Quick Tax Flashcards
Steps in Determining Tax Liability
- Determine Gross Income (GI)
- Subtract Above the Line Deductions to get Adjusted Gross Income (AGI)
- Subtract Standard or Itemized Deductions to get Taxable Income (TI)
- Multiply by Tax Rate (Tentative Liability)
- Subtract any Available Credits (Final Tax Liability)
Four Essential Tax Questions
- What is Income?
- To Whom is it Income?
- When is it Income?
- What is the Character of the Income?
Gross Income
Defined: any economic benefit or any clearly realized accession to your wealth.
Realization
Defined: the increased or decreased value of an asset is not taken into account for tax purposes until it is realized through the sale or other disposition of the asset.
Non-Cash Receipts
Defined: gross income includes the FMV of any property received and the FMV of any services rendered.
Claim of Right
Property received WITHOUT RESTRICTION as to USE OR DISPOSITION
Rule: property or funds received under a claim of right MUST BE REPORTED for tax purposes, even though the TP may later be required to return the property, funds, or their equivalent.
Tax Benefit Rule
Rule: if TP takes ANY deduction in one tax year and recovers the property that gave rise to the deduction in a later tax year, the TP has tax benefit income, to the extent that the earlier deduction provided an actual tax savings or a tax benefit to TP.
Alimony
Rule: unless otherwise provided in the written agreement, alimony is taxable to the receiving spouse and deductible to the paying spouse.
Elements:
- Writing: pursuant to a written divorce or separation agreement
- No Cohabitation: must have separate residences
- Must Cease at or Before Death: does not survive death of payor
- Made in Cash or Cash Equivalent: checks are ok
Child Support
Rule: child support is not taxable to the receiving spouse and is not deductible to the paying spouse.
In Disguise: if a payment is reduced upon a contingency relating to a child, the amount of the reduction is considered child support
-Ex: $1,000,000 until Jr. turns 21, then $700,000
Prizes and Awards
Rule: gross income includes the value of cash, property, or services received as a prize, award, or windfall.
Examples: raffle prizes, gambling or lotto winnings, treasure trove findings.
Cancellation of Indebtedness
Rule: a TP whose debt is cancelled or discharged at less than the full amount has COD income to the extent of the difference between the full amount of the obligation and the amount paid in satisfaction of the debt.
Exceptions to COD Income (RIG)
- Reduction in Purchase Price: usually involves a renegotiation of the original purchase price in the sale of goods
- Insolvency: if the discharge occurs when the TP is insolvent or bankrupt, there is no immediate discharge of indebtedness income.
- Gift: if the lender intended the discharge as a gift, the COD Income rules will NOT apply.
Exclusions: Life Insurance Proceeds
Rule: gross income does not include proceeds paid by reason of the death of the insured.
Exception: when proceeds are paid in installments, any interest paid will be taxable income.
Exclusions: Inheritances
Rule: gross income does not include amounts received by bequest, devise, or inheritance.
Exclusions: Gifts
Rule: gross income does not include amounts received by gift.
Defined: a transfer made out of detached and disinterested generosity, such as love, affection, or charity.
Exclusions: Tort Awards
Rule #1: gross income does not include damages received on account of a physical personal injury or sickness (includes lack of consortium for injured’s spouse)
Rule #2: By themselves, damages for emotional distress are not considered damages received on account of a physical injury, unless connected to an underlying physical injury claim.
Rule #3: punitive damages are ALWAYS taxable as income.
Exclusions: Qualified Scholarships
Rule: qualified scholarships for tuition and related expenses are excluded from gross income.
Qualified: must not be payment for past or future services, and must be primarily for the benefit of the individual.
Employee Exclusions: Receipts from Health and Accident Insurance
Rule: the value of employer provided health or accident insurance coverage, i.e. the premiums paid by the employer are excluded from gross income.
Note: health insurance reimbursements for medical expenses actually incurred are also EXCLUDED from gross income.
Employee Exclusions: Life Insurance by/through Employer
Rule: TP may exclude the value of the FIRST $50,000 of employer provided group term life insurance.
Note: gross income include the value of any excess life insurance coverage provided by the employer.
