solutions

12-4 2006 Comprehensive Volume/Solutions CHAPTER 12

DISCUSSION QUESTIONS

1. A taxpayer whose marginal tax rate is less than 25% would be better off taking a credit of25%. However, if the marginal rate is greater than 25%, a taxpayer would benefit morefrom taking a deduction. Alternatively, if the item were deductible from AGI (i.e., as anitemized deduction), a benefit would result only if the taxpayer itemized his or herdeductions. p. 12-3 and Example 4

2. Refundable credits are payable to the taxpayer even if the amount of the credit (orcredits) exceeds the taxpayer’s tax liability. Examples of refundable credits include taxeswithheld on wages and the earned income credit.

Nonrefundable credits are not refunded if they exceed the taxpayer’s tax liability.Examples of such credits are the general business credit and the tax credit for the elderlyor disabled. Some nonrefundable credits, such as the general business credit, are subjectto carryover rules if they exceed the amount allowable as a credit in a given year.

pp. 12-4, 12-5, and Exhibit 12-1

3. a. Net income tax is the sum of the regular tax liability and the alternative minimumtax reduced by certain nonrefundable tax credits.

Tentative minimum tax for this purpose is the tentative minimum tax reduced bythe foreign tax credit allowed.

Regular tax liability is determined from the appropriate tax table or tax rateschedule, based on taxable income. However, this term does not include certaintaxes, such as the alternative minimum tax.

Net regular tax liability is the regular tax liability reduced by certainnonrefundable credits, such as the credit for child and dependent care expensesand the foreign tax credit.

b. The general business credit is limited to the taxpayer’s net income tax reduced bythe greater of:

• The tentative minimum tax.

• 25% of net regular tax liability that exceeds $25,000.

p. 12-6

4. Unused general business credits are initially carried back one year and are applied toreduce the income tax during that year. Any remaining unused credits are then carriedforward for up to 20 years. A FIFO method is applied to the carryback, carryovers, andutilization of credits earned during a particular year. p. 12-6

5. Among the relevant tax issues are the following:

• Ability to use tax credits currently and the use of suspended credits. pp. 12-4 to 12-7

• The impact of the at-risk and passive activity loss rules on the deductibility of thelosses and the ability to benefit from the tax credits. Chapter 11

Tax Credits 12-5

• The at-risk amount (how the loan guarantee affects the calculation of the at-riskamount). Chapter 11

• Interaction between the at-risk and passive activity loss rules. Chapter 11

• Applicability of net operating loss rules that would allow John to benefit from anNOL carryback or carryforward. Chapter 7

6. The tax liability in the year of the premature disposition is increased by the differencebetween the tax credit for rehabilitation expenditures that was taken and the credit that isallowed based on the actual holding period. The same treatment applies in those caseswhen an asset ceases to be qualified property. p. 12-8

7. The work opportunity tax credit was enacted to encourage employers to hire individualsfrom one or more of a number of targeted economically disadvantaged groups. Thetaxpayer hiring the members of the targeted group benefits by qualifying for the credit.Examples of such targeted persons include qualified ex-felons, high-risk youths, foodstamp recipients, summer youth employees, veterans, and persons receiving certainwelfare benefits. pp. 12-8 and 12-9

8. The welfare-to-work credit was enacted to encourage employers to hire individuals whohave been long-term recipients of family assistance welfare benefits. Unlike the workopportunity credit, which is available for wages paid in the first year of employmentonly, the welfare-to-work credit is available for qualifying wages paid to eligibleindividuals during the first two years of employment.

The credit is equal to 35% of the first $10,000 of qualified wages paid to an employee inthe first year of employment, plus 50% of the first $10,000 of qualified wages in thesecond year of employment.

pp. 12-9 and 12-10

9. The research activities credit is intended to encourage research and experimentation inthe United States. The qualifying expenditures incurred, usually described as researchand development (R & D) expenditures, give rise to the credit, which is the sum of twocomponents: an incremental research activities credit and a basic research activitiescredit. pp. 12-10 to 12-12

10. Changes qualifying for the disabled access credit must involve the removal ofarchitectural, communication, physical, or transportation barriers that otherwise couldmake a business inaccessible to disabled or handicapped individuals. Examples ofqualifying projects include installing ramps, widening doorways, and adding raisedmarkings on elevator control buttons. Note that the building must originally have beenplaced in service before November 6, 1990 for the expenditures to qualify for the credit.p. 12-13

