Income Tax Planning (12%)

Question 1

What are the buisness entity types?

Answer 1

When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file.

The most common forms of business are:

• sole proprietorship
• partnership
• corporation
• S corporation

A Limited Liability Company (LLC) is a business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.

Question 2

What are flow-through entities and how are they taxed?

Answer 2

Many businesses are taxed as flow-through entities that, unlike C corporations, are not subject to the corporate income tax.

Instead their owners include their allocated shares of profits in taxable income under the individual income tax, which is taxed as ordinary income up to the maximum 39.6 percent rate.

Flow-through businesses include sole proprietorships, partnerships, and S corporations.

Question 3

What are the advanges of flow-through entities?

Answer 3

Flow-through businesses generally face the same tax rules as C corporations for inventory accounting, depreciation, and other provisions affecting the measurement of business profits.

But organizing as a flow-through business has several advantages.

• Income is only subject to a single layer of income tax, unlike C corporation profits, which are first subject to the corporate income tax (at rates up to 35 percent) and then taxed again when paid out as dividends to shareholders or when shareholders realize capital gains arising from retained earnings (at rates up to 23.8 percent).
• Profits from flow-through businesses are taxed just once, at the owner’s individual tax rate for ordinary income.
• Individuals may deduct business losses against current income from other sources, subject to some limitations for “passive losses.”

Question 4

What is a Sole Proprietor?

Answer 4

A sole proprietor is someone who owns an unincorporated business by himself or herself.

However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.

Sole Proprietorships: A business with a single owner does not file a separate tax return, but rather reports its net income on Schedule C of the owner’s individual tax return. Generally all net income from sole proprietorships is also subject to payroll taxes under the Self Employed Contributions Act (SECA).

Question 5

What is a Partnership?

Answer 5

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.

Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.

Partnerships file an entity-level tax return (Form 1065), but profits are allocated to owners who report their share of net income on Schedule E of their individual tax returns.

Under “check the box” regulations instituted by the Treasury Department in 1997, limited-liability companies (LLCs) can elect to be taxed as partnerships.

General partners are subject to Self Employed Contributions Act (SECA) tax on all their net income, while limited partners are only subject to SECA tax on “guaranteed payments” that represent compensation for labor services.

Question 6

What is a Corporation?

Answer 6

In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock.

• A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income.
• A corporation can also take special deductions.
• For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity.
• A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.

Question 7

What are DisAdvantages of C Corporations?

Answer 7

• C corporation profits, which are first subject to the corporate income tax (at rates up to 35 percent) and then taxed again when paid out as dividends to shareholders or when shareholders realize capital gains arising from retained earnings (at rates up to 23.8 percent).
• C-corporation losses cannot be used to offset income earned outside the corporation. C-corporation losses may, however, be carried back (up to two years) or carried forward (up to 20 years) and deducted against profits in previous or future years.
  
  • To the extent corporations are unable to claim loss carrybacks, the tax benefit from these losses is delayed and reduced in terms of present value.

Question 8

What is a Subchapter S Corporation?

Answer 8

• S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
• Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.
• This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
• Eligible domestic corporations that elect S-corporation status file a corporate tax return (Form 1120S), but profits flow through to shareholders and are reported on Schedule E of the shareholders personal income tax.
• S corporation owners do not pay Self Employed Contributions Act (SECA) tax on their profits, but are required to pay themselves “reasonable compensation,” which is subject to the regular Social Security tax (i.e., the Federal Insurance Contributions Act or FICA).

Question 9

How does a Corporation qualify for a S Corporation Status?

Answer 9

To qualify for S corporation status, the corporation must meet the following requirements:

• Be a domestic corporation
• Have no more than 100 shareholders
• Have only one class of stock
• Have only allowable shareholders
  
  • May be individuals, certain trusts, and estates and
  • May not be partnerships, corporations or non-resident alien shareholders
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

Question 10

What is a Limited Liability Company (LLC)?

Answer 10

A Limited Liability Company (LLC) is a business structure allowed by state statute.

Owners of an LLC are called Members.

• Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities.
• There is no maximum number of members.
• Most states also permit “single-_member_” LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies.

Question 11

Basis for Property

Answer 11

1. The basis of property acquired by purchase is equal to cost increased by acquisition (i.e., capitalized) costs, such as legal fees, commissions, sales taxes, freight, etc.
2. The basis of property acquired by inheritance is the fair market value on the date of the decedent’s death or the alternate valuation date if so elected. An asset acquired by inheritance is deemed to be held for the long-term holding period.
3. The basis of property acquired by gift
4. If the FMV on the date of the gift is greater than the donor’s adjusted basis, then use donor’s adjusted basis.
5. If the FMV on the date of the gift is less than the donor’s adjusted basis in the asset, then
6. if sold for less than FMV on date of gift, basis is FMV on the date of the gift
7. if sold for more than the donor’s basis, then basis is the donor’s basis
8. if the sale price of the asset is between the donor’s basis and the FMV on the date of the gift, no gain or loss is recognized—basis is tied to the sale price
9. if donor’s basis is used, the holding period is “tacked”; if FMV is used, there is no tacking of the holding period
10. basis further increased by improvements, but not repairs
11. improvement significantly increases the useful life of, or the value of, the asset involved
12. repair merely maintains the asset in normal working condition

Question 12

Tax Basis for Partnership / LLC

Answer 12

• 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.

Question 13

Tax Basis of Property acquited by Inheritance?

Answer 13

• The basis of property acquired by inheritance is the FMV on the date of the decedent’s death or the alternate valuation date if so elected.
• An asset acquired by inheritance is deemed to be held for the long-term holding period.

Question 14

Tax Basis of Property acquired by Purchase?

Answer 14

• The basis of property acquired by purchase is equal to cost increased by acquisition (i.e., capitalized) costs, such as legal fees, commissions, sales taxes, freight, etc.

Question 15

Tax Basis of Property acquired by Gift?

Answer 15

• If the FMV on the date of the gift is greater than the Donor’s Adjusted Basis, then use Donor’s Adjusted Basis (DAB) as the Basis.
• If the FMV on the Date of the Gift is less than the Donor’s Adjusted Basis (DAB) in the asset, then (Favorable Tax Treatment if sold below or above Donor’s Basis)
  
  • if sold for less than FMV on Date of Gift, Basis is FMV on the Date of the Gift (If sold below DAB, then Basis is lower number).
  • if sold for more than the Donor’s Adj Basis, then basis is the Donor’s Adj Basis (DAB)
  • if the sale price of the asset is between the Donor’s Adj Basis and the FMV on the Date of the Gift, no gain or loss is recognized—basis is tied to the sale price.
  • if donor’s basis is used, the holding period is “tacked”; if FMV is used, there is no tacking of the holding period

Question 16

What are the Cost Recovery Deductions (CRD) Rules under MACRS?

