REG Flashcards
Qualified surviving spouse
-The taxpayer’s spouse died in one of the two pervious years and the taxpayer didn’t marry in the current year
-The taxpayer has a child who can be claimed as dependent
-The child lived in the taxpayer’s home for all of the current year
-The taxpayer paid over half of the living expenses for the child
-The taxpayer could have filed a joint return in the year the spouse died
Qualified Business Income (QBI)
Is taken from adjusted gross income (“below the line”). It is not part of the itemized deductions
If the spouse dies in the current year
The surviving spouse is considered to be married for the entire current year
Individuals
Are required to have a calendar year end
Head of household
can only be elected if the taxpayer is legally separated at year-end and live apart from the spouse for six months
If more than two year have passed since the spouse has died
The taxpayer can no longer file as a qualified surviving spouse
Head of household
can be used when the taxpayer maintains more than half of the upkeep on another person’s principal residence for the ENTIRE tax year. The taxpayer is not required to live with the individual
Social security benefits
are not included in gross income for purposes of the qualifying relative gross income test
Interest earned on a refund
Is taxable
Child support funds qualification
- A specific amount is fixed or is contingent on the child’s status (reaching a certain age)
- It is paid solely for the support of minor children
- Payable by decree, instrument, or agreement
Note that for all divorce or separation agreements executed after 12/31/2018, the alimony is neither taxable to the recipient or deductible by the payor
Awards can be excluded from gross income when
- The taxpayer was selected for the award without entering the contest
- The award is paid to a governmental or charitable organization
Cash basis taxpayers
Should report gross income for the year in which the income is either actually or constructively received, whether in cash or property
Group term life insurance premiums paid by an employer
Are excludable from gross income up to $50,000. The first $50,000 is nontaxable, then the rest is
A trip for meeting sales goals
Would be included in an employees gross income
Gross income
Does not include inheritances. It does include treasure troves and employee achievement awards
Noncash income
The amount of income to be reported is the FMV of the property or services received
Even if a company car is provided to a spouse and the employee doesn’t use it
It’s still considered a taxable fringe benefit for the employee and not for the spouse
Moving expenses
Are only deductible by armed forces personnel who are moving pursuant to a military order
Employer contributions to a traditional defined contribution retirement plan, and earnings on those amounts contributed
Are not taxable income to the employee until distributed
Interest earned on Series EE bonds issued after 1989
May qualify for exclusion from gross income if the interest is used to pay tuition and fees for the taxpayer, spouse, or dependent enrolled in higher education. The interest exclusion is reduced by qualified scholarships that are exempt from tax and other nontaxable payments received for education expenses. The purchaser of the bonds must be the sole owner of the bonds.
Interest on state government obligations
Is not taxable
Interest income from muni bonds
Is not taxable
If common stock is received for services rendered
The FMV of those shares is recognized as income and dividend income on those shares of stock is also recognized as income
Under the tax benefit rule
an itemized deduction recovered in a subsequent year is included in income in the year recovered. Only the amount of the benefit, not the entire refund, is included in taxable income for the current year
Misc. items that aren’t included in income
- Rental value of parsonages (furnished by churches and synagogues) is excluded from the AGI of the minister
- Compensation for injuries and sickness
Taxes on alimony
Includes only payments received in cash (must be settled before 12/31/2018)
Child support and cash from property settlements
Are not included in gross income of the receiving spouse
Money received for child support and alimony - allocation
The money received must first be used to satisfy the child support category for the given time period, the remaining money is then applied to alimony, which is taxable if the divorced was finalized prior to 12/31/2018
Marginal tax rate should be used
When receiving a distribution from a traditional IRA. There will also be a 10% penalty assessed if the taxpayer is over 59.5 years old
For a cash and accrual basis taxpayer
Gain or loss on a sale of stock occurs when the trade date
Rules for alimony deductions for divorces executed on or before 12/31/2018
- Payments must be in cash or cash equivalents
- Payments cannot extend beyond the death of the payee-spouse
- Payments must ne legally required pursuant to an agreement
- Payments cannot be made to members of the same household
- Payments must not be designated as anything other than alimony
- The spouses may not file a joint return
Taxes on annuity (and life insurance) distributions
To calculate the nontaxable portion (nontaxable return on capital): Initial investment/years
Anything over this amount is taxable
Taxes on social security benefits
Depends on the income of the benefit holder. The maximum amount of taxable Social Security benefits is 85% if the total benefit received. The amount depends on whether modified AGI ( AGI plus tax-exempt interest plus 50% of the SS benefit) is greater than a threshold amount. For higher income taxpayers with a modified AGI of more than 24,000, up to 85% of the SS benefits received during the year are taxable
Unemployment compensation
Is included in taxable income
Tax returns for a dead person
Are due the next year
Interest income received after death
Are taxable to the estate, not the individual
Damages awarded as a result of physical personal injury
Are not taxable
Misc. items included in gross income
- Payment to a part-time student for teaching services provided
- Payment to a degree candidate for participation in a university-sponsored research project
If vacation time is used on a business trip
The airfare isn’t deductible, even if business activities were involved part of the time
Consideration for cancelling a lease
Is considered rental income
A partnership generates net ordinary business income or loss
And passes each partner’s distributive share through on Schedule k-1
Net self employment income
Gross income - license fees - marketing expenses
Salaries paid to yourself as a business owner
