Topics You Should Know (Modules 7-15) Flashcards
Taxpayers redeeming qualified U.S. SERIES EE BONDS in the same year that QUALIFIED HIGHER EDUCATION expenses are paid may _______________________. There are two conditions that must be met: _______________ and _____________.
EXCLUDE the interest income on the bonds from gross income
- the purchaser of the bond must have made the purchase after reaching the AGE OF 24
- the purchaser must be the SOLE OWNER of the bonds (or joint owner with his or her spouse)
TAXABLE bonds purchased at a PREMIUM are ________ to be amortized. NONTAXABLE bonds purchased at a PREMIUM are ______ to be amortized.
allowed (optional)
required
The amortized bond PREMIUM is based on the _____________. The amount amortized usually ______ the taxpayer’s basis in the bonds and, for TAXABLE bonds, RESULTS IN AN _____________ for interest received from the bond.
constant yield to maturity
reduces
offsetting deduction
Under the ACCRUAL METHOD of accounting, income is reported for tax purposes once all EVENTS to establish a taxpayer’s RIGHT TO RECEIVE the income _______ and the AMOUNT can be determined with ________.
have occurred
reasonable accuracy
If an amount of income has been ACCRUED on the basis of a _____________ with the exact amount to be determined at a later date, any DIFFERENCE BETWEEN the ESTIMATE and EXACT AMOUNT is to be _______ or _______ in the year when the exact amount can be determined.
reasonable estimate
included in income
deducted
Generation-skipping transfer tax
- imposed on outright or in trust transfers to beneficiaries more than one generation BELOW the generation of the donor
- flat tax equal to the maximum gift and estate tax RATE
- a SEPARATE tax imposed in addition to the gift and estate taxes
INTEREST-FREE LOANS are subject to the IMPUTED INTEREST RULES if they ______. The INTEREST that is not being paid by the borrower to the lender is CONSIDERED a _____ from the lender ______ that the loan is outstanding.
EXCEED $10,000
gift
each year
A corporation may DEDUCT the FAIR MARKET VALUE of the contributed property but _______ the SAME AMOUNT to ________ for the receipt of the gift.
must add
its gross income
The amount of INCOME REALIZED by a taxpayer from SERVICES RENDERED equals the SUM OF the amount of _________ AND the ________________________.
cash received
fair market value of any property received
Under the TAX BENEFIT RULE, if the taxpayer takes a DEDUCTION in a PREVIOUS year and then receives a REFUND or reimbursement in a LATER year, the refund/reimbursement must be included in ______ to the _____________ of the deduction received.
income
extent of the benefit
The NINE taxes subject to the TAX BENEFIT RULE are:
- state income taxes
- personal property taxes
- real property taxes
- state sales and use taxes
- state corporation franchise taxes
- stamp taxes
- federal excise taxes
- customs duties
- farmland preservation credits.
ALIMONY RECEIVED by a taxpayer is ___________ and ALIMONY PAID by a taxpayer is _______________.
INCLUDED in that taxpayer’s GROSS INCOME
DEDUCTIBLE from that taxpayer’s GROSS INCOME
To be considered ALIMONY, the PAYMENTS must be MADE UNDER a __________.
divorce or separation agreement
Taxable income
- Wages, salaries, tips
- Interest received on state and federal income tax refunds
- Interest received on U.S. Treasury certificates
- Interest received on life insurance proceeds
- Interest on federal government obligations
- Dividends received (stock dividends on preferred stock is taxable)
- Alimony received
- Business income or (loss)
- Capital gain or (loss)
- Other gains or (losses)
- IRA distributions [Traditional IRA taxable amount = (always use marginal tax rate + 10% penalty if under 59 1/2)distribution; Roth IRA taxable amount = (marginal tax rate if ownership is less than five years + 10% penalty if under age 59 1/2)distribution]
- Pensions and annuities (contributions made with AFTER-TAX dollars will be PARTIALLY included in taxable income; simplified method to determine taxable amount)
- Rental income (realty that is used for both personal and rental purposes will be treated as if it was used 100% for personal use if the amount of rental days is less than 14, then no income recognized)
- Unemployment compensation
- Social Security Benefits (up to 85% can be taxed; refer to rules below)
- Other income (some prizes or rewards, gambling winnings, money found on street, income from a hobby, jury duty pay)
Nontaxable income
- Child support payments
- Property settlements
- State and federal income tax refunds
- Scholarships and fellowships used to pay tuition and course‐related fees, books, supplies, and equipment for a DEGREE CANDIDATE
- Principal received on life insurance proceeds (up to $50,000 for GROUP-TERM)
- Dividends received from a life insurance policy (total dividends have NOT YET EXCEEDED accumulated premiums paid)
- Inheritances
- Employee fringe benefits (with limitations)
- Gifts received
- Loans
- Cash support from parents
- Prizes or awards (if the below exclusion requirements are met)
- Interest received on state government obligations
- Interest received on qualified U.S. Series EE Bonds in the same year that QUALIFIED HIGHER EDUCATION expenses are paid
- Stock dividends
- Interest received from the city
- Realized gains up to $250,000 ($500,000 if filing joint; both spouses must meet the use test, but only one must meet the ownership test) on the SALE OF A RESIDENCE if the residence has been owned and used by the taxpayer as a PRINCIPAL residence for at least TWO of the preceding FIVE years.
