CFP - 4.1 Tax Flashcards
What is the taxable income formula?
INCOME minus EXCLUSIONS equals GROSS INCOME
GROSS INCOME minus DEDUCTIONS equals AGI
AGI minus the greater of the STANDARD DEDUCTION or ITEMIZED DEDUCTIONS equals
TAXABLE INCOME
What is the business purpose doctrine?
A business must have a valid business purpose and cannot be formed just to take advantage of lower tax rates on a transaction
What are tax law doctrines?
Made by the IRS to guide people in what is proper vs abusive tax management
What is the substance-over-form doctrine?
Allows the IRS to look through the formalities of a transaction to determine its actual economic substance
What is the assignment-of-income doctrine?
“Fruit and the tree” A taxpayer who earns income cannot assign that income to someone else for tax purposes
Jill is in the highest income tax bracket. She directs her employer to assign $18k of her income to her son who is in the lowest tax bracket. What is the tax consequence?
Can’t do this according to the assignment of income doctrine. Jill’s W-2 would include the $18k AND she would have made a gift of the $18k to her son. She would have to file a gift tax return.
A corporate executive has the company loan him money rather than receive it as income. What is the tax consequence?
Substance-over-form: the IRS will likely deem this as income as the loan proceeds are in lieu of salary
What is the tax benefit doctrine?
The principle that if a loss was suffered in a previous year and taken as an income reduction for tax purposes, and an insurance reimbursement for that loss is received in the current year, that reimbursement must be counted as part of gross income for the current year
What is an example of the tax benefit doctrine?
Bob deducted medical expenses last year, then received reimbursement this year. The reimbursement will be considered income because he already got the tax benefit of the deduction.
What is the constructive receipt doctrine?
If there is no substantial limit to the taxpayer’s right to bring the funds under personal control, the income is taxed as though it had been received
A payroll check is issued and available for pickup December 31st 2018. The employee picks it up January 3rd and cashes it January 4th 2019. What year is the income taxed?
- Constructive receipt.
Dan is in a high tax bracket. He solely owns a rental property that generates $2k per month in rent. He instructs his tenant to pay the rent to his daughter who is in the lowest tax bracket. What is the tax consequence?
Assignment - Because Dan owns the property, the payment of rent is his that he has assigned to his daughter.
What types of corporate structures are pass-throughs?
Partnerships and S corps
How is income taxed in a partnership?
Income is taxed to each partner at their own individual rates
Who pays tax on S corp income?
Shareholders
What form does a partnership have to file and what form do partners receive?
1065, informational return
K-1, self employment income
What form does an S corp file and what form do shareholders receive?
Form 1120S
K-1, passive income
What form do employees of S corps and partnerships receive?
S corp - W-2
Partnership - K-1, self employment income
How is trust income taxed?
Income distributed to beneficiaries is taxable to them as income. Undistributed income is taxable to the estate.
When is a below-market loan’s interest imputed?
When the interest charged on the loan is less than the federal rate
How is imputed interest compounded?
Semi annually
Can gift loans occur between businesses?
No, only between individuals
How is imputed interest on a gift loan recognized?
The borrower has an interest expense, the lender has interest income. The lender is viewed as gifting the imputed interest to the borrower.
What are compensation-related below market loans?
Employer loans to employees. The imputed interest is treated as compensation and the loan amount is considered income.
What are corporation-shareholder loans?
The imputed interest is treated as a dividend to the shareholder
No interest is imputed on gift loans, compensation-related loans, or corporation shareholder loans if the loan is ________ or less.
$10,000
For below market loans above _____ but below ______, the imputed interest cannot exceed what?
$10k, $100k
The borrower’s investment or interest income from all sources for the year
Richie loaned Beth $90k and didn’t charge her interest. Richie’s investment income was $200k. Beth’s income was $30k in salary and $3k in interest income. The relevant federal rate was 9%. How much imputed interest must Richie recognize?
$3,000. The loan is below $100k and Beth only had $3,000 in interest income for the year.
