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Chapter 2
Tax Determination, Payments, and Reporting Procedures
©2002, CCH INCORPORATED
4025 West Peterson Ave.
Chicago, IL 60646-6085
http://tax.cchgroup.com
CCH Essentials of Federal Income Taxation
Taxpayer Filing Status by Rank(for same amount of income)
Married filing separately
Single
Head of household
Married filing jointly [also, qualifying widow(er)]
CCH Essentials of Federal Income Taxation 2 of 38
Highest Tax
Lowest Tax
Chapter 2
Federal Taxes Withheld
• Income
– Based on three factors
• Amount earned / period
• Marital status
• exemptions & deductions
• FICA (social security and Medicare)
– 6.2% on first $97,500 of wages
– 1.45% on all wages for HI
CCH Essentials of Federal Income Taxation 3 of 38Chapter 2
Tax Rate Schedules—example p. 2-3Step 1 Choose the correct rate schedule (based on
filing status).
Step 2 Locate the proper income bracket and note the tax applicable to the lowest income in that bracket.
Step 3 Subtract the lowest income in that bracket from taxable income.
Step 4 Multiply this difference by the listed tax rate.
Step 5 Add this result to the tax in step 2 to arrive at the tax on taxable income.
CCH Essentials of Federal Income Taxation 4 of 38Chapter 2
• Jesse James is a single taxpayer who has a 12 year old dependent son who live with him. Jesse’s income came from his salary which was $148,500; interest of $225 and dividends of $2,400. Calculate his income tax liability.
CCH Essentials of Federal Income Taxation 5 of 38
Tax Tables—back of book
• Tax Table Cannot Be Used by:
• A person filing for a short period (less than 12 months) because of a change in accounting period
• A person claiming the foreign earned income exclusion
• A person filing Form 1040 with taxable income of $100,000 or more
• An estate or trust
CCH Essentials of Federal Income Taxation 6 of 38Chapter 2
• Amanda and Samuel Adams are married and lived together during the tax year, with their two children, both under age 19. Amanda works one job and earned $29,500. Samuel worked two jobs and earned $18,500 on the first, and $11,400 on the second. Samuel also earned tips of $4,650. They have no other source of income. Find their tax liability.
CCH Essentials of Federal Income Taxation 7 of 38
Excess Social Security Tax
Sometimes employees have too much in OASDI taxes withheld from their wages. Too much withholding can occur when a person works for two or more employers. Taxpayers can recover the excess through the tax reporting system.
How much must a taxpayer earn before excess OASDI taxes occur?
CCH Essentials of Federal Income Taxation 8 of 38Chapter 2
Assignment
•Chapter 2 Problems 1--4
CCH Essentials of Federal Income Taxation 9 of 38
Tax Credits
• Use to reduce tax liability after tax is determined
• Refundable credits—guarantee a payment from the givernment even when the amount of the credit exceeds the tax liability
• Nonrefundable—taxpayer will not receive a refund for the credit if their tax liability is zero
CCH Essentials of Federal Income Taxation 10 of 38
Personal Tax CreditsNonrefundable
• Child and dependent care credit
• Elderly or disabled credit
• Adoption credit
• Child tax credit
• Education credits
• Retirement savings contributions credit
• Hybrid automobile credit
• Residential energy credits
Refundable
• Earned income credit
• Additional child tax credit
• Federal tax withholdings and payments
• Excess OASDI taxes withheld
CCH Essentials of Federal Income Taxation 11 of 38Chapter 2
Nonrefundable Credits
Most tax credits are nonrefundable. Nonrefundable credits can reduce the taxpayer’s regular tax liability to zero but cannot result in refund.
CCH Essentials of Federal Income Taxation 12 of 38Chapter 2
Tax Credits—Guaranteed?
Refundable Credits
• Credit for federal income tax withheld or paid toward the current year’s tax liability
• Earned Income Credit (EIC)
• Additional child tax credit
• Excess OASDI tax withheld
CCH Essentials of Federal Income Taxation 13 of 38Chapter 2
Child and Dependent Care Credit
See page 2-10--11Qualified expenses are the amounts taxpayers spend for child and dependent care so that they can work, look for work, or go to school.
Maximum expense allowed is $3000/$6000
Credit amount ranges from 35% down to 20% of AGI
This is Nonrefundable
Uses form 2441 or Schedule 2, p. 2-13
CCH Essentials of Federal Income Taxation 14 of 38Chapter 2
Child and Dependent Care CreditQualified person: The taxpayer must maintain a home where one of the following persons live:
– A child under age 13 whom the taxpayer may claim as a dependent
– A dependent physically or mentally unable to provide self-care
– A spouse physically or mentally unable to provide self-care
CCH Essentials of Federal Income Taxation 15 of 38Chapter 2
Child Tax Credit
Pages 2-19--21
Taxpayers may be able to claim a credit of $1,000 for each qualifying child, if:
– The child is a descendent, stepchild, or foster child of the taxpayer who is under the age of 17 as of the end of the tax year, or permanently and totally disabled
– The child is a citizen, national, or resident of the U.S.
