Tax Lesson 2

Question 1

Basic Tax Formula

Answer 1

Income-exclusions = gross
Gross-deductions = AGI
AGI-(larger of itemized or standard deduction)-any qbi x 20% deduction = taxable income
Tax on taxable income-tax credits(including Fed income tax withheld & other prepayments) = tax payment/refund due

Question 2

Cash basis taxpayers recognize income

Answer 2

When received, credited, set apart, or made available to be taken into possession
Property & services included in income at FMV
Must be consistent with constructive receipt doctrine

Question 3

Accrual basis taxpayers recognize income

Answer 3

When earned 
Most businesses
Report in gross income on earliest of following dates:
Payment received
Income amount due to taxpayer
Taxpayer earns income

Question 4

Doctrine of constructive receipt

Answer 4

When income available to taxpayer without substantial limitations/restrictions, deemed to be constructively received & should be taxed

Question 5

Taxable year __?

Fiscal year __?

Answer 5

Calendar year

12 month period, adequate records & form 1128 for IRS approval

Question 6

Qualifying Widower with Qualified Child Filing Dtatus

Answer 6

2 years following the year in which taxpayer’s spouse died
Not remarried
Has child/stepchild claim as qualified
Child lived in home all year
Paid more than 1/2 cost of keeping up home

Question 7

Taxpayers who are blind

Answer 7

Must file to receive additional standard deduction

Question 8

Example Exam Question:
Bob & Barbara married & file joint return. Bob is 68. Barbara is 67. Barbara is legally blind. What is standard deduction?

A. $25900
B. $27300
C. $28700
D. $30100

Answer 8

D

Question 9

Certain taxpayers not eligible for standard deduction

Answer 9

MFS when other spouse itemizes
Nonresident aliens
Individuals filing tax return for tax year of less than 12 months

Question 10

A taxpayer who is claimed as a dependent will have limited standard deduction

Answer 10

Greater of:
$1150 OR
$400 + earned income (not exceeding normal standard deduction)

Question 11

Qualifying Child for Head or Household, Earned Income Credit, Child Tax Credit, & Credit for Child & Dependent Care Expenses. Must meet 4 tests:

Answer 11

Relationship
Abode
Age
Support

Question 12

Relationship Test

Answer 12

Child
Descendant of child
Sibling
Descendant of sibling

Question 13

Abode Test

Answer 13

Live with taxpayer for more than half the year
*considered to occupy household during temporary absences due to illness, education, business, vacation, or military service

Question 14

Age Test

Answer 14

Under age 19 or student under age 24 as of end of calendar year
Student = full time 5 months of year

Question 15

Support Test

Answer 15

Qualifying child doesn’t provide more than 1/2 own support during the year
*scholarships not considered support

Question 16

If more than 1 person eligible to claim dependent, tie-breaker rules:

Answer 16

Both parents: parent lived with longer
Both parents & child lives with each same amount: parent higher AGI
Only one is parent: parent
Neither is parent: higher AGI

Question 17

Qualifying Relative must meet joint return test & citizenship/residency test as well as

Answer 17

Relationship test
Gross income test
Support test
Not a qualifying child test

Question 18

Relationship Test

Answer 18

Child/descendent of child
Sibling/descendent of sibling 
Ancestor
Step parent
Uncles/aunts
In laws
Any other individual who has had same place of a one & is member of taxpayer’s household (not married to taxpayer during year)

Question 19

Gross Income Test

Answer 19

Less than personal exemption amount ($4400)

Question 20

Support Test

Answer 20

Must provide more than half support

Income received by dependent does not count as support from dependent unless expensed for that purpose

Question 21

Not a Qualifying Child Test

Answer 21

Cannot be qualifying child of any taxpayer for tax year

Question 22

Joint Return Test

Answer 22

Married dependent must not file joint return with spouse unless filed only to claim refund for tax withheld, if neither spouse required to file return, and if no tax liability would exist for either taxpayer on separate returns