Are considered draws and are not factored into gross income
Total self employment income
Gross business receipts - Business expenses
1040 schedule c, profit or loss from business
Personal expenses are not allowed as deductions on schedule c. Schedule c items should only be related to the operation of the business itself
Business expenses
Do not include investment expenses
Business meals
Are only 50% deductible on form 1040 C
State income taxes for businesses
Are not deducted on schedule C. They are an itemized deduction
Bad debt allowance
Is a direct write off only for accrual basis taxpayers
Prepaid interest
Is deductible, and must be prorated over the life of the loan
If a residence is rented for less than 15 days of the year
No rental income needs to be reported
Shareholder distributions
Are not taxable if they don’t exceed the basis of the corporation
Each shareholder in an S corp
Must report their share of the S corp’s profits in their gross income
The income is passed through to the shareholder whether or not it was actually distributed
Partnership ordinary income
Ordinary income x 50%
A partner
Is not considered an employee. They receive guaranteed payments on form K-1. This income is subject to the self employment tax
Taxable vs. Nontaxable Events
Taxable = FMV for income and basis
Nontaxable = none for income and NBV for basis
In order to be a taxable gain
The gain must be recognizable and realizable
Bargain purchases
The difference is income to the employee
Net income for partnerships
Gross income
- guaranteed partner payments (nothing withheld)
= net income
Life insurance
Premiums above the first $50,000 are taxable
1040 Schedule B
Is for stocks and bonds, and for interest
Interest items that aren’t taxable
Interest on state and local bonds
Mutual fund dividends for funds invested in tax free bonds
Bonds of a US possession
Interest on US EE bonds after 1989 (higher education) for bond holders making under 100k
Types of distributions and tax results
From corporate earnings and profits - Taxable dividend
If there are no earnings or profits but the taxpayer has basis in stock (return on your capital) - Nontaxable reduced basis of stock
If there are no earnings or profits and the taxpayer has no basis (earnings in excess of your capital) - taxable capital gain
Stock dividends vs cash
Stock dividends are generally not taxable, unless cash could also be given
1040 Schedule D - Capital gains and losses formula
Amount earned
- Basis
= Gain or loss
Traditional (Deductible) IRA distributions
Are taxed as ordinary income
Required minimum distributions start at 73
Nondeductible traditional IRAs
The principle portion (contributions) isn’t taxed, but earnings are taxable as ordinary income when withdrawn
Roth IRAs
Are never taxable. Minimum distributions start at 59.5 years old
Rental income formula - Reported on 1040 schedule E
Rental income
- Total rental apartment expenses
= Net amount
Unemployment compensation
Is taxable
Modified AGI (MAGI) - AEIOU
Foreign income and housing
Interest income from EE bonds
Any deduction claimed for student loan interest
Any employer paid adoption expenses that were excluded
Any deduction claimed for an annual contribution to a traditional IRA
Gambling losses
- Are deductible on schedule A as an itemized deduction
- Gambling losses can only be deducted to the extent of gambling winnings
Cancellation of debt
Is taxable except for certain circumstances
1040 schedule C (company)
Net income from self employment is reported as one net amount
Gross business income (cash, property received in lieu of cash, cancelled debt)
- business expenses (COGS, salaries paid, state and local tax, office expenses, auto expenses, business meals (50%), depreciation of business assets (IBM), we benefits, legal and professional fees, bad debts if accrual basis is used), interest on business loans)
= Profit or loss, Net income (an adjustment to income is allowed for one half of SE taxes: Medicare plus SS paid. This is because as a sole prop you pay the business tax. All self-employment income is subject to the 2.9% Medicare tax. Up to 168k is subject to 12.4% SS tax, adding up to 15.3% self employment tax)
Easy self employment tax calculation
Earnings * 92.35% = a
a * 15.3% = self employment tax
Business losses
Go against income
Three of five presumption
If an activity is profitable for three out of five years, the activity is presumed to be an activity engaged in for profit
Rental activity, 1040 schedule e (easy money)
Gross rental income
Prepaid rental income
Rent cancellation payment
Improvement in lieu of rent
- rental expense
= Net rental income or loss
Exclusively rented properties - losses
Are considered passive and only go against passive income
A maximum loss of $25,000 can be deducted against passive income. The rest can be carried forward
Types of flow through entities
Partnership
S Corps
LLC’s taxed as partnerships or S corps
Basis - Partnership
Beginning capital account
% income
- % loss
- distributions
= Ending capital account
% partnership liabilities
= Ending tax basis
Basis - S Corp
Beginning stock basis
% income
- % losses
- distributions
= Ending stock basis
Shareholder loan to S corp
= Ending tax basis
Tax basis loss limitation
A loss can only flow through to the individual and deducted to the extent of the owners tax basis
Adjustment to AGI - above the line deductions
Educator expenses
Traditional IRA deduction
Student Loan interest deduction - limited to $2,500. Phased out at 80k single or 165k MFJ
HSA account deduction
Moving expenses for Military - started in 2017
Deductible portion of self employment tax
Self employment health insurance deduction
Deductions for contributions to certain self employment retirement plans
Penalty on early savings accounts
Alimony paid (only for divorces before 12/31/18)
Attorney fees paid in certain discrimination and whistleblower cases
IRA’s
Annual maximum contributions to IRA’s is limited to the lesser of:
Before age 50:
Unmarried - $7,000 or earned income
Married - $14,000 or earned income
Age 50+:
Unmarried - $8,000 or earned income
Married - $16,000 or earned income
Deductible traditional IRA’s
Can’t be deducted by those who earn too much or have a pension
Minimum distributions are required beginning at age 73
Roth IRAs
Can’t be used by those earning 146k - unmarried, and 230k - married
Capital losses in excess of capital gains
Are deducted up (up to $3k) on form 1040 before the calculation of AGI
SEP IRA Deduction formula
Net self employment income
- 50% of SE taxes
= Self employment earnings before SEP IRA
* 20%
= Calculated SEP IRA deduction
Itemized deductions: Medical Expense
For dependents in this instance, we don’t care about them failing the income test.