Alimony must be received in the FORM OF ________.
cash
Provisional Income (PI)
AGI + tax-exempt interest + 50% (Social Security Benefits)
Calculation for the taxable amount of Social Security Benefits (SSB) included in income
If Provisional Income EXCEEDS Base Amount 1 ($32,000 married or $25,000 single) BUT NOT Base Amount 2 ($44,000 married or $34,000 single), then the TAXABLE AMOUNT of SSB is the LESSER OF:
50% × SSB
50% × (PI − BA1)
If PI EXCEEDS BA2, then the TAXABLE AMOUNT of SSB is the LESSER OF:
.85 × SSB, or
.85 × (PI − BA2), PLUS the LESSER OF
amount included based on the 50% formula (50% × SSB), or $4,500 (unless married filing jointly, then $6,000).
If an EMPLOYER REQUIRES JURY PAY TO BE REMITTED in exchange for regular compensation for the period the employee was performing jury duty, the employee ______ the jury duty pay from _______ as an adjustment.
may deduct
gross income
(included in gross income, then deducted)
Generally, STOCK DIVIDENDS _________. The new basis can be calculated by:
are nontaxable
e.g.
paid $90,000 for 450 shares common stock
received a stock dividend of 50 new common shares
$90,000/(450 + 50) = $180 per share (new basis)
Any STOCK that is DISTRIBUTED on PREFERRED STOCK results in a _______ stock dividend. A taxpayer’s BASIS for original stock is _________ to the dividend stock in proportion to _________. The amount to be included in the shareholder’s income is the stock’s ______________________.
taxable
allocated
fair market values
fair market value on DATE OF DISTRIBUTION
e.g. Original common stock basis $300
Common stock (FMV) $450 Preferred stock (FMV) 150 Total value $ 600
The ratio of the common stock to total value is $450/$600 or 3/4. This ratio multiplied by the original common stock basis of $300 results in a basis for the common stock of $225. The basis of the preferred stock would be ($150/$600 × $300) = $75.
What is the THREE-STEP PROCESS for calculating the TAX of a corporation for a SHORT PERIOD?
- Annualize income by multiplying the income in the short period by 12 months divided by number of months in the short period
- Calculate the tax on annualized income
- Multiply the computed tax by the number of months in the short period divided by 12
Unless the IRS consents to a change of method, taxpayers are REQUIRED to use the ACCRUAL METHOD of accounting for purchases and sales if __________ are used.
inventories
Manufacturers and certain retailers and wholesalers are REQUIRED to use the ____________________ to CAPITALIZE all the DIRECT and INDIRECT COSTS allocable to property they produce and for property bought for resale. These costs are then ALLOCATED to ____________ and _________ during the year, which usually results in an ______ in the BASIS of the inventory.
uniform capitalization method
ending inventory
property sold
increase
e.g. quality control, off-site storage facilities, warehousing, taxes excluding income taxes
If PRICES ARE RISING and LIFO is used then the cost of inventory, and therefore the total for costs of goods sold, will be ______. If costs of good sold is ______ then taxable income will be ______, which also means that the current tax liability will be ______.
higher (contains all new inventory with higher prices)
higher
lower
lower
With an ACCOUNTABLE PLAN, all REIMBURSEMENTS are ______ in the employee’s income and all employee DEDUCTIONS will be _____________________.
included
2% miscellaneous itemized deductions
CAFETERIA PLANS allow employees to select from a ____________________ and __________ the value of the nontaxable benefits in their gross income.
menu of fringe benefits and cash
NOT include
The requirements of CAFETERIA PLANS are:
- all participants MUST BE EMPLOYEES
- participants MAY CHOOSE BETWEEN TWO OR MORE BENEFITS composed of cash or qualified benefits
- participants are REQUIRED TO MAKE ELECTIONS among the benefits
- the plan MUST BE IN WRITING and have certain SPECIFIED INFORMATION
- the plan MAY NOT PROVIDE participants with DEFERRED INCOME, except for under 401(k) plans
Treasure trove principle
- unexpected cash flows; money found
2. taxable income
The first _______ of GROUP-TERM LIFE INSURANCE provided by an employer is a TAX-FREE fringe benefit. The excess over _________ usually is taxable unless the proceeds were paid by ___________.