Question 23

Citizenship or Residency Test

Answer 23

Must be citizen or national or US or resident or US, Canada, or Mexico during some part of year (doesn’t apply for adopted children)

Question 24

Must pay quarterly estimates if both:

Answer 24

Expects to owe at least $1000 after withholding/credits
Expects withholding & credits to be less than smaller of:
90% tax shown on 2022 return or
100% tax shown on prior year’s return

Question 25

Gross income includes

Answer 25

Both earned & unearned income whether or not it is taxable

Question 26

Partnerships & S-Corps are pass through entities

Answer 26

Income from business passed through to owners tax returns

Question 27

Trusts & estates generally taxable to beneficiary

Answer 27

If income not distributed, taxable to trust/estate

Question 28

In community property states

Answer 28

1/2 of earnings considered owned by each spouse

Question 29

Annuity Payment Taxation Exclusion Ratio

Answer 29

Exclusion Ratio = investment/expected total return

Question 30

If die before end of term

Answer 30

Entitled to deduction from AGI in misc itemized deductions | Return of remaining capital

Question 31

Once recovered full basis from annuity payments

Answer 31

Entire benefit received is taxable

Question 32

Example Exam Question: On April 30, Ava age 60 received distribution from qualified plan of $150000. Adjusted basis in plan of $500000. FMV of $625000. What is taxable amount of distribution? A. Not taxable B. $30000 taxable C. $12000 taxable D. $15000 taxable

Answer 32

B

Question 33

Ratio of Return of Adjusted Basis

Answer 33

AB before withdrawal/FMV at withdrawal

Question 34

Social Security

Answer 34

Up to 85% of SS benefits may be taxable Based on MAGI MAGI = AGI plus tax exempt interest, interest earned on savings bonds used for higher ed, amounts excluded from income for adoption assistance, amounts deducted for interest paid for ed loans, income earned in foreign country excluded from income

Question 35

To calculate taxable portion of SS benefits,

Answer 35

MAGI + 1/2 SS benefits compared to hurdles 1st hurdle: $32000 MFJ, $25000 2nd hurdle: $44000 MFJ, $34000

Question 36

If MAGI + 1/2 SS exceeds 1st hurdle only, taxable amount is lesser of:

Answer 36

50% SS benefits | 50% (MAGI + .5SS Benefits - hurdle 1)

Question 37

Example Exam Question: Married & have $30k income. SS benefits of $20k. What amount included in taxable income? A. $0 B. $4000 C. $10000 D. $20000

Answer 37

B

Question 38

If MAGI + 1/2 SS exceeds 2nd hurdle, taxable amount is lesser of:

Answer 38

85% SS | 85% (MAGI + .5SS Benefits - hurdle 2) + lesser of: $6000 MFJ/$4500 or taxable amount calculated under 50% formula

Question 39

Example Exam Question: Married. Income of $45000. SS of $20000. What amount must be included in taxable income? A. $9350 B. $11500 C. $15350 D. $17009

Answer 39

C

Question 40

Below Market Loans:

Answer 40

Require imputed interest Loan $0-$10000: $0 imputed Loan $10001-$100000: lesser of net investment income or interest calculated using AFR less interest calculated using stated rate of loan *if net investment income

Question 41

Example Exam Question: Aidan loans $11000 to sister. Why would interest not be imputed on this loan? A. Because loan is less than amount of annual exclusion B. Loans of $100k or less are exempt from both income tax & gift tax consequences C. If unearned income of $500 D. If earned income less than $1000

Answer 41

C

Question 42

Below market rate loans by corporation to shareholder treated as dividend

Answer 42

Payments to corporation treated as interest income

Question 43

Below market rate loans from employer to employee treated as paid compensation for employee & subject to employment taxes

Answer 43

Loan payments are treated as taxable interest income to employer

Question 44

Exclusions from Income

Answer 44

Gifts, Bequests, Devise, Inheritance | Only to property, not income on property

Question 45

Gift

Answer 45

Donor intent to make voluntary transfer Donor competent to make gift Donee capable of receiving gift Donee take delivery Donor actually part with dominion & control over gifted property Definition: gratuitous transfer of property, detached & disinterested generosity Employer to employee not treated as gifts

