Part 1 Flashcards
Abode Test
A qualifying child must live with the taxpayer for more than one-half of the year. Temporary absences such as being away at school count as being with the taxpayer.
Adjusted basis
The property’s adjusted basis is frequently its cost.
Age Test
A qualifying child must be under the age of 19, or if they are a full-time student, under the age of 24.
Alimony and Separate Maintenance Payments
Alimony payments are deductible by the payor spouse, and included as income by the spouse receiving them. Should the spouse also have children, there may be an element of the payment which includes child support. Child support is not a taxable to the recipient.
Alimony Payments
A deduction is allowed for alimony payments made under a written decree of divorce or separate maintenance.
Alternative Valuation Date
The executor may also elect to value the estate at an alternate date, rather than at the date of death. If the alternate valuation date is elected, and any property is distributed prior to that date, that property is valued as of the distribution date.
Alternative Minimum Tax (AMT)
The AMT is the excess of the tentative minimum tax over the regular tax. The process to determine the AMT is to first identify the various tax preferences or adjustments which were properly elected and planned for by the taxpayer, and then, effectively, disallow them.
American Opportunity Credit
Taxpayers may elect to take a tax credit for tuition, fees and course materials paid during the first four years of postsecondary education. The credit is limited the lessor of the amounts paid or $2,500, and 40% of the credit may be used as a refundable credit.
Amortization Expense
Amortization is the cost of recovering intangible assets such as leasehold improvements and other Section 197 intangibles. The cost of the Section 197 intangibles may be amortized over a 15 year life on a straight-line basis.
Annuity Contracts & Pensions
The allowable methodology is a straight-line recovery of the cost. If the annuity continues after the recovery of cost, the entire payments represent income.
Bad Debts
When a taxpayer extends credit to another taxpayer in the form of a loan, and then the loan becomes uncollectible, a deduction is allowed. When an accrual based taxpayer sells goods and services in exchange for a receivable, and the receivable becomes uncollectible, a deduction is allowed.
Basis of Property in Like-Kind Exchange
The basis of property received in a like-kind exchange is the basis of the property being transferred by the taxpayer. If any gain is recognized, the basis is increased by that amount. If the taxpayer receives boot, basis must be allocated first to the boot and then to the transferred property.
Business Bad Debt
Results from the taxpayer being in the business of lending money or the rendering goods and services in exchange for the receivable. These bad debts are treated as an ordinary loss in the year incurred.
Business Gifts
A deduction is allowed for the cost of business gifts. However, the maximum per gift is $25 per person per year.
Business Meals & Entertainment
The ordinary and necessary expenses paid for business meals and entertainment are deductible if they are (1) directly related or (2) associated with your trade or business. The expense may not be lavish and the taxpayer must be present at the meal.
Cafeteria Plans (Fringe Benefit)
Companies may offer a variety of non-taxable benefits which an employee may choose from, similar to a cafeteria. There is generally no minimum waiting period for employees to take advantage of this plan.
Capital Expenditures of a Medical Nature
When it is necessary to make medical expenditures of a capital nature, they are deductible only to the extent that there is not a corresponding increase in the fair market value of the property.
Casualty Loss Deduction
If a taxpayer in business has a loss from a casualty such as fire, storm, shipwreck, or theft, a deduction is allowed for the decrease in value, or its adjusted basis, whichever is less, minus any insurance reimbursement.
Casualty Losses
A taxpayer may deduct a loss for a personal casualty loss. A casualty loss is sudden and unexpected, and may include a theft loss as well.
Charitable Contributions
A deduction is allowed for a charitable contribution or gift paid during the year to a qualified organization.
Citizenship Test
The dependent must be a citizen or resident of the United States, or resident of Canada or Mexico.
Club Dues and Membership Fees
No deduction is allowed for dues or membership fees in any club organized for business, pleasure, recreation, or other social purpose.
Common Stock Dividend
If a common stock dividend is received on the common stock, then the basis of the stock received is determined by merely allocating the existing basis of the common stock to the new total number of common shares currently held.
Complex Trust
A complex trust is any other trust than a simple trust. It is allowed a deduction for charitable contributions and may also distribute principal.
