Book 4 (Tax) Flashcards
Types of Tax Law Authority
- Internal Revenue Code (IRC)
- Treasury Regulations
- Revenue Rulings & Procedures
- Congressional Committee reports
- Private letter rulings
- Judicial sources
Amended Return Form
1040x
Estate & Trust Tax form
1041
Penalty amount for frivolous return
(omits necessary info)
(substantially incorrect tax)
$5,000
Negligence penalty amount?
(“accuracy-related” errors)
20% of the underpayment attributed to negligence
Penalty amount for fraudulent return?
75% underpayment attributable to the fraudulent tax amount
Failure to pay penalty?
0.5% per month that the tax is unpaid (max 25%)
Failure to file penalty?
5% of tax due each month (max 25%)
Crossing off “penalty of perjury” creates…
a frivolous return
If you reported SE income as dividends, which penalties would you face?
Frivolous penalty
&
Fraud penalty
Explain “Interest & penalties” on unpaid tax balances
Interest = automatically starts accruing on unpaid tax after April 15th (normally 8%)
Penalties = similar accrual but directed to the amount that applies to the penalty (0.5% fail to pay, 5% fail to file)
Gross Income Mnemonic
“BIGWRISTS” exclude “GWICC T-E N-T”
B = Business Income (SE income) - Sch. C
I = Interest & Dividends - Sch. B
G = Gains (Capital G/L & Property Sale) - Sch. D
W = W-2 and Salaries
R = Rental & Passive Income - Sch. E
I = IRA & Pension distributions
S = Social Security benefits (taxable portion)
T = Tax refunds (if PY itemized)
S = Supplemental unemployment compensation
Exclude:
G - Gifts
W - Workers’ Compensation
I - Inheritance
C - Child Support
C - Compensatory Damages (physical)
Tax-Exempt Interest (muni’s)
Non-Taxable Social Security Benefits
Tax Calculation
Gross Income
.
.
.
Net Tax Due/Refund
Gross Income
< Adjustments >
= AGI
< Std. Deduction >
or
< Itemized Deductions >
= Taxable Income
x Tax Rates
= Tax Liability
< Withholding & Quarterly Pmts >
= Net Tax Due/Refund
Are Qualified Dividends included in Gross Income?
Yes, just like ordinary dividends
(ultimately just taxed at qualified rates)
Where are taxable fringe benefits allocated to?
Considered an addition to W-2 income
For any exam question related to personal exemption, the answer is…
Zero (since 2018)
Tax Category Rates:
- Fed Income Tax
- State Income Tax
- Payroll Taxes (SS & Medicare)
- Net Investment Income
- Capital Gains Tax
1) Up to 37%
2) 13.3%
3) ~3.8% (+12.4% SE)
4) 3.8%
5) Varies
What is his Marginal Tax Rate?
(assume individual makes $80k)
The percentage applies to the last dollar of taxable income.
Tax Bracket Single
10% ——————-$0
12%——————–$11,600
22%——————–$47,150
24%——————–$100,525
Marginal tax bracket would be 24%
Qualifying Dividends & Lont-Term Capital Gains tax rates
Tax Bracket
10-12% brackets = 0%
22-35% brackets = 15%
35-37% brackets = 20%
List sources of Self-Employment Income
(Which would therefore be subject to SE tax)
- Net Sch. C Income
- General Partnership income (K-1)
- Board of Directors’ fees
- Part-Time earnings (1099 income)
Calculating SE Tax
Shortcut method
(To calculate the taxable wage base, not any additional Medicare tax)
Step 1) Calculate total self-employment income
Step 2) Multiply by .1413 and round up
Once you calculate the SE tax (using the shortcut), how is it actually paid?
The total SE tax is added to the total taxpayer’s liability. Then, 1/2 of the amount is subtracted on the front of Form 1040
Keywords to look for in Tax Credit questions
“Child credit” = CTC ($2,000 per child)
VS
“Childcare credit” = Childcare & Dependent credit ($3,000 per, $6,000 max)
Child Tax Credit amount
$2,000 per qualifying child
Childcare & Dependent Care Credit amount
1 Dependent = $3,000
2 Dependent = $6,000 (MAX)
[Qualifying Expenses amount]
x 20%
= Credit Amount
A deduction is worth ____ if in a lower tax bracket. A credit is worth ____ if in a lower tax bracket.