Question 46

Life Insurance Proceeds

Answer 46

Not taxable Interest component is taxable If cashed in prior to death, must recognize cash received above basis When transferred for valuable consideration, include me in gross income & death benefit taxable to new owner

Question 47

Proceeds from Life Insurance Excluded even when transferred for valuable consideration if:

Answer 47

Policy transferred to insured Transferred to partner of insured Transferred to partnership in which insured is partner Transferred to corporation in which insured is shareholder/officer Transferred by tax-free exchange or gift

Question 48

Qualified tuition & related expenses

Answer 48

Does not include room & board *taxable!

Question 49

Gain on sale of personal residence

Answer 49

Up to $250k/$500k MFJ if either spouse meets ownership requirement (2/5 years) & both spouses meet use requirement

Question 50

Qualified Roth IRA Distributions

Answer 50

``` Account held 5 years 1st time home purchase Disability Death On/After 59.5 ```

Question 51

Qualified Roth 401k Distributions

Answer 51

``` Held 5 years Disability Death 59.5 *distributed on pro-rata basis ```

Question 52

Excluded from gross income

Answer 52

Worker’s compensation Damages received on account of physical injury/sickness Payments from accident/health insurance personally owned by taxpayer

Question 53

Included In Income

Answer 53

Punitive damages Damages for emotional distress (unless attributable to physical injury/sickness or are paid for reimbursement of actual medical expenses arising from emotional distress

Question 54

Example Exam Question: Awarded $75k compensatory damages for harm to reputation. Was awarded additional $200k punitive damages. How much recognized as income? A. $0 B. $75k C. $200k D. $275k

Answer 54

D

Question 55

Employer Sponsored Medical General Rule

Answer 55

Contributions to insurance payable to employee generally excluded from income Excess amounts taxable

Question 56

Group Term Life Insurance

Answer 56

Premiums deductible as ordinary & necessary business expense for employer Exceptions: Deductions made on behalf of sole proprietors or partners Deductions made on behalf of stockholders unless providing substantial services When employer named beneficiary

Question 57

Section 79 Requirements

Answer 57

Death benefit excluded from federal income tax when provided to group of employees through policy carried by employer Individual selection of coverage outside standard salary amounts not permitted if death benefit is to be excluded from gross income Exceptions: if group term issued to trustees of qualified pension plan, amount paid by employer is taxable to employees

Question 58

Group Term not taxable to employees when:

Answer 58

Employee terminated due to disability Qualified charity named beneficiary Employer named beneficiary

Question 59

Taxation of group term insurance

Answer 59

First $50k not taxable Cost of excess coverage deterred by uniform premium table 1 Employee contributions subtracted from annual cost to arrive at taxable income

Question 60

Meals & lodging not included in income if furnished by employer

Answer 60

On premises & For convenience of employer Lodging must be condition of employment to be excluded from employee’s gross income

Question 61

Fringe Benefits

Answer 61

Dependent care: up to $5000 excluded Athletic facilities on premises excluded Educational assistance program: $5250/yr Adoption assistance: $14980 (MAGI phase out) Cafeteria plans: cash (taxable); nontaxable benefit nontaxable

Question 62

Foreign Earned Income Exclusion

Answer 62

$112000 Must have foreign earned income, tax home in foreign country, & one of the following: US citizen US resident alien from county with US tax treaty entire tax year US citizen/resident alien physically present in foreign country/countries at least 330 full days during 12 consecutive months

Question 63

Interest on following bonds is not tax exempt:

Answer 63

Private activity non qualified bonds Arbitrage bonds Bonds that don’t meet all requirements of section 149

Question 64

Discharge of Indebtedness

Answer 64

When creditor cancels debt creates income for debtor Gain is lower of: Amount of debt canceled Excess of assets over liabilities after debt is canceled Exceptions: bankruptcy, certain student loan debt forgiven for public service, qualified principal residence (2021-2025 $750k MFJ)

