High 5 Tax Planning

Question 1

Flow of the 1040

Answer 1

1. Gross Income
2. (-) Deductions for AGI
3. = AGI
4. (-) Deductions from AGI
5. = Taxable Income

Question 2

Gross Income

Answer 2

All income from whatever source derived.

Wages

Question 3

Qualified Dividends

Are taxed at the rates applicable to LTCG

Answer 3

0%:
if income < $83,350 MFJ

15%:
Income btwn $83,350-517,200K MJF

20%:
above $517,200 MFJ

Question 4

General Partnership

(2 or more people)

*Flow through conduit

(Partnership Form 1065 then each partner gets Schedule K-1)

Answer 4

1. Ease of Set Up
   Relatively simple to set up & each owner/investor may have significant voice in management
   DONT need to register w/ state to operate
2. Liability of Protection
   Unlimited liability of each general partner
3. Who Pays The Tax
   Income from partnerships is taxed to the partners at their own individual rates (Form K-1 typically reported as S.E. Income)
4. Nature of Owners Income
   Sharing of profits & losses in proportion to each partner’s interest % in the partnership.

Question 5

Sole Proprietorship

*Individual level taxed

(Schedule C Form 1040)

Answer 5

1. Ease of Set Up
   No legal documents req. to set up.
2. Liability of Protection
   Biz owner personally liable for all debts & claims against the biz
3. Who Pays The Tax
   Biz owner
4. Nature of Owners Income
   All income & losses pass directly through to the biz owner & reported on their income tax.

Question 6

C-Corp

(Form 1120)

Large number of shareholders allows C Corp to raise capital assets for funding.

Double taxation: income & dividends

NOT A FLOW THROUGH CONDUIT

Answer 6

1. Ease of Set Up
   File articles of incorporation with Secretary of State under state law
2. Liability of Protection
   Limited- most you can lose is amount invested
   Limited liability to the shareholders for corporate obligations
3. Who Pays The Tax
   Corporation → Shareholder
4. Nature of Owners Income
   Double taxation of profits:

a.) The corporation is taxed on its income & pays dividends from its after tax income to shareholders

b.) The shareholders are then taxed on on dividends received from corporation

Accumulated earnings tax.
The tax applies whenever a corporation accumulates earnings beyond its
reasonable needs, unless the corporation can prove to the contrary by a
preponderance of evidence.

The tax rate is 20% on the amounts deemed to be in excess of the
corporation’s reasonable needs (beyond $250K)

Question 7

S-Corp

(Form 1120S)

Flow Through Conduit

Answer 7

1. Ease of Set Up
   Must be organized under state law
   NO more than 100 shareholders (US citizens or residents, estates, trust, or tax exempt orgs.)
   One class of stock
2. Liability of Protection
   Limited-
3. Who Pays The Tax
   The shareholders pay the tax on income (Form K-1)
4. Nature of Owners Income
   Income & losses reported based on ownership % of each shareholder

Passive activity income

Question 8

Limited Liability Corp (LLC)

Answer 8

1. Ease of Set Up
   File articles of incorporation with Secretary of State under state law
2. Liability of Protection
   Members have limited liability to biz only and NO personal liability
3. Who Pays The Tax
   Can elect to be taxed as any entity for tax purposes
   Profits and losses are passed through to members, who report them on their individual tax returns.
4. Nature of Owners Income
   Schedule K-1 Form 1040

Question 9

At Risk Rules

(At risk applies to all investments, not only passive activities)

Answer 9

1. The maximum deductible loss for any investment activity is limited to the amount that the investor has at risk (invested).

An investor can NEVER lose more than the amount of investment at risk

2. Recourse Debt:
   The amount at risk is the total of the cash, property invested, & any debt for which the investor is personally liable.
3. If a loss is disallowed because of at-risk rules, the loss is a suspended loss that can be carried forward and taken in the first year the at-risk amount becomes a positive amount (enough to absorb all or part of the loss until the loss is offset completely)
4. when a passive activity interest is disposed of in a taxable transaction, any net passive loss first must be applied against income or gain from any other passive activities of the taxpayer.

Question 10

Nonrecourse Debt

(At Risk Rules)

Answer 10

Is a liability for which the partner has no risk of economic loss if the liability is NOT satisfied by the partnership (e.g., a mortgage or loan secured solely by a lien on an asset owned by the partnership).

Question 11

Passive Activity Loss (PAL) Rules Limit

*Every P-A-L needs a P-I-G

Answer 11

1. Passive losses may only be deducted against passive income.

*Every P-A-L needs a P-I-G

You can NOT deduct passive losses from active income (wages, or portfolio income)

2. Limits apply to
   a. Closely held C-Corps (PAL ok v. active income PAL NOT ok v. portfolio income)
   b. Individuals
   c. Trust
   d. Estates
   e. Personal Service Corps. (PSCs)
3. Passive activity divide all income into 3 buckets (active, passive, portfolio).
4. This limits the deduction for passive losses to the amount of passive income (exception of real estate activities)

Question 12

Disposition of Passive Activities/Suspended Losses/Carryovers

Answer 12

When a taxpayer disposes of his ENTIRE interest in a fully taxable transition to an unrelated purchaser (not related party), his suspended losses from that activity including any losses incurred in the year of disposition are generally deductible in full.

