Chapter 13 Tax Credits and Payment Procedures Individual Income Taxes © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1 The Big Picture • Tom and Jennifer Snyder have two dependent children in college. – Lora is a freshman • Her tuition and required fees in 2015 total $14,000. • She has a scholarship amounting to $6,500, and the Snyders paid the balance of her tuition ($7,500), plus room and board of $8,500. – Sam is a junior, and the Snyders paid $8,100 for his tuition plus $7,200 for his room and board. • The Snyders have AGI of $158,000. • They would like to know what tax options are available to them related to these educational expenses. – They have heard about education tax credits, but they believe that their income is too high for them to get any benefit. – Are they correct? • Read the chapter and formulate your response. 2 Tax Credit VS. Tax Deduction • Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer – Tax benefit received from a tax credit is not affected by the taxpayer’s marginal tax rate • Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates MTR 0% 15% 35% Tax benefit if a 25% credit is allowed $250 $250 $250 Tax benefit if tax deduction is allowed –0– $150 $350 3 Tax Credit VS. Tax Deduction • Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer – Tax benefit received from a tax credit is not affected by the taxpayer’s marginal tax rate • Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates MTR 0% 15% 35% Tax benefit if a 25% credit is allowed $250 $250 $250 Tax benefit if tax deduction is allowed –0– $150 $350 4 Tax Credit VS. Tax Deduction • Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer – Tax benefit received from a tax credit is not affected by the taxpayer’s marginal tax rate • Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates MTR 0% 15% 35% Tax benefit if a 25% credit is allowed $250 $250 $250 Tax benefit if tax deduction is allowed –0– $150 $350 5 Refundable vs Nonrefundable Credits (slide 1 of 2) • Refundable credits – Paid even if the tax liability is less than amount of credit 6 Refundable vs Nonrefundable Credits (slide 2 of 2) • Nonrefundable credits – Credit can only be used to offset tax liability – If credit exceeds tax liability, excess is lost • Exception: some nonrefundable credits have carryover provisions for excess 7 General Business Credit (slide 1 of 2) • Comprised of a number of business credits combined into one amount • Limited to net income tax reduced by greater of: – Tentative minimum tax – 25% of net regular tax liability that exceeds $25,000 • Unused credit is carried back 1 year, then forward 20 years 8 General Business Credit (slide 2 of 2) • Includes the following: – – – – – – 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 – Credit for employer-provided child care 9 General Business Credit (slide 2 of 2) • Includes the following: – – – – – – 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 – Credit for employer-provided child care 10 Rehabilitation Expenditure Credit (slide 1 of 3) • Credit is a percentage of expenditures made to substantially rehabilitate industrial and commercial buildings and certified historic structures • Credit rate – 20% for nonresidential and residential certified historic structures – 10% for other structures originally placed into service before 1936 11 Rehabilitation Expenditure Credit (slide 2 of 3) • To qualify for credit, building must be substantially rehabilitated meaning qualified rehab expenditures exceed the greater of: – The adjusted basis of the property before the rehab expenditures, or – $5,000 • Qualified rehab expenditures do not include the cost of the building and related facilities or cost of enlarging existing building 12 Rehabilitation Expenditure Credit (slide 3 of 3) • Basis in structure is reduced by the credit amount • Subject to recapture if rehabilitated property held less than 5 years or ceases to be qualifying property 13 Work Opportunity Tax Credit (slide 1 of 2) • Applies to first 12 months of wages paid to individuals falling within target groups – Credit limited to a percentage of first $6,000 wages paid per eligible employee • 40% if employee has completed at least 400 hours of service to employer • 25% if at least 120 hours of service – Deduction for wages is reduced by credit amount 14 Work Opportunity Tax Credit (slide 2 of 2) • Targeted individuals generally subject to high rates of unemployment, including – Qualified