– The child can be claimed as a dependent on the taxpayer’s tax return
CCH Essentials of Federal Income Taxation 16 of 38Chapter 2
Child Tax Credit
The full child credit is available only to taxpayers whose AGI does not exceed $75,000 (single) or $110,000 (married).
This credit is both refundable and nonrefundable.
CCH Essentials of Federal Income Taxation 17 of 38Chapter 2
Additional Child Tax Credit
• This is the refundable part of the Child Tax Credit
• Taxpayers unable to benefit completely from the child tax credit as a nonrefundable credit can claim a refundable child tax credit to the extent that 15% of their earned income exceeds $11,750.
• Uses form 8812 (page 2-21)
CCH Essentials of Federal Income Taxation 18 of 38
CCH Essentials of Federal Income Taxation 19 of 38
Education Tax Credits (College tuition) (Nonrefundable)
Applies toward what is actually paid Page 2-14
• HOPE scholarship credit– Maximum of $1,650 per eligible student
– Only for first two-years of college
– Must be at least ½ time student, in a degree program
– No felony drug convictions
– AGI limits:• Phaseout begins at $47,000 or $94,000
• May be claimed for yourself or your dependentCCH Essentials of Federal Income Taxation 20 of 38
Chapter 2
Education Tax Credits (College tuition) (Nonrefundable)
Applies toward what is actually paid
• Lifetime learning credit– Maximum of $2,000 per taxpayer, per year
– Any post-secondary education courses to acquire or improve job skills
– Unlimited number of years
– Student does not need to be seeking degree
– No minimum enrollment for credits
– No felony drug convictions
– Phaseout begins at $47,000 or $94,000
– May be claimed for yourself or your dependent
CCH Essentials of Federal Income Taxation 21 of 38Chapter 2
Earned Income Credit—Refundable p. 2-25Eligible individuals:• Must be over 24 years old, but not more than 64, at
the end of the year• Cannot be claimed as a dependent by another
taxpayer• OR Have a qualifying child (relationship, residency, age,
citizen) The child does have to meet the <50% rule self-support rule.
• Child is usually qualified for the custodial parent• Unmarried child does not have to be the taxpayer’s
dependent• Taxpayer must have “earned income”• Married couples must file “jointly”• May be taken as you earn (Advance EIC)• See EIC tables in text appendix
CCH Essentials of Federal Income Taxation 22 of 38Chapter 2
Adoption Credit--Nonrefundable
• Taxpayers adopting a child under age 18 (or one incapable of self-care) may receive a tax credit. The credit is available for qualified adoption expenses including court costs, legal fees, agency fees, and other adoption-related expenditures.
• The credit is limited to $11,390.
• Phaseout starts at AGI of $170,820
• Other conditions in Pub 17
CCH Essentials of Federal Income Taxation 23 of 38Chapter 2
Retirement Savings Contribution Creditp. 2-22
• A nonrefundable credit of up to $1,000 (50% or less of $2,000 of contribution) is available for contributions to a retirement savings plan.
• It is in addition to any deduction or exclusion relating to the contribution. The credit amount depends on filing status and AGI.
• Targeted to taxpayers below $26,000/52,000 AGI
• Phaseouts reduce % allowed
CCH Essentials of Federal Income Taxation 24 of 38Chapter 2
Foreign Tax Credit
This nonrefundable credit applies to both individuals and corporations. This credit reduces the U.S. income tax by the taxes paid to foreign countries, which prevents foreign income from being taxed twice. Individuals can deduct foreign taxes paid as an itemized deduction.
CCH Essentials of Federal Income Taxation 25 of 38Chapter 2
Credit for the Elderly or the DisabledP. 2-14
Taxpayers age 65 or older, and taxpayers under 65 who retire with a permanent and total disability, may receive a special nonrefundable credit.
Primarily, this credit benefits elderly, low-income taxpayers who receive little or no social security income.
