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49 Cards in this Set
- Front
- Back
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what is a sole proprietorship?
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the simplest form of business orgranization drfined as an unincorporated business activity owned by one individual. They own the business assets in his or her own name and is presonally liable for the business debt.
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sole proprietorship taxable income
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is reported on Schedule C of the proprietor's Form 1040. This is the income statement for the year. Tax on net profit is not computed on Schedule C. Instead, the net profit carries to the first page of Form 1040 as ordinary income and is combined with all other income items recognized during the year.
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The employer payroll tax has two components:
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A SS tax of 6.2 percent of a base amount of compensation paid to each employee and a Medicare tax of 1.45 percent of the employees total compensation
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If Schedule C business loss is greater than other sources of INcome...
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the NOL (net operating loss) can be carried back 2 years and forward 20 years
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Interest, dividends and rent income related to owner’s investments
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are not reported on Schedule C; see Schedules B and D instead
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Dispositions of business assets
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are reported on Forms 4797 and Schedule D
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Interest expense on business debt
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is deducted on Schedule C. Non-business interest expense may be deductible if it is for investments or home mortgages
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A portion of the taxpayer’s personal residence may be allowable as a Schedule C deduction if
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The office is used exclusively on a regular basis as
1) the principal place of business operated by the homeowner, OR 2) a place to meet with patients, clients or customers A home office used exclusively for administrative or management activities qualifies if the taxpayer has no other fixed location where such activities are conducted |
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If the home office qualifies
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Allocate expenses between business and personal use
Utilities Home mortgage interest and taxes Insurance Repairs Depreciation Home office deduction cannot exceed taxable income of the business before this deduction |
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FICA
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6.2% Social Security tax on wages up to $106,800 (2009 and 2010) + 1.45% Medicare tax on all wages; both employer and employee must pay this tax
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who pays employment taxes?
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Employers withhold income taxes and the employee’s share of FICA taxes.
Employers must remit the withheld taxes to the federal (and state if applicable) governments |
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Self-employed persons
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pay SE tax on net earnings from self employment
Tax base = 92.35% of net profit reported on Schedule C Tax rates Social security tax =12.4% of earnings up to $106,800 in 2009 and 2010 Medicare tax = 2.9% of earnings |
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The partnership agreement
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states the rights and obligations of partners, and the % of profits and losses allocable to each partner. Such agreements permit flexibility
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General partnership
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all partners have unlimited liability - joint and severable
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Limited partnership
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one or more limited partners are only liable for their contributed capital. Legally, all limited partnerships have at least one general partner
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Limited liability partnership (LLP
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used for professional services. General partners are not liable for malpractice of other partners but are personally liable for other debts of the LLP
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initial tax basis
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Two individuals, Jay and Kay, each contributed $25,000 cash to a new partnership. What is Jay’s basis in his partnership interest assuming that the partnership takes out a $10,000 loan and
The partnership assets secure the loan? ($25,000 + (.5*$10,000)) = $30,000 Jay personally guarantees the loan? $25,000 + $10,000 = $35,000 |
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The partnership files an information return
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Form 1065
Included with Form 1065 are Forms K-1, which show each partner’s ‘distributive share’ of income and deductions “Non-ordinary” items are separately stated and retain their character on the partner’s return Examples: muni interest, capital gains and losses Each partner reports his or her share of partnership income on Schedule E, as part of his or her Form 1040 |
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Because the partnership does not pay tax
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the partnership is referred to as a ‘flow-through’ or ‘pass-through’ entity
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Publicly Traded Partnerships
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Partnership interests traded on an established securities market
Generally taxed as corporations |
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LLCs
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are an alternative to a general or limited partnership. All members of an LLC have limited liability for LLC’s debt
Treated as a corporation for liability purposes, but as a partnership for federal tax purposes Relatively new organizational form - less legal precedence Every state (and DC) permits LLCs Still unclear when LLC income is subject to SE tax |
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coonsequence of partnership[
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Partners cannot deduct losses in excess of basis
Excess losses are carried forward indefinitely until additional basis is restored either by additional contributions or additional positive income This rule applies to each partnership separately |
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S Corporations
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is a flow-through entity for tax purposes
Income and loss items are allocated among shareholders based on their % ownership of stock; this allocation is not flexible like partnership agreements Flow-through items retain their character (e.g. ordinary income, capital losses, charitable contributions, etc) Distributions to S corporation shareholders are generally treated as non-taxable recoveries of investment, similar to partnership distributions Not treated as dividends (C corporation treatment) |
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S Corporation Eligibility
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Only individuals, estates and some trusts may be shareholders – not nonresident aliens, other corporations, or partnerships
The number of shareholders is limited to 100; all family members may be counted as 1 shareholder The corporation may only have one class of outstanding common stock Shareholders must unanimously elect S Corp status; the election is permanent unless shareholders owning a majority of the stock revoke the election |
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Initial basis S corp
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cash + adjusted basis of contributed property
Loan from a shareholder to S Corp increases basis for that shareholder. Any other debt of the S Corp does not increase shareholder basis (E.g., a bank loan guaranteed by shareholder does not increase basis for any shareholder, even the one that guaranteed the loan) Like partnerships, basis is increased by contributions and income items; basis is decreased by distributions and loss items |
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Pass-Through Entities
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Partnerships (includes LLCs) and S Corps are not taxed as entities; investors pay tax on their share of entity income
