Tax Planning 14% (24 Questions)

Question 1

Imputed Interest on Below Market Loans

Answer 1

1. No interest is imputed on gift loans of $10K or less between individuals, unless the proceeds are used to purchase income-producing property (exception for compensation related or corporation shareholder loans).
2. Loans $10K - $100K, the imputed interest cannot exceed the borrower’s investment income (from all sources) for the year.
3. If borrower’s investment income for the year <$1K, no interest is imputed on loans of $100K or less.

Question 2

Prize & Awards

Answer 2

Cash, and the FVM of prizes and awards are included in taxpayers gross income.

Question 3

Unemployment Compensation

Answer 3

Unemployment compensation benefits (in lieu of wages) are included in gross income.

Question 4

Structured Settlements

Answer 4

Periodic Payments Act allow annuity to be paid out for remainder of injured party’s lifetime.

Question 5

Compensatory Damages

(make whole again)

Answer 5

Injury from personal injury lawsuit

Income TAX FREE

*unless damages for age, sex, or racial discrimination

Question 6

Punitive Damages

Answer 6

Taxable

*unless wrongful death lawsuit (per state allowance).

Question 7

Self Employment Tax Calculation at or below taxable wage base of $160,200.

Answer 7

Step 1: Calculate self-employment income.

Step 2: Multiply the net earnings from self-employment by 0.9235.

Step 3: Multiply the resulting product by 0.153 (the full self-employment tax rate).

Shortcut Method for SE income at or below the taxable wage base is to simply multiply the amount of self-employment income by 0.1413 (0.9235 × 0.1530)

Paul has net Schedule C income of $40,000.
His self-employment tax due would be $5,652 ($40,000 × 0.9235 × 0.153).
His deductible portion of the self-employment tax is calculated when using the shortcut method as $2,826 ($40,000 × 0.1413 = $5,652 ÷ 2 = $2,826).

Question 8

Self Employment Tax Calculation at or below taxable wage base of $160,200.

Answer 8

Step 1: Calculate self-employment income.

Step 2: Subtract 7.65% or multiply by 0.9235 (1 − 0.0765).

Step 3: From step 2, subtract the taxable wage base and multiply the excess over the taxable wage base by 2.9% (Medicare portion of the tax).

Step 4: Multiply the taxable wage base by 15.3%.

Step 5: Add the results of steps 3 and 4 together to arrive at the total self-employment tax.

The additional Medicare Tax of 0.9% also applies to self-employed individuals who have a combined income greater than $200,000 if single and $250,000 if filing MFJ.

Question 9

Alimony Paid to Ex Spouse
v.
Alimony Received from Ex Spouse

Answer 9

Paid to Ex Spouse:

Before Dec 31, 2018 = deductible

After Jan 1 2019 =
NOT deductible

Received from Ex Spouse:

Before Dec 31, 2018 = taxable

After Jan 1 2019 =
NOT taxable

Question 10

IRA Contributions

Answer 10

$6500 for you
$6500 for your spouse (working or nonworking),

*increased to $7,500 for those age 50 or older.

Active participants in Qual Ret. Plan Contribution Deduction Limits (phase out):
Single: $73-83K
MFJ: $116K-136K

Question 11

Incentive Stock Options (ISOs)

1. No income recognized when option is granted.
2. No tax due when option is exercised.
3. Tax is due when stock is sold.
   If ISO stock held for two years after
   option grant and holds the stock for more than 1 year (after exercise), any gain will be LTCG

If taxpayer sells stock within 1 year after exercise date, gain is treated as ordinary
income. If within the calendar year, then it is W-2 income and there is no AMT positive adjustment.

4. AMT may require earlier recognition of income and so the difference between the
   option price and the FMV at date of exercise is an addback for AMT purposes.

Answer 11

George’s employer GRANTS him an incentive stock option (ISO) on January 1, 2022, with an
granted price of $25.

