Income Tax Planning

Question 1

Sources of

Federal Tax Law / Authority

Answer 1

• Internal Revenue Code: primary source of all tax law
• Treasury regulations: great authority, but not law
• Revenue rulings and Revenue procedures: administratve interpretation / may be cited
• Congressional Commitee reports: indicate the intent of congress / may not be cited
• Private letter ruling: apply to specific taxpayer
• Judicial sources: court decisions interpret

Question 2

Step Transaction

Answer 2

Ignore the individual transactions and instead tax the ultimate transaction.

Example: The XYZ corporation sells property to an unrelated purchaser who subsequently reslles the property to a wholly owned subsidiary of XYZ

Question 3

Sham Transaction

Answer 3

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.

Question 4

Substance Over Form

Answer 4

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

Example: The president of XYZ had the comany loan him the money he needs. He never intends to repay the loan or take a salary.

Question 5

Assignment of Income

Answer 5

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

Example: Mr. Towns XYZ, an S Corporation. He directs that all income be paid to his son. Mr. T reports no income

Question 6

Dates for Paying Estimated Taxes

Answer 6

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

Question 7

IRS Penalties

Answer 7

Frivolous return: -$5,000

Neglogence: 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: Oenalty is 5% of the tax due per month, with a maximum of 25%

Failure to PAY: Penalty is .05% per month the tax is unpaid, with a maximum of 25% (pay-point)

Question 8

Federal Withholding Tax Underpayment

Penalty

Answer 8

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% of the last year’s adjusted gross income exceeded $150,000)

Question 9

Adjustments for

Adjusted Gross Income

(AGI)

Answer 9

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 (after Dec 31, 2018)

Question 10

Schedule A

Itemized Deductions

Answer 10

• Medical, dental and LTC (7.5% AGI)
• Casualty and theft losses
• Real Estate Taxes (SALT capped at $10k)
• Investment interest expenses
• Home mortgage interest
• State and local taxes (SALT capped at $10k)
• Personal Property tax (SALT capped at $10k)
• Charitable gifts

Question 11

Investment Expense

(tax treatment)

Answer 11

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 offset by deductible investment advisor fees. (Advisor fees no longer decutible with new tax law 2017)

Question 12

Casualty Losses

(Calculation of the deductible loss)

Answer 12

First: Use the lesser of basis of FMV

Second: Subtract any insurance coverage

Third: Subtarct $100 (floor)

Fourth: Subtract 10% of AGI

Question 13

Kiddie Tax

Answer 13

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

Children under 18 are entitled (2018) to a standard deduction amount of ($1,050) and an additional of $1,050 of unearned income will be taxes at the child’s rate (10%)

Question 14

Self-Employment

Tax Calculation

Answer 14

The taxable wage base will not exceed $128,400 (2018). If you added up the self-employed income, and you exceed $128,400, you did something wrong.

Why? Social Security tax stops at $128,400 (2018)

Shortcut:

Multiply total self-employment income by .1413

Question 15

Self-Employment Income

Answer 15

• Net Schedule C Income
• General Partnership income (K-1 income)
• Board of Directors Fees
• Part-time earnings (1099)
• NOT wages for K-1 distributions from S Corp

Question 16

Tax Credits

Answer 16

• Credit for child & dependant care expenses
• Child tax credit (up to $1,400/child could be refundable)
• Adoption credit
• Elderly and disabled credit
• Foreign tax credit
• Earned income tax credit (refundable)

Question 17

Accounting Methods

Answer 17

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 accural for inventory portion of business and cash for cash portion of business.

Percentage of Completion: for long term contract whee the contract will not be completed within the taxable year started

Question 18

Personal services businesses that should stay

away from doing regular corporation

Answer 18

H Health

A Account, Architectural

L Law

E Engineering

Question 19

Subchapter S Corporation

(Eligibility)

Answer 19

• The number of sharelholders is limited to 100
• The corporation can have only 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 US) cannot be shareholders.

Question 20

Tax Basis - Partnership / LLC

Answer 20

• 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 guarentees the debt.

Question 21

Property Classes

Answer 21

5 year: Compute, 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)

Question 22

Boot / gain recognized / basis

Answer 22

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 basis
4. Basis carries over from prior property

Question 23

Capital Gains & Losses

Answer 23

1. ST capital gains and ST losses are netted / LT capital gains and LT losses are netted
2. If a gain and a loss remain, they are again netted
3. If a loss remains after netting capital gains and losses, only $3,000 ofo the net losses can be used to offset ordinary income

Question 24

Sale of Personal Residence

(Section 121)

Answer 24

• $250k (single) and $500k (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 resident for less than two years and moves because of a new job, for health reasons, etc. receives the prorated amount.

Question 25

Recapture (1245 property)

Answer 25

When the sole proprietor pruchases 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 propietor must:

• 1st look back and recapture the lesser of CRDs taken or the hain realized as 1245 gain (ordinary income)
• 2nd - recover any excess gains as 1231 gain (capital gain)

Question 26

Section 179

Qualifying vs. Non-qualifying Property

Answer 26

Qualifying:

Tangible personal property

1245 property

Non-qualifying:

Real estate

1250 property

Intangible (owning a franchise)

Question 27

AMT Preference Items

(IPOD)

Answer 27

Preference and adjustments (IPOD)

• Excess Intangible drilling costs (IDC)
• Private-activity municiple bons
• Oil & gas percentage depletion / Excess intangible drilling costs (IDC)
• Depreciation (ACRS/<acrs></acrs>

Question 28

AMT Add Back Items

AMT Not Deductible Items

Answer 28

Add Back:

• Incenive stock options bargain element
• Property income taxes

Non Deductible:

• Standard deduction

Question 29

Postponing AMT

Answer 29

• Accelerating receipt of taxable income or deferring the payment of property taxes, state income taxes, deductible medical expenses, or charitable giving, the regular (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 publilc purpose muni bonds instead of private purpose bonds

Question 30

Historic Rehabilitation Programs

Answer 30

Historic rehabilitiation programs that are held as passive actvity may generate a deduction-equivalent tax credit of up to $25,000. The benefit of the 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 tac 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.

Question 31

Low-income Housing

Housing Credit

Answer 31

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: Becasue there is no phaseoutm it produces a higher credit.

Question 32

Types of Phantom Income

Answer 32

Insurance: lapse of pilocy 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 distribution, secular trust

Question 33

Charitable Giving

Answer 33

1. Calculate the maximum deduction - 60% of AGI
2. Calculate the eligible amounts given to 50% organizations (public charities) such as all chruches, schools, hospitals and organizations such as the United Way, Red Cross, Humae Society, etc.
3. Calculate the eligable amounts given to 30% organizations (private charities) such as private non-operating foundations, war veteran groups, and fraternal orders.

Question 34

Charitable Giving

(types of property - 50% charities)

Answer 34

• Cash - deduct up to 60% of AGI
• 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