Tax Flashcards
Congressional committee reports
Explains the intent of tax laws.
Sham transaction
Intended for tax avoidance
Penalty for tax fraud
75% of tax due
Step transaction
Ignore the individual transactions and instead tax the ultimate transaction
Substance over form
An example is a president of a company receiving a loan from said company but never intending to pay it back
Assignment of income
An example is a parent giving income to the child due to being in a lower tax bracket
Schedule C income
Business income that must be included in gross income for tax purposes.
Scholarships and taxable income
Tuition and books are excluded from income but room and board are taxable. Entitled to standard deduction.
Taxable fringe benefits
Health insurance premiums paid for self-employed, partners, and more than 2% owners of an S corporation. 100% is deductible. Does not include disability insurance premiums.
Group life policy
Taxable in excess of $50k if the plan is nondiscriminatory.
Adjustments
IRA contributions, student loan interest, Keogh or SEP, self-employment tax, certain alimony paid, self-employment health insurance, moving expenses for military, penalty for early withdrawal of savings, HSA, $4k educational expense
Calculation of a deductible loss
Step 1: Use the lesser of basis or FMV
Step 2: Subtract any insurance coverage
Step 3: Subtract $100 (floor)
Step 4: Subtract 10% of AGI
Personal exemption
Always 0
Marginal tax rate
Percentage applying to the last dollar of taxable income.
Kiddie tax
- $1,250 standard deduction (no tax). If earned income is greater, add $400
- Next $1,250 taxed at 10%. Amounts greater than $2,500 taxed at the parents’ marginal tax rate.
Unearned income under $2,500 re kiddie tax
No need to know parent’s tax rate.
Self-employed income
Either salary or investment income. Does not include distribution from an S corporation
Childcare credit vs. child credit
$6k x 20% = $1200 vs. $2k x 3 = $6,000
Tax deduction vs. tax credit
Deduction is worth more to a high-bracket taxpayer and a credit is worth more to a low-bracket taxpayer.
Medical expense deduction
Not deductible if it has been reimbursed, subject to 7.5% of AGI floor, only deductible if itemizing, includes medical insurance premiums.
Child support payments
Not included in gross income
Itemized and standard deductions
Deductions from AGI
Cash gift at work
Subject to gift tax but not income tax
Margin interest
Only deductible up to investment income
S corporation wages
Subject to FICA, not self-employment taxes
Value of personal casualty loss (federally declared disaster)
The lower of basis or FMV
Investment interest expense
Deductible up to the amount of the year’s net investment income.
Phaseout of itemized deductions
Eliminated for 2018 through 2025
Constructive receipt and cash method
Revenue from services performed in the year the payment is received, regardless of when the services were performed.
Accrual method
Realize revenue when the earnings process with goods or services they provide is complete, regardless of when payment is received.
How does a business increase cash flow?
When they collect the revenues owed.
Installment sales
Permits capital gain recognized to be spread over the life of the note rather than in the year of the sale.
LIFO
Reduced earnings, deferral of taxes, understated inventory
FIFO
Increase earnings, greater tax liability, current cost inventory. Company will sell its lowest cost goods first.
What does a net operating loss (NOL) accomplish?
Corporations can utilize losses from prior years to offset current year income. Can only carry forward.
NOL and Schedule C
Losses attributable to a sole proprietorship can be claimed on personal 1040 and reduce AGI.
Accounting method for $25m or more in revenues
Accrual
How will inventory be reflected with FIFO?
It will reflect current cost.
Why would a business use the accrual method?
It maintains inventory
When can the sale of property be recognized under the installment method?
Property sold is undeveloped land.
S Corporations and NOL
S corps can’t use NOL because they already pass-through annual losses.
What inventory method to use to reduce taxes in an inflationary period?
LIFO
Qualified Business Income (QBI)
Net income (profit) from a pass-through business
Difference between a C Corp and an S Corp/Partnership/Sole Proprietorship
C Corp is not a pass through entity, so can’t utilize a tax deduction.
Personal service corporation (PSC)
H - Health (doctors, dentists, etc)
A - Accounting, architect, actors
L - Law
E - Engineering
Taxed at 21%
Advantage of S Corp over C Corp
Owner can take excessive compensation and not have it classified as dividends
Advantage of LLP over LP
LP only works for passive investors.
S Corp vs. Partnership
Basis in S Corp is determined up to cash contributed, so it doesn’t include loans from third party.
C Corp vs. S Corp
You become a PSC as a C Corp, meaning a flat tax of 21%. S owner means excess income is taxed at personal tax bracket.
Schedule C losses
Can reduce AGI
LLC advantage over S Corp
Same basis as a partnership, which would take more losses. An S corp has less losses they can deduct.
Regular corporation (Form 1120)
Can help reduce taxes by providing owner with a separate tax entity.
How does a regular corporation report earned income?
Form W-2 for employees and Form 1099 for dividends to shareholders
Trusts and Estates differences
An estate continues until all assets have been transferred and debts/taxes have been paid. A trust may benefit several generations.
Estates filing
Either the income tax return (1041) or as deductions from the gross estate (706)
Trusts filing
Form 1041. Share of income is reported on Schedule K-1
When should a fiduciary file a 1041 return for the estate or trust?
