Comprehensive Problems In 2010, Jack and Diane Heart are married with two children, ages 10 and 12. Jack works full-time and earns an annual salary of $75,000, while Diane works as a substitute teacher and earns approximately $25,000 per year. Jack and Diane expect to file jointly and do not itemize their deductions. In the fall of this year, Diane was offered a full time teaching position that would pay her an additional $20,000. a. Calculate the marginal tax rate on the additional income, excluding employment taxes, to help Jack and Diane evaluate the offer. If Diane refuses the position, the Heart’s 2010 AGI is $100,000, their taxable income is $74,000 [$100,000 - 11,400 - 14,600] and their gross tax is $10,862.50. Their marginal tax rate is 25%. Because the Hearts qualify for $2,000 of child tax credit (2 × $1,000) and $800 of making work pay credit, their net tax is $8,062.50. If Diane accepts the position, then their AGI and taxable income will increase by $20,000 and they will remain in the 25% tax bracket. Thus, their gross tax will increase by $5,000. However, since their AGI is now $120,000, it triggers the phaseout of the child tax credit. Their increased AGI exceeds the phase-out threshold by $10,000 which reduces their child tax credit by $500 [$50 × 10 (10,000 / 1,000)]. Hence, the Heart’s net tax on the income increases by $5,500 and their effective marginal tax rate on the income is 27.5% ($5,500/$20,000). Description (1) AGI
Decline Offer $100,000
Accept Offer $120,000
(2) Standard deduction (3) Exemptions (4) Taxable income (5) Tax liability (6) Child tax credit (7) Making work pay credit (8) Tax due/(refund) (9) Net tax increase if offer is accepted Marginal tax if offer is accepted
11,400 14,600 $74,000 $10,862.50 (2,000) (800)
11,400 14,600 $94,000 $15,862.50 (1,500) (800)
$8,062.50
$13,562.50 5,500
Reference 75,000 + 25,000 +20,000 (if accepted) MFJ standard deduction 3,650 x 4 (1) – (2) – (3) See tax tables for MFJ See analysis above $800 maximum credit (not phased-out) (5) + (6) + (7) 13,562.50 – 8,062.50
27.5%
5,500 / 20,000
b.
Calculate the marginal tax rate on the additional income, including employment taxes, to help Jack and Diane evaluate the offer.
If Diane refuses the position, the Heart’s 2010 AGI is $100,000, their taxable income is $74,000 [$100,000 - 11,400 - 14,600] and their gross tax is $10,862.50. Their marginal tax rate is 25%. Because the Hearts qualify for $2,000 of child tax credit (2 × $1,000) and $800 of making work pay credit, their net tax is $8,062.50. Jack’s FICA taxes are $5,738 and Diane’s FICA taxes are $1,913. So, the Heart’s total tax liability without the additional income is $15,713.50 ($8,062.5 + $5,738 + $1,913) If Diane accepts the position, then their AGI and taxable income will increase by $20,000 and they will remain in the 25% tax bracket. Thus, their gross tax will increase by $5,000. However, since their AGI is now $120,000, it triggers the phaseout of the child tax credit. Their increased AGI exceeds the phase-out threshold by $10,000 which reduces their child tax credit by $500 [$50 × 10 (10,000 / 1,000)]. Hence, the Hearts net tax regular tax increases by $5,500 – the change in the gross tax plus the phase out the child tax credit. Also, their FICA taxes increase by $1,530 ($20,000 × .0765). So their overall taxes increase by $7,030 ($5,500 + $1,530). Their marginal tax rate on the $20,000 of income is 35.15%. Description (1) AGI
Decline Offer $100,000
Accept Offer $120,000
(2) Standard deduction (3) Exemptions (4) Taxable income (5) Tax liability (6) Child tax credit (7) Making work pay credit (8) Employment taxes (9) Tax due/(refund) (10) Net tax increase if offer is accepted Marginal tax if offer is accepted
11,400 14,600 $74,000 $10,862.50 (2,000) (800)
11,400 14,600 $94,000 $15,862.50 (1,500) (800)
7,651 $15,713.50
9,181 $22,743.50 7,030
Reference 75,000 + 25,000 +20,000 (if accepted) MFJ standard deduction 3,650 × 4 (1) – (2) – (3) See tax tables for MFJ See analysis above $800 maximum, not phased-out See analysis above Sum of (5) through (8) 22,743.50 – 15,713.50
35.15%
7,030 / 20,000
c.
