Module 3: Charitable Gifts, Estates & Trusts, Kiddie Tax and AMT Flashcards
The Grantor
The person who creates the trust
How to have a trust qualify as a separate taxpayer
The grantor will have to give up virtually all rights in and to the property
Grantor Trust Rules
Require that the trust’s income be taxed to the grantor if the grantor retains too much power over, or interest in, the assets transferred into the trust
Grantor Trust Rules (Spouse)
The grantor is treated as holding any power or interest that is held by the grantor’s spouse.
Reversionary Interest Rule
Any income from property transferred to a trust in which the grantor (or grantor’s spouse) has more than 5% reversionary interest is taxed to the grantor.
Adverse party
A beneficiary whose economic interest in the trust may be diminished by the grantor’s exercise of the power of disposition.
When will the grantor not be taxed as owner of a trust
- by retaining power to allocate income or principal among charitable beneficiaries
- retaining power to allocate receipts and disbursements between income and principal
- retaining power to withhold income during the legal disability of a beneficiary
- retaining power to withhold income during the period that any income beneficiary is under age 21
When will the grantor be taxed as owner of the trust
- if the grantor directly or indirectly retains certain administrative powers like purchasing, exchanging, borrowing or dealing with trust assets without adquate interest or security
- If the income is or may be used for the benefit of the grantor or the grantor’s spouse
Juvenile Education Trust
A complex trust that allows people to use the gift exclusion to their children while also deferring the chance for them to get the money until they’re 21 years old
For a trust to qualify as irrevocable
the grantor cannot retain any right to alter, amend, revoke, or terminate the trust.
How is irrevocable trust income taxed
all income from the trust property will be taxed to the trust as a separate entity or to the trust beneficiaries, and not to the grantor.
What is a trust?
A trust is a legal arrangement whereby an individual transfers legal ownership of property to a trustee
Who can trust income be taxed to?
- Trust - if income is accumulated in the trust
- Beneficiary - if income is distributed from the trust
- Grantor - if the trust is grantor trust
What is an estate?
A legal entity that comes into existence upon the death of an individual and remains in existence until the decedent’s assets pass to the heirs.
What does an estate do?
- holds and protects the assets, collects income from those assets, and satisfies obligations of the estate until all the assets are distributed
What is a fiduciary on an estate or trust?
A person or entity that is responsible for the trust and estate
What are the types of trusts?
- Simple Trust
- Complex Trust
- Grantor Trust
Simple Trust Rules
- Trust is required to distribute all income to beneficiaries each year
- Charitable donations are prohibited
- Principal Distributions are prohibited
Complex Trust Rules
- Can accumulate income
- Principal can be distributed
- trust pays tax on accumulated income
Grantor Trust Rules
- If a trust is a grantor trust, the grantor pays tax on all trust income
- Trust is ignored for income tax purposes
- A trust will be a grantor trust if the grantor retains the power to control enjoyment
What are the grantors “power to control enjoyment”?
- add or remove beneficiaries
- determine the timing of distribution
- alter the beneficiaries share of principal or income
- retain a reversionary interest in either corpus or income
- control the beneficial enjoyment
- retain certain administrative powers
- revoke the trust
- retain the ability to take income distributions, apply the income to Life Insurance Policies or accumulate the income for future distributions to the owner or a nonadverse party
Accounting income of a fiduciary is determined by
The decedent’s will (in case of an estate) or the trust instrument (in case of a trust)
- each fiduciary may have its own unique set of rules
Difference between fiduciary accounting income and fiduciary taxable income
Treatment of Capital Gains
- Accounting Purposes - Cap gains generally represent an increase in the value of the principal and are not available for distribution to the income beneficiaries
- Tax Purposes - capital gains represent taxable income
Trustee Fees Taxation
- generally deductible but may be treated as either income or principal for trust accounting purposes.
