Income Tax Planning Flashcards
Sources of
Federal Tax Law/Authority
• Internal Revenue Code: primary source of all tax law
• Treasury regulations: great authority. but not law
• Revenue rulings and Revenue procedures: administrative interpretation/ma) 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
Step Transaction
Ignore the individual transactions 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.
Sham Transaction
A transaction that lacks a business purpose and economic substance will be ignored for tax purposes.
Example: A sale by XYZ to ABC, but both XYZ and ABC are owned by the same persons.
Substance Over Form
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.
Assignment of Income
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 Corporation. He directs that all income be paid to his son. Mr. T reports no income.
Dates for Paying Estimated Taxes
- April 15
- June 15
- September 15
- January 15
IRS Penalties
Frivolous return: - $5,000
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)
Federal Withholding Tax Underpayment
Penalty
To avoid, pay the lesser of
- 90% of the current year’s tax liability
- 100% of the prior year’s tax liability (or 110% if the last year’s adjusted gross inocme exceeded $150,000)
Adjustments for
Adjusted Gross Income
(AGI)
The second step in the 1040 calculation is adjusted gross income. It is total income (or gross income) less adjustments to income. The main adjustments or deductions to income are:
• IRA Contributions
• Self-employment tax
• Self-employment health insurance (100%)
• Keogh or SEP
• Alimony paid
Schedule A
Itemized Deductions
- Medical, dental and LTC (10% AGI)
- Casualty and theft losses
- Real estate taxes
- Investment interest expense
- Home mortgage interest
- State and local taxes
- Personal property tax
- Charitable gifts
Investment Expense
tax treatment
Investment expenses are directly connected with the production of investment income (IE: margin interest). In determining net investment income, the 2% miscellaneous itemized deductions must be taken into
account, specifically investment advisor fees. In other words, investment income is offset by deductible investment advisor fees.
Casualty Losses
Calculation of the deductible loss
First: Use the lesser of basis or FMV
Second: Subtract any insurance coverage
Third: Subtract $100 (floor)
Fourth: Subtract 10% of AGI
Schedule A
subject to 2% of AGI - major ones
. Fees to investment counselors
. Tax advice and preparation fees
. Professional and business association dues
. Unreimbursed employee business expense
. Employee home office expense
Kiddie Tax
All net UNEARNED income of a child who has NOT attained age 18 or turns 19-23 ifa full-time student and who has at least one parent alive is taxed at the marginal rate of child’s parents regardless of the source of the assets.
Children under 18 are entitled (2014) to a standard deduction amount ($1000) and an additional $1000 of unearned income will be taxed at the child’s rate (10%).
Self-Employment Income
- 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
Self-Employment
Tax Calculation
The taxable wage base will not exceed $117,000 (2014). If you added up the self-employed income, and you exceeded $117,000, you did something wrong.
Why? Social Security tax stops at $117,000 (2014)
Shortcut:
Multiply total self-employment income by .1413
Tax Credits
- Credit for child & dependent care expenses
- Child tax credit
- Adoption credit
- Elderly and disabled credit
- Foreign tax credit
- Earned income credit (refundable)
Accounting Methods
Cash: mandatory where taxpayer’s records reflect only cash transactions, and there are no inventories
Accural: mandatory for purchases and sales where there are inventories
Hybrid: combines accrual for inventory portion of business and cash for cash portion of business
Percentage of Completion: for long term contracts where the contract will not be completed within the taxable year started
Personal service businesses that should stay
away from doing a regular corporation
H Health
A Accounting, Architectural
L Law
E Engineering
Subchapter S Corporation
Eligibility
- The number of shareholders is limited to 100
- The corporation can have only a single class of outstanding common stock (no preferred), but the common stock can be voting or non-voting
- Must be a domestic corporation
- Only individuals, estates and certain trusts may be shareholders. NOTE: Nonresident aliens (persons who are neither citizens nor permanent residents of the U.S.) cannot be shareholders.
Tax Basis - Partnership / LLC
- 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.
Property Classes
5 year: Computers, Autos and Trucks (1245 property)
7 year: Office equipment except computers (1245 property)
27 1/2 year: Residential rental property (1250 property)
39 year: Non-residential real property (1250 property)
Boot / gain recognized / basis
- No boot received - recognized gain is zero.
- When boot is received just answer the recognized gain is the boot received.
- Boot paid is added to basis.
- Basis carries over from prior property.
Capital Gains & Losses
- ST capital gains and ST losses are netted
LT capital gains and LT losses are netted - If a gain and a loss remain, they are again netted
- If a loss remains after netting capital gains and losses, only $3,000 of the net losses can be used to offset ordinary income
Sale of Personal Residence
Section 121
- $250K (single) and $500 K (married filing jointly) of gain from sale is tax-free if lived in home for 2 out of the last 5 years.
- Exception available if taxpayer lives in the residence less than two years and moves because of a new job, for health reasons, etc. receives the prorated amount.
Recapture (1245 property)
When the sole proprietor purchases equipment and takes depreciation (cost recovery deduction - CRD), the CRDs offset the sole proprietor’s ordinary income. When the sole proprietor sells the equipment for a gain, the sole
proprietor must:
• 1st look back and recapture the lesser of CRDs taken or the gain realized as 1245 gain (ordinary income)
• 2nd - recover any excess gain as 1231 gain (capital gain)
Section 179
Qualifying vs. Non-qualifying Property
Qualifying:
Tangible personal property
1245 property
Non-qualifying:
Real estate
1250 property
Intangible (owning a franchise)
AMT Preference Items
IPOD
Preference and adjustments (IPOD)
• Excess Intangible drilling costs (IDC)
• Private-activity municipal bond
• Oil & gas percentage depletion / Excess intangible drilling costs (IDC)
• Depreciation (ACRS/MACRS) - but not straight-line
AMT Add Back Items
AMT Not Deductible Items
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
Postponing AMT
- 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 tax).
- Purchase public purpose muni bonds instead of private purpose bonds.
Historic Rehabilitation Programs
Historic rehabilitation programs that are held as passive activity may generate a deduction-equivalent tax credit of up to $25,000. The benefit of this deduction-equivalent tax credit phases out between $200,000 and $250,000 of AGI.
How does the deduction-equivalent tax credit work? You calculate your tax to determine the maximum marginal tax bracket. If it is 25%, for example, then you multiply $25,000 by 25% to get a credit of $6,250.
Low-income Housing
Housing Credit
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 ten-year “credit period”. The depreciation is straight-line over 27.5 years.
How does the credit work?
For example, you multiply 35% by $25,000 to get a credit of $8,750.
NOTE: Because there is no phaseout, it produces a higher credit.
Types of Phantom Income
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
Charitable Giving
- Calculate the maximium deductible - 50% of AGI
- Calculate the eligible amounts given to 50% organizations (public charities) such as all churches, schools, hospitals and organizations such as the United Way, Red Cross, Humane Society, etc.
- Calculate the eligible amounts given to 30% organizations (private charities) such as private non-operating foundations, war veteran
groups, and fraternal orders.
Charitable Giving (types of property - 50% charities)
- Long-term appreciated property - using FMV deduct up to 30% of AGI
- Use-unrelated property, ST capital gain property - using basis deduct up to 50% of AGI
