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.
Withdrawal of Cash Value
If there is a partial withdrawal of cash value from the policy, FIFO rules apply. There are no tax consequences until the amount withdrawn exceeds the cost basis in the policy.
Capital Gain
When a security is sold for a price higher than its cost basis
Adjusted Cost Basis
IRS requires cost basis be adjusted for evens such as stock splits and stock dividends. If an investor buys 100 shares at $55 per share and the company issues the investor 10 stocks as a dividend the new basis could be $50 per share ($5500 / 110).
Tax on Reinvested Dividends
Distributions received either in cash or dividends ar reported on Form 1099 as taxable for that year. B/c reinvestments have already been taxed, when a sale takes place, they are not taxed again, the amount reinvested adds to the investor’s tax basis (or cost).
Calculating Tax Liability
1.) Add all short-term capital gains and losses for the
year 2.) Then all long-term capital gains and losses 3.) Taxpayer offsets the totals to determine his net capital gain or loss for the year. If the result is a net capital gain, it is taxed at the capital gains rate of 15%. Capital losses are deductible against earned income up to $3,000/year. any losses not used can be carried forward to the next taxable year
Share Identification
An accounting method where investors keep track of the cost of each share purhcase and uses this information to liquidate the share that would prove the lowest capital gain. Used to identify the per share cost basis when shares are sold.
Average Cost Basis
An accounting methond where investors would calculate avearge basis by dividing the total cost of all shares owned by the total number of shares. Used usually for mututal fund shares.
Wash Sale
An investor may not use capital losses to offset gains or income if the taxpayer sells a security at a loss and pruchases the same or a substantitally identical security within 30 days before or after the trade date establishing the loss. Applies to realized losses, not gains.
What does the IRS look at when comparing similar securities in a wash sale?
Maturitiy, Coupon, and Issuer
Carryover basis
When a donor makes a gift of securities or virtually any asset, the cost basis to the receipient is the donor’s cost basis.
Taxes on the Capital Gains of a Primary Residence
The first $500,000 (for a couple, $250,000 for a single) in profit is excluded from capital gains so long as the primary residence has been lived in for at least 2 yrs.
Tax Filing Dates for Sole-Proprietorship
12/31 = YE ; 4/15 = Tax Return Due Date. use Schedule C to file their tax information
Tax Filing Dates forSingle Member LLC
12/31 = YE ; 4/15 = Tax Return Due Date
Tax Filing Dates for Partnerships & Multi Member LLCs
Form 1065 (Information Return w/ a K-1) filed on 3/15; YE = usually 12/31; Taxes are due 4/15 with the partners filing form 1040 showing their share of the business’s icnome or loss
Tax Filing Dates for Corporations
Any date can be choses for YE. Taxes are due on the 15th day of the fourth month after then end of the company’s fiscal YE. S-Corps must have a YE of 12/31 and Form 1065 (Information Return w/ a K-1) filed on 3/15; YE = usually 12/31; Taxes are due 4/15 with the partners filing form 1040 showing their share of the business’s icnome or loss
Distributable Net Income
Most trust distribute most of their income due to the onerous tax implications of high tax rates. Realized gains reinvested are not apart of DNI. Tax exempt interest from municipal bonds remains tax exempt to trust beneficiaries. Whether the income is distributed to the beneficiaries or not, each beneficiary is considered to be in receipt of taxable income
Bypass Trust
Used to take advantage of the lifetime estate tax exclusion. Commonly used between spouses. One spouse may leave another w/o incurring estate tax is unlimited, upon the death of that spouse, the lifetime exclusion is $5.45MM of assets that are not subject to estate tax. The Tax Relief Act of 2012 made it permanent that the portability of one spouse’s assets can be left to the other untaxed. Other than unusual circumstances, the necessity for busing bypass trusts has been eliminated after this act.
Portability of Unused Tax Exemption
The Tax Relief Act of 2010 allows the surviving spouse to take the unused portion of the first deceased spouse’s federal exemption estate tax exemption ($5.45 MM) and aggregate it with the surviving spouse’s unused portion. The Tax Relief Act of 2012 made this concept permanent.
Generation Skipping Trust (GST)
Used to pass money from family members to other members more than one generation removed. Therefore, instead of the assets being taxed upon the death of the parents and then again when their children pass them to the grandchildren, one level of taxation is eliminated
Direct Skip
When assets, either directly, through an estate, or thorough a trust are left to a beneficiary at least two generations below the transferor. The assets are directly skipping a generation. With a direct skip, where the estate is left to the grandchildren the donor or donor’s estate via the executor pays the generation-skipping transfer tax (GSTT).
Taxable Termination
A trust is terminated and pays out the remainder of its funds. The trustee is responsible for paying the GSTT.
Taxable Distribution
Any distribution from a trust to a skip person, the recipient is required to pay the GSTT.
Estate Tax
Imposed on the transfer of substantial amounts of property at death. An individual may transfer an unlimited amount to a spouse who is a U.S. citizen w/o the imposition of federal income tax (aka marital deduction). This also applies to a eligible charity.
Gross Estate
All interests in property held by an individual at the time of death (includes property that is transferred to a spouse or charity at death).
Adjusted Gross Estate (AGE)
Gross estate value after deductions are made (funeral, charity contributions, debts, etc). The net number is the taxable estate.
Alternative Valuation Date
An executor of an estate may choose to value the assets in the estate as of date of death or, alternatively six months later
Payment Date of Estate Taxes
Regardless if the date of death or alternative valuation date are used, estate taxes are due no later than nine months after death, extensions are available. The calculation is done on IRS form 706
Taxation of Estate Income
During the period of time before the estate is liquidated the estate may receive income and possibly capital gains. Taxation to the estate is the same as trust income, 39.6% for everything in excess of $12,400.
Gift Tax
Federal Tax imposed on the transfer of property during the lifetime of the donor; up to $5.45MM (2016). $14,000 can be given to any number of individuals w/o generating the federal gift tax. If a married couple join in the gift, $28,000 is allowed per person. Usually this unlimited for spouses, however, if your spouses is not a U.S. Citizen, the limit is $148,000 for the spouse that can be gifted in a single yr. Filing the gift tax is the responsibility of the donor, not the donee to report.
Taxation on Foreign Securities
Dividend and interest income received from foreign securities, including ADRs, is normally subject to withholding tax, typically 15%, by the issuer’s country of domicile. US tax law allows many investors to reclaim the withheld tax as a credit against taxes owed on their tax return
