Chapter I14
Special Tax Computation Methods, Tax Credits
and Payment of Tax
Discussion Questions
I14-1 Most taxpayers are not subject to the AMT because they do not have substantial tax
preferences and AMT adjustments, and because there is a liberal exemption amount to reduce the tax
base on which the AMT is calculated. p. I14-2.
I14-2 The Alternative Minimum Tax does not apply if an individual's tentative minimum tax under
the AMT rules is less than his regular tax liability. It applies only if the tentative minimum tax
exceeds the regular tax liability. p. I14-2.
I14-3 b. only. Only the 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 appreciated
element related to charitable contributions of capital gain real property was a tax preference item. p.
I14-4.
I14-4 a, b, c only. Itemized deductions that are not allowed in computing AMTI, excess
depreciation 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.
I14-4 through I14-6.
I14-5 a and b only. Charitable contributions and mortgage interest on a personal residence are
deductible when computing AMT. Mortgage interest is subject to the restrictions pertaining to
qualified housing interest. Other interest is deductible up to the amount of qualified net investment
income and since the individual has no investment income, the other interest (investment interest) is
not deductible. Medical expenses are deductible only for amounts in excess of 10% of AGI and state
and local taxes are not deductible for purposes of AMT. pp. I14-4 and I14-5.
I14-6 Most people are not subject to the self-employment tax because they are classified as
employees for tax purposes and make FICA employee contributions instead. p. I14-7.
I14-7 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 be
employed, he will not be subject to the non Medicare (OASDI) portion of the self-employment tax
on the first $68,400 of earnings. However, any income (i.e., salary or consulting) above this amount
will be subject to the hospital insurance (HI) premium portion of the FICA tax (1.45% for
I14-1
employment related income and 2.9% for his self-employment earnings). If he retires, Tony's
consulting income will all be subject to the 15.3% self-employment rate on the first $68,400 and
2.9% on income in excess of $68,400 although Tony will then receive a for AGI deduction for one
half of self-employment taxes paid. pp. I14-7 and I14-8.
I14-8 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. In
addition, the consulting firm will not be required to withhold the employee's share of FICA tax
either. Theresa will be subject to the self-employment tax. However, if her income as an employee
(e.g., college professor) is in excess of the ceiling amount of $68,400 for the OASDI portion of selfemployment 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. p. I14-7.
I14-9 a.
The taxable base for Ted is $20,000 (which is the lesser of (1) $20,000 selfemployment income or (2) $38,400 ($68,400 ceiling - $30,000 FICA wages). Ted's net earnings
from self-employment are $18,470 ($20,000 x 0.9235). The self-employment tax for Ted is $2,826
($18,470 x 0.1530).
The taxable base for Tina is $10,000 (which is the lesser of (1) $10,000 self-employment
income or (2) the $68,400 ceiling amount). Tina's net earnings from self-employment is $9,235
($10,000 x .9235). The self-employment tax for Tina is $1,413 (0.153 x $9,235). Combined selfemployment tax on the joint return is $4,239 ($2,826 + $1,413).
b.
Ted and Tina are entitled to a business deduction on their 1998 income tax return
equal to one-half of the self-employment taxes paid. If they file a joint return the deduction is $2,119
(0.50 x $4,239). pp. I14-7 and I14-8.
I14-10 a.
Foreign tax credits are provided to mitigate the effect of double taxation on foreign
source income.
b.
The research credit is given to encourage research and development activities to
enhance our technological base.
c.
Business energy credits were designed to encourage energy conservation measures
and the use of fuel other than petroleum.
d.
The work opportunity credit encourages employers to hire unemployed individuals
from economically disadvantaged groups.
e.
The child and dependent care credit was enacted to provide equitable relief for parents
and other individuals who are employed and who must incur expenses for household and dependent
care services.
f.
The earned income credit provides special tax breaks for certain low-income
individuals who have earned income and dependent children or other incapacitated individuals living
in the household. The credit is designed to encourage low-income individuals to become gainfully
employed.
g.