Note that most taxpayers are cash basis, meaning in order to be tax deductible the item must have been incurred and paid during the year.
Calculation:
Qualified medical expenses
- insurance reimbursement
= Qualified medical expenses
- 7.5% of AGI
= Deductible medical expenses
Allowable items:
Medicine and prescriptions
Doctors
Medical insurance premiums you pay
Medically necessary surgery
Transportation to the facility
Physically disabled costs - reduced by any increase in value of the home
Note that elective surgeries are not deductable, neither are vitamins or funerals
Spousal deductions
One spouse can’t take the standard deduction while the other itemizes
Itemized deductions: taxes
State local and foreign taxes are generally deductible.
Itemized deductions for SALT taxes, property taxes, and sales taxes are limited to $10k.
Foreign real estate property taxes, other than those incurred as a trade or business, are not deductible.
Real estate taxes:
Taxpayers must be legally obligated to pay.
Taxes are prorated in the year of sale or purchase.
Taxes paid under protest are deductible.
Taxes paid in escrow are deductible when paid to the authority.
Taxes on land held for appreciation (business) may be capitalized or deducted at the option of the taxpayer
Anything business related goes on schedule C
Personal property taxes:
To be deductible, the tax must be based on the value of the personal property and paid during the tax year.
Income taxes (state, local, federal)
Estimated taxes paid during the year are deductible.
Assessments for a prior years tax that are paid in the current year are deductible
Sales taxes:
A taxpayer must elect to deduct income taxes OR sales taxes.
The amount is determined by the amount of actual general sales taxes paid or the relevant IRS table, plus any amount paid for a vehicle boat or other approved items
Note a tax benefit rule applies here. If you would’ve gotten more back item itemizing sales taxes, it counts as income
Nondeductible taxes:
Federal taxes inheritance taxes for states
Business taxes on schedule c
Rental property taxes on schedule e
Itemized deductions: losses
$100 floor for each casualty event
The aggregate of these losses is over 10% of AGI
Losses are only deductible if sustained in a presidentially declared disaster area where the assets aren’t insured.
The amount of the deductible loss is it’s FMV immediately after the incident
Formula:
Smaller Loss of lost cost/adjusted basis or decrease in FMV
- insurance recovery
= Taxpayers loss
- $100
= Eligible loss
- 10% of AGI
= Deductible loss
Itemized deductions: interest expenses
Home mortgage interest:
Deductions are allowed for first and second homes (must be used for 14 days).
Mortgage on a business building goes on schedule C
mortgage on a rental property goes on schedule E
Interest on debt up to 750k is considered mortgage interest otherwise it’s personal
Investment interest:
Investment interest deduction for individuals is limited to net taxable investment income
Excess of investment interest paid over the allowed investment interest deduction can be carried forward forever
Personal interest is not deductible
Prepaid interest:
Must be allocated over the period of the loan, even for a cash basis taxpayer.
Deducted when incurred and paid
Prepaid interest received is income
Educational loan income:
The adjustment is limited to 2,500
Anything over is considered personal and not itemized
Itemized deductions: charitable contributions
Note gifts to individuals and political contributions are not deductible
Amount:
Cash given
FMV of property given
If it’s an ordinary income property (inventory, short term assets, depreciation recapture), it’s the lesser of the basis or FMV.
Note long term capital gains are deductible.
AGI limitations on deductions:
Cash - 60% of AGI to public charities and operations 30% to private nonoperating foundations
Ordinary income property - 50% of AGI to public charities and operations 30% of AGI to nonoperating
LTCG property - 30% of AGI to public charities and operations, 20% of AGI to nonoperating foundations
Carryover is permitted
Consideration for contribution:
Taxpayers may only deduct the excess contribution over the consideration received. Contributions received over $75 prompt the organization to give a statement to the donor indicating the deductible amount
Contributions for services aren’t deductible. Out of pocket expenses related to it are though
Students living abroad:
$50 a month is deductible
Records must be kept for all of this.
