Cfp Tax Planning - 2008

Front 1

What type of dividends do not receive preferential rates?

Back 1

dividends received from:
-credit unions
-mutual insurance companies
-real estate investment trusts
-farmers’ cooperatives
-tax-exempt entities
-deductible dividends from employer securities owned by an ESOP
-stock owned for less than 61 days in the 121-day period beginning 60 days before the ex-dividend date

Front 2

Adjustments to income(adjustments for AGI) reduce income dollar for dollar and include:

Back 2

-the penalty on early
withdrawal of savings
-alimony payments
-qualified moving expenses
-contributions to a Keogh (self-employed) retirement plan
-self-employed
health insurance deductions
-qualified medical savings account (MSA)contributions
-qualified education interest
-deductible IRA contributions
-qualified higher education expenses
-teacher’s education expenses up to $250
-jury duty fees paid over to the employer
-fees and costs related to
discrimination lawsuits
-one-half of the self-employment tax

Front 3

Taxpayers are allowed an above-the-line deduction for interest paid on qualified higher education loans. What is the maximum deduction and what are the income phaseout ranges?

Back 3

$2,500 and the deduction begins to phase out for married individuals with
modified adjusted gross income of $115,000 ($55,000 for single persons)
and is completely phased out at a modified adjusted gross income of $145,000 for married taxpayers ($70,000 for single persons)

Front 4

For single individuals, the IRA deduction is phased out for modified adjusted gross incomes between $______ and $______if the individual is
an active participant in a company-maintained retirement plan.

Back 4

$53,000 and $63,000

Front 5

For a married couple filing a joint return, the IRA deduction is phased
out (eliminated) for modified adjusted gross incomes between $_______ and $_______if both spouses are active participants in a company

Back 5

$85,000 and $105,000

Front 6

The rules for married taxpayers filing jointly, with only one spouse as an
active participant are:

Back 6

The active participant spouse is subject to the phaseout range of $85,000 to $105,000. Thus, under $85,000 of AGI on the joint return, the
active participant may still take a full deduction. Between $85,000 and
$105,000, the active participant spouse is allowed a partial deduction, and
above the $105,000 limit, there is no IRA deduction for the participant spouse. The non-active participant spouse may take a deduction for the
contribution subject to a phaseout ranging from $159,000 to $169,000
(indexed for inflation as a result of PPA). Thus, the non-active participant
may take a full deduction for the IRA contribution if the AGI on the joint
return is under $159,000. Between $159,000 and $169,000, the non-active
participant spouse is allowed a partial deduction, and above the $169,000
limit, there is no IRA deduction for the spouse that is not an active participant.

Front 7

The deductible floor for medical expenses is __% of the taxpayer’s adjusted gross income.

Back 7

7.5%

Front 8

The deductible floor for Tier II miscellaneous itemized deductions is __% of the taxpayer’s adjusted gross income.

Back 8

2%

Front 9

After subtracting a $100 floor per loss, casualty
and theft losses are deductible only to the extent they exceed __% of
the taxpayer’s adjusted gross income.

Back 9

10%

Front 10

For the Roth IRA, the possible $5,000 limit is phased out for individuals with AGIs between $101,000 and $116,000 or for joint filers with AGIs between $______ and $______ , without regard to active participant status

Back 10

$159,000 and $169,000

Front 11

What are the Standard Deduction amounts for 2008?

Back 11

Married persons filing jointly $10,900
Heads of households $8,000
Single persons $5,450
Married persons filing separately $5,450

Front 12

Married individuals who are elderly (age 65 before the close of the tax year) or blind are entitled to another standard deduction (for
2008) of $1,050 ($2,100 if both elderly and blind). Unmarried individuals
who are elderly or blind are entitled to an additional standard deduction
of $_______.

Back 12

$1,350 ($2,700 if both elderly and blind)

Front 13

Taxpayers are entitled to use the
tax schedules applicable to single taxpayers or, if they qualify, the head of
household rates, if they:

Back 13

(1) file a separate return (2) maintain as their
home a household that is a child’s or stepchild’s principal place of
residence for more than half of the tax year
(3) are entitled to a
dependency deduction for such child
(4) provide more than half of the cost of maintaining the household
(5) do not live with their spouse for any period during the last six months of the tax year.

Front 14

To qualify as a head of household, an individual must:

Back 14

(1) be a U.S. citizen
or resident for the entire taxable year
(2) be unmarried or considered
unmarried at the close of the taxable year
(3) provide more than half
of the cost of maintaining a household that is the principal place of
residence of a qualifying child or an individual for whom a dependency
exemption is allowed.
-A taxpayer supporting a parent in a rest home, nursing home, or separate
home will be able to qualify for head of household status as long as the first two requirements above are satisfied.

Front 15

Qualifying widows or widowers are entitled to use the married filing jointly tax rates. To qualify, the widow or widower must:

Back 15

(1) be unmarried at year-end; (2) have children for whom he or she is entitled to
a dependency exemption;
(3) furnish more than half the cost of maintaining a household that is the principal place of residence for such children; and
(4) have been entitled to file a joint return with the
deceased spouse for the year of death.
-Qualifying widows or widowers can file a joint return with the deceased
spouse for the year of death and are entitled to use the married filing jointly tax rates for the succeeding two taxable years, provided the
requirements remain satisfied.

Front 16

Itemized deductions are deductions from adjusted gross income and include:

Back 16

1. specified medical expenses that exceed 7.5% of adjusted gross income
2. state and local income taxes
3. real and personal property taxes
4. mortgage interest on primary and secondary residences
5. investment interest expense
6. charitable contributions
7. casualty and theft losses that exceed 10% of adjusted gross income after subtracting the $100 floor for each loss
8. miscellaneous deductions, which include impairment-related work expenses of handicapped individuals, gambling losses to the extent of gambling winnings, and a deduction if annuity payments cease before the investment is recovered, and
9. Tier II miscellaneous itemized deductions

Front 17

Tier II miscellaneous itemized deductions, which are deductible only
to the extent that the cumulative total exceeds 2% of adjusted gross
income. These expenses are comprised of:

Back 17

expenses related to the determination of, or collection of, a tax
liability, such as tax return preparation fees, legal fees to defend oneself during an audit, and appraisal expenses for certain charitable contributions; unreimbursed employee business expenses, such as union and
professional dues, home office expense for an employee,
unreimbursed travel expenses, uniforms or special clothing, etc.; and expenses related to the “production of income,” such as investment counsel or investment adviser fees, certain legal fees, etc.

Front 18

A taxpayer’s otherwise allowable itemized
deductions are reduced by the lesser of:

Back 18

(a) 3% of the excess of AGI over a specified amount or (b) 80% of the otherwise allowable itemized deductions for the year. The specified amount for all filing statuses (other
than married filing separately) in 2008 is $159,950 ($79,975 in the case of a married individual filing a separate return).

Front 19

The reduction (phaseout) of
the itemized deductions does not apply to:

Back 19

-medical expenses
-investment interest
-casualty and theft losses
-gambling losses

Front 20

Example 1. Mary, a single taxpayer, has AGI of $269,900. She has $30,000 of
itemized deductions, consisting of $2,125 of deductible medical expenses
(after the 7.5% floor), $8,000 of home mortgage interest, $11,000 of taxes,
$4,000 of charitable contributions, and $4,875 of investment interest.
Mary’s itemized deductions would be reduced by $3,299 (3% of $109,950). The $109,950 is the excess of the AGI over the $159,950
threshold. As a result of EGTRRA, the 2008 phaseout is only 1/3 of the calculated phaseout. Thus, her itemized deductions are reduced by $______:

Back 20

$1,100 (1/3 of the $3,299.) She will be allowed to deduct $28,900 of itemized
deductions ($30,000 reduced by the phaseout amount of $1,100).

Front 21

Three kinds of personal exemptions may be claimed:

Back 21

(1) the taxpayer’s
exemption for himself or herself, (2) an exemption for the taxpayer’s
spouse, and (3) exemptions for the taxpayer’s dependents.

