Federal Income Tax

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Determining Income Tax Liability - Formula

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GI - ATLD = AGI

AGI - SD/ID = TI

TI x TR = TTL

TTL - credits = TL

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Gross Income - Generally

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Any economic benefit or clearly realized accession to wealth - when in doubt, it's taxable!

Includes: compensation, interest income, trust income, partnership income, illegal income, alimony and maintenance income, annuities, prizes/awards, shareholder distributions, gain from sales of assets, bargain purchases, cancellation of debt

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Gross Income - Items Excluded, Generally

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Life insurance proceeds
Inheritance and gifts
Interest on state or local bonds
Physical personal injury damages
All or part of SS benefits
Some accident, health insurance proceeds and ER-paid premiums
Meals, lodging for ER's convenience on premises
Qualified scholarships and EE benefits

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Above-the-Line Deductions - Generally

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Ordinary and necessary business expenses
Qualified moving expenses
Alimony payments
Net capital losses
Self employed person's pension, profit-sharing or annuity contribution
Some pension plans and IRA contributions

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Personal Exemptions

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Exemptions each for spouse, dependents, qualified dependents = $3,500

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Standard Deduction

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Single taxpayer = $5,450
Married-joint = $10,900
+ extra for taxpayer who is blind or 65y+

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Itemized Deductions

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Mortgage interest (up to 2 homes)
State and local taxes
Charitable gifts (up to 50% AGI)
Medical expenses (over 7.5% of AGI)
Expenses incurred in production of income
Casualty, theft/loss over $100 and more than 10% of AGI
Half of business entertainment expense
Education expense if necessary to job or business
Meals, lodging while on business trips

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Tax Credits

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Child tax credit
Child care credit
Credit for elderly
Earned income credit

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Gross Income - Realization

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Increased or decreased value of an asset taken into account for tax purposes when it is realized through sale or other disposition.

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Gross Income - Non-Cash Receipts

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GI includes FMV of any property received AND any services rendered

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Gross Income - Claim of Right

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COR = Property or funds received w/o restriction as to use or disposition

M/b reported even though TP m/b required to return the property/funds/equivalent

Note: in event/year of repayment, TP can take a deduction

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Gross Income - Illegally-Obtained

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Stolen, embezzled, or otherwise illegally-acquired funds or property is taxable income!

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Tax Benefit Rule

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If TP takes a deduction in one year and recovers the property in another, she has Tax Benefit Income to the extent the earlier deduction provided a tax saving or benefit.

Note: c/n deduct federal taxes paid, so if it was over-withheld federal income tax, there is NO tax benefit

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Gross Income - Alimony

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Taxable to receiving spouse and deductible for paying spouse
- M/b pursuant to written divorce or separation agreement
- c/n live together
- liability to make payments M/cease at or before death
- payments M/b in cash or its equivalent

Note: written agreement can specify otherwise

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Gross Income - Child Support

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Not taxable or deductible!

Child Support in Disguise = when payments are reduced upon a contingency relating to the child, that portion is considered child support

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Gross Income - Prizes and Awards

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Includes raffle prizes, gambling or lottery winnings, treasure trove, windfall

Note difference b/t this and a bargain purchase

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Gross Income - Cancellation of Indebtedness

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Debtor whose debt is discharged or cancelled at less than the full principal amount = taxable income to the extent of the difference b/t full principal and amount paid in satisfaction

EXCEPTIONS = c/b excluded from income if:
- cancellation is a gift or bequest
- discharge occurs in bankruptcy, or TP is insolvent and reduces favorable tax attributes to balance the benefit of the exclusion
- reduction in indebtedness is an adjustment in purchase price - and cost basis is adjusted accordingly
- discharge is of qualified principal residence indebtedness of $2m or less for joint-married or $1m for single or separate-married and the Basis is reduced by the amount of the debt

Note: Exceptions = RIG (reduction in purchase price, insolvency, gift)

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Gross Income - Life Insurance

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Proceeds paid by reason of insured's death = EXCLUDED from GI

Note: if proceeds paid in installments, interest paid IS taxable GI

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Gross Income - Inheritances

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Amounts received by bequest, devise or inheritance EXCLUDED from GI
- if conditioned on a person's services, it is taxable federally (looks like compensation!)

