EA Individuals Review - Part 2 Flashcards
Capital Gains and Losses
Items a taxpayer owns and uses for personal or investment purposes are capital assets, the net gains that result may be subject to tax at favorable capital gains tax rates. Losses from the sale of personal use property are not deductible. A gain on sale of personal use property may be taxable
Non-capital Assets
Assets held for business-use or created to earn revenue .
- Inventory
- Depreciable property used in a business
- Real property used in a business
- Self-produced copyrights, manuscripts, drawings, photographs, or artistic compositions
- Accts receivable or notes receivable acquired by a business
- Stocks and bonds held by professional securities dealers
- Business supplies
- Commodities and derivative financial instruments
Holding Period (Short term or Long term)
Affects tax treatment of capital gain or loss. Long term capital gains taxed lower than short term gains.
- Holding period for a gift is treated differently than purchased property
- Holding period for gift includes donor’s holding period (tacking on holding period)
- Inherited property is considered to have held it longer than 1 year regardless of how long property is actually held
Determining Capital Gain or Loss
Determined by comparing amount realized with the adjusted basis of property. Can deduct up to 3K (1500 for MFS) of net capital losses against ordinary income in a tax year. Unused losses in excess of the limit are carried over to later years. Amounts carried over retain their character as either long term or short term. A loss can be carried over indefinitely.
Worthless Securities
May choose to “abandon” a security that has lost entire value in order to take advantage of loss for tax purposes. Treated as though they were sold for zero dollars on last day of tax year. Unlike other losses, a taxpayer is allowed to amend a tax return for up to 7 yrs in order to claim a loss from worthless securities. More than double the usual 3 yr statue of limitations for amending returns.
Capital Gains from Mutual Funds
Regulated investment company created by pooling funds of investors to allow them to take advantage of a diversity of investments and professional management.
- Profits made are reported to its won shareholders as capital gain distributions on 1099 DIV
- Taxed at long term capital gains rates**
- If taxpayer disposes of shares that represent all or a portion of his investment in mutual fund itself Form 1099 B is issued
- Taxable gains or loss that result from sale or exchange of shares is reported in 1040, Sch D
Qualified Small Business Stock (QSBS)
- Loss is considered an ordinary loss, but any gain is a capital gain.
- Amounts that can be deducted as an ordinary loss against ordinary gross income are 50K for S, and 100K for MFJ
- Can exclude up to 50% of the gain from the sale or exchange of qualified small business stock held for more than 5 yrs.
Wash Sales
When an investor sells a security to claim a capital loss, only to repurchase again soon thereafter. Can’t deduct a loss on the sale of an investment if an identical investment was purchased 30 days before or after the sale.
- Buys identical security
- Acquires a substantially identical security in a taxable trade
- Acquires a contract or option to buy the identical security
Rules for wash sales don’t apply to Trades of Commodity, future contracts, and foreign currencies.
Home Sale Gain or Loss
Selling Price: Total amount received for home
Amt Realized: Selling price - Selling expenses
Basis: How taxpayer obtained home
Adjusted Basis: Taxpayer’s basis in home increased or decreased by certain amounts
Basis + Increases-Decreases = Adjusted Basis
IF amt is less than adjusted basis, difference is a loss. Loss on primary residence can never be deducted
Related Party Transactions
Rules to prevent related persons and entities from shuffling assets back and and forth to take improper losses
- 50% Control Rule: If a taxpayer controls more than 50% of a corp or partnership, any property transactions between taxpayer and business are subject to related party transaction rules.
Related Party Transactions Cont.
Loss is not deductible is the transaction is between taxpayer and following related parties:
- Members of immediate family
- Partnership or corporation that taxpayer controls
- Tax exempt or charitable organization controlled by taxpayer or member of family
- Losses on sales between certain closely relatted trusts or business entities controlled by same owners
Installment Sales
*** Refer to Unit 7, pg 118
Sale of property in which at least one payment is expected to be received after tax yr in which sale occurs.
Installment method can’t be used for stocks and bonds. If property is sold within 2 yrs of original sale, taxpayer will lose benefit of installment sale reporting.
Depreciation recapture
When a taxpayer disposes of certain types of property that have been depreciated, recapture requires that a taxpayer report all or a portion of the prior depreciation deductions as ordinary income in the yr of the sale.
