Overview

In Chapter 2, The Federal Income Tax Return we learned that the gross tax liability is computed by using the tax tables or tax rate schedules. In this chapter, we will learn about special tax issues: computing tax for taxpayers in community property statescommunity property stateState using the community property system, which deems property acquired during marriage as equally owned; they include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin., the alternative minimum taxalternative minimum taxTax computation system, which a taxpayer must use if it yields a higher income tax liability., and children with investment income. Then we will cover credits that taxpayers deduct from the gross tax liability. The most common credits are covered in the section called “Child and Dependent Care Credit” through the section called “Earned Income Credit” and several others are discussed in the section called “Other Credits”. Credits are reported in the Tax, Credits, and Payments section of page 2 of Form 1040 or 1040A. A credit is a direct reduction in tax liability instead of a deduction from income. If a taxpayer has a choice of $1 as a deduction or $1 as a credit, only the credit saves the taxpayer $1. Credits are used by Congress in the tax laws because they can target tax relief to certain groups of taxpayers. Because of the progressive rate structure of the income tax, a deduction provides greater benefit to higher income taxpayers, while a tax credit provides equal benefit, regardless of the taxpayer‘s income level. It is a direct dollar reduction of a dollar of tax.