Essentials of taxation 2016 cengage chapter 17

– Tax credit for rehabilitation expenditures – Work opportunity tax credit – Research activities credit – Low-income housing credit – Disabled access credit – Credit for small employer p

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The Big Picture

• Mike, the CEO of Progress Corporation, has committed to

helping revitalize the downtown area in his hometown

• Mike is considering expanding his business and purchasing an

old office building in a historic section of downtown.

– The building will require substantial renovations.

– Mike has heard that there are tax credits that might help reduce his

costs

• He would also like to

– Hire inner-city workers, and

– Help working families by providing on-site child care for working

families.

• He is interested in learning whether his company might take

advantage of any other tax credits offered by the Federal

government that might reduce his costs

Tax Credit VS Tax Deduction

• Tax benefit received from a tax deduction depends on

the marginal tax rate of the taxpayer

– Tax benefit received from a tax credit is not affected by the

taxpayer’s marginal tax rate

• Example: $1,000 expenditure: tax benefit of 25%

credit compared to tax deduction at various marginal

tax rates

MTR 0% 15% 35%

Tax benefit if a 25% credit is allowed $250 $250 $250

Tax benefit if tax deduction is allowed –0– $150 $350

General Business Credit (slide 1 of 2)

combined into one amount

of:

– Tentative minimum tax

– 25% of net regular tax liability that exceeds

$25,000

forward 20 years

– Tax credit for rehabilitation expenditures

– Work opportunity tax credit

– Research activities credit

– Low-income housing credit

– Disabled access credit

– Credit for small employer pension plan startup

costs

– Credit for employer-provided child care

General Business Credit (slide 2 of 2)

– Tax credit for rehabilitation expenditures

– Work opportunity tax credit

– Research activities credit

– Low-income housing credit

– Disabled access credit

– Credit for small employer pension plan startup

costs

– Credit for employer-provided child care

Rehabilitation Expenditure Credit

(slide 1 of 3)

substantially rehabilitate industrial and

commercial buildings and certified historic

Rehabilitation Expenditure Credit

(slide 2 of 3)

substantially rehabilitated meaning qualified

rehab expenditures exceed the greater of:

– The adjusted basis of the property before the rehab

expenditures, or

– $5,000

the cost of the building and related facilities or

cost of enlarging existing building

held less than 5 years or ceases to be

qualifying property

The Big Picture - Example 4Tax Credit For Rehabilitation Expenditures (slide 1 of 2)

• Return to the facts of The Big Picture on p 17-1

rehabilitate a building (adjusted basis of

$40,000) that had been placed in service in

1932

– Progress is allowed a credit of $6,000 (10% X

$60,000) for rehabilitation expenditures

– The corporation then increases the basis of the

building by $54,000

• $60,000 (rehabilitation expenditures) - $6,000 (credit

The Big Picture - Example 4Tax Credit For Rehabilitation Expenditures (slide 2 of 2)

• If the building were a historic structure,

– The credit allowed would be $12,000 (20% X

Work Opportunity Tax Credit

(slide 1 of 2)

individuals falling within target groups

– Credit limited to a percentage of first $6,000 wages paid per eligible employee

• 40% if employee has completed at least 400 hours of

service to employer

• 25% if at least 120 hours of service

– Deduction for wages is reduced by credit amount

Work Opportunity Tax Credit

(slide 2 of 2)

rates of unemployment, including

– Qualified ex-felons, high-risk youths, food stamp

recipients, veterans, summer youth employees, and long-term family assistance recipients

• Summer youth employees: Only first $3,000 of wages

paid for work during 90-day period between May 1 and September 15 qualify for credit

The Big Picture - Example 6

Work Opportunity Tax Credit

• Return to the facts of The Big Picture on p 17-1

• In January 2015, Progress Corporation hires 4

members of a qualifying targeted group

– Each employee works 1,000 hours and is paid wages of

$8,000 during the year

• Progress’s work opportunity credit is $9,600

– ($6,000 X 40%) X 4 employees

– If the tax credit is taken, Progress reduces its deduction for

wages paid by $9,600

• No credit is available for wages paid to these

employees after their first year of employment

Work Opportunity Tax Credit: Long-Term

Family Assistance Recipient (slide 1 of 2)

individuals who have been long-term

recipients of family assistance welfare benefits

– Long-term is at least an 18 month period ending on hiring date

Work Opportunity Tax Credit: Long-Term

Family Assistance Recipient (slide 2 of 2)

$10,000 qualified wages paid in first and

second year of employment

Research Activities Credit

(slide 1 of 5)

– Incremental research activities credit

– Basic research credit

– Energy research credit

Research Activities Credit

(slide 2 of 5)