Employee achievement awards of less than $_____ per year based on length of service are excluded from gross income.
$400
Rose wins the lottery. Her winnings are $1,000,000. She chooses to receive an annuity of $50,000 per year for 20 years instead of a lump sum. How are her winnings taxed?
She will be taxed on the annuity amount ($50k) in the year that the income is received.
Wendy is 55. She is receiving annuity payments of $1,500 per month over her life expectancy of 25.5 years. Her contributions to the annuity were after tax and her basis is $91,800. How much of the annuity payment must she recognize for tax purposes?
$1,500 x 12 x 25.5 = $459,000
91,800/459,000 = 20%
She can exclude 20% (3,600) each year and must claim 80% (14,400)
Employees can exclude premiums paid by their employers on the first $________ of group term life insurance - except for who?
$50,000
Partners, proprietors, and S corp owners who own more than 2%
Are unemployment benefits included in gross income?
Yes
Up to ___% of Social Security benefits may be included in gross income.
85%
What is provisional income?
AGI from all sources plus 50% of SS benefits received, foreign income, and tax-free interest
What two things make up the FICA tax?
Social Security Tax (OASDI) and Medicare Tax (HI)
What is the earnings ceiling for OASDI?
$128,400
How much is the OASDI tax?
6.2% paid by employee and 6.2% paid by the employer
What does OASDI stand for?
Old Age Social and Disability Insurance, (SS)
How much is the HI (Medicare) tax?
1.45% for employee and 1.45% for employer
How much is the HI tax for self employed individuals?
2.9%, they pay the employee and employer parts together
What is the earnings ceiling for Medicare?
there isn’t one
What is the total self-employment FICA taxes?
15.3% (12.4% + 2.9%)
The Additional Medicare Tax is ____%
0.9%
Who pays the additional medicare tax?
Only the employee. No employer share
What corporate structure can avoid FICA taxes?
S Corp, as the earnings are not considered employment income
What are DBO benefits and how are they taxed?
Death Benefit Only, fringe benefit paid by employer to employee’s beneficiaries and included in gross income
Are compensatory damages taxable?
No, except in discrimination or defamation cases
Are punitive damages taxable?
Yes
Does the recipient of a gift have to include the FMV as income?
No
Does the recipient of an inheritance include the FMV in gross income?
no, unless it is income in respect of a decedent (IRD)
Are scholarships included in gross income?
No, as long as they are used for qualified education expenses and the recipient is a candidate for a degree
Are life insurance proceeds taxable?
Not if they are paid to the beneficiary
What tax is due on life insurance proceeds that are received in installment payments?
Tax on the interest income
When are life insurance dividends taxed?
When the aggregate received exceed the basis in the contract
Can businesses deduct life insurance premiums if the company is directly or indirectly a beneficiary?
No
Are losses on surrendered policies tax deductible?
No
Withdrawals or loans from life insurance policies are received on a ______ basis when surrendered.
FIFO
What is Transfer-For-Value Rule?
A transfer-for-value rule stipulates that, if a life insurance policy (or any interest in that policy) is transferred for something of value (money, property, etc.), a portion of the death benefit is subject to be taxed as ordinary income
What are the Transfer For Value Rule Exceptions? (5)
Transfers to…
- The insured
- A partner of the insured
- A partnership in which the insured is a partner
- A corporation in which the insured is an officer or shareholder
- A transferee (such as a child)
Are viatical settlement proceeds included in gross income?
No, as long as the recipient has been certified as terminally ill OR chronically ill and used for long-term care
What is the definition of terminally ill?
Having a condition or illness that can reasonably be expected to result in death in 24 months or less
What is the definition of chronically ill?
Unable to perform at least 2 activities of daily living for at least 90 days
How are viatical settlement benefits taxed to the purchaser?
Benefits received over the basis and premium payments are included in gross income
Is cost of insurance included in a cash surrender calculation?
NO
Bob surrenders a policy with $80,000 of cash value. He paid $70,000 in premiums and the cost of insurance was $11,000. What is his income?