$50,000
$50,000
reason of death
What is the latest date that an IRA CONTRIBUTION can be made in order to qualify as a DEDUCTION on the prior year’s return?
the original due date of the return, even if the return is extended
Marginal tax rates
the rate of tax that applies to the LAST DOLLAR of income
e.g. married filing jointly and taxable income is $100,000, within the 25% marginal tax BRACKET because the last dollar of income is subject to tax at a rate of 25%.
Effective tax rates
the AVERAGE RATE of taxation that applies to income
total tax liability divided by total income in any given year
DISTRIBUTIONS FROM THE TRADITIONAL IRA are taxable at the taxpayer’s __________ for federal income tax purposes.
ORDINARY INCOME
Contributions to ROTH IRAs are _________ whereas contributions to TRADITIONAL IRAs are _________ if certain requirements are met.
never deductible
deductible
A taxpayer will NOT RECEIVE A BASIS for their CONTRIBUTIONS TO AN IRA because they were made from earnings that were ________.
not taxed
NO TAXES are paid on the INTEREST income earned on IRAs UNTIL the retirement savings are ___________.
distributed
For determining the amount of income that a SELF-EMPLOYED individual may contribute to a KEOGH PROFIT-SHARING PLAN, EARNED INCOME is defined as ___________________________.
net self-employed earnings LESS the deductible Keogh contribution and one-half of the self-employment tax
Three conditions that allow prizes or awards to be EXCLUDED from gross income.
- the prize or award is made primarily in RECOGNITION OF religious, charitable, scientific, educational, artistic, literary, or civic achievement, but only if the recipient was selected WITHOUT ACTION ON HIS OR HER PART to enter the contest
- the recipient is NOT REQUIRED to render substantial FUTURE SERVICES as a condition to receiving the prize or award
- the prize or award is TRANSFERRED by the payor TO a governmental unit or tax‐exempt charitable organization.
A cash‐basis taxpayer should report gross income _________________________________.
For the year in which income is either ACTUALLY OR CONSTRUCTIVELY received, whether in cash or in property.
The EXCLUSION for interest received on U.S. SERIES BONDS applies only to education expenses INCURRED BY the taxpayer, the taxpayer’s spouse, or any person whom the taxpayer may claim as a dependent for the year. Otherwise (condition is not met) QUALIFIED HIGHER EDUCATION expenses are DECREASED by:
- qualified scholarships that are not includible in gross income
- payment of educational expenses to an institution that is an exempt organization
- reimbursement, payment, or waiver of qualified educational expenses through a state tuition program
- any educational allowance allowable under U.S. Tax Code
INCOME in respect of a DECEDENT is income earned by a decedent before death that __________ in the decedent’s final income tax return because of the decedent’s METHOD OF ACCOUNTING (e.g., receivables of a cash basis decedent). Such income MUST BE INCLUDED in ____________ and HAS ____________ as it would have had if the decedent had lived.
was not includible
gross income by the person who receives it
the same character (e.g., ordinary or capital)
e.g. Includes a bonus earned before the taxpayer’s death but not collected until after death
Although an S CORPORATION generally must use a ______ year, it may request permission from the IRS to have a _____ year if it can establish a valid business purpose.
calendar
fiscal
A C CORPORATION may elect to use either a _____ year or a ______ year as its annual accounting period.
calendar
fiscal
C CORPORATIONS are generally not allowed to use the ___ method of accounting. A limited EXCEPTION that permits the use of the _______ method is available if the C corporation is a ________________, the business is organized as a ____________, if the C corporation for every year has inventory gross receipts of _____________, or if the C corporation for every year has average gross receipts of _____________ for any prior three‐year period and does not have ________.
cash cash qualified personal service corporation partnership $1 million or less $5 million or less inventories
A taxpayer ________ LIFE INSURANCE PREMIUMS in which the taxpayer is directly or indirectly THE BENEFICIARY.
may not deduct
A taxpayer _______ the GROUP TERM LIFE INSURANCE premiums if the insured employee or his/her BENEFICIARIES would get the insurance proceeds.
may deduct
DEDUCTIONS can be divided into two broad categories:
deductions for AGI and deductions from AGI (i.e., itemized deductions).
ACTIVITIES/TRANSACTIONS can be divided into THREE mutually exclusive categories:
- Personal
- Trade/business
- Investment
Expenses related to one’s PERSONAL activities _______________.
CANNOT BE deducted unless specifically provided for in the IRC (e.g., charitable contributions, mortgage interest).
