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CFP Review > Income Tax Planning > Flashcards

Income Tax Planning Flashcards

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1
Q

What are NOT considered Capital Assets?

What ARE considered Capital assets?

A

EXAM TIP: All assets are capital assets except “ACID”

  • *A**ccounts/ notes receivable - ordinary income asset
  • *C**opyrights and creative works held by the creator - ordinary income asset
  • *I**nventory - ordinary income asset
  • *D**epreciable property used in a trade or business - generally a Section 1231 asset
  • *Capital assets are generally**:
  • Most personal use and most investment assets
    (e. g. A painting owned by an art collector).
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2
Q

What is the formula for determining the donee’s basis when a gift tax has been paid?

Brody and Tanya recently sold some land they owned for 150k. They received the land five years ago as a wedding gift from Brody’s Aunt Jeanette. Aunt Jeanette purchased the land many years ago when the property was worth $20k. At the time of the gift, the property was worth $100k, and Aunt Jeanette paid $47k in gift tax (the annual exclusion did not apply to the transfer). What is the long-term capital gain on the sale of the property?

A
  • *Donor’s basis + (Net Appreciation in gift) x Gift Taxes Paid**
  • *(Value of Taxable Gift)**

Answer: $92.4K

Adjusted basis: $20k + ($80k/$100k) x $47K = $57.6K
Capital Gain: $150K - $57.6K = $92.4K

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3
Q

What are some examples of items that increase the basis of an asset?

A
  • Capital improvements, such as an addition on your home, a new roof, paving your driveway, installing central air conditioning, or rewiring your home.
  • Assessments for local improvements, including water connections, sidewalks, and roads.
  • The cost of restoring damaged property after a casualty loss.
  • Legal fees, including the cost of defending and perfecting a title to the property.
  • Zoning costs.
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4
Q

What are some examples of items that decrease the basis of an asset?

A
  • Personal casualty or theft loss deductions, if applicable due to federally declared disaster.
  • Business casualty or theft loss deductions, regardless of where the loss occurred and if it was in a federally declared disaster area.
  • Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property
  • Section 179 deduction
  • Credit for qualified electric vehicles
  • Depreciation
  • Nontaxable corporate distributions
  • Exclusion from income of subsidies for energy conservation measures
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5
Q

`What is the double basis rule and when does it apply?

A

Loss property that is gifted will have a double basis

When the FMV of the gift is < Donor’s Basis. If the FMV is less than the donor’s basis, the beneficiary has a dual basis for the property, that is, a basis for loss and a basis for gain when the property is sold.

It also applies to Related Party Transactions (Section 276). The donor may never take a loss and the donee takes the asset with the double basis rule (FMV for losses and DB for gains). The holding period begins at the date of the sale for losses.

  • If the sale price of the asset is less than the fair market value on the date of the gift, then the recipient of the gift canclaim a lossequal to the difference between those two values; (Sales Price orSP < FMV = FMV Basis**)
  • If the sale price of the asset is more than the original owner’s basis on the gift date, then the recipient of the gift has acapital gainequal to the difference between those two values; and (Sales Price orSP > DB = Donor’s Basis**)
  • If the sale price of the gifted asset is in between the fair market value on the gift date and the original owner’s basis**, the recipient has neither a capital gain nor a capital loss.
  • (SP > FMV + SP < DB = No Gain/Loss)*

SP
< >
FMV - DB +
HPR HPR

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6
Q

Summarize the treatment of gains and losses for: Personal Use, Capital Assets, Trade or Business and Trade Ordinary Income

A
  • *Personal Use:**
  • *Gains** are short-term or long-term capital gain (depending on holding period).
  • *Losses** may not be recognized or deducted.
  • *Capital Asset:**
  • *Gains** are short-term or long-term capital gain (depending on holding period).
  • *Capital losses** (deductible to extent of capital gains plus $3,000).
  • *Trade or Business:**
  • *Gains** are short-term or long-term capital gain (depending on holding period).
  • *Ordinary losses** (deductible against ordinary income).
  • *Trade Ordinary Income:**
  • *Gains** are ordinary income.
  • *Ordinary losses** (deductible against ordinary income).
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7
Q

What are the steps for netting capital gains and losses?

A
  1. Net long term capital gains and long term capital losses.
  2. Net short term capital gains and short term capital losses.
  3. If the taxpayer has a net loss in one category and a net gain in the other category, then the net long term gain/loss should be netted against the net short term gain/loss.
    * Net capital losses of individuals are deductible FOR AGI up to $3,000 per year and losses realized above that amount may be carried forward indefinitely, and may be used to offset future capital gains, or, alternatively, generate a $3K loss deduction each year against other income until the loss is used up.
    * If the taxpayer has both long-term and short-term net GAINS, both should be recognized separately and cannot be “netted” due to the different tax rates.
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8
Q

Characteristics of capital losses on Section 1244 Small Business Stock

A

**This may show up in cases/footnotes. It will say “this is section 1244 stock.”

If we sell this as a loss, we can take up to $100K loss for MFJ and $50K Single filers.

