CHAPTER 6 Credits & Special Taxes

1. CHAPTER 6Credits & Special Taxes Income Tax Fundamentals 2009 Gerald E. Whittenburg Martha Altus-Buller Student’s Copy

2. Credits and Deductions • A credit is a direct reduction in tax liability • Credits are used to target certain groups for tax benefit • Provide equal benefit to all taxpayers • A deduction is a reduction of taxable income • Reduces tax liability in the amount of [deduction x tax rate] • Provides more benefit to higher income taxpayers

3. Tax Credits Illustration of difference between a $1,500 deduction and a $1,500 credit DeductionCredit TI (before) $ 70,000 $ 70,000 Deduction (1,500) -0- TI $ 68,500$ 70,000 Tax Liability $ 13,469 $ 13,844 Credit -0- (1,500) Tax due $ 13,469$ 12,344 *This is assuming a single taxpayer in the 25% tax bracket – using 2008 tax tables

4. Child Tax Credit Phased out $50 for each $1000 [or part thereof] that AGI exceeds threshold • Provides tax relief through a credit to taxpayers with children • Credit for each child under age 17 claimed as a dependent and meeting definition of “qualifying child” • Credit is $1000 per child • Credit begins phasing out when • AGI >= $110,000 (MFJ) • AGI >= $ 75,000 (HH, S) • AGI >= $ 55,000 (MFS) For 3 or more kids complex credit calculation applies: see www.irs.gov

5. Earned Income Credit [EIC] • Refundable credit • Serves as “negative” income tax • Can get refund equal to the amount of the credit • Taxpayer may get EIC even if no kids • Taxpayer must be between ages 25 and 65 and not someone else’s dependent • “Disqualified income” [certain type of investment income] must be les than $2900 • With kids, EIC available if • Child meets definition of “qualifying child” • Single or married taxpayers [MFJ only] • Earned income meets certain guidelines

6. Child &Dependent Care Credit • Gives tax relief to working parents who must provide childcare for dependents • Dependent must be under age 13 or • Spouse or dependent who cannot care for themselves • If child’s parents are divorced, child need not be dependent of taxpayer claiming credit if lives more than 50% of year with that parent • Multiply qualifying care costs (see next screen) by a percentage that decreases as AGI increases • From 35% down to 20% based on AGI • Table on p. 6-4

7. Child & Dependent Care Credit • Determine qualifying expenses • In-home and out-of-home care • Day camps qualify, but not overnight camps • If camp is focused on fun/games, not education • Limited to the lesser of • Earned income of lowest earning spouse or • $3000 (1 dependent) or $6000 (2+ dependents) • If spouse is fulltime student, count him/her as earning $250/month (1 dependent) or $500/month (2+ dependents) • Must reduce by any amount reimbursed by employer

8. Education Credits HOPE Credit • Provides tax relief for qualified higher education expenses • Tuition and fees only • Available for each eligible student in first 2 years of college • Eligible students are taxpayer, spouse or eligible dependent • Student must be at least 1/2 time for one term during tax year • Student must not have felony conviction for possessing or distributing a controlled substance • Credit = 100% of first $1,200 + (50% of the next $1,200) • Maximum credit = $1,800 • Phased out when AGI > certain levels [see p. 6-6]

9. Education Credits: Lifetime Learning Credit (LLC) • Provides tax relief for education expenses; meant to encourage taxpayers to take courses to acquire or improve job skills • Tuition and fees only • LLC can be used for less than ½ time students • Credit = 20% of first $10,000 • Maximum credit = $2,000 per year • Subject to same phase outs as HOPE Credit • Not limited to first two years - undergraduate, graduate or professional courses qualify • No limit on number of years you may claim LLC

10. Foreign Tax Credit = Net foreign income xUS tax liability Total US taxable income before credit • US taxpayers are allowed foreign tax credit on income earned in foreign country and subject to income taxes in that country • Mostly seen on dividends on foreign stock investments • Provides relief from double taxation on money generated from foreign sources • Credit is up to amount paid foreign governments • But limited to maximum credit

11. Adoption Credit • IRS provides a credit as relief to taxpayers who pay adoption expenses • Credit is amount spent up to $11,650 per adoption [not an annual amount] • Adoption credit phases out when AGI > $174,730 • Different rules • If pay expenses over more than one year or • If foreign adoption or special needs child • Qualified adoption expenses include court costs, legal fees, travel, etc. • Unused credits can be carried over for up to five years

12. Temporary Energy Tax Credits • Credit for hybrid vehicle purchase • Different credit per vehicle based on weight class/fuel economy • Credit only applies to first 60,000 sold by manufacturer • Go to irs.gov to get detailed information on available hybrid credits • As of 10/1/07, credits no longer available for Prius • Credit for energy saving improvements to principal residence • Lifetime credit up to $500 for energy-efficient expenditures in home • Varying amounts allowed for different qualifying improvements • Credit for alternative energy expenditures • 2006-2008: may be claimed on principal and second residence • Up to $2000 credit/year for 30% of amount paid for qualified solar water heaters and photovoltaic property • 30% credit for fuel cell property – max credit of $500 for each .5 kilowatt of capacity, with no cap on total credit

13. Individual Alternative Minimum Tax • Tax was originally intended for high income taxpayers with tax shelters • It has evolved to impact many middle income people • Separate [parallel] system for calculating taxes • If Alternative Minimum Tax (AMT) is higher than regular federal tax liability, must pay AMT amount • AMT Rates • 26% up to and equaling $175,000 ($87,500 MFS) AMT base • 28% above $175,000 ($87,500 MFS) AMT base • Long-term capital gains taxed at preferential rates See following screen for Alternative Minimum Taxable model

14. Alternative Minimum Tax Calculation of Alternative Minimum Tax Regular Taxable Income (before exemptions & standard deduction) +/- Adjustments +/- Tax Preferences - AMT Exemption AMT Base x AMT rate(s) Tentative Minimum Tax - Regular Tax = AMT due with tax return [if positive amount]

15. Unearned Income of Dependent Children • Provision designed to prevent parents from transferring income-producing assets to children in lower tax brackets • Net unearned income [NUI] of child under age 18 is taxed at parent’s highest tax rate • Applies to a child with at least one living parent, who is 18 or younger at end of tax year or students with ages 19 through 23 and has NUI NUI = Unearned income Less the greater of $900 or investment expenses Less statutory deduction [$900]