Income Tax Flashcards
Income Tax Authority Types
Internal Revenue Code: primary source for all tax law
Congressional Committee Reports: indicate intent of Congress
Tax Law Doctrines: Step, Sham, Substance over form & Assignment of income
Step Transaction: Ignore individual transactions, tax ultimate transaction
Sham Transaction: Lacks business purpose, economic substance ignored
Substance: Substance of transaction governs its tax consequence not just form
Assignment: Income is taxed to “tree that grows the fruit” although income may be assigned to another prior to receipt
Hobby loss
Eliminated. Any activity generating net profit in 3 out of 5 years is a business not a hobby. (2 out of 7 for Horses)
Categories for Taxpayers who are required to file income tax return & Filing Status
Categories:
Individuals (US Citizen)
Dependents
Children Under 24 (Kiddie Tax)
Self Employed
Aliens
Status:
Single: $13,850 standard deduction
Married filing separately: $13,850 standard deduction
Married filing jointly: $27,700 standard deduction
Head of Household: $20,800 standard deduction
Qualified Widower
Filing & Payment Dates
Must file by April 15th, possible 6 month extension to October 15th
- Failure to file is 5% of tax due each month up to 25% max
Payment dates: April 15th (1), June 15th (2), September 15th (3), January 15th (4)
- Failure to pay is 0.5% per month tax unpaid up to 25% max
Penalties for Incorrect tax returns (some way shape or form)
Frivolous: Omitted information ($5k)
Negligence: accuracy related (20% of underpayment attributable to negligence)
Fraud: intent to cheat government (75% of underpayment attributable to fraud)
Taxpayer may not be represented by CFP at audit. (Attorney, CPA, enrolled agent/actuary or anyone permitted by IRS)
Estimated Tax to avoid penalty
Lesser of
90% current years tax liability
100% of prior years liability
110% of prior years if AGI >$150k
Gross Income Included Elements
Wages, Salaries, Tips
Ordinary Dividends (Schedule B) - For GI sake Qualified Dividends included (taxed at LTCG rate)
Taxable Interest (Schedule B)
Business Income/Losses (Schedule C)
Capital Gains/Losses (Schedule D)
IRA Distributions
Pension/Annuities
Alimony received (divorced before 2019*)
Unemployment Income
Real Estate (Schedule E)
Taxable SS Income
Gross Income Exclusions
Gifts
Inheritances
Child support
Municipal Bond Interest
Worker’s Comp Payments
Compensatory Damages
Taxable vs Tax Free Fringe Benefits (Only major ones)
Tax Free: Occassional sport or theater tickets, premiums the employer pays for employee/spouse/dependent, same for up to $50k in premiums for employee life insurance, company car and employee assistance programs
Taxable: Health insurance premiums paid for self employed, partners and >2% owners of S-Corp. However it’s 100% deductible as adjustment to income on 1040 (medical, dental and long term care). Does not include disability premiums
Adjustments For AGI
For = Above the line
IRA contributions
Keogh or SEP contributions
1/2 Self Employment Tax = (Net income * .1413) * .5
100% of self-employment health insurance
Alimony from divorces prior to 2019
Student loan interest
AGI is reduced by the greater of the standard or itemized deduction.
Standard deductions
Single or MFS: $13,850
MFJ: $27,700
HOH: $20,800
Elderly: Extra $1,500 per person, jumps to $1,850 if >65
Blind: Extra $1,500 per person, jumps to $1,850 if >65
Child with unearned income: $1,250
Itemized Deductions From AGI
From = Below the line (4 letters)
Home mortgage interest
Charitable gifts
Personal property tax limited to $10k total for ‘d answers
State and local sales tax
Real estate taxes
Investment interest (margin account)
Medical, dental, LTC expenses > 7.5% AGI
Casualty losses from federally declared disaster area (formula below)
***No home office deduction
Casualty Loss:
Lesser of basis or FMV
- Insurance coverage
- $100
- 10% of AGI
How many personal exemptions are you allowed?