Cost Recovery and Depreciation Expense
A deduction is allowed for the exhaustion, wear and tear of personal and real property. Assets placed in service after 1986 are under the Modified Accelerated Cost Recovery System (MACRS). Under MACRS, assets have class lives and no salvage value.
Cost Recovery of 27.5 and 39 Year Classes
Assets under the 5 and 7 year classes are recovered under the double declining balance method. Assets under the 27.5 and 39 year classes are recovered under the straight-line method.
Coverdell Education Savings Account (CESA)
Taxpayers can make nondeductible contributions of up to $2,000 for each beneficiary under the age of 18 to a CESA. The contribution is phased-out for individuals with adjusted gross income beginning at $95,000 for single taxpayers and $190,000 for married taxpayers filing a joint return.
De Minimize Fringe Benefits
Refers to non-taxable benefits such as subsidized eating facilities when a plant is located in a remote location; occasional use of the company copy machine; use of company typing services, etc.
Death Benefits (Fringe Benefit)
There is no exclusion for death benefits paid to an employee’s family.
Deductibility of an IRA
In order for the IRA to be deductible, it must be paid during the taxable year, or by the due date of the return. Individuals may contribute up to the age of 70.
Dependent Care Credit
This credit applies to those taxpayers who pay for dependent or child care in order for them to work. To be eligible, the taxpayer must maintain a household for a dependent, age 12 or under, or any dependent of spouse who is physically or mentally incapacitated.
Dependent Day Care and Adoption Expenses
An employee may exclude, up to $5,000 per year, the cost of child and dependent care services paid by the employer to enable the employee to work. The exclusion may not exceed the earned income of the spouse with the lesser income when the taxpayer is married. In addition, an employee may exclude up to $12,170 of qualified adoption expenses.
Discharge of Indebtedness
When a taxpayer is obligated to pay a mortgage, loan or other indebtedness, and the lender discharges the taxpayer from the obligation, the amount of the discharge generally represents ordinary income.
Distributable Net Income
The amount of income that is taxable to the beneficiary is limited to the amount of distributable net income (DNI). This is regardless of the amount that is actually distributed to the beneficiary. In determining the DNI, no deduction is allowed for the personal exemption.
Early Withdrawal of Savings
The bank must report the total interest earned as gross income, the tax code allows a deduction for any penalty assessed for this early withdrawal from an account such as a Certificate of Deposit.
Early Withdrawal Penalties
There is a 10% penalty for the early withdrawal (age 59 ½) of an IRA, however, that 10% tax will not apply to amounts withdrawn for “qualified higher education expenses” or “first time homebuyer expenses.”
Earned Income Credit
This credit provides qualifying taxpayers with relatively low levels of income a credit against their tax liability. This is the only refundable credit. The nature of the credit is to encourage the taxpayer to “earn” income, rather than receive “non-earned” benefits.
Education Savings Bond
In an effort to assist parents in affording the spiraling cost of higher education, Congress passed a law stating that the interest earned on U. S. Savings Bonds is excluded from gross income if certain restrictions are met.
Educator Expense
A taxpayer who is an eligible educator is allowed a deduction of up to $250 for qualified expenses paid in teaching grades K-12 for at least 900 hours during the school year.
Elderly Credit
A credit is provided to the elderly and disabled to provide a form of relief from taxation. The credit applies to taxpayers 65 or older. It is also available to those under 65, provided they are retired with a total and permanent disability.
Employee Compensation
Some compensation is fully taxable, some is fully excluded, and some is partially excluded. Gross income that is fully included in gross income typically includes salaries and wages, bonuses, and commissions. Besides paying for compensation directly, an employee may receive other benefits which may or may not be taxable.
Employee Discounts (Fringe Benefit)
Allowed as a tax-free benefit when the discount on services is not greater than 20% and when the discount on purchases is not below the employer’s cost.
Excess Social Security Paid
This excess may be claimed as a credit against any taxes due.
Exemptions
Exemptions are divided into two types: Personal and Dependency
Failure to File a Return Statute of Limitations
Should a taxpayer fail to file a return, the statute does not begin to run. Once the tax return is filed, the statute runs from that date.
Filing Requirements of Gift Tax Returns
Gift tax returns (Form 709) are required to be filed on an annual basis if a taxable gift is made during the taxable year. The Form 709 is due on April 15th. If a gift is made for less than the $13,000 exclusion, or it qualifies for the marital deduction, then no return is required.