Calculate the marginal tax rate on the additional income, including selfemployment taxes, if Diane would be working as a self employed contractor.
If Diane accepts the job, she will be required to pay self-employment taxes on the additional $20,000 of income. Her self-employment tax liability is $2,826 ($20,000 × 92.35% × 15.3%). She is allowed to deduct half of the self employment taxes ($1,413) as a for AGI deduction. So, the increase in the Heart’s AGI from the
additional income is $18,587 ($20,000 – 1,413) giving them AGI of $118,587. The Heart’s increase in taxable income due to the additional $20,000 of self-employment income is $18,587. Because their taxable income level puts them in the 25% bracket this income increases their regular tax liability by $4,647 ($18,587 × 25%). Also, because their AGI is now $118,587 it triggers the phase-out of the child credit. The AGI exceeds the phase-out threshold by $8,587 reducing the child tax credit by $450 [$50 × 9 (8,587 / 1,000 (rounded up to 9)]. Hence, the Heart’s net regular tax increases by $5,097 ($4,647 additional tax + $450 reduction in child tax credit) – the change in the gross tax plus the phase out the child credit. http://www.ysegjvrv.com/nők-kabátok-c-20.html In summary, the Heart’s regular tax increases by $5,097 and their self-employment taxes increase by $2,826. So, their total tax increase from the additional income is $7,923. Thus, their marginal tax rate if the additional $20,000 is self-employment income is 39.62% ($7,923/20,000). Description (1) AGI (2) Standard deduction (3) Exemptions (4) Taxable income (5) Tax liability (6) Child tax credit
Decline Offer $100,000 11,400 14,600 $74,000 $10,862.50 (2,000)
Accept Offer $118,587 11,400 14,600 $92,587 $15,509.25 (1,550)
(7) Making work pay credit (8) Employment taxes
(800)
(800)
7,651
10,477
(9) Tax due/(refund) (10) Net tax increase if offer is accepted Marginal tax if offer is accepted
$15,713.50
$23,636.25 7,923
Reference See analysis above MFJ standard deduction 3,400 x 4 (1) – (2) – (3) See tax tables for MFJ See analysis above $2,000 - 450 $800 maximum credit, no phase-out See analysis above 7,651 + 2,826 Sum of (5) through (8) 23,636.25 – 15,713.50
39.62%
7,923 / 20,000
16. Matt and Carrie are married, have two children, and file a joint return. Their daughter Katie is 19 years old and was a full-time student at State University. During 2010, she completed her freshman year and one semester as a sophomore. Katie’s expenses while she was away at school during the year were as follows: Tuition $5,000 Class Fees 300 Books 500 Room and Board 4,500
Katie received a half-tuition scholarship that paid for $2,500 of her tuition costs. Katie’s parents paid the rest of these expenses. Matt and Carrie are able to claim Carrie as a dependent on their tax return. Matt and Carrie's 23 year old son Todd also attended graduate school (fifth year of college) full time at a nearby college. Todd’s expenses while away at school during the year were as follows: Tuition $3,000 Class Fees 0 Books 250 Room and Board $4,000 Todd paid for his own tuition and books, but Matt and Carrie paid for his room and board. Since Matt and Carrie still benefit from claiming Todd as a dependent on their tax return, they decided to provide Todd with additional financial assistance by making the payments on Todd’s outstanding loans. Todd used the proceeds from these loans to pay his tuition costs. Besides paying off some of the loan principal, Matt and Carrie paid a total of $900 of interest on the loan. This year Carrie decided to take some classes at the local community college to help improve her skills as a school teacher. The community college is considered to be a qualifying post-secondary institution of higher education. Carrie spent a total of $1,300 on tuition for the classes and she was not reimbursed by her employer. Matt and Carrie's AGI for 2010 before any education-related tax deductions is $112,000 and their taxable income before considering any education-related tax benefits is $80,000. Matt and Carrie incurred $2,300 of miscellaneous itemized deductions subject to the 2% floor not counting any education related expenses Required: Determine the mix of tax benefits that maximize tax savings for Matt and Carrie. Their options for credits for each student are as follows: a. They may claim either a credit or a qualified education deduction for Katie’s expenses. b. They may claim either a credit or a qualified education deduction for Todd. c. They may claim (1) a credit or (2) a qualified education deduction for Carrie. They may deduct any amount not included in (1) or (2) as a miscellaneous itemized deduction subject to the 2 percent of AGI floor.
