REG-02 F8fe2e8

REG
2
Individual Taxation: Part 2
Module
1 Adjustments 3
2 Itemized Deductions 15
3 Tax Computation and Credits 27
4 Employee Stock Options 49

NOTES
R2–2 © Becker Professional Education Corporation. All rights reserved.

1
MODULE
REG 2 1 Adjustments
Adjustments REG 2
1 Overview
Adjustments for AGI (often referred to as "above-the-line" deductions, or "deductions to arrive at
AGI") include the following:
Educator expenses
Traditional IRA contribution deduction
Student loan interest deduction Above-the-line (AGI)
Health savings account deduction deductions to arrive
Moving expenses (only for members of the U.S. Armed Forces moving pursuant to
at AGI
military order)
Not Deductible part of self-employment tax
deducted Self-employed health insurance deduction
on
Schedule C Deduction for contributions to certain self-employed retirement plans
Penalty on early withdrawal of savings
Alimony paid (only for divorce or separation agreements executed on or before
December 31, 2018)
Attorney fees paid in certain discrimination and whistle-blower cases
Pass Key
The CPA Examination will often refer to "adjustments" as "deductions to arrive at adjusted
gross income."
2 Educator Expenses
Eligible educators can deduct up to $300 of qualified expenses paid. If spouses are filing
jointly and both are eligible educators, the maximum deduction is $600.
Neither spouse can deduct more than $300 of his or her qualified expenses.
An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor,
principal, or aide working in a school for at least 900 hours during a school year.
© Becker Professional Education Corporation. All rights reserved. Module 1 R2–3

1 Adjustments REG 2
Qualified expenses include ordinary and necessary expenses paid in connection with books,
supplies, equipment (including personal protective equipment and supplies, computer
equipment, software, and services), and other materials used in the classroom.
y Deductible expenses also include costs of professional development.
y An ordinary expense is one that is common and accepted in one's educational field.
y A necessary expense is one that is helpful and appropriate for one's profession as an
educator (does not have to be required).
Qualified expenses do not include expenses for homeschooling or for nonathletic supplies
for courses in health or physical education. Qualified expenses must be reduced by the
following amounts:
y Excludable U.S. series EE and I Savings Bond interest from Form 8815.
y Nontaxable qualified state tuition program earnings.
y Nontaxable earnings from Coverdell education savings accounts.
y Any reimbursements received for these expenses that were not reported on Form W-2.
3 Individual Retirement Accounts
The three types of individual retirement accounts (IRAs) are:

1. Deductible traditional IRA
2. Roth IRA
3. Nondeductible traditional IRA
3.1 Contributions
3.1.1 General Rule
The annual maximum contribution to IRAs is limited to the lesser of:
2023 Under Age 50 Age 50 and Over

Unmarried $6,500 + $1,000 = $7,500
Or Or
Earned income Earned income
Married $13,000 ($6,500 each) + $2,000 = $15,000 ($7,500 each)
Or Or
Earned income of married couple Earned income of married couple
Combine
their
income
R2–4 Module 1 Adjustments

© Becker Professional Education Corporation. All rights reserved.
REG 2 1 Adjustments
The annual limits apply to the sum of a taxpayer's contributions to deductible IRAs,
nondeductible IRAs, and Roth IRAs.
Earned Income Includes:
y Salary and wages
y Commissions
y Bonuses
y Alimony (for divorce or separation agreements executed before December 31, 2018)
y Net earnings from self-employment
y Non-tuition fellowship and stipend payments treated as taxable compensation
Earned Income Does Not Include:
y Interest and dividends
y Annuity income
y Pensions
y Alimony (for divorce agreements executed after December 31, 2018)
3.1.2 Retirement Plan Contribution Credit

Eligible taxpayers also may be entitled to a tax credit for contributions to either a traditional IRA
or a Roth IRA, subject to certain limitation.
3.2 Deductible Traditional IRA 1 of 3 Deductible Traditional

Contributions to traditional IRAs may or may not be deductible.
Roth
The traditional IRA is deductible from gross income to arrive at
adjusted gross income. The adjustment is allowed for a year only
Nondeductible Traditional
if the contribution is made by the due date of the tax return for
individuals, which is April 15 (filing extensions are not considered).
Earnings on deductible traditional IRA contributions accumulate tax free until withdrawn.
Distributions of both principal (contributions) and earnings from deductible traditional IRAs
are taxable as ordinary income and may be subject to applicable early withdrawal penalties.
Minimum distributions are required to be taken by April 1 of the year following the year in
which the taxpayer reaches age 73. RMD
3.2.1 Limitations on Deduction of Traditional IRA Contributions

A taxpayer's deduction for a traditional IRA contribution is limited if the taxpayer or spouse
participates in an employer-sponsored plan.
Participation in Employer-Sponsored Retirement Plans: If a taxpayer participates in an
employer-sponsored retirement plan, AGI limitations apply to the deduction allowed for the
contribution made to the traditional IRA. The allowed deductible contribution phases out
proportionately within the following ranges:
Filing Status 2023 AGI Phase-out No IRA deduction

Unmarried $73,000–$83,000
1. In retirement plan &
Married filing jointly $116,000–$136,000 2. Rich

1 Adjustments REG 2
IRA: OK if spouse not working, unless "super rich"

Special Rule: If a married taxpayer is not an active participant in an employer's retirement
plan, but the spouse is, the deduction for the spouse who is not an active participant is
phased out based on the following AGI limitations:
Filing Status 2023 AGI Phase-out

Married filing jointly $218,000–$228,000 (couple's AGI)
$0–$10,000 (each spouse is subject to this limitation—both the
Married filing separately
participant and the nonparticipant)
3.2.2 Summary Chart for Married Individuals
Traditional IRA Income Phase-Out Ranges for Married Individuals

If Spouse 2 has
Spouse 1 has earned income no earned income
Pension plan Can IRA be
2023 Modified AGI Phase-out In ESRP? deducted? Can IRA be deducted?
N/A No Yes Yes
< $116,000 Yes Yes Yes
$116,000–$136,000 Yes Yes * Yes
$136,001–$217,999 Yes No Rich Yes
$218,000–$228,000 Yes No Rich Yes **
> $228,000 *** Yes No Rich No Super rich
Note: If Spouse 2 has earned income, follow the same rules as Spouse 1.
ESRP = Employer Sponsored Retirement Plan
* The IRA deduction for the working spouse is phased out.
** The IRA deduction for the nonworking spouse is phased out.
*** At modified AGI of more than $228,000, neither the working spouse nor the nonworking
spouse can deduct their traditional IRA.

REG 2 1 Adjustments
Example 1 Phase-out of Traditional IRA Deduction
Facts: Kristi, a 40-year-old single taxpayer, is an active participant in her employer's

retirement plan. Kristi's 2023 AGI is $75,000.
Required: Calculate Kristi's maximum IRA deduction.
Solution: Kristi's maximum 2023 IRA deduction is $5,200, calculated as follows:
2023 AGI $ 75,000

Less phase-out threshold (73,000)
Excess over phase-out threshold 2,000 Over
Divided by $10,000 phase-out range ÷ 10,000
Phase-out percentage 20% % over
× maximum IRA deduction allowed 6,500
Phase-out amount 20% x $6,500 = < 1,300 > Disallowed
2023 allowable IRA deduction $ 5,200
Question: What is Kristi's maximum IRA deduction if she does not participate in an
employer-sponsored retirement plan?
Answer: $6,500. She would not be subject to the AGI limitations if she did not participate in
an employer-sponsored retirement plan.
3.3 Roth IRA 2 of 3 Deductible Traditional

Contributions to a Roth IRA are not deductible when made.
Roth 2
Earnings accumulate tax free while in a Roth IRA account.
Nondeductible Traditional
No deduction is allowed for Roth IRA contributions, so distribution
of principal (contributions) is tax free. Distribution of earnings
may be taxable, depending on whether the distribution is "qualified" or "nonqualified."
3.3.1 Allowable Roth Contributions

The ability to contribute to a Roth IRA is limited by modified AGI.
Filing Status 2023 MAGI Phase-out

Unmarried $138,000–$153,000
Married filing jointly $218,000–$228,000
Married filing separately $0–$10,000

1 Adjustments REG 2
3.3.2 Distributions From Roth IRA

Distributions from Roth IRAs are considered to first come from principal (contributions), then
earnings. Distributions of principal (contributions) from a Roth IRA are non-taxable because no
deduction was taken when the contributions were made. Distribution of earnings from a Roth
IRA are nontaxable if the distribution is a "qualified distribution."
A "qualified distribution" is a distribution from a Roth IRA that:
1. is made at least five years after the first day of the year of the taxpayer's first contribution to
the Roth; and
2. meets one of the following requirements:
y Taxpayer is age 59½ or older
y Taxpayer is disabled
y Taxpayer is a "first-time" homebuyer (has not owned a home for two years) and uses
the distribution to purchase a home (limited to $10,000)
y Distribution is made to a beneficiary after the taxpayer's death
A distribution that does not meet these requirements is a "nonqualified distribution" and any
earnings distributed are taxable ordinary income.
The required minimum distributions starting on April 1 of the year after the taxpayer reaches
age 73 do not apply to Roth IRAs. No RMD, because Roth IRA is not taxable
3 of 3 3.4 Nondeductible Traditional IRA Deductible Traditional

Final option - used when not eligible for
If a taxpayer's deduction for a contribution to a traditional IRA is
Roth
limited, a nondeductible traditional IRA contribution can be made
instead. The overall limitation still applies to the combined deductible Nondeductible Traditional
and nondeductible contributions ($6,500 or earned income). 3
Earnings on nondeductible traditional IRA contributions accumulate tax free until withdrawn. No phase-out
Distributions from a nondeductible traditional IRA will be taxed as follows: (disallowed)
based on
y Taxable: Earnings (taxed as ordinary income)
high income
y Nontaxable: Principal contributions (because not deducted when contributed)
A distribution is allocated between principal (contributions) and earnings pro rata based on
relative amounts in the IRA account at the time of the distribution.
Minimum distributions are required to be taken by April 1 of the year following the year in
which the taxpayer reaches age 73. = RMD
3.5 Early Distribution Penalty = Regular tax + 10% penalty

Distributions taken before the taxpayer reaches the age of 59½ are subject to a 10 percent
penalty. The penalty applies to taxable distributions from traditional (deductible and
nondeductible) and Roth IRAs. Early distributions are exempt from penalty if used for:
Qualifying medical expenses or health insurance premiums if unemployed
Disability, terminal illness, or death
Qualified higher education expenses
First-time home purchases (limited to $10,000) or a federally declared disaster (limited
to $22,000)
Qualified birth or adoption of child within one year of birth or adoption (limited to $5,000)

REG 2 1 Adjustments
Combined limit
IRA Summary
Deductible Nondeductible
Traditional IRA Traditional IRA Roth IRA
Maximum contribution (2023): $6,500 combined annual maximum contribution with $1,000
additional "catch up" contribution for age 50 and older
Above-the-line deduction for
Yes No No
contribution:
Withdrawals of contributions: Taxable Nontaxable Nontaxable
Withdrawals of earnings: Taxable Taxable Nontaxable
(if qualified distribution)
Taxable
(if nonqualified distribution)
- Regular tax
3.6 Rollover From Traditional to Roth IRA - No penalty tax
Taxpayers can transfer funds from a traditional IRA to a Roth IRA. The amount transferred
is taxed as if it is a distribution: Contributions that were not deducted are nontaxable, and
both contributions that were deducted and earnings are taxable ordinary income. However,
the withdrawal from the traditional IRA is not subject to the 10 percent early withdrawal
penalty if the taxpayer contributes the entire amount to a Roth IRA account within 60 days of
the withdrawal.
4 Student Loan Interest Expense
The adjustment for education loan interest is limited to $2,500.