Differences between trust taxable income and individual taxable income
- a trust is entitled to a deduction for distributions made to beneficiaries
- A trust is not entitled to the standard deduction
- A trust is entitled to a personal exemption of #300 for a simple trust and $100 for a complex trust
If an administrative expense is claimed as a deduction on the estate tax return of a decedent
It may not also be claimed as a deduction on the income tax return of the decedents estate
Two ways medical expenses paid for the care of the decedent before death can be handled
- if paid within one year after death, can be deducted from EITHER the decedent’s final income tax return or the decedents estate tax return. Want to do it on the estate tax return normally because there is no 10% minimum threshold.
How are deductions for distributions made to beneficiaries treated?
- The fiduciary is allowed a deduction for the amount of distributions made to beneficiaries during the year
- The amount deductible by the fiduciary is the same amount that is taxable to the beneficiaries
- the income distribution deduction is calculated as the lesser of the distributable net income or the amount distributed
Distributable Net Income
- Similar to fiduciary accounting income
- includes most normal income/expense items
- excludes items relating to corpus, such as capital gains, stock splits, and depreciation of business assets
What and when do fiduciaries file for taxes?
Fiduciaries file form 1041 on or before the 15th day of the fourth month after the tax year. Grantor trust may also file a form 1041
What is considered a “tax year” for Estates and Trusts for filing?
Estates - may adopt either a calendar year or a fiscal year, the first taxable year begins on the day following the decedents death.
Trust - must adopt a calendar year
Tax Treatment of Distributions Made to Beneficiaries
- The beneficiary is taxed on an amount equal to the distribution deduction
- Fiduciary receives a deduction for distribution
- Income distributed to the beneficiary retains its character (LTCG or OID)
- Beneficiary who receives a distribution will receive a Schedule K-1
Dependent’s Standard Deduction
$1,100, may be used against unearned income
OR
$350 plus any earned income, not to exceed the full standard deduction
Who does the Dependent’s Standard Deduction Apply to?
- all taxpayers eligible to be treated as a dependent on another taxpayer’s return
Kiddie Tax Rule
- $1,100 standard deduction
- next $1,100 taxed at child’s marginal tax rate
- rest of the unearned income is taxed to the child at the parent’s marginal income tax rate (if higher than the child’s marginal income tax rate)
Who does the Kiddie Tax apply to?
- a child under 19 years old
- under age 24 if a full-time student
Who does the kiddie tax not apply to?
- a child who is married and files a joint return for the tax year
- the child has earned income that exceeds half his support.
- must have one living parent
Kiddie Tax with earned income calculation
- AGI (earned plus unearned) - earned income deduction
- calculate unearned income taxable
- subtract the unearned income taxable from the earned taxable income * marginal tax rate
- do regular unearned income taxation
- add those together
Tax reduction techniques using the Kiddie Tax
- Gifts to Minors (use UGMA and UTMA)
- Employment of Family Members
Gifts that qualify for the charitable deduction (2)
- direct gift of cash or property to the charitable organization
- indirect gift that includes the provision of goods and services to the charity to make possible tha achievement for charitable purposes
Examples of Indirect Gifts for charitable contributions
- using a taxpayer’s car for an organizations charitable purposes (14 cents per mile
- the cost of meals and lodging for the taxpayer on a charitable business for which the taxpayer receives no reimbursement
- The basis in something created (like the cost of creating a painting, not the value of the painting itself)
Four exceptions to the “less than a donor’s entire interest” rule
- a gift of an undivided portion of the donor’s entire interest
- a gift of a remainder interest in a personal residence or farm
- a gift to a public charity of a remainder interest in a real property granted solely for conservation purposes
- a gift of a partial interest transferred through a qualifying form of trust
What is a qualifying charity?
- no part of the corporations earnings can benefit any private shareholder or similar individual
When is a gift considered to be given for tax purposes?
- delivery of the gift to the charitable organization determines the date of the gift. The USPS is considered to be the agent of the recipient, so when the receive it it counts.
What does the IRS require for proof of the gift?
