Whittenburg Gerald E., Altus-Buller Martha. Income Tax Fundamentals
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by the community property laws, may be relieved of any liability related to this income. To
be granted relie f, the taxpayer mu st not know of or have r eason to know of the omitted
community property income.
Self-Study Problem 6.10
Tom and Rachel are married and living together in California. Their income is
as follows:
Tom’s salary $40,000
Rachel’s salary 30,000
Dividends (Tom’s property) 5,000
Dividends (Rachel’s property) 3,000
Interest (community property)
4,000
Total
$82,000
a. If Rachel files a separate tax return, she should report income of:
$ ____________
b.If Tom and Rachel lived in Texas, what should Rachel report as income?
$ ____________
KEY POINTS
Learning Objectives Key Points
LO 6.1:
Calculate the child tax credit.
Credits are a direct reduction in tax liability instead of a deduction from income.
For 2010, the child tax credit is $1,000 per qualifying child.
Child tax credit begins phasing out when AGI reaches $110,000 for joint filers ($55,000 for
married taxpayers filing separately) and $75,000 for single or head of household taxpayers.
LO 6.2:
Determine the earned income
credit (EIC).
The earned income credit (EIC) is available to qualifying individuals with earned income and
AGI below certain levels and is meant to assist the working poor.
The EIC formula for calculating the credit is based on the adjusted gross income of the tax-
payer and the number of qualifying children of the taxpayer.
To compute the credit, the taxpayer must fill in a form calculating the credit from the tables
based on earned income from wages, salaries, and self-employment income.
To be eligible for the credit with no qualifying children, a worker must be over 25 and
under 65 years old and not be claimed as a dependent by another taxpayer.
LO 6.3:
Compute the child and dependent
care credit for an individual
taxpayer.
To be eligible for the child and dependent care credit, the dependent must either be under
the age of 13 or be a dependent or spouse of any age who is incapable of self-care.
If a child’s parents are divorced, the child need not be the dependent of the taxpayer claim-
ing the credit, but the child must live with that parent more than he or she lives with the
other parent.
Section 6.10
Community Property 6-31
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The expenses that qualify for the credit include amounts paid to enable both the taxpayer
and the spouse to be employed.
For taxpayers with adjusted gross income of less than $15,000, the child and dependent care
credit is equal to 35 percent of the qualified expenses. For taxpayers with AGI of $15,000 or
more, the credit gradually decreases from 35 percent to 20 percent for AGI over $43,000.
In determining the credit, the maximum amount of qualified expenses to which the applicable
percentage is applied is $3,000 for one dependent and $6,000 for two or more dependents.
Full-time students with little or no income are deemed to have earned income of $250 per
month for one dependent and $500 per month for two or more dependents for purposes of
calculating this limitation.
LO 6.4:
Apply the special rules applicable
to the American Opportunity and
lifetime learning credits.
For 2010, the partially refundable American Opportunity credit is 100 percent of the first
$2,000 of tuition, fees, books, and materials paid and 25 percent of the next $2,000, for a
total annual credit of $2,500 per student.
The American Opportunity credit is available for the first 4 years of post-secondary education.
Taxpayers can elect a nonrefundable lifetime learning tax credit of 20 percent of tuition and
fees up to $10,000 in 2010.
The American Opportunity credit is phased out for joint filers with income between
$160,000 and $180,000 and for single and head of household filers with income between
$80,000 and $90,000. The lifetime learning credit is phased out between $100,000 and
$120,000 for married taxpayers and between $50,000 and $60,000 for those single or head
of household taxpayers.
Taxpayers cannot take both the American Opportunity credit and the lifetime learning credit
for the same student in the same tax year.
The credits cannot be used for expenses that are deducted from taxable income on a tax
return.
LO 6.5:
Understand the operation of the
foreign tax credit, the adoption
credit, and the energy credits.