Reporting Asset Sales
Capital gains and losses are reported using two forms
- Sch D (Reports gains or losses on sales and other capital gain distributions)
- Form 8949
Nonrecognition Property Transactions
Sale of Main Home
Like-kind exchanges
Involuntary Conversions
Sale of Main Home
May exclude the fain from the sale of main home
250K S
500K MFJ
Gain from sale of home that is not main home must be reported as income.
121 Exclusion
- Sold main home
- Meet ownership and use tests (during 5 yr period ending on date of the sale, taxpayer must have owned and lived in home for 2 yrs (24 mo or 730 days)
- Not have excluded gain in the 2 yrs prior to current sale of home
Different Rules for Married Homeowners (Sale of Main Home)
500K excluded if:
- MFJ
- Either spouse meets ownership test
- Both meet use test
- Neither excluded gain in 2 yrs prior to current sale of home
Unrelated Individuals (Sale of Main Home)
Unmarried couples/taxpayers who own a home together may take 250K exclusion individually if ownership tests are met
Deceased Spouse (Sale of Main Home)
Taxpayer is considered to have owned and lived in a home during any period of time that the spouse owned and lived in it as a main home (but can’t remarry at date of sale) Holding period tacked on - surviving spouse my exclude up to 500K even if home is old within 2 yrs. Also applies to a home that is transferred by a spouse in a divorce. Receiving spouse is considered to have owned home during any period of time transferor owned it.
Military Personnel Exceptions (Sale of Main Home)
5 Yr period can be suspended up to 10 yrs
Disability Exception (Sale of Main Home)
During 5 yr period before sale of home, if a taxpayer becomes physically or mentally unable to care for himself, he must have lived in home for 1 yr to qualify. Considered still to have lived in home even if forced to move to licensed facility
Reduced Exclusions
Taxpayers who do not meet ownership and use tests within prior two yr period may be able to claim a reduced exclusion if
Death/Divorce/Legal Separation
Health Reasons related to care
Unemployment/job exchange (50 Miles for new job)
Multiple births from same pregnancy
Damage to residence from disaster
Involuntary conversion of the property
Reduced Exclusions Cont.
Reduced exclusion amount equals full 250K or 500K(MFJ) multiplied by a fraction. Numerator is the shorter of:
- Period owned and used the home as a principal residence during 5 yr period ending on sale date
- Period b/t last sale for which taxpayer claimed exclusion and sale date for the home currently being sold
Denominator is 2 yrs or equivalents in months or days
(Full Exclusion amount x number of days (or months))/730 days or 24 months
Land Sales
Can’t exclude gain if only land is sold but not house, sale of vacant land does not qualify for 121 day exclusions. Gain from sale of vacant land that was used in connection with principal residence (land adjacent) may be excluded if the land sale occurs within 2 yrs or after sale of home.
Like-Kind Exchanges (Section 1031 Exchange)
Occurs when a taxpayer exchanges business or investment property for similar property. Does not pay tax on resulting gain and can’t deduct a loss until property is disposed.
- Must be held fr investment or for productive use in a business
- Must not be “held primarily for sale: aka inventory
- Must be an actual exchange of two or more assets or properties
- Must be received within 45 days after date of transfer
If to be received later:
- 180th day
- Due date including extensions of the tax return for the yr in which transfer occurs
Must be a trade of real property to real property or personal property to personal property
Non-qualifying Exchanges
Exchanges of equipment or business assets that are used within the US for similar items outside US are not considered an exchange of qualifying like-kind property. Applies to real estate outside US too - does not apply as well as the following:
- Livestock
- Securities
- Currency
- Partnership Interests
Taxable Exchanges
If property is received in exchange for other property not similar or related in use to property exchanged, taxpayer may need to recognize gain if FMV of property received is greater than adjusted basis of property exchanged.
Boot
Used to describe cash or other property added to an exchange in order to compensate for difference in values of properties traded. If liability is transferrered, its treated as if transfer was cash and considered boot by party relieved of liability
Related Party Transactions
Like-kind exchanges are allowed between related parties, including family members. if property is disposed within 2 years after exchange, then exchange is disqualified
Does not apply if:
- One of the involved parties dies
- Property is subsequently converted in an involuntary exchange (fire/flood)
- Can be established to satisfactions of IRS that the exchange and disposition were not done mainly for tax avoidance purposes.
