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 imposed on a gross receipts basis.   Such a tax would be an excise or a sales tax rather than an income tax.

Deductions for Individuals

Query:  What is the availability of deductions for individuals when:

(1) not engaged in a “trade or business,” or

(2) having an “investment” producing income?

Certain deductions are available when attributable to generating gross income (e.g., to determine “AGI”).

What about  “personal deductions”, i.e., costs unrelated to generating gross income?

Tax Computation for Individuals               p.559

Gross Income (after any CGS offset) - §61

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)).

Pre-2018, also, a deduction was available for personal exemption(s). §151(a)).  Suspended.

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.

Cf., “below the line” deductions – eliminated in 2017 tax legislation (through 2025).

Personal Exemption &  Standard Deduction P.563

Personal exemption ($4,050 for 2017).  §151.

Subject to an annual inflation adjustment.

Amount for 2018-2025:  zero.  §151(d) per 2017 TCJA.                                       & see next slide.

2) Standard deduction for 2018 ($12,000 for single person; $24,000 for a married couple). §63(c)(2).  Annual inflation adjustment applies.

Additional standard deduction available for aged and blind persons. $1,300 or $1,600 for 2018. §63(f).

Prior Personal Exemption
p.563-4                & Ch. 17

§151 provided each taxpayer a “personal exemption” & two exemptions for a joint return if married.  Pre-TCJA amount for 2018 - $4,150. 

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 on their income tax returns.

This 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.

TCJA-2017 increases taxpayers who will not itemize deductions.

Problem 1
p.565    

Child has $3000 interest income from bonds received by gift.

1)  Personal exemption suspended (previously limited). §151(d)(2).

2)  Child has limited standard deduction ($1,050 in year 2018). §63(c)(5) & Rev. Proc. 2018-18.

3) §1(g) – special rules for the “kiddie tax” – tax (previously) at the parent’s marginal tax rate; under TCJA – at trust income tax rates (§1(e)).

Problem 2
p.565    

Child realizes $5,000 of summer earnings.

This income is not subject to the “kiddie tax” since “earned income.”

No personal exemption.

Standard deduction:  greater of $1,050 or

$350 plus individual’s earned income.  §63(c)(5). See Rev. Proc. 2018-18 (limited to $12,000?).

Itemized Deductions P.565

“Itemized” deductions (§63(d)) are deductions permitted for personal (i.e.,  not business) expenditures, including:

Employee business expenses (§67) (? TCJA)

Personal interest expense (§163)

State and local taxes (§164)

Charitable contributions (§170)

Medical expenses (§213)

Casualty or theft losses (§165(c))

Additional limitations apply to these deductions.

Miscellaneous Itemized Deductions            P.566

Prior §67 – an additional limitation on certain deductions was imposed.  These deductions were only allowable to extent exceeding 2% of AGI.  These deductions (§67(b)) include(d):

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?

Miscellaneous Itemized Deductions, continued

TCJA 2017 – “miscellaneous itemized deductions” are not allowed as below the line deductions for tax years 2018-2025.

But, available for federal income tax returns being filed for 2017 (and, unless changed, in 2026 and thereafter).

Is this repeal of these deductions a “tax increase”?

Rev. Rul. 2012-25
p.569    

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” deductions are reduced under §68 (providing an overall limit) by the lesser of:

3 percent of AGI, or

80 percent of itemized deductions.

“Applicable amount” (in 2018) was to be $320,000 for a joint return & $266,700 for an unmarried individual.

TCJA 2017 & §68(f) – suspension of this limitation for years 2018-2025.

Rate Schedules        p.577

Code §1  - under TCJA-2017 separate progressive income tax rate brackets for:

Married filing jointly (37% at $600,000).

Heads of households (37% at $500,000).

Unmarried individuals ($37% at 500,000).

Married filing separately (37% at $300,000).

Trusts and estates (37% at $12,500).

Rates are indexed -  §1(f)(3).

Plus: Obamacare tax on passive income – 3.8% tax rate – Code §1411 (retained after TCJA).

Tax Credits                 
p. 578   

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
P.579         “Refundable”

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

income limitations/phaseouts.

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.  No changes in TCJA.

Child tax credit - § 24 (next slide).

Adoption credit - § 23.

4)  Hope Scholarship credit, etc. - §25A.

Child Tax Credit - §24

Taxpayer has a $2,000 credit for each qualifying child under age 17 (increased from $1,000 in TCJA-2017) for years 2018-2025.  §24(h).

Partial credit for other dependents.  Subject to a phase-out when “modified adjusted gross income” is above a “threshold amount.”

The credit is partially refundable. §24(d) (up to $1,400 under TCJA-2017).

No/partial? credit if name of child and SS number not included on the return.  §24(e).

Chapter 9