FEDERAL INCOME TAX FEDERAL TAX LAW UPDATE

Transcription

1 FEDERAL INCOME TAX FEDERAL TAX LAW UPDATE COPYRIGHT CALIFORNIA TAX INSTITUTE (Our 32 nd Year) YORBA LINDA, CA REVISION SEPTEMBER 2017 CTEC 1022-CE-0011 KJPF4-U S Parts of this publication were provided from information furnished by the Internal Revenue Service. This publication is provided with the understanding that the publisher is not engaged in rendering accounting or legal service

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3 INTRODUCTION CALIFORNIA TAX INSTITUTE #1022 has been approved by the California Tax Education Council (CTEC) to offer CONTINUING EDUCATION that meets the annual requirement imposed by the State of California. A listing of additional requirements to renew tax preparer registration may be obtained by contacting CTEC at PO Box 2890, Sacramento, CA , by phone at , or on the Internet at CALIFORNIA TAX INSTITUTE #KJPF4 is approved by the IRS Return Preparer Office to offer CONTINUING EDUCATION. COURSE SCHEDULE FEDERAL TAX LAW UPDATE #1022-CE-0011 #KJPF4-U S This course is based on Federal tax law and reviews tax law changes for 2016 and currently approved 2017 Federal tax law changes. A. CORRESPONDENCE SCHOOL OPERATING DAYS AND HOURS Office Hours are 9:00 am to 5:30 pm - Monday through Friday (holidays excluded). Our help line is available most evenings until 5:30 pm at to answer questions regarding this course. B. EFFECTIVE DATE OF CATALOG January 1, 2017 to December 31, 2017 C. COURSE INFORMATION The QUALIFYING FEDERAL INCOME TAX correspondence course (#1022-QE-0004) is designed to help you develop the professional and proficiency skills required in the preparation of Federal income tax. This section of this correspondence course is comprised of five sections: Federal Tax Law Update Review Questions Review Answers Final Examination Course Evaluation The program has been prepared in accordance with the standards set forth in Circular 230 section CE credits have been granted based on a 50-minute hour. The course is self-taught by the student. Advance preparation is not required. The program level is basic Federal taxation. Competency of each student is determined by written examination that covers all sections of the course. The student should read FEDERAL TAX LAW UPDATE and then answer the review questions related to that section. The answers to the review questions are given with reference explanation. Complete the final examination at the end of the text. Mark all answers on the enclosed answer sheet. Complete the Evaluation form at the end of the answer sheet. D. REFUND POLICY Any student that is not satisfied with this course can receive a complete refund of tuition by returning all course materials in satisfactory condition within 30 days of receipt. E. ENROLLMENT REQUIREMENTS Students may enroll any school day as instruction is offered in continuous modules allowing student entry at any time. To be admitted, a student must be CTEC registered California tax preparer or IRS Registered Tax Return Preparer.

4 F. GRANTING OF CREDIT FOR PREVIOUS EDUCATION This course is an all-inclusive course comprised of Federal income tax instruction. G. ATTENDANCE POLICY The course is self-taught by the student. Competency of each student is determined by written examination that covers all sections of the course. The course shall be completed within 365 days from placing your order. H. GRADING SYSTEM The student should review text materials prior to taking the open book test. There are a total of 15 interactive review questions with a review of the correct answers and a final examination of 15 open book questions. Each question has only one answer. The California Tax Education Council and the Internal Revenue Service requires a passing score of 70%. The answer sheet also has a comment section for the student to evaluate this correspondence course. This section is required by the California Tax Education Council and the Internal Revenue Service and will help us to continue to improve this correspondence course. Upon receiving a passing score of 70%, you will receive your certificate of completion. An additional test will be available to any registrant that does not receive a minimum score of 70%.

5 TABLE OF CONTENTS Federal Tax Law Update 2016 Federal Income Tax Law Changes 1 Filing Information 7 Certain Children with Investment Income 8 When Are You Required To File Extension of Time to File 9 Accounting Periods and Methods Where Do You File Exemptions and Dependents Credits, Other Taxes, and Payments Phase Out of Exemption Income 10 Educator Expense 13 IRA (Individual Retirement Arrangements) Deduction 15 Spousal IRA Limit 16 Roth IRA 17 First Interactive Review Questions 20 First Interactive Review Answers Credits 21 Paid Preparer s Due Diligence Credit Checklist 25 Other Taxes 28 Additional Medicare Tax 29 Net Investment Income Tax 31 Earned Income Credit 33 Examples of Medical and Dental Expenses That Are Deductible 34 Examples of Medical and Dental Expenses That Are Not Deductible 36 Depreciation 43 Election to Expense Recovery Property (Section 179) 45 Residential Rental Property (27.5 years) 48 Nonresidential Property (31.5 years) Nonresidential Property (39 years) 49 Section 179 and Depreciation Limit for Automobiles 2016 Special Depreciation 50 Power of Attorney and Declaration of Representative Form Including Additional Powers 52 Excluding Powers Non-cash Charitable Contributions Form 8283 Passive Activity Loss Limitation Form Income That Is Not Passive Activity Affordable Care Act Tax Provisions 55 Health Insurance Marketplace Statement Form 1095-A 56 Premium Tax Credit (PTC) Form 8962 Taxpayer Bill of Rights 60 Second Interactive Review Questions Second Interactive Review Answers Final Exam 61..

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7 FEDERAL TAX LAW UPDATE 2016 Personal and Dependent Exemption Amount Filing Status Maximum AGI Personal Exemption Single $259,400 $4,050 Married Filing Separately $155,650 $4,050 Married Filing Jointly $311,300 $4,050 Head of Household $285,350 $4,050 Qualifying Widow(er) $311,300 $4,050 Taxpayers with income exceeding these amounts may receive a reduced personal exemption Personal and Dependent Exemption Amount Filing Status AGI Exceeding Personal Exemption Single $381,900 $-0- Married Filing Separately $216,900 $-0- Married Filing Jointly $433,800 $-0- Head of Household $407,850 $-0- Qualifying Widow(er) $433,800 $ Limitation on Itemized Deductions Filing Status Maximum AGI Single $259,400 Married Filing Separately $155,650 Married Filing Jointly $311,300 Head of Household $285,350 Qualifying Widow(er) $311,300 Itemized deductions for taxpayers with income exceeding these amounts may receive a reduced amount. The calculation for determining the reduced amount will not include medical expenses, investment interest, gambling losses, or casualty and theft losses. The deductions will be reduced by 3% of the excess adjusted gross income above the maximum AGI limitation. The reduction cannot exceed 80%. Medical and Dental Expenses Medical and dental expenses incurred in 2016 that exceed 7.5% of AGI are deductible on Schedule A if either the taxpayer or spouse is age 65 or over and will increase to 10% of AGI in 2017 for all taxpayers. The exclusion amount is 10% for those taxpayers under 65 in Schedule A Medical Long-Term Care Premiums Age of Person 1 Maximum Deduction on Schedule A or under $390 $ $730 $ $1,460 $1, $3,900 $4, or older $4,870 $5,110 Standard Deduction for Each Filing Status Single $6,300 $6,350 Married Filing Jointly $12,600 $12,700 Qualifying Widow(er) $12,600 $12,700 Head of Household $9,250 $9,350 Married Filing Separately $ 6,300 $6,350 and your spouse does not itemize deductions Earned Income Credit 2016 Taxpayers may be able to take the EIC if: - Three or more children lived with taxpayer and taxpayer earned less than $47,955 ($53,505 if married filing jointly).

8 - Two children lived with taxpayer and taxpayer earned less than $44,648 ($50,198 if married filing jointly). - One child lived with taxpayer and taxpayer earned less than $39,296 ($44,846 if married filing jointly). A child did not live with taxpayer and taxpayer earned less than $14,880 ($20,430 if married filing jointly). If the taxpayer does not have a qualifying child s/he must be at least 25 years old but under 65, cannot be a dependent of another person, cannot be a qualifying child of another person, and must have lived in the United States more than half of the year. The maximum investment income your client can have in 2016 is $3,400. Section 179 Expense Your client may choose to expense part of the cost of recovery property up to: Amount Tax Year $500, $510, There is a dollar limitation for the tax year. If your client places over $2,010,000 of Section 179 property in service, the amount greater than $2,010,000 is subtracted from the maximum Section 179 property of $500,000 for 2016 tax year ($2,030,000 for 2017 tax year). Special Depreciation The special depreciation is for MACRS property with a depreciation period of 20 years or less. The property must be purchased and placed in service in % special depreciation has been approved for In 2018 special depreciation will be 40% and will be 30% in Maximum Depreciation Deduction for Passenger Automobiles Year Placed In Service 1st 2nd 3rd 4th Year Year Year Year and after 2016 (with special depreciation) $11,160 $5,100 $3,050 $1, (without special depreciation) $3,160 $5,100 $3,050 $1,875 Maximum Depreciation Deduction for Trucks and Vans (6,000 pounds or less) Year Placed In Service 1st 2nd 3rd 4th Year Year Year Year and after 2016 (with special depreciation) $11,560 $5,700 $3,350 $2, (without special depreciation) $3,560 $5,700 $3,350 $2,075 Standard Mileage Deduction Cents per mile Classification Business $.54 $.535 Medical $.19 $.17 Moving $.19 $.17 Charity $.14 $.14 Adoption Credit The adoption credit in 2016 has increased to $13,460 of total costs. Form 8839 must be completed. For adoptions that are finalized in the United States the adoption order must be attached to the tax return. The Hague Adoption Certificate is required for adoptions finalized in a country that is a party to the Hague Convention. A state determination letter must be attached for special needs children. Special needs adoptions will receive the full $13,460 credit even if the costs are less. Returns claiming the adoption credit cannot be e-filed. The adoption credit is nonrefundable. If the credit is more than your client s tax, the excess is not refundable but the excess may be carried over to a future year. The adoption credit is completely phased out at a modified AGI of $241,920 or more. Adoption credit for 2017 is $13,570 and is completely phased out at a modified AGI of $243,540. 2

9 Alternative Minimum Tax Exemption for 2016 (Publication 505) Filing Status Exemption 2017 Single $53,900 $54,300 Married Filing Separately $41,900 $42,250 Married Filing Jointly $83,800 $84,500 Head of Household $53,900 $54,300 Qualifying Widow(er) $83,800 $84,500 Social Security Tax 2016 and 2017 Social Security will be withheld by employers at 6.2% up to a maximum wage limit of $118,500 in 2016 and increases to $127,200 in Self-Employment Tax 2016 and 2017 The self-employment tax will be calculated up to the social security wage limit of $118,500 in 2016 and Increases to $127,200 in The deduction for self-employment tax on Form 1040 is 50%. Additional Medicare Tax Form 8959 If the total of your client s Medicare wages, Railroad Retirement Tax Act compensation, or self-employment income was more than: $125,000 if Married Filing Separately $250,000 if Married Filing Jointly $200,000 if Qualifying Widow(er) with Dependent Child $200,000 if Single $200,000 if Head of Household Your client will be required to file Form The additional Medicare Tax is 0.9%. Employers are required to withhold Additional Medicare Tax for the calendar year on wages exceeding $200,000 regardless of the employee s filing status. EXAMPLE Medicare Wages $225,000 Single $200,000 Subtract $25,000 Multiply by 0.9% (.009) $225 Additional Medicare Tax to Line 60, Form Net Investment Income Tax (NIFT) Form 8960 Form 8960, Net Investment Income Tax is used to determine your client s amount of net investment income and pay any required tax on this income. If your client has net investment income and his or her 2016 Modified Adjusted Gross Income* was more than: $125,000 if Married Filing Separately $250,000 if Married Filing Jointly or Qualifying Widow(er) with Dependent Child $200,000 if Single or Head of Household Your client will be required to file Form 8960 and pay 3.8% of net investment income. Net investment income includes gross income from annuities, rent, dividends, royalties, and interest. Net gain or loss that is included in taxable income calculations for the disposition of property that is not used in a trade or business is included in net investment income. Excluded from net investment income includes unemployment compensation, wages, alimony, social security benefits, income subject to self-employment taxes, income from certain qualified retirement plan distributions, and wages. *Modified Adjusted Gross Income is the taxpayer s Adjusted Gross Income less income from a Controlled Foreign Corporation (CFC), or Passive Foreign Investment Company (PFIC), or Foreign Earned Income Exclusion, or amounts under section 911. The Net Investment Income Tax does not apply to nonresident alien individuals. If your client is a U.S. citizen and is married to a nonresident alien, he or she will be required to file as Married Filing Separately to determine their MAGI, net investment income, and whether your client is subject to the net investment income tax. 3

