Acct 5400 Exam 1

Front 1

Tax

Back 1

Payment required by a government that is unrelated to any specific benefit or service received from the government.

Front 2

General purpose of a tax:

Back 2

To fund the operations of the government (to raise revenue).

Front 3

Sin taxes

Back 3

Impose relatively high surcharges on alcohol and tobacco products.

Front 4

T/F: Taxes are not intended to punish or prevent illegal behavior.

Back 4

TRUE: Nonetheless, by allowing deductions from income, our federal tax system does encourage certain behaviors like charitable contributions, retirement savings, and research and development, and we can view it as discouraging other legal behavior.

Front 5

Key components of a tax:

Back 5

1) The payment is required (it is not voluntary)
2) The payment is imposed by a government agency (federal, state, or local)
3) The payment is not tied directly to the benefit received by the taxpayer.

Front 6

Why is an earmarked tax, a tax that is assessed for a specific purpose, still considered a tax?

Back 6

Because the payment made by the taxpayer does not directly related to the specific benefit received by the taxpayer.

Front 7

Tax =

Back 7

Tax Base x Tax Rate

Front 8

Tax base

Back 8

Defines what is actually taxed and is usually expressed in monetary terms.

Front 9

Tax rate

Back 9

Determines the level of taxes imposed on the tax base and is usually expressed as a percentage.

Front 10

Common tax bases (and related taxes):

Back 10

Taxable income (federal and state income taxes), purchases (sales tax), real estate values (real estate tax), and personal property values (personal property tax).

Front 11

Flat tax

Back 11

Single tax applied to an entire base.

Front 12

Graduated taxes

Back 12

The base is divided into a series of monetary amounts, or brackets, and each successive bracket is taxed at a different (gradually higher or gradually lower) percentage rate.

Front 13

Three different tax rates that will be useful in contrasting the different tax rate structures:

Back 13

1) Marginal: tax rate that applies to the next additional increment of a taxpayer's taxable income (or deductions).
2) Average--taxpayer's average level of taxation on each dollar of taxable income.
3) Effective--taxpayer's average rate of taxation on each dollar of total income (taxable and nontaxable income).

Front 14

The marginal tax rate is useful . . .

Back 14

in tax planning.

Front 15

The average tax rate is useful . . .

Back 15

in budgeting tax expense.

Front 16

The effective tax rate is useful . . .

Back 16

in comparing the relative tax burdens of taxpayers.

Front 17

Except when the taxpayer has more nondeductible expenses (such as fines or penalties) than nontaxable income (such as tax-exempt interest), the effective tax rate will be _____ __ or ____ ____ the average tax rate.

Back 17

equal to, less than

Front 18

Three basic tax rate structures used to determine a tax:

Back 18

1) Proportional
2) Progressive
3) Regressive

Front 19

Proportional tax rate structure (flat tax):

Back 19

1) Imposes a constant tax rate throughout the tax base.
2) As a taxpayer's tax base increase, the taxpayer's taxes increase proportionally.
3) The marginal tax rate remains constant and always equals the average tax rate.
4) Example: sales tax.

Front 20

Progressive tax rate structure:

Back 20

1) Imposes an increasing marginal tax rate as the tax base increases.
2) As a taxpayer's tax base increases, both the marginal tax rate and the taxes paid increase.
3) Examples: federal and state income taxes.

Front 21

Regressive tax rate structure:

Back 21

1) Imposes a decreasing marginal tax rate as the tax base increases.
2) As a taxpayer's tax base increases, the marginal tax rate decrease while the total taxes paid increases.
3) Examples: Social Security tax and federal and state unemployment taxes.

Front 22

The federal government imposes a variety of taxes to fund federal programs such as . . .

Back 22

national defense, Social Security, an interstate highway system, educational programs, and Medicare.

Front 23

Major federal taxes include:

Back 23

1) The individual and corporate income taxes
2) Employment taxes
3) Estate and gift taxes
4) Excise taxes

Front 24

Value-added tax

Back 24

A type of sales tax imposed on the producers of good sand services based on the value added to the goods and services at each stage of production.

Front 25

Most significant tax assessed by the US government is . . .

Back 25

the income tax, representing approximately 59% of all tax revenues collected in the United States.

Front 26

Income taxes are levied on:

Back 26

1) Individuals (max rate of 35%)
2) Corporations (max rate of 39%)
4) Estates (max rate of 35%)
5) Trusts (max rate of 35%)

Front 27

__________ ______ ___ represents the largest source of federal tax revenues followed by employment taxes and the corporate income tax.

Back 27

Individual income tax

Front 28

Second largest group of taxes imposed by the US government:

Back 28

Employment and unemployment taxes.

