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61 Cards in this Set

  • Front
  • Back
Ordinary gain or loss
Gain or loss that is not capital
Capital gain examples
Dividens on corporate stock
Capital gain/ordinary loss
Real estate used in a business – rental properties, taxpayer’s owner-occupied business premises, leased land, copyright on music created by the taxpayer.
Capital gain/capital loss
Stock in a corporation, bonds, mutual fund shares (unless held by broker or underwriter for sale to customers). Any other asset held for investment, e.g., land held by an insurer.
Capital gain/nondeductible loss
Assets held for taxpayer’s personal use, e.g., your clothes.
Ordinary income/ordinary loss
Inventory held by the taxpayer, other assets held for sale to customers, e.g., real estate held by a real estate dealer, copyrights on property created by the taxpayer except music, most equipment and vehicles used in a business (income is “depreciation recapture”).
Ordinary income/nondeductible loss
An individual’s personal services.
Personal service income - Taxed to who
Must be taxed to the service provider, no matter whom it is actually paid to.
Income from one's property - When taxed to someone else
 Outright gift of the entire property successfully puts the income from the property on the donee’s return.
 Gifts of present income interests (e.g. a life estate or a term of years) are ineffective to shift the income from the property to the donee’s return if the donor retains the future interest (e.g. a reversion).
 Gifts in trust with grantor-retained powers (e.g., a power to revoke the trust or change the beneficiaries) are ineffective to shift the income from the property to the donee’s return.
 Gifts in trust with no grantor-retained interests or control shift the income from the property to the trust or its beneficiaries, just as outright gifts do.
Kiddie Tax
All unearned income of children under the age of 18 is taxed to the children at their parents’ highest marginal tax rates. Unearned income is all income other than compensation that the child earns for his or her own personal services.
Above the line deductions
Deduct above the line deductions to arrive at AGI
Below the line deductions
Deduct below the line deductions from AGI to arrive at taxable income
Take only above the line deductions then personal exemptions and standard deduction
Deductions - cost of living
Not deductible
Deductions - Losses on personal use property
Not deductible, except for casualty losses
Deductions - Cost of making a living
Deductible. All the “ordinary and necessary” expenses of business or investment activity are generally deductible. Includes expenses of being an employee of someone else. Cost of making money is deductible against money made.
Personal deductions
• Personal exemption
• Alimony paid
• Casualty losses
• Medical expenses
• Charitable contributions
• Interest
• Home mortgage interest
• Student loan interest
• State and local taxes
• “Miscellaneous deductions”
Personal exemption
A deduction just for being alive. One for the taxpayer, one for his/her spouse if spouse doesn’t need to file, and one for each dependent of the taxpayer. Typically $3,300 per person.
o A “qualifying child,” namely, the taxpayer’s child, sibling, niece or nephew who (1) lives with the taxpayer (including time away from school or illness) for more than half the year, (2) is under age 19 (or under age 24 and a full-time student), and (3) doesn’t provide more than one-half of his or her own support (you don’t have to provide their support). OR
o A relative or member of taxpayer’s household who has gross income less than $3,300 per year, if the taxpayer provides more than one-half of the person’s support, and the person is not someone else’s “qualifying child.”
If tie for who can claim qualifying child
Goes to parent. If tie between parents, whoever has kids most of the year. Other ties go to one with highest income.
Special qualifying child rule for children of divorced parents - Overrides other rule
Non-custodial parent gets the dependency exemption if divorce decree or separation agreement says so.
If someone else can take you as a dependent
You can't take an exemption for yourself
Deductions - Alimony paid
Payer of alimony generally gets to deduct it, as payee reports it as income. Above-the-line deduction, even nonitemizers take it. Beware disguised child support and disguised property settlements – not deductible.
Deductions - Casualty Losses
Below-the-line deduction for uninsured losses from fire, storm, shipwreck, or other “casualty” (sudden and unexpected), or from theft.
• Deduction limited by an annual “floor,” a.k.a. “threshold” – 10% of AGI – and by an additional $100-per-event “floor.”
• Most that can be deducted is property’s basis- no basis, no deduction.
• Mere loss of property does not establish theft.
Deductions - Medical expenses
Below-the-line deduction for uninsured losses from fire, storm, shipwreck, or other “casualty” (sudden and unexpected), or from theft.
• Deduction limited by an annual “floor,” a.k.a. “threshold” – 10% of AGI – and by an additional $100-per-event “floor.”
• Most that can be deducted is property’s basis- no basis, no deduction.
• Mere loss of property does not establish theft.
Deductions - Charitable contributions
• Generally deductible, no “floor.” A 30-50% AGI ceiling – in the real world, not usually an issue.
• Contributions of property generally deductible as FMV of property.
• But dealer in property, self-created works deductible only in amount of taxpayer’s basis.