Answer 16

• Cost recovery deductions (CRD) are an allowance for the exhaustion and wear and tear of property used in a trade or business, or held for the production of income. (Can Depreciate)
• The modified accelerated cost recovery system (MACRS) applies to all recovery property (not land or intangibles) placed in service after 1986.

Question 17

Boot / Gain Recognized / Basis

Answer 17

1. No boot received - recognized gain is zero
2. When boot is received, just answer the recognized gain is the boot received
3. Boot paid is added to the adjusted basis
4. Basis carries over from the prior property

Question 18

Netting Capital Gains and Losses

Answer 18

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 $3000 of the net losses can be used to offset ordinary income

Question 19

Property Classes?

Answer 19

Study Hint: C A T O L R N

1231 Property

• ‘Section 1231 property’ is an umbrella term for section 1245 property and section 1250 property, both of which are subdivisions of section 1231.
• Section 1231 defines the tax treatment that the gains and losses of property fitting the definitions of sections 1245 and 1250.

1245 Property

• 5 year - Computers, Autos, Trucks
• 7 year - Office Equipment except computers
• 15 year - Landscape improvements (such as fences, sidewalks and driveways).

1250 Property

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

Question 20

Sale of a Personal Residence

(Section 121)

Answer 20

• $250K (single) and $500k (MFJ) of gain from the sale is tax-free if lived in for 2 out of the last 5 years.
• Exception available if taxpayer lives in the residence less than two year and moves because of a new job, for health reasons, etc. - receive a pro-rated amount

Question 21

What is 1231 Property?

Answer 21

1231 property, defined by section 1231 of the U.S. Internal Revenue Code, is real or depreciable business property held for over a year.

Section 1231 property includes buildings, machinery, land, timber and other natural resources, unharvested crops, cattle, livestock and leaseholds that are at least a year old, but does not include poultry, trademarks, or inventory

Question 22

What are the benefits of 1231 Property?

Answer 22

• 1231 Gains are LTCG which is better rate than Ordinary Income.
• 1231 Losses are Ordinary Income and 100% deductible against income. Ordinarily this would be capital loss and only available to deduct $3,000 for the year with an outstanding Loss Carry Forward.
• This law makes it so taxpayers and business owners get the best of both worlds.

Additional Explainations:

• Broadly speaking, if gains on property fitting Section 1231’s definition are more than the adjusted basis and amount of depreciation, the income is counted as capital gains, and as result it is taxed at a lower rate than ordinary income.
• When losses are recorded on section 1231 property, however, that loss is classified as an ordinary loss and is 100% deductible against their income.
• Ordinarily, if income was qualified as capital gains, so would any losses which can only be deductible up to $3,000 for the tax year, and any losses in excess of that figure would be arrived at in the following year.
• This law makes it so taxpayers and business owners get the best of both worlds.

Question 23

Example of 1231 and 1245 (recapture)

Answer 23

Any sales price between the cost basis and the adjusted basis results in Section 1245 gain.

Example of 1231 and 1245 (recapture)

It is best not to consider something a 1231 or a 1245 asset, but rather thinking of the character of the gain/loss.

• Say you have a $100 widget which is personal property that was subject to depreciation and now has an adjusted tax basis of $25 because you took $75 of depreciation.
  
  • If you sell that widget for $125, you have a $100 gain. Of that $100, $75 is 1245 ordinary gain (recapture of the depreciation taken is 1245 gain), $25 is 1231 LTCG gain or capital gain.
  • If you sell that widget for $10, you have a $15 loss. That loss is a 1231 ordinary loss

Summary:

• 1231 loss - the loss on personal property used in a trade or business. there are netting and lookback rules, but net 1231 losses are ordinary losses
• 1245 gain (never a loss) - recapture of depreciation to the extent there is gain. 1245 gain is an ordinary gain.
• 1231 gain - gain above after depreciation has been fully recaptured. subject to capital gain rates.

Question 24

What is Section 1245 Property?

Answer 24

• Section 1245 Property is any new or used tangible or intangible personal property that has been or could have been subject to depreciation or amortization. It is Personalty Property.
  
  • Examples of tangible personal property are machinery, vehicles, equipment, grain storage bins and silos, blast furnaces, and brick kilns.
  • Examples of intangible personal property are patents, copyrights and trademarks.
• Section 1245 property is NOT land or land improvement, nor its buildings or inherently permanent structures, nor its structural components.
  
  • Examples of property that is NOT personal property are land, buildings, walls, garages and HVAC.

Question 25

Recapture

(1245 Property)

Answer 25

1245 Property is Personalty 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:

• 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)

Question 26

How do you Calculate 1245 Property (Personalty) using MACRS?

Answer 26

Straight-line is an option under MACRS–100%

Property Class Life (5, 7 or 15) times 50% (half-year convention in first year and last year of acquisition). It takes 6 YEARS to depreciate 5 YEAR PropCalerty. DO NOT USE THE TABLE (5,000/5 x 50% = $500. REMEMBER THE SONG - Straight-line means don’t use the TABLE. So the answer is $500 in year one, but $1,000 in year 2, 3, 4, 5, and $500 in year 6. Remember it takes 6 years to depreciate 5 year property and the first and last year is multiplied by %50.

MACRS table for personalty is 200% declining-balance method w/half-year convention (and switch to S/L at optimal point). They will not provide this table on the exam. You will have to memorize it.

Question 27

Section 1245 Property Steps:

Answer 27

1. This applies to the sale of personalty that is or has been subject to an allowance for depreciation.
2. Section 1245 also applies to nonresidential real property placed in service after 1980 and before 1987, and depreciated under the ACRS rules.
3. The amount of gain treated as ordinary income on the disposition of Section 1245 property generally is equal to the lesser of:
   
   1. the cost recovery deductions taken, or
   2. the gain realized on the sale.
4. If a loss is recognized on the disposition, there is no Section 1245 recapture; the entire loss is treated as a Section 1231 loss.
5. The gain not characterized as Section 1245 recapture is treated as a Section 1231 gain.
6. The gain attributable to the taking of cost recovery deductions is ordinary income; only gain caused by appreciation of the asset is potential long-term capital gain.

Question 28

Example of a Sale of Section 1245 Property?

Answer 28

Here is an example that may help clear the fog. A business owns a $100 widget and takes $75 of depreciation. The widget’s adjusted tax basis is its $100 cost minus $75 of depreciation, or $25.

• The business sells the widget for $150. The gain is the $150 sale price minus the $25 adjusted tax basis, or $125. Of that $125, $75 is section 1245 gain taxed at ordinary income rates and and $50 is section 1231 gain taxed at capital gains rates.
• If the business sells the $100 widget for $20, you have a loss of $20 sale price minus $25 adjusted tax basis, or $5. Since there is $0 gain, Section 1245 does not apply and the $5 loss is a section 1231 loss that is ordinary.