This increases investing in small businesses

Capital losses**
on small business stock can be recategorized into ordinary losses if certain requirements are met:

Ordinary Loss deductions up to $50K (S), $100K (MFJ) of the loss on small business stock in any given year if the following requirements are met:

  • The stock represents ownership in a domestic corporation.
  • The corporation was a small business corporation (less than $1 million in total capital contributions plus paid-in capital) at the time the stock was issued.
  • The company was incorporated after November 6, 1978.
  • The loss was sustained by the original owner of the stock (the person to whom the stock was issued by the corporation), who is not a corporation, trust, or estate.

Note: any loss in excess of the per year limit ($50K S or $100K MFJ), is treated as capital loss (which can be deducted up to $3K/year). Furthermore, Section 1244 does not apply to gains. Any gains associated with Section 1244 stock are treated as capital gains.

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9
Q

What are the “wash sale” rules?

A
  • Wash sales occur when a taxpayer disposes of securities at a loss and acquires substantially identical securities within 30 days before or after the date of the loss sale.
  • The disallowed loss is added to the cost of the new stock or security to determine the new basis of the substantially identical securities.
  • Wash sale rules do not apply to gains.
  1. Was there a loss?
  2. Was the sale/purchase for a substantially identical security?
    A) S&P index for another S&P index
    B) IBM for Call option or Convertible Bond on IBM
    C) Spouse 1 buys, Spouse 2 purchases
    D) A sells in Brokerage, A purchases in IRA
  3. Did the sale/purchase occur within 61 days?
    (30 days——LOSS——30 days).
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10
Q

Characteristics of Section 1231 Assets

A
  • They are used in a trade or business.
  • They are either (1) depreciable property or (2) real property.
  • They do not include:
    • Inventory
    • Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business
    • Copyrights or creative works
  • Section 1231 specifically includes certain property, such as:
    • Timber
    • Coal
    • Iron Ore
    • Certain Livestock
    • Unharvested crops (under certain conditions)
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11
Q

Requirements and Benefits of Section 1231 Assets

A
  • The owner of the asset must have a long-term holding period (more than 1 year).
  • The definition of Section 1231 asset is “depreciable or real property used in a trade or business.”
  • The main benefit of Section 1231 is that the gains generated** from the sale of a Section 1231 asset **are treated as capital gains** for income tax purposes after recapture of depreciation taken, and **losses generated from the sale of a Section 1231 asset are treated as ordinary losses for income tax purposes.
    • Therefore, gains in excess of recapture will qualify for long-term capital gains tax rate, and
    • Losses will not be subject to the limitations that typically apply to capital assets.
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12
Q

1231 Gain

A

Any sale amount in excess of the original purchase price of a 1231 asset is 1231 gain.

Ex: Roscoe sells equipment used in his business for $18K. He had originally purchased the equipment for $15K and had taken $7K of depreciation. What is the Section 1231 gain for Roscoe?

Sale amount = $18K
Original Purchase Price = $15K

$18K - $15K = $3K of Section 1231 Gain

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13
Q

Depreciation Recapture Comes in which forms?

A

Section 1245 Property and Section 1250 Proprety

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14
Q

What is the only way to have a 1231 gain on 1245 property?

A

The only way to have a 1231 gain on 1245 property is to sell it for more than it was originally purchased for.

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15
Q

What is Section 1245 Property?

A
  • *Section 1245 Property - Depreciable Business Personalty**
  • Intangible or tangible personal property that could be subject to depreciation/amoritzation
  • Does NOT include buildings (real estate) and structural components
  • Gains are ordinary income to the extent of depreciation allowed or allowable on the property
  • Gains above the original purchase price are treated as Section 1231 gain (capital gains).
  • If property is sold at a loss, the loss is ordinary loss

(Section 1245 property is is merely section 1231 property that has been depreciated. Section 1245 property is section 1245 property only as long as it has unrecaptured depreciation. Once its depreciation is fully recaptured, it becomes section 1231 property).
*Watch GTP Supplemental Lectures - Tax - Disposition of Property - Sec 1231 Property 6:30.

Example: Jason sells a front end loader with a backhoe for $19,500. He had originally purchased it for $13K at an auction and he took depreciation of $5K. What is the ordinary income component of gain on this transaction?

Answer: $5K. Depreciation is recaptured as ordinary income to the extent of the gain.

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16
Q

Section 1250 Property

A
  • *Section 1250 - Depreciable Business Realty**
  • Business REAL property (real estate)
  • 1st Gains are ordinary income to the extent of accelerated (straight line) depreciation taken
  • 2nd Gains are taxed at capital gains rate of 25% to the extent of straight-line depreciation taken (unrecaptured Section 1250 depreciation).
  • 3rd any additional gain is taxed at capital gains rates. (1231 gain).
  • Losses are ordinary.

*Watch GTP Supplemental Lectures - Tax - Disposition of Property - Sec 1231 Property 6:30.

Ex:
Land that cost $1M. Straight line depreciation: $400K. Accelerated Depreciation: $100K. Sale price: $1.3M. Adjusted basis: $500K ($1M - $400K - $100K).

Gain/Loss=$800K
Ordinary Income=$100K (accelerated depreciation)
Unrecaptured 1250 on straight-line=$400k at 25%
1231 LTCG=$300K

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17
Q

1031 Exchange

1031 Qualifying Property

A
  • no gain or loss recognized on exchange of certain property held for investment or productive use in trade or business
  • “like kind” exchange
  • Domestic real estate only
  • TCJA eliminated use of personal property exchanges
  • must be of same nature but not same quality; must be domestic
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18
Q

What does Section 1031 Like-Kind Exchanges not apply to?

