Income Tax: Basics Flashcards
Basic tax formula
What are the two accounting period methods?
- Cash basis
- Accrual basis
*you can use one for business and one for personal without an issue
What is the cash basis account method?
- taxpayer received income when it is credited to the taxpayers account, set apart for the taxpayer or made available to be taken into the taxpayers possession.
- include in gross income, all items of income you actually constructively receive during the tax year.
- recognition of income must be consistent with the constructive receipt doctrine.
What is the constructive receipt doctrine?
- states that when income is readily available to the taxpayer that income is not subject to substantial limitations or restrictions, that income is deemed to be constructively received and should be taxed.
- Substantial limitations or restrictions include:
Any substantial limitation or restriction on either the time or manner of payment, and
If the financial condition of the devote makes payment of income in question impossible there is no constructive receipt.
What is the accrual basis method?
- recognition of income when earned.
- most business are accrual basis
- report an amount in their gross income on the following dates:
When payment is received
When income amount is due to the taxpayer
When the taxpayer earns the income
What is the assignment of income doctrine?
-taxpayer cannot assign income earned by themselves to another party
What is a taxable year?
- a taxable year is an annual accounting period for keeping records and reporting income and expenses
- two types
Calendar year
Fiscal year - only can be elected if adequate records are maintained
What form must a taxpayer file to change from a calendar year to a fiscal year?
Form 1128!
What are the five filing categories for individuals?
- Single
- Married filing jointly
- Must be married on last day of year
- may still file joint if spouse died during the year
- Married filing separately
- Head of Household
- Qualifying widower with qualified child
- eligible to file qualifiying widower for two years following the year in which a taxpayers spouse died, have to meet certain requirements
What are the requirements to file as head of household?
- available for individuals who are either unmarried or considered unmarried on the last day of the taxable year.
- required to have paid more than half of the cost of keeping up a home during the year
- qualifying person generally must have lived with the taxpayer more than half of the year.
What are the requirements to file as a qualifying widower with qualified child?
- The taxpayer was eligible to file a joint return with his or her spouse in the year in which the taxpayer’s spouse died,
- The taxpayer has not remarried,
- The taxpayer has a child or stepchild for whom the taxpayer can claim as qualified,
- The child lived in the taxpayer’s home all year, and
- The taxpayer paid more than half the cost of keeping up a home during the year.
What are the requirements to receive an additional standard deduction?
- Age 65+, or
- Blind
If you are both than you receive two standard deductions
Who is not eligible for the standard deduction?
- if a couple is married filing separately and one itemizes, they both must itemize
- non resident aliens
- individuals filing returns for tax year of less than 12 months
What is a dependents standard deduction?
Greater of $1,150 or $400 plus earned income (cannot exceed normal standard deduction)
Age 65 older and blind additional deductions still apply
What are the four test a qualifiying child must meet?
-relationship test
Taxpayers child (stepchild, adopted,foster), grandchild, brother, sister, step bro/sister, half bro/sister.
Descendant of all of those lifted above
-abode test
Qualifiying child must live with the taxpayer more than half of the year. (Absences due to illness, education, business, vacation, or military service do not count.)
-age test
Child must be under the age of 19 at the end of the calendar year or a full time student (5 months) under the age of 24 at the end of the calendar year.
-support test
Parents must provide more than half of their child’s support throughout the year. (Scholarships don’t count)
-joint return test
Married dependent must not file a joint return with a spouse, unless a return is filed only to claim a refund for tax withheld.
-citizenship or residency test
Dependent must be a U.S. citizen or a resident of us, Canada, or Mexico during some part of the year (does not apply to adopted children
*The rules for qualifying child relate to the definition of a child for purpose of head of household filing status, the earned income tax credit, the child tax credit, and the crdit for child and dependent care services.
Tie Breaker Rules - qualifiying child
What test must be met to for a qualifying relative to be claimed as a dependent for the child tax credit?
-Relationship test
Pretty much any potential family member except for cousins
Any other individual who has the same place of abode as the taxpayer.
-gross income test
Dependent cannot have gross income exceeding $4,400 (exemption for scholarships)
-support test
Taxpayer must provide more than one half of the support of a dependent.