Question 29

1245 Personalty Property - Types of Property and Number of years to depreciate?

Answer 29

5-year property:

• Computers, and peripheral equipment
• Automobiles, taxis, buses, and trucks
• Office machinery (such as typewriters, calculators, and copiers

7-year property:

• Office furniture and fixtures (such as desks, files and safes)
• Agriculture machinery and equipment

15 year property:

• landscape improvements such as fences, sidewalks, driveways

Question 30

What is Section 1250?

Answer 30

Section 1250 is a section of the United States Internal Revenue Service Code that states that a gain from selling real property that has been depreciated should be taxed as ordinary income, to the extent that the accumulated depreciation exceeds the depreciation calculated using the straight-line method.

Section 1250 bases the amount of tax due on the type of property, such as residential or nonresidential property, and on how many months the property was owned.

Question 31

Breaking down Section 1250

Answer 31

Section 1250 deals with taxing gains at an ordinary tax rate that arises from selling depreciable real property, such as commercial buildings, warehouses, barns, rental properties and their structural components.

Personal property, either tangible or intangible, and land do not fall under the scope of this tax regulation. Section 1250 is mainly applicable when a company depreciates its real estate using the accelerated depreciation method, which results in larger deductions in the early life of a real asset, in comparison to the straight-line method.

Section 1250 says that if a real property sells for a purchase price that produces a taxable gain, and that property is depreciated using the accelerated depreciation method, the difference between the actual depreciation and the straight-line depreciation is taxed as ordinary income.

Because all post-1986 real estate is required to be depreciated using the straight-line method, treatment of gains as ordinary income under Section 1250 is rare.

If the property is disposed of as a gift, transferred at death, sold as part of a like-kind exchange, or disposed of through other methods, no possible taxable gain exists.

Question 32

Unrecaptured Section 1250 Income - Real Estate

Answer 32

The gain attributable to straight-line depreciation on realty is treated as long-term capital gain income (Section 1231 income), subject to a maximum 25% long-term capital gain rate.

The gain created by actual appreciation of the realty is “regular” long-term capital gain, generally subject to a 15% or 20% maximum rate (also Section 1231).

Any sales price between the cost basis and the adjusted basis results in unrecaptured Section 1250 income. Any gain created by actual appreciation of the realty is “regular” LTCG.

Question 33

An Example of Section 1250 Applicability?

Answer 33

An Example of Section 1250 Applicability

Consider an investor who purchased real estate with a useful life of 40 years for a total purchase price of $800,000. After five years, the investor claimed $120,000 in accumulated depreciation expenses using the accelerated depreciation method, resulting in a cost basis of $680,000.

• Suppose that the investor sells this property after five years for $750,000, for a total taxable gain of $70,000. Because the accumulated straight-line depreciation is $100,000 (initial price of $800,000 divided by 40 years times five years of use), $20,000 of the actual depreciation that exceeds straight-line depreciation must be taxed as ordinary income, while the remaining $50,000 of the total gain is taxed at applicable capital gains tax rates.

The recapture of gain as ordinary income under Section 1250 is limited to the extent of actual gain recorded on a sale of real property.

• If the real property in the above example was sold for $690,000, producing a gain of $10,000, only $10,000 would be considered ordinary income, not the excess $20,000.

Question 34

Section 179

Qualifying vs. Non-Qualifying Property

Answer 34

Qualifying:

• Tangible personal property
• 1245 Property

Non-Qualifying:

• Real Estate
• 1250 Property
• Intangible (owning a franchise)

Question 35

Historic Rehabilitation Programs

Answer 35

• 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 $200k- 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 $6,250.

Question 36

Low Income Housing Credit

Answer 36

• 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.

Question 37

Types of Phantom Income

Answer 37

• Insurance - Lapse of policy loan, Section 162 life/disability
• Investments - Zero/Strip Income, TIPS, declared but not paid dividends.
• Tax - K-1 Income from LP/FLP, recapture
• Retirement - NUA, 20% withholding plan distributions, secular trust

Question 38

Charitable Giving

Answer 38

1. Calculate the maximum deductible - 50% of AGI **Not rure here, but says you must use basis for this** pg 89 Live ITB but Q10 ITP Test.
2. 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.
   
   1. 50% for ordinary income property
   2. 30% for LTCG property
3. Calculate the eligible amounts given to 30% AGI organizations (private charities) such as private non-operating foundations, war veteran groups, and fraternal orders.
   
   1. 30% for ordinary income propety
   2. 20% for LTCG property

Question 39

Charitable Giving

(Types of property - 50% charities)

Answer 39

• 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

Question 40

Sources of Federal Tax Law/Authority

Answer 40

Study Hint: I T R C P J

• • • 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

Question 41

Step Transaction

Answer 41

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.

Question 42

Sham Transaction

Answer 42

A transaction that lacks a business purpose and economic substand will be ignored for tax purposes.

Example: A sale by XYZ to ABC, but both XYZ and ABC are owned by the same persons.

Question 43

Substance Over Form

Answer 43

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.

Question 44

Assignment of Income

Answer 44

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.

Question 45

Dates for Paying Estimated Taxes

Answer 45

• April 15
• June 15
• September 15
• January 15

Question 46

IRS Penalties

Answer 46

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, 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)

Question 47

Federal Withholding Tax Underpayment Penalty

Answer 47

To avoid, pay the lesser of:

1. 90% of the current year’s tax liability
2. 100% of the prior year’s tax liability (or 110% if the last year’s adjusted gross income exceeded $150,000)

Question 48

Schedule A

Itemized Deductions FROM AGI

Answer 48

• Medical, dental and LTC (10% AGI)
• Casualty and theft losses
• Real estate taxes
• Investment interest expense
• Home mortgage interest
• Personal Property tax
• State and local income taxes (or sales taxes)
• Charitable gifts or contributions
• Miscellaneous Deductions
• Tier II miscellaneous itemized deductions (exceeding 2% of AGI)

Question 49

Tax Treatment of Investment Expenses

Answer 49

Investment expenses are directly connected with the production of investment income (i.e., margin interest). In determining net investment income, the 2% miscelleanous itemized deductions must be taken into account, specifically investment advisor fees. In other words, investment income offset by deductible investment advisor fees.

Question 50

Casualty Losses

(Calculation of the Deductible Loss)

Answer 50

First: Use the lesser of basis or FMV

Second: Subtract any insurance coverage

Third: Subtract $100 (floor)

Fourth: Subtract 10% of AGI

Question 51

Schedule A

(subject to 2% of AGI - major ones)

Answer 51

• Fees to investment counselors
• Tax advice and preparation fees
• Professional and business association dues
• Unreimbursed employee business expense
• Employee home office expense

Question 52

Kiddie Tax

Answer 52

All net UNEARNED income of a child who has NOT attained the age 18 or turns 19-23 if a full-time student and who has at least one parent alive is taxed at the marginal rate of a child’s parents regardless of the source of the assets.