A
  • Personal assets,
  • Stock in trade held primarily for sale (inventory),
  • Stocks, bonds, notes, interests in partnerships, certificates of trust or beneficial interests, or
  • Other securities or evidences of indebtedness or interest, or choices in action.
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19
Q

1031 Nonqualifying Property

A
  • inventory of a business
  • principal residence
  • tangible personal property
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20
Q

Income tax consequences of a Section 1031 exchange

A
  • Clients who receive only like-kind property in the exchange will not have any current income tax consequences.
  • The party trading up recognizes no gain and adds to their old basis any boot/cash given to the other party.
  • The party trading down (receiving less like-kind property than given up) will be required to recognize gain to the extent of boot received. If the boot exceeds gain, the amount of boot in excess of the gain is treated as a return of capital and reduces the basis in the new asset.
  • Losses realized in a like-kind exchange are not recognized until the replacement property is sold. The taxpayer’s basis in the replacement property equals the fair market value of the property received in the exchange plus the disallowed loss
  • Debt relief is treated as boot, requiring gain recognition for the party no longer responsible for paying back the loan. The party assuming the debt will increase their basis in the replacement property by a like amount.
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21
Q

Like-kind Exchanges - Steps

A
  • Gain realized
  1. FMV of like-kind property received
  2. Plus net value of unlike property received
  3. Equals amount realized
  4. Less basis of property transferred
  5. Equals gain realized
  • Gain recognized
    6. Lesser of the net value of unlike property received and gain realized
  • Substituted basis
    7. FMV of like-kind property received
    8. Less gain not recognized
  • Gain realized less gain recognized
    9. Equals substituted basis
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22
Q

1031 Time Limit

A
  • must identify like property within 45 days after transfer/sale
  • must receive new property within 180 days of transfer/sale
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23
Q

Boot

A
  • cash or other non-like-kind property involved in the exchange to make it equal
  • party receiving boot must recognize the portion of the realized gain equal to the lesser of boot or realized gain
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24
Q

1031 Calculation

A

Only use 3 numbers for one side of the transaction

  • FMV of like-kind property received
  • Adjusted basis of property given up
  • Boot (non-like kind property) given or received

0) Amount realized=
FMV property received + boot

1) Realized Gain =
FMV property received (+ boot received)
- adjusted basis (or + boot given)

2) Recognized gain =
< of boot received or realized gain

3) Deferred gain =
realized gain - recognized gain

4) Adjusted basis of new property =
FMV of property received
(-) deferred gain
(+) deferred loss

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25
Q

Related Party 1031

A

-if exchanges with relative and within 2 years they dispose of the property, gain must be recognized on date of sale

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26
Q

Installment Sales

Installment Sale Calculation of Gain

A

Realized gain is not recognized in year of sale, is spread over the life of the note
exceptions:
-all payments received year of sale
-publicly-traded securities
-sold at a loss
-sold to a related party who sells it within 2 years (SEC 276)

Total Gain/Sale Price x Total number of payments = Recognized Gain

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27
Q

Installment Sale Recapture

A
  • if installment sale of tangible personal property, all depreciation recapture must be reported in income in the year of disposition
  • phantom income, disadvantage
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28
Q

MACRS Property Classes

A

Tractors/Rent-To-Own property (3 yrs)
CAT - Computers, Automobiles, Trucks (5 yrs)
*O - Office Furniture and Fixtures (7 yrs)
*R - Rental Real Estate (27.5 yrs) Use a MID-MONTH CONVENTION
N - Non-Residential Real Estate/Office Building (39 yrs) Use a MID-MONTH CONVENTION

*These two categories are most likely to be tested

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29
Q

Capital Losses

A
  • if loss remains after netting capital gains and losses, only $3,000 of net losses can be used to offset ordinary income in a single year
  • carryforward the remainder
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30
Q

Individual Income Tax Calculation

A

Gross Income

- Above the line deductions (FOR AGI)

= Adjusted Gross Income

  • Below the line deductions (FROM AGI) (Standard or Itmeized)
  • Personal and dependency exemptions (suspended 2018 - 2025)

= Taxable income

Calculate tax based on filing status

  • Credits

+ Other taxes

- Prepayments

= Tax or Refund Due

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31
Q

Tax Return Due Dates

A

Individual income tax returns

  • 15th day of the 4th month after tax year end
  • Can be extended for up to 6 months.

Partnership and S-Corporation income tax return

  • 15th day of the 3rd month after tax year end
  • Can be extended for up to 6 months.

C-corporation income tax returns

  • 15th day of the 4th month after tax year end
  • Can be extended for up to 6 months.

Extension of time to file does not extend the time to pay the tax.

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32
Q

What are the rules for “Married filing jointly”.

