Bryant - Course 4. Tax Planning. 12. Tax Implications of Changing Circumstances Flashcards
Module Overview
There are five different filing statuses but only four rate schedules. The five filing statuses are:
* married filing jointly,
* married filing separately,
* qualified widow(er) with a dependent child,
* head of household, and
* single.
For federal income tax purposes, income is allocated between a husband and wife depending on the state of residence. In the U.S., 42 states follow a common law property system, while eight states use a community property system. We will see that the married filing jointly status was created to equalize the tax effects regardless of whether the taxpayers’ state is a common law or a community property state.
In addition to claiming one personal exemption, an individual taxpayer also may claim an exemption for each dependent. This exemption is called a dependency exemption. To help parents fund their children’s education, there are two kinds of tax credits, the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit.
The case of alimony, child support, and property settlement comes into the picture only if there is divorce or separation. The lesson touches upon the Qualified Domestic Relation Order (QDRO) briefly. The last lesson deals with the final income tax filing of a person who has passed away.
To ensure that you have an understanding of the tax implications of changing circumstances, the following lessons will be covered in this module:
* Marriage
* Divorce
* Death
Marriage
There are seven tax brackets applicable to individual taxpayers. These rates are progressive; as a taxpayer’s income increases, the taxpayer moves into higher tax brackets. The income level at which higher tax brackets begin depends on the taxpayer’s filing status.
There are five different filing statuses but only four rate schedules and/or tax tables because married couples filing jointly and certain surviving spouses use the same rate schedule or tax table. The taxpayers may also be able to avail themselves of child tax credit and child dependent care credit. These credits are direct tax cuts in the dollar amounts of tax liability. Education of children is also beneficial, with the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit.
Different states in the US follow different laws to recognize marriage and income. For federal income tax purposes, income is taxed to the person who earns it. Usually, income cannot be allocated between a husband and wife. In the eight states that use a community property system, however, the income of married persons is deemed to belong to each spouse equally regardless of who earns the income. In this module, we review how the tax code handles this issue.
To ensure that you have an understanding of marriage, the following topics will be covered in this lesson:
* Filing Status
* Premarital agreements
* Children
* Common law and community income
Upon completion of this lesson, you should be able to:
* Describe the various rules, conditions, and ways (depending on their income and situations) for married couples to file returns,
* List the qualifications for a valid premarital agreement,
* Determine in a given situation or case study whether a person can claim dependency exemption or not,
* Determine in a given situation or case study whether a person can claim the child and dependent care credit,
* Distinguish between AOTC and Lifetime Learning credit, and
* Define what is meant by common law and community property.
What are the seven tax brackets applicable to individual taxpayers?
The seven tax brackets applicable to individual taxpayers are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
As a taxpayer’s income increases, the taxpayer moves into higher tax brackets. The income level at which higher tax brackets begin depends on the taxpayer’s filing status.
How did MFJ come about? When?
When did HOH start?
Who has the highest tax rates? And lowest?
Before 1948, all taxpayers used one rate schedule. If a husband and wife both had income, each filed a return. This treatment was deemed to be unfair because various states allocated income between spouses differently. Some states used a community property law system while others used a common law system.
Today, only eight states continue to use the community property law system. Community property law allocates community income equally between a husband and wife, regardless of which spouse actually earns the income. In other states, income belongs to the spouse who produces the income. With a progressive tax system, placing income on one return instead of two can result in a much greater tax. For this reason, couples residing in non-community property states often paid more tax than their counterparts who resided in community property states.
In 1948, Congress developed the joint-rate schedule to rectify this problem. Unmarried taxpayers who headed families felt they also should receive tax relief because they shared their incomes with their families. So, in 1957, Congress created a rate schedule for heads of households. Currently, the highest tax rates are those for married filing separately, and the lowest are those for married filing jointly.
Filing Status. Must maintain a household. Must have dependent. Marital status. Must be a citizen or resident alien. Tax Rates.
* MFJ
* Surviving Spouse
* Head of household
* Single
* MFS
Filing Status. Must maintain a household. Must have dependent. Marital status. Must be a citizen or resident alien. Tax Rates.
* MFJ No requirement No Married Yes Lowest rates, but two incomes are combined
* Surviving Spouse Yes Yes, son or daughter Widowed in prior or second prior year Yes Uses the same schedule as married filing joint return
* Head of household Yes Generally, yes Generally, single Yes Intermediate tax rates
* Single No requirement No Single No Highest tax rates for unmarried taxpayers
* MFS No requirement No Married No Highest tax rates
What are the four requirements for a valid premarital or prenuptial agreement to stand up in court are?
The four requirements for a valid agreement that will stand up in court are:
* The agreement must be in writing and signed by both parties,
* Full and complete disclosure of parties’ net worth must be made with no designed concealment,
* The agreement must not be intended to promote the procurement of divorce, and
* Both parties must execute the agreement willingly without duress or coercion.
