Chapter 14 - The Individual Tax Formula

Chapter14

QuestionsandProblemsforDiscussion

1. AGIincludesnetprofitfromsoleproprietorships,netincomefromrentalrealestate,andshares
ofnetbusinessincomeearnedbypassthroughentitiesinwhichthetaxpayerownsaninterest.It
alsoincludesnetcapitalgains(capitalgainsreducedbycapitallosses).

2. a. AnincreaseinAGIcandecreasetotalitemizeddeductions.
b. AnincreaseinAGIhasnoeffectonthestandarddeduction.
c. AnincreaseinAGIcandecreasetheexemptionamount.
d. AnincreaseinAGIincreasesalternativeminimumtaxableincome(AMTI).
e. AnincreaseinAGIcandecreasethepercentageusedtocalculatethedependentcare
credit.

3. Presumably,theseindividualsarelivingonafixedretirementincomeandhavespecialneeds
(increasedmedicalcare)thatreducetheirfinancialabilitytopayincometax.

4. Nonethattheauthorcanthinkof.

5. Theoveralllimitationonitemizeddeductionsandthereductionoftheexemptionamount
increasethetaxburdenonhighincomeindividualsbyincreasingtheirtaxbase.Abaseincrease
isamoresubtleapproachthanarateincreaseandtendstobelesspoliticallydifficultto
accomplish.

6. AbovethelinedeductionsthatreduceAGIalwaysyieldabenefitintheformofcurrenttax
savingswhileitemizeddeductionsyieldabenefitonlyiftheirtotalexceedsthestandard
deduction.Also,areductioninAGImaycauseanincreaseinAGIsensitivedeductionsand
credits,totalitemizeddeductions,andtheexemptionamount.

7. No,abovethelinebusinessdeductionsthatreduceAGIarenotinterchangeablewithitemized
deductionsbecausetheAGInumberaffectssomanyothercomputationsonForm1040.A
$2,700increaseinAGIcoupledwitha$2,700additionalitemizeddeductionmaycausean
increaseinMr.Gstaxableincome.

8. PostponingpaymentofexpensesimprovesNPVofcashflows,whileacceleratingpaymentof
expensesreducesNPVofcashflows.

9. AGIisabettergaugeofdisposableincomethantaxableincome.Taxableincomeisnetofthe
standarddeductionandexemptionamount,whicharenotbasedonmonetaryexpensesor
economiclossesandbearnorelationshiptospecificcashflows.

10. Thesinglepersoncouldarguethattwopeoplecanliveascheaplyasone.Forexample,asingle
personmightneedthesameconsumerdurables(oneautomobile,onesetofdiningroom
furniture,onelawnmower)asamarriedcouple.Asinglepersonmaypaymoreforservicessuch
asrestaurantmeals,laundry,andyardmaintenancethanamarriedcoupleinwhichonespouse
worksathomeprovidingtheseservices.

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11. a. Thestandarddeductionformarriedfilingjointlyistwicethestandarddeductionforsingle
individuals.Consequently,SandZsaggregatestandarddeductiondidnotchange.
b. SandZsaggregateexemptionamountshouldnothavechangedunlesstheirAGIonthe
jointreturnexceededthethresholdandcausedareductionoftheirexemptionamount.
c. SandZsaggregatedependentcarecreditdecreasedonthejointreturniftheircredit
percentagedecreasedbecauseoftheirjointAGI.
d. TheAMTIexemptionformarriedfilingjointlyislessthantwicetheAMTIexemptionforsingle
individuals.Consequently,SandZsaggregateAMTIexemptiondecreased.

12. Thestandarddeductionandexemptionamountareartificialdeductionsbecausetheyarenot
basedonmonetaryexpensesoreconomiclossesandbearnorelationshiptospecificcash
flows.TheysimplyprovideshelterforabaseamountofAGIthatisnottaxed(i.e.,taxedata
zerorate).