-not a qualifying child test
To be claimed as a qualifying relative, person cannot be qualifying child of the taxpayer for the tax year
-joint return test
Married dependent must not file a joint return with a spouse, unless a return is filed only to claim a refund for tax withheld.
-citizenship or residency test
Dependent must be a U.S. citizen or a resident of us, Canada, or Mexico during some part of the year (does not apply to adopted children
Summary of test for qualifying dependent and qualifying child
What is included in gross income?
Annuity payments,
Compensation for services (including certain fringe benefits),
Gross income derived from business,
Gains derived from dealings in property,
Interest & dividends,
Rents & royalties,
Alimony and separate maintenance payments for divorce decrees finalized by 12/31/18 (repeal
divorce decrees after 12/31/2018),
Income from life insurance and endowment contracts,
Pensions,
Discharge of indebtedness,
Distributive share of partnership gross income,
Income in respect of a decedent, and
Income from an interest in an estate or trust.
How is income treated in community property states?
-one half of earnings of each spouse is considered owned by the other spouse
50/50
How is income of a trust or estate taxes?
-income of a trust or estate is generally taxable to the beneficiary.
If the income is not distributed, it will be taxable to the trust or estate
How are annuity payments taxed?
An annuity taxation is broken down into two types of taxation
-a portion is taxed as a return of capital - this is tax free
A portion of interest, which is taxable as ordinary income
What is the exclusion ratio?
The exclusion ratio determines the portion of each annuity payment that is excluded from taxation
Calculated at the starting date of the annuity
Exclusion Ratio = investment in contract/expected total return
- if annuitant outlives their life expectancy, all annuity payments after that time will be 100% taxable
- if annuitant passes before their life expectancy, they will get a misc itemized deduction not subject to AGI limitation for any principal they didn’t receive.
How are distributions from retirement plans taxed?
Distributions from qualified retirement plans are subject to ordinary income tax.
Participant will have an adjusted basis in distributions received from a qualified plan if either have occurred:
- made after tax contributions to a contributory qualified plan
- participant was taxed on premiums for life insurance held in the qualified plan.
- see example for how to calculate taxable portion of a plan distribution with adjusted basis
How are traditional IRAs taxed?
Taxed at ordinary income unless;
Distribution consist of a combination of tax-deferred earnings and the return of adjusted basis that results from non deductible it’s contributions or rollovers of contributions from qualified plan balances that include after tax contributions.
To solve amount that is tax free:
Ratio = adjusted basis before withdrawal/ FMV of account at withdrawal
How are SSN benefits taxed?
- tax ability of SSN benefits is based on the taxpayers Modified AGI (MAGI)
- MAGI for SSN is the taxpayers AGI plus:
Tax exempt interest
Interest earned on savings bonds used for qualified education
Income earned in a foreign country, a US Possession, or puerto rico, that is excluded from income.
- to calculate, MAGI plus one-half of the taxpayers SSN benefits must be compared to the hurdle amounts.
- see other flash cards for how to calculate if benefits exceed 1st hurdle and 2nd hurdle
Taxation of SSN benefits that exceed first hurdle (50%)
For SSN - MAGI = Taxpayers AGI + Tax exempt interest, interest earned on savings bonds used for higher education, income earned in a foreign country, a US Possession, or puerto rico, that is excluded from income.
If MAGI plus half of SSN benefits exceed the first hurdle and not the second, taxable SSN benefits is the lesser of:
- 50% of SSN benefits or
- 50%[MAGI + .50(SSN benefits) - hurdle 1]
Taxation of SSN benefits that exceed the second hurdle (85%)
If MAGI plus half of SSN benefits exceed the second hurdle, the taxable amount of SSN benefits is the lesser of:
- 85% if SSN benefits
- 85%[MAGI + .50(SSN benefit)-hurdle 2], plus the lesser of:
$6,000 MFJ or $4,500 all others, or
Taxable amount calculated under 50% formula only considering hurdle 1
How are Below-Market Loans taxed?
- require lender to impute interest income on the loan that they would have been earned if it was lent at market rates.
- the amount of imputed interest is also treated as a gift from the lender to the borrower.