Children under 18 are entitled (2017) to a standard deduction amount ($1,050) and an additional $1,050 of unearned income will be taxed at the child’s rate (10%).

Question 53

How much can i deduct for my Charitable Contributions?

Answer 53

1. Contributions to organizations that are PUBLIC charities are limited to 50% of taxpayer’s AGI (includes contributions to churches, schools, hospitals, and governmental units).
   
   1. 50% for ordinary income property
   2. 30% for LTCG property (unless 50% election made)
2. Contributions to PRIVATE nonoperating foundations, veterans groups, fraternal associations, and other not-for-profit associations are limited to 30% of taxpayer’s AGI.
   1. 30% for ordinary income property
   2. 20% for LTCG property

Question 54

Self-Employment Income

Answer 54

• Net schedule C income
• General partnership income (K-1 income)
• Board of Directors fees
• Part-time earnings (1099)
• NOT wages or K-1 distributions from an S corp

Question 55

Self-Employment Tax Calculation

Answer 55

The taxable wage base will not exceed $127,200 (2017). If you added up the self-employed income, and you exceeded $127,200, you did something wrong.

Why? Social Security tax stops at $127,200 (2017).

Shortcut: Multiply self-employment income by 0.1413

Question 56

Tax Credits

Answer 56

• Credit for child and dependent care expenses
• Child tax credit
• Adoption credit
• Elderly and disabled credit
• Foreign tax credit
• Earned income credit (refundable)

Question 57

Accounting Methods

Answer 57

Cash: Mandatory where taxpayer’s records reflect only cash transactions, and there are no inventories. Mostly Small Business under $5MM revenues. Cash accounting is an accounting method in which payment receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid. In other words, revenues and expenses are recorded when cash is received and paid, respectively.

Accrual: Mandatory for purchases and sales where there are inventories. Large companies and C Corpororations are required to do Accrual Method. Accrual accounting is an accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur. The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a company’s current financial condition.

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.

Question 58

Personal service businesses that should stay away from doing a regular corporation

Answer 58

H Health

A Accounting / Architectural

L Law

E Engineering

Question 59

Realized gain versus recognized gain…. What’s the difference

Answer 59

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

Question 60

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

Answer 60

$400

Question 61

What is FICA and What does FICA Stand for?

Answer 61

FICA taxes are the Social Security and Medicare taxes paid by individuals and employers. FICA taxes are called payroll taxes because they are based on the amounts paid to employees.

FICA taxes have two elements. withheld from employee paychecks and paid by employees and employers for (1) Social Security (OASDI) and (2) Medicare. This article gives you information about how to calculate FICA taxes, how to report and pay these taxes, what earnings are not part of FICA taxes, and more.

The term “FICA” is short for the Federal Insurance Contributions Act. The Act was introduced in the 1930s to pay for Social Security; Medicare was added later.

Question 62

How much is the FICA Tax?

Answer 62

The total FICA tax is 15.3%. That percentage is applied to the employee’s gross pay.The employer and employee each pays 7.65%.

Here is the breakdown of these taxes:

Within that 7.65%, the OASDI (Old Age, Survivors, and Disability program, AKA, Social Security) portion is 6.2% (5.7% is OA + 0.50% is SDI), up to the annual maximum wages subject to Social Security.

The Medicare portion is 1.45% for each employee, on all employee earnings.

The Social Security portion is capped each year at a set amount (2017 is $127,200); the Medicare portion is not capped.

Question 63

What is OASDI and What does OASDI Stand for?

Answer 63

Within that 7.65%, the OASDI (Old Age, Survivors, and Disability program, AKA, Social Security) portion is 6.2% (5.7% is OA + 0.50% is SDI), up to the annual maximum wages subject to Social Security.

The Medicare portion is 1.45% for each employee, on all employee earnings.

The Social Security portion is capped each year at a set amount (2017 is $127,200); the Medicare portion is not capped.

Question 64

What are the above the line deductions?

Answer 64

• Penalty on early withdrawal from CD
• Alimony payments
• SE Retirement Plan like Keogh
• Deductible IRA Contribution (as long as qualify as Active Participant)
• Qualified job-related moving expenses (50 miles distance requirement)
• 1/2 of SE Tax
• Qualified Student loan interest deduction (Phaseout MFJ is $135K to $165K for 2017. Single is half)
• Health Savings Account (HSA) Contributions
• Higher Education Expenses like tuition and related expenses
• Educator expenses deduction - up to $250 for trade or business
• Legal fees and court costs related to discrimination lawsuits
• Jury duty fees paid to ER

Question 65

Classification of Property by Character

Answer 65

1. Realty (or real property) is comprised of land, improvements, real estate and fixtures
2. Personalty (or personal property) is any property that is not considered to be realty. Back hoe, fork lift or other heavy machinery. This property is movable and not fixed like land our building.
3. Tangible property is property that has physical existence, that can betouched, felt, or occupies space like furniture, clothing art, jewelry writings, or household goods.
4. Intangible property is property that signifies intellectual or legal rights, orownership or indebtedness; it has no physical existence of its own (Stocks/Bonds, Trademarks, Copyrights or IP)

Question 66

Classification of Property By Use

Answer 66

1. Property used in a trade or business is property used in an activity that is regularly and continuously undertaken for profit (but not investment activities) Highest Level. We can depreciate this or do a Section 179 (allows small business to deduct full purchase price of qualifying equipment up to $510K - for 2017.)
2. Property held for the production of income is property held to realize income from current operations (as in rental property) or from ultimate sale (as in stock); it generally involves a lower level of activity than the conduct of trade or business. Rental Real Estate. Depreciate this but no section 179 expense
3. Inventory is property that is held out for resale in the normal course of a trade or business. No depreciation
4. Personal use property is property that is held for the taxpayers’ personal pleasure or enjoyment. Sailboat. No depreciation.

Question 67

How do you calculate Federal Income Tax?

Answer 67

Total Gross Income

- Adjustments to Income (AGI Deductions => I EMBRACED HITS)

= AGI

• Standard Deduction

or

• Itemized personal deductions (FROM AGI => MGMCCRISTTT)

- Personal Exemption Amount (1 for self, 1 for spouse and 1 for each dependent)

= Taxable Income

Question 68

How to calculate Total Gross Income (TGI)?

