Tax 1-9 Evaluate a situation to select fundamental methods of managing the client’s tax liability. Flashcards
Managing the client’s tax liability
Mark Ford contributed $ 12,000 to his company’s 401(k) account this year. What 2 tax planning strategies did Mark employ?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9)
a. tax reduction
e. tax deferral
Managing the client’s tax liability
Carl Rain purchased $ 60,000 of municipal bonds for his portfolio. What tax planning strategy did Carl employ?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9)
b. tax avoidance
Managing the client’s tax liability
- Which of the following statements regarding capital gains is correct?
a. Net long-term capital gains are subject to a 0% tax rate if the taxpayer is in a 10% or 15% marginal income tax bracket.
b. Net short-term gains are subject to a taxpayer’s ordinary income tax rate.
c. A maximum rate of 28% applies to long-term gain on collectibles.
d. All of the above.
(1-9)
d. All of the above.
Net long-term capital gains are subject to a 0% tax rate if the taxpayer is in a 10% or 15% marginal income tax bracket. Net short-term gains are subject to a taxpayer’s ordinary income tax rate. A maximum rate of 28% applies to long-term gain on collectibles.
Managing the client’s tax liability
What is the use of exclusions and deductions to reduce the current income tax liability?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9)
b. tax avoidance
Managing the client’s tax liability
What is postponement of the ultimate taxes that must be paid on the income?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9)
e. tax deferral
Managing the client’s tax liability
What is converting short-term capital gains (ordinary income) to long-term capital gains, taxed at favorable rates lower than the marginal rates?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9)
d. conversion
Managing the client’s tax liability
What is the transfer of income-producing assets to another taxable entity, typically another individual in a lower marginal income tax bracket than the transferor?
a. tax reduction
b. tax avoidance
c. income shifting
d. conversion
e. tax deferral
(1-9, pg 78)
income shifting
Because some individuals are in higher tax brackets than others, shifting income from the higher-taxed person to the lower-taxed person is one advantageous tax strategy. This is often accomplished by a parent gifting income or gain-producing investments assets to a child. This situation falls under the so-called “kiddie tax” rules. The child will generally pay no taxes on the first $1,050 of investment income and pay a probable lower rate than the parents on the next $1,050.
Managing the client’s tax liability
Taxpayers who have long-term capital gains (and qualifying dividends) will calculate their tax liabilities Schedule __.
(1-9, pg 77)
D
On a worksheet for Schedule D, the net long-term capital gains and qualifying dividends are subtracted from the taxable income. The regular tax is calculated on this reduced amount. The applicable preferential rates are then applied to the net long-term capital gains and the qualified dividends to determine the tax on these items. The amounts from these two computations are combined to provide the tax on all taxable income.
Managing the client’s tax liability
Assume, for example, that a married taxpayer filing jointly has taxable income of $160,200 for 2016. Included in the taxable income is $15,000 of qualifying dividends and net long-term capital gains. The tax would be computed as follows:
1-9
$160,200 total income
$15,000 qualifying dividends
So, $145,200.00 is ordinary income
Using tax tables, the couple is in the 75,300 to 151900 bracket. So they must pay $10,367 + the amount over 75300 * 25% = $17,475.00 for a total of $27,842.50.
Then the $15,000 qualifying dividends are taxed at a rate of 15% becauase in the 25% tax bracket for a total of 2,250.00.
All together, the couple owes $30,092.50
Practice Test 1
Managing the client’s tax liability
- Neil McElroy is an engineer for Causley Computer Inc. In addition, Neil operates a janitorial service that cleans several local office buildings. Neil was divorced four years ago, and his wife received custody of their two children. He has assembled the following information for preparation of his tax return for the current tax year.
71,500 (salary) 9,500 (interest income) 1,500 (monthly alimony paid to ex spouse) 500 (monthly child support) 10,000 (purchase of business equipment) 5,500 (IRA contribution)
Based on the information given, which of the following are fundamental methods of managing Neil’s tax liability?
I. Tax credit: Neil could take an investment tax credit for purchases of qualifying business equipment.
II. Deductions for AGI: Neil may deduct alimony payments of $18,000 made to ex-spouse.
III. Deductions for AGI: Neil may deduct child support payments of $6,000.
IV. Exclusions: Neil could have invested in municipal bonds to receive tax-free income.
I and III only
II and IV only
I, II, and IV only
I, III, and IV only
II, III, and IV only
(LO 1-9)
II and IV only
Neil may deduct alimony paid to the former spouse, and indeed may invest in municipal bonds to receive tax-free income. There is no investment tax credit for equipment purposes. Some students confuse this with the Section 179, but that provision provides a deduction, not a credit. Child support payments are specifically nondeductible.
Practice Test 2
Managing the client’s tax liability
- Martin and Jan Matthews, both age 43, have lived in their house for 12 years but must move to another city at the end of the year due to Jan’s change of employment. The original cost of their house was $75,000. The fair market value of their house is $410,000. They have located a single-family home priced at $330,000 in the city to which they are moving. The Matthews are trying to decide what they should do with their present house when they move.
Which one of the following alternatives would be the most appropriate for them and would offer the greatest tax savings?
a. making a like-kind exchange of their house for the single-family home to defer any gain
b. renting their house now and selling it when they are both age 55 so that the gain will be excluded
c. selling their house and excluding the gain
d. selling their house through an installment sale to defer any gain
(LO 1–9)
c. selling their house and excluding the gain
They may exclude the full gain from the residence under the Section 121 rules. They have owned and lived in the residence for at least two of the five previous years.
Answer choice a. is incorrect because the like-kind exchange rules do not allow for an exchange of personal use property.
Answer choice b. is incorrect because of the two years out of five years ownership and use rule.
Answer choice d., although a possibility, is not as beneficial from a tax standpoint because the gain realized would be recognized over a period of years. The purchase of the new residence is irrelevant under Section 121.