• Used autos, planes, boats – deduction capped at amount charity sells vehicle for
• Benefits taxpayer receives in return decrease the deduction; substantial quid pro quo negates deduction entirely
• Taxpayer needs written proof
• Below the line – itemizers only.
Deductions - Interest incurred in a business
Deductible above the line as an “ordinary and necessary” expense
Deductions - Interest on debt used to buy investment property
Deductible only against income from investments
Deductions - Interest incurred in personal life
Not deductible at all, except for home mortgage interest and student loan interest. Interest on credit cards, personal auto loans not deductible.
Deductions - Home mortgage interest
• Interest is deductible on two types of home mortgages
o Acquisition indebtedness. Money used to buy or improve the house. Limit: interest on $1,000,000 of debt (nice house).
o Home equity indebtedness. Money borrowed with house as collateral, but used for purposes other than buying or improving the house. Limit: interest on $100,000.
Deductions - Home mortgage interest - Mortgage on two homes
• Mortgages on two residences generate deductible interest: the taxpayer’s principal residence plus one other used for personal purposes (e.g., vacation home). If total debt exceeds the $1,000,000 and $100,000 limits, interest on the excess is not deductible.
• Below-the-line (itemized) deduction.
Deductions - Student loan interest
• Interest on student loans is deductible up to $2,500 a year per return.
• Deduction is “phased out” as AGI exceeds $100,000 on joint return, $50,000 single.
• Deduction is above-the-line – even nonitemizers get it.
Deductions - State and local taxes
• Personal income and property taxes deductible below the line (itemized). In sales tax states, deduct either state sales tax paid in personal life or state income tax – taxpayer’s choice.
• Business taxes (other than federal income tax) generally are deductible, above the line, as “ordinary and necessary” business expenses. Even sales taxes paid in a business.
Miscellaneous Deductions
Other deductions are allowed below-the-line, but only to the extent they exceed a 2% of AGI floor. Include union dues, unreimbursed employee business expenses, tax return preparer’s fees, deductible attorney’s fees in lawsuits not involving business.
Deductions - Hobbies Definition
• Losses and expenses from activities not engaged in for profit are not deductible, except for personal deductions above
• To determine whether a taxpayer engaged in activity for profit, look to the taxpayer’s primary purpose.
o Honest but unreasonable profit motive sufficient.
o Case-by-case determination.
o Objective evidence can show profit motive or lack thereof (manner conducted, expertise, amount of time spent, elements of recreation)
o Hobby expenses deductible against hobby income.
Deductions - Attorney's fees general rule
Deductibility of lawyer’s fees incurred in a dispute depends on nature of the claim.
Deductions - Attorney's fees for defendant
Look to origin of claim. If personal, no deduction. If business or other profit-motivated transaction, deduction.
Deductions - Attorney's fees for plaintiff
Look to the type of relief plaintiff is seeking. If nontaxable type of recovery, no deduction, if taxable, will get a deduction, win or lose.
Deductions - Attorney's fees for everyday advice
Look to nature of advice. If personal, no deduction. If business or other profit-motivated transaction, deduction.
Deductions - Tax advice
Deductible. Computing and minimizing taxes is deemed to be profit-oriented.
Deductions - Home Offices
• No deduction for depreciation, insurance, maintenance, utilities, unless taxpayer uses home office exclusively for business use.
• In addition, home office must be (1) taxpayer’s primary place of business or (2) meeting place with clients or customers or (3) structure detached from house.
• Very difficult to establish deduction.
Deductions - Vacation Home
• Deductions for depreciation, maintenance, insurance, utilities, etc., scaled back based on a formula – the more personal the use, the smaller the percentage of these deductions allowed.
• Total deductions cannot exceed rent from vacation home.
• Home mortgage interest on second home, and property taxes on any property, always deductible for itemizers.
Deductions - Child/elder care
• No deduction. Limited tax credit allowed for such expenses that enable taxpayer to work outside home.
• Credit is percentage of child/elder care expenses – 20-35% depending on income. The higher one’s income, the lower the percentage.
• Expenses capped at $3,000 for one dependent, $6,000 for two or more.
Deductions - Travel & Travel Meals
• Business travel expenses (transportation and lodging) are deduction if primary purpose of trip is business or investment. Not commuting to one’s usual place of business, however – even long-range commuting that involves housing in two different cities if not deductible.
• Meals while on business trip are deductible, but only if the taxpayer stays overnight or does business with other over the meal.
o All meal expenses are only 50% deductible (full cost of transportation and lodging o.k.).
Deductions - Business meals
• Doing business with associates, partners, customers, etc., over a meal in any locality entitles a taxpayer to deduct its cost, but only 50%. Not every day, either.
