Presentation:
Federal Income Taxation
Chapter 9 Personal Deductions, Exemptions, Credits
Professors Wells
October 5, 2015
Basic Tax Structure
p.560
Gross Income (§61)
minus
Above the Line Deductions (§62(a))
Equals
Adjusted Gross Income (§62)
minus
Below the Line Deductions
(either standard deduction (§63(c)) or itemized deductions (§63(d))
and
Deduction for Personal Exemptions (§151)
Equals
Taxable Income (§63)
2 Adjusted Gross Income
Example
p.561
Alice is a lawyer who conducts her own practice. She collects fees of about $400,000 in
a year. But that amount is not available to her for personal consumption or
accumulation because she has to use much of it to pay rent for her office, salaries of a
secretary and a junior associate, bar association dues and fees, the cost of telephone
service etc. On a less regular basis she has to buy up-to-date computer and network
equipment, books for her library, and office furniture.
Her net income, after deducting these costs, is around $85,000. If she were taxed on
$400,000 at 2015 rates the tax would be about $115,000 (assuming she files as an
unmarried individual with no dependents; see Table 1-1) and she would end up almost
$30,000 in the hole. So the first function of deductions is to make taxable income for
Alice something like $85,000 rather than $400,000. To that end, most of the items
mentioned for Alice would be deductible under §162 as business expenses. For the
computer equipment, depreciation would be allowed pursuant to §§167 and 168. If she
had borrowing attributable to her business, interest paid on the borrowing would be
allowed by §163. Moreover, all these items would be allowed above-the-line, in going
from gross income to adjusted gross income, because all are ‘‘attributable to a trade or
business carried on by the taxpayer’’ other than performance of
3 services as an employee, as specified in §62(a)(1).
Personal and Dependency Exemption
p.563
•  §151(b) provides exemption for taxpayer & spouse. For 2015, the
inflation adjusted amount is $4,000.
•  §151(c) provides additional exemption for each dependent.
Ø  §152 defines a dependent.
•  §151(d)(3) provides a phase-out:
(AGI – Applicable Percentage)/$2,500 x 2% = % Reduction*
*(but not greater than 100%)
4 Itemized Deductions or Standard Deduction
p.565
“Itemized Deductions” are all deductions except those allowed to compute
AGI and the personal exemption.
Taxpayer choice: AGI minus itemized deductions or standard deduction
§63(a) itemized deductions
(subject to limitations of §67/§68)
+Plus+
Personal Exemptions §63(a)
-or-
§62(b) Standard Deduction
($12,600 Joint / $6,300 Single)
+Plus+
Personal Exemptions §63(b)(1)
5 Phase-Out of
p.568
Itemized Deductions and Personal Exemptions
§67: Miscellaneous Itemized Deductions: Allowed only to the extent
they exceed 2% of AGI. Miscellaneous Itemized List: 1.67-1T(a)(1).
§68: Allowable Itemized Deduction Phase-Out:
All itemized deductions (other than those for medical
expenses, investment interest, and casualty or theft losses)
is reduced by the lesser of:
(1) 3% of the excess of AGI - the “applicable amount,” or
(2) 80% of the itemized deductions (other than the three
mentioned above).
6 Itemized Deductions
Rev. Rul. 2012-25
p.569
Section 62(c): an arrangement will not be treated as a reimbursement if (i) it does not
require the employee to substantiate the expenses covered by the arrangement, or (ii)
such arrangement provides the employee the right to retain any amount in excess of the
substantiated expenses covered under the arrangement.
Situation 1: Hourly tool charge to mechanic employee.
Holding: Because employer pays wages determined without regard to
reimbursable expenses, the designation of part of those wages as reimbursements
(e.g., reimbursement for costs of tools) does not satisfy the business connection
requirement because same gross amount is paid regardless.
Situation 2: Hospital provides per diem for deductible travel expenses.
Holding: Same as Holding #1 because amount is not dependent on reimbursable
expenses.
Situation 3: Employer pays per diem mileage reimbursement.
Holding: Same as above because amount does not vary with actual expense.
Situation 4: Employer reimburses employees for their equipment expenses
Holding: Reimbursement based on actual expenses so qualifies. 7 Tax Rate
(§1(a) through (e))
p.384
Credits are dollar-for-dollar reductions of tax liability.
§32 Earned Income Credit
§32(b) varies amount by number of children
§32(i) denies credit for those with excessive investment
income.
Phased Out for higher income taxpayers
§22
Credit for Elderly and Disabled
§23
Adoption Assistance Credit
8 Credits Based on Personal Circumstances
p.384
Credits are dollar-for-dollar reductions of tax liability.
§32 Earned Income Credit
§32(b) varies amount by number of children
§32(i) denies credit for those with excessive investment
income.
Phased Out for higher income taxpayers
§22
Credit for Elderly and Disabled
§23
Adoption Assistance Credit
9