U.S. taxpayers are allowed to claim a foreign tax credit on income earned in a foreign
country and subject to income taxes in that country.
Taxpayers may make an annual election to claim a deduction instead of a credit for the for-
eign taxes, but most taxpayers receive a greater tax benefit by claiming the foreign tax credit.
Generally, the foreign tax credit is equal to the amount of the taxes paid to foreign govern-
ments; however, there is an ‘‘overall’’ limitation on the amount of the credit, which is calcu-
lated as the ratio of net foreign income to U.S. taxable income times the U.S. tax liability.
Unused foreign tax credits may be carried back 1 year and forward 10 years to reduce tax
liability in those years.
Individuals are allowed an income tax credit for qualified adoption expenses. The total
expense that can be taken as a credit for all tax years with respect to an adoption of a
child is $13,170 (for 2010).
A tax credit for the purchase of new personal- or business-use hybrid gas-electric vehicles is
available from 2006 through 2010.
For 2009 and 2010, taxpayers may claim credits of up to $1,500 for energy-efficient home
improvements and a 30 percent credit for solar, wind, or geothermal property.
LO 6.6:
Understand the basic alternative
minimum tax calculation.
The AMT was designed in the 1960s to ensure that wealthy taxpayers could not take advan-
tage of special tax write-offs (tax preferences and other adjustments) to avoid paying tax.
Adjustments are timing differences that arise because of differences in the regular and AMT
tax calculations (e.g., depreciation timing differences), while preferences are special provi-
sions for the regular tax that are not allowed for the AMT (e.g., state income taxes).
For 2010, the alternative minimum tax rates for calculating the tentative AMT are 26 per-
cent of the first $175,000 ($87,500 for married taxpayers filing separately), plus 28 percent
on amounts above $175,000 applied to the taxpayer’s alternative minimum tax base.
6-32 Chapter 6
Credits and Special Taxes
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Reinforce the tax information covered in this chapter by completing the online
interactive tutorials located at the Income Tax Fundamentals Web site:
www.cengagebrain.com.
LO 6.7:
Apply the rules for computing tax
on the unearned income of minor
children and certain students.
The tax law contains provisions that limit the benefit of shifting income to certain minor
children.
The net unearned income of minor children is taxed at their parents’ rates.
This parental tax rate applies to dependent children who are 18 or younger or are students
ages 19 through 23 at the end of the year, have at least one living parent, and have ‘‘net
unearned income’’ for the year.
If certain conditions are met, parents may elect to include a child’s gross income on the
parents’ tax return. The election eliminates the child’s return filing requirements and saves
the parents the trouble of filing the special calculation Form 8615 for the ‘‘kiddie tax.’’
LO 6.8:
Distinguish between the different
rules for married taxpayers residing
in community property states when
filing separate returns.
Income derived from community property held by a married couple, either jointly or sepa-
rately, as well as wages and other income earned by a husband and wife, must be allo-
cated between the spouses if filing separately.
Nine states use a community property system of marital law. These states are Arizona,
Louisiana, Texas, California, Nevada, Washington, Idaho, New Mexico, and Wisconsin.
In general, in a community property state, income is split one-half (50 percent) to each spouse.
There are exceptions for certain separate property (e.g., property owned prior to marriage, etc.).
QUESTIONS and PROBLEMS
GROUP 1:
MULTIPLE CHOICE QUESTIONS
.............................................. .............................................. .
LO 6.1
1. Russ and Linda are married and file a joint tax return claiming their three children,
ages 4, 7, and 18, as dependents. Their adjusted gross income for 2010 is $105,300.
