Tax Flashcards
Basic Rules of Income Taxation
all accretions to wealth, from whatever source derived, constitute income
for every deduction taken for income tax purposes, there must be an inclusion in income (but keep in mind there are exceptions even to these two rules)
3 Types of Income
- Active (Ordinary) income
- Portfolio income
- Passive income
3 Tax Accounting Methods
- Cash method
- Accrual Method
- Hybrid method
3 Key Tax Principles
- Doctrine of Constructive Receipt
- Economic Benefit Doctrine
- Doctrine of the Fruit & the Tree
3 Components for Classifying Gains
- Type of asset that was held
- Use to which the asset was put
- Holding period (how long the asset was held)
3 Types of Assets
- Capital assets
- Ordinary income assets
- IRC Section 1231 Assets
3 Uses of Assets
- They can use it for personal purposes (personal use assets)
- Active conduct of a trade or business (business assets)
- Production of income (production of income assets)
3 Types of Rental Real Estate
- Tax-Free Rental Activities
- Ordinary Rental Use Activities
- Mixed Use Activities
3 Anti-Abuse Provisions
- Alternative Minimum Tax (AMT)
- At-Risk Rule Limitations
- Passive Activity Rules
3 Types of Administrative Rulings
- Revenue Rulings
- Private Letter Rulings
- Determination Letters
3 Types of Final Regulations
- Procedural Regulations
- Interpretative Regulations
- Legislative Regulations
3 Courts to Resolve Disputes
- U.S. Tax Court
- U.S. District Court
- U.S. Court of Federal Claims
Rules of Law
Internal Revenue Code & Treasury Regulations
2 Parts of Federal Income Tax
- Property taxation deals w/ acquisitions, holdings, & dispositions
- Income taxation generally follows the Form 1040
Statute of Limitations (In Years)
In General = 3 years
Understatement of Gross Income > 25% = 6 years
Fraud = no limit
Collection of Deficiency by IRS = 10 years
Refund Claim by Taxpayer = 3 years
Failure to File
5% per month up to 25%
Failure to Pay
0.5% per month up to 25%
Accuracy Related
20% of underpayment up to 30%**
**40% if d/t substantial valuation misstatement, substantial overstatement of pension liabilities, or substantial estate or gift tax valuation understatement
Fraud Penalty
75%
Tax Penalties Partial Months
failure to file & failure to pay:
parts of months are counted as whole months
Tax Court
Tax only cases
taxpayer NOT required to pay the tax
no maximum for amount of claim
no jury trial available
located around U.S.
appeals brought to U.S. Court of Appeals
Tax Court - Small Claims
Tax only cases
taxpayer NOT required to pay the tax
maximum amount of claim = $50,000
no jury trial available
court located around U.S.
No Appeals
U.S. District Court
all types of cases
taxpayer is required to pay the tax
no maximum amount of claim
jury trial is available
court located around U.S.
Appeals brought to U.S. Court of Appeals
U.S. Court of Federal Claims
Claims against the U.S. Government
taxpayer is required to pay the tax
no maximum amount of claim
no jury trial available
located in D.C. only
Appeals brought to the U.S. Court of Appeals - Federal Circuit
If less than $50,000?
Use Small Claims Division of Tax Court
Three Methods of Tax Planning
Planners need to know the income tax rules so they can help clients minimize exposure to taxation while achieving their desired financial goals; 3 Primary Ways:
- Legally avoid taxation
- Deduct expenses to reduce taxable income & take tax credits to reduce taxes due
- Defer income & thus defer taxation
Additional methods to consider:
- Shift income to related taxpayers in lower income tax brackets
- Realize income in a form that is taxed at lower tax rates (LTCG or qualified dividends)
Taxable Income Formulas
Income - Deductions = Taxable Income
Taxable Income x Tax Rate = Tax Liability
Income Definition
broadly defined, means the total amount of money & the FMV of the property, services, or other accretion to wealth received
Partial List of Gross Income Exclusions
Interest income from municipal bonds
Child support payments received
Cash or property received by inheritance
Specified employee fringe benefits
Qualifying distributions from a Roth IRA during retirement
Cash or property received by gift
Deferral contributions to certain retirement plans
Gain on the sale of a principal residence
Scholarship or fellowship
Life insurance proceeds received d/t death of the insured
Items Included in Gross Income
Gains from the sale of assets
Distributions from retirement plans
Rental income
Unemployment compensation benefits
Royalty income
Compensation (salaries, wages, etc.)
