9033 CREDIT FOR QUALIFIED RETIREMENT SAVINGS

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1 Tax Credits, Prepayments, and Alternative Minimum Tax 9 7 EXAMPLE 9.4 Arleta Kern is single and has two qualifying children. If Arleta has gross income of $18,000, she will have a child tax credit of $4,000. Her gross income will be reduced to zero by the standard deduction for head of household. The initial nonrefundable child tax credit of $4,000 ($2,000 2) is unavailable since there is no income tax liability. Arleta s refundable child tax credit is $2,325, which is 15 percent of her earned income over $2,500, subject to a $2,800 ($1,400 2) limit. If Arleta has gross income of $23,000, she would have a tax of $500. The initial child tax credit is $3,075 ($23,000 $2,500).15). The $500 would be reduced to zero by the first $500 of the nonrefundable credit, leaving a refundable credit of $2,575 (the smaller of $2,575 ($3,075 $500) or $2,800. Any tax liability must first be reduced by any dependent care credit, credit for the elderly, and education credits. EXAMPLE 9.5 John and Barbara Hassen have three children. Their adjusted gross income would have to exceed $24,000 before they could qualify for the nonrefundable child tax credit. The standard deduction for a married couple will reduce their taxable income to zero. They will not qualify for a nonrefundable child tax credit. They will qualify for a refundable child tax credit of $3,225 (($24,000 $2,500).15 = $3,225 limited to $4,200 ($1,400 3)). If the entire $24,000 were subject to FICA taxes, the Hassens would have paid $1,836 in FICA taxes. Assuming they qualify for the maximum earned income credit, their earned income credit would be $6,444. Thus, until the FICA taxes exceed the earned income credit, the second method of computing the refundable child tax credit will create no refundable child tax credit. However, when using a $2,500 reduction, the 15 percent computation will always give a higher refundable credit than the excess of FICA taxes over the earned income credit. A family credit of $500 is allowed with respect to each dependent other than a qualifying child. The family credit is effective for taxable years ending before January 1, The credit begins to phase out at $200,000 for singles and $400,000 for married. The phaseouts are not indexed for inflation. The family credit is nonrefundable CREDIT FOR QUALIFIED RETIREMENT SAVINGS A nonrefundable tax credit is allowed for elective contributions made by eligible taxpayers to a qualified retirement plan. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on the adjusted gross income of the taxpayer. Only joint returns with adjusted gross income of $63,000 or less, head of household returns of $47,250 or less, and single returns of $31,500 or less are eligible for the credit. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contributions. The credit is available to individuals who are 18 or over, other than individuals who are full-time students or claimed as a dependent on another taxpayer s return. The credit rates based on adjusted gross income are as follows: Adjusted Gross Income Joint Return Head of a household All other cases Applicable percentage Over Not over Over Not over Over Not over $0 $38,000 $0 $28,500 $0 $19, ,000 41,000 28,500 31,000 19,000 20, ,000 63,000 31,000 47,250 20,500 31, ,000 47,250 31, ADOPTION ASSISTANCE CREDIT A nonrefundable tax credit of up to $13,810 of qualified adoption expenses per child has been provided for Qualified expenses include adoption fees, court costs, attorney fees, and other expenses related to the legal adoption of an eligible child. Also, employees are entitled to exclude from income up to $13,810 of adoption expenses per adopted child where such amounts are paid or incurred by their employers 9034

2 9 22 CCH Federal Taxation Comprehensive Topics expenditures must be amortized ratably over 10 years. For tax years after 1990, individuals who materially participate in an activity are not required to capitalize and amortize research and experimental expenditures generated by such activity that are otherwise allowed as a business expense deduction under Code Sec. 174(a). The basis for gain or loss upon disposition is determined using the AMTI basis. Pollution Control Facilities For property placed in service after 1986, the five-year amortization method for depreciating pollution control facilities must be replaced by the alternative depreciation system. The adjusted basis used in AMTI calculations (but not for regular tax calculations) to determine the gain or loss on the sale of property for which depreciation has been adjusted must reflect the depreciation adjustment rather