Discussion Questions

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I:14-1

Chapter I:14

Special Tax Computation Methods, Tax Credits, and Payment of Tax

Discussion Questions

I:14-1 Most individual taxpayers are not subject to the alternative minimum tax (AMT) because they do not have substantial tax preferences and AMT adjustments and because there is a generous exemption amount to reduce the tax base on which the AMT is calculated. p. I:14-2.

I:14-2 No, the alternative minimum tax does not apply if an individual’s tentative minimum tax is less than his regular tax liability. It applies only if the tentative minimum tax exceeds the

regular tax liability. p. I:14-2.

I:14-3 b only. Only excess depreciation for real property placed in service before 1987 is a tax preference item. For tax years prior to 1987, net long-term capital gains were a tax preference item (i.e., the 60% long-term capital gain deduction) and for taxable years prior to 1993 the appreciated portion of the fair market value of capital gain real property contributed to charity

was a tax preference item. p. I:14-4.

I:14-4 a, b, c only. Itemized deductions that are not allowed in computing AMTI, excess depreciation on real property placed in service after 1986, and excess MACRS depreciation for personal property placed in service between 1987 and 1998, are all AMT adjustments. Tax- exempt interest is not an AMT adjustment but may be a tax preference item if the bonds are private activity bonds. pp. I:14-4 through I:14-6.

I:14-5 a, b, e only. Charitable contributions and mortgage interest related to the purchase of a personal residence are deductible when computing AMT. Medical expenses in excess of the 7.5% floor are deductible for AMT. Investment interest is deductible up to the amount of qualified net investment income. Because the individual has no investment income, the investment interest expense is not deductible. pp. I:14-4 and I:14-5.

I:14-6 Most people are not subject to the self-employment tax because they are classified as employees for tax purposes. Employees pay employment taxes through withholding and in

amounts that must be matched by their employers. p. I:14-8.

I:14-7 Tony will be required to pay FICA taxes on wages and net self-employment (SE) earnings (92.35%*SE earnings). The Social Security portion of FICA taxes (6.2% on wages and 12.4% on net SE earnings) applies up to $176,100 ceiling (2025). The Medicare portion of FICA taxes (1.45% on wages and 2.9% on net SE earnings) applies to all earnings without a ceiling.

Tony’s net SE earnings equal $55,410 (92.35%*$60,000).

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I:14-2

If Tony continues as an employee, the Social Security portion of FICA will be imposed on his salary of $90,000 and on $86,100 ($176,100 ceiling − $90,000 salary) of his net SE earnings.The Medicare portion will be imposed on both his employee earnings and his net SE earnings.

If Tony retires and no longer earns a salary, the Social Security portion of FICA will be imposed on his net SE earnings ($55,410) and the Medicare portion will be imposed on his net SE earnings ($55,410).

As shown below, because the Social Security portion of FICA will apply to all of his net SE earnings, Tony’s consulting earnings after payroll taxes will increase by $3,805 after he retires.

While an employee and consultant:

Net employee earnings = $90,000 – (7.65% x $90,000) = $83,115 Net consulting earnings = $60,000 – [12.4% x ($176,100 – $90,000 salary)] – (2.9% x

$55,410) = $47,717

Total earnings after FICA taxes = $83,115 + $47,717 = $130,832

While a consultant only:

Net consulting earnings = $60,000 – (12.4% x $55,410) – (2.9% x $55,410) = $51,522 Total earnings after FICA taxes = $51,522

Difference (after retirement) in consulting earnings: $51,522 − $47,717= 3,805

pp. I:14-8 and I:14-9.

I:14-8 If the engagement is set up as a consulting arrangement rather than an employment contract, then the consulting firm will be able to avoid making matching FICA contributions for Theresa’s earnings and will not be required to withhold the employee’s share of FICA tax. If the compensation paid to Theresa would be the same whether she was an employee or independent consultant, the cost of Theresa’s services would be less if she were a consultant rather than an employee. Theresa, if paid as a consultant, will be subject to the self-employment tax. If her income as an employee (e.g., college professor) is in excess of the ceiling amount for the Social Security portion of self-employment income, she will not be subject to the 12.4% Social Security portion of the tax. She will however, be subject to the 2.9% Medicare portion on her self- employment income. Thus, receiving compensation as a consultant is more expensive to Theresa because she bears both the employer and employee sides of the FICA tax. p. I:14-8.

I:14-9 a. The couple’s AMT exemption equals $137,000 (2025). Their alternative minimum taxable income is below the threshold for the phaseout ($900,000 < $1,252,700

[2025]).

• If the couple’s AMTI increases by $400,000, their AMT exemp tion will be

$125,175. $137,000 – [25% x ($1,300,000 − $1,252,700)] = $125,175 pp. I:14-3 and I:14-4.

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I:14-3

I:14-10 a. Foreign tax credits are provided to reduce the effect of double taxation on foreign source income.

• The research credit is given to encourage (reduce the after tax cost of) research

and development activities.

• Business energy credits are incentives to encourage energy conservation measures

and the use of fuel other than petroleum.

• The premium tax credit is designed to make the cost of health insurance more

affordable for taxpayers with modest household incomes.

• The child and dependent care credit was enacted to reduce the cost of child care

for parents and other individuals who must incur expenses for household and dependent care services while they are away from home at work.

• The earned income credit is designed to encourage low-income individuals to

become gainfully employed or to continue to work despite low earnings.

• The purpose of the American Opportunity tax credit is to reduce the cost of

postsecondary education for low and middle income taxpayers.

• The adoption credit is designed to reduce the financial burdens associated with

adopting children. Topic Review I:14-2 on p. I:14-26.

I:14-11 To a taxpayer in the 12% marginal tax bracket, a $200 deduction is worth $24 in tax savings and is therefore worth less than a $40 credit. To a taxpayer in the 22% marginal tax bracket, the deduction is worth $44 in tax savings, more than a $40 credit. Thus, for all taxpayers with a marginal tax rate of 22% or more, the deduction is more advantageous than the credit. p.

I:14-10.

I:14-12 The general business credit includes the work opportunity credit, the rehabilitation expenditures credit, research credit, business energy credits, and the disabled access credit.pp. I:14-19 through I:14-23.

I:14-13 a. The general business credit may not exceed the smaller of: (1) net income tax minus the tentative AMT or (2) net income tax minus 25% of the “net regular tax” in excess of $25,000. The first limit prevents the credit from reducing the tax liability to less than AMT. The second limit prevents the credit from entirely eliminating the tax liability of high-income taxpayers.

• The general business credit is a nonrefundable credit and has a lower priority than

personal tax credits. An individual must use personal tax credits as well as the foreign tax credit to offset tax liability before the general business credit is used. Since the credit is nonrefundable, if the tax liability is eliminated by credits with a higher priority than the general business credit, the taxpayer will only be able to carryback or carryforward the unused general business credit.

• The general business tax credit may be carried back 1 year and any remaining

credit may be carried forward 20 years. Credits carried forward from prior years (commencing with the earliest carryover years) are used before credits arising from the current year. p. I:14-23.

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