Question 13

Passive Losses from PTP or MLP
(Publicly Traded Partnerships on exchange)

Answer 13

Losses from a PTP:

1. Losses can only be offset from income from the SAME PTP
2. CANNOT be used to offset income from a non publicly traded partnership

Question 14

Losses from Non-Publicly Traded Limited Partnerships (RELPS)

Answer 14

Losses from a (RELP):

1. May only be used to offset income from another non-publicly traded limited partnership.
   Does NOT have to come from the SAME RELP…any will do.

Question 15

Real Estate Professionals Exception to Passive Activity Loss Rules

Answer 15

Losses are NOT considered passive if:

1.) Real estate activities are > 50% of their personal services in all trades or businesses for the year

2.) Performs > 750 hours of service in real property trades or business in which the taxpayer materially participates.

b. Real estate professionals who meet rules 1 & 2, will treat losses from real estate rental activities as NONPASSIVE & can offset those losses against ACTIVE & PORTFOLIO INCOME

Question 16

Small Investor Real Estate Rental Activities Exception to Passive Activity Loss Rules

(Standards for up to $25K deduction vs. active or portfolio income)

Answer 16

1. Individuals can deduct up to $25,000 of rental real estate losses against ACTIVE and PORTFOLIO income.
2. Deduction Rules:

a.) Active participant (the individual makes management decisions

b.) 10% Ownership or more (in value) of all interests in the activity during the taxable year

3. The $25,000 offset allowance is reduced by 50% of AGI in excess of $100,000 (complete phaseout at $150,000 AGI) for single filers and those MFJ. The loss is deducted from the $25,000 maximum available.
   d. Married taxpayers who have lived apart the entire year and file as MFS have a phaseout threshold beginning at $50,000 and an applicable loss allowance of $12,500. If the MFS taxpayers have lived together at any time during the tax year, the loss allowance is not allowed

AGI exceeds 100K
[25K - (.50 x $ amount of AGI over 100K)]

Ex:
Small investor Rental income loss $6K
Persons AGI $110K
Allowable deduction
[25K - (.50 x 10K)] = $20K max allowable deduction
The full $6K loss is deductible by small investor

Question 17

Home Owner Section 121 Exclusion

(Use & Ownership Test)

Exceptions are change of employment or health related.

Answer 17

Cap Gain Exclusion up to $225K single or $500K MFJ. Following Criteria must be met:

Ownership Test:
The home must have been owned and used as principal residence for at least 2 out of 5 years preceding the sale.

Use Test:
Both spouses have to meet.
Used as primary residence 2 out of 5 years.

Question 18

Vacation Home/Rental Property Rules

Answer 18

1. Personal:
   If property rented < 15 days/yr
   Tax Treatment:
   All rental income is EXCLUDED from gross income.
2. Rental Use:
   If property is rented at least 15 days/yr
   &
   is NOT used for personal use > the greater of 14 days/yr or 10% of rental days
   Tax Treatment:
   Possible deduction of rental losses up to $25K (passive income rules apply)
3. Mixed Use:
   If property is rented for at least 15 days/yr
   &
   is also used for personal use > the greater of 14 days/yr or 10% of the rental days
   Rental expenses can only be deducted up to rental income.
   Tax Treatment:
   NO LOSS may be generated.
   NO 25K ordinary loss against ordinary income.

Question 19

Gift Basis

Answer 19

1. The basis is usually the donor’s basis
2. If FMV on date of the gift is < Donor’s basis on date of the gift then…
   Basis = FMV on date of the gift

Question 20

Inheritance Basis (Stepped Up Basis)

Answer 20

Basis = FMV on the date of death (step up basis)

Tommy inherited 200 shares of ACME, Inc., stock from his uncle, who died 3 months ago.
His uncle originally bought the stock for $5,300.
The value of the stock was $6,000 on the date of his uncle’s death. Tommy sold the stock when its value rose to $6,500.
Tommy’s taxable gain on the sale is
$500 long-term capital gain

Question 21

Original Basis

Answer 21

The amount of funds used to make the investment.

Question 22

Adjusted Basis

Answer 22

Cost basis + improvements - depreciation

Ex:
Buy house for $500K
Make improvements for $100K
Depreciation of $220K
Adjusted Basis = 500 + 100 - 220 = $380K

Expenditures that simply maintain an asset in working condition are considered repairs and are expensed when made.

Question 23

Carry Over Basis

Answer 23

When the donor gives appreciated property to the donee, generally, the basis to the donee is the carryover basis of the donor.

The donee’s basis is the donor’s old basis (ex: gift basis).

Question 24

Substitute Basis

Answer 24

The property’s FMV - any deferred gain + any postponed loss.