11. Yes, the earned income credit is a form of a negative income tax because it is arefundable credit even for taxpayers who do not have any income tax liability. p. 12-15

12. In general, the earned income credit is available to individuals whose income is belowcertain thresholds. For example, the earned income credit may be claimed by taxpayerswho have a qualifying child or children in their home and whose earned income or AGIdoes not exceed the thresholds listed in Table 12-2. In addition, the credit is available totaxpayers ages 25 through 64 who have no qualifying children and who cannot be

12-6 2006 Comprehensive Volume/Solutions

claimed as a dependent on another taxpayer’s return. For these situations, the credit isavailable even though a qualifying child is not living with the taxpayer, but it is notavailable after the taxpayer’s income exceeds the thresholds listed in Table 12-2. pp.12-15 to 12-17 and Table 12-2

13. The base amount, which depends on filing status, is reduced dollar for dollar by SocialSecurity payments. Therefore, a taxpayer who receives Social Security payments equalto or greater than the base amount will not receive any benefit from this tax credit.pp. 12-17 and 12-18

14. The purpose of the overall limitation on the foreign tax credit is to prevent foreign taxesfrom offsetting taxes on U.S.-source income. Because U.S. income tax rates arerelatively low compared to historical norms, many foreign tax rates are higher causingthis limitation to play an important role. p. 12-19

15. • The optimal combination of using the foreign earned income exclusion, the deductionfor foreign income taxes paid, and the foreign tax credit. p. 12-19, and Chapters 5and 10

• The application of the passive activity loss rules to any potential loss generated on therental of her home. Chapter 11

• Calculation of the amount and nature of gain or loss realized and recognized on thesale of major tangible assets such as her automobile. Chapters 3 and 13

• Potential deductibility of employee expenses incurred in conjunction with heroverseas assignment such as travel and transportation expenses. Chapter 9

16. In 2005, up to $10,630 ($10,390 in 2004) of nonrecurring costs directly associated withthe adoption process of an eligible child, such as legal costs, adoption fees, social servicereview costs, and transportation costs, qualify for the credit. An eligible child is one whois:

• under 18 years of age at the time of the adoption, or

• physically or mentally incapable of taking care of himself or herself.

An individual claims the adoption expenses credit in the year expenses were paid orincurred if the expenses were paid during or after the year in which the adoption wasfinalized. For expenses paid or incurred in a year prior to when the adoption wasfinalized, the credit must be claimed in the tax year following the tax year during whichthe expense is paid or incurred. The amount of the credit that is otherwise available isphased-out for taxpayers whose AGI (modified for this purpose) exceeds $159,450 (in2005 and it is totally eliminated when the AGI reaches $199,450. In 2004, the phaseoutbegan when AGI exceeded $155,860.

The credit is a nonrefundable credit and is available to taxpayers only in a year in whichthis credit and the other nonrefundable credits do not exceed the taxpayer’s tax liability.However, any unused adoption expenses credit may be carried over for up to five years,being utilized on a first-in first-out basis.

p. 12-20

Tax Credits 12-7

17. The child tax credit is available to individual taxpayers based solely on the number ofqualifying children under age 17 and does not depend on the taxpayer working or seekingemployment. The maximum credit equals $1,000 per qualifying child. The credit isphased-out for taxpayers having AGI in excess of specified thresholds. The credit forchild and dependent care expenses is available to taxpayers who incur employment-related expenses for a child under age 13 or dependent care. The credit for child anddependent care expenses is computed as a percentage of qualifying child and dependentcare expenses (20% to 35%, depending on the taxpayer’s AGI). The amount the rate isapplied to is subject to statutory ceilings of (1) the lower earned income of the taxpayeror spouse and (2) the lesser of actual child and dependent care expenses or $250 permonth for one qualifying child or dependent or $500 per month for two or morequalifying children or dependents. pp. 12-21 to 12-23

18. The credit is allowed for child care expenses incurred on behalf of a child under the ageof 13 that enable the taxpayer to work or seek employment. Gail is deemed to be fullyemployed for each month that she is a full-time student (the entire year in this case) andto have earned $250 for each such month. Because their child is under age 13, Gary andGail are eligible for the credit if they incur eligible expenses and comply with thereporting requirements. pp. 12-22, 12-23, and Example 30

19. If Polly’s and Leo’s AGI is $70,000, they would save income taxes by taking advantageof the plan because income taxes would be avoided on the $3,500 in salary "given-up,"and the reimbursement of child care expenses would be excludible from gross income.Alternatively, if Polly does not take advantage of the plan, her income taxes will be $275higher than they otherwise would be.

