Income Tax Flashcards
primary source of all tax law
internal revenue code
what can be cited as precedent besides the actual law?
revenue rulings and revenue procedures
step transaction
ignores the individual transactions and instead taxes the ultimate transaction
Examples: XYZ corporation sells property to an unrelated purchaser who subsequently resells the property to a wholly owned subsidiary of XYZ
sham transaction
lacks a business purpose, and economic substance will be ignored for tax purposes
example: A sale by XYZ to ABC when both are owned by the same person
Substance over form
the substance of a transcation and not merely its form governs its tax consequences
Example: the president of XYZ has the company lend him money. there is no written loan agreement. he never intends to repay the loan or take a salary. the loan is taxed to the president
assignment of income
income is taxed to the tree that grows the fruit although it may be assigned to another prior to receipt
business vs hobby
any activity generating new income (profit) in three out of five consecutive years is a business, not a hobby.
(2/7 for horses)
Hobby loss rules
you cannot deduct expenses associated with hobbies
an individual is required if net earnings from self employment are at least _______
$400
estimated tax payments
April
June
Sept
January
all the 15th
who can represent a taxpayer in an audit?
attorney
CPA
Enrolled agent
enrolled actuary
Generally not a CFP Certificant
form used to amend returns
1040X
frivolous return
omits info necessary to determine the tax liability
substantially incorrect tax
based on the taxpayers desire to impede the collection of tax
penalty is $5k
negligence
“accuracy-related” penalty
no intent to defraut
penalty is 20% of the underpayment attributed to negligence
fraudulent tax return
intent to cheat the government
penalty is 75% of the portion of tax underpayment attributable to fraud
Failure to pay penalty
.5% per month
25% max
failure to file
5% per month
25% max
estimated tax (to avoid the penalty)
lesser of the following:
1. 90% of the current year tax liability OR
2. 100% of the prior year’s liability (or 110% if the prior year’s AGI exceeded $150k)
insurance premiums for the self employed
taxable income (for self employed, partners, and more than 2% owners of an S corp)
100% is deductible as an adjustment to income on the front of the 1040 to the extent that such cost do not exceed the net income from the business
DOES NOT include disability insurance premiums
Self employment tax adjustment
= .07065
1/2 of the self employment tax
=7.65% x .9235 (1-7.65%) or 1/2 of the 14.13%
deduction from income for alimony
non deductible for divorces settled after 12/31/2018
student loan interest deduction cap
$2,500
MAGI
AGI
+ tax exempt interest
+non taxable social security income
+student loan interest
+ a few other items
limite on state, local, sales, real estate and personal property taxes
limited to $10k
limit on mortgage interest deductibility
$750k
if before 12/15/17 up to $1M
qualified dividends
taxed at the lower long term capital gains rate
note about qualified dividends
unless a question indicates a qualified dividend, treat it as an ordinary dividend
casualty losses
must be a “federally declared disaster”
Calculation
1. use the lesser of basis or FMV
2. subtract any insurance coverage
3. subtract $100 (floor)
4. Subtract 10% OF AGI
Home office deduction
must be self employed
AND
home office must be used for the business
AND
there must be no other fixed location of substantial business use
deduction is limited to the gross income derived from the activity
miscellaneous itemized deductions
repealed for 2018 to 2025
deductibility of business meals provided for the convenience of the employer
50% deductible
meals for employees while traveling
50% deductible
personal exemptions
NO personal exemptions
NO dependent exemptions
marginal tax rate
percentage applying to the last dolalr of taxable income
medicare tax rate applicable to wages in excess of $200k single and $250k MFJ
will increase to 2.35%
(1.45% + .9)
unearned income deduction for kiddie tax
$1,300
how does kiddie tax work?