ex-felons, high-risk youths, food stamp recipients, veterans, summer youth employees, and long-term family assistance recipients • Summer youth employees: Only first $3,000 of wages paid for work during 90-day period between May 1 and September 15 qualify for credit 15 Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 1 of 2) • Applies to first 24 months of wages paid to individuals who have been long-term recipients of family assistance welfare benefits – Long-term is at least an 18 month period ending on hiring date 16 Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 2 of 2) • Maximum credit is a percentage of first $10,000 qualified wages paid in first and second year of employment – 40% in first year – 50% in second year • Maximum credit per qualified employee is $9,000 – Deduction for wages is reduced by credit amount 17 Research Activities Credit (slide 1 of 5) • Comprised of three parts – Incremental research activities credit – Basic research credit – Energy research credit 18 Research Activities Credit (slide 2 of 5) • Incremental research activities credit – Credit amount = 20% × (qualified expenditures – base amount) • Expenditures qualify if research relates to discovery of technological info intended for use in developing a new or improved business component for taxpayer – Expenditures qualify fully if research done in-house – Only 65% qualifies if research conducted by outside party (under contract) 19 Research Activities Credit (slide 3 of 5) • Tax treatment of R&E expenditures – Full credit and reduce expense deduction by credit amount – Full expense deduction and reduce credit by (100% × credit × max. corp. tax rate) – Full credit and capitalize research expenses and amortize over 60 months or more • Amount capitalized is reduced by full amount of credit only if the credit exceeds the amount allowable as a deduction 20 Research Activities Credit (slide 4 of 5) • Basic research credit – Additional 20% credit is allowed on basic research payments in excess of a base amount • Basic research payments - amounts paid in cash to a qualified basic research organization, such as a college or university or a taxexempt organization operated primarily to conduct scientific research – Basic research is any original investigation for the advancement of scientific knowledge not having a specific commercial objective • The definition excludes basic research conducted outside the United States and basic research in the social sciences, arts, or humanities 21 Research Activities Credit (slide 5 of 5) • Energy Research Credit – – This credit is intended to stimulate additional energy research – Credit amount = 20% of amounts paid or incurred by a taxpayer to an energy research consortium for energy research 22 Low-income Housing Credit • Credit is issued on a nationwide allocation program • Credit amount – Based on qualified basis of the property which is dependent on the number of units rented to lowincome tenants – Credit is allowed over a 10-year period – Subject to potential recapture 23 Low-income Housing Credit • Credit is issued on a nationwide allocation program • Credit amount – Based on qualified basis of the property which is dependent on the number of units rented to lowincome tenants – Credit is allowed over a 10-year period – Subject to potential recapture 24 Disabled Access Credit • Credit available for eligible access expenditures made by small businesses – Includes amounts paid to remove barriers that would otherwise make a business inaccessible to disabled and handicapped individuals – Facility qualifies if placed in service before November 6, 1990 • Credit amount – 50% × expenditures that exceed $250 but not in excess of $10,250 • Thus, max. credit is $5,000 – Basis in asset is reduced by credit amount 25 Disabled Access Credit • Credit available for eligible access expenditures made by small businesses – Includes amounts paid to remove barriers that would otherwise make a business inaccessible to disabled and handicapped individuals – Facility qualifies if placed in service before November 6, 1990 • Credit amount – 50% × expenditures that exceed $250 but not in excess of $10,250 • Thus, max. credit is $5,000 – Basis in asset is reduced by credit amount 26 Credit For Pension Plan Startup Costs • Small businesses can claim nonrefundable tax credit for admin costs of establishing and maintaining a qualified retirement plan – Small business has < 100 