Foreign Income
When a taxpayer earns income from working in a foreign country, there is an exclusion available which is limited to the lesser of $91,500 or the foreign earned income.
Foreign Tax Credit
The foreign tax credit cannot exceed the lesser of the amount of the foreign taxes paid or the pro-rata share of US taxes on the foreign income.
Foreign Taxes
the taxpayer has an option of treating the taxes paid to that foreign country as either a credit against his US taxes, or a deduction.
Fraudulent Return Statute of Limitations
When a taxpayer files a fraudulent return, the statute of limitations does not begin to run. The return may be audited at any time.
Gain or Loss in Related Party Transaction
If the property is subsequently sold for a gain, the disallowed loss may be used to offset the gain. If, instead, the property is subsequently sold for a loss, the disallowed loss is never recognized.
Gambling Losses
Deductible up to the extent of gambling winnings. There is no carryover of any unused losses.
Gambling Winnings
Amounts received from gambling winnings, lotteries, etc., are included in gross income. Gambling losses are deductible only to the extent of the earnings.
Gross Income
All income, from whatever source derived.
Group Term Life Insurance (Fringe Benefit)
An employer may provide an employee with group-term life insurance coverage of up to $50,000 as a non-taxable fringe benefit.
Head of Household Filing Status
This status is available to an unmarried taxpayer who maintains a household and provides for more than 50% of the year the cost for your qualifying child or any other relative who is a dependent as a member of his household.
Health Insurance Premiums and Benefits (Fringe Benefit)
The premiums paid by an employer for an employee’s health insurance coverage are not included as gross income, nor are any of the benefits received from the policy.
Health Savings Account
Qualified participants are able to deduct contributions made into this plan for health care. The limitation on the deduction is calculated on a month by month basis. It is the lesser of 1/12th of the annual deductible amount under a high deductible insurance plan or $3,000 for a single individual (or $5,950 for a married couple).
Hobby Income
Income from the hobby is reported as other income and the deductions are reported on Schedule A as a miscellaneous itemized deduction. They are not reported on Schedule C.
Hobby Loss Rules
In order to claim a deduction, the taxpayer must be carrying on a trade or business. There is the assumption that the taxpayer is engaged in the activity for profit.
Income Averaging for Farmers
A taxpayer engaged in the farming business may now elect to use income averaging to compute his tax. In determining income, the farmer may include the gain from the sale of farming business property.
Individual Retirement Account Deduction
Contributions to an Individual Retirement Account (IRA) are deductible in determining adjusted gross income. The amount allowable as a deduction is the lesser of $5,000, or the taxpayer’s earned income.
Inheritances and Gifts Received
Amount received from an estate as an inheritance, or as a gift out of detached generosity, is excluded from gross income.
Interest Deduction
A taxpayer is allowed an itemized deduction for payments of qualified residence interest and investment interest.
Interest Income
Generally included as gross income. Interest income is reported on Schedule B and typically represents interest on savings accounts, certificates of deposits, tax refunds, loans by the taxpayer, bonds and other investments.
Investment Interest Expense
When a taxpayer borrows money to acquire investments, the interest expense is classified as investment interest expense. The general rule is that the investment interest expense is allowed only to the extent of the net investment income.
Joint Return Test
The dependent does not file a joint return with his spouse (if married). If the dependent is not required to file a joint return but does so only to receive a refund of withheld taxes, then this does not disqualify the child as a dependent.
Jury Duty Pay
Compensation received while performing jury duty is included in gross income.
Kiddie Tax
When a child who is claimed as a dependent has net unearned income in excess of $1,900, the tax on the excess will be taxed at the parent’s rate.
Life Insurance
The proceeds from a life insurance policy by reason of death of the insured are excluded from gross income.
Lifetime Learning Credit
Taxpayers may elect to take a nonrefundable tax credit for qualified tuition and related expenses for undergraduate, graduate and professional degree courses. The credit is the lesser of $2,000, or 20% of up to $10,000 in qualified tuition and fees.
Like-Kind Exchanges
In general, real property may be exchanged for real property. Personal property may be exchanged for personal property. However, personal property cannot be exchanged for realty on a tax-free basis.