13. Individualsengageinatremendousvarietyofnonbusinessactivitieswithfinancialoreconomic
consequences.Becausetheseconsequencesaffecteachpersonsabilitytopay,thetaxlaw
mustprescribetheirtreatmentinthecomputationoftaxableincome.Incontrast,corporations
engageonlyinprofitmotivatedbusinessactivities.Asaresult,corporateabilitytopay
correspondsmuchmorecloselytotheaccountingconceptofnetprofit.

14. Anonrefundablecreditcanreduceprecredittaxtozero.Inotherwords,itcanonlyeliminate
negativecashflow(incometaxcost).Arefundablecreditcanreducetaxtozeroandgeneratea
refundoftheexcesscredit.Thus,arefundablecreditcancreatepositivecashflow.

15. Underthefederalentitlementsystem,onlypeoplewhopaidFICApayrolltaxorselfemployment
taxduringtheirworkinglivesareeligibletoreceiveSocialSecurityandMedicarebenefits.Iflow
incomepeoplewereexemptfromthesetaxes,theywouldbeineligibleforSocialSecurityand
Medicare.

16. Byoverpayinghistaxduringthecourseoftheyear,Mr.MGismakinganinterestfreeloanto
thefederalgovernment.Hewouldbebetterofffinanciallyifhedecreasedhiswithholdingtothe
minimumallowedbylaw,investedtheresultingincreaseinhispaycheckinthemutualfund,and
paidthebalanceoftaxduefromthisaccountonApril15ofthefollowingyear.

17. AlthoughMs.JRcanautomaticallyextendthefilingdateofherprioryearForm1040toAugust
15,shemustpaythe$20,000estimatedbalanceoftaxduewithherApril15extensionrequest
toavoidinterestandpenalties.

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ApplicationProblems

1. a Marriedfilingjointlyorseparately
b. Single
c. Marriedfilingjointlyorseparately
d. Headofhousehold

2. a. Single
b. Marriedfilingjointlyorseparately(withthesecondMrs.J)
c. Marriedfilingjointly(withthedeceasedMrs.J)
d. Marriedfilingjointly(survivingspouse)
e. Single
f. Headofhousehold

3. a. $11,750($10,700+$1,050additionaldeductionbecauseMr.Kisoverage65)

b. $12,800($10,700+$2,100additionaldeductionsbecauseMr.KandMrs.Karebothover
age65)

c. $13,850($10,700+$3,150additionaldeductionsbecauseMr.KandMrs.Karebothover
age65,andMrs.Kisblind)

4. a. Deemeetsthethreerequirementsforaqualifyingchild.
b. Lulumeetsthethreerequirementsforaqualifyingrelative.
c. Bryanmeetsthethreerequirementsforaqualifyingchild.AlthoughBryansfatherprovided
morethanonehalfofBryanssupport,Bryandidnotprovideanyofhisownfinancial
support.
d. Betsyisnotaqualifyingrelativebecausehergrossincomeexceedstheexemptionamount.

5. a. Jackisnotaqualifyingchildbecauseheisoverage19andisnotastudent.Heisnota
qualifyingrelativebecausehisgrossincomefromemploymentpresumableexceedsthe
2006exemptionamount.
b. Brendameetsthethreerequirementsforaqualifyingchild.
c. Eddiemeetsthethreerequirementsforaqualifyingchild.
d. Mildredisnotaqualifyingrelativebecausehergrossincomeexceedstheexemption
amount.
e. RichardisnotaqualifyingrelativebecauseMr.andMrs.Odonotprovidemorethanone
halfofhisfinancialsupport.

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6. a. Ms.Gstotalincome $68,250
Standarddeduction (5,350)
Exemptionamount (3,400)
Taxableincome $59,500
Incometaxon$59,500(single) $11,299

Mr.Hstotalincome 171,000
Standarddeduction (5,350)
Exemptionamount (3,400)
Taxableincome $162,250
Incometaxon$162,250(single) $39,611
Ms.GandMr.Hscombinedtaxis$50,910

b. Ms.GandMr.Hstotalincome $239,250
Standarddeduction (10,700)
Exemptionamount($3,400 2) (6,800)
Taxableincome $221,750
Incometaxon$221,750(marriedfilingjointly) $52,378