Any extra interest
expense is "personal"
All interest payments qualify for the adjustment. Per year and not deductible
It is phased out for AGI between: (disallowed itemized
2023
deduction)
Robin Hood Unmarried $75,000–$90,000
rule MFJ $155,000–$185,000
Deduction is completely phased out at AGI equal to or more than $90,000 (2023) for
unmarried taxpayers (single or head of household) and $185,000 (2023) for married
taxpayers filing jointly. Married taxpayers must file jointly to claim the adjustment.
A dependent may not claim the adjustment.
The taxpayer must be legally obligated to pay the loan (e.g., interest paid by a parent on a
child's student loan will not qualify for the adjustment).
Interest is only deductible on loans incurred by a taxpayer solely to pay for qualified
education expenses (e.g., general loans such as a home equity line of credit would
not qualify).

1 Adjustments REG 2
5 Health Savings Accounts
5.1 Pretax Contribution

Health savings accounts (HSAs) enable workers with high-deductible health insurance plans
to make pretax contributions of up to $3,850 in 2023 ($7,750 for families) to cover health care
costs. These amounts are increased by $1,000 for taxpayers age 55 or older. No contributions
are allowed once a taxpayer becomes covered by Medicare Parts A or B.
5.2 Excludable Distributions = Tax free

Any amount paid or distributed out of an HSA that is used exclusively to pay the qualified
medical expenses of any account beneficiary is not includable in gross income. Note that
distributions for qualified drugs include only those prescribed by a physician.
Distributions made prior to age 65 that are not used to pay qualified medical expenses are
includable in gross income and subject to an additional 20 percent tax.
5.3 High-Deductible Plan Defined

A high-deductible health insurance plan is a plan that has at least a $1,500 annual deductible for
self-only coverage and a $3,000 annual deductible for family coverage plans (2023).
Out-of-Pocket Limitation: Annual out-of-pocket expenses paid under the plan must be
limited to $7,500 for self-only coverage plans and $15,000 for family coverage plans (2023).
Out‑of-pocket expenses include deductibles, co-payments and other amounts (other than
premiums) that must be paid for plan benefits.
5.4 Archer Medical Savings Account (MSA) Contributions

No new Archer MSAs could be established after the year 2007; however, any accounts
established prior to 2008 are allowed to continue.
Archer MSAs are similar to IRAs, but they are used for health care. Typically, they are used
only if an HSA is unavailable, as HSAs are generally more flexible.
Qualified participants are self-employed individuals or employees of small businesses (fewer
than 50 employees).
These accounts were designed to be and must be used in conjunction with a high‑deductible
(2023: $2,650–$3,950 self-only coverage/$5,300–$7,900 family coverage) health
insurance plan.
The maximum out-of-pocket expenses limit is $5,300 for self-only coverage plans and $9,650
for family coverage plans (2023).
6 Moving Expenses
Moving expense deductions are only allowed for members of the Armed Forces (or spouses and
dependents) on active duty who move pursuant to a military order and incident to a permanent
change of station.

REG 2 1 Adjustments
7 Self-Employment Tax (50 Percent) = Social Security tax
Self-employed taxpayers with net business income are subject to two taxes: income tax and
self-employment (Social Security and Medicare) tax. Fifty percent of the self-employment tax is
deducted to arrive at adjusted gross income. You pay both: employer and employee
Not
deducted
on 8 Self-Employed Health Insurance
Schedule C
Self-employed individuals may deduct all of the health insurance premiums paid for the
taxpayer, spouse, and dependents, provided that the plan is set up in the name of the
self‑employed individual or the individual's business. The deduction is limited to the amount of
the taxpayer's self-employment income. The health insurance premiums are deducted above
the line (adjustment), rather than as an itemized deduction subject to a percentage of AGI floor.
9 Self-Employed Retirement Plans
Self-employed taxpayers are allowed to deduct contributions made to qualified self-employed

non‑Roth retirement plans as an above-the-line deduction (adjustment) for AGI. As with
employer-sponsored non‑Roth plans, the earnings are not taxed until they are distributed.
Distributions from the plan are fully taxable as ordinary income and are subject to the same
early and late distribution penalties as other retirement plans. For plans that are designated as
Roth, contributions are not deductible and qualified distributions are nontaxable.
The maximum amount that a self-employed taxpayer can contribute to a self-employed
retirement plan each year depends on the type of plan. The most common self-employed
retirement plans are simplified employee pension (SEP) IRAs, savings incentive match plan for
employees (SIMPLE) IRAs, and Solo 401(k)s.
9.1 SEP IRA

The 2023 maximum contribution to a SEP IRA is the lesser of:
20 percent of self-employment net income reduced by one-half of self-employment tax
deduction; or
$66,000 ($73,500 for taxpayers age 50 or older).
9.2 SIMPLE IRA

The 2023 maximum contribution to a SIMPLE IRA is the lesser of:
deduction; or
$15,500 ($19,000 for taxpayers age 50 and older).
9.3 Solo 401(k)

The 2023 maximum contribution to an individual 401(k) is the lesser of:
deduction; or
$66,000 ($73,500 for taxpayers age 50 or older).

1 Adjustments REG 2
Example 2 Calculating Maximum Allowable Contribution to SEP IRA
Facts: Peter has self-employment net income (after the deduction for one-half of the
self‑employment tax, but before any SEP IRA contribution) of $100,000.
Required: Calculate Peter's maximum allowable contribution to his SEP IRA self‑employed
retirement plan for 2023.
Solution:
Self-employment net income (after deduction for one-half $100,000

of self-employment tax)
Times × 20%
Maximum allowable contribution $ 20,000
10 Penalty on Early Withdrawal of Savings Do not net against

interest income
(Interest Income): Interest Forfeited
An example of forfeited interest is the interest penalty on early withdrawal of savings when
funds in a certificate of deposit are withdrawn before maturity.
2018 & before = Adjustment to payor

11 Alimony 2019 & after = Nothing
Alimony payments to a former spouse are adjustments deductible to arrive at AGI only for
divorce or separation agreements executed on or before December 31, 2018.
11.1 Alimony/Spousal Support (Income to Payee/Adjustment to Payor)

Payments for the support of a former spouse are income to the spouse receiving the payments
and are deductible to arrive at adjusted gross income (adjustment) by the contributing spouse.
The following conditions must exist for alimony to be deductible:
Payments must be legally required under a written divorce (or separation) decree
or agreement;
2018 Pay credit card bills
Payments must be in cash (or its equivalent);
& Pay tuition
Payments cannot extend beyond the death of the payee-spouse;
before
Payments cannot be made to members of the same household; and
Payments must not be designated as anything other than alimony.

REG 2 1 Adjustments
11.2 Child Support (Nontaxable to Payee/Nondeductible to Payor)

Nontaxable
If any portion of the payment is fixed by the decree or agreement as being for the support
of minor children (or is contingent on the child's status, such as reaching a certain age), such
portion is not deductible by the spouse making payment and is not includable in income by
the spouse receiving payment.
Payment Applies First to Child Support
If the decree or agreement specifies that payments are to be made both for alimony and for
support, but the payments subsequently made fall short of fulfilling these obligations, the
payments will be allocated first to child support (until the entire child-support obligation for
the year is met), and then to alimony.
Him or her
11.3 Property Settlements (Nontaxable/Nondeductible) HI D E IT
If the divorce settlement provides for a lump-sum payment or property settlement by a spouse,
that spouse gets no deduction for payments made, and the payments are not includable in the
gross income of the spouse receiving the payment.
12 Attorney Fees Paid in Discrimination Cases
In certain cases, an adjustment is allowed for attorney fees paid in connection with age, sex,
racial discrimination, and whistle-blower cases. The adjustment amount is limited to the amount
claimed as income from the judgment.
Question 1 MCQ-15962
For the current year, Val and Pat White filed a joint return. Val earned $40,000 in wages and
was covered by his employer's qualified pension plan. Pat was unemployed and received
$5,000 in alimony payments (from a divorce agreement executed in 2017) for the first four
months of the year before remarrying. The couple had no other income. Each contributed
$5,000 to a traditional IRA account. The allowable IRA deduction on their current year joint
income tax return is:
a. $10,000
b. $5,000
c. $1,000
d. $0

1 Adjustments REG 2
The self-employment tax is:

a. Fully deductible as an itemized deduction.
b. Fully deductible in determining net income from self-employment.
c. One-half deductible from gross income in arriving at adjusted gross income.
d. Not deductible.

2
MODULE
REG 2 2 Itemized Deductions
Itemized Deductions REG 2
Below-the-line
(AGI)
1 Standard Deduction = 1040 EZ deductions
Those who do not itemize receive a standard deduction, with the amount determined based on
filing status:
2023
Single $13,850
Freebie
Head of household 20,800
Married filing jointly or surviving spouse 27,700
Married filing separately* 13,850
*Available only if both taxpayer and spouse do not itemize. No double-dipping
1.1 Additional Standard Deduction for Age 65 or Older and/or Blindness
The standard deduction for a taxpayer who is age 65 or over or blind is increased by an
additional amount.
2023
Unmarried Married
One Qualified Taxpayer
65 or blind $1,850 $1,500
Both 65 and blind 3,700 3,000
Two Qualified Taxpayers
Each 65 or blind $3,000
Both 65 and blind 6,000
Illustration 1 Additional Standard Deduction
Bob and Suzanne DeFilippis are both age 66 and file a married filing joint
income tax return. For tax year 2023, the standard deduction would be $30,700
($27,700 plus $3,000) because each spouse is age 65 or over.
For tax year 2023, Ed Joback, a blind, single taxpayer, may claim a standard deduction of
$15,700 if he is under age 65 ($13,850 plus $1,850), or $17,550 ($13,850 plus $3,700) if he
is age 65 or over.

