How to figure your tax

06 Dec, 2015 TAX LAW 0

Chapter 31
How to figure your tax

What’s New

Personal exemption amount increased for 2014. For tax years beginning in 2014, the personal exemption amount is increased to $3,950.

Standard deduction amount increased for 2014. The personal standard deduction amount for tax years beginning in 2014 is increased to $6,200 for unmarried taxpayers, $12,400 if married filing jointly or surviving spouse, $9,100 if head of household, and $6,200 if married filing separately.

Alternative Minimum Tax (AMT) exemption amount increased. For 2014, the exemption amounts for AMT are increased to $52,800 for unmarried taxpayers, $82,100 if married filing jointly or a surviving spouse, and $41,050 if married filing separately.

AMT exemption for a child with unearned income increased. The AMT exemption for a child whose unearned income is taxed at the parent’s rate has increased to $7,250.

TAXALERT

In recent years, Congress has repeatedly enacted temporary measures (typically called an “AMT patch”) that significantly raised the applicable exemption amounts above the level that last applied in 2000. The American Taxpayer Relief Act of 2012 enacted a permanent AMT patch and indexed it for inflation in future years. For 2014, the AMT exemption is:

$82,100 (up from $80,800 in 2013) for married couples filing jointly and surviving spouses;
$52,800 (up from $51,900 in 2013) for other unmarried individuals; and
$41,050 (up from $40,400 in 2013) for married individuals filing separate returns.

The exemption phases out at higher levels of alternative minimum taxable income (AMTI). A taxpayer’s exemption amount is reduced (but not below zero) by 25 percent of the amount by which AMTI exceeds the following:

For married taxpayers filing jointly or a surviving spouse, $156,500
For a taxpayer filing as single or as a head of household, $117,300
For a married taxpayer filing a separate return, $78,250

The exemptions fully phase out at: $484,900 of AMTI for married couples filing jointly and surviving spouses; $328,500 for other unmarried individuals; and $242,450 for married individuals filing separately. Those taxpayers with AMTI in the above phase-out income ranges can be subject to a marginal tax rate of as high as 27% (20% top statutory rate plus 7%, which is onefourth of the 28 percent AMT rate) on capital gains and qualified dividends.

Individual Shared Responsibility Payment. When you file your 2014 federal income tax return in 2015, you will report minimum essential health care coverage, report exemptions, or make any individual shared responsibility payment. If you don’t have coverage nor qualify for an exemption, you may have to make an individual shared responsibility payment when you file your 2014 income tax return. For 2014, generally, the payment amount is the greater of 1% of your household income above your filing threshold or $95 per adult ($47.50 per child) limited to a family maximum of $285. See Individual Shared Responsibility Provision—Calculating the Payment later in this chapter.

After you have figured your income and deductions as explained in Parts One through Five, your next step is to figure your tax. This chapter discusses:

The general steps you take to figure your tax,
An additional tax you may have to pay called the alternative minimum tax (AMT), and
The conditions you must meet if you want the IRS to figure your tax.

TAXPLANNER

As described later in more detail in the Tax Alert on “How the AMT works,” the AMT structure requires taxpayers to “add back” certain preference and adjustment items to arrive at AMT income, subject to tax at the 26% or 28% minimum tax rates. Under prior law, one of the preference items was tax-exempt interest on certain bonds issued for private activities.

Tax legislation enacted in 2009, however, provides that interest received on tax-exempt private activity bonds issued in 2009 and 2010 is not an AMT preference item. You should consult with your investment advisor to see how the new provision may have affected the interest rate on private activity bonds issued during this 2-year period (issuers may have been able to issue bonds with a somewhat lower interest rate than they otherwise would have had to do when interest paid was treated as a preference item), as well as the effect on market pricing for new and previously issued bonds. Interest received on private activity bonds issued prior to 2009 and after 2010 is counted as an AMT preference.