Answer 68

The starting point for computing your AGI is determining your income for the year. This includes salaries and wages, which are reported on Form W-2, self-employment income, and income reported on 1099 forms, such as proceeds from Broker and Barter Exchange Transactions reported on Form 1099-B, proceeds from Real Estate Transactions reported on Form 1099-S, Form 1099-INT used to report taxable interest and 1099-DIV, which is used to report taxable dividend. You will need to add other taxable income, such as:

STUDY HINT: F U R C O D B O A T S

• Farm income
• Unemployment compensation
• Rental real estate, royalties, partnerships, S corporations, trusts, etc.
• • • Capital gains or losses
• Other gains or losses
• Distributions from retirement accounts that are taxable
• • • Business income
• Other income not reported elsewhere on your tax return
• Alimony
• Taxable refunds, credits, or offsets of state and local income taxes
• Social security benefits

Question 69

What are the Exclusions not counted in Gross Income (GI)?

Answer 69

Study Hint: WIG QMCC

• Workers Comp Received
• Inheritances Received
• Gifts Received
• Qualified Roth Distributions Received
• MUNI Bond Interest Received
• Child Support Received
• Certain Fringe Benefits

Question 70

Deductions FOR AGI? Deductions FOR AGI (use this and delete the other one)

Answer 70

Study Hint: I EMBRACED HITS

• I nterest from student loans paid for you, spouse or dependent ($2,500 AGI Phaseout on CFP handout)
• 1/2 self E mployment tax (Net Inc x 0.9235 = S/E Taxable Income, then take S/E Taxable Income x 0.1530 = S/E Total Tax, then take S/E Total Tax x 0.50 = 1/2 S/E Tax Deduction)
• M oving expenses for qualified job
• B usiness expenses (certain exp from reservists, performing artists and fee-basis govt officials)
• R ent, royalty, and pass through entities (ONLY Addition)
• A limony paid (recipient must include in Gross Income)
• C ontributions to S/E SEP, SIMPLE, Keogh and Qualified Plans
• E arly withdrawal savings & CDs penalty
• jury D uty fees paid to ER
• H ealth Savings Account (HSA) Deduction
• I RA Contribution (What for A/P and Phaseouts)
• T uition ONLY up to $4K or $2K or $0 (Subject to Phase out on CFP handout)
• S /E Health Insurance Deduction for medical and LTC

Question 71

How to calculate S/E income deduction for AGI?

Answer 71

Step 1: Figure out the amount of your earnings that is actually taxable for the S/E taxable income

Step 2: Calculate the amount you owe for S/E Tax

Step 3: Report half of your S/E tas as an adjustment

Ex: S/E of $100K

Step 1: $100,000 x 0.9235 = $92,350 ($92,350 is the S/E Taxable Earnings/Income - we times it by 92.35% because 7.65% is the ER half of FICA tax

Step 2: $92,350 x 0.1530 = $14,129.55 (we times it by 15.30% becuase this is the OASDI HI or FICA amount)

Step 3: $14,129.55 x 0.50 = $7,064.78 (this is the 1/2 S/E amount you can deduct Above the Line for AGI)

Shortcut is to multiply $100,000 x .1413 = 14,130

Question 72

Deductions FROM AGI (use this and delete the other one)

Answer 72

Study Hint: M M C C R I S T T T for Mother G Mary C C R I S T

• M edical expenses (10% AGI)
• G ambling losses deducted here => gains are added to Gross Income.
• M ortgage interest on primary and secondary residence (up to $1MM acquisition and $100K HELOC)
• C haritable contributions
• C asualty and theft losses
• R eal Estate Taxes and Personal Property Taxes like DMV Registration
• I nvestment interest expense
• S tate and Local Income Taxes Paid
• T ier II misc deductions over 2% of AGI
  
  • U nreimbursed Business Expenses
  • E xpenses incurred in “production of income”
  • E xpenses related to recovering tax collection liability

Question 73

Who is an Active Participant?

Answer 73

Deductible IRA contributions:

• For married taxpayers filing jointly, who are both active participants in a company-maintained retirement plan, the IRA deduction is phased out between $99,000 and $119,000 of AGI for joint returns.
• A taxpayer who is not an active participant, but who has a spouse who is an active participant, may take a deduction for the contribution, subject to a phaseout ranging from $186,000 to $196,000. The active participant spouse is subject to the $99,000 and $119,000 AGI limitation.
• For single taxpayers who are active participants, the phaseout is between $62,000 and $72,000 in 2017.

Question 74

AMT Preference Items

Answer 74

AMT Preferences - Study Hint (IPOD)

• I ncentive stock options bargain element
• P rivate activity bonds
• O il and Gas Percentage depletion / Excess intangible drilling costs (IDC)
• excess Depreciation on personal property

Question 75

AMT Add-Back Items

AMT Not-Deductible Items

Answer 75

Add Back:

• Incentive Stock option bargain element
• Property and income taxes
• Miscellaneous Deductions - specifically watch out for financial advisor fees
• Home Equity interest NOT used for home improvement

Non-Deductible:

• Standard Deduction
• Personal exemption

Question 76

AMT Adjustments or add backs?

Answer 76

Study Hint: AMT Adjustments (SIMPLER)

• S tandard deduction
• I nterest on home equity loans HELOC
• M edical expenses under 10% AGI
• P ersonal and dependent exemptions
• L ocal and state taxes
• E mployee business expenses and other 2% misc expenses
• R eal Estate and personal property taxes

Question 77

Postponing AMT

Answer 77

• 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.

Question 78

How do you calculate MACRS?

Answer 78

Straight-line is an option under MACRS–100%

Step 1: Property Class Life (5, 7 or 15) times 50% (half-year convention in first year and last year of acquisition). Remember, t takes 6 YEARS to depreciate 5 YEAR Property.

Step 2: DO NOT USE THE TABLE (5,000/5 x 50% = $500. REMEMBER THE SONG - Straight-line means don’t use the TABLE. So the answer is $500 in year one, but $1,000 in year 2, 3, 4, 5, and $500 in year 6.

Step 3: Remember it takes 6 years to depreciate 5 year property and the first and last year is multiplied by %50.

Question 79

What is the 1250 Property gain Rate when using Striaght Line Depreciation Method?

What is the 1250 property gain rate when using Accelerated Depreciation Method?

Answer 79

25% for LTCG if used Straight Line Depreciation Method?

Oridinary Income if used Accelerated Depreciation Method?

If Accelerated Depreciation Method is used then the gain is the difference between the Actual Accelerate Depreciation Method and the Straight-Line Method and the gain is taxed as Ordinary Income.

Section 1250 says that if a real property sells for a purchase price that produces a taxable gain, and that property is depreciated using the accelerated depreciation method, the difference between the actual depreciation and the straight-line depreciation is taxed as ordinary income.

Question 80

Under MACRS, real estate is depreciated under which of the following methods?

A: 200% declining balance method

B: 150% declining balance method

C: sum-of-the-years’ digits method

D: straight-line method

Answer 80

Under the Modified Accelerated Cost Recovery System, real estate is depreciated using the straight-line method, with a mid-month convention, while personalty is generally subject to a 200% declining balance method, with a half-year convention. Note that the taxpayer may elect the straight-line method for personalty. The MACRS system applies for all property placed in service after 1986.

