Most individual taxpayers maintain their financial records for tax purposes on a cash basis and for the calendar year (Jan. 1 through Dec. 31). Income is counted in the year it is received or made available regardless of when earned, and expenses are deducted in the year paid regardless of when incurred.
(Exception: Prepaid interest may not be deducted when paid if the loan extends beyond the current year. The deduction may be taken only in the year the interest is due.)
The "cash basis" method simplifies tax preparation. With the exception just noted, you need only keep track (for tax purposes) of cash receipts and cash payments.
If you have checked off your filing status, entered your personal and dependent exemptions, and accounted for the year's income and deductions, you're now ready for the tax calculations themselves. IRS Tax Computation
The Internal Revenue Service will figure your tax for you if you file Form 1040A. Simply complete the form through line 11a, attach all W-2s, and sign and date the return.
The IRS will calculate the tax liability, as well as the Earned Income Credit (if you are eligible). It then will mail you a refund of any overpayment, or a bill for any balance due.
If you use Form 1040, the IRS will also compute your tax if:
Your adjusted gross income (line 31) was $40,000 or less for married taxpayers filing jointly or for a qualifying (widower), or not more than $20,000 for all others.
Taxable income consisted only of wages, salary, tips, dividends, interest and pension or annuity payments.
You elect to use the zero bracket amount instead of itemizing deductions.
You do not use Schedule G (income averaging).
TAX TIP: If you ask the IRS to figure the tax on a joint return and both spouses had income, be sure to show the income of each separately so the IRS can use either joint or separate filing (whichever gives the lower tax). Enter the figures, identified by "H" or "W," between lines 7 and 8 on the 1040A, or at the bottom left in the space under the words "Adjustments to Income" on 1040.
If you prefer to calculate your own tax or if you are not eligible for IRS computation, use either the tax tables or the tax rate schedules, whichever is applicable, to determine your tax liability. Tax Tables
Use the proper tax table for your filing status and the column that matches your exemptions. Each table is limited by your tax-table income (line 34 on Form 1040) and by the total number of exemptions claimed (line 7 on Form 1040, line 6 on the 1040A).
Table A is for a single taxpayer (checking Box 1) with up to $20,000 of tax-table income and not more than three exemptions.
Table B should be used by married taxpayers filing a joint return (Box 2) and by a qualifying (widower) with a dependent child (Box 5), with not more than $40,000 income and with up to nine exemptions.
Table C -- a married taxpayer filing a separate return (Box 3), with income not exceeding $20,000 and up to three exemptions.
Table D is for a head of a household (Box 4) reporting income up to $20,000 and claiming not more than eight exemptions.
If you are filing Form 1040A, you must use the tax table unless you ask the IRS to figure the tax. You also should use the table with Form 1040 if neither your tax-table income (line 34) nor the number of exemptions you claim exceed the ceilings given above for your filing status.
The tax table figures already take into account your personal and dependent exemptions, the zero bracket amount and the general tax credit. Do not subtract any of these before going to the table to find your tax.
TAX TIP: Because the tables allow for the zero bracket amount, if you itemize deductions, be sure you subtract (on line 33 of Form 1040) only the excess deductions. This is the amount on line 41 of Schedule A. Tax Rate Schedules
If you are not eligible to use the tax tables, you must calculate the tax liability yourself. Use Part I of the Tax Computation Schedule (TC) for the calculations. Figure the amount of the tax from the appropriate tax rate schedule for your filing status.
The zero bracket amount has been built into the tax rate schedules, so if you itemize deductions, enter only excess deductions from Schedule A. You also must deduct -- on line 2 of Schedule TC -- the dollar amount of your personal and dependent exemptions at$750 each.
Then on Schedule TC, after determining your initial tax from the tax rate schedule, deduct the general tax credit. As in 1976 and 1977, the tax credit is the larger of 2 percent of your net taxable income (not to exceed $180) or $35 per exemption, including exemptions for age or blindness.
TAX TIP: If the supplementary tax rate (+ percent on the tax rate schedule) is greater than 50 percent, you should go to Form 4726 to see if the application of the maximum tax on earned income will result in a lower tax liability.
Whether you use the tax table or the tax rate schedule, an assortment of tax credits is available. A tax credit is generally more valuable than an adjustment or a deduction because the amount of the credit is subtracted in full from the tax itself rather than from income. General Tax Credit
As explained earlier, the general tax credit is built into the tax tables. And if you use the tax rate schedules, you claim the general tax credit on Schedule TC. (The general tax credit is eliminated for 1979 and the future tax years.) Political Contributions
It was pointed out in yesterday's column that qualifying contributions to political parties or to candidates for elective office could be claimed for 1978 either as an itemized deduction or a tax credit.
If you use the zero bracket amount, of course you should take the tax credit. If you itemize deductions, there are no general rules. Figure the tax both ways, then use the method that gives you the larger benefit.
If you select the credit, it is taken on line 38 of Form 1040. Claim half the amount of your total contributions up to a ceiling of $50 on a joint return or $25 on all others. (This ceiling goes up to $100/ $50 for 1979 and following years.) Tax Credit for the Elderly
You may qualify for the tax credit for the elderly if you were 65 and had taxable income of any type during 1978. The credit is not restricted to those with "retirement" income, but there are limitations, explained later.
The credit is calculated on Schedule R. You start with an initial maximum allowance figure:
$2,500 if you were single or if only one spouse on a joint return had reached 65 by Dec. 31, 1978.
$3,750 if you file jointly with your spouse and both of you were 65 or older.
$1,875 if you were married but didn't live with your spouse during 1978 and you're filing a separate return.