A
  • In order to file as married filing jointly, the taxpayer and his/her spouse must have been married as of the last day of the year.
  • If the taxpayer’s spouse died during the year and the taxpayer did not remarry, the taxpayer may still file a joint return with that spouse for the year of death.
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33
Q

Estimated Taxes

A
  • Most people can avoid paying estimated tax if their withholding and credits equal 100% of the tax shown on the prior year’s return or 90% of the current year’s tax liability.
    • Taxpayers may not rely on this rule if the taxpayer had a short (less than 12 months) taxable year for the previous year.
  • A taxpayer does not have to pay estimated tax if:
    • the taxpayer had no tax liability for the previous year;
    • the taxpayer was a U.S. citizen or resident for the entire year,
    • and the taxpayer’s tax year covered a 12-month period.
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34
Q

What is the standard deduction for a taxpayer who is claimed as a dependent?

A

reater of:

  • $1,100 (2021), or
  • $350 plus earned income (but not exceeding the single standard deduction).
  • Additional standard deduction if it applies.
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35
Q

A Qualifying Relative must meet which four tests?

A
  1. Not a Qualifying Child Test - The person cannot be the qualifying child of any other taxpayer.
  2. Relationship Test - The person either (a) must be related to the taxpayer as follows: son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them, mother, father, brother or sister of mother or father, brother/sister in law, son/daughter in law, or mother/father in law or (b) must live with the taxpayer all year as a member of their household (and the relationship must not violate local law).
  3. Gross Income Test - The person’s gross income for the year must be less than $4,300 (2020)
  4. Support Test – The taxpayer must provide more than half of the person’s total support for the year.

Additional tests: joint return test, and citizenship or residency test

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36
Q

A Qualifying Child must meet what four tests?

A
  1. Relationship Test - The child of the taxpayer must be the taxpayer’s son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.
  2. Age Test - The child must be (a) under age 19 at the end of the year, (b) under age 24 at the end of the year and a full-time student, or (c) any age if permanently and totally disabled.
  3. Abode Test - The child must have lived with the taxpayer for more than half of the year.
  4. Support Test - The child must not have provided more than half of his or her own support for the year.

Additional tests: joint return test, and citizenship or residency test

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37
Q

What is the Exclusion Ratio for the Taxation of Annuity Payments?

A

Exclusion Ratio = Investment in the Contract
Expected Total Return

38
Q

Social Security Benefits Taxation

A
  • Social Security benefit taxation is based on MAGI (modified adjusted gross income)
  • MAGI = AGI
    -social security benefits
    +tax exempt interest
    +interest earned on savings bonds used for higher education
    +amounts excluded from income for employer-provided adoption assistance*
    +amounts deducted for interest paid for educational loans*
    +income earned in a foreign country/US Possession or Puerto Rico.
  • To calculate taxable portion of benefits, MAGI plus ½ of the taxpayer’s SS benefits must be compared to the hurdle amounts

MFJ
1st hurdle: $34K
2nd hurdle: $44K
(50%)

All other taxpayers, EXCEPT MFS=0
1st hurdle: $25K
2nd hurdle: $34K
(85%)

If MAGI plus ½ of SS benefits exceeds the 1st hurdle (but not 2nd), the taxable amount of SS benefits is the lesser of:
50% of Social Security Benefits OR
50% of [MAGI + 0.50(SS benefits) - 1st Hurdle]

If MAGI plus ½ of SS benefits exceeds the 2nd hurdle, the taxable amount of SS benefits is the lesser of:
85% of Social Security Benefits OR
85% of [MAGI + 0.50(SS benefits) - 2nd Hurdle] PLUS, the lesser of
$6000 for MFJ or $4,500 for all other tax payers OR
The taxable amt calculated under the 50% formula and only considering 1st Hurdle

39
Q

What are the life insurance transfer for value exceptions?

A
  • The proceeds of a life insurance policy can still be excluded from gross income even if the policy is transferred for valuable consideration. These circumstances include:
    • If the policy is transferred to the insured,
    • If the policy is transferred to a partner of the insured,
    • If the policy is transferred to a partnership in which the insured is a partner,
    • If the policy is transferred to a corporation in which the insured is a shareholder or officer, or
    • If the policy is transferred by tax-free exchange or gift.
40
Q

What are the characteristics of Modified Endowment Contracts (MECs)?

A
  • An MEC is a life insurance contract that fails to meet the 7-pay test.
    • A contract fails to meet the 7-pay test if the accumulated amount paid under the contract at any time during the 1st 7 contract years exceeds the sum of the net level premiums which would have been paid on or before such time if the contract provided for paid-up future benefits after the payment of 7 level annual premiums.
  • Loans and withdrawals from MECs are subject to LIFO treatment.
  • When loans or withdrawals are made from a MEC, the proceeds of the loan or withdrawal are included in gross income to the extent of earnings.
41
Q

What are the rules regarding excluding gain on a personal residence?

A
  • Qualification requirements for the exclusion under Section 121:
    • First, the property must have been owned and occupied as a principal residence for 2 out of the last 5 years. (Note that a one year stay in a nursing home does not count toward the 2 year requirement.)
    • Second, the exclusion can only be used once every 2 years.
    • Any appreciation during non-qualified use periods are not subject to the exclusion.
  • Single taxpayers may exclude up to $250,000 of gain from the sale of their principal residence.
  • Married taxpayers filing jointly may exclude up to $500,000 of gain from the sale of their principal residence.
    • For married taxpayers: They must both meet the use requirement and not have utilized the exclusion within the last two years but either may meet the ownership requirement.

