REG Lecture 1

Question 1

When should a cash basis taxpayer report income?

Answer 1

A cash basis taxpayer should report income in the year in which income is either actually or constructively received whether in cash or property.

Question 2

State the basic tax formula.

Answer 2

Gross Income
LESS Adjustments

Adjusted Gross Income

LESS Deductions (greater of itemized OR standard)
LESS Exemptions
Taxable Income

x Federal Income Tax
LESS Tax Credits
Other Taxes
LESS Prepayments
Tax due OR refund

Question 3

Identify the due date and extension available for individuals.

Answer 3

Due Date: April 15

Extension: Form 4868–Automatic six months

Question 4

Identify the various filing statuses.

Answer 4

• Single
• Married, filing jointly
• Married, filing separately
• Head of household
• Qualifying widow(er) with dependent child

Question 5

What are the criteria for filing single?

Answer 5

• Unmarried or legally separated from spouse at the end of tax year.
• Does not qualify for another filing status.

Question 6

What are the criteria for filing married filing jointly?

Answer 6

At year-end of tax year:

• Married and living together as husband and wife; or
• Living together in a recognized common law marriage; or
• Married and living apart but not legally separated or divorced.

Question 7

What are the criteria for filing married filing separately?

Answer 7

At year-end of tax year:

• Married; and
• If one spouse wants to be responsible only for own tax; or
• If both spouses do not agree to file a joint return.

Question 8

What are the criteria for filing head of household?

Answer 8

• Individual is not married, legally separated, or is married and has lived apart from his/her spouse for the last six months of the year
• Individual is not a “qualifying widow(er)”
• Individual is not a nonresident alien
• Individual maintained a house that for more than half the taxable year is principle residence of a:
  
  • son or daughter who is a qualifying child or qualifies as the taxpayer’s dependent (qualifying relative);
  • a dependent relative who resides with the taxpayer; or
  • a dependent father or mother, regardless of whether they live with the taxpayer.

Question 9

What are the criteria for filing qualifying widow(er) (surviving spouse)?

Answer 9

• Unmarried at end of tax year; and
• Surviving spouse must maintain a household, which for the entire taxable year was the principal place of abode of a son, stepson, daughter or stepdaughter; and
• The surviving spouse is entitled to a dependency exemption for the son, daughter, etc.

The taxpayer qualifies for this status for two years after year of death of spouse.

Question 10

Name the tests for claiming an exemption for a “qualifying child.”

[CARES]

Answer 10

A taxpayer is entitles to an exemption for each qualifying child and/or qualifying relative.

QUALIFYING CHILD

• *C**lose relative
• *A**ge limit (19/24) and younger than the taxpayer
• *R**esidency and filing requirement
• *E**liminate gross income test (exemption required)
• *S**upport test changes

Question 11

Name the tests for claiming an exemption for a “qualifying relative.”

[SUPORT]

Answer 11

A taxpayer is entitles to an exemption for each qualifying child and/or relative.

QUALIFYING RELATIVE

• *S**upport (over 50%) test
• *U**nder the personal exemption amount of (taxable) gross income test
• *P**recludes dependent filing a joint tax return test
• *O**nly citizens (residents of USA/Canada or Mexico) test
• *R**elative test OR
• *T**axpayer lives with individual for the whole year test

Note that either the R or T test must be met. Although both of them may be met, only one is required.

Question 12

What are the requirements for a multiple support agreement?

Answer 12

• Two or more people together provide more than 50% of support, but no one contributes more than 50%
• To claim the exemption, a person must provide more than 10% of support, and meet the other dependency tests
• A multiple support declaration, Form 2120, must be filed

Question 13

Define gross income.

Answer 13

Gross income includes all income from whatever source derived, unless specifically excluded.

Question 14

What are the four categories of individual income?

Answer 14

Categories of Individual Income:

• Ordinary (wages, salaries)
• Portfolio (dividends, interest)
• Passive (real estate investment limited partnership income, and some S corporations)
• Capital

Question 15

Name some nontaxable fringe benefits (exclusions).

