CFP Tax Planning Flashcards
What is imputed interest (income)?
Term used in tax law to describe a situation where a lender charges no interest on a loan, but the IRS considers the loan to have been made at an interest rate that is “imputed” or implied by market conditions. This can happen when a lender charges a lower interest rate than the market rate, or when a borrower receives a loan from a family member or friend at a below-market interest rate. In such cases, the IRS may require the lender to pay taxes on the difference between the actual interest rate and the imputed interest rate.
When does imputed interest (income) NOT apply?
- For individual loans with an aggregate outstanding amount of <$10k
- Debt subject to original issue discount provisions.
- Sales of property for $3,000 or less.
- Any sales where all of the payments are due within six months.
- Sales of patents to the extent the payment is contingent on the use or disposition of the patent.
- Certain carrying charges for personal property or educational services covered by Section 163(b), when the interest charge cannot be ascertained.
- Charges for the purchase of personal-use property.
What are the exceptions to limit the application of imputed interest in situations where tax avoidance may be immaterial?
- Interest is not imputed on gift loans between individuals totaling $10,000 or less, except when the borrowed funds are used to purchase the income-producing property.
- Interest is not imputed on corporate loans and compensation-related loans totaling $10,000 or less.
- For loans between individuals that range between $10,001 and $100,000: the imputed interest is limited to the borrower’s net investment income. If the net investment income is $1,000 or less, imputed interest will not apply. In cases when the borrower’s net investment income exceeds what would otherwise be imputed based on the Applicable Federal Rate (AFR), the AFR will apply.
Are punitive damages taxable?
Yes. Victims are awarded amounts that are intended to punish the guilty party. These so-called “punitive damages” are taxable even when they are awarded for physical injuries.
Deductions for AGI vs. Deductions from AGI
Above the line deductions vs. Below the line deductions
To find the purchase price at which an OID would be zero, the following formula is used to determine the amount of the maximum discount:
(0.0025 x face value of the bond x bond term)
How long must property be held to qualify for Section 1231 treatment? What are a few examples of Section 1231 property?
Property must be held for at least 12 months or longer. Examples include:
- Real property or depreciable property used in a trade or business or held for the production of income
- Timber, coal or domestic iron ore
- Livestock
- Unharvested crops
What is the main purpose of Section 1245?
The main purpose of this IRC Section is to eliminate any advantage taxpayers would have if they were able to reduce ordinary income by deducting depreciation and subsequently receive Section 1231 capital gain treatment when an asset was sold.
Herbert and Betty are married and file jointly. They bought a small 2-bedroom condo for $250,000 in a rapidly appreciating development. Nine months later, Betty gave birth to triplets. They immediately realized they needed more room, sold the condo for $445,000, and bought a larger condo in the same development for $695,000. They had lived in the small condo for a total of 283 days.
How much gain must be reported on the transaction?
Reduced Exclusion: $500,000 X 283/730 = $193,836
Gain: $445,000 - $250,000 = $195,000
Taxable Amount: $195,000 - $193,836 = $1,164
According to the wash sale rules, a taxpayer realizes a loss on a sale of a security and acquires a substantially identical security within a _____ period.
61-day period. Explanation: A wash sale occurs when: A taxpayer realizes a loss on the sale of stock or securities, and the taxpayer acquires “substantially identical” stock or securities within a 61-day period of time that extends from 30 days before the date of sale to 30 days after the date of sale. Loss is allowed!
What is Distributable Net Income (DNI)?
___________ is an estimate of the actual benefit available to the income beneficiaries of an estate or trust and is the maximum amount that can be taxed to beneficiaries. Distributions in excess of ____________ are generally treated as tax-free distributions of principal.
The three most common deferral or exclusion transactions in the tax code are:
- Like-kind exchanges under Section 1031 (deferred gain or loss)
- Involuntary conversions under Section 1033 (deferred gain)
- Sales of a personal residence under Section 121 (excluded gain)
IRC Section 1036 - Stock Exchanges
No gain or loss is recognized on the exchange of:
* Common stock for common stock within the same corporation
* Preferred stock for preferred stock within the same corporation
Applies even if common stock is exchanged for non-voting common stock within the same corporation
Susan sells a piece of land to Jack. A few weeks later, she buys another piece of land from Linda. Does this qualify as a like-kind exchange?
No. These transactions are not interdependent and are not part of a direct exchange, so they do not qualify as a like-kind exchange. Susan must recognize the gain from the sale to Jack.
Michael sells a warehouse to Sarah. Several months later, Michael purchases another warehouse from Tom. Does this qualify as a like-kind exchange?
No. The delay between the sale and the purchase, along with the transactions involving different parties, means that this does not qualify as a like-kind exchange. Michael must recognize the gain from the sale to Sarah.