- name and address of organization
- date of the gift
- description of property
- date acquired by taxpayer
- fmv of property and how value was obtained
- taxpayer’s adjusted basis in any appreciated property gift
- any reduction in the value of the appreciated property claimed by the taxpayer
- terms of any agreement with the charitable organization
- amount claimed as a deduction
Qualified Appraisal
- required for donated property when the claimed value is over $5,000, or in the case of closely held stock, $10,000
Qualified Vehicle
- automobile, boat, or airplane
Deduction limits for qualified vehicles
- generally limited to the amount that the charity receives from the sale of the vehicle unless the organization plans to use it, in which case the taxpayer may value the donation at the time of the contribution, using reasonable methods.
Amount of taxpayer deduction allowed for “appreciated property”
depends on the purpose for which the recipient charity uses or does not use the property.
Use-unrelated Property
- if the recipient charity does not have a related use for the gifted tangible personal property, the maximum deduciton allowed is limited to the lesser of the FMV of the property or the donor’s tax basis in the property (limited to 50% or 20% of AGI annually)
Use-related property
if the charity does have a use for the property, and the taxpayer chooses to deduct the tangible personal properties FMV, then the taxpayer is limited to 30% or 20% of AGI annually.
- if they choose to deduct the basis in the property, the limits move up to 50% and 20%.
Ordinary Income Property Definition
Property that, if sold, would result in recognition of ordinary income by the taxpayer (like a work of art from the taxpayer)
Types of income property
- cash
- short-term capital gains property
- works of art, books, or letters, when given by the person who produced them
- Inventory
How are gifts of Ordinary Income Property Deducted?
it is based on the lesser of the FMV or the adjusted basis.
Contributions of Clothing and Household Items
- should be deducted by the taxpayer at their current FMV as estimated by the taxpayer, not at their original retail value.
Public Charities Deduction Limits
- considered 50% organization, because for gifts of ordinary income property, taxpayers generally may not deduct more than 50% of their AGI for donations to public charities.
What is considered a public charity?
- churches, schools, hospitals and medical research organizations, and governmental units.
When does a 50% charity only allow for a 30% deduction?
if donating long-term capital gain property if the deduction is based on the FMV of the property
Donor Advised Funds
- a taxpayer may lump several years worth of charitable contributions into a single DAF contribution, take the charitable contribution deduction in that year, and then direct that grants to their selected charities be paid from the DAF over the next few years
Private Charities Deduction Limits
- called 30% organization
What is considered a 30% organization?
private nonoperating foundations, veterans groups, fraternal associations, and other not-for-profit associations.
When does a 30% charity only allow for a 20% deduction?
if donating long-term capital gain property if the deduction is based on the FMV of the property
The 50% election
- The taxpayer elects a deduction of up to 50% of AGI in a given year, but they are limited to the adjusted basis of the property as the total allowable amount of the deduction. This election only applies to contributions of long-term capital gain property made to 50% organizations.
Excess Contributions Carryforward
The taxpayer is entitled to carry forward excess deductions for up to five years.
Qualified Charitable Distribution Limits
$100,000 per year, but the QCD will be reduced by the cumulative post 72 IRA contributions
Sole Proprietor Charitable Contribution
- ## Charitable contributions will be claimed on their schedule A rather than schedule C
Contributions by Flow-Through Entities
- not deductible in computing the net income of the entity, but instead retains its character as it flows through to the individual from the S corp or partnership on the K-1 and that person will claim the charitable deduction on their schedule A
Contributions by C Corps
A corporation may normally only deduct, in a given tax year, up to 10% of its taxable income.
- in-kind donations of food are normally limited to 15%
Depreciated or Loss Property
- Only the current lower value may be deducted as a charitable contribution, any capital loss inherent to the loss of value on the property is non deductible.
