Tax 2 Flashcards
0
Q
Incentive Stock Options - AMT Adjustment
A
AMT may require earlier recognition of income because the difference between the option price and FMV at date of exercise is an add back for AMT purposes
1
Q
Incentive Stock Options - ISOs
A
- No income when recognized when option is granted
- No tax due when option is exercised.
- Tax due when stock is sold!
a. Capital Gain if held at least 2 yrs from grant date and 1 year after exercise.
b. Ordinary Income if stock sold within 1 year of exercise date, reported on W-2. subject to ordinary income but IS NOT Subject to FICA or FUTA
2
Q
ISO’s Taxation
A
- With an ISO, EE pays no tax on exercise, and company gets no deduction.
- If the EE holds the stock for 2 yrs after grant date + 1 yr after exercise date, EE only pays capital gains tax on the difference between the exercise price and the sales price.
3
Q
ISO’s Big Disadvantage
A
ISO’s are subject to AMT tax. The difference between the purchase price and the grant price is subject to AMT.
4
Q
ISO Taxation Example
A
George’s ER grants him ISO on Jan 1, 2012, with an exercise price of $25.00. George exercises the ISO on Jan 2, 2013, when the market price is $40.00. No Ordinary income recognition is triggered (but $15 will be an AMT adjustment). George sells stock two years later for $60, his basis for regular income tax is $25 and he has a $35 long-term capital gain for regular tax.
NOTE: His AMT basis is $40, and AMT gain is $20.00
5
Q
Nonqualified Stock Options (NQSO’s)
A
- EE will recognize income when NQSO is granted, (is option is traded on exchange & not subject to substantial risk of forfeiture)
- EE taxed on the bargain element when the option is exercised (difference between FMV of the stock on the date of exercise and the option price)
- Bargain element considered compensation income & taxed at ordinary income tax rates and will be included in EE’s W-2 by ER and subject to FICA & FUTA.
- Any appreciation after the date of exercise is taxed as capital gain
- Basis is the FMV at date of exercise
- The holding period begins on the date of exercise, which determines if the gain is long term or short term
6
Q
Non-Qualified Options (NSO)
A
- Additional Taxable Income to Recipient
- AT EXERCISE Taxable AMOUNT = Market Price - Exercise Price
- If FMV is $100 and Exercise Price is $50.00 = $50.00 of Ordinary Income
- Company can deduct the Equal Amount of Profit that you have Gained. If FMV is $100 and Exercise is $50 not only will the investor have to declare $50.00 additional income but also the company can now deduct $50.00 from their taxes.
7
Q
Itemized Medical & Dental Deductions
A
- Before you can deduct these expenses, you must be above the floor before you can deduct the medical and dental expenses.
- Subject to 7.5%/10% of AGI Floor
a. Under 65 > 10% of AGI
b. Age 65 and older > 7.5 of AGI (2013-2016)
8
Q
HSA’s Contributions 2013
A
Individual Plan - $3,250
Family Plan - $6,450
9
Q
Business Gifts
A
- $25/donee
- Gifts less than $4.00 allowed for incidental items are excluded from limits
- Additional deductions allowed for incidental costs (engraving, dlivery, gift wrapping)
- No deduction for gifts to Superiors or ER’s
- EE achievement non-qualified plan awards based on length of service or safety under $400 are excluded.
10
Q
Deduction of Interest Paid on Points: Gary took out a $100,000 mortgage loan to buy his home in current year, he was charged 1% point ($1000). He met all the tests for deducting points, except the only funds he provided were $750 down payment. Of the $1,000 charge for points, how much can he deduct in the current year?
A
$750.00 (money he paid)
11
Q
When Stephanie took out a $100,000 mortgage to buy her home in the current year, she was charged 1% ($1,000). Tim, who sold her the home, also paid one point ($1,000) to help her get her mortgage. Stephanie met all the tests for deducting points, except the only funds she provided was the $750 down payment. In the current year how much can Stephanie deduct?
A
$1,750.00 ($750.00 of the amount she was charged plus the $1,000 paid by Tim). She must also reduce the basis of her home by the $1,000 paid by Tim
12
Q
Deductible Expenses for Medical Care
A
Medical/Dental services, supplies, equipment and prescription med’s
Health Insurance premiums (medical/dental)
Long Term Care premiums based upon age-based IRS table (not actual expenses)
Travel
Capital Improvements
13
Q
Mortgage Interest
A
Up to Two Homes
Includes second mortgages
Acquisition or improvements up to $1 million
Home Equity loan not used for building improvement - up to the lesser of $100,000 or FMV less acquisition debt
14
Q
Investment Interest and Casualty Losses
A
- Investment Interest - deduction is net investment income less investment expenses (subject to 2% of AGI limit)
a. Carry over of excess interest allowed indefinitely - Casualty losses - lesser of decline of value or basis subject to10% per year hurdle and $100 year casualty floor in 2013.
a. Cash/property received for losses will reduce damage property amount of loss.
15
Q
Casualty Losses: Larry had art with FMV of $10,000 (basis of $15k) stolen from his apartment. During the year, he had a salary of $30k and no other deductions. Calculate Larry’s itemized deduction from the theft of art.
A
Loss = $10,000 (lesser of basis or reduction of FMV)
Less: 10% of AGI (10% x $30,000) = ($3,000)
Less: $100 floor = (100)
Itemized Deduction $6,900
16
Q
Charitable Contributions Itemized Deduction
A
Contributions exceeding AGI limits may be carried forward for five years.
17
Q
Charitable Deduction
A
Private non operating foundations that do not make timely qualifying distributions, the amount of deduction is limited to basis. There is an exception for contributions of publicly traded stock that receives a FMV deduction
18
Q
Miscellaneous Itemized Deductions not subject to 2% AGI floor
A
Impairment related work expenses for handicapped
Gambling losses (must have gambling winnings)
Unrecovered investment in annuity contract when annuity ceases because taxpayer died
Death taxes attributable to IRD
19
Q
Charitable Contributions over $5000 ($10,000 non public stock)
A
- Non cash contributions over $5000 - qualified appraisal.
- Appraisal not required for readily traded securities
- Costs of appraisal not deductible
- Generally…FMV on date of gift
20
Q
Charitable Deduction - Ordinary Income Property that if sold gives rise to income.
A
- Includes: Inventory, tax payer created art, short term capital assets. (Artist may deduct supplies but not value for time or artistic talent)
- Deduction is the lesser of FMV or Adjusted Basis.
21
Q
Charitable Deduction - Property if sold results in Capital Gain
A
- Examples: Stocks, bonds, real estate
- Deduction amount equals FMV
- If operating foundation spends it’s income on charitable purpose then fully deductible.
- If non operating (grantmaking) FMV allowed for publicly traded stock that if sold, would result in a long-term capital gain
- If non-operating foundation (non - grant making) only adjusted basis is deductible.
22
Q
Charitable Deduction Exception for Capital Gain portion of asset to an organization
A
- Use-unrelated property, donor cannot deduct FMV and is limited to 50% or 20% AGI annually, depends on identity of charity.
- Use-related property and donor-taxpayer choose to deduct the property’s FMV, the taxpayer limited to 30% or 20% of AGI.
a. If taxpayer chooses to deduct the basis in property, the limits are 50% and 20%
23
Q
Contributions to which organizations cannot exceed 50% of AGI
A
- Religious, public, education, governmental
- Private Foundations
- Some Private non-operating Foundations
a. Distribute in 2.5 months
24
Charitable contributions limited to 30% of AGI
1. Cash/ordinary income property to private non-operating foundations (do not qualify for 50% organizatioins)
2. Long-term capital gain property donated to 50% Organizations
3. If donor elects to forego deduction of capital gain, property moves to 50%
4. If donor elects to forego capital gain, deduction is lost, not carried over.
5. Donations to 50% organizations are applied to limits before 30% gifts
25
Gina graduated from M U. She donated $2000 to athletic department of MU to guarantee priority to purchase two premium season tickets to home football games. In addition, Gina purchase two season tickets for the regular price of $500 ($250 each). Gina's charitable contribution for the current year is...