Married Couple with a Nonworking Spouse IRA Contributions
For a married couple with a non-working spouse, a spousal IRA of $5,000 is allowed for the non-working spouse provided the combined earned income of the couple exceeds the total contributed.
Married Filing Jointly Filing Status
To qualify for this status, the taxpayer must be married as of the last day of the year.
Married Filing Separately Status
Issues of privacy, disclosure of tax returns by public officials, and possible tax planning in the shifting of deductions are some reasons as to why this status is available.
Married Taxpayer IRA
If the taxpayer is married, each is entitled to an IRA, subject to the same earned income limitation.
Miscellaneous 2% Deductions
There are a number of employee-related expenses which, if unreimbursed by the employer, are allowed as itemized deductions. In addition, there are a number of deductible expenses related to investments, tax determination, and trade or businesses. These expenses are grouped together as what is referred to as miscellaneous itemized deductions, and they are deductible, only to the extent that they exceed 2% of adjusted gross income.
Moving Expense Reimbursements
These reimbursements are no longer reported as gross income to the extent that the amount represents a qualified moving expense
Moving Expenses
A deduction is allowed for the qualified costs of moving in connection with starting work at a new place of business.
Municipal Bond Interest
Interest on state and municipal obligations is excluded from gross income.
Net Operating Loss
When an individual’s allowable deductions exceed its gross income, a net operating loss (NOL) exists. An NOL is generally carried back 2 years, then forward 20 years.
Netting Process
In summarizing a taxpayer’s capital activity for the year, it is important to group the gains and losses correctly. This is due to the various tax treatments and limitations affecting capital transactions.
Non-Business Bad Debt
A non-business bad debt is always treated as a short-term capital loss.
Non-Refundable Tax Credits
Most tax credits are called non-refundable credits because they can only reduce the tax to zero.
Nursing Home Costs
Nursing home costs are deductible medical expenses when the condition of the patient requires medical or nursing attention. The deductible costs may also include the cost of staying at that facility.
Omission of Income Statute of Limitations
When there is an understatement of gross income by at least 25% of the amount reported on the return, the statute extends from three years to six years.
One-Half of the Self-Employment Tax
A deduction is allowed for one-half of the self-employment tax paid. The logic behind the allowance of one-half of the tax is that it is, in essence, the matching portion of the social security tax an employer would have to pay on its employees.
Passive Activity Defined
A passive activity is defined as any trade or business, or income producing activity, where the taxpayer does not materially participate.
Passive Activity Losses General Rule
Losses from passive activities are deductible only to the extent of passive income. Passive losses may not be offset against active income (salaries, wages, etc.) or portfolio income (interest, dividends, etc.). This passive loss limitation applies to individuals, personal service and closely held corporations.
Personal Exemptions
Each taxpayer is entitled to one personal exemption when filing their return. When a taxpayer files married filing jointly, they are entitled to two personal exemptions.
Personal Expenses
The payment of personal expenses through the self-employed taxpayer’s business account does not make the expense deductible.
Personal Injury
A taxpayer receiving amounts from workers compensation, accident and health insurance claims, lawsuits for personal injuries and disability benefits are not included as gross income.
Personal Property Taxes
A tax on personal property is deductible if the tax is based upon the value of the property and is assessed on an annual basis.
Points Paid for Loans
Points paid for obtaining a loan as it relates to acquisition indebtedness are fully deductible in the year paid.
Preferred Stock Dividends
If a preferred stock dividend is received on the common stock, then the basis of the preferred stock is determined by allocating the existing basis of the common stock to the common stock and the new preferred stock based upon the relative fair market of all the stock.
Prizes and Awards
The fair market value of prizes and awards is generally included as gross income.
Property Received by Inheritance
When a taxpayer receives property as an inheritance (from a decedent), the basis of the property is its fair market value as of the date of death. The holding period is automatically long-term for the purpose of determining gain or loss on the subsequent sale by the beneficiary.
Qualified Employer Provided Educational Assistance
For undergraduate studies only, the amounts paid by the employer under a qualified plan for tuition, fees, books and supplies is excluded up to an annual amount per employee of $5,250.
Qualified Residence Interest
Interest paid on loans for the acquisition of a qualified residence or a home equity loan generally qualify for the deduction.
