Federal Personal Income Tax Flashcards
4 Essential Tax Questions
1) “Income”- what is “Income”?
2) To Whom- to Whom is it income?
3) When- When is it income?
4) Character- what is the “Character” of the income?
Gross Income- definition
Gross income- includes any economic benefit or any clearly realized accession to your wealth
1) Economic Benefit, or 2) Realized accession to one's wealth
“Gross Income”- 4 basic principles to
1) Realization
2) Non-cash Receipts
3) Claim of Right
4) Tax Benefit Rule
Realization - def.
The increased or decreased value of an asset is NOT taken into account for tax purposes UNTIL it is “realized” through the ‘sale’ OR other disposition of the asset.
- asset must be realized by sale or other disposition of it in order to be accounted for
Non-cash Receipts
Gross income includes fair market value of any property received and the fair market value of any services received
- Property, or - Services
Ex. If partners of law firm gives the summer associate who bills the most hours Eagles tickets, that associate must report that gross income
Claim of Right - def.
Taxpayer has received property or funds under a “claim of right” when they are received w/o RESTRICTION as to use or DISPOSITION
1) funds, or
2) property
Claim of Right - rule
Property or funds received under a “claim of right” must be reported for tax purposes, EVEN though taxpayer may later be required to return the property, funds, or other equivalent
Ex. If P sues Beyonce and the court orders Beyonce to pay royalties to the P, even though Beyonce plans to appeal, P must report the royalty as apart of her gross income in year 1.
Claim of Right - what’s the tax consequence if in the following year, the person loses their claim to the money or property acquired in the previous year? (i.e. if appeals court reverses trial court’s award for a P, P won’t have a right to the money paid to her in previous year)
- Deduction in year that it is repaid (i.e. for P)
- Don’t amend year 1 return
Claim of Right: Illegally Acquired Funds rule
- are considered taxable income? - rule
Yes.
R: Stolen, embezzled, or otherwise illegally acquired funds are considered taxable income
Tax Benefit Rule
- rule
- HOW MUCH- is the returned income?
If taxpayer takes deduction in 1 yr and RECOVERS the property that gave rise to the deduction in a LATER tax year, taxpayer has tax benefit income to the extent that the earlier deduction provided a tax savings or a tax benefit
How much: Amount of the prior deduction
Tax Benefit hypo
Y1: Manning donated property to charity valued at $150K and took deduction
Y2: unable to use the property, charity returns the property to Manning, and it’s now valued at $200K.
- Does Manning have income in Y2 from the return of this property?
- If so, how much
- Yes
- 150K$, amount of prior deduction
Alimony Rule
- rule
- receiving spouse
- paying spouse
unless otherwise provided in written agreement, alimony is taxable to the receiving spouse and deductible for paying spouse
1) receiving spouse–> taxed
2) paying spouse–> tax deductible
Alimony - 4 elements
1) Writing- must be pursuant to written divorce or separation agreement
- can’t be verbal promise even if kept
2) No living disallowed- cannot be members of same household
3) Cease At or Before DEATH: liability to make payments must cease at or before death
- Note: this is death of receiving spouse
- Note: if payed to estate, it’s not alimony
4) Cash: payments must be case or it’s equivalent
- Can’t be property
- i.e. check is sufficient
Child Support
1) is it taxable to the receiving spouse?
2) is it deductible for to paying spouse
1) No
2) No
Note: this is opposite of Alimony rule
Child Support in Disguise rule
if payment is reduced upon a contingency relating to a child, amount of the reduction is considered child support
- must relate to a child
- triggering event: look for a reduction
Child Support in Disguise - hypo
Under agreement Dad pays Mom 1,000,000$ per yr until the kid reaches age of 21. at that time, payment is reduced to 700K.
1) How much of this yearly payment should be considered child support?
2) How much should be considered alimony?
1) Amount of the reduction- 300K (Not taxable or deductible)
2) 700K (taxable or deductible)
Which must be paid first if $ is falling short, child support or alimony?
-rule
Child Obligation
R: where total payments for alimony and child support fall short, payments are considered first to be the child obligation.
Gross Income: Prizes and Awards rule
Gross Income includes - the value of cash, property, or services as a prize, award, or windfalls.
