Chapter 11 Flashcards
At risk limitation
law that says you can only deduct up to your basis in an investment when it comes to losses
Income Categories
active
passive
portfolio
Passive Losses offset
Passive income
active income
Wages, salary, commissions, bonuses, and other payments for services rendered
by the taxpayer.
• Profit from a trade or business in which the taxpayer is a material participant.
• Gain on the sale or other disposition of assets used in an active trade or
business.
• Income from intangible property if the taxpayer’s personal efforts significantly
contributed to the creation of the property.
Portfolio income
• Interest, dividends, annuities, and royalties not derived in the ordinary course
of a trade or business.
• Gain or loss from the disposition of property that produces portfolio income
or is held for investment purposes.
passive income
• Any trade or business or income-producing activity in which the taxpayer does
not materially participate.
• Subject to certain exceptions, all rental activities, whether the taxpayer materially
participates or not.
Passive Loss
Can only be deducted from passive income
Gain or loss on Sale of a Passive Activity is deducted or added to
ordinary income
You can deduct current year, and losses suspended from a passive activity in excess of net income or gain for the tax year form all passive activities
true
Equation to allocate passive activity losses between activities
loss from activity/Sum of losses for taxable year from all activities having losses
Passive Credits
Any tax paid towards a passive activity can be deducted against regular passive income tax up to 30000
Carryovers of Passive Credits are
carried forward forever, until the activity is disposed of and even then they can be used against passive income in that year
When a taxpayer has sufficient regular tax liability from passive activities to trigger
the use of suspended credits, the credits lose their character as passive credits.
They are reclassified as regular tax credits and made subject to the same limits as
other business credits
Passive Activity Changes to Active
If a formerly passive activity becomes an active one, suspended losses are allowed to
the extent of income from the now active business.8 If any of the suspended loss
remains, it continues to be treated as a loss from a passive activity.
personal service corporation
- The principal activity is the performance of personal services.
- Such services are substantially performed by employee-owners.
closely held corporation
if at any
time during the taxable year more than 50 percent of the value of its outstanding
stock is owned, directly or indirectly, by or for five or fewer individuals. Closely held
C corporations (other than personal service corporations) may use passive losses to
offset active income but not portfolio income.
material participation tests
1.Does the individual participate in the activity for more than 500 hours during
the year?
2.Does the individual’s participation in the activity for the taxable year constitute substantially
all of the participation in the activity of all individuals (including nonowner
employees) for the year?
3. Does the individual participate in the activity for more than 100 hours during the year,
and is the individual’s participation in the activity for the year not less than the participation
of any other individual (including nonowner employees) for the year?
4. Is the activity a significant participation activity for the taxable year, and does the individual’s
aggregate participation in all significant participation activities during the
year exceed 500 hours?
5. Did the individual materially participate in the activity for any 5 taxable years (whether
consecutive or not) during the 10 taxable years that immediately precede the taxable
year?
6. Is the activity a personal service activity, and did the individual materially participate in
the activity for any three preceding taxable years (whether consecutive or not)?
7. Based on all of the facts and circumstances, did the individual participate in the activity
on a regular, continuous, and substantial basis during the year?
significant participation activity
a trade or business in which the individual’s
participation exceeds 100 hours during the year.
rental activity
defined as any activity where payments are received principally
for the use of tangible (real or personal) property.
Rental Material Participation tests
- The average period of customer use of the property is seven days or less.
- The average period of customer use of the property is 30 days or less, and the owner of the
property provides significant personal services. - The owner of the property provides extraordinary personal services. The average period of
customer use is of no consequence in applying this test. - The rental of the property is treated as incidental to a nonrental activity of the taxpayer.
- The taxpayer customarily makes the property available during defined business hours for
nonexclusive use by various customers. - The property is provided for use in an activity conducted by a partnership, S corporation,
or joint venture in which the taxpayer owns an interest.
Extraordinary personal services
are services provided by individuals where the
customers’ use of the property is incidental to their receipt of the services. For
example, a patient’s use of a hospital bed is incidental to his or her receipt of medical
services.
Exceptions to rental activities being passive
• More than half of the personal services that the taxpayer performs in trades
or businesses are performed in real property trades or businesses in which
the taxpayer materially participates.