than the costs that were deductible in regular tax computations. Long-Term Contracts The percentage-of-completion method of accounting to determine gain or loss from long-term contracts must be substituted for any other method of accounting, such as the completed-contract method or the cash basis method, for both regular tax purposes and for AMT purposes. This change will directly affect those taxpayers who were using a form of completed-contract method of accounting for AMT purposes. The adjustment is the excess of income from use of the percentage-of-completion method over the longterm contract method used on long-term contracts. For example, if the deferred income from a three-year contract is $750,000, no income is reported under the completed-contract method of reporting until the third year. Assuming the costs on the contract are incurred in equal proportions, $250,000 is included in AMTI for each of the three years. Passive Farming Losses No deduction is allowed for losses from any farming syndicate or any other farming activity in which the taxpayer does not materially participate. A loss from one farm activity may not be used to offset income from another farm activity. Disallowed losses are carried forward indefinitely and used for AMTI purposes to offset future income from the farming activity. Suspended losses are deductible when the activity is disposed of. Code Sec. 58(a). Incentive Stock Options An adjustment must be made to taxable income when incentive stock options are exercised. The excess (if any) of the stock s fair market value at the time of exercise over the amount paid by the employee for the stock is an adjustment that in figuring AMT taxable income is added to the taxable income shown on the tax return. This adjustment is made in the first year in which the rights in the stock are freely transferable or are not subject to a substantial risk of forfeiture. EXAMPLE 9.24 Arthur Aster pays an exercise price of $15 to purchase stock having a fair market value of $20. The adjustment in the year of exercise is $5, and the stock has a basis of $15 for determining gain or loss for regular tax purposes and $20 for alternative minimum tax purposes. If, in a subsequent year, Arthur sells the stock for $45, the gain recognized is $30 for regular tax purposes and $25 for alternative minimum tax purposes. Section 1202 Small Business Stock An adjustment must be made to taxable income for the sale of Small Business Stock purchased before September 10, The adjustment is 7% of the excluded gain. Net Operating Losses The net operating loss (NOL) must be calculated under special rules and cannot offset more than 100 percent of AMT income. The AMT rules generally require that the regular tax NOL must be adjusted for AMTI adjustments and tax preferences. Gains and Losses on Sale or Exchange of Property AMTI must be adjusted for any difference between gain or loss reported for the regular tax and that figured for the AMT. For AMT purposes, a property s basis is reduced only by the amount of depreciation allowed in computing AMTI. Therefore, the adjusted basis of the property may differ for regular and minimum 9415

3 Tax Credits, Prepayments, and Alternative Minimum Tax 9 27 EXAMPLE 9.29 Mark and Samantha Mandell, the parents of two children, had the following tax facts: Income Wages $401,198 Business Income 89, Capital Gain (stock purchased in 2012) 50,000 Collectibles Capital Gain 25,000 Dividend Income 7,000 Interest Income 8,500 Expenses 1/2 Self-Employment Tax 1,198 Moving Expenses 10,000 Medical Expenses 42,000 Casualty Loss (Federal disaster) 92,100 Housing Interest 8,000 Investment Interest 28,000 Personal Interest 2,000 Charitable Contributions 27,000 State & Local Income Taxes Real Estate Taxes 12,000 Other Nonbusiness Deductions 23,000 Other Tax Preferences Private Purpose Municipal Bond Income 50,000 Excess of Accelerated Depreciation 15,000 General Business Credit 10,000 The computation of their income is as follows: Gross Income Wages $401,198 Business Income 89, Capital Gain 0 Collectibles Capital Gain 25,000 Dividend Income 7,000 Interest Income 8,500 Total Gross Income $531,198 Deductions from Gross Income 1/2 Self-Employment Tax $ 1,198 Adjusted Gross Income $530,000 Itemized Deductions Medical Expenses ($42, % AGI) $ 2,250 State & Local Income Taxes Real Estate Taxes 10,000 Housing Interest 8,000 Investment Interest 8,500 Personal Interest ($2,000 0%) 0 Charitable Contributions 27,000 Casualty Loss ($92,100 $100 10% AGI) 39,000 Total Itemized Deductions 94,750 Taxable Income 435,250 Income Tax 100,567 General Business Credit 0 Regular Tax for the Year 100,