The purpose of the HOPE scholarship credit is to help low and middle income
taxpayers pay for the cost of postsecondary education.
I14-2
h.
The disabled access credit is to encourage small businesses to make their existing
business facilities accessible to disabled individuals.
i.
The empowerment zone employment credit is intended to reduce the level of
unemployment in distressed urban and rural areas.
j.
The adoption credit is designed to assist taxpayers with the financial burden of
adopting children.
p. I14-10.
I14-11 For a taxpayer in a 15% tax bracket a $200 deduction is worth $30 and is therefore worth less
than a $40 credit. For a taxpayer in a 28% bracket the deduction is worth $56 which is more than a
$40 credit. p. I14-9.
I14-12 The general business credit includes the rehabilitation expenditures credit, work opportunity
credit, research credit, business energy credits, the empowerment zone credit, work-to-welfare credit
and the disabled access credit. The investment tax credit consists of the rehabilitation credit,
business energy credit and the reforestation credit. pp. I14-17 through I14-21.
I14-13 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
personal tax credits. This means that a person must use personal tax credits (as well as the foreign
tax credit, orphan drugs testing credit, and nonconventional source fuel credit) to offset their tax
liability before the general business credit is used. Since the credit is nonrefundable, if the tax
liability has already been eliminated by credits with a higher priority than the general business credit,
the taxpayer will only be able to carryback or carryforward the unused general business credit.
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
before credits arising from the current year may be used. p. I14-17.
I14-14 a.
The foreign tax credit is equal to the income taxes paid or accrued to a foreign country
but limited to the taxpayer's U.S. tax liability times the ratio of foreign source taxable income to
worldwide taxable income. This limitation applies when the effective foreign tax rate exceeds the
effective U.S. tax rate. In this case the foreign tax rate is lower than the U.S. rate and the foreign tax
credit would be $14,000 ($70,000 x 0.20).
b.
In this case Wayne would be better off choosing the earned income exclusion since
$70,000 of his income each year could be excluded from U.S. taxation resulting in an actual
reduction of $21,000 ($70,000 x 0.30) in his U.S. tax liability. pp. I14-16 and I14-17.
I14-15 The work opportunity credit is 40% of up to $6,000 of qualified first-year wages for each
qualified employee hired. In this case, the work opportunity credit for King Corporation is $9,600
(0.40 x $6,000 x 4). p. I14-20.
I14-3
I14-16 Queen Corporation is eligible for the disabled access credit because it is considered as an
eligible small business. Even though the company had $1 million or more of gross receipts in the
preceding year it meets the test because it had 30 or less employees. The credit is $5,000 (0.50 x
$10,000). The $10,250 ceiling amount does not apply because the cost of the eligible expenditures
was only $10,000. The depreciable basis of the property is reduced by the $5,000 allowable credit.
p. I14-18.
I14-17 a.
The credit for rehabilitation expenditures applies to expenditures for the rehabilitation
of older industrial and commercial buildings and certified historic structures. Expenditures may not
be for residential real estate unless the structure is a certified historic structure.
b.
There is an applicable tax credit rate of 10% for structures placed in service before
1936 and 20% for certified historic structures.
c.
Depreciation for expenditures qualifying for this credit must be computed using the
straight line depreciation method.
d.
For the purpose of depreciation, the basis of the property must be reduced by the full
amount of the credit taken.
e.
The rehabilitation credit must be recaptured in the event of an early disposition of the
property at a rate of 20% per year. Therefore, 20% of the credit is earned per year. pp. I14-18 and
I14-19.
I14-18 Solar, and geothermal property which conserves energy qualifies for the business energy
credit. p. I14-19.
I14-19 The underlying reason for personal tax credits is to aid social welfare rather than to address
economic issues. p. I14-9.
I14-20 A refundable tax credit is a type of negative income tax. If the credit exceeds the tax liability
the government pays the taxpayer the remaining excess credit. A nonrefundable tax credit may only
be used to offset the tax liability, therefore, if the credit exceeds the tax liability the taxpayer receives
no payment and at best can only carryback or carryforward the excess credit. The earned income
credit and withholding on wages are refundable tax credits. Child and dependent care credits, tax
credits for the elderly and the general business credit are nonrefundable credits. pp. I14-9 through
I14-16.