Use schedule 3 or schedule R
See Pub 17, p. 219
CCH Essentials of Federal Income Taxation 26 of 38Chapter 2
Alternative Motor Vehicle Creditp. 2-24
• Called the “hybrid vehicle credit”
• Varies for type of vehicle
• May be limited or eliminated depending on sales of cars that qualify
• Credits range from $250 to $3400
• See. Pub 17 p. 247
CCH Essentials of Federal Income Taxation 27 of 38
Residential Energy Credits
• 10% credit for qualified home energy efficiency improvements like insulation, new windows/doors, high-efficiency heating or cooling or hot water appliances
• 30% credit for alternative energy installations involving solar or fuel-cell items
• See Pub 17 p. 248
CCH Essentials of Federal Income Taxation 28 of 38
Form 1040EZ
Users of Form 1040EZ must:
• Be single or joint filers, under age 65 and not blind
• Claim the standard deduction
• Make no claim for a dependency exemption
• Have very limited sources of gross income
• Have taxable interest income of $1,500 or less
• Have taxable income of less than $100,000
• Have no dividend income
• Not earn $20 or more in monthly tips from one employer that are omitted from Form W-2
• Not receive any advance earned income credit (EIC) payments
CCH Essentials of Federal Income Taxation 29 of 38Chapter 2
Form 1040A• Only taxpayers with taxable incomes of less than $100,000
can use Form 1040A
• Form 1040A permits more types of income than Form
1040EZ, but fewer types than Form 1040
• Form 1040A permits only four deductions for AGI:
– A qualifying IRA contribution
– Certain interest on student loans
– Educator expenses
– Tuition and fees deduction
• This form allows taxpayers to reduce AGI only by the
standard deduction and allowable exemptions
CCH Essentials of Federal Income Taxation 30 of 38Chapter 2
Form 1040
Taxpayers must use Form 1040 when they do not qualify to use either Form 1040EZ or Form 1040A. They may also elect Form 1040 over one of these other forms to save taxes (more deductions and credits are available). This form provides for all types of income, deductions, credits, and other taxes that might be owed.
CCH Essentials of Federal Income Taxation 31 of 38Chapter 2
Extensions of Time to File
CCH Essentials of Federal Income Taxation 32 of 38Chapter 2
Entity
Individual (Form 1040,
1040A, or 1040EZ)
Automatic
Second Extension
Partnership (Form 1065)
Automatic
Second Extension
S Corporation (Form 1120S)
Automatic
C Corporation (Form 1120
or 1120A)
Automatic
Form Number
for Extension
Form 4868
Form 2688
Form 8736
Form 8800
Form 7004
Form 7004
Extension of Time
Four months
Up to two more months
Three months
Up to three more months
Six months
Six months
Tax Penalties
CCH Essentials of Federal Income Taxation 33 of 38
Type of Penalty Amount of Penalty
Failure to file 5% of amount due for each month or fraction of
month that the return is late (maximum penalty = 25%)
Failure to pay .5% of amount due for each month or fraction of
month that the return is late (maximum penalty = 25%)
Accuracy-related 20% of tax due
Fraud 75% of tax due (accuracy-related penalties
will not also be applied)
Fraudulent return $10,000 and/or one year in prison
Frivolous return filing $500
Criminal intent to defraud $100,000 and/or five years in prison
Preparer penalties From $5 to $500 for each wrongful act
Improper disclosure of $1,000 and/or 1 year in prison
information acquired
from a taxpayer by a
tax preparer
Chapter 2
Reasonable Cause
• Death or serious illness
• Unavoidable absence
• Destruction of certain facilities or records
• Timely mailing
• Wrong filing place
• Reliance on competent tax advisor
• Unobtainable records
• IRS office visit in which an IRS employee was unable to be seen for reasons beyond taxpayer control
• Erroneous IRS information
CCH Essentials of Federal Income Taxation 34 of 38
The IRS lists the following circumstances as reasonable
causes for failure to comply with the tax laws:
Chapter 2
Common Information Returns
Form 1099-DIV, Dividends and Distributions
Form 1099-INT, Interest Income
Form 1099-G, Certain Government Payments
Form 1098, Mortgage Interest Statement
Form 1099-MISC, Miscellaneous Income
Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc.
Form 1099-B, Proceeds from Broker and Barter Exchange Transactions
Form 1099-S, Proceeds from Real Estate Transactions
Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips
Form 5498, Individual Retirement Arrangement Information
CCH Essentials of Federal Income Taxation 35 of 38Chapter 2
Audit Process
An IRS computer checks for the following errors:
• An error in arithmetic shown on the return
• Incorrect use of any IRS table, if such use is apparent from the existence of other information on the return
• Inconsistent entries on the return
• Omission of information necessary to substantiate a return entry
• Entry of a deduction or credit item that exceeds a statutory limit based on information appearing on the return
CCH Essentials of Federal Income Taxation 36 of 38Chapter 2
Factors Affecting a Return’s Selection for Audit
• Large gross income
• Self-employed taxpayers with high incomes and large deductions
• Cash businesses (e.g., restaurants, service businesses)
• Excessive itemized deductions in relation to income level
• Claims for large refunds
• Disagreement between reported income and information returns (e.g., Form 1099, Form W-2)
• A large increase in exemptions
• A major decrease in rental income
• Informant information
• Prior tax deficiencies
CCH Essentials of Federal Income Taxation 37 of 38Chapter 2
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