What is Russ and Linda’s total child credit for 2010?
a. $600
b. $1,200
c. $1,000
d. $2,000
e. Some other amount
LO 6.1
2. Jennifer is divorced and files a head of household tax return claiming her children, ages
4, 7, and 17, as dependents. Her adjusted gross income for 2010 is $81,300. What is
Jennifer’s total child credit for 2010?
a. $850
b. $1,200
c. $1,650
Questions and Problems 6-33
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d. $2,000
e. Some other amount
LO 6.2
3. Assuming they all meet the income requirements, which of the following taxpayers
qualify for the earned income credit in 2010?
a. A married taxpayer who files a separate tax return and has a dependent child
b. A single taxpayer who waited on tables for 3 months of the tax year and is claimed as
a dependent by her mother
c. A single taxpayer who is self-employed and has a dependent child
d. a and c above
e. None of the above qualify for the earned income credit
LO 6.3
4. Which of the following payments does not qualify as a child care expense for purposes
of the child and dependent care credit?
a. Payments to a day care center
b. Payments to the taxpayer’s sister (21 years old) for daytime babysitting
c. Payments to a housekeeper who also babysits the child
d. Payments to the taxpayer’s dependent brother (16 years old) for daytime babysitting
e. All of the above qualify for the child and dependent care credit
LO 6.4
5. The American Opportunity credit is 100 percent of the first ______ of tuition and fees
paid and 25 percent of the next ______.
a. $600; $1,200
b. $1,100; $550
c. $2,000; $2,000
d. $1,100; $5,500
e. None of the above
LO 6.4
6. Jane graduates from high school in June 2010. In the fall, she enrolls for six units at Big
State University. Big State University considers students who take twelve or more
units full-time. Jane’s father pays her tuition and fees of $2,500 for the fall semest er
and in December prepays $2,500 for the spring semester. In 2010, the American
Opportunity credit for Jane’s tuition and fees before any AGI limitation is:
a. $5,000
b. $2,500
c. $2,200
d. $1,800
e. Some other amount
LO 6.4
7. In September 2010, Sam pays $2,200 to take a course to improve his job skills to qual-
ify for a new position at work. His lifetime learning credit for 2010 is:
a. $220
b. $240
c. $360
d. $1,100
e. Some other amount
LO 6.4
8. In November 2010, Simon pays $6,200 to take a course to improve his job skills to
qualify for a new position at work. Simon’s employer reimbursed him for the cost of
the course. For 2010, Simon’s lifetime learning credit is:
a. $0
b. $1,000
6-34 Chapter 6
Credits and Special Taxes
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
c. $2,500
d. $1,500
e. Some other amount
LO 6.4
9. John, a single father, has AGI of $51,000 in 2010. In 2010, he pays $4,000 in qualified
tuition for his dependent son, who just started attending Small University (SU). What
is John’s American Opportunity credit for 2010?
a. $1,650
b. $1,485
c. $2,500
d. $660
e. Some other amount
LO 6.4
10. Joan, a single mother, has AGI of $85,000 in 2010. In September 2010, she pays $5,000
in qualified tuition for her dependent son who just started at Big University (BU).
What is Joan’s American Opportunity credit for 2010?
a. $1,650
b. $1,485
c. $990
d. $1,250
e. Some other amount
LO 6.4
11. Becky, a college freshman, works part-time and pays $1,600 of her college tuition
expenses. Although Becky files her own tax return, her parents claim her as a dependent
on their tax return. Becky’s parents have AGI of $50,000. What is the amount of American
Opportunity credit her parents can claim on their tax return for the tuition Becky paid?
a. $0
b. $495
c. $1,600
d. $1,650
e. Some other amount
LO 6.5
12. Taxpayer L has income of $55,000 from Norway, which imposes a 30 percent income
tax, and income of $45,000 from France, which imposes a 40 percent income tax. L has
taxable income from U.S. sources of $200,000 and U.S. tax liability before credits of
$90,000. What is the amount of the foreign tax credit?
a. $16,500
b. $34,500
c. $30,000
d. $100,000
e. $45,000
LO 6.5
13. John and Joan pay $16,500 of qualified adoption expenses in 2010 to finalize the adop-
tion of a qualified child who is not a sp ecial ne eds child. Their AGI is $190,000 for
2010. What is their adoption credit for 2010?
a. $16,500
b. $13,170
c. $10,707
d. $2,463
LO 6.5
14. In connection with the adoption of an eligible child who is a U.S. citizen and who is
not a child with special needs, Sean pays $4,000 of qualified adoption expenses in 2009
and $3,000 of qualified adoption expenses in 2010. The adoption is finalized in 2010.