Nondeductible Property
If money or property is given to:
- Foreign Organizations (except certain Canadian, Israeli, and Mexican charities)
- Individuals
- Political Groups or candidates for public office, political campaigns, or political parties
Money or property paid FOR the following:
- Cost of raffle, bingo, or lottery tickets
- tuition
- Value of a person’s time or services donated to the charity
Bargain Sale Charitable Contribution
- when a seller transfers property to a charity in exchange for a sum that is less than the FMV of the property.
Bargain Sale Deduction
- considered part sale and part charitable contribution, for which the donor’s basis in the property and any appreciation are allocated on a pro rata basis to both the sale and gift portions.
Constructive Receipt Income Tax Rule
If there is no substantial limitation or restriction on a taxpayer’s right to bring the funds under personal control
Imputed Interest
When a lender has engaged in a below-market-interest rate loan transaction, the lender may have to report interest income even without actually receiving this interest.
How is imputed interest calculated?
Using the federal governments borrowing rate, compounded semiannually and adjusted monthly
Types of below-market-rate loans:
- Gift Loans
- Compensation Related Loans
- Corporation-Shareholder loans
- Tax avoidance Loans
Exceptions to the imputed interest rules
- no interest is imputed on total outstanding gift loans in the aggregate of 10k or less between individuals, unless the proceeds are used to purchase an income-producing property
- On loans between individuals greater than 10k but less than or equal to 100k, the imputed interest cannot exceed the borrower’s investment income (from all sources) for the year
Alternative Minimum Tax
It was created to ensure that taxpayers who reduced their liability below a certain point by utilizing tax preference items will be required to pay at least a minimum amount of income tax.
Tax Preference Items and Adjustments
- Accelerate cost recovery deductions
- Percentage depletion of adjusted basis
- Excess intangible drilling costs
- Bargain element on the exercise of an incentive stock
- Research and experimental costs, circulation expenses, and mining exploration and development costs deducted over a 10 year amoritization
- rapid amortization of a certified pollution control facility
- The completed-contract method for long-term contracts entered into after feb 28 1986
- Tax-exempt interest on qualified private-activity municipal bonds
- passive farm losses
- seven percent of the excluded gain from qualified business stock
AMT Test Tip about Preference Items
It is not crucial for students to understand the intricacies of the various depreciation adjustments, however, it is important to realize that depreciation will often cause a potential AMT problem
Itemized Deductions Against the AMT
- medical expenses in excess of 7.5 of AGI
- casualty losses in excess of 10 of agi and the 100 floor
- gambling losses to the extent of gambling winnings
- qualified housing interest
- investment interest expense
- estate taxes paid on a decedents home
- charitable contribution deductions
What is a positive adjustment?
When the deduction or exemption allowed for regular income tax purposes exceeds the deduction or exemption allowed for AMT purposes.
What is a negative adjustment?
Made when the deduction allowed for AMT purposes exceeds that for regular income tax purposes
AMT exemptions
Each taxpayer is allowed a special AMT exemption before calculating the AMT.
AMT Tax Rates
26% for first 199,900
28% for the rest
Steps for Calculating AMT
- AGI is increased by any tax preference items and increased or decreased by the appropriate adjustments.
- That figure is reduced by the allowable itemized deductions (this is your AMTI)
- The AMTI is reduced by the appropriate AMT Exemption amounts to arrive at the AMT Base
- Apply the tax rates to the AMT amount (LTCG rates apply the same as normal)
- the AMT amount is compared to the regular tax amount and if the regular tax is less than the AMT amount, then the difference is the AMT payment required
- The AMT payment is reduced by any refundable and nonrefundable credits and the allowable AMT foreign tax credits
Tax Planning for AMT
- Move income into an AMT year
- Move deductions into a non-AMT year
- Time the recognition of certain AMT adjustments and tax preference items
AMT Credit
Available for years after an AMT liability has occurred. Based on deferral, but not exclusion preferences and adjustments. is available only to the extent the AMT was attributable to deferral items.
Deferral Preferences
those other than the standard deduction and personal exemptions, disallowed itemized deductions, depletion adjustments, private activity muni bond interest, and small business stock exclusions.
