Tax - Bryant Course

Question 1

What are the two goals of tax law?

Answer 1

1. Primary = raise revenue for government
2. Economic and social policy objectives
   
   1. Example - Low income housing, rehabilitation of old buildings, personal home ownership, employer provided healthcare, private savings for retirement

Question 2

What number title is the Internal Revenue Code?

How many subtitles are there?

What are the names of the subtitles

Answer 2

1. Title 26 of the IRC of 1986
2. There are 11 subtitles
3. Income Tax
4. Estate and Gift Tax
5. Employment Tax
6. Miscellaneous Excise Taxes
7. Alcohol, Tobacco, and Certain Other Excise Taxes
8. Procedure and Administration
9. The Joint Committee on Taxation
10. Financing of Presidential Election Campaigns
11. Trust Fund Code
12. Coal Industry Health Benefits
13. Group Health Plan Requirements

Question 3

What are the references beyond Titles and subtitles?

Answer 3

Titles - Subtitles - Chapters - Subchapters - Parts - Subparts - Sections - Subsections - Paragraphs - Subparagraphs and Clauses

Example

Title 26 of Internal Revenue Code - Substitle A. Income Taxes - Chapter 1. Normal Taxes and Surtaxes - Subchapter P. Capital Gains and Losses - Part III. General Rules for Determining Capital Gains and Losses - Section 1221. Capital Asset Defined

Question 4

Difference Between Economic Definition of Income and Accounting Definition of Income

Answer 4

Economic Definition of Income

• Under the economist’s definition, income are:
  
  • Unrealized gains
  • As well as gifts and inheritances
• Furthermore, the economist adjusts for inflation in measuring income

Mark to Market Accounting Income - Exception to realization rule

1. There are exceptions to the methodology of reporting net income, based solely on the historical cost of acquired assets. US GAAP includes the principle of “Mark to Market Accounting.” Under this accounting principle, valuation of commodities, securities and other financial instruments on a company’s balance sheet are based on the market values of such assets.
2. For example, if the cost of a precious metal acquired by a company for use in its production process, such as using silver to produce a catalyst used by the petrochemical industries was $10 per troy ounce and the market value of silver increases to $ 15 per troy ounce, the company would value the silver on its balance sheet at $15 per troy ounce. It would also report the increase in inventory value as an element of its net income for the period being reported.

Question 5

EXAMPLE

Alice earned a salary of $40,000

She consumed $30,000 of food, clothing, housing, medical care and other goods and services.

Assets owned by Alice had a net worth of $100,000 at the beginning of the year. Her assets, including $10,000 of salary that was saved, were worth $115,000 at the end of the year.

Her liabilities did not change during the year.

Answer 5

Economic Income = 40,000 + 5,000 of increased value in her savings

Economic Income = 45,000

Accounting Income = 40K

Account Income = the 5K increase in value is not a realized gain

Question 6

What is the definition of Accounting Income?

Answer 6

1. In accounting, income is measured using a transactional approach.
2. An individual has no income to the extent that an increase in the measured value of property is caused by a decrease in the value of the measuring unit.
3. In other words, inflation does not increase wealth and therefore does not cause an individual to be better off.
4. Values measured by transactions are relatively objective as accountants recognize income, expenses, gains and losses that have been realized because of a completed transaction.

Question 7

Income Tax Law more favorable to accounting income?

Answer 7

Yes:

1. Tax law mainly follows accounting income rather than the economists
   
   1. Administrative Convenience
   2. Wherewithal-to-pay concept

Exceptions:

1. Wherewithal-to-pay
   
   1. Prepaid income is not income from an accounting standpoint until it is earned. The tax law, however, takes the position that prepaid income is subject to taxation, for the cash method, at the time it is collected, rather than as it is earned. At the time of collection, the taxpayer clearly has the cash available to pay the tax. If the tax were deferred until the income is earned, the taxpayer may no longer have the cash.

Question 8

Three Conditions Must be Met to be Taxable

Answer 8

1. There must be economic benefit: The economic benefit is not limited to cash payments. Employees, who receive a company’s stock, rather than cash, are receiving an economic benefit. Taxpayers benefit, even if they direct that payments be made to other persons. As a result, employees cannot avoid being taxed on their earnings by ordering that their salaries be paid to creditors or family members.
2. The income must be realized: In general, realization occurs when the earning process is complete and a transaction with another party takes place that permits an objective measure of the income. This objective measurement increases “administrative convenience” which is discussed below. Unlike financial accounting, there are many exceptions that result in income being reported when the taxpayer receives payment even if that is at a time other than when the earning process is complete. These exceptions result in taxes being owed when the taxpayer has the “wherewithal to pay” (see below). Taxpayers who use the “cash method” of reporting, discussed later in this module, are normally taxed when payment is received.
3. The income must be recognized: Some items of income are not taxable because of special provisions in the tax law.
   
   1. EXAMPLE
      
      1. certain real estate exchanges and corporate reorganizations are not taxable because of statutory non-recognition rules. In such cases, the taxpayer receives a lower basis in replacement property, and that often means that the income is recognized when the replacement property is sold. The tax law also contains exclusions that exempt specific types of income such as scholarships, inheritances and municipal bond interest. Within statutory limitations, taxpayers are never taxed on such items of income.

Question 9

What is the definition of Gross Income?

Is it defined in the positive or negative?

Answer 9

1. Gross Income – means all income from whatever source derived, including (but not limited to) the following items:
   
   1. Compensation for services, including fees, commissions, fringe benefits and similar items
   2. Gross income derived from business
   3. Gains derived from dealings in property
   4. Interest
   5. Rents
   6. Royalties
   7. Dividends
   8. Alimony and separate maintenance payments (divorces prior to January 1, 2019 only)
   9. Annuities
   10. Pensions
   11. Income from discharge of indebtedness
   12. Distributive share of partnership gross income
   13. Income in respect of a decedent
   14. Income from an interest in an estate or trust
2. NOTICE:
   
   1. The phrase “except as otherwise provided” means that all sources of income are presumed to be taxable unless there is a specific exclusion in the income tax law.
   2. The IRS does not have to prove that an item of income is taxable
   3. Rather, the taxpayer must prove that the item of income is excluded.
   4. Thus, gambling winnings and illegal income are taxable simply because no specific provisions in the tax law exclude such amounts from taxation

Question 10

Why are certain indirect economic benefits excluded from income? What is essential to this judicially developed rule?

Answer 10

1. Frequently, however, an employer may make an expenditure in which its employees may incidentally or indirectly benefit
2. Example
   
   1. Security guards patrol an employer’s plant, protecting both the employer’s property and the employees. The employees receive an indirect benefit for the protection provided by the security guards
   2. An employer requires employees to undergo an annual checkup, the cost of which is paid by the employer.
   3. An employer provides protective clothing worn by employees while on the job.
   4. A shipping company provides sleeping accommodations to sailors while ships are at sea.
   5. A company requires certain employees to wear shoes manufactured by the company and provide regular reports on the quality of the shoes.
3. ESSENTIAL = It is now well established that taxpayers may exclude such indirect benefits from gross income. This judicially developed rule holds that an expenditure is excludable if it is made in order to serve the business needs of the employer and any benefit to the employee is secondary and incidental

Question 11

Primary Benefits?

What are the two factors discussed with regards to non-cash fringe benefits?

Answer 11

Advantage of Fringe Benefits =The other major advantage of taking fringe benefits in lieu of cash payments is the fact that employees do not have to use after-tax income to obtain the product or service

1. Congress has also established rules dealing with situations where expenditures are made primarily to benefit employees.
2. Generally
   
   1. While expenditures made by employers that primarily benefit employees are generally taxable,
3. Exceptions
   
   1. there are instances whereby such expenditures are not taxable. These rules permit employees to exclude certain fringe benefits (such as employee discounts) from gross income

In reviewing this list of non-cash fringe benefits, TWO factors are discussed:

1. Employer - Whether the benefit is or can be deductible to the employer as a business expense. In order to be deductible, you must be able to demonstrate to the IRS that the expense was “ordinary and necessary” to the business.
2. Employee - Whether the benefit is taxable as compensation (remuneration) to the employee.

NOTE - If a benefit is taxable to the employee, the value is the amount the employee would have to pay for this benefit in an arm’s length transaction.

Question 12

How are tickets at sporting events treated?

Answer 12

1. Boxes at a Sporting Venue:
   
   1. If a company purchases or leases a skybox or luxury box at a sporting venue, the company can deduct no more than the price of the same number of regular seats at that venue. Other associated expenses (catering, for example), must be “ordinary and necessary” to the business to be deductible as entertainment expenses.
   2. A box purchased or leased for the benefit of a specific executive may be taxable income.
   3. Example - Tickets in exchange for services - Six basketball tickets given to an employee for painting an office
      
      1. Transaction Type = Payment in-kind, a form of compensation
      2. Employee Taxable - Yes
      3. Spouse/ Family Taxable - Yes
   4. Example - Clear business purpose requiring attendance - Ensuring microphones, speakers and displays are working properly
      
      1. Transaction Type = Working condition fringe benefit
      2. Employee Taxable - No - working condition fringe benefit
      3. Spouse/ Family Taxable - Yes
   5. Example - Award of tickets - Season/single tickets to an employee as an award
      
      1. Transaction Type = Non-cash fringe, taxable income
         
         1. This is compensation and must be reported on the employee’s W-2, regardless of value
      2. Employee Taxable - Yes
      3. Spouse/ Family Taxable - Yes
   6. Example - Employee is affiliated with the program, but is not fulfilling any job responsibilities - Coach of one sport attends the event of another sport to show support -
      
      1. Transaction Type = Not qualified as working condition fringe benefit - does not meet directly-related or associated tests for business purpose
         
         1. This is compensation and must be reported on the employee’s W-2, regardless of value
      2. Employee Taxable - Yes
      3. Spouse/ Family Taxable - Yes
   7. Example - Attending event to host University guests as prospective donors, or with student recruits. Employee and spouse host community leaders and their spouses to cultivate donors
      
      1. Transaction Type = Working condition fringe benefit - appears to meet directly-related or associated tests
         
         1. To be non-taxable, the University must keep sufficient records to substantiate the business purpose for ALL attendees and their affiliations.
         2. To qualify as non-taxable, a bona fide business purpose for the spouse’s participation must be documented in detail. Their participation must be essential, not just beneficial.
      2. Employee Taxable - No
      3. Spouse/ Family Taxable - No
   8. Example - Tickets from a random drawing - Door prizes for four tickets
      
      1. Transaction Type = Raffle winnings. Prizes are taxable to recipients, regardless of value. The University is required to report it to the IRS on Form 1099-MISC when the aggregate value is greater than $600 per year (for non-employees)
      2. Employee Taxable - Yes
      3. Spouse/ Family Taxable - Yes
   9. Example - Excess capacity or unsold tickets - Event did not sell-out - University gave away extra tickets to employees
      
      1. Transaction Type = No-additional-cost services. The tax exemption does NOT apply to highly-compensated employees where the program or benefit favors those highly compensated employees.
      2. Employee Taxable - No
      3. Spouse/ Family Taxable - No

Question 13

What types of meals are excluded from employee income?

Example 1 - You operate a restaurant business. You furnish your employee, Carol, who is a waitress working 7 a.m. to 4 p.m., two meals during each workday. You encourage but don’t require Carol to have her breakfast on the business premises before starting work. Can you exclude from Carol’s wages the breakfast and lunch?

Example 2 - A hospital maintains a cafeteria on its premises where all of its 230 employees may get meals at no charge during their working hours. The hospital must have 120 of its employees available for emergencies. Each of these 120 employees is, at times, called upon to perform services during the meal period. Although the hospital doesn’t require these employees to remain on the premises, they rarely leave the hospital during their meal period.

Example 3 -

Frank is a bank teller who works from 9 a.m. to 5 p.m. The bank furnishes his lunch without charge in a cafeteria the bank maintains on its premises. The bank furnishes these meals to Frank to limit his lunch period to 30 minutes, since the bank’s peak workload occurs during the normal lunch period.

Example 4 -

Generally, meals furnished before or after the working hours of an employee aren’t considered as furnished for your convenience.

Answer 13

Fringe Benefits of Meals for Employees

1. De Minimis Meals
2. Meals on your Business Premises
3. Reimbursements
   
   1. If your employer decides to reimburse your expenses, make sure they use an “accountable plan” that meets all IRS requirements. Using an accountable plan allows your employer to deduct reimbursed expenses and not include the reimbursed amount with your wages on Form W-2. If your employer does not use an accountable plan, any reimbursements must be included on your Form W-2 as taxable income.

De Minimis Meals

1. Exclusion from wages. - You can generally exclude the value of de minimis meals you provide to an employee from the employee’s wages.
2. You can exclude any occasional meal you provide to an employee if it has so little value (taking into account how frequently you provide meals to your employees) that accounting for it would be unreasonable or administratively impracticable. The exclusion applies, for example, to the following items.
   
   1. Coffee, doughnuts, or soft drinks.
   2. Occasional meals or meal money provided to enable an employee to work overtime. However, the exclusion doesn’t apply to meal money figured on the basis of hours worked, or meals or meal money provided on a regular or routine basis.
   3. Occasional parties or picnics for employees and their guests.

Meals on your Business Premises

1. You can exclude the value of meals you furnish to an employee from the employee’s wages if they meet the following tests.
   
   1. They are furnished on your business premises. Generally, for this exclusion, the employee’s place of work is your business premises.
   2. They are furnished for your convenience. Whether you furnish meals for your convenience as an employer depends on all the facts and circumstances. You furnish the meals to your employee for your convenience if you do this for a substantial business reason other than to provide the employee with additional pay. This is true even if a law or an employment contract provides that the meals are furnished as pay. However, a written statement that the meals are furnished for your convenience isn’t sufficient.
   3. Meals excluded for all employees if excluded for more than half.
      
      1. If more than half of your employees who are furnished meals on your business premises are furnished the meals for your convenience, you can treat all meals you furnish to employees on your business premises as furnished for your convenience.
   4. Food service employees.
      
      1. Meals you furnish to a restaurant or other food service employee during, or immediately before or after, the employee’s working hours are furnished for your convenience. For example, if a waitress works during the breakfast and lunch periods, you can exclude from her wages the value of the breakfast and lunch you furnish in your restaurant for each day she works.
   5. Employees available for emergency calls.
      
      1. Meals you furnish during working hours so an employee will be available for emergency calls during the meal period are furnished for your convenience. You must be able to show these emergency calls have occurred or can reasonably be expected to occur, and that the calls have resulted, or will result, in you calling on your employees to perform their jobs during their meal period.

EXAMPLE 1

1. Since Carol is a food service employee and works during the normal breakfast and lunch periods, you can exclude from her wages the value of her breakfast and lunch.
2. If you also allow Carol to have meals on your business premises without charge on her days off, you can’t exclude the value of those meals from her wages.

EXAMPLE 2

1. Since the hospital furnishes meals on its premises to its employees so that more than half of them are available for emergency calls during meal periods, the hospital can exclude the value of these meals from the wages of all of its employees.

EXAMPLE 3

1. If Frank got his lunch elsewhere, it would take him much longer than 30 minutes and the bank strictly enforces the time limit. The bank can exclude the value of these meals from Frank’s wages.

EXAMPLE 4

1. However, meals you furnish to an employee immediately after working hours are furnished for your convenience if you would have furnished them during working hours for a substantial nonpay business reason but, because of the work duties, they weren’t obtained during working hours.

Question 14

This section discusses the exclusion rules that apply to fringe benefits. These rules exclude all or part of the value of certain benefits from the recipient’s pay.

In most cases, the excluded benefits aren’t subject to federal income tax withholding, social security, Medicare, federal unemployment (FUTA) tax, or Railroad Retirement Tax Act (RRTA) taxes and aren’t reported on Form W-2.

This section discusses the exclusion rules for the following fringe benefits.

Answer 14

Accident and health benefits.

