Tax 7-1,2,3 Intrafamily Transfers

Question 1

Unearned Income Rules

For any taxpayer eligible to be claimed as a dependent, with earned income or a combination of earned and unearned income, the rules are slightly more complex. The allowable standard deduction for the dependent is the greater of (1) $1,050 or (2) the amount of earned income plus $350, not to exceed the full ____ deduction amount

(7-1,2,3, pg 9)

Answer 1

standard ($6,300 in 2016).

These rules apply to all taxpayers eligible to be claimed as a dependent on another taxpayer’s return.

Question 2

Unearned Income Rules

Assume that a taxpayer, Frank, provides over 50% of the support for his elderly father, Don, who has $3,050 of unearned income only. Frank may claim Don as a dependent, and thus claims a dependency exemption for Don. Note that Don may not claim his own exemption, because Frank is claiming it. Don is entitled to a limited standard deduction, however. The limited standard deduction would shelter $ _, _ _ _ of the income, and the remaining $ _, _ _ _ would be taxed at Don’s tax bracket rate of 10%.

(7-1,2,3, pg 10)

Answer 2

$1,050, $2,000

Thus, Don’s tax liability would be $200. Note that the result would be the same for a dependent child who is not subject to the kiddie tax.

Question 3

Unearned Income Rules

Assume that Billy, age 17, is properly claimed as a dependent on his parents’ tax return. Note that Billy may not claim his own exemption, because his parents are claiming it. Billy has income from a part-time summer job of $4,600 and has interest income of $425. Billy’s standard deduction is $4,950; the amount of earned income ($4,600) plus $350. Thus Billy’s tax return would show taxable income of $ _ _

(7-1,2,3, pg 10)

Answer 3

$75

$5,025 total income
- $4,950 standard deduction
= $75

Question 4

Kiddie Tax Rules (unearned income of a child)

Certain children are subject to even more restrictive rules: the kiddie tax rules. The kiddie tax rules provide for a limited standard deduction of $1,050 against unearned income on the child’s income tax return. The next $1,050 is taxed to the child at the _____ marginal tax rate. Any unearned income over $2,100 is taxed to the child at _____ marginal tax rate (if higher than the child’s).

(7-1,2,3, pg 11)

Answer 4

child’s

the parents’

The standard deduction rules applicable to earned income, or a combination of earned and unearned income, are the same as those previously discussed in the Unearned Income Rules section.

Question 5

Kiddie Tax Rules (unearned income of a child)

The kiddie tax applies to a child aged…

1. under _ _ years of age, or
2. under _ _ years of age if a full-time student.

(7-1,2,3, pg 11)

Answer 5

1. under 19 years of age, or

2. under 24 years of age if a full-time student.

Question 6

Kiddie Tax Rules (unearned income of a child)

Assume that Fred and Linda, married taxpayers filing jointly, have taxable income of $180,000 and are therefore in a 28% marginal income tax bracket. Their dependent daughter Sarah, age 15, has $4,900 of unearned income only. Sarah may not claim her own exemption, because Fred and Linda are claiming it on their return. On Sarah’s tax return, the first $1,050 is sheltered by her limited standard deduction. The next $1,050 is taxed to her at who’s rate?

(7-1,2,3, pg 11)

Answer 6

her own tax rate, in this case 10%, for a tax of $105. The remaining $2,800 is taxed to Sarah at the parents’ marginal rate of 28%, or $784. Thus, Sarah has a total tax liability of $889.

$4,900 Total Income
$1,050 Limited Standard Deduction
$1,050* 10% Child’s rate = $105
$2,800 * 28% Parent’s Rate = $784

Total = $889

Question 7

Intrafamily Transfers

Assume that a 12-year-old has qualified dividend income of $3,100 and that her parents are in a 28% marginal income tax bracket. The first $1,050 of income received is sheltered by the limited standard deduction. The next $1,050 of qualified dividends received is eligible for the preferential rate of 0%. The remaining $1,000 of dividend income is taxed at 15%, the dividend rate of the parents.

Thus, the child’s tax liability is $ _ _ _

7-1,2,3

Answer 7

$150;

the $1,050 at 0%, combined with the remaining dividend income of $1,000 taxed at 15%.

Question 8

Strategies for Kiddie Tax Rules

Probably the first and most important planning technique is to transfer only certain types of income-producing assets to the child. For example, Series EE government bonds may be an excellent type of property to transfer, because interest income is deferred until redemption (unless the bondholder elects to pay tax currently). Another excellent investment to place in a child’s name is growth stock that pays little income or dividends. A third investment that looks favorable for transfers between parent and child is a single premium variable life insurance policy.

