Tax Accounting

Front 1

Why do we have an income tax?

Back 1

The United States has a big budget. The government taxes our income so it can pay for the things we need.

Front 2

What other types of taxes are individuals and/or professionals subject to?

Back 2

Sales tax,Property tax,Excise tax,Estate Tax

Front 3

How do tax laws affect decisions made by individuals? Businesses?

Back 3

It can affect what type of investments you make, what you buy, and what job you take, if you should get married or not. What type of real estate you may or may not purchase.

Front 4

How does the accrual basis vs. cash basis of accounting effect the amount of tax liability?

Back 4

The cash method is most used by small businesses and for personal finances. The cash method accounts for revenue only when the money is received and for expenses only when the money is paid out. On the other hand the accrual method accounts for revenue when it is earned and expenses goods and services when they are incurred. The revenue is recorded even if cash has not been received or if expenses have been incurred but no cash has been paid. This is the most common method used by businesses.

Front 5

How does congress use the tax laws

Back 5

To pay debts and provide for the common deference and general welfare of the US.

Front 6

What is the audit process utilized by the IRS as part of the administration of tax law?

Back 6

The IRS preforms audits to Assure that all income is report and that the expense deductions are legitimate to assure compliance with tax law. You will receive a letter from the IRS, then you reply with a letter with the information they request, then you will receive a letter from the IRS with their decision, and you can ask for an appeal.

Front 7

What are the ethical guidelines that will apply to individuals in tax practice

Back 7

Do not take questionable positions on a client's tax return in the hope that the return will not be selected for the audit by the IRS. Any positions taken should be supported by a good faith belief that they have a realistic possibility of being sustained if challenged. The client should be fully advised of the risks involved and of the penalties that will result if the position taken is not successful

Front 8

What are the economic, social, equity, and political considerations that justify various aspects of the tax law?

Back 8

Economic: tax provisions help regulate the economy,Social considerations: some tax provisions are designed to encourage (or not) socially desirable practices.,Equity considerations: tax provisions that alleviate the effect of multiple taxation,Political considerations: tax provisions that represent special interest legislation, reflect political expediency, and exhibit the effect of state and local law

Front 9

Describe the role played by the IRS and the courts in the evolution of the federal tax system.

Back 9

Many tax provisions are intended to aid the IRS in collection of revenue and the administration of tax law. Courts decisions have established a body of judicial concepts related to tax law that help clarify or negate statuary provisions.

Front 10

Describe the purpose of each of these three sources of tax law: statutory, administrative, and judicial.

Back 10

Statutory sources are IRS, codification of the Federal tax law,Administrative sources of tax law: treasury department, revenue rulings, revenue procedures,Judicial sources: US tax court (regular), us tax court (small cases division), federal district court, US court of federal crimes

Front 11

What is the difference between the economic, accounting, and tax concepts of gross income?

Back 11

Economic concept of income: wealth that flows to individuals, and changed in value in individual's wealth,Accounting: values are measured by transaction approach, income realized as result of completed transaction, use historical cost,Tax concept: conditions to make income taxable, administrative convenience, wherewithal to pay, gross income defined

Front 12

Explain why congress creates tax credits that reduce federal tax collections.

Back 12

For recognition of taxes already paid, as a subsidy, pr to encourage investment or other behaviors

Front 13

What is the alternative minimum tax and how does it apply to individual taxpayers?

Back 13

Is income tax owned using a parallel tax code designed to ensure that every tax payer, particularly rich ones and corporations, pay at least some income tax each year. It is to ensure that people with high income and corporations could not avoid taxes by using various tax shelters. The AMT rules disallow many personal exemptions and many deductions. The taxpayer compares the tax calculated under AMT method to the tax calculated under regular method and owes the higher of the two.

Front 14

What are the rules pertaining to partnership taxation?

Back 14

Partnerships are flow through entities. The entity does not pay taxes on its income instead the owners of the entity pay tax on their distributive share even if no funds are distributed to the owners.

Front 15

What are the rules pertaining to corporate taxation?

Back 15

Because a corporation is a separate entity from its owners the company itself is taxed on all profits that it cannot deduct as business expenses. Taxable profits consist of money kept in the company to cover expenses or expansion and profits that are distributed to the owners as dividends.

Front 16

Do partnership provisions also apply to limited liability companies (LLCs) and limited liability partnerships (LLPs)

Back 16

They provide some of their owner's limited personal liability for business debts, but they are treated as a partnership for federal tax purposes, the entity itself will not be subject to federal income tax.

Front 17

What are trusts, estates, beneficiaries, and other parties?

Back 17

A trust is a document that spells out the rules that you want followed for property to be held in trust for your beneficiaries,A beneficiary is anybody who gains an advantage and or profits from something like a trust, will, or life insurance policy

Front 18

How are the accounting and taxable income of a trust or estate and the related taxable income of the beneficiaries determined?

Back 18

For a trust the amount taxable to the beneficiaries of a simple trust is limited by a trust's distributable net income,For an estate or a complex trust makes only discretionary distributions. In those cases the distributable net income is apportioned ratably according to the distributed amounts.

Front 19

What are the objectives of financial accounting?

Back 19

The objective it preparation of financial statements that shows a company's operating performance over a particular period, and financial position at a specific point in time.

Front 20

What are generally accepted accounting principles?

Back 20

They are a common set of accounting principles, standards and procedures that companies use to compile their financial statements. It is the commonly accepted way to record and report accounting information.

Front 21

Do accountants have ethical rules to follow related to financial reporting?

Back 21

Yes. Do not take questionable positions on a client's tax return in the hope that the return will not be selected for the audit by the IRS. Any positions taken should be supported by a good faith belief that they have a realistic possibility of being sustained if challenged. The client should be fully advised of the risks involved and of the penalties that will result if the position taken is not successful.

Front 22

What are the basic assumptions used in accounting?

Back 22

A practitioner can use a client's estimates if they are reasonable under the circumstance.,Every effort should be made to answer questions on tax returns. ,Upon learning of an error on a past tax return, advise the client to correct it. Do not however inform the IRS of the error. If the error is material and the client refuses to correct it consider withdrawing from the engagement.

Front 23

What are qualitative characteristics of accounting information?

Back 23

Relevance and faithful representation

Front 24

What impact do constraints have on reporting accounting information?

Back 24

Cost should not exceed the benefits of reporting practice.

Front 25

What is the rule-setting authority of the Financial Accounting Standards Board, the Securities and Exchange Commission with regard to accounting regulations and enforcement, and the International Accounting Standards Board?

Back 25

The FASB is a private non for profit organization that primary purpose is to develop GAAP,The SEC designated the FASB as the organization responsible for setting accounting standard for public companies in the US.,The IASB is the independent accounting standard setting body of the IFRS foundation. It is responsible for developing international accounting standards issued after 2001 and promoting using and application of these standards

Front 26

What is the difference between a single-step and multiple-step Income Statement?-

Back 26

Single step income statements reorganize all items in to revenue and expenses. No distinction is necessary between operating and non-operating activities. ,Multi step income statement has three parts: Sales revenue, operating expenses and non-operating expenses. Sales and cost of goods sold are in the first section. Selling and administrative expenses make up the second section. Non-operating activities include non-repetitive profit activities, such as interest revenues, interest expenses and gains or losses on investment sales.

Front 27

What are the sections reported on a multiple-step income statement?

Back 27

Sales revenue, operating expenses and non-operating expenses

Front 28

What are the rules to account for discontinued operations?

Back 28

Discontinued operations must be reported when they are resulting in elimination. The disposable transaction will result in the operations and cash flows if the component is eliminated from company operations. And continuing involvement is when there will be no significant continuing involvement by the company in the operations of the component once the disposable transaction has been completed. Continuing involvement implies the ability to influence the operating or financial policies of the disposed component. ,If both of these conditions are met and a component id held for sale the business but report the results of operations of the component for current or prior periods in a separated discontinued operations section of the income statement. Under the same conditions but where the component has been sold, the business must report the results of operations of the component for current and prior periods, as well as any gain or loss on disposal, in a separate discontinued operations section of the income statement.

Front 29

What are extraordinary items? How are they accounted for?

Back 29

These are income statement items that are unusual in nature and infrequent in occurrence. IE loss from earthquake. They are shown on the income statement and the amounts shown on it will include the gross amount and the net amount after deducting in the income tax expense or savings associated with the item. Extraordinary items appear on the income statement near the end of the income statement after discontinued operations and before the cumulative effect from a change in the accounting principle.

Front 30

What is a change in Accounting Principle?

Back 30

It's a change in accounting principles, accounting estimates, or the reporting entity. Ie changing depreciation method, changing inventory methods (LIFO to FIFO). Accounting changed require full disclosure in the footnotes of the financial statements to describe justification and financial effects of the change.

Front 31

How does a change in accounting principle affect the income statement?

Back 31

It can affect the company's reported income in previous reporting periods.

Front 32

What is a change in estimates?

Back 32

The calculations of depreciation, depletion, or amortization requires estimates of both service life and residual value. Changes in methods are accounted for prospectively

Front 33

How does a change in estimates affect the income statement?

Back 33

When a company revises a previous estimate based on new information, prior financial statements are not restated. Instead the company merely incorporated the new estimate in any related accounting determinations from the on. It affects both aspects of the balance sheet and the income statement in the current and future periods.

Front 34

How do errors affect the income statement?

Back 34

It can result in misleading net income figure and it throws off profitability ratios such as operating margin and profit margin.

Front 35

What are the account classifications shown on the balance sheet?

Back 35

Current,Long term investments,Property, plant and equipment,Intangible assets,Other assets,Liabilities are classified as current or long term noncurrent

Front 36

What information does the balance sheet provide about a company?

Back 36

A balance sheet reports the dollar amounts of a company's assets, liabilities, and owners' equity

Front 37

What information requires additional disclosure in the notes to the financial statements?

Back 37

Information on debt, going concern criteria, accounts, contingent liabilities, or contextual info explaining the financial numbers. Other things could be if a company lists a loss on a fixed asset, valuations used to prepare statements

Front 38

What is the purpose of a statement of cash flows?

Back 38

It is to provide information about a company's gross receipts and gross payments for a specific period of time.

Front 39

What are two methods for preparing a statement of cash flows?

Back 39

The direct method: it involves deducting from cash sales only those operating expenses that consumed cash. In this method each item on the income statement is converted directly to a cash basis and each cash effect is directly reported.,The indirect method: the accrual basis net income is first established, and then this net income is then indirectly adjusted for items that affected the reported net income but did not involve cash. The indirect method adjusts net income (rather than adjusting individual items in the income statement) for changes in current assets (other than cash), changed in liabilities and items that were included in net income but did not affect cash.

Front 40

What categories are shown on a statement of cash flows?

Back 40

Operating activities,Investing activities ,Financing activities

Front 41

What is the definition of time-value of money?

Back 41

The idea that money is available at the present time if worth more than the same amount in the future due to its potential earning capacity. Provided money can earn interest, so the sooner received the more worth it has.

Front 42

What is the difference between simple interest and compound interest? (this requires math)

Back 42

Simple interest is calculated only on the principle, or on the portion of the principle that remains unpaid.,Compound interest is the concept of adding accumulated interest back to the principle so that the interest is earned on interest from that moment on.

Front 43

What accounting situations require the use of time-value of money concepts?

Back 43

Basic Annuities, deferred annuities, valuation of long term bonds

Front 44

What is a present value table and when is it used?

Back 44

It is used when you want to calculate the present value of future amounts. It calculates future money that has been discounted today to reflect its current value as if it existed today

Front 45

What is the difference between present value and future value of 1 concept?

Back 45

Future value is the value of an asset at a specific date. It is the present value multiplied by the accumulation function.

Front 46

What is the difference between an ordinary annuity and annuity due?

Back 46

Ordinary annuities are when payments are made at the end of each period.,Annuity due is when payments are made at the beginning of each period. Regular investments made at the beginning of a compounding period grow into larger sums because they have more time to compound.

Front 47

What are two methods used to estimate bad debt expense?

Back 47

One method is the direct write off method when a company determines a particular account to be uncollectible; it charges it to the Bad debt expense.,The allowance method of accounting for bad debts involves estimating uncollectable accounts at the end of each period.

Front 48

What are the journal entries to record bad debt under each method?

Back 48

For Allowance method,Bad debt expense (Number), Allowance for Doubtful Accounts (Number)

Front 49

What are the journal entries used to write-off an account deemed uncollectible

Back 49

For write off it would be ,Allowance for Doubtful Debts (Number), Accounts receivable (Number)

Front 50

What are the journal entries to record receivables factored or sold with recourse and without recourse?

Back 50

Receivables with recourse,Cash debit (multiplied by the transferred amount by the percentage remitted true for situation with or without recourse ,Loss on sale of receivables debit (the loss on sale of receivables is determined by multiplying the amount transferred into receivables by the retained fee when the bank collects and then adding it to recourse obligation. Without recourse would be the same except you do not include the recourse obligation,Receivable factor Debit: receivable factor is what happens if you take the money transferred and multiply it by the retained percentage and subtract out the percentage the bank will remit usually the amount of the loss on sale receivables. ,Recourse Liability Credit: this only shows up in JE's with recourse. This is the monetary recourse amount ,Accounts receivable Credit: balance sold or the original amount transferred

Front 51

Explain how discounts offered to customers affect the value of receivables.

Back 51

When a discount is offered it is decreases the sale revenue and accounts receivable by the amount of the discount. Receivables are credited to reduce their balance to the amount that is expected to be recovered from them.

Front 52

What impact do free on board (FOB) terms have on inventory valuation?