Answer: $1,600. 80% of the $2000 for paying for the right to purchase tickets. The $500.00 expenditure for the tickets cannot be claimed because they provided Gina with a benefit.
26
Bargain Sale to Charity
1. Difference between the sales price of the asset and the seller's basis allocated to the asset will be a capital gain for income tax purposes.
2. The difference between the FMV of the asset and the consideration received is considered the allowable amount of charitable contribution. The basis not allocated to the sale of the asset is the basis .
27
Formula to calculate the basis of the property sold for charitable bargain sale is:
Amount Realized on sale to charity
divided by
Fair market value of entire property x adjusted basis of entire property
28
Charitable Gift of Remainder Interest
1. A gift of remainder interest, a lifetime transfer is a gift of partial interest.
2. If the charity's interest is a remainder interest, (charity receives what remains after non charitable income beneficiary, receives the income) strict rules apply.
3. A transfer in trust will only qualify if it is a charitable annuity trust, unit-trust or pooled income fund
4. Taxpayer may obtain both an income tax and transfer tax (gift tax) deduction
5. Income tax deduction for a partial interest transfer is restricted to the % of AGI limitations, but the transfer (gift) tax deduction is unlimited so long as the transfer is made to a qualifying charitable organization.
29
Charitable Deductions Partnerships & S Corporations
1. As pass through entities, the charitable contributions are deducted by the partners and shareholders on their individual income tax returns.
2. Amount of deduction is reported on the partners and S corporation shareholders on Schedule K-1
30
Charitable Gifts C Corporations
1. Charitable deductions reported on corporations income tax return
a. Ordinary Income (Inventory) - deduct the basis of the property
b. Capital Gain Property - deduct FMV of cap gain property donated to charity. Deduction limited to property's adjusted basis in the following situations:
b1. Property is tangible personal property use-unrelated, (not related to charity's exempt purpose)
ba. If it's use-unrelated, the donor cannot elect to deduct FMV.
bb. If use-related, donor can deduct FMV, subject to corp. limits
31
Charitable Gifts Limit on Corporation Deduction
1. Maximum charitable contribution deduction 10% of taxable income.
XYZ net income of $60k, and received dividend of $4000 which is eligible for the 70% dividend's received deduction. XYZ donated $8,000 cash to NJU.
Max charitable contribution: (60,000 + 4,000 = $64,000 x 10% = $6,400. ($6,400 entitled deduction)
32
Kiddie Tax
1. Dependent 19 yr old, full-time students 23 and have attained 24 by close of taxable year. (Full time for 5 months of calendar yr)
2. Not for 18 (or students 19-24), if earned income exceeds 1/2 of their support.
33
Kiddie Tax
1. Gross Income = Unearned Income (UI) + Earned Income
2. Standard deduction = Greater of $1,000 or EI + $350, limited to $6,100
3. Unearned income of child > $2,000 is taxed at parents rate
4. Taxable income of child in excess of that taxed at parent's rate is then taxed at the child's rate.
34
Kiddie Tax Rules
1. The first $2,000 of unearned income is taxed to the child at the child's rate.
2. Any excess earned income over the standard deduction is taxed to the child at child's rate.
3. The only income taxed at the parent's highest marginal rate is unearned income greater than $2,000
4. No personal exemption for one who may be claimed as dependent by another parent
5. Standard deduction equal to the greater of $1,000 or earned income + $350.
35
Kiddie Tax Qualified Dividends
1. Qualified Dividends taxed at capital gains rate of 0% for the 10%-15% marginal income tax bracket, and 15%-20% (depending on taxpayer's AGI), for higher brackets for both parents rate and child's rate, if qualifying dividend treatment is available and elected.
36
Mr and Mrs J transferred (gifted) $70,000 of assets to their granddaughter, Jen age 8, via an UTMA account. Jen received $2200 interest. Jen's parents marginal income tax rate is currently 25%. Jen's net unearned income taxed at her parent's rate is....
$2,200 (total unearned income)
-1,000 (standard deduction)
- 1,000 (taxed at child's rate of 10%* = $100) **Assume tax rate of
10% for child unless told otherwise
$200.00
37
Mary Sue, age 16, has earned income of $10k and interest income of $800 in 2013. She is claimed as a dependent on her parents' income tax. Mary Sue's standard deduction for earned income is $6,100, and her standard deduction of unearned income is only....
answer: $1000
| Mary Sue would elect to offset her total income of $10,800 by a standard deduction of $6,100
38
Section 179 Expensing: What is it?
1. Election to expense newly purchased business/trade personal property.
2. $500,000 and reduced dollar for dollar $$ over 2 million.
3. Limited to taxable income of trade or business
a. Taxpayer may also include wages, salaries, tips, compensation earned as EE
4. Unlimited carry over of excess expenses
39
Straight Line Depreciation
1. Simplest form of depreciation
2. Assumes depreciation is uniform throughout useful life of asset
3. SL = (Cost - residual value) / useful life
4. Can be used under MACRS and ACRS, using the applicable recovery method period instead of the useful life, and salvage value is not considered.
5. Must use half year convention
40
Section 179 Allows immediate tax write off for newly purchased business/trade personal property in the year the property was purchased. What are the limitations?
* *Applies to: office equipment, business computers, and so forth
1. Reduced dollar for dollar for amounts over 2 million.
2. Limited to taxable income of trade/business. Can only deduct if they have earned income.
3. Max. write off under 179 for sports utility vehicle is $25,000. (Sports utility vehicle 6000 but no more than 14,000 pounds)
41
Roth Corporation purchased and placed into service a piece of machinery costing $600,000. Roth's income was $52,000. What is the maximum Section 179 expense deduction for this machine in 2013?
$52,000. ($500,000 for 2013 but amount is limited by the taxable income)
$448,000 will be carried forward to 2014
42
In 2013, Lewis Corp. purchased $20k of new equipment and had taxable income of $200,000. Section 179 expense deduction would be how much?
1. $20,000 for 2013. This is under the $500k limit
43
Section 179 Adjusted Basis
The adjusted taxable basis of the property is reduced by the amount of the Section 179 deduction taken as adjusted for property placed in service limitation and is not adjusted for the income limitation.
$600,000 (price) - $500,000 (179 limit) = $100,000 for equipment purchased
44
In 2013, Adorn Corp. purchased and placed in service a machine to be used in its manufacturing operations. This machine cost $2,007,000. What portion of the cost may Adorn elect to treat as a current, deductible expense rather then as a capital expenditure assuming net taxable income of 1.6 million?
$2,007,000 - $2,000,000 = $7,000
$500,000 - $7,000 = $493,000
45
in 2013, Berry Corp, purchased and placed in service a machine to be used in it's manufacturing operations. This machine cost $2,09,000. What portion of the cost may Berry elect to treat as an expense rather then as a capital expenditure assuming net taxable income of 4 million?
Maximum allowable Section 179 expense for 2013 $500,000
Reduction ($2,09,000 - $2,000,000) (90,000)
Allowed Section 179 expense $410,000
Cost of Property $2,090,000
Section 179 expense ($410,000)
Adjusted tax basis of property $1,680,000* (Ignoring any depreciation allowed)
46
Child and Dependent Care Credit; To qualify, taxpayer must
1. Keep a Home
2. Have earned income
3. Pay for care so taxpayer can work or attend school
4. Have a dependent <13 or person living with taxpayer who is physically/mentally incapactitated.
47
Child and Dependent Care Credit
1. Qualifying expenses have a ceiling of $3,000 for one qualifying child/dependent and $6,000 for two or more qualifying children/dependents.