The last requirement may be an issue if the agreement is not entered into with ample time prior to a wedding. For instance, a judge may rule that the contract was not without duress and coercion, because the agreement was entered into two days prior to the wedding.
When can a couple can file a joint return?
A couple can file a joint return, according to the following rules:
* They must be legally married as of the last day of the tax year. Whether a couple is married depends on the laws of the state of residence. Common law marriages recognized by the state of residence are covered. On the other hand, an annulled marriage is viewed as never having been valid. Thus, such a couple cannot file a joint return.
* Couples in the process of divorce are still considered married until the date the divorce becomes final.
* A couple need not be living together in order to file a joint return.
* A joint return can be filed if one spouse dies during the year as long as the survivor does not remarry before the year-end. The executor of the estate must agree to the filing of a joint return.
* A joint couple must have the same tax year-end (except in the case of death).
* Both spouses must be US citizens or residents. An exception allows a joint return if the nonresident alien spouse agrees to report all of his or her income on the return. Normally, nonresident aliens are taxed only on income earned in the United States. Otherwise, if a joint return was filed by a US citizen and his or her foreign spouse, and only the US citizen reported income on the return, they would receive the benefit of the low rate schedule. Thus, to file a joint return, the couple must agree to report both incomes.
Describe Married Filing Separately
Married individuals who choose to file separate returns must use the separate rate schedule. The rates on this schedule are higher than other individual rate schedules. Several disadvantages are associated with the filing of separate returns by married individuals.
For example, a taxpayer may lose all or part of the benefits of contributions or deductions for individual retirement accounts, the childcare credit (a tax credit that offsets your taxes in a direct dollar-to-dollar manner for child and dependent care expenses), and the Earned Income Credit (a tax credit available to low-income taxpayers, which effectively serves as a negative income tax).
When can a widow or widower can file a joint return?
A widow or widower can file a joint return for the year his or her spouse dies if the widow or widower does not remarry. For the two years after the year of death, the widow or widower can file as a surviving spouse only if he or she meets specific conditions.
The surviving spouse (sometimes called a qualifying widow or widower) must:
* Have not remarried as of the year-end in which surviving spouse status is claimed.
* Be a US citizen or resident.
* Have qualified to file a joint return in the year of death.
* Have at least one dependent child (includes an adopted child, a stepchild, or a foster child) living at home during the entire year and the taxpayer must pay over half of the expenses of the home.
In the year of death, a joint return can be filed. On the joint return, the income of the deceased spouse (earned before death) and the survivor are both reported.
In the two years following death, surviving spouse status can be claimed only if the conditions outlined above are met. Only the surviving spouse’s income is reported and, of course, no personal exemption is available for the deceased spouse. What the two situations have in common is that in both instances, the taxpayer can use the more favorable joint rate schedule and standard deduction amount.
Surviving Spouse Filing Example:
Connie and Carl are married and have no dependent children. Carl dies in 2023. Connie can file a joint return, even though her husband died before the end of the year. Alternatively, Connie can file as a married individual filing a separate return.
* In 2024, how must Connie file?
Alternatively, if Connie and Carl had dependent children, Connie could file as a __ ____??____ __ for 2024 and 2025 and use the __ ____??____ __ rate schedules.
In 2024, however, Connie must file as a single taxpayer since she has no dependent children who would qualify her as a surviving spouse or a head of household.
Alternatively, **if Connie and Carl had dependent children, Connie could file as a surviving spouse (qualifying widow) **for 2024 and 2025 and use the joint return rate schedules.
What conditions must a taxpayer meet o claim head of household status?
A second rate schedule or tax table is available to a head of household. The head of household rates are higher than those applicable to married taxpayers filing jointly and surviving spouses, but lower than those applicable to other single taxpayers.
To claim head of household status, a taxpayer must meet all of the following conditions:
* Be unmarried as of the last day of the tax year. Exceptions apply to individuals married to non-resident aliens and to abandoned spouses. An individual cannot claim head-of-household status in the year his or her spouse died. Such individuals must file a joint return or a separate return.
* Not be a surviving spouse.
* Be a US citizen or resident.
* Pay over half of the costs of maintaining his or her home as a household in which a dependent relative lives for more than half of the tax year.
Head of Household Example:
Brad and Ellen divorced. Ellen receives custody of their child, and Brad is ordered by the court to pay child support of $6,000 per year. If Ellen maintains the home in which she and her child live, she can claim head of household status even though the child is Brad’s dependent.
As noted, the taxpayer must pay over half the cost of maintaining the household. These expenses include property taxes, mortgage interest, rent, utility charges, upkeep and repairs, property insurance, and food consumed on the premises. Such costs do not include clothing, education, medical treatment, vacations, life insurance, transportation, or the value of services provided by the taxpayer.