$10k
Bob sells a policy with $80k cash value to Jim for $95k. He paid $70,000 in premiums and the cost of insurance was $11,000. How is he taxed on the transaction?
$95k - $70k - $11k = $36k.
Basis = $80k - $70k = $10k.
Capital gain of $26k
How is Section 1202 qualified small business stock (QSBS) taxed?
Noncorporate investors can exclude up to 50% of the gain realized. Remaining gain is taxed at the 28% capital gains rate.
What is the tax consequence of a lender forgiving a debt?
The borrower must report the forgiven debt as income, except in the case of bankruptcy
What is the tax consequence of a taxpayer paying a debt with appreciated property?
This is treated as though the taxpayer sold the property, then repaid the debt. They cannot give away the appreciation without paying taxes.
How is foreclosure taxed?
It is treated as a sale or exchange
What is the max amount of foreign income that can be excluded from US gross income?
$103,900
What qualifications must be met to qualify for the foreign exclusion?
The taxpayer must be a bona fide resident of the foreign country
OR
Be present in a foreign country for at least 330 days during any 12 consecutive months
How is the foreign exclusion pro rated?
Max Exclusion (103,900) x (# of days in a foreign country / # of days in the year)
Can you contribute to a Coverdell and 529 in the same year for the same beneficiary?
Yes
Coverdell amounts must be distributed by age _____ if not used.
30
Can Coverdells be rolled over?
Yes, free of taxation and penalty if rolled over to a beneficiary who is a member of the same family
Can Coverdells pay for K - 12 education?
Yes
Can 529s pay for K - 12 education?
Yes, but there is a $10,000 limit per student
Can 529s be rolled over?
Yes, free of taxation and penalty if rolled over to a beneficiary who is a member of the same family
Are unreimbursed business expenses of an employee deductible?
No
What 2 things can a business owner/taxpayer deduct expenses from gross income to arrive at AGI?
- Expenses incurred in carrying on a trade or business
2. Expenses incurred in connection with property held for the production of rents or royalties
What Schedule are Farm income and expenses reported on?
Schedule F (duh)
How much self-employment tax can self-employed individuals deduct?
- 2% of OASDI up to SS taxable wage base and 1.45% with no earnings limit.
- 65% total
What is the Social Security taxable wage base for 2018?
$128,400
What is the self-employment tax applied to?
Net income from self-employment
If net earnings from self-employment are less than $_____, no self employment tax is payable.
$400
What is the formula for calculating the total amount of self employment tax below the taxable wage base?
SE Income x 0.9235 x 0.153
What is the formula for calculating the deductible portion of the self-employment tax below the taxable wage base?
SE Income x 0.9235 x 0.0765
Paul has net Schedule C income of $40,000. What is his self-employment tax due and what is his deductible portion of the self-employment tax?
$5,651.82 tax due
$2,825.91 deductible
What is the formula for calculating the self-employment tax above the taxable wage base?
(Income - 128,400) x 2.9%
PLUS
128,400 x 15.3%
Is alimony paid to an ex-spouse deductible from gross income?
Yes
Is alimony received taxable?
Yes
What are the requirements of a prenup?
- In writing
- Signed by both parties
- Complete disclosure of assets
- Nothing regarding future alimony or child support
Is forfeited interest on early CD withdrawals deductible for AGI?
Yes
Dan needs cash and he needs it now. His most liquid asset is a $10,000, 2.5%, 3 year CD with 18 months to go. He redeems the CD early and is charged 3 months interest as a penalty. What is the tax consequence?
He will owe income tax on the 3 month’s interest but can also deduct for AGI.
$62.50 income
$62.50 deduction
What is the limit to which capital losses can offset capital gains?
There is no limit
How much of capital losses are deductible against ordinary income?
$3,000
$1,500 for MFS
Can unused capital losses on a final tax return be used by the estate or a beneficiary?
No, they are lost
How much capital loss beyond capital gain can a corporation deduct?
None, they can can only be used to offset cap gains
How long can unused capital losses be carried forward for corporations?