Salary $3,500Income tax rate X 25%Income tax on salary $ 875Credit for child and dependent care expenses ($3,000 X 20%) (600)Net income tax $ 275

In addition, to the extent Polly participates in the plan, her FICA taxes will be reduced by$267.75 ($3,500 X 7.65%), given that her salary does not exceed $90,000 in 2005.

Alternatively, if their AGI were $14,000, Polly and Leo would benefit more by utilizingthe credit for child and dependent care expenses rather than participating in thedependent care reimbursement plan. Specifically, such a strategy would generate a creditthat would not only offset the taxes on the $3,500 of income, but $432 would be availableto offset Polly’s and Leo’s tax liability on their remaining income.

Salary $3,500Income tax rate X 10%Income tax on salary $ 350Plus: FICA tax on $3,500 ($3,500 X 7.65%) 268 Total taxes $ 618 Less: Credit for child and dependent care expenses ($3,000 X 35%) (1,050)Net tax savings $ 432

p. 12-23


20. Various income exclusions, deductions, and tax credits are available in the tax law tohelp make college more affordable, particularly for low- to middle-income taxpayers.The list of provisions that provide such benefits include the following:

• Two education tax credits are available to help offset the cost of a college education.These credits are the HOPE scholarship credit and the lifetime learning credit.pp. 12-23 to 12-25

• Educational savings bonds. (Chapter 5)

• Qualified tuition programs. (Chapter 5)

• Scholarships. (Chapter 5)

• The deduction for interest paid on student loans. (Chapter 6)

• Qualified tuition and related expenses under § 222. (Chapter 9)

• Coverdell Education Savings Accounts (CESAs).

• Penalty-free withdrawals from traditional IRAs to pay for qualifying educationalexpenses.

21. The credit for small employer pension plan startup costs is available for small employerswho incur administrative costs associated with establishing and maintaining certainqualified plans. By allowing the credit, the after-tax cost to the employer of establishinga retirement plan for its employees is reduced. Congress expects that the availability ofthe credit will encourage employers to establish qualified plans for their employees.p. 12-14

The credit for certain retirement plan contributions (the “saver’s credit”) is available toencourage lower- and middle-class taxpayers to contribute to qualified retirement plans.The benefit provided by this credit is in addition to any deduction or exclusion thatotherwise is available due to the qualifying contribution. As one’s AGI increases, therate applied to the contributions in calculating the credit is reduced and once thetaxpayer’s AGI exceeds the upper end of the applicable range, no credit is available. p.12-25

22. a. Tax credit for rehabilitation expenditures. The credit is based on expendituresincurred to rehabilitate industrial and commercial buildings and certified historicstructures. It is intended to discourage businesses from moving from older,economically distressed areas to newer locations and to encourage thepreservation of historic structures. p. 12-7

b. Low-income housing credit. The credit is designed to encourage building ownersto make affordable housing available for low-income individuals. p. 12-12

c. Research activities credit. The research activities credit is intended to encourageresearch and experimentation in the United States. p. 12-10

d. Earned income credit. This credit has been justified as a means of providing taxequity to the working poor. It is intended to help offset the regressive taxes thatare a part of our tax system, such as the gasoline excise tax and the FICA tax. In

Tax Credits 12-9

addition, it is designed to encourage economically disadvantaged individuals tobecome contributing members of the workforce. p. 12-15

e. Foreign tax credit. The purpose of the foreign tax credit is to mitigate the doubletaxation that results when income earned in a foreign country is subject to bothU.S. and foreign taxes. p. 12-19

PROBLEMS

23. Carol’s allowable general business credit for the current year is limited to $25,000,determined as follows:

Net income tax $125,000*Less: The greater of:

$100,000 (tentative minimum tax)$25,000 [25% X ($125,000 – $25,000)] (100,000)

Amount of general business credit allowed $ 25,000

*Net income tax = $125,000 (regular tax liability) + $0 [alternative minimum tax($100,000 tentative minimum tax – $125,000 regular tax liability)] – $0 (nonrefundablecredits).

p. 12-6 and Example 7

24. 2005 general business credit $45,000Total credit allowed (based on tax liability) $80,000Less: Utilization of carryovers on FIFO basis

2001 (5,000)2002 (15,000)2003 (5,000)2004 (20,000)

Remaining credit allowed $35,000Applied against

2005 general business credit (35,000)2005 unused amount carried forward to 2006 $10,000

Therefore, the sources of the $80,000 general business credit allowed in 2005 are thecarryovers of $45,000 from the four previous years and $35,000 of the $45,000 generalbusiness credit generated in 2005.