2. $0-$15,000 AGI = 35% applicable %
3. $15,000 - $43,000 = 34%, reduced 1% for each $2,000 of AGI over $15,000
4. $43,000 - No Limit = 20%
48
Flexible Spending Account (FSA)
1. Cafeteria plan EE's can be reimbursed for qualified expenses.
2. Two Common Types:
a. Health FSA's
b. Dependent Care Assistance FSA's
49
Health FSA's
1. Cafeteria Plan for EE's
| 2. Max. amount for reimbursement of incurred medical expenses of an EE cannot exceed $2,500
50
FSA are appropriate when...
1. ER wants to expand EE benefit choices without significant extra out of pocket costs
2. FSA provides tax benefit for EE's not available for any other plan
3. Because of costs, not good for small company
4. No FSA for self employed
51
Advantages of FSA's
1. Can be funded entirely by EE's contributions
2. Contributions not subject to payroll taxes
3. Salary reductions not subject to Federal Income tax or Payroll Tax
4. Using FSA to pay dependent child care expenses may provide more tax savings than using the child and dependent care credit
52
Disadvantages of FSA
1. Required to meet all complex non discrimination requirements
2. FSA could result in adverse selection and raise benefit costs
3. Adm costs
4. $$ if not used by EE
5. LTC services/coverage cannot be reimbursed tax free with FSA
53
FSA Tax Implications
1. EE's salary contributions no income/payroll tax
2. ER receives tax deduction for amounts it pays
3. ER's payroll taxes reduced by the amount of EE salary reductions under FSA
4. Worker's compensation is not paid
5. State unemployment tax not paid on contributions
54
Child Tax Credit
1. Tax Credit of $1,000 each child under 17
2. Credit reduce $50 for each $1,000 by which MAGI exceeds $110,000 (MFJ)/ $75,000 (Single)
3. Qualifying child is one claimed as a dependent
55
Tax Credits
1. Generally, dollar-for-dollar reductions of income tax liability
2. Provide benefits on a more equitable basis than tax deductions
3. Credits not affected by tax rate of taxpayer
56
Tax Credits
1. Refundable tax credits paid to taxpayer even if the amount exceeds the tax payer's tax liability, (creates a refund)
2. Non Refundable tax credits - at best, the tax liability can be reduced to zero. If the tax payer has multiple non refundable tax credits, they must be off set using IRS priority list
3. Some tax credits are subject to carry over: Foreign tax credit.
a. Does not create a refund
57
Tax Credits
1. Earned Income Credit (EIC) - economically disadvantaged
2. Elderly/Disabled Credit - Nonrefundable, 65 and older
3. Foreign Tax Credit - avoid double taxation
4. Child and Dependent Care Credit
5. Adoption Credit - $12,970
6. Child Tax Credit - $1,000/child under 17
7. AOTC - qualified tuition expenses: 100% of 1st $2000, & 25% of next 2000 for max. $2,500
8. Lifetime Learning Credit: 20% up to $10k of tuition/fees undergraduate, graduate or professional degree,
58
Earned Income Credit
1. To encourage economically disadvantaged individuals to join the work force.
59
Credit for Elderly or Disabled
1. Limited, Non refundable credit >65+, or under 65 retired and permanently/totally disabled
2. MFS spouses must have lived apart entire year
60
Foreign Tax Credit
1. Avoid double taxation by tax credit on taxes paid or accrued to foreign county or US possession
2. Taxpayer may not use both the foreign tax credit and the foreign earned income exclusion
3. If the tax in the foreign jurisdiction is more than US tax, taking the tax credit is generally more advantageous
61
FSA maximum for Child Care
$5000.00
62
Amortization
1. Certain intangible assets are amoritizable over 15 years
2. Section 197 assets include: goodwill, trademarks, covenants not to compete, copyrights, patents if they are used in a trade or business for for the production of income. Self created intangibles not considered amortizable assets under Section 197
63
Modified Accelerate Cost Recovery System (MACRS)
1. Tangible personalty is either 3 yr, 5 yr, 7 yr, 10 yr, 15 yr, or 20 yr. Percentages based on 200% declining balance for 10 year and less property and 150% declining balance for 15 yr and 20 yr property.
2. Both 200% declining balance and 150% declining balance switch over to straight line depreciation when it results in a larger deduction.
3. Half-year convention/depreciation is allowed during the year placed in service; and half year depreciation allowed in the year of disposition.
64
MACRS and Mid-Month & Mid-Quarter Convention
1. Under MACRS, residential real estate has a 27.5 yr life; nonresidential has a 39 yr life.
a. Cost recovery %'s are calculated using straight line
b. Mid-month convention used (a half-month depreciation allowed for month placed in service, and half-month is allowed for month of disposition).
65
MACRs - When Mid-Quarter Convention is Required
1. To reduce benefits of the half-year convention for property placed in service late in the year, the mid-quarter convention was developed.
2. >40%+ of personal property placed in service during last quarter of year, THEN MID-QUARTER convention applies to ALL Personal Property assets placed in service that year.
3. First year of service: 1st Quarter Assets - 10.5 months depreciation; 2nd Quarter Assets - 7.5 months; 3rd Quarter Assets - 4.5 months; 4th Quarter Assets - 1.5 months.
4. Mid-Quarter convention does not apply to Real Property
66
Cost of Repairing Business Property...
1. Is currently Deductible as business expense.
2. Repair Requirements:
a. Incidental expense that does not add to the value of the property
b. Incidental expense that does not appreciable prolong the life of the property
c. Expense that maintains the property in normal operating state
67
Repairs vs Capital Expenditures for Business
1. If cash out is considered a capital expenditure, the cash outlay is not currently deductible. INSTEAD, the cost must be capitalized and depreciated over the property's useful life. Capital Expenditure could include:
a. Expenditures that materially add to the value of the property
b. Expenditures that substantially prolong the property's useful life
c. Expenditures as part of a general plan of renovating, improving, or altering the property.
68
Business Use of Listed Property
Listed property includes passenger auto's, entertainment assets, computers and phones. If the business use of listed assets is greater than 50%, the taxpayer may use the statutory % for depreciation. If business use is less than or equal to 50%, the tax payer is limited to straight line.
69
Alternative Depreciation System (ADS)
ADS must be used for alternative minimum tax adjustment, international asset use, tax exempt entites, tax exempt bond financed assets, and assets from certain discriminating countries for earnings and profit purpose
70
S Corporation Characteristics
1. Equal to or less than 100 shareholders
2. Citizens, resident aliens, certain estates & trusts
3. No more than 1 Class of Stock
4. IRS treats S Corporation Shareholders as Partners
5. Income and Deductions reported according to pro rate share of ownership
71
General Partnerships treated as an entity, separate & apart from individual members for certain purposes. What purposes?
1. Partnership has capacity to sue and be sue in name of Partnership
2. Judgments can be entered against partnership in it's name
3. Partnership is subject to liquidation proceedings under federal bankruptcy laws
4. Partnership can participate in transfers and ownership of personal and real property
72
Formation of Partnership
1. No special state filings
2. Contribution of $$ or property to partnership, in exchange for a partnership interest is a nontaxable transaction
3. Basis in Partnership Interest:
a. Cash or Property contribution
b. Distributions to partners will reduce basis
c. Partnership's basis also decreased by any share of his liabilities assumed by the partnership
73
Uniform Limited Partnership Act specifies the following order for distribution of the partnerships assets
1. Outside Creditors
2. Limited partner's shares of profit and any other compensation
3. Limited partner's return of capital contributions
4. Advances and loans made by general partners
5. General partner's shares of profits
6. General partner's return of capital contributions
**The Revised Uniform Limited Partnership Act changes the order by including claims of partners, who are creditors, with outside creditors and combining limited and general partners.