Back 52

When a company obtains legal title to goods it must record them as purchases in that fiscal period, assuming a periodic inventory system. Thus goods shipped to the company FOB shipping point belong to that company. It should show the purchase in its records because they have legal title to them.

Front 53

Who owns the inventory given FOB shipping point? FOB destination? Consignment goods?

Back 53

At FOB shipping point the buyer owns it, this means that the goods in transit should be reported as a purchase and as inventory by the buyer.,At FOB destination the sellers own it until it reaches the buyers location.,Consignment goods are merchandise that is not owned by the party in possession of the goods.

Front 54

What are the various methods that can be used to value inventory?

Back 54

Perpetual: requires accounting records to show the amount of inventory on hands at all times,Periodic: sales are recorded as they occur but inventory is not updated,First in First out (FIFO),Last in First Out (LIFO),Average cost

Front 55

What are the strengths and weaknesses of each method?

Back 55

Perpetual system allows for better accounting and if you need to share merchandise between different locations but this is a more costly inventory method, while periodic is more simpler and cheaper but it does not keep track as well and lost inventory is harder to account for.,With LIFO versus FIFO, FIFO this way can give you a higher net income and lower cost of goods sold but your taxable income is higher. With LIFO net income is lower thus taxable income is lower. Average cost is just that it is an average so a middle per say between LIFO and FIFO.

Front 56

In what situation would it be better to use one method over another, such as FIFO or LIFO?

Back 56

If you need more capital during the year the FIFO method is better since you are getting a higher net income, and it is more consistent with rising prices. With LIFO it is more beneficial to get a lower taxable income and if prices rise you can make more income.

Front 57

Define the lower-of-cost-or-market rule.

Back 57

So when you buy inventory for a certain price and in that same market the manufacturer drops that price and then you have to adjust your sales price in order for competitors not to beat you out of the market. Inventory must be recorded at the lower of either the cost to produce it, the cost to repurchase it or the market value of the inventory.

Front 58

Define the net realizable value method of inventory.

Back 58

The value of an asset that can be realized by a company or entity upon the sale of the asset, less the reasonable prediction of the costs associated with wither the eventual sale or disposal of that asset. It's basically evaluating the assets worth.

Front 59

Explain the relative sales value method of inventory.

Back 59

It's a method that gives businesses the ability to control costs. Since the assets that a business pays will produce goods that sell for different prices the relative sales method reveals the cost of that asset for each product it helps deliver.

Front 60

Explain the concept of dollar-value LIFO

Back 60

An accounting method used for inventory that follows the last in first out model. It uses the approach that with all figures in dollar amounts rather than inventory units.

Front 61

What is the calculation for a change in beginning of year prices using dollar-value LIFO?

Back 61

Get ending inventory at base year prices, so taking ending year prices, compute real dollar increase in inventory, then value this real dollar quantity in inventory at year end prices

Front 62

What is the cost of property, plant, and equipment?

Back 62

Cost of land: includes all expenditures to acquire land and to ready it for use like purchase cost, closing costs, cost incurred to prep land, assumptions of any liens or mortgages, any additional land improvements,Cost of building: materials, labor, and overhead costs incurring during construction, professional fees and building permits,Cost of equipment: purchase price, freight and handling charges, insurance on equipment when in transit, cost of special foundations if required

Front 63

How are construction-project interest costs including avoidable interest, calculated and recorded?

Back 63

Only actual interest should be capitalized. During construction the asset is not in use and not making any revenue, but once it is ready it is ready for revenues to be earned.

Front 64

What is a lump-sum purchase of assets, and how is each asset valued?

Back 64

Acquisition of a group of assets for a single price. Costs are allocated to assets based on their fair market values.,Divide fair market value by totals of fair value market and then multiply by allocated total cost.

Front 65

What is depreciation?

Back 65

A method of allocating the cost of a tangible asset over its useful life, a decrease it an assets value caused by unfavorable market conditions

Front 66

What are the formulas for calculating straight-line, sum-of-the years digits, and double-declining balance methods of depreciation?

Back 66

Straight line: cost-salvage value\/life in number of periods,Sum of the years: Depreciable base * (remaining useful life\/sum of the years digits); depreciable base =cost-salvage,Double declining balance: depreciation rate * book value of asset; depreciation rate= accelerator * straight line rate

Front 67

What is depletion?

Back 67

An accrual accounting method that companies use to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. Depletions is calculated for tax-deduction and bookkeeping purposes.

Front 68

What are the factors involve in computation of a depletion base?

Back 68

Percentage depletion and cost depletion

Front 69

What is the formula to calculate the depletion rate?

Back 69

(Cost-salvage value\/ estimated number of units)*number of units extracted

Front 70

What is the difference between a tangible and intangible asset?

Back 70

Tangible assets have a physical form, intangible assets are nonphysical assets such as patents, trademarks, copyrights, goodwill, brand recognition.

Front 71

What is goodwill?

Back 71

An intangible asset that arises as a result of the acquisition of one company by another for a premium value; The value of the company's brand name, solid customer base, good customer relations, ect.

Front 72

What is the formula for calculating goodwill?

Back 72

Sale value - asset value= goodwill

Front 73

What is the estimated useful life of a trademark, copyright, and patent?

Back 73

Trademark: 10 years,Copyright: Life of Creator + 70years,Patent: 20 years

Front 74

What method is used to allocate costs of an intangible asset?

Back 74

Ration of current revenues to current and anticipated revenues (percentage of revenue approach),Straight line method over the remaining useful life of the asset ,Use whichever one amounts to greater

Front 75

How are research and development costs accounted for?

Back 75

Costs associated with R&D activities: materials, equipment, facilities, personnel, purchases intangibles, contract services, indirect costs

Front 76

How do the impairment rules impact asset value?

Back 76

Assets are said to be impaired when their net carrying value is greater than the future discounted cash flow that these assets can provide and be disposed for. Once impairment has been recognized it cannot be restored. The loss should be reported on the income statement before tax as a component of continuing operations. Generally impairment recognized for financial reporting is not deductible for tax purposes until the affected assets are disposed of. So it's usually a deferred tax asset.

Front 77

How are computer software costs accounted for?

Back 77

They can either be classified as intangible assets or Property, plant and equipment. If the software provides goods and services than it can be classified as PPE, and if the software package costs more than 100,000 and can be amortized, if neither of these conditions are met then it would be an intangible asset.

Front 78

How are short-term payables recorded?

Back 78

Current liabilities, Notes payable,Short term debt, Notes payable refinanced, Total liabilities

Front 79

How are dividends payable recorded?

Back 79

Accounting impact on date of declaration,Retained earnings: debit,Common stock distributable credit,Paid in capital in excess of par credit,,Accounting impact on date of issuance,Common stock dividend distributable debit,Common stock credit

Front 80

What are unearned (or deferred) revenues, and how are they recorded?

Back 80

A liability account that reports amounts received in advance of providing goods or services. When the goods or services provided, this account is decreased and a revenue account is increased. ,So when revenue has not been earned,Cash debit,Unearned revenue (liability) credit,When a certain amount of the earned revenue is recognized you debit unearned revenue the amount earned to that point and then credit revenue

Front 81

What items are included in payroll and the associated payables?

Back 81

Taxes, social security taxes and income tax withholding

Front 82

What are the journal entries to record payroll for both the employee and employer side of the transaction?

Back 82

Salary expense debit, Federal income taxes payable credit, State income taxes payable credit, FICA taxes payable credit, Cash credit

Front 83

What is a contingency, and when do the disclosure requirements require recording in the accounting records?

Back 83

An existing condition or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. Whenever there is a contingency companies determine if the contingency is probable and can be reasonably estimated. If both of these criteria are met the company records the contingency in the financial statements. ,If a contingent liability is only possible (not probable) or if the amount cannot be estimated a JE is not required.

Front 84

What is an imputed interest rate, and how is it used?

Back 84

Interest that is considered to be paid for tax purposes even though no interest payments has been made. This is used by the IRS as a means of collecting tax revenues on loans or securities that do not pay interest, or where the stated interest is particularly low.

Front 85

What are the characteristics of different types of corporate bonds?

Back 85

Secured bonds are backed by collateral,Unsecured bonds are not backed by anything; an example would be a debenture bond,Term Bonds: bonds that mature on a single date,Serial bonds: usually used by schools or other taxing bodies they come have maturity dates that are staggered over several or many years,Callable bonds: gives the issuer the right to call and retire the bonds prior to maturity,Convertible Bonds: bonds that is convertible into other securities of the corporation for a specific time after issuance,Commodity backed bonds: redeemable in measures of a commodity such as oil barrels,Registered Bonds: Bonds issues in the name of the owner are registered bonds and require surrender of the certificate and issuance of a new certificate to complete a sale,Bearer Bond: not recorded in the name of the owner and may be transferred from one owner to another by mere delivery,Income bonds: pay no interest unless the issuing company is profitable,Revenue Bonds: interest paid on them is paid from specific revenue sources

Front 86

Why are bonds issued at a price different from face value?

Back 86

They are traded in the open market. Prevailing interest rates are always changing, and existing bonds adjust their price to their yield to maturity approaches the yields to maturity on new bonds being issued. ,A bond trades at a premium when its coupon rate is higher than prevailing interest,A bond trades at a discount when its coupon rate is lower than its prevailing interest

Front 87

How is a bond issue-price determined?

Back 87

The issue price of a bond is based on the relationship between the interest rate that the bond pays and the market interest rate being paid on the same date.

Front 88

How are the accounting entries different for straight-line and effective interest amortization?

Back 88

The straight line method amortizes a constant amount each period,Interest expense debit,Discount on Bonds payable debit,Cash Credit,Effective interest amortization: bond interest rate: book value * effective interest rate, then determine the bond discount or premium amortization next by comparing the bond interest with the interest (cash) to be paid

Front 89

How is the accounting different for a bond issued between interest dates?

Back 89

The buyers normally pay the issuer the purchase price plus any interest accrued since the prior interest payment date,Cash debit, Interest payable credit, Bonds payable credit,,Interest payable debit,Bond interest expense debit, Cash credit

Front 90

How is the value of long-term notes payable calculated?

Back 90

Like a bond, a note is valued at the present value of its future interest and principle cash flows.

Front 91

What is off-balance-sheet financing and how is it used?

Back 91

An attempt to borrow funds to record recording obligations like non-consolidated subsidiaries, special purpose entities and operating leases

Front 92

What are the different classes of stock and what are their characteristics?

Back 92

Preferred stock no voting rights and common stock with voting rights but more risker

Front 93

What is the journal entry to record a stock issue?

Back 93

Cash Debit, Common stock credit, Additional paid in capital credit

Front 94

What is Treasury Stock?

Back 94

The portion of shares that a company keeps in their own treasury, it can come from buyback, or they may have never been issues. They don't pay dividends, have no voting rights, and should not be included in shares outstanding.

Front 95

What are the journal entries for Treasury Stock?

Back 95

Issuance of common stock,Cash debit, Common stock credit, Additional paid in capital credit,Purchase of treasury stock,Treasury stock debit,Additional paid in capital debit, Cash credit, Add paid in capital credit,Resale of treasury stock ,Cash debit, Treasury stock credit, Additional paid in capital credit

Front 96

How are stock splits accounted for?

Back 96

A stock split will not change the general ledger account balances and therefore will not change the dollar amounts reported in the stockholders equity section of the balance sheets (although number of shares may change the total dollar amount with not change)

Front 97

How does the accounting change if a stock dividend is large vs. small?

Back 97

A small stock dividend: a stock dividend is considered small if the new shares being issued are less than 20-25% of the total number of shares outstanding prior. On the declaration date of small stock dividend a JE is made to transfer the market value of the shares being issued from retained earnings to the paid in capital section of the stockholders equity,Retained earnings debit, Common stock dividend distributable credit, Paid in capital excess of par credit ,,Large stock dividends: a stock dividend s considered to be large id the shares being issues are more than 20-25% of the total value of shares prior to dividend. On the declaration date of a large stock dividend, a JE is made to transfer the par value of the shares being issued from retained earnings to the paid in capital section of stockholders equity,,Retained earnings debit, Common stock dividend distributable credit

Front 98

Does the income statement reflect gains from treasury stock reissuance?

Back 98

no

Front 99

How do common and preferred stock differ?

Back 99

Common stock shares represent ownership in a company and a claim on a portion of the profits. They have higher returns but greater risk.,Preferred stock has no voting rights, and is paid out first if the company was to bankrupt or liquidate. It can also be callable meaning that the company has the option to purchase the shares from shareholder at any time for any reason

Front 100

Do stock options have any effect on the balance sheet?

Back 100

Under the fair value method companies use acceptable option pricing models to value the options at the date of grant.

Front 101

What journal entries are recorded on each of the dates associated with a dividend?

Back 101

On the declaration date: ,Retained earnings debit, Dividends payable credit,,When Dividends are paid,Dividends payable debit, Cash Credit

Front 102

How do you account for a cash dividend, property dividend, and liquidating dividend?

Back 102

Cash Dividends:,Date of declaration,Retained earnings debit, Dividends payable credit,Date of payment,Dividend payable debit, Cash credit,,Property dividend,Date of declaration,Loss on disposition of equipment debit, Accumulated depreciation credit,Date of payment,Dividends payable debit,Accumulated depreciation debit, Equipment credit ,Liquidating dividend,Date of declaration ,Retained earnings debit,Additional paid in capital common stock debit, Dividends payable credit,Date of payment,Dividends payable debit, Cash credit

Front 103

What are stock options, stock warrants?