employees who have earned at least $5,000 of compensation • Credit amount = 50% of qualified startup costs limited to max credit of $500 per year for 3 years – Deduction for startup costs is reduced by amount of credit 27 Credit For Employer-Provided Child Care (slide 1 of 2) • Employers can claim a credit for providing child care facilities to their employees during normal working hours – Limited to $150,000 per year • Credit amount: – 25% of qualified child care expenses – 10% of qualified child care resource and referral services 28 Credit For Employer-Provided Child Care (slide 2 of 2) • Deductible qualifying expenses must be reduced by the credit amount • Basis of qualifying property must be reduced by credit amount • Credit may be subject to recapture if child care facility ceases to be used for qualifying purpose within 10 years of being placed in service 29 Earned Income Credit (slide 1 of 3) • General qualifications for credit – Must have earned income from being an employee or self-employed – For 2009 through 2017, Congress has increased • Credit percentage for families with three or more children, and • Phaseout threshold amounts for married taxpayers filing joint returns 30 Earned Income Credit (slide 2 of 3) • Credit amount (2015 tax year) – Applicable percentage rate × earned income • Rate and maximum amount of earned income determined by number of qualifying children • Phase-out of credit begins when earned income (or AGI) exceeds $23,630 for MFJ with qualifying child ($18,110 for other taxpayers) • Use IRS tables to calculate exact credit amount 31 Earned Income Credit (slide 3 of 3) • Credit for taxpayers having no children – Available to taxpayers aged 25 through 64 • Credit amount for couple filing jointly with no qualifying children (2015 tax year) – 7.65% × earned income (up to $6,580) – Phase-out of credit begins when earned income (or AGI) exceeds $13,750 for MFJ ($8,110 for others) 32 Earned Income Credit (slide 3 of 3) • Credit for taxpayers having no children – Available to taxpayers aged 25 through 64 • Credit amount for couple filing jointly with no qualifying children (2015 tax year) – 7.65% × earned income (up to $6,580) – Phase-out of credit begins when earned income (or AGI) exceeds $13,750 for MFJ ($8,110 for others) 33 Credit for Elderly or Disabled Taxpayers (slide 1 of 2) • General qualifications – Age 65 or older, or – Under age 65 and permanently and totally disabled 34 Credit for Elderly or Disabled Taxpayers (slide 2 of 2) • Credit amount – Maximum credit = $1,125 • Amount reduced for taxpayers with Social Security benefits or AGI in excess of specified amounts – IRS will calculate credit for taxpayer if necessary 35 Foreign Tax Credit (slide 1 of 2) • The purpose of the foreign tax credit (FTC) is to mitigate double taxation since income earned in a foreign country is subject to both U.S. and foreign taxes – Credit applies to both individuals and corporations that pay foreign income taxes – Instead of claiming a credit, a deduction may be claimed for the taxes paid 36 Foreign Tax Credit (slide 2 of 2) • Amount of the credit allowed is the lesser of: – The foreign taxes imposed, or – The overall limitation determined using the following formula: Foreign-source TI × U.S. tax before credit Worldwide TI = Overall FTC limitation • For individual taxpayers, worldwide taxable income is determined before personal and dependency exemptions • Unused FTCs can be carried back 1 year and forward 10 years 37 Adoption Expenses Credit (slide 1 of 2) • Credit for qualified adoption expenses incurred in adoption of eligible child – Examples of expenses: adoption fees, court costs, attorney fees • Maximum credit is $13,400 (in 2015) – Credit is phased-out ratably for modified AGI between $201,010 and $241,010 (in 2015) 38 Adoption Expenses Credit (slide 2 of 2) • Eligible child is one that is – Less than 18 years of age, or – Physically or mentally incapable of taking care of himself or herself • Nonrefundable credit – Excess may be carried forward for five years • Married taxpayers must file jointly to claim 39 Child Tax Credit (slide 1 of 2) • Credit amount is $1,000 per child • Eligible children are: – Under age 17, – US citizen, and – Claimed as dependent on taxpayer’s tax return 40 Child Tax Credit (slide 2 of 2) • Credit is phased out by $50 for each $1,000 (or part thereof) of AGI above specified levels – $110,000 for joint filers – $55,000 for married