Interest income
Dividend income
Alimony received (pre-2019 divorce)
Gross income from self-employment
Partial List of Deductions FOR Adjusted Gross Income (ATL)
Contributions to traditional IRAs
Business expenses
Interest paid on student loans
Rental or royalty income expenses
Losses from the sale of business property
Moving expenses (Armed Forces)
Keogh contributions
1/2 SE tax
HSA deduction
Standard Deduction for a dependent
$1,300 or earned income plus $450 not to exceed the standard deduction amount
Surviving Spouse filing status
a surviving spouse will generally file MFJ in the year in which their spouse dies
Personal & Dependency Exemption
TCJA 2017 repealed the personal & dependency exemption beginning in 2018
Child Tax Credit Refund Amount
refundable up to $1,700 per child
Qualifying Child
MUST meet all 4 tests
- Relationship test
- Abode test
- Age test
- Support test
Qualifying Relative
in addition to the joint return test & the citizenship or residency test, a qualifying relative MUST meet the 4 tests to qualify as a dependent of a taxpayer:
- Relationship test
- Gross Income test
- Support test
- Not a Qualifying Child test
Multiple Support Agreements
- the taxpayer provides more than 10% of the potential dependent’s support
- Two or more persons who individually provide more than 10% also provide more than 50% of the individual’s total support & meets the requirements to claim person as a dependent
Kiddie Tax
Unearned income of a child under the age of 19, or a child under the age of 24 who is a full time student & is claimed as a dependent by their parents, may be subject to income tax at the parents’ tax rate if over $2,600
Earned income is always taxed to the child at the child’s rate
Excess unearned income > $2,600 is taxed to the child at the parents’ rate
Non-Refundable Credits
credits that can be carried back or forward
most important are the child & dependent care, lifetime learning, AOTC, child tax, qualified adoption, & foreign tax credits
Refundable Credits
credits that can generate a refund
most important are the AOTC (partially), earned income credit, & child tax credit (up to $1,700 per child refundable in 2024)
Foreign Tax Credit
take credit or itemized deduction
Credit for Child & Dependent Care
qualifying child < 13 years old
$3,000 for one child; $6,000 for 2 or more children
subject to earned income, 20% general to 35% of actual expenditure ($0-$15,000 income)
typical credit = $3,000 x 20% = $600, $6,000 x 20% = $1,200
American Opportunity Tax Credit (AOTC)
$2,500 first 4 years post-secondary, phaseout $80k-$90k, $160k-$180k
100% first $2,000 qualifying expenses; 25% next $2,000
half-time requirement
Lifetime Learning Credit (LLC)
$10,000 x 20% (all years post secondary)
phaseout $80k-$90k, $160k-$180k
Child Tax Credit
$2,000 for each qualifying child < 17 years old (U.S. citizen, 1/2 support, lived w/ claimant for > 1/2 year)
phaseout MFJ $400k, $200k others
lose $50 per $1,000 over
any additional tax credit unused up to $1,700 may create a refund
Qualified Adoption Credit
$16,810 2024
phaseout $252,150 - $292,150
Earned Income Credit
$7,830 max credit 2024
Other Dependent Credit
$500
Gross Income Definition
all income from whatever source derived unless it is specifically excluded by the Code
Gains Normally Taxed when Realized
gains from property transactions are taxed when they can be objectively determined through a sale or exchange (realization)
Investment Items Included in Gross Income
Capital Gains
Interest Income
Original Issue Discount (OID) Bonds
Accrued income when transferring a debt instrument (gift or sale)
Dividend Income
Qualified Dividends Tax Rate
LTCG
Income from Annuities
an annuity contract is annuitized when regular periodic payments begin for life or for a specified period of time in excess of one year
use inclusion/exclusion ratio
Bodily Injury
Compensatory Damages EXCLUDED
Punitive Damages INCLUDED
Personal Injuries Not Including Bodily Injury
Compensatory Damages INCLUDED
Punitive Damages INCLUDED
Lost Income
Compensatory Damages INCLUDED
Punitive Damages INCLUDED
Any other type of injury
Compensatory INCLUDED
Punitive Damages INCLUDED
3.8% Medicare Tax
3.8% Medicare tax on the LESSER of NII or MAGI over threshold amounts: $250k MFJ, $200k Single, $125k MFS
there is also an additional Medicare tax equal to 0.9% of the wages or self-employment income that is in excess of the same limits