What are the two special rules with filing HOH?
First, a taxpayer with a dependent parent qualifies even if the parent does not live with the taxpayer.
Second, an unmarried descendant who lives with the taxpayer (Includes an adopted child, stepchild, and a descendant of a natural or adopted child) need not be the taxpayer’s dependent.
The second exception often comes into play in cases of divorced parents. This exception may allow the custodial parent to still claim head-of-household status.
Who files as a single taxpayer?
An unmarried individual who does not qualify as a surviving spouse or a head of household must file as a single taxpayer. The tax rates are higher than those that apply to other unmarried taxpayers. To file as a single taxpayer, the individual has to be single at the end of the year and not have any dependent children.
For example, Becky, an unmarried individual with no dependents, files her first tax return. She will file as a single taxpayer.
When can a married individual can use the abandoned spouse rule?
An abandoned spouse is a taxpayer who was abandoned by his or her spouse that is granted permission to file as head of household. If no relief were granted, this person would be required to use the married filing separately tax rate schedule, which contains the highest rates. But Congress has provided relief for taxpayers in this situation if they can meet certain conditions.
A married individual can use the abandoned spouse rule if:
* The taxpayer lived apart from his or her spouse for the last six months of the year.
* The taxpayer pays over half of the cost of maintaining a household in which the taxpayer and a dependent child (including an adopted child, stepchild, or foster child) live for over half of the year.
* The taxpayer is a US citizen or resident.
* The taxpayer must have a dependent child. This requirement is met if a taxpayer who is qualified to claim the child as a dependent signs an agreement that allows the child’s non-custodial parent to claim the dependency.
Abandon Spouse Example:
In October, Bianca and Gail decide to separate. Gail supports their children after the separation and pays the costs of maintaining the home. Gail cannot claim abandoned spouse status because Bianca lived with her for over one-half of the year. If she had obtained a divorce before the end of the year, she could have filed as a head of household. In the absence of a divorce, Gail must file a separate return, unless both Bianca and Gail agree to file a joint return.
Assume the same facts as in the example above except that Gail continues to support her children and pay household expenses during the next year. She can file as a head of household even if she has not obtained a divorce.
Dependency Qualification
To qualify as a dependent, an individual must meet the definition of either a qualifying child or a qualifying relative. All dependents must meet several requirements. Four requirements are common to all dependents.
* What are the 4 requirements?
All dependents must:
* Have a qualifying identification number
* Meet a citizenship test
* Meet a separate return test
* Not themselves claim another person as a dependent
To claim as a dependent an individual who is considered a qualifying child, what 4 additional requirements must be met?
To claim as a dependent an individual who is considered a qualifying child, the following additional requirements must be met:
* A relationship test
* An age test
* An abode test
* A support test
A qualifying relative may also be considered a dependent. To be eligible, dependents must meet the common requirements above and what three additional requirements?
To be eligible, dependents must meet the common requirements above and three additional requirements:
* Relationship test
* Gross income test
* Support test
Key tax credits for taxpayer has a dependent that is a qualifying child
Being considered a dependent is important bc it entitles taxpayer to several different tax benefits.
Two types of dependents:
* Qualifiying child
* Qualifying relative
Qualifying child requirements (feed into common tax credits available to parents):
* Earned income tax credit
* Child and dependent care credit
* Child Tax Credit
* Additional Child Tax Credit
Series of initial 3 tests:
* Can’t be claimed as dependent by a different taxpayer
* Joint return requirement - Can’t claim a married person that files jointly
* Citizenship requirement - Person has to be a US citizen, US resident alien, resident of Canada, or US national
If above 3 met, what are the 5 tests for qualifying child?
If above 3 met, 5 tests for qualifying child:
* Relationship test - child to be son, daughter, step-child, foster child, sister, brother, step-brother, step-sister, or descendant of any of them
* Age test - must be under 19 at end of year, or 24 if full time student, or permanently disabled (any age)
* Residency test - live with over half of year
* Support test - child must not have provided more than half of their own support for the whole year
* Joint return test - child is not filing a joint return for the year
If qualifying child test is applied, child is qualifying for more than 1 person, there’s tie-breaker rules to determine who is eligible to claim child as a qualifying child:
* If one person is a qualifying parent, and the other person has a higher AGI - ??
* If parent has the AGI, it goes to parent
Who qualifies for the Child Tax Credit?
The 2023 Child Tax Credit is available to parents with dependents under the age of 17 at the end of the year and who meet certain eligibility requirements.
Taxpayers with eligible children will be able to claim a credit worth up to $2,000 per child. This year the credit is partially refundable, and there is an earnings threshold to be able to start claiming the up to $1,500 portion known as the Additional Child Tax Credit.