Front 22

A qualifying child is a child who:

Back 22

meets the relationship test,
has the same principal place of abode as the taxpayer for more than one-half of the tax year, meets the age test, and
has not provided more than one-half of his or her own support for the tax year.

Front 23

A qualifying relative is an individual who:

Back 23

bears a specified relationship to the taxpayer or whose principal place
of abode is the taxpayer’s home and is a member of the taxpayer’s household,has gross income for the tax year that is less than the exemption amount, has over half of his or her support provided by the taxpayer, and
isn’t a qualifying child of that taxpayer or any other taxpayer.

Front 24

A tax credit is a dollar-fordollar
offset against the tax liability and typically is determined by use of
a formula—often a percentage of a base amount. Tax credits are allowed for such things as:

Back 24

-investments in low-income housing
-certain real estate
rehabilitation expenditures
-qualified research expenditures
-qualified child care expenses
-qualifying adoption expenses

Front 25

Effective for tax years beginning in 2002 through
2010, a nonrefundable tax credit of $11,650 (for 2008) of qualified
adoption expenses for each eligible adoptee is available. The credit is phased out between:

Back 25

$174,730 and $214,730 of modified AGI.

Front 26

Child tax credit. A maximum tax credit of $______ for 2006 through 2009 is
provided for each qualifying child. The credit is phased out, $50 for each $1,000 or part thereof, for taxpayers
with modified AGI that exceeds $110,000 (for married taxpayers filing
jointly), $75,000 (for single taxpayers), and $55,000 (for married taxpayers
filing separately)

Back 26

$1,000

Front 27

A qualifying child generally is defined as an individual:

Back 27

-under the age of 17 (determined at the close of
the calendar year) for whom the taxpayer may claim a dependency exemption.
A qualifying child includes a child or a descendant of a child, a stepchild, or an eligible foster child.

Front 28

If the taxpayer’s gross income is equal to or less than the sum of his or her
applicable standard deduction and exemptions:

Back 28

No return will be required to file.

Front 29

The equivalent tax benefit of exclusions or deductions to tax credits can
be determined by applying the following formula:

Back 29

TC = B × t
Where:
TC = Amount of tax credit (or tax savings)
B = Before-tax benefit (amount of exclusions or deductions)
t = Marginal income tax bracket

Front 30

If one knows the amount of tax credit and wishes to
determine the amount of exclusions or deductions that would equal the
credit, the following formula applies:

Back 30

B=TC/t

Front 31

Taxpayers using the accrual basis method of accounting also are subject
to certain advantages and disadvantages. The main advantage is that a
deduction may be taken for an expense that has not been paid. The main
disadvantage is that taxpayers using this method:

Back 31

May have to recognize
and pay tax on income that has not been received.

Front 32

Economic performance occurs when:

Back 32

Economic performance occurs when the property or service to which the
accrual relates is actually provided or used.

Front 33

C corporations (other
than qualified personal service corporations), and partnerships with a C
corporation partner (other than qualified personal service corporations),
with average annual gross receipts of more than $5,000,000 for any prior
three taxable-year period (or, if less, the period of its existence) may not
use the _____ method of accounting

Back 33

Cash Method

Front 34

Regarding the inventory requirement, there are two exceptions granted to
small taxpayers:

Back 34

Taxpayers with average annual gross receipts of
$1,000,000 or less for each of the three prior taxable years do not have to
account separately for inventories, or use the accrual method of
accounting.
Certain taxpayers with average annual gross receipts of more than $1,000,000, but less than $10,000,000, for the three prior taxable year
periods may use the cash method, without having to separately account
for inventory. These are taxpayers whose principal business activity is an
activity other than mining, manufacturing, wholesale or retail trade, or
information industries.

Front 35

The hybrid method of accounting involves the use of both the cash basis
method and the accrual basis method by the same taxpayer. This method
of accounting will be considered an acceptable method if it clearly reflects
income and is used consistently. Under the hybrid method of accounting,
the taxpayer uses the ____________ method of accounting for sales and
purchases and the _______________ method of accounting for all other items of
income and expense.

Back 35

accrual basis; cash basis

Front 36

Taxpayers dealing with long-term contracts generally must use the
_____________________ method for accounting for the long-term
contract.

Back 36

percentage-of-completion

Front 37

The lookback method does not apply to any contract that
satisfies both of the following requirements:

Back 37

1. The gross receipts of the contract cannot exceed the lesser of
$1,000,000 or 1% of the average annual gross receipts of the taxpayer
for the three taxable years preceding the taxable year in which the
contract was completed.
2. The contract must be completed within two years of the contract
commencement date.

Front 38

Once an accounting method has been chosen, the taxpayer must continue to use it until:

Back 38

(1) the IRS requires him or her to change, or (2) a request is made by the taxpayer to the IRS for permission to change and the permission is granted

Front 39

The following are examples of a correction of an error:

Back 39

1. correction of mathematical or posting errors
2. correction of errors involving the computation of tax liability
3. adjustment of income or deduction items that do not involve proper timing for inclusion of items
4. adjustment of the useful life of a depreciable asset
5. change in the treatment of any item that results from a change in underlying facts

Front 40

During inflationary periods, the _________ method of valuation will provide greater
deductions for cost of goods sold than would the first in, first out (FIFO) method.

Back 40

last in, first out (LIFO)

Front 41

During periods of escalating inventory prices, this
method results in taking the least expensive items into cost of goods sold,
and leaving the highest priced inventory in ending inventory. Thus, this
method results in relatively lower cost of goods sold, relatively higher taxable income, and relatively higher tax liability.

Back 41

first in, first out (FIFO)

Front 42

Concerning the inventory requirement, there are two exceptions that are
granted to small taxpayers. Taxpayers with average annual gross receipts
of $____________ or less for each of the three prior taxable years do not have
to account separately for inventories. Certain taxpayers with average annual gross receipts of more than
$___________, but less than $___________ for the three prior taxable year
periods may use the cash method, and do not have to separately account
for inventory. These are corporations whose principal business activity is
an activity other than mining, manufacturing, wholesale or retail trade, or
information industries.

Back 42

$1,000,000; $1,000,000 and $10,000,000.

Front 43

Tax treatment of the partnership provides for _________________, which is considered to be one of the most notable features of a partnership

Back 43

conduit taxation

Front 44

Conduit taxation can be an advantage or disadvantage, depending on the
particular circumstances of the partners. It generally is considered an advantage in situations where the partnership is:

Back 44

producing losses,
deductions, or tax credits that can be used by the partner to offset income
from other sources.

Front 45

Conduit taxation is a disadvantage if the partnership is:

Back 45

producing a large amount of income that is subject to
tax at the highest marginal rate of the individual partners.

Front 46

Formation of partnerships generally is tax free, except in three situations:

Back 46

First, when a partnership is formed that has an appreciated portfolio of
securities, gain may be recognized on the appreciation of those securities upon their contribution to the partnership.
Second, taxation also can be triggered when a partnership is formed with a service partner.
Finally, income may be recognized on partnership formation if a partner’s
individual liability is decreased because the partnership assumes that
debt.

Front 47

Nonrecourse financing is debt that is:

Back 47

secured by the property, but for which no individual has personal liability.

Front 48

The taxation on the income of the partnership, whether distributed or not, results in there being:

Back 48

no retained
earnings in the partnership.

Front 49

How is the income tax treatment of a partnership upon liquidation is considered
to be an advantage of the business form?

Back 49

Because the partner’s basis in the partnership is adjusted upward to reflect all income and downward for
each distribution during the operation of the partnership, there generally is no income or loss upon liquidation.

Front 50

The IRS has ruled that if all the income is to be allocated to one partner in
the current year and to another partner in the subsequent year, then there
is no substantial economic effect. The IRS viewed this special allocation as
being merely for the purpose of _____________.

Back 50

tax avoidance

Front 51

The many nontax advantages of partnerships include:

Back 51

-can be easily organized and
the partners are not required to enter into a formal partnership agreement.
-the partners need not obtain state approval before operating their
business. This simplicity is advantageous in that it reduces the amount of
time and costs associated with starting a business.
-Partnerships also are free from annual legal reporting requirements and do not have to pay taxes.
-no separation between the
partners as owners and as managers in the day-to-day operation of the business.