1- cash
2-property
3-services
4-windfallsGross Income: Gains or Losses from Gambling rule
1) Winnings- included are gross income
2) Losses - unless taxpayer is actively engaged in trade or business of gambling, gambling losses for taxable yr may be used only to extent of gains
–Net losses–> NO deduction (assuming not a pro)
–Net gains –> taxed
CHECK ON THIS
Cancellation of Indebtedness
- 2 parts
1) Borrow has no gross income upon initial receipt of borrowed funds
- borrowing is NOT a taxable event
2) However, a taxpayer whose debt is CANCELLED or DISCHARGED at less than full amount has discharged of indebtedness income to extent of the difference between the full amount of the obligation and the amount paid in satisfaction
- –When debt cancelled or discharged (i.e. paid off in full) –> taxed at that point
Cancellation of Indebtedness: 3 exceptions
memory device- the debt is RIGed
1) Reduction in Purchase Price
2) Insolvency
3) Gift
Cancellation of Indebtedness
1) Reduction in Purchase Price exception
- If “apparent” discharge of debt is really a reduction in purchase price in connect w/ sale of goods, discharge of indebtedness rules will apply (i.e. won’t have another taxable event)
- apparentness is key
- very fact specific- look for 1) purchase of goods, 2) negotiating
- ex. lecture p. 8
Cancellation of Indebtedness
2) Insolvency exception
- rule - main points (2):
Rule: if discharge occurs when taxpayer is bankrupt OR insolvent, there’s no immediate discharge of indebtedness income
main points:
- this is an exclusionary rule - excluded from gross income
- even though you have income–> no tax on these when bankrupt or insolvent
Cancellation of Indebtedness
3) Gift exception
Rule: If lender of gift intends the discharge as a gift, the discharge of indebtedness rules will not apply
- exclusionary rule - excluded from gross income
Exclusions- 5 main types/scenarios covered in lecture
Exclusions - mean excluded from personal gross income (i.e. won’t be taxed on these)
1) Life Insurance Proceeds
2) Inheritances
3) Gifts
4) Tort Awards
5) Employee-Related exclusions
Exclusion: LIFE INSURANCE PROCEEDS
-2 part
1) Proceeds paid at death - Gross income does not include proceeds paid by reason of DEATH of the insured
- Proceeds NOT taxed
however…
2) Proceeds Paid In Installments - when proceeds are paid in installments, any INTEREST paid will be taxable
- Interest from proceeds paid in installments ARE taxed
Exclusion: INHERITANCES
note: popular exam topic
- Gross income does NOT include amounts received by bequest, devise, or inheritance
watch for things received by “bequest” to make sure it’s really not “compensation” (b/c compensation is taxed)
Note: this still doesn’t meant it can’t be taxed under state laws
Exclusion: GIFTS
1-Definition
2-rule for taxation purposes
1- A gift is a transfer made out of “detached” and “disinterested” generosity.
- usually transfers made out of : love, affection, charity, or similar impulses are gifts
2- Gross income does NOT include amounts received by gift
Exclusion: TORT AWARDS
- do these rules apply to Settlements too?
- 3 rules
1) Physical Injuries
2) Emotional Injuries/Distress
3) Punitive Damages
Yes: these rules apply not just to awards, but ALSO to Settlements
1) Gross income does NOT include damages received on account of physical personal injuries
- Important: As long as underlying tort is a physical tort/injury claim–> NOT Taxed
- ex. emotional distress as a result of car crash–not taxed
2) By themselves, damages for emotional distress are not considered damages received on account of physical injuries–> Taxable
3) Punitive damages received in connect w/ personal injuries are taxable
- Important: even if they arise in personal injury claim–> still taxable
Exclusion: Employee-Related exclusions
-5 mentioned from the lecture
1) Receipts from Health and Accident Insurance
2) Life Insurance Provided by or Through an Employer
3) Meals and Lodging
4) Qualified Scholarships
5) Tax-Free Fringe Benefits to Employees (several)
Employee-Related exclusion:
Receipts from Health and Accident Insurance
Two rules
1) General rule
2) Health Insurance Reimbursements
1) value of employer provided health or accident insurance coverage paid by the employer ARE excluded
- employer (ER) must pay for it
- Ex. Premiums
- this includes value of the insurance even if you don’t use it
2) Health Insurance Reimbursements- for medical expenses actually incurred are also excluded from gross income
- reimbursement required
