Income Tax Flashcards
Step Transaction
Ignore the individual transactions and instead tax the ultimate transaction.
Ex. The XYZ corporation sells property to an unrelated purchaser ho subsequently resells the property to a wholly owned subsidiary of XYZ
Sources of Federal Tax law/Authority
Internal Revenue Code- primary source of all tax law
treasury regulations: great authority but not law
revenue ruling and revenue procedures: administrative interpretation/may be cited
Congressional Committee reports: indicate the intent of congress/may not be cited
private letter rulings:apply to a specific taxpayer
Judicial sources: court decisions interpret
Sham Transaction
a transaction that lacks a business purpose and economic substance will be ignored for tax purposes
ex: a sale by xyz to abc where both xyz an abc are owned by the same persons
substance over form
the substance of a transaction and not merely its form governs its tax consequences
ex the president of xyz has the company to lend him the money he needs. he never repays the loan or take a salary
assignment of income
income is taxes to the tree that grows the fruit even though it may be assigned to another prior to receipt
mr. t owns xyz, an s corporation. he directs that all income is paid to his son. mr t reports no income
dates for paying estimated taxes
april 15 june 15 september 15 Jan 15 ajsj
frivolous return
a frivolous return is one that omits information necessary to determine the tax liability, shows a substantially incorrect tax, or is based on the taxpayers desire to impede the collection of tax
IRS Penalties
Frivolous return = $5000
Negligence: penalty is 20% of the portion of the underpayment attributed to negligence
Civil Fraud: Penalty is 75% of the portion of the tax underpayment attributable
Failure to file: Penalty is 5% of the tax due per month, whith a maximum of 25%
Failure to PAY: Penalty is .5% per month the tax is unpaid with a max of 25% , pay point
Federal Withholding Tax Underpayment Penalty
To avoid, pay the lesser of the following:
1) 90% of the current year’s tax liability
2) 100% of the prior year’s tax liability (or 110% if the 2011 adjusted gross income exceeded $150,000)
Adjustment for Adjusted Gross Income - AGI
The second step in the 1040 calculation is adjusted gross income. It is the total income (or gross income) less adjustments to income. The main adjustments or deductions to income are the following: IRA Contributions Self-employment tax Self-employment health insurance 100% Keogh or SEP Alimony paid *self employment income X .07065
Schedule A- Itemized Deductions
medical, dental, and LTC (7.5% AGI) casualty and theft losses real estate taxes investment interest expense home mortgage interest state and local taxes personal property taxes charitable gifts
investment expense (tax treatment)
investment expenses are directly connected with the production of investment income (margin interest) In determining net investment income, the 2% miscellaneous itemized deductions must be taken into account, specifically investment advisor fees. In other words, investment income is offset by deductible investment advisor fees.
Casualty Losses - Calculation of the deductible loss
1st - use the lesser of the basis or FMV
2nd - subtract any insurance coverage
3rd - subtract $100 floor
4th - subtract 10% AGI
Miscellaneous Deductions Schedule A
Subject to a 2% AGI
fees to investment counselors
tax advice and preparation fees
professional and business association dues
unreimbursed employee business expense
employee home office expense
They are accumulated and then 2% of AGI is subtracted
Kiddie Tax
All net UNEARNED income of a child who has NOT attained age 24 and who has at least one parent alive is taxed at the marginal rate of child’s parents regardless of the source of the assets creating theincome
Children under 24 are entitled 2012 to a standard deduction amount ($950), and an additional $950 of unearned income will be taxed at the child’s marginal rate (10%)
Self-Employment Income
Net schedule C income
general partnership income (k-1) income
board of directors fees
Part-time earning (1099)
Does NOT include the following: wages from an S Corp K-1 distributions from an S corp Real estate income or rents paid Gains from property, securities, or commodities dividends or interest on investments
Self-Employment Tax Calculation
shortcut! multiple total net self employment income by 12.28% and round up
Tax credit
Credit for child and dependent care expenses (nonrefundable)
child tax credit (earned more than 12,550 - refundable)
adoption credit (refundable)
elderly and disabled credit (nonrefundable)
foreign tax credit (nonrefundable)
earned income credit (refundable)
Installment sales exceptions
if all payments received are in the year of sale
if property is publicly traded securities
if property is sold at a loss
if property is sold to a related party (son, daughter, etc) who is in turn sell the property within 2 years of original purchase date
accounting methods
cash: mandatory where taxpayer’s records reflect only cash transactions with no inventories
accural: mandatory for purchases and sales where there are inventory.