Qualified Transportation Benefits
Employers may provide employees with a transit pass for the use of mass transit. The employee may exclude the value of up $230 per month. In addition, employers may provide free parking of up to $230 in value per month. And for those taxpayers who bicycle to work, the employer may provide up to $20 per month tax free.
Qualifying Relative Support Test
The dependent must not be self-supporting. This basically means that the dependent must receive more than 50% of their support from the taxpayer.
Qualifying Widow(er) with Dependent Child
If your spouse dies during the taxable year, you are entitled to file married, filing jointly for that year.
Real Estate Taxes
Taxes paid on the ownership of real property, wherever situated, are allowed as a deduction. This would include the tax on the taxpayer’s residence(s), land, and vacation homes, both domestic and foreign.
Real Estate Taxes on Rental Properties
Should the real property be rental or even part rental, the real estate taxes allocable to that portion must be shown as a rental expense, not an itemized deduction.
Realized Gain or Loss
When a taxpayer sells or exchanges property, a realized gain or loss is determined for the difference between the amount realized and the property’s adjusted basis.
Recapture Rules
When a taxpayer sells property used in a trade or business, or property used for the production of income, the gain is the difference between the selling price and the adjusted basis. The adjusted basis is usually made up of the original cost less any depreciation. The depreciation claimed by the taxpayer gives rise to an ordinary deduction, not a capital deduction (loss).
Recapture Rules of Personal Property
Any gain attributable to the depreciation taken is classified as ordinary income.
Recapture Rules of Real Property
Any gain attributable to excess of accelerated depreciation over straight-line depreciation is treated as ordinary income. However, if the property is held for one year or less, all the depreciation will be recaptured as ordinary income, not just the excess.
Receiving Property as a gift & fair market value is less than adjusted basis
When the fair market value of the property is less than the adjusted basis of the property, the donee’s basis will be the donor’s basis only for the purpose of determining a gain.
Refundable Credit
This credit provides the taxpayer with relief beyond reducing the tax liability to actually generating a refund, even if no taxes were ever paid.
Reimbursed Expenses
When an employee incurs expenses on behalf of his employer, and the amount of the expenditure is reimbursed by the employer after the employee makes an adequate accounting, that amount is not income to the employee.
Reimbursements of Medical Expenses
The deductible medical expenses must be reduced by any insurance reimbursements received during the year. If the reimbursement is received in the following year, then it must be reported in the following year as gross income, up to the extent of the tax benefit received by the taxpayer in the year of the deduction.
Related Party Transactions
When a taxpayer enters into a sale or exchange of property with a related party, the general rule is that no loss is recognized. The disallowed loss, however, is suspended until the related party disposes of the property.
Rental Activity
The Code also defines all rental activities as passive activities, unless this is the taxpayer’s business. However, an exception to the “no loss is allowed” rule exists for rental activity losses of up to $25,000 per year.
Rental Value of Parsonage
Amounts received by an ordained minister designated as a housing allowance is excluded to the extent of the actual costs of maintaining the parsonage.
Rents and Royalties
Amounts received from rental property, less the related rental expenses are included as gross income.
Roth IRA
A taxpayer can make a nondeductible IRA (Roth IRA) contribution of up to $5,000 per year. For taxpayers age 50 and older, the contribution ceiling is raised to $6,000.
Sale of Principle Residence
With regards to the sale of a taxpayer’s principal residence, any taxpayer, regardless of age, who has owned and used their home as a principal residence for at least 2 of the last 5 years before the sale, can exclude from income up to $250,000 of the gain on the sale ($500,000 if married and filing a joint return).
Scholarships
Payments made to an individual to be used for tuition and fees (such as books, supplies and fees), are excluded from gross income. The individual must be a degree candidate at a higher educational institution for study.
Section 1231 Code
Recharacterizes the gain from the sale of the depreciable property as capital even though it has been exempted from the capital asset classification.
Self-Employed Business Income
Income from carrying on a trade or business on an unincorporated basis is reported on Schedule C.
Self-Employed Retirement Plans
A deduction is allowed for contributions made to the self-employed taxpayer’s qualified retirement plan.
Self-Employment Tax
If a taxpayer has earnings from self-employment of at least $400, a self-employment tax must be paid on earnings. The self-employment tax is equivalent to the employee’s share and the employer’s share of the Social Security and Medicare taxes withholding tax.