Because unused credits may be carried over for up to 20 years, the carryovers from eachof the four previous years may be utilized.


25. a. The rehabilitation expenditures credit is 10% of $250,000, or $25,000.

b. Cost recovery of building $4,487[$200,000 – $25,000 (land)] X 2.564%

Plus: Cost recovery of improvements

Cost of improvements $250,000Less: Rehabilitation expenditures credit (25,000)


Depreciable basis $225,000

Cost of recovery of improvements 1,204($225,000 X 0.535%)

Total cost recovery for the year $5,691

pp. 12-7, 12-8, and Chapter 8

26. a. The work opportunity tax credit for the year is as follows:3 qualified employees X $6,000 limit on wages for each employee X 40% $ 7,2003 qualified employees X $4,000 wages for each employee X 25% 3,000Total work opportunity tax credit $10,200

b. $109,800 [$120,000 (total wages) – $10,200 (credit)]. pp. 12-8, 12-9, and Example 11

27. a. The welfare-to-work credit for 2005 is calculated as follows: 3 qualifiedemployees X $10,000 limit on wages for each employee X 35% $10,500

The welfare-to-work credit for 2006 is calculated as follows: 1 qualifiedemployee in second year of employment X $10,000 limit on wagesper employee X 50% $ 5,000

The welfare-to-work credit is not available with respect to the compensation paidto Cassie because she was hired after December 31, 2005.

b. The wage deduction for 2005 is $314,500 [$325,000 (total wages) – $10,500(credit)]. Wage deduction for 2006 is $337,000 [$342,000 (total wages) – $5,000(credit)].


28. a. Qualified research expenditures for the year $50,000Less: Base amount (35,000)Incremental research expenditures $15,000Tax credit rate X 20%Incremental research activities credit $ 3,000

pp. 12-10, 12-11, and Example 15

b. The tax benefit of Michael’s choices is determined as follows:

Choice 1 Reduce the deduction by 100% of the credit and claim the fullcredit.

$50,000 (qualified expenditures) – $3,000 (credit) $47,000Tax rate X 25%Tax benefit of reduced deduction $11,750Plus: Allowed credit 3,000Total tax benefit of Choice 1 $14,750

Tax Credits 12-11

Choice 2 Claim the full deduction and reduce the credit by the product of100% of the credit times 35% (the maximum corporate rate).

Deduction (qualified expenditures) $50,000Tax rate X 25%Tax benefit of full deduction $12,500Plus: Reduced credit: $3,000 – [(100% X $3,000) X 35%] 1,950Total tax benefit of Choice 2 $14,450

Thus, Choice 1 provides Michael a greater tax benefit. pp. 12-10, 12-11, andExample 16

29. Willis, Hoffman, Maloney, and Raabe, CPAs5191 Natorp Boulevard

Mason, OH 45040

September 30, 2005

Mr. Ahmed Zinna16 Southside DriveCharlotte, NC 28204

Dear Mr. Zinna:

This letter is in response to your inquiry regarding the tax consequences of the proposedcapital improvement projects at your Calvin Street and Stowe Avenue locations.

As I understand your proposal, you plan to incur certain expenditures that are intended tomake your restaurants more accessible to disabled individuals in accordance with theAmericans with Disabilities Act. The capital improvements that you are planning (e.g.,ramps, doorways, and restrooms that are handicapped accessible) qualify for the disabledaccess credit if the costs are incurred for a facility that was placed into service beforeNovember 6, 1990. Therefore, only those projected expenditures of $8,500 for yourStowe Avenue location qualify for the credit. In addition, the credit is calculated at therate of 50% of the eligible expenditures that exceed $250 but do not exceed $10,250.Thus, the maximum credit in your situation would be $4,125 ($8,250 X 50%). Youshould also be aware that the basis for depreciation of these capital improvements wouldbe reduced to $4,375, the amount of the expenditures of $8,500 reduced by the amount ofthe disabled access credit of $4,125. The capital improvements that you are planning foryour Calvin Street location, even though not qualifying for the disabled access credit,may be depreciated.

Should you need more information or need to clarify the information in this letter, pleasecall me.