Back 103

Stock option: a benefit in the form of an option given by a company to an employee to buy back stock in the company at a discount or at a stated fixed price,Stock warrant: a type of security issued by a corporation (usually together with a bond or preferred stock) that gives the holder the right to purchase a certain amount of common stock at a stated price

Front 104

What are the journal entries associated with stock options and stock warrants?

Back 104

Stock options,Compensation expense debit, Additional paid in capital for stock options credit,Stock warrants,Compensation expense debit, Stock warrants outstanding credit,Exercise of warrants,Cash debit,Stock warrants outstanding debit, Common stock par value credit, Additional paid in capital common stock credit

Front 105

What is convertible debt?

Back 105

When a company borrows money from an investor or a group of investors and the intention of both the investors and the company is to convert the debt to equity at some later date.

Front 106

How is a conversion from debt to common stock recorded?

Back 106

Cash debit,Discount of bonds payable debit, Bonds payable credit, Contributed capital conversion feature of debt credit

Front 107

What impacts does a convertible preferred class of stock have on earnings per share?

Back 107

It usually causes the earnings per share to decline and results in the dilution of earnings

Front 108

Do stock dividends and stock splits impact earnings per share calculations?

Back 108

Although a stock split does not affect the value of the investments in a particular stock the split does affect some of the metrics you might use to judge the value of the shares. The EPS will be directly affected. When the split happens the share price declines by the ratio of the split and the number of company shares is increased in the ration.

Front 109

What is the difference between basic earnings per share and diluted earnings per share?

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The difference is the diluted earnings per share include if all convertible securities were exercised so basically total earnings would be divided among more shares of stock. Basic earnings per share are based on the assumption that the convertible securities are not converted.

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What is the difference between a simple capital structure and a complex capital structure?

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Complex capital structure is the use of different forms of securities rather than relying solely on one class of common stock. There might be different classification of stock that has different voting privileges and dividend rates, while a simple capital structure may only have common stock.

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What is the difference between debt securities and equity securities?

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Both financial instruments assist companies to finance their operations. Debt securities are legal obligations to repay borrowed funds at a specific maturity date and provide interim interest payments. Equity securities represent ownership stake in a company such as common or preferred stock, but they receive dividends after all creditors have been paid.

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What are the three categories securities?

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Held to maturity securities: it is purchased with the intention of holding the investment until maturity. ,Available for sale securities: purchased with the intent of selling before maturity ,Trading securities: purchased with the intent of selling them within a short period of time (usually one year)

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How is each type of security valued and recorded?

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Traded securities: increase in book value are recorded on the income statement as unrealized holding gains on marketable securities, and decrease in book value are recorded on the income statement as unrealized holding losses on marketable securities,Available for sale securities: its treated as holding gains or losses as equity adjustments, not income statement adjustments. Increase in book value is recorded on the balance sheet as unrealized holding gains on marketable securities available for sale. Decreases in book value are recorded as unrealized holding losses on marketable securities available for sale. ,Held to maturity: valued at their respective economic values, assuming events progress as expected. The valuation is amortized cost.

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What effect did the Securities Act of 1933 have on investments? What were the major provisions of the act?

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Require that investors receive financial and other significant information concerning securities being offered for public sales and prohibit deceit, misrepresentation and other fraud in the sale of securities

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What effect did the Securities Exchange Act of 1934 have on investments? What were the major provisions of the act?

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It established the SEC, and regulates the secondary trading of those securities between person often unrelated to the issue, frequently through brokers or dealers

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What were the major provisions of the Sarbanes Oxley act?

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A mandate that required senior management to certify the accuracy of the financial statement, and a requirement that management and auditors establish internal controls and reporting methods on the adequacy of those controls.

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What are forms 10-K, 10-Q, and 8-K? When are these forms required to be filed?

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10-k: a comprehensive summary report of a company's performance that must be annually submitted to the SEC commission. More detailed than annual report. Required to be filed within 60 days after the end of the fiscal year,10-q: a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the SEC. Due 35 days after each of the first 3 fiscal quarters. There is no filing after the fourth quarter bc that is when the 10-k is filed,8-k: a report of unscheduled material events or corporate changes at a company that could be of importance to the shareholders or the SEC. Ie bankruptcy, resignation of directors, change of fiscal year

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What is the revenue recognition principle?

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For most businesses income is recognized as revenue whenever the company delivers or preforms its product or services and receives payment for it. However there are several situations which exceptions apply, for example if a company's business has a very high rate of product return revenue should be recognized after the return period expires

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What are the methods used to recognize revenue?

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Sales basis method: revenue recognized as the time of sale when the goods are transferred to the buyer.,Percentage of completion method: popular with construction and engineering companies. Used if 2 conditions are met there is long term legally enforceable contract and it is possible to estimate the percentage of the project that is complete and its revenues and costs. Two ways to recognize revenue under these methods using milestones and cost incurred to estimate total cost,Complete contract method: revenues and expenses are recorded only at the end of the contract only used when there is no long term legal contract and it's hard to estimate completion percentage. ,Cost recoverability method: no profit is recognized until all of the expenses incurred to complete the project have been recouped.,Installment method: if customer collections are unreliable a company should use this. Ie real estate

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What is channel stuffing (trade loading), and how does the practice affect revenue recognition?

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When a company inflates its sales and earnings by sending retailers in their distribution channel more products than they can sell to the public. It temporarily beefs up their accounts receivable but then the excess products are sent back instead of cash. Usually used to raise value of stock

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What methods can be used to report revenue on long-term construction projects? How is the amount calculated?

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Percentage of completion method: (services provided to date\/total expected services) * total expected inflow,Percentage of work completed= expenditures incurred from inception to date\/ total estimated costs for contract ,Completed contract method: the end revenue received when contract is completed

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What are the journal entries to record revenue under each method of revenue recognition for long-term construction projects?

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Percentage of completion: ,Unbilled contract receivables debit, Contract revenue earned credit

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What is a deferred tax asset or deferred tax liability?

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Deferred tax asset is: an asset on balance sheet that can be used to reduce any subsequent period's income tax expense ,Deferred tax liability: an account on a company's balance sheet that is a result of temporary differences between the companies' accounting and tax carrying values, the anticipated and enacted income tax rate and the estimated taxes payable for the current year.

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Explain temporary and permanent tax differences.

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Temporary differences between book incomes versus taxable income are due to items of revenue or expense that are recognized in one period for taxes, but in different period for the books.,Permanent tax differences are differences that never reverse. That is they are items of book revenue or expense in one period but they are never items of tax revenue or expense.

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How are deferred taxes over multiple years affected based on the marginal-rate tax system?

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They will increase or decrease based on the tax rate of that time.

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How do the rules for tax loss carry backs and carry forwards differ?

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The tax laws allow corporations to carry tax losses back up to 2 years and forward up to 20 years.

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What are intra-period tax allocations?

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It is the allocation of income taxes to different parts of the results appearing in the income statement of a business, so that some items are stated net of tax. It is used to reveal the true results of certain transactions net of all effects rather than disaggregating them from income taxes.

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What are the two types of pension plans?

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Defined contribution plan: a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. There is no way to know how much the plan will ultimately give the employee upon retiring. The amount contributed is fixed but the benefit is not. Employee bears no risk no firm liability,Defined benefit plan: employee benefits are sorted out based on a formula using factors such as salary history and duration of employment. Investment risk and portfolio management is entirely under the control of the company. If the investment is shortfall the company had to dip into their earnings. Firm bears risk and has liability

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What is the journal entry to record pension expense under each type of plan?

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Defined contribution plan,Pension expense debit, Cash credit

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Identify the differences between an operating lease and a capital lease.

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Operating lease: a contract that allows for the use of an asset but does not convey ownership of the asset.,Capital lease: a lease considered to have the economic characteristics od asset ownership.

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What are the four capitalization rules to classify a lease as a capital lease or an operating lease?

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The life of the lease is 75% or greater of the assets useful life,The lease contains a purchase agreement for less than market value,The lessee gains ownership at the end of the lease period,The present value of lease payments is greater than 90% of the assets market value

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How do you calculate the minimum lease payments with and without residual value?

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A measure the present value of which is determined and used as part of the recovery of investment (90% test). Minimum lease payments include minimum rental payments, a guaranteed residual value, a penalty for failure to renew the lease, and a bargain purchase option. The lessee does not include executory costs in computing the present value of the minimum lease payments.

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What are the journal entries to record a lease payment with and without residual value?

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Cash debit, Lease receivable credit,Lease payable debit, Cash credit

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ad valorem tax

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A tax imposed on the value of property. The most common of these taxes is that imposed by states, counties, and cities on real estate. These taxes can be imposed on personal property as well.

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correspondence audit

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An audit conducted by the IRS by mail. Typically, the IRS writes to the taxpayer requesting the verification of a particular deduction or exemption. The completion of a special form or the remittance of copies of records or other support is all that is requested of the taxpayer.

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death tax

Back 136

A tax imposed on property transferred by the death of the owner.

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employment taxes

Back 137

These taxes are those taxes that an employer must pay on account of its employees. These taxes include FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. These taxes are paid to the IRS in addition to income tax withholdings at specified intervals. Such taxes can be levied on the employees, the employer, or both.

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estate tax

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A tax imposed on the right to transfer property by death. Thus, an this tax is levied on the decedent's estate and not on the heir receiving the property.

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excise tax

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A tax on the manufacture, sale, or use of goods; on the carrying on of an occupation or activity; or on the transfer of property. Thus, the Federal estate and gift taxes are, theoretically, excise taxes.

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FICA tax

Back 140

An abbreviation that stands for Federal Insurance Contributions Act, commonly referred to as the Social Security tax. This tax is comprised of the Social Security tax (old age, survivors, and disability insurance) and the Medicare tax (hospital insurance) and is imposed on both employers and employees. The employer is responsible for withholding from the employee's wages the Social Security tax at a rate of 6.2 percent on a maximum wage base of $106,800 (for 2009) and the Medicare tax at a rate of 1.45 percent (no maximum wage base). The employer is required to match the employee's contribution.

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field audit

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An audit conducted by the IRS on the business premises of the taxpayer or in the office of the tax practitioner representing the taxpayer.

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flat tax

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In its pure form, a this tax would eliminate all exclusions, deductions, and credits and impose a one-rate tax on gross income.

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franchise tax

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A tax levied on the right to do business in a state as a corporation. Although income considerations may come into play, the tax usually is based on the capitalization of the corporation.

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FUTA tax

Back 144

An employment tax levied on employers. Jointly administered by the Federal and state governments, the tax provides funding for unemployment benefits. FUTA applies at a rate of 6.2 percent on the first $7,000 of covered wages paid during the year for each employee. The Federal government allows a credit for FUTA paid (or allowed under a merit rating system) to the state. The credit cannot exceed 5.4 percent of the covered wages.

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gift tax

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A tax imposed on the transfer of property by gift. The tax is imposed upon the donor of a gift and is based on the fair market value of the property on the date of the gift.

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inheritance tax

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A tax imposed on the right to receive property from a decedent. Thus, theoretically, this tax is imposed on the heir. The Federal estate tax is imposed on the estate.

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national sales tax

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Intended as a replacement for the current Federal income tax. Unlike a value added tax (VAT), which is levied on the manufacturer, it would be imposed on the consumer upon the final sale of goods and services. To keep the tax from being regressive, low-income taxpayers would be granted some kind of credit or exemption.

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occupational tax

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A tax imposed on various trades or businesses. A license fee that enables a taxpayer to engage in a particular occupation.

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office audit

Back 149

An audit conducted by the IRS in the agent's office.

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personalty

Back 150

All property that is not attached to real estate (realty) and is movable. Examples of this are machinery, automobiles, clothing, household furnishings, inventory, and personal effects.

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revenue neutrality

Back 151

A description that characterizes tax legislation when it neither increases nor decreases the revenue result. Thus, any tax revenue losses are offset by tax revenue gains.

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sales tax

Back 152

A state- or local-level tax on the retail sale of specified property. Generally, the purchaser pays the tax, but the seller collects it, as an agent for the government. Various taxing jurisdictions allow exemptions for purchases of specific items, including certain food, services, and manufacturing equipment. If the purchaser and seller are in different states, a use tax usually applies.

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severance tax

Back 153

A tax imposed upon the extraction of natural resources.

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statute of limitations

Back 154

Provisions of the law that specify the maximum period of time in which action may be taken on a past event. Code § 6501-6504 contain the limitation periods applicable to the IRS for additional assessments, and § 6511-6515 relate to refund claims by taxpayers.

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sunset provision

Back 155

A provision attached to new tax legislation that will cause such legislation to expire at a specified date. These are attached to tax cut bills for long-term budgetary reasons in order to make their effect temporary. Once the this comes into play, the tax cut is rescinded and former law is reinstated. An example of a this is the one contained in the Tax Relief Reconciliation Act of 2001 that relates to the estate tax. After the estate tax is phased out in 2010, this will reinstate the estate tax as of January 1, 2011.

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use tax

Back 156

A sales tax that is collectible by the seller where the purchaser is domiciled in a different state.

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value added tax (VAT)

Back 157

A national sales tax that taxes the increment in value as goods move through the production process. A VAT is much used in other countries but has not yet been incorporated as part of the U.S. Federal tax structure.

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wherewithal to pay

Back 158

This concept recognizes the inequity of taxing a transaction when the taxpayer lacks the means with which to pay the tax. Under it, there is a correlation between the imposition of the tax and the ability to pay the tax. It is particularly suited to situations in which the taxpayer's economic position has not changed significantly as a result of the transaction.

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acquiescence

Back 159

Agreement by the IRS on the results reached in certain judicial decisions; sometimes abbreviated Acq. or A.