1. Income Tax Withholding
   
   1. Exempt1, except for long-term care benefits provided through a flexible spending or similar arrangement.
   2. The exemption doesn’t apply to S corporation employees who are 2% shareholders.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt, except for certain payments to S corporation employees who are 2% shareholders.
3. Federal Unemployment
   
   1. Exempt

Achievement awards.

1. Income Tax Withholding
   
   1. Exempt up to $1,600 for qualified plan awards ($400 for nonqualified awards)
   2. The exemption doesn’t apply to S corporation employees who are 2% shareholders.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Adoption assistance.

1. Income Tax Withholding
   
   1. Exempt
   2. The exemption doesn’t apply to S corporation employees who are 2% shareholders.
   3. Exemption doesn’t apply to certain highly compensated employees under a program that favors those employees.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Taxable
3. Federal Unemployment
   
   1. Taxable

Athletic facilities.

1. Income Tax Withholding
   
   1. Exempt if substantially all use during the calendar year is by employees, their spouses, and their dependent children, and the facility is operated by the employer on premises owned or leased by the employer.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

De minimis (minimal) benefits.

1. Income Tax Withholding
   
   1. Exempt
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt
3. Federal Unemployment
   
   1. Exempt

Dependent care assistance.

1. Income Tax Withholding
   
   1. Exempt up to certain limits, $5,000 ($2,500 for married employee filing separate return).
   2. The exemption doesn’t apply to certain highly compensated employees under a program that favors those employees.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Educational assistance.

1. Income Tax Withholding
   
   1. Exempt up to $5,250 of benefits each year. (See Educational Assistance , later in this section.)
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Employee discounts.

1. Income Tax Withholding
   
   1. Exempt up to certain limits. (See Employee Discounts , later in this section.)
   2. The exemption doesn’t apply to certain highly compensated employees under a program that favors those employees.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Employee stock options.

1. Income Tax Withholding
   
   1. See Employee Stock Options , later in this section.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. See Employee Stock Options , later in this section.
3. Federal Unemployment
   
   1. See Employee Stock Options , later in this section.

Employer-provided cell phones.

1. Income Tax Withholding
   
   1. Exempt if provided primarily for noncompensatory business purposes.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt if provided primarily for noncompensatory business purposes.
3. Federal Unemployment
   
   1. Exempt if provided primarily for noncompensatory business purposes.

Group-term life insurance coverage.

1. Income Tax Withholding
   
   1. Exempt
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt up to cost of $50,000 of coverage. (Special rules apply to former employees.)
   2. Exemption doesn’t apply to S corporation employees who are 2% shareholders.
   3. Exemption doesn’t apply to certain key employees under a plan that favors those employees.
   4. You must include in your employee’s wages the cost of group-term life insurance beyond $50,000 worth of coverage, reduced by the amount the employee paid toward the insurance. Report it as wages in boxes 1, 3, and 5 of the employee’s Form W-2. Also, show it in box 12 with code “C.” The amount is subject to social security and Medicare taxes, and you may, at your option, withhold federal income tax.
3. Federal Unemployment
   
   1. Exempt

Health savings accounts (HSAs).

1. Income Tax Withholding
   
   1. Exempt for qualified individuals up to the HSA contribution limits. (See Health Savings Accounts , later in this section.)
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt for qualified individuals up to the HSA contribution limits. (See Health Savings Accounts , later in this section.)
3. Federal Unemployment
   
   1. Exempt for qualified individuals up to the HSA contribution limits. (See Health Savings Accounts , later in this section.)

Lodging on your business premises.

1. Income Tax Withholding
   
   1. Exempt if furnished on your business premises, for your convenience, and as a condition of employment.
   2. The exemption doesn’t apply to S corporation employees who are 2% shareholders.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Meals.

1. Income Tax Withholding
   
   1. Exempt if furnished on your business premises for your convenience.
   2. Exemption doesn’t apply to S corporation employees who are 2% shareholders.
   3. Except if de minims
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

No-additional-cost services.

1. Income Tax Withholding
   
   1. Exempt
   2. Exemption doesn’t apply to certain highly compensated employees under a program that favors those employees.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Retirement planning services.

1. Income Tax Withholding
   
   1. Exempt
   2. Exemption doesn’t apply to services for tax preparation, accounting, legal, or brokerage services.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Transportation (commuting) benefits.

1. Income Tax Withholding
   
   1. Exempt up to certain limits if for rides in a commuter highway vehicle and/or transit passes ($265) or qualified parking ($265).
   2. Exemption doesn’t apply to S corporation employees who are 2% shareholders.
   3. Exempt if de minimis
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Tuition reduction.

1. Income Tax Withholding
   
   1. Exempt if for undergraduate education (or graduate education if the employee performs teaching or research activities).
   2. Exemption doesn’t apply to certain highly compensated employees under a program that favors those employees.
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Same as above
3. Federal Unemployment
   
   1. Same as above

Working condition benefits.

1. Income Tax Withholding
   
   1. Exempt
2. Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000)
   
   1. Exempt
3. Federal Unemployment
   
   1. Exempt

Question 15

Is Adoption Assistance excluded as a fringe benefit?

Answer 15

Federal Tax- Exclude

• You must exclude all payments or reimbursements you make under an adoption assistance program for an employee’s qualified adoption expenses from the employee’s wages subject to federal income tax withholding.
• Adoption fees,
• Court costs,
• Attorney fees and
• Other expenses related to an adoption

FICA / Medicare / FUTA - Include

• However, you can’t exclude these payments from wages subject to social security, Medicare, and FUTA taxes.

You must report all qualifying adoption expenses you paid or reimbursed under your adoption assistance program for each employee for the year in box 12 of the employee’s Form W-2. Use code “T” to identify this amount.

Maximum Amount

The maximum amount that may be excluded from an employee’s gross income under an employer-provided adoption assistance program for the adoption of a child will be $14,080 for 2019 (up from $13,810). In addition, the maximum adoption credit allowed to an individual for the adoption of a child will be $14,080 for 2019 (up from $13,810). Both the exclusion and the credit will begin to be phased out for individuals with modified adjusted gross incomes greater than $211,160 and will be entirely phased out for individuals with modified adjusted gross incomes of $251,160 or more.

WRITTEN PLAN REQUIREMENTS

1. It benefits employees who qualify under rules set up by you, which don’t favor highly compensated employees or their dependents. To determine whether your plan meets this test, don’t consider employees excluded from your plan who are covered by a collective bargaining agreement, if there is evidence that adoption assistance was a subject of good-faith bargaining.
   
   1. Highly Compensated Employee for 2019 =
      
      1. The employee was a 5% owner at any time during the year or the preceding year.
      2. The employee received more than $120,000 in pay for the preceding year. But this can be ignored if employee wasn’t also in the top 20% of employees when ranked by pay for the preceding year.
2. It doesn’t pay more than 5% of its payments during the year for shareholders or owners (or their spouses or dependents). A shareholder or owner is someone who owns (on any day of the year) more than 5% of the stock or of the capital or profits interest of your business.
3. You give reasonable notice of the plan to eligible employees.
4. Employees provide reasonable substantiation that payments or reimbursements are for qualifying expenses.

EXCEPTIONS:

1. S-CORP - For this exclusion, don’t treat a 2% shareholder of an S corporation as an employee of the corporation. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation’s stock or stock with more than 2% of the voting power. Treat a 2% shareholder as you would a partner in a partnership for fringe benefit purposes, but don’t treat the benefit as a reduction in distributions to the 2% shareholder. For more information, see Revenue Ruling 91-26, 1991-1 C.B. 184.

Question 16

What are the rules for exclusion of Employer Contributions to accident or health plan?

Answer 16

Employer Contributions?

1. Excluded
2. Contributions by an employer to any accident or health plan from which benefits are provided to employees, their spouses, their dependents and children who will be under age 27 at the end of the calendar year, are excluded from the gross income of employees.
3. Thus, if employer contributions are made to an insurance company or to a trust or other fund to provide for medical benefits to employees, the employees will not be taxed on those contributions.

Question 17

Achievement Awards?

What is an employee?

Does the exclusion apply to gifts of cash?

Answer 17

You can generally exclude the value of achievement awards you give to an employee from the employee’s wages if their cost isn’t more than the amount you can deduct as a business expense for the year. The excludable annual amount is $1,600 ($400 for awards that aren’t “qualified plan awards”).

This exclusion applies to the value of any tangible personal property you give to an employee as an award for either length of service or safety achievement. The exclusion doesn’t apply to awards of cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than arrangements granting only the right to select and receive tangible personal property from a limited assortment of items preselected or preapproved by you).

The exclusion also NOT apply to vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

The award must meet the requirements for employee achievement awards discussed in chapter 2 of Pub. 535

Employee - For this Exclusion, treating the following as employees:

1. A current employee.
2. A former common-law employee you maintain coverage for in consideration of or based on an agreement relating to prior service as an employee.
3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

To determine for 2019 whether an achievement award is a “qualified plan award” under the deduction rules described in Pub. 535, treat any employee who received more than $120,000 in pay for 2018 as a highly compensated employee.

If the cost of awards given to an employee is more than your allowable deduction, include in the employee’s wages the larger of the following amounts.

1. The part of the cost that is more than your allowable deduction (up to the value of the awards).
2. The amount by which the value of the awards exceeds your allowable deduction.

Exclude the remaining value of the awards from the employee’s wages

Question 18

Athletic Facilities?

What matters about the On-Premises Facility?

What employees are included?

What about the cost of employer-provided gym memberships?

Answer 18

You can exclude the value of an employee’s use of an o_n-premises gym_ or other athletic facility you operate from an employee’s wages if substantially all use of the facility during the calendar year is by your employees, their spouses, and their dependent children. For this purpose, an employee’s dependent child is a child or stepchild who is the employee’s dependent or who, if both parents are deceased, hasn’t attained the age of 25. The exclusion doesn’t apply to any athletic facility if access to the facility is made available to the general public through the sale of memberships, the rental of the facility, or a similar arrangement.

On-premises facility.

The athletic facility must be located on premises you own or lease and must be operated by you. It doesn’t have to be located on your business premises. However, the exclusion doesn’t apply to an athletic facility that is a facility for residential use, such as athletic facilities that are part of a resort.

Employee - For this exclusion, treat the following individuals as employees:

1. A current employee.
2. A former employee who retired or left on disability.
3. A widow or widower of an individual who died while an employee.
4. A widow or widower of a former employee who retired or left on disability.
5. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.
6. A partner who performs services for a partnership.

However, these amounts may be taxable to certain employees if provided on a discriminatory basis. Wellness rewards provided in cash (including gift cards and other items readily convertible into cash) or in the form of goods and services that are not medical care are also taxable at the fair market value. The only exception for goods and services is if the value of the non-cash reward is so small that it would be unreasonable to account for it. The cost of employer-provided gym memberships (whether paid in full by the employer or subsidized at a fixed amount) are taxable to employees.Use of athletic facilities on the employer’s premises is nontaxable to employees; however, beginning in 2018, tax-exempt employers will owe unrelated business income tax (UBIT) on the cost of providing an onsite athletic facility if it primarily benefits employees who are highly compensated.

Question 19

De Minimis (Minimal) Benefits?

What is unique about cash (or cash equivalents) under the De Minims Rules?

Answer 19

EXCLUSION =

You can exclude the value of a de minimis benefit you provide to an employee from the employee’s wages. A de minimis benefit is any property or service you provide to an employee that has so little value (taking into account how frequently you provide similar benefits to your employees) that accounting for it would be unreasonable or administratively impracticable.

Cash and cash equivalent fringe benefits (for example, gift certificates, gift cards, and the use of a charge card or credit card), no matter how little, are never excludable as a de minimis benefit.

However, meal money and local transportation fare, if provided on an occasional basis and because of overtime work, may be excluded as discussed later.

Examples of de minimis benefits include the following.

Personal use of an employer-provided cell phone provided primarily for non-compensatory business purposes.

Occasional personal use of a company copying machine if you sufficiently control its use so that at least 85% of its use is for business purposes.

Holiday or birthday gifts, other than cash, with a low fair market value. Also, flowers or fruit or similar items provided to employees under special circumstances (for example, on account of illness, a family crisis, or outstanding performance).

Group-term life insurance payable on the death of an employee’s spouse or dependent if the face amount isn’t more than $2,000.

Certain meals.

Occasional parties or picnics for employees and their guests.

Occasional tickets for theater or sporting events.

Certain transportation fare.

NOT DE MINIMIS

Some examples of benefits that aren’t excludable as de minimis fringe benefits are season tickets to sporting or theatrical events; the commuting use of an employer-provided automobile or other vehicle more than 1 day a month; membership in a private country club or athletic facility, regardless of the frequency with which the employee uses the facility; and use of employer-owned or leased facilities (such as an apartment, hunting lodge, boat, etc.) for a weekend. If a benefit provided to an employee doesn’t qualify as de minimis (for example, the frequency exceeds a limit described earlier), then generally the entire benefit must be included in income.

Question 20

Dependent Care Assistance?

What is the amount of the exclusion from gross income under a dependent care assistance program each year?

What is the one filing status it is reduced for?

Answer 20

They are generally referred to as DCAPs or dependent care flexible spending accounts (dependent care FSAs).

Amount = An employee can generally exclude from gross income up to $5,000 of benefits received under a dependent care assistance program each year. This limit is reduced to $2,500 for married employees filing separate returns. You can exclude the value of benefits you provide to an employee under a dependent care assistance program from the employee’s wages if you reasonably believe that the employee can exclude the benefits from gross income

Application = This exclusion applies to household and dependent care services you directly or indirectly pay for or provide to an employee under a written dependent care assistance program that covers only your employees. The services must be for a qualifying person’s care and must be provided to allow the employee to work. These requirements are basically the same as the tests the employee would have to meet to claim the dependent care credit if the employee paid for the services. For more information, see Can You Claim the Credit? in Pub. 503.

EXCEPTIONS:

1. Earned Income = However, the exclusion can’t be more than the smaller of the earned income of either the employee or employee’s spouse. Special rules apply to determine the earned income of a spouse who is either a student or not able to care for himself or herself. For more information on the earned income limit, see Pub. 503.
2. Highly Compensated Employee = You can’t exclude dependent care assistance from the wages of a highly compensated employee unless the benefits provided under the program don’t favor highly compensated employees and the program meets the requirements described in section 129(d) of the Internal Revenue Code. 2019 HCE:
   
   1. The employee was a 5% owner at any time during the year or the preceding year.
   2. The employee received more than $120,000 in pay for the preceding year.
      1. You can choose to ignore test (2) if the employee wasn’t also in the top 20% of employees when ranked by pay for the preceding year.
3. Reporting
   
   1. Report the value of all dependent care assistance you provide to an employee under a dependent care assistance program in box 10 of the employee’s Form W-2. Include any amounts you can’t exclude from the employee’s wages in boxes 1, 3, and 5. Report in box 10 both the nontaxable portion of assistance (up to $5,000) and any assistance above that amount that is taxable to the employee.
4. Example
   
   1. Oak Co. provides a dependent care assistance FSA to its employees through a cafeteria plan. In addition, it provides occasional on-site dependent care to its employees at no cost. Emily, an employee of Oak Co., had $4,500 deducted from her pay for the dependent care FSA. In addition, Emily used the on-site dependent care several times. The fair market value of the on-site care was $700. Emily’s Form W-2 should report $5,200 of dependent care assistance in box 10 ($4,500 FSA plus $700 on-site dependent care). Boxes 1, 3, and 5 should include $200 (the amount in excess of the nontaxable assistance), and applicable taxes should be withheld on that amount.

Question 21

Educational Assitance Program?

What is the threshold?

Answer 21

Exclusion from wages.

You can exclude up to $5,250 of educational assistance you provide to an employee under an educational assistance program from the employee’s wages each year.

Assistance over $5,250.