- expenses must have actually incurred
Employee-Related exclusion:
Life Insurance Provided by or Through an Employer
1) Excluded from gross income tax
2) Included in gross income tax
1) Exclude- Taxpayer may exclude value of first $50K of employer-provided group term life insurance
2) Included- includes the value of any excess life insurance coverage provide by the ER
Employee-Related exclusion:
Meals and Lodging - 3 elements
Employer provided meals and lodging excluded if:
1) Convenience- provided for the convenience of the ER;
AND
2) In-Kind = must actually provide the meals and lodging;
-Not just giving you $ for them and you don’t spend them
AND
3) on the ER’s premises
Employee-Related exclusion:
Qualified Scholarships
- rule - 2 elements (first one has 3 sub-rules)
rule: Qualified scholarships for TUITION are excluded from gross income
1) “Qualified” - (3)
a) must not be payment for past or future services (i.e. so ER can’t condition the scholarship for staying with company)
b) it must be primarily for benefit of the individual c) Merit-based scholarships/these types only apply; not athletic
2) TUITION- only can be excluded
- Not room and board
- Not personal living expenses
Employee-Related exclusion:
Other Tax-Free Fringe Benefits to Employees (5)
1) De Minimus - i.e. coffee, pens or pencils for personal use of EEs
2) No Additional Cost to the Employer - i.e. airline may offer tickets to EEs on a standby basis for seats that otherwise would have been empty
- Note: if this wasn’t for standby, a customer could have bought the ticket, so it wouldn’t be excluded if that had occured
3) Qualified Employee Discounts - certain discounts offered to EE on goods or services ordinarily sold to the public
4) Contributions to Qualified Pension Plans
- Contributions = $ put into the plan; EE taxed for taking them out
5) Employee Safety or Length of Service Award - see next card
Employee-Related exclusion: Other Tax-Free Fringe Benefits to Employees
Employee Safety or Length of Service Award
-3 elements
Not taxed if these are met
1) Tangible personally property- can’t be cash
2) Value of property must not be worth more than 400$;
3) Meaningful Presentation- award must be presented as apart of a meaningful presentation
Deductions- 2 kinds
I. Above-the-line
II. “Itemized” or Standard Deduction
Deductible = not accounted for as personal income, so the more you deduct, the less personal income you have, and there is less $/value to tax.
Above-the-line deductions
6 main types
1) Ordinary and Necessary Business Expenses
2) Depreciation
3) Capital Losses
4) Alimony
5) Moving Expenses
6) Limited Deduction for School Loan Interest
Above-the-line: Ordinary and Necessary Business Expenses
1) -Ordinary and Necessary Business expense rule
2) Business Interest
3) Business Taxes
1- all necessary and ordinary expenses paid or incurred in carrying on a trade or business are deductible
- must be customary, and usual in ordinary trade of business - Excessive portion of excessive salaries is NOT deductible (i.e. a CEO's salary)
2) Yes- Deducted from Personal Income
- this allows people to take out loans and/or start a business
- i.e. borrowing $ for the business will be deducted, but it won’t be when they reimburse whoever they got the loan from.
3) Yes- Deducted from Personal Income, EXCEPT federal taxes
Above-the-line: Depreciation
Deducted from gross personal income as long as: (1)
1) must be a business or investment; NOT personal assets
- Not personal assets
Above-the-line: Capital Losses
2 requirements
Deducted from gross personal income if:
1) Max- up to a maximum of 3,000$,
and
2) Net - must be “net” capital loss (i.e. selling stock at a loss)
Above-the-line: ALIMONY
-who can take deduction?
popular exam subject
Payor
Above-the-line: Moving Expenses
- rule
- elements (2)
-Moving expenses can be deducted if incurred in DIRECT connection with establishing a new principle place of work
1) Direct Connection, AND
2) Est. Principle place of work
-Ex. meals along the way of the move are indirect expenses- not deductible
Itemized (Non-Business) Deductions - 10 listed types
1-Home Mortgage Interest 2-State and Local Taxes 3-Unreimbursed Casualty Losses 4-Unreimbursed Medical Expenses 5-Charitable Contributions 6-Miscellaneous Deductions 7-Personal v. Business Expenses - legal fees 8-Home Office Deductions 9-Investment Fees or Expenses 10-Exemptions
Itemized (Non-Business) Deductions: Home Mortgage Interest
- Max Dollar amount requirement
- Mortgages for how many homes/residences?