Expenses related to TRADE OR BUSINESS activities ________________________.
are DEDUCTIBLE if they are RELATED to the business operations and are ORDINARY, NECESSARY, and REASONABLE.
Expenses related to INVESTMENT activities or other activities that produce income ______________.
are DEDUCTIBLE if ORDINARY, NECESSARY, and REASONABLE.
Expenses related to the MANAGEMENT or MAINTENANCE of property and in connection with the DETERMINATION OF ANY TAX ____________.
are DEDUCTIBLE
Items that are NOT DEDUCTIBLE
- Fines and penalties (additional tax that was not paid, interest on that payment)
- Bribes
- Life insurance premiums in which the taxpayer is directly or indirectly the beneficiary
- Contributions to ROTH IRAs
- Expenses related to one’s PERSONAL activities
- Amounts related to controlled substances
- Federal income taxes
- State and local fees
- Assessments for public improvements (tend to increase the value of the taxpayer’s property)
NO DEDUCTION OR CREDIT shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of _____________________(within the meaning of schedule I and II of the ______________) which is PROHIBITED BY federal LAW or the law of any state in which such trade or business is conducted. However, a DEDUCTION is allowed for the ______________.
trafficking in controlled substances
Controlled Substances Act
cost of merchandise purchased
Deductions for CASH-BASIS taxpayers generally are taken when ________. However, for expenses covering _________, the deduction must be SPREAD over the period for which the expenses apply.
actually paid
12 months or more
Deductions FOR AGI
- Educator expenses paid up to $250 ($500 if married filing jointly and both spouses are eligible educators, but not more than $250 each)
- Certain business expenses of reservists, performing artists, and fee-basis government officials
- Health savings account deduction
- Moving expenses [limited to moving the household goods and lodging; if closely related to the start of work at a new location and a distance test (50 miles) and a time test (39 weeks in the 12-month period or if self-employed, 78 weeks in the 24-month period with at least 39 weeks in the 12-month period) are met]
- Self-employment tax (7.65% employer-equivalent portion; 50% limitation)
- Self-employed SEP, SIMPLE, and qualified plans
- Self-employed health insurance
- Penalty on early withdrawal of savings
- Alimony paid
- Traditional IRA contributions (covered=phase out based on AGI; not active=lesser of $5,500 ($6,500 if age 50 or older) or 100% of compensation in 2017)
- Student loan interest (limited to $2,500 and is reduced by AGI in excess of $60,000 if single, head of household, or a qualifying widow(er); $120,000 if married filing jointly)
- Tuition and fees
- Domestic production activities
- Other deductions (jury duty pay required to be remitted by employer; group term life insurance premiums if the insured employee or his/her beneficiaries would get the insurance proceeds; section 179 depreciation; expenses incurred from a passive activity)
Deductions FROM AGI (Itemized Deductions on Schedule A)
- Medical and dental expenses paid (paid with a credit card prompts deduction) in excess of 10% (7.5% if age 65 or older) of AGI
- Taxes paid [state and local income taxes or sales/use tax (the greater of the two); state, local, and foreign real property; state and local personal property; foreign income]
- Interest paid [home mortgage; acquisition debt to buy, build, or improve your home up to $1,000,000 ($500,000 if married filing separately); home equity debt (second mortgage taken out) up to a loan balance equal to the lower of $100,000 or the FMV less acquisition debt of the house; points paid to refinance a loan must be amortized over the life of the loan; insurance premiums; investment up to the amount of net investment income and the excess can be carried forward]
- Gifts to charity paid below the 50% of AGI ceiling (the amount that exceeds this ceiling may be carried forward for 5 years)
- Casualty and theft losses, not the premiums for casualty insurance, resulting from NONINCOME-PRODUCING property paid in excess of the $100 and 10% of AGI floors (the loss must be SUDDEN and UNEXPECTED; e.g. water heater explosion; not an e.g. termites or water damage to roof)
- Miscellaneous expenses paid in excess of 2% of AGI (unreimbursed employee expenses—job travel, meals and entertainment - additional 50% limitation, union dues, work clothes and uniforms, business gifts - up to $25, job education, etc.; tax preparation fees, legal fee for tax advice related to a divorce, IRA trustee’s fees, appraisal fee for a charitable contribution; other expenses—investment, safe deposit box, hobby, etc.)