If you don’t have an educational assistance plan, or you provide an employee with assistance exceeding $5,250, you must include the value of these benefits as wages, unless the benefits are working condition benefits. Working condition benefits may be excluded from wages. Property or a service provided is a working condition benefit to the extent that if the employee paid for it, the amount paid would have been allowable as a business or depreciation expense. See Working Condition Benefits , later in this section.

What expenses qualify?

• Educational assistance means amounts you pay or incur for your employees’ education expenses. These expenses generally include the cost of books, equipment, fees, supplies, and tuition.

What expenses don’t qualify?

• However, these expenses don’t include the cost of a course or other education involving sports, games, or hobbies, unless education:
  
  • Has a reasonable relationship to your business, or
  • Is required as part of a degree program.
• Education expenses don’t include the cost of tools or supplies (other than textbooks) your employee is allowed to keep at the end of the course.
• Nor do they include the cost of lodging, meals, or transportation.
• Your employee must be able to provide substantiation to you that the educational assistance provided was used for qualifying education expenses.

Educational Assistance Program

An educational assistance program is a separate written plan that provides educational assistance only to your employees. The program qualifies only if all of the following tests are met.

1. The program benefits employees who qualify under rules set up by you that don’t favor highly compensated employees. To determine whether your program meets this test, don’t consider employees excluded from your program who are covered by a collective bargaining agreement if there is evidence that educational assistance was a subject of good-faith bargaining.
2. The program doesn’t provide more than 5% of its benefits during the year for shareholders or owners (or their spouses or dependents). A shareholder or owner is someone who owns (on any day of the year) more than 5% of the stock or of the capital or profits interest of your business.
3. The program doesn’t allow employees to choose to receive cash or other benefits that must be included in gross income instead of educational assistance.
4. You give reasonable notice of the program to eligible employees.

2019 HCE

1. The employee was a 5% owner at any time during the year or the preceding year.
2. The employee received more than $120,000 in pay for the preceding year.
   
   1. You can choose to ignore test (2) if the employee wasn’t also in the top 20% of employees when ranked by pay for the preceding year.

Employees:

1. Your program can cover former employees if their employment is the reason for the coverage
2. A current employee.
3. A former employee who retired, left on disability, or was laid off.
4. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.
5. Yourself (if you’re a sole proprietor).
6. A partner who performs services for a partnership.

Basically - Both undergraduate and graduate level courses may be paid or reimbursed, whether or not related to an employee’s current job responsibilities. The program cannot discriminate in favor of highly compensated employees. In addition, an employer may provide nontaxable education benefits to an employee if the education serves a bona fide business purpose of the employer or maintains or improves the skills needed by an employee in his current job position. Student loan repayments made by an employer (either directly or as reimbursement) are taxable income to an employee.

Question 22

Employee Discounts

What is the amount excluded from wages?

Answer 22

Fringe Benefit Exclusion - Limit of discount is:

1. Service = For a discount on services, 20% of the price you charge nonemployee customers for the service.
2. Merchandise = For a discount on merchandise or other property, your gross profit percentage times the price you charge nonemployee customers for the property.

This exclusion applies to a price reduction you give your employee on property or services you offer to customers in the ordinary course of the line of business in which the employee performs substantial services. It applies whether the property or service is provided at no charge (in which case only part of the discount may be excludable as a qualified employee discount) or at a reduced price. It also applies if the benefit is provided through a partial or total cash rebate.

EXCEPTIONS:

1. Real + Personal Property = Employee discounts don’t apply to discounts on real property or discounts on personal property of a kind commonly held for investment (such as stocks or bonds).
2. Line of Business = They also don’t include discounts on a line of business of the employer for which the employee doesn’t provide substantial services, or discounts on property or services of a kind that aren’t offered for sale to customers.
3. Example = Therefore, discounts on items sold in an employee store that aren’t sold to customers, aren’t excluded from employee income. Also, employee discounts provided by another employer through a reciprocal agreement aren’t excluded.

Employee - For this exclusion, treat the following individuals as employees:

1. A current employee.
2. A former employee who retired or left on disability.
3. A widow or widower of an individual who died while an employee.
4. A widow or widower of an employee who retired or left on disability.
5. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.
6. A partner who performs services for a partnership.

Exception for Highly Compensated Employees?

You can’t exclude from the wages of a highly compensated employee any part of the value of a discount that isn’t available on the same terms to one of the following groups.

1. All of your employees.
2. A group of employees defined under a reasonable classification you set up that doesn’t favor highly compensated employees.

HCE 2019:

1. The employee was a 5% owner at any time during the year or the preceding year.
2. The employee received more than $120,000 in pay for the preceding year.
   
   1. You can choose to ignore test (2) if the employee wasn’t also in the top 20% of employees when ranked by pay for the preceding year.

Question 23

What are the Employee Stock Options?

What is the tax treatment of ISOs

EXAMPLE

assume stock options are granted on August 18, 2018 (and immediately 100% vested). The employee exercises the options, one year later, on August 18, 2019. To benefit from the likely lower long-term capital gains rates, that employee shouldn’t sell the shares before

Answer 23

Fringe Benefits

1. Incentive stock options,
2. Employee stock purchase plan options
3. Non-Statutory (Non-qualified) Stock Options

Wages for social security, Medicare, and FUTA taxes don’t include remuneration resulting from the exercise of an incentive stock option or an employee stock purchase plan option, or from any disposition of stock acquired by exercising such an option.

Additionally, federal income tax withholding isn’t required on the income resulting from a disqualifying disposition of stock acquired by the exercise of an incentive stock option or an employee stock purchase plan option, or on income equal to the discount portion of stock acquired by the exercise of an employee stock purchase plan option resulting from any qualifying disposition of the stock. The employer must report as income in box 1 of Form W-2 (a) the discount portion of stock acquired by the exercise of an employee stock purchase plan option upon a qualifying disposition of the stock, and (b) the spread (between the exercise price and the fair market value of the stock at the time of exercise) upon a disqualifying disposition of stock acquired by the exercise of an incentive stock option or an employee stock purchase plan option.

ISO

1. Employer grants employee the option to purchase stock in the employer’s corporation, or parent-subsidiary corporations, at a pre-determined price (i.e. exercise or strike price)
2. Strike price set at the time of grant
3. Options vest over time

ISO Taxation

1. You need the following:
   
   1. The grant date of ISO
      
      1. • not a taxable event
   2. Grant Expiration Date - (be careful not to let them expire!)
   3. Strike Price of Stock
   4. Exercise Date
      
      1. This is when normal taxation COULD BEGIN! and this is when AMT Adjustment happens!
      2. Known as the “bargain element”, this gap is considered compensation and taxed at ordinary income tax rates. This may also trigger the dreaded Alternative Minimum Tax (AMT) – which is why many people seek out the expertise of a Certified Financial Planner™ and CPA to help them minimize the sting of taxes on their stock options.
   5. Selling Price
   6. Selling Date
2. Taxation depends on the following:
   
   1. how and when the stock is disposed of (i.e. qualified disposition)
3. Qualifying Disposition
   
   1. Two Year = Stock acquired is disposed more than two years from the grant date and
   2. One Year = More than one year after the stock was transferred to the employee (usually the exercise date).
   3. Continuously Employed = There is an additional qualifying criteria: the taxpayer must have been continuously employed by the employer granting the ISO from the grant date up to three months prior to the exercise date.
4. Time of Exercise = AMT Purposes
   
   1. Exercising an ISO is treated as income solely for the purposes of calculating alternative minimum tax (AMT), but it is ignored for the purposes of calculating regular federal income tax.
   2. Amount subject to AMT Tax
      
      1. The spread between the fair market value of the stock and the option’s strike price is considered income for AMT purposes. The fair market value is measured on the date when the stock first becomes transferable or when the employee’s right to the stock is no longer subject to a substantial risk of forfeiture.
   3. This inclusion of the ISO spread in AMT income is triggered only if the employee continues to hold the stock at the end of the same year in which the option was exercised.
5. Tax Treatment of Qualifying Disposition
   
   1. ​A qualifying disposition for an ISO is taxed as a capital gain at long-term capital gains tax rates and on the difference between the selling price and the cost of the option.
6. Tax Treatment of Disqualifying Dispositions of Incentive Stock Options
   
   1. A disqualifying or nonqualifying disposition of ISO shares is any disposition other than a qualifying disposition. Disqualifying ISO dispositions are taxed in TWO ways:
      
      1. Compensation Income (subject to ordinary income rates), and
      2. Capital Gain or Loss (subject to short term or long term capital gains rate
   2. Determined as follows:
      
      1. FMV when option was exercised - Strike Price = Compensation Income
      2. Any profit above compensation income is capital gain.
      3. If the ISO shares are sold at a loss, the entire amount is a capital loss, and there is no compensation income to report.
7. Withholding
   
   1. Be aware that employers are not required to withhold taxes on the exercise or sale of incentive stock options. Accordingly, those who have exercised but not yet sold ISOshares at the end of the year may have incurred alternative minimum tax liabilities. Additionally, those who sell ISO shares may have significant tax liabilities not covered by payroll withholding. Taxpayers should send in estimated tax payments to avoid having a balance due on their tax return. Taxpayers may also want to increase the amount of withholding in lieu of making estimated payments.
8. Reported on Form 1040 and Three Types of Reporting:
   
   1. Reporting the Exercise of Incentive Stock Options and Shares Not Sold in the Same Year
      
      1. In this case, AMT income is increased by the spread between the fair market value of the shares and the exercise price. This can be calculated using data found on Form 3921 provided by ther employer.
      2. BASIS NOTE = Because income is being recognized for AMT purposes, there is a different cost basis in the shares for AMT than the shares for regular income tax purposes. It is advisable to keep track of this different AMT cost basis for future reference. For regular tax purposes, the cost basis of the ISO shares is the price paid (the exercise or strike price). For AMT purposes, the cost basis is the strike price plus the AMT adjustment (the amount reported on Form 6251, line 14).
   2. Reporting a Qualifying Disposition of ISO Shares
      
      1. Schedule D = The gain should be reported on Schedule D and Form 8949. The gross proceeds from the sale are required, which are given by the broker on Form 1099-B. Also required to be reported is the regular cost basis (the exercise or strike price, found on Form 3921). A separate Schedule D and Form 8949 should be completed to calculate the capital gain or loss for AMT purposes. On the separate schedule, report gross proceeds from the sale and the AMT cost basis (exercise price plus any previous AMT adjustment).
         
         1. On Form 6251, there will be a negative adjustment on line 17 to reflect the difference in gain or loss between the regular and AMT gain calculations. Refer to the Instructions for Form 6251 for details.
   3. Reporting a Disqualifying Disposition of ISO Shares
      
      1. W-2 = Compensation income is reported as wages on Form 1040, line 7, and any capital gain or loss is reported on Schedule D and Form 8949. Compensation income may already be included on Form W-2, the wage and tax statement from the employer in the amount shown in box 1. Some employers will provide a detailed analysis of the box 1 amounts at the top portion of the W-2. If the compensation income has already been included on the W-2, then simply report wages from Form W-2 box 1 on Form 1040, line 7. If the compensation income has not already been included on the W-2, then calculate compensation income and include this amount as wages on line 7 in addition to the amounts from Form W-2.
      2. SCHEDULE D = On Schedule D and Form 8949, report the gross proceeds from the sale (shown on Form 1099-B from the broker) and the cost basis for the shares. For disqualifying dispositions of ISO shares, the cost basis will be the strike price (found on Form 3921) plus any compensation income reported as wages. If the ISO shares were sold in a year other than the year in which the ISO was exercised, the cost basis will be different and a separate Schedule D and Form 8949 should report the different AMT gain. Use Form 6251 to report a negative adjustment for the difference between the AMT gain and the regular capital gain.

Calculating AMT on Exercise of ISO

1. If an ISO is exercised and the shares are not sold before the end of the calendar year, report additional income for the AMT. The amount included for AMT purposes is the difference between the fair market value of the stock and the cost of the incentive stock option. The fair market value per share is shown in box 4. The per-share cost of the incentive stock option, or exercise price, is shown in box 3 of Form 3921. The number of shares purchased is shown in box 5. To find the amount to include as income for AMT purposes, multiply the amount in box 4 by the amount of unsold shares (usually the same as reported in box 5) and, from this product, subtract the exercise price (box 3) multiplied by the number of unsold shares (usually the same amount shown in box 5).

Report this amount on Form 6251, line 14.

2. Calculating Cost Basis for Regular Tax
   
   1. The cost basis of shares acquired through an incentive stock option is the exercise price, shown in box 3. The cost basis for the entire lot of shares is the amount in box 3 multiplied by the number of shares shown in box 5. This figure will be used on Schedule D and Form 8949.
3. Calculating the Cost Basis for AMt
   
   1. Shares exercised in one year and sold in a subsequent year have two cost bases: one for regular tax purposes and one for AMT purposes. The AMT cost basis is the regular tax basis plus the AMT income inclusion amount. This figure will be used on a separate Schedule D and Form 8949 for AMT calculations.
4. Calculating Compensation Income Amount on Disqualifying Disposition
   
   1. If ISO shares are sold during the disqualifying holding period, some of the gain is taxed as wages subject to ordinary income taxes, and the remaining gain or loss is taxed as capital gains. The amount to be included as compensation income, and typically included on Form W-2, box 1, is the spread between the stock’s fair market value when you exercised the option and the exercise price. To find this, multiply the fair market value per share (box 4) by the number of shares sold (usually the same amount in box 5) and, from this product, subtract the exercise price (box 3) multiplied by the number of shares sold (usually the same amount shown in box 5).

This compensation income amount is typically included on Form W-2, box 1. If it is not included on the W-2, include this amount as additional wages on Form 1040, line 7.

5. Calculating the Adjusted Cost Basis of Disqualifying Disposition
   
   1. Start with the cost basis and add any amount of compensation. Use this adjusted cost basis figure to report capital gain or loss on Schedule D and Form 8949.

EXAMPLE

August 18, 2020.

Question 24

What are Employee Stock Options?

What are the two Pricing Advantages?

Example

• For example, Jeremy purchased stock in his ESPP on March 23, 2012. The stock closed at $11.16 on the offering date of January 1st and $18.65 on the purchase date of June 30th. The plan gives him a 15% discount and provides for the lookback provision. What is the actual purchase price?
• What is the date for a qualifying disposition?
• If Qualifying, what amount is reported as ordinary income?
• What if the sale is a disqualifying disposition?

Answer 24

Fringe Benefits

1. Incentive stock options,
2. Employee stock purchase plan options
3. Non-Statutory (Non-qualified) Stock Options

Employee Stock Purchase Plan (different than Employee Stock Option Plan - ESOPs are defined contribution plans that operate in a similar manner to 401(k) plans)

Employee stock purchase plans are essentially a type of payroll deduction plan that allows employees to buy company stock without having to effect the transactions themselves. Money is automatically taken out of all participants’ paychecks on an after-tax basis every pay period, and accrues in an escrow account until it is used to buy company shares on a periodic basis, such as every six months. These plans are similar to other types of stock option plans in that they promote employee ownership of the company, but do not have many of the restrictions that come with more formal stock option arrangements. Plus, they are designed to be somewhat more liquid in nature. A qualified ESPP plan (that is, one that meets all the rules laid out in ​section 423 of the Internal Revenue Code) can offer discounts of up to 15% on the purchase price of the stock.

Pricing Advantages

• Built-in Discount. Most ESPPs give employees an automatic discount on the share price for all of their purchases, such as 10% or 15%. This creates an instant gain for all participants at the time of purchase.
• Lookback Provision. This provision permits the plan to purchase the stock on the purchase date at either the closing price of the stock on the purchase date or the original offering date, whichever is lower. Obviously, this can make a huge difference in the amount of profit that employees realize from their plans. If the company stock closed at $15 on the original offering date and is trading at $40 when the market closes on the purchase date, then the plan can purchase the stock at its offering date price – or rather, at the discounted percentage of that price, if the plan offers both benefits (which is usually the case). Therefore an employee could get the stock for $12.75 in this scenario if the plan also offered a 15% built-in discount.