10 EXAMPLE Based on Form 8960 George Low is married and his 2016 MAGI was $265,000. Line 1 Taxable Interest $5,500 Line 2 Ordinary Dividends $4,500 Line 4c Rental Real Estate Profit $4,400 Line 8 Net Investment Income $14,400 Line 12 Net Investment Income $14,400 Line 13 Modified Adjusted Gross Income $265,000 Line 14 Filing Status Amount - $250,000 Line 15 Subtract Line 14 from Line 13 $15,000 Compare Line 12 to Line 15 and enter the smaller number Multiply $14,400 by 3.8% (.038) = $547 Additional Net Investment Income Tax to Line 62 of Form 1040 Qualified Principal Residence Indebtedness (QPRI) Due to the housing crisis, Congress had approved up to $2,000,000 of cancelled debt, by a financial institution, could be excluded from the taxpayer s income from the sale of your primary home after 2006 and before The Protecting Americans from Tax Hike Act of 2015 (PATH) extended the relief through Home equity loans did not qualify except for loan amounts canceled that were used to make home improvements. Qualified principal residence indebtedness is debt secured by your client s principal residence that was borrowed to buy, build, or substantially improve his/her principal residence. This indebtedness cannot exceed the cost of your client s principal residence plus improvements. The maximum amount of QPRI your client can exclude as QPRI is $2,000,000 or $1,000,000 if married filing separately in EXAMPLE Your client s principal residence is secured by a debt of $1,000,000 of which $800,000 is qualified principal residence indebtedness and $200,000 is nonqualified indebtedness. The residence is sold for $700,000 and $300,000 of debt is cancelled. Only $100,000 of canceled debt from the sale can be excluded from federal income tax. $300,000 cancelled indebtedness - $200,000 nonqualified indebtedness $100,000 excludable Traditional IRA Income Limits 2016 Your client may be able to take a traditional IRA contribution if s/he were covered by a retirement plan and his/her modified adjusted gross income is less than $71,000 ($118,000 if s/he is married filing jointly or a qualifying widow(er) and $10,000 if s/he is married filing a separate return). One-Rollover-Per-Year Limitation In 2016, regardless of the number of IRAs a taxpayer has, your client can make only one rollover from an IRA to another (or the same) in any 1-year period. Trustee to trustee transfers between IRAs is not considered a rollover. There are no limits on the number of IRA conversions to a ROTH IRA. Extended Tax Credits and Deductions for the 2016 tax year: Mortgage Insurance Premium Deduction. The election to deduct state and local sales taxes instead of state and local income taxes is permanent. Tax-free IRA transfers directly to charities of up to $100,000 if the taxpayer is 70 1/2 or older. Home Energy Improvements are extended for The lifetime limit continues to be $500. Increased limits for charitable contributions of real estate for conservation purposes is permanently 50% of adjusted gross income. The increased contribution limits for qualified ranchers and farmers is 100% of adjusted gross income. Tuition and Related Fees is extended for Educator Expenses has been permanently extended. The Child Tax Credit of $1,000 per eligible child has been permanently extended. The Earned Income Tax Credit (ETIC) has been permanently extended 4

11 Employer Provided Transit and Parking Benefits are $255 per month in American Opportunity Credit has been made permanent. Student Loan Interest Deduction Employer Provided Education Assistance up to $5,250 Exclusion for cancellation of qualified principal residence mortgage debt. Research Credit for businesses has been permanently extended. Same-Sex Marriage Same-sex legally married couples are recognized as married when filing their 2016 Federal income tax return. The same-sex legally married couple will generally be required to file as married filing jointly or married filing separately. The ruling does not apply to registered domestic partners, civil unions, or other relationships recognized by state law. The ruling applies to the following for federal tax purposes: - filing status - personal and dependent exemptions - standard deduction - employee benefits - contributions to an IRA - child tax credit - earned income credit Same-sex couples are also allowed to amend the previously filed Federal tax returns that are still open under the statute of limitations, namely, 2013, 2014 and Health Care Coverage Individual Responsibility The tax preparer is required to ask his or her client the following question regarding health care coverage: - Did the client and his/her family have health care coverage throughout 2016? or, - Did the client claim an exemption from the health care coverage requirement for some or all of 2016? or, - Did the client make a payment if s/he did not have coverage or an exemption from the health care coverage requirement for all 12 months of 2016? Premium Tax Credit Premium Tax Credit Form 8962 is only completed for taxpayers who have purchased health insurance coverage in a qualified health plan through a Health Insurance Marketplace. The Health Insurance Marketplace includes a State Marketplace or through The Premium Tax Credit provides financial assistance to the taxpayer to pay the insurance premiums by: - reducing the amount of income tax that they may owe - giving the taxpayer an income tax refund, or - increasing the taxpayer s income tax refund The Premium Tax Credit is a tax credit for taxpayers that enroll or whose family members enroll in a qualified health insurance plan purchased through a Health Insurance Marketplace. Form 8962 is used to determine the amount of the taxpayer s credit and compare this credit with any Advanced Premium Tax Credit (APTC) previously received. The Advanced Premium Tax Credit was determined by the Marketplace estimating the amount of Premium Tax Credit that the taxpayer will be able to claim on his/her tax return. This advanced premium tax credit is used to pay for part or all of the taxpayer s premiums for the taxpayer or individuals in the taxpayer s family. Paid tax preparers must meet due diligence requirements in determining the taxpayer s eligibility to claim Earned Income Credit (EIC), Child Tax Credit (CTC), American Opportunity Tax Credit (AOTC), and the amount of the credit. Form 8867 is to be submitted with the tax return. The penalty for failure to meet the due diligence requirement for returns and claims for refund filed in 2017 is $510 per credit per return. The penalty is now indexed for inflation. The name of the tax preparer that determined the taxpayer s eligibility, and his/her PTIN must be entered on the tax form even if the tax preparer is not the signing preparer. Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return For decedents dying in 2016, Form 706 must be filed by the executor for the estate of 5

12 every U.S. citizen or resident: a. Whose gross estate, plus adjusted taxable gifts and specific exemption, is more than $5,450,000; or, b. Whose executor wants to make the election to permit the decedent s surviving spouse to use the decedent s unused exclusion amount, regardless of the size of the decedent s gross estate. The maximum estate tax rate for 2016 remains 40%. Executors of taxable estates are required to provide heirs the basis of inherited assets for Form 706 beginning August 1,

13 WHO MUST FILE FILING INFORMATION 2016 Your client's marital status, filing status, age, and gross income determine whether s/he is required to file a federal tax return as follows for 2016: MARITAL STATUS FILING STATUS AGE GROSS INCOME Single (including Single under 65 $10,350 divorced and legally separated) 65 or over $11,900 Married with a Head of House- under 65 $13,350 dependent child hold and living apart 65 or over $14,900 from your spouse during last 6 months of 2016 Married and living Married, Joint under 65 $20,700 with your spouse return (both) at end of 2016 spouses) (or on the date your spouse died) 65 or over $21,950 (one spouse) 65 or over $23,200 (both spouses) Married, Sep- any age $4,050 arate return Widowed before Qualifying Widow(er) under 65 $16, and not with dependent remarried in 2016 child 65 or over $17,900 A person born on January 1, 1952 is considered to be 65 in OTHER FILING REQUIREMENTS Your client must file a return if any one of the following conditions applied for 2016: Your client owes special taxes that include: - Social Security and Medicare tax or RRTA tax on tips your client did not report to his/her employer. - Alternative minimum tax (AMT). - Additional tax on a qualified plan including an individual retirement arrangement (IRA), or other tax favored plan. - Recapture tax of first-time homebuyer credit. - Your client received advanced payments of the premium tax credit. - Your client had net earnings from self-employment of at least $ Your client had wages of $ or more from a church or qualified church-controlled organization that is exempt from employer Social Security and Medicare taxes. - Recapture taxes. - Your client received health savings account (HSA), Archer MSA, or Medicare Advantage MSA distributions. Single dependents under 65 and not blind that can be claimed as a dependent on another person's return must file a tax return if any of the following apply: - Your client s unearned income was more than $1, Your client s earned income was more than $6,300. 7

14 - Your client s gross income was more than the larger of - $1,050, or - Your client s earned income (up to $5,950) plus $350. Single dependents 65 or over or blind that can be claimed as a dependent on another person's return must file a tax return if any of the following apply: - Your client s unearned income was more than $2,600 ($4,150 if 65 or older and blind). - Your client s earned income was more than $7,850 ($9,400 if 65 or older and blind). - Your client s gross income was more than the larger of: - $2,600 ($4,150 if 65 or older and blind), or - Your client s earned income (up to $5,950) plus $1,900 ($3,450 if 65 or older and blind). Married dependents under 65 and not blind that can be claimed as a dependent on another person s return must file a tax return if any of the following apply: - Your client s unearned income was more than $1, Your client s earned income was more than $6, Your client s gross income was at least $5 and your spouse files a separate return and itemizes deductions. - Your client s gross income was more than the larger of: - $1,050, or - Your client s earned income (up to $5,950) plus $350. Married dependents 65 or over or blind that can be claimed as a dependent on another person's return must file a tax return if any of the following apply: - Your client s unearned income was more than $2,300 ($3,550 if 65 or older and blind). - Your client s earned income was more than $7,550 ($8,800 if 65 or older and blind). - Your client s gross income was at least $5 and your spouse files a separate return and itemizes deductions. - Your client s gross income was more than the larger of: - $2,300 ($3,550 if 65 or older and blind), or - Your client s earned income (up to $5,950) plus $1,600 ($2,850 if 65 or older and blind). CERTAIN CHILDREN UNDER AGE 19 OR FULL-TIME STUDENTS Your client may elect to report the income of his/her child, legally adopted child, or stepchild that is under the age of 19 or a full-time student under age 24 on their return if all of the following apply: - the child does not file a joint return for the child had income only from interest and dividends (including capital gain distributions) and - the child's gross income was less than $10,500; and - the child had no Federal Income Tax withheld from his/her income or did not make estimated tax payments. A child born on January 1, 1993 is considered to be age 24 at the end of A child born on January 1, 1998 is considered to be age 19 at the end of WHEN IS YOUR CLIENT REQUIRED TO FILE The 2016 federal income tax return is due by April 18, 2017 if your client uses the calendar year. If your client uses a fiscal year (a year ending on the last day of any month except December, or a week year), your client s tax return is due by the 15 th day of the 4 th month after the close of his/her fiscal year. The tax return is considered filed on time if it is mailed in an envelope that is properly addressed, has the required postage, and is postmarked by the due date. If your client is a nonresident alien that earns wages subject to United States income tax you are to use Form 1040NR or Form 1040NR-EZ. The 2016 federal income tax return is due by April 18, 2017 if your client uses the calendar year. If your client uses a fiscal year (a year ending on the last day of any month except December, or a week year), your client s tax return is due by the 15 th day of the 4 th month after the close of his/her fiscal year. The tax return is considered filed on time if it is mailed in an envelope that is properly addressed, has the required postage, and is postmarked by the due date. 8