4 Tax Credits, Prepayments, and Alternative Minimum Tax If a taxpayer does not file estimated taxes and is underpaid for the year, what penalty may be imposed? 34. What is the purpose of the alternative minimum tax? 35. What is a tax preference item? 36. When is it possible to have a tax preference for the alternative minimum tax if the taxpayer is using straight-line depreciation? 37. List the itemized deductions that are not allowed in the computation of alternative minimum taxable income. 38. When is interest deductible as an itemized deduction for income tax purposes but not allowed as an itemized deduction for the alternative minimum tax. 39. What items create the alternative minimum tax credit? PROBLEMS 40. Compute the child and dependent care credit in each of the following independent cases: a. Jack and Jill Jones are married and file a joint return. Jill worked full time earning $20,000, while Jack attended law school the entire year. They incurred $6,500 of child care expenses during the year for their two children, ages eight and six. b. Mary Morgan is a widow who worked full time the entire year earning $23,000. She incurred the following child care expenses for her six-yearold daughter in order to be employed during the year: Kindergarten $400 Babysitters 600 Private school (first grade) 600 c. Bill and Debra Page are divorced and have one dependent child, Betty, age nine. Bill had custody of Betty for five months this year and claimed Betty as an exemption on his tax return. Debra had custody of Betty for the remainder of the year. Debra incurred $3,600 of employment-related expenses during the year, while Bill incurred $2,500 of employment-related expenses. Both were employed for the entire year and each earned $20,000 in wages this year. 41. Frank and Emma Browne are both over 65 and file a joint return. Emma received $800 from Social Security benefits and Frank received $1,200 from railroad retirement benefits. In addition to the benefits, they reported income of $18,000 from their antique shop. a. Compute Frank and Emma s tax credit for the elderly. b. Assume that only Emma was over 65 and compute the tax credit for the elderly. 42. A married couple with two children has $16,000 of earned income. What is the amount of their child and family tax credit? 43. Fannie, a widow, lives in an apartment with her two minor children (ages 4 and 6) whom she supports. Fannie earns $35,000 during She uses the standard deduction. Calculate the amount, if any, of Fannie's earned income credit. 44. A married couple with two children has earned income of $30,000 with no withholding. Assume they have a taxable income of $100, they paid $2,295 in FICA taxes, and they will receive an earned income credit of $3,749. Their tax on $100 is $10. What is the amount of their income tax liability?

5 9 32 CCH Federal Taxation Comprehensive Topics 45. A married couple with three children has earned income of $15,000 and adjusted gross income of $50,000 with no withholding. Assume a standard deduction of $24,000. Their tax on $24,000 is $2,600. They have no earned income credit. They paid $1,148 in FICA taxes. What is the amount of their income tax due? 46. Walt is single, age 67, and retired. His taxable income for 2018 is $1,320, and the tax on this amount is $132. Walt's tax credit for the elderly is $225. What is the amount of the credit for the elderly that Walt can claim on his tax return? 47. Philip and Susan Moyer have two children who are both in the first four years of college. They incur $4,500 in tuition expenses for each of the two children. What is the maximum amount of American Opportunity Tax Credit? 48. Cathy Thomas, a single mother, has modified AGI of $82,000. In 2018, her daughter begins work on her bachelors degree at an accredited institution. Cathy pays $6,000 in qualified tuition for the daughter s first semester. What is the amount of American Opportunity Tax Credit Cathy is allowed on her return? 49. Michael is divorced and the exemption for his daughter is claimed by his ex-wife. What is the amount of American Opportunity Tax Credit allowed Michael when he pays $2,500 in tuition for his daughter to attend her first year at an accredited four-year college? 50. What is the amount of Lifetime Learning Credit allowed a taxpayer assuming that he or she incurred $3,000 in tuition and fees and $8,000 in room and board for an eligible college student? 51. In 2018, Lenny Traveler had adjusted gross income of $32,000 from investments in the U.S., while earning $40,000 from foreign sources. Lenny s potential U.S. tax liability is $7,600, and he had to pay $9,000 in foreign income taxes. What amount can Lenny, a U.S. citizen, claim as a foreign tax credit? 