Answer 15

• De minimis fringe benefit
• Qualified tuition reduction
• Qualified employee discounts
• Employer paid accident, medical and health insurance

Unless specifically excluded by law, the fringe is includable in gross income.

Question 16

Are life insurance premiums paid by an employer taxable to an employee?

Answer 16

Premiums on the first $50,000 (face amount) of group term life insurance are not includable in gross income. Premiums paid for coverage above $50,000 should be included in gross income. This is calculated from an IRS table, and is not the entire amount of the premium over $50,000.

Question 17

Give some examples of exempt interest.

Answer 17

Exempt interest examples:

• State and local government bonds
• Bonds of a U.S. possession
• Series EE (U.S. Savings Bond) if used for higher education
• Interest on Veterans Administration insurance

Question 18

What is the tax treatment of unearned income of a child who falls under the “kiddie tax” rules?

Answer 18

Net unearned income of dependent child who falls under the “kiddie tax” rules are taxed at his parents’ higher tax rate.

Net unearned income = Child’s total unearned income less the child’s standard deduction of $1,050 (in 2015) (or investment expenses, if greater) less an additional $1,050 (which is generally taxed at the child’s rate of 10% or 15%).

Question 19

State the tax treatment of property settlements in a divorce.

Answer 19

For a property settlement in a divorce, the transferring spouse gets no deduction for payments made (or property transferred), and the payments are not includable in the gross income of the spouse receiving the payment or property.

Question 20

What are the requirements for alimony to be deductible by the paying former spouse and includable by the recipient?

Answer 20

• Payments must be legally required pursuant to a written decree
• Payments must be in cash or its equivalent
• Payments cannot extend beyond death of payee
• Payments cannot be made to members of same household
• No joint tax return filed

Before alimony is taxable by the recipient, any child support due must be paid.

Question 21

Describe the self-employment tax.

Answer 21

• All net self-employment income is subject to the 2.9% Medicare tax, but only self-employment income up to $118,500 (in 2015) is subject to the 12.4% Social Security tax.
• An adjustment to income for one-half (e.g. 7.65% on up to $118,500 self-employment income for 2015) of self-employment tax (Medicare plus Social Security) paid.

Question 22

On what property do the uniform capitalization rules apply?

Answer 22

• Real or tangible personal property produced by the taxpayer for use in his trade or business
• Real or tangible personal property produced by the taxpayer for sale to customers (manufacturer’s inventory)
• Real or tangible personal property purchased by the taxpayer for resale (retailer’s inventory)

Exception: The uniform capitalization rules do not apply to (retailer’s inventory) property purchased for resale if the taxpayer’s gross receipts for the preceding three tax years do not exceed $10,000,000 annually.

Question 23

When are funds in a nondeductible IRA taxable?

Answer 23

Withdrawals from nondeductible IRAs are partially taxable.

When withdrawn, amounts previously contributed (principal) are nontaxable. Any earnings on those contributions are taxable when withdrawn.

A pro rata allocation is generally applied to the distribution to determine the taxable amount.

Question 24

What is the formula to determine the excludable portion of an annuity?

Answer 24

Excludable amount in current year = [Investment in contract/Age factor (in months)]

Note: If the annuitant lives longer than the factor in months, further payments are fully taxable. If the annuitant dies before the factor payments are collected, the unrecovered portion of the investments is a miscellaneous itemized deduction on the annuitant’s final tax return (not subject to the 2% limitation).

Question 25

In premature distributions of an IRA, what are the exceptions to the penalty tax?

[HIM DEAD]

Answer 25

• Home buyer (first time): $10,000 max if used toward first home (within 120 days)
• Insurance (medical)
  
  • unemployed with 12 consecutive weeks of unemployment compensation
  • self-employed (who are otherwise eligible for unemployment compensation)
• Medical expenses in excess of 10% of AGI (or 7.5% if 65 or over)
• Disability
• Education: College, tuition, books, fees etc.
• and
• Death

Question 26

How is rental income from a vacation house treated?