Front 29

Employment taxes consist of:

Back 29

1) Old Age Survivors
2) Disability Insurance (OASDI) tax, commonly called the Social Security tax
3) Medical Health Insurance (MHI) tax known as the Medicare tax

Front 30

Social Security tax

Back 30

Pays the monthly retirement, survivor, and disability benefits for qualifying individuals.

Front 31

Medicare tax

Back 31

Pays for medical insurance for individuals who are elderly or disabled.

Front 32

The tax base for Social Security and Medicare taxes is wages or salary, and the rates are ___ percent and ___ percent, respectively.

Back 32

12.4, 2.9

Front 33

T/F: In 2010, the tax base for the Medicare tax is capped at $106,800.

Back 33

FALSE; The tax base for the Social Security tax is capped at $106,800, and the tax base for Medicare tax is not capped.

Front 34

Unemployment taxes

Back 34

Fund temporary unemployment benefits for individuals terminated from their jobs without cause.

Front 35

Currently, the Federal Unemployment Tax rate is ___ percent on the first ____ of wages. The US government allows a credit for state unemployment taxes paid up to ___ percent. Thus, the Federal Unemployment Tax rate may be a slow as ___ percent.

Back 35

6.2, $7,000, 5.4, 0.8

Front 36

Third largest group of taxes imposed by the US government:

Back 36

Excise taxes

Front 37

Excise taxes

Back 37

Taxes levied on the retail sale of particular products (the quantity of products sold).

Front 38

Estate and gift taxes are levied on . . .

Back 38

the fair market values of wealth transfers upon death or by gift.

Front 39

Federal transfer taxes:

Back 39

1) Estate
2) Gift

Front 40

Common state and local taxes:

Back 40

Income taxes, sales and use taxes, excise taxes, and property taxes.

Front 41

The tax base for a sales tax is . . .

Back 41

the retail sales of goods and some services.

Front 42

The tax base for the use tax is . . .

Back 42

the retail price of goods owned, possessed, or consumed within a state that were not purchased within the state.

Front 43

Income taxes

Back 43

Taxes on individuals and corporations who either reside in or earn income within the state.

Front 44

Typically, sales tax is collected . . .

Back 44

at the point of sale.

Front 45

Purpose of a use tax:

Back 45

To discourage taxpayers from buying goods out of state in order to avoid or minimize the sales tax in their home state.

Front 46

State and local governments commonly use two types of property taxes as sources of revenue:

Back 46

1) Real property taxes--land and structures permanently attached to land
2) Personal property taxes--all other types of property, both tangible and intangible

Front 47

Relative to personal property tax, real property taxes are ______ to administer because real property is not moveable and purchases often have to be registered with the state.

Back 47

easier

Front 48

Property taxes are __ _______ taxes, meaning that the tax base for each is the fair market value of the property.

Back 48

ad valorem

Front 49

Explicit taxes

Back 49

Taxes directly imposed by a government that are easily quantified.

Front 50

Implicit taxes

Back 50

1) Indirect taxes--not paid directly to the government--that result from a tax advantage the government grants to certain transactions to satisfy social, economic, or other objectives.
2) The reduced before-tax return that a tax-favored asset produces because of its tax-advantaged status.

Front 51

An asset is said to be tax-favored when . . .

Back 51

the income the asset produces is either excluded from the tax base or subject to a lower (preferential) tax rate, or if the asset generates some other tax benefit such as large tax deductions.

Front 52

Why do tax-advantaged assets bear an implicit tax, or a reduced before-tax return as a result of the tax advantage?

Back 52

The tax benefits associated with the tax-favored asset increase the demand for the asset. Increased demand drives up the price of the asset, which in turn, reduces its before-tax return, which is an implicit tax by definition.

Front 53

T/F: Implicit taxes are difficult to quantify, but are important to understand in evaluating the relative tax burdens of tax-advantaged investments.

Back 53

TRUE

Front 54

Criteria used to evaluate alternative tax systems:

Back 54

1) Sufficiency
2) Equity
3) Certainty
4) Convenience
5) Economy

Front 55

Sufficiency

Back 55

Assessing the aggregate size of the tax revenues that must be generated and ensuring that the tax system provides these revenues.

Front 56

Static forecasting

Back 56

Ignores how taxpayers may alter their activities in response to a proposed tax law change bases projected tax revenues on the existing state of transactions.

Front 57

Dynamic forecasting

Back 57

Attempts to account for possible taxpayer responses to a proposed tax law change.

