Income Tax Flashcards
1
Q
What is the primary source of all tax law?
A
Internal Revenue Code
2
Q
What is a source for all tax law? (They are not laws in and of themselves.)
A
Treasury Regulations
3
Q
What are hobby loss rules?
A
The tax law presumption that any activity generating net income (profit) in three out of five consecutive years is a business (not a hobby).
A Hobby gives no tax benefits
4
Q
When is an individual required to file taxes from self-employment?
A
An individual is required to file if net earnings from self-employment are at least $400
5
Q
When are estimated taxes due?
A
April 15, June 15, September 15, and January 15.
6
Q
What are the tax forms? 1040, 1040X, and 1041?
A
1040 - individual income tax
1040X - Amendment
1041 - estates and trusts
7
Q
What is the penalty for a frivolous return?
A
$5000. A frivolous return is one that omits information necessary to determine the taxpayers tax liability.
8
Q
What is the accuracy related (negligence) penalty?
A
The penalty is 20% of the under payment attributed to the negligence.
9
Q
What is the penalty for fraud?
A
The penalty is 75% of the portion of a tax under payment attributable to fraud.
10
Q
What are the penalties for failure to pay and failure to file?
A
Failure to Pay - .5% per month the taxes unpaid with a maximum of 25%
Failure to File - 5% of the tax due each month with a maximum of 25%
11
Q
How much estimated taxes should you pay to avoid the penalty?
A
90% of the current years tax liability or 100% of the prior years liability.
(if the prior years AGI exceeded 150,000 - then 110% of last year‘s tax liability or 90% of this year‘s tax liability whichever is less)
(if you owe 4100 and pay 4000, you don’t pay the penalty because you paid 90% of this year‘s tax liability)
12
Q
Married filing separately, HOH, MFJ, and qualifying widow filing status?
A
Married filing separately - big difference in income and one qualifies for itemized deductions.
HOH - an unmarried taxpayer that has dependents and provides more than 50% of their child’s support.
Qualifying widower - Always file married filing jointly in the year spouse dies. Then qualifying widower for two years after death As long as you have a qualifying child and you do not remarry.
13
Q
Inclusions for gross income
A
Ordinary dividends – schedule B, taxable interest – schedule B
business income and losses – schedule C
capital gains and losses – schedule D real estate – schedule E
punitive damages (except wrongful death)
Wages salaries tips
IRA distributions
pensions and annuities
alimony received divorce before 2019 unemployment income
taxable Social Security
14
Q
Exclusions
A
Gifts
Inheritance
Child support
Municipal bond interest
Workers Compensation
Compensatory damages
15
Q
Are room and board taxable income?
A
Yes. Room and board are taxable income to student. Tuition and books are not.
16
Q
Are disability insurance premiums taxable?
A
No they are tax free
17
Q
How much investment interest can you deduct?
A
You can deduct your investment income from your investment interest. (Qualified dividends will not be treated as ordinary income so you cannot count them as investment income)
- You have to opt out of long-term capital gain treatment to count it as investment income
Investment interest is paid on property held for INVESTMENT. such as purchasing a home mortgage (not personal residence) or purchasing treasuries, GNMAs, zeros, etc.
18
Q
What is a marginal tax rate?
A
Marginal tax rate is the percentage applying to the last dollar of taxable income.
19
Q
Kiddie tax?
A
First 1150 is tax free, the next 1150 is tax at 10%, anything more is tax up parents tax rate
- if child has both earned and unearned income the standard deduction is greater of 1150 unearned income or earned income plus $400 but no more than the single person standard deduction ($12,950)
20
Q
Can you claim personal exemptions?
A
No
21
Q
Dependent care expense credit? (Child care credit)
A
20% of expenses up to $3000 for one kid or $6000 for two kids.
(You can only claim 20% up to 3000 (1 kid) or 6000 (2 kids) even if daycare costs are higher than that
22
Q
Child tax credit
A
$2000 for each child under 17. This is a refundable credit up to 1400 per child. It is reduced at 20,000 (single) and at 400,000 (MFJ)
(Children, step children, and foster children)
23
Q
What is the cash method of accounting?