Note: a pro rated amount pro rates the exclusion amount (250k/500k) not the amount of gain.

42
Q

Which of the following are included in taxable income?

A

EXCLUDED: Workers’ Compensation for personal physical injury or sickness are excluded from gross income.

INCLUDED: Punitive Damages and Damages for Emotional Distress are included in taxable income.

43
Q

List the deductions for AGI

A
  • Trade or business expenses
  • Deductions from losses on sale or exchange of property
  • Deductions from rental and royalty property
  • Alimony payments, for divorces finalized before 12/31/2018
  • One-half of self-employment tax paid
  • 100% of health insurance premiums paid by a self-employed individual
  • Contributions to pension, profit sharing, annuity plans, IRAs, etc.
  • Penalty on premature withdrawals from time savings accounts or deposits
  • Interest on student loans (up to $2,500 with phase outs).
  • Tution and Fees for tax years 2018 - 2020
  • $300 ($600 MFJ) for contributions to qualified charities made in tax years 2020 and 2021 (for taxpayers that do not itemize).
  • Health Savings Accounts
44
Q

What are the characteristics and the shortcut formula for “Excess Alimony” Payments?

A
  • Alimony deduction – only applies to contracts signed prior to 12/31/2018 (for contracts signed after that no income or deduction)
  • 3 year review period
  • Excess payments are included in payor’s taxable income in third post-separation year.
  • Payee is permitted a deduction equal to the amount includible in the payor’s income in that year.
  • Shortcut formula to determine if there is an excess alimony payment:
  • *P1 + P2 – 2(P3) – $37,500 = Recapture**
  • *If greater than 0, then excess alimony**
  • Note: Child support is not alimony applicable on divorces filed and amended before 12/31/2018. Divorces finalized or amended in 2019 and after will not allow for alimony deductions.
45
Q

What are eligible medical expenses that are subject to 7.5% of AGI?

A
  • Prescriptions,
  • Non-cosmetic surgeries,
  • Some qualified long-term care services,
  • Insurance premiums including schedule for long-term care policies,
  • Tuition for special, medically necessary schools (e.g., school for deaf or blind dependent).
  • 7.5% applies to all tax years after 12/31/2020.

Capital expenditures
* On the advice of a physician,
* To the extent that the fair market value of the property is not increased,
* Includes operating expenses (e.g., cost of operating a pool),
* For handicapped entrances and railings, there is no increased value test
(note that this does not apply to elevators).

Transportation and lodging

* Parking, tolls, travel to and from doctor (deductible at .16 cents (2021) per mile if you drive your own car).
* Lodging limit of $50 per night **per person**.
* Deduction for meals not allowed.
46
Q

What are 50% Organizations for the purpose of determining a charitable deduction amount?

A

50% Organizations are:

  • *-Public Charities** (including churches, schools, hospitals)
  • *-Pass-Through Private Foundations** (Private operating foundations/private nonoperating foundations that distribute their contributions to either public charities or private operating foundations within two and one-half months of their tax year end (referred to as a pass-through private foundation).

60% or 100% (for 2020/2021) AGI Ceiling when:
-Cash only donations are made to a public charity.

47
Q

What are 30% Organizations for the purpose of determining a charitable deduction amount?

A

30% Organizations are:
-Private nonoperating foundations (who do not distribute contributions within two and ½ months of the organization’s tax year end).

20% Ceiling when:
-Contributions are long-term capital gain property

30% Ceiling when:
-Contributions are cash or ordinary income property

48
Q

Examples and characteristics of federally declared disaster area personal casualty losses subject to a $500 floor per casualty.

A
  • Federally declared disasters caused by fire, storm, shipwreck, or other casualty.
  • To be deductible the loss must be from an event that is identifiable, damaging to taxpayer’s property, and sudden, unexpected, and unusual in nature.
  • The deduction is limited to the net disaster loss (above $500).
  • For personal casualties, the loss must be related to a federally declared disaster.
  • Business casualties do not require a federal declaration.
  • Losses during an Estate Administration do not require a federal declaration.
49
Q

Adoption Expenses Credit

A
  • Credit for qualified adoption expenses incurred in adoption of eligible child.
  • Examples of expenses include adoption fees, court costs, and attorney fees.
  • Maximum credit is $14,440 (2021).
    • Credit is phased-out ratably for modified AGI in between $216,660 and $256,660.
  • An eligible child is one that is:
    • Less than 18 years of age, or
    • Physically or mentally handicapped.
  • The Adoption Expenses Credit is a nonrefundable credit, but the excess may be carried forward for five years.
50
Q

Child Tax Credit Increase for 2021

Tested for the November 2021 CFP® Exam

A

Increased Child Tax Credit for the Tax year 2021 tested on the November 2021 CFP® Exam:

  • $3,000 for each dependent child ages 6-17 and $3,600 for a child under age 5 (for 2021 only).
    • Includes stepchildren and foster children
  • Married taxpayers must file jointly to be eligible for the credit.
  • Eligible children are:
    • Under age 18, a US citizen, and claimed as dependent on taxpayer’s tax return.
  • To qualify for the increased amount, you must be below the phase outs. Otherwise the $2,000 credit is available for parents who qualify based on income.
  • Credit is phased out by $50 for each $1,000 of AGI above specified levels (2021):
    • $150,000 for joint filers or surviving spouse
    • $112,500 for head of household
    • $75,000 for all others
  • Fully refundable, no minimum earnings requirement.
51
Q