- loans of less than $10,000 are not required to impute any interest.
- if borrower has less than $1000 in net investment income for the year no imputed interest.
- see chart for how imputed interest is calculated
What are the two specials below market loans?
- Below-market rate loans by a corporation to a shareholder in that corporation are treater
dividend to shareholder. As the shareholder makes loan payments, the payments are treated
corporation as interest income. - Below-market rate loans from an employer to an employee are treated as paid compensa
employee and are subject to employment taxes. As the employee makes loan payments,
employer must treat the payments as taxable interest income.
What are some high level exclusions from income?
- gifts, bequest, devise or inheritance
- life insurance proceeds
- Scholarships
- gain on sale of personal residence
- distributions from Roth IRAs and 401ks
- compensation for injuries and sickness.
- employer sponsored accident and health plans
- Meals and lodging
- other employee fringe benefits
- foreign earned income
- interest on certain state and local government obligations
- discharge of indebtness
Exclusion - Gift & Inheritances
- amounts received by gift, bequest, devise or inheritance are excluded from income.
- payment or gift must be made as a result of:
Detached and disinterested generosity
Constraining force of any moral or legal duty or from the incentive of anticipated of an economic nature
- amounts transferred by an employer to an employee are not treated as a gift.
- exclusion applies only to property, not income that is later generated on that property.
Exclusion - life insurance proceeds
-death benefits paid to the beneficiary of a life insurance policy are not included in income.
If proceeds are received in installment payments, interest is taxable to the beneficiary.
- when life insurance cashed out prior to insureds death, owner of the policy must recognize income in excess of what owner paid in premiums.
How are life insurance policies transferred for value treated for income tax purposes?
- the amount received is includable in the owners gross income to the extent the amount exceeds the owners basis in the policy. (Amount payed in premiums)
- death benefits taxable to the new owner (buyer)
- transfer for value is excluded from gross income if:
Policy transferred to the insured
Policy transferred to a partner of the insured
Policy transferred to a partnership in which the insured is a partner
Policy transferred to a corporation in which insured is shareholder or officer
Policy transferred by a tax free exchange
Itemized Deduction - charitable contributions
Non itemized tax filers : cash contributions can be deducted up to $300 ($600 MFJ)
Itemized tax filers: deduction depends on type of property and type of charity. (See chart)
-any charitable contributions disallowed due to AGI limitations is carried over for up to 5 years and used in FIFO order.
Qualified Business Income Deduction (QBI)
- deduction of for pass through entities from 2018-2015. ( sole proprietorships, partnerships, LLCs, S corps, REITS, Master Limited Partnerhips (MLPS)
- can take deduction regardless if you are itemizing or taking the standard deduction.
- generally 20% of the taxpayers Qualified Business Income.
Qualified Business Income does not include investment income, reasonable compensation paid to an S Corp Owner, or guaranteed payments to a partner or LLC member for services.
What is the kiddie tax?
- Applies to income of a child under age of 19 or age 24 if the child is a full time student.
- Unearned for the child in excess of $2,300 is taxed to their parents rate.
Standard Deduction of $1,150
Next $1,150 is taxed at the childs marginal rate
anything above that is taxed at the parents rate.
-Kiddie tax unearned income: interest dividends capital gains royalties rents pension and annuity income unearned income from trust
What is the Alternative Minimum Tax (AMT)?
- taxpayer is liable for the greater of his regular tax liability or the AMT
- all deductions still apply except for state and local taxes up to $10,000
Preference items can only be positive and increase AMTI
- Percentage depletion:
The amount of percentage depletion taken for regular tax in excess of the adjusted basis of the property at the end of the year is a preference item.
- Intangible drilling cost:
- Interest on private activity bonds:
This interest is not taxable for regular tax purposes but is included in income for AMT purposes.
What are the at-risk-rules?
- These rules apply before the passive activity rules.
- losses can only be deducted to the extent of property/money that is at risk.
How are publicly traded partnerships (PTP’s) treated?
- you can only offset deductions from passive activities of a PTP against income or gain from passive activities of the same PTP.
- nonpublicly traded partnership deductions cannot be offset against the gain of PTP.