- Other Miscellaneous expenses (amortizable premium on taxable bonds; casualty and theft losses from INCOME-PRODUCING property; federal estate tax on income in respect of a decedent; gambling losses up to the amount of gambling winnings; impairment-related work expenses of persons with disabilities; loss from other activities from Schedule K-1 (Form 1065-B), box 2; losses from Ponzi-type investment schemes; repayments of more than $3,000 under a claim of right; unrecovered investment in an annuity)
ALIMONY payments you make under a divorce or separation instrument, such as a divorce decree or a written agreement incident thereto, are DEDUCTIBLE if all of the following requirements are met:
- You and your spouse or former spouse DO NO FILE A JOINT RETURN with each other
- You pay in CASH (including checks or money orders)
- The divorce or separation instrument DOES NOT SAY that the payment is NOT ALIMONY
- If legally separated under a decree of divorce or separate maintenance, you and your former spouse are NOT MEMBERS OF THE SAME HOUSEHOLD when you make the payment
- You have NO LIABILITY to make any payment (in cash or property) AFTER the DEATH of your spouse or former spouse
- Your payment is NOT treated as CHILD SUPPORT
Net investment income
- investment INCOME less investment EXPENSES
- remaining amount after deduction is carried over, INDEFINITELY, and deducted in a year that has sufficient net investment income
Taxpayers may deduct the qualified MEDICAL EXPENSES incurred for both _____________________________.
their treatment and the treatment of spouses and dependents
Qualified medical expenditures include:
- Diagnosis
- Cure
- Mitigation
- Treatment or prevention of disease
- For the purpose of affecting any structure or function of the body
- Meals and lodging furnished as NECESSARY incidents to the care of an individual PRIMARILY at an institution (not a hospital) for medical care
e. g. prescription drugs, eye examinations and eyeglasses/contact lenses, necessary medical procedures (appendix, foot), tooth extraction, hearing aids, unreimbursed insurance premiums, drug rehabilitation, wheelchair, cosmetic surgery deemed necessary, emergency room, crutches, wigs relating to hair loss resulting from chemotherapy treatments, annual physical exam, transportation for medical and dental examinations, physical therapy, dental implants, paid for a dependent (the gross income and joint return tests do not apply) and hearing aid batteries
* expenses are reduced by reimbursed insurance premiums
Charitable contributions are made to:
- Churches
- Educational institutions that maintain a regular faculty and curriculum
- Hospitals and medical schools
- Organizations supported by the government that hold property and/or investments for the benefit of a college or university
- Federal, state or local governmental units
- Organizations normally receiving most of its support from the public or a governmental unit
Calculation for casualty loss itemized deduction
Lower of decline in FMV or AB of property Less: Insurance Reimbursements Less: $100 per casualty Less: 10% × AGI = Casualty loss deduction
Jimet, an unmarried taxpayer, qualified to itemize deductions. Jimet’s adjusted gross income was $30,000 and he made a $2,000 cash donation directly to a needy family. Jimet also donated stock, valued at $3,000, to his church. Jimet had purchased the stock four months earlier for $1,500.
What was the maximum amount of the charitable contribution allowable as an itemized deduction on Jimet’s income tax return?
$1,500
The $2,000 cash donated to a needy family is not deductible because the needy family is not a qualified charitable organization. The stock was purchased for $1,500 and NOT HELD FOR ONE YEAR to be capital gain property, therefore the deduction for the stock is the fair market value of the stock ($3,000) less the short-term capital gain ($1,500) if the stock had been sold ($3,000 − basis of $1,500) = $1,500.
Stock contributed to a charitable organization
- If NOT HELD for one year, then the deduction is the FMV of the stock LESS the short-term capital gain if the stock had been sold. The deduction is limited to 50% of AGI.
- If HELD for more than one year, then the deduction is FMV of the stock. The deduction is limited to 30% of AGI.
FOOD AND BEVERAGE EXPENSES are only deductible, if:
- the expenses are not lavish or extravagant
- the taxpayer (or one of his employees) is present when the food or beverages were provided
- the expense relates directly to the conducting of business
For MEALS AND ENTERTAINMENT EXPENSES that an employee is REIMBURSED by his/her employer, the 50% limit applies to the ________. However, if the reimbursement is included in the employee’s INCOME, the 50% limits apply to the __________.
employer
employee
Destry, a single taxpayer, reported the following on his 2017 U.S. Individual Income Tax Return Form 1040:
Income: Wages $ 5,000 Interest on savings account 1,000 Net rental income 4,000 Deductions: Personal exemption $ 4,050 Standard deduction 6,350 Net business loss 16,000 Net short-term capital loss 2,000
What is Destry’s net operating loss that is available for carryback or carryforward?
$7,000
Wages $ 5,000
Interest on savings account 1,000
Net rental income 4,000
Net business loss (16,000)
Net short-term capital loss (2,000)
AGI ( 8,000)
Deductions:
Personal exemption $ 4,050
Standard deduction 6,350
Taxable loss (18,400)
Adjustments to arrive at NOL carry back or carry forward (Use Form 1045, Schedule A for calculation purposes.)