hybrid: combines accrual for inventory portion of business and cash for cash portion of business
percentage of completion: for long-term contracts where the contract will not be completed within the taxable year started
FIFO vs. LIFO
Fifo- (first-in, first out)
increase earning
greater tax liability
current cost inventory
LIFO (last-in, first-out)
Reduced earnings
Deferral of taxes
Understated inventory
Net Operating Losses (NOL)
An NOL sustained in one year may be used to reduce the taxable income for another year. It may be carried back two years, and/or it may be carried forward twenty years
NOL is allowed to the self-employed and regular corporations. It is not allowed to partnerships or S corporations
S Corporation - Special Requirements
the number of shareholder is limited 100
the corporation can have only a single class of outstanding common stock (no preferred) , but the common stock can be voting or non-voting
must be a domestic corporation
only individuals, estates, and certain trusts may be shareholders. Note: nonresident aliens (persons who are neither citizens nor permanent residents of the U.S.) cannot be shareholders
Personal service business that should avoid operating as a regular corporation
Health
Accounting, architectural, artists
Law
Engineering
Personal Service Corporation PSC
a closely held C corporation that is owned by certain individuals who perform service is denied the progressively of corporate rate schedule. Any income retained by a PSC is taxed at a flat 35% (no graduated rates like a regular corporation)
Conduit Entities Partnerships
Partnership is an unincorporated association of two or more persons to conduct business as co-owners. A partnership must file a tax return (form 1065), but it is for information purposes only. Each partner includes in his/her return the distributed share of the partnership income or loss items
Losses up to basis: basis equals cash contributed by the partner, direct loans made to the partnership by the partner, and loans made to the partnership - not the partner (share of partnership debt for which the partner may ultimately be held responsible)
Conduit Entities - S Corporations
Losses up to basis: basis equals cash contributed by the shareholder plus direct loans made by the shareholder to the s-corporation
Note: when an s-corp incurs debt, shareholders typically do not have personal liability for the debt. Therefore, s-corp debt is not included in the shareholders’ basis. however, even if the shareholders have personally guaranteed the debt, the debt does not increase the shareholder’s basis. S-corp basis does not include bank loans even if the owner personally guarantees the debt.
Sale of Personal Residence (section 121)
250,000 (singe) and 500,000 (married filing jointly) of gain from sale is tax-free if lived in home for two out of the last five years.
Exception available - taxpayer lives in the residence LESS than two years and moves and moves because of a new job, for health reasons, etc., he/she receives the prorated amount
Trusts vs. Estates
Similarities -both have the following.
beneficiaries, decedents/grantors are responsible for creation of estates or trust, transfer property, administer in a fiduciary capacity, distinct tax entities.
Differences
Estate comes into existence involuntarily by operation f law upon the decedent’s death a living trust is created intentionally and voluntarily, estates exist for limited period. Trusts generally exist many years, the estates primary purpose is to serve as an asset receptacle whereas the trustee’s primary duty is to be a good manager
estate supervised by court; trustee operates private arrangement
Simple Trust vs. Complex Trust
Simple
income is distributed, income taxed to the beneficiary, n distributin of carpus, no charitable gifts
Complex income must or may be accumulated income accumulated is taxed to the trusts. income distributed is taxed to the beneficiary corpus can be distributed may make charitable gifts
Revocable Living Trusts (inter vivos or grantor)
popular alternative to probate for many estate planning clients
most grantors name themselves as trustee.
at trustor’s death, the revocable trust becomes irrevocable and either terminates with the corpus distribute to the remainderment or continues until a later date.
usually has no income tax consequence during the grantor’s lifetime
under grantor trust rules, all income earned by a revocable trust is taxable to grantor.
Irrevocable Trust
the grantor completely gives up all rights in the property transferred to the trust. Then, the grantor holds no rights to revoke, terminate, or modify the trust in any material way. It become a nongrantor trust
Amortization
a business may own a variety a assets with no physical substance. However, the assets represent a valuable property right or economic attribute, for example, goodwill. The tax basis is such that intangible assets may be recoverable under some type of amortization method. Intangibles are amortized under a tax section called Section 197 intangibles. The recovery method is similar to straight-line depreciation.
