Income Tax Flashcards
To calculate the taxable portion of the Social Security benefits, MAGI plus one-half of the taxpayer’s Social Security benefits must be compared to these hurdle amounts.
MFJ:
1st Hurdle - $32,000
2nd Hurdle - $44,000
All Other Taxpayers Except MFS = 0
1st Hurdle - $25,000
2nd Hurdle - $34,000
If MAGI plus one-half of Social Security benefits exceeds the first hurdle but not the second, the taxable amount of SS benefits is the lesser of: 50% of Social Security benefits or 50% x [MAGI + 0.50 (Social Security Benefits) - Hurdle 1].
If MAGI plus one-half of the SS benefits exceeds the second hurdle, the taxable amount of SS benefits is the lesser of : 85% Social Security benefits or 85% x [MAGI + 0.50 (social security benefits) - Hurdle 2}, plus the lesser of: $6,000 for MJF or $4,500 for all other taxpayers or, the taxable amount calculated under t 50% formula and only considering Hurdle 1.
Below-Market Loans
- Below-market loan rules apply to term or demand loans that are gift loans, or tax avoidance loans. Below-market loans have special income tax treatment that requires the lender to impute the interest income that would have been earned had the lender made a bona fide interest-bearing market loan.
- The interest, also known as phantom interest income, is included in income even though the lender did not actually receive and money.
- The lender is also considered to have made a gift to the borrower in the amount of the imputed interest. Whatever the amount the lender (donor) must impute as interest income for income tax purposes is also the amount of the gift from the donor (lender) to the donee (borrower). Note that the amount of the gift may be eligible for the annual gift tax exclusion.
Modified Endowment Contract (MECs)
MECs are not treated the same as other insurance policies.
- An MEC is a life insurance contract that fails to meet the 7-pay test.
- A contract fails to meet the 7-pay test if the accumulated amount paid under the contract at any time during the first 7 contract years exceeds the sum of the net level premiums which would have been paid on or before such time if the contract provided for paid-up future benefits after the payment of 7 level annual premiums.
- Loans and withdrawals from MECs are subject to LIFO treatment. In other words, basis is recovered last. Therefore, when loans or withdrawals are made from a MEC, the proceeds of the loan or withdrawal are included in gross income to the extent of earnings.
Above-the-Line Deductions (For AGI)
- Trade or business expenses
- Deductions from losses on sale or exchange of property.
- Deductions from rental and royalty property.
- Alimony payments (for divorce decrees prior to 10/31/2018).
- One-half of self -employment tax paid
- 100% of health insurance premiums paid by a self-employed individual
- Contributions on pension, profit sharing, annuity plans, IRAs, etc.
- Penalty on premature withdrawals from time savings accounts or deposits
- Interest on student loans
- Health Savings Accounts
- Teacher Expense Deduction (up to $300 deduction for qualified expenses for primary and secondary education professionals) (made permanent by PATH 2015)
Trade or Business Expenses
In order for expenses to be deductible, they must be:
- Ordinary: normal, usual, or customary for others in similar business, and not capital in nature.
- Necessary: prudent businessperson would incur same expense
- Reasonable: question of fact
- Incurred in conduct of business.
Unreimbursed employee business expenses are no longer deductible as a miscellaneous itemized deduction, subject to the 2% of AGI floor. (TCJA 2017 repealed all itemized deductions subject to the 2% floor through tax year 2025)
Below-the-Line Deductions (From AGI)
- The total deductions from AGI must exceed standard deduction to provide any tax benefit.
Include:
- Medical Expenses (in excess of 7.5% of AGI)
- Certain state and local taxes (property tax, state income tax paid or state and local sales tax). Taxes are capped to $10,000 total per TCJA
- Contributions to qualified charitable organizations
- Casualty losses
- Certain personal interest expense
- Qualified Business Income
- Miscellaneous itemized deductions not subject to the 2% floor (2017-2025)
Public Charities
Include churches, schools, hospitals and governmental entities. Ex. the Red Cross, Salvation Army, ASPCA, etc.
