Federal Taxation II: More about Income

Question 1

Realization

Answer 1

Event that triggers taxation of income… difficult to define precisely

Question 2

Return of Capital

Answer 2

Not income.

Cost of goods/property sold.

Question 3

Gross Income

Answer 3

Amount of realized income after eliminating deferred/ excluded income

Question 4

Tax Shelter

Answer 4

Legal way of minimizing investor’s taxable income.

1. Entity other than C-Corp
2. Ownership interests have been offered for sale
3. Offering required to be registered with fed/state security agencies.

Question 5

Qualified personal service corp

Answer 5

Corp that exists if:

1. substantially all activity is services in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting
2. at least 95% of its stock is owned by the employees performing the services

Question 6

Hybrid Method of accounting

Answer 6

Business w/ inventory must use accrual to report purchases and sales.

Hybrid if rest of accounts are kept using cash basis.

Question 7

Uniform Capitalization Method

Answer 7

Mfg and some retailers/wholesalers must capitalize direct/indirect costs allocable to property they produce or buy for resale.

Costs are allocated to ending inv and property sold during the year (usually increasing basis of inventory)

Question 8

Long-term contract special rule: Percentage of Completion

Answer 8

Gross profit from a project recognized over time period it takes to complete project.

Question 9

Long-term contract special rule: Completed Contract Method

Answer 9

Gross profit deferred until production is complete.

Only usable by:

1. $10m or less in preceding 3 yrs
2. Home construction contractors
3. Contract where less than 10% of total costs relate to actual construction of property on land

Question 10

Prepaid interest, rents, royalties (when taxed?)

Answer 10

Usually taxed when received

Question 11

Short Tax Year (e.g. 5 months)

Answer 11

1. multiply income by 12/5 to annualize
2. compute corporate tax liability on the full 12 months
3. multiply that amount by 5/12 to prorate for short tax year

Question 12

Cafeteria Plan Requirements (5)

Answer 12

1. all participants employees
2. may choose b/w 2 or more benefits
3. required to make elections among the benefits
4. plan must be in writing with certain specified info
5. plan may not provide deferred income except for 401k

Question 13

Taxation of Employee Benefits (general rule)

Answer 13

Any benefit received by an employee included in gross income unless specific provision excludes the benefit

Question 14

When are disability benefits taxable?

Answer 14

1. When the policy is paid for by the taxpayer: benefits NOT income
2. When policy paid for by employer: benefits ARE income

Question 15

Life Insurance Premiums

Answer 15

Not income if group-term life paid by employer. Exclusion limit = $50K.

Employee premiums are income if whole-life.

Question 16

Health Insurance Premiums

Answer 16

Not income if paid by employer

Question 17

Self-employed health insurance premiums

Answer 17

Can deduct 100% for self, spouse, dependents.

Deduction cannot exceed net earnings from self-employment

Question 18

Personal Expenses paid by employer

Answer 18

Always income

Question 19

Food and Lodging

Answer 19

Not income if:

1. for convenience of employer
2. provided in kind on the employer’s premises (not cash for meals)
3. employer must require employee to accept lodging as a condition of employment (must also be on premises)

Question 20

Working Condition Benefit

Answer 20

Benefit provided by employer that would be deductible if paid by employee

Question 21

De Minimus fringes

Answer 21

Excluded b/c benefits are small in value/infrequent (coffee)

Question 22

No additional cost services

Answer 22

Excluded when provided to employee, spouse, dependents by employers at no substantial additional cost (airline empty plane seats)

Question 23

Employee discounts

Answer 23

Excluded if not excessive (20% of value of services or av. gross profit % on merch)

Question 24

Nominal gifts

Answer 24

Excluded up to $25 as long as not cash/gift certificates

Question 25

Safety/Length of Service Awards

Answer 25

Excluded, subject to $400 limit (non-qualified plan) or $1600 limit (qualified)

1. can’t be cash
2. only given b/c of safety/length of service
3. no more than once every 5 yrs

Question 26

Transportation and Parking

Answer 26

Excluded up to limits:
$130/month for trans
$250/month for park
(2015)

Question 27

Accountable plan

Answer 27

When employees are reimbursed for business expenses, determination of taxability depends on accountable plan:

1. YES: not taxable
2. NO: included in income and 2% misc itemized deduction

Question 28

Stock Option Key Dates (3)

Answer 28

1. Grant date - date option granted to employee
2. Exercise date - date option is exercised & stock is purchased
3. Sale date - date stock is sold

Question 29

Nonqualified stock options

Answer 29

1. No income recognized when option granted
2. On exercise date, employee income = (FMV-Exercise Price) x # of share exercised.
   a. employer receives salary deduction for same amt
   b. employee has basis in stock = FMV

Question 30

Incentive stock options

Answer 30

No income recognized when option granted/exercised.

Consequences when stock is later sold vary.

Question 31

Retirement Savings

Answer 31

Contributions made by employer (sometimes employee) not subject to tax until withdrawn from plan

Question 32

Qualified Pension Plan

Answer 32

Contributions of salary to “qualified” pension plans deferred until distributions

Question 33

Traditional IRA

Answer 33

Contributions deductible to limit of $5,500 (2014).

Withdrawals taxed as income in year of withdrawal.

Question 34

Modified AGI

Answer 34

AGI + IRA deduction + domestic production activities deduction + student loan interest + foreign earned income/housing cost exclusion + exclusion for employer-provided adoption assistance

Question 35

Roth IRA

Answer 35

Contributions are not deductible

Withdrawals may be tax exempt

Question 36

Conversion of traditional to roth IRA

Answer 36

Can be done, but it is a taxable event