I14-21 If an individual is unemployed and has no earned income, it is not possible to receive a child
and dependent care credit because the intention of the credit is to help a person who is employed to
pay for dependents in order to enable an individual to work. One exception to this rule is a spouse
who is either a full-time student or is incapacitated. Such individuals are deemed to have earned
income of $200 per month. pp. I14-9 through I14-12.
I14-22 There are several significant differences between the HOPE Scholarship Credit and the
Lifetime Learning Credit. First, the HOPE credit only applies during a students’ first two years of
postsecondary education whereas the Lifetime Learning credit applies to undergraduate, graduate,
I14-4
and professional education. Second, the HOPE credit applies per student (maximum $1,500 per
student) whereas the Lifetime Learning credit is based on the amount of dollars spent on qualified
tuition and related expenses by the taxpayer. Finally, the HOPE credit applies to only two years
whereas the Lifetime Learning credit has no limit on the number of years the credit is allowed.
The principal types of taxpayers most likely to qualify for both credits are low and middle
income taxpayers.
pp. I14-14 and I14-15.
I14-23 The maximum child and dependent care credit for an individual who has $4,800 in qualifying
child care expenses is $1,440 (0.30 x $4,800). p. I14-12.
I14-24 Vivian's child and dependent care credit is initially limited to the $4,800 ceiling amount
which is then reduced by the $3,000 employer reimbursement. The maximum allowable credit is
$540 (0.30 x $1,800). pp. I14-11 and I14-12.
I14-25 a.
The adoption credit allowed is the amount of qualified adoption expenses incurred in
years after 1996 to a maximum of $5,000 ($6,000 for special needs children). The credit is allowable
in the year following the year the qualified adoption expenses were paid unless the expenses are
incurred in the year the adoption becomes final. This rule is intended to prevent the taking of a credit
for adoption expenses where the adoption is not finalized. Finally, there is a phaseout of the credit
depending on the taxpayer's AGI. For taxpayers with AGI between $75,000 and $115,000, the credit
is ratably phased out and is fully phased out when the taxpayer's AGI reaches $115,000.
b.
As with other phase-outs in the tax law, Congress does not intend this credit for
higher-income taxpayers.
pp. I14-13 and I14-14.
I14-26 Alice is eligible for the earned income credit since she has qualifying children, and has
earned income which does not exceed the phase-out limitation amounts. The credit amount is
$3,756 (0.40 x $9,390). There is no scale-down on the credit because Alice's AGI (or earned income
if greater) is less than $12,260. If Alice expected to be eligible for the credit, she could obtain
advance payment of the credit by filing a Form W-5 with her employer. Alice's employer would
increase her pay by the amount of the credit. pp. I14-21 and I14-22.
I14-27 Most elderly people are unable to qualify for the tax credit for the elderly because they
receive social security benefits which exceed the ceiling limitation, or they have AGI, in excess of
the limitation, which eliminates the credit. p. I14-13.
I14-28 Penalties are imposed if an employer fails to withhold federal income tax and pay this tax to
the IRS. In addition corporate officers, directors, and other officials may be held personally liable for
payment of the tax. p. I14-23.
I14-5
I14-29 Jet Corporation should withhold federal income tax on the reimbursed amounts which are not
deductible on Tracy's individual tax return because the excess reimbursement is considered as
additional income paid to Tracy. Withholding should therefore be made on $2,000 ($6,000 moving
expense - $4,000 deductible moving expense). p. I14-23.
I14-30 a.
Vicki should elect to have no tax withheld; however, she must make estimated tax
payments.
b.
If Vicki does not make estimated tax payments she may be required to pay a penalty
(underpayment penalty) if she fails to meet the minimum payment requirement.
c. The withholding percentage rate on periodic pension plan payments is based on the same
rates applicable for regular wages and salaries determined by the filing status claimed on Form W4P. If no W-4P is filed, the withholding is based on the table for a married individual claiming 3
withholding allowances. A 10% withholding rate is generally applied to the taxable portion of a
lump-sum distribution. pp. I14-23 and I14-24.
