Income Tax Flashcards
Types of Authority (Tax Resources)
Sources of tax law
- Internal Revenue Code (IRC): primary source of all tax law
- Treasury Regulations: source of tax law
- Revenue Rulings and Revenue Procedure: administrative interpretation / may be cited as precedent
Secondary Source - may not be used in court of law
- Private Letter Ruling: guidance on specific tax situation / may not be cited as precedent
- Congressional Committee Reports: indicate intent of congress / may not be cited as precedent
Tax Compliance
Extension: 6 months from filing (April 15th is primary October 15th is extension)
- Form 4868 must show the full amount of estimated tax (not to be confused with 4562)
- 1040X is amended return
- 1040 V: Voucher you send with payments on the 1040
- 1040 ES: voucher that accompanys estimated tax payments throughout the year
Who can represent in an audit?: Lawyer, CPA, Enrolled Agent, Enrolled Actuary
Tax Penalties
- Frivolous Return (is not filled out or purposefully omitted information): $5,000
- Negligence: 20% of the underpayment due to negligence
- Fraud: 75% of the underpayment due to fraud
- Failure to File: 5% of tax due per month with a max 25%
- Failure to Pay: 0.5% of tax unpaid per month with a max 25%
- Failure to file and failure to pay do not coordinate and can get hit with both
Estimated tax: Lesser of
- 90% of this years tax
- 100% of last year or 110% if AGI is above $150k
of the amount of tax due not the amount of taxable income
Quarterly Payments: April 15th + 2 (June 15th) + 3 (September 15th) + 4 (January 15th)
- Cumulative, later installments may be used to amend earlier ones
What to File Taxes As?
Divorced and maintain principal residence with children = Head of Household
Divorced no children = Single
Widowed this year and maintains home for children = Qualifying widower and use MFJ tax rate for 2 years
Widowed no children = MFJ or MFS for the year of death, next year Single
Form W-2
How employers report wages
What is deductible on W-2?
- retirement plan contributions
- employer provided health care
- SALT taxes
Gross Income (Schedule 1 and B-F)
Inclusion in Gross Income
- Wages / Salaries / Tips
- Taxable Interest (Schedule B)
- Ordinary Dividends (Schedule B) - includes qualified dividends
- Business Income or Losses (Schedule C)
- Alimony received (before 2019)
- Taxable Social Security
- Real Estate (Schedule E)
- Pensions and annuities
- Capital gains or losses (Schedule D) - includes long term gains
- IRA Distributions - Qualified Plan Distributions
- Punitive Damages - unless wrongful death or bodily injury
Excluded:
- Compensatory Damages
- Gift
- Inheritance
- Municipal Bond Income
- Child Support
- Medical expense reimbursements
Tax Schedules
A = Itemized Deductions
B = Interest / Ordinary Dividends
C = Self-Employment
D = Capital Gains
E = Passive Income / Loss
F = Farming Profit / Loss
H = Household Employee (pay more than $2,600) & report FICA taxes
Schedule 1 = is the 1040 itself
Schedule SE = where the self-employment tax is calculated
Above The Line Adjustments
- IRA Contributions
- Keogh or SEP Contributions
- Alimony Paid (prior to 2019)
- 1/2 Self-Employment Tax (.07065)
- Self-Employment Health Insurance
- $2,500 Student loan interest
- Contributions to health savings accounts
- Penalty for early withdrawal of savings
- Moving expenses for military
- School teacher expense up to $300
Below the Line Deductions
Standard Deduction: See CFP provided tax tables
- Watch out for elderly individuals or blind
- Child standard deduction is $1,250
Itemized Deductions
- Medical, Dental, & Qualified LTC expense (7.5% AGI floor)
- SALT ($10,000 Cap)
- Charitable Gifts - see note card
- Impairment related work expenses
- Gambling losses up to gambling income
- Investment Interest expense up to net investment income
- Casualty Loss - see note card
Bunching: bunch all itemized deductions into one year, then trade off between standard deduction and itemized deduction
Itemized Deduction: 7.5% AGI Floor for Health Care
Deduct the amount of expenses that exceed 7.5% of AGI
Investment Interest Deduction
Interest paid on indebtedness on property held for investment (margin account)
Max deduction = investment interest expense up to net investment income
Qualified taxes (LTCG or Qualified Dividends) do not count… can’t double dip
- investor could elect to not use preferential treatment
The remaining interest carry’s forward
Casualty Losses (must be presidentially declared)
- Lesser of Basis or FMV
- Subtract reimbursement from insurance company (must apply for the insurance if you have it on a timely basis)
- Subtract $100
- Subtract 10% of AGI
Home Office Deduction for Self-Employed
Schedule C
Deduction is limited to net business expenses
- The deduction can not create a loss
Entertainment Expense
Only thing that can be deducted for entertainment is 50% of meals
Kiddie Tax
Kiddie tax only apply to unearned income for children up to age 18 or children 19-23 if they are full time students before the end of the tax year
First $1,250 tax free / next $1,250 @ 10% / Remaining @ parents marginal tax rate
watch out for kids having to pay SE tax
Self-Employment Tax
Who Pays SE Tax?