7. a. Mr.Ostotalincome $89,000
Standarddeduction (5,350)
Exemptionamount (3,400)
Taxableincome $80,250
Incometaxon$80,250(marriedfilingseparately) $16,966
Mrs.Ostotalincome $40,330
Standarddeduction (5,350)
Exemptionamount (3,400)
Taxableincome $31,580
Incometaxon$31,580(marriedfilingseparately) $4,346
Mr.andMrs.Oscombinedtaxis$21,312

b. Mr.andMrs.Ostotalincome $129,330
Standarddeduction (10,700)
Exemptionamount($3,400 2) (6,800)
Taxableincome $111,830
Incometaxon$111,830(marriedfilingjointly) $20,805

8. Mr.andMrs.Dstotalincome $95,600
AbovethelinedeductionforonehalfofSEtax (2,953)
AGI $92,647
Standarddeduction (10,700)
Exemptionamount($3,400 2) (6,800)
Taxableincome $75,147
Incometaxon$75,147(marriedfilingjointly) $11,634

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9. Mr.andMrs.Sstotalincome $96,140
AbovethelinedeductionforonehalfofSEtax (6,452)
AGI 89,688
Itemizeddeductions (13,050)
Exemptionamount($3,4003) (10,200)
Taxableincome $66,438
Incometaxon$66,438(marriedfilingjointly) $9,457

10. Ms.Tstotalincome $23,435

AbovethelinedeductionforonehalfofSEtax (2,254)
AGI $21,181
Standarddeduction (7,850)
Exemptionamount($3,4002) (6,800)
Taxableincome $6,531
Incometaxon$6,351(headofhousehold) $653

11. Mr.andMrs.Kstotalincome $306,750

Abovethelinedeductions 0
AGI $306,750
Itemizeddeductionsperworksheet (25,191)
Exemptionamountperworksheet (8,339)
Taxableincome $273,220
Incometaxon$273,220(marriedfilingjointly) $69,363

12. Mr.Cstotalincome $184,800

Abovethelinedeductions 0
AGI $184,800
Itemizeddeductionsperworksheet (16,732)
Exemptionamountperworksheet (2,856)
Taxableincome $165,212
Incometaxon$165,212(single) $40,588

13.. Mr.andMrs.Lstotalincome $30,625

Abovethelinedeductions 0
AGI $30,625
Standarddeduction($10,700+$2,100) (12,800)
Exemptionamount($3,400 2) (6,800)
Taxableincome $11,025

Incometaxon$6,300dividendsandcapitalgain(5%) $315
Incometaxon$4,725ordinaryincome(MFJ) 473
$788

14. Mr.RGstotalincome $320,700

Abovethelinedeductions 0
AGI $320,700
Itemizeddeductionsperworksheet (30,712)
Exemptionamountperworksheet (7,925)
Taxableincome $282,063
Incometaxon$282,063(headofhousehold) $76,035

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15. a. $26,311
b. $23,451($20,151regulartaxon$93,000+[15%$22,000])

16. a. $41,508
b. $38,912
c. $36,033

17. a. AGI $15,700

Standarddeduction(limited) (850)
Exemptionamount(dependent) 0
Taxableincome $14,850
Incometaxon$14,850(single) $1,836

b. AGI $15,700
Standarddeduction (5,350)
Exemptionamount(dependent) 0
Taxableincome $10,350
Incometaxon$10,350(single) $1,161

c. AGI $15,700
Standarddeduction($5,350+$1,300) (6,650)
Exemptionamount (3,400)
Taxableincome $5,650
Incometaxon$5,650(single) $565

18. a. AnadditionalexemptionreducesMr.andMrs.PJstaxableincomeby$3,400.

b. AnadditionalexemptionreducesMr.andMrs.SGstaxableincomeby$2,629($3,400
[$3,40034%66.7%]basedontheExemptionAmountWorksheetinAppendix14.B).

c. AnadditionalexemptionreducesMr.andMrs.SGstaxableincomeby$1,132($3,400
[$3,400100%66.7%]basedontheExemptionAmountWorksheetinAppendix14.B).

