Ch 8 HW Solutions

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Chapter 8 11. Yes, Lauren is under age 18 at year end and her unearned income exceeds $2,500, so she is subject to the kiddie tax. Note that the kiddie tax base is the child’s net unearned income. Net unearned income is the lesser of the child’s gross unearned income minus $2,500 or the child’s taxable income. In this case, Lauren’s taxable income is calculated as $9,200 gross income less her standard deduction of $3,400 (earned income of $3,000 plus $400) = $5,800. Her gross unearned income minus $2,500 is calculated as $6,200 less $2,500 = $3,700, which would be taxed at her parents’ marginal tax rate. The remaining $2,100 would be taxed at Lauren’s regular tax rate of 10%. 22. Employees must pay FICA taxes on their wages. This tax consists of a Social Security and a Medicare component. The Social Security tax is intended to provide basic pension coverage for the retired and disabled. The Medicare tax helps pay medical costs for qualifying individuals. The Social Security tax rate for employees is 6.2% of their salary or wages, the Medicare tax rate for employees is 1.45% of salary or wages, and the additional Medicare tax rate is .9% of salary or wages in excess of $200,000 ($125,000 for married filing separate; $250,000 of combined salary or wages for married filing joint). The tax base on which Social Security taxes are paid is limited to an annually determined amount. The 2023 limit is $160,200. While employees share their FICA tax burden with employers, self-employed taxpayers must pay the entire FICA tax burden on their self-employment earnings. Self-employed earnings equal 92.35% of net schedule C income. Just as it is with FICA taxes for employees, self-employed taxpayers are subject to both Social Security and Medicare taxes, and the base for the Social Security tax is limited to $160,200. The Social Security tax rate for self-employed taxpayers is 12.4% (6.2% employer share + 6.2% employee share). The Medicare tax rate for self-employed taxpayers is 2.9% on the taxpayer’s self-employment income (1.45% employer share + 1.45% employee share). The additional Medicare tax is .9% of the taxpayer’s self-employment income in excess of $200,000 ($125,000 for married filing separate; $250,000 of combined salary or wages for married filing joint). Finally, employees have their FICA tax payments withheld by their employers while self-employed taxpayers pay their FICA taxes with their estimated tax payments and with their tax return.

24. The IRS published a list of 20 factors to be considered when determining whether a worker should be classified as an independent contractor or as an employee. Some of the major factors for making this determination include the following. Note that each factor is presented as though all other factors are held constant. 1. If the worker is able to set their own working hours it is more likely that they will be considered a contractor rather than an employee. 2. If the worker works for more than one firm at a time, they are more likely to be considered a contractor rather than an employee. 3. If the worker is at risk financially for recognizing a profit or loss, the worker is more likely to be considered a contractor rather than an employee. 4. If the worker is able to perform work somewhere other than the employer’s premises, the worker is more likely to be considered a contractor rather than an employee. 5. If the worker is able to work without frequent oversight, they are more likely to be considered a contractor than an employee. 6. If the worker is able to work for more than one firm, the worker is more likely to be considered a contractor rather than an employee. Note that these are only a few of all the possible factors to be considered. The determination is not made by adding the number of factors for each classification. Rather, the factors should be considered together in making the contractor – employee determination. 48. The couple would have a marriage benefit of $568. That is, they pay $568 less in taxes by filing jointly than their combined tax liability if they each had filed as a single taxpayer. 2023 Marriage penalty or (benefit) Two income vs. Single income married couple Married couple Taxable income Tax if file Jointly (1) Tax if file Single (2) Marriage penalty (benefit) (1) − (2) Lisa $225,000 $50,832 † Fred 175,000 35,400 ‡ Combined $400,000 $85,664 * $86,232 ($568) * $74,208 [ 400,000 364,200 .32] ( ) + − × † $37,104 [ 225,000 182,100 .32] ( ) + − × ‡ 16,290 [ 175,000 95,375 .24] ( ) + − ×

50. a. All of her income is salary from her employer. Lacy’s total tax is $5,867.50. Description Amount Explanation (1) Taxable income $48,000 (2) Preferentially taxed income 0 (3) Income taxed at ordinary rates 48,000 (1) − (2) (4) Tax on income taxed at ordinary rates $5,867.50 (48,000 − 44,725) × 22% + 5,147 (see tax rate schedule for Single individuals) (5) Tax on preferentially taxed income 0 Tax on taxable income $5,867.50 (4) + (5) b. Her $48,000 of taxable income includes $1,000 of qualified dividends. Lacy’s total tax is $5,797.50. Description Amount Explanation (1) Taxable income $48,000 (2) Preferentially taxed income 1,000 (3) Income taxed at ordinary rates 47,000 (1) − (2) (4) Tax on income taxed at ordinary rates 5,647.50 (47,000 − 44,725) × 22% + 5,147 (5) Tax on preferentially taxed income 150 ($48,000 − $47,000) × 15% [The $1,000 falls in the 15% tax bracket]. Tax on taxable income $5,797.50 (4) + (5) c. Her $48,000 of taxable income includes $5,000 of qualified dividends. Lacy’s total tax is $5,446.25. Description Amount Explanation (1) Taxable income $48,000 (2) Preferentially taxed income 5,000 (3) Income taxed at ordinary rates 43,000 (1) − (2) (4) Tax on income taxed at ordinary rates 4,940.00 (43,000 − 11,000) × 12% + 1,100 (5) Tax on preferentially taxed income 506.25 − × + $44,625 $4 ( ) 3,000 0% − ( ) $48,000 $44,625 × 15% [The first $1,625 of preferentially taxed