$18,400 TAXABLE LOSS
Plus $ 4,050 Personal exemption, Destry cannot deduct his personal exemption.
Plus $5,350 Adjustment for deductions that are not connected to a trade or business or employment, such as the standard deduction of $6,350 reduced by the non-business income of $1,000 interests from savings.
Plus $ 2,000 Short-term capital loss as adjusted by business capital gains and losses (-0-).
($ 7,000) Correct carryback or carryforward
An INDIVIDUAL’S LOSSES on transactions entered into for PERSONAL purposes are only DEDUCTIBLE if the losses qualify as ________________________.
casualty or theft losses
The net operating loss CARRY BACK allows an individual or corporation to offset a NOL against taxable income for the previous _________ years. The net operating loss CARRY FORWARD allows an individual or corporation to offset a NOL against taxable income for the next _______ years. An individual or corporation MAY CHOOSE not to _______ an NOL and only __________.
2
20
carry back
carry it forward
CORPORATIONS other than certain financial institutions are REQUIRED to use the _________ method in accounting for BAD DEBTS. CERTAIN FINANCIAL INSTITUTIONS are allowed to use the ______ method.
direct charge-off
reserve
Under the DIRECT-CHARGE OFF METHOD, CORPORATIONS may claim a DEDUCTION once a specific BUSINESS debt becomes ___________________ and a specific NONBUSINESS debt becomes ___________.
partially or wholly worthless
wholly worthless
You can generally DEDUCT HOBBY EXPENSES, but only up to the amount of _______. A hobby isn’t a business because it isn’t carried on to __________.
hobby income
make a profit
Unreimbursed employee expenses
- Miscellaneous itemized deduction subject to 2% of AGI floor
- Paid or incurred during the tax year, for carrying on your trade or business of being an employee, and ordinary and necessary.
Passive Activity
A profit-seeking activity in which the taxpayer DOES NOT MATERIALLY PARTICIPATE in its management.
e.g. limited partners; rental income regardless of the level of participation by the taxpayer
Portfolio Income
Investment income such as interest, dividends, capital gains, and royalties.
PASSIVE LOSSES can be deducted to the EXTENT OF _______. The net result will have NO EFFECT on ___________________.
passive income
portfolio income or income from active businesses
A natural person is allowed a ________ allowance/deduction for offsetting NON PASSIVE INCOME WITH PASSIVE LOSSES resulting from RENTAL ACTIVITIES. However, the allowance/deduction must be reduced by ________ of the amount that the taxpayer’s AGI exceeds ________ and is fully phased out when AGI exceeds _______.
$25,000
50 percent
$100,000
$150,000
e. g. AGI is $125,000, the special $25,000 allowance/deduction is reduced by $12,500 [($125,000 − $100,000) × 50%]. Thus, $12,500 ($25,000 − $12,500) of the rental loss can be offset against income from nonpassive sources.
e. g. AGI is $160,000, $15,000 passive income, and $35,000 passive loss. The $25,000 allowance/deduction does not apply since AGI exceeds $150,000. Passive losses can only be deducted to the extent of passive income. Therefore, only $15,000 of the real estate rental activity is deductible.
Two ways to meet material participation requirement.
- to work more than 500 hours in the activity
2. to work more than 100 hours if no other individual works more than 100 hours
Active Participation
Occurs for taxpayers who own AT LEAST 10% of the property and SIGNIFICANTLY participate in decision-making.
Smith has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities. What amount of the rental losses may Smith deduct in determining taxable income?
$15,000
Since Smith actively participates in the rental real estate activity he can deduct up to $25,000 of rental losses. However, this deduction is reduced once modified AGI exceeds $100,000. Smith has $20,000 of excess AGI ($120,000 − $100,000) so he loses $10,000 ($20,000 × 50%) of the deduction. Of the $40,000 of losses, he can deduct $15,000 ($25,000 − $10,000). The remaining $25,000 of losses is suspended.
A review of Bearing’s year 2 records disclosed the following tax information:
Wages $ 18,000
Taxable interest and qualifying dividends 4,000
Schedule C trucking business net income 32,000
Rental (loss) from residential property (35,000)
Limited partnership (loss) (5,000)
Bearing actively participated in the rental property and was a limited partner in the partnership. Bearing had sufficient amounts at risk for the rental property and the partnership. What is Bearing’s year 2 adjusted gross income?
$29,000
Wages, interest, dividends, and Schedule C income are all taxable for a total of $54,000. $25,000 of the rental loss is allowed since Bearing actively participates in the rental real estate activity and his modified AGI does not exceed $100,000. However, the $5,000 passive loss from the partnership cannot reduce other income. Therefore, AGI is $29,000.