Child & Dependent Care Credit

A
  • Must have employment-related care costs for a: dependent under age 13, or handicapped dependent or spouse.
  • Married taxpayers must file a joint return to obtain credit.
  • Credit amount
    • Eligible care costs x applicable percentage
    • Applicable percentage ranges from 20% to 35%.
      • 20% applies to AGI over $43,000.
  • Amount of costs that qualify is the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individuals.
    • Costs for care of qualified individual within taxpayer’s home or outside home.
    • If outside home, handicapped dependent or spouse must spend at least 8 hours a day within taxpayer’s home.
  • *EXAM TIP: Most likely to be tested is the lesser of: 20% x eligible costs or $3,000 for one child or $6,000 for two children.**
52
Q

American Opportunity Tax Credit

A
  • The maximum credit per eligible student is $2,500 (2021) per year for first 4 years of post-secondary education.
    • 100% of first $2,000 of qualifying expenses, plus
    • 25% of next $2,000 of qualifying expenses.
  • To be eligible, the student must take at least 1/2 of full-time course load.
  • Not eligible if student already has a 4-year degree
  • Refundable tax credit up to 40% or $1,000 (2021).
53
Q

Lifetime Learning Credit

A
  • The maximum credit per taxpayer is 20% of qualifying expenses (up to $10,000 per year 2021).
    • This credit cannot be claimed in same year (for the same person) the American Opportunity Tax Credit is claimed.
    • Taxpayer cannot claim a credit for amounts otherwise excluded from income (e.g. scholarships and employer-paid education assistance).
    • Subject to phaseouts (on exam tax tables)
54
Q

Kiddie Tax

A
  • Net unearned income of a child under age 19 (or under 24 if full-time student), with a living parent is taxed at the parent’s rate (or AMT rate if applicable).
  • Net unearned income does not include:
    • Standard deduction of $1,100 for unearned income
    • The next $1,100 of income which is taxed at the child’s marginal rate
    • The Kiddie Tax does not apply unless the child has unearned income greater than $2,200.

Exam TIP: The Kiddie Tax only applies to “unearned income” in excess of $2,200 (2021).

55
Q

What is the AMT?

A

Under the tax law, certain tax benefits can significantly reduce a taxpayer’s regular tax amount. The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.

https://turbotax.intuit.com/tax-tips/irs-tax-return/alternative-minimum-tax-common-questions/L50YotKHP

56
Q

What are the preference items for AMT?

A
  1. 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.
  2. Intangible drilling costs
    - AMT requires 10 year amortization. Intangible drilling costs are currently deductible for regular tax.
    - Preference is excess of regular tax deduction over [AMT amortization plus (65% x net oil & gas income)].
  3. Interest on private activity bonds
    - This interest is not taxable for regular tax purposes, but is included in income for AMT purposes.
    - Expenses incurred in carrying these bonds are not deductible for regular tax purposes, but offset the interest income in computing the AMT preference.

EXAM Tip: Make sure to know the three preference items above

57
Q

What are the exceptions to non-vacation rental property that are being deemed as passive losses?

A
  • Rental activities by dealers are considered active.
  • Residential rental losses up to $25,000 are deductible against ordinary income by taxpayers with AGI less than or equal to $100,000. Phase out between $100,000 and $150,000.
58
Q

Personal use vs. rental use for the determination of vacation home treatment

A
  • Fewer than 15 rental days: No gross income from rentals and no deductible rental expenses. In addition, the mortgage interest and property taxes are treated as if on personal residence (generally deductible in full).
  • More than 14 rental days: Treatment depends on amount of personal use. If the personal use days are NOT more than the greater of 14 days or 10 percent of fair rental days, then the taxpayer can deduct all expenses allocated to rental use even if loss results. (Rental losses are subject to passive loss rules).
59
Q

Definition of a Passive Activity

A
  • Passive losses can only offset passive gains. PALs v PIGs.
  • Income/loss is considered passive when the taxpayer does not have a material role in the activity used to generate that income or loss
  • Rental activities with material participation are generally still considered passive in nature.
    • 1st Exception: You’re a qualified real estate professional / dealer.
    • 2nd Exception: If the taxpayer “actively participates” in the activities (requires less than “material participation”) and if the taxpayer’s AGI doesn’t exceed specified levels.
      • If the real estate is actively managed, then the taxpayer can deduct up to $25,000 against ordinary income.
        • This exception is subject to a phaseout of $1 for every $2 AGI exceeds $100,000.
        • Completely phased out at AGI of $150,000.
60
Q

Definition of Material Participation

A
  • Greater than 500 hours per year, OR
  • Greater than 100 hours and the most of any participant.
61
Q

What are the rules regarding Suspended Losses from an At-Risk Limitation?

A
  • Losses are limited to the at-risk amount and then to the passive activity amount. (See pg. 88, Q1 of Income Tax Planning book)
  • If suspended losses are from “At Risk” activity, they are NOT deductible until the at risk amount is positive from additions or income.
  • If losses are suspended under passive activity rules, the losses are deductible upon disposition.
62
Q

Formula for excess alimony?