Zero
LTCG Rates and Kiddie Tax
Tax Bracket LTCG Rate
10-12% 0%
22-35% 15%
35-37% 20%
Kiddie Tax for unearned income
First 1,250 tax free
2nd 1,250 taxed at 10%
Remainder taxed at parents ordinary income rate
Kiddie Tax for earned income
If child has earned income + $400 > $1,250 standard deduction, use earned income +$400 as new standard
Self employment tax
Self employment income: Net schedule c income, board of directors fees, K-1 GP income, part time earnings
Total self employment income * .1413 = self employment tax
Child tax credit for expenses
Multiply numbers below by 20%
$3,000 for 1
$6,000 for 2 or more
Tax deduction vs tax credit
Lower tax bracket: Credit worth more than a deduction
Higher tax bracket: Deduction worth more than credit
Account methods
Cash: Businesses with $29mil ($25mil indexed) in revenues
Accrual: Used for goods and services
Hybrid: Mix of both
Cant be changed without IRS permission
Installment sale recognized gain
Gross Profit % = Profit / Sale Price
Installment amount * Gross Profit % = recognized gain
Inventory Valuation and Flow
LIFO: Typically use during times of inflation/rising prices
FIFO: Increases earnings and raises current cost of inventory
NOL
Net operating losses for pass through business can be carried forward indefinitely
Sole Proprietorship
For risk free entities
Advantages:
100% medical premiums deductible
Keogh or SEP available
Income or loss conduit to owner (gains or losses) on schedule C
No legal formalities
Disadvantage:
Unlimited Liability
Business dies with owner
Capital structure depends on owners personal resources
Tax:
Interest paid on debt is deductible
General Partnerships
For risk free entities
Advantages:
100% medical premiums deductible
Keogh or SEP available
Income conduit to owner (gains or losses)
Partnership agreement can be oral
Disadvantage:
Unlimited personal liability
Business dissolves on death, incapacity or bankruptcy of one partner
Capital structure depends on resources of partners
LLC (Risky entities)
Is a partnership if no more than 2 of the following:
Centralization of management, limited liability, continuity of life or free transferability of interests
If LLC may operate like a GP, then members can still be involved in daily operations
Pass Thru Businesses
Sole Prop, Partnership, S corp and other pass throughs may deduct up to 20 percent of income if the taxpayer has qualified business income.
Single taxpayer AGI < $182k or Joint <$364,200 can claim full deduction
Partnerships: Losses deductible up to basis.
Basis is cash contributed by partner, direct loans made by partner and partnership debt
S Corp: Losses deductible up to basis
Basis is cash contributed by shareholder, direct loans made by shareholder (3rd party loans not allowed)
LLP
Limited partnership where general partners are not personally liable for malpractice claims of the other general partner
C Corp
For profitable businesses
Advantages:
Separate tax entity
Unlimited investors (sale of stock)
Limited Liability
Continuity of life
Dividend received exclusion (50% if 20% owner, 65% if 20-80% owner & 100% if >80% owner)
Disadvantages:
Corporate formalities
Dividends paid after tax (Double taxation)
Double taxation on accumulated earnings beyond certain limit
PSC
C Corp owned by HALE individuals. Flat tax of 21%, for profitable businesses
H - Health
A - Accounting, Architectural, Actors
L - Law
E - Engineering
S Corp (Risky entities)
Becomes an S corp by unanimous election of shareholders
Advantages:
<= 100 shareholders
Only a single class of common stock, can be voting or non (not preferred)
Domestic corp
Individuals, estates and certain trusts can be shareholders
Files on 1120S
Disadvantages:
Corporate formalities
Sale of stock limited by eligibility standards
Limited Partnership (Risky entities)
Any business can be a limited partnership. Must have one General Partner. Limited partner is passive investor and liable up to their capital contribution.