Note: inherited property that generates income = income IS taxable GI

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Gross Income - Gifts

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Not taxable
- transfers made out of "detached and disinterested generosity" (i.e. love, affection, charity)
- irrebutable presumption that ERs do NOT make gifts to EEs

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Gross Income - Tort Awards

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Compensatory damages on account of personal physical injury (medical expenses, lost wages) EXCLUDED from GI.
- Emotional Distress damages NOT included if received on account of personal physical injury

Punitive damages ARE taxable GI

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Gross Income - ER/EE Exclusions

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Receipts from Health and Accident Insurance = premiums paid by ER are excluded
- Health insurance reimbursements for actually-incurred medical expenses are excluded so long as it is for legitimate medical care

LIfe Insurance Provided by or through ER = TP c/exclude the value of the first $50k of ER-provided group term life insurance
- Excess life insurance coverage provided by ER M/b included in GI

Meals and Lodging = if ER provided for the its convenience, in-kind AND on the premises

Miscellaneous Tax-Free EE Benefits:
- De minimis supplies
- No additional cost to ER (airline seats, etc)
- Qualified EE discounts (retail stores)
- Contributions to qualified pension plans
- EE safety or length of service award if presented in meaningful ceremony

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Gross Income - Qualified Scholarships

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For tuition and related expenses (not room and board) are EXCLUDED from GI
- c/n/b payment for past or future services
- M/b primarily for benefit of the individual

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Above the Line Deductions

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Subtotal reached after subtracting from GI = Adjusted Gross Income

Include = ordinary and necessary business expenses, depreciation (not personal assets), capital losses up to $3k, alimony, moving expenses, limited deductions for school loan interest

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Above the Line Deductions - Ordinary and Necessary Business Expenses

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Includes rent, salary, etc.
- includes business interest paid over time
- includes business taxes, but NOT federal

Cannot deduct excessive portions of excessive salaries

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Itemized Non-Business Deductions/Standard Deductions

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Home Mortgage Interest
State and local taxes (NOT sales tax u/l business)
Unreimbursed casualty losses
Charitable contributions
Unreimbursed medical expenses
Miscellaneous Deductions
Divorce/separation legal fees
Investment fees or expenses

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Itemized/Standard Deductions - Home Mortgage Interest

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TP c/deduct home mortgage interest on mortgages of up to $1m aggregate on principal and secondary personal residences.
- home equity loan of up to $100k
- personal interest NOT deductible (car, school loans, credit card)

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Itemized/Standard Deductions - State and Local Taxes

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Taxes paid to state and local gov'ts are deductible - except sales tax.

Businesses c/deduct all

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Itemized/Standard Deductions - Unreimbursed Casualty Losses

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Deductible if:
- loss is > $100
- loss is sudden and unexpected AND
- only to the extent that aggregate losses exceed 10% of AGI

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Itemized/Standard Deductions - Unreimbursed Medical Expenses

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Deductible to extent that aggregate exceeds 7.5% of AGI

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Itemized/Standard Deductions - Charitable Contributions

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C/deduct FMV or property contributed to Qualified Charities

C/deduct amount of cash contributed to Qualified Charities

Does NOT include time or services contributed or for Quid Pro Quo

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Itemized/Standard Deductions - Miscellaneous

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Eligible miscellaneous deductions to extent that aggregate exceeds 2% of AGI

Ex: unreimbursed EE-related business expenses, certain educational expenses (CLEs), etc.