Question 65

Above the Line Deductions (FOR AGI)

Answer 65

Trade/business expense Losses on sale or exchange of property Rental & royalty property Alimony priory to 2019 1/2 self employment tax paid 100% health insurance premiums paid by self employed individual Tax deferred contributions Penalty on premature withdrawals from time savings accounts/deposits Interest on student loans HSAs Teaches education qualified expenses ($300)

Question 66

Functions of AGI

Answer 66

Limiting measure (floor) for medical expenses Limiting measure (ceiling for charitable deductions) Determines deductibility of IRA contributions Determines phase out of other tax benefits

Question 67

Trade/business expenses

Answer 67

``` Deductible must be: Ordinary: normal, usual, customary Necessary: prudent would incur same expense Reasonable: question of fact Incurred in conduct of business ```

Question 68

Above the Line Deductions For AGI For Self Employed

Answer 68

Education expenses: if to maintain/improve existing skills or meet requirements of employer, profession, licensing, or state law * or if to meet minimum Ed standards for existing job or if will qualify taxpayer for new trade or business; includes tuition, books, supplies, transportation, travel (lodging & 50% meals) Business gifts: $25 ($4 or less with logo considered advertising) Entertainment: not deductible; meals 50% (100% through end of 2022) Home office expense: only for self employed

Question 69

Below the Line Deductions From AGI

Answer 69

Itemized or Standard Itemized: Medical: in excess of 7.5% AGI (includes prescriptions, non cosmetic surgeries, some qualified LTC services, insurance premiums for LTC, tuition for special/medically necessary school, capital expenditures-on advise of physician, to extent FMV of property not increased, includes operating expenses, for handicap expenses no increased value test - does not apply to elevators) Certain state & local taxes: May deduct property taxes on US property, May deduct state income tax paid or state & local sales tax - capped to $10k total per TCJA Contributions to Qualified Charities: itemized - 20/30/50/60% AGI; overall cannot exceed 50% AGI

Question 70

Deduction Clustering Examples

Answer 70

Early state income or property tax payment Early mortgage interest payment Medical expenses Charitable donations (good opportunity for DAF)

Question 71

QCDs

Answer 71

70.5 | Cannot exceed $100k/yr

Question 72

Casualty Losses

Answer 72

Deductible in Year loss sustained Personal casualty losses only deductible if national disaster declared by President Net disaster: deducted subject to $100 per casualty floor; after floor must exceed 10 of AGI floor Business casualty losses deductible Occurring during administration of estate deductible to estate To be deductible must be from identifiable event & damaging to property as well as sudden, unexpected, unusual Theft loss deductible in year discovered

Question 73

Effect of Claim for Reimbursement

Answer 73

If reasonable prospect of full recovery loss should be deducted in year of settlement If partial recovery expected, deduct in year of loss any amount not covered by insurance

Question 74

Amount of casualty (only deductible if declared national disaster)

Answer 74

Non personal Casualty & theft losses: Theft: FMV after is $0; adjusted basis in property less insurance proceeds Partial: lesser of decline in value, difference between FMV before & FMV after less insurance received, or adjusted basis less insurance received Net gains & losses- treat as gains & losses from sale of capital assets (not netted with business/income producing property)

Question 75

Certain Personal Interest Expense

Answer 75

Limited to investment interest income Excess May be carried over indefinitely Special election can be made for LTCG to be treated as ordinary income to offset investment interest income

Question 76

Example Question: Purchased 10000 shares stock by borrowing $50000 on margin. Paid $4000 in interest this year. Investment income is $13000. LTCG is $8000. Investment fees $1300. Single & does itemize. What is max interest deduction? A. $0 B. $13000 C. $21000 D. $29000

Answer 76

C

Question 77

Qualified Personal Residence Interest

Answer 77

Limited to $750000 mortgage debt Limited to 2 houses No home equity interest

Question 78

Qualified Business Income (QBI)

Answer 78

Sole proprietorships Partnerships LLCs S corporations REITs Master Limited Partnerships (MLPs) Reduces taxable income not AGI Permitted to take deduction whether itemize or standard deduction 20% QBI (does not include investment income or reasonable compensation paid to S corp owner or guaranteed payments to part er or LLC member) Combined QBI is net of deductible QBI + qualified REIT dividend & qualified publicly traded partnership income *Below the line

Question 79

Other:

Answer 79

Allowed: Other employee expenses: uniforms, union dues, professional expenses, job hunting in same profession

Question 80

Earned Income Credit

Answer 80

Must have earned income & qualifying child Qualifying child must meet relationship, residency, & age tests Applicable percentage rate x earned income Taxpayers 25-64 credit with no children

Question 81

Adoption Expenses Cresit

Answer 81

Max is $14,890 Phased out between $223410-$263410 Non refundable but can carry forward for 5 years Eligible child is less than 18 or physically or mentally handicapped

Question 82

Child Tax Credit

Answer 82

$2,000 for each dependent under 17 (stepchildren & foster children includes) Married must file joint Eligible children must be less than 17, a US citizen, & claimed as dependent Phase out Up to $1400 per child May be refundable

Question 83

Family Credit (Qualifying Dependent Credit)

Answer 83

$500 for those who would qualify as dependent | Qualifying child 17+ or qualifying person

Question 84

Child & Dependent Care Credit

Answer 84

Must have employment related care costs for: Dependent under 13 or handicapped dependent or spouse Married must file joint Amount = eligible care costs x applicable percentage AP 20-35% AGI $43000+: 20% Expenditures that qualify are lesser of actual costs or $3000 for 1/$6000 for 2 Cannot be made when care provided by dependent of taxpayer Cannot exceed earned income Full time student or disabled taxpayer are assumed to have earned income up to max per month limits

Question 85

American Opportunity Tax Credit

Answer 85