Net Investment Income (NII)
broadly defined term that includes gross income from interest, dividends, annuities, royalties, & rents other than such income derived from the ordinary course of a trade or business, plus other trade or business income, for which the entity is a passive activity, plus net gain attributable to the disposition of property other than property held in a trade or business
NOTE: NII does NOT include any distribution from a 401(k), 403(b), 457(b) plan or an IRA or Roth IRA; however such distributions may cause a taxpayer to exceed the threshold amounts
Foreign Income
taxpayer can exclude up to $126,500 for 2024 of foreign earned income, OR
taxpayer can claim a credit for some or all of the taxes paid to the foreign country, OR
taxpayer’s foreign taxes paid may be deducted as an itemized deduction
Taxation of Fringe Benefits
fringe benefits require the employer to NOT discriminate against different classes of employees, especially employees who are not highly compensated (HC)
Highly-Compensated Employees (HC)
hold a GREATER than 5% ownership interest or have compensation in excess of $155,000 for 2024
Individuals who may enjoy fringe benefits = worker, spouse, dependents, & retirees
Health Insurance = employer premiums deductible/no inclusion
Group Term Life Insurance
an employer can deduct the cost of up to $50,000 of group term life insurance for each employee
employee can exclude the premiums paid by the employer from gross income
premiums paid for DB in excess of $50k is taxable to employee
Flexible Spending Account (FSA)
type of cafeteria plan that is funded by employee salary reductions; use it or lose it
use FSA for dependent care expenses to provide more tax savings than using Child & Dependent Care Credit
2024 limit for health FSA is $3,200; limit for dependent care FSA is $5,000
Meals & Lodging Provided by Employer
employees can exclude the value of meals & lodging provided by the employer:
- on the employer’s premises
- for convenience of employer
No-Additional-Cost Services
Exclude value of any service provided to the employee by the employer if:
1. offered for sale to customers
2. in the line of business in which the employee works
3. employer incurs no substantial additional costs
Qualified Employee Discounts
discounts for merchandise limited to the gross profit percentage multiplied by the retail price; discounts on services cannot exceed 20% of the regular price
a working condition fringe benefit can be excluded from the employee’s gross income; NOT subject to nondiscrimination requirements (e.g., company car)
De Minimis Fringe Benefits
benefit is so small as to make accounting unreasonable or impracticable
Qualified Transportation Fringe Benefits
2017 TCJA disallows a deduction by the employer after 2017 for expenses associated w/ providing any qualified transportation fringe to employees of the taxpayer, & except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting b/t the employee’s residence & place of employment
Qualified Moving Expense Reimbursement
includes direct or indirect payment by the employer to pay for the cost of moving an employee’s family & belongings
2017 TCJA suspends the deduction for moving expenses for tax years 2018 through 2025 EXCEPT for members of the Armed Forces on active duty who move pursuant to a military order & incident to a permanent change of station
Value of the Use of Athletic Facilities
value of the use of on-premises gyms & other athletic facilities can be excluded from an employee’s income if:
- the facilities are located on the premises of the employer
- the employer operates the facilities
- substantially all the use of the facilities is by employees of the employer, their spouses, & their dependent children
Educational Assistance Program
value of the educational assistance provided by the employer through an educational assistance program to employee can be excluded from employee’s gross income up to $5,250 per year
Dependent Care Assistance
provided by an employer through a dependent care assistance program can be excluded from the employee’s gross income up to $5,000 per year ($2,500 for a married employee filing separately)
dependent must be under age 13
Unemployment vs Workers Compensation
Unemployment = included in gross income
Workers Compensation = benefits excludable from an employee’s gross income as making the taxpayer whole