SUSPENDED PASSIVE LOSSES can be __________________, but they cannot be _________.
carried forward indefinitely
carried back
The TIME TEST for deductible MOVING EXPENSES does NOT have to be met in case of _______ , _____________, or __________________.
death
taxpayer’s job at new location ends because of disability
taxpayer is laid off for other than willful misconduct
Since a NOL generally represents a BUSINESS loss, an INDIVIDUAL taxpayer’s _______________, ___________________________, and _____________ cannot be subtracted in computing the NOL.
personal and dependency exemptions
an excess of nonbusiness deductions over nonbusiness income
a net capital loss
No ____________ for INTEREST EXPENSE is allowed. Instead, interest expense must be ________ over the period to which it relates.
advance deduction
amortized
Taxable Income Calculation
Gross Income - Deductions for AGI = AGI - Standard Deduction or Deductions from AGI (whichever is greater) - Personal Exemption ($4,050) = Taxable Income
Standard Deduction Amounts
Single or Married filing separately, $6,350
Married filing jointly or Qualifying widow(er), $12,700
Head of household, $9,350
Tax Liability Calculation
Filing Status = Single
Disregard Self-Employment Tax
Taxable Income = $94,750
Net Taxable Income = $94,750 Taxable Income - $1,300 Qualified Dividend Income = $93,450
Bracket = 28%
Tax Liability = $18,713.75 + [$1,550 (excess over $91,900) * 28%]
Plus Qualified Dividend Income Tax = $1,30015% (within the 28% bracket) = $195
Plus Penalty on Premature IRA distribution (before age 59 1/2) = $5,000 Distribution10% Penalty = $500
Total Tax Liability = $19,843
Qualified dividend income is taxed at a ____________ for individuals. The tax rate is ______ for qualified dividends if the taxpayer is in the _______ tax bracket, _____ for qualified dividends if the taxpayer is in the ________ tax bracket, and _____ for qualified dividends if the taxpayer is in the _________ regular rate.
preferential rate
0% tax –> 10 or 15% bracket
15% tax –> 25, 28, 33, or 35% bracket
20% tax –> 39.6% bracket
Investment income includes taxable _______, _______, __________, and _________.
- interest income
- dividends
- annuities
- certain royalties and rents
Net investment income tax
The tax equals 3.8% of the LESSER OF 1) an individual’s net investment income or 2) the excess of AGI over a threshold amount. The threshold amount is $250,000 for married filing joint ($125,000 for married filing separate) and $200,000 for unmarried individuals.
If property is sold for which a depreciation deduction was claimed or could have been claimed, the SELLER must report any ____________ in the year of sale, whether or not an installment payment was received that year.
depreciation recapture income
Depreciation recapture is equal to the LESSER OF ____________ or ______________.
realized gain on the sale
depreciation taken
The depreciation recapture amount is also ______ to the original adjusted basis for INSTALLMENT SALE PURPOSES.
added
The GROSS PROFIT % for installment sale purposes is determined by _________________________.
taking the gross profit and dividing by contract price (sales price)
Installment sale income calculation
Payment in Year 1*Gross Profit % = Installment Sale Income for Year 1
Generally, a lessor will NOT recognize any income as a result of the __________ made by a lessee that revert to the lessor at the expiration of the lease. However, if the parties intend the __________ to be, in whole or in part, a SUBSTITUTE for rental payments, then the lessor must recognize the improvements as __________ equal in amount to the reduction in rental payments.
capital improvements
improvements
rental income
Insurance proceeds as payment on the debt, rather than as life insurance proceeds paid “by reason of death of the insured”
tax-free only to the extent of the amount of unpaid debt, and any proceeds in excess of the debt repayment must be included in gross income
Not deductible charitable contributions
- The value of your time or services
- Political contributions
- A needy family
Determine the interest that is deductible on Schedule A-Itemized Deductions.
Olympic 1098 (Acquisition) Interest Paid $28,750
Principal $625,000
Spartan 1098 (Home Equity) Interest Paid $5,150
Principal $100,000
Total interest expense Interest Paid $33,900
Principal $725,000
Olympic - Interest Deductible $28,750
Spartan - Interest Deductible $3,863 (see below)
Total - Interest Deductible $32,613
Home Equity Limitation:
FMV of residence = $700,000
Home equity interest expense is deductible only on the portion of the home equity loan that does not exceed the LESSER OF:
The fair market value of the residence less the acquisition debt ($700,000 – 625,000 = $75,000), or
$100,000 ($50,000 for married filing separate)
Allowable percentage $75,000 Limitation/100,000 Principal = .75
Allowable home equity interest $5,150 Interest Paid × .75 = 3,863
Schedule A (Form 1040)
Itemized Deductions
Schedule B (Form 1040)
Interest and Ordinary Dividends
Schedule C (Form 1040)
Profit or Loss From Business (Sole Proprietorship)
Schedule D (Form 1040)
Capital Gains and Losses
Schedule E (Form 1040)
Supplemental Income or Loss (rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in REMICs)
Form 4562
Depreciation and Amortization
The ______ method, using the increase in the allowance for doubtful accounts based on an aging of accounts receivable, cannot be used for _______.