15 EXTENSION OF TIME TO FILE A taxpayer may be able to get an extension of time to file their tax return if they are outside the United States or serving in a combat zone (Arabian peninsula area, Kosovo area, or Afghanistan area). A taxpayer that cannot file by the due date of April 18, 2017 may be able to get an automatic six month s extension until October 16, 2017 by filing Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. Individuals outside the United States are allowed an automatic two month extension without filing Form The taxpayer should determine if they will owe taxes and include the payment with Form Payment should be made with a check or money order payable to the United States Treasury and the taxpayer should note their daytime phone number, Social Security number, and 2016 Form 4868 on his/her check or money order. Form 4868 may also be filed electronically (E-File) if you have the proper software and any payment required may be made with a credit card. ACCOUNTING PERIODS AND METHODS Most individual tax returns cover a calendar year the 12 months from January 1 through December 31. If your client uses a fiscal year (a year ending on the last day of any month except December, or a week year), your client s tax return is due by the 15 th day of the 4 th month after the close of his or her fiscal year. The accounting method used by your client is the way s/he accounts for their income and expenses. Most taxpayers use the cash method or the accrual method. A taxpayer chooses a method when they file their first income tax return. If the taxpayer wants to change accounting methods, s/he generally must get approval from the IRS. Under the cash method the taxpayer reports all items of income in the year actually or constructively received. A person constructively receives income when it is credited to their account or set apart in any way to make it available. If another person cancels or pays a taxpayer s debts (but not as a gift or loan), the taxpayer has constructively received the amount and generally must include the amount in their gross income for the year. Under the accrual method the taxpayer generally reports income when they earn it rather than when it is received. Expenses are generally deducted when they are incurred rather than when paid. WHERE DO YOU FILE Tax return preparers that file 10 or more tax returns are required to e-file. Individual taxpayers that file their own forms have the option to e-file or mail their tax returns. Taxpayers may obtain information from Publication 17 or Form 1040, 1040A, or 1040EZ instructions guiding them where to mail their 2016 return based upon the state they live in, if the taxpayer is enclosing or is not enclosing payment, and a separate zip code for Form 1040, Form 1040A, or Form 1040EZ. The zip code is based on which form is being filed. EXEMPTIONS AND DEPENDENTS PERSONAL one exemption $4,050 $ SPOUSE one exemption $4,050 $ The taxpayer s spouse is never considered as the taxpayer s dependent. A married couple that files jointly can claim two exemptions. If the taxpayer s spouse died during the year, the taxpayer can claim two exemptions if s/he files married filing jointly. If the taxpayer files a separate return, s/he may claim an exemption for his/her spouse if the spouse did not have any gross income. If the taxpayer s spouse died during the year and the taxpayer remarried, s/he is not able to claim an exemption for the deceased spouse. If the taxpayer has no gross income and the taxpayer s spouse died during the year and the taxpayer remarries in the same year, a tax return can be prepared for the deceased spouse, filing separately, and claim an exemption for the living spouse. The new spouse may file separately and also claim an exemption for his/her new spouse. If the taxpayer provides all of the support for his/her spouse during the tax year and then gets a final decree of divorce or separate maintenance, the taxpayer may not claim the former spouse s exemption. 9

16 PHASE OUT OF EXEMPTIONS In 2016, exemptions may be reduced or eliminated based on the taxpayer s adjusted gross income Personal and Dependent Exemption Amount Filing Status Maximum AGI Personal Exemption Single $259,400 $4,050 Married Filing Separately $155,650 $4,050 Married Filing Jointly $311,300 $4,050 Head of Household $285,350 $4,050 Qualifying Widow(er) $311,300 $4,050 Taxpayers with income exceeding these amounts may receive a reduced personal exemption. EXEMPTION PHASEOUT DEDUCTION FOR EXEMPTION WORKSHEET FORM 1040 LINE 42 EXAMPLE In this example, John and Maria Avila file married filing jointly and claim two dependents. Their 2016 AGI (adjusted gross income) is $384,000 (line 38 of Form 1040). 1. Is the amount on Form 1040, line 38 (AGI), more than the amount shown on line 4 following your client s filing status? If no, multiply $4,050 by the number of exemptions claimed on Form 1040, line 6d. If yes, continue 2. Multiply $4,050 by the total number of exemptions claimed on Form 1040, line 6d. $16, Enter the amount from Form 1040, line 38 (AGI). $385, Enter the amount shown for your client s filing status. Single $259,400 Married Filing Jointly or $311,300 $311,300 Qualifying Widow(er) Married Filing Separately $155,650 Head of Household $285, Subtract line 4 from line 3. $73,700 If the result is greater than $122,500 ($61,250 if Married filing Separately), enter $-0- on Form 1040, line Divide line 5 by $2,500 ($1,250 if Married Filing Separately). 30 If the result is not a whole number, increase it to the next higher whole number. For example, would be increased to Multiply line 6 by 2% (.02) and enter the result as a decimal X.02 = Multiply line 2 by line 7. $9, Deduction for exemptions. Subtract line 8 from line 2. $6,480 Enter the result here and on Form 1040, line 42. In this example the taxpayer s exemption decreased from $16,200 to $6,480. INCOME EXAMPLES OF INCOME TAXPAYERS DO NOT REPORT (NOT ALL INCLUSIVE) - welfare benefits. - workers' compensation benefits, insurance damages, etc, for injury or sickness. - child support payments. - gifts, money, or other property you inherited or that was willed to you. - Black Lung benefits. - meals and lodging provided by employer. - mileage allowance. - scholarship and fellowship grants. - cash rebates. - Veteran s benefits paid under any law, regulation, or administrative practice managed by the Department of Veterans Affairs (VA). The following amounts received by the veteran or their families are not taxable: -grants for homes designed for wheelchair living. -interest on insurance dividends left on deposit with the VA. -bonus paid by a political subdivision or state because of service in a combat zone. -payments received under the compensated work therapy program. 10

17 -death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, grants for motor vehicles for veterans that lost their sight or the use of their limbs. -benefits under a dependent-care assistance program. -education, training, and subsistence allowances. -disability compensation and pension payments for disabilities paid to either veterans or their families. - dividends on Veterans' life insurance. - life insurance proceeds received because of a person's death. - interest on certain state and municipal bonds. - amounts your client received from insurance because s/he lost the use of his/her home due to fire or other casualty to the extent the amounts were more than the cost of his/her normal expense while living in his/her home. - cancellation of certain student loans. - value of accident or health plan coverage provided by employer. - contributions by taxpayer s employer to provide long-term care services (unless through a flexible spending or similar arrangement). - contributions by taxpayer s employer to provide Health Flexible Spending Arrangement (health FSA) that qualifies as an accident health plan are not taxable to the employee. Reimbursements of medical expenses from the FSA are usually not taxable to the employee. FSAs are subject to a $2,500 salary reduction limit on contributions. - reimbursements received for reimbursements of medical care expenses from the taxpayer s employer provided Health Reimbursement Arrangement (HRA) that qualifies as an accident or health plan are not taxable to the employee. - contributions by your employer to the taxpayer s Archer MSA This amount is generally not included in the taxpayer s income but is reported in box 12 of your client s W-2 and coded R. - contributions by taxpayer s employer for a Health Savings Account (HAS) are not included in the taxpayer s income. Distributions that are not used for medical expenses are taxable. - contributions made by family members or the employee to the employee s HAS are deductible on the employee s tax return. - contributions by taxpayer s employer for disability premiums. - dependent child care assistance from employer for nursery or baby-sitting. - employee purchase discounts. - qualified adoption expenses paid by your employer in connection with the taxpayer s adoption of an eligible child. - the value of a turkey, ham, or other item of nominal value given to taxpayer at Christmas or other holidays. - your client can exclude up to $5,250 of qualified educational assistance provided by his/her employer. For additional information see Publication 970, Tax Benefits For Education. - the cost of up to $50,000 of group-term life insurance coverage provided by your client s employer (or former employer). Taxpayer must claim as income the cost of insurance their employer paid for group term life insurance exceeding $50,000. The taxpayer may reduce this amount by any amount they paid toward the purchase of the insurance. Group-term life insurance is also known as term life insurance. The insurance normally provides a death benefit to employees, does not discriminate, and is provided by the employer to a group of employees. - qualified retirement planning services provided to taxpayer (and taxpayer s spouse). - qualified transportation fringe benefit can be excluded up to certain limits. Exclusion for commuter highway vehicle transportation and transit pass cannot be more than $255 a month. - qualified parking fringe benefit exclusion cannot exceed $255 a month. - reimbursed employee business expenses. - qualified bicycle commuting fringe benefit exclusion cannot exceed $20 a month. - taxpayer s employer s contribution to a qualified retirement plan. - income received from activities related to Indian fishing rights if the taxpayer is a member of a qualified Indian tribe that secured the rights by treaty, executive order, or an Act of Congress as of March 17, interest on frozen deposits. - interest on qualified savings bonds taxpayer redeems if the taxpayer paid qualified educational expenses in the same year. - if debt is cancelled under a bankruptcy proceeding under title 11 of the U.S. Code, the amount cancelled is not Income. - qualified moving expenses paid by taxpayer s employer. 11

18 EXAMPLES OF INCOME TAXPAYERS MUST REPORT (NOT ALL INCLUSIVE) - wages, including salaries, fringe benefits, bonuses. - commissions, fees, and tips. - dividends Dividends are distributions of money, stock, or other property that corporations pay to stockholders. They also include dividends your client receives from a partnership, an S corporation, or an estate or trust. If total dividends exceed $1,500, Schedule B must be completed. Dividends include: - ordinary dividends - these are paid out of earnings and profits and are ordinary income. - nontaxable distributions -these distributions are nontaxable until your client gets back all of his/her cost. Do not report as dividends the following: - mutual insurance company dividends that reduced the premiums your client paid - amounts paid on deposits or accounts from which your client could withdraw money (report as interest on line 8a Form 1040) - interest Examples of interest you must report: - accounts with banks, credit unions, and savings and loan associations. - building and loan accounts. - notes, loans, and mortgages. - tax refund interest. - bonds and debentures. - US treasury bills. - US savings bonds. -bond deposits, bonus, notes U.S. savings bonds. mortgages on which your client receives payments. certain arbitrage bonds. accounts with savings and loans association, mutual savings bond, credit unions, in certain instances part of federal Social Security benefits and tier 1 railroad retirement benefits may be taxable. - partnership income and S corporation income reported on Schedule K-1. - tier 2 and supplemental annuities under the railroad retirement act. - original issue discount. - unemployment compensation. - distributions from an Individual Retirement Arrangement (IRA), including SEPs. - amounts received in place of wages from accident and health plans (including sick pay and disability pensions) if your client's employer paid for the policy. - bartering income your client received. - business expense reimbursements your client received that are more than s/he spent for these expenses. - alimony, separate maintenance, or support payments received. - refunds of state and local taxes if your client deducted the taxes in an earlier year and got a tax benefit. If your client received a refund of state taxes in 2016, he/ she may have to report all or part of this amount as income if s/he itemized deduction and claimed state taxes as a deduction. Do not report the state tax refund as income if it was for a tax paid in a year for which your client did not itemize deductions on Schedule A. - the value of free tours received from a travel agency for organizing a group of tourists. - benefits received under a credit card disability or unemployment insurance plan that exceed the amount of premiums paid during the tax year. - Pulitzer, Nobel, and other prizes in recognition of past accomplishments (in religious, charitable, scientific, artistic, educational, literary, or civic fields) are claimed as income unless your client meets all of the following requirements: - your client was selected without any action on his/her part to enter the contest or proceeding. - your client is not required to perform substantial future services as a condition to receive the prize or award, and the prize or award is transferred directly to a governmental unit or tax exempt charitable organization as designated by your client. 12