Sincerely,

Raymond Cook, CPAPartner

pp. 12-13 and 12-14


30. a. Eduardo is not eligible for the earned income credit because he does not have aqualifying child and is too young (i.e., must be at least age 25) to qualify for thecredit that is available when the taxpayer does not have a qualifying child.

b. Kate is eligible because she has a qualifying child and her earned income andAGI are below the disqualifying thresholds.

c. Keith and Susan are not eligible for the earned income credit because they do nothave a qualifying child, and their income exceeds the disqualifying threshold forthe credit that is available when there is not a qualifying child.

d. Even though George does not have a qualifying child, he is eligible for the creditbecause he is between 25 and 64 years of age, cannot be claimed as a dependenton another taxpayer’s return, and has earnings that do not exceed thedisqualifying threshold.

pp. 12-15 to 12-17

31. Gross income (earnings) $19,500Less: Deduction for AGI (traditional IRA) (500)Adjusted gross income $19,000

Maximum credit available for 2005 for two or more children $4,400($11,000 X 40%)

Less: Credit phase-outEarned income* $19,500Threshold (14,370)Excess $ 5,130Phase-out rate X 21.06% (1,080)

Available earned income credit for Vern $3,320

*Earned income ($19,500) is greater than AGI ($19,000).

pp. 12-15, 12-16, Table 12-2, and Example 22

32. a. Maximum credit available for 2005 for two children $4,400 ($11,000 X 40%)Less: Credit phase-out

Earned income $32,000Threshold (14,370)Excess $17,630Phase-out rate X 21.06% (3,713)

Available earned income credit for Joyce $ 687

Table 12-2 and Example 22b. Keeps Takes

old job new job Tax calculation:Salary $32,000 $36,000Less: Standard deduction* (7,300) (7,300)

Personal and dependency exemptions ($3,200 X 3) (9,600) (9,600)

Taxable income $15,100 $19,100

Tax Credits 12-13

Income tax (based on tax rate schedule)* $ 1,743 $ 2,343Less: Earned income credit (687) (-0-)Net tax due $ 1,056 $ 2,343

After-tax cash-flow:Salary $32,000 $36,000Less: Net tax due (1,056) (2,343)After-tax cash-flow $30,944 $33,657

* Joyce qualifies for head of household status.

Based on the calculations above, even though Joyce will not qualify for theearned income credit and even though her Federal income taxes will increase by$1,287 ($2,343 – $1,056) if she takes the new job, her net cash-flow will increaseby $2,713 ($33,657 – $30,944). Therefore, based on these quantitative factorsalone, Joyce should probably accept the new job offer.

pp. 12-15, 12-16, and Chapter 3

33. Base amount (married filing jointly; both 65 or older) $7,500Less: Social Security benefits $4,000

(AGI over $10,000) X 1/2($10,500 – $10,000) X 1/2 250 (4,250)

Balance subject to credit $3,250Tax credit rate X 15%Tax credit for the elderly (subject to tax liability limitation) $ 488

Unfortunately for Roger and Thelma, they may not claim the $488 tax credit for theelderly in 2005 because of the tax liability limitation (i.e., their income tax liability is $0before considering the credit).

Gross income ($8,000 + $2,500) $10,500Less: Regular standard deduction $10,000

Additional standard deduction for taxpayers65 years of age or older ($1,000 + $1,000) 2,000Personal exemptions ($3,200 X 2) 6,400 (18,400)

Taxable income $ -0-

Income tax liability $ -0-

Therefore, because the tax credit for the elderly is nonrefundable and they have noincome tax liability, they may not claim any benefit from this credit.

pp. 12-17, 12-18, Table 12-3, and Example 24

34. a. $50,000 (Foreign source TI) X $18,330** (U.S. tax) $ 7,901$116,000 (Worldwide TI)*

Total foreign taxes paid $26,000

Foreign tax credit: [lesser of $7,901 (foreign tax credit limitation) or $26,000 (foreign taxes paid)] $ 7,901


*$100,000 + $16,000 [5 X $3,200 (personal and dependency exemptions notallowed)].