7-1,2,3

Answer 8

The common thread among all these assets is that they allow for the taxation of unearned income to be deferred until after the kiddie tax stops applying, or they produce income under the $2,100 annual level (for 2016) that is taxed favorably to the child, or they are tax-exempt entirely. The tax rate applicable to net long-term capital gains and qualifying dividends is 0% for an individual in a 10% or 15% marginal income tax bracket. An individual subject to the kiddie tax obtains only a partial benefit from this rate reduction.

7-1

Question 9

Intrafamily Transfers

For a child not subject to the kiddie tax, proper planning with long-term capital gains or qualifying dividends may yield tremendous tax savings. For an individual in a 10% or 15% marginal income tax bracket, the tax rate on net long-term capital gains and qualifying dividends is 0%.

7-1,2,3

Answer 9

Given that the top rate on net long-term capital gains and qualifying dividends is 20% (for individuals with taxable income that places them in the 39.6% marginal income tax bracket) there’s an opportunity to save 20% on over $36,000 of qualified dividends or net long-term capital gains.

7-1

Question 10

Personal Exemption Allocation (Multiple Support Agreement)

Another technique of intrafamily planning involves the allocation of personal exemptions among family members. The most common examples of potential exemptions involve the support of children, parents, or dependents of deceased or disadvantaged relatives. Careful planning of financial support for these persons can result in an exemption being allocated to a high-bracket taxpayer.

7-1,2,3

Answer 10

Example. Siblings Bill, Mary, and Susan together provide over 50% of the support for their elderly father, Stan. Each provides equal support for the father. Because no child provides over 50% of the total support, none of them individually would normally be entitled to claim the father as a dependent. However, by utilizing a multiple support agreement (Form 2120), the three siblings may declare which one will be entitled to the exemption for a given year.

Question 11

Intrafamily Transfers

1.1. Identify how the Tax Reform Act of 1986 reduced the benefit of family income shifting.

7-1,2,3

Answer 11

The ’86 act instituted the unearned income rules. For any individual eligible to be claimed as a dependent, there is a limited standard deduction allowed against unearned income. In addition, the kiddie tax rules (imposition of the parental rate on unearned income in excess of $2,100) also reduced the tax savings available through income shifting.

Question 12

Intrafamily Transfers

1.2. Describe the kiddie tax rules.

7-1,2,3

Answer 12

The kiddie tax applies to children under 19 years of age under 24 years of age if the child is a full-time student, For the kiddie tax to apply, the child must have at least one living parent. The kiddie tax does not apply to a child who is married and files a joint return for the tax year; or if the child has earned income that exceeds half of his support. The first $1,050 of unearned income is “sheltered” by the child’s limited standard deduction, and the next $1,050 is taxed to the child, at the child’s rate. Unearned income in excess of $2,100 in any one year is taxed to the child at the parents’ marginal tax rate (if higher). The child may not use his or her personal exemption if he or she is eligible to be claimed as a dependent on the parents’ tax return.

Question 13

Intrafamily Transfers

1.3. Identify planning suggestions that still may provide a significant income-shifting advantage in the transfer of assets from parent to child.

7-1,2,3

Answer 13

transfer only certain types of income-producing assets to the child (e.g., Series EE bonds)

wait until the child is no longer subject to the kiddie tax before giving substantial income-producing assets

use trust arrangements, such as the Section 2503(c) trust, that are not required to distribute income at least annually to the child as beneficiary

take advantage of the first $2,100 being taxed at a very low rate; essentially $105 of tax on the first $2,100 of income, in most circumstances—the first $1,050 of unearned income offset by the child’s limited standard deduction, and the next $1,050 taxed to the child, at the child’s rate (typically 10%).

Question 14

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      a. family partnerships and S corporations

7-1,2,3

Answer 14

They use a conduit approach to pass through income and losses directly to partners or corporate shareholders. Because an individual partner or shareholder may have a lower marginal tax rate, it may be advantageous to transfer ownership of a family business into these forms. In order to shift income between family members, capital must be a material income-producing factor.

Question 15

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      b. gift (sale) leasebacks

7-1,2,3

Answer 15

This is a gift or sale of property from a high-bracket taxpayer (HBT) to a lower-bracket taxpayer (LBT), with rental payments then paid by HBT for use of the property. HBT receives a deduction for rental payments as ordinary and necessary business expenses. This technique is used primarily in situations involving fully depreciated property and/or property of substantial business value.

Question 16

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      c. personal exemptions allocation (multiple support agreement)

7-1,2,3

Answer 16

This allows the exemptions for supported family members to be allocated to a higher-bracket taxpayer.

