Tax Lesson 2 Flashcards
Basic Tax Formula
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
Cash basis taxpayers recognize income
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
Accrual basis taxpayers recognize income
When earned Most businesses Report in gross income on earliest of following dates: Payment received Income amount due to taxpayer Taxpayer earns income
Doctrine of constructive receipt
When income available to taxpayer without substantial limitations/restrictions, deemed to be constructively received & should be taxed
Taxable year __?
Fiscal year __?
Calendar year
12 month period, adequate records & form 1128 for IRS approval
Qualifying Widower with Qualified Child Filing Dtatus
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
Taxpayers who are blind
Must file to receive additional standard deduction
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
D
Certain taxpayers not eligible for standard deduction
MFS when other spouse itemizes
Nonresident aliens
Individuals filing tax return for tax year of less than 12 months
A taxpayer who is claimed as a dependent will have limited standard deduction
Greater of:
$1150 OR
$400 + earned income (not exceeding normal standard deduction)
Qualifying Child for Head or Household, Earned Income Credit, Child Tax Credit, & Credit for Child & Dependent Care Expenses. Must meet 4 tests:
Relationship
Abode
Age
Support
Relationship Test
Child
Descendant of child
Sibling
Descendant of sibling
Abode Test
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
Age Test
Under age 19 or student under age 24 as of end of calendar year
Student = full time 5 months of year
Support Test
Qualifying child doesn’t provide more than 1/2 own support during the year
*scholarships not considered support
If more than 1 person eligible to claim dependent, tie-breaker rules:
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
Qualifying Relative must meet joint return test & citizenship/residency test as well as
Relationship test
Gross income test
Support test
Not a qualifying child test
Relationship Test
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)
Gross Income Test
Less than personal exemption amount ($4400)
Support Test
Must provide more than half support
Income received by dependent does not count as support from dependent unless expensed for that purpose
Not a Qualifying Child Test
Cannot be qualifying child of any taxpayer for tax year
Joint Return Test
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
Citizenship or Residency Test
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)
Must pay quarterly estimates if both:
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
Gross income includes
Both earned & unearned income whether or not it is taxable
Partnerships & S-Corps are pass through entities
Income from business passed through to owners tax returns
Trusts & estates generally taxable to beneficiary
If income not distributed, taxable to trust/estate
In community property states
1/2 of earnings considered owned by each spouse
Annuity Payment Taxation Exclusion Ratio
Exclusion Ratio = investment/expected total return
If die before end of term
Entitled to deduction from AGI in misc itemized deductions
Return of remaining capital
Once recovered full basis from annuity payments
Entire benefit received is taxable
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
B
Ratio of Return of Adjusted Basis
AB before withdrawal/FMV at withdrawal
Social Security
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
To calculate taxable portion of SS benefits,
MAGI + 1/2 SS benefits compared to hurdles
1st hurdle: $32000 MFJ, $25000
2nd hurdle: $44000 MFJ, $34000
If MAGI + 1/2 SS exceeds 1st hurdle only, taxable amount is lesser of:
50% SS benefits
50% (MAGI + .5SS Benefits - hurdle 1)
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
B
If MAGI + 1/2 SS exceeds 2nd hurdle, taxable amount is lesser of:
85% SS
85% (MAGI + .5SS Benefits - hurdle 2) + lesser of: $6000 MFJ/$4500 or taxable amount calculated under 50% formula
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
C
Below Market Loans:
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
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
C
Below market rate loans by corporation to shareholder treated as dividend
Payments to corporation treated as interest income
Below market rate loans from employer to employee treated as paid compensation for employee & subject to employment taxes
Loan payments are treated as taxable interest income to employer
Exclusions from Income
Gifts, Bequests, Devise, Inheritance
Only to property, not income on property
Gift
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
Life Insurance Proceeds
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
Proceeds from Life Insurance Excluded even when transferred for valuable consideration if:
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
Qualified tuition & related expenses
Does not include room & board *taxable!