Less
More
Forms for Distributed Income
Form K-1 of 1041
Form K-1 of 1065
Form K-1 of 1120s
1099
Schedule E (trick question)
1041 = Trusts & Estates
1065 = Partnerships
1120s = S-Corp
1099 = SE income
Sch. E = reporting form of K-1 income from Real Estate
When can a firm use Cash Method Accounting?
If average revenue is <$29 million
Installment Gain Calculation
- Pedro sells land for 400k (basis 100k)
- Note to pay 400k plus interest over 10yrs
- What is the recognized gain per year?
Profit / Total contract price
= 300k / 400k = 75% gross profit %
75% x 40k per year = 30k Gain Recognized per year
For an Installment Sale, how long must the purchaser wait in order for the seller to continue the installment gains annually?
The purchaser must wait at least 2yrs before reselling
Current NOL rules for 2024
Example) Your business has 100k NOL in 2024
- you cannot carry it back to prior years (offset PY income to receive refund)
- you can carryforward indefinitely
Assume in 2026 that carrybacks were announced. How would you apply NOLs to prior year returns?
Use a special IRS form to claim the NOL carryback refund for prior years
“New” QBI tax deduction applies to income from which entities?
Sole Proprietorships, Partnerships, and other Pass-Through entities
What type of entity can enjoy dividends received exsclusion?
C-Corps
If a C-Corp owns —-% in another company, and that company pays dividends…
< 20% ownership => Exclude 50% of dividend income
20-80% ownership => Exclude 65% of dividend income
80-100% ownership => Exclude 100% of dividend income
How to think of Section 1244 QSBS
Similar to expanding on an individual’s capital loss limit ($3k per year)
If a small business (<$1million cap) closes down, the individual can take up to 100k +3k loss on their individual return
Personal Service Corporation (PSC)
(closely held C-Corp owned by certain individuals)
HALE
Health (doctors, dentists, etc.)
Accounting, Architecture, Actors
Law
Engineering
Grandma Chickensoup transferred $1.5million to an irrevocable trust seventeen years ago. She died this year. Under what circumstance will this trust not be part of her gross estate?
A. She had the power to specify the amount of income and the beneficiary of the trust each year.
B. She received income from the trust for life. After death it will go to her children.
C. She received income from the trust for 15 years. Now the income goes to her children.
D. She had the power to specify whether income should be accumulated of disbursed annually.
C. She received income from the trust for 15 years. Now the income goes to her children.
Grandma’s right to income had expired (or lapsed), and she has no beneficial enjoyment at death.
Answers A and D are subject to beneficial enjoyment exposure.
Answer B, she had right to income and retained that* income interest at death*
What type of trust can make charitable gifts?
Complex Trust (Non-Grantor)
“Living Trust” refers to what?
A trust created while the grantor was still alive
What is an “Inter vivos” trust?
Synonym for Living Trust
Exemption Amounts
Trusts required to distribute ALL income (Simple) = —– income tax exmeption
Trusts not required to distribute all income (Complex) = —– income tax exemption
Required = $300 exemption
Not Required = $100 exemption
Keywords to look for to determine grantor vs non-grantor trust
“for his own benefit”
= Grantor
=> Tax at grantor’s (taxpayer) rates
True or False
A client should not establish an irrevocable trust that is “tainted” for both income and estate tax purposes
Always true
- The trust would serve no purpose otherwise
- The grantor might as well keep the assets in his own name
What increases property basis?
Acquisition costs: “FLICS”
Freight charge
Legal fees
Improvements
Commissions
Sales tax
NOT repairs, real estate taxes, or normal business expenses
Why are improvements considered an increase to basis vs. repairs?
Improvements must be capitalized
Repairs are deducted as expenses
What do these all have in common?