• Incremental research activities credit

– Credit amount = 20% × (qualified expenditures – base

amount)

• Expenditures qualify if research relates to discovery

of technological info intended for use in developing a

new or improved business component for taxpayer

– Expenditures qualify fully if research done in-house

– Only 65% qualifies if research conducted by outside party

(under contract)

Research Activities Credit

(slide 3 of 5)

– Full credit and reduce expense deduction by credit

amount

– Full expense deduction and reduce credit by (100%

× credit × max corp tax rate)

– Full credit and capitalize research expenses and

amortize over 60 months or more

• Amount capitalized is reduced by full amount of credit

only if the credit exceeds the amount allowable as a deduction

Research Activities Credit

(slide 4 of 5)

• Basic research credit

– Additional 20% credit is allowed on basic research

payments in excess of a base amount

• Basic research payments - amounts paid in cash to a qualified basic research organization, such as a college or university or a tax-

exempt organization operated primarily to conduct scientific research

– Basic research is any original investigation for the

advancement of scientific knowledge not having a specific

commercial objective

• The definition excludes basic research conducted outside the United States and basic research in the social sciences, arts, or humanities

Research Activities Credit

(slide 5 of 5)

– This credit is intended to stimulate additional

energy research

– Credit amount = 20% of amounts paid or incurred

by a taxpayer to an energy research consortium for

energy research

Disabled Access Credit

• Credit available for eligible access expenditures

made by small businesses

– Includes amounts paid to remove barriers that would

otherwise make a business inaccessible to disabled and

• Thus, max credit is $5,000

– Basis in asset is reduced by credit amount

Disabled Access Credit

• Credit available for eligible access expenditures

made by small businesses

– Includes amounts paid to remove barriers that would

otherwise make a business inaccessible to disabled and

• Thus, max credit is $5,000

– Basis in asset is reduced by credit amount

Credit For Pension Plan Startup Costs

• Small businesses can claim nonrefundable tax credit

for admin costs of establishing and maintaining a

qualified retirement plan

– Small business has < 100 employees who have earned at

least $5,000 of compensation

• Credit amount = 50% of qualified startup costs

limited to max credit of $500 per year for 3 years

– Deduction for startup costs is reduced by amount of credit

Credit For Employer-Provided Child Care

(slide 1 of 2)

child care facilities to their employees during

normal working hours

– Limited to $150,000 per year

– 25% of qualified child care expenses

– 10% of qualified child care resource and referral

services

Credit For Employer-Provided Child Care

(slide 2 of 2)

reduced by the credit amount

by credit amount

care facility ceases to be used for qualifying

purpose within 10 years of being placed in

service

The Big Picture - Example 13

Credit For Employer-provided Child Care

(slide 1 of 2)

• Return to the facts of The Big Picture on p 17-1

constructs a child care facility for $400,000 to

be used by its employees’ preschool-aged

children

– In addition, Progress incurs $100,000 in salaries

and other administrative costs associated with the

facility

The Big Picture - Example 13

Credit For Employer-provided Child Care

(slide 2 of 2)

employer-provided child care is $125,000.

Foreign Tax Credit

(slide 1 of 2)

to mitigate double taxation since income

earned in a foreign country is subject to both

U.S and foreign taxes

– Credit applies to both individuals and corporations

that pay foreign income taxes

– Instead of claiming a credit, a deduction may be

claimed for the taxes paid

Foreign Tax Credit

(slide 2 of 2)

• Amount of the credit allowed is the lesser of:

– The foreign taxes imposed, or

– The overall limitation determined using the following formula:

Foreign-source TI × U.S tax before credit

Worldwide TI

= Overall FTC limitation

• For individual taxpayers, worldwide taxable income is

determined before personal and dependency exemptions

• Unused FTCs can be carried back 1 year and forward 10

years

substantial economic income pay at least a

minimum amount of federal taxes

quasi-flat tax rate applied to a corporation’s

economic income

Alternative Minimum Tax (slide 2 of 2)

• If tentative alternative minimum tax > regular

corporate income tax, corporation must pay

regular tax plus the excess, the alternative

minimum tax (AMT)

Small Corporation Exemption

(slide 1 of 2)

corporations are not subject to AMT

• A corporation initially qualifies as a small

corporation in its first tax year in existence

regardless of its gross receipts

• After the initial year, the exemption applies if

the corp meets two requirements

Small Corporation Exemption

(slide 2 of 2)

• The exemption applies if these 2 requirements are

met:

– The corp was treated as a small corporation exempt from

the AMT for all prior years beginning after 1997

– Annual average gross receipts for the 3 year period ending

before its current tax year did not exceed $7.5 million

• $5 million if the corporation had only one prior tax year

• This provision exempts up to 95% of all C corps from the AMT

AMT Formula for Corporations

Tax Preference Items

basis of property

bonds”

Adjustments for AMT

(slide 1 of 2)

– A portion of depreciation on property placed in

service after 1986

– A portion of amortization claimed on certified

pollution control facilities

– Difference between percentage of completion and

completed contract income

– Difference between gain (loss) on sale of property

for regular tax and AMT purposes

Adjustments for AMT

(slide 1 of 2)

– A portion of depreciation on property placed in

service after 1986

– A portion of amortization claimed on certified

pollution control facilities

– Difference between percentage of completion and

completed contract income

– Difference between gain (loss) on sale of property

for regular tax and AMT purposes

Adjustments for AMT

(slide 1 of 2)

– A portion of depreciation on property placed in

service after 1986

– A portion of amortization claimed on certified

pollution control facilities

– Difference between percentage of completion and

completed contract income

– Difference between gain (loss) on sale of property

for regular tax and AMT purposes

Adjustments for AMT

(slide 1 of 2)

– A portion of depreciation on property placed in

service after 1986

– A portion of amortization claimed on certified

pollution control facilities

– Difference between percentage of completion and

completed contract income

– Difference between gain (loss) on sale of property

for regular tax and AMT purposes

Adjustments for AMT

(slide 2 of 2)

– Passive activity losses of certain closely held

corporations and personal service corporations

– A portion of the difference between “ACE” and

“AMTI”

ACE Adjustment

(slide 1 of 2)

unadjusted AMTI and ACE

– Can be positive or negative

– Negative adjustment is limited to aggregate

positive adjustments less previous negative

adjustments

ACE Adjustment

(slide 2 of 2)

– AMTI is defined as regular taxable income after

AMT adjustments and tax preferences (other than

the NOL and ACE adjustments)

Impact of Certain Transactions on ACE and

E & P (slide 1 of 2)

Impact of Certain Transactions on ACE and

E & P (slide 2 of 2)

– Reduced by 25% of excess of AMTI over

$150,000

– Exemption is totally phased-out when AMTI

reaches $310,000

Minimum Tax Credit

against future regular tax liability that exceeds

its tentative minimum tax

– Indefinite carryforward

– Cannot be carried back

– Cannot offset any future minimum tax liability

• Installment gain (not on inventory sale) 80,000

• Federal income tax provision on

financial stmts 75,000

• Penalties and fines 2,000

• Private activity bond interest income (Issued 2007) 25,000

• Other tax-exempt interest 20,000

– The depreciation adjustment is an AMT adjustment and the private

activity bond interest is a tax preference for AMTI.

Plus: private activity bond income 25,000

Plus: depreciation adjustment 18,000

AMT Example

(slide 3 of 4)

Calculation of ACE Adjustment:

AMTI before ACE $143,000

Plus: deferred installment gain 80,000

Plus: other tax-exempt income 20,000

Adjusted current earnings $243,000

AMT Example

(slide 4 of 4)

Calculation of AMT:

AMTI before ACE $143,000

Plus: ACE Adjustment 75,000

Less: Exemption 23,000

Alternative minimum tax base $195,000

20% rate × 20%

Tentative minimum tax $ 39,000

Less: regular tax (22,250)

AMT(TMT-Regular tax) $ 16,750

Total cash paid = Regular tax + AMT = $ 39,000

Individual AMT

(slide 1 of 3)

• AMT applicable to individuals is similar to the

corporate AMT with several important

differences

– The individual AMT rate is slightly progressive,

with rates at 26% on first $185,400 ($92,700 for

married, filing separately) of AMTI and at 28% on

any additional AMTI

– The alternative rate on net capital gain of 0% or

15% applies

Individual AMT

(slide 2 of 3)

– The AMT exemption and phaseout amounts are

tied to the individual’s filing status for the year

– Individuals make no AMT adjustment for ACE

– Taxes, misc itemized deductions subject to the 2%

floor, the standard deduction and personal and

dependency exemptions are not allowed

– Medical expenses are allowed only to the extent

that they exceed 10% of AGI (instead of a 7.5% for those at least age 65)

Individual AMT

(slide 3 of 3)

– Interest expense deductions are limited to

• Qualified residence interest

• Interest on certain student loans, and

• Investment interest (subject to limitations)

– The 3% phaseout of itemized deductions for certain high-income taxpayers does not apply in

computing the individual AMT

– Determination of the minimum tax credit is more

complex for individual taxpayers

• The credit applies only to AMT generated as a result of