Front 52

The most significant nontax disadvantage of partnerships is:

Back 52

the unlimited personal liability of the partners. Partners in a partnership have joint and several liability. All partners are liable for the acts of the partnership, the other partners, and obligations made by any partner in the performance of partnership duties. This means that a partner is liable for the acts of every other partner in the partnership as if they were the partner’s own
acts.

Front 53

How is the lack of continuity in the life of a partnership a significant disadvantage?

Back 53

The partnership is automatically dissolved by operation of law upon the death, incapacity, or bankruptcy of any one of the
individual partners. This could be a severe disadvantage in a large
partnership because of the increased likelihood of this occurring. The dissolution of the partnership may cause severe losses by forcing a
business sale.

Front 54

The sale of a partnership (or LLC) may take the form of a sale of
partnership assets, or as a sale of an ownership interest. If the transaction is a sale of the partnership assets, then the sale is treated:

Back 54

as the sale of a capital asset, although ordinary income treatment may exist in unrealized accounts receivables or substantially appreciated inventory.

Front 55

Limited partnerships generally are used in three situations:

Back 55

-First, limited partnerships are appropriate for the pass-through of losses from taxadvantaged investments.
-Second, limited partnerships are well suited for
investors who wish to invest in a business, but who want to protect the
rest of their financial resources from a potential business failure.
-Finally, a limited partnership offers the entrepreneur the advantage of locking any financial partners out of the management of the venture.

Front 56

The principal purpose and advantage of the limited partnership is that it
permits the limited partner to invest in the venture without being:

Back 56

subjected to personal liability for obligations of the business (which is the
case in a general partnership). The limited partner’s total liability is
restricted to the promised capital contribution. If the limited partner
commits to contribute $50,000 and has done so, then upon the
partnership’s default, the limited partner is liable for nothing more

Front 57

The limited partnership must have at least one:

Back 57

general partner that has
unlimited liability.

Front 58

The disadvantages of a limited partnership are:

Back 58

-it requires a great deal more formality than the regular or general partnership, and it
necessitates a written agreement.
-The limited partners also are subject to a number of restrictions. First, the
limited partners must contribute cash or property to the limited
partnership’s capital. There can be no service-limited partners. Second,
the limited partners cannot have control of the day-to-day management
of the limited partnership. If the limited partners assume such control,
they forfeit their protection as limited partners and become general
partners, and their liabilities for partnership obligations are exactly the
same as those of the general partners

Front 59

The most widely recognized nontax advantage of the corporation is the:

Back 59

limited personal liability of the owners.

Front 60

Acts that are in excess of the authorized
corporate powers are called:

Back 60

ultra vires

Front 61

In addition to limited liability, corporations also have the advantage of
perpetual life. Sole proprietorships and partnerships will terminate at
some point in time, but corporations theoretically can exist forever. The continuity of life of the corporation may be extremely
important if the client wishes to:

Back 61

transfer partial ownership to a family member.

Front 62

Significant nontax disadvantages of corporations include:

Back 62

-Corporations are very formal in nature. To
maintain the corporate status, the shareholders, directors, and
management must devote significant time and energy to the corporation’s formalities.
-Corporations regularly generate copious paperwork.
-Related to the formality and required paperwork is the fact that the corporation usually is more expensive to run.
-Because corporations are state-chartered, they are limited in their ability to
conduct business in other states.
-Corporations tend to be less flexible than other business forms.
Management decisions tend to be stratified into layers of officers, directors, and shareholders.
-Majority shareholders can oppress the minority.

Front 63

For a taxpayer who is in a high marginal tax bracket and has a successful business, the corporation offers the
ability to create a new taxpayer with which income can be split. This
allows the taxpayer to have the income from the business taxed at the initially ________ tax rates of the corporation.

Back 63

lower

Front 64

The corporation’s earnings
are taxable to the shareholder only if the shareholder receives the
earnings in the form of:

Back 64

dividends, salary, rent, or other form of payment.

Front 65

Shareholders must
recognize income realized from the exchange of their property for the stock
of the newly formed company in three situations:

Back 65

-First, a shareholder who
contributes appreciated securities in exchange for the stock of an investment
company must recognize the gain on the appreciated securities. A transfer to
an investment company, which results in diversification of the transferor’s interests, may be treated as a taxable incorporation.
-Second, a shareholder who contributes services to the corporation
in exchange for stock of the corporation must recognize ordinary income to
the extent of the fair market value of the stock received.
-The third situation
occurs when the corporation relieves a shareholder of debt (greater than the
adjusted basis of the property) that was the shareholder’s individual debt
prior to incorporation.

Front 66

Corporations (C and S) offer the advantage of ordinary loss
treatment on Section 1244 stock, which is the first $1,000,000 of stock
issued after incorporation.
However, a loss on Section 1244 stock
is treated as a business loss. Section 1244 losses are deductible up to:

Back 66

$50,000 per year against other sources of income and up to $100,000 per
year on a joint return.

Front 67

The most significant potential disadvantage for
a corporation is:

Back 67

double taxation.

Front 68

There are a number of methods available to mitigate the effect of double
taxation which include:

Back 68

Probably the most widely used means is the payment of salaries and bonuses to owners. In addition, many owners receive rental
payments for the use of their assets by the corporation. These payments
are deductions to the corporation from its taxable income, but they are
fully reportable by the recipients.

Front 69

The nature of any corporate distribution is determined in a three-step
manner:

Back 69

-First, to the extent that the corporation has either current or accumulated earnings and profits, the distribution to a shareholder is treated as an ordinary dividend. In most cases, these dividends will be
subject to preferential tax rates through 2008.
-Second, if the corporation
has no current or accumulated earnings and profits, then the distribution
is treated as a nontaxable return of basis to the shareholder to the extent
of the shareholder’s basis.
-Finally, if the corporation has no accumulated
or current earnings and profits and if the stockholder has exhausted his
or her adjusted basis in the stock of the corporation, then all further
distributions are treated as capital gain income.

Front 70

A Personal Service Corporation is defined as:

Back 70

a C corporation in which
substantially all of the activities involve the performance of services in the
fields of health, law, engineering, architecture, accounting, actuarial
science, performing arts, veterinary services, or consulting if substantially
all of the stock is owned by employees, retired employees, or their estates.The law taxes all taxable income of “qualified personal service
corporations” (PSCs) at the highest corporate tax rate of 35%. This provision encourages employee-owners of PSCs to take more salary out of
the corporation, thereby avoiding the accumulation of highly taxed
earnings.

Front 71

Personal Holding Company income is taxed at 15% (over and above the regular tax) and includes:

Back 71

income from annuities, interest, dividends, rents, and royalties.

Front 72

Taxpayers other than C corporations who hold qualified small business
stock for more than five years may exclude __% of the gain on the sale of
the stock. The amount of gain not excluded under this provision is subject to a
maximum capital gain rate of __%. Also, __% of the amount of gain excluded under this provision is treated as a preference item for purposes
of the alternative minimum tax.

Back 72

50%; 28%, 7%

Front 73

Requirements of S corporations include:

Back 73

-there may be no
more than 100 shareholders (75 prior to 2005)
-may not have more than a
single class of stock, which is usually common voting stock.
-to secure the S election, all shareholders must consent in writing to the election.

Front 74

The S corporation is a true conduit entity, parallel to ___________ in
virtually all respects

Back 74

partnerships

Front 75

What is an S corporation "sting tax"?

Back 75

The sting tax is a tax on passive investment income earned by the S corporation. To be subject to the sting tax, the S corporation must have accumulated
earnings and profits as a C corporation from prior periods, and more than
25% of the S corporation’s gross receipts must be from passive investment
income. If the corporation meets both requirements, then the tax applied
is the lesser of the net passive income or the entire taxable income of the
corporation at the highest corporate marginal rate of 35%

Front 76

There are a number of methods available to mitigate the effect of double
taxation which include:

Back 76

Probably the most widely used means is the payment of salaries and bonuses to owners. In addition, many owners receive rental
payments for the use of their assets by the corporation. These payments
are deductions to the corporation from its taxable income, but they are
fully reportable by the recipients.