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Circuit Court of Appeals

Back 160

Any of 13 Federal courts that consider tax matters appealed from the U.S. Tax Court, a U.S. District Court, or the U.S. Court of Federal Claims. Appeal from a U.S. Court of Appeals is to the U.S. Supreme Court by Certiorari.

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citator

Back 161

A tax research resource that presents the judicial history of a court case and traces the subsequent references to the case. When these references include the citating cases' evaluations of the cited case's precedents, the research can obtain some measure of the efficacy and reliability of the original holding.

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Court of original jurisdiction

Back 162

The Federal courts are divided into courts of original jurisdiction and appellate courts. A dispute between a taxpayer and the IRS is first considered by a court of original jurisdiction (i.e., a trial court). The four Federal courts of original jurisdiction are the U.S. Tax Court, U.S. District Court, the Court of Federal Claims, and the Small Cases Division of the U.S. Tax Court.

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determination letter

Back 163

Upon the request of a taxpayer, the IRS will comment on the tax status of a completed transaction. Determination letters frequently are used to clarify employee status, determine whether a retirement or profit sharing plan qualifies under the Code, and determine the tax-exempt status of certain nonprofit organizations.

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Federal District Court

Back 164

A Federal District Court is a trial court for purposes of litigating Federal tax matters. It is the only trial court in which a jury trial can be obtained.

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Finalized Regulation

Back 165

The U.S. Treasury Department Regulations (abbreviated Reg.) represent the position of the IRS as to how the Internal Revenue Code is to be interpreted. Their purpose is to provide taxpayers and IRS personnel with rules of general and specific application to the various provisions of the tax law. Regulations are published in the Federal Register and in all tax services.

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Interpretive Regulation

Back 166

A Regulation issued by the Treasury Department that purports to explain the meaning of a particular Code Section. An interpretive Regulation is given less deference than a legislative Regulation.

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Legislative Regulation

Back 167

Some Code Sections give the Secretary of the Treasury or his delegate the authority to prescribe Regulations to carry out the details of administration or to otherwise complete the operating rules. Regulations issued pursuant to this type of authority truly possess the force and effect of law. In effect, Congress is almost delegating its legislative powers to the Treasury Department.

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letter ruling

Back 168

The written response of the IRS to a taxpayer's request for interpretation of the revenue laws, with respect to a proposed transaction (e.g., concerning the tax-free status of a reorganization). Not to be relied on as precedent by other than the party who requested the ruling.

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nonacquiescence

Back 169

Disagreement by the IRS on the result reached in certain judicial decisions. Nonacq. or NA.

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precedent

Back 170

A previously decided court decision that is recognized as authority for the disposition of future decisions.

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Procedural Regulation

Back 171

A Regulation issued by the Treasury Department that is a housekeeping-type instruction indicating information that taxpayers should provide the IRS as well as information about the internal management and conduct of the IRS itself.

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Proposed Regulation

Back 172

A Regulation issued by the Treasury Department in proposed, rather than final, form. The interval between the proposal of a Regulation and its finalization permits taxpayers and other interested parties to comment on the propriety of the proposal.

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Revenue Procedure

Back 173

A matter of procedural importance to both taxpayers and the IRS concerning the administration of the tax laws is issued as a Revenue Procedure (abbreviated Rev.Proc.). A Revenue Procedure is first published in an Internal Revenue Bulletin (I.R.B.) and later transferred to the appropriate Cumulative Bulletin (C.B.).

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Revenue Ruling

Back 174

A Revenue Ruling (abbreviated Rev.Rul.) is issued by the National Office of the IRS to express an official interpretation of the tax law as applied to specific transactions. It is more limited in application than a Regulation. A Revenue Ruling is first published in an Internal Revenue Bulletin (I.R.B.) and later transferred to the appropriate Cumulative Bulletin (C.B.).

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Small Cases Division

Back 175

A division within the U.S. Tax Court where jurisdiction is limited to claims of $50,000 or less. There is no appeal from this court.

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tax avoidance

Back 176

The minimization of one's tax liability by taking advantage of legally available tax planning opportunities. Tax avoidance can be contrasted with tax evasion, which entails the reduction of tax liability by illegal means.

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tax research

Back 177

The method used to determine the best available solution to a situation that possesses tax consequences. Both tax and nontax factors are considered.

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technical advice memoranda (TAMs)

Back 178

TAMs are issued by the IRS in response to questions raised by IRS field personnel during audits. They deal with completed rather than proposed transactions and are often requested for questions related to exempt organizations and employee plans.

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Temporary Regulation

Back 179

A Regulation issued by the Treasury Department in temporary form. When speed is critical, the Treasury Department issues Temporary Regulations that take effect immediately. These Regulations have the same authoritative value as Final Regulations and may be cited as precedent for three years. Temporary Regulations are also issued as proposed Regulations.

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U.S. Court of Federal Claims

Back 180

A trial court (court of original jurisdiction) that decides litigation involving Federal tax matters. Appeal from this court is to the Court of Appeals for the Federal Circuit.

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U.S. Supreme Court

Back 181

The highest appellate court or the court of last resort in the Federal court system and in most states. Only a small number of tax decisions of the U.S. Courts of Appeal are reviewed by the U.S. Supreme Court under its certiorari procedure. The Supreme Court usually grants certiorari to resolve a conflict among the Courts of Appeal (e.g., two or more appellate courts have assumed opposing positions on a particular issue) or when the tax issue is extremely important (e.g., size of the revenue loss to the Federal government).

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U.S. Tax Court

Back 182

The U.S. Tax Court is one of four trial courts of original jurisdiction that decides litigation involving Federal income, death, or gift taxes. It is the only trial court where the taxpayer must not first pay the deficiency assessed by the IRS. The Tax Court will not have jurisdiction over a case unless a statutory notice of deficiency (90-day letter) has been issued by the IRS and the taxpayer files the petition for hearing within the time prescribed.

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Writ of Certiorari

Back 183

Appeal from a U.S. Court of Appeals to the U.S. Supreme Court is by Writ of Certiorari. The Supreme Court need not accept the appeal, and it usually does not (cert. den.) unless a conflict exists among the lower courts that must be resolved or a constitutional issue is involved.

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abandoned spouse

Back 184

The abandoned spouse provision enables a married taxpayer with a dependent child whose spouse did not live in the taxpayer's home during the last six months of the tax year to file as a head of household rather than as married filing separately.

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child tax credit

Back 185

A tax credit based solely on the number of qualifying children under age 17. The maximum credit available is $1,000 per child through 2010. A qualifying child must be claimed as a dependent on a parent's tax return in order to qualify for the credit. Taxpayers who qualify for the child tax credit may also qualify for a supplemental credit. The supplemental credit is treated as a component of the earned income credit and is therefore refundable. The credit is phased out for higher-income taxpayers. § 24.

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collectibles

Back 186

A special type of capital asset, the gain from which is taxed at a maximum rate of 28 percent if the holding period is more than one year. Examples include art, rugs, antiques, gems, metals, stamps, some coins and bullion, and alcoholic beverages held for investment.

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dependency exemption

Back 187

The tax law provides an exemption for each individual taxpayer and an additional exemption for the taxpayer's spouse if a joint return is filed. An individual may also claim a dependency exemption for each dependent, provided certain tests are met. The amount of the personal and dependency exemptions is $3,650 in 2009 ($3,500 in 2008). The exemption is subject to phaseout once adjusted gross income exceeds certain statutory threshold amounts. This phaseout provision is subject to partial phaseout beginning in 2006.

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E-file

Back 188

The electronic filing of a tax return. The filing is either direct or indirect. As to direct, the taxpayer goes online using a computer and tax return preparation software. Indirect filing occurs when a taxpayer utilizes an authorized IRS e-file provider. The provider often is the tax return preparer.

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head of household

Back 189

An unmarried individual who maintains a household for another and satisfies certain conditions set forth in § 2(b). This status enables the taxpayer to use a set of income tax rates that are lower than those applicable to other unmarried individuals but higher than those applicable to surviving spouses and married persons filing a joint return.

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itemized deductions

Back 190

Personal and employee expenditures allowed by the Code as deductions from adjusted gross income. Examples include certain medical expenses, interest on home mortgages, state income taxes, and charitable contributions. Itemized deductions are reported on Schedule A of Form 1040. Certain miscellaneous itemized deductions are reduced by 2 percent of the taxpayer's adjusted gross income. In addition, a taxpayer whose adjusted gross income exceeds a certain level (indexed annually) must reduce the itemized deductions by 3 percent of the excess of adjusted gross income over that level. Medical, casualty and theft, and investment interest deductions are not subject to the 3 percent reduction. The 3 percent reduction may not reduce itemized deductions that are subject to the reduction to below 20 percent of their initial amount. Beginning in 2006, this reduction is subject to a partial phaseout.

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kiddie tax

Back 191

Passive income, such as interest and dividends, that is recognized by a child under age 19 (or under age 24 if a full-time student) is taxed to him or her at the rates that would have applied had the income been incurred by the child's parents, generally to the extent that the income exceeds $1,900. The additional tax is assessed regardless of the source of the income or the income's underlying property. If the child's parents are divorced, the custodial parent's rates are used. The parents' rates reflect any applicable alternative minimum tax and the phaseouts of lower tax brackets and other deductions. § 1(g).

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multiple support agreement

Back 192

To qualify for a dependency exemption, the support test must be satisfied. This requires that over 50 percent of the support of the potential dependent be provided by the taxpayer. Where no one person provides more than 50 percent of the support, a multiple support agreement enables a taxpayer to still qualify for the dependency exemption. Any person who contributed more than 10 percent of the support is entitled to claim the exemption if each person in the group who contributed more than 10 percent files a written consent (Form 2120). Each person who is a party to the multiple support agreement must meet all the other requirements for claiming the dependency exemption. § 152(c).

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personal exemption

Back 193

The tax law provides an exemption for each individual taxpayer and an additional exemption for the taxpayer's spouse if a joint return is filed. An individual may also claim a dependency exemption for each dependent, provided certain tests are met. The amount of the personal and dependency exemptions is $3,650 in 2009 ($3,500 in 2008). The exemption is subject to phaseout once adjusted gross income exceeds certain statutory threshold amounts. This phaseout provision is subject to partial phase-out beginning in 2006.

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qualifying child

Back 194

An individual who, as to the taxpayer, satisfies the relationship, abode, and age tests. To be claimed as a dependent, such individual must also meet the citizenship and joint return tests and not be self-supporting. § 152(a)(1) and (c).

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qualifying relative

Back 195

An individual who, as to the taxpayer, satisfies the relationship, gross income, support, citizenship, and joint return tests. Such an individual can be claimed as a dependent of the taxpayer. §152(a)(2) and (d).

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standard deduction

Back 196

The individual taxpayer can either itemize deductions or take the standard deduction. The amount of the standard deduction depends on the taxpayer's filing status (single, head of household, married filing jointly, surviving spouse, or married filing separately). For 2009, the amount of the standard deduction ranges from $5,700 (for married, filing separately) to $11,400 (for married, filing jointly). Additional standard deductions of either $1,100 (for married taxpayers) or $1,400 (for single taxpayers) are available if the taxpayer is either blind or age 65 or over. For 2008 and 2009, a real property tax standard deduction is available in the amount of $500 ($1,000 on a joint return). For 2009, there also is a limited auto sales taxes standard deduction. Limitations exist on the amount of the standard deduction of a taxpayer who is another taxpayer's dependent. The standard deduction amounts are adjusted for inflation each year. § 63(c).

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surviving spouse

Back 197

When a husband or wife predeceases the other spouse, the survivor is known as a surviving spouse. Under certain conditions, a surviving spouse may be entitled to use the income tax rates in § 1(a) (those applicable to married persons filing a joint return) for the two years after the year of death of his or her spouse. § 2.

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tax table

Back 198

A tax table that is provided for taxpayers with less than $100,000 of taxable income. Separate columns are provided for single taxpayers, married taxpayers filing jointly, heads of households, and married taxpayers filing separately. § 3.

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unearned income

Back 199

Income received but not yet earned. Normally, such income is taxed when received, even for accrual basis taxpayers.

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accounting income

Back 200

The accountant's concept of income is generally based upon the realization principle. Financial accounting income may differ from taxable income (e.g., accelerated depreciation might be used for Federal income tax and straight-line depreciation for financial accounting purposes). Differences are included in a reconciliation of taxable and accounting income on Schedule M-1 or Schedule M-3 of Form 1120 for corporations.

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accounting method

Back 201

The method under which income and expenses are determined for tax purposes. Important accounting methods include the cash basis and the accrual basis. Special methods are available for the reporting of gain on installment sales, recognition of income on construction projects (the completed contract and percentage of completion methods), and the valuation of inventories (last-in, first-out and first-in, first-out). § 446-474.

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accrual method

Back 202

A method of accounting that reflects expenses incurred and income earned for any one tax year. In contrast to the cash basis of accounting, expenses need not be paid to be deductible, nor need income be received to be taxable. Unearned income (e.g., prepaid interest and rent) generally is taxed in the year of receipt regardless of the method of accounting used by the taxpayer. § 446(c)(2).

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alimony and separate maintenance payments

Back 203

Alimony deductions result from the payment of a legal obligation arising from the termination of a marital relationship. Payments designated as alimony generally are included in the gross income of the recipient and are deductible for AGI by the payor.

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alimony recapture

Back 204

The amount of alimony that previously has been included in the gross income of the recipient and deducted by the payor that now is deducted by the recipient and included in the gross income of the payor as the result of front-loading. § 71(f).