I14-31 a.
Yes, a person may claim fewer allowances than she is entitled to.
b.
An individual might claim fewer allowances in order to increase the amount withheld.
This might be done if the person anticipates that tax will be owed at the end of the year and the
person does not wish to make quarterly estimated tax payments. pp. I14-24 and I14-25.
I14-32 a.
Mario should file exempt status on a Form W-4 to avoid having amounts withheld.
b.
Mario would receive a smaller pay check each period due to withholding, and, since
he owes no taxes, would be entitled to a refund of all withholding amounts. In effect, Mario would
be loaning the government the withholding amount interest-free. p. I14-24.
I14-33 Backup withholding was implemented to prevent abusive noncompliance with tax provisions.
Backup withholding provides for withholding of taxes from pension income. It also requires
withholding on most payments reported in form 1099 such as interest, dividends, and royalties under
certain circumstances (e.g., where the taxpayer fails to provide the payor with his tax identification
number (Social Security number, for example), or fails to report this type of income on his return).
p. I14-23.
I14-34 An individual may claim additional withholding allowances if the individual will have large
deductions from adjusted gross income, alimony deductions or tax credits thus reducing the end- ofthe-year tax liability. p. I14-24.
I14-35 a.
Vincent is not required to make tax payments in 1998 since the estimated tax is less
than $500. In addition, Vincent will have more withheld in 1998 ($11,600) than 100% of his tax
liability in 1997 ($8,000).
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.
I14-6
c.
No, for the same reason cited in part (b) above. If Vincent's AGI for the prior year
was in excess of $150,000, the 110% of prior year's tax exception would also have been met because
$11,600 is greater than $8,800 (1.10 x $8,000). pp. I14-25 and I14-26.
I14-36 In order to avoid the estimated tax underpayment penalty a taxpayer should make combined
estimated payments and withholding of at least 100% (or 110% if AGI in 1997 was greater than
$150,000) of his tax liability for the prior year. pp. I14-26, I14-28, and I14-29.
I14-37 It is preferable to have an underpayment of the tax liability because the IRS does not pay
interest on overpayments if it refunds the overpayment within 45 days from the later of the due date
of the return or its filing date. This has the effect of making an interest free loan to the IRS. p. I1430.
I14-38 Many people overpay their taxes in the form of additional withholding in order to be sure that
they will not have to come up with a lump-sum tax payment at the filing date, and also to use the
withholding system as a "forced savings" program. As mentioned previously, the disadvantage with
this forced savings is that no interest is earned on such savings. p. I14-30.
Issue Identification Questions
I14-39 The primary issue is the tax effect of self-employment taxes vs. continued FICA taxes on his
employment income. In addition, Daryl should consider the effect of the change upon 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 accident and health insurance. pp. I14-7 and I14-8.
I14-40 The primary issue is whether Jennifer should make quarterly estimated tax payments to avoid
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 that is accorded to the property
settlement and the tax basis of the securities. pp. I14-26 and I14-28.
I14-41 Coastal needs to evaluate whether it qualifies for the work opportunity credit and the amount
of tax benefit after the deduction for wages is reduced by the amount of the credit. The net tax
benefit should be compared to the additional job training expenses. pp. I14-19 and I14-20.
Problems
I14-42 a.
Taxable income
Plus: Personal and dependency exemptions ($2,700 x 2)
Tax preference items
Adjustment related to itemized deductions
AMTI
Minus: Exemption
Alternative minimum tax base amount
I14-7
$ 50,000
5,400
50,000
30,000
$135,400
( 45,000)
$ 90,400
b.
c.