filing separately – $75,000 for single 41 Child and Dependent Care Credit (slide 1 of 4) • General qualifications for credit – Must have employment related care costs for a • Dependent under age 13, or • Dependent or spouse who is physically or mentally incapacitated and who lives with the taxpayer for more than one-half of the year 42 Child and Dependent Care Credit (slide 2 of 4) • Credit amount – Eligible care costs × applicable percentage – Applicable percentage ranges from 20% to 35% depending on AGI • Married taxpayers must file a joint return to obtain credit 43 Child and Dependent Care Credit (slide 3 of 4) • Eligible care costs defined – Costs for care of qualified individual within taxpayer’s home or outside home • If outside home, physically or mentally incapacitated dependent or spouse must spend at least 8 hours a day within taxpayer’s home – Amount of costs that qualify is the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individuals 44 Child and Dependent Care Credit (slide 4 of 4) • Earned income limitation – Amount of eligible care costs cannot exceed lower of taxpayer’s or spouse’s earned income – Full-time student or disabled taxpayer or spouse are deemed to have earned income up to maximum per month limits 45 Child and Dependent Care Credit (slide 4 of 4) • Earned income limitation – Amount of eligible care costs cannot exceed lower of taxpayer’s or spouse’s earned income – Full-time student or disabled taxpayer or spouse are deemed to have earned income up to maximum per month limits 46 Education Tax Credits (slide 1 of 5) • 2 education tax credits are available – American Opportunity credit (previously known as the Hope scholarship credit) – Lifetime learning credit • Both credits are available for qualifying tuition and related expenses – 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 47 Education Tax Credits (slide 2 of 5) • Maximum credits – American Opportunity credit maximum per eligible student is $2,500 per year for first 4 years of postsecondary education • 100% of the first $2,000 of tuition expenses plus 25% of the next $2,000 of tuition expenses – Lifetime learning credit maximum per taxpayer is 20% of qualifying expenses (up to $10,000 per year in 2015) • Cannot be claimed in same year the American Opportunity credit is claimed 48 Education Tax Credits (slide 3 of 5) • Eligible individuals include taxpayer, spouse, and taxpayer’s dependents • To be eligible for American Opportunity credit, student must take at least 1/2 of fulltime course load – No such requirement for lifetime learning credit 49 Education Tax Credits (slide 4 of 5) • Both education credits are subject to income limitations, which differ for years after 2008 – In addition, 40% of the American Opportunity credit is refundable and the entire credit allowed may be used to offset a taxpayer’s AMT liability • The lifetime learning credit is neither refundable nor an AMT liability offset • The American Opportunity credit is phased out, beginning when the taxpayer’s modified AGI reaches $80,000 ($160,000 for MFJ) – The credit is completely eliminated when modified AGI reaches $90,000 ($180,000 for MFJ) 50 Education Tax Credits (slide 5 of 5) • The lifetime learning credit amount is phased out when modified AGI reaches $55,000 ($110,000 for MFJ) – The credit is completely eliminated when AGI reaches $65,000 ($130,000 for MFJ) • Taxpayers are prohibited from receiving a double tax benefit associated with qualifying educational expenses – Can’t claim education credit and deduct the same expenses – Can’t claim the credit for amounts that are excluded from income • e.g., scholarships, employer-paid educational assistance – May claim an education tax credit and exclude from gross income amounts distributed from a Coverdell Education Savings Account as long as the distribution is not used for the same expenses for which the credit is claimed 51 The Big Picture - Example 32 American Opportunity Credit • Return to the facts of The Big Picture on p. 13-1. • Recall that Tom and Jennifer Snyder are married, file a joint tax return, have modified AGI of $158,000. – Both Lora (a freshman) and Sam (a junior) are full-time students and are Tom and Jennifer’s dependents. • The Snyders paid the following education expenses. – $7,500 of tuition and $8,500 for room and board for Lora, and – $8,100 of tuition plus $7,200 for room and board for Sam. • Lora’s and Sam’s tuition are qualified expenses for the American Opportunity credit. – For 2015, Tom and Jennifer may claim a $2,500 American Opportunity credit [(100% $2,000) + (25% $2,000)] for both Lora’s and Sam’s expenses. – In total, a $5,000 American Opportunity credit. 