• The taxpayer performs more than 750 hours of services in these real property
trades or businesses as a material participant.
Real Estate Deduction Exception, 25000
allows individuals to deduct up to $25,000 of losses
from real estate rental activities against active and portfolio income.30 The potential
annual $25,000 deduction is reduced by 50 percent of the taxpayer’s AGI in
excess of $100,000. Thus, the entire deduction is phased out at $150,000 of AGI.
To qualify for the $25,000 exception, a taxpayer must meet the following
requirements:31
• Actively participate in the real estate rental activity.
• Own 10 percent or more (in value) of all interests in the activity during the
entire taxable year (or shorter period during which the taxpayer held an interest
in the activity).
Order of allowance over 25000
first to the losses(including
real estate rental activity losses suspended in prior years)
then your credits in this order
(1) credits other than rehabilitation and low-income housing credits,
(2) rehabilitation credits, and (3) low-income housing credits.
Disposition of a Passive Activity by Gift
In a disposition of a taxpayer’s interest in a passive activity by gift, the suspended
losses are added to the basis of the property.
Installment Sale of a Passive Activity
An installment sale of a taxpayer’s entire interest in a passive activity triggers recognition
of the suspended losses.35 The losses are allowed in each year of the installment
obligation in the ratio that the gain recognized in each year bears to the total
gain on the sale.
Nontaxable Exchange of a Passive Activity
when this happens the suspended losses can be deducted either when it is sold or if the activity is the same as the previous owners then i can be deducted before the sale
investment interest
deduction for investment interest expense is limited to net investment income
Investment income
gross income from interest, dividends (see below), annuities,
and royalties not derived in the ordinary course of a trade or business.
The following types of income are not included in investment income unless the
taxpayer elects to do so.
• Net capital gain attributable to the disposition of (1) property producing the
types of income just enumerated or (2) property held for investment purposes.
• Qualified dividends that are taxed at the same marginal rate that is applicable
to a net capital gain.
Net investment income
the excess of investment income over investment
expenses.
Rental Exceptions to Passive Income
?
To qualify as a rental activity
the annual income must be at least two percent of the basis of the property
Chapter 12
here we go
Refundable Credits
Are paid to the taxpayer even if it exceeds their tax liability
Taxes withheld on wages
Earned income credit
Non-Refundable Credits
Are not paid if they exceed the taxpayer’s liability
Credit for child and dependent care expenses
Credit for elderly or disabled
Adoption expenses credit
Child tax credit*
Education tax credits**
Credit for certain retirement plan contributions
Foreign tax credit
General business credit, which includes the following:
• Tax credit for rehabilitation expenditures
• Work opportunity tax credit
• Research activities credit
• Low-income housing credit
• Disabled access credit
• Credit for small employer pension plan startup costs
• Credit for employer-provided child care
general business credit
carried back one year and carried forward twenty years
2. limited to tentative minimum tax and 25% of regular tax liability that exceeds 25000
rehabilitation
expenditures credit
Taxpayers are allowed a tax credit for expenditures incurred to rehabilitate industrial
and commercial buildings and certified historic structures.
10% Nonresidential buildings and residential rental property,
other than certified historic structures, originally
placed in service before 1936
20% Nonresidential and residential certified historic
structures
recapture on rehabilitation credit
based on a holding period requirement of five years and is
added to the taxpayer’s regular tax liability in the recapture year.The recapture
amount also is added to the adjusted basis of the property for purposes of determining
gain or loss realized upon disposition.
If the Property Is Held for The Recapture Percentage Is
Less than 1 year 100
One year or more but less than 2 years 80
Two years or more but less than 3 years 60
Three years or more but less than 4 years 40
Four years or more but less than 5 years 20
Five years or more 0
substantially rehabilitated qualifications
if qualified rehabilitation expenditures exceed
the greater of:
• the adjusted basis of the property before the rehabilitation expenditures, or
• $5,000.
work opportunity tax credit
The credit generally is equal to 40 percent of the first $6,000 of wages (per eligible
employee) for the first 12 months of employment. If the credit is taken, the
employer’s tax deduction for wages is reduced by the amount of the credit.