When there is any taxable income for the year, when there is gross income over $600, or when a beneficiary is a nonresident alien.
Taxable year for trusts and estates
Estates may select any calendar tax year or fiscal year. Trusts, except for a charitable (501(a), must use a calendar year.
Unfunded ILIT vs. funded ILIT
Unfunded: Yearly gift to the trust pays the life insurance premium (not income taxable to grantor)
Funded: Investment income from investments in the trust pays the insurance premium (taxable to the grantor)
Simple trust
Conduit for forwarding income to beneficiaries, who pay taxes on their own tax brackets (distributable net income)
Complex trust
It is irrevocable, grantor has not retained any control, and income is accumulated.
Income accumulated is taxed to trust. Income distributed is taxed to beneficiary.
Revocable trust
Grantor trust where grantor will be responsible for any income tax liability.
Irrevocable trust
Non-grantor trust that can be taxed as a simple or complex trust depending whether income is distributed in a specific tax year.
Complex trust exemptions
If required to distribute income, it is $300. If not required to distribute, $100.
Distributable net income (DNI) rules
Claim a deduction for the amount distributed.
Limit the portion of the distribution that is taxable to the beneficiaries.
Ensure the character of the distributions remains the same for the beneficiary as it was to the trust.
When is a grantor trust tainted?
When trust income will be used to pay life insurance premiums.
Estate and business expenses
An estate is entitled to take a deduction for ordinary and necessary business expenses.
When will trust income be taxed to the grantor?
If the trust income is used to satisfy a grantor’s legal support obligation.
What does not increase basis?
Repairs, real estate taxes, and normal business expenses.
Adjusted basis
Cost basis less cost recovery (deductions)
Cost basis
The original investment plus improvements
Modified Accelerated Cost Recovery System (MACRS)
Applies to all recovery property (not land or intangibles) placed in service after 1986.
1245 property
Equipment that has a short depreciation schedule. Not expensed immediately, unless under Section 179.
Repair to 1250 property
Trigger an immediate tax deduction
Spouse basis in community property
Full step-up in basis at death of first spouse.
AMT Preference Items
Private-activity municipal bond
Oil and gas % depletion / Excess Intangible drilling costs % depletion
Depreciation (ACRS/MACRS) not straight-line
Add back items in AMT
Property, state, city/income and sales taxes (10k)
Incentive stock option “bargain element” (the excess of the FMV at the exercise date)
AMT Payable
Difference between the AMT total and the regular tax. It is not the AMT total alone.
Examples of reducing AMT payable
Increasing taxable income, selling home and renting a home, paying off current mortgage balance
Example of how to decrease AMT exposure?
Increasing 1040 income tax such as a business owner paying himself a large bonus
Difference between depreciation and straight line depreciation for AMT
Straight-line depreciation is not a preference item.
AMT exemption
Subject to phaseout rules
Losses from passive activities
May only offset profits from other passive activities
Real estate loss deduction
Up to $25k
Home rental tax consequence avoidance
Can be rented up to 15 days with no tax consequence
When is a home treated as a residence?
Personal use exceeds the longer of 14 days or 10% of the period of rental use.
Community property
If separate returns are filed by a married couple, one-half of the community income must be reported by each spouse
Alimony requirements
For divorces after 12/31/18, alimony payments are no longer deductible, nor must the recipient declare the amount as taxable income.
Non-publicly traded partnership
Passive activity that can be used to deduct losses
How does STRIPS produce phantom income?
As zero-coupon bonds, they produce taxable income that is not received until the bond matures
Exception to passive rules
Active participation in real estate
Standard deduction and charitable deduction
There is no charitable deduction unless you itemize.
Maximum charitable deduction for LTCG property
30% of AGI
Charitable deduction for corporations
File under Form 1120 and limit is 10% of taxable income.
What is excluded from gross income?
Child support
IRA Contributions and AGI
IRA Contributions reduce AGI.
Deductions FOR AGI
Net business losses and net capital losses
Active participation income vs. Active participation loss
Income is included in gross income. Losses are limited to $25k
Income from an S corporation
Not considered to be self-employment income.
S Corp and basis
Limited to capital contribution and direct loans.
Active participation deduction limit
Eliminated at $150,000 of AGI
Wash sale rule
Disallows a loss if identical securities are purchased before 30 days after the sale that resulted in the loss.
STRIPS and children
Least suitable. They are zero coupon treasury bonds that would generate phantom income. The child would be subject to kiddie tax.
Alimony and pre-2019 divorces
Taxable to the payee and deductible to the payor.
LTCG property
Limited to 30% of AGI
When is an IRA contribution not deductible?
When already covered under a qualified retirement plan and when AGI is above the phaseout.
What happens when no boot is received?
No gain is recognized.
Section 179
Expenses for the purchase of business personal property are deductible up to the net income from the business. Deduction can’t create a loss.
How is a policy classified as a MEC?
When it fails the “seven-pay test”
What can increase basis in an S corporation?
Direct loans
When should a business do the cash accounting method?
When they carry both inventory and consignment property.
Excess earnings passed through from an S corporation
Treated as K-1 investment income and are not subject to self-employment tax.