George EXERCISES the ISO on January 2, 2023, when the market price is
$40.
No ordinary income recognition is triggered (but $15 will be an AMT adjustment 40-15).

George SELLS the stock two years later for $60, his basis for regular income tax is $25 and he has a $35 long-term capital gain for regular tax ($60-$25).

Note: His AMT basis is $40, and AMT gain is $20.

Question 12

Major Itemized Deductions

C-M-I-T

Answer 12

Casualty/Charity-
Casualty (Only in Federal declared event. lesser of decline in value or basis subject to 10% AGI
Charity- See table Big book p143

Medical- If over 7.5% of AGI

Interest- paid or incurred debt qualified residence of taxpayer

Investment Interest- limited to amount of investment income w/ carryforward.

Taxes- property/income
$10K cap
state/local/foreign income

Question 13

Child & Dependent Care Tax Credit

(Care for child that allows adult to work)

Answer 13

$3K ceiling for 1 kid
$6K ceiling for 2 kids

AGI limitations
Below $15K (35% applicable)
Above $43K (20% applicable)

Question 14

Child Tax Credit

Answer 14

Tax credit of $2K is available for each child under 17 y/o that taxpayer claims as dependent

Refundable for each child up to $1600/child

The credit is reduced $50 for each $1,000 by which MAGI exceeds $400,000
(MFJ) / $200,000 (Single).

Question 15

Adoption Credit

(taken in year adoption finalized)

Answer 15

Max credit $15950 w/ 5 year carryforward

Phased out ratably for taxpayers with modified AGIs of
$239,230 and $279,230 (2023).

Question 16

Personal Service Corp.

(regular corps operating in professional fields of the following:)

H-A-L-E

Health
Accounting/Architecture/Actuarial science
Law
Engineering

Answer 16

Retained income held by a PSC is taxed at a flat rate of 21%.

Question 17

Life Insurance Transfer for Value

Transferor → Transferee

Answer 17

The insurance proceeds ARE includible in the gross income of the transferee to the extent the proceeds exceed the basis (amount paid for policy plus any subsequent premiums paid).

Question 18

Life Insurance Surrender Tax Implications

Answer 18

Lump Sum Payments:
The living benefit of a lump-sum payment of the cash value above the
owner’s cost basis is taxable to the owner as ordinary income.

Interest Payments:
Upon maturity or cash surrender, if the owner leaves the proceeds with
the insurer and selects the interest-only option, the interest is taxable as
ordinary income when received or credited to the payee.

Installment Payments:
The portion of living benefit installment payments that are not a return of
principal are taxed as ordinary income.

Exchanges:
Non Section 1035 triggers gains if proceeds > premium paid

Question 19

What is a Capital Asset v. what is NOT

Answer 19

Capital asset is the taxpayer’s property whether or not it is connected with a trade or business.

What is NOT a Capital Asset:

*A-C-I-D Test

Accounts Receivable
Copyrights
Inventories
Depreciable Property

Question 20

Section 1033 Involuntary Conversion

Answer 20

1. Destruction, theft, seizure, requisition, or condemnation (or sale/exchange under
   threat of )
2. Natural disaster = 2 years to reinvest gain
   Gov’t Seizure = 3 years to reinvest gain
3. Realization occurs when the taxpayer can actually determine the amount of gain that would have been realized if the property had been sold.

Question 21

1035 Exchange

No gain or loss shall be recognized on the exchange of one life insurance contract for another life insurance contract, annuity or endowment contract.

Answer 21

Life Insurance → Annuity = OK

Annuity → Annuity = OK

Annuity → Life Insurance = NOT OK

Question 22

Wash Sale Rules

Answer 22

1. Occurs if the taxpayer sells or exchanges stock/securities for a loss
   and, within 30 days before or after the date of the sale or exchange, acquires
   substantially identical/similar stock/securities.
2. If such an event occurs, the realized loss is disallowed and the basis of the new stock/securities will include the unrecovered portion of the basis of the
   formerly held stock/securities.