2 Itemized Deductions REG 2
1.2 Standard Deduction: Dependent of Another : Your young children

For 2023, the standard deduction amount for a taxpayer who is a dependent of another taxpayer is the
greater of $1,250 or earned income plus $400. Thus, a dependent taxpayer with $1,300 earned income
could claim a standard deduction of $1,700 ($1,300 plus $400). The dependent's standard deduction
remains limited by the regular standard deduction for the tax year. Dependent taxpayers may claim
the same additional standard deduction as other taxpayers for blindness and/or age 65‑or‑over status.
Schedule A - Business Schedule C
2 Itemized Deductions (Personal items) - Rental Schedule E
Itemized deductions are referred to as "from AGI" deductions and are reported on Schedule A of
an individual taxpayer's Form 1040. A taxpayer itemizes deductions when "from AGI" deductions
are greater than the standard deduction. Taxpayers who are married filing separately must both
take the standard deduction or both itemize. One spouse cannot take the standard deduction
and the other spouse itemize.
2.1 Medical Expenses

Medical
2.1.1 Payments
Taxes
Payments on behalf of the following individuals qualify:
No Filing taxpayer
Interest
pets Charity
Spouse
Dependent who received more than half of his or her support from the Casualty
filing taxpayer
Note: The definition of "dependent" for this purpose does not consider the Misc.
dependent's gross income or the joint return requirement. Thus, there is no
limitation to the dependent's gross income when it relates to medical or dental expenses
(however, all other dependency tests will continue to apply).
Support over 50 percent Yes

Under taxable gross income limit No Mom is OK, even if
Precludes joint return No she has taxable income
Only citizens Yes
Relative or Yes
Taxpayer lives with Yes
2.1.2 Timing of Deduction

Include as potentially deductible expenses:
Paid (cash or check) amounts during the year.
Amounts charged to a credit card during the year (regardless of when paid).
Payments made for a deceased spouse (deductible in the year paid, even if it is different
from the year the spouse died).
Amounts reimbursed to the taxpayer (or anyone else for the taxpayer) by hospital, health,
or accident insurance must reduce otherwise allowable expense (before the percentage of
AGI floor is applied).
R2–16 Module 2 © Becker Professional Education Corporation. AllItemized Deductions

rights reserved.
Pass Key
Individuals are typically "cash basis." Therefore, generally in order to be tax deductible, the
item must have been:
incurred as an expense
paid or charged to credit card before year-end
2.1.3 Calculation of Deductible Medical Expenses

Qualified medical expenses to the extent that they exceed medical insurance reimbursement
and the 7.5 percent of AGI floor are deductible.
Qualified medical expenses

< Insurance reimbursement >
Qualified medical expenses "paid"
< 7.5% of AGI >
Deductible medical expenses
2.1.4 Types of Deductible Medical Expenses

Medicine and prescription drugs, including Medicare part D premiums
Doctors
Medical and accident insurance premiums (including qualified long-term care premiums,
although the deduction is limited based on the age of the taxpayer)
Medically necessary surgery
Allowed Transportation to medical facility
y Actual costs, or
y Allowance (22 cents per mile for 2023)
Physically disabled costs = Deduct/do not depreciate
Expenses incurred by the physically disabled for the removal of structural barriers in their
residences to accommodate a disability are treated as medical expenses.
2.1.5 Types of Nondeductible Medical Expenses

Elective surgery, elective cosmetic operations, drugs that are illegal, travel, vitamins, the part
of Social Security tax paid for basic Medicare, funerals, cemetery lots, and insurance against
loss of earnings due to sickness or accident (note that cosmetic surgery required due to an
accident or deformity can qualify).
Not Life insurance. = Financial insurance
allowed Capital expenditures (up to the increase in the fair market value (FMV) of the property
because of the expenditure).

Health club memberships recommended by a doctor for general health care (it would have
to be more specific to make it deductible).
Personal hygiene and other ordinary personal expenses (e.g., toothpaste, toiletries,
over‑the‑counter medicines, bottled water, diaper service, maternity clothes, etc.).
2.1.6 Insurance Reimbursement

Amounts repaid to the taxpayer (or anyone else for the taxpayer) by hospital, health, or accident
insurance must reduce otherwise allowable expense (before the percentage of AGI floor is applied).
Reimbursement of expenses by an employer (or by policies provided by an employer) that
exceed the total of medical or dental expenses paid by a taxpayer will be included as part of
gross income.
Reimbursement of any expense deducted in a prior year will be included as part of gross
income in the year received.
2.1.7 Percentage of AGI Floor

Only medical expenses in excess of 7.5 percent of AGI floor are deductible.
2.2 State, Local, and Foreign Taxes : Not federal income taxes Medical
Real estate
For cash-method taxpayers, deductible taxes are generally deductible in the year Income
paid. For accrual-method taxpayers, taxes are generally deductible in the year in Taxes
Property
which they accrue. Itemized deductions for state and local income taxes, state Sales
Interest
and local property taxes, and sales tax are limited to $10,000 in the aggregate.
In addition, foreign real property taxes, other than those incurred in a trade or
Charity
business and those incurred with respect to property held as an investment, are
not deductible. Casualty
2.2.1 Real Estate Taxes (State and Local Taxes)
Misc.
The taxpayer must be legally obligated to pay in order to deduct the taxes.
Prorate taxes in year of sale/purchase.
Taxes paid under protest are deductible. Subsequent recovery is included in gross income.
Real estate taxes do not include street, sewer, and sidewalk assessment taxes. Not
special assessment
Taxes paid through an escrow account are deductible when paid to the taxing authority. By bank
Foreign real estate taxes paid are only deductible if paid in carrying on a trade or business
Real estate taxes on land held for appreciation may be capitalized or deducted at the option
of the taxpayer.
Real estate taxes allocated to part of the home that is used exclusively for business may be
deductible on Schedule C.
2.2.2 Personal Property Taxes (State and Local Taxes)

Personal property taxes are those assessed by state and local governments on personal
property owned by the taxpayer, such as vehicles and boats. To be deductible, the tax must be
based on the value of the personal property and paid during the tax year.

rights reserved.
Cash basis
2.2.3 Income Taxes (State, Local, and Foreign Taxes)
Estimated taxes paid during the year are deductible. - Deduct in year paid
Taxes withheld from paychecks during the year are deductible.
- Not year applied
Assessments for a prior year's tax that are paid in the current year are deductible.
Itemized deductions
Refunds are included in gross income (if the tax was deducted in a prior year) and should
not be netted against the current year itemized tax deduction.
2.2.4 Sales Tax: Instead of state income taxes

A taxpayer may elect to deduct either state and local income taxes or state and local general
sales taxes. If the taxpayer chooses to deduct the sales tax, the amount is determined by either:
the total amount of actual general sales taxes paid; or
the relevant IRS table, plus any amount of sales tax paid for a motor vehicle, boat, or other
IRS-approved items.
Note: A "tax benefit rule" applies to the impact of sales tax. If a taxpayer itemizes deductions in
a year and takes a deduction for state income taxes instead of a deduction for sales taxes in that
year, the tax benefit rule will calculate the taxability of the state tax refund on the extra benefit
received from claiming the higher state income tax deduction instead of what would have been
allowed if the state sales tax had been deducted.
2.2.5 Nondeductible Taxes

The following taxes are not deductible as itemized deductions on Schedule A:
F Federal taxes (including Social Security)
I Inheritance taxes for states
B Business (on Schedule C) and rental property taxes (on Schedule E)
Pass Key
Once again, "cash basis" taxpayers are entitled to a deduction in the year an item is paid or
charged. Note that there is no "matching" to the year the tax is applicable.
2.3 Interest Expense Medical
2.3.1 Home Mortgage Interest H IPPE Taxes

Deductions are allowed for "qualified residence interest" on a first or a second
home (a taxpayer's principal residence and one other residence). A home that is Interest
used for personal purposes for at least 14 days in a tax year qualifies as a "second
Charity
home." Mortgage interest allocated to part of the home that is used exclusively
for business may be deductible on Schedule C and mortgage interest allocated to
Casualty
rental of the home may be deductible on Schedule E.
Misc.

Interest on up to $750,000 ($375,000 MFS) of home-related indebtedness is deductible as home

mortgage interest. Interest on excess principal (over $750,000, or $375,000 MFS) is treated as
1st and personal interest and, as such, is not deductible. Qualified indebtedness may be in the form of
2nd home original acquisition debt or a home equity loan, but must meet the following:
Incurred in buying, constructing, or substantially improving the taxpayer's principal and
second home; and
Secured by the home.
Points related to the debt on the home are deductible immediately. Points related to refinancing
must be amortized over the period of the loan.
2.3.2 Investment Interest Expense H I PPE Like gambling loss rules

The investment interest deduction for individuals is limited to net taxable investment income.
Include as Net Taxable Investment Income No "negative" amount allowed
y Interest
as a tax deduction
y Dividends (other than qualified dividends)
y Short-term capital gains
y Royalties (in excess of expenses)
y Net long-term capital gains and qualified dividends (only if the taxpayer elects not to
claim the reduced capital gains tax rate)
Dividend Income From Stock Purchased With Borrowed Funds
Any dividend income from stock purchased with borrowed funds that the taxpayer treats as
investment income for purposes of the limitation on investment interest expense is not a
qualified dividend available for preferential 15 percent tax rate.
Exclude From Net Taxable Investment Income
Interest expense used to purchase tax-free bonds is not deductible (because the interest
earned on the bonds is not taxable).
Disallowed Expense: Carry Forward
The excess of investment interest paid over the "allowed" investment interest deducted can
be carried forward indefinitely.
Pass Key
An easy way to understand and remember this rule is to think of it like the limitations on
gambling losses. Investments (a risk/gamble) have the limitation of not being permitted to
deduct a "net investment expense."

rights reserved.
2.3.3 Personal (Consumer) Interest Is Not Deductible HI P PE
Personal interest includes interest on:

A personal note to a bank or person for borrowed funds
Life insurance loans
Not
allowed Bank credit cards or other revolving charge accounts
as an A purchase of personal property such as autos, television sets, clothes, etc.
itemized
deduction Federal, state, or local tax underpayments
A home equity loan not used to improve the home Incurred
2.3.4 Prepaid Interest (Allocate to Proper Period) HIP P E Deduct when both &
Prepaid interest must be allocated over the period of the loan, even for a cash basis taxpayer.
Paid
(Remember that prepaid interest received is taxable as income in the year received and is
not allocated.)
2.3.5 Educational Loan Interest (Adjustment/Not Itemized Deduction) HIPP E
Educational loan interest is a deduction to arrive at adjusted gross income and not an
itemized deduction. $2,500 per year
2.4 Charitable Contributions Medical

2.4.1 Types of Contributions Taxes
Charity: Items given to qualifying charitable organizations (tax deductible).
Not Interest
deductible Gifts: Items given to individuals (e.g., needy family) (nondeductible).
Political Contributions: Items given to candidates (nondeductible). Charity
2.4.2 Amount of Deduction

Cash Casualty
FMV property
A charitable contribution may be in the form of cash or property. The amount of Misc.
the deduction for contributions of property depends on whether the property is
ordinary income property or long-term capital gain (LTCG) property.
The amount of the deduction for ordinary income property is the lesser of the property's
adjusted basis or its fair market value (FMV) at the time it is contributed. Ordinary income
property includes:
Inventory
Short-term assets (held for one year or less)
Investment or personal-use assets that have depreciated in value
Depreciation recapture on long-term, business-use assets
The amount of the deduction for LTCG property is its FMV at the time of the contribution.
LTCG property is appreciated capital gain property that has been held for more than one year
and includes:
Investment assets
Personal-use assets
Gain in excess of ordinary income depreciation recapture for long-term, business-use assets