Question 17

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      d. outright gifts (other than to minors)

7-1,2,3

Answer 17

All future income is taxable to the donee. A gift of appreciated property is most favorable. It requires giving up all rights by the donor (which could produce a hardship).

Question 18

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      e. gifts to minors (children under age 24)

7-1,2,3

Answer 18

The rules on taxation of unearned income (the kiddie tax) may apply. It is possible to have up to $2,100 of unearned income taxed to the child at an effective rate much lower than the parents’ rate.

Question 19

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      f. installment sales

7-1,2,3

Answer 19

These permit a transfer of income-producing properties by spreading payments and tax impact over a period of time (rather than all in one year). Capital gain on sale may be taxed at favorable capital gain rates. Related-party rules (acceleration of the remaining gain) generally apply if the purchasing family member disposes of the installment sale property within two years.

Question 20

Intrafamily Transfers

1. 4. Identify characteristics of each of the following forms of intrafamily transfers that may operate to produce a tax advantage.
      g. employment of family members

7-1,2,3

Answer 20

This allows a portion of business income to be paid out as salary to a family member, with a deduction as a business expense. There have been problems with attempts to employ either an underage family member or an absent family member. The unearned income rules do not apply. Thus, a child may utilize up to the full standard deduction amount against the earned income

Question 21

Intrafamily Transfers

5. James Donley is 42 years of age, married, and has taxable income of $250,000. He has one child, Jeremy, age 12. James is considering opening an UGMA account for Jeremy in the current year. James will transfer to this account a certificate of deposit that has a face value of $75,000 and currently pays 3% interest on the principal. He has heard mention of the “kiddie tax.” Accordingly, James has asked his father, Gerald, to serve as custodian and transfer the CD into the account as James’s agent.
   a. Given the above facts, what is the income tax implication to Jeremy of the UGMA account?

7-1,2,3

Answer 21

$2,250 Total Income
$1,050 Limited Standard Deduction
$1,050 10% Child’s rate $105
$150 33% Parent’s Rate $50

Total $155

At current interest rates, Jeremy will receive unearned income of $2,250 in the current year. With $250,000 of taxable income, James and his spouse are in the 33% marginal income tax bracket. Thus, Jeremy will pay tax on the excess over $2,100 at his parents’ marginal tax rate. Jeremy can apply a $1,050 limited standard deduction and pay tax at 10% on the next $1,050, and the remaining $150 would be taxed at his parents’ rate of 33%. The fact that James’s father, Gerald, transferred the funds to the UGMA account for Jeremy would have no bearing on this tax result. Unearned income above $2,100 to a child subject to the kiddie tax is taxed at the parents’ rate regardless of the source of the property.

Question 22

Intrafamily Transfers

5. James Donley is 42 years of age, married, and has taxable income of $250,000. He has one child, Jeremy, age 12. James is considering opening an UGMA account for Jeremy in the current year. James will transfer to this account a certificate of deposit that has a face value of $75,000 and currently pays 3% interest on the principal. He has heard mention of the “kiddie tax.” Accordingly, James has asked his father, Gerald, to serve as custodian and transfer the CD into the account as James’s agent.
   b. Assume the CD was earning 4% interest on $30,000 of principal. What is the income tax implication to Jeremy in this instance for the current year? In future years?

7-1,2,3

Answer 22

In the current year, there will be no income taxed at the parents’ rate since less than $2,100 per year in unearned income is received by Jeremy. In future years, as interest is compounded in the account, the unearned income rules could apply as income in excess of $2,100 per year is received by Jeremy. In the current year, $1,050 would be sheltered by the limited standard deduction, and $150 would be taxed at Jeremy’s 10% tax rate.

Question 23

Intrafamily Transfers

5. James Donley is 42 years of age, married, and has taxable income of $250,000. He has one child, Jeremy, age 12. James is considering opening an UGMA account for Jeremy in the current year. James will transfer to this account a certificate of deposit that has a face value of $75,000 and currently pays 3% interest on the principal. He has heard mention of the “kiddie tax.” Accordingly, James has asked his father, Gerald, to serve as custodian and transfer the CD into the account as James’s agent.
   c. Assume Jeremy will turn 19 during the current year, and that he is not a full-time student. What is the income tax implication to Jeremy in this situation?

7-1,2,3

Answer 23

The “kiddie tax” stops applying in the year that the child turns 19, provided the child is not a full-time student; thus, there would be no application of the parental tax rate. Jeremy would still use his limited standard deduction of $1,050, and the remaining income of $1,200 would be taxed at Jeremy’s rate of 10%.