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Itemized/Standard Deductions - Personal vs. Business Expenses

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Personal legal fees generally not deductible EXCEPT:
- portion of legal fee to either party in divorce/separation proceeding attributable to tax advice
- recipient spouse c/deduct legal fees necessary to generate taxable alimony
Legal fees incurred in business or investment ARE deductible

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Itemized/Standard Deductions - Investment Fees or Expenses

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C/deduct fees or expenses necessary to generate taxable income (broker fees, settlement expenses in successful lottery dispute)

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Exemptions

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TP c/deduct one exemption for herself, and one for each dependent = parents, grandparents, etc., for whom they pay more than 50% of care

After divorce = custodial parent gets exemption for child u/l otherwise agreed

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Assignment of Income Rule

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Income M/b taxed to she who earns it, or w/r/t property, she who owns it.

Contingent fees paid to attorney to cover P's legal expenses w/r/t civil litigation that otherwise w/h/b taxable to P are taxable to BOTH P and lawyer.

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Cash Method of Accounting

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Reports income when she receives payment AND take deductions for eligible expenses when she makes payment

Constructive Receipt = when funds or property are credited to her account, set apart, or otherwise made available so she can draw upon them

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Accrual Method of Accounting

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Reports income when all events have occurred that fix the right to receive it AND when the amount c/b determined w/ reasonable accuracy

Deductions when all events have occurred that establish the fact of liability and when amount c/b determined w/ reasonable accuracy

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Realization vs. Recognition

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Realization = sale, disposition or exchange (moment in time)

Recognition = reporting for tax purposes

General Rule = when a gain is realized, it M/b recognized for tax purposes u/l statute or CL exception says otherwise

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Basic Sale Formula

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Amount Realized - Adjusted Basis = Gain/Loss

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Amount Realized

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Money Received PLUS FMV or property/services rendered PLUS mortgages or liabilities to which property sold is subject/buyer assumes

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Adjusted Basis - Cost Basis Rule

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TP's basis in property acquired by purchase = cost of property (money paid PLUS any borrowing incurred)
- Note: renovations increase the basis

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Adjusted Basis - Substituted Basis

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Divorce Property Settlements = transfer of property b/t (ex) spouses incident to divorce is NOT taxable to either party
- Receiving spouse steps into donee's shoes and has same basis he had

Gifts = recipient takes the donor's basis ("Gain Rule")

Inherited Property = FMV of property at either date of decedent's death OR upon executor's election, 6m after decedent's death
- GOOD b/c eliminates/decreases taxable gain, unlike gifts

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Gain/Loss - Like-Kind Exchanges

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No gain/loss recognized when TP exchanges property held for productive use in business or for investment for like-kind property also held for productive use in business or investment

Ex: B owns X apartment for investment purposes w/ $100k basis and $250k FMV. B exchanges X for Y farm worth $250k.
- Realized gain = $250k AR - $100k AB = $150k Gain
- D/n/h to recognize b/c it's Like-Kind!
- Basis in farm = substituted basis from apartment X = $100k

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Gain/Loss - LIke-Kind Exchange, Involuntary Conversion

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No gain recognized when property is involuntarily lost due to theft, fire, seizure, requisition or condemnation, or conversion into property that is "similar or related in service or use"
- If TP purchase replacement property "similar or related in service or use" w/in 2y of involuntary conversion, no gain/loss w/b recognized
- Gain/loss IS recognized to the extent that any money received exceeds replacement cost

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Gain/Loss - Sale of Principal Residence

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C/exclude up to $250k ($500k for joint returns) of the Gain from sale of principal residence IF the property h/b used and owned as TO's principal residence for periods aggregating 2y during the preceding 5y period ending on date of sale.

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Capital Gains

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Top marginal rate on long-term CGs (15% for assets held for > 12m) = lower than top marginal rate on ordinary income (35%)

Capital Assets = stock or real estate held for investment
- does NOT include inventory, property held primarily for sale to customers, depreciable property, copyrights

Note: most SH dividends (domestic corporations) eligible for tax at CG rates

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Ordinary Income

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Top marginal rate on ordinary income = 35%
- salary, rents, interest, royalties