``` Max per eligible student $2500 for 1st four years 10% first $2000, 25% next $2000 Student must be at least 1/2 time Refundable up to 40% or $1000 Phase out: $160k-$180k (MFJ) ```

Question 86

Lifetime Learning Credit

Answer 86

Max per taxpayer is 20% of qualifying expenses up to $10000 Cannot be claimed in same year as AOTC Phase out: $160k-$180k (MFJ)

Question 87

Kiddie Tax

Answer 87

Net unearned income of child under 19 taxed at parents rate or AMT (age 24 if full time student) Standard deduction is $1150 for unearned income Next $1150 taxed at child’s marginal rate Only applies to unearned income in excess of $2300

Question 88

Alternative Minimum Tax (AMT)

Answer 88

Liable for greater of regular tax liability or AMT Deductions allowed for charitable contributions, certain estate tax for income in respect of decedent, gambling losses to extent of winnings, casualty losses from federally declared disasters, medical expenses in excess of 7.5% AGI, qualified business income 199a, qualified resident interest, & investment interest to extent of qualified net investment income Does not include state/local taxes or itemized deductions subject to 2%

Question 89

AMT Formula

Answer 89

``` Taxable income +/- adjustments + preferences = AMTI - exemption = AMT tax base x AMT Rate(s) = tentative minimum tax - foreign tax credit - regular tax = AMT ```

Question 90

AMT Exemption

Answer 90

Reduced AMTI

Question 91

Adjustment items

Answer 91

Accelerated depreciation for personal & real property: real (depreciation in excess of 40year straight line); personal (depreciation in excess of 150% declining balance method) Standard deduction or itemized (remember no state/local taxes on itemized)

Question 92

AMT Preference Items (increase AMTI)

Answer 92

1. Percentage Depletion: amount taken for regular tax in excess of adjusted basis of property at end of year 2. Intangible Drilling Costs: requires 10 year amortization; currently deductible for regular tax; preference is excess of regular tax deduction / (amt amortization + 65%net oil & gas income) 3. Interest on Private Activity Bonds: not regular, yes AMT, expenses incurrent in carrying bonds not deductible but offset interest income in computing AMT preferences

Question 93

Loss Limitations on Rental Property

Answer 93

Nonvacation: some rental activity passive losses only deductible to extent of passive income (2 exceptions: rental activity by dealers is active income, losses up to $25k deductible by AGI less than $100k; phase out $100k-$150k) Rental Vacation: considered not for profit (like hobbies); no expenses in excess of income allowed, expenses deducted in same order as hobby, fewer than 15 rental days (no income no deductible expenses), more than 14 rental days (personal use not greater than 14 days or 10% fair rental days all expenses deductible even to point of loss) Subject to passive loss rules Mortgage interest & taxes: IRS requires allocation total days used, courts allow allocation days in year Rental income included in gross income; rental expenses deductible for AGI (above the line) - schedule E Personal portion: primarily rental: taxes deductible from AGI, mortgage interest non deductible; personal/rental use: taxes & mortgage interest deductible; personal portion of other expenses: non deductible

