

4. From a cash-flow perspective, it should be pointed out to Barbara that a sizeable tax payment will be due on the $20,000 back alimony and $18,000 of current year alimony. She needs to have sufficient self-discipline to save such amounts andinvest in securities that are readily marketable.

I:14-74 The IRS considers several factors when determining whether an individual will beclassified as an employee. Revenue Ruling 87-41 provides guidance and specifies 20 factors to beconsidered in making this determination. The overall decision usually centers around who has theright to control the individual’s activities and time. The ruling gives examples, one of which issimilar to the case at hand. The IRS would most likely rule that Simone was an employee of thecorporation primarily because the corporation had control over what services she performed and hadto insure that the services were performed satisfactorily.

The corporation will be responsible for withholding and remitting payroll taxes for Simone. Simonewill be required to file a Form W-4 with the corporation listing the number of withholdingallowances. The corporation's failure to pay the employment taxes may make certain officers of the

corporation liable for the payment of these taxes. Those liable are persons responsible for theaccounting, collection and payment of the tax who willfully fail to do so. A corporation shoulduphold its ethical responsibilities in the collection and payment of employment taxes. The employer has a legal and ethical responsibility to file a W-4 for each employee and remit the appropriate taxes

to the government willingly.

Tax Research Problem

I:14-75 Section 6672 states that "Those persons charged with the responsibility of collecting,accounting for, and paying over the tax to the government are subject to a penalty for willful failureto collect or account for the tax." "Responsible person" has been determined by the courts by

considering such factors as: 1) Did the person have day to day management responsibilities? 2) Is hean officer, director, or major stockholder? 3) Was he involved and knowledgeable concerning theaffairs of the corporation? 4) Did he sign checks, approve disbursements? 5) Was he or she afounder of the corporation? "Willful conduct" has been defined as the voluntary, conscious, or intentional act to prefer other creditors over the United States.

The facts in this tax research problem are based on the cited case ( Ernest W. Carlson v.

U.S.). In the tax research problem Carl Jones (1) was not the one who had final word on which billsshould or should not be paid; (2) did not have significant or exclusive control over the company; (3)did not have a significant role in corporate decision making; (4) did not have managementresponsibilities; (5) was not knowledgeable concerning the affairs of the corporation except those

which he was assigned; and (6) was not a founder of the corporation. In addition, he was notwillfully failing to pay the taxes. Thus, Carl Jones is not subject to the penalty provisions of Sec.6672.

However, Bruce Smith (1) was one the incorporators; (2) was authorized to sign bank checks; (3) had authority to make management decisions, and (4) was a key officer and member of the board of directors, and (5) was responsible for insuring that payroll taxes were paid. Thus, he

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I:14-23

does meet the definition of "responsible person." Furthermore, he did willfully fail to pay the taxesas evidenced by the decision to prefer other creditors to the IRS. Thus, he is liable for the penaltiesunder Sec. 6672.

In Schiff v. U.S., the court held that Jones and Schiff were responsible for collecting and

paying taxes for employees because they both were responsible persons with significant control over the corporation's finances even though they did not hold official corporate titles. The court explainsthat the actual mechanics of decision making instead of the absence of official title will helpdetermine one who is a responsible person and those with significant control can be liable for willfulavoidance of payment of taxes.

In Tsouprake v. U.S., the sole shareholder and chairman of the corporation did not partakein daily management of the corporation. However, he was held liable for the penalty for failure to pay employment taxes because he was a responsible person and willfully avoided the tax payments.The court looked at his stock ownership, check-signing authority, and corporate financing ability.

In Guito, Jr. v. U.S., an officer of the corporation was a responsible party for payment of employment taxes. He willfully did not pay the taxes and was held partly liable because he participated in major decision making, was chief policymaker, corporate boss, and held sufficient power to insure timely payments of the corporate tax liability.

“What Would You Do In This Situation?” Solution

Ch. I:14, p. I:14-31.

Mr. Princeton is probably liable for payroll taxes on the amounts paid to the domesticworkers. The issue is whether the domestic workers were employees or independent contractors.

The distinction generally depends on the amount of control the employer has over the worker. TheIRS has published a list of 20 factors that taxpayers should use to determine the degree of controlover the workers. Since Mr. Princeton specifically provides the tasks to be performed, the workerswill likely be classified as employees. The fact that a contract was signed declaring that they wereto be classified as independent contractors is irrelevant in making the determination.

Statement No. 6 of the Statements on Standards for Tax Services sets forth theresponsibilities of CPAs in situations where the CPA is aware of an error. In this case, no payrolltaxes were paid and no returns were filed. Therefore, the CPA should advise Mr. Princeton of themeasures that should be taken to correct this situation. Returns should be filed to report the amounts paid as wages and appropriate payroll taxes should be paid. If Mr. Princeton refuses to file suchreturns, the CPA must consider whether to continue the professional relationship with Mr. Princeton.

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Pope Phft2012 Ind Sm 14

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