Figuring Your Tax

Your income tax is based on your taxable income. After you figure your income tax and AMT, if any, subtract your tax credits and add any other taxes you may owe. The result is your total tax. Compare your total tax with your total payments to determine whether you are entitled to a refund or if you must make a payment.

This section provides a general outline of how to figure your tax. You can find step-by-step directions in the Instructions for Forms 1040EZ, 1040A, and 1040. If you are unsure of which tax form you should file, see Which Form Should I Use? in chapter 1.

Tax. Most taxpayers use either the Tax Table or the Tax Computation Worksheet to figure their income tax. However, there are special methods if your income includes any of the following items.

A net capital gain. (See chapter 16.)
Qualified dividends taxed at the same rates as a net capital gain. (See chapters 8 and 16.)
Lump-sum distributions. (See chapter 10.)
Farming or fishing income. (See Schedule J (Form 1040), Income Averaging for Farmers and Fishermen.)
Unearned income over $2,000 for certain children. (See chapter 32.)
Parents’ election to report child’s interest and dividends. (See chapter 32.)
Foreign earned income exclusion or the housing exclusion. (See Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion, and the Foreign Earned Income Tax Worksheet in the Form 1040 instructions.)

Credits. After you figure your income tax and any AMT (discussed later), determine if you are eligible for any tax credits. Eligibility information for these tax credits is discussed in chapters 33 through 37 and your form instructions. The following table lists the credits you may be able to subtract from your tax and shows where you can find more information on each credit.

Some credits (such as the earned income credit) are not listed because they are treated as payments. See Payments, later.

There are other credits that are not discussed in this publication. These include the following credits.

General business credit, which is made up of several separate business-related credits. These generally are reported on Form 3800, General Business Credit, and are discussed in chapter 4 of Publication 334, Tax Guide for Small Business.
Renewable electricity, refined coal, and Indian coal production credit for electricity and refined coal produced at facilities placed in service after October 22, 2004 (after October 2, 2008, for electricity produced from marine and hydrokinetic renewables), and Indian coal produced at facilities placed in service after August 8, 2005. See Form 8835, Part II.
Text intentionally omitted.
Credit for employer social security and Medicare taxes paid on certain employee tips. See Form 8846.

Other taxes. After you subtract your tax credits, determine whether there are any other taxes you must pay. This chapter does not explain these other taxes. You can find that information in other chapters of this publication and your form instructions. See the following table for other taxes you may need to add to your income tax.

You also may have to pay AMT (discussed later in this chapter).

There are other taxes that are not discussed in this publication. These include the following items.