FOUR PHASES

1. Grant Phase = The employer grants its employees the option to purchase stock in the employer’s company (or parent company) at a predetermined price.
2. Offering Period = The offering period is the time during which employees accumulate savings for the future purchase of the company’s stock. Employees choose to have a percentage or fixed dollar amount deducted from each of their paycheck. These payroll deductions occur on an after-tax basis. This means that income tax and FICA taxes have already been taken out of your pay before the money is set aside for ESPP purchases
3. Transfer Phase =

At the end of the offering period, the employer takes all the money that has been saved up and uses that money to purchase shares of the company’s stock.The securities brokerage administering the ESPP plan will purchase shares of the company’s stock and transfer ownership of the stock to the participating employees. Any cash not used to purchase stock is refunded back to the employee. There is no tax impact when the shares are purchased and transferred to you. There will be tax impacts in the future, when you sell or otherwise dispose of the ESPP shares.

4. Disposition Phase = After the shares are transferred into your name, you are free to do with them as you please. You may sell, trade, exchange, transfer or give them away. Disposing of ESPP shares triggers tax impacts.

Categorizations:

1. Qualifying or Non-qualifying
   
   1. Qualifying =
      
      1. sale after stock is held for more than 1 year after the date of transfer AND
      2. more than 2 years after the date the options were granted
2. Short-Term or Long-Term
   
   1. Long Term determined from the day after the stock is purchased and ends on the date of sale.

EXAMPLE

1. Here’s what I mean: let’s say our client acquires 1 share of XYZ stock for $85. On that day, XYZ stock was worth $100 per share. The employee got a 15% discount on the purchase price. Now he sells his 1 share of XYZ for $125. Overall, our client earns $40 on this investment: the $125 he sold the stock for minus the $85 he paid for the stock. What we do now is separate this $40 income into two components: compensation income and capital gains.
2. Qualifying Disposition
   
   1. Compensation Income = Lower of:
      
      1. The fair market value of the stock on the date the option was granted, minus the price paid to exercise the option.
      2. The fair market value of the stock on the date the stock was sold, minus the price paid to exercise the option.
3. Non-Qualifying Dispositions
   
   1. Compensation Income is:
      
      1. Fair market value of the stock on the date the option was exercised, minus the price paid to exercise the option.

Example - Answer

1. Actual purchase price of $9.49 (85% of $11.16 via the look-back provision)
2. He will have to hold his stock at least until March 24, 2014 in order for this to be a qualifying disposition. If he does this and sells the stock in April of 2014 for $22.71, then only the discounted amount of $1.67 per share ($11.16 x 15%) will be reported as ordinary income.
3. On the other hand, if Jeremy were to sell the stock before the holding period expired, he would recognize $9.16 as ordinary income ($18.65 minus the discounted purchase price of $9.49). The market price on the day of purchase ($18.65) then becomes the cost basis for the sale.
4. In this case, the remaining $4.06 of sale proceeds (sale price of $22.71 minus the market price on day purchase of $18.65) will then be taxed as a long or short-term capital gain, depending upon the length of his holding period. This holds true even if the stock price declines before he can sell it. If he sells the stock for $7.55, he must still recognize $9.16 as ordinary income, even though he can partially offset this with a long- or short-term capital loss of $1.94 ($9.49 minus $7.55).

Question 25

What are Employee Stock Options?

Non-Statutory Stock Options?

For example, if you are lucky enough to be granted 1,000 shares of stock, at an exercise price of $150 per share, and the current market value is $300 per share at the time of exercise

Answer 25

Fringe Benefits

1. Incentive stock options,
2. Employee stock purchase plan options
3. Non-Statutory (Non-qualified) Stock Options

Grant

• Not a taxable event

Exercise

1. THIS IS WHEN TAXATION BEGINS!
2. When you exercise non-qualified stock options, the difference between the market price of the stock and the grant price (called the spread) is counted as ordinary earned income, even if you exercise your options and continue to hold the stock.
3. Earned income is subject to payroll taxes (Social Security and Medicare), as well as regular income taxes at your applicable tax rate.

Calculation

1. Payroll Taxes
   
   1. OASDI or Social Security – which is 6.2% on earnings up to the Social Security benefit base which is $118,500 in 2015
   2. HI or Medicare - which is 1.45% on all earned income even amounts that exceed the benefit base.
2. If your earned income for the year already exceeds your benefit base, then your payroll taxes on gain from exercising your non-qualified stock options will be just the 1.45% attributable to Medicare.
3. If your year-to-date earned income is not already in excess of the benefit base than when you exercise nonqualified stock options, you will pay a total of 7.65% on gain amounts up until your earned income reaches the benefit base than 1.45% on earnings over the benefit base.
4. You should not exercise employee stock options strictly based on tax decisions. That being said, keep in mind that if you exercise non-qualified stock options in a year where you have no other earned income, you will pay more payroll taxes than you’ll pay if you exercise them in a year where you do have other sources of earned income and already exceed the benefit base.
5. In addition to the payroll taxes, all income from the spread is subject to ordinary income taxes. If you hold the stock after exercise, and additional gains beyond the spread are achieved, the additional gains are taxed as a capital gain (or as a capital loss if the stock went down).
6. An employer must report the excess of the fair market value of stock received upon exercise of a nonstatutory stock option over the amount paid for the stock option on Form W-2 in boxes 1, 3 (up to the social security wage base), 5, and in box 12 using the code “V.” See Regulations section 1.83-7.

EXAMPLE -

• you will have a bargain element of $150,000 (1,000 x $150). That assumes all of the shares exercised were fully vested.
• Another taxable event occurs when you eventually sell the shares that you have previously exercised. Selling shares immediately, or less than one year of exercising the shares will result in the transaction being subject to short-term capital gains (or loss) rates.

Question 26

83(a) - what is it?

83(b) Election - DEADLINE?

Assume you receive 100,000 shares subject to vesting, worth $.01 per share at the time of grant, $1.00 per share at the time of vesting, and $5.00 per share when sold more than one year later. We’ll also assume you are subject to the maximum ordinary income tax rate and long-term capital gains rate. For simplicity, we will not discuss the employment tax or state tax consequences.

In this example you timely file a Section 83(b) election within 30 days of the restricted stock grant, when your shares are worth $1,000. You pay ordinary income tax of $396 (i.e., $1,000 x 39.6%).

Earl Exercise Example -

1. On Jan 1, 2017 you’ve been granted 30,000 options = the right to buy 30k shares at a price of $0.10. And this right is granted over time (4 years, the 1st 25% vested on your 1 year anniversary).
   
   1. Scenario A = You do nothing and wait for options to vest
   2. Scenario B = You have the opportunity “early exercise” these options — that is, write the company a check for $0.10 * 30,000 = $3,000 right away, while the assessed market value of the company is still $0.10 per share.
   3. What happens under each scenario one year later on January 1, 2018 when the value of the company has now risen to $1.00?

Answer 26

83(a) = services, the value of that property is included in taxable wages of the taxpayer when the property is either transferable or vests — i.e., is no longer subject to a substantial risk of forfeiture

83(b) = within 30 days of the date the unvested employer stock is transferred to him or her. The holding period for long-term capital gains treatment also begins on the date the stock is transferred, if an 83(b) election is made.

A section 83(b) election allows an employee that receives non-vested property from an employer to include in gross income in the year of transfer the excess of the FMV of the property at the date of transfer over the amount (if any) paid for the property. A section 83(b) election cannot be made at the date of grant of an option if such option has no readily ascertainable FMV because section 83(a) does not apply at that time.

Because you filed a Section 83(b) election, you do not have to pay tax when the stock vests, only on the later sale. Generally, restricted stock is taxed as ordinary income when it vests.

On the later sale which occurs more than one year after the date of grant you recognize a taxable gain of $4.99 per share (not $5.00, because you get credit for the $.01 per share you already took into income), and pay additional tax of $99,800 (i.e., $499,000 x 20%). Your economic gain after tax? $399,804 (i.e., $500,000 minus $396 minus $99,800).

NO 83(b) Election:

In this example you do not file a Section 83(b) election. So you pay no tax at grant (because the shares are unvested), but instead recognize income of $100,000 when the shares vest and thus have ordinary income tax of $39,600. On the later sale which occurs more than one year after the date of vesting you recognize a taxable gain of $4.00 per share (not $5.00, because you get credit for the $1.00 per share you already took into income), and pay additional tax of $80,000 (i.e., $400,000 x 20%). Your economic gain after tax? $380,400 (i.e., $500,000 minus $39,600 minus $80,000).

BENEFITS:

1. Likely reduce the overall tax burden
2. prevented a tax hit at the time of vesting, which may not be a time when cash is available to pay
3. starts your long-term capital gains holding period clock earlier – meaning that you get the long-term capital gains rate as long as the sale of your shares occurs more than a year after grant, rather than a year after vesting.

POSSIBLE DRAWBACKS

1. If you receive restricted stock worth a nominal amount, it virtually always makes sense to file one. However, what if instead of receiving 100,000 shares of restricted stock worth $.01 per share, you received 100,000 shares of restricted stock worth $1.00 per share? Filing a tax code Section 83(b) election would immediately cause you tens of thousands of dollars of tax. And if the company subsequently fails, and in particular if it fails before your stock vests, you likely would have been economically better off to not have filed a Section 83(b) election.

Early Exercise Example -

1. Send a cover letter and originally executed 83(b) form and one (1) additional copy via certified mail or Federal Express to the IRS, within 30 calendar days of the date of transfer, with a self-addressed stamped envelope. Retain receipt of mailing;
2. On Jan 1, 2017 you’ve been granted 30,000 options = the right to buy 30k shares at a price of $0.10. And this right is granted over time (4 years, the 1st 25% vested on your 1 year anniversary).
3. Scenario A
   
   1. you’ve done nothing and just waited for your options to vest:
      * On Jan 1, 2018, you receive your 1st vest: 7,500 options, i.e. the right to buy 7,500 shares at a price of $0.10.
      * So you have received the option to buy 7,500 shares worth $1.00 each for $0.10. Options vesting are not a taxable event.
      * But if you were to exercise these options (paying $0.10 for shares worth $1.00), as the IRS is concerned, you’ll have received ($0.90 * 7,500) = $6,750 of income.
4. Scenario B
   
   1. Scenario B: you’ve “early exercised” these options on 1/1/17:
      * On Jan 1, 2018, you receive 7,500 options, i.e. the right to buy 7,500 shares at a price of $0.10.
      * However you’ve already previously pre-paid for these options. You paid $0.10 per option a year ago, when the assessed market value was still $0.10. At the time of early-exercise, you paid $0.10 and received something valued at $0.10, so you’ve received $0 in income, and so you had $0 in extra income tax last year.
      * Now on 1/1/18, 7,500 options vest, you already early-exercised them a year ago, so these are immediately “exercised” into shares. At this moment, you have on paper something worth $7,500.
      * You pay NO income tax on this (by pre-paying last year, you get to recognize the transaction as $0 of extra income last year).

Question 27

83(i)

Answer 27

What is the Effect of Making an 83(i) election? If an eligible employee has a stock option or RSU to acquire qualified stock, the employee can make an 83(i) election to convert the qualified stock into “deferral stock” within 30 days of the date when the stock option or RSU vests.

1. FMV - The fair market value of the deferral stock on the date the deferral stock is transferred to the employee (less any amount the employee paid for the deferral stock) will not be taxed until the first to occur of the following events:
   
   1. The first date the deferral stock becomes transferable (including to the employer),
   2. The date the qualified employee first becomes an “excluded employee,”
   3. The first date the corporation’s stock becomes readily tradable on an established securities market,
   4. Five years after the first date the employee’s qualified equity grant vests or becomes transferable, whichever is earlier, OR
   5. The date the employee revokes his or her election with respect to his or her deferral stock
2. Holding Period:
   
   1. The deferral stock will be treated as a capital asset and the holding period for long-term capital gain begins on the date the qualified stock is converted to deferral stock. If the deferral stock is held for at least 12 months, then the fair market value of the deferral stock on the date of the sale, minus the fair market value of the qualified stock on the date it vested or was transferred to the employee, whichever is later, will be taxed at the favorable rates for long-term capital gains.

Who can make qualified equity grants? An “eligible corporation” is:

1. a privately held company (i.e., no stock is traded on an established securities market),
2. that has a written plan that provides stock options or RSUs, to acquire “qualified stock,”
3. to at least 80% of its employees in the United States,
4. with the same rights and privileges under the plan as required under Code section 423(b)(5) for qualified employee stock purchase plans.

Who is eligible to receive qualified equity grants and make an 83(i) election? The term “qualified employee” is defined as an employee who is not an “excluded employee.” An excluded employee is an employee who:

1. Has been a one-percent owner at any time during the calendar year or during the ten preceding calendar years;
2. Has been at any time the chief executive officer or chief financial officer, or an individual acting in either capacity;
3. Is a spouse, child, grandchild or parent of any individual listed in the two categories above; OR
4. Is one of the four highest compensated officers of the company for the taxable year or for any of the ten preceding taxable years.
5. THUS =
   
   1. qualified equity grant may not be awarded to an independent contractor
   2. It appears that employers have full flexibility to define which employees will be excluded from the plan, as long as no more than 20% of the eligible employees of the US corporation are excluded.

What is Qualified Stock?

1. The option or RSU must have been granted by the employer in connection with the employee’s performance of services during the calendar year in which the corporation was an “eligible corporation.” Moreover, the stock is not considered “qualified stock” if the employee can sell the stock to the company or receive cash in lieu of stock when the employee’s right to such stock becomes transferable or not subject to a substantial risk of forfeiture (i.e., vested)

When?

1. If a stock option or RSU meets all the conditions to be a qualified equity grant, an eligible employee must proactively choose to defer the tax associated with the qualified stock within 30 days of the first date the employee’s rights to the qualified stock are transferable or are vested, whichever comes first

Disqualifications:

1. An employee may not make an election under section 83(i) if he or she has made a section 83(b) election with respect to the qualified stock.
2. This deferral election is also not available if the company has repurchased any of its outstanding stock in the year before the date the employee’s rights to the qualified stock are transferable or vested, unless at least 25% of the total dollar amount is “deferral stock” (i.e. stock that was elected to be deferred under section 83(i)), and the determination of which individuals from whom such stock is purchased is made on a reasonable basis.
3. However, these two conditions — the 25% requirement and determination of whom the stock is purchased from – shall be treated as met if the employer purchases all outstanding deferral stock. Employers are also required to report on their tax returns the total dollar amount of their outstanding stock purchased during the calendar year

FICA = Social Security Tax, Medicare, and 0.9% Medicare Surtax

When an employee makes the deferral election, the employee will still be responsible for paying (and the employer will be responsible for withholding) Social Security and Medicare taxes.

Question 28

Employer-Provided Cell Phones

Answer 28

The value of the business use of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a working condition fringe benefit. Personal use of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a de minimis fringe benefit. The term “cell phone” also includes other similar telecommunications equipment. For the rules relating to these types of benefits, see De Minimis (Minimal) Benefits , earlier in this section, and Working Condition Benefits , later in this section.

Non-Compensatory Business Reasons

• You provide a cell phone primarily for noncompensatory business purposes if there are substantial business reasons for providing the cell phone. Examples of substantial business reasons include the employer’s:
  
  • Need to contact the employee at all times for work-related emergencies,
  • Requirement that the employee be available to speak with clients at times when the employee is away from the office, and
  • Need to speak with clients located in other time zones at times outside the employee’s normal workday.

Question 29

Group-Term Life Insurance Coverage

Example

Tom’s employer provides him with group-term life insurance coverage of $200,000. Tom is 45 years old, isn’t a key employee, and pays $100 per year toward the cost of the insurance. What is the yearly cost of coverage in excess of the exempt amount? What portion of the yearly cost is included in wages?

Answer 29

Exclusion from wages.