Adoption Assistance Programs
maximum exclusion of $16,810 for 2024
phaseout starts at (MAGI) $252,150 for 2024; phaseout is complete when the employee’s MAGI reaches $292,150 for 2024
Phaseout Calculation Formula
deduction reduced based on a proportion equal to the amount by which the individual’s AGI exceeds the lower limit of the phaseout range divided by the range of the phaseout
Employee Achievement Awards
awards & prizes are normally includible in an individual’s gross income
maximum amount that an employee can exclude is $1,600 ($400 for awards that are not “qualified plan awards”
awards must be “tangible personal property” & CANNOT be cash, gift cards, vacations, sporting events, etc
NQSO (Nonqualified Stock Option)
At Grant Date:
NO income tax consequences if Exercise Price greater than or equal to FMV
At Exercise Date:
ordinary (W-2) income = FMV - Exercise Price
At Sale Date:
LT or ST CG/CL depending on holding period from exercise
Basis = FMV at date of exercise
TIP: NQSOs create W-2 income at exercise; the basis equals the FMV upon exercise
ISO (Incentive Stock Option)
At Grant Date:
NO income tax consequence if Exercise Price greater than or equal to FMV
At Exercise Date:
NO ordinary income
AMT Preference = FMV - Exercise Price
At Sale Date:
if stock was held for 2 years from date of grant & 1 year from date of exercise gain = LTCG
if holding period not met, bargain element is treated as ordinary (W-2) income
Deductions
income tax deductions fall into two basic categories: ATL (for AGI, expenses for business & production of income activities/investments, IRA deductions, student loan interest, & educator expenses) & BTL (from AGI)
Itemized Deductions (BTL)
reported on Schedule A of Form 1040
Include = Medical Expenses (above 7.5% of AGI)
Taxes
Interest
Charitable Contributions
Casualty Losses
Miscellaneous Itemized Deductions (those subject to 2% hurdle repealed)
Capital expenses incurred for medical purposes that improve the taxpayer’s home are deductible in an amount equal to the difference b/t the cost of the improvements & the increase in the value of the taxpayer’s home
Travel & lodging expenses incurred to acquire medical care also deductible; maximum deductible lodging expense = $50 per night per person, & a normal mileage allowance is permitted
Taxes paid to state/local/foreign governments deductible as an itemized deduction & are deducted in the year paid (up to $10,000)
Taxes do NOT include fines & fees even if paid to a state or local government
Time spent volunteering for a charitable organization is NOT deductible, however a nominal mileage allowance is permitted for travel related to such volunteer activities
10% Penalty Exceptions
death
disability
equal payments
QDRO
Medical > 7.5% AGI
birth or adoption (up to $5,000)
terminal illness
qualified disaster (max $22,000)
domestic abuse
emergency (limited)
Fines, Penalties, Political Contributions
NOT deductible
Hobby Losses
NOT deductible, mixed use real estate treated as a hobby
3 Tier deduction system for hobbies & mixed use real estate:
- Interest & Taxes
- Operating Costs
- Depreciation (there are NO net losses)
Personal Home
no income if rented < 15 days
Rental Property
becomes mixed-use property if used personally more than the greater of 14 days or 10% of rental days
Bad Debts
use cash basis
Worthless Securities
go to year end to determine long or short term (capital loss)
1244 Stock
first $100,000 deductible as ordinary loss if MFJ ($50k if filing other)
balance of loss is capital loss
Personal Losses
NOT deductible
NOLs
NO carrybacks
carry forward (up to 80% of income)
Specific Penalties
6% = excise tax on excess contributions to IRAs
10% early distribution penalty (prior to 59.5)
25% for failure to take RMDs beginning at age 73 (for those who turn age 72 after 2022; age 75 for those who turn age 74 after 2032)
1031 Tax-Free Exchanges
realized losses added to basis
Wash Sale
loss is deferred & added to new basis
Related Party Transactions
Double Basis rule
Gifts below FMV
double basis rule (tested in estates)
Calculating Gain or Loss
to calculate gain or loss, the taxpayer’s adjusted basis is subtracted from the amount realized
Basis
represents capital (or after-tax income) that a taxpayer uses to purchase an investment
used to determine gain or loss on an investment