Times: Rate
Tentative minimum tax
Minus: Regular tax
Alternative minimum tax
x 0.26
$ 23,504
( 12,000)
$ 11,504
Taxable income
Plus: Personal and dependency exemptions
Tax preference items
Adjustment related to itemized deductions
AMTI
Minus: Exemption
[$33,750 - 0.25 x ($132,700 - $112,500)]
Alternative minimum tax base amount
Times: Rate
Tentative minimum tax
Minus: Regular tax
Alternative minimum tax
$ 50,000
2,700
50,000
30,000
$132,700
( 28,700)
$104,000
x
0.26
$ 27,040
( 12,000)
$ 15,040
Taxable income
Plus: Personal and dependency exemptions
Tax preference items
Adjustments related to itemized deductions
AMTI
$ 50,000
5,400
50,000
60,000
$165,400
Minus: Exemption
[$45,000 - 0.25 x ($165,400 - $150,000)]
Alternative minimum tax base amount
Times: Rate
Tentative minimum tax
Minus: Regular tax
Alternative minimum tax
( 41,150)
$124,250
x
0.26
$ 32,305
( 12,000)
$ 20,305
pp. I14-2 and I14-3.
I14-43 Taxable income
Personal exemption
AMT adjustments
Tax preferences
AMTI
Minus: Exemption: $33,750 - 0.25 x
($202,700 - $112,500)
AMT tax base
Tax on initial $175,000 x 0.26
I14-8
$130,000
2,700
30,000
40,000
202,700
( 11,020)
$191,680
45,500
Tax on amounts in excess of $175,000
($191,680 - $175,000) x 0.28
Tentative minimum tax
Minus: Regular tax
Alternative minimum tax
4,670
$ 50,170
( 36,440)
$ 13,730
pp. I14-2 and I14-3.
I14-44 Tax preferences:
Excess depreciation on real property
Tax exempt interest on private activity bonds
Total tax preferences
$ 20,000
30,000
$ 50,000
Excess depreciation on tangible personal property placed in service in 1993 is an AMT
adjustment and is not a tax preference. Neither is the appreciated element relative to the contribution
of capital gain property made after 1992. pp. I14-3 and I14-4.
I14-45 a.
b.
AMT adjustments:
Medical expenses ($4,375 for regular tax
- $2,500 for AMT)
Real estate taxes
State income taxes
Total adjustments
$ 1,875
8,000
5,000
$14,875
Taxable income
Plus: Tax preferences
Personal Exemption
Adjustment related to itemized deductions
AMTI
Minus: Exemption
Alternative minimum tax base amount
Times: Rate
Tentative minimum tax
Minus: Regular tax liability
Alternative minimum tax
$30,000
25,000
2,700
14,875
$72,575
(33,750)
$38,825
x 0.26
$10,095
( 6,000)
$ 4,095
pp. I14-3 through I14-5.
I14-46 Tax base for OASDI portion:
lesser of $46,175 ($50,000 x 0.9235) self-employment earnings or
$38,400 ($68,400 - $30,000)
$38,400 x 0.124 = $4,762
Tax base for HI portion:
I14-9
$46,175 x 0.029 = $1,339
Total self-employment tax ($4,702 + $1,339) = $6,101
Amelia may deduct one-half of the self-employment taxes paid as a business deduction. This
amount is $3,051 (0.50 x $6,101). pp. I14-7 and I14-8.
I14-47 Arnie:
Taxable self-employment income (OASDI)
($70,000 x 0.9235 = $64,645 subject to
the overall $68,400 limit)
Times: Rate
Self-employment tax (OASDI portion)
HI premium portion ($64,645) x 0.029
Total self-employment tax.
$64,645
x 0.124
$ 8,016
1,875
$ 9,891
Note: Arnie and Angela's self-employment taxes are computed separately.
Angela:
Taxable self-employment income
Self-employment tax
none
none
pp. I14-7 and I14-8.
I14-48 a.
Taxable net earnings from self-employment
($10,000 + $10,000 - $15,000) x 0.9235
Times: Rate
Self-employment tax
$ 4,618
x 0.153
$ 707
b.
There should be no self-employment tax on the OASDI portion since taxable selfemployment income would be zero ($68,400 ceiling - $70,000 FICA wages). The self-employment
tax on the HI portion is $134 ($4,618 x 0.029). pp. I14-7 and I14-8.