EX:
Chelsea sold one share of stock w/
Adjusted Basis: $100
FMV: $70
70-100= 30 loss
Two weeks later, she buys the same stock for $50.
Her $30 loss will be added to the
basis of the share of stock.

$30 (unallowed loss) + $50 (new basis) = $80 new basis in stock

She will be able to take the loss when the reacquired stock is sold.

Question 23

Justin, age 55, earns $50,000 annually working for Stone, Inc., an S corporation. He owns 10% of Stone, Inc.’s stock. Justin is a participant in the Stone, Inc., profit-sharing plan. His spouse, Meghan, is 50 years old and is employed by JP Co. She earns $40,000 annually and participates in JP’s Section 401(k) plan, under which JP makes matching contributions of up to 3% of covered salary. Assuming that both the Stone, Inc. plan and JP plan have loan provisions, which of the following statements is CORRECT?

Answer 23

If Meghan’s Section 401(k) vested account balance is $10,000, she may borrow the entire amount.

Loans are never assessed a 10% penalty, regardless of the participant’s age, when the loan is issued. However, the outstanding balance on a retirement plan loan becomes subject to income tax and the early withdrawal penalty (if applicable) if the loan is defaulted. Loans from qualified plans to sole proprietors, greater-than-10% partners, and greater-than-5% shareholders in an S corporation are permitted. Generally, loans are limited to one-half the vested account balance and cannot exceed $50,000. When account balances are less than $20,000, however, loans up to the lesser of $10,000 or the vested account balance are available. Participant loan limits are a function of the participant’s account balance, not compensation.

Question 24

Delbert is a single taxpayer and is an active participant in rental real estate.

He has earned income of $75,000,
$5,000 of unearned income,
$16,500 in deductions, and
$5,000 in losses related to his real estate holdings.

What is Delbert’s taxable income?

Answer 24

earned income of $75,000
+
$5,000 of unearned income
=
$80K total income

• ($16,500 in deductions)
• # ($5,000 in losses related to his real estate)$62,500 Taxable Income

Question 25

Ricardo, age 47 and unmarried, purchased a variable annuity in 2005 and has a modified AGI of $350,000. The annuity is in the accumulation period. Ricardo’s basis is $50,000, and the contract has $100,000 in earnings. This year, he withdraws $60,000 from the annuity. Which of the following statements regarding the tax consequences of this withdrawal is CORRECT?

Answer 25

Ricardo must include $60,000 in gross income, pay a penalty of $6,000, and the $60,000 is subject to the 3.8% Medicare contribution tax.

B/C Ricardo purchased the annuity on or after August 14, 1982, the withdrawal is subject to last in, first out (LIFO) taxation. Under LIFO, withdrawals are treated as coming from earnings first and are taxed to the extent of earnings. Premature distributions (prior to age 59½) are also subject to a 10% penalty.
In addition, the $60,000 taxable gain is also subject to the 3.8% Medicare contribution tax that applies to net investment income of single taxpayers with a MAGI exceeding $200,000.

Question 26

You have a client who is considering starting his own business. He wants to know about the various types of business forms. Specifically, which of the following entities will not have income classified as self-employment for the owner who is also an employee?

A) S corporation
B) Sole proprietor
C) LLC
D) Partnership

Answer 26

A) S corporation

Owners of an S corporation who are also employees will have W-2 income.
S corporation income on the K-1 is not considered self-employment income for shareholders of S corporations.

*All other business forms will be subject to self-employment taxes.

Question 27

Amy bought a factory for $40,000.
In the current year, as a result of depreciation deductions taken on previous income tax returns, her adjusted basis for the factory was $38,000.
Also in the current year, she added a new wing to the factory, which cost $40,000.

What is her adjusted basis for the building in the current year after the addition to the building?

