1. Adjustments and itemized deductions Tax calculations and credits Individual taxation other taxes... 45

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1 Regulation 2 1. Adjustments and itemized deductions Tax calculations and credits Individual taxation other taxes Individual taxation other items Simulation Class questions Regulation 2

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3 Becker CPA Review Regulation 2 ADJUSTMENTS AND ITEMIZED DEDUCTIONS I. OVERVIEW Once gross income has been determined, certain amounts may be deducted. For individuals, there are two levels of deductions: those deducted from gross income to arrive at adjusted gross income (for AGI), and those deducted from adjusted gross income to arrive at taxable income (from AGI). Adjusted gross income is significant in determining the percentage limitations for charitable deductions, medical expenses, and certain miscellaneous itemized deductions. II. ADJUSTMENTS TO GROSS INCOME TO ARRIVE AT AGI (DEDUCTIONS TO ARRIVE AT AGI) A. INTRODUCTION Adjustments for AGI (often referred to as "above the line" deductions) include the following: Educator Expenses IRA Student Loan Interest Expenses Tuition & Fee Deduction Health Savings Account Moving Expenses One-Half Self-Employment FICA Self-Employed Health Insurance Self-Employed Retirement Interest Withdrawal Penalty Alimony Paid Attorney Fees Paid in Certain Discrimination and Whistleblower Cases Domestic Production Activities Deduction PASS KEY The CPA Examination will often refer to "adjustments" as "deductions to arrive at adjusted gross income." 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-3

4 Regulation 2 Becker CPA Review B. EDUCATOR EXPENSES (expired December 31, 2007, but is expected to be extended) 1. If you are an eligible educator, you can deduct up to $250 of qualified expenses you paid. If you and your spouse are filing jointly and both of you were eligible educators, the maximum deduction is $ Neither spouse can deduct more than $250 of his or her qualified expenses. 3. An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in a school for at least 900 hours during a school year. 4. Qualified expenses include ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom. An ordinary expense is one that is common and accepted in your educational field. A necessary expense is one that is helpful and appropriate for your profession as an educator. An expense does not have to be required to be considered necessary. 5. Qualified expense does not include expenses for home schooling or for non-athletic supplies for courses in health or physical education. You must reduce your qualified expense by the following amounts: a. Excludable U.S. series EE and I savings bond interest from Form b. Nontaxable qualified state tuition program earnings. c. Nontaxable earnings from Coverdell Education Savings Accounts. d. Any reimbursements you received for these expenses that were not reported to you in box 1 of your Form W-2. C. INDIVIDUAL RETIREMENT ACCOUNTS 1. Introduction There are four different types of individual retirement accounts (IRAs) and one other type of retirement plan, called a Keogh Plan, that have been tested on the CPA exam. The four IRA accounts include: a. Deductible IRA b. Non-Deductible IRA c. Roth IRA d. Coverdell Education Savings Accounts (IRA) R DeVry/Becker Educational Development Corp. All rights reserved.

5 Becker CPA Review Regulation 2 2. Individual Retirement Accounts (IRAs) (Deductible) Contributions to regular IRAs may or may not be deductible. The regular IRA is deductible from gross income to arrive at adjusted gross income. The adjustment is allowed for a year only if the contribution is made by the due date of the tax return for individuals, which is April 15 (filing extensions are not considered). a. Earnings Tax Deferred Earnings accumulate tax-free (deferred). b. Withdrawals Taxable Withdrawals from deductible IRAs are taxable as ordinary income and may be subject to applicable penalties. c. Deductibility Requirements INDIVIDUAL RETIREMENT ACCOUNTS Deductible Roth Non- Deductible Coverdell Education A taxpayer will (generally) not be permitted to deduct a contribution to an IRA when the following two conditions are both present: (1) Excessive AGI When adjusted gross income (AGI) of the taxpayer exceeds the following amounts, one of the two conditions that disqualify deduction of contribution is met; however, both conditions must be present (see also below). Single / H of H Joint 2008: 53-63, ,000 (2) Active Participation in Another Qualified Plan When a taxpayer or spouse actively participates in another qualified plan, the second condition that disqualifies deduction of a contribution is met, although there is an exception (and related phase-out of exception). Remember, however, that both conditions (i.e., excessive AGI and active participation) must exist before the deduction is disallowed. (a) Exception: An individual is not considered to be an active participant in an employer-sponsored retirement plan merely because the individual's spouse is an active participant. (b) Phase-out: The maximum deductible IRA contribution for an individual who is not an active participant, but whose spouse is, is phased out for taxpayers with modified AGI between $159,000 and $169,000 (2008) DeVry/Becker Educational Development Corp. All rights reserved. R2-5

6 Regulation 2 Becker CPA Review EXAMPLE Kristi, a single taxpayer, is an active participant in her employer's pension plan. Kristi's 2008 AGI is $55,000. Kristi's maximum 2008 IRA contribution is $4,000, calculated as follows: 2008 AGI $55,000 Less (53,000) Excess over $52,000 2,000 Divided by $10,000 (phase-out range) 10,000 Phase out percentage 20% Times maximum IRA deduction x 5,000 Amount of IRA phased out (1,000) 2008 maximum IRA deduction $ 4,000 d. Amount of Deduction (1) General Rule A taxpayer may generally deduct from income the amount of a regular IRA contribution. The maximum deduction is limited to the lesser of: (a) 2008 $5,000 OR (b) The individual's compensation. (2) Married Taxpayers The maximum contribution for a married couple filing jointly is as follows, provided their combined earnings total at least that much $10,000 ($5,000 each spouse) e. Compensation Defined (1) Compensation includes: (a) Salary, (b) Wages, (c) Commissions, (d) Bonuses, and (e) Alimony. (2) Compensation does not include: (a) Interest, (b) Dividends, (c) Annuity income, and (d) Pensions. R DeVry/Becker Educational Development Corp. All rights reserved.

7 Becker CPA Review Regulation 2 f. Summary Chart for Married Individuals RULES SUMMARY: TRADITIONAL IRA Earned Income Pension IRA Spouse 1 Spouse 2 Spouse 1 Spouse M.A.G.I. Spouse 1 Spouse 2 Yes Yes No No Unlimited Yes Yes Yes No No N/A Unlimited Yes Yes Yes No Yes N/A Under $85,000* Yes Yes Yes No Yes N/A $105,000 $159,000** No Yes Yes No Yes N/A Over $169,000 No No * For M.A.G.I. between $85,000 and $105,000, the IRA deduction for the working spouse phases-out. ** For M.A.G.I. between $159,000 and $169,000, the IRA deduction for the non-working spouse phases-out. g. Additional Catch-Up Contribution (Age 50 or Over) Individuals who are 50 years of age (by December 31) or older have an additional contribution ("adjustment") of an extra $1,000 (2008). h. Retirement Plan Contribution Credit Eligible taxpayers may also be entitled to a tax credit (maximum $1,000) for contributions to either a traditional IRA or Roth IRA, subject to certain income limitations (discussed later in this chapter). 3. Roth IRA a. Non-Deductible Contributions Contributions to a Roth IRA are not deductible when made. b. Tax-Free Accumulation of Earnings Earnings accumulate tax-free while in a Roth IRA account. Deductible Roth Non- Deductible Coverdell Education c. Tax-Free Distributions (Withdrawals) Distributions, both of principal and interest, are also tax-free provided they are qualified distributions. (1) Principal withdrawal is tax-free. (2) Earnings (accumulated) are tax-free. d. Contribution Limits The overall limit for regular deductible and Roth IRA contributions in a year (i.e., annual aggregate contributions to all IRA accounts except the Coverdell Education Account) remains at: 2008 (1) Single taxpayer $ 5,000 (2) Married taxpayers $10,000 (3) The amount that can be contributed to a Roth IRA is the amount remaining after subtracting any contribution made to a regular IRA DeVry/Becker Educational Development Corp. All rights reserved. R2-7

8 Regulation 2 Becker CPA Review Deductible Roth Non- Deductible Coverdell Education (4) These limits are the same regardless of whether the taxpayers are active plan participants, including participants in SEP and simple plans. Because the Roth phase-out income levels are higher, many taxpayers will qualify for Roth IRAs but not for regular IRAs. Roth IRAs are not subject to the minimum distribution rules of deductible IRAs, which apply once the individual reaches age 70½. e. Phase-Out Income Limits (Modified Adjusted Gross Income) (1) Single taxpayers with MAGI between $101,000 to $116,000 (2) Joint filers with MAGI from $159,000 to $169,000 (3) Married filing separately with MAGI from $0 to $10,000 f. Qualified Nontaxable Distributions of Roth IRAs are Those Made at Least Five Years After the Taxpayer's First Contribution to a Roth IRA and Made: (1) After the taxpayer reaches age 59½. (2) To a beneficiary after the taxpayer's death, or (3) Because the taxpayer is disabled, or (4) For use by a "first time" (taxpayer not owning a principal residence in the two year period before buying this residence) homebuyer to acquire a principal residence. There is a lifetime $10,000 limit on qualified distributions for this purpose. g. Rollovers from Regular to Roth IRAs Transfers can be made from regular IRAs to Roth IRAs in any year that the taxpayer's AGI is $100,000 or less ($159,000 if MFJ or SS). Any transferred amounts that were previously deducted (and any earnings) are includible in income, but there is no penalty. Withdrawals allocable to the transferred amounts cannot be made until amounts have been in the Roth IRA for at least five years. Note: For tax years beginning in 2010, the $100,000 AGI limit has been eliminated. h. Retirement Plan Contribution Credit Eligible taxpayers may also be entitled to a tax credit (maximum $1,000) for contributions to either a traditional IRA or Roth IRA, subject to certain income limitations (discussed later in this chapter). 4. Non-Deductible IRA Individuals not eligible to make deductible contributions to regular (deductible) and Roth IRAs may still make contributions to non-deductible IRAs. a. Non-Deductible Contribution Limitations Up to the Lesser of: (1) $5,000 for 2008 (2) Individual's compensation (3) Limit not contributed to other (regular and Roth) IRAs b. Tax-Free (Deferred) Accumulation of Earnings Earnings on such contributions will accumulate tax-free (deferred) until withdrawn. R DeVry/Becker Educational Development Corp. All rights reserved.