5 years
Can unused capital losses be carried back?
Yes, up to 3 tax years
Are capital losses carried forward or back treated as short term or long term?
Short term
Which two types of taxpayers can deduct 100% of their health insurance amounts paid?
Self-employed
S-corp shareholders more than 2%
What are the contribution limits for HSAs?
Single coverage =
Family coverage =
Single coverage = $3,450
Family coverage = $6,900
HSA withdrawals that aren’t used for qualified medical expenses are subject to what?
Income tax and a 20% penalty
At what age do HSA withdrawals start acting like Traditional IRA withdrawals?
65
What is the maximum annual deduction for interest on student loans?
$2,500
When CANT a taxpayer deduct for student loan interest besides phase out income?
If the taxpayer is claimed as a dependent
What 3 itemized deductions use AGI to calculate the limit?
- Charitable (50%)
- Medical (7.5%)
- Casualty losses for federally declared disasters (>10%)
Is there a liability to make alimony payments for any period after death of the payee?
No
Do alimony payments have to be maid directly to the payee spouse?
No, they can be paid to third party (i.e. mortgage)
What household rules for alimony?
Payments while you are in the same household are not considered alimony. If you are planning to separate within 1 month, then it is alimony.
What triggers the alimony recapture rule?
A decrease by more than $15k from the 2nd year to the 3rd year or a significant decrease from the 1st year to the 2nd and 3rd.
If alimony recapture is triggered, what is the tax consequence?
Part of the alimony deducted in the first or second year is going to count as income in the third year
Why would someone purposefully trigger alimony recapture?
If they expect their tax bracket to be higher in year one than year 3
Is child support received included in taxable income?
No
Is child support paid deductible?
No
Dave has to pay Michelle $4,000 per month according to their divorce settlement. When their daughter turns 18, the payments go down to $2,800 per month. How much can Dave deduct of the $4,000?
$2,800. Because the $1,200 goes away when the daughter turns 18, it is considered child support, which is never deductible.
What are the age qualifications for the kiddie tax?
A dependent child under the age of 19 by the close of the tax year
OR
Full-time student under the age of 24 by the close of the tax year
How many months of the year do you have to be a full-time student to be considered a full-time student for the whole year for tax purposes?
5 months
The kiddie tax does not apply to individuals age 18 if their earned income for the taxable year exceeds ______% of their support
50%
Unearned income above $______ is taxed at the estates and trusts tax rate (kiddie tax)
$2,100
Lil Suzie is 14 and earned $2,200 in interest from her bank account. How much is taxable at the estates and trusts rate?
$2,200 - $2,100 = $100
Suze is 14 and earned $2,200 in interest in her bank account. She also made $5,600 babysitting. What is her standard deduction?
$5,600 + 350 = $5,950
Suze is 14 and earned $2,200 in interest in her bank account. She also made $5,600 babysitting. What is her taxable income?
$5,600 + $2,200 - $5,950 = $1,850
What is the standard deduction for kiddies?
Earned income plus $350, capped off at $12,000
What is the max standard deduction for kiddies?
$12k
What percentage of self employment tax can be deducted?
50%, not both halves
What is the “line” for above the line and below the line deductions?
AGI, above comes before, below comes after
Expenses must be _____ and _____ to qualify for deduction.
Ordinary (customary to make the expenditure, not capital) and necessary (a prudent person would do the same thing in that situation)
How do S corp shareholders prefer to be paid?
Distribution rather than salary. The distribution is usually treated as a tax-free return of capital. Salary would be subject to FICA taxes.
What happens if the IRS deems a C Corp distribution as unreasonably high?
They will count it as a dividend and it will be double-taxed, once as earnings to the corp and once to the recipient shareholder as income.
What are the two most common methods of accounting for tax payers?
Cash-basis and Accrual-basis
When using the cash-basis method…
When can the taxpayer receive a deduction for the expense?
When it has been paid
When using the accrual-basis method…
When can the taxpayer receive a deduction for the expense?