A
  • P1 + P2 - 2(P3) - $37,500 = Excess Alimony/Recapture
  • Look for > $15K decrease between years 1 and 2 or 2 and 3.
  • Excess payments are included in payor’s taxable income in third post-separation year.
  • Payee is permitted a deduction equal to the amount includable in the payor’s income in that year.
63
Q

What are the rules for taking a home office deduction?

A
  • Office must be used exclusively and on a regular basis as:
    • The principal place of business, or
    • A place of business used by clients, patients, or customers.
    • For employees, office must also be for the convenience of the employer
  • A home office qualifies as a principal place of business if:
    • Taxpayer conducts administrative and management activities in the home office, and
    • There is no other fixed location where taxpayer conducts these activities.
  • Home office expenses cannot cause net loss from the business activity.
  • Home office deduction is limited to business gross income in excess of other business expenses (ordering rules apply).
    • Excess is carried forward (subject to limit).
64
Q

What is the first primary source of tax law?

What two sources of tax law have the rule of law?

A

The Internal Revenue Code

The Internal Revenue Code and Treasury Regulations

65
Q

Characteristics of Treasury Department Regulations

  • Proposed Regulations
  • Temporary Regulations
A
  • There are three types of regulations (Proposed, Temporary and Final):
  1. Proposed - Proposed regulations are a preview of final regulations and do not have legal precedence.
  2. Temporary - Temporary regulations are issued when guidance is needed quickly and have the same authoritative value as final regulations.
  3. Final - Final regulations have the full force and effect of law. There are three types of final regulations:
  • Procedural regulations are essentially “housekeeping” instructions.
  • Interpretive regulations implement the “intent of committee reports” and the IRC.
  • Legislative regulations allow the Treasury to determine the “details of the law”. However, Congress must specifically delegate this authority to the Treasury.
66
Q

Characteristics of Revenue Rulings

A
  • Revenue Rulings are interpretations of the tax laws issued by the IRS. They are usually provided in response to a taxpayer request and are based on facts common to many taxpayers.
  • While Revenue Rulings do not have the full force and effect of law, they are binding on officials of the IRS.
67
Q

Characteristics of Revenue Procedures

A
  • Revenue procedures describe internal practices and procedures within the IRS.
  • Revenue procedures, like Revenue Rulings, are published in the Internal Revenue Bulletin.
  • Revenue Procedures generally state changes in techniques and administrative procedures used by the IRS.
68
Q

Characteristics of Private Letter Rulings

A
  • Private Letter Rulings (PLRs) are issued by the IRS at the request of the taxpayer. - With regard to the taxpayer who requested the PLR, the IRS is bound by its determination in the ruling.
  • PLRs are made available to the public after deletion of certain materials and can be used by other taxpayers as guidance regarding the described transaction.
  • PLRs cannot be relied on by other taxpayers as precedent.
69
Q

Interest Penalty for Noncompliance on Internal Revenue Code

A
  • Interest accrues from the original due date of the return, even if the taxpayer obtained an extension.
  • Interest is compounded daily. The interest rate is the federal short-term rate plus 3 percent. That rate is determined every three months.
  • Interest is paid on refunds if not received within 45 days of the taxpayer filing a claim for a refund.
70
Q

“Failure to File” penalty

A
  • The “failure to file” penalty accrues on a monthly basis at the rate of 5% per month up to 25%.
    • If the failure to file penalty relates to a fraudulent failure to file, then the penalty is increased to 15% per month up to 75%.

* Remember that a failure to File = Five %
* Filed more than 60 days late, the minimum failure to file penalty is $435 in 2021, or the amount of tax due.

71
Q

“Failure to Pay” penalty

A
  • The “failure to pay” penalty accrues at a rate of .5% per month up to 25%.
    • If both a failure to file penalty and a failure to pay penalty apply, then the failure to file penalty is reduced by the failure to pay penalty.

* Remember that a failure to Pay = Point five %

72
Q

Statute of Limitations

  • For Assessment of Deficiency
  • For Refund
A
  • For Assessment of Deficiency
    • Generally 3 years from due date of return
    • 6 years if material omission (25% of income or more)
    • No statute if fraudulent return
  • For Refund
    • Later of 3 years from date return is filed or 2 years from date of payment.
73
Q

Who may represent a client during an audit by the IRS?