Computation of the Work Opportunity Tax Credit: Qualified Summer
Youth Employees
The credit for qualified summer youth employees is allowed on wages for services
during any 90-day period between May 1 and September 15.8 The maximum wages
eligible for the credit are $3,000 per summer youth employee.
A qualified summer youth employee must be age 16 or 17 on the hiring date. In addition,
the individual’s principal place of abode must be within an empowerment
zone, enterprise community, or renewal community.
Computation of the Work Opportunity Tax Credit: Long-Term
Family Assistance Recipient
The credit is equal to 40 percent of the first $10,000 of qualified wages paid to
an employee in the first year of employment, plus 50 percent of the first $10,000 of
qualified wages paid in the second year of employment, resulting in a maximum
credit per qualified employee of $9,000 [$4,000 (year 1) + $5,000 (year 2)].
research activities credit
20 percent of the excess of qualified
research expenses for the taxable year over the base amount.
research not qualified
Research conducted after the beginning of commercial production of the
business component.
• Surveys and studies such as market research, testing, or routine data collection.
• Research conducted outside the United States (other than research undertaken
in Puerto Rico or possessions of the United States).
• Research in the social sciences, arts, or humanities.
Computation of the Work Opportunity Tax Credit: Qualified Summer
Youth Employees
The credit for qualified summer youth employees is allowed on wages for services
during any 90-day period between May 1 and September 15.8 The maximum wages
eligible for the credit are $3,000 per summer youth employee.
A qualified summer youth employee must be age 16 or 17 on the hiring date. In addition,
the individual’s principal place of abode must be within an empowerment
zone, enterprise community, or renewal community.
Computation of the Work Opportunity Tax Credit: Long-Term
Family Assistance Recipient
The credit is equal to 40 percent of the first $10,000 of qualified wages paid to
an employee in the first year of employment, plus 50 percent of the first $10,000 of
qualified wages paid in the second year of employment, resulting in a maximum
credit per qualified employee of $9,000 [$4,000 (year 1) + $5,000 (year 2)].
research activities credit
20 percent of the excess of qualified
research expenses for the taxable year over the base amount.
Computation of the Work Opportunity Tax Credit: Qualified Summer
Youth Employees
The credit for qualified summer youth employees is allowed on wages for services
during any 90-day period between May 1 and September 15.8 The maximum wages
eligible for the credit are $3,000 per summer youth employee.
A qualified summer youth employee must be age 16 or 17 on the hiring date. In addition,
the individual’s principal place of abode must be within an empowerment
zone, enterprise community, or renewal community.
Computation of the Work Opportunity Tax Credit: Long-Term
Family Assistance Recipient
The credit is equal to 40 percent of the first $10,000 of qualified wages paid to
an employee in the first year of employment, plus 50 percent of the first $10,000 of
qualified wages paid in the second year of employment, resulting in a maximum
credit per qualified employee of $9,000 [$4,000 (year 1) + $5,000 (year 2)].
research activities credit
20 percent of the excess of qualified
research expenses for the taxable year over the base amount.
low-income housing credit
credit given to land lords who rent to low income families
disabled access credit
The credit is
calculated at the rate of 50 percent of the eligible expenditures that exceed $250
but do not exceed $10,250. Thus, the maximum amount for the credit is $5,000
($10,000 × 50%).17
An eligible small business is one that during the previous year either had gross
receipts of $1 million or less or had no more than 30 full-time employees. You cannot deduct any amount recovered by the credit
credit for small employer pension plan startup costs
The maximum credit is $500 (based on a maximum $1,000 of qualifying
expenses), and the deduction for the startup costs incurred is reduced by the
amount of the credit.
credit for employer-provided child care
limited annually
to $150,000, is composed of the aggregate of two components: 25 percent of qualified
child care expenses and 10 percent of qualified child care resource and referral
services.
earned income credit,
In addition to being available for taxpayers with qualifying children, the earned
income credit is available to certain workers without children.23 However, this provision
is available only to taxpayers ages 25 through 64 who cannot be claimed as a
dependent on another taxpayer’s return.For 2012, the maximum earned income credit is $3,169 for a taxpayer with
one qualifying child, $5,236 for a taxpayer with two qualifying children, and
$5,891 for a taxpayer with three or more qualifying children. A taxpayer with no
qualifying children can qualify for an earned income credit up to a maximum of
$475. The credit is available for a taxpayer who is married filing jointly, single, or
as a head of household. The credit phases out to zero as earned income increases
from about $22,000 to about $50,000.
tax credit for the elderly or disabled
• Taxpayers age 65 or older.