Gain on sale of personal residence
Up to $250k/$500k MFJ if either spouse meets ownership requirement (2/5 years) & both spouses meet use requirement
Qualified Roth IRA Distributions
Account held 5 years 1st time home purchase Disability Death On/After 59.5
Qualified Roth 401k Distributions
Held 5 years Disability Death 59.5 *distributed on pro-rata basis
Excluded from gross income
Worker’s compensation
Damages received on account of physical injury/sickness
Payments from accident/health insurance personally owned by taxpayer
Included In Income
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
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
D
Employer Sponsored Medical General Rule
Contributions to insurance payable to employee generally excluded from income
Excess amounts taxable
Group Term Life Insurance
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
Section 79 Requirements
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
Group Term not taxable to employees when:
Employee terminated due to disability
Qualified charity named beneficiary
Employer named beneficiary
Taxation of group term insurance
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
Meals & lodging not included in income if furnished by employer
On premises &
For convenience of employer
Lodging must be condition of employment to be excluded from employee’s gross income
Fringe Benefits
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
Foreign Earned Income Exclusion
$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
Interest on following bonds is not tax exempt:
Private activity non qualified bonds
Arbitrage bonds
Bonds that don’t meet all requirements of section 149
Discharge of Indebtedness
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)
Above the Line Deductions (FOR AGI)
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)
Functions of AGI
Limiting measure (floor) for medical expenses
Limiting measure (ceiling for charitable deductions)
Determines deductibility of IRA contributions
Determines phase out of other tax benefits
Trade/business expenses
Deductible must be: Ordinary: normal, usual, customary Necessary: prudent would incur same expense Reasonable: question of fact Incurred in conduct of business
Above the Line Deductions For AGI For Self Employed
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
Below the Line Deductions From AGI
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
Deduction Clustering Examples
Early state income or property tax payment
Early mortgage interest payment
Medical expenses
Charitable donations (good opportunity for DAF)
QCDs
70.5
Cannot exceed $100k/yr
Casualty Losses
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
Effect of Claim for Reimbursement
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
Amount of casualty (only deductible if declared national disaster)
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)
Certain Personal Interest Expense
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
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
C
Qualified Personal Residence Interest
Limited to $750000 mortgage debt
Limited to 2 houses
No home equity interest
Qualified Business Income (QBI)
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
Other:
Allowed: Other employee expenses: uniforms, union dues, professional expenses, job hunting in same profession
Earned Income Credit
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
Adoption Expenses Cresit
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
Child Tax Credit
$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
Family Credit (Qualifying Dependent Credit)
$500 for those who would qualify as dependent
Qualifying child 17+ or qualifying person
Child & Dependent Care Credit
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
American Opportunity Tax Credit
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)
Lifetime Learning Credit
Max per taxpayer is 20% of qualifying expenses up to $10000
Cannot be claimed in same year as AOTC
Phase out: $160k-$180k (MFJ)
Kiddie Tax
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
Alternative Minimum Tax (AMT)
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%
AMT Formula
Taxable income \+/- adjustments \+ preferences = AMTI - exemption = AMT tax base x AMT Rate(s) = tentative minimum tax - foreign tax credit - regular tax = AMT
AMT Exemption
Reduced AMTI
Adjustment items
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)
AMT Preference Items (increase AMTI)
- Percentage Depletion: amount taken for regular tax in excess of adjusted basis of property at end of year
- 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)
- Interest on Private Activity Bonds: not regular, yes AMT, expenses incurrent in carrying bonds not deductible but offset interest income in computing AMT preferences
Loss Limitations on Rental Property
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
Hobby Rules
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)
At Risk Rules & Passive Activity Treatment
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
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
A
Example Exam Question:
From previous, how much of loss is suspended under passive activity rules?
A. $0
B. $75k
C. $175k
D. $250k
B
Passive Income
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)
Material Participation in Passive Activity
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
Portfolio Income
From investments (interest, dividends, royalties, annuities)
Suspended Loss At Risk
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
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
D
Passive Activity Rules different for publicly traded partnerships
Can only offset deductions from passive activity of PTP against income/gains from same PTP
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
D
Lesson 2 Review
See Book