used to determine depreciation deductions that an investor can take on an investment
used to determine the amount an investor has “at-risk” which limits loss deductions under the at-risk & passive activity loss rules
includes cash paid but also the amount of any recourse debt
Recourse Debt
allows the lender to pursue the borrower’s personal assets for satisfaction of the indebtedness
recourse debt ADDS to a taxpayer’s basis
Nonrecourse Debt
cannot be recovered tax-free by the taxpayer
NOT added to basis
Items Included in Basis
Purchase Price
Sales Tax
Freight
Installation & Testing Costs
“All costs to get the asset into operations”
Increases in Basis
additions to the investment
amortization of the discount on bonds purchased below face value
Decreases in Basis
distributions from business entities that have pass-through tax treatment (such as partnerships, LLCs, & S corporations)
depreciation deductions taken
Basis of Inherited Property
the FMV of the asset on the date of the decedent’s death
the basis of IRD (income in respect of a decedent) assets do NOT receive a step-to FMV at the death of the transferor
IRD = untaxed income that a decedent had earned or had a right to receive during their lifetime
IRD assets were NOT subject to ordinary income tax during the life of the transferor
IRD assets examples = IRAs, annuities, installment notes, back wages payable to the decedent
IRD assets are included in the gross estate of the decedent & subject to income tax when received by the beneficiary
there is an income tax deduction for the estate tax attributable to IRD assets IRC 691(c) deduction
Basis of Gifted Property
generally the donor’s basis typically carries over to the donee
2 Exceptions = Gift Tax & donor gifts property that has a FMV less than the donor’s adjusted basis as of the date of the gift (double basis rule)
Basis of Gifted Property Exception - Gift Tax Paid
donor pays gift tax on the transfer
basis of gifts of appreciated property to the donee = donor basis + [gift tax paid x (appreciation in excess of donor basis / taxable gift)]
Basis of Gifted Property Exception - Double Basis Rule
applies for property gifted when the FMV is less than the donor’s basis
general rule = holding period in hands of donee includes HP of the donor
basis to donee is FMV for losses; holding period for donee starts on date of the gift
donor’s basis for gains; carryover holding period
no gain or loss if sold b/t the FMV & the donor’s basis
EXAM TIP = never gift or sell an asset to a related party when the donor’s basis is greater than the FMV of the asset
Basis of Property Transferred Between Spouses or Incident to Divorce
Section 1041
regardless of whether property is sold or given to a spouse the basis of the original owner spouse will carry over to the new owner spouse
this treatment is mandatory
Related Party Transactions (Sales, Gifts, & Basis - IRC Section 267)
when property is sold to a related party & the sale will result in a gain to the selling party, the normal basis rules apply
if property is sold to a related party at a loss, the seller is NOT permitted to deduct the loss & the double basis rule applies
Basis of Jointly Held Property
ALWAYS use actual contribution rule, EXCEPT for spouse
for spouses, use deemed (50%) contribution rule, EXCEPT for tenants in common (TIC) (use actual)
Bonus Depreciation - For Qualifying MACRS Property
for qualified investors, a 60% bonus depreciation is available in the year the asset is placed in service, for new or used assets placed in service in 2024
Modified Accelerated Cost Recovery System (MACRS)
depreciation method
applies to most types of depreciable property placed in service after 1986
Real Estate - Depreciation
if real estate used for residential rental purposes
property depreciated according to straight-line depreciation method over 27.5 years
if real estate used for commercial purposes = depreciation occurs on a straight-line basis over 39 years
Personalty - Depreciation
to calculate depreciation for personalty, under MACRS, the property must first be assigned to a class life or recovery period
3-Year Class Life Assets
automobiles used as taxis, hogs used for breeding, racehorses
5-Year Class Life Assets
most cars, trucks & airplanes, heavy construction equipment
7-Year Class Life Assets
office furniture, fixtures, & equipment
10-Year Class Life Assets
vessels, barges, tugs & water transportation equipment