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19. a. Mr.andMrs.MsAGI $209,000

Standarddeduction (10,700)
Exemptionamount($3,400 2) (6,800)
Taxableincome $191,500
Incometaxon$191,500(marriedfilingjointly) $42,613

b. Mr.andMrs.Msseparatereturnswouldshowthefollowing.
Mr.M Mrs.M
AGI $95,000 $114,000
Standarddeduction (5,350) (5,350)
Exemptionamount (3,400) (3,400)
Taxableincome $86,250 $105,250
Incometax(MFS) $18,646 $24,333
Combinedtax $42,979

c. IfMr.andMrs.Mcouldfileassingletaxpayers,theirreturnswouldshowthefollowing.
Mr.M Mrs.M
AGI $95,000 $114,000
Standarddeduction (5,350) (5,350)
Exemptionamount (3,400) (3,400)
Taxableincome $86,250 $105,250
Incometax(single) $18,261 $23,581

Taxonjointreturnfromparta. $42,613
Combinedtaxassingletaxpayers (41,842)
Marriagepenalty $771

20. The$2,500expenseshiftwilldecreaseMs.NMs2007taxableincomebyonly$350($5,700
itemizeddeductions$5,350standarddeduction)Theshiftwillreduceher2008taxableincome
by$2,500($5,700itemizeddeductions+$2,500additionaldeductions).

21. a. Mrs.AsAGI $40,000

Standarddeduction (7,850)
Exemptionamount($3,400 2) (6,800)
Taxableincome $25,350
Incometaxon$25,350(headofhousehold) $3,243

b. ChildsAGI $5,485
Standarddeduction (5,350)
Exemptionamount 0
Taxableincome $135
Incometaxon$135(single) $14

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22. Mr.GWsAGI $29,600

Standarddeduction (7,850)
Exemptionamount($3,400 2) (6,800)
Taxableincome $14,950
Precredittaxon$14,950(headofhousehold) $1,683
Childcredit (1,000)
Dependentcarecredit($1,630cost27%) (440)
Incometax $243

Thedependentcarecreditpercentageiscomputedasfollows.
AGI $29,600
AGIfloor (15,000)
ExcessAGI $14,600
$14,600excessAGI$2,000=7.3
Maximumcreditpercentage 35%
Reduction(roundeduptowholepoint (8)
Creditpercentage 27%

23. a. $3,000childcredit($1,0003childrenunderage17)
b. AGI $131,600
AGIthreshold (110,000)
ExcessAGI $21,600
$21,600excessAGI$1,000(roundedup) 22
Maximumtotalcredit $3,000
Phaseout($5022) (1,100
)
Childcredit $1,900
c. AGI $167,000
AGIthreshold (110,000)
ExcessAGI $57,000
$57,000excessAGI$1,000(roundedup) 57
Maximumtotalcredit $3,000
Phaseout($5057) (2,850
)
Childcredit $150

24. a. BecauseMrs.OPhasnoearnedincome,thecouplehasnodependentcarecredit.
b. Mr.andMrs.OPhavetwoqualifyingchildren,andthelesseroftheirearnedincomes
($28,000)exceedsthe$6,000limitationonthecostforcomputingthedependentcarecredit.
Consequently,theirdependentcarecreditis$1,200(20%$6,000).

25. a. TheCoulterschildcreditis$4,000($1,000fourchildren).
b. TheCoultersdependentcarecreditis$828($3,600cost23%).
AGI $37,600
AGIfloor (15,000)
ExcessAGI $22,600
$22,600excessAGI$2,000=11.3

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 Chapter 14 - The Individual Tax Formula
Maximumcreditpercentage 35%
Reduction(roundeduptowholepoint (12)
Creditpercentage 23%
c. IftheCoultersAGIis$137,700,theirchildcreditis$2,600.
AGI $137,700
AGIthreshold (110,000)
ExcessAGI $27,700
$27,700excessAGI$1,000(roundedup) 28
Maximumtotalcredit $4,000
Phaseout($5028) (1,400
)
Childcredit $2,600
TheCoultersdependentcarecreditis$720($3,600cost20%).

