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CFP EXAM FLASHCARDS > Income Tax > Flashcards

Income Tax Flashcards

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1
Q

What are the eligibility requirments for a

Subchapter S Corporation?

A
  • Number of shareholders is limited to 100
  • can only have a single class of outstanding Common Stock (no preferred), but the Common can be voting or non-voting.
  • Individuals, estates and certain trusts may be shareholders.
  • can only take losses up to basis (major disadvantage), remained can be NOL
  • unearned income and losses become an adjustment to basis. (phantom income)

NOTE: Non-resident aliens cannot be shareholders.

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2
Q

AMT Add-Back Items

AMT Not-Deductible Items

A

add-back items: itemized deduction items allowable for 1040 but not for AMT.

  • Incentive Stock Option Bargain Element*
  • Property and Income Taxes (SALT)

*bargain element = FMV @ exercise date - option price

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3
Q

Sole proprietorship

A

Advantages

  • conduity entity
  • Taxes reported on Schedule C
  • Losses can be carried forward indefinetely as a NOL (like a corp)
  • 100% of med, dental, & LTC are deductible for owner
  • Interest paid on debt is deductible on Schedule C (no limit)

Disadvantages

  • Lack of continuity
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4
Q

Section 179

Qualifying vs. Non-Qualifying Property

A

179 = election to expense up to $1,040,000 of qualifying propety in the year of aquisition

Qualifying: (CATCO)

  • Tangible Personal Property (manufacturing equipment)
  • 1245 Property

Non-Qualifying:

  • Real Estate
  • 1250 Property
  • Intangible (owning a franchise, 197)
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5
Q

Charitable deduction for Loss Property

A

deduction is limited to FMV

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6
Q

Step Transaction

A

Ignore the individual transaction and instead tax the ultimate transaction

  • Example: The XYZ Corporation sells property to an unrelated purchaser who subsequently resells the property to a wholly owned subsidiary of XYZ.
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7
Q

Oil and Gas Working Interest

A
  • exempt from PAL rules
  • Losses from OGWI are deductible against active or portfolio income without limits. No AGI phaseout.
  • To qualify the form of ownership may not limit personal liability (LP)
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8
Q

Substance Over Form

A

The substance of a transaction, and not merely its form, governs its tax consequences.

  • Example: The president of XYZ has the company loan him the money he needs. He never intends to repay the loan or take a salary.
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9
Q

An individual is required to file a tax return if earnings from self employment (1099) are more than ______?

A

$400

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10
Q

Tax Section 197

A

amortization of Intagibles (ex goodwill & franchises)

uses straight-line depreciation

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11
Q

Assignment of Income

A

Income is taxed to the tree that grows the fruit, even though it may be assigned to another prior receipt.

  • Example: Mr. T owns XYZ, an S Corp. He directs that all income be paid to his son. Mr. T reports no income.
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12
Q

Sham Transaction

A

A transaction that lacks a 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 persons.
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13
Q

IRS Penalties

A
  • Frivolous Return: $5000
  • NeGliGence: Penalty is 20% (2 g’s) 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, with a maximum of 25%.
  • Failure to PAY: Penalty is 0.5% per month the tax is unpaid, with a maximum of 25% (Pay-Point)
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14
Q

Tax filing extension

A
  • you get a 6mo extension (Oct 15)
  • form must show full amount estimated as tax.
  • If payments are due they must be made. Taxpayers may extend filing but not payment
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15
Q

Passive Acitivites Loss Rule

A

If an individual owns an interest in a business, but does not materially particiapte, the interest is passive interest.

Can only deduct loss to the extent of income generated by other passive activies.

Exceptions: May deduct up to $25k/year of net losses from RE activity from their active or portfolio income. Phaseout $100-150k

  • Material participation
  • Acitve Participation
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16
Q

Sources of Federal Tax Law/Authority

A
  • Internal Revenue Code: Primary Source of all tax law.
  • Treasury Regulations: Great authority, but not law.
  • Revenue Rulings 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
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17
Q

Holding period taxation

A
  • STCG & 1245 are taxed at ordinary income tax rates
  • LTCG are subject to a maximum of:
    • 0% in 10-12% tax bracket
    • 15% in the 25-35% tax bracket
    • 20% in the 35-37% tax bracket
  • Collectible long-term gains subject to tax rate of 28%
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18
Q

Low Income Housing Credit

A

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.