Front 77

The nature of any corporate distribution is determined in a three-step
manner:

Back 77

-First, to the extent that the corporation has either current or accumulated earnings and profits, the distribution to a shareholder is treated as an ordinary dividend. In most cases, these dividends will be
subject to preferential tax rates through 2008.
-Second, if the corporation
has no current or accumulated earnings and profits, then the distribution
is treated as a nontaxable return of basis to the shareholder to the extent
of the shareholder’s basis.
-Finally, if the corporation has no accumulated
or current earnings and profits and if the stockholder has exhausted his
or her adjusted basis in the stock of the corporation, then all further
distributions are treated as capital gain income.

Front 78

A Personal Service Corporation is defined as:

Back 78

a C corporation in which
substantially all of the activities involve the performance of services in the
fields of health, law, engineering, architecture, accounting, actuarial
science, performing arts, veterinary services, or consulting if substantially
all of the stock is owned by employees, retired employees, or their estates.The law taxes all taxable income of “qualified personal service
corporations” (PSCs) at the highest corporate tax rate of 35%. This provision encourages employee-owners of PSCs to take more salary out of
the corporation, thereby avoiding the accumulation of highly taxed
earnings.

Front 79

Personal Holding Company income is taxed at 15% (over and above the regular tax) and includes:

Back 79

income from annuities, interest, dividends, rents, and royalties.

Front 80

Taxpayers other than C corporations who hold qualified small business
stock for more than five years may exclude __% of the gain on the sale of
the stock. The amount of gain not excluded under this provision is subject to a
maximum capital gain rate of __%. Also, __% of the amount of gain excluded under this provision is treated as a preference item for purposes
of the alternative minimum tax.

Back 80

50%; 28%, 7%

Front 81

Requirements of S corporations include:

Back 81

-there may be no
more than 100 shareholders (75 prior to 2005)
-may not have more than a
single class of stock, which is usually common voting stock.
-to secure the S election, all shareholders must consent in writing to the election.

Front 82

The S corporation is a true conduit entity, parallel to ___________ in
virtually all respects

Back 82

partnerships

Front 83

What is an S corporation "sting tax"?

Back 83

The sting tax is a tax on passive investment income earned by the S corporation. To be subject to the sting tax, the S corporation must have accumulated
earnings and profits as a C corporation from prior periods, and more than
25% of the S corporation’s gross receipts must be from passive investment
income. If the corporation meets both requirements, then the tax applied
is the lesser of the net passive income or the entire taxable income of the
corporation at the highest corporate marginal rate of 35%

Front 84

There are a number of methods available to mitigate the effect of double
taxation which include:

Back 84

Probably the most widely used means is the payment of salaries and bonuses to owners. In addition, many owners receive rental
payments for the use of their assets by the corporation. These payments
are deductions to the corporation from its taxable income, but they are
fully reportable by the recipients.

Front 85

The nature of any corporate distribution is determined in a three-step
manner:

Back 85

-First, to the extent that the corporation has either current or accumulated earnings and profits, the distribution to a shareholder is treated as an ordinary dividend. In most cases, these dividends will be
subject to preferential tax rates through 2008.
-Second, if the corporation
has no current or accumulated earnings and profits, then the distribution
is treated as a nontaxable return of basis to the shareholder to the extent
of the shareholder’s basis.
-Finally, if the corporation has no accumulated
or current earnings and profits and if the stockholder has exhausted his
or her adjusted basis in the stock of the corporation, then all further
distributions are treated as capital gain income.

Front 86

A Personal Service Corporation is defined as:

Back 86

a C corporation in which
substantially all of the activities involve the performance of services in the
fields of health, law, engineering, architecture, accounting, actuarial
science, performing arts, veterinary services, or consulting if substantially
all of the stock is owned by employees, retired employees, or their estates.The law taxes all taxable income of “qualified personal service
corporations” (PSCs) at the highest corporate tax rate of 35%. This provision encourages employee-owners of PSCs to take more salary out of
the corporation, thereby avoiding the accumulation of highly taxed
earnings.

Front 87

Personal Holding Company income is taxed at 15% (over and above the regular tax) and includes:

Back 87

income from annuities, interest, dividends, rents, and royalties.

Front 88

Taxpayers other than C corporations who hold qualified small business
stock for more than five years may exclude __% of the gain on the sale of
the stock. The amount of gain not excluded under this provision is subject to a
maximum capital gain rate of __%. Also, __% of the amount of gain excluded under this provision is treated as a preference item for purposes
of the alternative minimum tax.

Back 88

50%; 28%, 7%

Front 89

Requirements of S corporations include:

Back 89

-there may be no
more than 100 shareholders (75 prior to 2005)
-may not have more than a
single class of stock, which is usually common voting stock.
-to secure the S election, all shareholders must consent in writing to the election.

Front 90

The S corporation is a true conduit entity, parallel to ___________ in
virtually all respects

Back 90

partnerships

Front 91

What is an S corporation "sting tax"?

Back 91

The sting tax is a tax on passive investment income earned by the S corporation. To be subject to the sting tax, the S corporation must have accumulated
earnings and profits as a C corporation from prior periods, and more than
25% of the S corporation’s gross receipts must be from passive investment
income. If the corporation meets both requirements, then the tax applied
is the lesser of the net passive income or the entire taxable income of the
corporation at the highest corporate marginal rate of 35%

Front 92

What are the advantages the S corporation offers over the partnership or
limited partnership in terms of dealing with passive investments?

Back 92

-the shareholders have a right to participate in the corporate management
in a representative sense.
-limited liability is obtained without the
corresponding risk that a limited partnership has—that it may be reclassified as an association taxable as a corporation.
-the stock
presumably is freely transferable.
-The flow-through of income from an S corporation is not subject to the
self-employment tax.

Front 93

S corporations, like partnerships, are generally thought of as nontaxable
entities. There are, however, three taxes for which an S corporation may
be liable:

Back 93

1. Built-in gains tax. This tax will apply when the S corporation
disposes of an asset, held at the time of conversion to S status, in a
taxable disposition within 10 years after conversion. The tax applies to any unrealized gain attributable to appreciation in the value of an
asset while held by the C corporation.
In this situation, the highest corporate tax rate applies to the lesser of:
a. the recognized built-in gains of the S corporation for the taxable
year, or
b. the amount of “taxable income” of the corporation if it were a
C corporation.
2. LIFO recapture tax. If a C corporation used the LIFO method of
inventory valuation for its last year before making an S corporation
election, it must include, in income, the amount of excess found when
comparing the inventory’s value under FIFO with the LIFO value.
This LIFO recapture tax is payable in four installments, with the first
payment due on or before the due date for the final C corporation
return.
3. Net passive income penalty tax. For this tax to apply, the S
corporation must have accumulated earnings and profits as a C
corporation from prior periods, and more than 25% of the S
corporation’s gross receipts must be from passive investment income.
If the corporation meets both requirements, then the tax is applied to
the lesser of the net passive income, or the entire taxable income of the
corporation, at the highest corporate marginal rate of 35%.
Passive investment income is gross income derived from rents,
royalties, dividends, interest, annuities, and sales of securities.

Front 94

LLCs generally have the following features:

Back 94

1. limited liability to all owners or “members”
2. limited life, such as 30 years or a period stated in the operating
agreement
3. dissolution upon the death, retirement, or resignation of a member
unless the remaining members elect by majority to continue the LLC
4. prohibition against the transfer of management or membership rights
without the majority approval of the remaining members
5. deferral to the LLC’s operating agreement for purposes of
determining the LLC’s management structure

Front 95

The LLP is clearly taxed as a partnership. The partners are jointly and
severally liable for contractual liability, as in a general partnership. They
are also personally liable for their own malpractice or other torts (negligence, for example). However, they are not personally liable for the
malpractice or torts of their __________.

Back 95

partners

Front 96

If two or more individuals operate a business
without consciously selecting a business form, the business will be a __________________ by default

Back 96

general partnership

Front 97

A partnership, while it is not a separate taxable
entity, is required to file a separate “informational” tax return on Form
1065 and to report each partner’s distributive share of profits and losses
on Schedule ___.