Question 24

Intrafamily Transfers

6. Jane Johnson, age 11, has $3,500 of interest income for 2016. Jane’s parents, who file jointly, have a taxable income of $420,000. Compute the tax liability for Jane

7-1,2,3

Answer 24

$3,500 Total Income
$1,050 Limited Standard Deduction
$1,050 * 10% Child’s rate = $105
$1,400 * 35% Parent’s Rate = $490

Total = $595

Jane may not use her personal exemption because the exemption is claimed on her parents’ tax return.

Question 25

Intrafamily Transfers

7. Fran provides over 50% of the support for her elderly aunt, Sherry, who has $2,000 of interest income only. Fran is in the 28% marginal income tax bracket for the current year, and properly claims Sherry as a dependent. Compute the tax liability for Sherry

7-1,2,3

Answer 25

Sherry may not claim her own exemption because Fran is claiming it. Sherry is entitled to a limited standard deduction, however. The limited standard deduction of $1,050 is applied against the $2,000 of interest income, leaving a taxable income of $950. The $950 is taxed at the 10% bracket, for total tax of $95. Note that this is the same result that would be obtained for a child not subject to the kiddie tax.

Question 26

Intrafamily Transfers

8. Sandra Shullman is the owner/sole proprietor of Sandy’s Shades, a merchandiser of designer sunglasses. She is in the maximum marginal income tax bracket. Sandra owns the building in which she operates her business, and it has been fully depreciated for tax purposes. Upon the advice of her financial planner, she is considering gifting the building to her adult son, Harold, and then leasing it back for a fair rental value.

Identify the income tax implication to Sandra as a result of this gift-leaseback with Harold. (Ignore the potential gift or estate tax consequences.)

7-1,2,3

Answer 26

Assuming the leaseback arrangement resulted from a valid business purpose, Sandra would receive a deduction for the value of rental payments to her son, Harold. Thus, she could continue to achieve a tax advantage from the use of fully depreciated property.

Question 27

Intrafamily Transfers

9. Donna Lupchick is married, an architect, and a partner in an architectural firm with her older brother, Hugh. Donna is currently in the maximum marginal income tax bracket and expects to stay there in the future. Recently, Donna has hired her son, David, age 15, to work after school as a draftsman for the firm. David has shown an interest in art, but he has no formal training in drafting architectural plans. He has earned $2,500 during the past year as a draftsman for the firm.
   a. Given the above facts, would Donna be allowed to deduct (as a business expense) salary payments made to David? Explain.

7-1,2,3

Answer 27

Probably not. Given David’s lack of expertise in architecture, it is doubtful that his employment in the position of draftsman could be shown as useful to the family business. Thus, his employment by Donna may be seen as a tax avoidance scheme.

Question 28

Intrafamily Transfers

9. Donna Lupchick is married, an architect, and a partner in an architectural firm with her older brother, Hugh. Donna is currently in the maximum marginal income tax bracket and expects to stay there in the future. Recently, Donna has hired her son, David, age 15, to work after school as a draftsman for the firm. David has shown an interest in art, but he has no formal training in drafting architectural plans. He has earned $2,500 during the past year as a draftsman for the firm.
   b. What is the income tax implication to David of the $2,500 paid to him by his mother’s firm?

7-1,2,3

Answer 28

The $2,500 paid to David is probably earned income (however, if there is no business purpose for his employment, it could be construed as a gift). Accordingly, he could use his own standard deduction to offset the income in full.

Question 29

Intrafamily Transfers

9. Donna Lupchick is married, an architect, and a partner in an architectural firm with her older brother, Hugh. Donna is currently in the maximum marginal income tax bracket and expects to stay there in the future. Recently, Donna has hired her son, David, age 15, to work after school as a draftsman for the firm. David has shown an interest in art, but he has no formal training in drafting architectural plans. He has earned $2,500 during the past year as a draftsman for the firm.
   c. Would it make a difference if David were hired to perform cleaning tasks instead? Explain your answer.

7-1,2,3

Answer 29

Probably. David could certainly perform cleaning tasks that would have a valid business purpose; thus, the funds could be deducted by the business.

Question 30

Intrafamily Transfers

10. Adam Conrad is a 43-year-old dentist. He does not share his office with any other dentists. Adam’s wife, Judy, is a partner in a regional accounting firm. The Conrads are in the 33% marginal income tax bracket for the current year. Adam owns his office building and equipment outright, but the Conrads’ only other major investment is their personal residence. The Conrads have two children. One will be ready for college in two years and the other in three years. The Conrads are interested in paying for the children’s education with dollars not taxed at 33%.

From an income tax standpoint, what is the most appropriate form of intrafamily transfer for the Conrads? (Ignore the potential gift or estate tax consequences.)

installment sale

outright gift

gift-leaseback arrangement

7-1,2,3

Answer 30

A gift-leaseback arrangement of the office building and equipment to a trust established for the children would be most appropriate.