Tax Forms
Corp: 1120 (Filing), W-2 (Employee), 1099 (Distributions)
Sole: Schedule C (Filing), Sched. C (Employee), N/A (Distribution)
Partnership: 1065 (Filing), W-2 (Employee), K-1 (Distributions)
S Corp: 1120S (Filing), W-2 (Employee), K-1unearned (Distributions)
Differences between estates and trusts?
- Trust is created intentionally. Estate comes into existence by operation of law upon decedents death
- Estates operate for a limited period. Trusts operate for many years
- Estates move property to beneficiaries. Trusts may retain property
- Court supervises the estate. Trustee operates trust under private agreement
Tax Filing of Estates and Trusts
Estate: File 1041, due on 15th of the fourth month after the entity’s year ends,
only file if either >$600 gross income, any taxable income or bene is a nonresident alien.
Estate can deduct admin costs, attorney fees and expense for preparing return
Trusts: Must file using calendar year, except charitable trusts
Distribution to beneficiaries of trusts and estates for tax reporting
Beneficiaries must report all income to be distributed, whether or not it was received and all amounts actually paid or credited up to the amount of their distributed net income
Grantor Trusts
Also known as tainted or defective trusts. The following violations taint the trust and tax the grantor rather than the trust itself.
- Trust income is/may be distributed or accumulated for later distribution to grantor or spouse
- Trust income is/may be used to discharge any legal obligation of the grantor
- Trust income is/may be used to pay premiums on life insurance of either grantor or spouse
Can also be tainted for estate tax if grantor….
1. Has Beneficial enjoyment: right to income or right to use/enjoy trust property
2. Has reversionary interest (interest that reverts back to grantor) that exceeds 5% at the time of death
All others would be non-grantor trusts
ILIT
Insurance Life Insurance Trust
Unfunded: if yearly gift to the trust pays the insurance premium
Funded: If lump sum (corpus) is given at beginning and income generated pays premium.
Only the amount of the premium is taxable to the grantor. The remainder is taxed to the trust
Simple Trust/Estate
Used as conduit for distributing income to beneficiaries. Beneficiaries pay the taxes not the trust.
Cannot make charitable gifts
Complex Trust
Taxed as a separate entity.
It’s irrevocable and grantor has not retained any control
Income must or may be accumulated.
Income accumulated taxed to trust, income distributed taxed to beneficiary.
Can make charitable gifts, and corpus can be distributed
*Not all irrevocable trusts are complex
Revocable Vs Irrevocable Trusts
Revocable: Grantor trusts, all income earned is taxed to the grantor. At death, trust becomes irrevocable corpus is either distributed or continues to later date.
Irrevocable: Grantor gives up all rights in property transferred to trust. It becomes a non grantor trust. Can be taxed as simple or complex depending on whether all income is distributed in that tax year
Trust Tax Deductions (exceptions to what an individual can deduct otherwise similar)
Charitable deduction: Only for complex
Administrative expenses
All income the trust is required to distribute, doesn’t matter whether or not it’s actually distributed. Complex trust has a $300 exemption if it has to distribute all income and $100 if it is not required to distribute income
DNI and DNI deduction
DNI (Distributable Net Income): Limits amount beneficiaries must report as gross income on distrubtion.
The deduction is the lesser of the DNI and the distributions for the year.
Must limit portion of distribution that is taxable to beneficiary
Cost Basis & Adjusted Basis
Cost Basis = Original purchase price or investment in any asset + improvements (including legal fees, commission and sales tax)
Improvements: Increase cost basis, but must be capitalized first. Replacing A/C, plumbing or roof. Add fence, room. Pave Driveway. Incur assessment.
Repairs: Deducted as expenses, never affect cost basis. Repair or pay for something are typical key words.
Adjusted Basis = Cost basis less cost recovery (deductions). Deduction generates tax savings but reduces basis of the asset
Amortization
Assets with no physical substance can still be recoverable similar to straight line depreciation
Accretion
Creates phantom income for each year of the bond’s life for the discount earned on that bond (often for zero coupon bonds)
Gifting property for income tax
Use the lesser of the FMV or the adjusted basis on date of gift.