Questions and Problems 6-35
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There is no phase-out of the adoption credit. What are the adoption credits for both
2009 and 2010, respectively?
a. $0; $7,000
b. $4,000; $1,000
c. $4,000; $3,000
d. $7,000; $0
LO 6.5
15. In 2010, Irene, an unmarried individual, pays $6,500 in qualified adoption expenses to
an adoption agency for the final adoptio n of an eligible child who is not a child with
special needs. In the same year, the individual’s employer, under a qualified adoption
assistance program, pays an additional $4,000 for other qualified adoption expenses to
an attorney on behalf of Irene for the adoption of the child. Assuming Irene is not sub-
ject to the phase-out, she may exclude, from her personal income, how m uch of the
$4,000 payment made by her employer?
a. $6,500
b. $5,000
c. $4,000
d. $2,000
LO 6.5
16. If a taxpayer does not have enough tax liability to use all the available adoption credit,
the unused portion may be carried forward for how many years?
a. Two
b. Three
c. Five
d. Seven
LO 6.6
17. Which of the following is not a tax preference or adjustment item for the individual
alternative minimum tax computation?
a. Miscellaneous itemized deductions
b. State income taxes
c. State income tax refunds
d. Private activity bond interest
e. All of the above are adjustments or tax preference items
LO 6.8
18. Dana and Larry are married and live in Texas. Dana earns a salary of $45,000 and
Larry has $25,000 of rental income from his separate property. If Dana and Larry
file separate tax returns, what amount of income must Larry report?
a. $0
b. $22,500
c. $25,000
d. $47,500
e. None of the above
LO 6.8
19. Which of the following conditions need not be satisfied in order for a married tax-
payer, residing in a community property state, to be taxed only on his or her separate
salary?
a. The husband and wife must live apart for the entire year.
b. A minor child must be living with the spouse.
c. The husband and wife must not file a joint income tax return.
d. The hu sband and wife must not transfer earned income between themselves.
e. All of the above must be satisfied.
6-36 Chapter 6
Credits and Special Taxes
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GROUP 2:
PROBLEMS
.............................................. .............................................. .
LO 6.1 1. Calculate the child credit for the following taxpayers. Please show your work.
a. Jeremy is a single (head-of-household) father with a dependent 8-year-old son and
$79,600 of AGI:
_______________________________________________________________________
b. Jerry and Ann have two dependent preschool children and $100,000 of AGI:
_______________________________________________________________________
c. James and Apple have two dependent children and $120,400 of AGI:
_______________________________________________________________________
LO 6.2 2. How does the earned income credit produce a ‘‘negative’’ income tax?
_________________________________________________ ________________________
_________________________________________________ ________________________
_________________________________________________ ________________________
LO 6.2 3. Diane is a single taxpayer who qualifies for the earned income credit. Diane has two
qualifying children who are 3 and 5 years old. During 2010, Diane’s wages are
$16,100 and she receives dividend income of $500. Calculate Diane’s earned income
credit using the EIC table in Appendix B.
$ ____________
LO 6.2 4. Margaret and David Simmons are married and file a joint income tax return. They
have two dependent children, Margo, 4 years old (Social Security number 316-31-
4890), and Daniel, who was born during the year (Social Security number 316-31-
7894). Margaret’s wages are $4,000, and David has wages of $14,000. In addition,
they receive interest income of $200 during the year. Margaret and David do not
have any other items of income and do not have any deductions for adjusted gross
income. Assuming the Simmons file Form 1040A for 2010, complete Schedule EIC,
the Earned Income Credit Worksheet, from the 1040A Instructions on pages 6-39
and 6-40. (The Earned Income Credit table is in Appendix B.)