19 - life insurance proceeds that are more than the premiums paid. - profits from businesses and professions. - your client's share of profits from partnerships and S corporations. - profits from farming. - pensions, annuities, and endowments. - lump-sum distributions. - gains from the sale or exchange of: real estate silver securities gems coins other property gold - gains from the sale of your client's personal residence that are greater than the excludable amount. - rents and royalties. - your client's share of estate or trust income, including accumulation distributions from trusts. - prizes and awards. - contests. - raffles. - lottery. - gambling winnings. - earned income from sources outside the United States (foreign government, an international organization, a foreign embassy, or any foreign employer). - director's fees. - fees received as an executor or administrator of an estate. - stock options if you receive a nonstatutory option to buy or sell stock or other property for your services, you usually will have income when you receive the option, when you exercise the option, or when you sell or otherwise depose of the option. - if you receive property for your services, you must include its fair market value in your income. - severance pay (pay received by employees who lose their job). - employer-provided vehicles personal use of the car is usually a taxable noncash fringe benefit. - Social Security and Medicare taxes paid by employer. - stock appreciation rights granted by your employer when exercised. - bribes received. - campaign contributions diverted to a candidate for his/her personal use. - employment agency fees that you pay and later your employer reimburses you, the amount is included in your Income. - rewards for providing information. - kickbacks. - if you steal property, you must report its fair market value in your income in the year you steal it unless in the same year, you return it to its rightful owner. - embezzled or other illegal income. - strike and lockout benefits including both cash and the fair market value of other property. - if you find and keep property that does not belong to you that has been lost or abandoned, it is taxable to you at its fair market value in the first year it is your undisputed possession. - if a debt is cancelled or forgiven, other than as a gift or bequest, a taxpayer generally must include the cancelled amount in his/her gross income for tax purposes. - a recovery of an amount previously deducted on a taxpayer s return (bad debt). - hobby income (expenses cannot exceed hobby income reported). - back pay awards received in a settlement or judgment for back pay. Included are payments received for damages, unpaid health insurance premiums, and unpaid life insurance premiums. - military retirement pay received based on age or length of service. EDUCATOR EXPENSES 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. An eligible educator in 2016 may deduct up to $250 of qualified expenses paid in A taxpayer and spouse that are eligible educators may each deduct up to $250 of qualified expenses. Qualified expenses include books, supplies, equipment (including computer equipment, software, and service), and other materials used in the classroom. Qualified expenses must be reduced by the following amount: - Excludable U.S. Series E and I saving bond interest from Form

20 - Nontaxable qualified state tuition program earnings. - Nontaxable earnings from Cloverdale education savings accounts. - Any reimbursement received for qualified expenses that were not reported to the taxpayer in Box 1 of Form W-2. To deduct additional educator expenses in 2016, the taxpayer must itemize his/her deductions. The Protecting Americans from Tax Hikes Act (PATH) permanently extended the educator expenses deduction. In 2016 the limit may be increased for inflation. Professional development courses qualify for the deduction in CERTAIN BUSINESS EXPENSES OF RESERVISTS, PERFORMING ARTISTS, AND FEE-BASIS GOVERNMENT OFFICIALS Include the following deductions - Certain business expenses of National Guard and reserve members who traveled more than 100 miles from home to perform services as a National Guard or reserve member. -Performing-arts-related expenses as a qualified performing artist. -Business expenses of fee-basis state or local government officials. HEALTH SAVINGS ACCOUNT (HSA) Your client may be able to take this deduction if he or she made contributions to his or her Health Savings Account in Employer contributions, rollovers, and qualified HAS funding contributions from an IRA do not qualify for this adjustment to income. DEDUCTIBLE PART OF SELF-EMPLOYMENT TAX If your client was self-employed and owes self-employment tax that was calculated on Schedule SE, he or she may deduct 50% of the amount owed. MOVING EXPENSE Form 3903 is used if your client moved to a new principal work place within the United States or its possessions and your client qualifies to deduct his/her moving expense. Your client must have moved his/her residence because of a change in the location of his/her job. Your client must meet the distance and time test. Your client may move to a new location up to one year after he or she obtains employment. Moving expenses may not be allowed if your client delayed his or her move to the new location for more than one year unless he or she has a valid reason for the delay. Your client's new work place must be at least 50 miles farther from his/her old residence than the distance from his or her old residence to his or her old work place. SELF-EMPLOYED HEALTH INSURANCE DEDUCTION Your client may deduct up to 100% of the amount paid for health insurance on behalf of himself/herself, spouse, and dependents that were under age 27 at the end of 2016 if s/he was self-employed and had a net profit for the 2016 year. Your client s child is not required to be the taxpayer s dependent. Self-employed health insurance deduction may not exceed your client's net profit and any other earned income from the business under which the insurance plan is established. However, your client may not take the deduction if s/he were eligible to participate in any subsidized health plan maintained by his/her employer or his/her spouse's employer. PENALTY ON EARLY WITHDRAWAL OF SAVINGS Your client will receive Form 1099-INT showing the amount of any penalty s/he was charged for withdrawing funds from a time savings deposit prior to its maturity. The penalty amount is deductible as an adjustment to income. ALIMONY PAID Your client can deduct periodic payments of alimony or separate maintenance made under a court decree. Do not deduct lump-sum cash or property settlements, voluntary payments not made under a court order or a written separation agreement, or amounts specified as child support. Enter recipient's Social Security number on Form 1040, line 31b. Failure to enter this information may result in a $50 penalty to your client and disallowance of the deduction. 14

21 IRA (INDIVIDUAL RETIREMENT ARRANGEMENTS) DEDUCTION Your client can deduct contributions made to his/her traditional IRA if the taxpayer is not covered by another retirement plan. A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA. To contribute to a traditional IRA you (or, if you file a joint return, your spouse) received taxable compensation during the year, and you were not age 70 1/2 by the end of the year. The most that can be contributed to the taxpayer s traditional IRA is the smaller of the following amounts: - $5,500 ($6,500 if the taxpayer is 50 or older) or - Taxpayer s taxable compensation for the year. Prior to figuring your client's traditional IRA deduction you must know if 2016 contributions were deducted on 2015 income tax forms or if 2017 contributions made by the tax return due date, April 18, 2017, will be deducted on 2016 Form Modified AGI is the AGI less the taxpayer s IRA deduction and add the following: - Student loan interest deduction - Tuition and fees deduction - Foreign earned income exclusion - Foreign housing exclusion or deduction - Exclusion of qualified bond interest shown on Form Exclusion of Interest From Series EE U.S. Savings Bonds issued after Exclusion of employer-paid adoption expenses shown on Form Qualified Adoption Expenses. Tax Year 2016 If the taxpayer is covered by a company-sponsored retirement plan restrictions are placed on the IRA deductions based on Modified Adjusted Gross Income. Modified AGI Filing Status Maximum IRA Deduction $118,000 Joint/Qualifying $-0- Widow(er) $71,000 Single/Head of Household $-0- $61,000 or less Single/Head of $5,500 Household $6,500 if age 50 or older $98,000 or less Joint/Qualifying $5,500 Widow(er) $6,500 if age 50 or older >$61,000 - <$71,000 Single/Head of Partial Household >$98,000 - <$118,000 Joint/Qualifying Partial Widow(er) $ <$10,000 Married filing Partial Separately $10,000 Married filing $-0- Separately < less than > more than 15

22 Tax Year 2016 If the taxpayer is not covered by a company-sponsored retirement plan restrictions are placed on the IRA deductions based on Modified Adjusted Gross Income. Modified AGI Filing Status Maximum IRA Deduction Any amount Single/Head of $5,500 Household, $6,500 if age 50 or older Qualifying widow(er) Any amount Married filing jointly or $5,500 Separately with a spouse $6,500 if age 50 or over who is not covered by a plan at work $184,000 Married filing jointly or $5,500 Separately with a spouse $6,500 if age 50 or over who is covered by a plan at work More than $184,000 Partial but less than $194,000 $194,000 or more No deduction <$10,000 Married filing separately Partial with a spouse who is covered by a plan at work $10,000 or more No deduction < less than > more than SPOUSAL IRA LIMIT 2016 If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts: - $5,500 ($6,500 if the taxpayer is 50 or older), or - The total compensation includible in the gross income of both spouses for the year reduced by the following three amounts: - The IRA deduction for the year of the spouse with the greater compensation. - Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation. - Any designated nondeductible contribution for the year made on behalf of the spouse with the greater compensation. ADDITIONAL TAX ON IRAS AND OTHER QUALIFIED RETIREMENT_PLANS TRADITIONAL IRA PENALTIES The tax advantage of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if your client does not follow the rules. Prohibited Transactions Resulting In Penalties or Additional Taxes include the following: - Borrowing money from it. - Selling property to it. - Receiving unreasonable compensation for managing it. - Using it as security for a loan. - Buying property for personal use (present or future) with IRA funds. - Investing in collectibles. These include: - art works - stamps - rugs - certain other tangible property - antiques - alcoholic beverages 16

23 - metals - coins* - gems * Investing in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department is approved. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion. Making excess contributions If the excess contributions for the year are not withdrawn by the due date of your client s tax return (including extensions), your client is subject to a 6% excise tax. Taking early distributions 59½ Rule Early distributions (before 59½ years of age) of taxable amounts from your client s traditional IRA are subject to a 10% additional tax. Exceptions to the additional tax are as follows: - The taxpayer has unreimbursed medical expenses that are more than 10% of his/her adjusted gross income. (7.5% if 65 or over). - The distributions are not more than the cost of the taxpayer s medical insurance. - The taxpayer is disabled. - The taxpayer is the beneficiary of a deceased IRA owner. - The taxpayer is receiving distributions in the form of an annuity. - The distributions are not more than the taxpayer s qualified higher educational expenses. The education must be for the taxpayer, spouse, or the children or grandchildren of the taxpayer or taxpayer s spouse. -The taxpayer uses the distribution to buy, build, or rebuild a first home. -The distribution is due to an IRS levy of the qualified plan. -The taxpayer is a reservist called to active duty for an indefinite period of time or at least 180 days. Allowing excess amounts to accumulate (failing to take required distributions). Your client may have to pay a 50% excise tax for the year on the amount not distributed as required. Generally, if your client or his/her beneficiary engages in a prohibited transaction in connection with your client s traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected. ROTH IRA 2016 A Roth IRA is an individual retirement plan that is subject to the rules that apply to a traditional IRA. Unlike a traditional IRA, a taxpayer cannot deduct contributions to a ROTH IRA. But, qualified distributions are tax free. Contributions can be made to a taxpayer s Roth IRA after s/he becomes 70 ½ and a taxpayer can leave amounts in their Roth IRA as long as they live. Contributions to only a Roth IRA for 2016 are limited to the smaller of the following amounts: - $5,500 ($6,500 if the taxpayer is 50 or older), or - The taxpayer s taxable compensation for the year. These amounts to a Roth IRA are not deductible on your client s income tax return. Generally, you can contribute to a Roth IRA if you have taxable compensation and your modified AGI is less than: $194,000 Married filing jointly or qualifying widow(er) $132,000 Single, head of household, or married filing separately and you did not live with your spouse at any time during 2016 $10,000 Married filing separately and you lived with your spouse at any time during 2016 If a taxpayer contributes to a Roth IRA and a Traditional IRA, his/her contribution limit for the Roth IRA is the same as the limit to the Roth IRA but then reduced by the contributions to the traditional IRA for the year. 17