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19
Q

Credit equivalent deduction

(calculation)

A

Tax Credit / Tax Bracket = Deduction

hint: CBD

  • ​Credits are worth more to a low-bracket taxpayer
  • Deductions are worth more to a high-bracket taxpayer
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20
Q

Original/Adjusted basis

A
  • Basis = taxpayer’s investment in any asset or property right
  • Basis is increased by legal fees, commissions, sales tax, freight and improvements (hint: CLIFS)
  • Basis is NOT effected by repairs (deductable expense), real estate taxes, or normal business operating expenses
  • Improvements MUST be capitalized
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21
Q

Income Tax calculation (form 1040)

A
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22
Q

Schedule A Itemized Deductions

A
  • Medical, Dental, and LTC (above 7.5% of AGI)
  • Casualty and Theft Losses (federal disaster)
  • Real Estate Taxes**
  • Investment Interest Expense
  • Home Mortgage Interest
  • State and Local Taxes**
  • Personal Property Tax**
  • Charitable Gifts

Remember: My Doctor Likes Casual Theft, Real E? I-IE, Homie. SALT, Pretty Please? Great! **Limited to $10,000/yr.

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23
Q

Personal Service Corporation (PSC)

A

​PSC = closely held C-corp owned and funded by fees from proessionals who perform certain services

  • Health
  • Accounting / Architectural
  • Law
  • Engineering

Remember: H.A.L.E.

income retained is taxed at flat 21% rate

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24
Q

Exclusions to Gross Income

A
  • gifts
  • inheritances
  • municipal bond interest
  • worker’s comp
  • child support
  • compensatory damages

Hint: GIMBO and the 3 C’s

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25
Q

Tax Cuts and Jobs Act-eliminated deductions

A
  • Miscellaneous deductions
  • Unreimbursed personal casualty losses (unless federal distater)
  • Home office deduction for employees (Self-employed individuals can still claim deduction)
  • Stricter limit on Meals and Entertainment Expense
    • No Entertainment deduction
    • Meals for EEs while traveling are 50% deductible
    • Travel is 100% deductible
    • Office parties still deductible
    • Tickets to sporting and cultural events NOT deductible
26
Q

Installment Sale (calculation of gain)

A

Profit / total contract price = Gross profit percentage

Installment x Gross Profit percentage = total gain

Related party tax trap = property purchased through installment sold within 2 years, the insteallment sale collapses

27
Q

Casualty Losses (Calculation of the Deductible Loss)

A

First: Use the lesser of basis or FMV

Second: Subtract any insurance coverage

Third: Subtract $100 (floor)

Fourth: Subtract 10% of AGI.

*Must be a presidentially declared “natural disaster”

28
Q

Types of Phantom Income

A

Insurance:

  • Lapse of Policy Loan
  • Section 162 Life/Disability

​Investments:

  • Zero/Strip Income
  • TIPS
  • Declared but not paid Dividends

Tax/Retirement:

  • K-1 Income from LP/FLP
  • Recapture
  • NUA
  • 20% withholding plan distributions, Secular Trust
29
Q

Calculating chartiable gifts

A
  • Step 1: Calculate the maximum amount deductible (60% AGI)
  • Step 2: Amount to public charities (50% organizations)
    • Up to to 60% AGI for cash donation
    • Up to 30% of AGI for LTCG property
    • Up to 50% of AGI but using:
      • basis for inventory
      • basis for artwork
      • basis for STCG property
      • basis for use-unrelated property
  • Step 3: Amount to private charities (30% organizations)
30
Q

Depreciation Recapture (1245 Property)

A

When a business purchases equipment and takes depreciation (cost recovery deduction), the CRDs offset the business’ ordinary income. When the business sells the equipment for a gain, the business must:

  • 1st: Look back and recapture the lesser of the CRDs taken or the gain realized as 1245 Gain (ordinary income)
  • 2nd: Recover any excess gain as 1231 (capital gain)
31
Q

Tax Basis for Partnership / LLC

A
  • Cash invested
  • 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 the S-Corp owner personally guarantees the debt.

32
Q

Can certain taxpayers do both 121 exclusion and 1031 like-kind exchange?

A

Yes, as long as the requirements are satisfied

33
Q

Kiddie Tax

A

All net UNEARNED income of a child who has:

  • NOT attained the age 18
  • Is 19-23 and a full-time student
  • Has at least one parent alive

…is taxed at Parent’s Rates regardless of the source of the assets.