- repair roof
- repair AC
- patch holes in driveway
- repair fence
- pay liability insurance
- pay property tax
- pay for lawn service
- pay property management
All are considered repairs
=> Never affects basis
Section 1231 Property =
Depreciable trade or business assets
Section 1231 branches off into:
Section 12– property (—-)
&
Section 12– property (——–)
1250 (REAL) property = Immovable assets like land/buildings
Think: “REALly hard to move”
1245 (PERSONAL) property = Movable assets like equipment, machinery, etc. and intangible assets
If your Section 179 property (tangible 1245 property) qualifies for the max depreciation deduction, what is the max deduction you could take on 600k equipment?
The entire 600k (but it cannot create an NOL for your business)
Difference in tax deductions for the following:
- Purchase of land
- Purchase of 1250 property
- Repair of 1250 property
- Depreciation of 1245 property
- Purchase of land = no depreciation / amortization
- Purchase of 1250 property = depreciate over life
- Repair of 1250 property = immediate deduction
- Depreciation of 1245 property = depreciate over life (or immediate 100% Section 179 deduction)
How is inherited stock taxed if sold?
Sale of inherited stock produce LTCG regardless of how long either of the people held it
What is Section 1031?
Like-Kind Exchange:
Rental property for Rental property
(used in trade / business)
Like-Kind Exchange calculation steps (1-4)
Solve for…
1) Realized Gain/Loss
2) Recognized Gain/Loss
3) Deferred Gain/Loss
4) New Basis
Netting Capital Gains/Losses on securities
STCG + STCL = Net ST
LTCG + LTCL = Net LT
Then net those 2 amounts
Effective tax rate
The average rate of tax paid across all taxable income
Highest possible effective Fed & State income tax rate
Top Fed ordinary rate: 37%
Top State income tax: 13.3% (CA)
Payroll tax: 3.8% (SE Medicare tax)
Net Investment Income Tax (NIIT): 3.8%
Two months ago, Mr. Lowe (single) died. He had 9k in carryforward losses from prior year. How will his carryforward loss be treated now?
$3,000 can be deducted on his estate’s 1041 tax return.
The loss can be claimed in the year of death, any unused carryforward after that is lost.
3 ways to determine basis when selling mutual funds
Investor’s choice:
1) FIFO
2) Specific ID (specific shares) - allows investor to maximize gains, neutralize gains, or maximize loss
3) Average cost
Home sale exclusion amount
250k [500k] exclusion
Sale of Residence
Must have been used as primary residence for aggregate — out of — years
…aggregate 2 out of 5 years
- think of this rule as a proportional rate and on a “per person” basis
Is there a deduction for loss on personal home sales?
NO, but the selling expenses are typically deductible
In questions for “gains”, what keywords should you look for?
“realized gain”
vs
“recognized gain”
vs
“deferred gain”
3 main questions to ask about a trust
1) Who pays taxes on it?
- Grantor (taxpayer) vs Non-grantor (beneficiaries or trust itself)
2) Who controls the assets?
- Revocable vs Irrevocable
3) How is income distributed?
- Simple vs Complex
How to think about an Estate?
Individual files a 1040 each year
-> Individual dies
–> Estate is formed (until all assets are distributed)
—> Executor/Fiduciary of the estate files Form 1041 (the estate essentially becomes the taxpayer)
Estate Form 1041 filing requirement & deadline
Required IF:
- Any taxable income for the year
- Gross income over $600
- Beneficiary is non-resident
Deadline:
- 15th day of the 4th month after the entity’s year ends
Estate vs Trust taxable year
Estate = choice of calendar year or fiscal year
Trust = calendar year (except 501(a) or Charitable Trusts)
True or False
Any power or interest held by the spouse is treated as if that interest was held by the grantor
True
Basics of Grantor Trust vs Non-Grantor Trust
Grantor = holds a lot of control over property
=> Trust income is taxed to the grantor
Non-Grantor = Trust income is taxed to the trust itself or to the beneficiaries
3 thoughts when you see “Revocable” trusts
1) Full control & flexibility
2) NO asset protection or estate tax benefits
3) Pass-Through taxation
3 thoughts when you see “Irrevocable” trusts
1) Loss of control
2) Asset protection and estate tax benefits
3) Files Form 1041 (unelss Grantor)
General tax treatement of distributions to beneficiaries (Trusts & Estates)
Beneficiaries are taxed on the income currently distributed (regardless if received yet or not), and the trust or estate is taxed on the income it has accumulated and retained
What are common examples of irrevocable grantor trusts?
