A. Filing Status: There are two choices of filing status available to this taxpayer couple, married filing separately and married filing jointly. For this taxpayer couple the recommended filing status is married filing jointly. The tax rates would be higher if they filed separately.
Additionally, some deductions (e.g. tuition and student loan interest), credits (e.g. Earned Income Credit) and exclusions would not be allowed if they filed separately. Since they sold a personal residence during this tax year, they will be able to exclude up to $500,000 profit from the sales as joint filers rather than only up to $250,000 if filing separately.
There will be 2 qualified personal exemptions and 3 exemptions for the 3 dependent children. All the children qualify as dependents because they are all under age 19 and the parents provide over half or all of their support . Spouse B’s mother cannot be claimed as a dependent because she provided for over half of her own support with contributions of $7,920 while her family calculates their contributions for her support to be $7,000. A2a.
Taxable and Non-Taxable Income: The IRS defines taxpayer income as all income, both taxable and non-taxable. Items that are considered taxable income for this couple are: $142,000 for Spouse A from K-1 partnership income (business or self-employed income). $2,000 Spouse A wages income from city park job.$88,000 Spouse B wages income from electronics firm. Total of Spouse A’s dividends from Company E qualifies as dividends for capital gains rate.
Stock bought 11 years ago satisfies the holding period requirement of IRS. ($5,000) loss on day trading by Spouse B classified business activity . Items considered to be non-taxable for this couple are:$900 municipal bond interest ($5,000 at 9% semi-annual payments) is exempt per Section 103. $2,400 Spouse B Child Support received is considered to be for child care and is not taxable (IRS Publication 525). $296,000 ($430,000 sale - $100,000 basis - $34,000 improvements) income on the sale of their personal residence.
Section 121 allows married joint filers to exclude up to $500,000 gains on the sale of a personal residence. Spouse A withdrew $83,500 from the partnership which Section 706 treats as recovery of capital. Therefore the withdrawals are not taxable income, only the partner’s share of profit or loss as reported on form 1065 and passed through to the Spouse A on the K-1 is taxable. Healthcare premiums paid by the employer are not included in taxable gross income for the employee .
A2b. Capital Gains and Losses: Capital gains and losses apply to assets. Capital gains occur when the sale or trade of the asset results in a profit. Capital losses occur when an asset is sold or traded at a loss.
Capital gains and losses can be either short-term (assets held less than one year) or long-term (assets held longer than one year) The short and long term designations are important because long term capital gains generally enjoy a lower tax rate while short term gains are taxed at the ordinary income tax rate (IRS Pub 550).Short and long term assets are netted against each other (i.e. short/short and long/long).
If the final sum of short-term and long-term assets is opposite signs, then the results will be netted between against each other. There was a $5,000 capital loss for Spouse B from day trading. Only $3,000 is allowed by the IRS per year so the additional $2,000 will need to be carried forward to the next year. However, this couple has a gain of $44,000 gain from the sale of a rental house. The gain will need to be calculated to take into account any selling costs, repairs, accumulated depreciation and so on.
If there is a gain after calculating the adjusted basis it is a capital gain and can be netted against the short term loss. If the capital losses exceed the capital gains the long term loss is netted up with the short term day trading loss and up $3,000 can be deducted from total income and any amount over $3,000 would need to be carried forward to the upcoming year(s). A2c.Profit or Loss from the Sale of Property: The taxpayer couple sold personal and rental property for this tax period. Both sales have potential gains. However, the gain from the sale of the personal residence qualifies for exclusion up to $500,000 under Section 121 as they lived in and used the residence at least two of the five years prior to the sale.
The gain or loss is calculated as the sale price less selling costs and adjusted basis of the property. Proceeds from the sale of the rental property are taxable because it is an income producing property and would be considered normal income. However, Section 1231 designates that exchanges of business property held longer than one year may be considered a long-term capital gain if there is a gain realized and any loss would be considered an ordinary loss.Any depreciation taken in past tax years will need to be recaptured in the tax year of the sale. A2d.
Partnership Income and Losses: Income and loss from a partnership is business income. The loss or income for the business is reported to the IRS on form 1065 but the partnership does not pay taxes on the income. Instead, the profits or losses are passed through to the individual partners on Schedule K-1 and they account for the taxes on their individual tax returns. Spouse A’s $142,000 from Schedule K-1 will be reported as income on their 1040 tax return. The $85,000 in withdrawals from the business will not be taxable unless they were to exceed the partner’s basis.A2e/A3 Passive Activity Gains and Losses: Passive activities are ones in which the taxpayer is not a material participant such as estates and trusts.
Rental activities are also considered passive unless the taxpayer is a real estate professional. Losses from passive activities can only be offset by income from passive activities (IRS Pub 527). In this case, the couple’s rental income of $23,000 completely covers the expenses of$29,200. There is also the $44,000 passive gain for the sale of the rental property.
