Chapter 13, Problem 45CP

To determine

Compute net tax payable or refund due for T and S for 2019.

Explanation of Solution

Step 1: Compute taxable income of T and S for the year of 2019.

Details	Amount ($)	Amount ($)	Reference
T’s net business		124,000	Refer working note 1
S’s salary		145,000
Interest income		7,000
Gross income		276,000
Less: Deduction for AGI
Capital losses	(3,000)		Refer working note 2
Self-employment tax deduction	(8,760)	(11,760)	Refer working note 3
Adjusted gross income		264,240
Less: ‘From AGI deduction’
Itemized deductions	(27,900)
Deduction for qualified business income	(23,048)	(50,948)	Refer working note 4
Taxable income		$213,292

Step 2: Compute net tax payable or refund due for T and S.

Details	Amount ($)	Amount ($)	Reference
Tax Liability	39,539		Refer working note 5
Add: Self-employment tax	17,521		Refer working note 3
Total tax liability		57,060
Less: Prepayments and credits:
Income tax withheld	(31,850)
Estimated tax payments	(20,000)
Child tax credit	4,000		Refer working note 7
Credit for child and dependent care expenses	(600)	(56,450)	Refer working note 6
Net tax payable (refund due)		$610

Working note (1): Calculate T’s net business.

$\begin{array}{c}\text{Net business}=\text{Gross income}-\text{Business expenses}\\ =\text{\$325,000}-\$201,000\\ =\$124,000\end{array}$

Working note (2): Calculate the capital losses for the year of 2019.

Step 1: Calculate short-term capital loss.

$\begin{array}{c}\text{Short-term capital loss}=\text{Cost of an asset}-\text{Sale value}\\ =\text{\$12,000}-9,800\\ =\$2,200\end{array}$

Step 2: Calculate long-term capital loss.

$\begin{array}{c}\text{Long-term capital loss}=\text{Cost of an asset}-\text{Sale value}\\ =\text{\$5,000}-\$3,800\\ =\$1,200\end{array}$

Step 3: Calculate total capital losses.

$\begin{array}{c}\text{Total capital losses}=\left(\begin{array}{l}\text{Short-term capital loss}\\ +\text{Long-term capital loss}\end{array}\right)\\ =\text{\$2,200}+\text{\$1,200}\\ =\text{\$3,400}\end{array}$

In a taxable year, an individual can deduct a maximum of $3,000 of net capital losses. Hence, T and S can deduct capital losses of $3,000.

Working note (3):

Calculate self-employment tax deduction.

Step 1: Calculate net earnings from self-employment.

$\begin{array}{c}\text{Net earning from self-employment}=\text{Business income}\times \text{92}\text{.35\%}\\ =\left(\$325,000-\$201,000\right)\times 92.35\%\\ =\$114,514\end{array}$

Step 2: Calculate self-employment tax.

The self-employed tax rate for 2014 is 15.3% on the first $117,000 of net earnings from self-employment and then 2.9% on the portion in excess of $117,000.

$\begin{array}{c}\text{Self-employment tax}=\text{Net earnings}\times \text{Self employment tax rate}\\ =\text{\$114,514}\times 15.3\%\\ =\$17,521\end{array}$

Step 3: Calculate self-employment tax deduction.

In 2019, ‘For AGI Deduction’ the deduction part of the self-employment tax is 50% of self-employment tax. Hence, the deduction is $8,760.5$\left(\$17,521\times 50\%\right)$.

Working note (4): Calculate deduction for qualified business income.

$\begin{array}{c}\begin{array}{l}\text{Deduction for qualified}\\ \text{ business income}\end{array})\text{ =}\left\{\begin{array}{l}\left(\begin{array}{l}\text{Net Business income }\\ -\text{ Self-employment tax deduction}\end{array}\right)\\ \times \text{20\%}\end{array}\right\}\\ \text{= }\left(\$124,000-\$8,760\right)\times 20\%\\ \text{=}\text{\$115,240}\times 20\%\\ =\$23,048\end{array}$

Working note (5): Calculate tax liability for T and S.

$\begin{array}{c}\text{Tax Liability}=\text{\$28,765}+\text{24\%}\times \left(\text{Taxable Income – \$168,400}\right)\\ =\text{\$28,765}+\text{24\%}\times \left(\text{\$220,540}-\text{\$168,400}\right)\\ =\text{\$28,765}+\text{24\%}\times \text{\$44,892}\\ \text{=\$28,765}+\$10,774\\ =\$39,539\end{array}$

Working note (6): Calculate credit for child and dependent care expenses.

In general, the maximum credit for child and dependent care expenses is limited to $3,000 for one qualifying child. The credit rate varies between 20% and 30%, depending on the AGI of the taxpayers.

In this case, the expenses are limited to 20% of $3,000 or $600. S is eligible to get the credit of $600 because, her age is under 13. But, D does not qualify to get the credit due to her age of 16.

The amount of credit for child and dependent care expenses is calculated as below:

$\begin{array}{c}\begin{array}{l}\text{Credit for child and }\\ \text{dependent care expense}\end{array}]=\left[\begin{array}{l}\text{Annual child and}\\ \text{dependent care expense}\\ \times \text{ Credit rate}\end{array}\right]\\ =\text{\$3,000}\times \text{20\%}\\ =\text{\$600}\end{array}$

Working note (7): Calculate child tax credit.

Both children are under age 17. Hence, both are qualifying for the child tax credit. So, the child tax credit is $4,000 (2 × $2,000).