(“Irrevocable” & “Grantor” you would think are contradictory)
Intentionally Defective Grantor Trusts (IDGT)
- Grantor pays tax, but assets grow outside of their estate
Special Lifetime Access Trust (SLAT)
- Grantor pays tax, but spouse can still access funds
Irrevocable Life Insurance Trust (ILIT)
- Grantor pays tax, but the premiums on life insurance are paid by the trust
Social Security payouts are based on your highest —– years of earnings
35 years
Estimated taxes are due…
April 15th (1st), June 15th (2nd), Sept. 15th (3rd), Jan. 15th (4th)
1, +2mo, +3mo, +4mo
Casualty/Theft Loss calculation
Lesser of : 1) Basis 2) FMV
- Insurance coverage
- $100
- 10% of AGI
= Deductible Casualty Loss
Self-Employed = SE Tax (—-%)
W-2 Earners = FICA Taxes (—-%)
SE Taxes = 14.13%
- Half of this amount is deductible on the front of the 1040
FICA Taxes = 15.3% ((6.2%+1.45%)x2))
- 6.2% is the Social Security tax portion (subject to 168k phaseout)
- 1.45% is the Medicare tax (unlimited)
For FICA taxes, what amount is deductible?
(Assuming W-2 earner, not Self-employed)
NONE
- Individuals cannot deduct any portion of this tax (unless self employed)
- The businesss can deduct their portion (7.65%)
Exam may try and confuse:
Section 197
Section 179
Section 197 = general amortization of intangibles
Section 179 = depreciable, tangible, business assets that may qualify for 100% immediate deduction
(Think: “Lower to the ground like cars and desks”)
Like-Kind Exchange
Does land qualify in a like-kind exchange?
(example; exchanging a rental home for land you plan to develop)
Yes, the land can still qualify as long as it is used for trade/business/held for investment
Keys for SE Calculation:
- Taxable wage base given in SE question should not exceed $168,600
- If SE income exceeds $168,600, you did something wrong
- Schedule SE calculations involve multiple steps, but they combine to 0.1413
What type of interest can be deducted without any limits?
Sole Proprietor loans
QBI-199A applies to which entities?
Pass-Through entities
Which answer is typically wrong for choosing business forms (on exam)?
Limited Partnerships
What service typically requires specialized training?
Business valuations
Section 197 deductions (amortization of intangibles) cannot create an NOL
1245 property cost-recovery deductions (CRDs) or (1245 recaptures) are taxed at what rate?
STCG (OI tax)
Sale of Residence (Section 121)
Exclude 250k [500k] from gross income
Requirements: 2 of 5 years used as principal residence
Transfer of property between spouse’s incident to a divorce is tax-free! Basis carried over! What is the most common property involved?
Transfer of Life Insurance policies. This is an exception to the “transfer for value” rules
Hobby losses NOT deductible after 2017
Schedule H
Household employees (think caretakers)
Casualty Loss
During a storm, a tree fell on your house causing 8k damage. Insurance company denied claim because the tree had termites. How much can be claimed as Casualty Loss?
NONE
Reason 1) Insurance denied your claim, so why would the IRS accept it?
Reason 2) NOT a federally declared disaster area
——- tax credit can be claimed as an itemized deduction or a tax credit
Foreign tax credit
Mr. Long bought an interest in a low-income housing program. It generated a 27k loss for the year. If he is in a 35% marginal tax bracket, what dollar amount of credit can he claim?
Multiply loss (max 25k) by marginal bracket:
25,000 x 35%
= 8,750 over 10 years