For contributions over 500, the taxpayer must fill out form 8283
For something over 5,000 an appraisal is required, except stock
Private operating vs private nonoperating foundations
Private operating - conducts charitable activities and distributes funds to it’s own programs
Private nonoperating - distributes funds to other programs
Itemized deductions vs. adjustments
Itemized deductions are a deduction from AGI itself
Adjustments are made to arrive at AGI
If lack of dependency due to the income limitation is the only reason someone can’t be claimed
You can still deduct their medical expenses if you paid them
Top five income items for individuals to arrive at AGI
- Wages, salaries and tips (use box 1 of W-2)
- Interest income (1099-B)
- Total Ordinary Dividend income (1099-B)
- Capital gain (loss) (1099-B, Proceeds minus cost or other basis)
- Other income (for gambling winnings, report the amount. The losses are backed out below the line to the extent of the winnings)
Real estate taxes
Maximum deduction is 10k
Mortgage interest
Can’t be deducted after the total amount outstanding on your mortgages exceeds 750k
You can’t deduct losses on personal transactions
An example would be selling a used car for less than you bought it
QBI deduction on 199A
20% deduction for eligible flow through entities (S corps, partnerships, LLC, trusts)
Below the line, from AGI
Deduction given to business owners
QTB vs SSTB: QBI deduction
SSTB: specified service trade or business (health, law, accounting, athletics)
QTB: anything other than an STTB
Calculating QBI: Overview
Maximum deduction: QBI x 20%
Limitations:
Taxpayers total taxable income before the QBI deduction
Whether the flow through is an SSTB or QTB
Categories:
Under beginning threshold: QTB and SSTBs are the same
Over ending threshold: QTB is calculated and SSTB isn’t allowed
In between thresholds (192k-242k single) (384k-484k MFJ): Don’t need to worry about calculating
Calculating QBI for category 1 (under the threshold)
- QBI x 20%
- Calculate overall limit ((TI before QBI deduction - cap gains) x 20%
- Choose lesser of 1 and 2
Calculating QBI for category 2 (above the income threshold)
- Determine if SSTB (nothing needed, $0) or QTB (proceed to step 2)
- Calculate tentative QBI deduction (QBI x 20%)
- Calculate full W2 wage and property limitations. Take the GREATER of: W-2 wages x 50% OR (W-2 wages x 25%) + (UBIA x 2.5%)
- Take the lesser of step 2 or 3
- Calculate overall limit: Taxable income before the QBI deduction x 20%
- Choose the lesser of step 4 or 5
Two types of tax credits
Nonrefundable personal tax credits - reduce tax, no refund. Includes the child and dependent credit, elderly and permanently disabled credit, education credits, retirement contribution credit, foreign tax credit, general business credit and adoption credit
Refundable credit - reduce taxes, create a refund. Includes child tax credit, earned income credit, federal income tax withheld, excessive SS paid
Child dependent care credit
20-35% of work related expenses to care for qualifying persons. 3,000 for one and 6,000 for two x the percentage based on income
Both parents must be working. Child must be under 13 unless disabled
The credit decreases by 1% for every 15,000 of AGI
American Opportunity Tax Credit
Qualified expenses include tuition and fees, and course materials
Applies to the first four years of college education at an eligible institution.
Max is 2.5k
Credit is phased out when MAGI exceeds $90k, starts at $80k.
40% of the credit is refundable (up to 1k)
Lifetime learning credit
Available to be claimed for one person
20% of qualified expenses up to 10k
Fully phased out at 90k
Coverdell education savings account
Contributions are non-deductible, and maximum contribution per beneficiary is 2k annually.
Each beneficiary has a separate account (includes grandchildren).
Maximum contribution is phased out and earnings accumulate tax free.
Distributions are tax free as long as they are used for education. Can be used at any education level
Any amounts left over once the beneficiary reaches 30 years are required to be distributed and taxed. It can be rolled over though.
Elderly or disabled credit
Eligible for people over 65 or under 65 and permanently disabled.
15% of eligible income
5k for single and 7.5k MFJ
Eligible income is reduced by: SS payments and other excludable pensions or annuities received by the taxpayer and one half of the taxpayers AGI that exceeds the credit amount
Summary of calc:
Credit base amount based on filing status
Less: all SS payments
Less: (AGI - credit base) x 50%
Times: 15%
Adoption credit
Indexed every year (currently around 16k)
Credit is non refundable- can be used to reduce tax liability but nothing more.
Can be carried forward 5 years
Phased out starting at 252k MAGI
Medical expenses don’t qualify as adoption expenses
Claimed for years after the payment is made until the adoption is final. Eg. Expenses made in prior years only count when the adoption is finalized.
Savers credit
If you have a low enough income and still contribute to a IRA plan, their government helps out by giving you a credit
Must be at least 18, not a full time student, not a dependent. 10, 20, or 50%
Maximum contribution is 2k
Credit amount is 2k x applicable rate
Foreign tax credit
No limit on foreign taxes as a deduction.
Foreign tax credits are limited to the lesser of foreign taxes paid or a formula
Carry back one year, or carry forward 10.
General business credit
Calculating the credit
Tax liability up to 25k is 100%
Anything over 25k is 75%
Total is the max credit permitted
Carried back one year, carried forward 20
Work opportunity credit
Available to employers who hire employees from a targeted group.
Credit is 40% of first 6k of first years wages
Qualified: disabled, 18 to 24 year olds from poor families, Vietnam vets, food stamp recipients
Small business retirement plan start up credit
No more than 100 employees who received at least 5k compensation
At least one plan participant is a non highly compensated employee
Expenses include costs to start the plan and EE education regarding the plan
Credit is the greater of 100% of the first 1k start up costs with 50 or fewer employees or the lesser of $250 for each non highly compensated EE or $5k
Small business health care credit
Credit of up to 50% of the employers costs of plan premiums
Excludes owners who own up to 2% or stockholders own more than 5%.
If expenses were used to qualify for the credit, they can’t be used as tax deductions as employee benefits expense
Clean vehicle credit
Max credit of 7.5k for new vehicle l
Max credit of 4k for pre-owned vehicles placed into service after 2022
Both are subject to AGI limitations
Child tax credit
2k for each qualifying child
Under the age of 17
Phase out is based on AGI
500 for non children
Earned income credit
To be eligible:
Must be between 25-65
Income must be wages and tips.
Phased out quickly (30k MFJ)
Cannot claim if investment income is over 11.6k
Excess FICA
Excess social security tax withheld is treated as additional tax payments withheld.
Must be from multiple employers
Premium tax credit
Must be purchased on the health insurance marketplace within AGI limits (Obamacare)
Safe harbor estimated taxes
90% of this years tax liability or 100% of last year’s taxable amount, both in four equal installments
If the taxpayer had AGI in excess of $150k, then 110% is used
Tax withholdings
Are treated as estimated taxes.