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annuity

Back 205

A fixed sum of money payable to a person at specified times for a specified period of time or for life. If the party making the payment (i.e., the obligor) is regularly engaged in this type of business (e.g., an insurance company), the arrangement is classified as a commercial annuity. Also-called private annuity involves an obligor that is not regularly engaged in selling annuities (e.g., a charity or family member).

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assignment of income

Back 206

A taxpayer attempts to avoid the recognition of income by assigning to another the property that generates the income. Such a procedure will not avoid the recognition of income by the taxpayer making the assignment if the income was earned at the point of the transfer. In this case, the income is taxed to the person who earns it.

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cash receipts method

Back 207

A method of accounting that reflects deductions as paid and income as received in any one tax year. However, deductions for prepaid expenses that benefit more than one tax year (e.g., prepaid rent and prepaid interest) usually are spread over the period benefited rather than deducted in the year paid. § 446(c)(1).

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claim of right doctrine

Back 208

A judicially imposed doctrine applicable to both cash and accrual basis taxpayers that holds that an amount is includible in income upon actual or constructive receipt if the taxpayer has an unrestricted claim to the payment. For the tax treatment of amounts repaid when previously included in income under the claim of right doctrine, see § 1341.

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community property

Back 209

Louisiana, Texas, New Mexico, Arizona, California, Washington, Idaho, Nevada, and Wisconsin have community property systems. Alaska residents can elect community property status for assets. The rest of the states are common law property jurisdictions. The difference between common law and community property systems centers around the property rights possessed by married persons. In a common law system, each spouse owns whatever he or she earns. Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse. Assume, for example, Jeff and Alice are husband and wife and their only income is the $50,000 annual salary Jeff receives. If they live in New York (a common law state), the $50,000 salary belongs to Jeff. If, however, they live in Texas (a community property state), the $50,000 salary is owned one-half each by Jeff and Alice.

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constructive receipt

Back 210

If income is unqualifiedly available although not physically in the taxpayer's possession, it is subject to the income tax. An example is accrued interest on a savings account. Under the constructive receipt concept, the interest is taxed to a depositor in the year available, rather than the year actually withdrawn. The fact that the depositor uses the cash basis of accounting for tax purposes is irrelevant. See Reg. § 1.451-2.

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economic income

Back 211

The change in the taxpayer's net worth, as measured in terms of market values, plus the value of the assets the taxpayer consumed during the year. Because of the impracticality of this income model, it is not used for tax purposes.

Front 212

fruit and tree metaphor

Back 212

The courts have held that an individual who earns income from property or services cannot assign that income to another. For example, a father cannot assign his earnings from commissions to his child and escape income tax on those amounts.

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gross income

Back 213

Income subject to the Federal income tax. Gross income does not include all economic income. That is, certain exclusions are allowed (e.g., interest on municipal bonds). For a manufacturing or merchandising business, gross income usually means gross profit (gross sales or gross receipts less cost of goods sold). § 61 and Reg. § 1.61-3(a).

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group term life insurance

Back 214

Life insurance coverage provided by an employer for a group of employees. Such insurance is renewable on a year-to-year basis, and typically no cash surrender value is built up. The premiums paid by the employer on the insurance are not taxed to the employees on coverage of up to $50,000 per person. § 79 and Reg. § 1.79-1(b).

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hybrid method

Back 215

A combination of the accrual and cash methods of accounting. That is, the taxpayer may account for some items of income on the accrual method (e.g., sales and cost of goods sold) and other items (e.g., interest income) on the cash method.

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imputed interest

Back 216

For certain long-term sales of property, the IRS can convert some of the gain from the sale into interest income if the contract does not provide for a minimum rate of interest to be paid by the purchaser. The seller recognizes less long-term capital gain and more ordinary income (interest income). § 483 and the related Regulations.

Front 217

income

Back 217

For tax purposes, an increase in wealth that has been realized.

Front 218

original issue discount

Back 218

The difference between the issue price of a debt obligation (e.g., a corporate bond) and the maturity value of the obligation when the issue price is less than the maturity value. OID represents interest and must be amortized over the life of the debt obligation using the effective interest method. The difference is not considered to be original issue discount for tax purposes when it is less than one-fourth of 1 percent of the redemption price at maturity multiplied by the number of years to maturity. § 1272 and § 1273(a)(3).

Front 219

partnership

Back 219

For income tax purposes, a partnership includes a syndicate, group, pool, or joint venture, as well as ordinary partnerships. In an ordinary partnership, two or more parties combine capital and\/or services to carry on a business for profit as co-owners. § 7701(a)(2).

Front 220

recovery of capital doctrine

Back 220

When a taxable sale or exchange occurs, the seller may be permitted to recover his or her investment (or other adjusted basis) in the property before gain or loss is recognized.

Front 221

S corporation

Back 221

The designation for a small business corporation. See also Subchapter S.

Front 222

taxable year

Back 222

The annual period over which income is measured for income tax purposes. Most individuals use a calendar year, but many businesses use a fiscal year based on the natural business year.

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de minimis fringe

Back 223

Benefits provided to employees that are too insignificant to warrant the time and effort required to account for the benefits received by each employee and the value of those benefits. Such amounts are excludible from the employee's gross income. § 132.

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accelerated death benefits

Back 224

The amount received from a life insurance policy by the insured who is terminally ill or chronically ill. Any realized gain may be excluded from the gross income of the insured if the policy is surrendered to the insurer or is sold to a licensed viatical settlement provider. § 101(g).

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accident and health benefits

Back 225

Employee fringe benefits provided by employers through the payment of health and accident insurance premiums or the establishment of employer-funded medical reimbursement plans. Employers generally are entitled to a deduction for such payments, whereas employees generally exclude such fringe benefits from gross income. § 105 and § 106.

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cafeteria plan

Back 226

An employee benefit plan under which an employee is allowed to select from among a variety of employer-provided fringe benefits. Some of the benefits may be taxable, and some may be statutory nontaxable benefits (e.g., health and accident insurance and group term life insurance). The employee is taxed only on the taxable benefits selected. A cafeteria benefit plan is also referred to as a flexible benefit plan. § 125.

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compensatory damages

Back 227

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Compensatory damages are those paid to compensate one for harm caused by another. Compensatory damages are excludible from the recipient's gross income.

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death benefit

Back 228

A payment made by an employer to the beneficiary or beneficiaries of a deceased employee on account of the death of the employee.

Front 229

educational savings bonds

Back 229

U.S. Series EE bonds whose proceeds are used for qualified higher educational expenses for the taxpayer, the taxpayer's spouse, or a dependent. The interest may be excluded from gross income, provided the taxpayer's adjusted gross income does not exceed certain amounts. § 135.

Front 230

flexible spending plan

Back 230

An employee benefit plan that allows the employee to take a reduction in salary in exchange for the employer paying benefits that can be provided by the employer without the employee being required to recognize income (e.g., medical and child care benefits).

Front 231

foreign earned income exclusion

Back 231

The Code allows exclusions for earned income generated outside the United States to alleviate any tax base and rate disparities among countries. In addition, the exclusion is allowed for housing expenditures incurred by the taxpayer's employer with respect to the non-U.S. assignment, and self-employed individuals can deduct foreign housing expenses incurred in a trade or business. The exclusion is limited to $91,400 per year for 2009 ($87,600 in 2008). § 911.

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gift

Back 232

A transfer of property for less than adequate consideration. Gifts usually occur in a personal setting (such as between members of the same family). They are excluded from the income tax base but may be subject to a transfer tax.

Front 233

health savings account (HSA)

Back 233

A medical savings account created in legislation enacted in December 2003 that is designed to replace and expand Archer Medical Savings Accounts.

Front 234

life insurance proceeds

Back 234

A specified sum (the face value or maturity value of the policy) paid to the designated beneficiary of the policy by the life insurance company upon the death of the insured.

Front 235

long-term care insurance

Back 235

Insurance that helps pay the cost of care when the insured is unable to care for himself or herself. Such insurance is generally thought of as insurance against the cost of an aged person entering a nursing home. The employer can provide the insurance, and the premiums may be excluded from the employee's gross income. § 7702B.

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no-additional-cost services

Back 236

Services that the employer may provide the employee at no additional cost to the employer. Generally, the benefit is the ability to utilize the employer's excess capacity (e.g., vacant seats on an airliner). Such amounts are excludible from the recipient's gross income.

Front 237

punitive damages

Back 237

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Punitive damages are those awarded to punish the defendant for gross negligence or the intentional infliction of harm. Such damages are includible in gross income. § 104.

Front 238

qualified employee discounts

Back 238

Discounts offered employees on merchandise or services that the employer ordinarily sells or provides to customers. The discounts must be generally available to all employees. In the case of property, the discount cannot exceed the employer's gross profit (the sales price cannot be less than the employer's cost). In the case of services, the discounts cannot exceed 20 percent of the normal sales price. § 132.

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qualified real property business indebtedness

Back 239

Indebtedness that was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property. The taxpayer must not be a C corporation. For qualified real property business indebtedness, the taxpayer may elect to exclude some or all of the income realized from cancellation of debt on qualified real property. If the election is made, the basis of the property must be reduced by the amount excluded. The amount excluded cannot be greater than the excess of the principal amount of the outstanding debt over the fair market value (net of any other debt outstanding on the property) of the property securing the debt. § 108(c).

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qualified tuition program

Back 240

A program that allows college tuition to be prepaid for a beneficiary. When amounts in the plan are used, nothing is included in gross income provided they are used for qualified higher education expenses. § 529.

Front 241

scholarships

Back 241

Scholarships are generally excluded from the gross income of the recipient unless the payments are a disguised form of compensation for services rendered. However, the Code imposes restrictions on the exclusion. The recipient must be a degree candidate. The excluded amount is limited to amounts used for tuition, fees, books, supplies, and equipment required for courses of instruction. Amounts received for room and board are not eligible for the exclusion. § 117.

Front 242

tax benefit rule

Back 242

A provision that limits the recognition of income from the recovery of an expense or loss properly deducted in a prior tax year to the amount of the deduction that generated a tax saving. Assume that last year Gary had medical expenses of $3,000 and adjusted gross income of $30,000. Because of the 7.5 percent limitation, Gary could deduct only $750 of these expenses [$3,000 — (7.5% × $30,000)]. If, this year, Gary is reimbursed by his insurance company for the $3,000 of expenses, the tax benefit rule limits the amount of income from the reimbursement to $750 (the amount previously deducted with a tax saving).

Front 243

working condition fringe

Back 243

A type of fringe benefit received by the employee that is excludible from the employee's gross income. It consists of property or services provided (paid or reimbursed) by the employer for which the employee could take a tax deduction if the employee had paid for them.

Front 244

de minimis fringe

Back 244

Benefits provided to employees that are too insignificant to warrant the time and effort required to account for the benefits received by each employee and the value of those benefits. Such amounts are excludible from the employee's gross income. § 132.

Front 245

accelerated death benefits

Back 245

The amount received from a life insurance policy by the insured who is terminally ill or chronically ill. Any realized gain may be excluded from the gross income of the insured if the policy is surrendered to the insurer or is sold to a licensed viatical settlement provider. § 101(g).

Front 246

accident and health benefits

Back 246

Employee fringe benefits provided by employers through the payment of health and accident insurance premiums or the establishment of employer-funded medical reimbursement plans. Employers generally are entitled to a deduction for such payments, whereas employees generally exclude such fringe benefits from gross income. § 105 and § 106.

Front 247

cafeteria plan

Back 247

An employee benefit plan under which an employee is allowed to select from among a variety of employer-provided fringe benefits. Some of the benefits may be taxable, and some may be statutory nontaxable benefits (e.g., health and accident insurance and group term life insurance). The employee is taxed only on the taxable benefits selected. A cafeteria benefit plan is also referred to as a flexible benefit plan. § 125.

Front 248

compensatory damages

Back 248

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Compensatory damages are those paid to compensate one for harm caused by another. Compensatory damages are excludible from the recipient's gross income.

Front 249

death benefit

Back 249

A payment made by an employer to the beneficiary or beneficiaries of a deceased employee on account of the death of the employee.

Front 250

educational savings bonds

Back 250

U.S. Series EE bonds whose proceeds are used for qualified higher educational expenses for the taxpayer, the taxpayer's spouse, or a dependent. The interest may be excluded from gross income, provided the taxpayer's adjusted gross income does not exceed certain amounts. § 135.

Front 251

flexible spending plan

Back 251

An employee benefit plan that allows the employee to take a reduction in salary in exchange for the employer paying benefits that can be provided by the employer without the employee being required to recognize income (e.g., medical and child care benefits).

Front 252

foreign earned income exclusion

Back 252

The Code allows exclusions for earned income generated outside the United States to alleviate any tax base and rate disparities among countries. In addition, the exclusion is allowed for housing expenditures incurred by the taxpayer's employer with respect to the non-U.S. assignment, and self-employed individuals can deduct foreign housing expenses incurred in a trade or business. The exclusion is limited to $91,400 per year for 2009 ($87,600 in 2008). § 911.

Front 253

gift

Back 253

A transfer of property for less than adequate consideration. Gifts usually occur in a personal setting (such as between members of the same family). They are excluded from the income tax base but may be subject to a transfer tax.

Front 254

health savings account (HSA)

Back 254

A medical savings account created in legislation enacted in December 2003 that is designed to replace and expand Archer Medical Savings Accounts.

Front 255

life insurance proceeds

Back 255

A specified sum (the face value or maturity value of the policy) paid to the designated beneficiary of the policy by the life insurance company upon the death of the insured.

Front 256

long-term care insurance

Back 256

Insurance that helps pay the cost of care when the insured is unable to care for himself or herself. Such insurance is generally thought of as insurance against the cost of an aged person entering a nursing home. The employer can provide the insurance, and the premiums may be excluded from the employee's gross income. § 7702B.