child gets a $1,300 standard deduction (unearned income)
Next $1,300 is taxed at 10% (the child’s rate)
anything greater than $2,600 in unearned income is taxed at the parents rate
what if a child has earned income
if the child has earned income greater than the standard deduction, the amount of earned income plus $450 is used in the first step of calculation
Self employment income includessss
net schedule C income
general partnership income (k-1 income)
board of directors’ fees
part time earnings (1099)
self employment income doesn’t include
dividends or interest on investments
gains (or deducitons for losses ) from property, securities, or commodities
real estate income or ents paid
distributive share of income or loss of. limited partner
wages from an S corporation
distributions (K1 income) from an S corporation
self employment income wage base
$168,600
if on the exam you calculate the self employment income greater than $168,600, you did something wrong
- calculate the total self employment income
- subtract 7.65% (or multiply by .9235)
- multiply remainder by 15.3% (7.65% + 7.65%)
credit for child and dependent care expenses
until age 13
$3k limit for one dependent
$6k for two or more dependents
multiply by 20% on the exam
child tax credit
$2k for each qualifying child under 17
up to $1700 per child is refundable
$500 family credit for each dependent who is not a qualifying child
adoption credit
$16,810
when to claim the adoption credit
the year of claim depends on when the adoption was finalized and whether the adopted child is a US citizen, resident alien, or foreign national
if the child is a foreign national, the adoption credit is available only in the year when the adoption becomes final
credit for the elderly and the permanently and totally disabled
(1) age 65 or
(2) is under 65, is retired with a permanent and total disability, and receives disability income
earned income credit
for certain peopel who are at low paying jobs
REFUNDABLE
tax deduction vs credit
deduction is worth more to a high bracket payer
cash method of accounting
firms realize revenue from services performed in the year the payment is received, regardless of when the services were performed
accrual method of accounting
firms realize revenue when the earnings process with goods or services they provide is complete, regardless of when payment for those goods and services is received
installment sells and taxes
the installment method permits the capital gain recognized to be spread over the life of the note rather than be recognized entirely in the year of the sale
exceptions to installment sales
-if all payments are recieved in the year of sale
if property is publically traded securities
if property is sold at a loss
if property is sold to a related party who in turn sells the property within two year of the original purchase date
calculation for installment sale(s)
percentage is calculated by dividing the gain realized on the sale by the total contract price
during periods of rising prices it is generally typical to adopt what inventory valuation and flow methods
LIFO
NOL
if a firm’s business operations for a taxable year result in an excess of deductible expenses over gross income
if a business reports no taxable income, the firm obviously incurs no current year tax cost
advantages of sole props
availability of retirement plans (Keogh, SEP)
100% of medical insurance premiums are deductible by the owner
no legal formalities
conduit of income or losses to owner (files on a schedule C)
Disadvantages of sole props
unlimited liability
business dies with owner
capital structure depends on the owner’s personal resources
advantages of partnerships
availability of retirement plans (Keogh, SEP)
100% medical insurance premiums deductible by partners
partnership agreement can be oral (written preferable)
conduit of income or losses to owner
disadvantages of partnership
unlimited personal liability for acts of the partnership or a partner acting on behalf of the partnership (joint and several liability)
partnerships dissolve upon the death, bankruptcy, or incapacity of a partner
capital structure depends on resources of partners
two classes of pass through businesses
personal services (law firms, medcial practices) and firms where revenues come form the talents of entertainers and athletes
and all other
Tier 1 - pass through businesses
single <$191,950
MFJ < $383,900
can claim the full 20 % deduciton
Tier 2 - pass through business
single >$241,950
MFJ >$483,900
NO deduction whatsoever if their business is a personal service firm
Tier 3 - Pass through business
those with incomes between the thresholds are eligible for a partial benefit
LLP
partnership in which the general partners are not personally liable for malpractice-related claims arising from the professional misconduct of another of another partner
c corporations
function as a separate tax entity
(double taxation)
corporation profits are taxed at what rate?