(If you lived with your spouse at any time during the year, you must file a joint return to qualify for this credit.)
From this starting point, you must deduct certain types of pension or annuity payments not included in gross income -- principally Social Security or Railroad Retirement Act benefits.
Then there is a 50 percent offset for adjusted gross income (line 31 of Form 1040) above specified amounts. If you are single, you must deduct half the excess of your AGI over $7,500. Thus the credit is eliminated entirely if AGI equals or exceeds $12,500.
For married taxpayers filing a joint return, the phase-out starts above $10,000 of AGI. If only one spouse is 65 or older, the credit is eliminated at an AGI of $15,000; if both husband and wife are 65, the elimination point is $17,500.
For a married taxpayer filing separately, the offset base is $5,000 and the credit disappears at an AGI of $8,750.
The tax credit is 15 percent of the amount remaining after deducting the specified annuity benefits and the AGI offset from the appropriate starting figure for your status.
There is a special tax credit for taxpayers under 65 who are retired under a federal, state or local government retirement system. This credit, determined on Schedule RP, is similar to the old retirement credit.
The initial maximum amount of government retirement pay eligible for the credit is the same as for the tax credit for the elderly. And a similar reduction must be made for Social Security and Railroad Retirement Act benefits.
But then you must reduce the base amount dollar-for-dollar by all earned income (not AGI) in excess of considerably lower minimums, which vary with age and are given on the tax relief form itself. Care of a Dependent
Since 1976, the tax relief procedure for expenses for child or dependent care has been a tax credit rather than a deduction. Thus you can take advantage of this tax break even if you use the zero bracket amount and itemize deductions.
There is no income ceiling for this credit. If you otherwise qualify, you may claim the tax credit regardless of the amount of your gross income. In addition, the credit is available in some circumstances to a married couple even if only one sponse was employed full time.
Regardless of your marital status, you must have maintained a home of your own during 1978, and the "qualifying individual" for whose care you claim the credit must have been a member of your household. To qualify, the individual must be one of the following:
A child under the age of 15 for whom you claim an exemption as your dependent.
A spouse who was mentally or physically incapable of self-care.
Any other person incapable of self-care whom you claim as a dependent, or whom you could claim except that he or she had income of $750 or more.
If you are married, you normally must file a joint return to claim the credit. However, you may file a separate return and still be eligible if you meet all three of these requirements:
You maintained a home and paid more than half the cost of maintaining that home in 1978.
It was the principal home of the qualifying individual for more than half the year.
Your spouse was not a member of the household during at least the last six months of the year.
The tax credit is 20 percent of the cost of household services and other expenses incurred for qualifying care in the home and paid during 1978. Care outside the home also may qualify, but only if the expense was incurred for care of a dependent child under age 15.
TAX TIP: If child care payments were made to an individual who provided services in your home, you may be liable for withholding and reporting Social Security taxes for that individual. Contact the local IRS office for assistance, or see IRS Form 942 (quarterly tax return for household employes).
In either case -- whether care is rendered inside or outside the home -- the expense ceiling for 1978 is $2,000 for care of one qualifying individual or $4,000 for two or more. This equates to a maximum tax credit of either $400 or $800 for the full year, and $33 or $67 a month for less than the full year.
TAX TIP: If in 1978 you paid for care provided in 1977, you may claim on your 1978 return any allowable balance for 1977 in addition to the 1978 ceiling.
But the total credit for 1977 -- that is, the amount claimed on the 1977 return plus the amount claimed for 1977 on the 1978 return -- may not exceed the maximum authorized credit for 1977 alone.
If you are single, the amount of expense you may take into account may not exceed the amount of your earned income (wages, salary, net income from self-employment) for the year, less any disability exclusion claimed.
In the case of married taxpayers filing jointly, the amount of expenses claimed may not be greater than the earned income of whichever spouse earned less.
However, if one spouse was incapable of self-care or was a full-time student, for the purpose of this ceiling you may consider that he or she was "employed" with "earned income" of $166 a month if you are claiming care of one dependent or $333 a month if you have two or more qualifying dependents.
You can apply this exception to only one spouse in any month. Thus at least one spouse must have been employed with earned income equal to or in excess of whichever of these amounts is applicable.
In addition, this assumption of earned income applies only for those months in which the spouse was either incapable of self-care or a full-time student.
Payments to a close relative for care generally do not qualify for the credit. However, such payments may qualify if you do not claim an exemption for the relative and you comply with the Social Security and tax reporting rules.In other words, payments to a relative who is not a dependent will not be disqualified if you maintain a bona fide employer/employe relationship.
TAX TIP: Under the new law, effective Jan. 1, 1979, you may take the credit for payments to any relative except your child under 19 unless the relative is claimed as a dependent on your (or your spouse's) tax return.
The cost of nursing care for a disabled dependent might be claimed for tax credit under this provision or as a deduction for medical expense. You cannot claim both for the same expenses -- but legally you may take a qualified deduction wherever it gives you the larger tax benefit.
If you are using the zero bracket amount, then of course you should take the tax credit. But if you itemize and you already have enough medical expenses to exceed the 3 percent exclusion, then the choice depends on your tax bracket. Remember that a deduction reduces taxable income, while a credit reduces tax liability.
If you are eligible for either the credit or the deduction, you should check both methods to see which gives you the better tax break. If you take the tax credit, any qualifying expenses in excess of the $2,000/$4,000 limit may be added to medical expenses on Schedule A.
If you decide to itemize on Schedule A, include the costs with your other medical expenses. If you qualify for and elect to take the tax credit, attach Form 2441 to your 1040 to document the claim.