9 Becker CPA Review Regulation 2 c. Distributions (Withdrawals) Distributions from a non-deductible IRA will be taxed as follows: (1) Taxable previously accumulated untaxed earnings (2) Non-taxable the principal contributions (not deducted when contributed) 5. Coverdell Education Savings Accounts (Education IRA) A separate education savings account (a trust or custodial account, with limits independent of those for other IRAs) is available. These accounts are set up to pay the qualified education expenses of a designated beneficiary. a. Non-Deductible Contributions Deductible Roth Non- Deductible Coverdell Education Contributions are non-deductible; maximum contribution per beneficiary is $2,000 annually. b. Tax-Free Accumulation of Earnings Earnings accumulate tax-free while in an education savings account. c. Tax-Free Distributions (Withdrawals) Distributions, both of principal and interest, are also tax-free to the extent they are used for qualified education expense of the designated beneficiary. (They may also be used for qualified elementary and secondary school expenses.) (1) Qualified Education Expenses Qualified expenses include tuition, fees, tutoring, books, room and board, supplies and equipment. (2) Time Limitation (Beneficiary Reaches 30 Years of Age) Any amounts remaining when the beneficiary reaches 30 years of age must be distributed (except in the case of a special needs beneficiary). Distribution may take one of two forms: (a) Distributed to Beneficiary When distributions are made directly to a beneficiary, the distributed amount is: (a) Taxable to beneficiary, and (b) Assessed a 10% penalty. (b) Rollover to Another Family Member Alternatively, the balance can be rolled over to another family member of the taxpayer. (a) Tax-free rollover is permitted. (b) No 10% penalty is assessed. (3) Hope or Lifetime Learning Credit (Combination Rules) A taxpayer can claim a Hope Credit or Lifetime Learning Credit for a tax year and also exclude from gross income amounts distributed from Coverdell Education Savings Account (Educational IRA) DeVry/Becker Educational Development Corp. All rights reserved. R2-9

10 Regulation 2 Becker CPA Review d. Contribution Requirements (1) Beneficiary/Child Under Age 19 The designated beneficiary may be any child under age 19. There is no limit on the number of beneficiaries (each beneficiary has a separate account). (2) Maximum Contribution (per Beneficiary) Contribution limit is set at the following per beneficiary: 2008 $2,000 (3) Phase-Out (Modified AGI Test) The contribution amount is phased-out for taxpayers with the following modified adjusted gross income between these amounts: 2008 (a) Single: $95,000 $110,000 (b) Married: $190,000 $220,000 (4) Active Plan Participants The phase-out limits are the same regardless of whether the taxpayers are active plan participants. IRA Contribution and Withdrawal Summary Traditional Deductible IRA Catch-Up IRA Roth IRA Non-Deductible IRA Coverdell Education IRA Tax "adjustment" Yes Yes No No No Maximum contribution: 2008 $5,000 $1,000 $5,000 $5,000 $2,000 Accumulate tax-free/deferred Yes Yes Yes Yes Yes Withdrawals: Principal Taxable Taxable Non-taxable Non-taxable Non-taxable Earnings Taxable Taxable Non-taxable Taxable Non-taxable R DeVry/Becker Educational Development Corp. All rights reserved.

11 Becker CPA Review Regulation 2 D. STUDENT LOAN INTEREST EXPENSE The adjustment for education loan interest is limited to $2, All interest payments qualify for the adjustment. 2. It is phased-out for AGI between: 2008 a. Single $55,000 $70,000 b. Married taxpayers $115,000 $145,000 (must file jointly to claim the adjustment) 3. A dependent may NOT claim the adjustment. 4. The taxpayer must be legally obligated to pay the loan (e.g., interest paid by a parent on a child's student loan will not qualify as an allowable adjustment). 5. Interest is only deductible on loans incurred by a taxpayer solely to pay for qualified education expenses (e.g., general loans such as home equity line of credit would not qualify). E. TUITION AND FEES DEDUCTION The qualified higher education expenses above-the-line deduction (adjustment), which applied regardless of whether the education was work-related expired on December 31, (Prior: These expenses were only deductible as education expenses (itemized deductions subject to 2% of AGI limitation.)) It is expected to be extended, but the law did not pass as of the date of this publication. 1. Maximum $4,000 Pending Legislation 2. Maximum Income Limit For 2007, the maximum adjustment of $4,000 is allowed for taxpayers with AGI equal to or less than $65,000 ($130,000 for joint filers). The maximum adjustment is $2,000 for taxpayers with AGI in excess of $65,000 ($130,000 for joint filers) but less than or equal to $80,000 ($160,000 for joint filers). No adjustment exists for taxpayers with AGI in excess of $80,000 ($160,000 for joint filers). 3. Restriction on Deduction A taxpayer is not eligible to claim the deduction if the expenses were applied to either: a. The Hope Credit and/or Lifetime Learning Credit b. Non-Taxable Education Savings Account distributions F. HEALTH SAVINGS ACCOUNTS 1. Pre-Tax Contribution Health Savings Accounts (HSAs) enable workers with high-deductible health insurance to make pre-tax contributions of up to $2,900 in 2008 ($5,800 for families) to cover health care costs DeVry/Becker Educational Development Corp. All rights reserved. R2-11

12 Regulation 2 Becker CPA Review 2. Excludable Withdrawals Any amount paid or distributed out of an HSA that is used exclusively to pay the qualified medical expense of any account beneficiary is not includible in gross income. a. An exception is distributions not used to pay qualified medical expenses are includible in gross income and subject to a 10 percent penalty. 3. High Deductible Plan Defined For 2008, a high-deductible health plan is a plan that has at least a $1,100 annual deductible for self-only coverage and a $2,200 deductible for family coverage. These amounts are indexed for inflation. a. Out-of-Pocket Limitation Annual out-of-pocket expenses paid under the plan must be limited to $5,600 for individuals and $11,200 for families. Out-of-pocket expenses include deductibles, co-payments and other amounts (other than premiums) that must be paid for plan benefits. 4. Archer Medical Savings Account (MSA) Contributions (After 2007, no new Archer- MSAs may be established; however, any accounts established prior to 2008 may continue) a. Archer MSAs are similar to IRAs, but they are used for health care. Typically, they are used only if the HSA is unavailable, as HSAs are generally more flexible. b. Qualified participants are self-employed individuals or employees of small businesses (less than 50 employees). c. These accounts are designed to be and must be used in conjunction with a high deductible health insurance plan. d. The limitation on contributions to the MSA is 65% (75% if coverage is for the entire family) of the annual (high) deductible amount. G. MOVING EXPENSES MOVING EXPENSES A taxpayer may deduct moving expenses paid or incurred during the taxable year in connection with the commencement of work by him as an employee or as a self-employed individual at a new principal place of work. 1. New Workplace Fifty Miles Farther from Old House than Old Workplace Was No deduction is allowed unless the distance between the employee's new place of business and his old residence is at least 50 miles greater than his old residence was from his former principal place of work. In other words, if staying in the old house would increase the commuting distance by at least 50 miles, the employee qualifies, assuming that the employee does move. There are no limits on the location of the new house. If he had no former principal place of work, the new place of business must be at least 50 miles from his former residence. R DeVry/Becker Educational Development Corp. All rights reserved.

13 Becker CPA Review Regulation 2 2. Thirty-Nine-Week Stay The employee must work full-time in the new location at least 39 weeks during the 12- month period immediately following his arrival. Self-employed persons must work fulltime at least 78 weeks during the 24-month period after arrival to meet the test. If the time period has not expired at the time the tax return is due, the employee may deduct the moving expense; but if he subsequently moves before the time period is up, he must include the amount deducted as income in the following year. 3. Only Direct Moving Costs are Allowable Costs of moving the following items are deductible: a. Travel and lodging of the taxpayer and his family (1) Transportation expenses are deductible at actual out-of-pocket amounts or 19 per mile (1/1/08-6/30/08) and 27 per mile (7/1/08-12/31/08). (2) Tolls and parking fees, but not other amounts, can be added to the mileage rate if it is used. b. Household goods and personal effects from the old to the new location PASS KEY The CPA Examination frequently includes the following items in moving expense questions: Non-deductible Meals Pre-move house hunting Expense of breaking a lease Temporary living expenses 4. Employer Reimbursements Employer reimbursements are excludable from income to the extent the amounts qualify as deductions. H. TAX ON SELF-EMPLOYMENT (SOCIAL SECURITY 50%) Self-employed taxpayers with net business income are subject to two taxes: income tax and Social Security/Medicare tax. Fifty percent of the self-employed Social Security/Medicare tax is deducted to arrive at adjusted gross income. I. SELF-EMPLOYED HEALTH INSURANCE (100% DEDUCTIBLE) Self-employed individuals may deduct all of their medical insurance premiums paid for the taxpayer, spouse, and dependents DeVry/Becker Educational Development Corp. All rights reserved. R2-13

14 Regulation 2 Becker CPA Review J. KEOGH (PROFIT SHARING) PLANS A self-employed taxpayer subject to the self-employment tax is generally allowed to set up a Keogh plan. 1. Maximum Annual Deductible Amount The maximum annual deductible amount is limited to the lesser of: RETIREMENT PLANS OR KEOGH PLANS 2008 $46,000 (indexed for inflation) OR 25% net (Keogh/self-employed) earnings 2. Maximum Annual Addition (Contribution) The maximum annual addition may exceed the deductible amount for the year. It is limited to the lesser of: 2008 $46,000 OR 100% net earnings (only if compensation is less than $46,000) 3. Net Earnings (from Self-Employment) Net earnings = net earnings from self-employment (after the Keogh deduction and onehalf of the self-employment tax). Business Income < Business Expenses > Net Business Income < ½ Self Employment Tax > < Keogh Deduction > Keogh Net Earnings Hint: 25% of self-employment after the Keogh deductions is the mathematical equivalent of 20% (25% 125%) of self-employment income before the Keogh deduction. EXAMPLE Peter has self-employment net income (after one-half of the self-employment tax, but before any Keogh deduction) of $100,000. Calculate Peter's maximum allowable deduction to his Keogh plan for Gross self-employment income $100,000 Times (shortcut) x 20% Maximum allowable deduction $20,000* *($100,000 - $20,000 = $80,000) x 25% = $20,000 R DeVry/Becker Educational Development Corp. All rights reserved.