2.4.3 AGI Limitations on Amount of Deduction

The maximum allowable deduction for charitable contributions depends on the type of property
contributed and the type of charity to which the contribution was made.
Overall limits
Private Private
Public Operating Nonoperating
Charities Foundations Foundations
Cash 60% of AGI 60% of AGI 30% of AGI
Ordinary income property 50% of AGI 50% of AGI 30% of AGI
FMV Long-term capital gain property 30% of AGI 30% of AGI 20% of AGI
A private operating foundation actively conducts charitable activities and distributes funds
to its own charitable programs. A private nonoperating foundation distributes funds to other
charitable organizations.
When a taxpayer has charitable contributions that are subject to different AGI limitations, the
AGI limitations are applied first to cash (60% AGI limit), then ordinary income property (50% AGI
limit), then LTCG property (30% AGI limit).
2.4.4 Carryover of Excess Charitable Contributions (Five Years)

All charitable contribution carryovers are applied on a first-in, first-out basis, after current year
contributions are deducted, subject to the percentage of income limitations.
Example 1 Charitable Contribution Deduction
Facts: Joe Kelly itemizes deductions and made the following charitable contributions during
the year:
Cash United Way: Cash $15,000
Ordinary Goodwill: Personal furniture (cost $25,000 three years ago, FMV at date of
contribution $10,000)
Capital Art Museum: Sculpture (cost $20,000 five years ago, FMV at date of contribution $30,000)
Kelly's adjusted gross income (AGI) for the year is $100,000.
Required: Calculate the taxpayer's charitable contributions deduction for the year.
Solution:
Cash: The $15,000 cash contribution to United Way, a public charity, is subject to the
60 percent of AGI limitation.
1. Limitation for contributions subject to 60% limit
(AGI $100,000 × 60%) $60,000
2. Cash contribution to United Way 15,000
3. Allowable deduction for cash contribution (lesser of 1 or 2) 15,000
(continued)

rights reserved.
Cash $15,000
(continued)
Ordinary Income Property: The personal furniture contributed to Goodwill, a public charity,
has depreciated in value, so it is ordinary income property and is subject to the 50 percent
of AGI limitation. The amount of the contribution is the lesser of the cost basis or the FMV
at the date of contribution, which is $10,000.
4. Limitation for contributions subject to 50% limit:

AGI $100,000 × 50% $50,000
Less: cash contribution allowed (line 3) (15,000) $35,000
5. Contribution of ordinary income property to Goodwill (FMV) 10,000
6. Allowable deduction for ordinary income property contribution
(lesser of 4 or 5) 10,000
LTCG Property: The sculpture contributed to the Art Museum, a public charity, is a long-term
investment or personal-use asset that has appreciated in value, so it is long-term capital
gain (LTCG) property and is subject to the 30 percent of AGI limitation. The amount of the
contribution is the FMV at the date of contribution, which is $30,000.
7. Limitation for contributions subject to 30% limit:

Lesser of:
y AGI $100,000 × 30% $30,000 (a)
y AGI $100,000 × 50% $50,000
Less: cash contribution allowed (line 3) (15,000)
Less: ordinary income property contribution
allowed (line 6) (10,000) 25,000 (b)
8. Limitation of deduction (lesser of a or b) $25,000
9. Contribution of LTCG property to Art Museum (FMV) 30,000
10. Allowable deduction for LTCG property contribution
(lesser of 8 or 9) $25,000
11. Total charitable contributions deduction:

Cash $15,000
Ordinary income property 10,000
LTCG property 25,000
Total charitable contribution deduction $50,000
12. Charitable contribution carryforward:
LTCG property contribution (FMV) $30,000
Less: amount deducted in current year (25,000)
LTCG property contribution carryforward 5 years $ 5,000

2.4.5 Consideration Received for Contribution Only deduct "excess" paid for item
The taxpayer may only deduct the excess contribution over the consideration received.
Charitable organizations that receive contributions of more than $75 in exchange for services
or property must provide the donor with a written statement that estimates the value of the
deductible portion of the payment.
Illustration 2 Deductible Contribution
Raffle tickets bought at a charity bazaar that have a chance of winning a prize do not give
rise to a charitable deduction.
JoAnn Veiga buys a ticket to a charity ball for $200. The actual value of attending the ball
was $50. Veiga may take a charitable deduction of $150.
2.4.6 Timing of Deduction

A deduction is allowed only for the tax year in which the contribution is made:
Same rule Cash or Check: Actually paid.

as medical Credit Card: When charged, a contribution made by a bank credit card is deductible
in the year the charge is made, even if payment to the bank for the charge occurs the
following year.
2.4.7 Contribution for Services : Cannot deduct value of free services

A taxpayer may deduct out-of-pocket expenses incurred as a result of providing services to a
charity. This includes the cost of driving to and from the volunteer work. The taxpayer may take
14 cents per mile (2023) or the actual cost of gas and oil. With either method, the taxpayer may
also include parking and tolls.
2.4.8 Student Living in Taxpayer's Home

A charitable deduction may be taken for the expense incurred when the taxpayer takes into the
home a full-time student (e.g., an exchange student). The student may not be beyond the 12th
grade. The total deduction is up to $50 per month for each full month (15 or more days) the
student is in the home and attending school.
2.4.9 Substantiation Requirements

Regardless of the amount of the cash contribution, taxpayers must keep records that
substantiate their deductions. Either a bank record (e.g., canceled check or itemization on a bank
statement with the charity's name) or a written acknowledgement from the charity is required.
The acknowledgment must be obtained by the earlier of the filing date or the due date of
the return.
For contributions of more than $500 of noncash property, the taxpayer must file Form 8283,
giving certain information. In addition, taxpayers claiming more than $5,000 for any one item or
group of similar items, such as a stamp collection, need a written appraisal for each such item or
group donated, except that no appraisal is needed for publicly traded securities.

rights reserved.
2.5 Casualty Losses (10 Percent of AGI Floor) Medical

Casualty losses of nonbusiness property are deductible to the extent that each
individual loss exceeds $100 and that the aggregate of these excess losses (excess Taxes
over $100) exceeds 10 percent of AGI. The $100 floor applies to each separate
casualty event. The losses are only deductible if sustained in a presidentially Interest
declared disaster area.
Charity
2.5.1 Amount of Loss
Casualty
The amount regarded as a casualty loss is the difference between the market value
of the property immediately before the casualty and its fair market value (FMV) Misc.
immediately afterward. However, the loss may not exceed the adjusted basis of
the property. Whichever amount is used must be reduced by the amount of any
insurance recovery.
1. Lost cost/adjusted basis

Smaller loss
2. Decreased FMV
< Insurance recovery >
Taxpayer's loss
< $100 >
Eligible loss
< 10% AGI >
Deductible loss
2.5.2 Failure to Notify Insurer

A casualty loss for nonbusiness property cannot be deducted unless:
an insurance claim was filed; or
the losses are not covered by insurance.
2.5.3 Lost, Misplaced, or Broken Property = No deduction

No casualty loss deduction is allowed for lost, misplaced, or broken property.
- 0 - 2.6 Miscellaneous Itemized Deductions (2 Percent of AGI Floor) Medical
The Tax Cuts and Jobs Act of 2017 suspended all miscellaneous itemized deductions Taxes
subject to the 2 percent of AGI floor for tax years 2018–2025.
Not Interest
subject 2.7 Gambling Losses Charity

to 2% AGI Gambling losses remain fully deductible, but only to the extent of gambling winnings. Casualty
Misc.
Exam hint: Test will ask you which item is an
"adjustment" or "itemized deduction"

Which of the following requirements must be met in order for a single individual to qualify
for the additional standard deduction?
Must Support Dependent Must Be Age 65

Child or Aged Parent or Older or Blind
a. Yes Yes
b. No No
c. Yes No
d. No Yes
Carroll, a 35-year-old unmarried taxpayer with an adjusted gross income of $100,000,

incurred and paid the following unreimbursed medical expenses:
Doctor bills resulting from a serious fall $ 5,000
Cosmetic surgery that was necessary to correct a congenital deformity 15,000
Carroll had no medical insurance. For regular income tax purposes, what was Carroll's
maximum allowable medical expense deduction, after the applicable threshold limitation,
for the year?
a. $0
b. $12,500
c. $15,000
d. $20,000
Taylor, an unmarried taxpayer, had $90,000 in adjusted gross income for the current year.
During the current year, Taylor donated land to a church and made no other contributions.
Taylor purchased the land 15 years ago as an investment for $14,000. The land's fair
market value was $25,000 on the day of the donation.
What is the maximum amount of charitable contribution that Taylor may deduct as an
itemized deduction for the land donation for the current year?
a. $25,000
b. $14,000
c. $11,000
d. $0

rights reserved.
3
MODULE
REG 2 3 Tax Computation and Credits
Tax Computation
and Credits REG 2
1 Individual Ordinary Income Tax Calculation

and Limitations
1.1 Individual Ordinary Income Tax Rate Structure

The ordinary income tax rates for individuals are 10, 12, 22, 24, 32, 35, and 37 percent.
Highest Lowest 1/2 Married
2023 Married Married
Tax Rate Single Head of Household Filing Jointly Filing Separately
10% $0–$11,000 $0–$15,700 $0–$22,000 $0–$11,000
12% $11,001–$44,725 $15,701–$59,850 $22,001–$89,450 $11,001–$44,725
22% $44,726–$95,375 $59,851–$95,350 $89,451–$190,750 $44,726–$95,375
24% $95,376–$182,100 $95,351–$182,100 $190,751–$364,200 $95,376–$182,100
32% $182,101–$231,250 $182,101–$231,250 $364,201–$462,500 $182,101–$231,250
35% $231,251–$578,125 $231,251–$578,100 $462,501–$693,750 $231,251–$346,875
37% Over $578,125 Over $578,100 Over $693,750 Over $346,875
1.2 Individual Preferential Income Tax Rates

Long-term capital gains and qualified dividends are taxed at preferential income tax rates, as
shown in the table below.
2023 Taxable Income

Tax Rate Single Head of Household Married Filing Jointly Married Filing Separately
0% $0–$44,625 $0–$59,750 $0–$89,250 $0–$44,625
15% $44,626–$492,300 $59,751–$523,050 $89,251–$553,850 $44,626–$276,900
20% Over $492,300 Over $523,050 Over $553,850 Over $276,900

3 Tax Computation and Credits REG 2
Example 1 Calculating Individual Income Tax Liability
1. Facts: A taxpayer with single filing status has $100,000 of taxable income.
Required: Calculate the income tax liability in 2023.
Solution:
($11,000 − $0) × 10% = $1,100
($44,725 − $11,000) × 12% = $4,047
($95,375 − $44,725) × 22% = $11,143
($100,000 − $95,375) × 24% = $1,110
$1,100 + $4,047 + $11,143 + $1,110 = $17,400
2. Facts: A taxpayer with head of household filing status has $60,000 of taxable income.
Solution:
($15,700 − $0) × 10% = $1,570
($59,850 − $15,700) × 12% = $5,298
($60,000 − $59,850) × 22% = $33
$1,570 + $5,298 + $33 = $6,901
3. Facts: A taxpayer with married filing jointly filing status has $75,000 of taxable income.
Solution:
($22,000 − $0) × 10% = $2,200
($75,000 − $22,000) × 12% = $6,360
$2,200 + $6,360 = $8,560
4. Facts: A taxpayer with married filing separately filing status has $50,000 of
taxable income.
Solution:
($11,000 − $0) × 10% = $1,100
($44,725 − $11,000) × 12% = $4,047
($50,000 − $44,725) × 22% = $1,160.50
$1,100 + $4,047 + $1,160.50 = $6,307.50
1.3 Progressive Tax Rate Structure

