Federal Income Taxation Chapter 9 Personal Deductions, Exemptions, Credits

Transcription

1 Presentation: Federal Income Taxation Chapter 9 Personal Deductions, Exemptions, Credits Professors Wells September 28, 2016

2 Basic Tax Structure p.560 Gross Income ( 61) minus Above the Line Deductions ( 62(a)) Equals Adjusted Gross Income ( 62) minus Below the Line Deductions (either standard deduction ( 63(c)) or itemized deductions ( 63(d)) and Deduction for Personal Exemptions ( 151) Equals Taxable Income ( 63) 2

3 Adjusted Gross Income p.561 Example Alice is a lawyer who conducts her own practice. She collects fees of about $400,000 in a year. But that amount is not available to her for personal consumption or accumulation because she has to use much of it to pay rent for her office, salaries of a secretary and a junior associate, bar association dues and fees, the cost of telephone service etc. On a less regular basis she has to buy up-to-date computer and network equipment, books for her library, and office furniture. Her net income, after deducting these costs, is around $85,000. If she were taxed on $400,000 at 2015 rates the tax would be about $115,000 (assuming she files as an unmarried individual with no dependents; see Table 1-1) and she would end up almost $30,000 in the hole. So the first function of deductions is to make taxable income for Alice something like $85,000 rather than $400,000. To that end, most of the items mentioned for Alice would be deductible under 162 as business expenses. For the computer equipment, depreciation would be allowed pursuant to 167 and 168. If she had borrowing attributable to her business, interest paid on the borrowing would be allowed by 163. Moreover, all these items would be allowed above-the-line, in going from gross income to adjusted gross income, because all are attributable to a trade or business carried on by the taxpayer other than performance of 3 services as an employee, as specified in 62(a)(1).

4 Personal and Dependency Exemption p (b) provides exemption for taxpayer & spouse. For 2016, the inflation adjusted amount is $4, (c) provides additional exemption for each dependent. Ø 152 defines a dependent. 151(d)(3) provides a phase-out: (AGI Applicable Percentage)/$2,500 x 2% = % Reduction* *(but not greater than 100%) 4

5 Itemized Deductions or Standard Deduction p.565 Itemized Deductions are all deductions except those allowed to compute AGI and the personal exemption. Taxpayer choice: AGI minus itemized deductions or standard deduction 63(a) itemized deductions -or- 63(b) & (c) Standard Deduction (subject to limitations of 67/ 68) ($12,600 Joint / $6,300 Single) +Plus+ Personal Exemptions 63(a) +Plus+ Personal Exemptions 63(b)(1) 5

6 Phase-Out of p.568 Itemized Deductions and Personal Exemptions 67: Miscellaneous Itemized Deductions: Allowed only to the extent they exceed 2% of AGI. Miscellaneous Itemized List: T(a)(1). 68: Allowable Itemized Deduction Phase-Out: All itemized deductions (other than those for medical expenses, investment interest, and casualty or theft losses) is reduced by the lesser of: (1) 3% of the excess of AGI - the applicable amount, or (2) 80% of the itemized deductions (other than the three mentioned above). Ex. AGI= 500,000. Single. Misc. Itemized Deductions $50,000 Misc. Itemized Deductions: $15,000 67(a) Limit: 2% x 500,000 = $10,000 Same ($10,000) 68(a) Lessser: 3% x (500, ,400) = $7,218 3% x (500, ,400) = $7,218 80% x (50,000 10,000) = $32,000 80% x (15,000 10,000) = $4,000 6

7 Itemized Deductions p.569 Rev. Rul Section 62(c): an arrangement will not be treated as a reimbursement if (i) it does not require the employee to substantiate the expenses covered by the arrangement, or (ii) such arrangement provides the employee the right to retain any amount in excess of the substantiated expenses covered under the arrangement. Situation 1: Hourly tool charge to mechanic employee. Holding: Because employer pays wages determined without regard to reimbursable expenses, the designation of part of those wages as reimbursements (e.g., reimbursement for costs of tools) does not satisfy the business connection requirement because same gross amount is paid regardless. Situation 2: Hospital provides per diem for deductible travel expenses. Holding: Same as Holding #1 because amount is not dependent on reimbursable expenses. Situation 3: Employer pays per diem mileage reimbursement. Holding: Same as above because amount does not vary with actual expense. Situation 4: Employer reimburses employees for their equipment expenses Holding: Reimbursement based on actual expenses so qualifies. 7

8 Tax Rate p.384 ( 1(a) through (e)) Credits are dollar-for-dollar reductions of tax liability. 32 Earned Income Credit 32(b) varies amount by number of children 32(i) denies credit for those with excessive investment income. Phased Out for higher income taxpayers 22 Credit for Elderly and Disabled 23 Adoption Assistance Credit 8

9 Credits Based on Personal Circumstances p.384 Credits are dollar-for-dollar reductions of tax liability. 32 Earned Income Credit 32(b) varies amount by number of children 32(i) denies credit for those with excessive investment income. Phased Out for higher income taxpayers 22 Credit for Elderly and Disabled 23 Adoption Assistance Credit 9