15 Becker CPA Review Regulation 2 K. PENALTY ON EARLY WITHDRAWAL OF SAVINGS (INTEREST INCOME): INTEREST FORFEITED An example of forfeited interest is the interest penalty on early withdrawal of savings when funds in a certificate of deposit are withdrawn before maturity. L. ALIMONY Alimony payments to a former spouse are adjustments deductible to arrive at AGI. 1. Alimony/Spousal Support (Income to Payee/Adjustment to Payor) Payments for the support of a spouse are income to the spouse receiving the payments and are deductible to arrive at adjusted gross income (adjustment) by the contributing spouse. The following conditions must exist for alimony to be deductible: a. Payments must be legally required under a written divorce (or separation) decree or agreement; b. Payments must be in cash (or its equivalent); c. Payments cannot extend beyond the death of the payee-spouse; d. Payments cannot be made to members of the same household; e. Payments must not be designated as anything other than alimony; and f. The spouses may not file a joint tax return. 2. Child Support (Non-Taxable to Payee/Non-Deductible to Payor) a. Non-Taxable If any portion of the payment is fixed by the decree or agreement as being for the support of minor children (or is contingent on the child's status, such as reaching a certain age), such portion is not deductible by the spouse making payment and is not includible in income by the spouse receiving payment. b. Payment Applies First to Child Support If the decree or agreement specifies that payments are to be made both for alimony and for support, but the payments subsequently made fall short of fulfilling these obligations, the payments will be allocated first to child support (until the entire child support obligation for the year is met), and then to alimony. 3. Property Settlements (Non-Taxable / Non-Deductible) If the divorce settlement provides for a lump-sum payment or property settlement by a spouse, that spouse gets no deduction for payments made, and the payments are not includible in the gross income of the spouse receiving the payment. M. ATTORNEY FEES PAID IN DISCRIMINATION CASES In certain cases, an adjustment is allowed for attorney fees paid in connection with age, sex, or racial discrimination and whistleblower fees cases. The adjustment amount is limited to the amount claimed as income from the judgment. This assists some taxpayers in avoiding the AMT related to the deduction, which was previously reported as a miscellaneous itemized deduction (disallowed for AMT purposes). N. DOMESTIC PRODUCTION ACTIVITIES There is an adjustment for Domestic Production Activities (Code Section 199). Taxpayers will receive an adjustment for a percentage (6% in 2007) of qualified production activities income or the taxpayer's taxable income without considering the deduction (whichever is less). The deduction is for businesses of architectural and engineering, construction, film production, and the sale, rental, or lease of the company's manufactured equipment. A form 8903 will be filed DeVry/Becker Educational Development Corp. All rights reserved. R2-15

16 Regulation 2 Becker CPA Review III. STANDARD DEDUCTION DEDUCTIONS FROM ADJUSTED GROSS INCOME (AGI) A. STANDARD DEDUCTION Nonitemizers receive a standard deduction, with the amount determined based upon filing status: 2008 Single $5,450 Head of household $8,000 Married filing jointly or surviving spouse $10,900 Married filing separately* (same as single) $5,450 *Available only if both taxpayer and spouse do not itemize. 1. Additional Deduction for the Elderly and/or Blind The standard deduction for a taxpayer who is age 65 or over or blind is increased by an additional amount. 1 Qualified Single 2008 Married 65 OR Blind $1,350 $1,050 Both 65 AND Blind $2,700 $2,100 2 Qualified Each 65 OR Blind -- $2,100 Both 65 AND Blind -- $4,200 EXAMPLES (1) Bob and Suzanne DeFilippis are both age 66 and file jointly. For the year 2008, the standard deduction would be $13,000 ($10,900 plus $2,100 because each spouse is age 65 or over). (2) For tax year 2008, Ed Joback, a blind single taxpayer, may claim a standard deduction of $6,800 if only blind ($5,450 plus $1,350), or $8,150 ($5,450 plus $2,700) if Ed were both blind and 65 or over. PASS KEY A taxpayer who uses the standard deduction and is elderly and/or blind is entitled to an increased standard deduction. The CPA Examination has often presented questions that incorrectly suggest that being blind and/or old will entitle the taxpayer to an additional exemption. R DeVry/Becker Educational Development Corp. All rights reserved.

17 Becker CPA Review Regulation 2 2. Standard Deduction Dependent of Another For 2008, the amount is the greater of $900 (or the higher amount adjusted for inflation) or his earned income plus $300. Thus, a dependent taxpayer with $1,300 earned income could claim a standard deduction of $1,600 ($1,300 + $300). The dependent's standard deduction remains limited by the regular standard deduction for the tax year. Dependent taxpayers may claim the same additional standard deduction as other taxpayers for blindness and/or age 65 or over status. B. ITEMIZED DEDUCTIONS ITEMIZED 1. Limitation on Itemized Deductions DEDUCTIONS For 2008, this limitation applies to the itemized deductions of taxpayers with AGI exceeding $159,950 ($79,975 for married taxpayers filing separately). The limitation reduces, but not by more than 80%, applicable itemized deductions (taxes, interest, contributions, and miscellaneous itemized deductions) by 3% of the amount of AGI exceeding $159,950 (or $79,975). Itemized deductions that are not subject to limitation include: a. Gambling losses b. Investment interest expense c. Medical expenses d. Casualty and theft losses (non-business) EXAMPLE A single taxpayer with AGI of $500,000 in 2008 will lose $10,202 [3% x ($500,000 - $159,950)] in applicable itemized deductions before the applicable 66 2 /3% reduction of the phase-out. But if his applicable itemized deductions were $10,000, the reduction would be only $8,000 (80% x $10,000) because the reduction cannot be more than 80%. Note: Starting in 2006, the phase-out was reduced. For , it was 2/3 of the amount calculated above. For , it is 1/3 of the amount. By 2010, it will be eliminated DeVry/Becker Educational Development Corp. All rights reserved. R2-17

18 Regulation 2 Becker CPA Review R DeVry/Becker Educational Development Corp. All rights reserved.

19 Becker CPA Review Regulation 2 2. Medical Expenses a. Payments Payments on behalf of the following individuals qualify: (1) Yourself (2) Spouse (3) Dependent who received over half his or her support from you Medical Taxes Interest Charity Casualty Misc. MEDICAL EXPENSES Note: The definition of "dependent" for this purpose does not consider the dependent's gross income or the joint return requirement. Thus, there is no limitation to dependent's gross income when it relates to medical or dental expenses (however, all other dependency tests will continue to apply). Support over 50% Under $ taxable income Precludes joint return Only citizens Relative (OR) Taxpayer lives with Yes No No Yes Yes Yes b. Timing of Deduction Include as potentially deductible expenses: (1) Paid (cash or check) amounts during the year. (2) Charged amounts during the year (regardless of when paid). (3) Payments made for a deceased spouse (deductible in the year paid, even if it is different from the year the spouse died). (4) Amounts repaid to the taxpayer (or anyone else for the taxpayer) by hospital, health, or accident insurance must reduce otherwise allowable expense (before the 7.5% is applied). PASS KEY Individuals are typically "cash basis." Therefore, generally in order to be tax deductible, the item must have been: Incurred as an expense Paid or charged before year end 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-19

20 Regulation 2 Becker CPA Review c. Deductible Medical Expenses Formula Qualified medical expenses to the extent they exceed medical insurance reimbursement and 7.5% of the taxpayer's AGI are deductible. Qualified Medical Expenses < Insurance Reimbursement > Qualified Medical Expense "Paid" < 7 ½ % AGI > Deductible Medical Expenses d. Types of Deductible Medical Expenses (1) Medicine and drugs (prescription), including Medicare D premiums (2) Doctors (3) Medical and accident insurance (4) Required surgery (5) Transportation to medical facility (a) Actual cost (b) Allowance (19 per mile for 1/1/08-6/30/08 and 27 per mile for 7/1/08-12/31/08) (6) Physically handicapped costs: Expenses incurred by the physically handicapped for the removal of structural barriers in their residences to accommodate their handicapped condition are treated as a medical expense. e. Types of Non-Deductible Medical Expenses (1) Elective surgery, elective cosmetic operations, drugs that are against the law, travel, vitamins, the part of Social Security tax paid for basic Medicare, funerals, cemetery lots, and insurance against loss of earnings due to sickness or accident (but, cosmetic surgery required due to an accident or deformity can qualify) (2) Life insurance (3) Capital expenditures (up to the increase in FMV of the property because of the expenditure), except those noted above (4) Health club memberships recommended by a doctor for general health care (it would have to be more specific to make it deductible) (5) Personal hygiene and other ordinary personal expenses (e.g., tooth paste, toiletries, over-the-counter medicines, bottled water, diaper service, maternity clothes, etc.) R DeVry/Becker Educational Development Corp. All rights reserved.

