Mac 740 - Individual Income Tax - Part 2

Front 1

Business vs. Investment Activities.

Business when taxpayer commits _____ and ____ on a regular basis (profit attributed to personal involvement). Investment when profit is primarily due to invested capital / taxpayer takes passive role (even if time is spent managing _____ / _______).

Investments:

Returns include:
-Interest (tax at _______ rate)
-Dividends (if _____, tax at ______ rate - ___ if in anything but top 2 brackets). If dividends are _____, then they are still ______ but they increase the stocks basis to avoid double taxation. Qualified means for individuals received from taxable domestic corporations. Sometimes corps return corporate capital instead of divid. on corp. earnings. In this case, the ________, and the cash is nontaxable. Mutual Funds will often have different amount of Cap Gains, Dividends, etc..

Back 1

time and talent;

portfolio / property;

ordinary rate; qualified; preferential rate; 15%; reinvested; taxable; stock's basis is decreased.

Front 2

Investments:

Returns include:
-Tax exempt interest income: Municipal bond interest is _____ at the federal level and ____ at the state level if _____. If the bond is a private activity bond, then it is _________. US debt is _______ at the fed. level and _______ at the state level.

-Bond Interest: Cash basis taxpayers recognize income when it is received. If a bond is sold at a discount / premium in a _____ transaction, taxpayer may elect to delay recognition of loss / gain until maturity (deferral of discount). Includes EE savings Bonds. However, with ______, the taxpayer must recognize the accrued income by amortization (NO deferral of discount). There are no deferrals for TIPS, the inflation increase in principal is recognized yearly.

-Life insurance policies: Term: you pay a premium and when term is up, you get nothing. Whole: investment element and a death benefit. A ___ builds up every year that the policy in effect in case liquidated. The ___ less ___ is taxable upon liquidation. * exceptions

Back 2

nontaxable; nontaxable; you live in the state of the bond; an AMT preference item; taxable; nontaxable;

market; Originally issued debt (OID);

Cash Surrender Value (CSV); CSV; premiums paid; *exception for accelerated death benefits. If you are chronically / terminally ill, if you liquidate to pay medical costs, non taxable.

Front 3

Investments:

Returns include:
-Annuities: Pay single lump sum / string of payments, then receive benefits until you die. A portion of the annuity payments are nontaxable. 1. Calculate _______ ratio. (________ / ________). 2. Multiply time the total annuity payments received. This is the nontaxable return on investment. The rest of annuity payments are _____ as ________. This method will be applied until the full return on investment is recovered, then all further amounts are fully taxable. If the full return on investment is not returned (death); then unrecovered amount can be a ________ on _______.

Back 3

exclusion; investment in annuity / expected return on annuity (based on life expectancy tables); taxable; ordinary income; itemized deduction; final tax return;

Front 4

Investments:

Returns include:
CAPITAL GAIN (Long term capital gain is ______). Brokerage fees / commissions reduce amount realized from the sale. Reinvested dividends ____ total basis, while nontaxable distributions ______ total basis. Sale of stock uses either _____ or _____ (likely) method of matching basis with sales. Mutual fund shares sold typically use an ______ basis method. Example: Sold 150 shares for $1500. $50 fee. Had bought 100 shares for $5 and 100 shares for $7.5. Gain?

Back 4

One year and ONE DAY!; increase; decrease; specific ID; FIFO; Average;

Ex: First 100 = $500 basis
Second 50 = ($750)(.5) = $375 basis
$1500 - $875 = $625

Front 5

Investments:

Capital Gain: Worthless securities treated as if sold on last day of year. Often ________. Non-business bad debts (personal loans) are always treated as __________. Nontaxable exchanges include trading securities within same corporation and reorganizations (mergers). These simply change the basis of security and defer taxes.

Back 5

Long term capital loss (can be ST); Short term capital loss

Front 6

Investments:

Capital Gain: ST is one year or less and recorded as ordinary income; LT is one year or longer and has preferential rates. Can be one of 3 rates:
1. _______
2. _________________.
3. _________________.

Normal: Net STCG and LTCG separately. If both gain / loss, don't net. (Total capital losses are netted against ordinary income only for $_____ - rest carryforward indefinitely. If both LTCL and STCL, use _______.) However, net the 2 if opposites exist (ie. STCL and LTCG, etc..)

Back 6

1. Normal LTCG = 15% (or 0% if lower bracket)
2. (max 28%) LTCG on collectibles and small business stock
3. 1250 unrecaptured gain for realty (25%).