Taxpayers who owe less in taxes than the refundable amount will have it added to their tax refund, the non-refundable portion will reduce taxes owed dollar-for-dollar.
Parents of eligible children must have an adjusted gross income (AGI) of less than $200,000 for single filers and $400,000 for married filing jointly to claim the full credit. For every $1,000, or fraction thereof, in excess of those thresholds, the credit is reduced by $50.
See IRS Publication 5549 for additional information.
The age limit for the Child Tax Credit is __ ____??____ __.
* sixteen
* seventeen
* thirteen
* nineteen
seventeen
Seventeen (i.e., under 18) is the age limit for the Child Tax Credit (CTC).
Who qualifies for the Child and Dependent Care Credit?
The Child and Dependent Care Credit provides relief for taxpayers who incur child and dependent care expenses because of employment activities. To qualify for the credit, an individual must meet two requirements:
* Child or dependent care expenses must be incurred to enable the taxpayer to be gainfully employed, and
* The taxpayer must maintain a household for a dependent under the age of 13 or an incapacitated dependent or spouse.
Child and Dependent Care Eligibility Example:
Tim and Tina are married and have two children under age 13. They incur childcare expenses by employing a housekeeper and nurse in order to work on a full-time basis. The childcare expenditures are eligible for the child and dependent care credit because Tim and Tina incurred the childcare expenses to enable themselves (taxpayers) to be gainfully employed.
Alternatively, if Tina was not employed but incurred childcare expenses to play tennis and other social activities, the expenditures would not be eligible for the Child and Dependent Care Credit.
Child and Dependent Care Calculation Example:
In 2023 a taxpayer with one qualifying person, $3,000 in qualifying expenses and an AGI of $60,000 would qualify for a nonrefundable credit of approximately $600 (20% x $3,000).
The credit is 35% of the qualifying expenses (after the ceiling limitations of $3,000 - individual or $6,000 - family have been applied). However, the credit rate is reduced by 1 percentage point for each $2,000 (or fraction thereof) of adjusted gross income (AGI) in excess of $15,000 but goes no lower than 20%. The minimum tax credit (20%) is applied once a taxpayer’s AGI exceeds $43,000 (2023).
What happens if an employee has payments made by an individual’s employer and provided to the employee?
An employee may exclude amounts up to $5,000 from gross income for dependent care assistance payments made by an individual’s employer and provided to the employee. The exclusion amount is limited to the earned income of the employee (or in the case of a married taxpayer, the lesser of the employee’s earned income or the spouse’s earned income). To avoid a double benefit, the otherwise eligible expenses for computing the child and dependent care credit are reduced by the amount of the assistance excluded from gross income.
How do you compute the Child and Dependent Credit?
The credit is 35% of the qualifying expenses after the ceiling limitations of $3,000 or $6,000 have been applied. However, the Child and Dependent Credit rate is reduced by one percentage point for each $2,000 or fraction thereof of adjusted gross income (AGI) in excess of $15,000 but goes no lower than 20%. The minimum credit of 20% is applied once a taxpayer’s AGI exceeds $43,000.
Dependent Care Assistance Example:
Vincent and Vicki are married, file a joint return, and have three children under age 13. Vincent and Vicki’s employment-related earnings are $25,000 and $10,000, respectively. Assume their AGI is $37,000. They incur $9,000 of childcare expenses during the current year. The eligible childcare expenses are limited to $8,000 because Vincent and Vicki have more than one child who is qualified and this limitation is less than Vicki’s earned income or the actual expenses incurred.
Suppose Vincent was reimbursed $4,000 under a qualified dependent care assistance program by his employer and this amount was excluded from his gross income. As $4,000 was excluded under a qualified dependent care assistance program, expenses eligible for the child and dependent care credit must be reduced. Therefore, the eligible childcare expenses are reduced to $4,000 ($8,000 - $4,000) and the childcare credit is $2,000 (0.50 x $4,000).
Sent in email question on $8000 limit
In the case of a married taxpayer, the dependent care assistance exclusion amount is limited to the greater of the employee’s earned income or the earned income of the spouse.
* False
* True
False.
The exclusion amount is limited to the lesser of the employee’s earned income or the earned income of the spouse.
Describe the American Opportunity Tax Credit (AOTC)
Qualifying taxpayers are allowed up to a $2,500 credit for tuition and related expenses paid during the taxable year for each qualified student through the American Opportunity Tax Credit (AOTC). Qualified tuition and related expenses include tuition and fees required for enrollment, as well as course materials such as textbooks. Qualifying expenses do not include room and board, student activity fees, and other expenses unrelated to an individual’s academic course of instruction. The AOTC applies to expenses paid after December 31, 1997, for education furnished in academic periods beginning after such date.