This treatment results in a single level of taxation Cash distributions are generally not taxable The cash represents a return of investment and does not affect the income or loss reported by the owner |
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Family Income Shifting
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Goal - have income taxed at lower rates (e.g. children’s rates) or avoid estate tax
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Limits on Family Income Shifting
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Family members cannot be partners in a personal service business unless they can perform the services
In contrast, a family member can be a partner in a business in which property is a material income-producing factor Family members providing services must first receive guaranteed payments that constitute reasonable compensation before net income is allocated |
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Limits on Family Income Shifting
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Income of family partnerships is allocated according to proportionate interests in partnership capital
Income of all S corporations is allocated according to the proportionate shares of stock held by each shareholder |
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Closely-Held Corporations
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Biggest challenge is how investors can avoid double taxation of corporate earnings; one way is to have the investor assume an additional role with respect to the corporation
If shareholders are also creditors, interest expense is deductible to corporation If shareholders are also employees, wage expense is deductible to corporation If shareholders are also landlords, rent expense is deductible to corporation |
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Accumulated earnings tax
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Penalty is to assess tax on accumulated taxable income at highest individual tax rate - like forcing a deemed dividend
Penalty = 15% of accumulated taxable income (taxable income less income tax less dividends paid less reasonable needs of business) Common traits that IRS looks for when investigating corporate tax shelters: Little or no dividends paid Abundance of liquid assets not reinvested in production capacity, or Especially substantial loans to shareholders |
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nexus
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the degree of contact between a business and a state necessary to establish jurisdiction
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Nexus can be established via
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Legal domicile: nexus in the state where incorporated
Physical presence: employees or real or personal property; however, sales reps alone do not create nexus Regular commercial activity is argued by some states to create an economic nexus; the law is still unclear |
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Employee is
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an individual
Whose duties are controlled (as to how, when, and where) by an employer Who works according to a regular schedule in return for a wage or salary.Employer withholds income and payroll taxes from salary or wage payments Employer issues Form W-2 to employees |
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Independent contractor
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is a self-employed individual
Who performs services for a fee Who controls the way the services are performed Whose work relationship with a client is temporary. Who can have many clients at the same time.Clients do not withhold tax from fee payments Contractor reports fees as Schedule C business income Contractor pays income and self-employment tax directly Client issues Form 1099-MISC to independent contractors . |
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Employee Fringe Benefits
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General rule: fringe benefits are taxable
Nontaxable fringe benefits include: Health and accident insurance $50,000 group-term life insurance Dependent care assistance |
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Employee Expenses
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When employers reimburse employees for employment-related expenses, the employee neither reports the cash reimbursement as income nor deducts the expense.
Employees may deduct unreimbursed business expenses as miscellaneous itemized deductions Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of AGI Consequently, employees may derive no tax benefit from unreimbursed business expenses |
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IRAs
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Any person who earns employee compensation or self-employment income can save for retirement through an individual retirement account (IRA).IRAs are tax-exempt so that earnings on the account grow at a before-tax rate
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types of IRAs
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With a traditional IRA, earnings on the account are taxed when the owner withdraws them
With a Roth IRA, withdrawals are tax-exempt so the earnings on the account are never taxed |
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Traditional IRAs
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contributions can be fully deductible, partially deductible, or nondeductible based on two factors
Participation or nonparticipation by the individual in another qualified retirement plan AGI level (deduction phased down to zero for higher-income taxpayers) |
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Roth IRAs
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contributions are nondeductible
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Traditional IRAs
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Withdrawals must begin when owner reaches age 70½
Tax consequences of withdrawals: Amount attributable to deductible contributions and accumulated earnings is taxed as ordinary income Amount attributable to nondeductible contributions is excluded from income |
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Roth IRAs
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Qualified withdrawals are tax-exempt
Contributions are qualified if they occur after: Owner has reached age 59½ Five-year period beginning with year of initial contribution |
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Interest Income
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Interest on savings accounts, CDs, and corporate bonds is taxable as ordinary income
Municipal bond interest income is exempt from federal tax If the bond is a private activity bond, the interest is an AMT preference Interest on U.S. debt (Treasury bills, notes, bonds) is subject to federal tax but exempt from state tax |
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Passive Activities
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an interest in a business in which the owner of the interest does not materially participate
Material participation requires involvement in day-to-day operations on a regular, continuous and substantial basis..The classification of a business interest as a passive activity does not effect how income is taxed but does effect the deductibility of losses |
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Passive Loss Limitation
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Loss on passive activity is only deductible to the extent of other passive income
No deduction against active income (wages, income from material activities), and portfolio income (interest, dividends) Nondeductible losses are carried forward indefinitely Taxpayer can deduct unused losses upon disposition of the business interest |
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Exception for Rental Real Estate (Passive Activity)
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Passive rental losses up to $25,000 can be deducted without limit
Taxpayer must actively manages the rent property $25,000 exception is reduced by 50% of AGI in excess of $100,000 Exception reduced to zero when AGI exceeds $150,000 |
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Gift Tax
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Gifts are excluded from the donee’s gross income
No income tax cost to donee Donor’s basis carries over to donee Donor may exclude $13,000 per year per donee from taxable gifts Married couple can elect to treat a gift made by one spouse as made equally by each Gift-splitting double the annual exclusion Gifts to spouse or charities are nontaxable Payment of tuition or medical costs of another individual is not a taxable gift |
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Gift Tax Lifetime Exclusion
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If the FMV of a gift exceeds the annual exclusion, the excess is a taxable gift
Only the amount of a donor’s cumulative taxable gifts in excess of a $1,000,000 lifetime exclusion is subject to tax |