Children under 18 are entitled (2020) to a Standard Deduction amount ($1,100) and an additional $1,100 of unearned income will be taxed at the child’s rate (10%).

34
Q

Self-Employment Tax Calculation

A

The Taxable Wage Base will not exceed $137,700 (2020).

  • If you added up the self-employed income, and you exceeded $137,700, you did something wrong. Why? Social Security tax stops at $137,700 (2020).

Shortcut: Multiply Self-employment Income by 0.1413

35
Q

Dates for Paying Estimated Taxes

A
  • April 15 (1mo)
  • June 15 (+2mo)
  • September 15 (+3mo)
  • January 15 (+4mo)
36
Q

Accounting Methods

A
  • Cash: Mandatory where taxpayer’s records reflect only cash transactions, and there are no inventories.
  • Accrual: Mandatory for purchases and sales over $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 the contract will not be completed within the taxable year started.
37
Q

Sale of a Personal Residence (Section 121)

A

$250K (single) and $500k (MFJ) of Gain from the sale is tax-free if lived in for 2 out of the last 5 years.

  • Surviving spouse can use MFJ exemption for up to 2 years and spouse dies
  • Exception available if taxpayer lives in the residence less than two years and moves because of a new job, for health reasons, etc. Receives a pro-rated amount.
38
Q

What qualifies as investment income?

A
  • Income from property held for investment
    • interest
    • dividends*
    • royalties
    • STCGs**

* dividends are included as investment income ONLY if taxpayer elects not to use the reduced rate.

** LTCG can be included if the taxpayer elects out of LT rates

39
Q

Property Classes

A

1245 Property (non real estate)

  • 5 year:Computers,Autos,Trucks
  • 7 year:Office Equipment except computers,

1250 Property (real estate)

  • 27.5 year: Residential rental property
  • 39 year: Non-residential real property

Remember: CATCORN

40
Q

When are Fringe Benefits taxable?

A
  • Health Insurance Premiums paid for self-employed, partners, and more than 2% owners of an S-Corp are Taxable Income.
  • 100% is deductible as an adjustment to income on the FRONT of the 1040.
  • This can include all types of health insurance programs.
41
Q

Boot / Gain Recognized / Basis

A
  • Boot received = recognized gain
  • Boot paid = Added to Basis
  • Basis carries over from last propety
42
Q

Historic Rehabilitation Programs

A

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.
43
Q

Taxation of Business Entities

A
44
Q

Net operating loss

A
  • NOL = excess of deductible expenses over gross income
  • allowed for self-employed, corporations, estates, and trusts
  • CANNOT be carried back but may be carried forward indefinitely
45
Q

Netting Capital Gains and Losses

A

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

Step 3:

  • If a Loss remains after Netting Capital Gains and Losses, only $3,000 of the Net Losses can be used to offset ordinary income
46
Q

Federal Withholding Tax Underpayment Penalty

A

To avoid, pay the lesser of:

  • 90% of the current year’s tax liability
  • 100% of the prior year’s tax liability (or 110% if the last year’s adjusted gross income exceeded $150,000)
47
Q

Self-Employment Income

A
  • Net Schedule C Income
  • General Partnership Income (K-1 income)
  • Board of Directors fees
  • Part-time earnings (1099)

Does not include:

  • Real Estate income or rents paid
  • distributive share of income or loss of a LP
  • Wages or K-1 Income from an S Corporation
48
Q

Charitable Giving

(AGI limits, organizations, & carryforward)

A

Calculate the Maximum Deductible - 60% of AGI

  • Calculate the eligible amounts given to 50% organizations (public charities) such as all churches, schools, hospitals and organizations such as United Way, Red Cross, Humane Society, etc.
  • Calculate the eligible amounts given to 30% organizations (private charities) such as private non-operating foundations, war veteran groups, and fraternal orders.
  • Any contribution in excess of such limits is carried forward as itemized deduction for up to 5 years (or death)
49
Q

AMT Preference Items

A
  • Excess Intangible Drilling Costs (IDC)
  • Private Activity Municipal Bond
  • Oil and Gas Percentage Depletion / Excess intangible drilling costs (IDC) (NOT cost depletion)
  • Depreciation (ACRS/MACRS) but not straight line

Remember: I.P.O.D.