If determined that the withholding won’t be enough, excess withholdings at the end of the year is ok
Self employed tax
Represents both employee and employer piece (15.3%)
100% of the self employment tax is collected as an “Other Tax” in the other taxes section of the 1040
Note a 50% adjustment is required to arrive at AGI
Additional Medicare tax
.9% is imposed on wages of 250k (MFJ) and 200k for all other taxpayers
Net income investment tax
Application of a 3.8% tax of the lesser of 1) the taxpayers net investment income or 2) the excess of MAGI over a threshold amount. Imposed on those making $200k or $250k MFJ
Generally imposed on interest, dividends and capital gains, rental and royalty income, trading
Kiddie tax
Net unearned income of a dependent child under 18 years old is taxed at the parents rate (under 24 if in college). Also applies to full time student ages
Net unearned income =
The child’s unearned income
Less: $2,600
Only hits when $2,600 is exceeded
When property is purchased
The basis is the price paid plus capital improvements. This is called an initial basis
Real property vs personal property
Real - land and all items affixed to the land
Personal - machinery, equipment, trucks, etc.
Holding period
Starts when purchased. Helps determine short vs long term capital gain
Depreciation expense
Is tax deductible
Adjusted basis
Means the same as NBV
Fair market value
If property is given instead of cash for services provided, FMV is used to calculate the tax. FMV is also the basis
Nontaxable transactions
Use net book value as the basis
Basis spreading adjustment
The receipt of a nontaxable stock dividend results in basis spreading. Spread the amount paid for the shares initially across all shares held. This is the new basis per share
Gifted property
Donee never has to pay tax on the gift
Donor might have to depending on gift size
Donee’s tax basis on gifted property
The donors basis becomes the donee’s basis
Usually NBV
If the gift is sold, a gain or loss is recognized using the basis
Exception:
When the FMV at the date of the gift is greater than the donors NBV, we won’t know the donee’s basis until the gifted property is sold
Gifted property basis exceptions: when the donor is upside down
Scenario 1: sales price is greater than the donors basis (NBV)
Use NBV as the basis. Gain recognized
Scenario 2: sales price is less than the FMV
Use FMV as the basis. Loss is recognized.
Scenario 3: sales price is between NBV and FMV.
Use the sale amount as the basis. No gain or loss recognized
Gifted basis for depreciation
Lesser of the donors NBV or the FMV on the date of the gift
Long term vs short term gains
Long term held property (greater than 1 year) - pay tax at capital gain rates
Short term held property (1 year or less) - pay tax at ordinary income level, which is higher than the capital gain rates
If the donee sells the gifted property for more than the NBV
The donee will use the donors holding period
If the donee sells the gift for less than FMV
The holding period begins at the date of the gift
If the sale price falls between the NBV and FMV
Not relevant, there’s not a gain or loss
Basis for inherited property
FMV at the date of death usually. This is good because: sales price - FMV will result in a lower gain
Alternate valuation date
If elected, the basis of the asset is the FMV at the earlier of:
Distribution date of the asset or 6 months after the death
Holding period for inherited property
Automatically considered to be long term property, regardless of how long it’s been held
Expense vs capitalize
If useful life is greater than one year, capitalize with some exceptions
De minimis safe harbor rule
Businesses can follow a policy to immediately expense low-cost personal property items. They must have audited financials to deduct an items cost up to 5k. if no AFS, only 2.5k is expenses.
If the cost is greater than the threshold, it must be capitalized
Property converted from business
If converted, the basis for depreciation is similar to calculating gift basis:
Use the lesser of the original cost basis (adjusted for improvements) or the FMV at the conversion date
Tax basis for gain/loss purposes
Tax basis is different than depreciation basis
To determine gain or loss on sale, compare the sales price to the adjusted basis at the date of the sale, which is the original cost basis less any depreciation taken
If gain: tax basis = adjusted basis
If loss: tax basis = lesser of adjusted basis or FMV, then reduce by any depreciation deductions taken after the conversion to business use
Basis: intangible property
Section 197: purchased intangibles
Examples include goodwill, franchise fees, etc.
Research and Development costs
Must be immediately capitalized and amortized
Any unamortized costs remaining after a patent is earned is added to the basis of the intangible
Parents and copyrights
Initial basis of the parents and copyrights that are purchased directly is the purchase price
Organization and startup costs
Taxpayers are allowed to immediately expense the first 5,000. This 5,000 is reduced dollar for dollar though, when the total costs exceed 50,000
15 year useful life
Legal fees, accounting fees, etc.
Don’t include equity-added costs like stocks or partnership interests and transferring assets to the corporation
Gain or loss calc
Sales price - adjusted basis
Amount realized
Money received, cancellation of debt (boot), FMV of property, less selling expenses
Adjusted basis
Purchase = cost
Gift = rollover or FMV
Inheritance = stepup to FMV
Character of gain or loss
Classification depends on how it was used by the taxpayer
Capital assets: investments, personal use. Taxed as a capital gain on disposal
Noncapital assets: anything used in business like inventory or AR. Taxed as ordinary income or loss
Collectibles and qualified small business stock: 28% rate group
Long term gains on sales of collectables
Section 1202 QSBS:
Original issue C corp stock held for more than five years
Allowed to exclude the great of $10M or 10x basis
Any gain in excess is taxed at 28%
Net capital loss deduction and loss carryover rules
$3k maximum deduction for all per year
If net capital loss is more than $3k, taxpayers can carry it forward forever until exhausted.
