Individual Taxation: Income Tax and Credits

Question 1

How are income taxes calculated?

Answer 1

There is a table listing different filing statuses and ranges within which a tax rate applies

E.g. for 2013, a MFJ return will have all income between $72,500 and $146,400 taxed at 25%

Question 2

Does the tax rate apply to the entirety of an individual’s income?

Answer 2

No, since then people would be penalized for barely reaching a higher tax rate

Instead, everybody with a given filing status receives the same tax rate for a given range of income, and then only those whose income exceeds that range have the higher tax rate apply to that range of income, and so on

Question 3

Can a taxpayer be taxed for his children’s unearned income?

Answer 3

Yes, so long as they are under age 14 by year-end

This amount is added to the parent’s income and taxed at that rate, though an amount can be deducted

Question 4

How much can be deducted from a taxpayer’s children’s unearned income?

Answer 4

For 2013, it is the sum of $1000 and either (a) $1000 or (b) the total itemized deductions relating to that unearned income

Question 5

What is the alternative minimum tax (AMT)?

Answer 5

Implemented to ensure that taxpayers did not get off easy with their deductions – this provides a minimum tax that must be calculated and compared to a regular tax liability, with the greater amount being the taxpayer’s actual liability

Question 6

Does a taxpayer receive any sort of benefit for paying an AMT?

Answer 6

The difference between the regular tax liability and AMT can be carried forward indefinitely and applied to future regular taxes (as a tax credit), though not to future AMTs

Question 7

What is the formula to calculate AMT?

Answer 7

Regular taxable income
\+ net operating loss deduction
\+/- AMT adjustments
\+ tax preferences
= AMT income (AMTI)
- exemption
x AMT rate
- various credits
= AMT

Question 8

What is the net operating loss (NOL) deduction?

Answer 8

Any deduction for having a NOL in a business for a given year (or carried to this year from a different tax year)

This has to be added back to compute AMT

Question 9

What are some items included in AMT adjustments?

Answer 9

(1) standard deduction
(2) second-tier miscellaneous deductions
(3) itemized deductions
(4) tax refunds
(5) interest expenses from investments

For this and other categories when calculating AMT, you will want to look up these items in the authoritative literature

Question 10

How does the exemption (subtracted from AMTI) work?

Answer 10

There is a given exemption for each filing status, though this exemption is phased out over a particular threshold

Question 11

What are the AMTI exemptions?

Answer 11

For 2013,
MFJ/SS: $80,800
S/HH: $51,900
MFS: $40,400
Estates/trusts: $23,100

Phase-out thresholds:
MFJ/SS: $153,900
S/HH: $115,400
MFS: $76,950
Estates/trusts: $76,950

Question 12

How does the AMTI exemption phase-out work?

Answer 12

If the AMTI surpasses the phase-out threshold, the exemption is decreased by 25% of the amount over the threshold

Thus the phase-out range is four times the exemption amount

Question 13

What is the AMT rate?

Answer 13

For 2013, if the AMTI (minus the exemption) is less than $179,500, the AMT rate is 26%

Otherwise it is 28%

This threshold is cut in half for MFS status

Question 14

Which credits are permitted to reduce AMT?

Answer 14

(1) refundable child tax credit
(2) retirement savings credit
(3) foreign tax credit

Question 15

How do tax credits differ from deductions?

Answer 15

Deductions reduce the amount of taxable income, i.e. the amount of money subject to a tax rate

Credits reduce the tax liability directly

Question 16

What is the difference between refundable and nonrefundable tax credits?

Answer 16

Both directly reduce one’s tax liability, but refundable credits can also result in a refund by reducing one’s tax liability below zero

Question 17

What is the earned income credit (EIC)?

Answer 17

A refundable credit for those who have earned low incomes in a given year – applies especially if the taxpayer has qualifying children

Also called the earned income tax credit (EITC)

Question 18

What are the general requirements to attain the EIC?

Answer 18

(1) if married, must have filed jointly
(2) must be eligible to work in the U.S.
(3) must have earned taxable income

Question 19

Who counts as a qualifying child for an EIC?