**Tax on $100,000 = $18,330 per Tax Rate Schedule for 2005.

Kim’s net U.S. income tax payable = $18,330 – $7,901 (foreign tax credit) =$10,429.

b. While it is true that all foreign income taxes paid are available to offset ataxpayer’s U.S. income tax liability on worldwide income, in any current year theoverall limitation effectively allows only the amount of foreign taxes that is equalto the foreign-source taxable income’s proportionate share of the U.S. income taxliability (before the foreign tax credit) in relation to the total worldwide taxableincome. Thus, in part a. of this problem, a $18,099 carryback or carryforward iscreated [$26,000 (foreign taxes paid) – $7,901 (current benefit of the foreign taxcredit)] because Kim is not able to offset fully the foreign taxes paid against theU.S. income tax liability. Even though the one-year carryback and ten-yearcarryforward provision exists to provide relief, it is unlikely that Kim wouldbenefit assuming the relative income levels and tax rates remain the same in thefuture. Therefore, if Kim moves his novelty goods business to a lower taxjurisdiction, the projected foreign income taxes that would be due could be fullyused to offset the U.S. income tax liability on worldwide income and not belimited by the overall limitation. Further, generation of foreign source income ata foreign tax less than the U.S. tax could create an excess credit limitation forKim; thus, he could use the carryover of the foreign tax credit generated by thehigh tax country. Consequently, moving his business as he contemplates couldproduce significant savings to Kim.


35. a. $150,000 (Foreign-source TI) X $170,000 (U.S. tax) $51,000$500,000 (Worldwide TI)

Foreign tax credit overall limitation $51,000

Total foreign income taxes paid $45,000

Foreign tax credit allowed: [lesser of $51,000 (foreign tax creditlimitation) or $45,000 (foreign taxes paid)] $45,000

Blue Corporation’s Federal income tax, net of the foreign tax credit, is $125,000($170,000 – $45,000). Since the U.S. tax rates are higher than the foreign taxrates, the overall limitation does not apply.

b. The amount of the foreign tax credit carryback and carryover is $0.


36. a. Ann and Bill must claim the adoption expenses credit in 2005 ($4,000 + $6,630,limited to $10,630), since they paid or incurred qualified adoption expenses priorto the year in which the adoption was finalized and in the year finalized. In theirparticular case, they may take the credit in 2005 for $10,630. The amount ofexpenses paid in excess of $10,630 is a nondeductible personal expense. Further,

Tax Credits 12-15

because their modified AGI is less than $159,450, the amount of the creditotherwise available is not reduced.

b. $6,498 = $10,630 – {$10,630 X [($175,000 – $159,450) ÷ $40,000]}.

p. 12-20 and Examples 26 and 27

37. a. Durell and Earline may only claim the child tax credit for their two children, ages5 years and 6 months. The full amount of the child tax credit is available forqualifying children born during the tax year. Although Earline’s son from aprevious marriage is claimed as a dependent, he is not eligible for the child taxcredit since he is not under age 17. Since Durell and Earline’s combined AGI isbelow $110,000, their child tax credit is $2,000 ($1,000 X 2).

b. Since Durell and Earline’s combined AGI exceeds $110,000, the maximum childtax credit of $2,000 must be reduced. The credit reduction is computed as $50 foreach $1,000 of AGI or fraction thereof exceeding the threshold amount.

AGI $119,000Threshold amount (110,000)Excess $ 9,000

$9,000$1,000 X $50 = $450 reduction.

Durell and Earline’s child tax credit is $1,550 ($2,000 maximum credit – $450reduction) for the year.


38. The earned income ceiling does not apply since Kevin, as a full-time student, is deemedto have earned $3,000 ($250 X 12 months) and only $2,900 was paid for child care.Also, Sara is a qualified care provider. Though a related party, she is not Kevin andJane’s child who is under age 19.

In terms of the AGI effect on the rate, the applicable rate for the credit is 24%.Consequently, a credit of $696 (24% X $2,900) is allowed.

pp. 12-21, 12-22, and Examples 29 and 30

39. For two children, the maximum expense for purposes of the credit for child anddependent care expenses is $6,000. However, since the qualifying expenditures arelimited to the earnings of the lesser paid spouse (i.e., $5,000), this amount is used incalculating the credit. Using the combined AGI of $27,500 ($22,500 + $5,000), theapplicable rate for the credit is 28%. Thus, the credit is $1,400 (28% X $5,000).