Character is maintained. (Short vs long term)
Worthless stock
Cost or other basis is treated as a capital loss, as if it were sold on the day it went to 0
Short sale
Stock is valued high but you think it will go down in the future
Netting process for individuals
Short term ordinary tax rate group, long term 28% tax rate group, and long term cap gains are all netted
1) short term gain or loss is offset from the 28% group
2) offset remaining goes against long term cap gain or loss
C corp gain and loss rules
Net cap gains: added to ordinary income and taxed at the regular rate
No distinction between short and long term
Corps can’t deduct any net capital losses from ordinary income
Net cap losses:
Carried back three years or forward five years
Non-deductible losses
Wash sales: exists when a security is sold for a loss and is repurchased within 30 days before or after the sale date. This only applies to losses not gains. Basis is repurchase price of the sale + disallowed loss on wash sale. Acquisition date is considered to be the original purchase date. Oldest shares are sold first
Related party transactions: close family relationship. Not considered “arms length”
Personal losses
Depreciation
Most common method is MACRS
Deducts more upfront to lower revenue
Basis is reduced annually by allowable depreciation.
Even if depreciation expense is not claimed, basis is lowered every year
MACRS personal property
5 years: autos, trucks, computers copiers
7 years: furniture and fixtures, machinery, other equipment
Computed using the 200% declining balance method (3, 5, 7, and 10)
Salvage value is ignored under MACRS
Half year convention applies to most personal property. Property is treated having been placed in service or disposed of halfway through the year. Built into the tables.
If property is disposed of before the last year, take full MACRS rate and multiply by 50%
MACRS mid quarter convention
If more than 40% of personal property is placed into service in the last quarter of the year, the mid quarter convention is used.
Property is treated as having been placed into service or disposed midway through the quarter.
Separate tables that correspond to the appropriate in-service quarter
If the disposal occurs prematurely, the full year MACRS rate must be multiplied by a mid quarter ratio for the mid quarter convention in the year of disposal and multiplied again by 12.5%
Macrs Depreciation: real property
There is usually more wear and tear on residential property vs. Non residential. As such, it is depreciated more quickly under MACRS
Ignore salve value
Residential property: use straight line depreciation over 27.5 years
Nonresidential property: SL over 39 years
Remove land from the calculation
MACRS depreciation: mid-month convention
One half month is taken in the month the property is placed in service and when it’s disposed
Section 179 depreciation
Used for personal property, unless it’s a qualified real property improvement. Must be nonresidential real property.
Maximum annual deduction allowed. Currently 1.22M. Increases annually for inflation.
Dollar for dollar phase out if the purchased property exceeds $3M
Must be acquired from an unrelated party. Limited to taxable income. Cannot be used to create a loss or if you’re operating at a loss.
If the amount of the property is under the maximum allowable amount and phase about amount, the full amount is deductable
Bonus depreciation
Allows for an additional deduction of qualified property placed service. Qualified property must have a recovery period of 20 or less. Can’t be acquired by a related party
Order of deductions
First: Section 179 deduction
Amount > 3.05M - 3.05M = a
1.22M - a = 179 dep deduction
Second: Bonus depreciation
Amount - MACRS deduction = a
A * 60% = Bonus dep. Deduction
Third: MACRS
Amount - section 179 deduction - bonus dep deduction = a
a * MACRS table % = MACRS deduction
Total cost recovery deduction is the sum of the three totals
Amortization
Amortized straight line with a full month convention.
Tax rule - amortized SL over 15 years
GAAP - subject to impairment test
Infinite life intangibles aren’t amortized
Amortization: recovery period
Section 197: Purchased intangibles
Amortized over 180 months, beginning with the month purchased, regardless of the useful life
Capitalized R&D costs
5 years for domestic, 15 years for foreign research, beginning with the midpoint of the year in which the costs were incurred. Costs are no longer amortized once the patent is obtained
If just the patent or copyright is purchased
Amortize the remaining life separately
Loan costs
Amortize debt issuance costs over the term of the loan
Organizational Costs or startup costs amortization
Amortize any remaining costs after the 5,000 expense allowance over 180 months, beginning when the business starts
Any time the amount exceeds 50k, a dollar for dollar phase out begins
C corp gross income
Similar to individuals
Corporate taxation - income is recognized when RECEIVED. this differs from GAAP.
Cash received in advance of accrual GAAP income is taxed, such as:
Interest income received in advance
Rental income received in advance including deposits
Royalties received in advance
These are known as temporary differences.
Some GAAP items are not included in taxable income:
Interest income from state or muni bonds
Certain proceeds from life insurance on key employees, when the corporation is the beneficiary. Anything that exceeds the premiums paid is taxable though.
These are known as permanent differences.
Corporate capital gains are taxed at the same rate as ordinary corporate income.
Cash vs accrual
Cash basis is used for individuals whose annual gross receipts do not exceed 30 million for the prior three year period. Also used by qualified personal service corporations
Accrual basis is used when:
Accounting for purchases and sales of inventory as long as they exceed 30 million for each of the prior 3 years
Tax shelters
Farming corporations as long as they exceed 30 million of annual gross receipts for the last 3 years
C corps, trusts with unrelated trade or business income, and partnerships where a C corp is a partner, provided the c corp exceeds 30 million of annual gross receipts for the last 3 years
Trade or business deductions (ordinary and necessary business expenses)
Most are generally deductible.
Expenses must be:
Common in the profession
Related to the production of CY income
Examples:
Reasonable salaries
Rentals
Supplies
Travelling expenses
Executive comp:
Publicly held corps may not deduct more than $1 million in comp for the CEO, CFO, and three other most highly comped officers.
Entertainment expense:
For officers, directors, and shareholders with more than 10%, may be deducted only to the extent that they are included in the individuals gross income
Corporations are allowed to deduct shareholding employee salary expenses to the extent that they are reasonable. If unreasonable, the expense is reclassed as a dividend distribution and taxable to the c corp
Bonus accruals
Are deductable in the CY if the liability is accurate and it is paid within 2.5 months of YE
Bad debt: specific charge off method
Accrual basis taxpayers must use the direct write-off method. The allowance method isn’t allowed for tax purposes.