24 COVERDELL EDUCATION SAVINGS ACCOUNT (ESA) A Coverdell ESA is a trust or custodial account created only for the purpose of paying the qualified education expenses of the designated beneficiary of the account. The expenses can be used for qualified higher education, qualified elementary, or qualified secondary education. Contributions to a Coverdell ESA are not tax deductible, but amounts in the account grows tax free until distributed. The contributions must be made before the beneficiary is 18, unless the beneficiary is a special needs beneficiary and the balance in the account must be withdrawn within 30 days after the earlier of the beneficiary becoming age 30, unless the beneficiary is a special needs beneficiary, or the beneficiary s death. The maximum yearly contribution cannot be more than $2,000 and must be paid in cash. SIMPLE IRA A SIMPLE IRA plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. All contributions under a SIMPLE IRA plan must be made to SIMPLE IRAs. A SIMPLE IRA plan is a written agreement with you and your employer that allows you to: - Reduce your compensation (salary) by a certain percentage each pay period, and - Have your employer contribute the salary reductions to a SIMPLE IRA on your behalf. These contributions are called salary reduction contributions. Early distributions (before 59½ years of age) of funds from your client s SIMPLE IRA retirement account made within two years of beginning participation in the SIMPLE are subject to a 25% rather than a 10% early distribution penalty for a Traditional IRA. STUDENT LOAN INTEREST DEDUCTION Your client may be able to claim a deduction of up to $2,500 for interest paid on a qualified student loan. The deduction may be taken if each of the following applies: 1. Your client paid interest in 2016 on a qualified student loan. 2. Your client's filing status cannot be married filing separately. 3. Your client's modified adjusted gross income must be less than: $80,000 if single, head of household, or qualifying widow(er). $160,000 if married filing jointly. 4. Your client may not be claimed as a dependent on someone else s 2015 tax return. Student loan interest is the interest the taxpayer pays for himself/herself, spouse, or dependent who was enrolled at least one half time in a program that leads to a degree, certificate, or educational credential at a qualified educational institution. The student loan must have been taken out only for the payment of qualified education and cannot be taken from a relative or made under a qualified employer plan. The student loan may only be used to pay tuition, fees, room and board, and necessary expenses. There is a qualification limit on the amount that can be paid for room and board. See Publication 17, Qualified Education Expenses for additional information. TUITION AND FEES DEDUCTION Your client may be able to claim a deduction of up to $4,000 for tuition and fees paid to an eligible educational institution. Your client may take this deduction if each of the following applies by completing Form 8917: 1. Taxpayer paid qualified tuition and fees in 2016 for taxpayer, taxpayer s spouse, or taxpayer s dependents. 2. Filing status cannot be married filing separately. 3. Modified adjusted gross income (AGI) is not more than $80,000 if single, head of household, or qualifying widow(er); $160,000 if married filing jointly. 4. Taxpayer cannot be claimed as a dependent on someone s 2016 tax return. 5. Taxpayer cannot claim an education credit for the same student. Eligible educational institutions include: most colleges, universities, and certain vocational schools. Qualified tuition and fees do not include any of the following: - Amounts paid for room and board, insurance, medical expenses, transportation, or other similar personal, living, or family expenses. - Amounts paid for course related books, supplies, equipment, and non-academic activities. - Amounts paid for any course involving sports, games, or hobbies, unless the course is part of the student s degree program. 18

25 Your client may be able to claim a deduction for his/her jury pay given to his/her employer because their employer continued to pay their salary while s/he served on a jury. DOMESTIC PRODUCTION ACTIVITIES DEDUCTION Your client may be able to deduct up to 9% of his/her qualified production activities income for the following activities: - Construction of real property performed in the United States. - Engineering or architectural services performed in the United States for construction of real property in the United States. - Any lease, rental, license, sale, exchange, or other disposition of: - Tangible personal property, computer software, and sound recording that your client manufactured, produced, grew, or extracted in whole or part within the United States. - Any qualified film that your client produced. - Electricity, natural gas, or potable water that your client produced in the United States. The deduction does not apply to income from: - The sale of food and beverage your client prepared at a retail establishment; - Property your client leased, licensed, or rented for use by any related person; or - The transmission or distribution of electricity, natural gas, or potable water. - The lease, rental, license, sale, exchange, or other disposition of land. 19

26 FIRST INTERACTIVE REVIEW QUESTIONS and ANSWERS Please minimize this PDF book and return to your course. Take your First Review quiz at this time. 20

27 CREDITS FOREIGN TAX CREDIT Attach Form 1116 if your client paid income tax to a foreign country. A taxpayer can choose to take income taxes paid or accrued during the year to a foreign country or U.S. possession as a credit against his/her income tax. A taxpayer s foreign tax credit cannot be more than his/her U.S. tax liability, multiplied by a fraction that is determined when completing Form CREDIT FOR CHILD AND DEPENDENT CARE EXPENSES Your client may be able to take a credit for payments made for child and disabled dependent care while s/he and his/her spouse worked or looked for work. The credit is allowed if your client maintained a household that included a child under age 13 or your client's dependent or spouse who could not care for himself/herself. Credit for Child and Dependent Care Expense Form 2441 is used to take a tax credit for amounts your client paid to someone to care for his or her child or other qualifying person so that your client could work or look for work during The credit is based on a percentage of the amount your client paid during the year. The credit is based on a percentage of the amount your client paid during the year and can be as much as 35% of his/her qualified expenses. The most your client may take as a credit is $1,050, if he or she paid for the care of one qualifying person, or $2,100 if your client paid for the care of two or more qualifying persons. Form 1040A filers will file Form 2441 to claim child and dependent care expenses. Form 1040A filers will Form 2441 to claim child and dependent care expenses. QUALIFYING PERSON A qualifying person is any one of the following persons: - Any person under age 13 whom your client can claim as a dependent. If your client s dependent turned 13 during the tax year, your client may claim Child and Dependent Care Expenses while the dependent was under 13 during the year. - Your client's disabled spouse who is mentally or physically unable to care for himself/herself. - Any disabled person who is mentally or physically unable to care for himself/herself and whom your client could claim as a dependent except that he or she had income of $4,050 or more in Your client must have shared the same home with any person s/he claims as a qualifying person for more than six months during the tax year. CHILDREN OF DIVORCED OR SEPARATED PARENTS If your client was divorced, legally separated, or lived apart from his/her spouse during the last 6 months of 2016, s/he may be able to claim the credit even if the child is not his/her dependent. Your client must meet each of the following requirements: - Your client had custody of the child for the longer period of the year. - The child received over half of his/her support from one or both of the parents. - The child was in the custody of one or both parents over half of the year. - The child was under age 13, or was physically or mentally unable to care for himself/herself. - The child is not your client's dependent because your client waived the right to claim the child's exemption for 2016, or - Your client's divorce decree states that the other parent can claim the child as an exemption. TO CLAIM THE CREDIT Your client must file form 1040 or 1040A and meet the following requirements to claim the credit: - The care must be for one or more qualifying persons who are identified on the form the taxpayer uses to claim the credit. - Taxpayer (and taxpayer s spouse if married) must keep up a home that taxpayer lives in with the qualifying person or persons. - Taxpayer (and taxpayer s spouse if taxpayer married) must have earned income during the year. (Exceptions may apply for student-spouse or spouse unable to care for self). 21

28 - Taxpayer must pay child and dependent care expenses so taxpayer (and taxpayer s spouse if married) can work or look for work. - Taxpayer must make payments for child and dependent care to someone taxpayer (or taxpayer s spouse) cannot claim as a dependent. If taxpayer make payments to his/her child, he or she cannot be taxpayer s dependent and must be age 19 or older by the end of the year. - Taxpayer s filing status must be single, head of household, qualifying widow(er) with dependent child or married filing jointly. Taxpayer must file a joint return if taxpayer is married. - Taxpayer must identify the care provider on taxpayer s tax return. If taxpayer excludes dependent care benefits provided by taxpayer s employer, the amount taxpayer excludes must be less than the dollar limit for qualifying expenses (generally $3,000 if one qualifying person was cared for or $6,000 if two or more qualifying persons were cared for). QUALIFIED EXPENSE Qualified expenses include the following: - Service of a cook, maid, and babysitter. - Service of a housekeeper, governess, and cleaning person. - Services for the qualifying person's well being. - Dependent care center. Qualified expenses do not include the following: - Food. - Schooling for a child in the first grade or above. - Overnight camp expense is not considered necessary for the taxpayer to work. Education Credit Recapture If your client receives tax-free educational assistance for, or a refund of, an expense you used to figure his/her education credits on the 2015 tax return, the taxpayer may have to repay all or part of the credit. You will need to refigure the education credit as if the assistance or refund was received in Subtract the amount of the refigured credit from the amount of the credit claimed. The result is the amount of money your client must repay. You will add this repayment (recapture) to your client s tax liability for the year in which your client received the assistance or refund. Your client s original 2015 tax return does not change. American Opportunity Credit is reported on this line. RETIREMENT SAVINGS CONTRIBUTION CREDIT (SAVER S CREDIT) Your client may take this credit if the taxpayer or taxpayer s spouse, if filing jointly made: - Contributions to a traditional or Roth IRA - Elective deferrals to a 401(k) or 503(b) - Voluntary contribution to a qualified retirement plan or to a 501 (c) (18) Plan - Contributions to a SEP, SIMPLE, or governmental Voluntary employee contributions to a qualified retirement plan - Contributions to a 501 (18)(D) plan The credit is not available if: - Your clients MAGI is more than $30,500 ($45,750 if head of household; $61,000 if married filing jointly). - Client is under age 18 on December 31 of tax year. - Client claimed as a dependent on someone s 2016 tax return. - Client was a student during any 5 months of The credit is figured on Form See Form 8880 instructions. RESIDENTIAL ENERGY CREDITS Form 5695 is to be completed to claim either of the following credits. Nonbusiness energy property credit for improvements to the taxpayer s main home located in the United States in 2016 include: - Any insulation material or system primarily designed to reduce heat gain or loss in the home - Exterior windows (including skylights) 22

29 - Exterior doors - A metal roof or asphalt roof with pigmented coatings or cooling granules primarily designed to reduce the heat gain in the taxpayer s home. - Certain electric heat pump water heaters, electric heat pumps, central air conditioners, and natural gas, propane, or oil water heaters. - A qualified furnace or hot water boiler that uses natural gas, propane, or oil. - A stove that burns biomass fuel to heat the taxpayer s home or to heat water for use in the home. - An advanced main air circulating fan used in a natural gas, propane, or oil furnace. The nonbusiness energy property credit is up to 10% of the cost for energy efficiency improvements installed in 2016 and any residential energy property costs in The lifetime maximum for energy improvement costs after 2005 is $500. The maximum for windows is $200, advanced main air circulating fan is $50, natural gas, propane, or oil furnace or hot water boiler is $150, and $300 for any energy efficient building property. Residential Energy Efficient Property Credit - Qualified solar electric property for use in your home located in the United States. - Qualified solar water heating property for use in your home in the United States. - Qualified fuel cell property installed on or in connection with your main home located in the United States. - Qualified small wind energy property for use with taxpayer s home located in the United States. - Qualified geothermal heat pump properly installed on or in connection with taxpayer s home located in the United States. The credit is 30% of the taxpayer s costs for the items listed above except there is a $500 limit for each one-half kilowatt of capacity for qualified fuel cell property. The basis of the taxpayer s home must be reduced by the amount of the energy credit taken. MORTGAGE INTEREST CREDIT FORM 8396 The mortgage interest credit is intended to help lower-income individuals own a home. A taxpayer will qualify for this credit if s/he was issued a mortgage credit certificate from his/her state or government. If the taxpayer s allowable credit is reduced because of the limit based upon their tax, s/he can carry forward the unused portion of the credit to the next 3 years or until used, whichever comes first. ADOPTION CREDIT The adoption credit in 2016 has increased to $13,460 of total costs. Form 8839 must be completed. For adoptions that are finalized in the United States the adoption order must be attached to the tax return. The Hague Adoption Certificate is required for adoptions finalized in a country that is a party to the Hague Convention. A state determination letter must be attached for special needs children. Special needs adoptions will receive the full $13,460 credit even if the costs are less. Returns claiming the adoption credit cannot be e-filed. The adoption credit is nonrefundable. If the credit is more than your client s tax, the excess is not refundable but the excess may be carried over to a future year. The adoption credit is completely phased out at a modified AGI of $243,540 or more. CHILD TAX CREDIT Your client may be entitled to a child credit for each of his/her qualifying children. A qualifying child is: - under age 17 at the end of a citizen, national, or resident of the United States see Publication 519, U.S. Tax Guide for Aliens. - someone your client can claim as a dependent on his/her tax return. - your client's son or daughter, stepson or stepdaughter, grandchild, eligible foster child, sister, brother, stepsister, stepbrother, or their descendant. - the child did not provide more than one half of their own support. - the child lived with your client for more than one half of the year. there are exceptions to this rule - temporary absences for school, vacation, military service, detention in a juvenile facility, medical care are among the exceptions For 2016, the maximum credit your client can claim for each qualifying child is $1,000. The Child Tax Credit has been permanently extended by the Protecting Americans from Tax Hike Act of 2015 (PATH). The credit must be reduced if your client's tax liability is less than the credit. 23