You can generally exclude the cost of up to $50,000 of group-term life insurance coverage from the wages of an insured employee. You can exclude the same amount from the employee’s wages when figuring social security and Medicare taxes. In addition, you don’t have to withhold federal income tax or pay FUTA tax on any group-term life insurance you provide to an employee.

Coverage over the limit.

You must include in your employee’s wages the cost of group-term life insurance beyond $50,000 worth of coverage, reduced by the amount the employee paid toward the insurance. Report it as wages in boxes 1, 3, and 5 of the employee’s Form W-2. Also, show it in box 12 with code “C.” The amount is subject to social security and Medicare taxes, and you may, at your option, withhold federal income tax.

Example

The yearly cost of $150,000 of coverage is

• IRS Cost Per $1,000 of Protection for 1 Month x Excess Coverage x 12
• Yearly Cost = $270
• Tom pays $100 for insurance
• Answer:
• The employer includes $170 in boxes 1, 3, and 5 of Tom’s Form W-2. The employer also enters $170 in box 12 with code “C.”

Question 30

What is the de minimis exception for group-term life insurance coverage paid by the employer for the spouse or dependents of an employee?

Answer 30

Group-term life insurance coverage paid by the employer for the spouse or dependents of an employee may be excludable from income as a de minimis fringe benefit if the face amount isn’t more than $2,000. If the face amount is greater than $2,000, the dependent coverage may be excludable from income as a de minimis fringe benefit if the excess (if any) of the cost of insurance over the amount the employee paid for it on an after-tax basis is so small that accounting for it is unreasonable or administratively impracticable.

Question 31

What is an HSA

Answer 31

Fringe Benefit

Exclusion -Cash contributions to the HSA of a qualified individual (determined monthly) are exempt from federal income tax withholding, social security tax, Medicare tax, and FUTA tax, if you reasonably believe that the employee can exclude the benefits from gross income.

• For 2019, you can contribute up to
• $3,500 for self-only coverage under an HDHP or
• $7,000 for family coverage under an HDHP to a qualified individual’s HSA.

The contribution amounts listed above are increased by $1,000 for a qualified individual who is age 55 or older at any time during the year. For two qualified individuals who are married to each other and who each are age 55 or older at any time during the year, each spouse’s contribution limit is increased by $1,000 provided each spouse has a separate HSA. No contributions can be made to an individual’s HSA after he or she becomes enrolled in Medicare Part A or Part B.

A qualified individual must be

(1) covered by a High Deductible Health Plan (HDHP) and not be covered by other health insurance except for permitted insurance listed under section 223(c)(3) or insurance for accidents, disability, dental care, vision care, or long-term care
(2) For calendar year 2019, HDHP Deductible Limits:

• Self Only = $1,350
• Family = $6,750

(3) Must limit annual out-of-pocket expenses of the beneficiary to

• Self Only = $6,750
• Family $13,500

(3)(a) - Out of Pocket Expenses = The most you have to pay for covered services in a plan year. After you spend this amount on deductibles, copayments, and coinsurance, your health plan pays 100% of the costs of covered benefits

There are no income limits that restrict an individual’s eligibility to contribute to an HSA nor is there a requirement that the account owner have earned income to make a contribution.

Exceptions:

1. An individual isn’t a qualified individual if he or she can be claimed as a dependent on another person’s tax return
2. Also, an employee’s participation in a health FSA or health reimbursement arrangement (HRA) generally disqualifies the individual (and employer) from making contributions to his or her HSA.
3. However, an individual may qualify to participate in an HSA if he or she is participating in only a limited-purpose FSA or HRA or a post-deductible FSA

Cafeteria Plans:

1. You may contribute to an employee’s HSA using a cafeteria plan and your contributions aren’t subject to the statutory comparability rules. However, cafeteria plan nondiscrimination rules still apply. For example, contributions under a cafeteria plan to employee HSAs can’t be greater for higher-paid employees than they are for lower-paid employees. Contributions that favor lower-paid employees aren’t prohibited.

Nondiscrimination Rules

1. Your contribution amount to an employee’s HSA must be comparable for all employees who have comparable coverage during the same period. Otherwise, there will be an excise tax equal to 35% of the amount you contributed to all employees’ HSAs
2. For guidance on employer comparable contributions to HSAs under section 4980G in instances where an employee hasn’t established an HSA by December 31 and in instances where an employer accelerates contributions for the calendar year for employees who have incurred qualified medical expenses, see Regulations section 54.4980G-4

Exception: The Tax Relief and Health Care Act of 2006 allows employers to make larger HSA contributions for a nonhighly compensated employee than for a highly compensated employee.

Question 32

Common Law vs. Community Property?

Answer 32

.42 States Common Law

9 Community Property Law

In community property states, income may be either separate or community. Community income is considered to belong equally to the spouses. In all community property states, the income from the personal efforts of either spouse is considered to belong equally to the spouses. Furthermore, income from community property is considered to be community income. Thus, if a wife’s salary is used to purchase stock, subsequent dividends are community income

Separate Property in Community Property States:

1. Prior to Marriage
   
   1. Separate property consists of all property owned before marriage
2. After Marriage
   
   1. Separate property consists of gifts and inheritances acquired after marriage.

Income from Community Property:

1. Whether income from separate property is community or separate depends on the state
   
   1. In Idaho, Louisiana, and Texas, income from separate property is community income.
   2. In Arizona, California, Nevada, New Mexico, and Washington, such income is separate income

Question 33

You work in Atlanta and take a business trip to New Orleans in May. Your business travel totals 900 miles round trip. On your way home, you stop in Mobile to visit your parents. You spend $2,165 for the 9 days you are away from home for travel, non-entertainment-related meals, lodging, and other travel expenses. If you hadn’t stopped in Mobile, you would have been gone only 6 days, and your total cost would have been $1,633.50.

Answer 33

You can deduct $1,633.50 for your trip, including the cost of round-trip transportation to and from New Orleans. The deduction for your non-entertainment related meals is subject to the 50% limit on meals mentioned earlier.

Question 34

The 2017 Tax Cuts and Jobs Act (TCJA), effective for 2018 through 2025 tax years, has made major changes in a number of business tax-related issues, including taxability of employee moving expenses

What are the four main changes?

Answer 34

1. Unreimbursed Moving Expenses No Longer Deductible to Employees. Employee costs for a business move that are not reimbursed by employers are no longer deductible under the “Miscellaneous Expenses” section of Schedule A.
2. Reimbursed Moving Expenses Taxable to Employees. In previous years, if the company’s reimbursement program was an accountable plan (as described below), the employee benefit wasn’t taxable to the employee. Now (2018-2025) these benefits are always taxable to employees. You must withhold and pay all employment taxes and include these costs on the employee’s W-2 form and with
3. Moving Expenses Still Deductible to Employers. Whether or not you have an accountable plan, the expense of moving employees for business reasons is still a deductible expense for your business.
4. Employees Can No Longer Deduct Unreimbursed Business Expenses
   
   1. Prior to the Act, an employee who itemized tax deductions could deduct unreimbursed employee business expenses as a miscellaneous itemized deduction (to the extent that the aggregate miscellaneous itemized deductions exceeded 2% of the employee’s adjusted gross income). However, beginning January 1, 2018 miscellaneous itemized deductions are no longer allowed. That means that if an employer reimburses an employee for a business expense, the reimbursement is tax-free to the employee. However, if the employer does not reimburse the employee’s business expense, the employee no longer will be able to claim a tax deduction for the expense.

Question 35

About the Section 125 Plan (Cafeteria Plan)

EXAMPLE - There is a rule in place that states you must use any remaining funds in the account by the end of the year or the money is forfeited to your employer. Although this may be true, is it also true that it could still result in a net benefit to the employee?

What are the types of Cafeteria Plans?

Answer 35

Section 125 cafeteria plans must be created by an employer. Once a plan is created, the benefits are available to employees, their spouses and dependents. Depending on the circumstances and details of the plan, section 125 benefits may also extend to former employees, but the plan cannot exist primarily for them.

On the employer side, section 125 plans offer lots of tax-saving benefits. For each participant in the plan, employers save on the Federal Insurance Contributions Act (FICA) tax, the Federal Unemployment Tax Act (FUTA) tax, the State Unemployment Tax Act (SUTA) tax and workers’ compensation insurance premiums. Employers on average save $115 per participant on FICA alone. Combined with the other tax savings, the section 125 plan usually funds itself, as the cost to open the plan is low.

For example, if an employee elects to have $600 per year deducted from his or her pay and placed into the plan and the company has 24 pay periods, then $25 per pay period is automatically deducted tax-free. The money gets sent to the plan’s third-party administrator to be held. It can then be distributed for reimbursement upon request for qualified expenses.

A wide variety of medical and child care expenses is eligible for reimbursement under a section 125 cafeteria plan. As for medical items and treatments, there are dozens of eligible expenses that can be reimbursed. The following are eligible expenses: acupuncture, alcoholism treatment, ambulance services, birth control, chiropractic services, dental and doctors’ fees, eye exams, fertility treatment, hearing aids, long-term care services, nursing homes, operations, prescription drugs, psychiatric services, sterilization, wigs and wheelchairs. But this is not an all-inclusive list.

There are also a large variety of eligible over-the-counter items. Allergy medicines, cold medicines, contact lens solutions, first aid kits, pain relievers, pregnancy tests, sleeping aids and throat lozenges are among the dozens of eligible items. Many dual-purpose items are eligible, such as dietary supplements, orthopedic shoes, prenatal vitamins and sunscreen.

EXAMPLE - Here is an example. Assume that you placed $1,000 in your section 125 plan. At the end of the year, you notice that you have $100 remaining in the account. If you are in the 28% marginal tax bracket, you have already saved $280 on taxes, or ($1,000 x 28%). Forfeiting the $100 means that you still have a net benefit of $180. While this simple example shows the possible scenario, in reality, there is a new carryover provision that was implemented in 2013. With the provision, plan participants can carry over $500 of unused funds from one year to the next.

Cafeteria plans have different levels of benefits.

1. A premium-only plan (POP) allows employees to pay their portion of insurance on a pretax basis.
2. The flexible spending account (FSA) version allows for out-of-pocket qualified expenses to be paid pretax, which is the style of plan described above.
3. The full-blown plan is called a consumer-driven health care (CDHC) plan and involves a credit system the employee can use on a discretionary basis for qualified expenses. Employees can then supplement the CDHC with their own money and use it to buy additional benefits or coverage.

Employers must hire and partner with a qualified section 125 third-party administrator, who can provide the most up-to-date documentation for plan setup and update the employer on the latest requirements necessary for compliance. Typical third-party administrators provide employers with an up-to-date plan document, summary plan descriptions, corporate resolution, any customized forms, legal review, attorney opinion letters, discrimination testing, signatory-ready Form 5500, if required, and employee education.

Generally:

• Under cafeteria plans, employees may select from a list of nontaxable fringe benefits. On the other hand, employees who so choose may receive cash in lieu of some or all of the nontaxable benefits. Thus, each employee selects what he or she wants most. One common result is that high-tax-rate employees select the non-taxable fringe benefits, whereas other employees choose to receive cash.
• An employer-sponsored cafeteria plan allows you to select among certain employee benefits, including health, life, and disability insurance. You normally pay for these benefits on a pretax basis. Sometimes, however, your employer pays the premium for the benefits you choose (up to a certain amount), and if you choose additional benefits, you pay for extra coverage using either pretax or after-tax dollars.

Question 36

Advice for a client with large stock options?

Answer 36

1. Consider selling enough shares, each year, to max out your retirement account contributions to a 401(k) and maybe your spouse’s retirement plan as well.
   
   1. I often recommend that clients sell a specified percentage of their stock options each year. For my best-paid executive clients, they tend to get more grants year-after-year. Even after selling, their net account balance in company stock have tended to increase over time. The important thing is their overall investment allocation risk was lowered by funding retirement and other investment accounts. Additionally, a date is set each year to sell a percentage of their stock options (e.g. 10%) regardless of whether the stock is up or down that day.

Question 37

What makes a good 401k?

What do you do if your 401k stinks?

Answer 37

Good 401K

1. Employer Match
   
   1. “A 100% match on contributions easily outweighs investments with slightly higher investment expenses.”
2. Vesting
   
   1. “Some employers’ matches are 100% vested immediately, some occur over time,” he said. “The faster the vesting schedule, the higher the probability that you will retain the full employer match.”
3. Plan and Investment Fees
   
   1. Another important factor to consider is cost. Lower costs generally lead to better returns, so prioritizing whichever 401(k) allows you to minimize costs may be a good idea.
4. Investment Options
   
   1. some 401(k)s have a relatively limited set of investment options while others allow you to choose from among thousands of mutual funds in a self-directed portfolio, which may make it easier for you to implement your desired strategy in a cost-effective way.
5. Availability of Roth IRA
   
   1. “While it’s not right for everyone, the tax advantages of Roth contributions are quite powerful,” said Ian Bloom, founder of Open World Financial Life Planning. “Potentially tax-advantaged savings with tax-free money in retirement? Having access to that is a big deal.”

401K Stinks

1. Match-
   
   1. Still always take the max matching amount
2. Priotize other Tax Advantage Accounts
   
   1. Either Traditional or Roth IRA
3. HSA
   
   1. If you’re eligible, another great option is a health savings account. These accounts offer special tax benefits when used for medical expenses, but in the right situations they can also be a powerful retirement account. You can get help finding a health savings account here.
4. Self-Employed
   
   1. Finally, if you have any self-employment income, even if it’s on the side of your day job, you can look into the self-employed retirement accounts available to you. Like with IRAs, you have a lot of control over the fees and investment options, and some of these accounts allow you to contribute up to $54,000 per year. Talk about turbocharging your retirement savings!
5. Pay down debt
   
   1. Let’s say you have student loans with a 6.8% interest rate. If you pay it off, you’ll essentially earn a 6.8% return on that money (because you won’t have to pay all that interest). That’s in line with what many experts are forecasting for long-term stock market returns, and paying it off comes without any risk that you won’t actually get that return. Every extra dollar you put towards that debt automatically saves you 6.8% in interest.
6. Taxable Investment Account
   
   1. The question of whether it’s better to use a taxable investment account than a 401(k) is a complicated one that depends heavily on the specifics of your situation. But here are a few things to consider:
      1. Your 401(k) would have to be excessively expensive for the fees to outweigh the tax benefits over a taxable investment account.
      2. The longer you plan to stay with your current company, the more of an impact those fees will have. Meaning a taxable investment account would start to be more appealing.
      3. The tax deduction and tax-free growth within a 401(k) will be more advantageous in higher tax brackets.

Question 38

Roth IRA vs. Traditional IRA

Answer 38

1. The numbers show that the Roth favors those savers more than conventional wisdom would suggest, and the differences are most extreme when tax savings from the traditional IRA contributions are not also separately invested themselves.
2. Maximum contributions always favor the Roth if traditional IRA tax savings aren’t invested separately. The analysis finds no tax scenarios in which the value of a traditional IRA at retirement beats the value of a Roth IRA, assuming both accounts receive maximum contributions and the traditional IRA tax savings aren’t invested in a separate investment vehicle.
3. Investors who pay the highest tax rates in retirement stand to benefit (or lose) the most. The additional value amassed in Roth IRAs is most significant for investors facing the highest effective income tax rates at retirement; they stand to net an additional $184,364 over a 30-year period. IF YOUR TAX RATES DROP IN RETIREMENT, YOU WILL BENEFIT FROM TRADITIONAL IRA
4. Investing tax savings can help the traditional IRA. If you invest 100% of the tax savings from each annual traditional IRA contribution, most tax scenarios still favor the Roth IRA. It is worth noting, however, that savers with very high tax rates during their careers and very low rates in retirement can also come out significantly ahead with a traditional IRA if they reinvest their tax savings — see the tables below for details.