I14-49 Note to Instructor: The targeted jobs credit has been replaced by the Work Opportunity
Credit (WOC) after September 30, 1996. The solution below is correct but the targeted jobs credit
should be replaced with the WOC.
a.
Allowable personal tax credits are $960 (child and dependent care).
b.
The total of the business tax credits is $15,600 ($1,000 + $14,000 + $600). The
allowable amount of the credit is $13,040 ($14,000 tax - $960 of personal tax credits).
c.
The unused business tax credits of $2,560 ($15,600 - $13,040) may be carried back 3
years and carried forward 15 years. pp. I14-9 through I14-17.
I14-10
I14-50 a.
The limitation on qualifying expenses is $4,800. Since AGI is greater than $28,000,
the credit rate is 20% and the credit equals $960 ($4,800 x 0.20).
b.
The credit is $960. Payments to relatives are qualified payments as long as the
relative is not a dependent or a child (under age 19) of the taxpayer.
c.
Qualifying expenses are limited to $1,400 ($2,400 - $1,000) since one child is older
than 12 and $1,000 was excluded from Bruce's gross income under Sec. 129. Since AGI is greater
than $10,000, the credit rate is 21% (AGI exceeds $10,000 by $17,000, and the credit rate is reduced
from 30% by 1% for every $2,000 [or fraction thereof] that AGI exceeds $10,000). The credit is
$294 (0.21 x $1,400).
d.
The qualifying expense is limited to $4,000. (The lower earned income of Bonnie).
The credit rate is 20%, and the credit is $800 (0.20 x $4,000). pp. I14-9 through I14-12.
I14-51 a.
Valerie and Brad's qualified adoption expenses for 1997 are $7,800, as follows:
Agency fees
$5,000
Travel expenses
1,500
Publications
300
Legal fees
1,000
TOTAL
$7,800
Without question, the agency fees, travel expenses, and legal fees are qualified adoption expenses.
The publications would qualify if they are directly related to, and the principal purpose of which is,
for, the legal adoption of an eligible child. Sec. 23(d). The authors take the position that the
publications qualify. The kennel fees for the dog are not qualified expenses.
In 1998, the qualified adoption expenses would be $3,600, consisting of $3,000 (agency fees), $400
(travel expenses), and $200 (court costs for adoption). The kennel fees and nursery furniture would
not qualify.
b.
The amount of the credit is $5,000 and may be taken in 1998. Sec. 23 provides that
the credit is allowed in the taxable year following the taxable year during which such expenses were
paid or incurred. However, in the year the adoption becomes final, expenses paid in that taxable year
are currently deductible. Thus, in Brad and Valerie's situation, the expenses in 1997 and 1998 would
be eligible for the credit in 1998. Even though they incurred $11,400 of qualified expenses, the
credit is limited to $5,000.
c.
If the child was a special needs child, the credit is increased to $6,000.
pp. I14-13 and I14-14.
I14-11
I14-52 Note to Instructor: There is an error in the problem, Jeff was a sophomore during the
Spring Semester, 1998, not the Fall Semester, 1998 as stated in the problem.
a.
John and Mary will be entitled to the HOPE credit for Jeff for the Spring Semester,
1998 and for Brooke for the Fall Semester, 1998. They also will be entitled to the Lifetime Learning
credit for Jeff for the Fall Semester, 1998. Jeff qualifies for the HOPE credit for the Spring
Semester, 1998 as the expenses were paid after December 31, 1997 and Jeff was in his second year
of postsecondary education. The tuition and laboratory fees are qualified expenses. Thus, John and
Mary would receive a credit of $1,500 [(100% x $1,000) + (50% x $1,000)] in 1998 for Jeff.
