Chapter 9 p.557 Deductions & Credits
Taxation of business enterprises is on the basis of the net accrual to wealth.
This necessitates enabling deductions for the cost/expenses of producing the income derived from that business activity.
Taxation is not on a gross receipts basis. Such a tax would be an excise or a sales tax.
Deductions for Individuals
What availability of deductions for individuals when:
(1) not engaged in a “trade or business,”
(2) having an “investment” producing income?
Certain deductions are available when attributable to generating gross income.
What about “personal deductions”, i.e., unrelated to generating gross income?
Tax Computation for Individuals p.559
Gross Income (after any CGS offset)
Less: Above the Line Deductions - §62
Equals: Adjusted Gross Income (AGI) - §62(a)
Minus: “Below the Line” Deductions (Sch. A) (1) itemized deductions (§63(d)), or
(2) the “standard deduction” (§63(c)).
Also, a deduction is available for personal exemption(s). §151(a)).
Equals: Taxable income. §63(a).
Adjusted Gross Income
(or “AGI”) p.560
Gross income - §61
Less: Business expenses (the “above-the-line” deductions) – deducting the costs incurred for earning business income.
See (for individuals) Code §62(a)(1) through (21) identifying those deductions which are available towards determining AGI.
Personal Exemption & Standard Deduction P.563
Personal exemption ($4,050 for 2017). §151.
Subject to an annual inflation adjustment.
Previously no phase-out of the personal exemption; but, phase-out in 2017 for high-income taxpayers. §151(d)(3). & next slide.
2) Standard deduction for 2017 ($6,350 for single person; $12,700 for a married couple). §63(c)(2). Annual inflation adjustment applies.
Additional standard deduction available for aged and blind persons. §63(c).
p.563-4 & Ch. 17
§151 provides each taxpayer a “personal exemption” & two exemptions for a joint return if married. Amount for 2017 - $4,050.
Also, exemption for each “dependent.” §151(c).
Who is a dependent? See (1) “qualifying child” (§152(c)) & (2) a “qualifying relative” (§152(d)).
How allocate exemptions in a divorce? §152(e).
What is the purpose of a “multiple support agreement”? See §152(d)(3).
What about a “foster child”? Missing children?
Effect of the Standard Deduction
The predominant portion of taxpayers claim a standard deduction – and therefore avoid the necessity of itemizing income tax deductions.
Reduces audit responsibilities for the IRS.
The effect of the standard deduction is a zero tax rate on the amount of the income up to the available standard deduction.
Child has $3000 interest income from
bonds received by gift. Parent claims the personal exemption & not the child. §151(d)(2).
Child has limited standard deduction. §63(c)(5).
And, §1(g) – special rules for the “kiddie tax” – tax at the parent’s marginal tax rate.
Child realizes $5,000 of summer earnings.
This income is not subject to the “kiddie tax.”
No personal exemp., but a standard deduction.
Itemized Deductions P.565
“Itemized” deductions (§63(d)) are those deductions which are permitted for personal (i.e., not business) expenditures, including:
Employee business expenses.
Personal interest expense
State and local taxes
6) Casualty or theft losses.
Miscellaneous Itemized Deductions P.566
See §67 – an additional limitation on certain deductions is imposed. These deductions are only allowable to extent exceeding 2% of AGI.
These deductions (§67(b)) include:
Unreimbursed employee business expenses
(§62(a)(1) re employee expense below the line).
Cf., reimbursed employee expense- §62(a)(2)(A)
Investment expenses - §212
Is this really just an income tax rate increase accomplished outside the usual tax brackets?
Rev. Rul. 2012-25
A §62(c) reimbursement arrangement enables a trade or business deduction of the employee towards determining AGI. §62(a)(2)(A).
But are the arrangements described in this Rev. Rul. “accountable plans” under §62(c)?
Holding: None of the described plans qualify - except Situation 4 where reimbursement for cleaning supply expenses occurred with separate reimbursement arrangement and actual deductible expenses were substantiated.
Section 68 – Overall Limit on Itemized Deductions
When AGI exceeds the “applicable amount” then deductions are reduced (under §68, providing overall limit) by the lesser of:
3 percent of AGI, or
80 percent of itemized deductions.
“Applicable amount” (in 2017) is $313,800 for a joint return & $261,500 for an unmarried individual.
Rate Schedules p.577
Code §1 - separate progressive income tax rate brackets for:
Married filing jointly.
Heads of households
Married filing separately.
Trusts and estates.
Rates are indexed - §1(f)(3).
Plus Obamacare tax on passive income – 3.8% tax rate – Code §1411.
Benefit of a personal “tax credit”? Credit is an offset against the tax liability, not against the gross income in reaching taxable income.
I.e., a subtraction occurs against the tentative income tax liability.
Credits can be (1) “refundable’ or (2) “nonrefundable.” What is the difference?
E.g., §31 permits refundable credit status for tax withholding from an employee’s wages (and previously transmitted to IRS by the employer).
Earned Income Tax Credit
File an income tax return and receive a rebate (even if no income tax liability arises).
§32 provides for the allowance of this credit.
The tax credit amount depends upon:
(1) number of dependents, and
primary objective: to encourage working
for one’s support & then reward with a tax credit to enable additional support (& relief from Social Security tax liability).
Other Income Tax Credits
1) §22 – provides a tax credit for the elderly and the disabled – up to 15% of the §22 amount.
Reduction as the §22 amount increases above $7,500 for single persons and $10,000 for joint returns.
Child tax credit - § 24 (next slide).
Adoption credit - § 23.
4) Hope Scholarship credit, etc. - §25A.
Child Tax Credit - §24
Provides a taxpayer a $1,000 credit for each qualifying child under age 17.
Subject to a phase-out when “modified adjusted gross income” is above a “threshold amount.”
The credit is partially refundable. §24(d).
No credit unless the name of child and ID number are included on the return. §24(e).
Subject to a “sunset” provision? Permanent extension in 2013 tax act.