3000; STCL;

Front 7

Investments:

Unrecaptured 1250 Capital Gain: For realty used in a business (including rentals), held for > 1 year, then it is a 1231 asset (not capital). When the realty is sold, it is subject to 1250 partial depreciation recapture (in other words, if depreciated too much, don't want pure preferential rate applied to gain after adjusted basis calculated). If the gain (Sale price - Adj. basis) is less than _____, then tax at ordinary tax rate up to ____. If gain is more than ____, then tax ___ amount of gain at ordinary rates up to ____ and the rest is calculated as a _____.

Back 7

Acc. Depreciation; 25%; Acc Depreciation; A/D; 25%; LTCG;

Front 8

Investments:

Investments in small businesses: There are two sections in tax code to encourage investing in start-ups:
1. 1202, if original purchaser and held for > ______, then if sold at a gain, get to ________ and the remaining ___ is taxed at a max ____. (Big AMT benefits). OBAMA - new proposal = if acquired in _____ then get to exclude ____ from tax.
2. 1244 stock (certain type - have to be within first 1 million dollars of stock issued). If sales of stock generates a loss, get to deduct _______ against ordinary income and then rest is capital loss (additional $3000). If gain, counts as capital gain.

Back 8

5 years; exclude 50% of gain; 50%; 28%; 2009/2010; 75%

100,000

Front 9

Investments:

Investment expenses: ie. _______, _______, and investment fees. These are classified as a _________ (subject to 2% floor).

Investment Interest Expense: ie. if you borrow money to invest: the interest is classified as a _______. Exception: if you borrow to invest in _________, the interest is nondeductible; However, it is limited to TOTAL net investment income (investment income less investment expenses); If investment income is taxed preferentially, they can elect to can the rate, or include it as investment income (to further deduct interest expense), but not both. Therefore LTCG and others are USUALLY excluded from the "Net Investment Income" figure in order to keep rates. *If the total investment income limitation prevents you from deducting full amount of interest, can _______.

Back 9

seminars, publications; Miscellaneous itemized deduction; itemized deduction; munincipal bonds; carryforward;

Front 10

Investments:

LAND classified as a ______ asset. Property taxes = deductible ________. Mortgage interest = ____________. However, if not itemizing deductions, these would be lost... therefore, for land, can __________ of land. Cutting land up into parcels can sometimes be viewed as a business activity, and if IRS believes it is a business activity, the sales of land are treated like sales of inventory, thus ordinary income...

Back 10

capital; itemized deduction; investment interest expense (deductible); be capitalized into basis;

Front 11

Investments:

Passive Activities: When don't materially participate in day to day activity. If business is classified as this, it effects the __________. _______ is always classified as a passive activity (rentals of DVDs, Autos, Hotels, are NOT). If passive activity generates a loss, it may only be deducted to the extent of ____________. Any disallowed loss is carried forward against future passive income. There is a large exception for rental real estate: _______ may be deducted if AGI is < _______. Phases out at _______.

The passive loss limitation is not ______. ie. in year of disposition, the _______ is fully deductible.

Back 11

deductibility of losses; Rental Real Estate; other income from passive activities. $25,000 of loss; $100,000; $150,000

permanent; disallowed loss;

Front 12

Transfer taxes:
Gift tax:
No tax on gifts to _____ or ______. Also no tax on payment of ______ or _____ costs of another.

Gift tax exclusion (not taxable):
1. Annual = 13,000 (each recipient of gift - can give 2 people 13,000 dollars to give to another person. Also can give 26,000 per donee if giving as a couple).
2. Lifetime = 1,000,000 (2,000,000 MFJ). The amount in excess of the annual exclusion counts towards the lifetime exclusion. Until the 1,000,000 threshold is crossed, no gift tax is owed.

If property / securities are transferred, the basis is transferred to the recipient.

Also for kids under 18, if unearned income excess annual base rate ($1900), they must pay taxes on parents marginal rate. (_______ tax).

Back 12

spouse; charity; tuition; medical;

kiddie;

Front 13

Estate tax;

includes FMV of all assets owned by decedent (including life insurance proceeds for others). Taxable estate is reduced by the _______ and _______. Also donations to charitable, educational, etc. organizations reduce taxable estate. There is also a __________ (meaning if you remarry, you can perpetually keep wealth). The estate tax exclusion is _________ and is reduced by _________ (how much of it you used up). The highest marginal rate is 45%.

Inherited property is not included as taxable income; If property received, basis is the FMV at date of death.

Back 13

decedent's debts; funeral / admin costs; unlimited marital deduction; 3.5 million; lifetime gift tax exclusion;

Front 14

Employee vs. Contractor; Employee - duties controlled by employer; Contractor - performs services for money; can have many clients at same time; DISTINCTION important! Employer avoids _____, _____ and ______ with ______. IRS also more likely to receive tax from ______. (Cos must report W2 to IRS, not 1099-MISC).