74
LLC - S Corporation available for LLC's that elect to be treated as a corporation (association) and file Form 2553 to elect small business treatment
1. Form 2553 must be filed by the 15th day of the third month after the beginning of the LLC
2. As with shareholder's of an S Corporation, members will report income on their individual fed. tax returns on the basis of the Schedule K-1 they received from the S Corporation Return.
75
What are four ways an LLC can be taxed?
1. Sole Proprietorship - only for single owner LLC's. The owner will disregard the LLC for tax purposes and simply file a Schedule C on the individual return (Form 1040) to report the activity of the LLC
2. Partnership - LLC's 2 or more owners. Partnership form 1065 will be filed to report the income of the LLC. Members each receive a K-1.
3. Corporation for any LLC - Corporate return (Form 1120) will be filed to report income of the LLC. Similar to a corporation, the LLC will have two levels of taxation.
4. S Corporation - for LLC that elect to be treated as corporation (association) and file Form 2553 to elect small business treatment.
a. Form 2553 must be filed by the 15th day of the 3rd month after beginning of the LLC. Members (shareholders) report income on their individual federal tax returns on basis of the K-1.
76
Owner's of LLC...Self Employment. Do the owners pay self-employment tax??
Answer; No. Owners of an LLC do not pay self-employment tax
77
Transfer for Value Rule: Includable in gross income of the transferee to the extent the proceeds exceed the basis (amount paid for policy plus any subsequent premiums paid). What are the exceptions:
1. Transferred to the Insured
2. Transferred to a partner of the insured
3. Transfer to a partnership in which the insured is a partner
4. Transfer to a corporation in which the insured is an office or shareholder
5. Transferee whose basis in the policy is determined by reference to the transferor's basis (tax free exchange or gift)
78
Capital Assets
Capital Assets are personal-use assets and most investment assets. Losses from personal-use are not deductible, but losses from investment assets are deductible
79
Capital Assets defined by Section 1221
1. Section 1221 defines what is not a capital asset.
A. Accounts and Notes Receivable - $$ acquired from sale of inventory or services associated with a business.
B. Copyrights & Creative Works - these assets are considered to be Ordinary and Not Capital Assets
C. Inventory - Inventory held for sale to customers; mainly for business use
D. Depreciable Property or Real Estate - If these assets are used by a business, they are not considered Capital Assets.
Remember: A-C-I-D
80
Section 1231 Assets
1. Depreciable personal or real property used in business or for production of income
81
Capital Gains Rate for Section 1250 (depreciable property)
12 months plus 1 day = Long Term taxed at 25%
82
Cap Gain Rates for Collectibles Held for Long Term (12 months and 1 day)
Tax rate: 28%
83
Capital Gains Rates on Section 1202 Qualifying Small Business Stock Held for 5 years or longer
Tax Rate: 28% (on 50% gain)
a. 75% for stock purchased 02/17/09 and before 09/28/10
b. Stock purchased 09/27/2010 and before 01/01/2014 is excluded from taxable income for both regular income tax and AMT
84
Personal Property: Tax
No tax benefit for losses; Gains are capital.
Example: Car
85
Trade or Business Assets: Gains/Losses
1. Gains are capital gains
2. Losses are always ordinary losses
Sections: 1231/1245/1250
86
Section 1231 Property
Limited capital gain treatment for depreciable property held long term.
Losses from disposition are fully deductible as ordinary income
87
Section 1245 - Depreciable Personal Property
1. Recapture
a. Any unrecognized gain is ordinary income to the extent of the lesser of the depreciation taken on the property disposed ot, or the gain recognized
2. Any remaining gain usually Section 1231 gain.
3. Includes all depreciable personal property (personalty)
88
Personal Assets - Personal Residence Section 121 - Exclusion of gain on sale of personal residence
1. Up to $250,000 of gain ($500,000 for joint filers)
2. Principal residence owned (either spouse) and BOTH SPOUSE USED for 2 out of 5 years
3. Available only 1 time every 2 years
4. Partial exclusion if fail ownership test, use test or sold residence within the 2 year period and took exclusion (number of qualifying months / 24)
89
Gross Income Exclusions: Items characterized by Love, Affection or Assistance
1. Gifts, bequests, and Inheritances (Section 102)
2. Scholarships (Section 117)
3. Life Insurance proceeds paid by reason of death (Section 101)
4. Accelerated death benefits, including sale of policy to a viatical settlement provider (Section 101)
90
Unemployment & Alimony
1. Unemployment compensation is taxable income (in lieu of wages)
2. Alimony and separate maintenance payments are deductible by the payor and are includable in gross income of payee.
* *Child Support not includable as taxable income, and not deductible
91
Alimony and IRA Contribution?
Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes.
92
IRA compensation that is not allowed as a contribution includes...
Earnings and profits from property: rental income, interest and dividend income, or any amount received from a pension or annuity income, or as deferred compensation.
93
Ian is 60, and covered under a group term life insurance policy in the amount of $90,000. How much must Ian include in his taxable income, assuming Table 1 cost per months is 66 cents and Ian pays a $60 annual premium.
```
Coverage (In $1,000) 90
Exclusion (50)
Excess Coverage 40
Table 1 Cost .66 (per month)
Monthly cost excess 26.40 (40 x .66)
Annual Cost $316.80 (26.40 x 12)
Premium Paid by Ian ($60)
Inclusion in W-2 Income $256.80
```
94
Imputed Interest on Below Market Loan (at applicable federal interest rate)
1. Gift loans - Generous gift
2. Compensation - related loans: ER loans to EE's
3. Corporation - Shareholder Loans: A Corporation's to shareholders
4. Tax Avoidance loans: Loans that significantly affect the borrower's or lender's federal tax liability
95
Imputed Interest Exceptions and Limitations
1. No interest is imputed on gift loans of $10,000 or less. (Only exception for ER to EE or Corporation Loan)
2. On loans of $100,000 or less between individuals, interest cannot exceed the borrower's net investment income
3. If net investment income is less than or equal to $1,000, no interest is imputed on loans of $100,000 of less.
96
How much income should be imputed by the lender? (Assume federal interest rate of 9%)
Loan Amount Net Investment Income Lender Imputes
$10,000 N/A $0
$100,000 $900 $0
$100,000 $1,200 $1,200
$100,000 $13,000 $9,000
$100,001 N/A $9,000
*Imputed interest is considered a gift by the donor to donee subject to the annual exclusion
97
Income from Annuities
1. Contracts pre-August 13, 1982 - w/d's (not annuitization), receive FIFO tax treatment (Capital out first)
2. Contracts post-August 13, 1982 - w/d's receive LIFO tax treatment (earnings out first)
3. Distributions which include earnings/not a return of basis (taxable) - subject to 10% penalty unless age 59.5, death, disability, distributed for life under 72(t) or 72(q) or meet other certain requirements.
98
Annuity Exclusion Ratio: distribution of an Annuity that includes both principal and earnings.
Investment x Annuity Payment = Exclusion Amount (Amount not
Expected Return not taxed)
1. Pre-Dec 31, 1986 - exclusion ratio is applied for the entire payout period
2. Post Dec 31, 1986 - exclusion ratio is applied only until basis has been recovered.
99
Val started receiving a monthly annuity of $1,000 payable for life. Assuming his life expectancy is eight years, and he contributed $24,000 to the cost of the annuity, what is the taxable portion of each monthly annuity payment?