“Home Equity Loan” rule/ amount
-Home Mortgage Interest- taxpayers can deduct home mortgage interest on mortgages of up 1,000,000$ (in the aggregate on a principle and second personal residence
- “Home Equity Loan”- deductible up to 1,000,000$
- Can use this loan for anything (i.e. consolidating other debts w/ this and paying them off as well)
- Personal interest is NOT deductible (i.e. consumer stuff, paying credit card debts)
-note: talking about acquisition of property here
Itemized (Non-Business) Deductions: State and Local Taxes
Deductible?
Exception?
- Deductible (i.e. paid to state and local gov’ts)
- Exception- state sales tax isn’t deductible
Itemized (Non-Business) Deductions: Unreimbursed Casualty Losses
3/4 elements
-AGI % limit?
Deductible if:
1) Loss is greater than 100$,
2) Loss is Sudden and Unexpected, AND
- ex. firestorm, theft
3) Exceed 10% of AGI- only to the extent that losses (in aggregate) exceed 10% of AGI
- only extraordinary losses can be excluded
4) Remember, this must be unreimbursed
AGI= Adjusted Gross Income
Itemized (Non-Business) Deductions: Unreimbursed Medical Expenses
-AGI % limit?
Deductible only to the extent that losses (in aggregate) exceed 10% of AGI
Ex. out of pocket medical premiums, co-pays, home changes to make it handicap accessible
Itemized (Non-Business) Deductions: Charitable Contributions
may deduct FMV of property and amount of cash contributed to qualified charities
Note: applies to property and cash; not time (i.e. lawyers)
Itemized (Non-Business) Deductions: Miscellaneous Deductions
Rule- AGI % limit?
Unreimbursed Employee Business Expenses, Certain Educational Expenses - what’s the added requirement under these circumstances???
Rule: may deduct eligible miscellaneous deductions to extent that (in aggregate) they exceed 2% of AGI
- AGI limit- exceed 2%
- Unreimbursed Employee Business Expenses: must be necessary to maintain and improve skills needed in the taxpayers CURRENT trade or business
Itemized (Non-Business) Deductions: Personal v. Business Expenses- legal fees
Legal fees- are the deducible for?
1-Personal expenses (generally)
2-Business/investment expenses
3- Divorce Setting expenses
Exceptions (2)
General Rule: Personal expenses- not deductible
1) incurred in personal setting - not deductible
2) incurred in a business or investment setting- deductible
3) divorce OR separation –considered personal –> NOT deductible
Exceptions (divorce OR separation)
1) Tax advice- Portion of legal fee to either party that is “attributable to tax advice” is deductible
2) Alimony- recipient spouse may deduct necessary legal fees in generating taxable alimony
Itemized (Non-Business) Deductions: Home Office Deductions
- rule-
- 2 main points/characteristics
homeowners who ALLOCATE and MAINTAIN use use a portion of their residence as principle place of business may deduct expenses based upon the PORTION of the residence devoted to business use
- exclusively dedicated for business use - consistent and regularly used for business purposes
Itemized (Non-Business) Deductions: Investment Fees or Expenses
- rule
- why?
- ex.
R: fees or expenses necessary to generate tax –> deductible
Why? b/c we only tax profit
Ex. broker fees, settlement expenses in a successful lottery dispute
Itemized (Non-Business) Deductions: Exemptions
Rule: 2 elements
-def. of “dependent”
Exemption after divorce - which parent get’s the deduction?
Rule: Taxpayers entitled to 1 exemption for themselves and 1 for each dependent
1) One's Self
2) Each Dependent
- Dependent= someone who's member of household and who you provide more than half of their financial support
Exemption after divorce: Unless other parent signs a written release, custodial parent gets the exemption for children of the marriage
-Custodial parent b/c we don’t care who’s proving the financial support
To Whom is it (income)?
1-general rule
2-Income from property (investment income) -who get taxed?
1) Earner taxed- income must be taxed to he or she who earns it
2) Owner- income from investment property is taxed to he or she who OWNs the property
Accounting- when is it income?
2 methods of Account
LEFT OF HERE- lecture book p. 17
Accounting- when is it income?
2 methods of Account
LEFT OF HERE- lecture book p. 17