Front 257

no-additional-cost services

Back 257

Services that the employer may provide the employee at no additional cost to the employer. Generally, the benefit is the ability to utilize the employer's excess capacity (e.g., vacant seats on an airliner). Such amounts are excludible from the recipient's gross income.

Front 258

punitive damages

Back 258

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Punitive damages are those awarded to punish the defendant for gross negligence or the intentional infliction of harm. Such damages are includible in gross income. § 104.

Front 259

qualified employee discounts

Back 259

Discounts offered employees on merchandise or services that the employer ordinarily sells or provides to customers. The discounts must be generally available to all employees. In the case of property, the discount cannot exceed the employer's gross profit (the sales price cannot be less than the employer's cost). In the case of services, the discounts cannot exceed 20 percent of the normal sales price. § 132.

Front 260

qualified real property business indebtedness

Back 260

Indebtedness that was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property. The taxpayer must not be a C corporation. For qualified real property business indebtedness, the taxpayer may elect to exclude some or all of the income realized from cancellation of debt on qualified real property. If the election is made, the basis of the property must be reduced by the amount excluded. The amount excluded cannot be greater than the excess of the principal amount of the outstanding debt over the fair market value (net of any other debt outstanding on the property) of the property securing the debt. § 108(c).

Front 261

qualified tuition program

Back 261

A program that allows college tuition to be prepaid for a beneficiary. When amounts in the plan are used, nothing is included in gross income provided they are used for qualified higher education expenses. § 529.

Front 262

scholarships

Back 262

Scholarships are generally excluded from the gross income of the recipient unless the payments are a disguised form of compensation for services rendered. However, the Code imposes restrictions on the exclusion. The recipient must be a degree candidate. The excluded amount is limited to amounts used for tuition, fees, books, supplies, and equipment required for courses of instruction. Amounts received for room and board are not eligible for the exclusion. § 117.

Front 263

tax benefit rule

Back 263

A provision that limits the recognition of income from the recovery of an expense or loss properly deducted in a prior tax year to the amount of the deduction that generated a tax saving. Assume that last year Gary had medical expenses of $3,000 and adjusted gross income of $30,000. Because of the 7.5 percent limitation, Gary could deduct only $750 of these expenses [$3,000 — (7.5% × $30,000)]. If, this year, Gary is reimbursed by his insurance company for the $3,000 of expenses, the tax benefit rule limits the amount of income from the reimbursement to $750 (the amount previously deducted with a tax saving).

Front 264

working condition fringe

Back 264

A type of fringe benefit received by the employee that is excludible from the employee's gross income. It consists of property or services provided (paid or reimbursed) by the employer for which the employee could take a tax deduction if the employee had paid for them. § 132.

Front 265

accelerated cost recovery system (ACRS)

Back 265

A method in which the cost of tangible property is recovered over a prescribed period of time. The approach disregards salvage value, imposes a period of cost recovery that depends upon the classification of the asset into one of various recovery periods, and prescribes the applicable percentage of cost that can be deducted each year. § 168.

Front 266

additional first-year depreciation

Back 266

See Fifty percent additional first-year depreciation.

Front 267

alternative depreciation system (ADS)

Back 267

A cost recovery system that produces a smaller deduction than would be calculated under ACRS or MACRS. The alternative system must be used in certain instances and can be elected in other instances. § 168(g).

Front 268

amortization

Back 268

The tax deduction for the cost or other basis of an intangible asset over the asset's estimated useful life. Examples of amortizable intangibles include patents, copyrights, and leasehold interests. The intangible goodwill can be amortized for income tax purposes over a 15-year period.

Front 269

cost depletion

Back 269

Depletion that is calculated based on the adjusted basis of the asset. The adjusted basis is divided by the expected recoverable units to determine the depletion per unit. The depletion per unit is multiplied by the units sold during the tax year to calculate cost depletion.

Front 270

cost recovery

Back 270

The portion of the cost of an asset written off under ACRS (or MACRS), which replaced the depreciation system as a method for writing off the cost of an asset for most assets placed in service after 1980 (after 1986 for MACRS). § 168.

Front 271

depletion

Back 271

The process by which the cost or other basis of a natural resource (e.g., an oil or gas interest) is recovered upon extraction and sale of the resource. The two ways to determine the depletion allowance are the cost and percentage (or statutory) methods. Under cost depletion, each unit of production sold is assigned a portion of the cost or other basis of the interest. This is determined by dividing the cost or other basis by the total units expected to be recovered. Under percentage (or statutory) depletion, the tax law provides a special percentage factor for different types of minerals and other natural resources. This percentage is multiplied by the gross income from the interest to arrive at the depletion allowance. §§ 613 and 613A.

Front 272

depreciation

Back 272

The deduction for the cost or other basis of a tangible asset over the asset's estimated useful life.

Front 273

half-year convention

Back 273

The half-year convention is a cost recovery convention that assumes all property is placed in service at mid-year and thus provides for a half-year's cost recovery for that year.

Front 274

intangible drilling and development costs (IDC)

Back 274

Taxpayers may elect to expense or capitalize (subject to amortization) intangible drilling and development costs. However, ordinary income recapture provisions apply to oil and gas properties on a sale or other disposition if the expense method is elected. §§ 263(c) and 1254(a).

Front 275

listed property

Back 275

The term listed property includes (1) any passenger automobile, (2) any other property used as a means of transportation, (3) any property of a type generally used for purposes of entertainment, recreation, or amusement, (4) any computer or peripheral equipment (with an exception for exclusive business use), (5) any cellular telephone (or other similar telecommunications equipment), and (6) any other property of a type specified in the Regulations. If listed property is predominantly used for business, the taxpayer is allowed to use the statutory percentage method of cost recovery. Otherwise, the straight-line cost recovery method must be used. § 280F.

Front 276

mid-month convention

Back 276

A cost recovery convention that assumes property is placed in service in the middle of the month that it is actually placed in service.

Front 277

mid-quarter convention

Back 277

A cost recovery convention that assumes property placed in service during the year is placed in service at the middle of the quarter in which it is actually placed in service. The mid-quarter convention applies if more than 40 percent of the value of property (other than eligible real estate) is placed in service during the last quarter of the year.

Front 278

modified accelerated cost recovery system (MACRS)

Back 278

A method in which the cost of tangible property is recovered over a prescribed period of time. Enacted by the Economic Recovery Tax Act (ERTA) of 1981 and substantially modified by the Tax Reform Act (TRA) of 1986(the modified system is referred to as MACRS), the approach disregards salvage value, imposes a period of cost recovery that depends upon the classification of the asset into one of various recovery periods, and prescribes the applicable percentage of cost that can be deducted each year. § 168.

Front 279

percentage depletion

Back 279

Percentage depletion is depletion based on a statutory percentage applied to the gross income from the property. The taxpayer deducts the greater of cost depletion or percentage depletion. § 613.

Front 280

residential rental real estate

Back 280

Buildings for which at least 80 percent of the gross rents are from dwelling units (e.g., an apartment building). This type of building is distinguished from nonresidential (commercial or industrial) buildings in applying the recapture of depreciation provisions. The term also is relevant in distinguishing between buildings that are eligible for a 27.5-year life versus a 39-year life for MACRS purposes. Generally, residential buildings receive preferential treatment.

Front 281

Section 179 expensing

Back 281

The ability to deduct a capital expenditure in the year an asset is placed in service rather than over the asset's useful life or cost recovery period. The annual ceiling on the deduction is $133,000 for 2009. However, the deduction is reduced dollar for dollar when § 179 property placed in service during the taxable year exceeds $530,000 in 2009. In addition, the amount expensed under § 179 cannot exceed the aggregate amount of taxable income derived from the conduct of any trade or business by the taxpayer.

Front 282

startup expenditures

Back 282

Expenditures paid or incurred associated with the creation of a business prior to the beginning of business. Examples of such expenditures include advertising, salaries and wages, travel and other expenses incurred in lining up prospective distributors, suppliers, or customers, and salaries and fees to executives, consultants, and professional service providers. A taxpayer may elect to immediately expense the first $5,000 (subject to phaseout) of startup expenditures and generally amortize the balance over a period of 180 months.

Front 283

401(k) plan

Back 283

A qualified, defined contribution retirement plan typically offered to employees that allows participants to elect either to receive up to $16,500 (in 2009) in cash (taxed currently) or to have a contribution made on their behalf to a profit-sharing or stock bonus plan. The plan may also be in the form of a salary-reduction agreement between an eligible participant and an employer under which a contribution will be made only if the participant elects to reduce his or her compensation or to forgo an increase in compensation.

Front 284

accountable plan

Back 284

An accountable plan is a type of expense reimbursement plan that requires an employee to render an adequate accounting to the employer and return any excess reimbursement or allowance. If the expense qualifies, it will be treated as a deduction for AGI.

Front 285

automatic mileage method

Back 285

Automobile expenses are generally deductible only to the extent the automobile is used in business or for the production of income. Personal commuting expenses are not deductible. The taxpayer may deduct actual expenses (including depreciation and insurance), or the standard (automatic) mileage rate may be used (55 cents per mile for 2009 and 50.5 cents per mile for the first six months of 2008 and 58.5 cents per mile for the last six months of 2008). Automobile expenses incurred for medical purposes or in connection with job-related moving expenses are deductible to the extent of actual out-of-pocket expenses or at the rate of 24 cents per mile in 2009(19 cents per mile for the first six months of 2008 and 27 cents per mile for the last six months of 2008). For charitable activities, the rate is 14 cents per mile.

Front 286

deduction for qualified tuition and related expenses

Back 286

Taxpayers are allowed a deduction of up to$4,000 for higher education expenses. Certain taxpayers are not eligible for the deduction: those whose gross AGI exceeds a specified amount and those who can be claimed as a dependent by another taxpayer. These expenses are classified as a deduction for AGI, and they need not be employment related. §222.

Front 287

education expenses

Back 287

Employees may deduct education expenses that are incurred either (1) to maintain or improve existing job-related skills or (2) to meet the express requirements of the employer or the requirements imposed by law to retain employment status. The expenses are not deductible if the education is required to meet the minimum educational standards for the taxpayer's job or if the education qualifies the individual for a new trade or business. Reg. § 1.162-5.

Front 288

entertainment expenses

Back 288

These expenses are deductible only if they are directly related to or associated with a trade or business. Various restrictions and documentation requirements have been imposed upon the deductibility of entertainment expenses to prevent abuses by taxpayers. See, for example, the provision contained in § 274(n) that disallows 50 percent (20 percent prior to 1994) of entertainment expenses. § 274.

Front 289

independent contractor

Back 289

A self-employed person as distinguished from one who is employed as an employee.

Front 290

individual retirement account (IRA)

Back 290

A type of retirement plan to which an individual with earned income could contribute a maximum of $3,000 ($3,000 each in the case of a married couple with a spousal IRA) per tax year for 2002-2004. The maximum amount increased to $4,000 in 2005 and to $5,000 in 2008. The amount remains at $5,000 in 2009. IRAs can be classified as traditional IRAs or Roth IRAs. With a traditional IRA, an individual can contribute and deduct a maximum of $5,000 per tax year in 2009. The deduction is a deduction for AGI. However, if the individual is an active participant in another qualified retirement plan, the deduction is phased out proportionally between certain AGI ranges (note that the phase-out limits the amount of the deduction and not the amount of the contribution). With a Roth IRA, an individual can contribute a maximum of $5,000 per tax year in 2009. No deduction is permitted. However, if a five-year holding period requirement is satisfied and if the distribution is a qualified distribution, the taxpayer can make tax-free withdrawals from a Roth IRA. The maximum annual contribution is phased out proportionally between certain AGI ranges. §§ 219 and 408A.

Front 291

keogh plans

Back 291

Retirement plans available to self-employed taxpayers. They are also referred to as H.R. 10 plans. Under such plans, in 2009, a taxpayer may deduct each year up to either 100 percent of net earnings from self-employment or $49,000, whichever is less. If the plan is a profit sharing plan, the percentage is 25 percent.

Front 292

moving expenses

Back 292

A deduction for AGI is permitted to employees and self-employed individuals provided certain tests are met. The taxpayer's new job must be at least 50 miles farther from the old residence than the old residence was from the former place of work. In addition, an employee must be employed on a full-time basis at the new location for 39 weeks in the 12-month period following the move. Deductible moving expenses include the cost of moving the household and personal effects, transportation, and lodging expenses during the move. The cost of meals during the move is not deductible. Qualified moving expenses that are paid (or reimbursed) by the employer can be excluded from the employee's gross income. In this case, the related deduction by the employee is not permitted. §§ 62(a)(15), 132(a)(6), and 217.

Front 293

nonaccountable plan

Back 293

An expense reimbursement plan that does not have an accountability feature. The result is that employee expenses must be claimed as deductions from AGI. An exception is moving expenses that are deductions for AGI.

Front 294

office in the home expenses

Back 294

Employment and business-related expenses attributable to the use of a residence (e.g., den or office) are allowed only if the portion of the residence is exclusively used on a regular basis as a principal place of business of the taxpayer or as a place of business that is used by patients, clients, or customers. If the expenses are incurred by an employee, the use must be for the convenience of the employer as opposed to being merely appropriate and helpful. § 280A.

Front 295

Roth IRAs

Back 295

See individual retirement account (IRA).

Front 296

statutory employee

Back 296

Statutory employees are considered self-employed independent contractors for purposes of reporting income and expenses on their tax returns. Generally, a statutory employee must meet three tests: (1) It is understood from a service contract that the services will be performed by the person. (2) The person does not have a substantial investment in facilities (other than transportation used to perform the services). (3) The services involve a continuing relationship with the person for whom they are performed. For further information on statutory employees, see Circular E, Employer's Tax Guide (IRS Publication 15).

