Income Tax Flashcards
What are the Eligibility Requirements for a Subchapter S-Corp?
LLC is the legal Entity registered with your state where S-Corp is a Tax Entity/Election (Form 2553) –> March 15 DEADLINE
* S-Corp is a pass-through entity (Where profits pass to Individuals who pay state and federal tax)
* S-Corp has larger list of business requirements (board meetings, issue stocks, salaries, dividends)
* Number of Shareholders limited to 100
* Corporation can only have single class of outstanding Common Stock (no preferred), but Common can be voting or non-voting (Potentially harder to Raise Capital)
* Domestic Corporation Only; Individuals, Estates, and Certain Trusts, may be shareholders
* NOTE: Non-resident aliens can not be shareholders
Tax Basis for Partnership/LLC
Sole Proprietorships, General Partnership, and Default LLC are pass-through legal Entities registered with your state which protects business assets from personal assets –> 1065 for Partnership Income and K-1s
* Cash Invested in partnership represents proportional tax basis
* Direct Loans made to the partnership
* Partnership Debt: Loans made to the partnership - not the partner (Bank Loans)
* NOTE: S-corp basis does NOT include bank loans even if S-corp owner guarantees the debt
At-Risk Amount in Partnership and LLC: Cash Contributed, adjusted basis of property, and liable debt (CAN BE TAX DEDUCTIBLE UP)
Property Classes
REMEMBER CATCORN
1245 Property (non real estate) → 1245 Property (non real estate) → Can use 200% DB Rate/Straight-Line and Half-Year Convention (Quarter-Year Exception if > 40% of property placed in last quarter)
* 5 Year: Computers, Autos, Trucks
* 7 Year: Office equipment (not computer)
1250 Property (real estate) → Straight-Line and Mid-Month Convention (Different before 1980s)
* 27.5 Year: Residential rental property
* 39 Year: Non-Residential real property
Boot/Gain Recognized Basis
1031 Exchange: Defer taxes by finding replacement rental property, commercial, or vacant to invest in within 45 days (close within 6 months of date sold)
* Boot is anything that is not of “Like-Kind” in a 1031 Exchange (Tax Consequence)
* Boot can be cash or mortgage (Debt Relief) → Sell 1M and Buy 900K House (100K Boot)
No Boot Received: The replacement property’s total value and mortgage must be equal to or greater than the relinquished property
* Cash Boot = If you receive cash instead of reinvesting all proceeds.
* Mortgage Boot = If the replacement property has a lower mortgage than the relinquished one, unless you replace it with personal funds
When Boot Received:
* Boot Paid is added to Basis
* Boot carried over from prior property
Netting Capital Gains and Losses
Step 1:
* ST Capital Gains and ST Losses are Netted
* LT Capital Gains and LT Losses are Netted
Step 2: If a gain and loss remain, they are again Netted (Clear Short/Long-Term Before Moving)
Step 3: If a loss remains after Netting, only $3000 Net Losses/yr can offset ordinary income
Note: Loss Carryover ENDS at death
Sale of a Personal Residence (Section 121)
Gain/Loss = Selling Price - Selling Expenses (Commissions Paid/Legal Fees) - Adjusted Basis (Purchase Price, Some Closing Costs, and Improvements)
* 250K (Single) and 500K (MFJ) of gain is tax free if lived in for 2 out of 5 years.
* EXCEPTION: If lived for < 2 years, a prorated amount is received if moved from new job, health, “unforeseen circumstances”
* EXCEPTION Calculation= Eligible exclusions x days lived/730 = $250,000 x 257/730 = $88,014. Any gain up to this amount can be excluded.
Recapture (1245 Property)
Sole Proprietor purchases equipment (or other business), holds it more than a year, and takes yearly depreciation to offset ordinary income. (Cost Recovery Deduction - CRD)
When selling for gain:
* Recapture the smaller of depreciation (CRD’s) taken or 1245 gain realized (ordinary income)
* Recover any excess gain as 1231 (capital gain)
Example: Buy computer for $100 and take $70 of depreciation over 7 years –> Always Calculate the Adjusted Basis First: $100 - $70 = $30
1. Sell computer for $10 → $10 - $30 = -$20 ordinary income loss
2. Sell computer for $80 → $80 - $30 = $50 of depreciation recapture
3. Sell computer for $150 → $100 - $30 = $70 of depreciation recapture; $150 -$100 = $50 capital gain
1250: Depreciation Recapture is flat 25%
Section 179 (Qualifying vs. Non Qualifying Property)
Encourage small businesses to purchase equipment and technology→Max Deduction $1,220,000 (2024), reduced every dollar above $3,050,000 (2024)
Qualifying: Use Section 179 and deduct full purchase price of asset in first year, then MACRS!