30 The threshold amount (modified adjusted gross income (AGI)*) for each filing status is as follows for 2016: Filing Status Amount Single, Head of Household, $75,000 Qualifying Widow(er) $75,000 Married Filing Jointly $110,000 Married Filing Separately $55,000 * modified AGI is the taxpayer s adjusted gross income increased by foreign earned income exclusion, exclusion of income from Puerto Rico, foreign earned income and any amount excluded from income for residents of American Samoa. The taxpayer is required to file Form 1040 or Form 1040A to claim the child tax credit and must owe tax prior to deducting credits. To claim a refund that exceeds tax owed the taxpayer must complete Schedule 8812, Additional Child Tax Credit. See Schedule If your client does not have a social security number or an Individual Tax Identification number (ITIN) by the due date of the return (including extensions), your client may not claim the Child Tax Credit on the original or an amended return, even if your client receives his or her social security number (or ITIN) at a later date. If your client s child does not have a social security number or an Individual Tax Identification number (ITIN) or Adoption Taxpayer Identification Number (ATIN by the due date of the return (including extensions), your client may not claim the Child Tax Credit for that child on the original or an amended return for the child, even if your client receives the child s social security number (or PTIN) or Adoption Taxpayer Identification Number (ATIN) at a later date. EDUCATION CREDITS (AMERICAN OPPORTUNITY AND LIFETIME LEARNING) The education credits cannot be taken if: - Your client or client s spouse, if filing jointly, are claimed as a dependent on someone else s 2016 tax return. - Your client's modified adjusted gross income is $90,000 or more ($180,000 or more in the case of a married filing jointly return in 2016). - Your client files married filing separately. - Your client or spouse was a nonresident alien for any part of 2016 unless their filing status is married filing jointly. - Your client is taking a deduction for tuition and fees on Form 1040, line 34, for the same student. Form 8863, Part II, Nonrefundable Education Credits, line 19 is entered on Form 1040, line 49. The student must be the taxpayer, spouse, or a dependent that the taxpayer claims on his or her tax return and was a student enrolled or attending an eligible educational institution. An eligible education institution includes college, university, postsecondary educational institution, and vocational school. Qualified educational expenses are amounts paid directly to the educational institution for tuition, student activity fees, and athletic fees. AMERICAN OPPORTUNITY CREDIT FORM 8863 American Opportunity Credit Expenses that your client paid in 2016 for qualified tuition and related expenses may be eligible for a credit of up to $2,500. This credit may be claimed for four taxable years for each eligible student. To be eligible the student must be your client or client's dependent. The educational institution must be any accredited college, university, vocational school, or other accredited postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. The eligible student must meet each of the following requirements: - Is enrolled in a program that leads to a degree, certificate, or other recognized educational credential - Is taking at least one-half of the normal full-time workload - Is free of any felony conviction for possessing or distributing a controlled substance The amount of the American Opportunity Credit is 100% of the first $2,000 plus 25% of the next $2,000 that your client pays for each eligible student's tuition and related expenses. The maximum credit for each eligible student of $2,500 may be reduced based upon your client's modified adjusted gross income. The Protecting Americans from Tax Hikes Act of 2015 (PATH) has permanently extended this credit. If your client does not have a social security number or an Individual Tax Identification number (ITIN) by the due date 24

31 of the return (including extensions), your client may not claim the American Opportunity Credit on the original or an amended return, even if your client receive his or her social security number (or ITIN) at a later date. If your client s child does not have a social security number or an Individual Tax Identification number (ITIN) or Adoption Taxpayer Identification Number (ATIN) or by the due date of the return (including extensions), your client may not claim the Child Tax Credit for that child on the original or an amended return for the child, even if your client receives the child s social security number (or PTIN or ATIN)) at a later date. Lifetime Learning Credit Your client may be able to claim a lifetime learning credit of up to $2,000 for the total qualified tuition and related expenses paid during the tax year for all students who are enrolled in eligible educational institutions. - The Lifetime Learning Credit is not based upon the student's workload. It is allowed for one or more courses. - The Lifetime Learning Credit is not limited to students in the first two years of postsecondary education. - Expenses for graduate-level degree work are eligible. - There is no limit on the number of years for which the Lifetime Learning Credit can be claimed for each student. - The amount your client can claim as a Lifetime Learning Credit does not vary based on the number of students for whom your client pays qualified expenses. - The amount of the Lifetime Learning Credit is 20% of the first $10,000 paid for qualified tuition and related expenses for all students in the family. The Lifetime Learning Credit is also figured on Form Your client s MAGI must be less than $65,000 ($130,000 if married filing jointly). - Your client can elect for any tax year only one of the credits or a tax-free withdrawal from an Education IRA. Form 8863, Part III, Student and Educational Institution Information and Part I, Refundable American Opportunity Credit are completed and line 8 of Part I is completed and line 8 of the form is entered on Form 1040, line 68. Form 8867, Paid Preparer s Due Diligence Credit Checklist Paid tax preparers must meet due diligence requirements in determining the taxpayer s eligibility to claim Earned Income Credit (EIC), Child Tax Credit (CTC), Additional Child Tax Credit 9ACTC), American Opportunity Tax Credit (AOTC), and the amount of the credit. Form 8867 is to be submitted with the tax return. The penalty for failure to meet the due diligence requirement for returns and claims for refund filed in 2017 is $510 per credit per return. The penalty is now indexed for inflation. The name of the tax preparer that determined the taxpayer s eligibility, and his/her PTIN must be entered on the tax form even if the tax preparer is not the signing preparer. A tax preparer that prepares the EIN, CTC, ACTC, and the AOTC and fails to meet the due diligence requirements for all of these credits, could be subject to a $1,530 penalty. The tax preparer is required to know the law for each credit claimed on the tax return or claim for refund and use this knowledge to ask your clients the correct question to insure that the taxpayer qualifies for the specific credit. The tax preparer is required to keep a copy of Form 8867 for three years from the latter of the due date of the tax return or the date the return was filed, the date the tax return was given to the taxpayer for his or her signature, or if you did not sign the tax return as the preparer, the date you submitted the tax return to the person signing the tax return as the preparer. These records may be kept electronically or on paper. In Rev. Procedure IRS describes guidance for maintaining records in electronic storage and hardcopy. The form must be attached to any tax return that claims Earned Income Credit, American Opportunity Tax Credit, and Child Tax Credit/Additional Child Tax Credit. Failure to include the form will result in a tax preparer penalty. When the IRS audits a tax return that was prepared by a paid tax preparer and finds that the paid tax preparer was not following federal tax laws, the IRS may audit a sampling of other tax returns prepared by the paid tax preparer. If there are tax related issues with the audits, the IRS may assess penalties to the paid tax preparer. 25

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34 OTHER TAXES SELF EMPLOYMENT TAX (2016) If your client had self-employment income in 2016, and earned less than $118,500 in wages from which Social Security tax or RRTA tax was withheld, s/he may have to pay self-employment tax. Schedule SE must be completed. UNREPORTED SOCIAL SECURITY AND MEDICARE TAX If your client received tips of $20 or more in any month and your client did not report the full amount to his/her employer, s/he must pay the Social Security or railroad retirement tax on the unreported tips. To figure the amount of Social Security tax on unreported income, complete Form Your client may be charged a penalty equal to 50% of the Social Security and Medicare tax due on tips s/he received and did not report to his/her employer. Form 8919 If your client was an employee who received wages from an employer who did not withhold Social Security and Medicare tax from his/her wages, use Form 8919 to report your client s share of the unreported taxes. HOUSEHOLD EMPLOYMENT TAXES Attach Schedule H if any of the following conditions apply to your client: - Client paid any one household employee cash wages of $1,900 or more in Client withheld Federal income tax during 2016 at the request of any household employee - Client paid total cash wages of $1,000 or more in any calendar quarter of 2016 to household employees A household employee is a person that you can control what will be done and how it will be performed and includes any person that does household work in or around your client s home such as babysitters, housekeepers, yard workers, nannies, health aides, and other domestic workers. A household employee is not a person who was under eighteen at any time in 2016 or was a student. HEALTH CARE: INDIVIDUAL RESPONSIBILITY Your client must either: - Have qualifying health care coverage for every month of 2016 for himself or herself, his or her spouse if filing jointly, and anyone that he or she can claim as a dependent. Having medical insurance for one day of a month qualifies as having medical insurance for the complete month. A child that was born or adopted during 2016 is considered to have insurance from January 1 of the year until birth or adoption. A spouse or dependent who died during the year will not have health insurance after death but will be considered as having insurance all year if the spouse or dependent had health insurance while alive. - Qualify for an exemption from the requirement to have health care coverage. - Make a shared responsibility payment with the tax return and enter the amount on the tax return. Your client, his or her spouse, and his or her dependents that are enrolled in minimum essential health care coverage covered by the Marketplace will receive this information on Form 1095-A, Health Insurance Marketplace Statement. Individuals enrolled in health insurance coverage by their employer will receive this information on Form 1095-B, Health Coverage or on Form 1095-C, Employer Provided Health Insurance Offer and Coverage. Individuals enrolled in in a government sponsored health program receive the information on Form 1095-B Health Coverage. Minimal essential coverage includes: - Most types of health insurance provided by your client s employer. - Certain types of health care coverage your client buys directly from an insurance company. - Many types of government sponsored health care coverage including Medicare, most Medicaid coverage, and most health care coverage provided to veterans and active duty service members. - Health care coverage your client buys through the Marketplace. Form 8965 is provided to determine if your client meets any exemptions or determining his or her shared responsibility. FIRST-TIME HOMEBUYER CREDIT REPAYMENT Form 5405 is used to report first-time homebuyer credit that your client is required to repay if s/he disposed of the home within 36 months of purchase, or stopped using the home as his/her main home within 36 months of purchase, or bought the home in

35 Additional Medicare Tax Form 8959 The following discussion is an overview to introduce you to Additional Medicare Tax. Additional information is available in the IRS instructions for Form If the total of your client s Medicare wages, Railroad Retirement Tax Act compensation, or self-employment income was more than: $125,000 if Married Filing Separately $250,000 if Married Filing Jointly $200,000 if Qualifying Widow(er) with Dependent Child $200,000 if Single $200,000 if Head of Household Your client will be required to file Form The additional Medicare Tax is 0.9%. Employers are required to withhold Additional Medicare Tax for the calendar year on wages exceeding $200,000 regardless of the employee s filing status. EXAMPLE Jasmine and Barry Nguyen file Married Filing Jointly and are required to complete Form 8959, Additional Medicare Tax, because Barry s 2016 Medicare wages exceeded $200,000. Jasmine was a homemaker. Barry s Medicare Wages $300,000 Married Filing Jointly - $250,000 Subtract $50,000 Multiply $50,000 by 0.9% (.009) = $450 Additional Medicare Tax to Line 64 of Form Additional Medicare Tax may be reported on Form 1040NR, line 60, Form 1040-SS, line 5 of Part 1, or Form 1040-PR, line 5 of Part 1. Form 8959 may not be used with Form 1040A, Form 104EZ, or Form 1040NR-EZ. EXAMPLE Patrick and Maureen Morton file Married Filing Jointly and are both employed. Maureen s 2016 Medicare wages were $165,000 and Patrick s 2016 Medicare wages were $140,000. They are not required to file Form 8959 because they each earned less than the threshold amounts for Additional Medicare Tax. See Form 8950 Additional Medicare Tax on next page. 29