Answer 27

Adjusted basis = $78,000

The Tax Code requires that certain items must be included when calculating adjusted basis. Two of the items included are expenditures affecting the capital account (i.e., the cost of an addition) and any depreciation deductions taken. When Amy first bought the building, her basis was $40,000. Her adjusted basis without the new addition, but including the $2,000 depreciation, would be $38,000. The cost of the new addition is not deductible from income, but is instead a capital expenditure which must also be depreciated. The $40,000 basis of the addition is added to the original basis of the building

Question 28

Fred wants to transfer $100,000 of AAA rated corporate bonds to his nine-year-old daughter, Sarah. The bonds have a coupon rate of 3.5% and will mature in 10 years. He is interested in using a Uniform Gifts to Minors Act (UGMA) account to hold the bonds. If he transfers the bonds to the UGMA account, which of the following statements is CORRECT?

Answer 28

b/c Sarah is under age 19 and a portion of the interest income exceeds the 2023 Kiddie Tax threshold of $2,500 ($100,000 x 3.5% = $3,500), the excess portion will be taxed at the parent’s marginal tax rate. UGMA account assets are considered an asset of the child and are considered in determining financial aid (student assets = 20% in the EFC calculation). The income from this type of account is not tax free.

Question 29

An insurer has calculated the annual premium that must be paid for 7 years in order to have a life insurance policy paid up. The annual net level premium is $10,000. Joe makes a $10,000 payment during the 1st year and pays $20,000 in premiums during the 3rd year.

What will happen to the tax status of this life insurance policy after the 3rd year?

Answer 29

It will NOT change.

The 7-pay test requires that, at any given time, the aggregate premiums paid must not exceed the net level premiums that would have been paid, if the policy had been calculated on a 7-year level premium basis. Because, at no time, did Joe have more money paid in than was equivalent to the sum of the net level premiums, this policy passes the 7-pay test.

Question 30

GRANTOR TRUST

Billy has established a trust that pays out $2,000 each month to his mother, Wendy. The trust department of All Word Bank acts as trustee. Billy retains the right to borrow assets from the trust without security, and he is the remainder beneficiary of the trust.

Who must pay the income tax on the $40,000 earned by the trust and in what amount?

Answer 30

Billy pays on $40,000

This is a grantor trust; therefore, the grantor (Billy) will be responsible for the tax on all of the income.
Billy’s right to borrow trust assets without security will cause the trust to be a grantor trust for income tax purposes.
The distribution to his mother is a gift from Billy.

Question 31

You are a CFP® professional and are meeting with your client Brenda to monitor her ongoing financial status. Brenda owns a vacation home in New Mexico. She rented the property to others for the entire year, except for 10 days during the summer when she and her family used it for their vacation. The gross rental income that Brenda received is $65,000. Her rental expenses total $5,000. Brenda would like you to explain how this will change her income tax situation, in particular, how much of the rental expenses are deductible. After reviewing the documents she sent to you prior to the meeting, you have an answer for Brenda. How much of a deduction for rental expenses can Brenda take on her tax return?

Answer 31

$5000

Brenda can deduct the cost of renting the home if she occupies it for the greater of no more than 14 days per year or for 10% of the number of days the property is rented. Because Brenda occupied the house for only 10 days during the year, this test is satisfied. Even though this rental use exception is allowed, the deductible expenses related to the rental of the house are limited. Specifically, she can only deduct a portion of the actual rental expenses, which equals the number of days during the year that the house is rented to others, divided by the total number of days that the house is used by either tenants or Brenda. Given 365 days per year, Brenda’s tenants occupy the house all but 10 days, for a total of 355 days. She is allowed to deduct 97.26% (355 days ÷ 365 days) of the $5,000 rental expenses, which equals $4,863.

Question 32

Portfolio Income v. Passive Income/Losses

Answer 32

Portfolio income/loss is derived from investment practices

Passive income/loss is derived from ownership of rental property and activities in which there is NO material participation.