50
Q

Charitable Bargain Sale

(calculating taxable gain)

A

Property sold to charity for less than FMV.

Calculation:

Sale Price / FMV x basis = adjusted basis

Sale Price - adjusted basis = taxable gain

51
Q

Tax credits (other than children)

A
  • Adoption Credit (nonrefundable)
    • included adption fees, court costs, attorney feeds, and cost to adopt.
    • credit can be claimed the year adoption is finalized
  • Elderly and Disabled Credit (nonrefundable)
  • Foreign Tax Credit (nonrefundable)
  • Earned Income Credit (refundable)
52
Q

Realized Gain vs Recognized Gain

What’s the difference?

A
  • Realized Gain is economic or inherent gain at the time of the transaction.
  • Recognized Gain part of realized gain that is immediately taxable.
53
Q

Recapture rules - excess front-loading of alimony

A

Excess alimony paid in 1st and 2nd years must be recaptured (included in income) in the third year if payments decrease by $15,000+ between years 2 & 3

  1. no alimony paid year 3: add year 1 + 2 then subtract $37,500
  2. payment made year 3: take year 3 multiply by 2 and add $37,500. Then subtract from year 1 + year 2.
  3. Comparison of year 2 & 3 - look for decrease of GREATER THAN $15,000
54
Q

Postponing AMT

A
  • 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 (preference item) to a later date or disqualifying the ISO so that it becomes NQSO (subject to ordinary income tax).
  • Purchase public purpose muni bonds instead of private activity bonds.
55
Q

C Corporation

(advantages & disadvantages)

A

Advantages

  • Separate tax entity, taxed at flat 21%
  • Dividend-received deduction (50% exclusion)
  • Limited liability & continuity of life

Disadvantages

  • corporate formalities
  • Dividends paid (after-taxs)
  • Accumulated earnings > double taxation above $250k
56
Q

What are the major Tax Free Fringe Benefits?

A
  • Health Care Premiums
  • Insurance Premiums on non-discriminatory group life policy up to $50k
  • Company car for working conditions only
  • Employer-provided transit passes ($270/mo. cap) or parking ($270/mo. cap)
  • Occasional overtime meal money, cab fare, theater or sporting event tickets
  • Discounts on services limited to 20% of selling price charged to customers
57
Q

Deductions for AGI vs Deductions from AGI

A

Deductions for AGI/above the line deductions

  • IRA contribution, Keogh/SEP, SE Tax & Insurance, Alimony

Deductions from AGI/below the line deductions

-Great of Standard or Itemized Deduction

58
Q

Tax Credits (children)

A
  • Credit for child and dependent care expenses​ (until age 13)
    • nonrefundable
    • 20% of allowable expense can be deducted
    • expenses limited to $3,000 for one dependent and $6,000 for two
  • Child Tax Credit (per child under 17)
    • partially refundable up to $1,400 per child
    • tax credit of $2,000
    • phase out above $400k MFJ/$200k Single
59
Q

Renting your vacation home (normally a business)

A
  • personal use cannot exceed the greater of:
    • 14 day; or
    • 10% of rental use
  • will be treated as a residence and lose any rental property deductions otherwise allowed.
60
Q

Adjustments for Adjusted Gross Income (AGI)

A

The second step in the 1040 calculation is adjusted gross income. It is Total Income (or Gross Income) less adjustments to income. (Adjustments FOR AGI)

The main Adjustments to income are:

  • IRA Contributions
  • Keogh or SEP
  • Self-employment Tax (50% of .1314)
  • Self-employment Health Insurance (100%)
  • Alimony paid (pre-2019 divorces)
61
Q

Section 1244 qualified small business stock

A
  • only applies to first $1MM of stock (C of S) initially issued
  • Loss of $100,000/yr (JT) is ordinary (not capital) loss

ex. business owner starts qualified C corp, losses $150,000 the first year. $100,000 can be claimed as 1244 ordinary loss and $3,000 as capital loss. VS $3,000 capital loss and $147,000 carry forward.

62
Q

Charitable Giving (Types of Property)

A
  • Appreciated long-term capital gains property (50% organization)
    • when valuing gift at FMV, may deduct 30% of AGI
    • when valuing gift at basis, may deduct 50% of AGI
  • Ordinary income property
    • ex. Inventory, artwork, copyright, STCG, use-unrelated property
    • Deduction is limited to basis

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