15-Year Class Life Assets
improvements to land
20-Year Class Life Assets
farm buildings
Depreciation method for personalty used under MACRS
accelerated depreciation system unlike the straight-line depreciation used for real property
assets that have a 3, 5, 7, or 10 year class life are depreciated under double declining balance method but switch to SL when the SL method would produce a greater deduction
property in the 15 & 20 year class lives depreciated under the 150 percent declining balance method but also switch to SL when SL would produce a greater deduction for the current tax year
Double Declining Balance Method
doubles the SL percentage
half-year convention permits 1/2 of deduction in first year
thus for first year 33.33% of the basis will be deducted for 3-year property, 20% for 5-year property & 14.29% for 7-year property
Amortization of Intangible Assets
intangible assets such as the goodwill of a business may be amortized on a straight-line (SL) basis over 15 years (180 months)
Section 179
provides business owners w/ an option to elect expense property placed in service during the year instead of capitalizing the assets & depreciating them over their MACRS class life
to qualify, an asset must be used more than 50% of the time in a trade or business
immediately expense up to $1,220,000 as indexed (2024)
reduced dollar for dollar for depreciable property placed in service during the year that exceeds $3,050,000 as indexed (2024)
electing Section 179 treatment cannot result in a loss for the business so the maximum Section 179 deduction that can be taken in any year will be further limited by the income of the business
Additional Limitations to Section 179 Expense Election
the maximum Section 179 expense that can be elected w/ respect to a sport utility vehicle is limited to $30,500 as indexed (2024)
Personal Assets - Sold for Gain & Sold for Loss:
Gain = capital gains except residence $250/$500k exemption
Loss = no loss deduction
Ordinary Assets - Sold for Gain & Sold for Loss:
Gain = ordinary income treatment
Loss = ordinary loss treatment
Capital Assets - Sold for Gain & Sold for Loss:
Gain = capital gain treatment
Loss = capital loss treatment (current loss may be limited to net $3,000)
1231 Assets - Sold for Gain & Sold for Loss:
Gain = capital gain treatment (part or all gain may require recapture as OI)
Loss = ordinary loss treatment
Tax deduction for losses on personal use assets & ordinary losses for trade or business assets =
NO TAX DEDUCTION ALLOWED
Capital Gain Holding Period
Long-Term = MORE than 1 year
Short-Term = less than or equal to 1 year
LTCG Tax Rates Summary
25 % = unrecaptured gain on 1250 assets (straight-line depreciation taken)
28% = collectibles (coins/art/guns)
Netting Capital Gains & Losses
if net ST & LT results are either both gains or both losses, no further action required
if net results are of different signs (one gain & one loss) net the ST & LT together
up to $3,000 of net capital losses (either ST or LT) may be recognized against other forms of income in any one tax year
3 Types of Income
- ordinary (active) income
- portfolio income
- passive income
*capital gains & losses fall into the portfolio “bucket”
Ordinary Income Assets - Business Assets
generate gains that are taxed at ordinary income tax rates
Recapturing Depreciation on Personal Property - Section 1245
personalty used in a trade or business or for the production of income
depreciation recaptured as ordinary income to the extent of the gain
excess gain over all depreciation is capital gain
compare the purchase price to the sales price, if sales price exceeds the purchase price the difference is capital gain; any other gain is ordinary
Treatment of Gain Under Section 1231 for Real Property - Section 1250
LESSER of gain or difference b/t depreciation taken & straight-line (SL) depreciation = taxed as ordinary income
if gain exceeds amount calculated above, LESSER of remaining gain or straight-line depreciation taken on the property taxed at 25% (unrecaptured Section 1250 depreciation)
any gain in excess of the above two calculations taxed at capital gains tax rates (0% to 20%) depending on taxpayer’s bracket
Ordinary Income vs Capital Gains tax rates
taxed at different rates for individuals
taxed at the same rate for corporations
Like-Kind Exchanges - Section 1031
nontaxable exchange
