Federal Income Tax

Question 1

Gross Income Definition

Answer 1

Any economic benefit or any clearly realized accession to wealth

Question 2

Four Basic Principles: Realization

Answer 2

The increased or decreased value of an asset is not taken into account until it is REALIZED THROUGH THE SALE or other disposition of the asset

Question 3

Four Basic Principles: Non-Cash Receipts

Answer 3

Gross income includes the FMV of any property RECEIVED and the fair market value of any SERVICES RENDERED

Question 4

Four Basic Principles: Claim of Right

Answer 4

Property or funds received under a claim of right must be reported for tax purposes even though the taxpayer may later be required to return the property, funds or their equivalent.

Question 5

Is illegally acquired property or money taxable? + Examples

Answer 5

Yes, stolen, embezzled, or otherwise illegally acquired property or money is considered taxable income

Question 6

Tax Benefit Rule + Underlying Assumption for Unpaid Taxes

Answer 6

If a taxpayer takes a DEDUCTION in one year, and RECOVERS the property in a LATER year, the taxpayer has tax benefit income to the extent that the earlier deduction provided a TAX SAVINGS OR BENEFIT

Note: The underlying assumption is that the taxpayer received a tax benefit by reducing the amount of taxes he pays in year 1 of deduction

Question 7

Specific Rules: Alimony and Child Support

Answer 7

The person paying alimony does not receive a deduction and the person receiving alimony does not have to include it in income. Child support is treated the same way; i.e., the payor does not get a deduction for amounts paid and the recipient does not include the amounts received in gross income.

Question 8

Specific Rules: Prize and Awards + (1) Exception for Recognition Awards + (2) Exception for Employee Achievement Awards

Answer 8

Gross income includes the value of cash, property, or services received as a prize, award, or windfall

(1) Recognition awards excluded where: (i) the award is made in recognition of religious, charitable, or educational achievement, (ii) recipient was not involved with the selection process, (iii) no future services are required, and (iv) the award is turned over by the payor, at the direction of the recipient to a gov’t organization
(2) Employee Achievement Award excluded where: (i) value of the award is less than $400, (ii) award is for length of service or safety, (iii) presented at a meaningful presentation, (iv) not part of a disguised compensation

Question 9

Specific Rules: Gambling Winnings and Losses

Answer 9

Gambling winnings are included in gross income. Gambling losses may be used to offset gambling winning but only to the extent of the winnings.

Question 10

Special Rules: Cancellation of Indebtedness

Answer 10

The borrower has no gross income upon the initial RECEIPT of borrowed funds.

However, a taxpayer whose debt is cancelled or discharged at less than the full amount, has discharge of indebtedness income to the extent of the difference between the full amount of the obligation and the amount paid in satisfaction of the debt

Question 11

Special Rules: Cancellation of Indebtedness - Exceptions + Tip RIGed

Answer 11

A cancellation of indebtedness that is less than the full amount would have to pay the difference as taxable income, UNLESS:

1) Reduction or re-negotiation of a purchase price (If the discharge of debt is because of a reduction in purchase price of a sale of good)
2) Insolvency (If the discharge of the debt occurs when the taxpayer is INSOLVENT or BANKRUPT)
3) Gift (If the lender intends to discharge as a gift)

Question 12

Exclusion from Gross Income: Life Insurance Proceeds + Exception

Answer 12

GI does not include proceeds paid by reason of DEATH of the insured

Exception: When proceeds are paid in installments, ANY interest paid will be taxable

Question 13

Exclusion from Gross Income: Inheritance

Answer 13

GI does NOT include amounts received by bequest, devise or inheritance

Question 14

Exclusion from Gross Income: Gifts

Answer 14

GI DOES NOT include amounts received by gifts (meaning a transfer made out of detached and disinterested generosity)

Question 15

Exclusion from Gross Income: Tort Awards - Compensatory Damages + Punitive Damages

Answer 15

Compensatory: Damages received on account of physical, personal, or sickness from compensatory damages are NOT INCLUDABLE in GI (but emotional damages are)

Punitive: Punitive damages received in ANY context are includable in GI

Question 16

Employee-Related Exclusions: Receipts from Health and Accident Insurance

Answer 16

Value of employer provided health or accident insurance (i.e. premiums), reimbursements for medical expenses, and value of medical care received is NOT INCLUDED on GI

Question 17

Employee-Related Exclusions: Life Insurance

Answer 17

Taxpayers may EXCLUDE the value of the first $50,000 of employer provided group term life insurance.

Gross income must INCLUDE the value of any excess life insurance coverage provided by the employer

Question 18

Employee-Related Exclusions: Meals and Lodging

Answer 18

Employer provided meals and lodging EXCLUDED if: 1) provided for the convenience of the employer, 2) in-kind, 3) on the employer’s premises

Question 19

Employee-Related Exclusions: Other Tax-Free Fringe Benefits to Employees

Answer 19

1) De minimis (i.e. pads and pens)
2) No additional cost to employer
3) Qualified employee discounts
4) Contributions to qualified pension plans

Question 20

Qualified Scholarships

Answer 20

Scholarships for tuition, not for past or future services are excluded from GI

Question 21

Deductions: Above the Line Deductions Definition + Examples + What is the result after calculating GI and Above the Line Deductions?