• Taxpayers under age 65 who are retired with a permanent and total disability
and who have disability income from a public or private employer on account
of the disability. A person generally is considered permanently and totally disabled
if he or she is unable to engage in any substantial gainful activity due to
a physical or mental impairment for a period of at least 12 months (or lesser
period if the disability results in death).
The maximum allowable credit is $1,125 (15% × $7,500 of qualifying income),
but the credit is less for a taxpayer who receives Social Security benefits or records
AGI exceeding specified amounts. Most taxpayers receive Social Security benefits
or report AGI high enough to reduce the base for the credit to zero.
foreign tax credit (FTC)
provides
a direct offset against the U.S. tax liability.
american opportunity credit
The American Opportunity credit permits a maximum credit of $2,500 per year (100
percent of the first $2,000 of tuition expenses plus 25 percent of the next $2,000 of
tuition expenses) for the first four years of postsecondary education.
The American Opportunity credit amount is phased out, beginning when the
taxpayer’s AGI (modified for this purpose) reaches $80,000 ($160,000 for married
taxpayers filing jointly).
40% is refundable
The lifetime
learning credit
permits a credit of 20 percent of qualifying expenses (up to $10,000
per year) incurred in a year in which the American Opportunity credit is not claimed
with respect to a given student.
The lifetime learning credit amount is phased out, beginning when the taxpayer’s
AGI (modified for this purpose) reaches $52,000 ($104,000 for married taxpayers
filing jointly).43 The reduction is equal to the extent to which AGI exceeds
$52,000 (or $104,000) as a percentage of a $10,000 ($20,000 for married filing
jointly) phaseout range. The credit thus is eliminated when AGI reaches $62,000
($124,000 for married filing jointly).
low-income housing credit
credit given to land lords who rent to low income families
disabled access credit
The credit is
calculated at the rate of 50 percent of the eligible expenditures that exceed $250
but do not exceed $10,250. Thus, the maximum amount for the credit is $5,000
($10,000 × 50%).17
An eligible small business is one that during the previous year either had gross
receipts of $1 million or less or had no more than 30 full-time employees. You cannot deduct any amount recovered by the credit
credit for small employer pension plan startup costs
The maximum credit is $500 (based on a maximum $1,000 of qualifying
expenses), and the deduction for the startup costs incurred is reduced by the
amount of the credit.
credit for employer-provided child care
limited annually
to $150,000, is composed of the aggregate of two components: 25 percent of qualified
child care expenses and 10 percent of qualified child care resource and referral
services.
earned income credit,
In addition to being available for taxpayers with qualifying children, the earned
income credit is available to certain workers without children.23 However, this provision
is available only to taxpayers ages 25 through 64 who cannot be claimed as a
dependent on another taxpayer’s return.For 2012, the maximum earned income credit is $3,169 for a taxpayer with
one qualifying child, $5,236 for a taxpayer with two qualifying children, and
$5,891 for a taxpayer with three or more qualifying children. A taxpayer with no
qualifying children can qualify for an earned income credit up to a maximum of
$475. The credit is available for a taxpayer who is married filing jointly, single, or
as a head of household. The credit phases out to zero as earned income increases
from about $22,000 to about $50,000.
tax credit for the elderly or disabled
• Taxpayers age 65 or older.
• Taxpayers under age 65 who are retired with a permanent and total disability
and who have disability income from a public or private employer on account
of the disability. A person generally is considered permanently and totally disabled
if he or she is unable to engage in any substantial gainful activity due to
a physical or mental impairment for a period of at least 12 months (or lesser
period if the disability results in death).
The maximum allowable credit is $1,125 (15% × $7,500 of qualifying income),
but the credit is less for a taxpayer who receives Social Security benefits or records
AGI exceeding specified amounts. Most taxpayers receive Social Security benefits
or report AGI high enough to reduce the base for the credit to zero.
foreign tax credit (FTC)
provides
a direct offset against the U.S. tax liability.
american opportunity credit
The American Opportunity credit permits a maximum credit of $2,500 per year (100
percent of the first $2,000 of tuition expenses plus 25 percent of the next $2,000 of
tuition expenses) for the first four years of postsecondary education.