DOING THE MATH

1. Roth IRA contributions are made with after-tax dollars, which means every contribution has a higher effective cost: To make a $5,500 contribution — the current annual contribution limit — at a tax rate of 25%, you’ll also have to pay an additional $1,833 in taxes.
2. If you put $5,500 into a traditional IRA, that money goes in pretax, which means the cost to you is $5,500. If you’re eligible for a deduction, the cost is offset by the value of that tax savings. That makes the traditional IRA a better deal in the short run. And it’s likely one reason why most savers opt for a traditional IRA. According to 2016 data from the Investment Company Institute, 25% of U.S. households have a traditional IRA, while only 17% have a Roth. Even though those numbers include all income levels, among those who meet Roth eligibility limits, the traditional IRA still leads by a significant margin.
3. When everything regarding taxes is considered, the question of which account will net a higher after-tax balance may hinge on whether the saver invests the traditional IRA tax savings each year. When $30,000 is withdrawn from a traditional IRA, the IRS takes a cut; exactly how much depends on unknown future tax rates, but will likely be several thousand dollars. But when $30,000 comes out of a Roth IRA in retirement, the full $30,000 reaches the retiree because the taxes were already paid when the contribution was made.

WHEN THE SAVE INVESTS THE TAX SAVINGS:

1. Because the contribution limit on these accounts is the same — $5,500 is the combined annual maximum for all IRA contributions — there is one way to possibly make a traditional IRA competitive with a Roth IRA in the case of maximum contributions: Invest the tax savings netted by the traditional IRA contribution in a separate investment account. That supplemental brokerage account should be invested in a way that mirrors the investments in the IRA. (Note that in scenarios in which the saver doesn’t make the maximum annual contribution to a traditional IRA, investing the tax savings may not require opening a separate brokerage account.)
2. In some scenarios, particularly in which the retiree’s tax rate stays at 25% or below, investing 100% of the taxes saved makes the traditional IRA a more valuable option than the Roth IRA. IRS data show that the majority of American taxpayers fall into brackets at or below the 25% level.

Question 39

Lodging on Your Business Premises

Example 1 -

You employ Sam at a construction project at a remote job site in Alaska. Due to the inaccessibility of facilities for the employees who are working at the job site to obtain lodging and the prevailing weather conditions, you furnish lodging to your employees at the construction site in order to carry on the construction project. You require that your employees accept the lodging as a condition of their employment.

Example 2 -

Answer 39

Fringe Benefits

You can exclude the value of lodging you furnish to an employee from the employee’s wages if it meets the following tests.

1. It is furnished on your business premises.
   
   1. your business premises is generally your employee’s place of work. For example, if you’re a household employer, then lodging furnished in your home to a household employee would be considered lodging furnished on your business premises.
2. It is furnished for your convenience.
   
   1. ​Whether or not you furnish lodging for your convenience as an employer depends on all the facts and circumstances. You furnish the lodging to your employee for your convenience if you do this for a substantial business reason other than to provide the employee with additional pay. This is true even if a law or an employment contract provides that the lodging is furnished as pay. However, a written statement that the lodging is furnished for your convenience isn’t sufficient.
3. The employee must accept it as a condition of employment.
   
   1. Lodging meets this test if you require your employees to accept the lodging because they need to live on your business premises to be able to properly perform their duties. Examples include employees who must be available at all times and employees who couldn’t perform their required duties without being furnished the lodging.

Exceptions

1. If you allow your employee to choose to receive additional pay instead of lodging, then the lodging, if chosen, isn’t excluded. The exclusion also doesn’t apply to cash allowances for lodging.

Example 1

1. You may exclude the lodging that you provide from Sam’s wages. Additionally, since sufficient eating facilities aren’t available near your place of employment, you may also exclude meals you provide to Sam from his wages

Example 2

1. A hospital gives Joan, an employee of the hospital, the choice of living at the hospital free of charge or living elsewhere and receiving a cash allowance in addition to her regular salary. If Joan chooses to live at the hospital, the hospital can’t exclude the value of the lodging from her wages because she isn’t required to live at the hospital to properly perform the duties of her employment.

Question 40

No-Additional-Cost Services

What are some examples?

Answer 40

Fringe Benefit for Employees

1. This exclusion applies to a service you provide to an employee if it doesn’t cause you to incur any substantial additional costs. The service must be offered to customers in the ordinary course of the line of business in which the employee performs substantial services.
2. Such substantial additional costs include foregone revenue and the cost of labor. The service is a no-additional cost service regardless of whether it is offered at no charge or at a reduced rate.
3. Services that aren’t eligible for treatment as no-additional-cost services are non-excess capacity services, such as the facilitation by a stock brokerage firm of the purchase of stock by employees. These services may however be eligible for a qualified employee discount of up to 20% of the value of the service provided.

Aren’t Eligible

1. A commercial airline allows its employees to take personal flights on the airline at no charge and receive reserved seating. Because the employer gives up potential revenue by allowing the employees to reserve seats, employees receiving such free flights aren’t eligible for the no-additional-cost exclusion.

Examples

1. No-additional-cost services are excess capacity services, such as airline, bus, or train tickets; hotel rooms; or telephone services provided free, at a reduced price, or through a cash rebate to employees working in those lines of business.
2. Athletic/Recreational Facilities
3. Complimentary and Discounted Tickets to Athletic and Entertainment Events
4. Communication Services
   
   1. University provided free electronic mail services, internet access, and local and long-distance telephone service, are considered no-additional cost services fringe benefits, as the university is using excess capacity that it has already purchased. In addition, the university is not incurring any substantial additional cost in providing the service because the university does not spend a substantial amount of time in providing the service to employees, over that time spent in providing the service to its main customers, students.

Question 41

Qualified Transportation Benefits

This exclusion applies to the following benefits.

Answer 41

Fringe Benefits

Exclusion from Wages: You can generally exclude the value of transportation benefits that you provide to an employee during 2019 from the employee’s wages up to the following limits.

1. $265 per month for combined commuter highway vehicle transportation and transit passes.
2. $265 per month for qualified parking.

Applies to the following benefits

1. A ride in a commuter highway vehicle between the employee’s home and work place.
2. A transit pass.
3. Qualified parking.

Transit Pass

A transit pass is any pass, token, farecard, voucher, or similar item entitling a person to ride, free of charge or at a reduced rate, on one of the following.

1. On mass transit.
2. In a vehicle that seats at least 6 adults (not including the driver) if a person in the business of transporting persons for pay or hire operates it.

Commuter Highway Vehicle

A commuter highway vehicle is any highway vehicle that seats at least 6 adults (not including the driver). In addition, you must reasonably expect that at least 80% of the vehicle mileage will be for transporting employees between their homes and work place with employees occupying at least one-half the vehicle’s seats (not including the driver’s).

Question 42

Qualified Parking

Answer 42

Fringe Benefit

Type of Qualified Transporation Benefits:

Exclusion from wages.

1. You can generally exclude the value of transportation benefits that you provide to an employee during 2019 from the employee’s wages up to the following limits.
   
   1. $265 per month for combined commuter highway vehicle transportation and transit passes.
   2. $265 per month for qualified parking.

Qualified parking is parking you provide to your employees on or near your business premises. It includes parking on or near the location from which your employees commute to work using mass transit, commuter highway vehicles, or carpools. It doesn’t include parking at or near your employee’s home.

Question 43

Working Condition Benefit

Answer 43

Examples

1. Pick up trucks
2. Vans
3. Education
4. Outplacement Services
5. Product Testing

Exclusion from wages.

1. You can generally exclude the value of a working condition benefit you provide to an employee from the employee’s wages.

This exclusion applies to property and services you provide to an employee so that the employee can perform his or her job. It applies to the extent the cost of the property or services would be allowable as a business expense or depreciation expense deduction to the employee if he or she had paid for it. The employee must meet any substantiation requirements that apply to the deduction. Examples of working condition benefits include an employee’s use of a company car for business, an employer-provided cell phone provided primarily for noncompensatory business purposes (discussed earlier), and job-related education provided to an employee.

This exclusion also applies to a cash payment you provide for an employee’s expenses for a specific or prearranged business activity if such expenses would otherwise be allowable as a business expense or depreciation expense deduction to the employee. You must require the employee to verify that the payment is actually used for those expenses and to return any unused part of the payment.

The exclusion doesn’t apply to the following items.

1. A service or property provided under a flexible spending account in which you agree to provide the employee, over a time period, a certain level of unspecified noncash benefits with a predetermined cash value.
2. A physical examination program you provide, even if mandatory.
3. Any item to the extent the payment would be allowable as a deduction to the employee as an expense for a trade or business other than your trade or business. For more information, see Regulations section 1.132-5(a)(2).

Question 44

Cash Receipts and Disbursements Method

Answer 44

Reported in the year the taxpayer actually or constructively receives the income rather than in the year the income is earned.

Question 45

Accrual Method

What type of business is required to use accrual?

What is the exception?

Answer 45

Income is reported in the year it is earned

Accrual basis is a method of recording accounting transactions for revenue when earned and expenses when incurred. The accrual basis requires the use of allowances for sales returns, bad debts, and inventory obsolescence, which are in advance of such items actually occurring. An example of accrual basis accounting is to record revenue as soon as the related invoice is issued to the customer.

A key advantage of the accrual basis is that it matches revenues with related expenses, so that the complete impact of a business transaction can be seen within a single reporting period.

Auditors will only certify financial statements if they have been prepared using the accrual basis of accounting.

The alternative method for recording accounting transactions is the cash basis.

Type of Business:

1. Inventory
2. C-Corps
3. Partnerships with Corporate Partners
4. Tax Shelters
5. Certain Trusts

Inventory Exception:

1. $1,000,000 or Less Inventory
2. However, the IRS recently ruled that taxpayers whose annual gross receipts for the three prior years averaged $1 million or less are exempt from this requirement and may use the cash method.

Another Example

1. Businesses with income from long-term contracts (such as construction firms and manufacturers), which generally must use the percentage-of-completion method.

Question 46

Hybrid Method

Answer 46

The hybrid method is a combination of the cash and accrual methods of accounting. The IRS says, you can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently.

Although most businesses use either the cash or accrual method of accounting, the hybrid method is sometimes used by businesses with inventory. Unless the business qualifies for the small-inventory-business exception, tax law requires businesses to use the accrual method of accounting to account for inventory and its sale, but many businesses with inventory also use a cash basis for all other income and expenses because of its simplicity. However, the same accounting method must be used to report both income and expenses.

Question 47

How to avoid tax - Two Options?

Answer 47

1. Establish that the item is not income
   
   1. a return of capital
   2. unrealized income
   3. self-help income
   4. rental value of personal-use property
   5. gross selling price of property
2. Establish a specific exclusion
   
   1. Statutory Exclusions
   2. Administrative Exclusions
      
      1. A liberal interpretation of the statute by the IRS may result in a broad definition of what constitutes an exclusion, and such a broad definition may reasonably be termed as an administrative exclusion
   3. Judicial Exclusions
      
      1. Although the courts cannot create exclusions, they can interpret the statute and decide whether a particular item is covered by a statutory exclusion

Question 48

What are 9 major statutory exclusions

Answer 48

1. Gifts and inheritances
2. Life insurance proceeds
3. Public assistance programs
4. Qualified adoption expenses
5. Payments for personal physical sickness and injury
6. Discharge of indebtedness during bankruptcy or insolvency
7. Gain on sale of personal residence
8. Partial exclusions for Social Security benefits
9. Alimony for divorces after December 31, 2018

Question 49

Gifts

Transfers of money or property between family members frequently create problems of classification. For example, assume a father, who owns a business, hires his son to work in the business. Is the payment to the son a salary (and, therefore, deductible by the business) or is it really just a gift from the father to the son?

Answer 49

The answer depends on the true value of the services performed by the son. If the son truly performs services that are commensurate with the salary paid, the payment may properly be classified as a salary. On the other hand, if the son is paid an amount that exceeds the value of the services, the excess amount will be treated as a gift

Question 50

Life Insurance:

Buddy is the beneficiary of a $100,000 insurance policy on his mother’s life. Upon her death, he elects to receive $13,000 per year for ten years instead of the lump sum.

OR

Buddy elects to receive full 100,000 upon his mother’s death

EXAMPLE 2 -

1. Let’s assume you sold your life insurance policy, which had a cash value of $150,000 for a $200,000 settlement. Furthermore, you’d already paid $125,000 in premiums.

Answer 50

He receives $10,000 per year tax-free ($100,000 / 10), but the remaining $3,000 per year is taxable as interest

OR

none of the 100,000 is taxable

EXCEPTIONS

1. Consideration - exclusion generally is not available if the insurance policy is obtained by the beneficiary in exchange for valuable consideration from a person other than the insurance company
   
   1. Jim is the owner and beneficiary of a $100,000 policy on the life of his father.
   2. Jim sells the policy to his brother Bob for $10,000. Bob subsequently pays premiums of $12,000. Upon his father’s death, Bob must include $78,000 ($100,000 -$10,000 - $12,000) in gross income.
   3. However, if Jim gave the policy to his brother, all of the proceeds would be excluded from gross income because the gift of the policy does not constitute valuable consideration

EXAMPLE 2 -

1. Portion Taxed as Income - This is calculated as the policy’s cash value minus the amount you’ve paid in premiums. Since term life insurance policies don’t have a cash value, this figure would be zero.
2. Portion Taxed as Capital Gains - First, you determine your total gain on the settlement by subtracting the total premium you’ve paid from the settlement you’ve received. You then subtract the amount that is subject to income tax, the previous result, to arrive at the portion that is taxable as capital gains.
3. The portion that would be taxed as income would be $25,000 since that is the difference between the policy’s cash value and what you’ve paid in premiums. To calculate the portion that would be taxed as capital gains, you subtract the premiums you’ve paid from the settlement you received, leaving you with $75,000. Then, you subtract the amount that is subject to income tax, which is $25,000 in our example. The remaining $50,000 would be subject to capital gains tax.

Question 51

Payments for Injury or Sickness

What about under Workers Compensation?

Answer 51

Publication 525 - Taxable and Nontaxable Income

Sick pay. Pay you receive from your employer while you’re sick or injured is part of your salary or wages. In addition, you must include in your income sick pay benefits received from any of the following payers.

• A welfare fund.
• A state sickness or disability fund.
• An association of employers or employees.
• An insurance company, if your employer paid for the plan.
  
  • If the coverage is provided through a cafeteria plan, the employer, not the employee, is considered to have paid the premiums; thus, the benefits are included in income.

However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy aren’t taxable. Many other amounts you receive as compensation for sickness or injury aren’t taxable. These include the following amounts:

• Compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments. Court awards.
• Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your income.
• Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy.
• Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement. This compensation must be based only on the injury and not on the period of your absence from work. These benefits aren’t taxable even if your employer pays for the accident and health plan that provides these benefits.

Workers Compensation?

• Exempt
  
  • Amounts you receive as workers’ compensation for an occupational sickness or injury are fully exempt from tax if They’re paid under a workers’ compensation act or a statute in the nature of a workers’ compensation act. The exemption also applies to your survivors.
• Non-Exempt
  
  • The exemption, however, doesn’t apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury
• Mix
  
  • If your disability pension is paid under a statute that provides benefits only to employees with service-connected disabilities, part of it may be workers’ compensation. That part is exempt from tax. The rest of your pension, based on years of service, is taxable as pension or annuity income. If you die, the part of your survivors’ benefit that is a continuation of the workers’ compensation is exempt from tax

Question 52

Qualified Long Term Care Insurance Tax Deduction

Answer 52

The benefits of tax-qualified long term care insurance policies are generally received tax-free by the policyholder.

WATCHOUT

• However, if your contract pays a set dollar amount per day (per diem), the tax-free treatment is subject to a certain limit, indexed annually for inflation. Benefits over and above this limit are generally considered taxable income.