Question 81

How do I qualify as a like-kind exchange?

Answer 81

1. The property to be received must be identified within 45 days after the date on which the old property is transferred.
2. The new property must be received within 180 days after the date on which the old property is transferred, but not later than the due date of the tax return (including extensions) for the year that the old property is transferred.
3. The like-kind provision is mandatory.

Question 82

General Rules of Like-Kind Exchanges

Answer 82

1. Losses are never recognized by the taxpayer who qualifies for like-kind exchange treatment.
2. Gain realized is FMV of property received minus A/B of property given up.
3. The gain recognized is always the lesser of the gain realized or the boot received.
4. Basis of the like-kind property received is its fair market value reduced by any gain realized but not recognized. (OR old basis, minus boot received, plus boot paid and gain recognized).

Question 83

What is Boot?

Answer 83

1. Boot is anything that is not qualified, like-kind property—cash, NET debt relief, or other nonqualifying property.
2. If a taxpayer is relieved of a mortgage liability due to the like-kind exchange, such relief is treated as a receipt of cash by the taxpayer and, as such, is treated as boot.
3. If the taxpayer assumes and is relieved of a mortgage liability, only the net debt relief is considered to be boot.

Question 84

Frank Farmer owns a warehouse that has a fair market value of $150,000 and an adjusted basis of $60,000. He wants to acquire Mary Pierce’s apartment building, which has a fair market value of $200,000 and an adjusted basis of $180,000. In the contemplated exchange, Frank will pay Mary $50,000.

What is Frank’s substitute basis in the acquired apartment building?

Answer 84

$110,000

Frank received a building with a fair market value of $200,000. He gave an adjusted basis of $60,000 and $50,000 in cash, for a total of $110,000. The difference between $200,000 and $110,000 is the gain realized of $90,000. The gain recognized is the lesser of the gain realized ($90,000) or the boot received ($0). In a like-kind exchange, the substitute basis of the acquired asset is the fair market value of the asset acquired less any gain realized but not recognized. In this situation, the fair market value of the acquired asset is $200,000. There is $90,000 of gain realized but not recognized; therefore, $110,000 is the substitute basis in the acquired asset.

Question 85

Dave Beeman owns equipment that has an adjusted basis of $10,000 and a fair market value of $75,000. Through an exchange, he acquires new equipment from Rachel Nelson that has a fair market value of $60,000 and an adjusted basis of $35,000. In the exchange, Dave receives $15,000 from Rachel.

What is the amount of gain or loss, if any, recognized by Dave in the exchange?

A. $10,000

B. $15,000

C. $50,000

D. $65,000

Answer 85

B. $15,000

In the exchange, Dave received new equipment with a fair market value of $60,000 and cash of $15,000. He gave up an adjusted basis in his property of $10,000. The difference between $75,000 and $10,000 is the gain realized, $65,000. The gain recognized, that is the taxable amount, is the lesser of the gain realized ($65,000) or the boot received ($15,000).

Question 86

Jacob Hugar has an apartment building in Atlanta that he would like to exchange. Which of the following assets could Jacob receive in a like-kind exchange?

(1) farmland
(2) interest in a low-income housing limited partnership
(3) parking lot
(4) an apartment building in Tahiti

Answer 86

In a like-kind exchange for real estate, only other real estate may be received as qualifying property. Thus, the farmland and the parking lot would be qualifying property in a like-kind exchange of realty. The like-kind exchange rules specifically prohibit the exchange of U.S. realty for foreign realty. The interest in a limited partnership is specifically not allowed as qualifying property.

Question 87

What is the penalty for late filing of your income tax return?

Answer 87

The penalty for failing to file an income tax return is 5% of the amount due for each month, or part thereof, that the return is late, up to a maximum penalty of 25%. Dan has filed his return five full months, and a part of another month, late, which seemingly results in a 30% penalty for late filing (5% per month for six months). However, the maximum failure to file penalty is 25% of the amount owed.

Question 88

What is the penalty for negligence of filing tax return? Client didn’t get a W-2 from his firm.

Answer 88

The negligence penalty is 20% of the deficiency due to the taxpayer’s negligence. For the $2,000 tax deficiency, 20% results in a negligence penalty of $400. It may be argued that the failure to report the income was fraud, but the fact pattern states that the act was merely negligent.

Question 89

How much interest is deductible on a HELOC even if the proceeds weren’t used to enhance the property. ie, they used it to buy a new car or pay off credit card debt.

Answer 89

Interest on a home equity loan up to $100,000 of principal is generally deductible.

Note that the interest would NOT be deductible for AMT purposes.

• The deduction for qualified housing interest (for AMT purposes) is limited to loans used for acquisition or renovation of a personal residence, or any loan secured prior to July 1, 1982, that is secured by a personal residence.

The interest on loans for other than acquisition or renovation of a principal residence is not allowed for AMT purposes.

There would be no deduction allowed for any purpose if the funds were used to purchase tax-exempt securities.

Question 90

What is the child care credit AGI limit and how much of a credit can you claim?

Answer 90

The child care credit is based on qualifying expenditures of up to $3,000 per child, up to $6,000 for two or more children. The qualifying expenditures are multiplied by an applicable percentage of 20% (for taxpayers with an AGI of $43,000 or more). For the student, it is important to remember the $3,000 for one child, $6,000 for two or more children, and the 20%. It is highly unlikely that the CFP Board would test a child care credit calculation where the AGI is less than $43,000.

Question 91

Judy Garber wants to exchange her boat, which she currently rents out for chartered cruises off the coast of Hawaii, for a larger boat, which will be used for the same purpose. In the exchange Judy is contemplating, she will receive $9,000 cash. Additional facts about the exchange include the following:

The old boat has a fair market value of $27,000.

Judy’s adjusted basis in the old boat is $26,000.

The new boat has a fair market value of $18,000.

What will be Judy’s substituted basis in the new boat?

A: $12,000

B: $16,000

C: $18,000

D: $20,000

Answer 91

In a like-kind exchange, the substitute basis of the acquired asset is the fair market value of the asset acquired less any gain realized but not recognized (deferred gain). In this situation, the fair market value of the acquired asset is $18,000. There is no gain realized but not recognized (all of the realized gain was recognized); therefore, $18,000 is the substitute basis in the acquired asset. The gain realized in the transaction is the difference between what she received in FMV (new boat of $18,000 plus cash of $9,000) reduced by what she gave up in adjusted basis ($26,000) to equal $1,000. She also recognizes $1,000, because that is the lesser of the gain realized ($1,000) or the boot received ($9,000).

Question 92

Boot in a like kind exhange explanations.

Answer 92

In a like-kind exchange,

• The gain recognized is always the lesser of the gain realized or the boot received.
• If there is no boot received, there is no gain recognized.
• Inventory is not eligible for like-kind exchange treatment, thus gain would be recognized.
• The basis in the acquired property is the FMV of the acquired property, reduced by the gain realized but not recognized (the deferred gain).