determine if taxpayer is trading up or down; taxpayers who receive only like-kind property (real estate only) in the exchange will NOT have any current income tax consequences; basis will be increased by any additional capital investment made
Party trading DOWN = receiving less like-kind property than given up; required to recognize gain to extent of boot received; if boot exceeds gain the amount in excess of gain is treated as return of capital
Party trading UP = receiving more valuable asset in exchange; generally no recognizable gain; boot paid results in increase basis
Debt relief = boot; required gain recognition for party no longer responsible for paying back the loan; party assuming the debt will increase basis in the replacement property by an equal amount
Losses realized in a like-kind exchange are not recognized until the replacement property is sold; taxpayer’s basis in the replacement property equals the FMV of the property received in the exchange plus the disallowed loss
Involuntary Conversions - Section 1033
nontaxable exchange
to avoid recognition of gain, taxpayer must reinvest proceeds in a replacement property that has a similar use to the property that was involuntarily converted either:
1. 2 years from the end of the year (12/31) in which realization (not the event) occurs
2. 3 years if caused by government
3. 4 years if presidentially declared natural disaster
Section 1041
nontaxable exchange
ALL transactions b/t spouses or incident to a divorce result in a carry-over basis & carry-over of holding periods
Sale of Personal Residence - Section 121
excludes up to $500k MFJ or $250k all others of the gain from the sale of a principal residence from income tax if certain requirements are met:
1. taxpayer must have owned & used the home as their principal residence for 2 out of the last 5 years (ownership & use test)
2. to claim the exemption, taxpayer must NOT have excluded gain on the sale of a principal residence w/in the last 2 years
if a principal residence is sold before the 2 year ownership & use test is met or exclusion was used during last 2 years, it may be possible to qualify for reduced exclusion
reduced exclusion available when sale of principal residence caused by:
1. change of employment
2. change of health
3. unforeseen circumstance
partial exclusion = (# of months of use or last exclusion / 24) x Applicable Exclusion ($250k or $500k)
Passive Activity Rules
anti-abuse provisions
apply to individuals, estates & trusts, certain personal service corporations, & closely held regular corporations
rules are intended to limit and/or suspend losses from businesses in which the taxpayer does NOT materially participate
if a taxpayer regularly participates in the conduct of the business generating the income/loss, that income/loss will be allocated to the active income bucket
if the taxpayer does NOT regularly participate in the conduct of the business activities the income/loss for that taxpayer is allocated to the passive bucket
Active Income
income earned through the active conduct of a trade or business & earned from the provision of labor
generally taxed at ordinary income rates
Portfolio Income
income derived from the investment of capital
interest/dividends/capital gains
subject to ordinary income rates or favorable capital gains rates (LTCG & qualified dividends)
Passive Income
generally includes income generated from all rental & real estate activities (unless specific exceptions are met) & income generated from trade or business activities when the taxpayer receiving the income does NOT materially participate in the conduct of that trade or business
passive income is considered net investment income (NII) for the 3.8% Medicare tax
Passive Activities
passive income or loss is derived from the conduct of a PASSIVE ACTIVITY
Section 469 defines a passive activity as any activity:
- in which the taxpayer does NOT materially participate,
- that is a limited partnership interest, OR
- that is a rental activity, even if the taxpayer materially participates in the activity
Material Participation
> 500 hours devoted to activity
> 100 hours devoted to activity AND the most of any participant
> 100 hours devoted to several activities that add to more than 500 hours
Grouping of Passive Activities
it is possible to group several passive activities into an “appropriate economic unit”