Such an arrangement permits a tax deduction to Adam for the amount of rental payments made to the trust, which is the new owner of the specified property.

Question 31

Intrafamily Transfers

11. Melissa Krupp is a widow, age 55, with over $480,000 in highly appreciated growth stock among her many assets. She is planning to sell this stock in the near future, and this year she is in the 28% marginal income tax bracket. Rance, her son, has just completed his residency and plans to enter private medical practice. Rance is in the 15% marginal income tax bracket. Melissa would like to assist him in starting his practice.

From an income tax standpoint, what is the most appropriate form of intrafamily transfer for Melissa? (Ignore the potential gift or estate tax consequences.)

installment sale

outright gift

gift-leaseback arrangement

7-1,2,3

Answer 31

An outright gift of the stock to Rance would be most appropriate (this ignores potential gift tax consequences).

Since Melissa is planning to sell the stock anyway, she should gift it to Rance to start his medical practice. Rance would take a basis in the stock equal to Melissa’s basis. By selling a portion of the stock each year over a period of several years, Rance could pay only a 0% tax (or 15% if the additional capital gain income pushed him into the 25% bracket) on the long-term capital gains.

Question 32

Intrafamily Transfers

12. George Franklin, age 60, owns several appreciated residential rental properties that he currently manages. He is in the 28% marginal income tax bracket. George wants to retire and move to a warmer climate. He would like to sell his rental properties but has been told that he would incur substantial income taxation on the appreciation. His oldest son, Jeff, has indicated a desire to manage George’s properties, but Jeff currently does not have enough money to buy the properties with one lump sum.

What is the most appropriate form of intrafamily transfer for George?

installment sale

outright gift

gift-leaseback arrangement

7-1,2,3

Answer 32

An installment sale of the rental properties to Jeff would be most appropriate.

The installment sale permits Jeff to buy the properties over time using rental income generated from the properties to make the payments. In addition, George avoids being taxed on the appreciation of the properties all at once and spreads his gain over several taxable periods.

Question 33

Intrafamily Transfers

Module Check

1. Which one of the following statements regarding the American Opportunity tax credit is correct?
   a. The education expenses must be for the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer.
   b. There is a phaseout between $100,000 and $120,000 of AGI for married taxpayers filing jointly.
   c. The credit applies during the first three years of post secondary school.
   d. Qualifying expenses include tuition, books, supplies, and room and board.

(LO 7-1)

Answer 33

a. The education expenses must be for the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer.

The phaseout is between $160,000 and $180,000 of AGI for married taxpayers filing jointly. The phaseout for single taxpayers is $80,000 to $90,000. (It is not necessary to memorize these phaseout numbers; they will be provided on the exam.)

The credit applies during the first four years, not three years, of post secondary school.

Qualifying expenses do not include room and board.

Question 34

Intrafamily Transfers

Module Check

2. Which one of the following statements regarding the Lifetime Learning credit is correct?
   a. The credit is equal to 50% of qualified tuition expenses up to $10,000.
   b. The credit applies during the first two years of postsecondary school.
   c. There is a phaseout between $55,000 and $65,000 of AGI for single taxpayers.
   d. Qualifying expenses include tuition, books, and supplies.

(LO 7-1)

Answer 34

a. There is a phaseout between $55,000 and $65,000 of AGI for single taxpayers.

There is a phaseout between $55,000 and $65,000 of AGI for single taxpayers. These phaseout numbers will be provided on the end of course exam.

The credit is actually equal to 20%, not 50%, of qualified tuition expenses up to $10,000.

The credit is available annually for an unlimited number of years, not just the first two years.

Qualifying expenses generally include only tuition. Amounts paid for books and supplies may be included only if required to be paid to the education institution as a condition of enrollment.

Question 35

Intrafamily Transfers

Module Check

3. Which one of the following statements regarding the Coverdell Education Savings Account is not correct?
   a. Annual contributions of up to $3,000 per beneficiary under age 18 may be made.
   b. Contributions are phased out between $190,000 and $220,000 of AGI for married taxpayers filing jointly or between $95,000 and $110,000 of AGI for single taxpayers.
   c. Distributions up to the amount of qualified education expenses are tax-free.
   d. Any balance remaining in a Coverdell account generally must be distributed when the beneficiary reaches 30 years of age.

(LO 7-1)

Answer 35

a. Annual contributions of up to $3,000 per beneficiary under age 18 may be made.

Annual contributions of up to $2,000, not $3,000, per beneficiary under age 18 may be made.