Private Charities
Contributions to exempt organizations that do not fit the definition of public charity. These charities include veterans organizations, fraternal orders, and certain private foundations that support comes from a small group as opposed to the public. This group is subject to either a 20% or 30% of AGI limitation, depending on the type of property contributed. Special Rules and Carry-forward of Disallowed Contributions:
- If a taxpayer makes donations to both a public and private charitable organization during a year, the 50% donations are considered first. Any charitable contribution deductions disallowed because of the AGI limitations may be carried over for 5 years and are used in a first-in-first-out order. The carryover amounts retain their classifications as 20%, 30%, 50% or 60% donations.
Deduction Clustering
Higher standard deductions have led to less taxpayers itemizing their deductions. Deduction clustering allows taxpayers to “cluster” itemized deductions together in one year and take the standard deduction in the following year. Itemized deductions that might be able to be bunched are:
- Early payment of state income or property taxes.
- Early payment of mortgage interest
- Medical expenses
- Charitable donations
- For taxpayers that feel charitable but don’t have a specific charity they contribute to, they can use donor-advised funds. The donor-advised funds allow for an immediate tax deduction and distribution to a selected charity at another time. Donor-advised funds can be set up through a brokerage firm or a charity.
Qualified Business Income (QBI)
The TCJA 2017 created a new type of below the line deduction under Section 199A for “Qualified Business Income” of pass-through entities for tax years 2018-2025. The QBI deduction is a below the line deduction that is not affected by a taxpayer’s standard deduction. The taxpayer that qualifies can take both the QBI deduction plus the greater of their itemized deductions or standard deduction. Qualifying entities include:
- sole proprietorships
- partnerships
- LLCs
- S corporations
- REITs
- Master limited partnerships (MLPs)
- Reduces taxable income but does not reduce adjusted gross income.
- The deduction is generally 20% of the taxpayer’s Qualified Business Income (QBI). The net result is to reduce the tax rate on the business income by 20%.
- Ex., for a taxpayer in the highest marginal bracket (37% in 2023), the tax on the business income is effectively reduced to 29.60% (37% x (1-0.20) = 29.60%
- “Deductible QBI” is determined for each business separately, and is generally 20% of business income, not including investment income (e.g. capital gains/losses, dividend income, or interest income), and not including reasonable compensation paid to an S corp. owner, or guaranteed payments to a partner or LLC member for services performed for the business.
- “Combined QBI” is the net amount of “deductible QBI” for all qualifying businesses owned by the taxpayer plus qualified REIT dividend and qualified publicly traded partnership income. In other words, combined QBI has already factored in the 20% of QBI for each business as the deductible amount.
*Note on QBI: QBI is not a business expense against revenue. It is a deduction on pass through income of the owners. It is taken at the individual level and is a below the line deduction.
Earned Income Credit
General qualifications for credit:
- Must have earned income (employee or self-employed), and
- Must have a qualifying child.
- Exception: credit is available for some taxpayers having no children.
- Qualifying child must meet relationship, residency and age tests.
Credit amount:
- Applicable percentage rate x Earned Income
- The applicable percentage rate and maximum amount of earned income are determined by the number of qualifying children.
- IRA tables should be used to calculate the exact credit amount.
Credit for taxpayers having no children:
- Taxpayers aged 25 through 64
Adoption Expenses Credit
- Credit for qualified adoption expenses incurred in adoption of eligible child.
- Examples of expenses include adoption fees, court costs, and attorney fees.
- Maximum credit is $15,950
- Credit is phased out ratably for modified AGI between $239,230 and $279,230
- An eligible child is one that is:
- Less than 18 years of age, or
- Physically or mentally handicapped.
- The adoption Expenses Credit is a nonrefundable credit, but the excess may be carried forward for 5 years.