flat 21%
advantages of a regular C corporation
separate tax entity
sale of stock to an unlimited number of investors
dividend received deduction
limited liability
continuity of life
disadvantages of regular c corproations
corporate formalities
dividends paid (after tax)
accumulated earnings beyond certain limits are subject to double taxation
Dividend received deduction (C corps)
US corporation investing in another US corporation receives a deduction for dividends received
section 1244
business is a corporation (C or S) that was initially capitalized with no more than $1M
Loss of $100k per year on a joint return is considered to be ORDINARY, rather than capital
discounts on services limit
limited to 20% of the selling price charged to customers
value of discounts on company products
cannot exceed the employer’s gross profit percentage
standard deduction for age 65 or older and/or blind
$1,550 for MFJ
$1,950 Single
Mortgage insurance qualified residence
<$100k AGI
Subchapter S Corporations
Eligibility
-limit, 100 shareholders
-must be domestic
advantages of S corporations
limited liability
conduit of income or loss to owner but limited losses up to basis
basis equals cash plus direct loans made by the shareholder to the corporation
disadvantages of S corporations
corporate formalities
sales of stock limited by eligibility standards
limited partnerships
must have at least one general partner
limited partners are liable for partnership debt only to the extent of their capital contributions to the partnership
conduit entities (avoid double taxation)
s corporations
llcs
sole proprietors
Estate tax return form
1041
grantor trusts (definition)
the maker holds too much control or “strings” over the property
violations creating a defective trust for income tax purposes
-trust income is, or may be , distributed or accumulated for later distribution to either the grantor or the grantor’s spouse
-trust income is, or may be, used to discharge any legal obligation of the grantor
-pay premiums on life insurance on the life of either the grantor or their spouse
simple trust
“conduit” for forwarding income to the beneficiaries
complex trust
taxed as a distinct entity for income tax purposes if it meet both criteria:
1. irrevocable, and the grantor has not retained any “control”
2. income is accumulated
an irrevocable trust is often ________
a complex trust
remember, often, but not always
revocable living trust
at trustor’s death, the revocable trust becomes irrevocable and either terminates with the corpus distributed to the remainderman or continues until a later date
gift tax consequences of funding a revocable trust
no gift tax consequence during the grantor’s lifetime
irrevocable trusts
the grantor gives up all rights in the property transferred to the trust
trust income
revocable
irrevocable
revocable - as the owner of the property, the grantor of a revocable trust will be responsible for any income tax liability
Irrevocable - can be taxed as a simple or a complex trust depending on whether all income is (or is not) distributed in a specific tax year
charitable deduction and trusts
only allowed for complex trusts
net operating carryforwards for trusts
allowed
exemption for taxable income (trusts)
a complex trust that is required to distribute all of its income has an exemption of $300
one that isn’t required to distribute all of it’s income = $100 exemption
Distributable net income (DNI)
allows
-claiming of a deduction for the amount distributed
-limit the portion of the distribution that is taxable to the beneficiaries
-ensure that the character of the distributions remain the same for the beneficiary as it was to the turst
increases to basis
legal fees
commissions
sales tax
freight
improvements
NOT increases for basis
repairs
real estate taxes
normal business expenses
why don’t repairs effect basis
repairs are typically deducted as expenses
adjusted basis
cost basis less cost recovery
value of the gift for gift tax purposes
FMV at the date of the gift
If the FMV on the date of the gift is greater than the donor’s adjusted basis, then use the donor’s adjusted basis
loss gift basis
if the FMV on the date of the gift is less than the donor’s adjusted basis in the gift, then the following occurs:
1. a loss is measured using the FMV on the date of the gift
2. a gain is measured using the donor’s basis
3. if the sale price of the gift is between the donor’s basis and the FMV on the date of the gift, no gain or loss is recognized
basis of inherited property
FMV on the date of the decedent’s death or the alternate valuation date if selected
basis of inherited property in community property states
marital property enjoys a full step up in basis if at least one half of the whole property is uncludible in the deceased spouse’s gross estate
In noncommunity property states, property only gets a half step up in basis
MACRS must use what?