The individual income tax rate structure is a progressive tax rate structure.
With a progressive tax rate structure, the marginal tax rate increases as taxable
income increases.
R2–28 Module 3 Tax Computation

© Becker Professional Education Corporation. and Credits
All rights reserved.
The tax rate applied to the next amount of incremental taxable income or deductions is the
marginal tax rate.
It is calculated as the change in tax divided by the change in taxable income.
Example 2 Increasing Marginal Tax Rate
Facts: Mark, a married taxpayer filing jointly, has discovered that he will receive an
additional consulting check in December 2023 that he did not expect until next year. Before
the additional income, his taxable income is $75,000. After the receipt of the additional
consulting income, his taxable income is $90,000.
Required: Determine Mark's marginal tax rate on the additional taxable income.
Solution:
Tax calculated on $75,000 for married filing jointly:
($22,000 − $0) × 10% = $2,200

($75,000 − $22,000) × 12% = $6,360
$2,200 + $6,360 = $8,560
Tax calculated on $90,000 for married filing jointly:
($22,000 − $0) × 10% = $2,200

($89,450 − $22,000) × 12% = $8,094
($90,000 − $89,450) × 22% = $121
$2,200 + $8,094 + $121 = $10,415
The marginal tax rate is calculated as follows:

$10,415 − $8,560 = $1,855 change in tax liability / $15,000 change in taxable income
= 12.4%
2 Tax Credits: Dollar-for-dollar reduction of tax
2.1 Tax Credits in General

Tax credits reduce personal tax liability. There are two basic types of tax credits.
2.1.1 Nonrefundable Personal Tax Credits : Reduce taxes, but not refund
Personal tax credits may reduce personal tax liability to zero, but they may not result in a refund.
Personal tax credits include:
Child and dependent care credit
Elderly and permanently disabled credit
Education credits
y Lifetime learning credit
y American opportunity credit (60 percent nonrefundable)

Retirement savings contribution credit

Foreign tax credit
General business credit
Adoption credit
2.1.2 Refundable Credits : Reduce taxes and can create a refund

Refundable credits are subtracted from income tax liability. They may result in a cash refund
when the credit exceeds tax liability owed even if no tax is withheld from wages. Refundable
credits and refundable payments include:
Child tax credit (refund is limited)
Earned income credit
Federal income tax withheld (Form W-2)
Excess Social Security tax paid
American opportunity credit (40 percent refundable)
2.2 Child and Dependent Care Credit

The child and dependent care credit is 20 percent to 35 percent of work-related expenses to care
for qualifying persons. The maximum allowable expenses are $3,000 for one qualifying person
and $6,000 for two or more qualifying people.
Maximum Expenditures
General rule
- Both parents work
One dependent $3,000
- Pay someone to care
Two or more dependents $6,000 for children
2.2.1 Qualifying Persons = Kids and disabled
The child and dependent care credit is available to taxpayers who maintain a household, work,
and incur eligible expenses for the care of the following qualifying persons:
A dependent qualifying child who is under age 13 when the care is provided.
A disabled dependent of any age who is unable to care for himself, whether or not he can
be claimed as a dependent, but who must meet the support test of a dependent (half of
support provided by the taxpayer).
A spouse who is disabled and not able to take care of himself or herself.
2.2.2 Earned Income Requirement

Married taxpayers must both produce earned income from wages, salary, or self‑employment
net income to be eligible for the child and dependent care credit (unless one is a full-time
student or physically or mentally incapacitated).

2.2.3 Eligible Expenses

Eligible expenditures must be for the purpose of enabling the taxpayer to be gainfully employed
(i.e., allowing that person to work or look for work).
Babysitter
OK Nursery school
Day care
Not elementary school
2.2.4 Calculation of Credit

The amount that is eligible for the credit is the lesser of: (1) the earned income of the
lesser‑earning spouse, (2) the actual expenses incurred, or (3) the maximum allowable amount
($3,000 or $6,000). The credit is the qualifying amount multiplied by the applicable percentage,
which is based on the taxpayer's adjusted gross income (AGI).
Maximum 35 Percent: The maximum child or dependent care credit is $1,050 ($3,000 × 35%)
if the taxpayer has one qualifying dependent, or $2,100 ($6,000 × 35%) if the taxpayer has two
or more qualifying dependents. In order to obtain the maximum credit, the taxpayer's AGI
must be $15,000 or less.
Phase-out From 35 Percent to 20 Percent: The credit decreases by 1 percent for each
$2,000 (or fraction thereof) of AGI over $15,000, but is not reduced below 20 percent.
Minimum 20 Percent: The maximum child care credit at the lowest rate of 20 percent for
taxpayers with AGI of more than $43,000 is $600 ($3,000 × 20%) if the taxpayer has one
qualifying dependent, or $1,200 ($6,000 × 20%) if the taxpayer has two or more qualifying
dependents.
Example 3 Child and Dependent Care Credit
Facts: JoAnn Veiga is a widow with two dependent children. Her current year AGI is
$50,000, for which the applicable child and dependent care credit rate is 20 percent. Her
work-related expenses for a home caregiver for the children are $3,600 and $3,800 for child
care at a nursery school.
Required: Calculate the amount of the child and dependent care credit for JoAnn.
Solution: JoAnn can take a child care credit of $1,200, calculated as follows:
Work-related expenses (home caregiver) $3,600
Nursery school expenses 3,800
Total qualifying expenses $7,400
Maximum allowable for two dependents $6,000 Max. with 2 or more kids
Applicable credit percentage × 20%
Amount of credit $1,200

2.3 Credit for the Elderly and/or Permanently Disabled

2.3.1 Eligibility
This credit of 15 percent of eligible income is available to individuals who are:
1. 65 years of age or older; or
2. under age 65, retired due to total and permanent disability, and received taxable disability
income for the year.
2.3.2 Base Amount

The base amount used to figure the credit is as follows:
$5,000 for a single person, widow, or widower.
$5,000 if married filing jointly and only one spouse is a qualified individual.
$7,500 if married filing jointly and both are qualified individuals.
$3,750 for a qualified individual who is married filing separately.
If a qualified individual is under age 65 and has disability income of less than $5,000, the
base amount is limited to $5,000.
2.3.3 Adjusted Gross Income Limit

Eligible income is reduced by:
1. any Social Security payments and other excludable pensions or annuities received by the
taxpayer; and
2. one half of the taxpayer's adjusted gross income that exceeds the following levels:
Single taxpayers $ 7,500

Married persons filing jointly $10,000
Married persons filing separately $ 5,000
2.3.4 Summary of Credit Calculation

A taxpayer who is 65 or older starts with a tax credit for the elderly based on a specified amount
that is reduced first by any Social Security payments and other excludable pensions and second
by one half (50 percent) of any adjusted gross income over the stated maximum. The results, if
any, are multiplied by 15 percent to arrive at the allowable tax credit. The credit is limited to the
amount of tax.
Single Joint
5,000 Base Amount 7,500
( ALL ) (Social Security) ( ALL )
(½ over $7,500) (½ Excess AGI) (½ over $10,000)
Balance Balance
× 15% Rate × 15%
Credit Credit

Example 4 Credit for the Elderly and/or Permanently Disabled
Facts: Peter is single and 68 years old. He received the following income for the year:
Social Security received $3,120 Nontaxable
Taxable interest 215
Taxable retirement distributions 3,600
Taxable income = $8,060 AGI
Wages from a part-time job 4,245
Required: Calculate Peter's credit for the elderly and/or permanently disabled.
Solution: His credit will be $240, computed as follows:
Peter's adjusted gross income is $8,060, calculated as follows:
Wages from part-time job $4,245
Taxable retirement distributions 3,600
Taxable interest 215
$8,060 AGI
To calculate credit:
Base amount $5,000
Less:
Social Security $3,120
Excess AGI: $8,060
(7,500)
560 × 50% 280 (3,400)
$1,600
Balance 15%
Credit $ 240
2.4 Education Tax Incentives

Assuming the requirements are met, a taxpayer has the opportunity to reduce taxes by
taking advantage of the American opportunity credit (AOC), the lifetime learning credit, and/
or a nontaxable distribution from a Coverdell education savings account used to pay higher
education costs.
2.4.1 American Opportunity Tax Credit (AOTC)

The American opportunity tax credit is available against federal income taxes for qualified
tuition, fees, and course materials (including books) paid for a student's first four years of College
postsecondary (college) education at an eligible educational institution.
The maximum AOTC credit is $2,500:
y 100 percent of the first $2,000 of qualified expenses; plus = $2,000
y 25 percent of the next $2,000 of expenses paid during the year. = 500
$2,500 Max. credit
per student
per year
Multiple kids in college is OK

The qualified expenses are on a "per student" basis and must be incurred on behalf of the:
y taxpayer;
y taxpayer's spouse; or
y taxpayer's dependent.
If a child is claimed as a dependent by a parent, expenses paid by both the parent and the
child are deemed to have been made by the parent for this purpose.
The student must be at least half-time for at least one academic period during the year.
The credit is not available for the expenses of a student convicted of a federal or state felony
drug offense in the calendar year for which expenses are incurred.
The credit phase-out begins with modified AGI exceeding $80,000 ($160,000 MFJ), with full Robin Hood
phase-out at $90,000 ($180,000 MFJ). rule
Refundable portion: Subject to certain restrictions, 40 percent of the American opportunity
tax credit is refundable. This means that up to $1,000 ($2,500 maximum credit × 40%) may
be refunded.
2.4.2 Lifetime Learning Credit (LLC)

The lifetime learning credit is available for an unlimited number of years for qualified tuition and
related course fees at eligible educational institutions.
The credit is equal to 20 percent of qualified expenses up to $10,000. = $2,000
Qualified expenses include tuition and course fees (not course materials) for undergraduate
courses, graduate-level courses, certain professional degree courses, and courses to acquire
or improve job skills.
Only one
The qualified expenses are on a "per taxpayer" basis, rather than a "per student" basis, so student
the maximum credit is $2,000 regardless of the number of qualifying students. per year
As with the American opportunity tax credit, expenses paid by a dependent child are treated
as if made by the parent.
The credit is phased out when modified AGI is $80,000 ($160,000 MFJ) and is fully phased Robin Hood
out when modified AGI is $90,000 ($180,000 MFJ). rule
2.4.3 Not Limited to One Type of Credit per Tax Return
AOC + Lifetime
The taxpayer does not have to choose one type of credit on his or her income tax return for the on different
year. For example, a parent may claim a lifetime learning credit for the expenses of one child
and an American opportunity credit for the expenses of another child in the same taxable year.
kids is OK
However, more than one credit cannot be claimed for the same student in the same year.
2.4.4 Coverdell Education Savings Accounts

A separate education savings account may be set up to pay the qualified education expenses of
a designated beneficiary.
Contributions are nondeductible; maximum contribution per beneficiary is $2,000 annually. Not limited
by any
The designated beneficiary may be any child under age 18. There is no limit to the number amounts
of beneficiaries (each beneficiary has a separate account). Lots of contributed
grandchildren to other IRAs

The maximum allowable contribution amount is phased out for taxpayers with modified
adjusted gross income between these amounts:
AGI Phase-out Ranges Robin Hood

Unmarried $95,000–$110,000 rule
Married $190,000–$220,000
Earnings accumulate tax-free while in an education savings account.