Question 94

Hobby Rules

Answer 94

9 factors to determine motivation/if hobby Profit activity: can deduct expenses for AGI in excess of income, at risk & passive loss rules may apply Presumptive rule of Section 183: if activity shows profit 3/5 years (2/7 for horses) presumed taxpayer has profit motive; burden of proof with IRS IRS collects taxes on hobby income & taxpayer could potentially pay less on for profit venture due to allowed deductions Hobby losses not deductible (tcja)

Question 95

At Risk Rules & Passive Activity Treatment

Answer 95

``` 3 types of income: Active Passive Portfolio Under at risk rules which apply before passive activity rules, losses only deductible to extent of property/money at risk ```

Question 96

Example Exam Question: Invests in limited partnership. Pays $250k for 10% interest in partnership. Receives k-1 showing proportional share of losses as $75k. This is only investment. How much is suspended under at risk rules? A. $0 B. $75k C. $175k D. $250k

Answer 96

A

Question 97

Example Exam Question: From previous, how much of loss is suspended under passive activity rules? A. $0 B. $75k C. $175k D. $250k

Answer 97

B

Question 98

Passive Income

Answer 98

Losses can only offset passive gains No material participation Rental activities: if client actively participates (estates & individuals only), limited partners never active, requires 10% ownership & involvement in management decisions, if active can deduct 25% against ordinary income, exception subject to phaseout ($1 for every $2 AGI exceeds $100k - complete phaseout at AGI $150k)

Question 99

Material Participation in Passive Activity

Answer 99

Must meet 1: Participates > 500 hours/year Taxpayer participation constitutes essentially all participation Greater than 100 hours & most of any participant Taxpayer participates 100 hours & total participation in all such activity exceeds 500 hours

Question 100

Portfolio Income

Answer 100

From investments (interest, dividends, royalties, annuities)

Question 101

Suspended Loss At Risk

Answer 101

If suspended losses from at risk activity, not deductible until at risk amount is positive If losses suspended under passive activity rules, losses deductible upon disposition

Question 102

Example Exam Question: Salary of $50k & 2 investments. Limited partnership investment a & b. Does not materially participate in either. Basis in partnerships is a: $50k, b: $25k. LLP A had $75k gain current year. LLP B had $100k loss. What is net gain/loss for 2 investments recognized on current tax return? A. $3000 loss B. $25000 loss C. $0 gain or loss D. $50k gain

Answer 102

D

Question 103

Passive Activity Rules different for publicly traded partnerships

Answer 103

Can only offset deductions from passive activity of PTP against income/gains from same PTP

Question 104

Example Exam Question: Following investments: Publicly traded limited partnership a: $10k loss Publicly traded limited partnership b: $15k gain Non publicly traded limited partnership: $22k loss Non publicly traded partnership: $16k gain Does not materially participate in investments. Assuming has appropriate amount at risk to take losses, what is total suspended loss for current year? A. $1000 B. $6000 C. $10000 D. $16000

Answer 104

D

Question 105

Lesson 2 Review

Answer 105

See Book