Involuntary Conversions (1033)
Occurs when a taxpayers’s property is lost, damaged, or destroyed and the taxpayer receives an award, insurance money or some other type of payments, as a result of
Casualty or theft
Disaster
Condemnation
Threat of Condemnation
A taxpayer can’t deduct a loss form an involuntary conversion of personal-use property unless loss resulted from casualty or theft
Replacement Period
Replacement period for an involuntary conversion generally ends two years after the end of the first tax year in which any part of the gain is realized.
Most property - 2 yrs
Real Property held for investment or business use, such as residential rentals and office buildings - 3 yrs
Sale of livestock due to weather-related conditions - 4 yrs
Main home in federally-declared disaster area - 4 to 5 yrs
Replacement Period Cont.
IF a taxpayer reinvests in replacement property similar to the converted property, the replacement property’s basis is the same as the converted property’s basis on the date of the conversion, subject to the following adjustments:
The basis is decreased by the following:
- Any loss a taxpayer recognizes on the involuntary conversion
Any money a taxpayer receives that he does not spend on similar property
Basis is increased by:
Any gain a taxpayer recognizes on the involuntary conversion
Any additional costs of acquiring the replacement property
Condemnations
Type of involuntary conversion. Condemnation is the process by which private property is taken from its owner for public use. The property may be taken by the gov’t or by a private organization that has the legal power to seize it. Owner generally receives a condemnation award in exchange for the property that is taken. Like a forced sale, with the owner being the seller and the gov’t being the buyer.
Condemnation of a Main Home
If a taxpayer has a gain because his main home is condemned, he can generally exclude the gain as if he had sold the home under section 121 exclusion. S Filers can exclude up to 250K of the gain and MFJ up to 500K
Rental Income
Any payment received for the use of occupation of property.
Advance Rent - Must report when constructively received
Lease Cancellation - Amount received for cancellation is rental income and included in yr received
Security Deposits - Not income upon initial receipt, amount can be recognized in yr forfeited by tenant
Property of Services in Lieu of Rent - FMV of service must be regarded as rental income
Insurance Premiums Paid in Advance - Can only deduct part of premium payment that applies to that year, not any part of the payment that is for an advance
Local Benefit Taxes - Can’t deduct charges for taxes that increase value of property (Sidewalks, etc)
Vacant Property - Can’t deduct a loss for vacant property
Depreciation of Rental Property
*Cost of land never depreciates
Deprciable Basis = Purchase Price (less land cost) + Cost of Improvements
Repairs vs Improvements
Repairs are deductible, Improvements are not. Materials costing less than 200$ are deductible in year used or consumed
Rental Rules
Tax Treatment of rental income, expenses, and losses
- Passive Activity Limits: Can’t deduct losses from passive activities to offset nonpassive income, but when a taxpayer actively participates in rental activity, he may be able to deduct 25K of losses against nonpassive income. Taxpayer must own at least 10% of property
- Modified Adjusted Gross Income (MAGI) - Taxpayer’s AGI with certain deductions added back in. For every 2$ by which MAGI exceeds 100K, allowance is reduced by 1$. If MAGI is 150K or more (75K MFS), the 25K allowance is fully phased out*
- Real Estate Professionals: Losses are fully deductible, owners of hotels and apartment buildings
- Not Rented for Profit: Can deduct rental expenses only to amount of rental income
- Renting Part of Property: Must divide certain expenses between part of the property used for rent and used personally (number of rooms in house or sq footage)
- Personal Use Dwelling Unit: Has a residence and uses it personally sometimes and rents it out at other times. Considered a home if used for 14 days or 10% of the total days it is rented. Personal days are counted when taxpayer or member of family uses property, anyone uses property at less than fair rental price, property is donated to charity. Any days taxpayer spends working on repairs is not counted as personal use.
- Minimal rental use: Rents main home for fewer than 15 days, income is not taxable, and can’t deduct any rental expenses
- Converting to Rental Use: Changes home to rental use at any time other than beginning of tax year, expenses between rental use and personal use must be divided. Rental expenses can be deducted only for portion that is for part of the year that property was rented.
Royalty Income
Copyrights, patents, oil, gas, and mineral properties are taxable as ordinary income. Based on number of units sold.