26. Mr.Rspayrolltaxwithheld:
MTInc.($82,600 7.65%) $6,319
PKCompany($93,000 7.65%) 7,115
$13,434
Mr.Rs2007payrolltaxon$175,600salary:
$97,500(maximum) 6.2% $6,045
$175,600 1.45% 2,546
(8,591)
Excesspayrolltaxwithholdingcredit $4,843

27. Mr.andMrs.KsAGI $14,610

Standarddeduction (10,700)
Exemptionamount($3,400 4) (13,600)
Taxableincome 0
Incometax 0
Refundoffederaltaxwithheld $850
Earnedincomecredit 4,716
Taxrefund $5,566

28. a. Mr.andMrs.BHsAMTIbeforeexemption $203,000

AMTIexemption:
$62,550(25%[$203,000$150,000]) (49,300)
TaxableAMTI $153,700
Tentativeminimumtax:
$153,700AMTI 26% $39,962
Regulartaxon$200,000(marriedfilingjointly) (45,200)
AMT 0

b. Mr.CKsAMTIbeforeexemption $98,000
AMTIexemption (42,500)
TaxableAMTI $55,500
Tentativeminimumtax:
$55,500AMTI 26% $14,430
Regulartaxon$77,300(single) (15,755)
AMT 0

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c. Ms.WsAMTIbeforeexemption $211,500
AMTIexemption:
$42,500(25%[$211,500$112,500]) (17,750)
TaxableAMTI $193,750
Tentativeminimumtax:
$175,000AMTI 26% $45,500
$18,750AMTI 28% 5,250
$50,750
Regulartaxon$181,000(headofhousehold) (42,685)
AMT $8,065

29. a. Regulartaxon$173,000ordinaryincome(HH) $40,312

Taxon$19,900capitalgain(15%) 2,985
Regulartax $43,297
AMTI $229,800
AMTIexemption:
$42,500(25%[$229,800$112,500]) (13,175)
TaxableAMTI $216,625

Tentativeminimumtax:
$175,000ordinaryAMTI 26% $45,500
$21,725ordinaryAMTI 28% 6,083
$19,900capitalgain 15% 2,985
$54,568
AMT($54,568$43,297regulartax) $11,271
Jaclynstotalincometaxfor2007is$54,568(regulartax+AMT).

b. Regulartaxon$168,100ordinaryincome(HH) $38,940

AMTI $174,500
AMTIexemption:
$42,500(25%[$174,500$112,500]) (27,000)
TaxableAMTI $147,500
.26
Tentativeminimumtax $38,350

Regulartax $38,940
Minimumtaxcredit(limited) (590)
Totalincometaxfor2007 $38,350
Jaclynsminimumtaxcreditcarryforwardinto2009is$4,610($5,200$590).

30. a. Taxpaidinprecedingyear $47,200

Percentofprecedingyeartaxforsafeharbor 1.10
$51,920
Projectedwithholding (25,000)
Totalquarterlyinstallmentsforsafeharborestimate $26,920
Quarterlyinstallment($26,9204) $6,730

b. Taxpaidinprecedingyear $36,800
Projectedwithholding (25,000)

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Totalquarterlyinstallmentsforsafeharborestimate $11,800
Quarterlyinstallment($11,8004) $2,950

IssueRecognitionProblems

1. WhatisMrs.LRsfilingstatusfortheyear?Cansheelecttofileajointreturnwitheitherher
deceasedspouseorhernewspouse?IfMrs.LRfilesajointreturnwithhernewspouse,whatis
Mr.LRsfilingstatusonhisfinaltaxreturn?

2. AreMr.andMrs.JCentitledtofileassingletaxpayersbecausetheywerenottechnically
marriedonthelastdayoftheyear?CantheIRSimposethesubstanceoverformdoctrineto
requirethemtofileajointreturnfortheyearinwhichtheydivorced?

3. IsMr.GSentitledtofileasheadofhousehold,eventhoughhismotherdidnotliveinhishome
fortheentiretaxableyear?

4. CanMr.Tsparentsclaimhimasadependentontheirtaxreturn?DoesMr.Tsscholarship
constitutefinancialsupportthatheprovidesforhimself?