Cash basis taxpayers wouldn’t have included AR in their revenue, so no bad debt write off is allowed to be deducted. Exception: uncollectible check
Business interest expense
Most interest paid or accrued during the tax year on debt is deductible. If the average gross receipts for the last three taxable years exceeds 30 million, interest expense deduction is limited by the sum of:
Business interest income
30% of ATI
Floor plan financing (debt used to acquire motor vehicles for sale or lease where the debt is secured by inventory)
If your business interest exceeds the threshold amount, it can be carried forward forever.
Prepaid interest expense
Must be allocated to the period to which it is related
Interest expense on debt incurred to purchase “tax free” bonds
Is not deductible
Charitable contribution deduction
Contribution is deductible up to 10% of their taxable income. If it exceeds 10%, the extra can be carried forward for five years
Any accrual must be paid within 3.5 months after YE
Charitable contributions, calculation
The 10% is calculated before:
The charitable contribution,
The dividends received deduction,
Or any capital loss carryback
Business loss or casualty loss related to the business
Any loss sustained during the taxable year, and not compensated for via insurance, is deductible.
Loss may be treated as ordinary income or capital loss, dependent on the type of asset.
Treated differently than individuals in a federally declared disaster area.
Two types of damage: partially vs totally destroyed
Partially destroyed:
The loss is limited to the lesser of the change in FMV or the adjusted basis immediately before the casualty (NBV), less insurance proceeds
Fully destroyed:
The amount of the loss is the NBV - insurance proceeds
Organizational expense and startup costs
Same rules as partnerships
Can elect to deduct up to $5k each.
If it exceeds 50k, the 5k is reduced dollar for dollar, so totally phased out at 55k.
Any excess org costs or startup costs are amortized over 180 months
Excluded costs include costs to raise capital (issue stock)
Purchased goodwill: book vs tax
Tax - amortized SL over 15 years
GAAP - not amortized, check for impairment
Life insurance premiums
If the beneficiary is the corp, premiums paid are not deductible.
If the beneficiary is the employee, the employee owns the policy (fringe benefit), the premiums are deductable
Business gifts
$25 per recipient per year is deductible
Business meals
50% deductible by the corp
Business entertainment expenses aren’t deductible
Penalties
Are not deductible
Sexual harassment and abuse are not deductible if
The settlement or payment is subject to an NDA
Taxes paid through the corp
State and local taxes and federal payroll taxes are deductible when incurred on property or on income related to business
Federal income taxes aren’t tax deductible
Foreign income taxes may be used as a credit
Lobbying and political expenses
Are not deductible
Capital losses for corps
3k deduction is allowed for individuals, but not corporations.
Corporations can only use cap losses to offset cap gains. Leftover losses can be carried back 3 years or forward five years
Inventory valuation
Certain costs normally expensed must be capitalized when the taxpayer exceeds an average of 30 million over the last 3 years
Dividends received deduction
Designed to avoid triple taxation.
The amount of avoided tax depends on the dividend income
Also depends on the percentage of the investee corporation owned by the investor corporation
Three tiered of DRD
0-<20% is a 50% DRD
20-<80% is a 65% DRD
80% or more is a 100% DRD due to consolidation
To qualify for the DRD
Shareholder must own the stock at least 46 days during a 91 day period
The 91 day period must begin on the date 45 days before the ex-dividend date
DRD taxable income limitation
Lesser of 50%, 65%, or 100% of the dividends received or the same percentage of taxable income computed without regard to the DRD, NOL carry forward, or cap loss carryback
Exception: doesn’t apply if taking the full DRD results in a loss. Then you’d take the GREATER of the two numbers
Entities not available to take the DRD
Personal service corps
Personal holding company
S corps
Don’t take it personally
100% DRD
Affiliated corporations and SBIC’s
Schedule M1 and M3 on the 1120
M-1: shows book income and all the items in categories. Presents a reconciliation of book income to tax income. Doesn’t distinguish between temporary and permanent differences
M-3: large corporations with assets of $10 million or more are required to use schedule M-3, which is more detailed. Distinguishes between temporary and permanent differences
C corp filing requirements
1120 due 4.5 months after year end (9/15 for 6/30 year ends)
If the due date falls on a federal holiday, it’s due the next day
Form 7004 allows for a 6 month extension. Not an extension for paying the tax due, just for filing the return. 6/30’s have a 7 month extension
Estimated payments for corporate tax
Due on 4/15, 6/15, 9/15, and 12/15
Pay one fourth of the estimated tax with each payment
Unequal payments may be made using the annualized income method
An underpayment penalty occurs due to late payments, and when the amount owed in the return is $500 or more
Corporations other than large: taxable income less than 1 million during the last 3 years. Required to pay the lesser of 100% of the tax shown this year or 100% of the tax shown last year. Cannot be used of no tax was owed last year or if business started midyear last year
Large corporations: income of 1 million or more in any of the last 3 years. Must pay 100% of CY tax
Flat tax rate and taxable income
Taxable income is calculated by:
Gross income
- allowable business expenses
= Taxable income
* 21%
= Amount of tax owed
Tax credits
General business credit:
Combination of any of the following: investment credit, work opportunity credit, alternative fuels credit, r&d credit, low income housing credit, pension startup credit
Limitation: cannot exceed net income tax less 25% of net regular tax liability above 25k
Can be carried back one year or forward 20 years
Foreign tax credit
Corp may choose between taking a credit and taking a deduction for taxes paid or accrued. If the company elects the credit they can’t take the deduction
Calculation:
- Determine the foreign income taxes paid or accrued for the tax year.
- Compute the foreign tax credit limitation.