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income falls in the 0% tax bracket; the remaining $3,375 falls in the 15% tax bracket]. Tax on taxable income $5,446.25 (4) + (5) 63. a. All of his income is salary from his employer. Assume his modified AGI is $570,000. Henrich’s total tax liability is $157,394.50. Description Amount Explanation (1) Taxable income $530,000 (2) Preferentially taxed income 0 (3) Income taxed at ordinary rates 530,000 (1) − (2) (4) Tax on income taxed at ordinary rates $157,394.50 (530,000 − 231,250) × 35% + 52,832 (see tax rate schedule for Single individuals) (5) Tax on preferentially taxed income 0 (6) Income tax $157,394.50 (4) + (5) (7) Net investment income tax 0 Henrich has no investment income Total income & net investment income tax $157,394.50 (6) + (7) b. His $530,000 of taxable income includes $2,000 of long-term capital gain that is taxed at preferential rates. Assume his modified AGI is $570,000. Henrich’s total tax liability is $157,170.50. Description Amount Explanation (1) Taxable income $530,000 (2) Preferentially taxed income 2,000 (3) Income taxed at ordinary rates 528,000 (1) − (2) (4) Tax on income taxed at ordinary rates 156,694.50 (528,000 − 231,250) × 35% + 52,832 (see tax rate schedule for Single individuals) (5) Tax on preferentially taxed income 400 (2) × 20% [The entire $2,000 falls in the 20% bracket that spans taxable income of $492,3001+] (6) Income tax $157,094.50 (4) + (5)

(7) Net investment income tax 76 Since Henrich’s modified AGI exceeds $200,000, the entire $2,000 long-term capital gain is subject to the 3.8% net investment income tax ($2,000 × 3.8% = $76). Total income & net investment income tax $157,170.50 (6) + (7) c. His $480,000 of taxable income includes $55,000 of long-term capital gain that is taxed at preferential rates. Assume his modified AGI is $570,000. Henrich’s total tax liability is $150,369.50. Description Amount Explanation (1) Taxable income $530,000 (2) Preferentially taxed income 55,000 (3) Income taxed at ordinary rates 475,000 (1) − (2) (4) Tax on income taxed at ordinary rates 138,144.50 (475,000 − 231,250) × 35% + 52,832 (5) Tax on preferentially taxed income 10,135.00 − × + 492,300 475 ( , 0 ) 00 15% 55,000 492,3 ) ( 00 475 ( ) ,000 − − × 20% 2595 (6) Income tax $148,279,50 (4) + (5) (7) Net investment income tax 2,090 Since Henrich’s modified AGI exceeds $200,000, the entire $55,000 long-term capital gain is subject to the 3.8% net investment income tax ($55,000 × 3.8% = $2,090). Total income & net investment income tax $150,369.50 (6) + (7) d. Now assume that Henrich has $195,000 of taxable income, which includes $50,000 of long-term capital gain that is taxed at preferential rates. Assume his modified AGI is $210,000. Henrich’s total tax liability is $36,080. Description Amount Explanation (1) Taxable income $195,000 (2) Preferentially taxed income 50,000 (3) Income taxed at ordinary rates 145,000 (1) − (2) (4) Tax on income taxed at ordinary rates 28,200 (145,000 − 95,375) × 24% + 16,290