Answer 26

1. If rented fewer than 15 days: Treat as personal residence.
2. If rented 15 or more days and personal use is not more than 14 days or 10% of day rented, if greater: Treat as rental property.
3. If rented more than 15 days and personal use is greater of 14 days or 10% of days rented: Allocate rental expenses to extent of rental income.

If treated as personal, income excluded and deductions for mortgage interest and taxes are reported on Schedule A. Other expenses are not deductible.

If the vacation property is treated as a rental property, the taxpayer reports income and deductions on Schedule E.

Question 27

Define passive activity. Give some examples of passive activities.

Answer 27

A passive activity is any activity in which the taxpayer does not materially participate.

Rental activities, interests in limited partnerships, and S corporations are examples of passive activities.

Note: Rental activities are passive by definition, even is the taxpayer does materially participate.

Question 28

What is the tax treatment of nondeductible passive activity losses?

Answer 28

• Nondeductible passive activity losses are unused passive activity losses that are held in suspension.
• Used to offset passive income in future years (indefinitely).
• Fully tax deductible in the year the property is disposed of (e.g., sold)

Question 29

What are the rules to determine taxable Social Security benefits?

Answer 29

Taxpayers are classified into five categories depending on the level of provisional income, which is defined as AGI plus tax-exempt interest plus 50% of Social Security benefits.

• Low income: No social security benefits are taxable
• Lower middle income: less than 50% of Social security benefits are taxable
• Middle income (over single $25K/MFJ $32K): 50% of Social Security benefits are taxable.
• Upper middle income: Between 50% and 85% of Social Security benefits are taxable
• Upper income (over single $34K/MFJ $44K): 85% of Social Security benefits are taxable

Question 30

Are scholarships and fellowships includable in gross income?

Answer 30

For a degree-seeking student, scholarships and fellowships are excludable up to the amounts spent on tuition, fees, books, and supplies. All remaining amounts are includable in gross income.

For a non-degree-seeking student, all amounts are includable in gross income.

Question 31

What are the test for foreign-earned income exclusion?

Answer 31

Tests for foreign-earned income exclusion:

• Bona fide residence test (an entire taxable year)
• Physical presence test (330 full days out of 12 consecutive months)

Question 32

List some nontaxable miscellaneous income items (exclusions).

Answer 32

Examples of nontaxable miscellaneous income items:

• Life insurance proceeds
• Gift and inheritances
• Medicare benefits
• Workers’ compensation
• Personal (physical) injury or illness award
• Accident insurance–premiums paid by taxpayer
• Foreign-earned income exclusion

Question 33

Describe the employee and employer taxation of nonqualified employee stock options.

Answer 33

Employee Taxation

• If there is a readily ascertainable value, the employee recognizes ordinary income in that amount in the year granted.
• In there is no readily ascertainable value, the employee recognizes ordinary income based on the fair value of the stock purchase less any amount paid for the option on the exercise date.

Employer Taxation

• The employer may deduct the value of the stock option as a business expense in the same year the employee recognizes ordinary income.

Question 34

Describe the employee and employer taxation of incentive stock options (ISOs).

Answer 34

Employee Taxation

• Generally, ISOs are not taxed as compensation. Basis of the stock is the exercise price plus any amount paid for the option. Generally, any gain or loss on the subsequent sale is capital.

Employer Taxation

• Generally, employers do not receive a tax deduction for ISOs.

Question 35

Describe the employee and employer taxation of employee stock purchase plans (ESPPs).

Answer 35

Employee Taxation

• Generally, ESPPs are not taxed as compensation. Basis of the stock is the exercise price plus any amount paid for the option. Generally, any gain or loss on the subsequent sale is capital.

Employer Taxation

• Generally, employers do not receive a tax deduction for ESPPs.