52 The Big Picture - Example 33 American Opportunity Credit Phaseout • Return to the facts of The Big Picture on p. 13-1. • Now assume that Tom and Jennifer’s modified AGI for 2015 is $172,000 instead of $158,000. • Tom and Jennifer are eligible to claim a $2,000 American Opportunity credit for 2015. – Their $5,000 available American Opportunity credit must be reduced because their AGI exceeds the $160,000 limit for married taxpayers. – The percentage reduction is computed as the amount by which modified AGI exceeds the limit, expressed as a percentage of the phaseout range, or – ($172,000 - $160,000)/$20,000) = 60% reduction. – Therefore, the maximum available credit for 2015 is $2,000. • $5,000 X 40% allowable portion. 53 The Big Picture - Example 34 Lifetime Learning Credit • Return to the facts of The Big Picture on p. 13-1. • Assume that Tom and Jennifer’s modified AGI is $122,000 and that Tom is going to school part-time to complete a graduate degree – He pays qualifying tuition and fees of $4,000 during 2015. • As Tom and Jennifer’s modified AGI is below $160,000, a $5,000 American Opportunity credit is available to them for Lora and Sam’s tuition . • In addition, Tom’s qualifying expenses are eligible for the lifetime learning credit. – The potential lifetime learning credit of $800 ($4,000 X 20%) must be reduced because their modified AGI exceeds the $110,000 limit for married taxpayers. – As their modified AGI exceeds the $110,000 limit by $12,000 and the phaseout range is $20,000, their lifetime learning credit is reduced by 60%. – Therefore, their lifetime learning credit for 2015 is $320 ($800 X 40%) • Their total education credits amount to $5,320 – $5,000 American Opportunity credit and $320 lifetime learning credit. 54 Credit For Certain Retirement Plan Contributions • Credit was enacted to encourage low and middle income taxpayers to contribute to qualified retirement plans • Eligible contributions of up to $2,000 qualify • Credit rate depends on level of AGI and filing status – Maximum credit is $1,000 ($2,000 × 50%) • To qualify, must be at least 18 years old and not a dependent of another taxpayer or a full-time student 55 Payment Procedures (slide 1 of 8) • Employer is responsible for withholding income taxes and employees’ share of FICA employment taxes (Social Security and Medicare) • Also, employer must match FICA and pay full cost of FUTA (unemployment taxes) 56 Payment Procedures (slide 2 of 8) • Social Security & Medicare – 2015 rates • Social Security: 6.2% of first $118,500 wages • Medicare: 1.45% of all wages – If employee is overwithheld for Social Security, excess is refundable credit 57 Payment Procedures (slide 3 of 8) • Federal withholding – Employee files Form W-4 with employer indicating marital status and withholding allowances – Form W-2 issued by employer summarizes employee’s wages, income tax withholding, and FICA • Must be issued to employee by January 31 following year-end 58 Payment Procedures (slide 4 of 8) • Estimated payments (ES payments) – Any taxpayer (employee or self-employed) who will owe at least $1,000 in taxes for the year (and meets none of the exceptions) must make ES payments 59 Payment Procedures (slide 5 of 8) • ES payments – To avoid penalties for underpayment, must annually pay the smaller of: • 90% of the current year’s tax, or • 100% of last year’s tax – Exception: Increased to 110% of last year’s tax if AGI last year exceeded $150,000 ($75,000 if married filing separately) 60 Payment Procedures (slide 6 of 8) • ES payments – For calendar year individual taxpayer, ES payments of 1/4 of annual amount are due • April 15, June 15, and September 15 of the tax year, and January 15 of the following year 61 Payment Procedures (slide 7 of 8) • Self-employment tax – Taxpayers with net self-employment earnings of at least $400 must pay self-employment tax • 2015 rates – Social Security: 12.4% of first $118,500 net self-employment income – Medicare: 2.9% of all net self-employment income • These rates are twice what an employee pays on wages 62 Payment Procedures (slide 8 of 8) • Self-employment tax – Taxpayer receives a deduction from net self-employment income of 7.65% for purposes of