Unit 5 - Investment Income & Expenses Flashcards
1099-INT
Reports interest, income via financial institution or another payer
Given if the interest is $10 or more for the year
Even if you don’t receive the form, all interest income must be reported on your tax return
Schedule B
Interest and ordinary dividends
Taxable interest that exceeds $1500 is reported on schedule B
Gift for opening a bank account – deposit less than $5000
Gifts or services valued at more than $10 is reported as interest in income
Gift for opening a bank account – deposit of $5000 or more
Gifts or services valued over $20 are reported as interest income
Interest a taxpayer pays on funds borrowed from a financial institution to meet the minimum deposit required for a CD
This interest can only be deducted if the taxpayer chooses to itemize deductions
Deducted as investment interest
As long as it does not exceed their net investment income
Form 4952, investment interest expense, deduction
If the borrowed money generates tax-free income, it is not deductible as investment interest
Municipal Bonds - muni bonds
Interest is tax exempt
Federal income tax is exempt, but maybe subject to income taxes by state and local governments
Still needs to be reported on the 1040 even if it’s not taxable
Series EE bond
Issued at a discount
The difference between the purchase price and the amount received when the bonds are later redeemed or cashed in is interest income
Series I Bonds
Issued at face value with a maturity period of 30 years
The face value and accrued interest are payable at maturity
Interest on US treasury bills, notes, and bonds
Normally taxable for federal income tax, purposes and exempt from state and local income taxes
When do you report interest income from a series, EE or series I savings bond
Either…
When the bond matures or is redeemed – whichever occurs first
Or each year as the bonds redemption value increases – if the taxpayer makes an election
Taxpayers must use the same reporting method for all the series EE and series I bonds they own
The education savings bond program
Both series, EE and series high savings bonds are also called educational savings bonds
Special rule permits, qualified taxpayers to exempt the interest earned upon redemption of eligible savings bonds, if they are used to pay higher education expenses in the same year
Must be for the taxpayer, a spouse, or dependence
Interest earned on these bonds is usually exempt from state taxes as well
Must use both the principal and interest to pay for qualified education expenses does not include textbooks or room and board
Taxpayer must be at least 24 years old before the bonds issue date
Bonds must be purchased by the owner – cannot be a gift
Qualified higher education, expenses must be reduced by scholarships and other tax-free benefits, like the American opportunity and lifetime learning credits
If principal and interest received from the bond do not exceed the education expenses, the percentage of the education expense Used of the principal and interest is multiplied by the interest to pay tax on that remaining value
Married filing separately, do not qualify for the tax exemption
Dividend income
A distribution of cash, stock, or other property from a corporation or a mutual fund
Form 1099 – DIV
If no form is received, the income must still be reported
If total dividend income is more than $1500, it must be reported on schedule be, interest, and ordinary dividends
Otherwise, the dividend income can be reported directly on form 1040
Dividend income - top rate
20%
The maximum tax rate for qualified dividends is 20% regardless of the taxpayers individual tax bracket
However, higher income taxpayers may also be subject to the net investment income tax (NIIT) on long-term capital gains and qualified dividends
Ordinary dividends
Are corporate distributions in cash that are paid to shareholders out of earnings and profits
At the taxpayers, ordinary income tax rates
Reported in box 1A form 1099 – DIV
Qualify dividends
Dividends that meet certain requirements are taxed at lower capital gains rates if specific criteria are met
The tax rates are 0%, 15%, and 20%
Reported in box 1B of form 1099 – DIV
Qualified dividend requirements
The dividend must be paid by a US corporation or qualified foreign corporation
And
The taxpayer must have held the stock for more than 60 days during the 121 day period that begins 60 days before the ex dividend date (date of purchase doesn’t count)
Non-dividend distributions
Distributions that are not paid out of a corporations earnings and profits
Considered a recovery or return of capital and therefore our generally not taxable
The distributions reduce the taxpayers basis in the stock of the corporation
Once the basis is reduced to zero, any additional distributions are capital gains and are taxed as such
Reported in box 3 of form 1099 – DIV
Money market funds
Money market funds pay dividends and are offered by non-bank financial institutions
Such as mutual funds and stock brokerage houses
Amount received should be reported as dividends, not as interest
Stock dividend
A distribution of stock rather than money by a corporation to its own shareholders
Generally Non-taxable
If the shareholder has the option to receive cash instead of stock, the stock dividend is taxable in the year. It is distributed. - must include the fair market value of the newly issued stock in gross income
The Education Saving Program (bonds) - MFS
They don’t qualify for the exemption
Dividend Reinvestment Plans (DRIP)
Dividends are used to buy more stock instead of receiving dividends in cash
Must still report the dividends as income at FMV
Mutual Fund
An investment vehicle that allows investors to pool their money to invest in stocks, bonds, and other securities
Managed by a portfolio manager
Combined holdings are the “portfolio”
Generally distribute all of their ordinary income to shareholders by the end of the year
Taxpayer will receive form 1099 – DIV, identifying the types of distributions received
Mutual fund distribution may include…
Ordinary dividends
Qualify dividends
Capital gain distributions
Exempt interest dividends
Non-dividend distributions
Ordinary dividends are the most common type from a mutual fund - taxable as ordinary income
Mutual fund – capital gain distributions
Short term or long term
Always treated as long-term, regardless of the actual period. The mutual fund investment is held.
Mutual fund – tax exempt securities
Distributions are tax exempt interest, and retain their tax exempt character for the payee
But the taxpayer must report them on the tax return
REIT
Real estate investment trust
Mutual fund and REIT – declared dividends
If a mutual fund or real estate investment trust declares a dividend payable to shareholders in October November or December, but actually pays the dividend during January of the following year. The shareholder is considered to have received the dividend on December 31 of the prior tax year and must report the dividend in the year it was declared.
Regardless, if the dividend is withdrawn or reinvested
Constructive distributions
Also called constructive dividends
Certain transactions between a corporation and its shareholders may be considered dividends – and therefore taxable to the shareholders and non-deductible to the corporation
6 Examples
Payment of personal expenses
Unreasonable compensation
Unreasonable rents
Cancellation of a shareholders debt
Property transfers for less than FMV
Below market or interest, free loans
Constructive distributions – payment of personal expenses
Corporation pays personal expenses on behalf of an employee – shareholder
Amount it should be classified as a distribution rather than expense
Constructive distributions – unreasonable compensation
Corporation pays an employee – shareholder and unreasonably high salary, considering the services performed
Excessive part of the salary may be treated as a distribution
Constructive distributions – unreasonable rents
Corporation rents property from a shareholder, and the rent is unreasonably higher then the shareholder would charge an unrelated party
Excessive part of the rent may be treated as a distribution
If corporation rents property to a shareholder that is unreasonably low
The discounted portion could be treated as a distribution
Constructive distributions – cancellation of a shareholders debt
Corporation cancels a shareholders repayment by the shareholder
Amount canceled may be treated as a distribution
Constructive distributions – property transfers, for less than FMV
Corporation transfers, or sell property to a shareholder for less than fair market value
Excess may be treated as a distribution
Constructive distributions – below market or interest, free loans
Corporation gives a loan to a shareholder on an interest-free basis or at a rate below the applicable federal rate
The uncharged interest may be treated as a distribution