The fact that the care was provided by Ralph’s mother is of no consequence as she is notRalph or Jill’s child.

pp. 12-21, 12-22, and Example 30

40. a. Bernadette is eligible to take the lifetime learning credit for her son’s tuition costsand the tuition expenses for her continuing professional education seminars. Thecosts for books incurred both by Bernadette and her son are ineligible for the


credit. The lifetime learning credit is available per taxpayer on the first $10,000of qualifying tuition expenses. Accordingly, her son’s tuition ($8,200) plus up to$1,800 of her tuition would qualify for the credit during 2005. Therefore,Bernadette’s maximum lifetime learning credit would be $2,000 (20% X $10,000)for 2005. However, the $2,000 maximum credit would have to be reduced by$800 since her $95,000 AGI exceeds the threshold level of $87,000 for marriedtaxpayers.

[($95,000 – $87,000)/$20,000] X $2,000 = $800 reduction

Maximum credit $2,000Less: Phaseout (800)Education credit $1,200

The portion of the costs associated with the continuing education seminars thatare not used in the lifetime learning credit calculation may qualify as employeebusiness expenses, deductible as education expenses (see Chapter 9).

pp. 12-23, 12-24, and Examples 32 and 33

b. “How the Tax Law Can Help Pay for College and Continuing ProfessionalEducation” Outline for Presentation to Rotary Club

I. Introduction.A. Many tax provisions are available to help defray the cost of both

college and continuing professional education.B. Complicated area of tax law so planning ahead is important.

II. Tax provisions that help pay for college.A. Contributions to Coverdell Educational Savings Accounts

(CESAs).B. Penalty-free withdrawals to pay for college from traditional IRAs.C. Participation in qualified tuition programs for tuition and room and

board costs. (Chapter 5)D. Deductibility of student-loan interest. (Chapter 10)E. Purchase of Series EE educational savings bonds. (Chapter 5)F. Education tax credits—HOPE scholarship credit and lifetime

learning credit. (Chapter 12)G. Employer-provided educational assistance programs. (Chapter 5)H. Scholarships exempt from taxation. (Chapter 5)I. The limited deduction for qualified tuition and related expenses.

(Chapter 9)

III. Tax provisions that help pay for continuing education.A. Lifetime learning credit. (Chapter 12)B. Employer-provided educational assistance programs. (Chapter 5)C. Deductibility of expenses ineligible for credit or assistance

program. (Chapter 9)

IV. Income limitations and interaction among various provisions also areimportant issues. (Chapter 12)

41. a. Kathleen and Glenn’s contributions to their respective § 401(k) plans arequalified contributions; however, the maximum amount that may be considered in

Tax Credits 12-17

calculating the credit is $2,000 for each taxpayer. In addition, because their AGIis $32,000, the rate of the credit is 20%. Therefore, the credit available toKathleen and Glenn is $800 [($2,000 X 2) X 20%]. Example 34

b. Joel may not claim the credit for certain retirement plan contributions because heis less than 18 years of age and claimed as a dependent on his parents’ return.p. 12-25

CUMULATIVE PROBLEMS

42. Wade’s net business ($280,000 – $200,000) $ 80,000Jane’s salary 160,000Interest income 8,000Gross income $248,000Less: Deductions for AGI

Capital losses (Note 1) $3,000 One-half of self-employment tax (Note 5) 5,652 (8,652)

Adjusted gross income $239,348Less: Itemized deductions (Note 2) (24,098)

Personal and dependency exemptions (Wade, Jane, Sean, and Debra) (Note 3) (10,496)

Taxable income $204,754

Computation of net tax payable or refund due

Tax from Tax Rate Schedule on $204,754 (Note 4) $48,160Plus: Self-employment tax (Note 5) 11,304Total tax $59,464Less: Prepayments and credits

Income tax withheld $29,000Estimated tax payments 30,000Credit for child and dependent care expenses (Note 6) 600 (59,600)

Net tax payable (or refund due) ($ 136)

Notes

(1) Capital asset transactions:Short-term capital loss ($8,000 – $10,000) $2,000Long-term capital loss ($4,800 – $6,000) 1,200Total capital loss $3,200

Capital loss deduction limitation $3,000

See Chapters 3 and 14.