Question 93

Itemized Deductions consiste of Home Mortgage Interest, state income taxes, property taxes, charitable contributions and gambling losses.

Answer 93

The itemized deductions consist of the home mortgage interest, state income taxes, property taxes, charitable contributions, and $1,500 of gambling losses. Gambling losses are only deductible to the extent of gambling winnings. Their overall itemized deductions are subject to a phaseout based on the AGI. The otherwise allowable itemized deductions of $19,775 are reduced by 3% of the excess of the AGI over a threshold amount of $261,500 for a single taxpayer. The itemized deductions are reduced by $3,459 (3% of $115,300). The $115,300 is the excess of the AGI over the $261,500 threshold. They are allowed to deduct $16,316 of itemized deductions ($19,775 reduced by the phaseout amount of $3,459).

Question 94

Do I get a deduction on interest paid or accrued on debt incurred via HELOC or mortgage to purchase tax exempt securities?

What amount can i deduct when taking out a HELOC to pay down debt or buy other things?

Answer 94

There is no deduction allowed for interest paid or accrued on debt incurred to purchase tax-exempt securities. This more specific rule overrides the more general home equity indebtedness rule, which typically allows for a deduction of the interest paid on up to $100,000 of indebtedness.

Question 95

How do you calculate the exclusion rate for an annuity payout?

Answer 95

The investment of $55,000 is divided by the total expected return of $61,200. This gives a 90% exclusion ratio. Because the annuity has a starting date (annuitized payments began) prior to 1987, the exclusion ratio is applied even after all basis is recovered. If the start date was after 1986, only the basis may be recovered tax-free. For a post-‘86 start date, once the annuitant has outlived the life expectancy, all future annuity payments are fully taxable, because the entire basis has been recovered.

Question 96

What are the Unearned income steps for calculating the tax for dependents?

Answer 96

Child qualifies if under 19 or under 24 as full-time student.

1st Step: The first $1,050 of unearned income is sheltered by the Child’s limited standard deduction (find this on page 4 of handout with **)

2nd Step: The second $1,050 is taxed at the child’s rate of 10%.

3rd Step: The remaining income is taxed at the Parent’s rate.

Question 97

What percentage of prior year

Answer 97

The common exception for avoiding estimated tax penalties generally is 90% of the current year’s tax, or 100% of the prior year’s tax. However, if the prior year’s AGI exceeds $150,000, then the requirement is 90% of the current year tax, or 110% of the prior year’s tax liability.

Question 98

Casualty and theft loss calculation off AGI?

Answer 98

The casualty loss deduction begins with the lesser of the decrease in fair market value, or the adjusted basis in the property.

Ex. FMV before loss is $400K and after loss is $300K

$100K - $100 for each separate casualty = 99,900 x (10% of AGI) = Loss Deduction amount

Question 99

During the current year, Sarah gave her daughter, Carol, 1,000 shares of publicly traded stock that Sarah purchased five years ago for $45,000. The stock was worth $100,000 at the time of gift. Sarah paid $41,000 in gift tax out of pocket as a result of this gift. What is Carol’s basis in the stock?

Answer 99

Because this is not loss property, a portion of the gift tax paid out of pocket by the donor can be added to the donor’s basis of $45,000 to compute the basis in the hands of the donee. The percentage of the gift tax paid that can be added to the basis is the unrealized appreciation divided by the fair market value of the asset at the time of gift reduced by the gift tax annual exclusion taken. This percentage is multiplied by the gift tax paid out of pocket. In this situation, the appreciation of $55,000 is divided by the taxable value of the gift ($86,000 − the $100,000 FMV reduced by the gift tax annual exclusion of $14,000) to give us 64%. This percentage is multiplied by the gift tax paid of $41,000 to equal $26,240. This is added to the original basis of $45,000 to give us $71,240.

The formula is shown as:

Donor’s Basis + [(appreciation / FMV - Gift Tax Exclusion) x gift tax paid] = Donee’s Adjusted Basis

$45,000 + [($55,000 / $100,000 - $14,000)] x $41,000 = $71,240

Question 100

How do you calculate the loss on the sale/exchange for a worthless security of section 1244 stock?

Answer 100

Loss on the sale, exchange, or worthlessness of Section 1244 stock is deductible as an ordinary loss up to $50,000 per year, $100,000 per year on a jointly filed return. Any excess loss in a given year is treated as a capital loss. In this case, the capital loss is long term, due to the more than one-year holding period.

Question 101

How do you calculate the Exclusion Ratio for a fixed annuity?

Answer 101

Q: Jim Jannsen purchased a deferred fixed annuity several years ago. His investment in the annuity contract was $48,000. His current life expectancy, based on IRS tables, is 20 years. During the current year, he received monthly annuity payments of $390.

What amount of each monthly payment is taxable to Jim?

A: The exclusion ratio for a fixed annuity is the investment in the contract ($48,000) divided by the expected return (20 years times 12 months times the $390 payment equals $93,600). The exclusion ratio is 51.28%. The $390 payment times 51.28% equals $200, the portion of each payment that is excluded, leaving $190 of each payment that is taxable.

Question 102

What schedule or form do the following entities file?

Answer 102

The sole proprietorship is the business that files a Schedule C with the individual’s Form 1040.

The limited partnership files a Form 1065 (K-1)

The C corporation files a Form 1120

The S corporation files an 1120-S.

Note that a single-member LLC would also file a Schedule C, as it would be treated as a “disregarded entity” for income tax purposes.

Question 103

Can a publicly traded limited partnership offset the income from a non-publicly traded partnership?

Answer 103

Income from a publicly traded limited partnership may not be offset by any other passive losses.

Question 104

Skip Black sold an automobile for $10,000 during the current tax year. The automobile had been used exclusively for business purposes. The cost basis was $18,000, which had been fully recovered through straight-line cost recovery deductions. The automobile was sold on an installment agreement, with a down payment of $1,000 and $2,000 principal payments beginning in the current year.

What amount of gain must be recognized in the current year and next year, respectively?

Answer 104

Good question becuase it tries to confuse you with the intallment sale when it is a 1245 or 1250 cost recovery sale.

In an installment sale, any cost recovery recapture, $10,000 in this situation, is recognized in the year of disposition. All gain in this situation is cost recovery recapture. Remember that with Section 1245 property (predominantly personalty), it does not matter whether straight-line, Section 179 or accelerated depreciation was used. All depreciation is subject to recapture as ordinary income. In this scenario, all future payments received are essentially tax-free, because all $10,000 of gain has been recognized in the year of disposition.

Question 105

Able Baker refinanced his home mortgage on January 1 of the current year, at which time he incurred $3,000 of points. The new mortgage is a 30-year note, with the first payment due on January 1 of the current year.