- Sole Proprietorship
- Partnership
- 1099 contractors / board of directors
- General partnership that is shown on a K-1 (other K-1 income is not part of SE tax)
What is not included?
- W2 Income
- Passive Income
- Real estate income or rents received
Calculating SE Tax = 14.13% or (0.07065 X 2) of SE Income watch out for expenses outside of Net schedule C income and 50% of meals
FICA Tax (on the W-2)
6.2% up to the taxable wage base ($160,200)
1.45% on everything (all income)
Income Tax Credits: Child Dependent Care Credit
Until Age 13
- Non-Refundable
- Qualifying expenses are limited to $3,000 for one child or $6,000 for two +
- 20% of expenses are the credit
Ex. 2 children with $6,000 in qualifying expenses: $6,000 X 20% = $1,200 (NON REFUNDABLE)
Income Tax Credits: Child Tax Credit
Under Age 17
- Partially refundable
- $2,000 for each qualifying kid
- Phaseout above $400,000 MAGI and $200,000 Single
- Reduced by $50 for each $1,000 above MAGI
- $1,400 of the $2,000 is now refundable
- $500 tax credit for dependents who are not qualifying children (elders or children 18 to 23 in school)
- Must earn less than $4,400 in gross income to be claimed
Income Tax Credits: Adoption Credit
Non-refundable
- Adoption fees, court costs, attorney fees, cost to adopt a foreign child
- DO NOT include the cost of surrogate arrangements or adopting spouses child
- 17 or younger
- Any child of any age who is a US citizen or resident alien and has special needs the full credit is available
- Expenses incurred in prior year may be used in the year adoption is finalized
Income Tax Credits: Other
Elderly or Permanently and Totally Disabled Credit
- Non-refundable
- reach 65 or is under 65 with permanent disability
Foreign Tax Credit
- can take credit or deduction
- Non-refundable
Earned Income Credit
- work and have income under certain amounts
- is refundable and IRS will send out a check
Installment Sales
Seller only has to recognize a portion of the gain in the year of sale (ratio)
Gain recognized = Profit / Total Price
Related Party Exception
- If the installment sale is conducted with a related party, and they sell it within 2 years of the original purchase date = seller must file amended tax return and all capital gain will be retroactively taxed back to the first year
C - Corporation
ONLY use when business is profitable ($650k +)
- Separate tax entity using 21% flat tax rate
- Dividend deduction: 50% when own 20% or less
- Ability to offer NQ plans
- Continuity of life
- Sale of stock to UNLIMITED number of investors
C - Corporation or S - Corp: 1244 Stock Election Election
- Applies up to $1,000,000 of capital at issue
- Total Failure of business can deduct $100,000 + $3,000 (if over $100,000) or $50,000 (S)
- Remaining carry’s forward
Business Has Losses / Don’t need Liability Protection
Sole - Proprietorship - Schedule C
- Retirement Plan (Keogh)
- 100% of medical, dental, & LTC insurance deductible for owner
- Deduct 1/2 SE Tax
- Lack of Continuity
- Profit or loss reported on schedule C (excess loss exceeds other income, loss can be carried forward indefinitely)
- Interest paid for debt is deductible on Schedule C (no limit when gross receipts are less than $27 million)
Partnership - Form 1065 for informational purposes only
- Retirement Plan (Keogh)
- 100% of medical, dental, & LTC insurance deductible for owners
- Lack of Continuity
- Losses up to Basis - unlike sole-prop where losses are added to 1040
- Deduct 1/2 of SE Tax
- Disadvantage = joint and several liability & Partnership can dissolve upon death, bankruptcy, incapacity of partner
Losses up to basis include money contributed as well as any loans provided personally or by the bank
Business Has Losses / Need Limited Liability Protection
LLC/LLP
- Partnership or Sole Prop wrapped with limited liability
- Limited partnership must have one general partner and the rest can be limited (limited partners only responsible up to basis)
S - Corporation - Form 1120-S
- Retirement Plan (not Keogh)
- 100% of medical, dental, & LTC for insurance deductible for 2% owners
- Losses up to basis (excluding debt from a bank) - basis is increased by gain for the year
- No more than 100 shareholders - immediate termination if loose eligibility - spouses are always 1
- usually held in ESOP
- only 1 class of stock (can do voting or non-voting)
- Must be domestic and shareholders must be US citizen or residents
- Unanimous consent by all shareholders to become S-Corp