(2) Itemized deductions $26,900Plus: Miscellaneous itemized deductions limited

to excess over 2% of AGI:(2% X $239,348 = $4,787)Travel expenses excluding meals $ 800Meals and entertainment ($800 X 50%) 400

$1,200 -0-


Itemized deductions before reduction $26,900Less: Itemized deduction reduction amount

[($239,348 – $145,950) X 3%] (2,802)Itemized deductions, net of reduction $24,098

(3) Personal and dependency exemptions ($3,200 X 4) $12,800Less: Phase-out

AGI before phase-out $239,348– Statutory threshold amount (218,950)

Excess $ 20,398÷ Statutory amount 2,500

Result 8.16Rounded 9

X Statutory percentage 2%= Percentage 18%

Amount of personal and dependency exemption deduction:

[(1 – .18) X $12,800] $10,496

(4) Tax on $182,800 $40,915Tax on $21,954 ($204,754 – $182,800) at 33% 7,245Total income tax $48,160

(5) The net earnings from self-employment are $80,000 ($280,000 – $200,000).Therefore, using the format presented in Figure 12-1 in the text, the self-employment tax is computed as follows:

(1) Net earnings from self-employment $80,000(2) Multiply line (1) by 92.35% $73,880(3) If the amount on line 2 is $90,000 or less, multiply

the line 2 amount by 15.3%. This is the self-employment tax. $11,304

Thus, the deduction for AGI is $5,652 ($11,304 X 50%).

(6) The credit for child and dependent care expenses is limited to 20% of $3,000 (themaximum qualifying for one child), or $600. The 16 year-old child does notqualify, due to the under age 13 limitation.

43. Gross income:Salary $63,000Interest income ($1,300 + $400) 1,700Dividend income ($500 + $400 + $1,200) 2,100State income tax refund 1,600Business income (Note 1) 19,800Net STCG (Note 2) 1,100Total gross income $89,300

Deductions for AGI:Business expenses (Note 1) (16,750)One-half of self-employment tax (Note 3) (216)

Adjusted gross income $72,334

Tax Credits 12-19

Deductions from AGI:Itemized deductions (Note 4) (9,868)Personal exemption (3,100)

Taxable income $59,366

Income tax (Note 5) $11,371Self-employment tax (Note 3) 431Total tax $11,802Taxes withheld (11,000)Estimated taxes (1,000)Net tax payable (or refund due) for 2004 ($ 198)

See the tax return solution beginning on page 12-21 of the Solutions Manual.

Notes

(1) Business receiptsPart-time tax practice revenues $ 3,800Software writing business royalties 16,000Total gross income $19,800

Business expensesPart-time tax practice processing fee $ 600Software writing business ($7,000 + $2,000 + $3,000 +

$650 + $3,500) 16,150Total business expenses (deducted for AGI) $16,750

(2) Gray stock ($7,000 – $8,800) STCL ($1,800)Utility vehicle ($3,400 – $3,000) STCG 400Blue stock ($5,500 – $3,000) STCG 2,500Net STCG $1,100

(3) Beth’s earnings from self-employment during 2004 were $3,050 ($19,800 –$16,750) and the self-employment tax on this amount is computed as follows:

Social Security Medicare Portion Portion

Ceiling amount $87,900Less: FICA wages (63,000)Net ceiling $24,900

Net self-employment income ($3,050 X 92.35%) $ 2,817 $2,817

Lesser of net ceiling or net self-employment income* $ 2,817 $2,817Tax rate X 12.4% X 2.9%Self-employment tax $ 349 $ 82

Total self-employment tax $431

Therefore, one-half of the self-employment tax, or $216, is deductible for AGI.

*All of Beth’s net self-employment earnings are subject to the Medicare portionof the self-employment tax of 2.9%.


(4) Medical expenses [($300 + $2,875) – (7.5% X $72,334)] $ -0-Taxes ($1,954 + $1,766) 3,720Home mortgage interest 3,845Charitable contributions ($1,560 + $520) 2,080Miscellaneous itemized deductionsProfessional dues and subscriptions $ 350Convention expenses, excluding meals 1,220Meals ($200 X 50%) 100

$1,670Less: 2% of AGI ($72,334 X 2%) (1,447) 223Itemized deductions $9,868

(5) Tax on taxable income of $59,366Tax on dividend income ($2,100 X 15%) $ 315Tax from Tax Table on remaining taxable income of $57,266 ($59,366 – $2,100) 11,056Total income tax $11,371

Tax Credits 12-21

43.


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Tax Credits 12-23

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Tax Credits 12-25

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43. continued

Tax Credits 12-27

43. continued


43. continued

Tax Credits 12-29

43. continued


43. continued

Tax Credits 12-31

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43. continued

Tax Credits 12-33

43. continued

solutions

Documents

foreign tax credit

taxpayers tax liability

tentative minimum tax

alternative minimum

net regular tax liability

marginal tax rate

work opportunity tax

tax rate schedule