Annuity value: 8 years x 12 x $1000 = $96,000
Exclusion ratio: $24,000 / $96,000 = 25%
Taxable amount: $1,000 x (1 - 25%) = $750/month
Shortcut:
Nontaxable: $24,000 / 96 = $250/payment
Taxable: $1,000 - $250 = $750/month
100
Social Security Benefits and Taxation
1. As much as 85% of SS benefits can be included in gross income.
2. The taxable amounts can be determined by one of two formulas using the modified adjusted gross income (MAGI)
3. MAGI is AGI from all sources (less Social Security) plus the foreign income exclusion and any tax-exempt interest income.
101
Social Security Calculation of Taxable Amount - Two Based Amounts are Established
1. First Base Amount:
a. $32,000 MFJ
b. $0 for MFS
c. $25,000 for ALL other Taxpayers
2. Second Base Amount
a. $44,000 MFJ
b. $0 MFS
c. $34,000 for all other taxpayers
102
Social Security Tax Basis 1st Threshold
1. If MAGI plus one-half of Social Security exceeds the first base amounts but not the second set, the taxable amount of SS is the lesser of the following:
a. .5 (Social Security Benefits) (In other words, 50% of the SS benefit), or
b. .5 (MAGI + .5 (Social Security) - base amount)
103
James and Patty married taxpayers filing MFJ. Their adjusted gross income is $30,000. They also received a $1,000 in tax-exempt income and $10,000 in Social Security Benefits. Is their SS benefit Taxed? If so, how much?
Their provisional income: $36,000 ($30,000 + $1000 + ($10,000 / 2).
Because their provisional income is greater than $32,000 and less than $44,000, a portion of their SS benefits will be taxable.
a. 50% of the SS benefits received, $5,000 or 50% of the excess provisional income over the first tier base amount, ($36,000 - $32,000) x .50 = $2,000
b. Therefore: $2,000 (the lesser of the $2,000 or $5,000) of the SS benefits is taxable.
104
Social Security Taxable Income Second Threshold
1. If MAGI plus one half of SS exceeds the second set of base amounts, the taxable amount of SS is the lesser of the following:
a. .85 (Social Security Benefits)
b. Sum of .85 (MAGI + .5 (Social Security) - second base amount), plus lesser of:
b1. Amount included through application of the first formula
b2. $4,500 ($6,000 MFJ)
105
Social Security Taxable Income Second Threshold Example: Carl and Veronica MFJ. Adjusted gross income is $90,000. They also received $10,000 in tax-exempt interest and $20,000 in SS benefits.
Their provisional income = $110,000 ($90,000 + $10,000 + ($20,000 divided by 2)
1. Step 1: 85% of the benefits received = $17,000 ($20,000 x .85)
Step 2: 85% of provisional income in excess of second tier base amount = $56,100 ($110,000 - $44,000 = $66,000 x .85) plus the lesser of:
a. The amount of the first tier income (one half of SS benefits received) $20,000 x .50
b. The statutory amount of $6,000 for MFJ
Because $6,000 is less than $10,000, $6,000 is added to $56,100 for total in Step 2 of $62,100.
Compare Step 1 ($17,000) to Step 2 ($62,100); the lesser amount must be included in gross income, therefore $17,000 of the SS benefits is taxable.
106
Summary of Social Security Threshold
Status Threshold Taxable
Single $25,000-$34,000 50%
>$34,000 85%
MFJ $32,000 - $44,000 50%
>$44,000 85%
107
Section 1031 (like kind exchanges)
1. Property is for productive use in trade/business or for investment
2. Is Like-Kind
a. Tangible Personalty for Tangible Personalty (Same Class) (business machine for another business machine)
b. Realty for Realty
108
Section 1031 Not Eligible
1. Inventory
2. Stock
3. Personal-use assets (autos)
4. Trade/Business Property including:
a. United States for foreign real estate
b. Tangible personalty for realty (Personal Property for Real Estate)
c. Livestock of different sexes
109
Boot and Section 1031 Like Kind Exchanges
"Boot" is Property that is part of the exchange that is "Not Like Kind. Most likely the "Boot" will be cash, and to make the like kind of exchange equitable one party will come up with cash or "boot"
1. Property exchanged in a like-kind transaction that is not like-kind
2. The receipt boot will: "General Rule: Boot is Taxable to the extent of gain in the transaction."
a. Result in the recognition of gain if there is a realized gain
b. Result in no recognition if there is a realized loss
110
Boot: Given and Received
**IMPORTANT TO ASK: Is the Party giving Boot? Is the Party receiving Boot? "Boot will most likely be cash for CFP Exam"
1. If boot is given, add it to the basis of the new property
| 2. If boot is received, gain is recognized up to the lesser of the realized gain or the boot received.
111
Basis of Like Kind Property received: Steps
```
Start with: Adjusted Tax Basis (ATB) of property surrendered:
+ ATB of boot given
+ Gain recognized
- FMV of boot received
- Loss recognized
```
Basis of boot:
FMV
New Holding Period
112
Section 1033 - Involuntary Coversions
1. Destruction, theft, seizure, requisition or condemnation (or sale/exchange under threat of same)
2. Must replace property within 2 years from the end of the year in which realization of gain occurred for nature disaster.
3. 3 years of Gov. Takings (can also be called eminent domain) and condemnation of real property used in a trade or business or held for investment.
113
Section 1033 Involuntary Conversion Rules
1. Amount reinvested has to be greater then or equal to the amount realized from conversion, then no gain recognized.
2. Amounts reinvested is less than amount realized from conversion, then lesser of realized gain or difference between amount realized and amount reinvested is recognized gain.
114
Replacement Property Functional Use Test
1. Use of the replacement property and involuntarily converted property must be the same.
a. Example: Office building used as an office building by the owner is subject to involuntary conversion.
b. Replacement property must be an office building used as an office building.
* *MUST have SAME FUNCTION
115
Replacement Property: Taxpayer Use Test
1. Owner- Investor's properties must be used in similar endeavors as the previously held properties
a. Example: If the owner had held the office building as an investment property, the replacement property could be any realty investment property.
2. Most flexible than the functional use test
116
Taxpayer's office building was condemned by a local government authority on May 10, 2009. The adjusted basis was $300,000. Condemnation proceeds of $500,000 were received on Feb. 1, 2010. The taxable year is the calendar year. What is the latest date that they taxpayer can replace the office building to qualify for Section 1033 (nonrecognition of gain from an involuntary conversion) treatment?
Answer: Dec. 31, 2013
117
Section 1041 - Property Transfers by Divorcing Spouses
1. Tax Free
2. Carry over of basis
3. Transfer for value does not apply where life insurance policy is transferred from one spouse to another as a result of a property settlement.
4. Death proceeds retain their income tax-free character.
118
A business must show a profit in at least _______ of the preceding five years otherwise it will be considered a hobby.
What are the exceptions?
1. A business must show a profit in at least 3 of the preceding five years.
Exceptions: Horse breeding, trading, showing and racing which required 2 out of the last 7 years.
119
Section 1041 provides for nontaxable exchange treatment for the transfer of property between spouses or between former spouses as a result of divorce. As part of the divorce agreement, the one spouse transfers their ownership interest in their personal residence to the other spouse...when their adjusted basis is $160,000. After the transfer what is the recognized gain to the one spouse transferring his interest, and what is the new adjusted basis?
1. The recognized gain is zero
| 2. The adjusted basis is the same as it was prior to the transfer and the divorce.
120
Interest on Educational Loans: What is the maximum allowable deduction for 2013?
$2,500
121
What are the income phase out for deducting interest on Educational loans?
1. Single: 60-75k
| 2. MFJ: 125-155k
122
What is the self-employment rate applicable to the amount of income less than or equal to the SS taxable wage base for 2013?
15.3%.
123
R and D MFJ. R's salary $32,000 D's salary $58,000. Annual interest earned on investments is $4,000. R has $16,200 of net earnings from self-employment income and paid $2,290 in self employment taxes. R contributed $750 to qualified retirement plan. During the year R and D had $4000 unreimbursed qualified moving expenses. What is their adjusted gross income?