Answer 21

Ordinary and necessary BUSINESS expenses (not for individuals) of usual and customary nature

Ex: business interest, depreciation, capital losses

Result: Adjusted Gross Income

Question 22

Deductions: Below the Line Deductions - When do you use itemized (non-business) deductions or standard deductions? + How much is the standard deduction? (Individual v. Couple)

Answer 22

If your total itemized (non-business) deductions exceed the standard deduction, you itemize and take the larger deduction, if they are less, you take the standard deduction

The standard deduction is $12k for an individual and $24k for married couples

Question 23

Deductions: Itemized Deductions - Home Mortgage Interest Limit

Answer 23

Taxpayers may deduct home mortgage interest on mortgages of up to $750k on a principal and a second personal residence

Question 24

Deductions: Itemized Deductions - State and Local Taxes Limit

Answer 24

State, local, or real estate taxes on property owned may be deducted up to $10,000

Question 25

Deductions: Itemized Deductions - Unreimbursed Casualty Losses

Answer 25

Not deductible UNLESS incurred in connection with a federally declared disaster (i.e. Hurricane Katrina)

Question 26

Deductions: Itemized Deductions - Unreimbursed Medical Expenses AGI Limit

Answer 26

Deductible to the extent they exceed 10% of AGI

Question 27

Deductions: Itemized Deductions - Charitable Contributions AGI Limit + What are qualified charities?

Answer 27

Taxpayers may deduct the FMV of property and the amount of cash contributed to qualified charities up to 60% of AGI

A qualified charity is a 501(c)(3) or

Question 28

Deductions: Itemized Deductions - Home Office Expense Rule

Answer 28

Expenses incurred in maintaining a home office are DEDUCTIBLE if the space is used EXCLUSIVELY for business on a REGULAR basis

Question 29

Deductions: Itemized Deductions - Investment Fees or Expenses Rule

Answer 29

Taxpayers may deduct the fees or expenses that were necessary to GENERATE TAXABLE INCOME

Question 30

Allocation: Assignment of Income Rule

Answer 30

Income must be taxed to he or she who EARNS it

Question 31

Allocation: Who is taxed from investment income on property?

Answer 31

The OWNER of the property is taxed

Question 32

When is it income?: Cash Method of Accounting

Answer 32

A cash method taxpayer reports income when she ACTUALLY RECEIVES the payment, and takes a deduction for eligible expenses when ACTUALLY MADE.

Question 33

When is it income?: Constructive Receipt Rule

Answer 33

A taxpayer has “constructive receipt” when funds or property are CREDITED to her account, set apart, or otherwise made available so that she may draw upon them

Question 34

When is it income?: Income in Respect of a Decedent (IRD)

Answer 34

If payment is received by an estate after D’s death, the executor must report the income on the ESTATE’S TAX RETURN, not his personal

Question 35

When is it income?: Accrual Method of Accounting

Answer 35

Reports income and deductions when ALL EVENTS have occurred that fix the RIGHT to receive it, and when the amount can be determined with REASONABLE ACCURACY

Question 36

Gains and Losses on Disposition of Property Rule

Answer 36

Whenever a gain is REALIZED (sale, disposition, or exchange) it must be RECOGNIZED for tax purposes

Question 37

Basic Sale Formula + Define Amount Realized

Answer 37

Amount Realized - Adjusted Basis = Gain (or Loss)

AR: Money received, plus the FMV of property or services received, plus mortgages or liabilities to which the property sold is subject or which the buyer assumes

Question 38

Cost Basis Rule

Answer 38

A taxpayer’s basis in property acquired by purchase is generally the COST OF THE PROPERTY, including money paid and borrowing incurred in connection with the purchase

Question 39

Adjusted Basis Rule

Answer 39

Equal to the cost basis of such property PLUS improvements or renovations

Question 40

Divorce Property Settlements Rule

Answer 40

A transfer of property between spouses (or Exes) incident to divorce is NOT
A TAXABLE EVENT to either party, and the spouse receiving will have the same basis the donor had

Question 41

Basis in Gift Property

Answer 41

The recipient of a gift takes the DONORS basis

Question 42

Basis in Inherited Property

Answer 42

The recipient’s basis in inherited property is the FMV of the property at the DATE OF DECEDENT’S DEATH

Question 43

1031 Exchanges or Like-Kind Exchanges Rule + Remember Timeline

Answer 43

No gain or loss is recognized when a taxpayer exchanges REAL PROPERTY held for productive use in a business or for investment for like-kind property also held for productive use in business or for investment

Remember, gain is DEFERRED, not forgiven, and must occur within 18 months of each other

Question 44

Involuntary Conversion Rule

Answer 44

No gain or loss is recognized if property INVOLUNTARY to theft, fire, seizure, is converted into property that is “similar or related in service or use”

Question 45

Sale of Principal Resident Rule + Remember Within 2 Years Exception

Answer 45

Up to $250k of gain from the sale of a principal residence can be excluded if the property has been used and owned as the taxpayer’s PRINCIPAL for periods AGGREGATING two years during the five-years before the date of sale

Remember: This exclusion CANNOT be available if the taxpayer has used it within 2 years

Question 46

Character of Income: Ordinary v. Capital Gains - Define + Which rate is higher?

Answer 46

Capital Gains: A gain from a capital asset (e.g.stocks, bonds, real estate for investment)

Ordinary Income: Salary, rents, interest, royalties

The top marginal tax rate on most long-term capital gains is LOWER than the top marginal rate on ORDINARY INCOME

Top marginal rate on long term capital gains is 20%. The top marginal rate on ordinary income is 37.0%. Long term means held for more than 1 year