Back 97

K-1

Front 98

A buy/sell agreement is essential with an S corporation,
because greater restrictions should be placed on the ability of a
shareholder of an ______________ to transfer his or her shares.

Back 98

S Corporation

Front 99

_________ or real property as it is more commonly known, is
comprised of land, anything that is permanently affixed or attached to the
land, or certain items that cannot easily be removed. Common examples

Back 99

Realty

Front 100

________ is defined as any type of
property that is not realty; it includes such items as automobiles,
airplanes, clothing, equipment, and furniture.

Back 100

Personalty

Front 101

_________ __________ has no
physical existence of its own and merely represents the evidence of
ownership or value. It is a type of property that cannot be felt or touched.
Examples of intangible property would be a leasehold interest in real estate
(realty) or stock certificates, promissory notes, and patents (personalty).

Back 101

Intangible property

Front 102

The distinction between tangible property
and intangible property becomes important in determining whether the
property qualifies for _______ _________ deductions or whether the cost must
be capitalized and amortized over a period of years.

Back 102

cost recovery

Front 103

When a taxpayer purchases an asset, three corresponding
expenses are generally involved. These three types of
expenditures are closely connected with the activity for which
the property is used. The types of expenditures, summarized are:

Back 103

(1) an expenditure that is not currently deductible, (2) an expenditure that is currently deductible, and (3) an expenditure that is
not currently deductible but can be recovered over a specified period of
time.

Front 104

Internal Revenue Code Section 162 provides the authority for the second
type of expense (those that are currently deductible). It states that the
taxpayer can deduct ordinary and necessary expenses incurred to carry
on a trade or business in the year they are incurred. This type of expense
includes:

Back 104

expenses for management, certain commissions, labor, supplies,
incidental repairs, advertising, and other selling expenses.

Front 105

The first type of expense is one that is incurred for purely personal
reasons by the taxpayer. Examples of this type of expense include:

Back 105

premiums paid for life insurance by the insured, the cost of insuring a
personal residence, and the costs incurred to maintain a household, such
as rent, water, and utilities. These types of expenses, for the most part, are never deductible by the taxpayer. There are, however, some exceptions to this general rule, such as interest on a home mortgage, charitable
contributions, unreimbursed medical expenses, and gambling losses to
the extent of gambling-related winnings. All of these are personal
expenses incurred by the taxpayer that can also be deducted.

Front 106

__________ an asset’s cost simply means that the cost of the expenditure
is added to the basis of the property.

Back 106

Capitalizing

Front 107

The basis of an asset acquired by gift is generally the donor’s basis.
However, there is one situation where the fair market value on the date of
the gift is used. If the fair market value on the date of the gift is _____ than
the donor’s basis in the asset, the donee’s basis in the asset for purposes
of determining a loss on the sale of the asset will be the asset’s fair market
value on the date of the gift. However, the basis for determining gain on
the sale will still be the donor’s basis. If the asset is sold at a price between
the fair market value on the date of the gift and the donor’s basis, no gain
or loss will be recognized.

Back 107

less

Front 108

This term refers to the original basis in the property,
increased by any adjustments such as acquisition expenditures or
improvements and reduced by any adjustments to basis, such as
depreciation deductions taken and the Section 179 deduction:

Back 108

adjusted basis

Front 109

Depreciation or _____________ refers to the various methods available
for recovering (deducting) the cost of an asset with a useful life of more
than one year over a period of time that approximates the asset’s useful
life. Three basic methods are available: accelerated depreciation, straightline
depreciation, and Section 179 expensing.

Back 109

cost recovery

Front 110

Under this method, a pro rata share of the cost
of the asset is taken as depreciation each year. Thus, for an asset with a
five-year useful life, the taxpayer would expect to take one-fifth, or 20%,
of the asset’s basis as depreciation each year. For an asset with a sevenyear
useful life, the taxpayer would expect to take one-seventh, or 14.29%,
of the asset’s basis as depreciation each year:

Back 110

straight line

Front 111

Under __________ of the Internal Revenue Code, taxpayers may elect to
treat a limited portion of the cost of certain qualifying property as an
immediate expense, rather than as a capital expenditure, during the first
year it is placed in service. Qualifying property is depreciable tangible
personal property purchased for use in the active conduct of a trade or
business. The deduction does not apply to property held merely for the
production of income.

Back 111

Section 179

Front 112

JGTRRA significantly liberalized the rules related to Section 179. The total
cost that a taxpayer may elect to deduct currently, rather than capitalize,
is $128,000 for 2008. If, however, more than $________ is spent on Section
179 property that is placed in service during the year for which the
deduction is being taken, the $128,000 election limit is reduced. There is a dollar-for-dollar reduction of the $128,000 amount for every dollar spent
on qualifying property in excess of the $510,000 limit. For example,
assume that in 2008 a taxpayer placed machinery in service at a cost of
$555,000. Since the cost of the machinery exceeds $510,000 by $45,000, the
maximum election allowed is $83,000 ($128,000 – $45,000).

Back 112

$510,000

Front 113

__________ refers
to an amount that is treated as ordinary income, instead of long-term
capital gain income as result of a sale where cost recovery deductions come into play.

Back 113

Recapture

Front 114

Section 1231 property is property that is:

Back 114

(1) is used in a trade or business or held for the production
of income (rental activities), (2) is generally eligible for a depreciation
allowance, and (3) has been held for the long-term holding period at the
time of disposition

Front 115

The amount of gain treated as
ordinary income on the disposition of Section 1245 property generally is
equal to the lesser of:

Back 115

1. the cost recovery deductions taken, or
2. the gain realized.
Such ordinary income is commonly referred to as “depreciation
recapture” or Section 1245 recapture. The amount not characterized as
ordinary income becomes a Section 1231 gain.

Front 116

a sales price greater than the adjusted basis, up to the
original cost basis, generally will generate Section ____ gain. Only gain to
the extent of actual appreciation of the asset will be entitled to potential
long-term capital gain treatment under Section ____. If a loss is
recognized on the disposition, there is no Section 1245 depreciation
recapture; the entire loss becomes a Section 1231 loss.

Back 116

1245; 1231

Front 117

Section 1250 property is all real
property that is subject to an allowance for depreciation and that is not
now nor has ever been Section 1245 property—generally this is
residential rental property and nonresidential real property not subject to
the ACRS rules. The amount of recognized gain required to be
characterized as ordinary income under the rules of Section 1250 is equal
to the lesser of:

Back 117

1. the “additional depreciation” taken on the Section 1250 property, or
2. the gain realized (the amount realized from the sale minus the
adjusted basis of the property).

Front 118

The Section 1231 netting process can best be described by the following
steps:

Back 118

1. Combine the current year Section 1231 gains and losses to arrive at a
net gain or a net loss.
2. If the result is a net loss, it is characterized as an ordinary loss.
3. If the result is a net gain, determine if the “lookback” rules apply.
4. If the lookback rules do not apply, the net gain is characterized as a
capital gain.
5. If the lookback rules do apply, the amount of net gain required to be
characterized as ordinary income is equal to the lesser of (a) the
unrecaptured Section 1231 losses, or (b) the current year’s net gain.

Front 119

The lookback period is defined as the _____ taxable years immediately
preceding the current taxable year. “Unrecaptured” net Section 1231
losses are net Section 1231 losses that have been claimed by a taxpayer
during the lookback period and that have not previously caused
recapture under the lookback rules

Back 119

five

Front 120

There are certain situations in which like-kind transactions are taxable. If the taxpayer receives ______ i.e., any property that is not qualified or like-kind, then gain may be recognized (subject to tax) in the exchange.

Back 120

“boot”

Front 121

Property held for productive use in a trade or business or held for investment purposes is referred to as:

Back 121

qualifying property

Front 122

The like-kind requirement does not mean that the property transferred must be identical to the property received. The term refers to the nature or character of the property, and not to its grade or quality. For instance, an exchange of an apartment building for vacant farmland is considered to be like-kind.
Three types of exchanges are specifically prohibited:

Back 122

1. Realty may not be exchanged for personalty, or vice versa.
2. An exchange of U.S. realty for foreign realty is not considered like-kind. Also, personalty used predominantly within the United States and personalty used predominantly outside the United States are not like-kind.
3. An exchange of livestock of different sexes is not considered like-kind.