5. Whichparentisentitledtoclaimthechildasadependent?DoMr.TBssupportpaymentsentitle
himtoclaimthechildashisdependent?DoesthefactthatMrs.TBhassolecustodyentitleher
toclaimthechildasherdependent?

6. BecausenoonetaxpayerprovidesoveronehalfofMr.Gsfinancialsupport,cannotaxpayer
claimhimasadependent?

7. CanMr.andMrs.WQclaimadependentcarecreditforpaymentstoarelativewhoprovides
childcare?

8. CanMr.TJclaimadependentcarecreditforpaymentstoarecreationalsummercamp?

9. IndeterminingthepayrolltaxwithholdingonMs.Vssalary,doesMWCompanytakeinto
accountherselfemploymenttaxfortheyear?WillMs.Vhaveexcesspayrolltaxwithholding
becauseshealsomustpayselfemploymenttaxfortheyear?

10. WillMr.andMrs.Poweanunderpaymentpenaltybecausetheirfirstthreeinstallmentpayments
didnotreflectthetaxattributabletotheunexpectedDecemberincome?

11. WilltheextraDecemberwithholdingresultinasafeharborestimate,eventhoughMr.Ksfirst
threeinstallmentpaymentsandwithholdingwereinsufficient?Whenisincometaxwithholding
consideredpaidforpurposesofdeterminingwhetheranindividualhasmadetimely
prepaymentsofcurrentyeartax?

12. AreMr.Psdividendandinterestincomecharacterizedasforeignsourceincomeincomputing
hisforeigntaxcreditlimitationfortheyear?

13. DotheslightincrementaltaxsavingsfromtheiritemizeddeductionsexceedMr.andMrs.CDs
aftertaxcostofthe$750incrementalfeetotheCPA?Wouldthecouplebebetteroffbytaking
thestandarddeductioneachyearandreducingtheirannualtaxreturnpreparationfeeby$750?

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ResearchProblems

1. AccordingtoSection151(d)(2),anindividualsexemptionamountiszeroforanyyearinwhich
anothertaxpayerisallowedtodeductanexemptionwithrespecttotheindividual.ThisIRS
reiteratesthisruleinPublication501bystatingIfanothertaxpayerisentitledtoclaimyouasa
dependent,youcannottakeanexemptionforyourself.Thisistrueeveniftheothertaxpayer
doesnotactuallyclaimyourexemption.AccordingtoSection63(c)(5),anindividualsstandard
deductionislimitedtothegreaterof(1)$850(2007),or(2)theindividualsearnedincomeplus
$300(2007)foranyyearinwhichanothertaxpayerisallowedtodeductanexemptionwith
respecttotheindividual.Basedonthisauthority,thefactthattheKelsosdonotactuallyclaim
BrendaontheirForm1040isirrelevant.Becausetheywereallowedtodoso,Brendaisallowed
onlyan$850standarddeductionandnoexemption.Thus,Brendastaxableincomeis$5,641
($6,491$850).

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2. AccordingtoRev.Rul.5866,19581CB60,themaritalstatusofindividualsasdetermined
understatelawisrecognizedintheadministrationofthefederalincometaxlaws.Consequently,
coupleswhohaveenteredintoavalidcommonlawmarriageunderstatelawareeligibletofilea
jointfederalincometaxreturn.TherulingalsostatesthattheIRSspositionisequally
applicableinthecaseoftaxpayerswhoenterintoacommonlawmarriageinastatewhich
recognizessuchrelationshipandwholatermoveintoastateinwhichaceremonyisrequiredto
initiatethemaritalrelationship.ThiswordingsuggeststhatBertBakerandErnestineMoffet
mustcontinuetofileasamarriedcouple(eitheronajointreturnoronseparatelyfiledreturns)
evenaftertheybecomepermanentresidentsofMaryland.