Taxable Recoveries
Return of an amount a taxpayer deducted or took a credit for in an earlier year - reimbursements. Refunds of federal income taxes are not included bc they are never allowed as a deduction.
Alimony
Taxable income to recipient and deductible by payer.
- The divorce agmt may not include a clause indicating that the payment is something else
- Spouses can’t live together when payments are made
- Payer must have no liability to make any payment after death of former spouse
Does not include:
- Payments that are a former spouse’s share of income from community property
- Payments to keep up the payer’s property
- Free use of payer’s property
- Noncash property settlements.
Gov’t Benefits
Social Security Benefits
- One Half of benefits plus
- All of his other income, including tax exempt interest
If sum is less than base amt for filing status, none of SS is taxable
Other Income
Includes items that do not have separately identified lines of 1040. Taxpayer is required to report this income
Cancellation of Debt Income
Taxpayer must include the debt forgiveness or cancellation of debt
Recourse Debt - Holds borrower personally liable for any amount not satisfied by the surrender of secured property (repossession)
Nonrecourse Debt - Type of loan that is secured by collateral in which borrower does not have liability for the loan (mortgage)
Nontaxable Canceled Debt
- Insolvency - Taxpayer is insolvent when his total debts are more than the FMV of his total assets.
- Bankruptcy
- Home Mortgage Debt
- Qualified Principal residence indebtedness*
- Cancellation of Student Loans
- Qualified Farm Indebtedness
- Canceled debt that is otherwise deductible
Gambling Winnings
- 600 or more
- 1200 or more from bingo/slots
- 1500 or more from keno
Gambling losses are deductible as a misc deduction, but limited to amount of winnings
Hobby Income
Determination of whether hobby is an activity for pleasure or for business. Not subject to SE tax and use of losses to offset income is limited. Expenses are deductible but only to amt of hobby income.
Court Awards and Damages
Generally taxable. Damages for emotional and physical distress are not included income. Emotional distress proceeds due unrelated physical injuries are taxable, but treatment is not
Prizes and Awards
Taxable unless prize is rejected.
Educational Assitance
Tax Free
- Scholarships and Fellowships
- Pell Grants
- Payment to Service Academy Cadets or Midshipmen
- Veteran’s Educational Benefits
- Qualified Tuition Programs (QTPS)
- Coverdell Education Savings Acct - taxable
Additional Line 21 Income Items
- Strike Benefits
- Jury Duty Pay
- Fees paid by an estate to personal rep/executor
- Gifts received by a host of party where sales were made
Bartering Income
Exchange of property or services without an exchange of cash. Taxable
Summary of Taxable Income
Taxable:
- Wages/Salaries/Tips/Bonuses/Vacation and Sick Pay/Severance/Commissions
- Interest Income (CDs, dvidends, etc)
- Gains from Sales of Properties, stocks and bonds
- Fees paid to an estate’s executor
- Alimony
- SS benefits
- Court awards
- Unemployment Compensation
- Barter/hobby income
- Certain distributions form Coverdell Savings acct
- Cancellation of debt
- Gambling winnings, prizes and awards
Summary of Nontaxable Income
Nontaxable:
- Fringe Benefits
- Interest on state/local bonds
- Life insurance proceeds
- Gifts/Inheritances
- Child support
- Welfare payments, food stamps, public assistance
- Compensation or court awards for physical injury/illness
- Worker’s compensation
- Combat pay and certain veteran’s benefits
- Scholarships, pell grants, employer-provided educational assistance
- Canceled debt from primary residence, bankruptcy, insolvency
- Certain employee awards for safety/achievement/service
Adjustments to Gross Income
“Below the Line” Deductions
Educator Expenses (23)
- Teacher/Instructor
- Counselor
- Principal
- Teacher’s aide
Can deduct up to 250$ of reimbursed expenses; college instructors do not apply
Certain Business Expenses of Reservists, Performing Artists, and Fee-Basis Gov’t Officials (24)
Allowed to claim specified work-related expenses as an adjustment to income, rather than a deduction of Sch A
Health Savings Acct Deduction (25)
To save funds intended to pay for health care expenses on a tax-preferred basis.