Front 123

If the taxpayer receives _______ i.e., any property that is not qualified or like-kind, then gain may be recognized (subject to tax) in the exchange.

Back 123

“boot”

Front 124

Property held for productive use in a trade or business or held for investment purposes is called:

Back 124

qualifying property

Front 125

Like-Kind Exchange Rules
The following are rules that can be applied in calculating the gain realized, the gain recognized, and the adjusted basis of the acquired property:

Back 125

1. Losses are never recognized by either taxpayer in a like-kind exchange.
2. The like-kind exchange provision is mandatory. Thus, if a taxpayer is contemplating a transaction in which there would be a loss recognized, the taxpayer should sell that property, and purchase the new property in an unrelated transaction in order to allow recognition (deductibility) of the loss.
3. There will be no gain recognized unless the taxpayer receives boot—cash, net debt relief, or nonqualifying property.
4. Gain generally is recognized by the taxpayer who receives cash, experiences net debt relief, or receives unlike or nonqualifying property.
5. The gain recognized is always the lesser of the gain realized or the boot received. If the taxpayer received no boot, there will be no recognized (taxable) gain.

Front 126

In a like-kind exchange between related parties, any gain or loss must be recognized (on an amended return) if either the property transferred or the property received is disposed of within ____________ after the exchange. However, dispositions due to involuntary conversion, death, or non-tax-avoidance purposes are not subject to this rule.

Back 126

two years

Front 127

If there is a recognized gain, it is necessary to determine the character of that gain. If the property is Section 1245 or 1250 property, then the gain is considered ________ ________ , up to the amount of gain that is subject to the recapture provisions. After that, any remaining gain on real estate, up to the amount of straight-line depreciation is considered 25% long-term capital gain (unrecaptured Section 1250 gain). Any gain in excess of the recapture (or unrecaptured Section 1250 gain) is capital gain.
If there is no gain recognized on the exchange, the potential recapture carries over to the qualifying property received (the replacement property).

Back 127

ordinary income

Front 128

If a taxpayer receives boot in a like-kind exchange, then gain will be recognized equal to:

Back 128

the lesser of the gain realized or the boot received. Thus, if there were no boot received, there is no gain that is subject to tax.

Front 129

Congress allows qualifying sellers to utilize installment sale treatment. The installment sale treatment allows the seller to:

Back 129

recognize the gain proportionately in each tax year in which payments are received. Interest, at a reasonable rate, should also be included in the contract.

Front 130

________ cannot be recognized on an installment sale basis.

Back 130

Losses

Front 131

What situations may cause a casualty loss?

Back 131

1. earthquakes 2. hurricanes 3. tornadoes 4. floods 5. storms 6. volcanic eruptions 7. shipwrecks 8. mine cave-ins
9. sonic booms 10. vandalism 11. fire—if the taxpayer did not intentionally start it 12. car accidents—if the accident was not caused by the taxpayer’s willful neglect or act

Front 132

A theft is defined as the unlawful taking and removing of money or property with the intent to deprive the owner of it. Theft includes, but is not limited to:

Back 132

money or property received through larceny, robbery, embezzlement, extortion, kidnapping, threats, or blackmail.

Front 133

The amount of a nonbusiness casualty or theft loss eligible to be deducted is the lesser of:

Back 133

(1) the decrease in the fair market value of the property as a result of the casualty or theft, or (2) the taxpayer’s adjusted basis in the property before the casualty or theft.

Front 134

Taxpayers who no longer have the use of their property due to casualties, thefts, or condemnations may be eligible to use the involuntary conversion rules to determine the gain or loss recognized in such situations. Under the involuntary conversion rules:

Back 134

the recognition of the gain realized and the resulting tax may be postponed if taxpayers purchase qualified replacement property within the specified replacement period; losses resulting from condemnations are deductible only if the property was business or investment property.

Front 135

A _________ is the lawful taking of taxpayers’ property, without their consent, for public use by the federal government, a state government, or a political subdivision in exchange for a reasonable amount of money or property—a right of government sometimes referred to as eminent domain.

Back 135

condemnation

Front 136

If a taxpayer is an owner/investor of the property, similar or related in service or use means that any replacement property must have the same relationship of services or uses to the taxpayer as the property it replaces. The following factors are used in determining if this relationship exists:

Back 136

1. whether the properties are of similar service to the taxpayer
2. the nature of the business risks connected with the properties 3. what the properties demand of the taxpayer in the way of management, service, and relations to tenants

Front 137

To postpone the recognition of gain from a casualty, theft, or condemnation, the replacement property must be purchased within a specified replacement period. The replacement period for a casualty or theft begins on the date the property was damaged, destroyed, or stolen and ends:

Back 137

on the last day of the second taxable year after the year in which the taxpayer realizes a gain with respect to the property.

Front 138

The replacement period for a condemnation begins on the earlier of the following dates:

Back 138

1. the date on which the condemned property was disposed of, or
2. the date on which the threat of condemnation first occurred.

Front 139

The general partnership form is seldom selected because of the:

Back 139

unlimited personal liability of each general partner.

Front 140

The ___________ ________ is the form most often selected for direct participation investments

Back 140

limited partnership

Front 141

The master limited partnership offers the advantage of:

Back 141

high liquidity

Front 142

A _______ _________ is an allocation of one or more items of income, gain, losses, deductions, or credits that depart from the partner’s bottom-line allocation of profits or losses. In other words, it may not be necessary to split all of these items pro rata among all of the owners.

Back 142

special allocation

Front 143

A special allocation of partnership items is allowed only if the allocation has substantial economic effect apart from the tax consequences. To have substantial economic effect, a partnership must:

Back 143

(1) keep capital accounts that reflect the allocation; (2) provide that, upon liquidation, partners with negative capital account balances must restore the balance to zero; and (3) upon liquidation, make distributions based upon the capital account balance.

Front 144

A partner may deduct losses only to the extent of the amount that he or she has “at risk.”
The amount at risk equals the sum of:

Back 144

1. the money invested (except to the extent the money invested was borrowed and was secured only by the investment);
2. the adjusted basis of other property contributed to the partnership;
3. amounts borrowed for use in the activity, but only to the extent that the partners are personally liable for repayment of the debt (recourse indebtedness);
4. the partner’s share of income, less the partner’s share of losses or withdrawals from the partnership; and
5. the proportionate share of qualified nonrecourse financing in a real estate activity ONLY.

Front 145

in a real estate activity only, the amount considered at risk includes the partner’s individual share of qualified nonrecourse financing. Qualified nonrecourse financing is financing:

Back 145

1. that is secured by real property,
2. for which no one is personally liable,
3. that is not convertible into an equity interest, and
4. that is provided either by
(a) an unrelated person or entity regularly engaged in the business of lending money (a bank, savings and loan, credit union, insurance company, pension fund, or government unit), or
(b) a “related” person on commercially reasonable terms.

Front 146

An additional problem with tax shelters is that they often “burn out.” That is, the tax advantages get used up in earlier years, and in later years they generate taxable income without any positive cash flow. This is known as:

Back 146

phantom income

Front 147

Phantom income often occurs when the _________ ________ is passed. This is when the nondeductible principal portion of a payment on a mortgage exceeds the deductible interest portion of the payment.

Back 147

“crossover point”

Front 148

Passive income and loss arise from passive activities, of which there are essentially two broad categories:

Back 148

First, any trade or business in which the taxpayer does not materially participate is a passive activity.
Second, almost all rental activities are deemed, by their very nature, to be passive activities.

Front 149

Material participation generally is defined as a regular, continuous, and substantial involvement in the activity’s operations. Generally, three factors must be considered:

Back 149

First, is the activity the taxpayer’s principal trade or business?
Second, what is the taxpayer’s actual day-to-day involvement in the activity? Third, what is the taxpayer’s knowledge, background, and experience in this or similar activities?