Student activity fees, books, and room and board are not qualified expenses. John and Mary also
would be allowed the HOPE credit in 1998 for Brooke for Fall Semester, 1998 in the amount of
$1,100 [(100% x $1,000) + (50% x $200)]. Finally, John and Mary would be allowed a Lifetime
Learning credit for Jeff for the Fall Semester, 1998 in the amount of $1,000. The tuition and
laboratory fees total $5,300, however, the maximum amount of qualified expenses is $5,000 times
20%. Student activity fees, books, and room and board are not qualified expenses. In summary, the
total education credits for 1998 would be $3,600 as follows:
HOPE credit - Jeff
HOPE credit - Brooke
Lifetime Learning credit - Jeff
TOTAL
$1,500
1,100
1,000
$3,600
b.
Yes, since Jeff received a scholarship that is excluded from his gross income under
Sec. 117, qualified tuition and related expenses eligible for both the HOPE and Lifetime Learning
credits must be reduced by such amounts. For the HOPE credit, however, the credit would still be
$1,500 as the qualified expenses reduced by the scholarship still exceed $2,000 ($4,500 + $500 $2,500). The Lifetime Learning credit for Jeff would be $560 [20% ($4,800 + $500 - $2,500)] in
1998.
c.
The credits of $3,600 must be reduced because John and Mary’s AGI exceeds
$80,000, as follows:
$3,600 x $90,000 - $80,000/$20,000 = $1,800
Thus, the maximum amount of credits allowable to John and Mary in 1998 would be
$1,800.
d.
Jeff would be eligible for the HOPE credit in 1998 as he would not be in his first two
years of postsecondary education and he also would not be eligible for the Lifetime Learning credit
for the Spring Semester, 1998 that was paid in January, 1998. The Lifetime Learning credit is
effective after June 30, 1998. Jeff would eligible fore the Lifetime Learning credit for the Fall
Semester, 1998 and Brooke would be eligible for the HOPE credit for the Fall Semester, 1998.
pp. I14-14 and I14-15.
I14-12
I14-53 a.
Initial ceiling amount
Minus: Nontaxable social security benefits
Plus: One-half of AGI in excess of
$7,500
(0.50 x [$8,500 - &7,500])*
Credit base
Times: Rate
Total credit
$5,000
$3,000
500
(3,500)
$1,500
x 0.15
$ 225
* Assume that social security benefits are nontaxable.
b.
All of Carolyn's $225 tax credit is allowed since the credit does not exceed her tax
liability. p. I14-13.
I14-54 a.
There is a $40,000 excess for 1995, but only $10,000 can be carried back to 1993.
b.
$30,000 of credits are carried forward. $22,000 are used in 1996 and $8,000 are used
in 1997.
c.
The 1996 credits will be applied in 1997 and 1998 ($12,000 and $8,000, respectively).
$7,000 of the 1996 credits will be applied in 1998 and $8,000 will be carried forward to 1999. All
of the 1998 credits ($15,000) will be carried forward to 1999; therefore, a total of $23,000 will be
carried forward to 1999 ($8,000 from 1997 and $15,000 from 1998). p. I14-17.
I14-55 Laser's tax credit is limited to $33,417 [($100,000 divided by $300,000) x $100,250], since
the effective foreign tax rate exceeds the effective U.S. tax rate. The $6,583 ($40,000 - $33,417)
unusual credit is carried back two years and forward for five years. pp. I14-16 and I14-17.
I14-56 a.
The tentative credit is $4,800 (0.40 x $6,000 x 2).
b.
Total general business credits for the current year are $54,800 ($50,000 + $4,800).
Last may utilize $40,000 {$50,000 - the greater of the tentative minimum tax of $10,000 or 0.25
[$50,000 - $25,000])} in the current year and may carryforward or carryback $14,800 ($54,800 $40,000).
c.
Last Corporation's deduction for salaries and wages is $61,200 ($50,000 + $16,000 $4,800). pp. I14-19 and I14-20.
I14-57 a.
$3,000 (0.20 x $15,000). $12,000 wages + $4,000 training expenses but limited to
$15,000 per employee.
b.
$9,000 ($12,000 wages - $3,000 credit)
pp. I14-20 and I14-21.
I14-13
I14-58 a.
The credit is $8,000 (0.20 x $40,000).
b.