* Tangible Personal Property/Machinery (Includes Roofs, Heating, Ventilation, fire protection, ect.)
* Autos up to 12,400 (2024)
* 1245 Property
Non-Qualifying
* Intangible (owning franchise)
* Real Estate
* 1250 Property
Business Income Limitation: Deduction cannot exceed taxable income of business including wages and any other income assigned to taxpayer from partnership or S Corp (cannot create/increase NOL)
AMT Preference Items
REMEMBER IPOD
* Excess Intangible Drilling Costs (IRD)
* Private Annuity Municipal Bond
* Oil and Gas Percentage Depletion / Excess Intangible Drilling Costs (IRD)
* Depreciation (ARCS/MARCS), but not straight line
AMT Add-Back Items / AMT Non-Deductible Items
REMEMBER PANIC TS
* Private Activity Bond Interest
* Accelerated Depreciation (MARCS)
* Net Operating Loss (NOL)
* Incentive (Qualified) Stock Option Bargain Element
* Circulation Costs (Newspaper, Magazine)
* Tax Deductions (SALT)→ $10,000 (2024)
* Standard Deduction
Postponing AMT
- Accelerating receipt of taxable income
- Deferring payment of property taxes, state income taxes, deductible medical expenses (10% AGI REQ), or charitable giving. (Regular Tax (1040) may exceed AMT payable (more taxable income)).
- Deferring exercise of incentive stock options (add back time to later date or disqualify ISO so it is NQSO (subject to ordinary income tax))
- Purchase public purpose municipal bonds instead of private activity bonds
Historic Rehabilitation Programs
Historic Rehabilitation programs that are held as passive activity may generate a Deduction:
Equivalent Tax Credit of up to $25,000.
The benefit of this Deduction:
Equivalent Tax Credit phases out between $200- 250k of AGI.
How does the Deduction Equivalent tax credit work?
Calculate tax to determine the maximum marginal tax bracket. If it is 25%, for example, then you multiply $25,000 by 25% to get $6250.
Low Income Housing Credit
Low-Income Housing programs that are held as passive activity may generate a Deduction:
* Equivalent Tax Credit up to $25,000. There is NO phase out.
* The Low Income Housing Credit is allowed annually over a 10 year “credit period.”
* The Depreciation is straight-line over 27.5 years.
How does the credit work?
* For example, multiply 35% by $25,000 to get a credit of $8750.
NOTE: Because there is no phaseout, it produces a higher credit.
Types of Phantom Income
Phantom income is a gain that has not yet been realized through a cash sale or a distribution and is taxable nonetheless
Insurance:
* Lapse of Policy Loan (Take 2M Life Insurance Loan and Cash Value only 1M→ 1M Taxed)
* Section 162 Life/Disability (Provide Life/Disability Income to Key Executives → Lapse could lead to phantom income)
Investments:
* Zero/Strip Income (Bond Income taxed each year even though it is not received)
* TIPS (Treasury Inflation Protected Securities - Like I Bonds, but high limits, more liquid)
* Declared by not paid dividends (Declared/Reinvested, triggers tax)
Tax/Retirements:
* K-1 income from LP/FLP (Limited Partnership) → Owe money on profits on K-1 even if profits rolled into retained earnings or reinvested in business
* Recapture (Income in Later Years)
* NUA (Net Unrealized Appreciation) → Selling Employer Stock after Qualifying Event in 401(k)
* 20% withholding plan distributions, Secular Trust → 401 (K), IRA
Charitable Giving
Cash/Check/Credit Card - 60% of AGI
* $250 or less → Receipt
* $250-$500 → Written Acknowledgment From Organization
* $500+ → Written Acknowledgment and Form 8283
* $5000+ (No Cash Donation) → Everything + Written Appraisal
Capital Gain Asset - 30% of AGI if deducted at Fair Market Value, 50% of AGI if deducted at cost
* Investment asset with long-term capital gain (FMV greater than you paid and held 1+ year)
Ordinary Income Asset / Use-Unrelated Property / Inventory - 50% of AGI, deducted at cost
* Investment asset with short-term capital gain (FMV greater than you paid and held <1 year)
Other Property - 50% of AGI, deducted at Fair Market Value (which is less than what you paid)
* Clothes, home furnishings, automobiles (FMV or Sale $), investments worth less than you paid
Eligible Amounts Given to 50% organizations (public charities)
Churches, schools, hospitals, and orgs like United Way, Red Cross, Humane Society, ect.