Accretion
a bond is discounted from par value at the time the bond is issued. for example, a bond may be issued at $500 per bond instead of $1000. The discount on the bond must be accreted over the bond’s life. Each year the portion of the discount that has been “earned” is included as taxable interest income, and the bond’s basis is increased.
Property Classes
5 year CAT - computers, autos, and light Trucks (1245 property)
7 year Office equipment except computers (1245)
27 1/2 - Residential rental property (1250)
39 year non-residential real property (1250)
Section 179
qualifying vs. non-qualifying property
Qualifying - 139,000 (2012)
Tangible personal property 1245 property
non-qualifying - real estate
1250 property - intangible (owning a franchise)
boot/gain recognized
the easiest answer to boot and recognized gain question is when there is no boot received, the recognized gain is zero
when boot is received, you should choose the answer that recognized gain is the boot received. it has a high probability of being right
Capital Gains & Losses
ST capital gains and ST losses are netted
LT capital gains and LT losses are netted
if a gain and a loss, they are again netted
if a loss remains after netting capital gains and losses, only $3000 of net losses can be used to offset ordinary income
Capital Gains & Losses (tax rates)
long-term gains (held more than 12 month) are subject to a maximum tax rate of 0% if the taxpayer is in 10-15% bracket and 15% for all the tax brackets short-term gain are taxed at ordinary income income rates collectible gains are subject to a tax rate of 28% for all tax brackets real property (1250) long-term gains are subject to a maximum tax rate of 0% if the taxpayer is in a 10-15% bracket and 15% for all other brackets; however, the IRS has special 25% depreciation " recapture" rate when the property is sold
Recapture 1245 property
When the sole proprietor purchases equipment and takes depreciation (cost recovery deduction - crd), the crds offset the sole proprietor’s ordinary income. when the sole proprietor sells the equipment for a gain, the sole proprietor must do the following
1st look back and recapture the lesser of CRDs taken or the gain realized as 1245 gain (ordinary income)
2nd - recover any excess gain as 1231 gain (capital gain)
Section 1244 small business stock election
individuals who realize a loss on 1244 stock may deduct a limited portion of loss as ordinary, rather than capital loss.
Married individuals filing jointly are limited to an annual $100,000 ordinary deduction (50,000 single). any loss in excess of these limits retains its character as a capital loss section 1244 has no downside
AMT Preference Items
intangible drilling costs (IDC)
private - activity municipal bond
oil & gas percentage depletion
depreciation (acrs/macrs) - but not straight-line
AMT Add Back Items
add back incentive stock option - bargain element property and income taxes miscellaneous deduction- specifically financial advisor fees home equity interest
Postponing AMT
When accelerating receipt of taxable income or deferring the payment of property taxes, state income taxes, deductible medical expenses, or charitable giving, the regular tax (1040) may exceed the AMT payable (more taxable income)
deferring exercise of incentive stock options to a later date or disqualifying the ISO so that it becomes NQSO (subject to ordinary tax)
purchasing public purpose muni bonds instead of private purpose bonds
Types of Phantom Income
Insurance - lapse of policy loan, Section 162 life/disability
Investment- zero/strip income, TIPS, declared but bot paid dividends
Tax- K-1 income LP/FLP, recapture
Retirement - NUA, 20% withholding plan distributions, secular trust
Low-income Housing
Housing Credit
Low-income housing programs that are held as passive activity may generate a deduction-equivalent tax credit up to 25K there is no phase out
the low income housing credit is allowed annually over a ten year “credit period” the depreciation is straight-line over 27.5 years
How does the credit work?
for example, you multiple 35% by $25,000 to get a credit f $8750
Note: becasue there is no phase-out, it produces a higher credit
Alimony Requirements
Alimony is deductible by payor and payor and taxable to payee if the following requirements are met.