A
Firms realize revenue from services performed in the year the payment is received regardless of when services are performed
Businesses cannot use cash method if they carry inventory.
24
Q
What is the accrual method of accounting?
A
Firms realize revenue when the services are performed regardless of one payment is received
Accrual method is mandatory if business carries inventory AND averages 25 million in revenues during prior three years
25
What is an installment sale?
When a buyer makes payments to the seller over time they may be entitled to recognize the capital gain over the life of the note rather than be recognized entirely in the year of sale.
* Exceptions - you can’t do this if the property is a publicly traded security, sold at a loss, or sold to a related party who then in turn sells the property within two years of the original purchase date.
If tax payer makes an installment sale of tangible personal property, all depreciation recapture up to amount of gain must be reported as income and the year of disposition
26
S corp
A corporation that elects to pass corporate income, losses, deductions, and credits to its shareholders.
* they can produce passive income to investors who do not materially participate
If they pass through and come to the sausage treated as K-1 investment income not self-employment tax which is 7.65% not the 14.13%
27
What entities may not claim a net operating loss?
S Corps and partnerships (flows to to individual loss)
28
FIFO method
This method of inventory valuation reflects current cost on balance sheet
Use LIFO if company wants to reduce taxes in an inflationary period
29
Net operating loss (NOL)
NOL can now be carried forward indefinitely. Carrybacks of NOLs are no longer allowed.
S corps and partnerships cannot claim NOL, but sole prop. can claim.
Starting in 2018 only 80% of offset is allowed. the rest can be carried forward
30
What is a qualified business income deduction?
Businesses may qualify to deduct up to 20% of qualified business income from AGI for each pass through business (So proprietorships, partnerships, other pass through business). This is net income for each business they own.
Any negative amount as carry forward to the next taxable year
31
Section 1244 qualified small business stock
A 1244 business is a C or S Corp. that was initially capitalized with no more than $1 million. A $100,000 loss per year can be ordinary rather than a capital loss.
Example - 1244 loss can be a $100,000 loss and 3,000 capital loss. Without 1244 he would still take the $3000 capital loss but $97,000 carry forward.
32
S corp
Shareholders limited to 100.
The basis equals cash plus direct loans made by the shareholder to the corporation
Must be a domestic corp
Must be US citizen or permanent resident alien.
Qualified trust can be a shareholder
Shareholders can issue only a single class of outstanding common stock (no preferred), but the common stock can be voting and/or non-voting.
33
S Corp versus a regular (C) corp?
High salary paid to the owners do not affect S Corp. status. The IRS would not reclassify salary as dividends, but may
try to re-classify excessive compensation as a constructive dividend in a regular corporation.
They can both offer pension plans and offer both voting and nonvoting shares.
C corp. does not allow pass through of losses.
34
Limited partnership
THIS IS NOT A LIMITED LIABILITY PARTNERSHIP
The limited partners are liable for partnership that only to the extent of the capital contributions to the partnership. However, there must be one general partner who would have unlimited.
But if a limited partner is an active participant, he or she forfeits limited liability for partnership debt.
35
Sole proprietorship
A sole proprietorship exposes person to unlimited personal liability.
Taxable income or losses are reported on schedule C.
If a business owner borrows money for business purposes relating to the sole proprietorship the interest on the debt is deductible on schedule C.
Losses can be applied against income earned in the same year
36
General Corporation
A corporation may retain profits as a separate tax entity. Retained earnings are not immediately taxable. A regular corporation can be owned by an unlimited number of stockholders with no eligibility requirements.
37
How to choose type of business ownership based on risk?
Choose sole proprietorship or partnership if it’s risk free. If it’s a risky entity choose an S Corp., limited liability company, or limited partnership. 
38
What tax return does a partnership have to file
1065, but this is just for informational purposes. Each partner includes in their own return the distributed share of partnership income or loss that has reported on the K-1 form.
39
what business types are conduit entities
S corporations, LLC’s, sole proprietors, General partnership, and limited partnership.
C corps may not pass losses through to their shareholders
40
How is personal service corporation (PSC) taxed?
Any income retained by a PSC is tax at a flat 21%. These are businesses such as doctors dentist accountants lawyers engineer.