Section 199A QBI (Pass Through Entities)
20% deduction of qualified business income (NET)
- pass through entities such as:
- Sole-Prop
- Partnerships
- Real Estate Investors (REIT Income)
- LLC’s
- S - Corp
- MLP’s
Service = phased out @ $182,100 - $232,100 (S) or $364,200 - $464,200 (MFJ)
Capital = not phased out but lesser of 20% or 50% of W2 Wages Paid
Dont get QBI on salary portion
Basis / Cost Basis / Adjusted Basis
Basis = taxpayers investment in asset or property
Cost Basis = basis + incidental fees (legal fees commissions, sales tax, freight, improvements (not repairs), real estate taxes, and normal business expenses)
Adjusted Basis = cost basis - recovery deductions (deprecation or amortization)
Amortization - Section 197
Intangibles are Amortized - recovery method very similar to straight line depreciation
- Goodwill
- Patents
- Franchise
Section 179 Deduction
Election to expense up $1,160,000 of qualifying property in year of acquisition (1245 Property)
It CAN NOT create a loss
Now includes renovations to an interior of 1250 property
1031 Like-Kind Exchanges
Can only be preformed with real business property - defers gain, does not erase it
Rules & Requirements
- Same taxpayer who sells property must buy (exchange)
- Must identify (select) property within 45 days
- Must close on property within 180 days
- Price of replacement property must be greater or equal to current property
Give Boot = increases substitute basis Receive Boot = Recognized Gain
Disposition of Property / Capital Assets
(Capital Gains Tax)
- Short term gain and losses are netted / Long term gains and losses are netted
- Short term loss can offset long term gain & Long term loss can offset short term gain
- Long term gains and short term gain can not be added together (short term gain is taxed at OI)
What is taxed at ordinary income?
- Short term gain
- 1245 depreciation recapture
- interest / ordinary dividends
- CD maturing
Long term capital gains
- must be held for at least 12 months and a day
- 10% - 12% tax bracket = 0% LTCG rate
- 37% tax bracket = 20% LTCG rate
- everything else is at 15%
- watch out for collectibles at 28%
- this could be a gold bullion ETF
Rates are based off of taxable income not AGI - could sell asset and be brought into higher taxable income rate
Section 121 Residence Exclusion
Exclusion Amount: $500,000 (MFJ) or $250,000 (S)
- Must have used the home in aggregate 2 out the last 5 years
- If entire gain is excluded, it is not reported
- Widowed spouses can use full $500,000 exemption within 2 years of death
Exceptions to living in residence less than 2 years
- Move for work 50 miles or more away
- unexpected child births
- Divorce / Death
- Health Reasons
Months lived / 24 X exclusion amount = adjusted exclusion
Alternative Minimum Tax (AMT)
AMT payable @ 26% or 28%
Preference Items
- Intangible Drilling Costs (excess)
- Private Activity Municipal Bond
- Oil and Gas percentage depletion (not cost)
- Depreciation (not straight line)
Add back items - can create credits
- ISO Bargin Element
- SALT taxes
Depletion - deprecation of natural resources
AMT Payable = difference between regular tax and AMT tax
Ways to avoid AMT
- Reduced taxable income/AGI
- Accelerate taxable income (pay more tax)
- Reduce or eliminate the preference or add back items
Passive Activity and At Risk Rules
Two Types of Passive Activities
- Limited Partnership (unless you are working)
- Equity Interests without any personal service to the business (non participating S-Corp interests)
Rules
- Non-publicly Traded Partnerships (RELP’s)
- Losses may not offset portfolio or active income
- RELP losses may only be offset by other RELP Income up to the amount at risk
- Netting Process on Schedule E
- Publicly Traded Partnerships (MLP’s)
- Income may only be offset by losses generated in the same MLP
- This is portfolio income and shown on schedule B
- Income may only be offset by losses generated in the same MLP
- Losses have to stay in the same MLP and can be carried forward to offset future income
- Can take loss if full interest is sold
Material and Active Participation (NOT Passive Income)
Material Participation: Involved in activity on a regular, continuous, and substantial basis
- Could be an S-Corp but it is indicated as active on Schedule E
Active Participation: Less demanding standard than material participation. Requires bona fide involvement in management decisions.