What amount, if any, may Able deduct in the current year with respect to the points?

Answer 105

The points paid on a loan refinance must be amortized ratably over the life of the loan. With $3,000 of points, and a 30-year note, $100 per year is included as an interest deduction on Schedule A.

Question 106

Which of the following incomes is/are not taxed under Social Security self-employment tax?

(1) rental real estate income
(2) a limited partner’s share of limited partnership net income
(3) shareholder’s share of an S corporation’s net income
(4) income of an individual working as an independent contractor

Answer 106

The income of an individual working as an independent contractor is subject to self-employment tax. The income in the other situations specifically is not subject to the self-employment tax.

Question 107

What is Section 179?

Answer 107

It is a depreciaiton method that allows business owners the right to depreciate Personalty (such as Autos, Trucks, Cars, Computer equipment and software) Not Realty, in the year of the purchase instead of using another depreciation method like MACRS. The limit for 2017 is $510,000.

Essentially, Section 179 of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year. That means that if you buy (or lease) a piece of qualifying equipment, you can deduct the FULL PURCHASE PRICE from your gross income. It’s an incentive created by the U.S. government to encourage businesses to buy equipment and invest in themselves.

Question 108

Which one of the following best describes the role of the substantial economic effect doctrine?

A: It allows the IRS to tax certain partnerships as if they were corporations.

B: It limits the ability to use special allocations.

C: It limits the ability to deduct limited partnership losses.

D: It limits the advantage gained through leverage.

E: It requires that the at-risk rules be satisfied.

Answer 108

The use of special allocations is limited by the substantial economic effect doctrine. Capital accounts must reflect the allocation; upon liquidation, partners with negative capital account balances must restore the balance to zero, and upon liquidation, distributions must be based on capital account balances.

Question 109

Installment Sale formula to calculate how much to recoginze in the year via 1245.

Answer 109

First: Figure out the 1245 recapture amount.

Second: Add the adjusted basis prior to computing the gross profit percentage. (Sale Price - Original Basis) x Sale Price = percentage to multiply by the Installment Payment amount.

Example:

The difference between the cost basis of $25,000 and the adjusted basis of $18,000, or $7,000, is recaptured via 1245 and recognized in the year of sale. This amount is then added to adjusted basis prior to computing the gross profit percentage: $15,000 profit ($40,000 − $25,000) divided by $40,000 contract price = 37.5%; 37.5% × $10,000 payment = $3,750. Thus the total gain recognized is $10,750 ($7,000 + $3,750).

Question 110

Section 179 Deduction when net income is lower than the equipment cost or the taxable (earned) income limitation.

Answer 110

Ex:

Equipment purchase is $620K

Net Income is $220K

The Section 179 deduction is subject to a taxable (earned) income limitation. However, for this purpose, wages received (even from a completely unrelated source) are considered to be from the active conduct of a trade or business. With only $220,000 of earned income, only $220,000 may be deducted under Section 179.

Question 111

What are the child care tax credits formulas?

Answer 111

The maximum amount of qualifying expenditures on which the credit may be based is $3,000 per child, or $6,000 for two or more children.

This is multiplied by 20% for taxpayers with an AGI greater than $43,000. Thus, $6,000 × 20% = $1,200.

Question 112

How is the Employee taxed with disabilit benefits paid by ER and by EE?

Answer 112

EE is taxed for benefits paid by ER

EE is not taxed if he pays for disability benefits with after tax money.

A portion of the benefit payments (the percentage of premium paid by the employer) will be taxable to the employee, and a portion (the percentage of premium paid by the employee) will not be taxable to the employee.

Note that the taxable portion of the benefit is subject to FICA for the first six months.

Question 113

Is flow-through of income from an S corporation (or limited partnership income to a limited partner) is considered to be self-employment income?

Is Sole Proprietorship net income considered self employment income?

Answer 113

No, it is not considered to be SE employment income so we do not have to calculate the SE tax.

Yes, S/P net income is considered employment income so you do have to calculate the SE tax and you can take the short cut by multiplying by 0.1413

Question 114

What is the 1245 lookback period and how does it work?

Answer 114

it is a 5 year lookback.

The current Section 1231 gain ($8,000) is treated as ordinary income to the extent of unrecaptured Section 1231 losses during the five-year lookback period. There are $5,000 of unrecaptured Section 1231 losses during the lookback period. Thus $5,000 is ordinary income, and the remaining $3,000 is treated as long-term capital gain.

Question 115

How are distributions from corporations determined to be taxed?

Answer 115

The distribution from a corporation is determined in a three-step manner.

Step 1: To the extent of current and accumulated earnings and profits, the distribution is an ordinary dividend, subject to long-term capital gain rates.

Step 2: The distribution is treated as a nontaxable return of capital until the basis in the stock is exhausted.

Step 3: Any distribution after that is considered long-term capital gain.

Example:

Rick Flood, a shareholder in ABC Corporation, received a cash distribution from the corporation in the amount of $22,000. The corporation had $8,000 of accumulated earnings and profits and $5,000 and current earnings and profits. Rick had basis in the stock of $6,000. Which one of the following correctly identifies the proper treatment of the distribution from the corporation?

A: $5,000 ordinary dividend, $6,000 return of capital, and $11,000 capital gain

B: $7,000 ordinary dividend, $6,000 return of capital, and $9,000 capital gain

C: $13,000 ordinary dividend, $6,000 return of capital, and $3,000 capital gain

D: $13,000 ordinary dividend, $6,000 capital gain, and $3,000 return of capital

answer is C.

Question 116

Lynnette Swann received 1,000 shares of stock from her uncle, Joseph Green. Joseph purchased the stock eight years ago for $12 per share. The fair market value on the date of the gift to Lynnette was $9 per share, and she recently sold the stock for $10 per share.

What is the amount of Lynnette’s gain or loss from the sale of the stock?

Answer 116

If the fair market value on the date of the gift is less than the donor’s basis, and the sale price is between the fair market value on the date of the gift and the donor’s basis, then there is no gain or loss on the sale. The basis is “tied to” the sale price of the asset.

No gain or loss because it is between 9 and 12. If it was above 12 then 12 is new basis and you would have a gain. If it was below 9 then 9 is the new basis and you would have a loss

Question 117

What are Employment Taxes according to the IRS?

Answer 117

FICA taxes (Social Security and Medicare taxes), based on the employee’s income, are shared by the employee and employer. Each pays 7.65%, up to a total of 15.3%. The same Social Security maximum amount applies to FICA taxes. And the additional Medicare tax applies to the Medicare portion of this tax.

Federal income taxes, which are withheld from employee wages and sent to the IRS by the employer.

Federal Unemployment (FUTA) tax, which is paid by the employer to provide unemployment benefits to employees. Self-employed individuals don’t pay unemployment taxes, and they can’t collect unemployment benefits.