The American Opportunity credit amount is phased out, beginning when the
taxpayer’s AGI (modified for this purpose) reaches $80,000 ($160,000 for married
taxpayers filing jointly).
40% is refundable
The lifetime
learning credit
permits a credit of 20 percent of qualifying expenses (up to $10,000
per year) incurred in a year in which the American Opportunity credit is not claimed
with respect to a given student.
The lifetime learning credit amount is phased out, beginning when the taxpayer’s
AGI (modified for this purpose) reaches $52,000 ($104,000 for married taxpayers
filing jointly).43 The reduction is equal to the extent to which AGI exceeds
$52,000 (or $104,000) as a percentage of a $10,000 ($20,000 for married filing
jointly) phaseout range. The credit thus is eliminated when AGI reaches $62,000
($124,000 for married filing jointly).
low-income housing credit
credit given to land lords who rent to low income families
disabled access credit
The credit is
calculated at the rate of 50 percent of the eligible expenditures that exceed $250
but do not exceed $10,250. Thus, the maximum amount for the credit is $5,000
($10,000 × 50%).17
An eligible small business is one that during the previous year either had gross
receipts of $1 million or less or had no more than 30 full-time employees. You cannot deduct any amount recovered by the credit
credit for small employer pension plan startup costs
The maximum credit is $500 (based on a maximum $1,000 of qualifying
expenses), and the deduction for the startup costs incurred is reduced by the
amount of the credit.
credit for employer-provided child care
limited annually
to $150,000, is composed of the aggregate of two components: 25 percent of qualified
child care expenses and 10 percent of qualified child care resource and referral
services.
earned income credit,
In addition to being available for taxpayers with qualifying children, the earned
income credit is available to certain workers without children.23 However, this provision
is available only to taxpayers ages 25 through 64 who cannot be claimed as a
dependent on another taxpayer’s return.For 2012, the maximum earned income credit is $3,169 for a taxpayer with
one qualifying child, $5,236 for a taxpayer with two qualifying children, and
$5,891 for a taxpayer with three or more qualifying children. A taxpayer with no
qualifying children can qualify for an earned income credit up to a maximum of
$475. The credit is available for a taxpayer who is married filing jointly, single, or
as a head of household. The credit phases out to zero as earned income increases
from about $22,000 to about $50,000.
tax credit for the elderly or disabled
• Taxpayers age 65 or older.
• Taxpayers under age 65 who are retired with a permanent and total disability
and who have disability income from a public or private employer on account
of the disability. A person generally is considered permanently and totally disabled
if he or she is unable to engage in any substantial gainful activity due to
a physical or mental impairment for a period of at least 12 months (or lesser
period if the disability results in death).
The maximum allowable credit is $1,125 (15% × $7,500 of qualifying income),
but the credit is less for a taxpayer who receives Social Security benefits or records
AGI exceeding specified amounts. Most taxpayers receive Social Security benefits
or report AGI high enough to reduce the base for the credit to zero.
foreign tax credit (FTC)
provides
a direct offset against the U.S. tax liability.
american opportunity credit
The American Opportunity credit permits a maximum credit of $2,500 per year (100
percent of the first $2,000 of tuition expenses plus 25 percent of the next $2,000 of
tuition expenses) for the first four years of postsecondary education.
The American Opportunity credit amount is phased out, beginning when the
taxpayer’s AGI (modified for this purpose) reaches $80,000 ($160,000 for married
taxpayers filing jointly).
40% is refundable
The lifetime
learning credit
permits a credit of 20 percent of qualifying expenses (up to $10,000
per year) incurred in a year in which the American Opportunity credit is not claimed
with respect to a given student.
The lifetime learning credit amount is phased out, beginning when the taxpayer’s
AGI (modified for this purpose) reaches $52,000 ($104,000 for married taxpayers
filing jointly).43 The reduction is equal to the extent to which AGI exceeds
$52,000 (or $104,000) as a percentage of a $10,000 ($20,000 for married filing
jointly) phaseout range. The credit thus is eliminated when AGI reaches $62,000
($124,000 for married filing jointly).