NOTE: each private limited partnership will have to be valued individually of itself & cannot be commingled
Limitations Imposed on Passive Losses
passive losses subject to three primary limitations:
- Basis Limitation
- At-Risk Rules
- Passive Activity Loss Rules
when a taxpayer generates a LOSS that is considered PASSIVE, each of these limitations must be applied in sequence
The Basis Limitation
first limitation
maximum allowable loss that the taxpayer can deduct is equal to their basis in the investment
At-Risk Rules
second limitation
after the basis rule has been applied to the loss from the activity
a taxpayer may NOT deduct in the current tax year more than the amount that they have “at risk” for the investment
Passive Activity Loss Rules
third limitation
after application of basis limitation rules & at-risk rules
last test before a passive loss deduction can be claimed for income tax purposes
losses falling into the passive activity bucket from a passive activity can only be offset against gains that are in the passive activity bucket unless special exceptions apply
Suspended Losses - Passive Activity Rules
suspended passive losses are fully deductible upon disposition of the trade or business
When Taxpayer Dies:
- if asset is stepped up, reduce the suspended losses by the amount stepped up
- if asset is stepped down, deduct the full suspended loss
Passive Activity Loss Exception
two circumstances where real estate activities can be classified as active businesses
1. Real Estate Professionals Exception
2. Individual Investor Exception = allows individual taxpayers who ACTIVELY participate in rental real estate activities to deduct up to $25,000 of losses from that activity against non-passive income for the year, some limitations
In order to qualify investor must:
1. actively participate in the activity
2. own at least 10% of the value of the real estate, AND
3. have AGI equal to or less than $100,000-$150,000 (including the phaseout)
AMT Adjustments & Preferences & the Standard Deduction
the standard deduction is DISALLOWED
Home Mortgage Interest - Regular Tax vs AMT
Regular Tax Deduction = qualified mortgage interest only
Qualified mortgage interest only deductible for AMT
Medical Expense Deduction - Regular Tax vs AMT
Regular Tax = excess above 7.5% AGI deductible
AMT = SAME
Tax Deduction - Regular Tax vs AMT
Regular Tax = property/sales/use/ad valorem taxes deductible
AMT = taxes are NOT deductible EXCEPT tax on qualified motor vehicles
Miscellaneous Deductions - Regular Tax vs AMT
Regular Tax = NOT deductible if subject to 2% of AGI
AMT = NOT DEDUCTIBLE AT ALL
Charitable Deductions - Regular Tax vs AMT
Regular Tax = regular rules
AMT = SAME
Private Activity Municipal Bonds - Regular Tax vs AMT
not taxable for regular tax
taxable for AMT
AMT preference item, must be added back to regular taxable income to arrive at AMTI
Incentive Stock Options ISOs - Regular Tax vs AMT
Regular Tax = no regular tax at exercise
AMT = at exercise AMT income to extent FMV > strike price
Nonqualified Stock Options NQSOs - Regular Tax vs AMT
Regular Tax = W-2 income at exercise
AMT = SAME
Maximum deduction for charitable contributions limited based on:
- type of property
- type of charity
- use of the property donated
Public Charities
Red Cross, includes operating foundations
operating foundations = private foundations that spend substantially all income on its charitable purpose
Private Charities
intended to further the charitable intentions of a donor
include private foundations & charitable lead trusts
Charitable Contribution Deduction (Percent of Taxpayer’s AGI Limit) - Cash
FMV for deduction
60% public charity
30% PNOF
Charitable Contribution Deduction (Percent of Taxpayer’s AGI Limit) - Ordinary Income Property (including STCG property)
LESSER of FMV or basis for deduction
50% public charity
30% PNOF
Charitable Contribution Deduction (Percent of Taxpayer’s AGI Limit) - LTCG property
Intangible
Tangible (related use)
Tangible (unrelated use)
Real
Intangible:
- FMV for deduction
- 30% or 50% if using basis public charity
- 20% of basis PNOF
Tangible (related use):
- FMV for deduction
- 30% or 50% if using basis public charity
- 20% of basis PNOF
Tangible (unrelated use):
- LESSER of FMV or basis for deduction
- 50% public charity
- 20% of basis PNOF
Real:
- FMV for deduction
- 30% or 50% if using basis public charity
- 20% of basis PNOF