(5) Tax on preferentially taxed income 7,500 ($50,000 × 15%) [The entire $50,000 falls in the 15% bracket that spans taxable income of $44,626 to $492,300] (6) Income tax $35,700 (4) + (5) (7) Net investment income tax 380 3.8% × the lesser of (a) $50,000 of net investment income or (b) ($210,000 modified AGI less $200,000 threshold) = 3.8% × $10,000 = $380. Total income & net investment income tax $36,080 (6) + (7) 66. A taxpayer’s tax base for computing a self-employed taxpayer’s self-employment tax (i.e., net earnings from self-employment) is the taxpayer’s net business profit from Schedule C multiplied by 92.35%. So, Alice’s net earnings from self-employment is her net profit from Schedule C of $190,000 × 92.35% = $175,465. Alice will owe $19,865 ($160,200 maximum amount × 12.4%, rounded) in Social Security taxes and $5,088 ($175,465 2.9%, rounded) × for the Medicare component of FICA taxes. Alice owes total self-employment tax of $24,953 . ($19,865 5,088) + She is not subject to the additional Medicare tax because her net earnings from self-employment do not exceed $200,000. 72. a. Elaine’s AGI is $80,000. Elaine may claim an American opportunity tax credit (AOTC) of $2,350. Description Amount Explanation (1) AOTC before phase-out $2,350 × + − 2 % ( ,000 100 3,400 × % ) 2,000 25 (2) AGI $80,000 (3) Phase-out threshold 160,000 (4) Excess AGI $0 (2) − (3) {but not <0 and limited to a maximum of $20,000} (5) Phase-out range for taxpayer filing as married filing jointly $20,000 $180,000 − $160,000 (6) Phase-out percentage 0% (4) ∕ (5) or 100% max (7) Phase-out amount $0 (1) × (6) AOTC after-phase-out $2,350 (1) − (7)

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b. Elaine’s AGI is $168,000. Elaine may claim an AOTC of $1,410. Description Amount Explanation (1) AOTC before phase-out $2,350 × + − 2 % ( ,000 100 3,400 × % ) 2,000 25 (2) AGI $168,000 (3) Phase-out threshold 160,000 (4) Excess AGI $8,000 (2) − (3) (5) Phase-out range for taxpayer filing as married filing jointly $20,000 $180,000 − $160,000 (6) Phase-out percentage 40% (4) ∕ (5) or 100% max (7) Phase-out amount $940 (1) × (6) AOTC after-phase-out $1,410 (1) − (7) c. Elaine’s AGI is $184,000. Because Elaine’s AGI exceeds the threshold amount, she may not claim an AOTC. Description Amount Explanation (1) AOTC before phase-out $2,350 × + − 2 % ( ,000 100 3,400 × % ) 2,000 25 (2) AGI $184,000 (3) Phase-out threshold 160,000 (4) Excess AGI $20,000 (2) − (3) (limited to $20,000) (5) Phase-out range for taxpayer filing as married filing jointly $20,000 $180,000 − $160,000 (6) Phase-out percentage 100% (4) ∕ (5) (7) Phase-out amount $2,350 (1) × (6) AOTC after-phase-out $0 (1) − (7) 76. Luke’s nonrefundable personal credit reduces his gross tax to zero ($1,800 − 2,400) and $600 of the unused credit expires unused. The $1,500 unused business tax credit carries over and Luke receives a refund of . $2,900 $600 refundable credit $2,300 tax ( es he paid) + 77. a. Taxpayers can avoid an underpayment penalty if their withholdings and estimated tax payments equal or exceed one of the following two safe harbors:

(1) 90 percent of their current tax liability [$10,000 × 90% = $9,000 for Lloyd] or (2) 100 percent of their previous year tax liability (110 percent for individuals with AGI greater than $150,000). [100% of $15,000 for Lloyd assuming his AGI was $150,000 or less]. Since Lloyd’s withholding does not equal or exceed $9,000 (safe harbor 1) or $15,000 (safe harbor 2), he will need to increase his withholding or make estimated payments this year to avoid the underpayment penalty. If he increases his withholding by ) $1,200 $9,000 $7, ( 800 − or makes four quarterly estimated payments of $300 each, he will avoid the underpayment penalty (assuming his current year tax projection is accurate). 80. a. Ricko, single taxpayer, with gross income of $15,000. Ricko is required to file a tax return because his gross income of $15,000 exceeds the applicable gross income threshold of $13,850 ($13,850 standard deduction). b. Fantasia, head of household, with gross income of $17,500. Fantasia is not required to file a tax return because her gross income of $17,500 is less than the applicable gross income threshold of $20,800 ($20,800 standard deduction). c. Ken and Barbie, married taxpayers with no dependents, with gross income of $20,000. Ken and Barbie are not required to file a tax return because their gross income of $20,000 is less than the applicable gross income threshold of $27,700 [$27,700 standard deduction]. d. Dorothy and Rudolf, married taxpayers, both age 68, with gross income of $25,500. Dorothy and Rudolf are not required to file a tax return because their gross income of $25,500 is less than the applicable gross income threshold of + × $30,700 $27,700 standard deduc ion [ ( t 2 1,500)] additional standard deduction for age). e. Janyce, single taxpayer, age 73, with gross income of $13,500. Janyce is not required to file a tax return because her gross income of $13,500 is less than the applicable gross income threshold of + $15,700 $13,850 1,850 additional standard deduction ( for age). 82. a. $20. Jolene will owe 2 months of the late payment penalty at .5% per month (i.e., 1% of her $2000 underpayment).

Ch 8 HW Solutions

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