Front 297

transportation expenses

Back 297

Transportation expenses for an employee include only the cost of transportation (taxi fares, automobile expenses, etc.) in the course of employment when the employee is not away from home in travel status. Commuting expenses are not deductible.

Front 298

travel expenses

Back 298

Travel expenses include meals (generally subject to a 50 percent disallowance) and lodging and transportation expenses while away from home in the pursuit of a trade or business (including that of an employee).

Front 299

acquisition indebtedness

Back 299

Debt incurred in acquiring, constructing, or substantially improving a qualified residence of the taxpayer. The interest on such loans is deductible as qualified residence interest. However, interest on such debt is deductible only on the portion of the indebtedness that does not exceed $1,000,000 ($500,000 for married persons filing separate returns). § 163(h)(3).

Front 300

capital gain property

Back 300

Property contributed to a charitable organization that, if sold rather than contributed, would have resulted in long-term capital gain to the donor.

Front 301

charitable contributions

Back 301

Contributions are deductible (subject to various restrictions and ceiling limitations) if made to qualified nonprofit charitable organizations. A cash basis taxpayer is entitled to a deduction solely in the year of payment. Accrual basis corporations may accrue contributions at year-end if payment is properly authorized before the end of the year and payment is made within two and one-half months after the end of the year. § 170.

Front 302

health savings account (HSA)

Back 302

A medical savings account created in legislation enacted in December 2003 that is designed to replace and expand Archer Medical Savings Accounts.

Front 303

home equity loans

Back 303

Loans that utilize the personal residence of the taxpayer as security. The interest on such loans is deductible as qualified residence interest. However, interest is deductible only on the portion of the loan that does not exceed the lesser of (1) the fair market value of the residence, reduced by the acquisition indebtedness, or (2) $100,000 ($50,000 for married persons filing separate returns). A major benefit of a home equity loan is that there are no tracing rules regarding the use of the loan proceeds. § 163(h)(3).

Front 304

medical expenses

Back 304

Medical expenses of an individual, spouse, and dependents are allowed as an itemized deduction to the extent that such amounts (less insurance reimbursements) exceed 7.5 percent of adjusted gross income. § 213.

Front 305

miscellaneous itemized deductions

Back 305

A special category of itemized deductions that includes such expenses as professional dues, tax return preparation fees, job-hunting costs, unreimbursed employee business expenses, and certain investment expenses. Such expenses are deductible only to the extent they exceed 2 percent of adjusted gross income. § 67.

Front 306

ordinary income property

Back 306

Property contributed to a charitable organization that, if sold rather than contributed, would have resulted in other than long-term capital gain to the donor (i.e., ordinary income property and short-term capital gain property). Examples are inventory and capital assets held for less than the long-term holding period.

Front 307

points

Back 307

Loan origination fees that may be deductible as interest by a buyer of property. A seller of property who pays points reduces the selling price by the amount of the points paid for the buyer. While the seller is not permitted to deduct this amount as interest, the buyer may do so.

Front 308

qualified residence interest

Back 308

A term relevant in determining the amount of interest expense the individual taxpayer may deduct as an itemized deduction for what otherwise would be disallowed as a component of personal interest (consumer interest). Qualified residence interest consists of interest paid on qualified residences (principal residence and one other residence) of the taxpayer. Debt that qualifies as qualified residence interest is limited to $1 million of debt to acquire, construct, or substantially improve qualified residences (acquisition indebtedness) plus $100,000 of other debt secured by qualified residences (home equity indebtedness). The home equity indebtedness may not exceed the fair market value of a qualified residence reduced by the acquisition indebtedness for that residence. § 163(h)(3).

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active income

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Active income includes wages, salary, commissions, bonuses, profits from a trade or business in which the taxpayer is a material participant, gain on the sale or other disposition of assets used in an active trade or business, and income from intangible property if the taxpayer's personal efforts significantly contributed to the creation of the property. The passive activity loss rules require classification of income and losses into three categories with active income being one of them.

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at-risk limitation

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Generally, a taxpayer can deduct losses related to a trade or business, S corporation, partnership, or investment asset only to the extent of the at-risk amount.

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closely held corporation

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A corporation where stock ownership is not widely dispersed. Rather, a few shareholders are in control of corporate policy and are in a position to benefit personally from that policy.

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extraordinary personal services

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These are services provided by individuals where the customers' use of the property is incidental to their receipt of the services. For example, a patient's use of a hospital bed is incidental to his or her receipt of medical services. This is one of the six exceptions to determine whether an activity is a passive rental activity. § 469.

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investment income

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Consisting of virtually the same elements as portfolio income, a measure by which to justify a deduction for interest on investment indebtedness.

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investment interest

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Payment for the use of funds used to acquire assets that produce investment income. The deduction for investment interest is limited to net investment income for the tax year.

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material participation

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If an individual taxpayer materially participates in a nonrental trade or business activity, any loss from that activity is treated as an active loss that can be offset against active income. Material participation is achieved by meeting any one of seven tests provided in the Regulations. § 469(h).

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net investment income

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The excess of investment income over investment expenses. Investment expenses are those deductible expenses directly connected with the production of investment income. Investment expenses do not include investment interest. The deduction for investment interest for the tax year is limited to net investment income. § 163(d).

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passive loss

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Any loss from (1) activities in which the taxpayer does not materially participate or (2) rental activities (subject to certain exceptions). Net passive losses cannot be used to offset income from nonpassive sources. Rather, they are suspended until the taxpayer either generates net passive income (and a deduction of such losses is allowed) or disposes of the underlying property (at which time the loss deductions are allowed in full). One relief provision allows landlords who actively participate in the rental activities to deduct up to $25,000 of passive losses annually. However, a phaseout of the $25,000 amount commences when the landlord's AGI exceeds $100,000. Another relief provision applies for material participation in a real estate trade or business.

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personal service corporation (PSC)

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A corporation whose principal activity is the performance of personal services (e.g., health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting) and where such services are substantially performed by the employee-owners. The 35 percent statutory income tax rate applies to PSCs.

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portfolio income

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Income from interest, dividends, rentals, royalties, capital gains, or other investment sources. Net passive losses cannot be used to offset net portfolio income.

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rental activity

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Any activity where payments are received principally for the use of tangible property is a rental activity. Temporary Regulations provide that in certain circumstances activities involving rentals of real and personal property are not to be treated as rental activities. The Temporary Regulations list six exceptions.

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significant participation activity

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There are seven tests to determine whether an individual has achieved material participation in an activity, one of which is based on more than 500 hours of participation in significant participation activities. A significant participation activity is one in which the individual's participation exceeds 100 hours during the year. Temp.Reg. § 1.469-5T.

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tax shelters

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The typical tax shelter generated large losses in the early years of the activity. Investors would offset these losses against other types of income and, therefore, avoid paying income taxes on this income. These tax shelter investments could then be sold after a few years and produce capital gain income, which is taxed at a lower rate than ordinary income. The passive activity loss rules and the at-risk rules now limit tax shelter deductions.

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adoption expenses credit

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A provision intended to assist taxpayers who incur nonrecurring costs directly associated with the adoption process such as legal costs, social service review costs, and transportation costs. Up to $12,150 ($12,150 for a child with special needs regardless of the actual adoption expenses) of costs incurred to adopt an eligible child qualify for the credit. A taxpayer may claim the credit in the year qualifying expenses are paid or incurred if the expenses are paid during or after the year in which the adoption is finalized. For qualifying expenses paid or incurred in a tax year prior to the year the adoption is finalized, the credit must be claimed in the tax year following the tax year during which the expenses are paid or incurred. § 23.

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american opportunity credit

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This credit replaces the Hope credit for 2009 and 2010 and applies for qualifying expenses for the first four years of post secondary education. Qualified expenses include tuition and related expenses and books and other course materials. Room and board are ineligible for the credit. The maximum credit available per student is $2,500 (100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses). Eligible students include the taxpayer, taxpayer's spouse, and taxpayer's dependents. To qualify for the credit, a student must take at least one-half the full-time course load for at least one academic term at a qualifying educational institution. The credit is phased out for higher income taxpayers. §25A.

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child tax credit

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A tax credit based solely on the number of qualifying children under age 17. The maximum credit available is $1,000 per child through 2010. A qualifying child must be claimed as a dependent on a parent's tax return in order to qualify for the credit. Taxpayers who qualify for the child tax credit may also qualify for a supplemental credit. The supplemental credit is treated as a component of the earned income credit and is therefore refundable. The credit is phased out for higher-income taxpayers. § 24.

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credit for certain retirement plan contributions

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A nonrefundable credit is available based on eligible contributions of up to $2,000 to certain qualified retirement plans, such as traditional and Roth IRAs and § 401(k) plans. The benefit provided by this credit is in addition to any deduction or exclusion that otherwise is available resulting from the qualifying contribution. The amount of the credit depends on the taxpayer's AGI and filing status. § 25B.

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credit for child and dependent care expenses

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A tax credit ranging from 20 percent to 35 percent of employment-related expenses (child and dependent care expenses) for amounts of up to $6,000 is available to individuals who are employed (or deemed to be employed) and maintain a household for a dependent child under age 13, disabled spouse, or disabled dependent. § 21.

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credit for employer-provided child care

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A nonrefundable credit is available to employers who provide child care facilities to their employees during normal working hours. The credit, limited to $150,000, is comprised of two components. The portion of the credit for qualified child care expenses is equal to 25 percent of these expenses while the portion of the credit for qualified child care resource and referral services is equal to 10 percent of these expenses. Any qualifying expenses otherwise deductible by the taxpayer must be reduced by the amount of the credit. In addition, the taxpayer's basis for any property used for qualifying purposes is reduced by the amount of the credit. § 45F.

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credit for small employer pension plan startup costs

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A nonrefundable credit available to small businesses based on administrative costs associated with establishing and maintaining certain qualified plans. While such qualifying costs generally are deductible as ordinary and necessary business expenses, the availability of the credit is intended to lower the costs of starting a qualified retirement program, and therefore encourage qualifying businesses to establish retirement plans for their employees. The credit is available for eligible employers at the rate of 50 percent of qualified startup costs. The maximum credit is $500(based on a maximum $1,000 of qualifying expenses). § 45E.

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disabled access credit

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A tax credit designed to encourage small businesses to make their facilities more accessible to disabled individuals. The credit is equal to 50 percent of the eligible expenditures that exceed $250 but do not exceed $10,250. Thus, the maximum amount for the credit is $5,000. The adjusted basis for depreciation is reduced by the amount of the credit. To qualify, the facility must have been placed in service before November 6, 1990. § 44.

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earned income credit

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A tax credit designed to provide assistance to certain low-income individuals who generally have a qualifying child. This is a refundable credit. To receive the most beneficial treatment, the taxpayer must have qualifying children. However, it is possible to qualify for the credit without having a child. To calculate the credit for a taxpayer with one or more children for 2009, a statutory rate of 34 percent for one child (40 percent for two children and 45 percent for three or more children) is multiplied by the earned income (subject to a statutory maximum of $8,950 with one qualifying child or $12,570 with two or more qualifying children). Once the earned income exceeds certain thresholds, the credit is phased out using a 15.98 percent rate for one qualifying child and a 21.06 percent rate for two qualifying children. For the qualifying taxpayer without children, the credit is calculated on a maximum earned income of $5,970 applying a 7.65 percent rate with the phaseout beginning later applying the same rate.

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employment taxes

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Employment taxes are those taxes that an employer must pay on account of its employees. Employment taxes include FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. Employment taxes are paid to the IRS in addition to income tax withholdings at specified intervals. Such taxes can be levied on the employees, the employer, or both.

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Energy tax credits

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One of a variety of tax credits for businesses and individuals to encourage the conservation of natural resources and the development of energy sources other than oil and gas.

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Estimated tax

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The amount of tax (including alternative minimum tax and self-employment tax) an individual expects to owe for the year after subtracting tax credits and income tax withheld. Any individual who has estimated tax for the year of $1,000 or more and whose withholding does not equal or exceed the required annual payment must make quarterly payments.

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First-time home buyer credit

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A credit designed to encourage home ownership and to alleviate the surplus of unsold houses. The first-time home buyer credit provides a tax incentive for first-time purchases. For home purchases from January 1, 2009 through December 1, 2009, a credit of 10 percent of the purchase price is allowed but not to exceed $8,000 ($4,000 for married individuals filing separately).

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foreign tax credit

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A U.S. citizen or resident who incurs or pays income taxes to a foreign country on income subject to U.S. tax may be able to claim some of these taxes as a credit against the U.S. income tax. §§ 27 and 901-905.

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general business credit

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The summation of various nonrefundable business credits, including the tax credit for rehabilitation expenditures, business energy credit, work opportunity credit, research activities credit, low-income housing credit, and disabled access credit. The amount of general business credit that can be used to reduce the tax liability is limited to the taxpayer's net income tax reduced by the greater of (1) the tentative minimum tax or (2) 25 percent of the net regular tax liability that exceeds $25,000. Unused general business credits can be carried back 1 year and forward 20 years. § 38.

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lifetime learning credit

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A tax credit for qualifying expenses for taxpayers pursuing education beyond the first two years of post secondary education. Individuals who are completing their last two years of undergraduate studies, pursuing graduate or professional degrees, or otherwise seeking new job skills or maintaining existing job skills are all eligible for the credit. Eligible individuals include the taxpayer, taxpayer's spouse, and taxpayer's dependents. The maximum credit is 20 percent of the first $10,000 of qualifying expenses and is computed per taxpayer. The credit is phased out for higher-income taxpayers. § 25A.