Question 36

Intrafamily Transfers

Module Check

4. Which one of the following is a characteristic of an intrafamily transfer that utilizes a Uniform Gift to Minors Act (UGMA) account?
   a. Income from such an account in excess of $2,100 (in 2016) is taxed at the child’s income tax rate if the child is subject to the kiddie tax.
   b. Income from such an account in excess of $2,100 (in 2016) is taxed at the parents’ marginal tax rate if the child is subject to the kiddie tax.
   c. A trust for the account is drafted in accordance with appropriate state law.
   d. A custodian for the account is named in a formal court proceeding.

(LO 7-2)

Answer 36

b. Income from such an account in excess of $2,100 (in 2016) is taxed at the parents’ marginal tax rate if the child is subject to the kiddie tax.

No formal trust is drafted.

No formal court proceeding is required to establish a custodian.

Question 37

Intrafamily Transfers

Module Check

10. Which one of the following statements is correct with respect to earned income received by a child who is subject to the kiddie tax and is eligible to be claimed as a dependent?
    a. The child has a limited standard deduction available (up to $1,050 in 2016).
    b. The child has up to a full standard deduction available ($6,300 in 2016).
    c. Any income that exceeds the total of the available standard deduction and $1,050 is taxable at the parents’ marginal income tax rate.

(LO 7-2)

Answer 37

The child has up to a full standard deduction available ($6,300 in 2016).

The child may utilize up to the full standard deduction against earned income. Because it is earned income, the parental rate does not apply. The parental rate only applies to unearned income.

Question 38

Intrafamily Transfers

Module Check

16. A dependent of another taxpayer may NOT use his or her own
    a. (limited) standard deduction.
    b. personal exemption.
    c. adjustments to income.

(LO 7-2)

Answer 38

personal exemption.

A dependent of another taxpayer may not use his or her own personal exemption because the taxpayer claiming the dependent is using it. He or she may use a limited standard deduction against unearned income, or up to a full standard deduction against earned income. The dependent is allowed to use her own adjustments to income on her tax return.

Question 39

Intrafamily Transfers

Module Check

17. Timmy Monford, age 11, has $1,500 of interest and dividend income, and $2,400 of income from a paper route. Timmy is claimed as a dependent on his parents’ tax return. What is the amount, if any, of Timmy’s standard deduction for 2016?

$0

$1,050

$2,750

(LO 7-2)

Answer 39

$2,750

The standard deduction for an individual eligible to be claimed as a dependent is the greater of $1,050 or the amount of earned income, $2,400, plus $350, not to exceed the full single standard deduction amount of $6,300. Thus, the earned income of $2,400 plus $350 equals $2,750.

Question 40

Intrafamily Transfers

Module Check

18. Tim Jones is single, 21 years old, and is in his third year of college. He has an AGI of $35,000 and receives no support from his parents. The college is a Title IV institution where students are eligible to receive federal financial aid, and Tim is pursuing an undergraduate degree in criminal justice. When Tim was 13, his parents established an UTMA account for him, and funded it with EE savings bonds. When Tim was a freshman, he was convicted of a felony drug possession charge.

Which one of the following is correct regarding Tim’s situation?

a. Tim qualifies for the Lifetime Learning credit.
b. Tim qualifies for the American Opportunity tax credit
c. Tim may redeem the EE bonds potentially tax-free if the proceeds are used for his qualifying education expenses.

(LO 7-2)

Answer 40

a. Tim qualifies for the Lifetime Learning credit.

Tim does qualify for the Lifetime Learning credit. His AGI is under the phaseout range. He is pursuing a degree at an eligible institution. The felony drug conviction would preclude the use of the American Opportunity tax credit, but not the Lifetime Learning credit. There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds, or unless they are held jointly with a spouse.

Question 41

Intrafamily Transfers

Module Check

20. Sandy Borland, age 15, is claimed as a dependent on her parents’ tax return. She has $1,500 of interest and dividend income, and $6,000 of income from a paper route. What is the amount of Sandy’s standard deduction for 2016?

$1,050

$6,300

$6,350

$7,500

(LO 7-2)

Answer 41

$6,300

The standard deduction for an individual eligible to be claimed as a dependent is the greater of $1,050 or the amount of earned income, $6,000, plus $350, not to exceed the full single standard deduction amount of $6,300. Thus, the earned income of $6,000 plus $350 equals $6,350, but this amount is limited to the full standard deduction amount of $6,300 (for 2016).

Question 42

Intrafamily Transfers

Module Check

26. Robert Johnson, age 14, has interest income of $1,900, and short-term capital gains of $700. Robert has no deductions, and is claimed as a dependent on his parents’ return. Robert’s parents, who are married filing a joint return, have a taxable income of $180,000. What is the amount, if any, of Robert’s income tax liability?