A
  • Attorney
  • CPA
  • Enrolled agent
  • Note that a CFP® Professional may not represent a client during an IRS audit.
74
Q

The US Tax Court

The US Tax Court - Small Claims

A
  • US Tax Court
  • No payment of tax is necessary in order to bring a claim before the US Tax Court.
  • Trial by jury is not available.
  • Appeals are to the US Court of Appeals
  • US Tax Court - Small Claims
  • The Small Tax Case Division handles deficiencies under $50,000 at the taxpayers request.
    • Note that this is an informal procedure with no appeal rights.
  • Tax Court decisions do not bind the IRS with respect to other taxpayers.
75
Q

The US Court of Federal Claims

A
  • Sits only in Washington, DC.
  • Tax deficiencies must be paid to proceed in this forum.
  • Appeals are to the US Court of Appeals for the Federal Circuit.
76
Q

The US District Court

A
  • Tax deficiencies must be paid to proceed in this forum. - The US District Court is the only forum which allows a jury trial. - The District Court is bound by decisions of its Appeals Court and the US Supreme Court.
77
Q

The US Court of Appeals

A
  • There are 12 Circuit Courts, located throughout the United States.
  • The US Court of Appeals handles appeals from Tax Court and District Court.
  • The Court of Appeals of one region is not bound to follow the decisions of the court of appeals in another region.
78
Q

The US Supreme Court

A
  • Decisions of the US Supreme Court are binding on taxpayers and the IRS.
  • The US Supreme Court generally reviews tax cases if:
    • there is a conflict between the circuit courts,
    • an important and recurring problem in tax law administration is involved,
    • many taxpayers are involved, or if
    • the decision of a lower court conflicts with long-standing practice or the regulations.
79
Q

In order to be depreciable, what requirements must the property meet?

A
  • It must be property you own.
  • It must be used in your business or income-producing activity.
  • It must have a determinable useful life.
  • It must be expected to last more than one year.
80
Q

Examples of property that cannot be depreciated

A
  • You cannot depreciate property that you use solely for personal activities.
    • If you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business or investment use.
    • For example, you cannot deduct depreciation on a car used only for commuting, personal shopping trips, family vacations, driving children to and from school, or similar activities.
  • You cannot depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.
  • Land cannot be depreciated.
81
Q

Election to expense assets – Section 179 General Rules

A
  • Can elect to immediately expense up to $1,050,000 (for 2021) of business tangible property placed in service during the year.
  • Cannot use Section 179 for realty or production of income property.
  • The amount expensed reduces depreciable basis.
  • Cost recovery available on remaining basis.
  • Expense limitation ($1,050,000 for 2021) is reduced by amount of Section 179 property placed in service during year that exceeds $2,620,000.
    • The result is a dollar-for-dollar reduction.
  • *The Section 179 deduction is the lesser of:**
  • *- Property Placed in Services (PPS)**
  • *- Taxable Income (TI) or**
  • *- Threshold of $1.05M phased out for PPS > $2.62M**
82
Q

What assets are subject to amortization?

A
  • goodwill
  • trademarks
  • covenants not to compete
  • copyrights and patents used in a trade or business
83
Q

Maximum deduction for Cash, Ordinary Income, and ST Capital Gain Property contributed to:

  • Public Charities
  • Private Operating Foundations and Certain Private Nonoperating Foundations
  • Private Nonoperating Foundations (PNOF)
A

Cash contributions made to qualified charities during tax years 2020 and/or 2021 will be deductible based on 100% of AGI.

84
Q

Maximum deduction for LT Capital Gain (Intangible & Tangible) Property contributed to:

  • Public Charities
  • Private Operating Foundations and Certain Private Nonoperating Foundations
  • Private Nonoperating Foundations (PNOF)
A
85
Q

Maximum deduction for Real Property contributed to:

  • Public Charities
  • Private Operating Foundations and Certain Private Nonoperating Foundations
  • Private Nonoperating Foundations (PNOF)
A
86
Q

What entities are flow through?

A
  • Partnership
  • LLP
  • S Corp
  • LLC (depends on taxpayer election)
87
Q

What entities have unlimited liability?

A
  • Sole Proprietor
  • General Partnership
88
Q

What is the nature of the owner’s income from various entities?

A
  • Self Employment Income (subject to self employment tax)
    • Proprietor
    • General Partnership
    • LLP
  • W-2 Income
    • Corporation (C Corp)
    • S Corp

Note: LLC – depends on taxpayer election

89
Q

Domestic Employee Tax

A

Taxpayers with domestic employees (for example nannies) must pay Social Security and Medicare taxes on 100% of compensation paid to the domestic employees.

  • Social Security taxes: 12.4% on the first $142,800 of earnings in 2021.
  • Medicare taxes of 2.9% on all earnings.

There is no above-the-line deduction for domestic employee taxes.

90
Q

Tax Reduction/Management Techniques

Ways to Defer Income

A
  • Qualified Retirement Plans
  • Defer selling investment until later years
  • Defer billing for cash basis clients
  • Defer year end bonuses
  • Incentive stock options
  • Non-qualified deferred compensation
  • Installment sales
  • Like-kind exchanges
  • Earning on annuitities
91
Q

Tax Reduction/Management Techniques

Ways to Accelerate Deductions

A
  • Pay deductible expenses due early next year
    • Estimated state tax payments
    • Real estate taxes
    • Mortgage payments
    • Charitable contributions
    • Repairs and Maintenance
    • Acquire assets
      • Section 179 expense
      • Half year convention, if qualify
      • Proper classification of depreciable assets can also accelerate deductions.
92
Q

Limitations on the Ability to Defer Income and/or Accelerate Deductions

A
  • A taxpayer’s ability to defer income or accelerate deductions depend on
    • Available cash flow
    • Current needs
    • Strategies the counteract each other
      • Need to collect the income in order to buy the asset.
    • Alternative minimum tax
  • Choices must be made considering all the consequences.

CFP Review (7 decks)

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