R salary of 32,000 + D's salary of 58,000 + $4000 interest + 16,200 self employment income - $750 qualified plan contribution - $4000 unreimbursed moving expenses - $1,144 deductible of self-employment taxes = $104,306
124
Education Expense Requirements
1 To maintain or improve existing skills in present job
2. To meet legally imposed or ER requirements to retain current job
3. Cannot be to meet minimum requirements or qualify for new trade of business
125
Home Office Expenses
1 Exclusive - space set aside used as a principal place of business
2. Be a place used for clients, patients, or customers
3. IF it's a separate structure that is not attached to dwelling, it must be used in connection with trade/business
126
Home Office Expenses Deductions and Limits
1. Requires allocation of total household expenses.
2. Cannot exceed net income of business.
3. First deduct expenses that would be allowed (taxes, mortgage, interest)
4. Self Employed - the Deduction is "for AGI" - Above the Line Deduction
5. EE's - the Deduction is from AGI (2% miscellaneous itemized deduction)
6. Disallowed expenses can be Carried Forward!
127
Vacation Home Rentals & Rental Property
1. Cannot use vacation homes to generate deductible rental losses
2. Taxation: Relative time the home is rented (for income purposes) vs the amount of time that the home is used personally
3. Three categories of use:
a. Primarily personal use
b. Primarily rental use
c. Mixed (personal and rental) use
128
Capital Gains
1. Personal Property - No taxable benefits for losses! Gains are capital!
2. Investment Property - Capital losses limited to $3,000 per year. Net Capital gains against capital losses
3. Trade/Business assets - Gains are capital gains; Losses are ALWAYS ORDINARY
129
Holding Period - Capital Gains
1. Short Term Holding - property owned by taxpayer less than a year and a day
2. Long Term Holding - Generally, property must be owned by taxpayer longer than a year
***CFP Exam: Property owned exactly for 1 year, will be short term, unless it's 1 year and a day
130
Holding Period Special Property
1. Gift Property - if Donor's basis carries over to donee, the donor's holding period is added on to donee's holding period. (Remember for EXAM)
2. Inherited Property - the property is treated as long term regardless of actual original holding period (ALWAYS LONG TERM, regardless of holding period)
3. Capital Asset or Section 1231 Asset - in a like-kind exchange between a Capital Asset or Section 1231 asset, the newly acquired property includes the holding period of the former property
131
Mark to Market (means that the value of your account is determined by the current market price of the contents at the end of every day)
1. Apply to Section 1256 contracts
a. Regulated futures contracts
b. Foreign currency contracts
c. Non-equity contracts, S&P 500 Index option
d. Dealer Equity Options
132
Mark-to-Market and Capital Gains
Capital gain or loss is treated as if 40% short term and 60% long term! No matter what!
End of year, these securities (generally derivatives), are Mark-to-Market (treated & valued on last day of the year), whatever gain or loss this is how the security is treated. The gain is adjusted by any amounts considered in the previous years, and is reflected in adjustment to basis.
133
Qualifying Dividends: In order to be taxed at the Qualified Dividend rate (Long Term Cap Gains Rate), the dividend must:
1. Be paid after Dec 31, 2002
2. Be paid by a US Corporation
3. Meet holding period requirements: You must hold the stock for more than 60 days during the 121 day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration date.
134
Capital Gains rates were modified by the American Taxpayer Relief Act of 2012. For tax years after 2012, the top rate for capital gains and dividends will permanently rise to...
1. 20% capital gains rate for taxpayers income exceeding $400,000 ($450,000 MFJ)
2. 15% capital gains rate for taxpayers income subject to 25% or greater rate on ordinary income, but whose income level falls below the $400,000/$450,000 threshold
3. 0% capital gains rate for taxpayers income at the 10% or 15% rate
135
Qualifying Dividend income for individuals - dividend income may be taxed as a Capital Gain if it meets the requirements:
1. Stock is from a domestic corporation or qualified foreign corporation
2. Stock must be held for 61 days of 121 day period beginning 60 days before the ex-dividend date
3. Dividends from a regulated investment company will qualify for the reduced rate to the extent they resulted from long term capital gain.
136
Harold bought a building for $20,000 cash and assumed a mortgage of $80,000. Harold's basis in the building is...
$100,000
137
Section 1033 Involuntary Conversion
1. Destruction, theft, seizure, requisition or condemnation (or sale under threat of)
2. Replace property within 2 years from the end of the year in which realization of gain occurred for natural disaster (3 yrs for Gov condemnation)
138
Section 1033 Involuntary Conversions
1. Amount invested > amount realized from conversion, then no gain recognized.
2. Amount invested < amount realized from conversion, then lesser of realized gain or difference between amount realized and amount reinvested is recognized gain.
3. Replacement Property:
a. Function use Test
b. Tax payer use test
139
Taxpayer's office building was condemned by a local gov. on May 10, 2012. The adjusted basis was $300,000. Condemnation proceeds $500,000 were received on Feb. 1, 2013. The tax year is the calendar year. What is the latest date that the taxpayer can replace the office building to qualify for Section 1033 (non recognition of gain from an involuntary conversion) treatment?
Answer: Dec 31, 2016
a. Taxpayer received $200,000 of gain over basis. Taxpayer does not want to pay taxes on the gain.
b. What is the deadline...how long can they go? They could do it sooner, but they don't want to recognize the gains they have made. Why is it Dec 31, 2016. The proceeds were not received until Feb 1, 2013. The gain occurred in 2013, so you go out to Dec 2013 and then go out three years, and then it's Dec 31, 2016.
(Time period started not on the date of condemnation
140
Involuntary Conversion Timing Rule
Must replace property within TWO YEARS from end of the year in which realization of gain occurred ($$ received) for natural disaster.
3 Years for Gov. taking and condemnation of Real Property used in trade/business for investment
141
Dr Dalton's office building, (used in his business with Adjusted Basis of $300,000) is destroyed by hurricane. A Insurance sent him a check for $450,000. What is the realized and recognized gain and basis if:
A. He acquires another office building for $460,000 (immediately)
Solution A: Replacement purchase $460,000.
Realized Gain = $150,000 ($450,000 - $300,000)
Recognized Gain = 0 (Amount Reinvested > amount realized)
New Basis = $310,000 ($300,000 + $10,000)
142
Dr Dalton's office building, (used in his business with Adjusted Basis of $300,000) is destroyed by hurricane. A Insurance sent him a check for $450,000. What is the realized and recognized gain and basis if:
A. He acquires another office building for $430,000 (immediately)
Solution: Replacement Purchase of $430,000
Realized Gain = $150,000 ($450,000 - $300,000)
Recognized gain = $20,000 (Lesser of Realized Gain or Amount
realized less amount reinvested)
New Basis = $300,000
143
Difference between Realized Gain Vs Recognized Gain
1. Realized Gain - Is the total of all money you receive plus the FMV of the property or services you receive. Amount realized includes any liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage. The gain/loss realized is the gain/loss on the books.
2. Recognized Gain - Amount that you pay tax on. Recognized gain must be included in gross income. Recognized losses are deductible from gross income. However, a gain or loss realized from certain exchanges of property is not recognized.