Eligible Amounts Given to 30% organizations (private charities)
Private non-operating foundations, war veteran groups, and fraternal orders
NOTE: A deduction CANNOT be taken for political compaign or non-U.S.-based charities
Sources of Federal Tax Law/Authority
Statutory (Congress)
* Internal Revenue Code: THE TAX CODE → Primary source of all tax law.
* Congressional Committee Reports: Indicate the intent of Congress. May not be cited.
Administrative (Treasury/IRS)
* Treasury Regulations: Official Interpretation of Tax Law → Great authority, but not law.
* Revenue Rulings and Revenue Procedures: Official Pronouncements of IRS / Instructions to Taxpayers → Administrative interpretations. May be cited.
* Private Letter Rulings: Apply to specific Taxpayers.
Judicial (Courts) –> Judicial Sources: Court decisions interpret.
* U.S Tax Court, U.S District Court → Appeal to U.S Court of Appeals
* U.S Court of Federal Claims → Appeal to U.S Court of Appeals for Federal Circuit
* U.S Supreme Court
Step Transactions
Ignore individual transaction and instead tax the ultimate transaction
Example: XYZ corporation sells property to unrelated purchaser who subsequently resells property to wholly owned subsidiary of XYZ
Sham Transactions
Transactions that lack business purpose and economic substance will be ignored for tax purposes.
Example: A sale by XYZ to ABC, but both XYZ and ABC are owned by the same person
Assignment of Income
Person who performs the service, earns the compensation.
Example: Mr. T owns XYZ, an S corp. He directs all income be paid to son, Mr. T reports no income.
Dates for Paying Estimated Taxes
- April 15
- June 15
- September 15
- January 15
IRS Penalties
Frivolous Return: $5000
Negligence: 20% of underpayment portion due to negligence.
Civil Fraud: 75% of underpayment portion due to civil fraud.
Failure to Pay: 0.5%/month of tax unpaid (max of 25%) (Pay-point)
Failure to File: 5%/month of tax due (max of 25%)
How to Avoid Federal Withholding Tax Underpayment Penalty
Pay taxes quarterly to avoid fees and if the following rules aren’t met: To avoid, pay the lesser of:
* 90% of current year’s tax liability
* 100% of prior year’s tax liability (or 110% if last year’s AGI exceeded 150K)
* Or owe less than $1000 in taxes after withholding
Adjustments for AGI
2nd Step in 1040 Calculation: Main adjustments/deductions to income are:
* 401(k)/HSA Contributions
* IRA (CAP 87K-Single, 143K-MFJ MAGI)
* Keogh/SEP
* Student Loan Interest ($2500 Max, CAP 95K-Single, 195K-MFJ MAGI)
* ½ Self-employment Tax (7.065%)
* Self-employment Health Insurance (100%)
* Alimony paid-divorce before 2019
* Business Income/Revenue (Schedule 1)
Schedule A Itemized Deductions
** → Limited to 10k/yr
* Medical, Dental, and LTC (7.5% of AGI)
* Casualty & Theft Losses
* Investment Interest Expense (Up to Investment Gains)
* Home Mortgage Interest (Up to 750K Mortages)
* Charitable Gifts
* Real Estate Taxes**
* State and Local Taxes**
* Personal Property Tax**
Casualty Losses (Calculation of the Deductible Loss)
Losses on Personal Use Property: Not Deductible unless declared “natural disaster” and Loss NOT COVERED by insurance
* 1st: Use lesser of Basis or FMV
* 2nd: Subtract any insurance coverage (FMV after)
* 3rd: Subtract $100 (floor)
* 4th: Subtract 10% of AGI. (Only Amounts ABOVE 10% AGI deductible)
* Personal Casualty Losses can Offset Personal Casualty Gains
* Casualty: Auto accident, flood, hurricane, tornado, fire, earthquake (Year Loss Occurs)
* Theft: Item must be stolen (larceny, embezzlement, and robbery) (Year of Discovery) disaster”
* Note: Business/Income Producing is deductible (Loss = Basis - Insurance)
Kiddie Tax