*Like Kind Exchange

Question 25

Failure to File (FTF)

Tax Penalties

Answer 25

Penalty is assessed by the IRA at a rate of 5% per month up to 25% max.

If the return is filed > 60 days after the due date or extended due date the minimum penalty is the lesser of $450 or 100% of the unpaid tax

Question 26

Failure to Pay (FTP)

Tax Penalties

Answer 26

Penalty is assessed by the IRS at a rate of 0.5% per month up to 25% maximum.
If both FTF and FTP penalties are assessed the FTF penalty is reduced by the FTP penalty

Question 27

Kiddie Tax (Unearned Income)

Rules:
Kid under 19 y/o OR 24 y/o if Full Time Student

Answer 27

Unearned Income (UI): $2500 threshold

1st $1250 (Standard Deduction)
Next $1250 (taxed at Kids rate 1250 x 10%)
Anything over $2500 (taxed at parents marginal tax rate)

Question 28

Kiddie Tax (Earned Income)

Rules:
Kid under 19 y/o OR 24 y/o if Full Time Student

Answer 28

With unearned income (UE) & earned income (EI)

Standard deduction = the greater of $1250 OR Earned Income (EI) + $400

Question 29

Kiddie Tax Example

$5500 Earned Income (EI)
$2500 Unearned Income (UI)

Answer 29

Step 1: Calculate Unearned Income

$2500 Unearned Income
-$2500 Kiddie Tax (UI) Threshold
= $0 taxed at parents marginal tax bracket

Step 2: Calculate Gross Income (EI + UI) - St. Deduction

$5500 (EI)
$2500 (UI)
= $8000 gross income
- $5900 (st. deduction = (EI + $400)
= $2100 taxable income

Step 3: Calculate Taxes Owed by Kid

$2100 taxable income
- $0 (parents tax)
= $2100 (taxed at kids rate)

Question 30

Above the Line AGI Deductions

Answer 30

1. Business or Trade Expenses
2. Self Employment Tax & Health Insur. Premiums Paid
3. Alimony (if divorced before 2019)
4. Qualified Plan (Keogh, Simple, SEP) & IRA ($6500) Contributions
5. HSA’s (fam $7750 limit/single $3850 limit)
6. Early w/d penalties (ex: CDs early w/d fees)
7. Capital Losses ($3K limit w/ unlimited carryforward)
8. Student Loan Interest ($2500 limit)

Question 31

Tax Credits

Allow dollar for dollar reduction of income tax liability of the taxpayer.

Answer 31

Refundable:
Paid to the taxpayer even if the amount exceeds the taxpayer’s tax liability (creates a refund).

Nonrefundable:
CANNOT create a refund. Nonrefundable credits can reduce the taxes owed to zero, not the refund itself to zero.

AOTC: $2500 (no room & board)
Per STUDENT credit (up to 40% refundable)
no drug felonies allowed

Lifetime Learning Credit: $2000
per HOUSEHOLD credit

Taxpayers CANNOT claim both the American Opportunity Tax and Lifetime Learning Credits for the same individual in the same year.

If 2 students in household:
It is possible to take the American Opportunity Tax and the Lifetime Learning Credits on the same return

Question 32

Charitable Deductions

Cash/Property Only
Time/Talent NOT deductible

Answer 32

Gifts that qualify 2 Types:

1.Direct gift of cash or property to the charitable organization

2. Indirect gift that includes the provision of goods and services to the shared to make possible achievement of the charitable purpose

If charitable donation < donors entire basis = nondeductible

IRS requires proof of property valued over $500

Appraisals needed for property valued over $5K
Closely held stock valued over $10K

Question 33

Charitable Donations

Use Unrelated v. Use Related

Answer 33

Use Unrelated:
If charity does NOT have use for gifted property.
Max Deduction = lesser of FMV or donor’s basis

Use Related:
If recipient charity has use for the gifted property.
Deduction:
FMV (30% or 20% AGI annually)
Basis (50% or 20% AGI annually)

Question 34

50% Public Charities Deductions

Deductions:
Cash: 60% of AIG
Ordinary Income: 50% of AGI
FMV: 30% of AGI

Answer 34

Cash: 60% of AGI

Ordinary Income Property-STCG (self constructed, inventory, use-unrelated, tangible personalty): 50% of AGI

FMV of property (use related): 30% of AGI

Question 35

30% Private Charities Deductions

(Private Nonoperating foundations, veterans groups, fraternal orgs.)

C- 30%
O- 30%
F- 20%

Answer 35

Cash: 30% of AGI

Ordinary Income Property STCG (self constructed, inventory, use-unrelated, tangible personalty): 30% of AGI

FMV of property LTCG (use related): 20%

Question 36

Qualified Charitable Distributions (QCDs)

Answer 36

Taxpayer over 70½ can make qualified charitable contributions of up to $100K/yr.

Proceeds are tax free & satisfy RMD rules.

Question 37

Medicare Contribution Tax

(Net Investment Income Tax)

Answer 37

Tax of 3.8% is taxed on the lesser of:

Net Investment Income OR excess MAGI over (200 single/250 MFJ)