Deductions - Business Entertainment
• Cost of entertaining clients, customers, recruits, etc. is deductible if “bona fide business discussion” directly precedes or follows entertainment. Virtually impossible for IRS to enforce. Only 50% is deductible. Taxpayer needs documentation to back up deduction – estimates unacceptable
Deductions - Work clothes
• Deductible only if specialized clothing not adaptable to general wear (e.g. postal workers’ or fast food servers’ uniform).
Deductions - Education
• Deductible only if maintaining or improving skills needed for job taxpayer already has (e.g., CLE). Not entry-level required education, and not education that qualifies taxpayer for new business. Law school tuition not deduction if you get a J.D. degree, regardless of whether you intent to become a lawyer, because it helps you qualify to become one.
• However, tax credits are available for certain expenses of college and beyond, subject to low ceilings.
Deductions - Business and Investment
 Taxpayers can deduct all the “ordinary and necessary” expenses incurred in carrying on a trade or business OR carrying on any other profit-oriented activity (such as investment).
Deductions - Business and Investment Limitations
• Lobbying
• Unreasonable compensation
• Highly unusual expenses
• Illegal payments
When is it deductible - Current expenses vs. capital expenditures
Not all profit-oriented cash outlays are immediately deductible. Some must be placed into the basis of an asset and recover later – either when the taxpayer sells the property, or through depreciation deductions. Outlays that must be included in basis are called capital expenditures, as opposed to current expenses.
Examples of capital expenditures
 Purchase price of property.
 Transaction costs of buying/selling.
• Includes attorney’s fees.
 Improvements to property.
 Long-term benefit.
• Costs incurred by taxpayer in building its own facilities.
• Outside writers hired by publisher to write book.
 Start-up expenses.
Choice of entity. Corporation or partnership
 The tax code sees every business entity as either a corporation or a partnership.
 Corporations. Two types
• C corporation (default for corporation)
• S corporation (elective)
C Corporation
Double tax. Usually bad. Subject to double taxes. C corporation pays tax when it has taxable income. Shareholders also taxed later when C corporation distributes its earnings and profits to them (dividends). Also, corporate operating losses (deductions are more than income) decrease share value, but do not trigger taxable losses to shareholders unless and until they sell their shares.
• Pass-thru. Usually, much better! Entity not subject to tax. Partnership files information return with IRS, but pays no income tax. Each partner must report every year his/her pro rata share of partnership income, and pay tax on that share, regardless of whether there has been any actual distributions of money or property. And if a partnership runs an operating loss (deductions are more than income) for a given year, partners can deduct their shares of loss on their own returns for that year, subject to limitations.
S Corporation
• Pass-Thru. Taxed pretty much like a partnership. However, qualification for this status is strictly limited: S Corporation cannot have more than 100 shareholders (all members of family = 1), cannot have preferred stock, only certain types of trust can be shareholders, etc. Partnerships (including LLCs), can have complicated capital structures, 100+ owners (so long as not publicly traded), etc., and still be taxed as a pass-thru.
Corporations Definitin
Any entity that is expressly incorporated under state law is a corporation (either C or S) for tax purposes
This tax category includes general partnerships, limited partnership, limited liability partnerships (LLPs), and most limited liability companies (LLCs). If it is not expressly incorporated under state law, it is generally a partnership for tax purposes unless it goes public! All publicly traded entities (shares sold on a national exchange or market) are taxed as C Corps.
Formation rules
 Nonrecognition rules. Formation of a corporation or a partnership is generally a non-recognition transaction, similar to a like-kind exchange.
 Carryover basis.
 The contributing owner (shareholder, partner, or LLC member) recognizes no gain. He/she takes a basis in his/her ownership interest (stock, partnership interest, or LLC interest) equal to the basis of the amount he/she contributed.
 The entity (corporation, partnership, or LLC) recognizes no gain. It takes a basis in the contributed property equal to the basis that the owner had in it prior to contribution.
 Transfers of personal services for ownership interests are generally taxable to service provider.
C Corporation Operations
Computes its taxable income and pays tax on it each year. Also keeps track of its “earnings and profits” – a number that determines whether distributions to shareholders are taxable dividends. Payments to shareholders out of “earnings and profits” are dividends – gross income (capital gain) to the shareholder. Corporation cannot deduct dividends paid, so a double tax results.
S Corporatin or Partnership Operations
Computes its taxable income but pays no tax on it. Each year, each shareholder/partner reports his/her share of the business’ taxable income in his/her own individual tax return. He/she must pay tax on this share as soon as the business earns it, even if the S corporation/partnership does not pay it out to shareholders/partners. Income taxed in this way increases the owner’s basis in his/her basis in his/her stock/partnership interest. Distributions of money from S corporation/partnership are generally not taxed to the owner unless they exceed his/her basis in his/her stock/partnership interest.