Unit 4 - Session 17 - Tax Considerations Flashcards
Regressive Taxes
Levied at the same rate regardless of income and thus represent a smaller percentage of income for wealthy taxpayers than for taxpayers with lower incomes.
Progressive Taxes
Increase the tax rate as income increases. Progressive taxes are costlier to people with high incomes. Aka known as the marginal tax rate
Earned Income
Salary, bonuses, tips, income derived from active participation in a trade or business
Alimony
Payment made under a divorce court order to an ex-spouse. Tax deductible
Child Support
Legal Obligation of a parent to provide financial support for a child. Not tax deductible.
Passive Income
and losses from rental property, limited partnerships, enterprises in which an individual does not actively participate.
Portfolio Income
Dividends, interest, net capital gains derived from the sale of securities. It is taxed in the year it is earned.
Dividend Income
If the dividend qualifies the tax rate is generally a max of 15%, otherwise the dividend is taxed at ordinary income rates
Interest Income
Interest on any debt security is always taxed at ordinary income rates. U.S. Treasuries is exempt from state taxation but not federal. Income distributions from bond funds are not qualified dividends and are taxed fully as ordinary income.
Reinvested Distributions
Distributions are taxable to shareholders whether the distributions are taken in cash or reinvested. Form 1099 details tax information related to distributions for the year.
Interest-on-interest plan
Banks savings account where its compounds (i.e. earning interest-on-interest
Reinvestments on Cost Basis
B/c taxes have already been paid on any income reinvested, when the investor sells the asset, the cost basis is increased so that the income is not taxed again
Alternative Minimum Tax
Ensures that high-income taxpayers do not escape federal income taxes. Certain items that receive favorable tax treatment muste be added back into taxable income for AMT
- ) Accelerated depreciation
- ) Certain costs associated with limited partnership programs, such as research and development costs and excess intagible drilling cost
- ) Local tax and interest on investments that do not generate income
- ) Tax-exempt interest on private purpose municipal bonds issued after 8/7/86. I.e. sports stadiums, hospitals, housing projects, etc.
- ) Incentive stock options to the extent that the fairm akret value of the employer’s stock is in excess of the strike price of the option, even when the stock is not sold in that year
AMT can lead to the loss of personal exemptions, deductions for state income tax and property tax and deudction for home equity line interst
Tax Preference Items
Items that must be added back in for the purpose of the AMT computation
Margin interest
Tax-deductible expense. The one exception is interest expenses incurred in the purchase of municipal securities b/c municipal securities interest income is tax exempt
Income Tax on Life Insurance
Premiums are generally nondeductible for income tax purposes and policies made to beneficiaries are exempt from federal income tax
Estate Tax Implications to Life Insurance
If someone named as the insured individual on a life insurance policy holds incidents of ownership in that policy, the entire death benefit payable under that policy is included for federal estate tax purposes in the in the insured individual’s estate.
Irrevocable Life Insurance Trust
Due to estate tax implications, it is frequently best that a party other than the insured own the life insurance policy in order to remove the proceeds from the state of the insured. One way to do this is to transfer to an irrevocable trust life insurance trust. If the ILIT has Crummey powers, then the premiums paid may qualify for the annual gift tax exclusion
Policy Loans
Like any loan received, loans against life insurance policies are non-taxable
Policy Surrender
If a variable life insurance policy is surrendered, any cash value in excess of the basis in the policy (the premiums paid) is taxable as ordinary income.