Employee Exclusions: Meals and Lodging
Rule: Employer provided meals and lodging are excluded if…
- Provided for the Convenience of the Employer
- Actually Provided by the Employer
- On the Premises of the Employer
Employee Exclusions: Fringe Benefits
- De Minimus: too small to account for
- No Added Cost: in ordinary course of business
- Qualified Employee Discounts: up to 20%
- Contributions to Qualified Pension Plans: if made by the employer
- Employee Safety/Length of Service Awards: an exception to the “No Gifts to Employees Rule”
Types of Deductions
- Above the Line
2. Choice of Itemized or Standard Deduction
Above the Line Deductions
- Ordinary and Necessary Business Expenses:
- Ex: salary to employees, rent for office space, office supplies - Depreciation: only for business assets that waste over time
- Net Capital Losses: usually stocks
- Alimony
- Moving Expenses
- Limited Deduction for School Loan Interest
Itemized Deductions: Home Mortgage Interest
Rule: TP may deduct mortgage interest on mortgages up to $1,000,000 in the aggregate on a principal and a second personal residence.
Note: TP may also deduct interest on a home equity loan of up to $100,000, when borrowing from the value of the home.
Itemized Deductions: State and Local Taxes
Rule: taxes paid to state and local governments are deductible, with the exception of the sales tax.
Itemized Deductions: Unreimbursed Casualty Losses
Rule: unreimbursed casualty losses are deductible…
- If the loss is greater than $100
- If the loss is Sudden and Unexpected
- But only to the Extent that those losses in the aggregate exceed 10% of TP’s AGI.
Itemized Deductions: Unreimbursed Medical Expenses
Rule: unreimbursed medical expenses are deductible to the extent that they, in the aggregate, exceed 10% of TP’s AGI.
Itemized Deductions: Charitable Contributions
Rule: TP generally may deduct the FMV of property and the amount of cash contributed to qualified charities.
Itemized Deductions: Miscellaneous Deductions
Rule: TP may deduct eligible miscellaneous deductions to the extent that, in the aggregate, they exceed 2% of TP’s AGI.
Examples: unreimbursed employee business expenses, certain educational expenses (CLE course, Lara’s classes)
Itemized Deductions: Personal vs. Business Expenses
Rule: personal expenses are NOT deductible
Legal Fees: not deductible if incurred in a personal setting
But: legal fees incurred in a business or investment setting are deductible.
Itemized Deductions: Investment Fees or Expenses
Rule: TP may deduct the fees or expenses that were necessary to generate taxable income
Examples: broker fees, advertising.
Exemptions
Defined: a special form of deduction for taxable income
Rule: TP are entitled to one exemption for themselves and one for each dependent.
Dependent: a member of the household to whom you provide at least 50% of the required support.
Allocation of Income
Rule #1: income must be taxed to the person who earns it
-The (No) Assignment of Income Rule
Rule #2: Income from property is taxed to the person who owns that property.
Cash Method of Accounting
Rule: where the TP reports income when she receives payment and takes deductions for eligible expenses when she makes payments.
Constructive Receipt: occurs when funds or property are credited to TP’s account, set apart, or otherwise made available so that TP may draw upon them.
Note: usually for personal accounting settings
Accrual Method of Accounting
Rule: where the TP reports income when all events have occurred that fix the right to receive it, and when the amount can be determined with reasonable certainty
Deductions: taken when all events have occurred that establish the fact of liability, and when the amount can be determined with reasonable accuracy.
Note: usually in business accounting settings
Gains and Losses on Disposition of Property
Realization: the sale, disposition, or exchange of property
Recognition: only occurs when recorded on a tax return
Rule: unless a specific statutory or C/L exception applies, a realized gain must always be recognized for tax purposes.
Basic Sale Formula
G/L = AR - AB
AR: includes the money received, plus the FMV or property or services received, plus mortgages or liabilities to which the property sold is subject or which the buyer assumes.
Cost Basis Rule
Rule: a TP’s basis on property acquire by purchase is generally the cost of the property, including the money paid and mortgages or liabilities incurred in connection with the purchase.
Upward: can be adjusted upward to reflect additional costs or improvements.
Downward: can be reduced to reflect deductions previously taken for depreciation or tother previous tax-free recoveries of basis.