reserve
tax purposes
To maximize the INVESTMENT INTEREST expense deduction, a taxpayer may ELECT to include ___________________ as investment income. If the taxpayer chooses to do so, he/she must REDUCE the amount of ___________________ eligible for the REDUCED preferential long-term capital gains RATE by the same amount included in _____________.
qualified dividends and capital gains
qualified dividend and capital gains
investment income
e.g. Joshua has the following investment income if he chooses to maximize his investment interest expense of $5,000:
Interest income $950
Qualified dividend income 1,250
Long-term capital gain 1,700
Investment income $ 3,900
Joshua is allowed to take $3,900 of his $5,000 as an investment interest expense deduction. The remainder is carried forward indefinitely.
One can qualify as a DEPENDENT as either a __________ or a ___________.
qualifying child
qualifying relative
Qualifying Child Tests
- Relationship test—The dependent must be a natural child, stepchild, adopted child, foster child, sibling, step-sibling, or a descendant of any of these. Note, that this definition includes brothers, sisters, nieces, and nephews.
- Residence test—The dependent must have the same principal place of abode as the taxpayer for MORE THAN ONE HALF of the tax year. Note, that one could live with several individuals who potentially qualify to claim the individual as a dependent (mother, aunt, grandfather) at the same time.
- Age test—The dependent must be UNDER the age of 19 at the end of the tax year, OR UNDER 24 if a full-time student for at least five months of the tax year. There is NO age LIMITATION if the individual is permanently and totally DISABLED.
- Joint return test—A dependent cannot file married-jointly.
- A dependent can file jointly to obtain a refund (the dependent is not required to file according to gross income level). Otherwise, a married-jointly taxpayer will not qualify as a dependent despite passing all of the other tests.
- Citizenship/residency test—A dependent must be a citizen or resident of the U.S., or a resident of Canada or Mexico.
- Not self-supporting test—To be claimed as a dependent, the individual must not have provided MORE THAN 50% of his or her own support.
- Other requirements—In addition to the above, a qualifying child must be younger than the taxpayer who is claiming the child as a dependent. Also, if a parent is qualified to claim the child as a dependent but declines, no other individual can claim the individual unless that individual’s AGI is higher than that of any parent.
Qualifying Relative Tests
- Support test—The taxpayer must provide MORE THAN 50% of the dependent’s total support. The multiple support agreement provision continues to apply.
- The support test traces the source of the funds
used to pay for necessities. - Support does not include unused sources of funds
of dependent. - Scholarships do not count as support.
- The support test traces the source of the funds
- Gross income test—The dependent’s gross income must be LESS THAN the exemption amount for the year ($4,150 for 2018). Gross income is defined as only the income that is taxable. Social security income is EXEMPT. There are TWO EXCEPTIONS to this test. These apply for a CHILD/STEPCHILD or for an ADOPTED or a FOSTER CHILD: That is under the age of 19 at the end of the tax year. or That is under 24 at the end of the tax year and is a full-time student for at least five months during the tax year.
- Joint return test—A dependent cannot file married-
jointly. - Citizenship/residency test—A dependent must be a
citizen or resident of the U.S., or a resident of
Canada or Mexico.
- Joint return test—A dependent cannot file married-
Multiple Support Agreements
- Allow a group of taxpayers who (together) support an individual more than 50%.
- Except for the support test, each individual in the group would otherwise be eligible to claim the individual as a dependent.
- The taxpayer claiming the exemption provides OVER 10% but LESS THAN HALF of the support and is a QUALIFYING RELATIVE.
- A written agreement allocates the dependency exemption to a member of the group. All members providing more than 10% of the support must sign.
When the taxpayer and spouse FILE SEPARATE RETURNS, the taxpayer only may take an EXEMPTION FOR THE SPOUSE when the spouse ____________ and _____________.
has NO GROSS INCOME
was NOT CLAIMED as a dependent on another taxpayer’s income tax return
For a taxpayer to claim an individual as an EXEMPTION on his tax return, the individual must be a ________ of the taxpayer.
dependent
Qualifying Child vs. Qualifying Relative
age test vs. gross income test