Front 150

The passive loss rules apply only to:

Back 150

1. individuals, estates, and trusts;
2. closely held C corporations; and
3. personal service corporations.

Front 151

Four distinct exceptions continue to provide potential tax advantages to real estate investment. These are:

Back 151

(1) the active participation rule,
(2) material participation for real estate professionals,
(3) the historic rehabilitation credit, and (4) the low-income housing credit.

Front 152

_________ __________ requires bona fide involvement in the management of the property. Ownership of less than a 10% interest or ownership of a limited partnership interest does not qualify. To qualify, a taxpayer must make the major management decisions concerning the operation of the property. Decisions such as defining rental terms, deciding which capital or repair expenditures to make, approving tenants, and collecting rents may qualify an individual for active participation status. A management agent can perform most of the functions, but the taxpayer must make the major management decisions.

Back 152

Active participation

Front 153

This real estate professional rule is occasionally referred to as the super-material participation standard. In order to deduct losses from these real property trades or businesses, the individual taxpayer (or closely held C corporation) must satisfy certain eligibility requirements. These requirements will be satisfied when:

Back 153

(1) more than 50% of the individual’s personal services during the tax year are performed in the real property trades or businesses in which the individual materially participates, and (2) the individual performs more than 750 hours of service in the real property trades or businesses in which the individual materially participates.

Front 154

The credit for historic rehabilitation expenditures is:

Back 154

used to offset tax on up to $25,000 in income (not $25,000 in tax liability).

Front 155

The phaseout of the historic rehabilitation credit does not begin until agi exceeds $_______

Back 155

$200,000, and complete phaseout occurs at $250,000

Front 156

The maximum combined benefit from active participation real estate, low-income housing, and historic rehabilitation may not exceed $________ in a given year

Back 156

$25,000

Front 157

Certain limited tax sheltering opportunities continue to exist in:

Back 157

(1) in real estate, through active participation, historic rehabilitation, or low-income housing programs; (2) in oil and gas, through the ownership of working interests;
(3) through material participation;
(4) for taxpayers who are C corporations; and
(5) through the combination of passive income and passive loss investments.

Front 158

If the home (dwelling unit) is rented out for ____ _____ or less, then the rental income is not required to be included in gross income. However, no deductions attributable to the rental are allowed. Deductions allowable in any event, such as mortgage interest, property taxes, and casualty losses, are not affected by this rule.

Back 158

14 days

Front 159

If the dwelling unit is rented for more than 14 days and the owner’s personal use per year exceeds the greater of (a) 14 days or (b) 10% of the number of days during the year that the home is rented, then the expenses attributable to the rental are allocated. If this residence test is met, then the rental deductions may not exceed:

Back 159

the amount by which the gross income derived from the rental activity exceeds the deductions otherwise allowed for the property (interest and taxes).

Front 160

If the vacation home is used by the taxpayer for personal use for more than 14 days a year and is rented for fewer than 15 days a year, the rental income is:

Back 160

not taxable

Front 161

The order in which rental property redeductions are taken is as follows:

Back 161

1. allocated taxes and interest
2. allocated operating expenses
3. depreciation and other basis adjustment items

Front 162

Life insurance proceeds payable at death are excluded from the gross
income of the beneficiary; during lifetime, the accumulation of cash value
within the policy is allowed to grow tax deferred until surrender. This is
commonly referred to as the:

Back 162

inside buildup

Front 163

in 1984 Congress adopted
two tests, one of which must be met for a product to be considered life
insurance. These tests are known as:

Back 163

(1) the cash value accumulation test
and
(2) the cash guideline premium and corridor test.

Front 164

Proceeds payable before death (i.e., the
surrender value) may be taxable if they exceed:

Back 164

the insured’s cost—the
investment in the contract.

Front 165

_________ ________ specifically states that no gain or loss shall be recognized on the exchange
of one life insurance contract for another life insurance contract, annuity,
or endowment contract.

Back 165

Section 1035

Front 166

To find the amount not taxable in a fixed annuity, it is necessary to set up
an exclusion ratio. The exclusion ratio consists of:

Back 166

the investment in the
annuity contract divided by the total expected return. This ratio is
multiplied by the annual return each year to determine the annual
amount that is excluded. To get the total expected return, multiply the
annual return by a life expectancy multiple supplied by the appropriate
Treasury table.

Front 167

With a variable annuity, the exclusion amount is determined by:

Back 167

dividing
the investment in the contract by the number of expected payments.

Front 168

A capital gain or loss is the result of a sale or exchange of a capital asset.
A capital asset is defined to be any asset held by the taxpayer (whether or
not connected with his or her trade or business) other than one that falls
under one of five excluded classes:

Back 168

1. inventory or property held primarily for sale to customers in the
ordinary course of business
2. property subject to depreciation and real property used in a trade or
business
3. a copyright; a literary or artistic composition; a letter, memorandum,
or similar property held by certain individuals
4. accounts or notes receivable acquired in the ordinary course of trade
or business for services rendered or from the sale of inventory
5. a publication of the United States government

Front 169

There is a maximum 28% rate. This rate applies to net
gains on collectibles, if held for more than one year. Collectibles include:

Back 169

coins, works of art, rugs, antiques, metals, gems, stamps, alcoholic
beverages, etc. Also, gold and silver exchange-traded funds (ETFs) are
generally not taxed as securities, but as collectibles, which means longterm
capital gains on the funds are taxed at the maximum rate of 28%
rather than the lower 15% rate that would apply to long-term capital
gains on the sale of stocks.

Front 170

On the sale of Section 1250 property (depreciable real estate)
held for more than one year, the portion of the gain attributable to
depreciation that is not treated as Section 1250 recapture is subject to a
maximum __% tax rate.

Back 170

25%

Front 171

Taxpayers other than C corporations who hold qualified small business
stock for more than five years may exclude __% of the gain on the sale of
the stock.

Back 171

50%

Front 172

This is interest paid or accrued on a debt that was
incurred to purchase property held for investment:

Back 172

Investment interest

Front 173

For individual taxpayers, an investment interest expense deduction is
allowed to the extent taxpayers have net investment income. The
investment interest expense is an itemized deduction, and is:

Back 173

not subject to
the 2% of AGI limitation.

Front 174

This is the most common type of distribution resulting from the
ownership of corporate stock, and it is a distribution to the shareholder of
either cash or property out of the corporation’s current earnings and
profits or earnings and profits

Back 174

dividend

Front 175

The 2007 Small Business Act expands the kiddie tax to include
children who have turned 18, and full time students age 19–23 provided:

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the child’s earned income does not exceed one-half of his or her support.

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For a taxpayer eligible to be
claimed as a dependent, with earned income or a combination of earned
and unearned income, the allowable
standard deduction is the greater of:

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(1) $900 or (2) the amount of earned
income plus $300, not to exceed the full standard deduction amount
($5,450 in 2008). These rules apply to all taxpayers eligible to be claimed
as a dependent on another taxpayer’s return.

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To take maximum advantage of parent-to-child transfers, the first and most important planning technique is to transfer only
certain types of income-producing assets to the child. For example:

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Series EE government bonds are an excellent type of property to transfer since the
adoption of the 1986 Act because interest income is deferred until maturity or
sale (unless the bondholder elects to pay tax currently). Another excellent
investment to place in a child’s name after 1986 is growth stock that pays
little income or dividends. A third investment that looks favorable for
transfers between parent and child is a single premium variable life
insurance policy.

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The Section 2503(c) trust is not required to distribute income annually to the child as long as:

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the
principal of the trust and any accumulated income are distributable to the
child upon reaching age 21.

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As a policing measure to ensure that a parent and a dependent
child do not take a double exemption on this same unearned income, the
law requires that:

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the parent include the child’s Social Security number on
his or her own tax return, and vice versa.

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To minimize taxation of closely held business profits, the high-bracket
owner might transfer ownership of a percentage of the partnership or the
S corporation to:

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a family member. Thus, the proportionate income
attributable to the new partner or shareholder’s ownership percentage is
shifted to the lower-bracket taxpayer’s income, provided that he or she is
age 18 or over. Therefore, the net wealth of the family increases at the
expense of tax revenues to the government.