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37 NET INVESTMENT INCOME TAX (NIIT) FORM 8960 The following discussion is an overview to introduce you to Net Investment Income Tax. Additional information is available in the IRS instructions for Form Form 8960, Net Investment Income Tax is used to determine your client s amount of net investment income and pay any required tax on this income. If your client has net investment income and his or her 2016 Modified Adjusted Gross Income* was more than: $125,000 if Married Filing Separately $250,000 if Married Filing Jointly or Qualifying Widow(er) with Dependent Child $200,000 if Single or Head of Household Your client will be required to file Form 8960 and pay 3.8% of net investment income. Net investment income includes gross income from annuities, rent, dividends, royalties, and interest. Net gain or loss that is included in taxable income calculations for the disposition of property that is not used in a trade or business is included in net investment income. Excluded from net investment income includes unemployment compensation, wages, alimony, social security benefits, income subject to self-employment taxes, income from certain qualified retirement plan distributions, and wages. *Modified Adjusted Gross Income (MAGI) is the taxpayer s Adjusted Gross Income less income from a Controlled Foreign Corporation (CFC), or Passive Foreign Investment Company (PFIC), or Foreign Earned Income Exclusion, or amounts under section 911. The Net Investment Income Tax does not apply to nonresident alien individuals. If your client is a U.S. citizen and is married to a nonresident alien, he or she will be required to file as Married Filing Separately to determine their MAGI, net investment income, and whether your client is subject to the net investment income tax. EXAMPLE Based on Form 8960 Heidi Austin is single and her 2016 MAGI was $300,000. Line 1 Taxable Interest $5,700 Line 2 Ordinary Dividends $6,500 Line 4c Rental Real Estate Profit $4,400 Line 8 Net Investment Income $16,400 Line 12 Net Investment Income $16,400 Line 13 Modified Adjusted Gross Income $300,000 Line 14 Filing Status Amount $200,000 Line 15 Subtract Line 14 from Line 13 $100,000 Compare Line 12 to Line 15 and enter the smaller number Multiply $16,400 by 3.8% (.038) = $623 Additional Net Investment Income Tax to Line 62 of Form 1040 See Form 8960 Net Investment Income Tax Individuals, Estates, and Trusts on next page. 31

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39 PAYMENTS EARNED INCOME CREDIT (EIC) The Earned Income Credit is available to your client if s/he has earned income. Earned income includes: - wages, salaries and tips - net earnings from self-employment - gross income received as a statutory employee The amount earned must be less than: $47,955 if your client has three or more qualifying children ($53,505 if married filing jointly). $44,648 if your client has two qualifying children ($50,198 if married filing jointly). $39,296 with one qualifying child ($44,846 if married filing jointly). $14,880 with no qualifying child and taxpayer is at least 25 years old and less than 65 ($20,430 if married filing jointly). - A qualifying child for the Earned Income Credit is a child who is the taxpayer s. son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of them (grandchild, niece, or nephew). - Child must be under the age of 19 at the end of 2016 and younger than taxpayer (or spouse if filing jointly), or a full time student under the age of 24, or - Child must be permanently and totally disabled at any time during the tax year, regardless of age. - Child must live with taxpayer in the United States for more than ½ of Temporary absences by taxpayer or qualifying child for school, vacation, business, medical care, military service, or detention in a juvenile facility count as time the child lived with the taxpayer. - Child may not file a joint return for 2016 or is filing a joint return for 2016 only to claim a refund of withheld income tax or estimated tax paid. - Client must have a valid Social Security number. - Client must be a U.S. citizen or resident alien for the whole year. - Client's investment income cannot be more than $3,400, unless filing Form Investment income is taxable, interest and dividends, tax-exempt interest, and capital gain net income. - Client does not file Form 2555 or Form 2555-EZ - Client's filing status is one of the following: - Married filing joint return. - Qualifying widow(er) with dependent child. - Head of household. - Single. If your client does not have a social security number by the due date of the return (including extensions), your client may not claim the Earned Income Credit on the original or an amended return, even if your client receive his or her social security number at a later date. If your client s child does not have a social security number by the due date of the return (including extensions), your client may not claim the Earned Income Credit on the original or an amended return for the child, even if your client receives the child s social security number at a later date. The Earned Income Credit (EIC) is one area of the tax return that IRS has had issues where substantial numbers of taxpayers are reporting incorrect information. Tax preparers are to use due diligence when obtaining taxpayer s information for preparing their EIC qualifying form. Form 8867, Paid Preparer s Earned Income Credit Checklist, must be attached to the tax return. The paid tax preparer may receive a penalty if the checklist is not attached to the return. NONTAXABLE COMBAT PAY ELECTION A taxpayer that was a member of the U.S. Armed Forces who served in a combat zone can elect to include income that was excluded from his/her taxable income in the earned income calculation for EIC. If the taxpayer is filing a joint return and both spouses received non taxable combat pay, each can make their individual election. ADDITIONAL CHILD TAX CREDIT The additional child tax credit may give your client a refund even if s/he does not owe any tax. Schedule 8812 is used to figure this credit. Your client cannot claim Additional Child Tax Credit if he or she files Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. If your client does not have a social security number by the due date of the return (including extensions), your client may not claim the Additional Child Tax Credit on the original or an amended return, even if your client receive his or her social security number at a later date. If your 33

40 client s child does not have a social security number by the due date of the return (including extensions), your client may not claim the Additional Child Tax Credit on the original or an amended return for the child, even if your client receives the child s social security number at a later date. EXAMPLE BASED ON 2016 SOCIAL SECURITY TAX George Mordarsky worked for two employers in 2016 and he had Social Security withholdings of $9, The worksheet is completed as follows: WORKSHEET 1. Add all Social Security tax withheld (but not more than $7, for each employer) Enter total here $9, Enter any uncollected Social Security tax on tips included in the total on Form 1040, line Add lines 1 and 2 above $9, Social Security tax limit $7, Subtract line 4 from line 3 and enter the total here and on Form 1040, line 65 $2, NOTE: If any one employer withheld more than $7, of Social Security tax, your client should ask the employer to refund the excess to the taxpayer. You cannot take credit for it on his/her tax return. File Form 843 if your client s employer refuses to refund the overpayment. ITEMIZED DEDUCTIONS SCHEDULE A PURPOSE OF SCHEDULE A taxpayer that itemizes can deduct part of his/her medical and dental expenses, amounts paid for certain taxes, interest, contributions, casualty and theft losses, and other miscellaneous expenses. Itemized deductions for taxpayers with adjusted gross income exceeding $155,650 may be reduced. See Schedule A at the end of this chapter. LINES 1-4 MEDICAL AND DENTAL EXPENSE You may deduct for your client, if either the taxpayer or spouse is age 65 or over, only that part of his/her medical and dental expenses that are more than 7.5% of his/her adjusted gross income on Form The exclusion amount is 10% for those taxpayers under 65. In tax year 2017 you may deduct for your client only that part of his/her medical and dental expenses that are more than 10% of his/her adjusted gross income on Form 1040 regardless of the taxpayer s age. Medical and dental bills can be deducted for your client, spouse, all of his/her dependents, and his/her child that is not claimed as a dependent because of the rules for children of divorced or separated parents. Medical and dental expenses may only be claimed when paid. But, medical and dental expenses that were paid with a credit card can be claimed based on the date charged and not when the credit card is paid. Your client cannot include medical or dental expenses that were paid by insurance companies or other sources. EXAMPLES OF MEDICAL AND DENTAL EXPENSES THAT ARE DEDUCTIBLE - Medicines and drugs that require a prescription. - Insulin. - Birth control pills. - Sterilization. - Abortion. - Alcoholism medical expenses including in-patient treatment at a therapeutic center including meals and lodging provided by the center. - Medical doctors, surgeons, dentists, dental hygienist. - Osteopaths, ophthalmologists, optometrists. - Chiropractors, chiropodists, podiatrists. - Psychiatrists, psychologists. - Christian Science practitioners. - Acupuncturists. - Bandages. - Braille books and magazines. - Breast pumps and supplies 34

41 - Breast reconstruction surgery. - Capital expenses for improvements to your client s home for medical care for the taxpayer. The capital expense must be reduced by the amount that the value of the residence increases. If the value of the residence does not increase the entire capital expense is deductible as a medical expense. If the capital expense increases the value of the residence, subtract the increased value from the capital expense and deduct the remainder. Examples of capital expenses include: - Modifying stairways. - Modifying hardware on doors. - Modifying electrical outlets and fixtures. - Installing railings and support bars in bathrooms. - Widening doorways to accommodate wheelchairs. - Entrance ramps or exit ramps. - Modifying hallways and interior doors. - Modifying kitchen cabinets and equipment. - Modifying fire alarms, smoke detectors, carbon dioxide alarm. - Installing porch or stairway lifts. - Elevators. - Amounts paid to maintain the medical capital expenses. - Special hand controls for a car and other special equipment including ramps. - Hospital therapy and service. - Diagnostic devices used in diagnosing and treating illness and disease. - Nursing services. - Surgery to improve defective vision (laser eye surgery or radial keratotomy). - Ambulance service. - Laboratory, surgical, obstetrical, diagnostic service. - Dental and x-ray service. - Meals and lodging provided by a hospital during medical treatment. - Meals and lodging provided by a center during treatment for alcoholism or drug addiction. - Medical, dental, and hospital insurance premiums for hospitalization, surgical services, X-rays, prescription drugs, dental care, contact lens replacement. - Special equipment including: - Motorized wheelchair. - Hand controls on a car. - Special telephone for the deaf. - Special items including: - false teeth. - artificial limbs. - contact lenses. - Eyeglasses. - Eye surgery. - Hearing aids. - Crutches. - Guide dog for the blind. - Program to stop smoking and the cost of medicines prescribed to aid in the quitting process (not over-the counter). - Transportation for medical care. $.19 for each mile in 2016 ($.17 for each mile in 2017). - You may add parking and tolls. - Hearing aids. - Special telephone equipment for hard of hearing. - Special television that displays the audio for persons with hearing disability. - Home care. - Physical therapy. - Medical expenses of an organ donor or possible donor. - Weight loss program as treatment for a specific disease (including obesity diagnosed by a doctor). - Medicare Part B and Part D insurance. - Pregnancy test kits. - Nursing home. 35

42 - Oxygen. - Fertility enhancement including in vitro fertilization and surgery to reverse an operation that prevented the person from having children. - Electronic body scan. - Annual physical examination. - Sex change operation due to gender identity disorder (except for breast augmentation). - Long-term Care Premiums. The amount your client may deduct for eligible long-term premiums depends on the age at the end of 2016 of the person for whom the premiums were paid. Age of Person at the End of the year Maximum Deduction or under $390 $ ,460 1, ,900 4, or older 4,870 5,110 EXAMPLES OF MEDICAL AND DENTAL EXPENSES THAT ARE NOT DEDUCTIBLE - Life insurance or income protection policies. - Nursing care, babysitting, childcare, for a healthy baby. - Medicine or drugs purchased without a prescription. - Health club dues. - Funeral, cremation, and burial expense. - Maternity clothes. - Illegal operations and treatments. - Diaper service. - Bottled water. - Toothpaste, toiletries, cosmetics. - Travel your doctor prescribed for rest or a change. - Travel to improve tax payer s morale. - Diet food. - Unnecessary cosmetic surgery. - Controlled substances including marijuana, even if legalized by state law. - Dancing lessons. - Electrolysis. - Hair transplant. - Household help. - Nutritional supplements, vitamins, herbal supplements, unless recommended by a medical practitioner for treatment of a specific medical condition. - Medical drugs bought from a foreign country. - Teeth whitening. - Veterinary fees. - Weight-loss program unless the treatment is for a specific disease. COBRA PREMIUM ASSISTANCE The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) provides to a taxpayer that s/he can elect to receive COBRA continuation health coverage under a plan if the taxpayer loses health insurance coverage due to a qualifying event such as the taxpayer losing his or her job. If the employer does not have a plan, the taxpayer may elect to purchase the COBRA health coverage. TAXES PAID Taxes and fees that are generally not deductible include the following items: - Federal income taxes. - Import duties. - Federal excise taxes. - Tobacco and liquor tax. - Social Security, Medicare, or railroad retirement taxes withheld from your client s pay. 36

