Chapter 9                            p.557         Deductions & Credits

Taxation of business enterprises on the net accrual to wealth necessitates enabling deductions for the cost/expenses of producing the income derived from that business.

What availability of deductions for individuals: (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, but what about  “personal deductions”?

Tax Computation for Individuals               p.559

Gross Income

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
p.560    

Gross income - §61

Less:  Business expenses (the “above-the-line” deductions) – deducting the costs for earning  business income. 

See (for individuals) Code §62(a)(1) through (21) identifying those deductions which are available towards determine AGI.

Personal Exemption &  Standard Deduction P.563

Personal exemption ($4,050 for 2016).

Subject to an annual inflation adjustment.

Previously no phase-out of the personal deduction; but, phase-out in 2016 for high-income taxpayers. §151(d)(3). & next slide.

2) Standard deduction for 2016 ($6,300 for single person; $12,600 for a married couple). §63(c)(2).  Annual inflation adjustment applies.

Additional standard deduction available for aged and blind persons. 

Personal Exemption
p.563-4                & Ch. 17

§151 provides each taxpayer a “personal exemption” & two exemptions for a joint return if married.  Amount for 2016 - $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?

Problems
p.565    

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).

§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 permitted for personal expenditures, including:

Employee business expenses.

Personal interest expense

State and local taxes

Charitable contributions

Medical expenses

6)  Casualty or theft losses.

Miscellaneous Itemized Deductions            P.566

See §67 – an additional limitation on deductions is imposed.  These deductions are only allowable to the extent they exceed 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 a tax rate increase accomplished outside the usual tax brackets?

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 the 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 2016) is $311,300 for a joint return & $259,400 for an unmarried individual.

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 transmitted to IRS by 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.

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. 

Chapter 9