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Ownership transfer from a family partnership or S corporation is
appropriate only when:

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a significant portion of the partnership or
S corporation income is generated from capital. If capital is not a material
income-producing factor, the family member is recognized as a partner (or shareholder) only if he or she contributes substantial services.

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The leaseback intrafamily planning technique allows the high-bracket
taxpayer to:

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either gift or sell property used in a trade or business to lowbracket
family members. After the sale or gift is completed, the highbracket
taxpayer leases the property back from the purchaser or donee
and continues using it in the business. The high-bracket taxpayer makes
reasonable rental payments to the low-bracket taxpayer, which constitute
a business deduction (as an ordinary and necessary business expense) for
the high-bracket taxpayer and income for the low-bracket taxpayer.

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The leaseback intrafamily planning technique is particularly attractive in what two situations?

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The
first involves a high-bracket taxpayer who has invested all or
substantially all of the family wealth in a business. The high-bracket
taxpayer may have no other means of wealth transfer available to
accomplish an intrafamily transfer. Second, the high-bracket taxpayer
may be holding property that has been fully depreciated. This means that
holding the property within the business is of no further tax value to the
high-bracket taxpayer, as all cost-recovery deductions and credits have
been exhausted. A gift or sale of this type of property allows the high bracket taxpayer a deduction for rental payments on property that has
otherwise lost its favorable tax advantage.

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The annual gift tax exclusion of $_________ (for 2007
and 2008) provides relief from a gift tax on gifts of that amount or less

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$12,000

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The Hope credit provides a maximum tax credit of $1,800 per student for
qualified tuition expenses incurred by:

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the taxpayer, the taxpayer’s
spouse, or a dependent of the taxpayer during the first two years of
postsecondary education, during which time the student attends school
at least half time. The credit is calculated as 100% on the first $1,200 of
qualified expenses and 50% on the next $1,200. Qualified tuition expenses
do not include room, board, textbooks, nonacademic fees (e.g., student
activity and athletic fees, insurance), or student health fees.

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The Hope credit is phased out between $_____ and $______of AGI for
single taxpayers and between $________ and $_______ of AGI for married
taxpayers filing jointly. These figures are for 2008 and are subject to
indexing for inflation.

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48,000 and $58,000; $96,000 and $116,000

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This is a nonrefundable credit of up to $2,000; it is equal to 20% of
qualified tuition expenses up to $10,000.

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The Lifetime Learning Credit

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Although the Lifetime Learning credit is generally similar to the Hope
credit, with respect to limitations and definitions, there are a number of
differences:

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The Lifetime Learning credit is available annually for an
unlimited number of years; it is available for expenses related to
acquiring or improving job skills (such as continuing professional
education through qualifying institutions); and it is available for
undergraduate, graduate, or professional degree expenses. Generally,
any accredited public, nonprofit, or proprietary postsecondary institution
whose students may receive federal financial aid, is treated as a qualified
institution.
Expenses for a student who qualifies for the Hope credit do not qualify
for the Lifetime Learning credit.

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It is a common misconception that the creation of a trust results in a
separate tax-paying entity. In fact, for the trust to qualify as a
taxpayer separate from the grantor, the grantor will have to give up:

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virtually all rights in and to the property.

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Gifts that qualify for the charitable deduction generally are one of
two types:

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A direct gift of cash or property to the charity and an indirect gift that includes
the provision of goods and services to the charity to make possible the
achievement of the charitable purpose. These types of indirect gifts are
said to be “to and for the use of charity” and are not considered to be
made directly to the charity.

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Generally, a charitable contribution of less than a donor’s entire interest
is nondeductible. There are four statutory exceptions to this rule:

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1. a gift of an undivided portion of the donor’s entire interest (e.g., a
right of ownership in a painting to an art museum for one-half of the
year)
2. a gift of a remainder interest in a personal residence or farm
3. a gift to a public charity of a remainder interest in real property
granted solely for conservation purposes
4. a gift of a partial interest transferred through a qualifying form of
trust (e.g., a charitable remainder annuity trust)

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The charitable contribution deduction is a function of two things:

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the
type of property contributed and the type of organization to which the
property is contributed.

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The amount of the charitable deduction allowed for qualifying
contributions is generally the fair market value of the property on the
date of the contribution. However, for gifts of ordinary income property,
the deduction is based on the adjusted basis of the property. The following
are ordinary income property:

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1. cash
2. short-term capital gain property (property held less than one year)
3. works of art, books, or letters, when given by the person who
produced them
4. inventory

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For gifts of
ordinary income property, a taxpayer may not deduct more than __% of
his or her AGI for donations to public charities. These public charities are
often referred to as 50% organizations. These 50% organizations include
churches, schools, hospitals, and governmental units. Other
organizations that allow charitable deductions of up to 50% of AGI
include operating, conduit, pass-through, distributing, community, and
pooled-fund foundations. Again, these are commonly referred to as 50%
organizations.
The limitation is reduced to 30% of A

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50%

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The limitation is reduced to __% of AGI if donating long-term capital
gain property (if the deduction is based on the fair market value of the
property) to a public charity.

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30%

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There are other types of charities to which a 30% limitation applies. These
include:

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certain private nonoperating foundations, veterans’ groups,
fraternal associations, and other not-for-profit associations. Regarding
charitable contributions to these organizations, the law limits the amount
that a taxpayer may deduct in a given year to 30% of the taxpayer’s AGI.
These are called 30% organizations. This 30% limitation applies to gifts of
ordinary income property

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For gifts of long-term capital gain property to 30% organizations, the
deduction is limited to __% of the taxpayer’s AGI.

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20%

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The method of calculating the amount of allowable deductions in the
current year can be summarized in the following steps:

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1. Calculate the maximum deduction possible (50% of the taxpayer’s
AGI).
2. Calculate the maximum amount of gifts available to a 50%
organization.
3. Calculate the maximum gift allowable to a 30% organization.
4. Reduce the value of long-term capital gain contributions to 30% of the
taxpayer’s AGI for gifts to 50% organizations. (If the 50% election is
made, the value of a contribution is limited to a taxpayer’s basis in
long-term capital gain property.)

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Example. Luke Wells has an AGI of $100,000. He has made charitable
contributions of $4,000 in cash and $60,000 of appreciated real estate
(held more than one year) to a 50% organization. In addition, Luke has
contributed $21,000 in cash to a 30% organization:

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Step 1: Maximum deduction available: 50% of $100,000 = $50,000.
Step 2: The 50% organization contributions are $64,000 ($60,000 in
property and $4,000 in cash).
Step 3: The 30% organization contributions are $21,000 (the 30% limit
allows a maximum deduction of $30,000).
Step 4: The 30% limitation on appreciated property limits the deduction
to $30,000 for a noncash contribution to a 50% organization.

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The four categories of property that will produce different results when it
comes to determining the real economic cost to the taxpayer when a
charitable gift is made are:

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(1) appreciated
property, (2) depreciated property, (3) cash, and (4) inventory.

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Alimony normally is an important issue debated during the divorce
process. Alimony payments fall into three categories:

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1. payments under a support decree
2. written separation agreement payments
3. payments under a separate maintenance or divorce decree or under a
written instrument incident to divorce/separation

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If the following requirements are met, the
payments are considered qualifying alimony and are deductible by the
payor and includible by the payee:

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1. The taxpayers cannot file a joint tax return or live together at the time
of payment.
2. Payments must be made in cash (not property).
3. Payments must be received by or for the benefit of the payee spouse
(i.e., not treated as child support).
4. The legal document cannot designate the payments as nonincludible
in the payee spouse’s income and nondeductible by the payor spouse.
5. The payments cannot extend beyond the death of the recipient
spouse, either as an operation of state law or as a provision under the
agreement.

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Benefit amounts awarded a spouse
under a QDRO may be paid to the alternate payee at the time that the
participant reaches his or her “earliest retirement age,” defined in the
1986 Act as the earlier of:

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(1) the earliest date that benefits are payable to
the participant under the plan, or (2) the later of the date when the
participant reaches age 50 or the date on which the participant could start
receiving benefits if separating from service.