52. ABC Corporation has international earnings of $500,000 and a U.S. tax liability of $170,000. From foreign operations ABC generated $120,000 of income on which a $55,000 tax was imposed. What is ABC s foreign tax credit and total tax liability? 53. Mark has a tentative general business credit of $120,000 for the current year. His net regular tax liability before the general business credit is $135,000, and his tentative minimum tax is $100,000. Compute Mark's allowable general business credit for the year. 54. Zap Industries had a tentative general business credit in 2018 of $60,000. Its tax liability in 2017 was $20,000. Its tax liability before the general business credit in 2018 is $50,000. a. What is Zap Industries 2018 tax liability? b. Are there any effects on the tax liabilities of the previous year? c. If so, what are they? 55. Yoyo Corporation bought $42,000 worth of energy equipment in November 2013, taking an investment credit of $4,200. In March 2018, the firm sells the equipment for $30,000. What is the investment credit recapture? 56. Martha and Marty Mertens are married and file a joint return. Marty started his own business at the beginning of the current tax year and reported net income of $14,000 for the year. Martha worked full time as a waitress earning $8,000, excluding tips of $3,000. Marty and Martha maintained a home for their 11-year-old son. What is their earned income credit for 2018? 57. What is the adjustment that must be made to taxable income in computing alternative minimum taxable income for 2018, assuming that an individual purchased an office building on January 8 for $400,000? 58. What is the amount of tax adjustment for alternative minimum tax purposes assuming that an individual sells some qualified small business stock purchased in 2009 at a $20,000 gain.

6 Tax Credits, Prepayments, and Alternative Minimum Tax What is the allowable exemption for the alternative minimum tax assuming that a married couple has alternative minimum taxable income of $1,200,000? 60. Calculate the exemption amount for the following cases for 2018 for a single taxpayer, married taxpayer filing jointly, and a married taxpayer filing separately when AMTI is $800, Tamara and Tony Mapp, a married couple, report the following items for the year: Taxable income $120,000 AMT adjustments 30,000 Tax preferences 40,000 Regular tax liability 16,000 What is their alternative minimum tax for the year? 62. Donna, an unmarried individual who is age 66, has taxable income of $300,000. She has AMT positive adjustment of $68,000 and tax preferences of $40,000. a. What is Donna's AMT? b. What is the total amount of Donna's tax liability? 63. Alex and Alicia Andrews file a joint tax return. On the return they show Alex s salary of $110,000, interest income from corporate bonds of $3,000, dividends from domestic corporations of $1,000, and a net long-term capital gain of $60,000. They also had the following expenses for itemized deductions: $18,000 medical expenses, $8,000 home mortgage interest, $5,000 in consumer interest, $4,000 in deductible taxes, $2,000 charitable contributions, and $1,200 in miscellaneous deductions. The Andrews claim five exemptions on their return. Determine their net alternative minimum taxable income. 64. What is the amount of AMT credit carryforward for 2018, assuming that an individual had an alternative minimum tax of $20,000 and an alternative minimum tax for AMT credit of $12,000? 65. Which of the following are tax adjustments or preference items for purposes of the alternative minimum tax? a. $20,000 net long-term capital gain over net short-term capital losses b. $3,000 net short-term capital gain c. $10,000 straight-line depreciation on building acquired in 1989 d. $1,500 interest from City of Buffalo bonds 66. Which of the following qualify as employment-related expenses for the credit for child care? a. Nursery school fees b. Transportation to nursery school c. Housekeeper s salary d. Housekeeper s meals e. Gardener s salary 67. What is the amount of dependent care credit before any income tax limitation for a couple with two children where they spend $6,500 for dependent care and the husband earns $25,000 for the year and the wife earns $4,500? a. $1,755 b. $1,215 c. $550 d. $0 68. Which of the following items is not an adjustment for the alternative minimum tax? a. Taxes b. Wagering losses c. Standard deduction 69. Comprehensive Problem. Determine the tax due, including the alternative minimum tax, for Patty Perkins, assuming she is single using the following tax information: Adjusted Gross Income $100,000 Itemized Deductions 20,000 Alternative Minimum Tax Itemized 12,000 Deductions Tax Preference Items 40,000 General Business Credit 17,000