21 Becker CPA Review Regulation 2 f. Insurance Reimbursement Amounts repaid to the taxpayer (or anyone else for the taxpayer) by hospital, health, or accident insurance must reduce otherwise allowable expense (before the 7.5% is applied). (1) Reimbursement of expenses by an employer (or by policies provided by an employer) that exceed the total of medical or dental expenses paid by a taxpayer will be included as part of gross income. (2) Reimbursement of any expense deducted in a prior year will be included as part of gross income in the year received. g. 7.5% AGI Test Medical expenses, to the extent they exceed 7.5% of the taxpayer's AGI, are deductible. 3. State, Local, and Foreign Taxes a. Deductible Taxes For cash-method taxpayers, deductible taxes are generally deductible in the year paid. For accrual-method taxpayers, taxes are generally deductible in the year in which they accrue. (1) Real Estate Taxes (State, Local, and Foreign Taxes) Medical Taxes Interest Charity Casualty Misc. STATE AND LOCAL TAXES (a) The taxpayer must be legally obligated to pay in order to deduct the taxes. (b) Prorate taxes in year of sale/purchase. (c) Taxes paid under protest are deductible. Subsequent recovery is included in gross income. (d) Real estate taxes do not include street, sewer, and sidewalk assessment taxes. (e) Taxes paid through an escrow impound account are deductible when paid to the taxing authority. (f) Foreign real estate taxes paid are only deductible for real estate held as an investment. (g) Real estate taxes on land held for appreciation may be capitalized or deducted at the option of the taxpayer. (2) Income Taxes (State, Local, and Foreign Taxes) (a) Estimated taxes paid during the year are deductible. (b) Withheld taxes from paychecks during the year are deductible. (c) Assessments paid during the year for prior year's tax are deductible. (d) Refunds are an item of gross income (if the tax was deducted in a prior year) and should not be netted against the itemized tax deduction. (3) Personal Property Taxes (State and Local Taxes) 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-21

22 Regulation 2 Becker CPA Review (4) Sales Tax (State and Local General Sales Taxes) A taxpayer may elect to deduct either state and local income taxes or state and local general sales taxes. If the sales tax is chosen to be deductible, the amount is either: (a) The total of actual general sales taxes paid; or (b) IRS table, plus any amount of sales tax paid for a motor vehicle, boat or other IRS approved items. Note: There is a "tax benefit rule" that applies to the impact of sales tax. If a taxpayer itemized deductions in a year and took a deduction for state income taxes instead of a deduction for sales taxes in that year, the tax benefit rule will calculate the taxability of the state tax refund on the extra benefit received from claiming the higher state income tax deduction compared to what would have been allowed if the state sales tax had been deducted. b. Non-Deductible Taxes The following taxes are not deductible: (1) Federal taxes (including Social Security) (2) Inheritance taxes for states (also called "federal estate pick-up tax") (3) Business (on Schedule C) and rental property taxes (on Schedule E) PASS KEY Once again, "cash basis" taxpayers are entitled to a deduction in the year an item is paid or charged. Note, that there is no "matching" to the year the tax is applicable. INTEREST PAID OR ACCRUED Home Investment Personal Prepaid Educational QUALIFIED RESIDENCE INTEREST Medical Taxes Interest Charity Casualty Misc. 4. Interest Expense a. Home Mortgage Interest H IPPE Deductions are allowed for "qualified residence interest" on a first or a second home (a taxpayer's principal residence and one other residence). A home that is used for personal purposes for at least 14 days in a tax year qualifies as a "second home." There are two categories of qualified residence interest: (i) acquisition indebtedness and (ii) home-equity indebtedness. (1) Acquisition Indebtedness ($1,000,000 Maximum) Interest on up to $1,000,000 of acquisition indebtedness is deductible as qualified residence interest. Interest on excess principal (over $1,000,000) is treated as personal interest, and as such, is not deductible. Acquisition indebtedness is debt that is: (a) Incurred in buying, constructing, or substantially improving the taxpayer's principal and second home, and (b) Secured by home. (c) Points related to acquisition indebtedness are deductible immediately. (d) Refinancing points must be amortized over the period of the loan. (2) Home Equity Indebtedness ($100,000 Maximum) Debt that is secured by the taxpayer's principal or second residence, but is not "acquisition indebtedness" (i.e., not used to acquire, build, or improve the home), is classified as "home equity indebtedness." R DeVry/Becker Educational Development Corp. All rights reserved.

23 Becker CPA Review Regulation 2 (a) Maximum Amounts The maximum amount that can be treated as "home equity indebtedness" is the lesser of: (1) $100,000 (2) FMV of the property reduced by the amount of outstanding "acquisition indebtedness" (b) Purpose of Loan The proceeds of home equity loans may be used for any purpose (e.g., vacation, medical expenses, etc.). (c) Disallowed Home Equity Indebtedness Interest on any excess amount is treated as personal interest. (3) Mortgage Insurance Premiums Mortgage insurance premiums paid in connection with qualified acquisition debt are deductible as home mortgage interest (phase-outs apply). b. Investment Interest Expense H I PPE The investment interest deduction for individuals is limited to net (taxable) investment income. (1) Include as Investment (Taxable) Income (a) Interest and dividends ("portfolio income") (b) Dividends (portfolio or investment income) (c) Rents (d) Royalties (in excess of expenses), and (e) Net long-term and short-term capital gains (only if the taxpayer elects not to claim the reduced capital gains tax rate). PASS KEY Any dividend income (from stock purchased with borrowed funds) which the taxpayer treats as investment income for purposes of the limitation on investment expense is NOT a qualified dividend, available for the 15% tax rate. (2) Exclude as Investment (Taxable) Income Interest expense used to purchase tax-free bonds is not deductible (because the interest earned on the bonds is not taxable). INVESTMENT INTEREST PASS KEY An easy way to understand and remember this rule is to think of it like the limitations on gambling losses. Investments (are a risk/gamble) have the limitation of not being permitted to deduct a "net investment expense." (3) Include as Investment Interest Expense Investment expenses (such as investment advice fees, safe deposit box rentals, etc.) other than interest are deductible on Schedule A as part of miscellaneous Itemized Deductions (subject to 2% of AGI). Only those expenses deducted on Schedule A (i.e., those exceeding 2% of AGI) are used when calculating the amount of net investment income (which is the limit for the investment interest deduction) DeVry/Becker Educational Development Corp. All rights reserved. R2-23

24 Regulation 2 Becker CPA Review CHARITABLE CONTRIBUTIONS Medical Taxes Interest Charity Casualty Misc. (4) Exclude as Investment Interest Expense Any Interest Expense Taken Into Account in Determining Income or Loss From: (a) A passive activity. (Losses and credits can be carried forward indefinitely.) (b) Rental real estate (a passive activity) in which the taxpayer does not actively participate. (Interest expense when the taxpayer does actively participate is treated separately.) (5) Disallowed Expense Carry Forward The excess of investment interest paid over the "allowed" investment interest can be carried forward indefinitely. c. Personal (Consumer) Interest is Not Deductible Personal interest includes interest on: HIP PE (1) A personal note to a bank or person for borrowed funds. (2) Life insurance loans. (3) Bank credit cards or other revolving charge accounts. (4) A purchase of personal property such as autos, television sets, clothes, etc. (5) Interest on federal, state, or local tax underpayments. d. Prepaid Interest (Allocate to Proper Period) HIPP E Prepaid interest must be allocated over the period of the loan (for the taxpayer making the payments), even for cash basis taxpayer. (Remember, however, that prepaid interest received is fully taxable as income in the year received and is not allocated.) e. Educational Loan Interest (Adjustment/Not Itemized Deduction) HIPPE Educational loan interest is an adjustment. It is a deduction to arrive at adjusted gross income. It is not an itemized deduction. 5. Charitable Contributions a. Definitions (1) Charity items given to organizations (tax deductible) (2) Gifts items given to individuals (needy family) (non-deductible) (3) Political contributions items given to candidates (non-deductible) b. General (1) Cash or FMV of Property A gift must be in the form of cash or (FMV) property. The deduction for contributed property is usually measured by the lesser of the property's basis or its fair market value at the time the contribution is made. R DeVry/Becker Educational Development Corp. All rights reserved.

25 Becker CPA Review Regulation 2 (2) Maximum Allowable Deduction (50% of AGI) The maximum allowable deduction for an individual is: (a) Cash = 50% of adjusted gross income (b) FMV Property = 30% of AGI for gifts of long-term capital gain property to public charities c. Appreciated Property Special rules apply to the deductibility of gifts of long-term capital gain property. (1) Deduct at Fair Market Value Appreciated property (property having a value greater than its basis) is deductible at its fair market value if it held over one year. (2) 30% / 50% AGI Limit A taxpayer may deduct the full value of long-term capital gain property (without paying capital gains tax on the appreciation), but the total value of such property deducted may not exceed 30% of taxpayer's adjusted gross income for gifts to a public charity. No more than 20% may be deducted for gifts to a nonoperating private foundation. (3) Combination Rules Always remember that in addition to the above, the total deduction for all gifts (to include long-term capital gain property, cash, and other property) may not exceed 50% of adjusted gross income. PASS KEY The CPA Examination has typically tested the following rules with regard to charitable contributions limitation: Overall limit = 50% AGI 1) Cash may be all 50% 2) General property lesser of basis or FMV 3) Long-term appreciated property is limited to the lesser of: a) 30% of AGI b) The remaining amount to reach 50% after cash contributions d. Consideration for Contribution The taxpayer may only deduct the excess contribution over the consideration received. Charitable organizations that obtain contributions of more than $75 in exchange for services or property must provide the donor with a written statement that estimates the value of the deductible portion of the payment. EXAMPLE (1) Raffle tickets bought at a charity bazaar that have a chance of winning a prize do not give rise to a charitable deduction. (2) Veiga buys a ticket to a charity ball for $200. The actual value of attending the ball was $50. Veiga may take a charitable deduction of $ DeVry/Becker Educational Development Corp. All rights reserved. R2-25

26 Regulation 2 Becker CPA Review e. Charitable Deduction by Those Not Itemizing Nonitemizers may not deduct charitable contributions. f. Time for Deduction A deduction is allowed only for the tax year in which the contribution is made: (1) Cash or check actually paid. (2) Credit card When charged, a contribution made by a bank credit card is deductible in the year the charge is made, even though payment to the bank for the charge occurs the following year. g. Contribution for Services A taxpayer may deduct out-of-pocket expenses incurred as a result of giving services to a charity. This includes the cost of driving to and from the volunteer work. The taxpayer may take 14 cents per mile or the actual cost of gas and oil. With either method, the taxpayer may also include parking and tolls. (Note: An act of Congress is required to change the standard mileage rate for charitable contributions.) (1) Services A taxpayer may not deduct the value of the time or services donated. h. Student Living in Taxpayer's Home A charitable deduction may be taken for the expense incurred when the taxpayer takes into the home a full-time student (e.g., an exchange student). The student may not be beyond the twelfth grade. The total deduction is up to $50 per month for each full month (fifteen or more days) that the student is in the home and attending school. i. Substantiation Requirement Regardless of the amount of the cash contribution, taxpayers must keep records that substantiate their deductions. Either a bank record (e.g., canceled check or itemization on a bank statement with the charity's name) or a written acknowledgement from the charity is required. The acknowledgment must be obtained by the earlier of the filing date or the due date of the return. j. Additional Substantiation Requirements for Large Noncash Contributions For contributions of more than $500 of noncash property, the taxpayer must file Form 8283, giving certain information. In addition, taxpayers claiming more than $5,000 for any one item or group of similar items, such as a stamp collection, need a written appraisal for each such item or group donated, except that no appraisal is needed for publicly traded securities. k. Carryover of Excess Charitable Contributions: Five Years All charitable contribution carryovers are applied on a first-in, first-out basis, after current year contributions are deducted, subject to the percentage of income limitations. R DeVry/Becker Educational Development Corp. All rights reserved.