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low-income housing credit

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Beneficial treatment to owners of low-income housing is provided in the form of a tax credit. The calculated credit is claimed in the year the building is placed in service and in the following nine years. § 42.

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Making Work Pay credit

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A refundable income tax credit for 2009 and 2010 of up to $400 ($800 for married taxpayers filing jointly) included in the American Recovery and Reinvestment Tax Act of 2009. This credit, calculated at a rate of 6.2 percent of earned income — phases out at a rate of 2 percent of modified adjusted gross income above $75,000 ($150,000 for joint returns).

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nonrefundable credit

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A nonrefundable credit is a credit that is not paid if it exceeds the taxpayer's tax liability. Some nonrefundable credits qualify for carryback and carryover treatment.

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permanent and total disability

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A person is considered permanently and totally disabled if he or she is unable to engage in any substantial gainful activity due to a physical or mental impairment. In addition, this impairment must be one that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than 12 months. The taxpayer generally must provide the IRS a physician's statement documenting this condition.

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refundable credit

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A refundable credit is a credit that is paid to the taxpayer even if the amount of the credit (or credits) exceeds the taxpayer's tax liability.

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rehabilitation expenditures credit

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A credit that is based on expenditures incurred to rehabilitate industrial and commercial buildings and certified historic structures. The credit is intended to discourage businesses from moving from older, economically distressed areas to newer locations and to encourage the preservation of historic structures. § 47.

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rehabilitation expenditures credit recapture

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When property that qualifies for the rehabilitation expenditures credit is disposed of or ceases to be used in the trade or business of the taxpayer, some or all of the tax credit claimed on the property may be recaptured as additional tax liability. The amount of the recapture is the difference between the amount of the credit claimed originally and what should have been claimed in light of the length of time the property was actually held or used for qualifying purposes. § 50.

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research activities credit

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A tax credit whose purpose is to encourage research and development. It consists of three components: the incremental research activities credit, the basic research credit, and the energy credit. The incremental research activities credit is equal to 20 percent of the excess qualified research expenditures over the base amount. The basic research credit is equal to 20 percent of the excess of basic research payments over the base amount. § 41.

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self-employment tax

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In 2009, a tax of 12.4 percent is levied on individuals with net earnings from self-employment (up to $106,800) to provide Social Security benefits (i.e., the old age, survivors, and disability insurance portion) for such individuals. In addition, in 2009, a tax of 2.9 percent is levied on individuals with net earnings from self-employment (with no statutory ceiling) to provide Medicare benefits (i.e., the hospital insurance portion) for such individuals. If a self-employed individual also receives wages from an employer that are subject to FICA, the self-employment tax will be reduced if total income subject to Social Security is more than $106,800 in 2009. A partial deduction is allowed in calculating the self-employment tax. Individuals with net earnings of $400 or more from self-employment are subject to this tax. §§ 1401 and 1402.

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tax credit for the elderly or disabled

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An elderly (age 65 and over) or disabled taxpayer may receive a tax credit amounting to 15 percent of $5,000 ($7,500 for qualified married individuals filing jointly). This amount is reduced by Social Security benefits, excluded pension benefits, and one-half of the taxpayer's adjusted gross income in excess of $7,500 ($10,000 for married taxpayers filing jointly). § 22.

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tax credits

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Tax credits are amounts that directly reduce a taxpayer's tax liability. The tax benefit received from a tax credit is not dependent on the taxpayer's marginal tax rate, whereas the benefit of a tax deduction or exclusion is dependent on the taxpayer's tax bracket.

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work opportunity tax credit

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Employers are allowed a tax credit equal to 40 percent of the first $6,000 of wages (per eligible employee) for the first year of employment. Eligible employees include certain hard-to-employ individuals (e.g., qualified ex-felons, high-risk youth, food stamp recipients, and veterans). The employer's deduction for wages is reduced by the amount of the credit taken. For qualified summer youth employees, the 40 percent rate is applied to the first $3,000 of qualified wages. See welfare-to-work credit for the calculation for long-term recipients of family assistance welfare benefits. § 51 and § 52.

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aggregate concept

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The theory of partnership taxation under which, in certain cases, a partnership is treated as a mere extension of each partner.

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basis in partnership interest

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The acquisition cost of the partner's ownership interest in the partnership. Includes purchase price and associated debt acquired from other partners and in the course of the entity's trade or business.

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capital account

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The financial accounting analog of a partner's tax basis in the entity.

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capital interest

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Usually, the percentage of the entity's net assets that a partner would receive on liquidation. Typically determined by the partner's capital sharing ratio.

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capital sharing ratio

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A partner's percentage ownership of the entity's capital.

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Constructive liquidation scenario

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The means by which recourse debt is shared among partners in basis determination.

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disguised sale

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When a partner contributes property to the entity and soon thereafter receives a distribution from the partnership, the transactions are collapsed, and the distribution is seen as a purchase of the asset by the partnership. § 707(a)(2)(B).

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disproportionate distribution

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A distribution from a partnership to one or more of its partners in which at least one partner's interest in partnership hot assets is increased or decreased. For example, a distribution of cash to one partner and hot assets to another changes both partners' interest in hot assets and is disproportionate. The intent of rules for taxation of disproportionate distributions is to ensure each partner eventually recognizes his or her proportionate share of partnership ordinary income.

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economic effect test

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Requirements that must be met before a special allocation may be used by a partnership. The premise behind the test is that each partner who receives an allocation of income or loss from a partnership bears the economic benefit or burden of the allocation.

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electing large partnership

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A partnership with 100 or more partners may elect to be subject to simplified tax reporting and audit procedures. The election allows the partnership to combine certain income and expense amounts and report net amounts to the partners. The result is fewer "pass-through" items to the partners, which makes the partners' tax returns easier to prepare. As an example, an electing large partnership with a long-term capital gain and a short-term capital loss would offset the two amounts and allocate the net amount among the partners.

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entity concept

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The theory of partnership taxation under which a partnership is treated as a separate and distinct entity from the partners and has its own tax attributes.

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general partnership

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A partnership that is owned by one or more general partners. Creditors of a general partnership can collect amounts owed them from both the partnership assets and the assets of the partners individually.

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guaranteed payments

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Payments made by a partnership to a partner for services rendered or for the use of capital to the extent that the payments are determined without regard to the income of the partnership. The payments are treated as though they were made to a nonpartner and thus are deducted by the entity.

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hot assets

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Unrealized receivables and substantially appreciated inventory under § 751. When hot assets are present, the sale of a partnership interest or the disproportionate distribution of the assets can cause ordinary income to be recognized.

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inside basis

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A partnership's basis in the assets it owns.

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least aggregate deferral method

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An algorithm set forth in the Regulations to determine the tax year for a partnership or S corporation with owners whose tax years differ. The tax year selected is the one that produces the least aggregate deferral of income for the owners.

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limited liability company (LLC)

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A form of entity allowed by all of the states. The entity is taxed as a partnership in which all members or owners of the LLC are treated much like limited partners. There are no restrictions on ownership, all members may participate in management, and none has personal liability for the entity's debts.

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limited liability limited partnership (LLLP)

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A limited partnership for which the general partners are also protected from entity liabilities. An LLLP—or "triple LP"—can be formed in about 20 states. In those states, a limited partnership files with the state to adopt LLLP status.

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limited liability partnership (LLP)

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A form of entity allowed by many of the states, where a general partnership registers with the state as an LLP. Owners are general partners, but a partner is not liable for any malpractice committed by other partners. The personal assets of the partners are at risk for the entity's contractual liabilities, such as accounts payable. The personal assets of a specific partner are at risk for his or her own professional malpractice and tort liability, and for malpractice and torts committed by those whom he or she supervises.

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limited partnership

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A partnership in which some of the partners are limited partners. At least one of the partners in a limited partnership must be a general partner.

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liquidating distribution

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A distribution by a partnership or corporation that is in complete liquidation of the entity's trade or business activities. Typically, such distributions generate capital gain or loss to the investors without regard, for instance, to the earnings and profits of the corporation or to the partnership's basis in the distributed property. They can, however, lead to recognized gain or loss at the corporate level.

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nonliquidating distribution

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A payment made by a partnership or corporation to the entity's owner is a nonliquidating distribution when the entity's legal existence does not cease thereafter. If the payor is a corporation, such a distribution can result in dividend income to the shareholders. If the payor is a partnership, the partner usually assigns a basis in the distributed property that is equal to the lesser of the partner's basis in the partnership interest or the basis of the distributed asset to the partnership. In this regard, the partner first assigns basis to any cash that he or she receives in the distribution. The partner's remaining basis, if any, is assigned to the noncash assets according to their relative bases to the partnership.

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nonrecourse debt

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Debt secured by the property that it is used to purchase. The purchaser of the property is not personally liable for the debt upon default. Rather, the creditor's recourse is to repossess the related property. Nonrecourse debt generally does not increase the purchaser's at-risk amount.

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outside basis

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A partner's basis in his or her partnership interest.

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precontribution gain or loss

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Partnerships allow for a variety of special allocations of gain or loss among the partners, but gain or loss that is "built in" on an asset contributed to the partnership is assigned specifically to the contributing partner. § 704(c)(1)(A).

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profit and loss sharing ratio

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specified in the partnership agreement and used to determine each partner's allocation of ordinary taxable income and separately stated items. Profits and losses can be shared in different ratios. The ratios can be changed by amending the partnership agreement. § 704(a).

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profits (loss) interest

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A partner's percentage allocation of partnership operating results, determined by the profit and loss sharing ratios.

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proportionate distribution

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A distribution in which each partner in a partnership receives a pro rata share of hot assets being distributed. For example, a distribution of $10,000 of hot assets equally to two 50 percent partners is a proportionate distribution.

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Proposed Regulation

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A Regulation issued by the Treasury Department in proposed, rather than final, form. The interval between the proposal of a Regulation and its finalization permits taxpayers and other interested parties to comment on the propriety of the proposal.

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qualified nonrecourse debt

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Debt issued on realty by a bank, retirement plan, or governmental agency. Included in the at-risk amount by the investor. § 465(b)(6).

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recourse debt

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Debt for which the lender may both foreclose on the property and assess a guarantor for any payments due under the loan. A lender may also make a claim against the assets of any general partner in a partnership to which debt is issued, without regard to whether the partner has guaranteed the debt.

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separately stated item

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Any item of a partnership or S corporation that might be taxed differently to any two owners of the entity. These amounts are not included in ordinary income of the entity, but are instead reported separately to the owners; tax consequences are determined at the owner level.

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special allocation

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Any amount for which an agreement exists among the partners of a partnership outlining the method used for spreading the item among the partners.

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syndication costs

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Incurred in promoting and marketing partnership interests for sale to investors. Examples include legal and accounting fees, printing costs for prospectus and placement documents, and state registration fees. These items are capitalized by the partnership as incurred, with no amortization thereof allowed.

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unrealized receivables

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Amounts earned by a cash basis taxpayer but not yet received. Because of the method of accounting used by the taxpayer, these amounts have a zero income tax basis. When unrealized receivables are distributed to a partner, they generally convert a transaction from nontaxable to taxable or an otherwise capital gain to ordinary income.

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complex trust

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Not a simple trust. Such trusts may have charitable beneficiaries, accumulate income, and distribute corpus. § 661-663.

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corpus

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The body or principal of a trust. Suppose, for example, Grant transfers an apartment building into a trust, income payable to Ruth for life, remainder to Shawn upon Ruth's death. Corpus of the trust is the apartment building.

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distributable net income (DNI)

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The measure that determines the nature and amount of the distributions from estates and trusts that the beneficiaries must include in income. DNI also limits the amount that estates and trusts can claim as a deduction for such distributions. § 643(a).

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expenses in respect of a decedent

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Deductions accrued at the moment of death but not recognizable on the final income tax return of a decedent because of the method of accounting used. Such items are allowed as deductions on the estate tax return and on the income tax return of the estate (Form 1041) or the heir (Form 1040). An example of a deduction in respect of a decedent is interest expense accrued to the date of death by a cash basis debtor.

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grantor

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A transferor of property. The creator of a trust is usually referred to as the grantor of the entity.

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grantor trust

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A trust under which the grantor retains control over the income or corpus (or both) to such an extent that he or she is treated as the owner of the property and its income for income tax purposes. Income from a grantor trust is taxable to the grantor and not to the beneficiary who receives it. §§ 671-679.

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income in respect of a decedent (IRD)

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Income earned by a decedent at the time of death but not reportable on the final income tax return because of the method of accounting that appropriately is utilized. Such income is included in the gross estate and is taxed to the eventual recipient (either the estate or heirs). The recipient is, however, allowed an income tax deduction for the estate tax attributable to the income. § 691.

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reversionary interest

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The trust property that reverts to the grantor after the expiration of an intervening income interest. Assume Phil places real estate in trust with income to Junior for 11 years, and upon the expiration of this term, the property returns to Phil. Under these circumstances, Phil holds a reversionary interest in the property. A reversionary interest is the same as a remainder interest, except that, in the latter case, the property passes to someone other than the original owner (e.g., the grantor of a trust) upon the expiration of the intervening interest.

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simple trust

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Simple trusts are those that are not complex trusts. Such trusts may not have a charitable beneficiary, accumulate income, or distribute corpus.

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sprinkling trust

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When a trustee has the discretion to either distribute or accumulate the entity accounting income of the trust and to distribute it among the trust's income beneficiaries in varying magnitudes, a sprinkling trust exists. The trustee can "sprinkle" the income of the trust.