Distributions, both of principal and interest, are tax-free to the extent that they
are used for qualified elementary, secondary, or higher education expenses of the
designated beneficiary.
Qualified education expenses include tuition, fees, tutoring, books, room and board, Through
supplies, and equipment. high school
Any amounts remaining when the beneficiary reaches 30 years of age must be distributed
(except in the case of a special needs beneficiary). If the distribution is made directly to the
beneficiary, the distributed amount is taxable to the beneficiary and subject to a 10 percent
penalty. Alternatively, the balance can be rolled over tax free to another family member of So you don't
the taxpayer with no penalty. lose it
A taxpayer can claim the American opportunity tax credit or lifetime learning credit for a tax
year and also exclude from gross income amounts distributed from a Coverdell education
savings account. However, the distribution cannot be used for the same educational
expenses for which either the American opportunity tax credit or the lifetime learning credit No
was claimed. double-dipping
2.4.5 Section 529 Qualified Tuition Programs (QTP)
A QTP is a program under which a person may purchase tuition credits or make cash
contributions to an account on behalf of a beneficiary for payment of qualified higher
education expenses. The program must be established and maintained by a state, state
agency, or by an eligible educational institution. Eligible educational institutions generally
include any accredited postsecondary educational institution, so long as contributions made
to the program are held in a "qualified trust."
Qualified higher education expenses include tuition, fees, books, supplies, and equipment
required by an educational institution for enrollment or attendance. These expenses
also include the reasonable cost of room and board if the beneficiary is enrolled at least
half‑time.
Distributions from a QTP, including cash, earnings, and in-kind distributions, may be
excluded from a designated beneficiary's gross income to the extent that the distribution is
used to pay for qualified higher education expenses.

2023 Education Tax Incentives: Summary
* Item
Income Exclusion
General Rule Limit Income Phase-out
U.S. Savings Exclude Must pay AGI $91,850–$106,850

Bond—Series EE interest income educational expense (MFJ $137,800–$167,800)
(2023)
Employer-paid Exclude Up to $5,250 per year No income limit
education expenses from income
Scholarships Exclude Only tuition, books, No income limit
from income and fees, not room and
board
Adjustments
Educator expenses Deduct as $300 No income limit
above‑the‑line
adjustment
Coverdell education Nondeductible $2,000 AGI $95,000–$110,000
savings account (MFJ $190,000–$220,000)
Student loan Deduct as $2,500 AGI $75,000–$90,000
interest deduction above‑the‑line (MFJ $155,000–$185,000)
adjustment
Credits
American First four years; $2,500 per person; AGI $80,000–$90,000
opportunity partially refundable tuition, fees, and course (MFJ $160,000–$180,000)
tax credit materials
Lifetime After first $2,000 per taxpayer; AGI $80,000–$90,000
learning credit four years; tuition and fees, not (MFJ $160,000–$180,000)
nonrefundable course materials
Miscellaneous
529 plan (qualified No deduction Vary by state None
tuition program) No income

2.5 Adoption Credit

A credit for qualifying expenses of adopting a child is available. For 2023, the maximum credit
allowed is the amount of qualified adoption expenses up to $15,950.
The adoption credit is nonrefundable, but any credit in excess of your tax liability may be carried
forward for up to five years.
Phase-out
The available adoption credit begins to phase out for taxpayers with modified adjusted gross
income (MAGI) over $239,230 and is completely phased out with MAGI of $279,230 (2023).
Eligible Expenses
y All reasonable and necessary expenses, costs, and fees are available for the credit.
y The credit is not available for adopting the child of a spouse or for a surrogate
parenting arrangement.
y Medical expenses do not qualify as eligible expenses.
Timing
The credit is claimed for years after the payment is made until the adoption is final, at
which point expenses paid in the year it becomes final are claimed in that year. For foreign
children adopted, no credit can be claimed until the year it becomes final. In either case,
expenses paid in later years can be claimed in the year paid.
- IRA "credit"
2.6 Retirement Savings Contributions Credit - In addition to "adjustment"
A nonrefundable tax credit is available for low- and moderate-income taxpayers for
contributions to a qualified employer-sponsored retirement plan or IRA.
Eligible Taxpayers
y At least 18 years old by the close of the tax year
y Not a full-time student
y Not a dependent of another taxpayer
Allowable Credit
The tax credit is 10 percent, 20 percent, or 50 percent of the taxpayer's contribution to a
qualified retirement plan for the year. The credit rate depends on the taxpayer's filing status
and AGI. The maximum contribution eligible for the credit is $2,000 per taxpayer.
No carryover is allowed.

2023 Adjusted Gross Income (AGI)

Head Married
Credit Rate Single or MFS of Household Filing Jointly Maximum Credit As income
50% $0–$21,750 $0–$32,625 $0–$43,500 $2,000 × 50% = $1,000 goes up,
20% $21,751–$23,750 $32,626–$35,625 $43,501–$47,500 $2,000 × 20% = $400 the credit
10% $23,751–$36,500 $35,626–$54,750 $47,501–$73,000 $2,000 × 10% = $200
goes down
0% Over $36,500 Over $54,750 Over $73,000 $2,000 × 0% = $0
2.7 Foreign Tax Credit

A taxpayer may claim a credit for foreign income taxes paid to a foreign country or United States
possession. There is a limitation on the amount of the credit an individual can obtain. In lieu of
this credit, an individual can deduct the taxes as an itemized deduction.
Allowable Credit
There is no limit on foreign taxes used as a deduction; however, foreign tax credits are
limited to the lesser of:
y Foreign taxes paid, or
$300,000
Taxable income from all
y foreign operations
× U.S. tax = Foreign tax credit limit $30,000 max. credit
Total taxable worldwide income
$1,000,000 $100,000
Carryover of Excess (Disallowed) Credit
Any disallowed foreign tax credit may be carried over as follows:
Foreign tax paid
y Carry back one year
Example 1 $25,000 Yes
y Carry forward 10 years
2.8 General Business Credit Example 2 $40,000 No

<30,000> Max.
2.8.1 Included Credits $10,000 Carryover
The general business credit is a combination of:
Investment credit
Work opportunity tax credit
Alternative fuels credit
Increased research credit (generally 20 percent of the increase in qualified research
expenditures over the base amount for the year)
Low-income housing credit

Facts: Tax $225,000

Qualified child care expenditures; Credits $225,000
Welfare-to-work credit; Tax Credits
Employer-provided child care credit;
$225,000 $225,000
Small employer retirement plan start-up costs credit; <25,000>
Alternative motor vehicle credit $200,000
Other infrequent (on exam) credits x 25%
2.8.2 Calculation of Credit $50,000 <50,000>
The credit is limited to regular tax liability after other tax credits, minus 25 percent of regular tax $175,000
liability (after other tax credits) over $25,000.
Usable
Tax Allowable Allowable
credit
Liability Percentages Amount
$0–$25,000 × 100% = ×
Excess × 75% = ×
Maximum credit permitted Total
2.8.3 Unused Credit Carryover

Although some limits must be applied separately, unused credits generally may be carried back
one year and forward 20 years.
2.9 Work Opportunity Credit

The work opportunity credit is available to employers who hire employees from a targeted
group. This credit is part of the general business credit.
2.9.1 Credit
40 percent of first $6,000 of first year's wages
40 percent of first $3,000 to certain summer youth
2.9.2 Qualified Groups

Disabled
18- to- 24-year-olds from poor families
Vietnam veterans from economically disadvantaged areas
Certain food stamp recipients
2.10 "Child" Tax Credit

For tax years 2018–2025, taxpayers may claim a $2,000 tax credit for each "qualifying child."

2.10.1 Qualifying Child

The "CARES" rules on dependency definitions apply here, except that a child must be under the
age of 17 (not the 19-year or 24-year age limits that "CARES" implies). The qualifying child must
be a citizen, a national, or a resident of the United States.
2.10.2 Phase-out of Child Tax Credit

Higher-income taxpayers must reduce the $2,000 allowable child tax credit by $50 for each
$1,000 (or fraction thereof) by which modified adjusted gross income (AGI) exceeds: Robin Hood rule
$400,000 for a married filing jointly return;
$200,000 for an unmarried individual; or
$200,000 for married individuals filing a separate return.
2.10.3 Refundable Amount

The child tax credit is refundable to the extent of the lesser of:
excess of child tax credit over tax liability;
earned income in excess of $2,500 multiplied by 15 percent; or
$1,600 per qualifying child (2023).
2.10.4 Due Diligence Requirements

To help prevent improper claims, paid preparers are subject to due diligence requirements for
returns that claim the child tax credit (similar due diligence requirements apply to returns that
claim the earned income tax credit).
2.10.5 Non-child Dependent Credit

A taxpayer may claim an additional non-child dependent tax credit of $500 for each dependent
who is not a qualifying child under age 17. This may include children who are age 17 and
above or other dependents who meet the requirements of a qualifying relative. The non-child
dependent credit is subject to the same AGI phase-out amounts and is not refundable.
* 2.11 Earned Income Credit (Refundable)

2.11.1 Eligibility
The lower the income,
the bigger the credit
To be eligible for the earned income credit, a taxpayer must:

live in the U.S. (main home) for more than half the taxable year;
meet certain earned low-income thresholds;
not have more than a specified amount of disqualified income;
if there are no qualifying children, be over age 25 and under age 65 (applies to both
taxpayer and spouse); and
file a joint return with one's spouse with certain exceptions (which means that the spouse
cannot be a dependent of another).