27 Becker CPA Review Regulation 2 6. Casualty and Theft Losses (10% AGI Test) Casualty and theft losses of nonbusiness property are deductible to the extent that each individual loss exceeds $100 and that the aggregate of these excess losses (excess over $100) exceeds 10% of AGI. The $100 floor applies to each separate casualty event. a. Amount of Loss The amount regarded as a casualty loss is the difference between the market value of the property immediately before the casualty and its market value immediately afterwards. However, the loss Medical Taxes Interest Charity Casualty Misc. CASUALTY LOSSES may not exceed the adjusted basis of the property. Whichever amount is used must be reduced by the amount of any insurance recovery. Smaller Loss < Insurance Recovery > 1. Lost Cost/Adjusted Basis 2. Decreased FMV Taxpayer s Loss < $100 > Eligible Loss < 10% AGI > Deductible Loss b. Suddenness A casualty loss must be sudden or unexpected; hence, the IRS has held that termite damage is not a deductible casualty loss because the damage occurs over a long period of time (some courts have disagreed). Similarly, damage caused to trees by Dutch Elm disease is not deductible. c. Failure to Notify Insurer A casualty loss for nonbusiness property cannot be deducted unless (1) An insurance claim was filed, or (2) The losses are not covered by insurance. d. Lost, Misplaced, or Broken Property No casualty loss deduction is allowed for lost, misplaced, or broken property DeVry/Becker Educational Development Corp. All rights reserved. R2-27

28 Regulation 2 Becker CPA Review Medical Taxes Interest Charity Casualty Misc. UNREIMBURSED BUSINESS EXPENSES 7. Miscellaneous Itemized Deductions (2% AGI Test) A deduction is allowed only to the extent that these miscellaneous deductions exceed in the aggregate 2% of adjusted gross income and were not taken as part of an allowable adjustment. a. Unreimbursed Business Expenses (Employee) While an employee is considered to be in a trade or business, he is allowed only certain limited deductions in determining his adjusted gross income. Before considering these items, one must distinguish between reimbursed and unreimbursed expenses. For all practical purposes, an employee may always deduct reimbursed expenses incurred on behalf of his employer. Note that the reimbursements must be included in his gross income. The unreimbursed items that may be deducted are: (1) Travel, Meals and Lodging (Overnight Business Travel) All expenses incurred for meals and lodging while away from home overnight may be deducted. (a) Overnight Rule The Internal Revenue Service insists that "away from home" means away from home overnight, and the Supreme Court has upheld this position. EXAMPLE An executive from Chicago flies to New York on business. He leaves at 5:00 a.m. and returns at 11:00 p.m. the same day. He is not entitled to a deduction for the cost of his meals while in New York. (b) Home When an employee goes away on a business trip for a short time, he is entitled to deduct his traveling expenses. No deduction is allowed for the travel expenses of a spouse, dependent, or companion unless that person is an employee of the taxpayer and has a bona fide business purpose in traveling. In addition, if he stays away for many months, the IRS may argue that he has shifted his tax "home" and that he is no longer "away from home" within the meaning of the IRC. R DeVry/Becker Educational Development Corp. All rights reserved.

29 Becker CPA Review Regulation 2 (2) Transportation Expenses (100% Deductible) All transportation expenses incurred in furtherance of the employee's business are deductible except ordinary commuting expenses. This includes both out-of-town and local travel and automobile expenses. The standard mileage allowance for 2008 is 50.5 (1/1/08-6/30/08) and 58.5 (7/1/08-12/31/08). Temporary Work Site Home Regular Office Second Job Out-of-Town Business EXAMPLES (1) An employee flies from Chicago to New York on business; the airfare is deductible. (2) An employee takes a cab from his office to the office of a client. The cab fare is deductible. (3) An employee takes a cab from his home to his office. The expense is not deductible as it is a commuting expense. (4) An employee takes a cab from his day job to his evening job. The expense is deductible. (3) Meals/Entertainment Expenses (50% Deductible) In order to be deductible, entertainment expenses must generally be either "directly related to" or "associated with" the active conduct of a trade or business. Only 50% of the cost of entertainment is deductible. No deduction is allowed for club dues DeVry/Becker Educational Development Corp. All rights reserved. R2-29

30 Regulation 2 Becker CPA Review b. Educational Expenses (Those Not Deducted Above AGI, if the Adjustment is Extended into 2008) (1) Qualified An individual may deduct education expenses if they either: (a) Maintain or improve the skills needed by the individual in his or her trade or business; or (b) Meet the express requirements of the individual's employer for retention of this job. (2) Disqualified An individual may not deduct educational expenses if they were to meet minimum job requirements, or if they qualified him for a new trade or business. EXAMPLE Barbara, an attorney employed by a law firm, takes a one-day course (not at a qualified higher educational institution) in Estate Planning. She may deduct the cost of the course as a miscellaneous itemized deduction if it helps her maintain or improve her legal skills. c. Uniforms The purchase, cleaning, and repair of uniforms qualify as deductible expenses. The uniforms must not be of a type normally worn as streetwear when off the job. d. Business Gifts $25 per recipient per year is the deduction for business gifts. e. Business Use of Home A taxpayer may not deduct expenses for the business use of part of his or her home unless that part of the home is used exclusively and on a regular basis for work purposes and for the convenience of the employer. f. Employment Agency Fees (Job Hunting Expenses) An individual may deduct employment agency fees for a new job in the same profession. These fees are not deductible for a first job or entirely new profession. g. Expenses of Investors Safe Deposit Box, Investment Advice Rental expenses for a safe deposit box used to store investments is deductible, along with investment advice and investment newsletters. h. Subscriptions to Professional Journals Subscriptions to professional journals are deductible. i. Tax Preparation Fee A deduction is allowed for the legal and accounting fees incurred in the preparation of the taxpayer's return. No deduction is allowed for legal and accounting fees incident to divorce; unless, for example, they are related to tax planning aspects or spent pursuing taxable income. R DeVry/Becker Educational Development Corp. All rights reserved.

31 Becker CPA Review Regulation 2 j. Activities Not Engaged in for Profit (Hobbies) No deduction attributable to an activity not engaged in for profit is allowed, with the following exceptions: (1) Deductions such as interest and taxes that would be allowed regardless of whether or not such activity was engaged in for profit; and (2) A deduction equal to the amount of the deductions that would be allowed if such activity were engaged in for profit, but only to the extent that the gross income derived from the activity exceeds allowable deductions. Consequently, no losses are allowed. (3) There is a statutory presumption that an activity is engaged in for profit if it shows a profit for three or more taxable years during a period of five consecutive taxable years ending with the year in question. In the case of businesses engaged in the breeding, training, showing, or racing of horses, this presumption will apply if a profit is made in two of seven consecutive taxable years. EXAMPLE 1 Ricki raises and sells guinea pigs as pets. Ricki shows a profit in 20X7, 20X4 and 20X3, and a loss in 20X6, 20X5 and 20X2. For 20X7, Ricki's business is considered to be "engaged in for profit." The three-of-five-years test includes the current year in question. EXAMPLE 2 Arnie, a lawyer, raises begonias as a hobby. He uses a vacant lot as his garden and borrowed $500 for equipment. A total of $50 in taxes on this lot is deductible even if Arnie has no income from the hobby. If Arnie sells some plants and makes $100 on this sale, he may also deduct his ordinary business expenses up to $50 ($100 profit less $50 in taxes, and $50 ordinary business expenses). 8. Other Miscellaneous Deductions (No 2% AGI Test) GAMBLING The following itemized deductions are fully deductible. They are not subject to the 2% of AGI deduction rule. a. Gambling Losses Gambling losses remain fully deductible, but only to the extent of gambling winnings. b. Federal Estate Tax Paid on Income in Respect of a Decedent This is estate tax that was paid by an individual because of income received by the individual as a beneficiary of an estate. The individual will have included the income he received as part of his gross income on Form 1040 (with the same nature of income (e.g., interest income, etc.) as it would have been in the hands of the decedent). Estate tax will apply because the item of income was considered to be part of the estate for the estate's valuation (e.g., accrual of the value of a "loaded" installment note receivable). The federal estate tax paid (on Form 706) that related to the value of this income item is an allowable deduction for income tax purposes. (Estate tax will be covered in great detail in a later class.) PASS KEY The CPA Examination has tested the candidate's ability to identify an itemized deduction from a group of adjustments and vice versa DeVry/Becker Educational Development Corp. All rights reserved. R2-31

32 Regulation 2 Becker CPA Review TAX CALCULATIONS AND CREDITS I. TAX CALCULATION AND LIMITATIONS A. INDIVIDUAL RATE STRUCTURE The tax rates for individuals are 10%, 15%, 25%, 28%, 33%, and 35% Tax Rate Single Head of Household Married Joint Married Separate 10% $0 $8,025 $0 $11,450 $0 $16,050 $0 $8,025 15% $8,025 $32,550 $11,450 $43,650 $16,050 $65,100 $8,025 $32,550 25% $32,550 $78,850 $43,650 $112,650 $65,100 $131,450 $32,550 $65,725 28% $78,850 $164,550 $112,650 $182,400 $131,450 $200,300 $65,725 $100,150 33% $164,550 $357,700 $182,400 $357,700 $200,300 $357,700 $100,150 $178,850 35% $357,700 and Over $357,700 and Over $357,700 and Over $178,850 and Over PASS KEY A reduced tax rate of 15% or 0% (if a taxpayer otherwise is in the 15% and/or 10% tax bracket) is provided for: Qualified dividends Long-term capital gains R DeVry/Becker Educational Development Corp. All rights reserved.