$0

$50

$245

(LO 7-2)

Answer 42

$245

$2,600 Total Income
- $1,050 Limited Standard Deduction
- $1,050 * 10% Child’s rate = $105
= $500 * 28% Parent’s Rate = $140

Total = $245

$180,000 of taxable income puts parents in 28% bracket

Question 43

Intrafamily Transfers

Module Check

29. In 2016, Edward Kramer, age 15, is claimed as a dependent on his parents’ income tax return and has $3,300 of investment income. What is Edward’s income tax liability if his parents, who are married filing jointly, have taxable income of $300,000?

$100

$396

$501

(LO 7-2).

Answer 43

$501

$3,300 Total Income
- $1,050 Limited Standard Deduction
- $1,050 * 10% Child’s rate = $105
= $1,200 * 33% Parent’s Rate = $396

Total = $501

$300,000 taxable income puts parents in 33% bracket.

Question 44

Intrafamily Transfers

Module Check

30. For 2016, the limited standard deduction for unearned income for a child subject to the kiddie tax is
    a. $1,000.
    b. $1,050.
    c. $6,300.

(LO 7-1)

Answer 44

b. $1,050.

The limited standard deduction is $1,050 for 2016.

The $6,300 is the full standard deduction amount—the amount that a dependent may use against earned income, or that a taxpayer who is not eligible to be claimed as a dependent may use in lieu of itemizing deductions.

Question 45

Intrafamily Transfers

The standard deduction amount may be reduced, or limited, for taxpayers eligible to be claimed as a dependent. A limited standard deduction of $1,050 (for 2016) may be used by the taxpayer against unearned income (interest, dividends, etc.). For this purpose, unearned income is defined as income other than earned income, i.e., income from wages, salaries, or other amounts received as compensation for personal services.

7-1,2,3

Answer 45

For any taxpayer eligible to be claimed as a dependent, with earned income or a
combination of earned and unearned income, the rules are slightly more complex. The allowable standard deduction for the dependent is the greater of

(1) $1,050

or

(2) the amount of earned income plus $350, not to exceed the full standard
deduction amount ($6,300 in 2016). 

These rules apply to all taxpayers eligible to be claimed as a dependent on another taxpayer’s return

Question 46

Practice Test 2

Intrafamily Transfers

51. Which one of the following is not a tax-advantaged strategy using an intrafamily transfer?
    a. a gift of property generating investment income to a 9-year-old child of the taxpayer who has other property generating $2,100 of investment income in the current year
    b. valid employment of a 13-year-old child of the taxpayer in the family business who has other property generating $2,100 of investment income in the current year
    c. valid employment of a 16-year-old child of the taxpayer in the family business who has other earned income of $6,000 in the current year
    d. an installment sale of property from the taxpayer to the taxpayer’s child

(LO 7–1)

Answer 46

a. a gift of property generating investment

income to a 9-year-old child of the taxpayer who has other property generating $2,100 of investment income in the current year
A child, who is under age 19, or a full-time student under age 24, generally is subject to the kiddie tax; thus, the gift would not generate any tax benefit, as the income will be taxed to the child at the parents’ marginal tax rate. This would apply to any investment income in excess of $2,100 until the year in which the kiddie tax no longer applies. All of the other options are tax-advantaged strategies. In choices b. and c., the earned income would not be subject to the parental rates, because only unearned income is subject to the parental rate.

Question 47

Practice Test 2

Intrafamily Transfers

52. In 2016, Eddie Jensen, age 12, is claimed as a dependent on his parents’ income tax return and has $3,100 of investment income. What is Eddie’s income tax liability if his parents, who are married filing jointly, have taxable income of $250,000?

The taxable income of $250,000 places the parents in the 33% marginal income tax bracket.

$100

$435

$676

$1,023

(LO 7–1)

Answer 47

$435

This is computed as follows:

$3,100 Total Income
- $1,050 Limited Standard Deduction
- $1,050 * 10% Child’s rate = $105
= $1,000 * 33% Parent’s Rate = $330

Total = $435

Question 48

Practice Test 1

29. Which one of the following is a characteristic of an intrafamily transfer utilizing a Uniform Gift to Minors Act (UGMA) account?

Income from the account in excess of $2,100 is taxed at the child’s earned income tax rate if the child is subject to the kiddie tax.

Income from the account in excess of $2,100 for a child subject to the kiddie tax is taxed at the parents’ marginal tax rate.

A trust for the account is drafted in accordance with individual state law.

A custodian for the account is named as a result of formal court proceedings.