Under this limit, the amount of your LTCI benefits that is excluded from taxation in a given period is figured by subtracting any reimbursement received (through insurance or otherwise) for the cost of qualified long-term care services during the period from the larger of the following amounts:

• The actual cost of qualified long-term care services during the period
• The dollar limit for the period ($360 per day for any period in 2018)

It’s a different story if you have a nonqualified LTCI policy, though. Such benefits may be subject to income tax.

Question 53

Medical and Health

Premiums paid by Employer? What are the benefits?

Premiums paid by Employee? What are the benefits?

Answer 53

Premiums Paid by Employer

1. Premiums not included in employee’s gross income
2. Benefits
   
   1. Excluded from employee’s gross income except when benefits exceed actual expenses

Premiums Paid by Employee

1. Premiums deductible as medical expense subject to 10% of AGI limitation
2. Benefits
   
   1. Excluded from gross income

Question 54

Disability Premiums

Premiums paid by Employer? What are the benefits?

Premiums paid by Employee? What are the benefits?

Answer 54

Premiums Paid by Employer

1. Premiums not included in employee’s gross income. Premiums deductible by employer.
2. Benefits
   
   1. Included in employee’s gross income. May qualify for credit for elderly and disabled

Premiums Paid by Employee

1. Not Deductible
2. Benefits
   
   1. Excluded from gross income

It comes down to this: If you never use your disability benefits, you’ll save money by paying your premiums with pretax dollars. But if you do use your disability benefits, using after-tax dollars to pay your premiums places you in a better position. Consult your tax professional for advice.

Question 55

Life Insurance Premiums

Premiums paid by Employer? What are the benefits?

Premiums paid by Employee? What are the benefits?

Answer 55

Premiums paid by Employer? What are the benefits?

1. Included in employee’s gross income (except for limited exclusion applicable to group term life insurance). Premiums deductible by employer (assuming employer is not the beneficiary).
2. Benefits
   
   1. Excluded from gross income.

Premiums paid by Employee? What are the benefits?

1. Not deductible
2. Benefits
   
   1. Excluded from gross income.

Question 56

Dan, an employee of Central Corporation, has a $40,000 life insurance policy and pays the premiums out of his salary.

Answer 56

Since his salary is taxable and the insurance is not offered through a cafeteria plan, the premiums are paid on an after-tax basis.

Question 57

Kay, an employee for Western Corporation, is covered by a $40,000 group term life insurance policy financed by Western Corporation. Western Corporation pays the premiums on the policy.

Answer 57

Because the premiums are excludable, Kay does not have to report the premiums as income.

Question 58

Foreign-Earned Income

Answer 58

Primary = Credit

• In general, the income of U.S. citizens is subject to the U.S. income tax even if the income is derived from sources outside the United States. The foreign income of U.S. citizens may also be taxed by the host country possibly leading to a substantial double tax on the same income. The double tax is mitigated by a foreign tax credit*. *Subject to limitations, U.S. citizens may subtract from their U.S. income tax liability the income taxes they pay to foreign countries.

Alternate=$104,000 Exclusions

• In the case of foreign-earned income, individuals have available the alternative option for 2018 excluding the first $104,100 of foreign-earned income from gross income. This exclusion amount is indexed for inflation. The exclusion is available in lieu of the foreign tax credit. If both a husband and wife have foreign-earned income, they may each claim an exclusion. The principal reasons for the exclusion are to encourage U.S. businesses to operate in foreign countries and to hire U.S. citizens and resident aliens to manage the businesses.

Question 59

1. If debt of a taxpayer is cancelled or forgiven, the taxpayer may have to include the cancelled amount in gross income. It is important to consider the reasons for debt cancellation.

Answer 59

1. If a debt is canceled as a gift or bequest to the recipient or as part of a renegotiation of a purchase price, such debt cancellation would not be a taxable event because the underlying cause of the debt cancellation is not a taxable event.
2. Bankruptcy
   
   1. If a debt is reduced during bankruptcy proceedings, the taxpayer recognizes no income even if the reduction in debt exceeds the available tax attributes.
3. Insolvency
   
   1. In the case of an insolvent taxpayer, no income is recognized as long as the taxpayer is insolvent after the reduction in debt takes place. A taxpayer is insolvent if the debts owed by the taxpayer exceed the Fair Market Value of assets owned. Thus, an insolvent taxpayer reduces the tax attributes to the point of solvency.
   2. From that point on, any reduction in debt results in the recognition of income even if all tax attributes have not been offset.
4. Student Debt
   
   1. Under Section 108(f)(2), the discharge of certain student loans is excluded from gross income if the discharge is contingent on the individual’s performing certain public services.
   2. The loans must have been made by governmental, educational, or charitable organizations, and the loan proceeds must have been used to pay the cost of attending an educational institution or used to refinance outstanding student loans.
   3. Further, the loan forgiveness must be contingent upon the individual’s working for a specified time period in certain professions, and the services must normally be performed for someone other than the lender.

Question 60

Example 1: Your assets are worth $35,000 and your debts total $45,000, so you’re insolvent to the tune of $10,000. You settle a debt with a creditor who agrees to forgive $8,500.

Example 2: Your assets are worth $35,000 and your debts still total $45,000, but the creditor writes off a $14,000 debt.

Answer 60

Example 1 - You don’t have to report any of that money as income on your tax return.

Example 2 - You don’t have to report $10,000 of the income, but you will have to report $4,000 as income on your tax return. And you have to fill out Form 982 to demonstrate to the IRS why you aren’t including the amount listed on the 1099-C in your taxable income.

Question 61

Gain from sale of personal residence

Answer 61

Taxpayer may exclude up to $250,000 ($500,000 in the case of a married couple filing a joint return) of gain from the sale of personal residence.

Question 62

Military

1. Military Disability Pay
2. Combat Pay
3. Military Housing Allowance

Answer 62

Military personnel may exclude disability pay, combat pay (noncommissioned personnel only), and housing allowances.

Question 63

Employer Benefit of Fringe Benefits

Answer 63

While employees receive the greatest income tax benefit from the exclusion of fringe benefits from gross income, employers receive a small benefit from the fact that fringe benefits are not subject to Social Security and Medicare taxes.

Question 64

Below Market Loans

Answer 64

The rules that apply to a below-market loan depend on whether the loan is a gift loan, demand loan, or term loan.

Gift Loan

1. Gift loan is any below-market loan where the forgone interest is in the nature of a gift.
2. Foregone Interest is treated as Gift to borrower and treated as income to the lender…

Demand Loan

1. A demand loan is a loan payable in full at any time upon demand by the lender.
2. Foregone interest is treated as a dividend, contribution to capital, pay for services, or other payment, depending on the substance of the transaction.

Term Loan

1. A term loan is any loan that is not a demand loan. A term loan is a below-market loan if the amount of the loan is more than the present value of all payments due under the loan.
2. The lender must report the annual part of the OID as interest income. The borrower may be able to deduct the OID as interest expense.

NOTE -

1. Regardless of the interest rate you intend to charge (if any), you want to be able to prove that you intended the transaction to be a loan rather than an outright gift. That way if the loan goes bad, you can claim a non-business bad debt deduction on your Form 1040 for the year you get the bad news.
2. Losses from non-business bad debts are classified as short-term capital losses.
3. Capital losses are valuable because they can offset capital gains and potentially up to $3,000 of income from other sources

Question 65

Net Investment Income Tax (NIIT)

Answer 65

You may be subject to the NIIT. The NIIT is a 3.8% tax on the lesser of

1. your net investment income OR
2. the amount of your modified adjusted gross income (MAGI) that is over a threshold amount based on your filing status.

Thresholds =

1. MFJ = $250,000
2. MFS = $125,000
3. Single = $200,000
4. HoH = $200,000
5. QW = $250,000

Question 66

Tax on unearned income of certain children-

Generally required to file Form 8615 if:

Answer 66

have more than $2,100 of unearned income;

are required to file a tax return;

meet certain age/earned-income/self-support threshold;

have at least one parent alive at the end of the year; and

don’t file a joint return for the year.

However, the parent can choose to include the child’s interest and dividends on the parent’s return if certain requirements are met. Use Form 8814, Parents’ Election To Report Child’s Interest and Dividends, for this purpose.

Question 67

Backup withholding. - When does it apply?

Answer 67

Your investment income generally is not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the bank, broker, or other payer of interest, original issue discount (OID), dividends, cash patronage dividends, or royalties must withhold, as income tax, on the amount you are paid, applying the appropriate withholding rate.

Backup withholding applies if:

You do not give the payer your identification number TIN in the required manner,

The IRS notifies the payer that you gave an incorrect TIN,

The IRS notifies the payer that you are subject to backup withholding on interest or dividends because you have underreported interest or dividends on your income tax return, or

You are required, but fail, to certify that you are not subject to backup withholding for the reason described in (3).

Question 68

Accuracy-related penalty

Answer 68

An accuracy-related penalty of 20% can be charged for underpayments of tax due to negligence or disregard of rules or regulations or substantial understatement of tax.

Question 69

Money market funds.

Answer 69

Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage houses, and pay dividends. Generally, amounts you receive from money market funds should be reported as dividends, not as interest.

Question 70

Interest on Instruments under 1 year

Interest on Instruments over 1 year

Answer 70

Interest on Instruments under 1 year

1. Must include the interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty.
2. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity.

Interest on Instruments over 1 year

1. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.

Question 71

You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2018, but you received only $265, which represented the $575 you earned minus $310 interest charged on your $5,000 loan

What is the limitation on investment interest expense deductions?

How do you determine investment interest expense? What must he proceeds be used for?

How do you calculate Investment Income?

Answer 71

The bank gives you a Form 1099-INT for 2018 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 2018. You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), Itemized Deductions, you can deduct $310, subject to the net investment income limit.

Limitations on the Deduction:

1. The amount of interest that can be deducted in any particular year is limited to a taxpayer’s net investment income for that same year. It can’t exceed that amount.

Investment Interest

1. Investment interest is interest paid on a loan where the proceeds were used to purchase property you held for investment. Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss.
2. Investment interest should also be deducted when you’re calculating the 3.8 percent unearned income Medicare contribution tax on net investment income.

How to Calculate Your Investment Income

1. Investment income means investment income minus investment expenses, other than any interest expenses that were incurred only for purposes of calculating the investment interest deduction.
2. Investment expense deductions can include accounting fees, legal fees, fees for automatic investment services, fees for investment advice, and safe deposit box costs.

The Capital Gains Election

1. Taxpayers can elect to include qualified dividends and net capital gains in the calculation of net investment income for the year for the purpose of deducting investment interest. This election is accomplished by choosing how much of your qualified dividends and net capital gains you want to include in net investment income on line 4(g) of Form 4952.
2. The effect of this election is that qualified dividends and net capital gains included in net investment income are taxed at ordinary tax rates, not at the lower long-term capital gains tax rates. But another effect of this election is that you could have higher net investment income and thus a higher deduction for investment interest.

Question 72

Applicable Federal Rate

Answer 72

Applicable federal rates are published as Revenue Rulings by the IRS each month in the Internal Revenue Bulletin. The Internal Revenue Bulletin is available through IRS.gov/ IRB. You also can find applicable federal rates in the Index of Applicable Federal Rates (AFR) Rulings at IRS.gov/FederalRates.

Rates are:

1. Short-term = 3 years or less
2. Mid-term = 3 years 1 day to 9 years
3. Long-term = more than 9 years

Also divided by period for compounding:

1. Annual, Semi-Annual, Quarterly, Monthly

June 2019

1. Semi-Annual Short-Term:
   
   1. AFR = 2.36%
2. Semi-Annual Mid-Term:
   
   1. AFR = 2.37%
3. Semi-Annual Long-Term:
   
   1. AFR = 2.74%

Question 73

Suppose a $300,000 interest-only demand loan is made in September 2011. The borrowers will be making payments of interest only, no amortization of the loan principal (although they may make any principal payments they wish). A demand loan, which means that it can be called as due any time by the lender, is a short-term obligation so it can use the short-term AFR. The annual interest on a $300,000 loan at the rate of 0.16% is $480, or $40 per month.

When the loan is a demand loan, the applicable Federal rate is the applicable Federal short-term rate in effect for the period for which the amount of forgone interest is being determined, compounded semi-annually.

If a demand note is outstanding for an entire calendar year, the government’s blended rate must be used. In July of each year, the government publishes the blended rate for the current year. For example, the blended rate published in October 2011 is 0.32%. Let’s say you made a loan today. It was a demand loan for $300,000; the AFR blended rate is 0.32%. If you charge at least that much interest, and the blended rate for subsequent years, you don’t have to worry about the rest of this explanation. What happens if you charge no interest, or interest less than the 0.32%?

Answer 73

you are treated as if you made a gift to the borrower. This gift is the difference between the AFR and the interest you actually charged, if any. The borrower is then deemed to have paid that amount back to you as interest (this is the imputed interest). You must report the imputed interest as income on your income tax returns. The borrower may get a deduction depending on what the funds were used for.

Question 74

Example 1: John and Mary wish to give their son and daughter in law $150,000.00 to purchase their first home. Instead of simply giving them the money, it can be structured as a loan, with proper interest ($15,000) being paid and claimed on John and Mary’s personal tax return. If they don’t make payments, then it’s treated how?

Answer 74

treated as parents making gift to both their son and daughter in law $15,000.00 of mortgage principal forgiveness, per year, until the loan is fully satisfied and the recognition / deduction of interest income.

Question 75

Exceptions to the below-market loan rules.

Answer 75

1. Exception for loans of $10,000 or less.
   
   1. ​The rules for below-market loans do not apply to any day on which the total outstanding amount of loans between the borrower and lender is $10,000 or less. This exception applies only to:
      
      1. Gift loans between individuals if the gift loan is not directly used to buy or carry income-producing assets, an
      2. Pay-related loans or corporation-shareholder loans if the avoidance of federal tax is not a principal purpose of the interest arrangement.
   2. NOTE– Won’t apply to Term Loan now reduced below $10,000
2. Limit on forgone interest for gift loans of $100,000 or less.
   1. ​For gift loans between individuals, if the outstanding loans between the lender and borrower total $100,000 or less, the forgone interest to be included in income by the lender and deducted by the borrower is limited to the amount of the borrower’s net investment income for the year. If the borrower’s net investment income is $1,000 or less, it is treated as zero. This limit does not apply to a loan if the avoidance of federal tax is one of the main purposes of the interest arrangement.
   2. Doesn’t apply to Gift Tax Consequences but should fall within the annual exclusion.

Question 76

Series HH Bonds

Answer 76

These bonds were issued at face value. Unlike EE bonds, HH bonds are current-income securities. You paid face value and receive interest payments by direct deposit to your checking or savings account every six months until maturity or redemption.

Interest is paid twice a year by direct deposit to your bank account. If you are a cash method taxpayer, you must report interest on these bonds as income in the year you receive it.

Series HH bonds were first offered in 1980 and last offered in August 2004. Before 1980, Series H bonds were issued. All have matured. Series H bonds are treated the same as Series HH bonds. If you are a cash method taxpayer, you must report the interest when you receive it.

Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years. The last Series H bonds matured in 2009. The last Series HH bonds will mature in 2024.

TAX

• Interest earnings are exempt from state and local income taxes but are subject to federal, state, and local estate, inheritance, gift, and other excise taxes.
• Interest earnings are subject to federal income tax.

Question 77

Series EE and Series I Bonds

Answer 77

Series EE Bonds

1. Paper Series EE bonds are issued at a discount. The face value is payable to you at maturity. Electronic Series EE bonds are issued at their face value. The face value plus accrued interest is payable to you at maturity. As of January 1, 2012, paper savings bonds are no longer sold at financial institutions.

Series I Bonds

1. Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The face value plus all accrued interest is payable to you at maturity.

Reporting options for cash method taxpayers.

If you use the cash method of reporting income, you can report the interest on Series EE, Series E, and Series I bonds in either of the following ways.

1. Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year in which they mature. (However, see Savings bonds traded , later.)
   