Settlement Date in Stock Transaction
The settlement date usually occurs a few days after the trade date, and is when the paperwork is completed, the money is transferred, etc. It is not the date to use for tax purposes.
Simple Trust
A simple trust is required to distribute all its income to its beneficiaries each year. A simple trust should not have any taxable income and is not allowed a deduction for charitable contributions.
Single Filing Status
If a taxpayer is unmarried on the last day of the tax year, or is separated by a decree of divorce or separate maintenance, that taxpayer is considered single.
Social Security Benefits
In general, these benefits are excluded from gross income. However, when a taxpayer’s modified adjusted gross income exceeds a base amount, they may have to include 50% to 85% of their social security benefits as gross income.
Special School Costs
Expenses related to tuition, room and board, as well as the cost of medical care may be deductible if the principal reason for sending a dependent to a special school is that school’s special resources for treating that specific sickness or disease.
State and Local Taxes
Payments for state and local income taxes made are deductible in the year paid, regardless of the tax period the tax pertains to.
Statue of Limitations General Rule
Once a return is filed, the government can audit the return at any time during the three year period beginning on the latest of (1) the date the return was filed, or (2) the due date of the return.
Statute Provisions in Requesting Refund of Prior Taxes Paid
In requesting a refund for prior taxes paid, the statute is the later of (1) the three year period, or (2) two years from the date the tax was paid.
Stock Dividends
In general, the receipt of a stock dividend by a shareholder is non-taxable.
Business Expense Substantiation
A taxpayer is required to provide substantiation for business expenses. The IRS requires substantiation for expenditures of $75 or more.
Support Test
The dependent must not be self-supporting. This basically means that the dependent must receive more than 50% of their support from the taxpayer.
Tax Benefit Rule
When a taxpayer claims a deduction in one year, and receives a refund in the subsequent year, the amount of the refund must be reported as income. However, if claiming the deduction did not result in a tax benefit, then the refund is not taxable.
Tax Computations
In computing the amount of tax, taxpayers with taxable income of less than $100,000 may use the Tax Tables. If you are required to calculate the tax on the exam, you will use the rates, not the tax tables.
Tax Credits
Tax credits generally reduce the amount of tax shown on the return. Most credits require special calculations to determine the amount of the credit and several are based upon the taxpayer’s filing status.
Taxation of Individuals Basic Formula
Gross Income - Deductions = Taxable Income
Taxpayers 50+ IRA Contribution
For taxpayers age 50 and older, the contribution ceiling is raised to $6,000.
Hierarchy for Netting Capital Transactions
- Net all the short-term transactions.
- Net all the long-term transactions.
- Net the net transactions, if possible.
Trade Date in Stock Transaction
When a stock transaction takes place. The trade date is the day the transaction actually takes place and is the one used for tax purposes.
Transportation and Lodging Costs
Cost of transportation for medical treatment, which includes a parent’s cost if they are accompanying a child, is allowed as a deduction.
Tuition and Fees Deduction
A taxpayer is allowed a deduction for qualified tuition and related expenses paid during the year for the taxpayer, his spouse and dependent. Unlike the Education Credits, books, supplies and equipment are also included as qualified expenses. There is a phase-out range.
U.S. Savings Bonds
Series E (before 1980) and Series EE (after 1979) Savings Bonds are issued at a discount, do not pay out interest, but are redeemed for fixed amounts in the future. The difference between the purchase price and the redemption price is recognized as interest income.
Unemployment Compensation
Various states provide benefits to unemployed workers for a set period of time.
Valuation of a Gift
In determining the amount of the gift for gift tax purposes, the taxpayer uses the fair market value, not the adjusted basis of the gift. However, for income tax purposes the general rule is that the adjusted basis of the gifted property and the related holding period transfers over from the donor to the donee.
Wash Sale
If a taxpayer sells, and repurchases substantially identical stock within thirty days of the sale, any loss on the transaction is disallowed.
Taxpayer Receives Property as a Gift
The basis of the property is transferred from the donor to the donee. In addition, the holding period of the property “tacks over” to the donee. This general rule applies when the fair market value of the gift exceeds the adjusted basis of the property transferred.