If FMV is less than adjusted basis: Use following for actual sale of the gift
Gain if sale price is > Adjusted basis
Nothing if between the two
Loss if sale price is < FMV
Community vs Noncommunity property: For marital property
Community: Receives a full step up in basis to FMV
Noncommunity (common law): 1/2 step up on basis to FMV
MACRS vs Straight Line recovery
MACRS requires half year convention for year of acquisition (recovers faster). Its used for non residential real estate property
Recovery MACRS Straight Line
Year 5 year 7 year 5 year 7 year
1) 20% 14.29% 10% 7.14% (straight is half for both 5&7)
2) 20% 14.29%
Property classes and recovery years
5 Year: Computer, Auto, Light Duty Trucks (1245 Property)
7 Year: Office furniture and fixtures (1245 Property)
27.5 Year: Residential rental property (1250 property)
39 Year: Nonresidential real property (1250 property)
CORN Accronym, residential is more useful therefore shorter schedule
Expensing using 179 deduction
Allows for 1245 property to be deducted $ for $ to the taxable income for the taxpayer of any trade or business up to $1,160,000. Cannot create a loss though.
1031
No gain or loss is recognized on exchange of certain like kind investments or for productive use in trade or business
Real estate is only qualifying property.
- Shopping center, rental property, apartment complex, farm, ranch
Taxpayer must use property for business purposes (no primary residence)
Boot
Any consideration in addition to exchange in a 1031 exchange
Boot Received: recognized basis
Boot Paid: Add to your current basis
Basis carries over from last property
1031 Calculations
Realized Gain: FMV of property acquired + boot - adjusted basis (amount will be provided)
Recognized Gain: Lessor of realized gain or boot received (if no boot received answer is 0)
Substitute basis: FMV of property acquired - (realized gain - recognized gain)
Capital Gains and Losses
Short term gains & losses are netted against each other
Long term gains & losses are netted against each other
Remaining gains & losses are netted against each other (not gains & gains or losses & losses)
Only $3k of losses can be used to offset ordinary income
LTCG and STCG Tax Rates
LTCG Single Joint HOH
0% <=44,625 89,250 59,750
15% <=492,300 553,850 523,050
20% Anything Above the numbers in 15%
STCG
Taxed at ordinary income rates, long term collectible rates are 28%
1250 property long term capital gains are taxed at LTCG rates, but a special 25% depreciation recapture is applied when property is sold
Mutual Fund Shares Sale Tax Implication
3 methods
FIFO
Specific Identification: Identify specific shares to sell
Average Cost: Average cost of all shares held. (Total cost held / # shares held)
Sale of Residence Code Section 121
Must have owned the home and it be their primary residence.
$500,000 is excluded from gross income on sale for joint, $250k for single
Can receive partial deduction if move is required by employer, health reasons or unforeseen circumstances (divorce or natural disaster). Deduction is percentage of how long you lived their prior to leaving
Depreciation recapture
Applies to all 1245 property.
Business claims cost recovery depreciation as a deduction of ordinary income.
When 1245 property is sold for a gain:
Look back and recapture the lesser of total CRD’s taken or gain realized (ordinary income)
recover any excess gain as 1231 gain. (If CRD’s taken are < gain, the excess gain minus the CRD’s)
Installment sale recapture
If taxpayer makes an installment sale of tangible personal property all depreciation recapture must be reported as income in the year of sale.
Wash Sale
No loss deduction for sale of a stock that is repurchased within 30 days
Related parties in like kind exchanges
Like kind exchanges and installment sales are subject to related party rules, meaning if they sell the property within 2 years any gain not recognized is recognized on the date of sale
AMT
Alternative minimum tax rate is either 26 or 28%.