144
Section 1041 Transfers by Divorce
1. Tax Free
| 2. Carry over basis - no step up or step down
145
As part of their divorce agreement, Ron transfers his ownership interest in their personal residence to Marge. The house has been jointly owned by Ron & Marge, and their adjusted basis was $160,000. At the time of the transfer to Marge, the fair market value is $210,000. What is the recognized gain to Ron, and what is Marge's new tax basis for the house?
a. 0-160,000
b. 0-210,000
c. 25,000 and 185,000
d. 25,000 and 210,000
Answer is: A
146
Section 1031: Non taxable Exchange
1. Exchange of property held for use in trade/business/investment
2. Property is like-kind property
a. Tangible personalty for tangible personalty (same class)
b. Realty for Realty: (Building for another Building)
147
Section 1031: What is not Like Kind of Exchange
1. Inventory: Products company is being sold.
2. Stock: Investments and stock. (Intangible personalty property cannot be felt or touched: securities, bonds, CD's
3. Personal - Use Assets (Autos)
4. US Real Estate for Foreign Real Estate. Real Estate over seas will not work.
5. Tangible Personalty for Realty: (Tangible Personalty is property that can be felt or touched. Includes: furniture, business equipment, vehicles, collectibles, jewelry.)
6. Livestock of Different Sexes
148
Boot (Like Kind Exchange)
(Boot is often cash or cash equivalent)
One of the property's has higher FMV to make the deal equal cash is added. The Cash added is boot.
1. Boot: Property exchanged in a like-kind transaction that is not like kind
2. Boot Received will...
a. Result in recognition of gain if there is realized gain
b. Result in no recognition if there is a realized loss
3. If boot is given - If you are adding Cash to the transaction...your cash will ADD it to the basis of the NEW Property.
4. If boot is received, RECOGNIZE the boot as Gain up the potential gain and Carryover the basis net of any excess boot
149
Section 1031 Like Kind Exchange - Basis Issue
1. Basis of like-kind property received (carry over holding period)
ATB (Adjusted Tax Basis) of Property Surrendered (Property Traded away)
+ATB of boot Given (FMV of the Cash or something different)
+Gain recognized
- FMV of boot received
- Loss recognized
-Basis of Boot
a. FMV
b, New holding period
150
Section 1231 Like Kind Exchange
T/F: Like kind exchange is automatic, not elective!
T/F: Liabilities discharged generally are treated as boot received.
1. T - Like kind exchange is automatic, not elective
| 2. T - Liabilities discharged generally are treated as boot received.
151
Jack sold his home this year for $432,000. He had lived in the home for 5 years and had an adjusted basis of $368,000. Jack purchased a new home for $398,000. What is his adjusted basis of the new home and his recognized gain from the sale?
Remember: A single taxpayer may exclude up to $250k gain on sale of personal residence.
1. Must live in home for 2 out of 5 years preceding the sale and cannot have used the exclusion on the sale of another home within the 2 year period.
3. $432,000 - $368,000 = $64,000. Because the $64,000 is an exclusion and not a deferral, the adjusted basis in the new home equals the amount paid = $398,000
152
What is the functional use test?
What is taxpayer use test?
1. Functional use test is part of a section 1033 exchange, in the functional use test, the taxpayer's use of the replacement property and of the involuntary converted property must be the same.
2. Taxpayer use Test, the owner investor's properties must be used in similar endeavors as the previously held properties.
153
Kathy owns a car with a FMV of $10,000, for which she originally paid $12,000. She trades for a new car, which is worth $10,000 and the dealership gives her $1,000. How much gain must Kathy recognize on this exchange for tax purposes?
When a taxpayer exchanges property for other property and receives cash (boot), a gain must be recognized to the extent of the cash received. Kathy's original cost is not relevant because the car was personal not business property
154
Mark and Mary, sold their home this year for $140,000. Originally paid $80,000 12 years ago. Incurred $6,750 in selling expenses )advertising, legal fees, seller paid points). Also the realtor's commission on their home sale was $8,400. What was the amount of their realize gain?
Selling price $140,000 - (the selling expenses of $6,750 + commissions of $8,400) - cost basis of $80,000 = $44,850
155
At what point are accumulated earnings subject to the accumulated earnings tax?
When they exceed the reasonable needs of the business
156
What is the accumulated earnings tax?
1. The objective of the accumulated earnings tax is to discourage individual taxpayers from using the corporate entity solely for tax avoidance.
2. The tax applies whenever a corporation accumulates earnings beyond its reasonable needs, unless the corporation can prove to the contrary by a preponderance of evidence.
3. The tax rate is 15%
157
Built In Gains Tax S Corp
1. Built in gains tax applies to S corporations that used to be C corporations
2. This tax is imposed on any unrealized built in gain that is recognized on the disposition of any asset by the S Corporation
3. The unrealized built in gain is the difference between the FMV and the basis of an asset as of the date the C Corporation converts to an S Corporation
4. The recognized built in gain is any gain recognized from the sale of an asset within the 10 year period following the S Corporation electin
5. Any appreciation of the asset after the date of conversion is not subject to the Built in gains tax.
6. The tax is calculated by applying the highest corporate income tax rate to the S Corporation's net recognized built in gain for the tax year.
7. The amount of recognized built in gain passed through and taxed to shareholders is reduced by the built in gains tax paid by the S Corporation
158
Built In Gains Tax - S Corporations
1. The built in gains tax applies only to S corporations that were formerly C Corporations
2. The built in gains tax is paid by the S Corporation not the shareholders
159
Jenny is a commercial real estate manager in Georgia. She owns an office building that has a FMV of $200,000. She paid $100,000 for the building several years ago. The value of the office building in California is $300,000. The exchange officially takes place. This year, Bart sell the Georgia office building for $300,000. How much gain must Jerry recognize this year?
Answer: $200,000
When properties are traded and the use for the newly acquired property is the same as the old property, Tax Code does not required the taxpayer to recognize any gain received in the exchange. The gain can be carried over into the future, unless the exchange is between related parties and one party sells the property within 2 years of the exchange. Because Jenny received Bart's $300,000 office building last year, but had a $100,000 basis on her office building, she effectively gained $200,000 through the exchange. Bart sold his building in the current year (within 2 years of the exchange), so Jenny must recognize her gain of $200,000 from the exchange a year ago.
160
Jenny is a real estate agent and investor in Georgia. She owns an office building that has a FMV of $200,000, which she is trying to sell. She has an adjusted basis in the building of $100,000. Her brother, a doctor, owns an office building in CA and agrees to trade buildings with her. The value of the office building in CA is $300k. If the exchange takes place this year, how much of a gain must Jenny recognize th is year because of the exchange?
Answer: $200,000.
When properties are traded and the use for which the newly acquired property is the same as the old property, the Code does not require the taxpayer to recognize any gain received in the exchange.
EXCEPTION: The Property that is traded cannot be treated this way IF it property held primarily for SALE!
DEALERS in REAL ESTATE who hold properties that are primarily for SALE must RECOGNIZE ANY GAIN or LOSS of an exchange.
The gain in this case is the value of the building received less Jenny's basis in her building. ($300k - $100k = $200k)
161
Like Kind Exchange
1. T/F Where there is no boot involved in the exchange, a taxpayer's basis for the property received will be the same value as the adjusted basis the taxpayer had in the property he/she surrendered in the exchange.
Answer: T
162
Like Kind Exchange
T/F: The taxpayer's basis in the property received is not determined by the other party's basis in the property the other party surrendered.
Answer: True
163
Like Kind Exchange
T/F: Boot is the cash or other property involved in a like-kind exchange that is in addition to the like-kind property. Boot makes the total value of the property surrendered in the exchange equivalent to the total value of property received.
Answer: True
164
Like Kind Exchange
T/F: The taxpayer who gives the boot property may have to recognize gain or loss on an otherwise qualifying exchange. However, the taxpayer who receives the boot property must recognize any realized gain but only to the extent of the value of the boot received.
Answer: True
165
Section 1035 Annuities/Life Policy may be exchanged for LTC.
| Rules are as follows:
1. Cash values will be used to offset premiums on the LTC
2. If a life policy or annuity contains a long-term care insurance rider, values used from the life policy or annuity to pay the LTC rider premium will not be considered taxable distributions, but will reduce basis.