A PSC with accumulated earnings exceeding 150,000 will be exposed to a 20% accumulated earnings tax. A regular corp can accumulate $250,000. This tax is in addition to the regular corporate tax rate.
41
C corp
Is a separate taxing entity
42
Schedule c
Use this to report income Or loss from a business that you operate as a sole proprietor
43
Do S Corp. C Corp. or general partnership have to file tax returns?
S Corp., C Corp., general partnership, and limited partnership all have to file tax returns. Some are for informational purposes only
44
1041
Estates file on a 1041.
This must be filed if there is any taxable income for the year, gross income of $650 or more, or a beneficiary who is a nonresident alien.
45
What type of trusts do not have to use a calendar year to file tax returns?
All trusts except 501a or charitable must use a calendar year
46
Funded verse unfunded ILIT
In the unfunded ILIT, the yearly gift to the trust pays the life insurance premium (Not income taxable to the grantor
In the funded ILIT, the investment income from investments in the trust pays the insurance premium (taxable to the grantor)
47
Are utma Subject to kiddie tax?
Yes
48
How is basis increased?
Increased by legal fees, commissions, sales tax, free, and improvements but not repairs, real estate taxes, or normal business expenses.
49
Revocable trust
Is tax neutral (conduit)
(Taxed to grantor)
50
Distributable net income (DNI)
DNI determines the amount of income to be distributed to the beneficiary as well as the corresponding deduction by the trust. The trust gets a deduction of the lesser of amount distributed to bene's or the DNI.
51
Dividend received deduction
A US Corp. that invest in another US Corp. can receive a 50% deduction of dividends received from qualifying corp. This would be excluded from income but only if the corporation owns 20% or less of the distributing corporation. If they own more than 20%, then its is 65%, or 80% exclusion
52
Simple
Income is distributed
Income is taxed to the beneficiary (distributable net income DNI)
Normally no distribution of corpus
No charitable gift
Trust exemption of $100 if trust is required to distribute all income.
53
Complex trust
Income must or maybe accumulated
Income accumulated is taxed to the trust, income distributed this taxed to the beneficiary.
Corpus can be distributed
Can make charitable gifts
Trust exemption of $300 if trust is NOT required to distribute all income.
54
Are capital gains and dividends included in cost basis?
Yes, Because these are taxed in the year they are received.
55
Modified accelerated cost recovery system (MACRS)
Applies to all recovery property placed in service after 1986, (not land or intangibles though). Used to depreciate nonresidential real property
Straight line is an option, but It requires the half year convention
It requires mid quarter convention if greater than 40% of the depreciable property is put in a service by the business during the fourth quarter of its tax year.
56
MACRS property classes
5 year is computers, cars
7 year is office furniture and fixtures
27 1/2 year is residential rental property
39 year is non-residential real property
Recovery Year MACRS Straight Line
5 yr 7 yr 5 yr 7 yr
20% 14.29% 10% 7.14% 32% 24.49% 20% 14.29%
57
Section 179
A business may expense up to $1,080,000 of qualifying property in the year of acquisition. Amount is further limited to income derived from the taxpayer from any trade or business.
Qualifying property is generally tangible property (Section 1245) (ONLY business personal property. NO other business or intangible property qualify!)
The maximum cost that can be annually expensed is reduced dollar for dollar by the cost of qualifying property that exceeds $2.7 million
It cannot be used to create a loss, but can be carried over
58
Section 179 versus MACRS
Section 179 gets a tax deduction the year you placed equipment into service. MACRS spreads the deduction by table schedules
MACR: (allows for la to ear deduction earlier on)
5 yr. 7yr
20%. 14.29%
32%. 24.49%
Straight line: (claims same deduction each year)
5yr. 7yr
10%. 7.14%
20%. 14.29%
Section 179 can expense up to lesser of $1,080,000 (max) or or whatever their taxable income derive from the business is
59
Like kind exchange (section 1031)
Only for real property
No matter how many numbers are given in the exam use only the following three.