- Must not be enrolled in Medicare
- Can’t be claimed as a dependent
- Must be covered under a high deductible health plan and have no other health coverage
Can contribute up to 3300$ or (6550$ for MFJ). 55 and over can contribute an extra 1K, excess contributions subject to 6% penalty
Withdrawals of HSA for purposes other than payment or medical expenses are subject to 20% penalty unless
- 65 or older
- Becomes disabled
- Dies
Moving Expenses (26)
To claim deduction, move must be:
- Related to work/business
- Time and Distance test must be met
Moving Expenses Time Test
For Employees:
- Works full time at new work location for 39 weeks in first 12 months
Self Employed:
- Works full-time for 39 weeks in first 12 months, and at least 78 weeks within first 24 months in new location
Exceptions and can deduct moving expense:
- Military (change of station)
- Main job was outside of US and retired
- Taxpayer is surviving widow or person whose main job location at time of death was outside US
- Job at new location ends bc of death or disability
- Laid off or transferred for a reason other than misconduct
Exceptions for Seasonal Work and Temp Absences - off season must be less than six months
Moving Expenses Distance Test
New job must be at least 50 miles father from the old home than the old job location was from the old home
Qualifying Moving Expenses
- The Cost of packing and moving household
- Storage costs
- Cost of connecting/disconnecting utilities
- Cost of shipping a car/pet to new home
- Travel expenses (lodging not meals) one trip per person.
- Car expenses (23.5 cents per mile), parking fees, tolls
Nondeductible Moving Expenses
- Pre-move House hunting expenses, or temp living expenses
- Meals
Expenses of buying/selling home (home improvements) - Real Estate Taxes
- Car tags and driver’s license renewal feels
- Storage charges except those incurred in transit or for a foreign move
Reimbursements from employers for moves are excluded from income, but reimbursements for nondeductible expenses (breaking a lease) are taxable as wages
Deductible Part of SE Tax (27)
Can subtract 50% of SE tax equal to the amount of SS and Medicare taxes normally paid by an employer
Self-Employed Retirement Plans (28)
Can deduct contributions to:
- Simplified Employee Pensions (SEP) plans
- Savings Incentive Match Plan For Employees (SIMPLE) Plans
- Qualified Plans
Self-Employed Health Insurance Deduction (29)
Can deduct up to 100% of health insurance premium as an adjustment to income, can’t take deduction if he or spouse have been eligible to participate in an employer sponsored health insurance plan, even if they deny coverage
Penalty on Early Withdrawal of Savings (30)
If a withdrawal of money from a CD acct is made before maturity, a penalty is incurred for early withdrawal. The penalty charged can by adjusted to income. Penalty for early withdrawal from an IRA is not deductible
Alimony Paid (31)
Deductible expense for payer.
IRA Deduction (32)
Individual Retirement Arrangement (IRA) offers tax advantages for setting aside money for retirement. A deduction can be claimed for the amounts contributed to a traditional IRA as an adjustment to gross income
Amts that do not qualify are:
- Contributions to Roth IRA
- Contributions to a traditional IRA that are nondeductible bc of MAGI or employer-sponsored retirement plan
- Contributions that apply to the previous tax year
- Rollover contributions
Student Loan Interest Deduction (33)
Interest on a qualified student loan is deductible
- Interest on a student loan was paid
- Filing status is not MFS
- Neither he nor spouse can be claimed as a dependent
Max deduction is $2500 and phases out for MAGI with 130 and phases out completely for 160K (for S its 65 to 80)
Student must have been enrolled at least half-time in a higher education program leading to a degree. Not eligible if it is from certain related persons, and an employer plan do not qualify.
**See pg 178-179
Student Loan Interest Deduction Cont.
Can deduct tuition and expenses depending on MAGI
- 4K if MAGI is 65K or
Domestic Production Activities Deduction (35)
Available to manufacturing businesses that have employees in the US. Designed to stimulate domestic production
Other Adjustments (36)
Obscure deductions.