33 Becker CPA Review Regulation 2 II. TAX CREDITS A. TAX CREDITS IN GENERAL Tax credits reduce personal tax liability. There are two basic types of tax credits DeVry/Becker Educational Development Corp. All rights reserved. R2-33

34 Regulation 2 Becker CPA Review CREDITS AGAINST TAX 1. Personal Tax Credits Personal tax credits may reduce personal tax liability to zero, but they may not result in a cash refund. Personal tax credits include: a. Child and dependent care credit b. Elderly and permanently disabled credit c. Education credits (1) Lifetime Learning credit (2) Hope Scholarship credit d. Adoption credit e. Retirement savings contribution credit f. Foreign tax credit g. General business credit 2. Refundable Credits Refundable credits are subtracted from income tax liability. They may result in a cash refund when the credit exceeds tax liability owed even if no tax is withheld from wages. The following are refundable credits (or are payments that are treated as refundable credits) and are shown in the "payments" section of Form 1040: a. Child tax credit b. Earned income credit c. Withholding taxes (W-2) d. Excess Social Security paid e. Long-Term Unused Minimum Tax Credit Through 2012, individuals with unused minimum tax credits that are at least three years old may generally recoup the greater of 1) $5,000 or 2) 20% of the unused amount per year against regular tax. Certain other more complicated calculations may exist (beyond exam scope), and the credit is subject to AGI phase-out provisions. B. CHILD AND DEPENDENT CARE CREDIT A tax credit of 20% to 35% of eligible expenditures: CHILD AND DEPENDENT CARE CREDIT 2008 Maximum Expenditures One dependent: $3,000 Two or more dependents: $6, Eligible People The child and dependent care credit is available to taxpayers who maintain a household, work, and incur eligible expenses for the care of the following eligible people: a. A qualifying child, under age 13, for whom an exemption may be claimed. b. Any disabled dependent of any age who is unable to care for himself, whether or not he can be claimed as a dependent, but who must meet the support test of a dependent (half of support provided for by the taxpayer); and c. A spouse who is disabled and not able to take care of himself or herself. R DeVry/Becker Educational Development Corp. All rights reserved.

35 Becker CPA Review Regulation 2 2. Earned (Work) Income Requirement Married taxpayers must both produce earned income from wages, salary, or net selfemployment income to be eligible for the child care credit (unless one is a full-time student or physically or mentally incapacitated). The credit is computed by using the lowest of (i) the earned income of the spouse with the lesser amount, (ii) the actual childcare expenditure, or (iii) the maximum amount (i.e., $3,000 or $6,000 for 2007). This lowest amount would then be multiplied by the applicable percentage to get the amount of the credit. 3. Eligible Expenses Eligible expenditures must be for the purpose of enabling the taxpayer to be gainfully employed (i.e., allowing that person to work or look for work). a. Babysitter b. Nursery School c. Day Care d. Not Grammar School 4. Credit Computation a. Maximum 35% The maximum child care credit against the tax liability is 35%. In order to obtain the maximum credit, the taxpayer's AGI (adjusted gross income) must be $15,000 or less. b. Phase out 20% 35% The credit decreases by 1% for each $2,000 (or fraction) of AGI over $15,000, but not below 20%. c. Minimum 20% The child care credit at the minimum rate of 20% for individuals with AGI of more than $43,000 is $600 (20% of $3,000) or $1,200 (20% of $6,000) if the taxpayer has two or more qualifying dependents. EXAMPLE JoAnn Veiga is a widow with two children. In 2008, her AGI is $43,500 for which the applicable table rate is 20%. Her work-related expenses for a housekeeper for the children are $3,600 and $3,800 for child care at a nursery school. JoAnn can take a child care credit of $1,200 calculated as follows: Work-related expenses $ 3,600 Nursery school expenses 3,800 Total $ 7,400 Maximum allowable for two dependents $ 6,000 Amount of credit (20%) percentage х 20% Amount of credit $ 1, DeVry/Becker Educational Development Corp. All rights reserved. R2-35

36 Regulation 2 Becker CPA Review C. CREDIT FOR THE ELDERLY AND/OR PERMANENTLY DISABLED 1. Eligibility This credit of 15% of eligible income is available to individuals who are: a. 65 years of age or older or b. Under 65 but who are retired due to permanent disability. 2. Base Amount The base amount used to figure the credit is as follows: a. $5,000 for a single person, widow, or widower; b. $5,000 if married filing jointly and only one spouse is a qualified individual; c. $7,500 if married filing jointly and both are qualified individuals; d. $3,750 for a qualified individual who is married filing separately. ELDERLY AND PERMANENTLY DISABLED TAX CREDIT If a qualified individual is under age 65 and has disability income of less than $5,000, the base amount is limited to $5, Adjusted Gross Income Limit Eligible income is reduced by: a. Any Social Security payments and other excludible pensions or annuities received by the taxpayer and b. One-half of the taxpayer's adjusted gross income that exceeds the following levels: (1) Single taxpayers $7,500 (2) Married persons filing jointly 10,000 (3) Married persons filing separately 5, Summary of Credit Calculation A taxpayer age 65 or older starts with a Tax Credit for the Elderly based on a specified amount that is reduced by (i) any Social Security payments and other excludible pensions and (ii) by one-half (50%) of any adjusted gross income over the stated maximum. The results, if any, are multiplied by 15% to arrive at the allowable tax credit. SINGLE JOINT 5,000 GROSS GIVEN 7,500 ( ALL ) (Social Security) ( ALL ) (1/2 over $7,500) (1/2 Excess AGI) (1/2 over $10,000) Balance Balance x 15% Rate x 15% Credit Credit R DeVry/Becker Educational Development Corp. All rights reserved.

37 Becker CPA Review Regulation 2 Rick is single and 68 years old. He received the following income for the year: Social Security received $3,120 Taxable interest 215 Taxable part of pension 3,600 Wages from a part-time job 4,245 His credit will be $240, computed as follows: Rick's adjusted gross income is $8,060, calculated as follows: EXAMPLE Wages from part-time job $4,245 Partly taxable pension 3,600 Taxable interest 215 $8,060 To calculate credit: Base amount $5,000 Less: Social Security $3,120 Excess AGI: $8,060-7, x 50% 280 (3,400) $1,600 Balance 15% Credit $ 240 D. EDUCATION TAX INCENTIVES Assuming the requirements are met, a taxpayer has the opportunity to reduce and/or avoid taxes by taking advantage of the Hope Scholarship Credit, the Lifetime Learning Credit, and/or a non-taxable distribution from a Coverdell Education Savings Account used to pay higher education costs. 1. The Hope Scholarship Credit ($1,800 Maximum in 2008) The Hope Scholarship Credit is available against federal income taxes for qualified tuition and related expenses paid for a student's first two years of post-secondary (college) education at an eligible educational institution. HOPE SCHOLARSHIP TAX CREDIT a. The credit is equal to (maximum credit of $1,800 in 2008): (1) 100% of the first $1,200 in 2008 of qualified expenses, plus (2) 50% of the next $1,200 in 2008 of expenses paid during the year. b. The qualified expenses are on a "per student" basis and must be incurred on behalf of the: (1) Taxpayer, (2) Taxpayer's spouse, or (3) Taxpayer's dependent DeVry/Becker Educational Development Corp. All rights reserved. R2-37

38 Regulation 2 Becker CPA Review LIFETIME LEARNING TAX CREDIT c. If a child is claimed as a dependent by a parent, expenses paid by both the parent and the child are deemed to have been made by the parent for this purpose. d. The student must be at least half-time for at least one academic period during the year. e. The credit is not available for the expenses of a student convicted of a federal or state felony drug offense in the calendar year for which expenses are incurred. f. For 2008, the credit phase out begins with modified AGI exceeding $48,000 ($96,000 on a joint return), with full phase out at $58,000 ($116,000 joint). 2. The Lifetime Learning Credit ($2,000 Maximum Per Year) The Lifetime Learning Credit is available for an unlimited number of years for qualified tuition and related expenses (not books, however) at an eligible educational institution. a. The credit is equal to 20% of qualified expenses up to $10,000. b. Qualified expenses include payments for undergraduate courses, graduate-level courses, certain professional degree courses, and courses to acquire or improve job skills. c. The credit does not vary based upon how many students are in the family. d. As with the Hope Scholarship Credit, expenses paid by a dependent child are treated as if made by the parent. e. For 2008, the credit phase out begins with modified AGI exceeding $48,000 ($96,000 on a joint return), with full phase out at $58,000 ($116,000 joint). 3. Coverdell Education Savings Account Distributions a. Use in Conjunction with Education Credits A taxpayer may claim a Hope Credit or Lifetime Learning Credit for a tax year and also exclude from gross income amounts distributed from a Coverdell Education Savings Account on behalf of the same student. b. Restriction The distribution cannot be used for the same educational expenses for which either the Hope Credit or Lifetime Learning Credit was claimed. 4. Not Limited to One Type of Credit The taxpayer does not have to choose one type of credit, on his tax return for the year. For example, a parent may claim a Lifetime Learning Credit for the expense of one child and a Hope Scholarship Credit for the expenses of another child in the same taxable year. R DeVry/Becker Educational Development Corp. All rights reserved.