The taxpayers cannot file a joint tax return or live together at the time of payment
payments must be made in cash
payments must be received by or for the benefit of the payee spouse (not child support)
the payments cannot extend beyond the death of the recipient spouse
Child Support
Payment are nontaxable the payee and nondeductible by the payor.
any amount tied to a contingency or occurrence of an event relating to a child is considered to the child support and not alimony
charitable contributions
public vs. private
public 50% organizations
all churches, schools, and hospitals
all organizations organized and operated for charitable, religious, educational, or literary purposes or for the prevention of cruelty to children or animals (United Way, Red Cross, Humane Society
Private - 30% organizations
private non-operating foundations
war veterans’ organization
fraternal orders
Charitable Giving
calculate the maximum deductible - 50% of AGI
Calculate the eligible amounts given to 50% organizations
calculate the eligible amounts given to 30% organizations (private charities) such as private non-operating foundation, war vet, fraternal orders
Charitable Giving
types of property - 50% charities
long - term appreciated property using FMV deduct up to 30% of AGI
use unrelated property, ST capital gain property- using basis deduct up to 50% of AGI
Charitable Bargain Sale = taxable gain
sale/fmv X basis
300,000/500,000 X 100,000 = 60,000
300,000-60,000 = 240,000 taxable gain
Rent Vacation Days
Longer of:
1) rent 180 days = 18 days rental income no report ok
2) up to 14 days
Charitable Deduction 50%AGI
church, school, hospital, united way, Red Cross, humane society
Charitable Deduction 30% AGI
private non operating foundations, fraternal orders, war - vets
AMT - preference items = IPOD
Intangible drilling cost
private activity mini bond
oil and gas percentage depletion
depreciation (acrs/macrs) not straight line
Realized gain on home if single
selling price = 375,000
selling expense = 9,000
Basis = 100,000
realized gain = 266,000 - 250,000 (exclusion) = 16,000 gain
Loss Deductibility
Lesser of basis 100,000 or FMV 120,000
100,000
60,000 = insurance paid
100 = floor don't forget
35,000 = 10% of AGI
4,900 = loss deductionAdjustment to bottom front of 1040
IRA CONTRIBUTIONS STUDENT LOAN INTEREST MEDICAL SAVING ACCOUNT (MSA) MOVING EXPENSE SELF EMPLOYMENT TAX (.07065) 4000 EDUCATIONAL EXPENSE (AGI LIMITS APPLY ALT TO AOC) 100% SELF EMPLOYMENT HEALTH INSURANCE KEOGH OR SEP PENALTY FOR EARLY WITHDRAWAL OF SAVINGS HEALTH SAVING ACCONT (HSA) ALIMONY PAID
Advisor Fee Ded question Remember 2% of AGI
also investment income = interest, dividends, royalties, and s-term gains.
100,000 AGI 5000 interest 7500 qualified div 22,500 s-term gains 40,000 margin interest expense
how much can they ded
Investment income = 27500
diff 40-27,500 carried forward
for fee example 40,000 investment income 10K fee 2K AGI ---- 8,K = 8000 offset = 32,000 up to the NET INCOME
Calculation of a deductible casualty or theft loss
1: use the LESSER of basis for FMV
2: subtract insurance coverage
3: subtract the $100 floor
4: subtract 10% of the AGI
The depended standard deduction is the greater of the limited deduction of 1000 or the amount of earned income plus $350
Jon earned income is $4350. What is his standard deduction?
greater of 1000 or
4350 + 350 = 4700
Self employment income includes which 4 items?
1) net schedule C income
2) General partnership income (k-1)
3) boar of director fees
4) part-time earnings (1099)
What are the 2 steps to calculate self employment tax
1) calculate the total self employment income
2) multiply by .1413 and round up, or may be exact
Child tax credit
until age 13
3000, for 1 kid, max is 6000, 2 or more this is the math for the exam
2 kids in day care at $600 per month. her credit is how much?
6000 X 20% = $1200
Which is more beneficial a tax credit or a tax deduction.
Deduction X tax bracket = equivalent credit
3000x.35 = 1050
tax credit / tax bracket = deduction
960/.35 = 2742.86
a deduction to a higher bracket
and a credit to a lower tax bracket is the most beneficial
MACRS Tables the is 5, 7, 271/2 and 39 5 yr = auto, light truck, computers 7 yr = office furniture and fixtures 27 1/2 - residential rental property 39 - nonresidential real property
Macrs
5 yr = 20%
7 yr = 14.29&
Straight line
5 yr = 10%
7 yr = 7.14%