166
Basis of Asset Acquired by Gift
1. General - Carryover donor's basis and holding period
2. When the FMV is less than the donor's basis, double basis rule is used. (Also, the Holding Period changes from the Donor's Original purchase date to the date of the gift)
3. When gift tax is paid by donor, add "Proportional Tax" on appreciation to donee's basis
a. FMV is reduced by any annual exclusion amount donor used for the gift
167
Basis of Asset Acquired by Inheritance
1. Assets inherited prior to Jan 1, 2010 and after Dec 31, 2010 - FMV at date of death, or alternate valuation date if properly elected.
2. Assets in 2010...basis rules must be elected by estate executor:
a. Long term holding period
b. Income in Respect of a Decedent (IRD) assets - carryover basis.
- Annuities (non qualified annuities where there is growth and income, no basis carry over)
- Installment Sales
- Pensions
168
Code Section Losses - Wash Sale Rule
1. Wash Sale Rule - taxpayer sells securities for a loss and acquires relatively identical securities within 30 days before or after date of sale of exchange
a. Cannot recognize loss
b. Add loss amount to FMV of new securities to derive tax basis
30 days before + 1 + 30 days after = total of 61 days
169
Section 1244 Stock Rules: Small Business Stock
Small Business is <$1 million in initial capital)
1. Losses are ordinary up to $50,000 per year ($100,000 MFJ)
** If the loss is more than $50,000 then the remaining loss would be a Capital Loss
170
Small Business (Section 1244) stock all of the following must be met.
Short Term vs Long Term doesn't matter.
1. Must be stock of a Domestic Corporation
2. Must have been issued for money or property
3. Issuing corporation must meet business receipts test
4. Corporation must be a small business corporation (less than $1 million of capital contributions and paid in surplus at the time the stock was originally issue.
171
Wash Sale Example
Chelsea sold one share of stock with an adjusted tax basis of $100 and a fair market value of $70.00. Two weeks later, she buys the same stock for $50.00. Her $30.00 loss will be added to the basis of the share of stock
Old New
FMV 70 FMV $50
ATB (100) Unrecognized loss $30
Unrecognized loss ($30) ATB $80
**The $30.00 loss not allowed, it's a realized loss but not a recognized or received loss that would have been a tax deductible.
172
Long Term Capital Gains - Rates
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0% = up to 15% marginal rate taxpayer (If the lower income person will not owe any taxes Long Term Capital Gains)
15% = all other marginal rate taxpayers up to income threshold
20% = Taxpayers with incomes exceeding $400,000 ($450,000 MFJ)
25% = Un-recaptured Section 1250 property (depreciable real property)
28% = Collectibles
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173
Section 1250 Recapture: What is a Section 1250 Recapture?
Section 1250 prevents taxpayers from receiving benefits of both accelerated depreciation and long term capital gain treatment and requires the recapture of depreciation deducted by the taxpayer over what it would have been using straight line depreciation.
174
Section 1250 Recapture
1. Section 1250 property is depreciable real property (typically buildings and structural components)
2. Losses do not have depreciation and are usually treated as a Section 1231 loss, (If a Business Loss - then Deducted For AGI; Other Losses are Deducted from AGI)
3. Gain attributable to straight-line depreciation is taxed at the 25% max. capital-gains rate
4. Any long term gain not attributable to depreciation is subject to the taxpayer's long term capital gain rate.
175
Example of Section 1250 Recapture
| Section 1250 property is depreciable real property, buildings and structural components.
a.
Mark sold a building on June 15 for $100,000. Mark's income tax rate is 28%. He had acquired the building more than five years earlier for $75,000. Straight-line depreciation taken was $30k. The character of the gain is $30k at the 25% rate and $25k at the 15% rate. The recaptured Section 1250 depreciation is taxed at the 25% rate, and the remaining long term capital gain receives a 15% rate
176
Netting Capital Gains and Losses
STCG LTCG
-STCL -LTCL
Net STCG/L Net LTCG/L
1. Net all LT gains & losses (NLTCG or NLTCL)
2. Net all ST gains & losses (NSTCG or NSTCL)
3. Offset any remaining positive and negative amounts
4. If signs are the same stop
5. Maximum of $3,000 of capital losses deductible against ordinary income
6. If there are both LTCL and STCL, taxpayer must use STCL before LTCL
177
Filing Status Thresholds
MFJ $250,000
MFS $125,000
Single $200,000
HH (with qualifying person) $200,000
Qualifying Widow
w/Dependent Child $200,000
178
Section 1202 Qualified Small Business Stock (QSBS)
1. Non corporate investors can exclude up to 50% of realized gain. (Individuals not corporations)
2. Feb 18, 2009 - Sep 27, 2010 - Stock issued during this dates, the 50% exclusion is increased to 75%
3. Sept 27, 2010 - Jan 1, 2014 - of Gain is excluded from both Regular income and AMT.
4. ANY REMAINING GAIN....TAXED AT 28% CAP GAINS RATE
179
Section 1202 Small Business Stock (QSBS)
Rules to gain 50% Cap Gains Rate
1. Stock must be issued after August 10,1993 and before Feb 18, 2009.
2. Stock must be held for more than 5 years
3. Exclusion limited to greater of 10 Million or 10 times the taxpayer's basis in the stock
4. A portion of the excluded amount of gain is a tax preference item for AMT purposes
180
Medicare Surtax on Investment Income
Tax is in addition to any other taxes on the investment income (Ordinary or Capital Gain)
1. Beginning 2013, a 3.8% Medicare surtax applies to net investment income of taxpayers with MAGI exceeding the applicable thresholds.
2. Rates
MFJ $250k
MFS $125k
Single $200k
HH $200k
Qualifying Widow $200K
Tax is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over the threshold amount.
181
Medicare Surtax on Investment Income on Trusts and Estates
1. For estates and trusts, tax is 3.8% of the lesser of:
a. Undistributed net investment income, or
b. The excess of AGI over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
182
Medicare Surtax on Investment Income does not apply to?
answer: tax does not apply to non resident aliens and certain charitable trusts.
183
Net Investment Income is generally ...
Total gross income from interest, dividends, annuities, royalties, and rents and net taxable gain attributable to the disposition of property.
184
Installment Sales - Basic Rules
| Critical to Know for Exam
1. Installment sale is complex
2. Installment sale characterized by a down payment made by the buyer (eg. 20%), which is made up of a partial return of basis and a partial capital gain to the seller (notice no ordinary income).
3. Buyer then provides the seller with promissory notes evidencing the remaining indebtedness (these notes are like bonds)
4. Buyer makes installment payments which include return of basis, capital gains, and ordinary income to seller, (ordinary income to the extent of the interest component)
5. Section 1245/1250 Recapture Rules - gain recaptured under either Section 1245 (depreciable property used in business) or gain recaptured as excess of accelerated depreciation over straight-line depreciation is taxed as ordinary income (Section 1250 depreciable real property used in trade or business) and is not eligible for installment sale treatmet.
185
Passive activity limitations do apply to all taxpayers. Which of the following statements is correct?
A. The passive activity limitation applies to individual taxpayers, estates, trusts, certain personal service corporations and any closely held corporation.
B. The passive activity limitation applies to partnerships and S Corporations because they are pass-through entities in which the reporting of income and losses flows through to the individual owners.
Answer: Both statements are true.
Passive loss limitations do not apply to C Corporations that are not closely-held corporations or personal service corporations.
186
Authur, an attorney, owns and participates in a separate business (not real estate) during the current year. He has one employee who works part time in the business. How many hours must Arthur work and the EE for Arthur to qualify as a material participant?
Answer: More than 500 hours. An individual who participates for more than 500 hours is a material participant, regardless of how much other EE's participate.