43 - Gift taxes. - License fees for personal purposes (marriage, driver s, dog license fees). - State or local per capita taxes. LINE 5 STATE AND LOCAL TAXES Include on line 5 state and local income taxes that were withheld from your client's salary and any estimated payments made or you may elect to deduct state and local general sales tax. There are two options for deducting state and local general sales tax: The actual state and local general sales tax you paid plus any selective sales taxes if the tax rate was the same as the general sales tax rate. For selective sales taxes on clothing, medical supplies, and motor vehicles, the tax is deductible even if the tax rate was less than the general sales tax rate. For selective sales taxes on motor vehicles for which the tax rate was more than the general sales tax rate, the tax is deductible only up to the amount of tax that would have been imposed at the general sales tax rate. Sales tax on items used in your client s trade or business may not be included. The Optional State Sales Tax Tables are found in 1040 Instructions. You may be able to add to the table amount any state and local general sales tax you paid on motor vehicles, boats, and other items specified. EXAMPLE $2,156 LINE 6 REAL ESTATE TAXES Include taxes that your client paid on property s/he owns that was not used for business. Transfer taxes (or stamp tax), homeowner s association charges, and trash and garbage pickup fees are not deductible. Do not include charges for improvements that will increase your client s property value. A charge for repairing a damaged sidewalk may be included. EXAMPLE $4,299 LINE 7 PERSONAL PROPERTY TAX Include personal property taxes such as automobile license tags. Your client may deduct only the part of the automobile license fee that is based on the car s value. List type and amount. (vehicle registration fees) EXAMPLE $793 LINE 8 OTHER TAXES List type and amount. SDI (State Disability Insurance) is deductible. LINE 9 TOTAL "TAXES" Add lines 5 through 8 and enter total EXAMPLE $7,248 $2,156 + $4,299 + $793 = $7,248 INTEREST YOU PAID LINE 10 HOME MORTGAGE INTEREST Enter on line 10 mortgage interest your client paid directly, or indirectly, to financial institutions. Only two personal residence interests may be deducted in The taxpayer can make the choice of which personal residence interest to deduct if the taxpayer has more than two. If the home is financed with an acquisition mortgage greater than $1,000,000, only the interest on $1,000,000 is deductible ($500,000 if married filing separately). Interest on $100,000 home equity debt is also deductible. In early 2017, the Form 1098 reporting 2016 mortgage interest will include the amount of mortgage principal for January 2016, the origination date of the mortgage, and the property s address. EXAMPLE $14,656 LINE 11 OTHER DEDUCTIBLE HOME MORTGAGE INTEREST Enter on line 11 mortgage interest your client paid to individuals. List the person's name and address in the space provided. You must also provide the person's Social Security number. Only two personal residence interest may be deducted in The taxpayer can make the choice of which personal residence interest to deduct. LINE 12 DEDUCTIBLE POINTS Enter deductible points that were paid by your client and not reported on Form LINE 13 QUALIFIED MORTGAGE INSURANCE PREMIUM Mortgage insurance premiums for mortgage insurance contracts issued since December 31, 2006, may be deductible. If your client s adjusted gross income is more than $109,000 ($54,500 if married filing separately) your client may not 37

44 deduct mortgage insurance. If your client s adjusted gross income is $100,000 ($50,000 if married filing separately), his or her deduction is limited. LINE 14 INVESTMENT INTEREST Enter investment interest paid by your client on money borrowed that was used for property held for investment. Deductible investment interest does not include interest paid on passive activities or securities that provide tax-exempt income. Attach Form 4952 if required. PERSONAL INTEREST Personal interest paid by your client is not deductible. LINE 15 TOTAL INTEREST Add the amounts on lines 10 through 14 and enter this on line 15. EXAMPLE $14,656 CONTRIBUTIONS YOU MADE LINE 16 CASH CONTRIBUTIONS Your client may deduct what s/he actually gave to organizations that are religious, charitable, educational, scientific, or literary in purpose. Receipts or cancelled checks for all cash donations, regardless of the amount, are required. The taxpayer must maintain as a record of the contribution a bank record (such as a cancelled check) or a written record from the charity. The written record must contain the name of the charity, date, and amount of the contribution. Examples of these organizations include: - Churches, temples, synagogues, mosques. - Salvation Army, Red Cross, CARE, Goodwill Industries, United Way. - Boy Scouts, Girl Scouts. - Boys Club of America. - Fraternal Orders. - Non-profit schools, hospitals. - Veterans' and certain cultural groups. - Gifts for public purposes to Federal, State, and local governments. Your client cannot deduct contributions to the following: - Dues, fees, or bills paid to country clubs. - Cost of raffle, bingo, or lottery tickets. - Cost of tuition. - Value of blood given to a blood bank. - Value of his/her time. - Gifts to: - Individuals. - Foreign organizations. - Civic leagues. - Social and sports clubs. - Labor unions. - Chambers of Commerce. - Travel expense while performing personal service - Political organizations. - groups whose purpose is to lobby for changes in the laws. - organizations engaged in political activities that may influence financial interest to your client s trade or business. If your client made a donation to a charitable organization and s/he received a benefit from the donation, your client cannot deduct the complete gift. For example, if your client donated $150 and received gift valued at $75, your client can only deduct $75. Enter on line 16 all of your client's cash contributions. EXAMPLE $2,266 LINE 17 OTHER THAN CASH Enter on line 17 your contributions of property, such as, clothing and furniture. Your client can deduct the fair market value of used items. The fair market value is what a willing buyer would pay a willing seller when neither has to buy or 38

45 sell and both are aware of the conditions of the sale. If other than cash contributions exceed $500, you must complete for your client Form 8283, Noncash Charitable contributions. Charitable donors will need acknowledgement from the donee on all donations of $250 or more. The standard mileage rate for operating a car for charitable purposes is 14 cents a mile in You may add parking and tolls. If the taxpayer deducts more than $500 for a contribution of a motor vehicle, boat, or airplane, s/he must attach a statement from the charitable organization to his/her tax return. Deductions can only be taken if the donated item is in good condition or better. A donated item in fair condition can be deducted only if it is worth $500 or more and the taxpayer has the item appraised. Hunters that donate their stuffed and mounted kills may only deduct the cost of the taxidermy and not the cost of the trip, gun, or bullets. EXAMPLE $455 LINE 18 CARRYOVER FROM PRIOR YEARS Enter any contribution carryover from prior years. LINE 19 TOTAL CONTRIBUTIONS Add lines 16 through 18 and enter total on line 19. EXAMPLE $2,721 $2,266 + $455 = $2,721 LINE 20 CASUALTY AND THEFT LOSSES Enter on line 20 casualty or theft losses of property that is not trade, business, rent, or royalty property. Your client may deduct all or part of each loss caused by theft, vandalism, fire, storm, and car, boat, and other accident. If your client's personal property was covered by insurance but your client does not file a claim, s/he will not be allowed to take a loss on the amount that his/her insurance company would have covered. Losses can be deducted if: - The amount of each separate loss exceeds $100, and - The total amount of losses exceeds 10% of your client's Adjusted Gross Income. Your client cannot deduct the following losses: - Money or property misplaced or lost. - Breakage of china, glassware, and furniture, under normal conditions. - Progressive damage to property. See instructions for Form 4684, Casualties and Thefts EXAMPLE $3,863 MISCELLANEOUS DEDUCTIONS Miscellaneous deductions are totaled and then you must subtract 2% of AGI. The following deductions are considered Miscellaneous deductions: - Malpractice insurance premiums. - Passport for business trip. - Occupational taxes. - Travel, transportation, entertainment, and gifts related to work. - Depreciation on computers and cell phones used in your work. - Home office expenses. - Union and Professional Dues. - Tax Return Preparation Fee. - Continuing Educational Courses related to your client s employment. - Fees to employment agencies and other costs to look for a new job in your client's present occupation, even if your client does not get a new job. - Job search expenses including travel, transportation mileage, and resumes. - Licenses and regulatory fees. - Hobby expenses but only up to the amount of hobby income. - Appraisal fees to determine the fair market value of donated property. - Investment fees and related expenses. - Service charges on dividend reinvestment plans. - Trustee s administrative fees for IRA. - Employee expenses. - Safety equipment. 39

46 - Uniforms. - Protective clothing. - Physical examinations required by employer. - Safe deposit box. - Subscriptions to professional journals. - Legal and accounting fees to produce or collect income. - Credit or debit card convenience fees to pay your income tax including estimated tax payments Miscellaneous expenses that are not deductible include: - Personal legal expense. - Lost or misplaced cash. - Expenses for going to and from work. - Fines and penalties. - Cost of entertaining friends. - Club dues. LINE TOTAL MISCELLANEOUS SUBJECT TO 2% AGI LIMIT Unreimbursed Employee Expense EXAMPLE $6,307 (line 21) See Form 2106 EZ Add the Miscellaneous deductions and then subtract 2% of the AGI. EXAMPLE $4,108 (line 27) $6,307 (line 24) $2,199 (line 26) = $4,108 LINE 28 TOTAL MISCELLANEOUS NOT SUBJECT TO 2% AGI LIMIT - Gambling losses, but not more than gambling winnings. - Federal estate tax on income in respect of a decedent. - Amortizable premium on taxable bonds. - Casualty and theft losses from income-producing property. - Impairment-related work expenses of persons with disabilities. - Repayments of more than $3,000 under a claim of right. - Unrecovered investment in an annuity. EXAMPLE $2,800 EXPENSES THAT ARE NOT DEDUCTIBLE - Club dues. - Health spa expenses. - Home security system. - Homeowner s insurance premiums. - Investment-related seminars. - Life insurance premiums. - Burial or funeral expenses. - Lost or mislaid cash. - Lunches with coworkers. - Meals while working late. - Personal legal expense. - Wristwatches. - Basic local telephone service for the first line to your residence. - Professional accreditation fees (bar exam fees, initial fees for medical and dental licensing, and accounting certificate fees for the initial right to practice accounting). - Tax-exempt income expense. - Travel expenses for a spouse or dependent that accompanies the taxpayer on a business trip. - Capital expenses. - Fees and licenses, such as driver s license, marriage license, dog tags. - Losses from the sale of a taxpayer s home, car, furniture, etc. - Personal disability insurance premiums. - Personal, living, or family expenses. - The value of wages never received or lost vacation time. - Political contributions. 40

47 - Check writing fees on a personal account. - Personal legal expense. - Fines and penalties. - Travel as a form of education. Your Clients Itemized Deductions may be limited if AGI is over $155,650. EXAMPLE Schedule A Itemized Deductions for Mark B. and Bertha M. Crown is completed on the following page. The Adjusted Gross Income (AGI) for Mr. and Mrs. Crown for 2016 was $335,000. TOTAL ITEMIZED DEDUCTIONS LINE 29 TOTAL DEDUCTIONS Add lines 4, 9, 15, 19, 20, 27, and 28 and enter total on line 29. $-0- (Medical and Dental Expenses Line 4) $7,248 (Taxes You Pay Line 9) $14,656 (Interest You Pay Line 15) $2,721 (Gifts to Charity Line 19) $3,863 (Casualty and Theft Losses Line 20) $4,108 (Miscellaneous Deductions Line 27) $2,800 (Miscellaneous Deductions not subject to 2% deduction Line 28) $35,396 The Total Itemized Deductions from line 29 is entered on Form 1040, line 40. If your clients AGI exceeds the following amounts in 2016, his/her deduction may be limited: $311,300 Married Filing Jointly $285,350 Head of Household $259,400 Single $155,650 Married Filing Separately Itemized Deduction Worksheet 1. Enter the total of lines 4, 9, 15, 20, 27, and 28 $35, Enter the total of lines 4, 14, and 20 $3, Is the amount on line 2 less than the amount on line 1? If no, your client s deductions are not limited If yes, subtract line 2 from line 1 $31, Multiply line 3 by 80% (.80) $25, Enter the AGI from Form 1040, line 38 $335, Enter the amount based on your client s filing status $311, Is the amount on line 6 less than the amount on line 5? If no, your client s deduction is not limited If yes, subtract line 6 from line 5 $23, Multiply line 7 by 3% (.03) $ Enter the smaller of line 4 or line 8 $ Total Itemized deductions. Subtract line 9 form line 1 $34,685 If the Bell s AGI had been $311,300 or less instead of $335,000, their itemized deductions would not be reduced by $711 as in this example. 41

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