When it is incurred
When using the cash-basis method…
When does the taxpayer recognize income?
When cash is received
When using the accrual-basis method…
When does the taxpayer recognize income?
In the same year that it is reported on financial statements (accounts receivable). Doesn’t have to be received in cash.
Are expenses to generate nontaxable income (like muni bonds) deductible?
No
Are political contributions tax deductible?
No
Are lobbying activities tax deductible?
No
Are capital expenditures tax deductible?
No (except as depreciation, amortization, or depletion)
Are expenditures on behalf of another taxpayer tax deductible?
No, except medical for a spouse or dependents
What is the most a company can deduct for executive compensation?
$1,000,000
Are startup expenses deductible?
For investigating a business similar to what they are in?
Yes, whether they acquire or not
Are startup expenses deductible?
For investigating a business different to what they are in?
Only if they acquire. They can deduct $5k immediately and amortize the remaining costs over a 180 month period.
Expenses over $50k reduce the $5k dollar for dollar
Vacation home rental income is excluded if it is rented less than _____ days of the year.
15
Vacation home rental expense are not deductible if it is rented less than _____ days of the year.
- Mortgage, interest, taxes, and casualty losses still deductible.
Vacation homes are classified as rental property if they are rented at least _____ days per year and not used for personal use more than ____ days or _____% of the time rented.
15, 14, 10%
How much loss can be deducted on a rental vacation home and what is the phaseout?
$25k, phaseout at AGI between $100 - 150k
What constitutes a mixed use vacation home and what are the tax rules?
Rented for 15 days or more but used for 14 or more or more than 10% of the rented days. Expenses can be deducted only to the extent of income - no deductible loss allowed.
How are legal fees tax deductible?
Personal legal fees are not. Legal fees to acquire an asset are added to the basis.
When are accounting and legal fees deductible?
Incurred in the determination of tax or in connection with trade, business, or production of rent/royalty, they are above the line deductible
How are worthless securities tax deductible?
Capital loss in the year they become worthless. Up to $3,000 net capital loss deduction available
How are small business stock (1244) losses treated?
They can be treated as an ordinary loss if they are bought from the corporation. The limit is $50k single, $100k joint. Anything beyond that is a capital loss.
In order to qualify for Section 1244 treatment (small business stock), the company must receive less than $______ in capital for stock at the time of issue.
$1,000,000
Does Section 1244 apply to losses or gains?
Losses only
When can you deduct a bad debt?
only in the year it becomes worthless
If you deduct a bad debt this year, but its repaid next year, what happens?
You have to recognize it as income
When are business bad debts allowed?
If the income from the receivable was previously included as income
Can bad debts be partially worthless and deducted for the following?
Business
Nonbusiness
Bus - yes
Non bus - no
How are nonbusiness worthless debts treated?
as short term capital losses
How are business worthless debts treated?
ordinary loss
What is the purpose of a Net Operating Loss ? (NOL)
Help cyclical businesses - they have big losses one year and big income the next
How can Net Operating Losses be carried forward and back?
Only carried forward, indefinitely
What is the limit for Net Operating Loss in carry forward years?
80% of total taxable income
Can taxpayers deduct expenses for home offices?
Yes, if they qualify
What are the 3 tests for a home office?
- Principal place of business - used regularly with no other fixed location
- Used exclusively and regularly as a place of business used to meet clients or patients
- If a separate structure not attached to the dwelling, it must be used in connection with the trade or business
Can home office expenses create a loss?
No they are limited to the gross income of the business and are deducted after mortgage interest and taxes.
What are the two methods for calculating home office deductions?
Simplified and Regular
Is there a difference in home office qualification for the simplified and regular methods?
No
Is there a difference in the allowable square footage of home use for business for the simplified and regular methods?
Yes.
Simple cannot exceed 300 sq feet
Regular is the % of home used for business
Is there a standard deduction for the simplified and regular methods?
Simplified yes, $5 per square foot with a $1,500 max per year
Can you depreciate a home office for the simplified and regular methods?