Standard Deduction
Specific dollar amount that reduces the amount of income on which a taxpayer is taxed. - S/MFS - 6,200 - MFJ/QW - 12,400 - HOH - 9,100 Additional amounts for - 65 and older and/or - Partially blind Standard deduction for a dependent who can be claimed on another person's return is limited to the greater of $1000 or the dependent's earned income (such as wages) plus $350, but not more than the regular standard deduction amount. For a single person, this is generally 6,200, higher if the dependent is 65 or older and/or blind
Itemized Deductions
Allow taxpayers to reduce their taxable income based on specific personal expenses. If the total itemized deductions are greater than the standard deduction amount, they will result in lower taxable income and a lower tax liability. Required to itemize if MFS and if one spouse itemizes, the other must; taxpayer is a nonresident or dual-status alien not married to US citizen, or if a taxpayer files a tax return for a period of less than 12 months due to a change in accounting methods
Limitations on Itemized Deductions
For higher income taxpayers, the limitation reduces the total amount of a higher income taxpayer's itemized deductions by the lesser of - 3% of the amount by which the taxpayers AGI exceeds a certain threshold Threshold amounts: MFJ/QW - 305, 050 HOH - 279,650 S - 254, 200 MFS - 152, 525 Limitation does not apply to: - Medical expenses - Investment interest expense - Casualty or theft losses - Gambling losses
Medical and Dental Expenses (Deductions)
Only deductible if a taxpayer itemizes deductions, and can only deduct the amount of unreimbursed medical expenses that exceeds 10% of the AGI. A taxpayer and his spouse if married, age 65 or over, can deduct the amount of unremibursed medical expenses that exceeds 7.5% of AGI rather than 10%. The 7.5% floor continues to apply if either spouse reaches age 65 by end of tax year.
Medical and Dental Expenses (Deductions )Cont.
Qualified Medical Expenses
- The taxpayer
- Taxpayer’s spouse
- Dependents
Include costs of medical treatments, not cosmetic
Deductible medical expenses (various expenses)
- Medical Insurance - Reimbursement for medical care are not deductible
- Long-Term Care Services - Limited by age, from $370 (40 and under) to $4660 (71 and older)
- Other Medical Expenses - Nursing homes
- Medical Expenses of Deceased Taxpayers - Can be deducted by executor of estate within one yr
- Cosmetic Surgery - Only deductible if it is used to correct a defect or disease
- Medically-Related Transportation, Meals and Lodging
- Capital Improvements for Medical Reasons
Taxes (Deductions)
Taxpayers can deduct certain taxes if they itemize deductions
- State and Local Taxes
- Real Estate Taxes
- Personal Property Taxes
- Foreign Income Taxes
Interest (Deductions)
Home Mortgage Interest Can't deduct mortgage interest on more than two homes, even though allowed to deduct real estate taxes on more than two homes. - Interest on Home Equity Debt - Points - Mortgage Insurance Premiums - Form 1098 ***Read pg 194-195
Investment Interest Expense
Interest paid on money borrowed for investment and may be deductible. Amount of interest expense one can deduct each year is limited to the amount of net investment income earned. Can carry forward any disallowed investment interest expense to the next year.
Nondeductible Interest and Investment Expenses
- Interest on personal loans
- Fees for credit cards/finance charges for nonbusiness credit card purchases
- Loan fees for services need to get a loan
Interest on a debt the taxpayer is not legally obligated to pay - Service charges
- Interest to purchase or carry tax-exempt securities
- Late payment charges paid to a public utility
- Expenses relating to stockholders meetings or investment-related seminars
- Interest expenses form single-premium life insurance
Interest incurred from borrowing gains an insurance policy - Short-sale expenses
- Fines and penalties paid to any gov’t entity for violations of the law
Charitable Contributions
Volunteer Expenses can’t be deducted
Exchange Students - some expenses can be deducted
Nonqualifying Organizations:
- Gifts to civic leagues, sports clubs
- Gifts to group run for personal profit
- Gifts to political groups, candidate, or political org
- Gifts to homeowners associations
- Cost of raffle
- Dues paid to country clubs
- Gifts and dues to labor unions
- Blood donated
- Any part of contribution that benefits the taxpayer, such as FMV of a meal eaten at charity dinner
Substantiation Requirements
Strict recordkeeping for deductions for charities - Cash donations of Less than 250 - Cash Donations of 250 or more - Noncash Contributions of Less than 250 - Noncash Donations of 250-500 - Noncash Donations over 500 - Noncash Donations over 5000 - Donated Motor Vehicles, Boats and Airplanes - Limits on Deductible Contributions - 50% Contribution Limit - 30% Limit and separate 30% Limit - 20% Limit Charitable Contribution Carryovers ***Read pgs 199-201