Answer 19

(1) shares taxpayer’s U.S. residence for more than half the year
(2) is permanently disabled, under 19 or, if a full-time student, under 24
(3) is the taxpayer’s child, stepchild, sibling, or a descendant thereof (or a foster child)
(4) has valid SS number

Question 20

If a taxpayer does not have a child, can he still claim the EIC?

Answer 20

Yes, though it will be reduced

Must be 25-65 years old

Question 21

How much of an EIC does an eligible taxpayer receive?

Answer 21

The number of qualifying children determines a credit rate (percentage) that reduces the amount of taxable income

There is a max income to which this rate applies, and above this max income is a phase-out threshold at which the credit begins to disappear

Question 22

What is the child tax credit?

Answer 22

A refundable credit for each qualifying child – $1,000 per child

Question 23

Who are qualifying children for the child tax credit?

Answer 23

Any children who qualify as dependents and are under age 17 at year-end

Question 24

When does the child tax credit not apply?

Answer 24

When the AGI begins to phase out

For each $1,000 (rounding up) over the phase-out threshold, the credit is reduced by $50

Question 25

How do nonworking spouses relate to the child tax credit?

Answer 25

Ordinarily both spouses must be working to attain the credit, but one can be a full-time student (or incompetent) and the couple can still qualify

Question 26

What is the adoption tax credit?

Answer 26

A credit for qualified adoption expenses

If married, must be a joint filing

Question 27

To what extent is the child tax credit refundable?

Answer 27

The excess of 15% of the taxpayer’s earned income over $3,000 can be refunded

For families with three or more kids, excess of SS taxes over the earned income credit is the refundable amount

Question 28

For what year should the adoption tax credit be claimed?

Answer 28

Either the year the adoption occurred or the year payment occurs, whichever is later

Question 29

How much is the adoption tax credit?

Answer 29

The amount actually spent on adoption expenses, except insofar as they’re reimbursed – and up to a maximum credit (for 2013, $12,970)

Adopters of special-needs children automatically receive the maximum credit

Question 30

What is the child and dependent care credit?

Answer 30

A non-refundable credit for unreimbursed child care expenses paid by the taxpayer

Amount ranges between 20-35% of qualifying expenses, with a max of $3,000 for one qualifying dependent and $6,000 for any higher number

Question 31

Is there a phase-out amount for the adoption tax credit?

Answer 31

Yes, though credits lost through a phaseout can be carried forward for five years

The 2013 phaseout range is $194,580 - $234,580

Question 32

How do nonworking spouses relate to the child and dependent care credit?

Answer 32

There must be at least one working spouse for the credit to count, but any spouses who are either (1) incapable or (2) full-time students count as “working” for this definition

For calculating the phaseout, nonworking spouses are treated as earning $250 per month for one child and $500 per month for any higher number

Question 33

How does the child and dependent care credit phase out?

Answer 33

According to 2013 numbers, for an AGI of $15,000 or less, the credit is for 35% of eligible expenses – but this reduces 1% for each $2,000 increase in AGI, though no further than 20%

Question 34

What is the foreign tax credit?

Answer 34

A nonrefundable credit for taxes paid to a foreign government, whether through foreign employment or foreign investments

Usually the taxpayer can choose between a deduction for this or a credit

Question 35

What is the elderly and disabled credit?

Answer 35

A nonrefundable credit for taxpayers who are either age 65 or permanently disabled

Requires both (1) AGI and (2) nontaxable income from annuities, SS, pensions, and disability income to be sufficiently low

Question 36

How do (nonrefundable) education credits generally work?

Answer 36

They only apply to tuition and other higher-education fees inasmuch as they are not paid for by scholarships – though these fees still generate a credit if they are paid for with gifts, bequests, or student loans

Question 37

What is the general business tax credit?

Answer 37

A nonrefundable credit which is actually a collection of various different business tax credits intended to promote research, reforestation, oil recovery, etc.

Question 38

What are some miscellaneous kinds of nonrefundable tax credits?

Answer 38

Credits for…

(1) saving for retirement
(2) driving an electric (but not hybrid) car
(3) retaining workers
(4) small employers offering healthcare insurance

Question 39

Can a dependent ever claim an education credit?

Answer 39

No, although if he pays for his higher-education fees, then his parents can still claim it on their return