1) Fair market value of property received
2) Adjusted basis of property given up
3) Boot (anything that is not qualified or like kind received in a transaction)
Realized gain (gain at time of transaction)= Fair market value minus adjusted basis, then + or - boot
Recognized gain (the gain that is immediately taxable) = Lesser of realized gain or boot
If no boot received then no gain recognized
Substitute basis - FMV of property acquired less (Realized gain-Recognized gain)
Inventory does not count for like kind exchange
60
Phantom Income
Reinvested dividends
61
Carryforward losses
You can take 3000 a year. If person dies you can take 3000 the year of death, but any unused carryforward losses are lost after the year of death.
62
Section 121
Sale of residence. $250,000 for single, 500,000 for married. Must own and both must live in the home two out of five year immediately preceding home sale.
Any broker commissions get subtracted off gain as well
If home sale is entirely excluded, the transaction is not reported on the tax payers return at all.
Question on exam - Can taxpayers do both 121 exclusion and 1031 like kind exchange? Yes, if the requirements are satisfied.
If you lived in the home less than two years, there are exceptions such as divorce, job related move, 50 miles away, natural disaster, change in employment, etc., that allows for you to have a partial deduction
63
CRD
Cost recovery deduction (depreciation) 
64
1245 property
One of business purchases equipment and takes depreciation to offset the businesses ordinary income off. When the business sells the equipment for a gain the business must do the following:
1) Look back and re-capture the lesser of depreciation taken or the gain realized. (Lesser of original cost minus depreciation or sale price less adjusted basis)
2) Recover any excess gain as capital gain (1231 gain).
*** When the amount realized it’s less than a adjusted basis the resulting loss is treated as ordinary income
65
AMT preference items
These are added.
Private activity municipal bond
Oil and gas percentage depletion/excess intangible drilling cost
Depreciation (ACRS/MACRS) but not straight line
* Cost depletion is not an AMT preference item
* Remember iPod
to minimize AMT, increase regular tax
If regular tax is higher than AMT then no AMT is due. If it is less than it is the difference between the two
Also Corporate AMT has been eliminated
66
What is the deduction for real estate losses

tax payers can deduct up to 25,000 per year of net losses from real estate activity. It’s phased out between AGI of 100 K to 150 K
67
How many days can you rent home during taxable year to have it be excludable from income?
Fewer than 15 (14)
Or 10% of rental period.
68
Alimony
Payments No longer deductible, Nor does recipient have to declare amount as taxable income after December 31, 2018.
Cash Payments such as rent, mortgage, tax, or tuition liabilities can qualify as alimony. HOWEVER, Any payments to maintain property owned by the payor spouse and used by the payee spouse will not qualify as payments even if required under divorce terms.

Child support doesn’t count
69
Active and passive income losses
Active participation and rental activities can be used to offset other passive losses.
Non-publicly traded income can be used to offset non-publicly traded losses.
An active participation rental real estate activity can offset non public LP income
Non-publicly traded losses may not be used to offset publicly traded income (LP), MLP, or portfolio income
Publicly traded losses remain in the partnership. Publicly traded income, becomes portfolio income.
70
What amount of alimony is subject to recapture?
If just two years are paid, then add together and subtract 37,500.
71
How much can you deduct for cash gifts to a public charity?
Generally 60% of AGI. Any excess is carryforward as an itemized deduction for five years
72
Gift of Appreciated long-term gain property (includes land)
30% of AGI unless he or she Elects to use the properties basis rather than fair market value, then it’s 50% of AGI
If you elect to use basis, you can’t carry forward
73
Gift of art
Fair market value can be used to evaluate the art donation only if the charity can use the art object in a charitable activity. Otherwise evaluate the gift at basis (Or date of death value) (Limited to 30% of AGI)
74
Charitable contributions and deductions
First Calculate the maximum amount deductible to 60% of AGI!!
Public charities - 50% church, school, hospital
Private charities- 30%
* Short term capital gains property must be evaluated at basis (max deduction is 50%AGI)
But long-term capital gain property can be evaluated at basis (50% of AGI) or (30% of AGI) if the use fair market value.
* A tax payer cannot deduct more than 60% of AGI for cash gifts to a public charity. Any more than that gets carried forward for five years or death if that’s sooner.
75
Child support
Are not included for income tax purposes
76
Deductions for AGI
Net business losses and net capital losses. Alimony PAID, not received, may be deductible.