2.11.2 Earned Income : The lower, the bigger the credit

Earned income is wages, salaries, tips, other employee compensation, and earnings from
self‑employment. It does not include pension and annuity income.
Pass Key
The most frequently tested issue involving the earned income credit is that it is a
refundable credit.
2.11.3 Qualifying Child

A qualifying child is not a requirement in order to be eligible for the earned income credit.
However, if the taxpayer has a qualifying child, the earned income credit percentage and
allowable earned income level is higher. A qualifying child is a child who:
is the taxpayer's son, daughter, adopted child, grandchild, stepchild, foster child, brother,
sister, stepbrother, stepsister, or descendant of those individuals;
was (at the end of the year) either under age 19 or under age 24 and a full-time student, or
any age and permanently and totally disabled;
lived with the taxpayer in the taxpayer's main home in the U.S. for more than half of the
taxable year; and
is the taxpayer's dependent (if the child is married).
2.11.4 Earned Income Credit Calculation

For 2023, the earned income credit table is as follows:
Three
No One Two or More
Children Child Children Children
Maximum earned income credit $600 $3,995 $6,604 $7,430
Earned income required to receive
$7,840 $11,750 $16,510 $16,510
maximum credit
Credit rate percentage 7.65% 34% 40% 45%
Phase-out percentage 7.65% 15.98% 21.06% 21.06%
Credit phase-out for AGI or earned income
(if greater) over this amount (all taxpayers $9,800 $21,560 $21,560 $21,560
except married filing jointly)
Credit phase-out for AGI or earned income
(if greater) over this amount (for married $16,370 $28,120 $28,120 $28,120
filing jointly)

Example 5 Earned Income Tax Credit
Facts: Karen is 26 years old. In 2023, she had gross income of $12,000 from her job at the
local university. She is single with no dependents.
Required: Calculate the amount of earned income credit Karen can take in the current year.
Solution: Karen is eligible to take an earned income credit in the amount of $432 after
phase-out.
Earned income $12,000

Maximum income eligible for credit $7,840
× 7.65% $600 [maximum credit]
$12,000 earned income − $9,800 phase-out threshold $2,200
× 7.65% phase-out percentage $168 [phase-out amount]
$600 maximum credit − $168 phase-out amount $432
2.11.5 Investment Income

An individual cannot claim the credit if the individual has investment income exceeding
$11,000 (2023). Investment income includes taxable and nontaxable interest, dividends, net
rental and royalty income, net capital gains income, and net passive income.
2.11.6 Due Diligence Requirements

To increase the prevention of improper claims, paid preparers are subject to due diligence
requirements for returns that claim the earned income tax credit.
Paycheck
2.12 Taxes Withheld (W-2) Refund or credit to next year
All income taxes withheld from a taxpayer's paycheck are treated as a "credit" against the
taxpayer's tax liability. When this credit exceeds the tax liability, a refund is provided to
the taxpayer.
2.13 Excess FICA (Social Security Tax Withheld)

Excess Social Security tax withheld is treated as additional tax payments withheld.
Two or More Employers: An employee who has had Social Security tax withheld in an
amount greater than the maximum for a particular year may claim the excess as a credit
against income tax (in the payment section), if that excess resulted from correct withholding
by two or more employers.
One Employer: If the excess was withheld by only one employer, the employer must refund
the excess to the employee. No credit is allowed.
They made a mistake

2.14 Small Employer Retirement Plan Start-up Costs Credit

Eligible small businesses are allowed a tax credit related to the start-up costs of establishing a
new qualified retirement plan. The credit is available for the first three years of the plan (may
elect to start claiming the credit in the tax year before the year the plan becomes effective).
2.14.1 Eligible Employers

No more than 100 employees who received at least $5,000 in compensation in the
preceding year; and
At least one plan participant is a non-highly compensated employee.
2.14.2 Eligible Start-up Costs

Eligible start-up costs include the ordinary and necessary costs to set up and administer the
plan, and to educate employees about the plan.
An employer can choose to either deduct the start-up costs or claim the credit for those costs,
but cannot do both.
2.14.3 Amount of the Credit

The credit is the greater of:
50 percent of the first $1,000 of eligible start-up costs for employers with 51 to
100 employees (100 percent for employers with 50 or fewer employees); or
The lesser of:
y $250 for each employee who is eligible for the plan and not a highly compensated
employee; or
y $5,000
Example 6 Small Employer Retirement Plan Start-up Costs Credit
Facts: Alice started a SEP IRA for her business in the current year that includes herself and two
employees. The eligible start-up costs were $1,200. Alice is not a highly compensated employee.
Required: Calculate the amount of Alice's small employer retirement plan start-up costs credit.
Solution: The amount of the credit is $1,000, which is the greater of:
100 percent of the first $1,000 of eligible start-up costs: $1,000 × 100% = $1,000 or
Lesser of: $250 × 3 employee-participants = $750, or $5,000
2.15 Small Business Health Care Tax Credit

A credit of up to 50 percent of the employer's costs of the plan premiums (or the average of
the group's premium for small businesses within the taxpayer's state) is allowed as a credit
for eligible employers, provided the employer contributes at least 50 percent of the costs of
health coverage on behalf of employees enrolled in a qualified health plan offered through
a Small Business Health Options Program (SHOP).
Smaller businesses receive the better tax benefits.

The credit is not refundable, and the unused amount is carried back one year and then
carried forward for 20 years. (Tax-exempt organizations, however, will receive a refund
of the tax credit.)
The costs for family members, sole-proprietors, partners, S corporation owners with
greater than two percent ownership, and shareholders owning more than five percent of
corporations are excluded.
If the expenses were used to qualify for the credit, they are not allowable as tax deductions
for employee benefits expense.
2.16 Residential Energy Credits

2.16.1 Residential Clean Energy Credit
A credit of 30 percent of the installation costs for qualifying solar, wind, and geothermal
energy‑generating systems in 2022 through 2032 is allowed. A reduced credit percentage is
allowed in 2033 (26%) and 2034 (22%).
2.16.2 Energy Efficient Home Improvement Credit

A credit for the costs of qualified energy efficiency improvements.
If placed in service in 2022, the credit is 10 percent of qualified costs with a lifetime credit
limit of $500.
If placed in service after December 31, 2022, the credit is 30 percent of qualified costs with
an annual credit limit of $1,200.
2.17 Vehicle and Fuel-Related Credits

2.17.1 Clean Vehicle Credit
A credit of up to $7,500 for new electric vehicles ($4,000 for previously owned electric vehicles)
placed in service after December 31, 2022. The credit is subject to modified AGI limitations.
2.17.2 Alternative Fuel Refueling Property Credit

A credit of 30 percent of the installation costs of "qualified alternative fuel vehicle refueling
property" installed in the home (e.g., electric vehicle recharging station). Maximum credit
of $1,000.
2.18 Premium Tax Credit (PTC)

The premium tax credit is a refundable credit that helps eligible individuals and families with
low or moderate income afford health insurance purchased through a Health Insurance
Marketplace. The "credits" are available immediately when the insurance is purchased to help
eligible individuals pay for their monthly health insurance premiums.

3 Estimated Tax and Inadequate Withholding
3.1 Tax Payments

A taxpayer typically makes prepayments of tax during the year. These payments reduce the
amount shown as "total tax" on the tax return and result in the calculation of tax owed to the IRS
or a refund owed to the taxpayer at the bottom of Form 1040. Payments include:
Taxes withheld from paychecks (W-2 or 1099)
Estimated taxes paid (quarterly, with extension, or applied from a prior year)
Excess Social Security tax withheld (from two or more employers)
3.2 Estimated Taxes (Required Minimum)

A taxpayer is required to make estimated quarterly tax payments if both of the following
conditions are met:
$1,000 or More Tax Liability
One condition is met if the amount of taxes owed (excess of tax liability over withholding) is
expected to be $1,000 or more.
Inadequate Tax Estimates
The other condition is met if the taxpayer's withholding is less than the lesser of:
y 90 percent of the current year's tax; or
y 100 percent of last year's tax.
Safe —This applies even if an individual files a tax return with a zero tax liability in the prior year.
harbor —Exception: If a taxpayer had adjusted gross income in excess of $150,000 ($75,000 for
rule married filing separately) in the prior year, 110 percent of the prior year's tax liability
is used to compute the safe harbor for estimate payments.
3.3 Failure to Pay Estimated Taxes (Penalty)

If the taxpayer does not make proper quarterly estimated payments, a penalty may be assessed.
There is no penalty due under any circumstances if the balance of tax owed at filing is under
$1,000. The Internal Revenue Service may waive the penalty if the failure to pay was the result of
casualty, disaster, illness, or death of the taxpayer.
3.4 Withholding Tax Treated as Estimated Payments

If, toward the end of the taxable year, a taxpayer determines that estimated payments have
been insufficient to avoid a penalty, a taxpayer can increase withholding from wages, and the
withholdings will be considered to have been paid evenly during the year. Such action will
usually reduce or eliminate any penalty. A new W-4 will have to be completed and submitted to
the taxpayer's employer.

4 Other Taxes Self

Employer: allowed as "adjustment"
4.1 Self-Employment Tax
Employee
The self-employment tax represents the employer portion and the employee portion of FICA
taxes (Social Security and Medicare) imposed on self-employment income. 100 percent of self-
employment tax is collected as an "other tax" and reported in the "other taxes" section of the
Form 1040. (Note that 50 percent of this amount is reported as an adjustment to arrive at AGI.)
4.2 Additional Medicare Tax

An additional Medicare tax of 0.9 percent is imposed on wages in excess of $250,000 for married
filing jointly; $125,000 for married filing separately; and $200,000 for all other taxpayers.
Employers are responsible for withholding this additional tax on all wages paid to an
employee that exceed $200,000 in a calendar year.
Any amounts withheld in excess can be claimed as a credit on the taxpayer's individual
income tax return.
4.3 Net Investment Income Tax

The net investment income (NII) tax applies a rate of 3.8 percent to certain net investment
income of individuals who have income above statutory threshold AGI amounts. The statutory
threshold amounts are $250,000 for a filing status of married filing jointly, and $200,000 for
taxpayers with a single or head of household filing status. The 3.8 percent tax is imposed on the
lesser of net investment income or the excess AGI over the threshold amount.
Generally, investment income includes, but is not limited to: interest, dividends, capital gains,
rental and royalty income, nonqualified annuities, income from businesses involved in the
trading of financial instruments or commodities, and businesses that are passive activities to the
taxpayer. Expenses allocable to the income can be deducted.
4.4 Kiddie Tax : On interest and dividends

The net unearned income of a dependent child under 18 years of age (or a child age 18 to under
24 who does not provide over half of his/her own support and is a full-time student) is taxed at
the parent's rate. Net unearned income is calculated by taking the child's total unearned income
(from dividends, interest, rents, royalties, etc.) and subtracting $2,500: the child's allowable 2023
standard deduction of $1,250 plus an additional $1,250 (which is taxed at the child's regular
income tax rate). If the child also has earned income of more than $1,250, the standard deduction
is earned income plus $400 (maximum of $13,850, the 2023 single standard deduction amount).
Parents may elect to include on their own return the unearned income of the applicable
child provided that the income is between $1,250 and $12,500 and consists solely of interest,
dividends, and capital gains distributions.
2023 Child's
Unearned Income Tax Rate
$0–$1,250 0%
$1,251–$2,500 Child's rate
Over $2,500 Parent's rate

Mr. and Mrs. Sloan incurred the following expenses during the year when they adopted
a child:
Child's medical expenses $5,000

Legal fees 8,000
Agency fee 3,000
Without regard to the limitation of the credit, what amount of the above expenses are
qualifying expenses for the adoption credit?
a. $16,000
b. $11,000
c. $8,000
d. $5,000
Which of the following credits can result in a refund even if the individual had no income
tax liability?
a. Lifetime learning credit
b. Elderly and/or permanently disabled credit
c. Earned income credit
d. Retirement savings contribution credit
Krete, an unmarried taxpayer with income exclusively from wages, filed her initial income
tax return for Year 8. By December 31, Year 8, Krete's employer had withheld $16,000 in
federal income taxes and Krete had made no estimated tax payments. On April 15, Year 9,
Krete timely filed an extension request to file her individual tax return and paid $300 of
additional taxes. Krete's Year 8 income tax liability was $16,500 when she timely filed her
return on April 30, Year 9, and paid the remaining income tax liability balance.
What amount would be subject to the penalty for the underpayment of estimated taxes?
a. $0
b. $200
c. $500
d. $16,500