__ Corporations have an incentive to pay unreasonably large salary (max. deductions)

_ Corps. have an incentive to pay unreasonably low salarys (min. payroll taxes).

Back 14

FICA tax; withholding taxes; fringe benefits; contractor; employee;

C; S;

Front 15

Employees generally must include all fringe benefits in income. However, excluded from taxes income:
1. Providing social welfare (_______, ________, _______)
2. Necessary for job (_________, ________).

Group term life insurance: If the benefits exceed ________, then the excess is taxable to the employee.

Dependent care is taxable if it is in excess of ________.

There are other, specific non-taxable fringe benefits; HOWEVER, if self employed, ONLY GET TO DEDUCT ________. Nothing else!

Back 15

health insurance; life insurance; child care benefits; moving expenses; supplies at work;

$50,000; $5,000; Health Insurance;

Front 16

Employee stock options:

Under GAAP, these are recorded as expense using Black-Scholes; However, at grant date in tax world, ESO are _______. Therefore there is a ______ B/T difference that reverses out at the _______. Afterwards, it depends whether the option is
1. ___________: At exercise date, the FMV less the strike price ("_________") is recorded as ________. The basis is the ____ and the employee must pay the employers the strike price. (Employer get tax deduction after exercised).
2. ___________: At exercise, the employee recognizes NO income, but _________. This is an incentive b/c the eventual sale in tax at preferential rates. However, employee must be careful because the _______ for ISO in the yr of exercise is a __________. Furthermore, the employer ______ a tax deduction for ISO (thus creating a _______ B/T diff. from Black - Scholes expense for books) *EXCEPTION Employer can deduct if there is early disposition of stock (within __ years of grant date or __ year of exercise date).

Back 16

nontaxable; unfavorable; exercise date; Non-Qualified Stock Options; "Bargain Element"; Ordinary Income; FMV of stock;
2. Incentive Stock Options; the basis is the strike price; bargain element; AMT adjustment to AMTI; never receives; permanent; 2; 1;

Front 17

Employee expenses:

______ expenses are NOT INCOME. Employee neither reports as income or deducts expense;

________ are deductible as a ____________.

Back 17

Reimbursed;

Unreimbursed; misc. itemized deduction;

Front 18

Qualified Retirement Plans:

General attributes:
-Cannot discriminate
-Contributions today are non-taxable;
-Retiree is taxed on withdrawls of all amounts;
-Premature withdrawals (before age ____) are subject to a ___ excise tax. (exceptions: ____, ____ or retiree is over 55 and terminated employment w sponsor).

3 types of Qualified Retirement Plans:
1. _________
2. _________
3. _________

Back 18

59 1/2; 10%; disabled; death;

1. employer provided
2. S-E plans
3. IRA's

Front 19

Employer provided Retirement plans:

Defined Benefit - pensions - don't care about for exam;

Defined Contribution: Employer gives employee certain amount of $$. Employee bears risk of return on investment; The contributions by employer is ________. Annual contribution amount by employer is equal to lesser of _______ or _______. Types of defined contributions:
1. ________ - firms contribution a % of current earnings to retirement trust. Under no obligation to contribute during net operating loss;
2. _________ - employer contributions are invested in ________. Upon retirement, the aggregate basis = ordinary income and basis for stocks;
3. ________ - ______ / ______ both contribute; Employee contribution limit = ______.

Back 19

tax deductible; 100% of annual income; 49,000 (inflation adjusted);
1. Profit sharing plan;
2. Employee Stock Ownership plans (ESOP);
3. 401K plan; employer / employee; $16,500;

Front 20

Nonqualified employer plan = __________; Because it is non qualified, it can _______. This is helpful to top executives. The receive future benefits from company, but don't recognize income today, while the company recognizes a current expense / non-current liability for book purposes, but not tax purposes. IE. the employee would want this is he was certain about _________ (he is essentially a _______).

Back 20

Deferred compensation plans; discriminate; health of the company; unsecured creditor;

Front 21

Self Employed Retirement Plans:
Can contribute up to the lesser of _________ or _________. _______ to discriminate (ie. __________);

IRAs
Individuals may contribute the lesser of _______ or _______. *if taxpayer has reached ____, he/she may make a _____ catch up contribution; ***HOWEVER, IRA contribution is limited if taxpayer / or spouse participating in other qualified retirement plan. (IE phase out becomes nondeductible if active participant and AGI > 89,000 / spouse active and AGI > 166,000).