half year convention
property classes for MACRS
5 year - computers, autos, and 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)
179 deduction
$1,220,000 of qualifying property in the year of acquisition
cannot create a loss
avoids the burden of maintaining MACRS depreciation schedules
property eligible for like-kind exchanges
only real estate
what is “like kind” property
the same in nature, even if they differ in grade or quality
realized gain (like kind exchange)
total value received - adjusted basis of property
recognized gain (like kind exchange)
lessor of realized gain or boot received
substitute basis (like kind exchange)
FMV of property acquired - (realized gain - recognized gain)
timing of like-kind exchanges
identified on or before 45 days
title received within 180 days
related party transactions (like kind exchanges)
if within two years the related party disposes of the property, the gain not recognized in the exchange is recognized on the date of the sale
the like kind exchange collapses
capital gain and losses netting
only $3,000 of net losses can be used to offset ordinary income in a single year
short term capital gains rates
taxed as ordinary income
depreciation recapture
25%
1245 property (depreciation recapture)
- look back and recapture the lesser of total CRDs taken or the gain realized as 1245 gain (ordinary income)
- recover any excess gain as 1231 gain (capital gain)
installment sale recapture
if a taxpayer makes an installment sale of tangible personal property, all depreciation recapture must be reported as income in the year of disposition
HUGE disadvantage
AMT calculation
- regular post-deduction 1040 income (if itemizing) or AGI (if electing the standard deduction)
- add back any item that was deductible for the 1040 but not for AMT
- add preference items
- result equals AMT base
- subtract exemptions
- results equals AMTI
- then calculate AMT
C corporations and AMT
no longer subject to the AMT
passive activity
trade or business in which the taxpayer does not “materially participate”
The owner of a passive activity (the limited partner) can only deduct losses up to what?
the extent of income generated by another passive activity
treatment of disallowed losses
suspended losses are carried forward until the taxpayer can dispose of the interest
for passive investments, there is no $3,000 per year loss allowed per year (like capital loss)
material vs active participation
material = involvement in the operation of the activity on a regular, continuous, and substantial basis
active = bona fide involvement in management decisions
real estate activity loss rules
UP TO $25,000 of net losses from the real estate activity (deductible)
rental of principal residence
when home is rented for fewer than 15 days during the taxable year, the rental income is excludable
BUT no deductions are allowed
tax treatment of renting a vacation home
owner’s use of the unit for personal purposes exceeds the longer of (1) 14 days or (2) 10% of the period of rental use
public charities
50 % organizations
-churches, schools, and hospitals
-all organizations organized and operated for charitable, religous, education, or literary purposes or for the prevention of cruelty to children or animals
private charities
30% organizations
-private nonoperating foundations
-fraternal orders
-war veterans’ organziations
maximum deductibility for cash gifts to public charities?
60% of AGI
can be carried forward as an itemized deduction for five years, or if sooner, death
deduction for appreciated long term gain property
deduction ceiling for gifts of appreciated long-term capital gains property to 50% organizations is 30% of AGI unless they use basis rather than FMV
if basis, deductibility up to 50% of AGI
charitable contributions by business entities
a corporation may not deduct more than 10% of its taxable income for (aggregate) charitable gifts
Schedules and what goes on them
A = itemized deducitons
b - interest & dividends
c - business income or losses
d- capital gains/losses
e - passive income
qualified dividends and long term gains
part of AGI
what qualifies as investment income?
income from property held for investment such as interest, dividends, royalties, and short term gains
dividends will only be included if the taxpayer elects not to use reduced rates
if a business is profitable what types should it be?
C corp or personal service corporation
if a business has losses and is risk free what do you pick?
sole prop
partnership
if a business has losses and is risky
s corp
llc
limited partnership
what type of interest can be deducted without any limits
sole proprietor loans
if borrowing money from a bank what business structure would you choose?
Likely LLC instead of S corp
what entity can’t do an ESOP?
a partnership because there are only partnership interests, not stock
intangibles are amortized
section 197 intangibles
(similar to straight line depreciation)
179 keys
election expense
generally tangible personal property 1245 property (5 or 7 year)
cannot create a loss
boot received =
recoginzed gain
what to do with boot paid?
add to basis
tax rate of 1245 recaptures
ordinary income tax rate
Preference items for AMT
(excess)Intangible drilling costs
private activy muni bonds
oil and gas percentage depletion (NOT cost depletion)
depreciation
(IPOD)
AMT add back items
incentive stock option bargain element
property, state and city/income taxes
home equity indebtedness unelss used for home improvements