LO 6.2 5. What is the maximum investment income a taxpayer is allowed to have and still be
allowed to claim the earned income credit? Please speculate as to why there is an
investment income limit in the tax law.
_________________________________________________ ________________________
_________________________________________________ ________________________
_________________________________________________ ________________________
LO 6.3 6. Calculate the amount of the child and dependent care credit allowed for 2010 in each
of the following cases, assuming the taxpayers had no income other than the stated
amounts.
a. William and Carla file a joint tax retu rn. Carla earned $26,000 during the year,
while William attended law school full- time for 9 months and earned no income.
They paid $3,500 for the care of their 3-year-old child, Carl.
$ ____________
b. Raymond and Michele file a joint tax return. Raymond earned $32,500 during the
year, while Michele earned $9,000 for the year from a part-time job. They paid
$7,000 for the care of their two children under age 13.
$ ____________
Questions and Problems 6-37
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
c. Beth is a single taxpayer who has two dependent children under age 5. Beth earned
$23,500 in wages during the year and paid $6,700 for the care of her children.
$ ____________
LO 6.3 7. Clarita is a single taxpayer with two dependent children, ages 10 and 12. Clarita pays
$3,000 in qua lified child care expense s during the year. If her adjusted gross income
(all from wages) for the year is $18,500, calculate Clarita’s ch ild and dependent care
credit for 2010.
$ ____________
LO 6.3 8. Go to the IRS Web site (www.irs.gov) and redo Problem 7 (Chapter 6, Group 2) using
the most recent interactive ‘‘Fill-in Forms’’ Form 2441, Child and Dependent Care
Expenses. Print out the completed Form 2441. Also note the ‘‘document rights’’ feature
available for saving filled-in forms to the computer.
LO 6.3 9. Mary and John are married and have AGI of $100,000 and two young children. John
doesn’t work, and they pay $6,000 a year to day care providers so he can shop, clean,
and read a little bit in peace. How much child and dependent care credit can Mary and
John claim? Why?
LO 6.3 10. Martha has a 3-year-o ld child and pays $10,000 a year in day care costs. Her salary is
$45,000. How much is her child and dependent care credit?
LO 6.3 11. Marty and Jean ar e married and have 4-year-old twins. Jean is going to school full-time
for 9 months of the year, and Marty earns $45,000. The twins are in day care so Jean
can go to school while Marty is at work. The cost of day care is $10,000. What is their
child and dependent care credit? Please explain your calculation.
_________________________________________________ ________________________
_________________________________________________ ________________________
_________________________________________________ ________________________
LO 6.4 12. What is the reason there are education tax credits in the tax law:
_________________________________________________ ________________________
_________________________________________________ ________________________
_________________________________________________ ________________________
LO 6.4 13. Please explain the difference between the types of education covered by the American
Opportunity credit and the lifetime learning credit.
_________________________________________________ ________________________
_________________________________________________ ________________________
_________________________________________________ ________________________
LO 6.4 14. Janie graduates from high school in 2010 and enrolls in college in the fall. Her parents
pay $4,000 for her tuition and fees.
a. Assuming Janie’s parents have AGI of $170,000, what is the American Opportunity
credit they can claim for Janie?
_________________________________________________ ______________________
_________________________________________________ ______________________
_________________________________________________ ______________________
b. Assuming Janie’s parents have AGI of $75,000, what is the American Opportunity
credit they can claim for Janie?____________________________________________
6-38 Chapter 6
Credits and Special Taxes
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Questions and Problems 6-39
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(Wages, Salaries)
(Adjusted Gross Income)
6-40 Chapter 6
Credits and Special Taxes
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.