NOTES
4
MODULE
REG 2 4 Employee Stock Options
Employee Stock Options REG 2
- Nonqualified
- Qualified
1 Overview - ISO
- Employee stock purchase plans
Corporations may grant their employees the option to purchase stock in the corporation. There
are two types of employee stock options: nonqualified options and qualified options.
2 Nonqualified Options
If the option does not meet certain conditions described below for qualified stock options, it will
be treated as a nonqualified option. A nonqualified option is taxed when granted if the option
has a readily ascertainable value at the time of the grant. Because nonqualified options often do
not have an ascertainable value, the option is generally taxed when exercised.
2.1 Definition of Readily Ascertainable Value = Taxable at grant (if FMV known)
If the option is traded on an established market, it will have a readily ascertainable value.
Otherwise, it will only have a readily ascertainable value if all of the following conditions are met:
The option is transferable.
The option is exercisable immediately in full when it is granted.
There are no conditions or restrictions that would have a significant effect on the value.
The fair value of the option privilege is readily ascertainable.
2.2 Employee Taxation: Readily Ascertainable Value = Taxable when granted

If there is a readily ascertainable value, the employee recognizes ordinary income in that
amount in the year granted. If there is a cost to the employee, then the ordinary income is
the value of the option minus the cost. = Bargain
There is no taxation on the date of exercise. The basis of the stock is the exercise price plus
any amount previously taxed on the date of grant. Any future sale of the stock could result
in a capital gain or loss.
The holding period begins with the exercise date.
If the employee allows the options to lapse (not exercised), there is a capital loss based on
the value of the options previously taxed.
2.3 Employee Taxation: No Readily Ascertainable Value = Taxed at exercise

If no readily ascertainable value exists, the taxable event is the exercise date, not the grant date.
On the date of exercise, the employee recognizes ordinary income equal to the "bargain
element"—the difference between the fair market value of the stock and the stock option
price exercised. The basis of the stock is the fair market value of the stock when stock option
was exercised. Any future sale of the stock could result in a capital gain or loss.
The holding period begins with the exercise date.
If the options lapse, the employee can deduct a capital loss equal to the price, if any, that the
employee paid for the options. There are no other income tax consequences.

4 Employee Stock Options REG 2
Deduct/expensein same year

2.4 Employer Taxation that employee reports income
Generally, an employer may deduct the fair market value (FMV) of the stock option as a
business expense in the same year that the employee is required to recognize the option as
ordinary income.
Illustration 1 Nonqualified Stock Option
On July 1, Year 10, Bob was granted a nonqualified stock option to purchase 200 shares
of his employer's stock for $12 per share. This option was selling for $4 per share on an
established exchange. Bob exercised these options on August 7, Year 11. The stock was
selling for $18 per share on the exercise date. On November 1, Year 12, Bob sold all of the
shares for $20 per share.
Employee Bob must report ordinary income in the amount of $800 ($4 × 200 shares) on the date of Grant •
the grant in Year 10 because the option has a readily ascertainable market value.
Bob's adjusted basis in the stock is $3,200 ($2,400 exercise price + $800 recognized Exercise basis
ordinary income). The $2,400 exercise price is 200 shares × $12.
Bob has a long-term capital gain in Year 12 in the amount of $800, which is the selling price Sold
of $4,000 (200 shares × $20) less the adjusted basis of $3,200.
Employer Bob's employer can take a tax deduction in the amount of $800 in Year 10, the amount of
ordinary income recognized by Bob. Same year
3 Qualified Options
There are two types of qualified stock options, incentive stock options (ISO) and employee stock
purchase plans (ESPP).
1 of 2 3.1 Incentive Stock Options

An ISO is usually granted to a key employee and is a right to purchase the stock at a discount.
3.1.1 Requirements
The ISO must be granted under a plan, approved by the shareholders, that sets out the total
number of shares that may be issued and who may receive them.
The options must be granted within 10 years of the earlier of the date when the plan was
adopted or approved. The options must be exercisable within 10 years of the grant date.
The exercise price may not be less than the FMV of the stock at the date of the grant.
The employee may not own more than 10 percent of the combined voting power of the
corporation, parent, or subsidiary as of the date of the grant.
Once exercised, the stock must be held at least two years after the grant date and at least
one year after the exercise date.
The employee must remain an employee of the corporation from the date the option is
granted until three months (one year if due to permanent and total disability) before the
option is exercised.
R2–50 Module 4 Employee

© Becker Professional Education Corporation. All rights Stock Options
reserved.
REG 2 4 Employee Stock Options
Granted
- Not taxable income/compensation when
3.1.2 Employee Taxation Exercised
- Taxable as capital gain <loss> when sold
Generally, there is no taxation of the option as compensation. Basis of the stock is the
exercise price plus any amount paid for the option (if any).
Generally, any gain or loss on a subsequent sale of the stock is capital. If the holding period
requirements are not satisfied, any gain is ordinary, up to the amount that the stock's FMV
on the exercise date exceeds the option price.
Generally, if the options lapse, no deduction is available as the option was not taxed in the
first place. There may be a loss if any amount was paid for the option itself.
An employee may exercise up to $100,000 of ISOs in a year. Any amount exercised that
exceeds this amount will be treated as a nonqualifying option.
3.1.3 Employer Taxation = No tax deduction

Generally, an employer does not receive a tax deduction for an ISO because it is not considered
compensation income to the employee.
Illustration 2 Incentive Stock Option
On July 1, Year 10, Mary was granted an Incentive Stock Option (ISO) to purchase 200 shares of
her employer's stock for $120 per share. The FMV of the stock on the date of grant was $120.
Mary exercised these options on August 7, Year 11. The stock was selling for $150 per share
on the exercise date. On November 1, Year 12, Mary sold all of the shares for $200 per share.
Mary does not recognize any ordinary income at the date of grant because this qualifies as Grant = -0-
an ISO.
Employee Mary's adjusted basis in the stock is the exercise price of $24,000 (200 shares × $120). Exercise = -0-
Mary has a long-term capital gain in Year 12 in the amount of $16,000, which is the selling
price of $40,000 (200 shares × $200) less the adjusted basis of $24,000. The holding period
Sold = Capital
gain
requirements have been met.
Employer Mary's employer receives no deduction for the granting of the option.
2 of 2 3.2 Employee Stock Purchase Plans

An ESPP may grant options to employees to purchase stock in the corporation.
3.2.1 Requirements
The plan must be written and approved by the shareholders.
An ESPP cannot grant options to any employee who has 5 percent or more combined voting
power of the corporation, parent, or subsidiary.
Generally, the plan must include all full-time employees other than highly compensated
employees and those with less than two years of employment.
The option exercise price may not be less than the lesser of 85 percent of the FMV of the
stock when granted or exercised.
The option cannot be exercised more than 27 months after the grant date.

4 Employee Stock Options REG 2
No employee can acquire the right to purchase more than $25,000 of stock per year.
Once exercised, the stock must be held at least two years after the grant date and at least
one year after the exercise date.
The employee must remain an employee of the corporation from the date the option is
granted until three months before the option is exercised. Grant
- Not taxable income/compensation
3.2.2 Employee Taxation Exercise
- Capital gain <loss> when sold
Generally, there is no taxation of the option as compensation. The basis of the stock is the
exercise price plus any amount paid for the option (if any).
Generally, any gain or loss on a subsequent sale of the stock is capital. If the holding period
requirements are not satisfied, any gain is ordinary up to the amount that the stock's FMV
on the exercise date exceeds the option exercise price.
Generally, if the options lapse, no deduction is available, as the option was not taxed in the
Exception
first place. There may be a loss if any amount was paid for the option itself.
Bargain
If the option exercise price is less than FMV of the stock on the grant date, then ordinary
income is recognized when the stock is sold. The ordinary income recognized is the lesser
of the difference of the FMV of the stock when sold and the exercise price, or the difference
between the exercise price and the FMV of the stock on the grant date.
3.2.3 Employer Taxation = No tax deduction

Generally, an employer does not receive a tax deduction for an ESPP because it is not
considered compensation income to the employee.
Which of the following statements is not correct?

a. Employee stock purchase plans are a type of qualified stock option plan.
b. The recipient of an incentive stock option will generally have to report
compensation income in the year that the option is received.
c. The employer may recognize a deductible expense for a nonqualified stock option
in the same year that the employee will recognize ordinary income.
d. For an incentive stock option, once exercised, the stock must be held at least two
years after the grant date and at least one year after the exercise date.
R2–52 Module 4 Employee

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REG

3 Tax Computation and Credits 27

4 Employee Stock Options 49

R2–2 © Becker Professional Education Corporation. All rights reserved.

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–3

3 Individual Retirement Accounts

The three types of individual retirement accounts (IRAs) are:

2023 Under Age 50 Age 50 and Over

R2–4 Module 1 Adjustments

3.1.2 Retirement Plan Contribution Credit

3.2 Deductible Traditional IRA 1 of 3 Deductible Traditional

3.2.1 Limitations on Deduction of Traditional IRA Contributions

Filing Status 2023 AGI Phase-out No IRA deduction

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–5

IRA: OK if spouse not working, unless "super rich"

Filing Status 2023 AGI Phase-out

3.2.2 Summary Chart for Married Individuals

Traditional IRA Income Phase-Out Ranges for Married Individuals

R2–6 Module 1 Adjustments

Example 1 Phase-out of Traditional IRA Deduction

Facts: Kristi, a 40-year-old single taxpayer, is an active participant in her employer's

2023 AGI $ 75,000

3.3 Roth IRA 2 of 3 Deductible Traditional

3.3.1 Allowable Roth Contributions

Filing Status 2023 MAGI Phase-out

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–7

3.3.2 Distributions From Roth IRA

3 of 3 3.4 Nondeductible Traditional IRA Deductible Traditional

3.5 Early Distribution Penalty = Regular tax + 10% penalty

R2–8 Module 1 Adjustments

4 Student Loan Interest Expense

The adjustment for education loan interest is limited to $2,500.

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–9

5 Health Savings Accounts

5.1 Pretax Contribution

5.2 Excludable Distributions = Tax free

5.3 High-Deductible Plan Defined

5.4 Archer Medical Savings Account (MSA) Contributions

R2–10 Module 1 Adjustments

7 Self-Employment Tax (50 Percent) = Social Security tax

9 Self-Employed Retirement Plans

Self-employed taxpayers are allowed to deduct contributions made to qualified self-employed

9.1 SEP IRA

9.2 SIMPLE IRA

9.3 Solo 401(k)

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–11

Example 2 Calculating Maximum Allowable Contribution to SEP IRA

Self-employment net income (after deduction for one-half $100,000

10 Penalty on Early Withdrawal of Savings Do not net against

2018 & before = Adjustment to payor

11.1 Alimony/Spousal Support (Income to Payee/Adjustment to Payor)

R2–12 Module 1 Adjustments

11.2 Child Support (Nontaxable to Payee/Nondeductible to Payor)

12 Attorney Fees Paid in Discrimination Cases

© Becker Professional Education Corporation. All rights reserved. Module 1 R2–13

The self-employment tax is:

R2–14 Module 1 Adjustments

Itemized Deductions REG 2

Illustration 1 Additional Standard Deduction