77
Approximate self-employment tax rate
14.13%
78
Gift of inventory
 charitable gifts of inventory are based on what the property can be sold for
79
Every permanent resident and U.S. citizen may be require to file tax
80
Private purpose muni bond interest is excluded from income
81
Health Insurance premiums
If paid for self-employed, partners, or more than 2% owners of a S corp it's taxable income. However, 100% is deductible as long as those costs do not exceed the net income from business (for self employment).
This can include all types of insurance (health, dental, Long term), but NOT disability.
HEAVILY TESTED
82
student loan interest is deductible on schedule 1 (up to 2,500) (not itemization)
83
Net the long term and short term gains/losses to get to AGI.
Only allowed to take 3k loss
84
Qualified dividends and Long term capital gains do not offset investment income
They would have to elect to have long term gains treated as non qualified to offset. (uncommon)
Muni bond interest also does not count
85
Casualty /theft losses are reduced by any insurance received and also reduced by a $100 floor. (Also only aggregate loss in excess of 10% of AGI is deductible.
Must start with lesser of basis or FMV
86
MIsc. itemized deductions have been repealed since 2018.
87
Self-employment tax
self-employment taxes is based on net earnings
includes the following: net schedule C income, board of director's fees, general partnership income (K-1 income), and part time earnings (1099)
does not include: dividends or interest, gains, real estate income, wages from an S corp, distributions (K-1 income) from a S corp.
88
Qualified dividends do not count as investment income. If it says long term capital gain, they must opt out of LT capital gain treatment to count as investment income.
(Margin expense is generally investment expense) This does not count if margining muni bonds.
89
You cant deduct depreciation/home maintenance costs from income from home business for deduction.
90
Medicare wage tax applies to wages over 150,000-250,000 it increases to 2.35% (1.45% +0.9%)
Medicare wages of 200,000 or less remains at 1.45%
Additional 3.8% Medicare tax also on investment income for people with investment income over 200,000
91
Qualified dividends/LT capital gain rates
0% if person is 10-12% bracket.
15% if person is in 22-35% brackets.
20% if person is in 35-37% bracket.
92
Calculating Self Employment tax
1. calculate self employment income
2. subtract 7.65% or multiply by .9235 (1-.0765)
3. multiply remainder by 15.3% (7.65+7.65)
SHORTCUT: multiply self employment income by .1413
93
Deduction is worth less if you are in a lower tax bracket and a credit is worth more if they are in a lower tax bracket.
94
Grantor trust
defective or tainted. Grantor rather than the trust gets taxed
95
You only get 1/2 step up in basis if you are in common law state.
96
Realized vs recognized gains
Realize is at the time of transaction. Recognize as what you actually owe or pay
97
CRD (cost recovery deduction)
When a business purchases equipment and takes depreciation, the CRD offsets the businesses ordinary income.
98
Section 1231
Capital gain
The difference between the gain and the CRD is the 1231 gain
99
Charitable, bargain sale
If you sell your property to charity for less than fair market value, you have to adjust your basis.
Take the amount you sold property for divided by fair market value, and that will equal a percentage. Take that percentage times your basis. Then take the sales price minus your adjusted basis.
100
AMT add back items
Property, state, local income taxes now limited to 10,000 a year.
ISO “ bargain element”
Some other itemized deductions
101
To avoid AMT
Have more taxable income.
Could defer charitable giving or defer deductible medical expense payments. Defer the exercise of ISO (add back item). Exercise nonqualified stock option. Earn more income.
102
Passive investors
A limited partner is Normally a passive investor.
An S corp can produce passive income to investors who do not materially participate.
103
Material vs active participation
Material - taxpayer must be involved in the operation of the activity on a regular continuous and substantial basis.
Active - Les stringent than material participation. Requires bona fide, involvement and management decision to qualify. The taxpayer must own at least 10% interest in the property.
104
Charitable deductions for art
For art objects - FMV can be used to evaluate the donation only if the charity can use the art and its charitable activity. Otherwise evaluate the gift at basis.
(giving art to a university doesn’t mean they can use it, use basis)
However, if the university operates in art museum on campus, then you can use FMV (limited to 30% of AGI)