Shift UNEARNED INCOME (interest, dividend, royalties, rent, ect) producing assets to child who has:
* NOT attained age 18 (Children under 18 are entitled (2024) to first $1300 tax free and next $1300 taxed at child’s rate (10% marginal tax bracket)
* Turns 19-23 if full-time student and who has at least one parent alive is taxed at parent’s rate regardless of source of assets
Self-Employment Tax Calculations
2 Parts: FICA (Social Security (12.4% up to 168.6K) and Medicare tax (2.9%) → 15.3% +0.9% Over 200K
* Only 92.35% of SE Income subject to tax because you can deduct half SE tax paid FROM AGI
* Net Schedule C Income (Amount x 92.35%)
* General Partnership Income (K-1 Income)
* Board of Directors Fees
* Part-time earnings (1099) NOT wages or K-1 distributions from s-corp
Tax Credits (Non/Partial/Full Refundable)
-Child
-Child and Dependent Care
-Adoption
-Saver’s
-Elderly & Disabled
-Earned Income
-Foreign
SAVES dollar for dollar on TAX!! (Non-Refundable, Refundable, Partially Refundable)
* Child Tax Credit ($2000 up to $1700 could be refundable) → Phase out: Single→200K, MFJ→ 400K
* Credit for Child and Dependent Care (20%-35% expenses for 3K/spouse) → Children under 13 Daycare, babysitting, and afterschool (nonrefundable)
* Adoption Credit → $16,810 qualified expenses (nonrefundable) → Phase out 292K
* Saver’s Credit → 50%, 20%, 10% Retirement Contributions (Phase Out: Single → 34K, MFJ → 54K)
* Elderly & Disabled Credit (3750-7500) → Over 65/disabled, Very low income
* Earned Income Credit (560-$6935 refundable) → Very Low Income
* Foreign Tax Credit (Dollar for dollar offset of Taxes paid in foreign country) (nonrefundable)
Accounting Methods
Cash: When CASH CHANGES HANDS. Mandatory where taxpayer’s records reflect only cash transactions and no inventories
Accrual: When TRANSACTIONS OCCUR. Mandatory for purchases and sales 25M+ where there are inventories
Hybrid: Combines accrual for inventory portion of business and cash for cash portion of business
Percentage of Completion: For Long-Term contracts where contracts will not be completed within the taxable year started.
Personal Service Businesses that are also regular Corporations (C-Corps)
REMEMBER HALE
* Health
* Accounting/Architectural
* Law
* Engineering
Realized Gain vs. Recognized Gain
Realized Gain: Economic or Inherent Gain at time of transaction
Recognized Gain: Part of Realized that is immediately taxable.
Important for tax planning and investment strategies when thinking about deferral of gains (1031, like-kind, installment sales)
An Individual is Required to File Tax Return if Earning from Self-Employment (1099) Greater than _?
$400
Taxation of C-Corporations
Double-taxation at Entity level and Personal Level
* Income taxed at corporate rate (Taxed Entity)
* Distributions are taken as dividend income and taxed (Personal Level)
AMT Calculation → Adjustment and Preferences
Regular taxable Income
+/- Adjustments → REMEMBER PANIC TS (Passive Activity Losses, Accelerated Depreciation, Net Operating Loss, Installment Method, Contracts, Taxes, Standard Deduction)
+Preferences → REMEMBER IPOD
Alternative minimum taxable income
(AMT exemption) → Full exemption up to 133K MFJ, Full Phase out after 1.2M
Alternative minimum tax base
X AMT rate → 26% or 28%
Tentative AMT tax
(Tax Credits)
Tentative minimum tax
(Regular income tax)
AMT
Types of Income (3-Types)
Active (W2, Guaranteed Payments, Business Income),
Portfolio (Capital Gains, Interest Income, Dividend Income, Annuity Income, Royalty Income),
Passive (activity in which the taxpayer does not materially participate) → Rental Real Estate ALWAYS PASSIVE (Never offset ACTIVE; However can be carried forward and used during SALE)
Note: Businesses Income can be Passive OR active.
