Tax Progressivity and splitting of income

Question 1

What is a progressive tax system?

Answer 1

as your income increases, your tax liability also increases. Each “bracket” is taxed at the rate for that bracket.
• Taxpayers get the benefit of the lower tax brackets

Question 2

What is the marginal income tax rate?

Answer 2

The rate of your highest income bracket. Or the rate you pay on the next dollar you earn.
• Because of the progressive rate, you only pay more tax on the amount in that particular bracket.
• Does not harm people who may have to pay significantly more tax on a small increase in income (harm = lower net income).

Question 3

What three principles are at the heart of the married filing jointly legislation?

Answer 3

Mathematically impossible to satisfy all three of the following principles:
• Marriage neutrality (no penalties or bonuses)
• Couple equality (couples with the same aggregate income bear the same tax burden)
• Progressivity

Question 4

What are the two types of rights in a bond and how do they affect ownership in regards to taxes?

Answer 4

1) right to demand and receive principle amount of the bond at maturity.
2) right to demand and receive interim payments of interest on the investment on the amounts specified on the coupons.

Court determined the gift of the coupons were similar to a gift of cash. Did not confer all rights of the Bond to the assignee, and the taxpayer received a benefit.

Question 5

When a commission is previously earned, but paid out in later years, who is taxed if the right to those commissions is assigned to another person?

Answer 5

Taxable to the person who earned the commissions (e.g. through services).

Question 6

What are the three possible taxpayers in a trust?

Answer 6

Donor, trust, beneficiary. Also the person who has the power to transfer the income or principle.

Question 7

When is the income from a trust taxed to the trust or the beneficiaries?

Answer 7

If the trust is irrevocable, and the grantor reserves little or no control over it

Question 8

What is the total income from a trust that can be distributed called?

Answer 8

Distributed Net Income (DNI)

Question 9

What is a simple trust and how is it taxed?

Answer 9

those that are required to distribute all income currently

Generally pays no tax because all income is distributed, and thus the beneficiaries pay tax on what they receive.

Question 10

What is a complex trust and how is it taxed?

Answer 10

Anything not a simple trust. Can accumulate income.

• Any income paid out to the beneficiaries, tax is paid by the beneficiaries. Tax on income remaining in the trust is paid by the trust.
• Marginal rates in a trust are highly compressed. 35% bracket is anything over $11,650 (2012).

Question 11

What is a grantor trust and how is it taxed?

Answer 11

a trust where the grantor or non-adverse party has the power to revoke the trust and convert the assets back to the grantor.

• Essentially ignored for income tax purposes during the life of the grantor. Grantor is taxable on the income (§ 676).

Question 12

What is an adverse party for a trust?

Answer 12

someone who has a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust.
• Beneficiary of a trust is an adverse party.

Question 13

What is an S Corporation for tax purposes?

Answer 13

the term “S corporation” means, with respect to any taxable year, a small business corporation for which an election under section 1362(a) is in effect for such year.
• Restrictions on the types of shareholders and how it can be organized (e.g., only one class of stock).
• Do not pay taxes. Taxes are paid by the shareholders (flow-through).

Question 14

What are the four factors to consider in analyzing gift and leaseback situations?

Answer 14

○ Duration of the transfer
○ The controls retained by the donor,
○ The use of the gift property for the benefit of the donor, and
○ The independence of the trustee.

Less control is more likely to be beneficial for tax purposes.

Question 15

What is a capital asset?

Answer 15

all “property” with eight exceptions:
• Inventory of a business
• Real property or depreciable property used in a trade or business
• Copyrights and similar property held by their creators
• Accounts receivable acquired in the ordinary course of a trade or business
• U.S. government publications held by someone who received them for free or at a reduced cost

Question 16

What is net capital gain?

Answer 16

the excess of the net long-term capital gain for the taxable year over the net short-term capital loss for such year. § 1222(11)

Question 17

What are long term capital gains?

Answer 17

more than one year.

Short term is one year or less.

Question 18

How does carryover work in regards to capital gains?

Answer 18

Can use up to $3,000 of capital loss to offset ordinary income. Remainder of Capital loss can be carried over.

Question 19

What is the difference in treatment for the sale of a property held as an investment or sold in the ordinary course of business?

Answer 19

If held as an investment, would be capital gains. If in the ordinary course of business, then profits would be taxed as ordinary income.

Look at the initial intent of the taxpayer. Intent can change though.

Question 20

What are the Winthrop factors that help determine whether a property was sold as an investment or in the ordinary course of business?

Answer 20

substantiality and frequency of sales, improvements, solicitation and advertising efforts, and broker’s activities.
○ More sales, to a large percentage of the property leans toward OCB
○ Building improvements on the property leans towards OCB

Question 21

What is a section 1231 gain and how is it treated for tax purposes?

Answer 21

Treated as ordinary income. Section 1231 losses can only offset Section 1231 gains.

(i) any recognized gain on the sale or exchange of property used in the trade or business, and
(ii) any recognized gain from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) into other property or money of—
	(I) property used in the trade or business, or
	(II) any capital asset which is held for more than 1 year and is held in connection with a trade or business or a transaction entered into for profit.

(B)Section 1231 loss The term “section 1231 loss” means any recognized loss from a sale or exchange or conversion described in subparagraph (A).

Question 22

What is a premium lease?

Answer 22

the lessor is paying a higher amount than the market would normally call for.
• Normally occurs when rents go down, but the lessor is already in a contract for a now above-market rate.

Question 23

What occurs when a life tenant sells an interest in a trust?

Answer 23

If a life tenant sells a life interest in a trust and the remainder holder does not sell, the entire amount of the proceeds is taxable, at the capital-gain rate.