calculating the actual selfemployment tax, and – Taxpayer receives a for AGI deduction for 50% of the selfemployment tax paid 63 Affordable Care Act Provisions • The Affordable Care Act (ACA), enacted to increase the quality and affordability of health insurance, included a number of tax provisions, such as – – – – The Individual Shared Responsibility Payment, The Premium Tax Credit, The Employer Shared Responsibility Payment, and The Small Employer Health Insurance Credit 64 Affordable Care Act Provisions • The Affordable Care Act (ACA), enacted to increase the quality and affordability of health insurance, included a number of tax provisions, such as – – – – The Individual Shared Responsibility Payment, The Premium Tax Credit, The Employer Shared Responsibility Payment, and The Small Employer Health Insurance Credit 65 Affordable Care Act Provisions • The Affordable Care Act (ACA), enacted to increase the quality and affordability of health insurance, included a number of tax provisions, such as – – – – The Individual Shared Responsibility Payment, The Premium Tax Credit, The Employer Shared Responsibility Payment, and The Small Employer Health Insurance Credit 66 Affordable Care Act Provisions • The Affordable Care Act (ACA), enacted to increase the quality and affordability of health insurance, included a number of tax provisions, such as – – – – The Individual Shared Responsibility Payment, The Premium Tax Credit, The Employer Shared Responsibility Payment, and The Small Employer Health Insurance Credit 67 Additional Medicare Taxes on High-Income Individuals • Two provisions increase Medicare taxes for high-income individuals beginning in 2013: – An additional .9% tax on wages received in excess of specified amounts, and – An additional 3.8% tax on unearned income 68 Additional Tax on Wages • For tax years beginning after 12/31/2012 an additional .9% Medicare tax is imposed on wages received in excess of – $250,000 for married taxpayers filing jointly, – $125,000 for married filing separately, and – $200,000 for all other taxpayers • The additional tax on a joint return is on the combined wages of the employee and the employee’s spouse • Also applies to self-employed individuals – Net earnings from self-employment is used for the threshold computations 69 Additional Tax on Unearned Income (slide 1 of 2) • For tax years beginning after 12/31/2012 an additional 3.8% Medicare tax is imposed on the unearned income of individuals, estates, and trusts – For individuals, the tax is 3.8% of the lesser of: • Net investment income, or • The excess of modified adjusted gross income (MAGI) over – $250,000 for married taxpayers filing a joint return – $125,000 if married filing separately, and – $200,000 for all other taxpayers • This is in addition to the additional .9% Medicare tax on wages or self-employment income. 70 Additional Tax on Unearned Income (slide 2 of 2) • In general, net investment income includes interest, dividends, annuities, royalties, rents, and net gains from the sale of investment property less related deductions • MAGI = AGI + any foreign earned income exclusion – Thus, for individuals who don’t have any excluded foreign earned income, MAGI is the same as AGI 71 Refocus On The Big Picture (slide 1 of 2) • Recent tax legislation made significant changes in education tax credits. • The American Opportunity tax credit provides some relief for Tom and Jennifer Snyder. – Both Lora and Sam qualify for a $2,500 American Opportunity credit in 2015. • 100% of the first $2,000 and 25% of the next $2,000 of qualified expenses. • These credits are phased out for married taxpayers’ as AGI exceeds $160,000. – Since the Snyders’ AGI is only $158,000, the total education credits available to them on their 2015 income tax return is $5,000. – Further, this credit may be used to offset any AMT liability. – 40% ($2,000) is refundable to the Snyders. 72 Refocus On The Big Picture (slide 2 of 2) • What If? • What if the Snyders’ AGI is $188,000? – In 2015, the Snyders would not qualify for any education credits • Their income exceeds the limits for both the American Opportunity and the lifetime learning credits. – A deduction for AGI is allowed for qualified tuition and related expenses involving higher education. • However, their AGI exceeds the $160,000 maximum allowed for a deduction (see Chapter 9 for additional details). 73 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 74