The income from the custodial account is not subject to the unearned income rules.

(LO 7-1)

Answer 48

Income from the account in excess of $2,100 for a child subject to the kiddie tax is taxed at the parents’ marginal tax rate.

To establish a UGMA, there is no formal trust required, nor a court-appointed guardian. The income is certainly treated as unearned income to the child subject to the kiddie tax, and the excess over $2,100 (for 2016) is taxable to the child, at the parent’s marginal tax rate, if higher.

Question 49

Practice Test 1

30. Bob Joseph is an accountant with his own business, B&J Tax Service. The business was organized and is currently operated as a sole proprietorship. Bob is presently in the maximum marginal income tax bracket. As a tax planning device, he is considering reorganizing the tax service into an S corporation with himself and his 18-year-old son, Bill, as shareholders. Bob is hopeful that Bill’s status as a corporate shareholder will encourage him to eventually join the business.

What is one income tax implication of the proposed S corporation as an intrafamily transfer?

All of the income will be taxed to Bob as an improper assignment of personal service income.

A proportion of the income will be taxed to Bill as a percentage owner of the corporation.

A proportion of the income will be taxed to Bill under the family attribution rules in tax law.

Bill will owe self-employment tax on his share of the income.

(LO 7-2)

Answer 49

All of the income will be taxed to Bob as an improper assignment of personal service income.

In order for an S corporation (or partnership) to function as an income-splitting device, capital must be a material income-producing factor. In the case of a tax service, the performance of personal service by Bob is the material income-producing factor. Thus, the income would be taxed to Bob. The flow-through of income from the S corporation is not subject to the self-employment tax.

Question 50

Practice Test 1

31. Marc Handle created an irrevocable trust for the benefit of his dependent children and his wife, Mary. Marc named the local bank as trustee of the trust and authorized it to invest in stocks, bonds, and negotiable certificates of deposit. All funds are currently invested in high-yielding bonds paying 3% interest on a par value of $100,000. The provisions of the trust require that all income be paid annually and used for the needs of Mary and the children.

Which one of the following taxpayers must pay tax on the income of the trust?

the trust, because it is irrevocable with no benefits to the grantor

Marc, because his spouse is an income beneficiary

Mary, because she can receive all income from the trust annually

the children, because there is unearned income paid to them in excess of $2,100

the bank, because of its broad authority as trustee

(LO 7-4)

Answer 50

Marc, because his spouse is an income beneficiary

The trust is definitely a grantor trust, causing the income to be taxed to Marc. The income is paid to the spouse of the grantor, which causes application of the grantor trust rules. Also, because the trust is being used to provide for the needs of Marc’s spouse and children, the result is the application of the grantor trust rules.

Question 51

48. Which of the following are techniques of income shifting or splitting?

I. allocation of a dependent parent’s personal exemption through a multiple support agreement

II. an installment sale of an income-producing asset from a parent to a child

III. transfer of income-producing property from the grantor to a grantor trust

IV. valid employment of a child in the parent’s business

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

(LO 7–2)

Answer 51

I, II, and IV only

Of the listed choices, only option III is not an example of income shifting or splitting. The transfer of property to a grantor trust, by definition, involves the income being taxed back to the grantor. Thus, there would be no income shifting or splitting.

Question 52

56. In 2016, Floyd Small, age 15, is claimed as a dependent on his parents’ income tax return. When Floyd was born, his parents established an UGMA with corporate bonds and have contributed a little to it every year since. This year, the account generated $4,900 of interest income. There were no distributions from the account this year. Floyd’s parents file jointly, and have taxable income of $245,000.

What is Floyd’s income tax liability for the current year?

$105

$280

$1,029

$1,271

(LO 7-2)

Answer 52

$1,029

$4,900 Total Income
- $1,050 Limited Standard Deduction
- $1,050 * 10% Child’s rate = $105
= $2,800 * 33% Parent’s Rate = $924

Total = $1,029

Question 53

70. Which of the following statements are correct with respect to earned income received by a 15-year-old child who is eligible to be claimed as a dependent?

I. The child has a limited standard deduction (up to $1,050 in 2016) available.

II. The child has up to a full standard deduction ($6,300 in 2016) available.

III. Any income in excess of the available standard deduction and $1,050 is taxable at the parents’ marginal income tax bracket.

IV. The income is not subject to the “kiddie tax” rules because it is earned income.

I only

II only

I and III only

II and III only

II and IV only

(LO 7-1)

Answer 53

II and IV only

The kiddie tax rules apply only to unearned income, not earned income. Thus the child may use up to his or her full standard deduction against the earned income. There is no application of the parental tax rate to the earned income.