Child Tax Credit
- $2,000 for each dependent child under age 17 (for 2023)
- Includes stepchildren and foster children
- Married taxpayers must file jointly to be eligible for the credit.
- Eligible children must be:
- Under age 17,
- a US citizen, and
- Claimed as a dependent on taxpayer’s tax return.
- Credit is phased out for modified AGI above specified levels (2023)
- Subject to limitations, up to $1,600 per child may be refundable
Family Credit (Qualifying Dependent Credit)
A $500 credit for those who would qualify as a dependent (i.e. qualifying child 17 or over and qualifying person)
Child & Dependent Care Credit
- General qualifications:
- Must have employment-related care costs for either: a) Dependent under age 13, or b) Handicapped dependent or spouse.
- Married taxpayers must file a joint return to obtain credit.
Credit amount:
- Eligible care costs x Applicable percentage
- Applicable percentage ranges from 20% to 35%
- AGI of $43,000 and above are at 20%. The expenditures that qualify are the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individuals. (Most likely to be tested is 20% x eligible costs).
- The deduction for care cannot be made for care provided by a dependent of the taxpayer. Ex., you cannot pay your 16 year old to watch your 9 year old and take a tax credit.
- Costs for care of qualified individual within taxpayer’s home or outside the home.
- If outside the home, handicapped dependent or spouse must spend at least 8 hours a day within taxpayer’s home.
Earned income limitation
- Amount of eligible care costs cannot exceed taxpayer’s or spouse’s earned income.
- Full-time student or disabled taxpayer (or spouse) are assumed to have earned income up to maximum per month limits.
Determination of vacation home treatment is dependent on personal use days vs. rental use days.
- Fewer than 15 rental days: No gross income from rentals and no deductible rental expenses. In addition, the mortgage interest and property taxes are treated as if on personal residence (generally deductible in full).
- More than 14 rental days: Treatment depends on amount of personal use. If the personal use days are NOT more than that greater of 14 days or 10% of fair rental days, then the taxpayer can deduct all expenses allocated to rental use even if loss results.
At-Risk Rules and Passive Activity Treatment
There are 3 types of income: Active, Passive and Portfolio.
Under the at-risk-rules, which apply before the passive activity rules, losses can only be deducted to the extent of property/money that is at risk.
- Three ways to increase basis (at risk amount):
- Add more capital (cash or property)
- Undistributed business income of a pass-through entity that is recognized on the owner’s income tax return
- The use of debt for the partnership.
- The use of recourse debt will increase basis. This is the type of debt the taxpayer is personally liable to repay.
- Non-recourse debt will not add to basis. This type of debt is secured by the investment itself and is not an obligation of the investor (taxpayer).
Passive losses can only offset passive gains.
Passive Activity (Definition)
No material participation.
Rental activities
- Exception: Real estate rental activities if the client actively participates. This deduction is only available to estates and individuals, and limited partners are never considered active participants. Active participation requires at least 10% ownership, as well as involvement in management decisions, such as approving new tenants or arranging for repairs.
- If the real estate is actively managed, then the taxpayer can deduct up to $25,000 against ordinary income.
- This exception is subject to a phaseout of 50 cents for every dollar that AGI exceeds $100,000
- Completely phased out at AGI of $150,000.
How to calculate percentage of social security that is taxable
- If MAGI plus one-half of social security benefits exceeds the first hurdle but not the second, the taxable amount of the ss benefits is the lesser of:
- 50% ss benefits or
- 50% [MAGI + 0.50 (social security benefits) - Hurdle 1]
- If MAGI plus one-half the ss benefits exceeds the second hurdle, the taxable amount of ss benefits is the lesser of:
- 85% social security benefits, or
- 85% {MAGI + 0.50 (social security benefits) - Hurdle 2], plus the lesser of:
- $6,000 for MFJ or $4,500 for all other taxpayers, or
- the taxable amount calculated under the 50% formula and only considering Hurdle 1.