Straight-line depreciation must be used. The regular MACRS depreciation rules
apply to the $20,000 portion of the basis that is not eligible for the credit.
c.
The basis is $52,000 ($20,000 + $40,000 - $8,000). pp. I14-18 and I14-19.
I14-59 a.
$6,680).
b.
c.
Carolyn's tentative earned income credit before the phase out is $2,271 (0.34 x
Carolyn can claim a credit of $2,153 ($2,271 - 0.1598 x [$13,000 AGI - $12,260).
Yes, the earned income credit is refundable.
pp. I14-21 and I14-22.
I14-60 a.
b.
c.
$341 (0.0765 x $4,460)
$146 [$341 - 0.0765 x ($8,000 - $5,570)].
Yes, the earned income credit is refundable.
pp. I14-21 and I14-22.
I14-61 a.
It is vital that the corporation forward FICA and withholding payments to the IRS.
Penalties may be imposed if Lake fails to pay these amounts to the IRS.
b.
The liability for payment can extend beyond the corporation. Responsible individuals
such as the treasurer, in this case, can be held personally liable for payment of the tax. p. I14-23.
I14-62 Wages for domestic servants, independent contractors fees, tips under $20 per month, and
nontaxable fringe benefits are exempt from withholding. Ordinarily withholding is taken from
pension payments; however, a taxpayer may elect to have no tax withheld. Only newspaper carriers
under age 18 are exempt. pp. I14-23 and I14-24.
I14-63 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 since additional withholding
allowances are only allowed if an individual has an unusually large amount of deductions from
adjusted gross income, alimony deductions or tax credits. pp. I14-24 and I14-25.
I14-64 a.
Bart may claim 10 withholding allowances, as follows: Bart, spouse, additional
special withholding allowance (spouse unemployed), four children, three withholding allowances
connected with Bart's alimony payments.
b.
The monthly withholding is $41.
c.
Bart's employer must forward the Form W-4 to the IRS if the number of Bart's
withholding allowances exceeds 10. pp. I14-24 through I14-26.
I14-65 a.
Anna is not subject to the underpayment penalty because she has already had
withholding taken which is greater than 100% of her tax liability for the previous year. The 100%
exception applies because her AGI for prior year was not more than $150,000.
I14-14
b.
If Anna's withholdings are only $15,000, she is subject to the underpayment penalty
because her withholdings are less than 100% of last year's tax liability of $18,000, and 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. pp. I14-26 and I14-28.
I14-66 a.
Anne is subject to the underpayment penalty because her $26,000 total withholding
and estimated tax payments are less than 110% of last year's actual tax liability of $25,000 (1.10 x
$25,000 = $27,500) and less than 90% of this year's tax liability (0.90 x $30,000 = $27,000). She
must meet the 110% exception instead of 100% because her AGI for 1997 was more than $150,000.
pp. I14-26 and I14-28.
I14-67 a.
Chuck is subject to the self-employment tax. The self-employment income (before
deducting one-half of self-employment taxes paid) is $20,000 ($30,000 - $10,000) because this
amount is less than Chuck's salary ($68,400 - $35,000). The self-employment tax base is $18,470
($20,000 x 0.9235) and the self-employment tax is $2,826 ($18,470 x 0.153). Chuck may deduct
one-half of the self-employment taxes paid as a business deduction on his income tax return. This
amount is $1,413 (0.50 x $2,826).
b.
Chuck is not subject to the underpayment penalty since the total of his withholding
and estimated tax payments of $7,500 are greater than $7,000 (100% of his tax liability for the prior
year). Chuck's AGI for the prior year was not in excess of $150,000 so the 100% exception applies.
pp. I14-7 and I14-8, I14-26 and I14-28.
Tax Form/Return Preparation Problems
I14-68 (See Instructor's Guide)
I14-69 (See Instructor's Guide)
Case Study Problems
I14-70 (See Instructor's Guide)
I14-71 (See Instructor's Guide)
Tax Research Problem
I14-72 (See Instructor's Guide).
I14-15