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Chap 007 modified

# Chap 007 modified - Chapter 07 Individual Income Tax...

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Chapter 07 - Individual Income Tax Computation and Tax Credits Chapter 7 Individual Income Tax Computation and Tax Credits SOLUTIONS MANUAL Discussion Questions 1. [LO 1] What is a tax bracket? What is the relationship between filing status and the width of the tax brackets in the tax rate schedule? A tax bracket is a range of taxable income that is taxed at a specified tax rate. Because only the income in the particular range is taxed at the specified rate, tax brackets are often referred to as marginal tax brackets or marginal tax rates. The level and width of the brackets depend on the taxpayer’s filing status. The tax rate schedules include six tax rate brackets. The rates for these brackets are 10%, 15%, 25%, 28%, 33%, and 35%. In general, the tax brackets are widest for Married filing jointly (for example, more income is taxed at 10%), followed by Head of household, Single, and then Married filing separately (the brackets for Married filing separately are exactly one-half the width of the brackets for Married filing jointly and the width of the 10% and 15% brackets for Single and Married filing separately are the same). 2. [LO 1] In 2010, for a taxpayer with \$50,000 of taxable income, without doing any actual computations, which filing status do you expect to provide the lowest tax liability? Which filing status provides the highest tax liability? For a taxpayer with \$50,000, the married filing jointly filing status should provide the lowest tax liability in 2010 because the MFJ tax rate schedule taxes more of this income at 10% and 15% than the other rate schedules (the 10% and 15% tax brackets are wider). Conversely, the married filing separately and the single filing statuses will generate the highest tax liability because a smaller amount of income is taxed at 10% and 15% (the 10% and 15% tax brackets are more narrow) than other tax rate schedules. 3. [LO 1] What is the tax marriage penalty and when does it apply? Under what circumstances would a couple experience a tax marriage benefit? A marriage penalty (benefit) occurs when, for a given level of income, a married couple has a greater (lesser) tax liability when they use the married filing jointly tax rate schedule to determine the tax on their joint income than they would have owed (in total) if each spouse would have used the single tax rate schedule to compute the tax on each spouse’s individual income. The marriage penalty applies to couples with two wage earners while a marriage benefit applies to couples with single breadwinners. 4. [LO 1] Once they’ve computed their taxable income, how do taxpayers determine their regular tax liability? What additional steps must taxpayers take to compute their tax liability when they have preferentially taxed income? 7-1

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Chapter 07 - Individual Income Tax Computation and Tax Credits Once taxpayers have determined their taxable income, they should split the income into two portions: (1) ordinary income and (2) income taxed at preferential rates (if any), and compute tax on each portion separately.
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