- Limited partners may not be active participants
- Shown on schedule E
- Can’t just collect rent, but if you set rent prices and organize maintenance this would be active
SNOW EXAMPLE
- Material shovels snow
- Active calls someone to shovel snow
- Passive does not care
Active Participation Real Estate Loss
Active participants in real estate may deduct up to $25,000 per year of net losses from real estate activity from their active or portfolio income.
Phased out between $100,000 to $150,000 ($2 for $1) of AGI
Rental of the Principal Residence
14 days & Under: do not have to report income but also dont get any expense deductions (must be reasonable rent)
Stay at residence for less than the greater of 14 days or 10% of total rental days: Rental Real Estate
- Allows the taxpayer to claim tax benefits like business expenses, depreciation, etc.
Low Income Housing Programs
Low income housing programs that are held as a passive activity, may generate a deduction equivalent tax credit of $25,000 (no phaseout)
Marginal Tax Bracket X $25,000 = credit
Allowed annually over 10 year period
Oil and Gas Working Interests
Oil and Gas working interests where taxpayer is general partner are exempt from passive activity rules
Losses are deductible against active and portfolio income without limits (must be general partner)
- Must assume unlimited liability relative to the business
Divorce: Property Settlements
Property transfers incident to a divorce = tax free
Basis is carried over
Life insurance does not have any consequences
Divorce: Filing Requirements
Divorced Last day of year = Single (no children) or Head of Household (primary residence and have children)
if you got married the last day of year, you can file as married
Dependency Issues
Deduction for medical expenses, medical insurance, child tax credit are dependent on dependency is awarded to the custodial parent (one having the kids for the majority of time)
unless written in an agreement to contrary
- child must receive more than half of his/her support from his/her parents for more than half of the calendar year (if not neither parent can claim)
Charitable Contributions and Deductions
Public Charities:
- All schools, hospitals, and churches
- All organizations for charitable, religious, educational or literary purposes or for the prevention of cruelty to children or animals
Private Charity:
- Private non-operating foundations
- Fraternities
- War veteran organizations
Deduction Limits (all based off AGI)
Rules
- If multiple charitable contributions, total can not exceed 50% of AGI
- Can carry forward for 5 years (Gift Year + 5 years)
- its a mistake on the exam if you loose a client a deduction
Amount of deduction
- Cash = 60% of AGI
- LTCG (stock, real estate) / Related Use Property = Basis (50% of AGI) or FMV (30% of AGI)
- STCG / Ordinary Income Property / Use Unrelated = Basis (50% of AGI)
- Inventory, Short term capital gain property, work of art (below), copyright, artwork and collectibles
- Work of art can just deduct materials (basis)
-Loss Property = 50% of FMV … wont you deduct basis as it is higher
Qualified Charitable Distributions (QCD’s)
- Can only be made if the distribution is made on or after the date the IRA owner reaches 70 1/2
- Only from IRA’s and after tax Roth IRA’s
- NO EMPLOYER PLANS
- Capped at $100,000 per year per person ($200,000 MFJ)
- Only to taxable amounts, no basis transfer
- Must be made in cash
After Tax Roth IRA: Non-Qualified Roth and it is the earnings portion
Basis in IRA: Non-deductible portion of IRA
can be used to reduce RMD Amounts
Watch out for double dipping = contributions to the IRA after 70 1/2 then to turn around a give to charity