   1. Note. Series EE bonds issued in 1988 matured in 2018. If you have used method 1, you generally must report the interest on these bonds on your 2018 return. The last Series E bonds were issued in 1980 and matured in 2010. If you used method 1, you generally should have reported the interest on these bonds on your 2010 return.
2. Method 2. Choose to report the increase in redemption value as interest each year.
3. You must use the same method for all Series EE, Series E, and Series I bonds you own. If you do not choose method 2 by reporting the increase in redemption value as interest each year, you must use method 1.
4. If you plan to cash your bonds in the same year you will pay for higher education expenses, you may want to use method 1 because you may be able to exclude the interest from your income. To learn how, see Education Savings Bond Program, later.

Question 78

Who Pays the Tax on U.S. Savings Bond Interest

1. you buy a bond in your name and the name of another person as co-owners, using only your own funds
2. you buy a bond in the name of another person, who is the sole owner of the bond
3. you and another person buy a bond as co-owners, each contributing part of the purchase price
4. you and your spouse, who live in a community property state, buy a bond that is community property

Answer 78

THEN the interest must be reported by …

1. You
2. the person for whom you bought the bond.
3. both you and the other co-owner, in proportion to the amount each paid for the bond.
4. you and your spouse. If you file separate returns, both you and your spouse generally report half of the interest.

Question 79

Treasury Bills

Answer 79

These bills generally have a

1. 4-week,
2. 13-week,
3. 26-week, or
4. 52-week maturity period.

They generally are issued at a discount in the amount of $100 and multiples of $100. The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income. Generally, you report this interest income when the bill is paid at maturity. If you paid a premium for a bill (more than face value), you generally report the premium as a section 171 deduction when the bill is paid at maturity.

If you reinvest your Treasury bill at its maturity in a new Treasury bill, note, or bond, you will receive payment for the difference between the proceeds of the maturing bill (par amount less any tax withheld) and the purchase price of the new Treasury security. However, you must report the full amount of the interest income on each of your Treasury bills at the time it reaches maturity.

Question 80

Treasury Notes and Bonds

Answer 80

Treasury Notes have maturity periods of more than 1 year, ranging up to 10 years.

Treasury Bonds have a maturity longer than 10 years.

Both generally are issued in denominations of $100 to $1 million and both generally pay interest every 6 months.

Generally, you report this interest for the year paid.

When the notes or bonds mature, you can redeem these securities for face value or use the proceeds from the maturing note or bond to reinvest in another note or bond of the same type and term. If you do nothing, the proceeds from the maturing note or bond will be deposited in your bank account.

Treasury notes and bonds are sold by auction. Two types of bids are accepted:

1. competitive bids and
2. noncompetitive bids.

If you make a competitive bid and a determination is made that the purchase price is less than the face value, you will receive a refund for the difference between the purchase price and the face value. This amount is considered original issue discount.

However, the original issue discount rules (discussed later) do not apply if the discount is less than one-fourth of 1% (0.0025) of the face amount, multiplied by the number of full years from the date of original issue to maturity. See De minimis OID , later. If the purchase price is determined to be more than the face amount, the difference is a premium. (See Bond Premium Amortization in

Question 81

Treasury Inflation-Protected Securities (TIPS)

Answer 81

These securities pay interest twice a year at a fixed rate, based on a principal amount adjusted to take into account inflation and deflation.

Interest payments from Treasury Inflation-Protected Securities (TIPS), and increases in the principal of TIPS, are subject to federal tax, but exempt from state and local income taxes.

Form 1099-INT shows the sum of the semiannual interest payments made in a given year.

Form 1099-OID shows the amount by which the principal of your TIPS increased due to inflation or decreased due to deflation. Increases in principal are taxable for the year in which they occur, even if your TIPS hasn’t matured, so you haven’t yet received a payment of principal.

Question 82

Bonds sold between interest date?

Answer 82

Part of sale represents interest accrued to the date of sale = interest income

If you are the buyer, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you on the next interest payment date, treat it as a return of capital and reduce the basis in your bond.

Question 83

What if you receive interest on life insurance proceeds because you choose installments?

What are the other options for Life Insurance proceeds?

Answer 83

Life insurance proceeds paid to you as the beneficiary of the insured person usually are not taxable. But if you receive the proceeds in installments, you usually must report part of each installment payment as interest income.

Options

1. Interest Income Option
2. Fixed Period Option
3. Fixed Amount Option
4. Life Income Option
5. Specific Income Option
6. Joint and Survivor Option

Question 84

Federally Tax-Exempt Interest

Answer 84

Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include:

• Port authorities,
• Toll road commissions,
• Utility services authorities,
• Community redevelopment agencies, and
• Qualified volunteer fire departments (for certain obligations issued after 1980).

There are other requirements for tax-exempt bonds. Contact the issuing state or local government agency or see sections 103 and 141 through 150 of the Internal Revenue Code and the related regulations.

Question 85

Prviate Activity Bonds

Answer 85

Interest on a private activity bond that is not a qualified bond (defined below) is taxable. Generally, a private activity bond is part of a state or local government bond issue that meets both the following requirements.

1. More than 10% of the proceeds of the issue is to be used for a private business use.
2. More than 10% of the payment of the principal or interest is:
   
   1. Secured by an interest in property to be used for a private business use (or payments for this property), or
   2. Derived from payments for the property (or borrowed money) used for a private business use.

Qualified bond.

1. Interest on a private activity bond that is a qualified bond is tax exempt. A qualified bond is an exempt-facility bond (including an enterprise zone facility bond, a New York Liberty bond, a Midwestern disaster area bond, a Hurricane Ike disaster area bond, a Gulf Opportunity Zone bond treated as an exempt-facility bond, or any recovery zone facility bond issued after February 17, 2009, and before January 1, 2011), qualified student loan bond, qualified small issue bond (including a tribal manufacturing facility bond), qualified redevelopment bond, qualified mortgage bond (including a Gulf Opportunity Zone bond, a Midwestern disaster area bond, or a Hurricane Ike disaster area bond treated as a qualified mortgage bond), qualified veterans’ mortgage bond, or qualified 501(c)(3) bond (a bond issued for the benefit of certain tax-exempt organizations).
2. Interest you receive on these tax-exempt bonds, if issued after August 7, 1986, generally is a “tax preference item” and may be subject to the alternative minimum tax. See Form 6251 and its instructions for more information.
3. The interest on the following bonds is not a tax preference item and is not subject to the alternative minimum tax.
   
   1. Qualified 501(c)(3) bonds.
   2. New York Liberty bonds.
   3. Gulf Opportunity Zone bonds.
   4. Midwestern disaster area bonds.
   5. Hurricane Ike disaster area bonds.
   6. Exempt facility bonds issued after July 30, 2008.
   7. Qualified mortgage bonds issued after July 30, 2008.
   8. Qualified veterans’ mortgage bonds issued after July 30, 2008.

Question 86

Discount on Debt Instruments

What type of OID bonds are exempt from tax? Are there exceptions?

Answer 86

A debt instrument, such as a bond, note, debenture, or other evidence of indebtedness, that bears no interest or bears interest at a lower than current market rate usually will be issued at less than its face amount. This discount is, in effect, additional interest income. The following are some types of discounted debt instruments.

1. U.S. Treasury bonds.
2. Corporate bonds.
3. Municipal bonds.
4. Certificates of deposit.
5. Notes between individuals.
6. Stripped bonds and coupons.
7. Collateralized debt obligations (CDOs).

The discount on these instruments (except municipal bonds) is taxable in most instances. The discount on municipal bonds generally is not taxable (unless it falls under an exception, i.e. interest on federally guaranteed state/local obligations issued after 1983 provided its not one of the excepted federal agencies (e.g. FHA, FNMA, GNMC)

Question 87

Original Issue Discount

When does OID arise?

What is the time period during which OID doesn’t apply?

Answer 87

OID is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.

A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price. All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.

The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue).

Question 88

What is the threshold of De Minimis OID

Example 1 = You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. Is it De Minimis?

Example 2 = The facts are the same as in Example 1, except that the bond was issued at $950. The OID is $50.

Answer 88

You can treat the discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. This small discount is known as “de minimis” OID.

Example 1 = One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)

Example 2 = Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.

Question 89

Example 1 - Assume dad makes an interest-free $75,000 loan to his son so that he may start a business. Dad forgoes the imputed interest each year ($1,100 for example). What are the tax implications?

Example 2 - You make a five-year term loan to your beloved nephew in May of 2019 and charge an interest rate of exactly 2.35% with monthly compounding (the AFR for mid-term loans made during May).

Example 3 - You make a $100,000 interest-free loan to your beloved niece who has $200 of net investment income for the year.

Answer 89

Example 1 - Foregone Interest is treated as a gift. No gift tax will be due since it is below the annual $15,000 exclusion, and dad owes no tax on the forgone interest if the son has $1,000 or less of net investment income.

Example 2 - You’ll have taxable interest income based on that rate for the life of the loan. Your nephew will have an equal amount of interest expense — which may or may not be deductible depending on how the loan proceeds are used. Tax-wise, that’s all you need to know about the interest rate issue. So if you decide to charge the AFR, you can ignore most of the rest

Example 3 - Your taxable imputed interest income is zero. However if your niece’s net investment income is $1,200, your imputed interest income is $1,200. In most cases, the borrower will have under $1,000 of net investment income. If so, you’ll have zero imputed interest income under the tax rules. Good! Gift tax consequences under this loophole: The gift tax results under the $100,000 loophole are tricky, but they will almost never have any meaningful impact under the current federal gift and estate tax regime. Reason: the unified federal gift and estate tax exemption for 2019 is $11.4 million, and the exemption is scheduled be even bigger next year thanks to an inflation adjustment.

Question 90

Are there any income limits affecting eligibility for HSA?

What are the out-of-pocket maximum costs?

Example -

1. Let’s say you need surgery with allowable costs of $20,000, and the following figures apply to your health insurance plan.
   
   1. Deductible: $1,300
   2. Coinsurance: 20%
   3. Out-of-pocket maximum: $4,400

Answer 90

No, everyone is eligible.

The out-of-pocket limit doesn’t include your monthly premiums. It also doesn’t include anything you spend for services your plan doesn’t cover.

Example -

1. You pay the first $1,300 of covered medical expenses (your deductible).
2. Your 20% coinsurance on the rest of the costs ($18,700) comes to $3,740.
3. So your total costs would be $5,040. That’s $1,300 (your deductible) plus $3,740 (coinsurance).
4. But your out-of-pocket maximum is $4,400. Your insurance company pays all covered costs above $4,400 — for this surgery and any covered care you get for the rest of the plan year.
5. Generally, plans with lower monthly premiums have higher out-of-pocket limits. Plans with higher premiums usually have lower out-of-pocket maximums.

Question 91

What is coinsurance?

Let’s say the following amounts apply to your plan and you need a lot of treatment for a serious condition. Allowable costs are $12,000.

Deductible: $3,000

Coinsurance: 20%

Out-of-pocket maximum: $6,850

Answer 91

The percentage of costs of a covered health care service you pay (20%, for example) after you’ve paid your deductible.

You’d pay all of the first $3,000 (your deductible).

You’ll pay 20% of the remaining $9,000, or $1,800 (your coinsurance).

So your total out-of-pocket costs would be $4,800 — your $3,000 deductible plus your $1,800 coinsurance.

If your total out-of-pocket costs reach $6,850, you’d pay only that amount, including your deductible and coinsurance. The insurance company would pay for all covered services for the rest of your plan year.

Generally speaking, plans with low monthly premiums have higher coinsurance, and plans with higher monthly premiums have lower coinsurance.

Question 92

What is one reason why startups issue stock options, instead of restricted stock?

Answer 92

Employees can wait to exercise the stock option until the employer’s stock can be sold on a securities exchange, or in a corporate transaction, when the employee can sell shares to cover the related income and employment taxes.

Question 93

Assume a vice president–level employee at a privately owned corporation is granted a restricted stock award for 10,000 shares of stock with a fair market value per share of $1 on the date of grant. If an 83(b) election is not filed, and the fair market value of the shares grows to $5 per share during the vesting period, then the employee would owe taxes (and the employer would be required to withhold income and employment taxes) on the $50,000 value of the shares on the date of vesting.

if the startup vice president had been granted qualifying RSUs for 10,000 shares of employer stock which vest after four years. In year four, the vested 10,000 shares are still worth $50,000. If the vice president makes an 83(i) election within 30 days of the date the RSUs vest, then the $50,000 value of the employer stock transferred to the employee (assuming the transfer date is the same date as the vesting date) would be deferred for up to five years.

Answer 93

At first glance, it may appear great that the employee has stock valued at $50,000, but the rub is that these are shares in a private corporation with no market to sell the shares. Unless this employee has really skyrocketed up the corporate ladder, he or she probably does not have the funds readily available to pay the taxes due on $50,000 of nontransferable and non-marketable employer stock.

By making a timely 83(i) election, the startup vice president does not have to pay any money out of pocket at the time of vesting. Five years is a long time in startup land for a liquidity event (sale, IPO, merger, etc.) to occur and put cash in the employee’s pocket to pay the taxes. Also, if during the five-year period the value of the stock increased to $20 per share (or $200,000), the employee would only pay ordinary income taxes on the deferred amount of $50,000 and would pay long-term capital gains rates on the remaining $150,000 in value.

Downside Risk

There are still some potential downside issues to consider when making an 83(i) election, which are very similar to the issues a person must consider when making an 83(b) election. First, even if the value of the deferral stock decreases in value during the deferral period, the amount of income taxes due on the deferral stock at the end of the deferral period will still be based on the value when the 83(i) election was made. In the example above, if the vice president makes an 83(i) election when the value of the qualified stock is $50,000, and during the deferral period the value of those shares decreases to $30,000, the employee will still owe income taxes on $50,000 at the end of the deferral period.

Question 94

Generally, you won’t have to pay a penalty for 2018 if any of the following apply.

Answer 94

100% of prior year = The total of your withholding and timely estimated tax payments was at least as much as your 2017 tax.

90% of 2017 Tax = The tax balance due on your 2018 return is no more than 10% of your total 2018 tax, and you paid all required estimated tax payments on time.

Your total tax for 2018 minus your withholding is less than $1,000.

You didn’t have a tax liability for 2017.

You didn’t have any withholding taxes and your current year tax (less any household employment taxes) is less than $1,000.

Question 95

Fixed Annuity

What are Tax Benefits?

Answer 95

Fixed annuities pay a guaranteed minimum rate of return and provide a fixed series of payments under conditions determined when you buy the annuity.

During the accumulation phase, the insurance company invests the premiums in high-quality, fixed-income investments like bonds. Because your rate of return is guaranteed, the insurance company bears all of the investment risk with fixed annuities.

A multi-year guarantee annuity (MYGA) is a type of deferred fixed-rate annuity that’s “great for conservative investors who want guaranteed principal protection,” Nuss says.

It works much like a certificate of deposit by guaranteeing a rate over a fixed period. However, unlike CD interest, the interest on a MYGA isn’t taxed annually but rather allowed to grow tax-deferred until withdrawal.

Question 96

How are benefits received under an Accident and Benefit Plan taxed?

What are the two main exceptions?

Answer 96

The general rule, set forth in §105(a), is that amounts received by an employee for personal injuries or sickness through accident and health insurance are taxable if such amounts are paid by the employer or are attributable to employer contributions not included in the gross income of the employee.

Exceptions:

1. Amounts Expanded for Medical Care - medical expense reimbursements under §105(b); and
2. Payments are unrelated to absence from work - permanent injury payments within the meaning of §105(c).

Section 105 supplements §104(a)(3), which excludes only sickness and personal injury benefits not financed by an employer. If both the employer and the employee(s) pay the premiums on accident or health insurance or contribute to a noninsured accident or health plan, it is necessary to determine what portion of a benefit is subject to §104(a)(3) and what portion to §105. Under Reg. §1.105-1(c)(1), each benefit received is divided in proportion to the amounts contributed (or the premiums paid) by the respective sources.