Self-employment tax. You must figure this tax if either of the following applies to you (or your spouse if you file a joint return).
1. Your net earnings from self-employment from other than church employee income were $400 or more. The term “net earnings from self-employment” may include certain non-employee compensation and other amounts reported to you on Form 1099-MISC, Miscellaneous Income. If you received a Form 1099-MISC, see the Instructions for Recipient on the back. Also see the Instructions for Schedule SE (Form 1040), Self-Employment Tax; and Publication 334, Tax Guide for Small Business.
2. You had church employee income of $108.28 or more.
  Text intentionally omitted.
Recapture taxes. You may have to pay these taxes if you previously claimed an investment credit, a low-income housing credit, a new markets credit, a qualified plug-in electric drive motor vehicle credit, an alternative motor vehicle credit, a credit for employer-provided child care facilities, an Indian employment credit, or other credits listed in the instructions for Form 1040, line 62. For more information, see the instructions for Form 1040, line 62.
Section 72(m)(5) excess benefits tax. If you are (or were) a 5% owner of a business and you received a distribution that exceeds the benefits provided for you under the qualified pension or annuity plan formula, you may have to pay this additional tax. See Tax on Excess Benefits in chapter 4 of Publication 560, Retirement Plans for Small Business.
Uncollected social security and Medicare tax on group-term life insurance. If your former employer provides you with more than $50,000 of group-term life insurance coverage, you must pay the employee part of social security and Medicare taxes on those premiums. The amount should be shown in box 12 of your Form W-2 with codes M and N.
Tax on golden parachute payments. This tax applies if you received an “excess parachute payment” (EPP) due to a change in a corporation’s ownership or control. The amount should be shown in box 12 of your Form W-2 with code K. See the instructions for Form 1040, line 60.
Tax on accumulation distribution of trusts. This applies if you are the beneficiary of a trust that accumulated its income instead of distributing it currently. See Form 4970 and its instructions.
Additional tax on HSAs or MSAs. If amounts contributed to, or distributed from, your health savings account or medical savings account do not meet the rules for these accounts, you may have to pay additional taxes. See Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans; Form 8853, Archer MSAs and Long-Term Care Insurance Contracts; Form 8889, Health Savings Accounts (HSAs); and Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.
Additional tax on Coverdell ESAs. This applies if amounts contributed to, or distributed from, your Coverdell ESA do not meet the rules for these accounts. See Publication 970, Tax Benefits for Education, and Form 5329.
Additional tax on qualified tuition programs. This applies to amounts distributed from qualified tuition programs that do not meet the rules for these accounts. See Publication 970 and Form 5329.
Excise tax on insider stock compensation from an expatriated corporation. You may owe a 15% excise tax on the value of nonstatutory stock options and certain other stock-based compensation held by you or a member of your family from an expatriated corporation or its expanded affiliated group in which you were an officer, director, or more-than-10% owner. For more information, see the instructions for Form 1040, line 62.
Additional tax on income you received from a nonqualified deferred compensation plan that fails to meet certain requirements. This income should be shown in Form W-2, box 12, with code Z, or in Form 1099-MISC, box 15b. For more information, see the instructions for Form 1040, line 62.
Interest on the tax due on installment income from the sale of certain residential lots and timeshares. For more information, see the instructions for Form 1040, line 62.
Interest on the deferred tax on gain from certain installment sales with a sales price over $150,000. For more information, see the instructions for Form 1040, line 62 and Publication 537, Installment Sales.
Excess advance premium tax credit repayment. For more information, see the instructions for Form 8962.

Payments. After you determine your total tax, figure the total payments you have already made for the year. Include credits that are treated as payments. This chapter does not explain these payments and credits. You can find that information in other chapters of this publication and your form instructions. See the following table for amounts you can include in your total payments.

Another credit that is treated as a payment is the credit for federal excise tax paid on fuels. This credit is for persons who have a nontaxable use of certain fuels, such as diesel fuel and kerosene. It is claimed on Form 1040, line 72. See Form 4136, Credit for Federal Tax Paid on Fuels.

Refund or balance due. To determine whether you are entitled to a refund or whether you must make a payment, compare your total payments with your total tax. If you are entitled to a refund, see your form instructions for information on having it directly deposited into one or more of your accounts, or to purchase U.S. savings bonds instead of receiving a paper check.

TAXPLANNER

You can elect to have your refund directly deposited into a traditional IRA, Roth IRA, or SEP-IRA, but not a SIMPLE IRA. You must establish the IRA at a bank or other financial institution before you request direct deposit.

Caution: The amount of any refund you choose to deposit into your IRA cannot, in combination with any other IRA contributions you have made, exceed the applicable annual limit on your IRA contributions. See How much can be contributed in chapter 17, Individual retirement arrangements (IRAs), for further details.
Caution: Any deposits into your IRA made on or before April 15, 2015, may be attributed to calendar year 2014 or 2015. Deposits made after April 15, 2015, may only be attributed to calendar year 2015. If you chose to deposit your 2014 refund directly into an IRA and your refund is deposited in the IRA after April 15, 2015, it will be attributed to calendar year 2015 and may result in an underfunding in 2014 or an overfunding in 2015. The determination of when the contribution to the IRA is made is when the money is deposited in the IRA account, not the date when you file your return directing the refund into the IRA account.