3. TimhasnofamilyrelationshiptotheBryants.AccordingtoSection152(d)(2)(H),heistherefore
notaqualifyingrelativeunlesshehasthesameprincipalplaceofabodeasthetaxpayerandisa
memberofthetaxpayer'shouseholdforthecurrenttaxableyear.Reg.Sec.1.1521(b)specifies
thatTimmusthavebeenamemberoftheBryanthouseholdfortheentireyearnotwithstanding
atemporaryabsenceduetospecialcircumstances.Unfortunately,theregulationconcludesthat
anabsenceofsixmonthsormoreisnotconsideredtemporary.Consequently,Timdoesnot
meetthedefinitionofqualifyingrelative,andtheBryantscannotclaimhimastheirdependentfor
thecurrentyear.

4. Section172(c)definesthetermnetoperatinglossastheexcessofallowabledeductionsover
grossincome.SuchexcessshallbecomputedwiththemodificationsspecifiedinSection172(d).
AccordingtoSection172(d)(3),allowabledeductionsdonotincludeanyexemptionamount.
AccordingtoSection172(d)(4),nonbusinessdeductionsofanindividualtaxpayerareallowed
onlytotheextentofthetaxpayersnonbusinessincome.Basedonthesetwomodifications,Bill
YoungsNOLiscomputedasfollows.
Salary(businessincomeperReg.Sec.1.1723(a)(3)) $16,600
Interest(nonbusinessincome) 400
Netlossfromsoleproprietorship (22,100)
Alimony(nonbusinessincome) 3,600
Standarddeduction(allowableonlytoextent
ofinterestandalimony) (4,000)
Netoperatingloss $(5,500)

TaxPlanningCases
1. Mr.andMrs.WGstaxcostontheinterestincomefromthebondportfoliois$7,000($20,000
35%).BecausetheirAGIissohigh,theexemptionamountfortheirdependentsonisreducedto
$1,132($3,400[$3,400100%66.7%]basedontheExemptionAmountWorksheetin
Appendix14.B),andtheirtaxsavingsfromtheexemptionis$396($1,132 35%).Bymaking
theirsonfinanciallyindependentthroughanincomeshift,Mr.andMrs.WGcannolongerclaim
himasadependent.Thus,theirnettaxsavingsfromtheshiftwouldbe$6,604($7,000$396).
Theirsonstaxcostoftheshiftedincomeiscomputedasfollows.
AGI $20,000
Standarddeductionforsingletaxpayer (5,350)
Exemption (3,400)
Taxableincome $11,250
Taxon$11,50(single) $1,296
Consequently,thefamilysaves$5,308($6,604$1,296)fromtheincomeshiftingplan.

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2. Mr.andMrs.TPmustcomputetheirincrementaltaxcostof$20,000additionalincomeby
makingawith/withoutcomputationoftheirtax.
WithoutAdditional WithAdditional
Income Income
EstimatedAGI $260,000 $280,000
Itemizeddeductionsperworksheet (37,927) (37,527)
Exemptionamountperworksheet (14,505) (12,691)
Taxableincome $207,568 $229,782
Incometax(marriedfilingjointly) $47,697 $55,028
Theincrementaltaxcostof$20,000additionalincomeis$7,331($55,028$47,697),whichisa
marginalrateof36.66percent($7,331 $20,000),eventhoughMr.andMrs.TPsmarginal
statutoryrateisonly33percent.
3. a. Ms.Msitemizeddeductions(onlyhermusiclessondeduction)wouldtotal$5,000,whichis
lessthanher$5,350standarddeduction.Consequently,thetaxsavingsfromthemusic
lessondeductioniszero.Ms.Mshouldelectthe$1,000credit,whichsaves$1,000intax.
b. Ms.Nsitemizeddeductionsexcludinghermusiclessondeduction($5,820)exceedher
$5,350standarddeduction.Hermarginaltaxrateis15percent.Consequently,thetax
savingsfromthemusiclessondeductionis$750($5,000 15%).However,thissavingsis
lessthan$1,000,soMs.Nshouldelectthe$1,000credit.
c. Ms.Ositemizeddeductionsexcludinghermusiclessondeduction($7,200)exceedher
$5,350standarddeduction.Hermarginaltaxrateis28percent.Consequently,thetax
savingsfromthemusiclessondeductionis$1,400($5,000 28%).Thus,Ms.Oshould
claimthedeductionratherthanthe$1,000credit.

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