Back 21

20% of S-E earned income; 49,000 (2009); Not allowed; must offer plan to all employees;

5,000; 100% of earned income (each spouse may contribute 5,000 if MFJ and combined earned income is > 10,000); 50; 1,000;

Front 22

Withdrawals from IRAs;

10% penalty still exists over 59.5; If all contributions were deductible, withdrawals are ________; If some were non-deductible, find out nontaxable withdrawal %. (_______ / ________) - this changes every year, but eventually nets out;
Withdrawals from IRA's can escape the 10% penalty for 2 reasons (must still pay tax though):
1. To pay for __________
2. To pay for ___________ ($10,000)

Roth IRA:

YOUNG PEOPLE; No deduction when you contribute, but no tax upon withdrawal; Not available for high income earners;

Back 22

ordinary income; unrecovered investment / current year IRA value;

higher education; first home purchase

Front 23

TAX COMPLIANCE:

Even if you rely on professional help, you are STILL responsible for complying and will bear consequences; Required filing date, corporations: ___ day of ___ month following end of fiscal year; both individuals and businesses may apply for ______ _______ extensions;

Late payment penalties:
___ of unpaid tax per MONTH if the return is late (__ month maximum, then reverts to __ for 45 additional months) - might be allowed to avoid penalty if reasonable excuse.

__________ + __ percentage points ("______ rate") - on all tax that is not paid by April 15th (and extension filed or mistake made on return).

JUST B/C CHECK CASHED OR REFUND MAILED DOESN'T MEAN RETURN IS ACCURATE, JUST PROCESSED

Back 23

15th; 3rd; automatic; 6 month;

5%; 5 month; .5%;

federal S-T rate + 3 percentage points; "underpayment rate";

Front 24

Statue of Limitations:

IRS may select a return for audit 3 years from the later of:
-________ (April 15th);
-_________.

If the taxpayer omits >___ of gross income, it extends to __ years;

If the return is fraudulent, statue is open indefinitely;

Record keeping for all documents should be kept for 3 years; Record keeping for basis in land, legal documents and old tax returns, should be kept indefinitely;

Audits chosen by the ___ system, scoring high for those who have ______, _____, and _______.

Back 24

Unextended filing date; Date actually filed;

25%; 6 years;

DIF; high income; high deductions; self-employed business income;

Front 25

3 types of audits by IRS:

1. ________ exams are through mail / phone;
2. ________ exams take place at IRS office and are limited in scope;
3. ________ exams take place at taxpayer's place of business and have complete analysis of taxpayers books and records;

Additional tax owed is called a _______; Interest charged on deficiency is only deductible by ________. If you are due an additional refund, you may also receive interest;

The ____________ office assists taxpayers in resolving problems and helps taxpayers who suffer hardship through IRS actions;

Back 25

Correspondence;
Office;
Field;

deficiency; corporate taxpayers;

National Taxpayer Advocate;

Front 26

Noncompliance penalties:

_______ tax return: tax protester filing blatantly incorrect tax return on basis of "not in Constitution", etc.. (penalty = _______)

Negligence: applies when IRS determines that taxpayer did not make a good faith effort to compute correct tax; The penalty is ___ of any ________ attributable to negligence. IRS must show a __________: Neg. vs. Mistake is based on taxpayer's experience, education, etc..

Civil Fraud: Penalty is ___ of any _______ attributable to fraud; Must have clear and convincing evidence (> preponderance).

Criminal Fraud = tax evasion (court of law), prison time may result; Penalty is up to 100,000 for individuals, up to 500,000 for corps. Must demonstrate guilt _________.

Back 26

Frivolous; $5000;

20%; underpayment; preponderance;

75%; underpayment;

beyond a reasonable doubt;

Front 27

Tax return preparer penalties:

Failure to sign a return as preparer: $___

Taking an unreasonable legal position (aggressive stance on tax deductions, etc..): penalty is _____ of _____ or ___ of compensation for return;

Intentional disregard for the law in preparing a return: penalty is _____ of _______ or ___ of compensation for return;

Monetary fines not large, but reputation damage is huge;

Back 27

50;

greater; $1000; 50%;

greater; $5000; 50%;

Front 28

__________ Rule:

Must meet 3 requirements:
1. Deficiency attributable to erroneous item from spouse;
2. Must establish that he/she did not know, nor had a reason to know that the return was understated;
3. It is inequitable to hold the person liable for the deficiency; (relief is unavailable if the ____ received any ____ from the ____ taxes)

Back 28

Innocent Spouse;

spouse; benefits; evaded;