Alternative Minimum Tax

This section briefly discusses an additional tax you may have to pay.

The tax law gives special treatment to some kinds of income and allows special deductions and credits for some kinds of expenses. Taxpayers who benefit from this special treatment may have to pay at least a minimum amount of tax through an additional tax called AMT.

TAXALERT

Begun in 1970, the AMT was originally intended to ensure the “rich” paid at least some minimum amount of tax. Until recently the vast majority of taxpayers were not subject to the AMT. But the reduction in regular income tax rates in 2001 and 2003 without a corresponding reduction in AMT rates caused more people to become subject to this tax.

How the AMT works: The simplest way to understand the AMT is to think of it as a separate tax system with its own allowable deductions and exclusions, many of which are different from those allowed for regular income tax purposes. Thus, although it is in many ways parallel to the “regular income tax” computation, some of the applicable rules are different. You first calculate your regular income tax as you always have, then you calculate your tax under the AMT system and pay the greater of the two amounts. The following are some of the more common items treated differently under the two tax systems that can affect your exposure to AMT:

State and local income and sales taxes
Real estate and personal property taxes
Miscellaneous itemized deductions that exceed the 2% of AGI floor
Interest expense from a mortgage or home equity loan that is not used for the purpose of acquiring, constructing, or improving a principal residence or “second home”
The “spread” on the exercise of incentive stock options (ISOs)
Deductions for personal exemptions
The standard deduction

Most of these items consist of deductions that are allowed in computing your regular income tax liability but are not allowed when you figure your AMT. Take, for example, state and local income, sales, and real estate taxes that you pay. They are allowable as a deduction against your income for regular tax purposes but not for AMT. (You’ll find a more detailed explanation of how to figure your AMT later in this section.)

TAXALERT

If your deduction for state taxes is unusually high—for example, perhaps you made a large payment with your 2013 state tax return when you filed in April 2014, or perhaps you have substantial state tax withholding during 2014 on your regular income—you should take a closer look at the possibility of being subject to the AMT.

Example

The Smiths have two children and gross wages totaling $250,000. Their itemized deductions consist of state and local income taxes and real estate taxes totaling $22,500 and mortgage interest of $20,000 (all related to the acquisition of their principal residence). Assume the Smiths have no interest, dividend, or capital gain income. Their regular tax will be $40,923. However, since their AMT tentative minimum tax is $43,232, the Smith’s will pay the higher of the two taxes effectively denying them some of their deductions for taxes paid and personal exemptions. On the Smith’s Form 1040, they will report $40,923 in regular tax and $2,309 in AMT.

TAXPLANNER

The AMT can not only affect the amount of tax you pay, but it can also potentially affect the most tax-efficient way to invest your money.

For example, if part of your investment portfolio consists of municipal bond holdings, beware. Interest paid on private activity bonds issued before 2009 and after 2010 is a preference item that can make it more likely that you will be subject to AMT. Generally, you earn a higher yield on such private activity bonds than other municipals. However, if you’re subject to the AMT, your effective yield on these bonds will be slashed. If you’re not sure what type of municipal bonds you have, ask your investment advisor. On the other hand, a tax law enacted in early 2009 provides that interest received on tax-exempt private activity bonds issued in 2009 and 2010 is not an AMT preference item. In 2014, long-term capital gains and qualifying dividends are subject to the same maximum rate, 20%, for AMT purposes as they are for regular tax purposes. But because these items of income are included in AMTI, which could reduce your allowable AMT exemption, the actual marginal AMT rate could be as high as 27%. Before deciding to invest in securities that generate these types of income, you should consider the effect of the AMT. In 2014 and beyond, tax and investment planning is further complicated for higher income taxpayers by the recent increases in the top tax rates on ordinary taxable income to 39.6% and on qualified dividends and net capital gains to 20%, as well as the additional 3.8% Net Investment Income Tax (NIIT) on certain Net Investment Income (NII) that was enacted as part of the Affordable Care Act.

Example

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