39 Becker CPA Review Regulation 2 E. QUALIFIED TUITION PROGRAMS (QTP) 1. Tax Rule Exempt from all federal income taxation. 2. Definition A QTP is a program under which a person may purchase tuition credits or make cash contributions to an account on behalf of a beneficiary for payment of qualified higher education expenses. The program must be established and maintained by a state, state agency, or by an eligible educational institution. Eligible educational institutions generally include any accredited post-secondary educational institution, so long as contributions made to the program are held in a "qualified trust" (i.e., meets the requirements under Code Sec. 408(a)(2) and (5)). 3. Qualified Costs Qualified higher education expenses (QHEEs) include tuition, fees, books, supplies and equipment required by an educational institution for enrollment or attendance. They also include the reasonable cost of room and board if the beneficiary is enrolled at least half-time. 4. Tax-Free Use of Funds Distributions from a QTP, including cash, earnings, and in-kind distributions, may be excluded from a designated beneficiary's gross income to the extent that the distribution is used to pay for QHEEs EDUCATION TAX INCENTIVES SUMMARY Item General Rule Limit Income Phase-out INCOME EXCLUSION U.S. Savings Bond Series EE Exclude interest income Must pay educational expense AGI $80,600/$128,400 (2007)* Employer paid education expenses Exclude from income Up to $5,250 per year No income limit Scholarships Exclude from income Only tuition and books Not room and board ADJUSTMENTS Educator expense* Deduct above line $500/$250 No income limit Coverdell Education Savings Acct. Non-deductible $2,000 AGI $110,000/$220,000 Student loan interest deduction Deduct above line $2,500 AGI $70,000/$145,000 Tuition and fee deduction* Deduct above line $4,000 AGI $65,000/$130,000 ITEMIZED DEDUCTIONS Educational expenses Maintain and improve Subject to 2% AGI test None CREDITS Hope Scholarship credit First two years $1,800 per person (2008) AGI $58,000/$116,000 Lifetime Learning credit After first two years $2,000 maximum AGI $58,000/$116,000 MISCELLANEOUS 529 Plan (Qualified Tuition Program) No deduction No income Gift tax rules * Information related to 2008 is pending legislation as of the date of this publication. None 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-39

40 Regulation 2 Becker CPA Review ADOPTION OF CHILDREN F. ADOPTION CREDIT A credit for qualifying expenses of adopting a child is available. 1. Limit (disregarding potential employer-provided benefits, which are beyond the scope of the exam) 2008 Per child: $11,650 Special needs child: $11, Phase-out The credit is phased out for modified adjusted gross income between: 2008 $174,730 - $214, Eligible Expenses a. All reasonable and necessary expenses, costs, and fees are available for the credit. b. The credit is not available for adopting the child of a spouse or for a surrogate parenting arrangement. c. Medical expenses do not qualify as eligible expenses. d. Beginning in 2007, a taxpayer can exclude up to $11,390 of qualified adoption expenses paid by his/her employer (exclusion is phased-out with modified AGI of $174,730 - $214,730). 4. Timing The credit is claimed for years after the payment is made until the adoption is final, at which point expenses paid in the year it becomes final are claimed in that year. For foreign children adopted, no credit can be claimed until the year it becomes final. In either case, expenses paid in later years can be claimed in the year paid. 5. Unused Credit The credit claimed in a given year is limited to the tax liability, less the tentative alternative minimum tax, the elderly and disabled credit, and the child care and dependent credit. Any unused portion can be carried forward up to five years. G. RETIREMENT SAVINGS CONTRIBUTIONS CREDIT A non-refundable tax credit that may offset both regular and alternative minimum tax is available for contributions to either a traditional IRA or Roth IRA (other eligible retirement plans are beyond the scope of the CPA Examination). 1. Eligible Taxpayers a. At least 18 by the close of the tax year b. Not a full-time student c. Not a dependent R DeVry/Becker Educational Development Corp. All rights reserved.

41 Becker CPA Review Regulation 2 2. Allowable Credit Married/Joint Income Single Income Credit Rate Maximum Eligible Contribution (per Taxpayer) Maximum Credit $0 - $30,000 $0 - $15,000 50% $2,000 $1,000 $30,001 - $32,500 $15,001 - $16,250 20% $2,000 $400 $32,501 - $50,000 $16,251 - $25,000 10% $2,000 $200 Over $50,000 Over $25,000 0% $2, H. FOREIGN TAX CREDIT A taxpayer may claim a credit for foreign income taxes paid to a foreign country or United States possession. There is a limitation on the amount of the credit an individual can obtain. In lieu of this credit, an individual might find it better to deduct the taxes instead as an itemized deduction (which is not limited). 1. Allowable Credit There is no limit on foreign taxes used as a deduction; however, foreign tax credits are limited to the lesser of: a. Foreign taxes paid or b. Taxable income from all foreign operations Taxable income + Exemptions* x U.S. Tax* = Foreign tax credit limit *These amounts are based upon worldwide income. 2. Carryover of Excess (Disallowed) Credit Any disallowed foreign tax credit may be carried over as follows: a. Carry back one year b. Carry forward ten years I. GENERAL BUSINESS CREDIT 1. Included Credits The General Business Credit is a combination of: a. Investment credit, b. Work opportunity credit, c. Alcohol fuels credit, d. Increased research credit, e. Low-income housing credit, f. Qualified childcare expenditures, g. Welfare-to-work credit, h. Employer-provided childcare credit, and i. Other infrequent (on exam) credits. FOREIGN TAX CREDIT 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-41

42 Regulation 2 Becker CPA Review 2. Formula The General Business Credit is generally net income tax less the greater of: a. 25% of regular tax liability above $25,000, or b. "Tentative minimum tax" for the year. Tentative Tax Allowable Percentage Allowable Amount $0 - $25,000 x 100% = X Excess x 75% = X Maximum Credit Permitted TOTAL CHILD TAX CREDIT c. "Net Income Tax" is regular tax plus alternative minimum tax less nonrefundable tax credits (other than the alternative minimum tax credit). 3. Unused Credit Carryover Unused credits can be carried back one year and forward twenty years. J. WORK OPPORTUNITY CREDIT The work opportunity credit is available to employers who hire employees from a targeted group. This credit is part of the general business credit. 1. Credit a. 40% of first $6,000 of first year's wages. b. 40% of first $3,000 to certain summer youth. 2. Qualified Groups a. Handicapped b year-olds from poor families c. Vietnam veterans from economically disadvantaged areas d. Certain food stamp recipients K. WELFARE-TO-WORK CREDIT (REPEALED) L. "CHILD" TAX CREDIT Taxpayers may claim a $1,000 tax credit for each "Qualifying Child." 1. Qualifying Child The "CARES" rules apply, except that a child must be under the age of 17 (not the 19-year or 24-year age limits that "CARES" implies). R DeVry/Becker Educational Development Corp. All rights reserved.

43 Becker CPA Review Regulation 2 2. Phase-Out Higher-income taxpayers must reduce the allowable child credit by $50 for each $1,000 (or fraction thereof) by which modified adjusted gross income exceeds: a. $110,000 for a joint return; b. $75,000 for an unmarried individual; c. $55,000 for married individuals filing a separate return. 3. Possible Use as a Credit Low-income families with children may use the credit to offset their income taxes as well as Social Security taxes paid for the year. 4. Refundable Limit The Child Tax Credit is refundable to the extent of the lesser of: a. Excess child tax credit (over tax liability); b. Earned income less $12,050 (2008) times 15%. M. EARNED INCOME CREDIT (REFUNDABLE) EARNED INCOME 1. Eligibility To be eligible for the earned income credit, a taxpayer must: CREDIT a. Live in the U.S. (main home) for more than half the taxable year, b. Meet certain earned low-income thresholds, c. Not have more than a specified amount of disqualified income, d. Be over the age of 25 and less than 65 (spouses apply as well) if there are no qualifying children, and e. File a joint return with spouse with certain exceptions (which means that the spouse cannot be a dependent of another). 2. Earned Income Earned income is wages, salaries, tips, other employee compensation, and earnings from self-employment. It does not include pension and annuity income. An alternative minimum tax liability will not affect an individual's earned income credit. PASS KEY The most frequently tested issue involving the earned income credit is that it is a refundable credit DeVry/Becker Educational Development Corp. All rights reserved. R2-43

44 Regulation 2 Becker CPA Review 3. Qualifying Child A qualifying child is not a requirement in order to be eligible for the earned income credit. However, if the taxpayer has a qualifying child, the earned income credit percentage is higher. A qualifying child is a child who: a. Is the taxpayer's son, daughter, adopted child, grandchild, stepchild, foster child, brother, sister, stepbrother, stepsister or decedent of those individuals; b. Was (at the end of the year) either under age 19 or under age 24 and a full-time student or any age and permanently and totally disabled; c. Lived with the taxpayer in the taxpayer's main home in the U.S. for more than half of the taxable year; and d. Is the taxpayer's dependent (if the child is married). 4. Computing Basic Earned Income Credit For 2008, the maximum basic earned income credit is as follows: a. Single Taxpayer 7.65% of earned income, for a maximum credit of $438 (2008) for taxpayer with no children. b. Taxpayer with One Qualifying Child 34% of earned income, for a maximum credit of $2,917 (2008) for taxpayers with one qualifying child. c. Taxpayer with 2 or More Qualifying Children 40% of earned income, for a maximum credit of $4,824 (2008) for taxpayers with two or more qualifying children. 5. Disqualified Income An individual cannot claim the credit if the individual has "disqualified income" exceeding $2,950 (2008). Disqualified income includes taxable and nontaxable interest, dividends, net rental and royalty income, net capital gains income, and net passive income other than self-employment income. N. WITHHOLDING TAX (PAYCHECK CREDIT) All income taxes withheld from a taxpayer's paycheck are treated as a "credit" against the taxpayer's tax liability. When this credit exceeds the tax liability, a refund is generated to the taxpayer. O. EXCESS FICA (SOCIAL SECURITY TAX WITHHELD) Excess Social Security tax withheld is treated as additional tax payments withheld (Form 1040, Line 63). 1. Two or More Employers An employee who has had Social Security tax withheld in an amount greater than the maximum for a particular year may claim the excess as a credit against income tax (in the payment section), if that excess resulted from correct withholding by two or more employers. 2. One Employer If the excess was withheld by only one employer, the employer must refund the excess to the employee. R DeVry/Becker Educational Development Corp. All rights reserved.