Remember to apply any applicable limits or phase-outs in your computations. Also, be sure to include the interest deduction for qualified educational loans in your computations. The education-related tax benefits available to Matt and Carrie are the following: 1. For AGI deduction for qualified educational expenses 2. American opportunity credit and lifetime learning credit 3. From AGI deduction for unreimbursed employee expenses for education Matt and Carrie are not eligible for the deduction for qualified student loan interest because they did not borrow the money. The $900 payment of Todd’s student loan interest will be treated as a gift from them to Todd. Let’s consider two alternatives: Alternative 1: Claim all $3,000 of Todd’s expense as a for AGI deduction and $1,000 of Katie’s expenses as a for AGI deduction. Finally, deduct Carrie’s expenses as a from AGI deduction. Note that Todd’s expenses are not eligible for the American opportunity credit because he is in his fifth year of post secondary education. Also, the lifetime learning credit for Todd’s expenses is $240 [$3,000 × 20% × 40% (due to 60% phase out)] so the for AGI deduction provides more tax savings than the lifetime learning credit. This alternative provides $1,325 of tax savings for Matt and Carrie, computed as follows: Description (1) $3,000 for AGI deduction for Todd’s expenses (2) $1,000 for AGI deduction for Katie’s expenses
(3) $1,300 from AGI deduction for Carrie’s expenses
Tax savings $750
250
325
Computation $3,000 × 25% marginal tax rate
$1,000 × 25% marginal tax rate. Note that Matt and Carrie may not claim any more tax benefits for Katie’s expenses in excess of $1,000 (the $4,800 excess can’t be used for anything else). $1,300 × 25% marginal tax rate. Entire amount is in excess of 2% of AGI floor for miscellaneous itemized deductions (AGI before deducting the for AGI deductions for education expense is $112,000. $112,000 × 2% = $2,240 which is below the $2,300 of non educational miscellaneous itemized
Total tax savings
$1,325
deductions. Consequently, the 2% threshold does not limit the education miscellaneous itemized deduction. (1) + (2) + (3)
Alternative 2: Claim $3,000 for AGI deduction for Todd’s expense, claim $1,000 of Carrie’s expense as a for AGI deduction, claim the remaining $300 of Carrie’s expenses as a from AGI deduction, and claim the American opportunity credit (AOC) for Katie’s expenses. h&m hu This alternative provides $3,575 of tax savings. Description (1) $3,000 for AGI deduction for Todd’s expenses (2) $1,000 for AGI deduction for Carries expenses (3) $300 from AGI deduction for Carrie’s expenses (4) AOC for Katie’s expenses Total tax savings
Tax savings $750
Computation $3,000 × 25% marginal tax rate
250
$1,000 × 25% marginal tax rate.
75
$300 × 25% marginal tax rate.
2,500
See below
$3,575
Sum of (1) through (4)
The AOC for Katie’s expenses is $2,500, computed as follows: Description (1) Katie’s AOC before phase-out (2) AGI after education interest deduction
(3) For AGI deduction for qualified educational expenses (4) AGI (5) Phase-out threshold (6) Excess AGI (7) Phase-out range for taxpayer filing as Head of Household (8) Phase-out percentage (9) Phase-out amount
Amount $2,500 112,000
4,000
Explanation $112,000 AGI minus $0 education interest expense for AGI deduction (Matt and Carrie did not borrow the money so they can’t deduct the interest). For Todd and Carrie’s expenses
108,000 160,000 0 20,000
(4) – (5), limited to $0 $180,000 – 160,000.
0% 0
(6) / (7) (1) × (8)
AOC after phase-out
$2,500
(1) + (9)
It appears that Alternative 2 provides the combination of tax benefits providing the most tax savings.