Simplified no
Regular yes, recaptured on sale of home
Can home office deduction exceed gross income from business use less business expenses for the simplified and regular methods?
No for either
Can home office expenses be carried over for the simplified and regular methods?
Simplified no
Regular yes
What is the AGI floor for deductible medical expenses?
7.5%
Whose medical expenses can be deducted by the taxpayer?
Own, spouse, dependent
What 4 things are covered as medical expense deductible items?
- Diagnosis, cure, mitigation, treatment, or prevention of disease, injury or accident
- Transportation for and essential to the items in #1
- Qualified long term care expenses
- Insurance premiums paid by taxpayer with after tax dollars for accident, health, and disability insurance
What 2 things are never covered as deductible medical expenses?
Unnecessary cosmetic surgery and funerals
What is the AGI floor for deductions for ambulance, tolls, and parking related to medical expenses?
10%
When can a taxpayer deduct health insurance premiums and what is the limit?
When there is no employer paid plan available and the premiums are paid with after tax dollars. 100% can be deducted for AGI.
What is the limit for deductible income and property taxes?
$10k ($5k for MFS)
If person X pays person Y’s real estate taxes, who can deduct the tax?
Only person Y, the person the taxes are imposed on
Are real estate assessments deductible?
No, but added to basis of the property
How are apportion property taxes treated during a sale?
The tax is based on # of days each held the property. The buyer is considered the holder on the day of sale.
Is personal interest deductible?
No
What is investment interest and what can it be deducted against?
Interest on funds borrowed to acquire investment assets.
Can be deducted against interest, dividends, annuities and royalties. NOT CAPITAL GAINS NOT TAX FREE INTEREST
Are investment expenses deductible?
No
What is acquisition indebtedness?
Home equity loans secured by that property where the proceeds were used for acquisition or substantial home improvement
What is the max allowable acquisition indebtedness for 2018?
$750,000 (half for MFS)
Are points on a home loan deductible?
Yes, in the year paid for principal residence loans only
Can interest paid on behalf of another be deducted?
No
When can losses on nonbusiness property be deducted?
Only when caused by a federally declared disaster
What is the deductible amount for federally declared disaster loss?
The lesser of the adjusted basis or the decline in FMV resulting from the event
Can gambling losses be deducted?
Only to the extend of gambling winnings
Is the value of time or services given to a charitable organization deductible?
No
Is the value of blood donated to a blood bank deductible?
No
Are donations to political groups or politicians running for office deductible?
No
Are donations to foreign charitable organizations deductible?
Only Mexican, Canadian, and Israeli
Are donations to lobbyists deductible?
No
Are donations to labor unions or chambers of commerce deductible?
No
Are donations to homeowners associations deductible?
No
Are donations to religious organizations deductible?
Yes
Are donations to federal, state, or local governments deductible?
Yes - gift to reduce public debt
Are donations to hospitals deductible?
Yes, if they are nonprofits
Are donations to public recreation facilities deductible?
Yes
Are donations to public parks deductible?
Yes
Are donations to Goodwill deductible?
Yes
Are donations to Boy/Girl Scouts deductible?
Yes
Are costs you pay for a student living with you sponsored by a qualified organization deductible?
Yes
Are out of pocket expenses when you serve a qualified organization as a volunteer deductible?
Yes
What are the two types of qualifying charitable organizations?
Public charities and Private foundations (conduct charitable activities instead of performing the activities themselves)
Appraisals are not required for noncash property donations over $_____ and less than or equal to $______
$500 - $5,000
If a donor donates $1,000 coins each to 6 different charities, is an appraisal required?
Yes, if similar items with a total value exceeding $5,000 are donated to multiple charities, an appraisal is required
If the donor receives a benefit from the donated property, what is the consequence?
FMV of the benefit must be reduced from the deduction if the benefit is consequential
What is the carryover limit for disallowed charitable donations?
5 years
What is the $ limit of charitable deductions?
___% of AGI if it is a public charity.
50%
What is the $ limit of charitable deductions?
___% of AGI if it is a private charity.
30%