AGI or Post 1040 income + Pref Items + Add back items - exemptions. Multiply by AMT tax rate
Preference items that need to be added back for AMT calculation: IPOD
Intangible Drilling Cost (Excess depletion)
Private activity municipal bond
Oil & Gas percentage depletion
Depreciation (ACRS & MACRS, Not straight line)
Add back items:
Taxes: Property, state, city/income & sales
Bargain element: On incentive stock options
AMT Tax Payable = AMT - estimate regular tax (if answer is negative then its 0)
How to avoid or postpone AMT
- Accelerate the receipt of taxable income or defer payment of taxes (property/state income), deductible medical expenses, or charitable giving (increases taxable income)
- Defer the exercise of ISO’s to a later date or disqualify it so it becomes a nonqualified stock option
- Purchase public purpose muni bonds (not private activity)
Passive activity income
A trade or business where the taxpayer does materially participate.
There are two types of passive activities:
1. Rentals, both equipment and rental real estate, and oil royalties
2a. Limited partnerships
2b. Partnerships, S-Corps and LLC’s (both 2a and 2b the taxpayer cannot materially participate)
May only deduct the loss to the extent of income generated from another passive activity
Publicly Traded Partnerships
Publicly Traded MLP’s: Cannot be used to offset losses from any other source. Losses are carried forward but can only be used for future income from that same partnership
Non-Publicly Traded MLP’s: Can uses losses to net against passive income generators. Can only take loss up to income generated can’t take extra.
PIG & PAL (Passive income generator & Passive Income Losses)
When owner disposes of their entire position in a passive activity or dies, any suspended losses are fully deductible in that year.
Material and Active Participation
Material: Taxpayer is involved in the operation of an activity on a regular, continuous and substantial basis. (Generally not a limited partner)
Active: Requires bona fide involvement in management decisions. Must own >=10% interest in the property (can never be a limited partner).
Passive Loss for Real Estate
Can deduct up to $25k in net losses for real estate. Phased out 2 for 1 with AGI between 100k-150k.
Principal Residence (Not a passive activity): Rented < 15 days, income excluded from gross income
Renting vacation home: included as a residence if owner uses it for personal purpose >14 days or 10% of the period of rental use.
Best ways to lower AGI with
Invest in low income housing that generates losses and credits
Invest in GP’s that is losing money (unlimited liability and pass through losses)
Special Circumstance Tax Implications
Widow: Can file jointly with deceased individual for that year. If they maintain the home for a dependent child, they can file jointly for the 2 years after the year of death
Divorce: Finalized after 12/31/2018, alimony payments are not deductible, and recipient doesn’t claim as income. Alimony is deductible if the below and finalized before 12/31/18 are met.
- Cannot live or file joint tax return together at time of payment
- Payments made in cash
a. Payments can be made to cover rent, mortgage, tax or tuition liabilities
b. If payee owns life insurance policy on payor, premiums paid would qualify for
payor if they make them
c. Payments in noncash (services, use of property etc) or payments to maintain
property owned by payor and used by payee all do not qualify
- Payments must be received by or FOB of payee spouse (not child support)
- Payments cannot extend beyond the death of recipient spouse
Recapture of Alimony
Payments made in first two years - $37,500 = Recapture amount
Amount recaptured is treated as ordinary income to payor (because they deducted too much in years 1 & 2)
Child Support
Nondeductible to payor and nontaxable to payee. Never considered as part of alimony
Charitable Contributions and Distributions
Cash Contribution: Max 60% of AGI for total contribution (50% to public and 30% to private)
For Appreciated property
Public Organization: 50% of AGI
Private Organization: 30% of AGI
If using basis you can use up to 50% of AGI, up to 30% of AGI for FMV
Use Related: Real Estate and Stocks
Use-unrelated: Inventory, copyright, short term capital gain property, use-unrelated property (land or artwork). Must use basis but can take the full 100% up to the AGI limit of the organization donating too.
Properties with a loss must use lower number, short term must use basis
Business Charitable Contributions
Business cannot deduct >10% of its taxable income for charitable gifts
Any business other than S-corp can deduct inventory as a gift.