After calculating the basis by taking into account the selling and purchase costs, improvements, accumulated depreciation and rent received for the period, there may be an offset for the $6,200 passive loss of the rental income producing a passive activity gain of $37,800. A4. Adjustments to Income: Adjusted Gross Income (AGI) is gross income minus certain allowed adjustments. This taxpayer couple is allowed the following adjustments to their income: $7,200 ($600/month) deduction from income for alimony payments.Taxes due on alimony payments are the responsibility of the recipient and thus can be deducted from the gross income of the payer . $14,200 for Spouse A’s contributions ($142,000 * 10%) to Keogh retirement plan are deductible.
This is a qualified retirement plan that allows deductions of up to 25% of compensation or $51,000 for 2013 . Self-employed health insurance – One month of Spouse A’s medical premium would qualify as a business expense because the wife’s medical plan was not available to him until February of the tax year when she started working . Based on the information provided this couple’s AGI is approximately $210,600 ($232,000 wages/partnership income - $21,400 retirement contributions and alimony). A5.
Deductions:$10,863 for Self-employment taxes. Self-employment taxes are the tax payments for Social Security and Medicare made by self-employed taxpayers. Spouse A can deduct 50% of the self-paid employment taxes for adjusted gross income (IRS Form 1040 Schedule SE). Spouse A’s self-total self-employment taxes would be calculated as $142,000 income from K-1 times 12.4% for Social Security and 2.9% for Medicare or $17,608 + $4,118 = $21,726 .
$6,000 for charitable contributions.As long as the donations were made to qualified domestic organization, Section 170 allows deductions for up to 50% of AGI depending on the type of property given. For example, the deduction for capital gain property is limited to 30% of AGI. Health Insurance premiums paid. In this case, no deduction is likely if Spouse B’s employer does not include the premiums paid in the employee’s gross income.
Spouse A may not deduct self-employment health premiums because there is an available subsidized health plan through Spouse B’s employer.Medical Expenses $0 deduction. Medical expenses net $16,300 ($45,000 total - $28,700 reimbursement). The medical deduction is limited to the excess over 10% of AGI for 2013 which for this couple is $21,060 ($210,600 AGI*.10) $16,300- $21,060 = ($4,760) . Moving expenses $0 deduction.
Spouse B’s new job is only 49 miles further from the old residence and does not meet the 50 mile requirement therefore, no allowance can be made for the moving expenses in this instance. Business suits $0 deduction. Spouse B spent approximately $2,600 on business suits for the new job. However, this is not deductible as the suits are appropriate for everyday wear and can be used for purposes other than business .
A5a. Recommendation: The standard 2013 deduction for married joint filers is $12,200 . Based only on the $16,863 deductions for self-employment taxes and charitable contributions above, the couple should itemize deductions as $16,863 is larger than the standard deduction of $12,200. Itemization could produce further deductions if there other deductible items such as mortgage interest and property taxes. A6. Tax Credits: Deductions and exemptions reduce the amount of income that is subject to taxes.
Once the amount of tax owed on income is calculated, available tax credits are then applied to reduce the amount of taxed owed.There are two basic types of credits, refundable and non-refundable. Refundable credits are primarily taxes withheld on wages and earned income credit and will be refunded to the taxpayer if there is excess over the tax liability. Most of the rest of tax credits are generally non-refundable so can only reduce taxes owed to zero but not any negative amount that would be refunded to the taxpayer.
Examples of non-refundable credits are credit for child, dependent or elderly care expense and foreign tax credit.It is generally beneficial to apply non-refundable credits first to the taxpayer’s liability. After that, refundable credits like prepaid tax payments would be applied. Possible tax credits for this couple are: Tax payments withheld by employers.
The total taxes payments withheld by the couple’s employers will be reported on the W-2 forms they receive and will be deducted from the total amount of taxes they owe. Child Tax Credit is $1,000 per child under the age of 17. This couple has a potential tax credit of $2,000 (2 children under 17) however, if their AGI is above $110,000 (as in this case) then this credit is phased out and is not available to them. Earned Income Credit (EIC) was designed basically to be a subsidy for low income working families (income under $51,567).
For married joint filers this credit is phased out for AGI over $48,378 and two qualifying children.This couple does not qualify as their AGI is over the threshold . American Opportunity Tax Credit provides a credit of up to $2,500 for qualified college expenses. However, this credit is phased out for couples with a modified adjusted gross income over $160,000 so this couple does not qualify for this credit . Saver’s Credit of up to $4,000 for joint filers for retirement plan contributions. The credit is based on tiers of 10%, 20% or 50% of the retirement contributions amounts.
This credit becomes unavailable when AGI reaches more than $59,000 for joint filers so it is not available for this couple during this tax year .