A. World tax income * US tax rate
B. Foreign income/World tax income
C. A * B
- Take lesser of step 1 or 2
Any unused credits can be carried back one year and then forward 10 years
Accumulated earnings tax and personal holding company tax (one or the other is paid)
Accumulated earnings tax: penalty tax imposed if RE are in excess 250k, and not paid out to high bracket shareholders. Only imposed if they’re improperly retained. Taxed at a 20% rate. Personal service corporations are capped at 150k. Only imposed on c corps. To avoid this, there must be a specific plan on the use of the RE or if there is a need to buyback stock from a deceased shareholder. Just because stock is held by many, doesn’t matter. IRS assessed
Personal holding company tax:
Corporations set up by higher bracket individuals that channel investment income to pay tax at a lower rate. This is legal. More than 50% of the corporation is held by 5 or fewer people and the corporation has 60% of it’s income from net rent, taxable interest, royalties or dividends from domestic companies. Taxed at an additional 20% on net income not distributed to shareholders. Not subject to accumulated earnings tax. Self assessed and filed on 1120 PH.
Net operating losses carryback and carry forward rules
Same as individuals
- NOL prior to 2018:
Can be carried back two years and forward 20 years. Carry forwards can offset 100% of future taxable income - For 2018, 2019, and 2020
Can be carried back 5 years and carried forward indefinitely. Carry forwards can offset 100% of the years mentioned. Any further than that, it can only offset 80% of income - For 2021 or later
Cannot be carried back but can be carried forward indefinitely. Can only offset 80% of income
Charitable contribution deductions can’t be used to make a greater loss. PY NOLs can’t be used to make or increase an NOL
Capital losses
The 3k deduction for net capital losses for individuals is not available for corps.
Corp capital losses can only be used to offset capital gains
Net capital losses are carried back three years and forward five years.
Carried over as short term losses, and only applied against capital gains
S corp eligibility
Must be domestic
All shareholders must consent to filing 2553
Can have no more than 100 shareholder
Family members may elect to be shareholder
Corporations and partnerships are not eligible to be shareholders
Charitable organizations and qualified retirement plans can be shareholders
There can be no more than one class of stock. Preferred stock is not allowed
S corp can own shares in a c corp, but can never file a consolidated tax return
An s corp can create a 100% owned sub in which it owns 100% of the stock
S corp election
Depends on calendar year vs fiscal and existence period
For existing calendar year s corps: s election (2553) filed by March 15 becomes effective as of January 1 of the year you filed. If filed after March 15, it takes effect the next year
For existing non calendar year: s election (2553) filed 3.5 months after their year end, it becomes effective that year. Otherwise it becomes effective the next year
For newly formed corps: if you don’t file for s corp eligibility in 60 days, you’re treated as a c corp that year
S corp new shareholders
Consent of new shareholders isn’t required. S corp continues until terminated
Voluntary term: majority determination of status
Involuntary term: if any shares of an s corp are sold to another corp or partnership
S corp tax year
Normally calendar year
S corps file 1120S
Usually due 3/15
No tax on s corps, like a partnership
Some exceptions:
If it was a c corp
All earnings are passed through to the shareholder and taxed the individual level
Termination of an s corp
If more than 50% vote to terminate
If the corp fails to meet the following:
Corporate or partnership owner
Foreign owner
More than 100 owners (family members count as 1)
If there is an excess of 25% of passive investment income for three consecutive years. MUST have previously been a C corp
Effective date of termination:
S corp can specify the termination date if a vote occurred.
If no date is specified, as long the revocation is filed by 3/15, it takes place this year. After 3/15, it takes place next year
If the corporation fails the requirements, it’s terminated immediately.
If there is more than 25% of passive income for 3 years, termination occurs on 1/1/year 4
Reelection of s corp status
S corp must wait until the beginning of the fifth year to elect a corp status again
Short tax years
When terminated, S corp applies for part of the year, C corp for the other part
Could create two short tax years for both S and C corp sides. This happens based on the voted upon date or failure date
Allocate based on the number of days or close the books on the date of the conversion
S corp income and loss
1120 s to schedule k to schedule k 1 to 1040
Each shareholder receives a K-1
Allocations are made on a per share, per share basis
S corp vs partnership
S corps shareholders share of ordinary business income is not subject to self employment tax, even if the shareholder is actively involved in operations
Partners run the partnership, but shareholders do not run the corporation.
S corp separately stated items
These flow through to the shareholders:
Rental RE income or loss (schedule E)
Interest and dividend income (schedule B)
Royalties (schedule E)
Net short term cap gain, net long term cap gain, and net section 1231 gain or loss (schedule D)
Charitable contributions (schedule A)
Section 179 items
QBI deduction of 20% may be available
S corp fringe benefits
Deductible: for nonshareholders or 2% or less shareholders
Non-deductible: for shareholders owning more than 2% unless it’s included in the W-2 as income
S corp stock and debt basis
Same as partnerships
B + A - S = E
Unlike partnerships, S corp shareholders do not include debt in their stock basis. Debt basis is accounted for separately. These are loans from the shareholder to the s corp. Added together, this is the “Tax Basis”
S corp tax basis limit
If an s corp suffers a loss, the shareholder can deduct that loss on their individual return if they have enough tax basis to do so (combination of stock and debt basis)
If there is a loss in excess of the tax basis, the loss is suspended until the tax basis is reinstated. Stock basis is reinstated when income, gains, and additional contributions. Debt basis is reinstated first, then stock basis.
Suspended losses are carried forward forever.
If suspended losses remain when the s corp is disposed of, the suspended losses disappear.
Accumulated Adjustments Account (AAA)
This is RE for an S corp