45 Becker CPA Review Regulation 2 I. ALTERNATIVE MINIMUM TAX INDIVIDUAL TAXATION OTHER TAXES ALTERNATIVE MINIMUM TAX The alternative minimum tax (AMT) is a tax designed to ensure that taxpayers who take a large number of tax-preferenced deductions pay a minimum amount of tax on their income. The alternative minimum tax is the excess of the tentative AMT over the regular tax. A. CALCULATION The alternative minimum tax is computed by first subtracting the AMT exemption amount from "alternative minimum taxable income" (AMTI) to compute the "taxable excess" AMTI. Tax is then applied at 26% on the first $175,000 of taxable excess AMTI and at 28% on all taxable excess AMTI exceeding $175,000. The alternative minimum tax is mandatory if it exceeds the regular tax. Regular Taxable Income ± Adjustments + Preferences Alternative Minimum Taxable Income < Exemption > Alternative Minimum Tax Base x Tax Computation Tentative AMT Tax < Tax Credits > Tentative Minimum Tax < Regular Income Tax > Alternative Minimum Tax 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-45

46 Regulation 2 Becker CPA Review R DeVry/Becker Educational Development Corp. All rights reserved.

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48 Regulation 2 Becker CPA Review PASS KEY The CPA Examination has focused the majority of their questions concerning individual alternative minimum tax on the following four areas: The exemption formula Distinguishing "adjustments" from "preferences" The A.M.T. credit carryforward period (against regular tax) Credits available to reduce A.M.T. (not regular tax) B. EXEMPTION AMOUNTS For 2008, the exemption amount is $33,750 less 25% (AMTI $112,500) for single taxpayers, $45,000 less 25% (AMTI $150,000) for joint filers, and $22,500 less 25% (AMTI $75,000) for married individuals filing separately. In no case can the exemption be less than zero. "Joint" Exemption $45,000 AMTI <$150,000> Excess x 25% <Reduction> AMT Exemption Note: The AMT exemptions were increased in 2007, but fell back to the lower amounts for Pending legislation may increase the exemption amounts for 2008, but it was not certain as of the date of this printing. C. ADJUSTMENTS Adjustments that are "timing differences" (e.g., items 1-5) may increase or decrease AMTI. Examples of common adjustments include: 1. Passive activity losses 2. Accelerated depreciation (post-1986 purchase) 3. Net operating loss of the individual taxpayer 4. Installment income of a dealer 5. Contracts percentage completion vs. completed contract 6.* Tax "deductions" 7.* Interest deductions on some home "equity loans" 8.* Medical deductions (limited to excess over 10% AGI) 9.* Miscellaneous deductions not allowed 10.* Exemptions (personal) and standard deduction D. TAX PREFERENCE ITEMS (ALWAYS "ADD-BACKS") Examples of common tax preference items include: 1.* Private activity bond interest income 2.* Percentage depletion the excess over adjusted basis of property 3. Pre-1987 accelerated depreciation R DeVry/Becker Educational Development Corp. All rights reserved.

49 Becker CPA Review Regulation 2 E. CREDIT FOR PRIOR YEAR MINIMUM TAX (AMT CREDIT) 1. Offsets Regular Tax Certain allowable AMT paid in a taxable year may be carried over as a credit to subsequent taxable years (for , a percentage of certain net long-term amounts created greater than three years prior to the tax year may be refundable). It may only reduce regular tax, not future alternative minimum tax. 2. Time Period is Forever The carry-forward is forever. 3. Limitation on Credit AMT created from certain permanent differences (identified by an asterisk "*" in items C and D, above) cannot be carried forward as part of the "credit." Therefore, if AMT is paid because of these items, it is never recovered. F. ALTERNATIVE MINIMUM TAXABLE INCOME (AMTI) CALCULATION: 1. Regular taxable income (base for calculation) 2. Adjustments (adds or subtracts) a. Passive activity losses are added back, or recalculated b. Accelerated depreciation adjustment (1) On real property, this is the difference between regular tax depreciation and straight-line using a 40-year life for property placed in service after (2) On personal property, this is the difference between regular tax depreciation and 150% declining balance (with switch to straight line). (If a taxpayer elects 150% declining balance depreciation for regular tax purposes, there will be no AMT depreciation adjustment of 200%-decliningbalance eligible property.) (3) No adjustment is required for property expensed under Section 179. c. Net operating loss must be recomputed. d. Installment method may not be used by dealer for property sales. e. Contracts (Long-term) The difference between "percentage of completion" and completed contract method or any other method of accounting is an adjustment. f. Itemized deductions (always "adds" to regular taxable income) (1) Taxes reduced by taxable refunds (if refunds meet the tax benefit rule) are added back. (2) Interest (a) Mortgage interest not used to buy, build, or improve home is added back (b) Investment interest expense must be recalculated. (3) Medical expenses must exceed 10% of AGI rather than 7.5%. (4) Miscellaneous deductions subject to the 2% floor are not allowed (i.e., they are added back). (5) Exemptions personal and standard deductions may not be claimed DeVry/Becker Educational Development Corp. All rights reserved. R2-49

50 Regulation 2 Becker CPA Review g. Other AMT adjustments: (1) Incentive stock options (2) Recalculate gain or loss on sale of depreciable assets (3) Pollution control facilities (4) Mining exploration and development costs (5) Circulation expenses (6) Research and experimental expenditures (7) (Passive) tax shelter farm activities 3. Tax preference items (always "adds" to regular taxable income) a. Private activity bond tax-exempt interest b. Pre-1987 accelerated depreciation on real property and leased personal property (excess over straight-line for property placed in service before 1987) c. "Percentage depletion" deduction (excess over adjusted basis of property) G. AMT CREDITS The following tax credits are permitted as a credit to reduce the alternative minimum tax. 1. Foreign tax credit 2. Adoption credit 3. Child tax credit 4. Contributions to retirement plans credit 5. Earned income credit II. SOCIAL SECURITY / MEDICARE TAX 100% of social security tax (FICA and Medicare) is collected as an "other tax" and reported in the same section of the tax return as Alternative Minimum Tax. (Note that 50% of this amount is reported as an adjustment to arrive at AGI.) R DeVry/Becker Educational Development Corp. All rights reserved.

51 Becker CPA Review Regulation 2 INDIVIDUAL TAXATION OTHER ITEMS I. STATUTE OF LIMITATIONS A. ASSESSMENTS STATUTE OF LIMITATIONS The statute of limitations on assessments is statutory period during which the government can assess an additional tax. 1. General Three years from later of: a. Due date of return or b. Date return is filed (including amended returns) % Understatement of Gross Income (Good Faith Mistakes Do Not Affect This Determination) Six years from later of: a. Due date of return or b. Date return is filed. 3. Reopen Closed Years If taxpayer prevails in a finding allowing a deduction in an open tax year that was taken erroneously in a closed tax year, the IRS may disallow the deduction in the closed tax year. 4. Fraud and False Returns There is no statute of limitations for fraud or filing false returns. B. REFUNDS (FORM 1040X) The statute of limitations on refunds is statutory period during which the taxpayer can claim and receive a refund. 1. Refund Claim Later of: a. Three years later from the date the return was filed or the original due date of the return, or b. Two years from the time the tax was paid (if not when return was filed). 2. Bad Debts, Worthless Securities Seven years from later of: a. Due date of return or b. Date return is filed DeVry/Becker Educational Development Corp. All rights reserved. R2-51

52 Regulation 2 Becker CPA Review II. ESTIMATED TAXES ESTIMATED TAX AND INADEQUATE WITHHOLDING A. TAX PAYMENTS A taxpayer typically makes pre-payments of tax during the year. These payments reduce the amount shown as "total tax" on the tax return and result in the calculation of tax due to the IRS or refund due to the taxpayer at the bottom of Form Payments include: 1. Taxes withheld from paychecks (W-2 or 1099) 2. Estimated taxes paid (quarterly, with extension, or applied from a prior year) 3. Excess Social Security tax withheld (from two or more employers) B. ESTIMATED TAXES REQUIRED MINIMUM A taxpayer is required to make estimated quarterly tax payments if both of the following conditions are met: 1. $1,000 or More Tax Liability One condition is met if the amount of taxes owed (excess of tax liability over withholding) is expected to be $1,000 or more. 2. Inadequate Estimated Payments The other condition is met if the taxpayer's withholding is less than the lesser of: a. 90% of current year's tax, or b. 100% of last year's tax. (1) This applies even if an individual files a tax return with a zero tax liability in the prior year. (2) Exception: For the year 2008, use 110% of the 2007 year's tax liability when the taxpayers had adjusted gross incomes in excess of $150,000 ($75,000 for married filing separately). C. FAILURE TO PAY ESTIMATED TAXES PENALTY If the taxpayer does not make the proper quarterly estimated payment, a penalty may be assessed. There is no penalty due under any circumstances if the balance of tax due at filing is under $1,000. The Internal Revenue Service may waive the penalty if the failure to pay was due to casualty, disaster, illness, or death of the taxpayer. D. WITHHOLDING TAX TREATED AS ESTIMATED PAYMENTS If, toward the end of the taxable year, a taxpayer determines that estimated payments have been insufficient to avoid a penalty, a taxpayer can increase withholding from wages, and the withholdings will be considered to have been paid evenly during the year. Such action will usually reduce or eliminate any penalty. A new W-4 will have to be completed and submitted to the taxpayer's employer. R DeVry/Becker Educational Development Corp. All rights reserved.

53 Becker CPA Review Regulation 2 SIMULATION 2009 DeVry/Becker Educational Development Corp. All rights reserved. R2-53

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58 Regulation 2 Becker CPA Review R DeVry/Becker Educational Development Corp. All rights reserved.