Front 58

In terms of a progressive tax, a tax rate increase or an expansion of the tax base can result in one of two taxpayer responses:

Back 58

1) Income effect--when taxpayers are taxed more, they will work harder to generate the same after-tax dollars
2) Substitution effect--when taxpayers are taxed more, rather than work more, they will substitute nontaxable activities like leisure pursuits for taxable ones because the marginal value of taxable activities has decreased

Front 59

T/F: If a tax system fails to generate sufficient revenues, the government must seek other sources to pay for government expenditures.

Back 59

TRUE; The most common source is the issuance of debt instruments such as Treasury bonds (short-term solution to a budget deficit).

Front 60

Equity

Back 60

Considers how the tax burden should be distributed across taxpayers.

Front 61

Two basic types of equity:

Back 61

1) Horizontal--two taxpayers in similar situations pay the same tax
2) Vertical--taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax

Front 62

Failures of horizontal equity are due to ___ ___________.

Back 62

tax preferences

Front 63

Certainty

Back 63

Taxpayers should be able to determine when, where, and how much tax to pay.

Front 64

Convenience

Back 64

A tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government. EX: Retailers collect sales taxes when buyers purchase goods.

Front 65

Economy

Back 65

A tax system should minimize its compliance and administration costs.

Front 66

Taxes are significant costs that influence many basic business, investment, and personal decisions:

Back 66

1) Business decisions: what organization form to take; where to locate; how to compensate employees; appropriate debt mix; owning vs. renting equipment; how to distribute profits, and so forth.
2) Investment decisions: alternative methods for saving for education or retirement, and so forth.
3) Personal finance decisions: evaluating job offers; gift or estate planning; owning vs. renting a home, and so forth.

Front 67

______ ___________ are specified by law for each type of taxpayer.

Back 67

Filing requirements

Front 68

T/F: All corporations must file a tax return annually regardless of their taxable income.

Back 68

TRUE

Front 69

Estates and trusts are required to file annual income tax returns if their gross income exceeds ___.

Back 69

$600

Front 70

Filing requirements for individual taxpayers depend on:

Back 70

1) Filing status
2) Gross income
3) Age

Front 71

Refund

Back 71

Occurs when taxes paid exceed tax liability.

Front 72

What determines whether a tax return is required?

Back 72

Gross income

Front 73

Due dates:

Back 73

1) The due date for tax returns varies based on the type of taxpayer.
2) Individual tax returns are due on April 15 for calendar-year individuals.
3) Due dates that fall on a Saturday, Sunday, or holiday are automatically extended to the next day that is not a Saturday, Sunday, or holiday.
4) Any taxpayer unable to file a tax return by the original due date can request an extension to file.
5) An extension allows the taxpayer to delay filing a tax return but does NOT extend the due date for tax payments.

Front 74

Partnership returns are due on . . .

Back 74

the 15th day of the 14th month following the partnership's year-end.

Front 75

For corporations, tax returns must be filed . . .

Back 75

by the 15th day of the 3rd month following the corporation's year-end (March 15 for calendar-year corporations).

Front 76

T/F: Partnerships may request an automatic six-month extension to file.

Back 76

FALSE; Any individual or corporation unable to file a tax return by the original due date can request a six-month extension to file, and partnerships may request an automatic five-month extension to file.

Front 77

What happens if the taxpayer fails to pay the entire balance of tax owed by the original due date of the tax return?

Back 77

The IRS charges the taxpayer interest on the underpayment from the due date of the return until the taxpayer pays the tax.

Front 78

Statute of limitations

Back 78

Period in which the taxpayer can file an amended tax return or the IRS can assess a tax deficiency for a specific tax year.

Front 79

The statute of limitations generally ends three years from the later of . . .

Back 79

1) The date the tax return was actually filed
2) The tax return's original due date

Front 80

T/F: For fraudulent returns, or if the taxpayer fails to file a tax return, the statute of limitations remains open indefinitely.

Back 80

TRUE

Front 81

Fewer than _ percent of all tax returns are audited.

Back 81

2

Front 82

Common computer initiatives for auditing tax returns include:

Back 82

1) DIF (Discriminant Function) system--assigns a score to each tax return that represents the probability the tax liability on the return has been underreported
2) Document perfection program--checks all returns for mathematical and tax calculation errors
3) Program matching program--compares the taxpayer's tax return to information submitted to the IRS from other taxpayers

Front 83

Three types of IRS audits:

Back 83

1) Correspondence
2) Office
3) Field examinations

Front 84

Correspondence examinations

Back 84

1) Most common
2) Conducted by mail and generally are limited to one or two items on the taxpayer's return
3) Generally the narrowest in scope and the least complex

Front 85

Office examinations

Back 85

1) Second most common audit
2) IRS conducts them at its local office
3) Typically broader in scope and more complex than correspondence examinations
4) Small businesses, taxpayers operating sole proprietorships, and middle- to high-income individual taxpayers to have office exmainations

Front 86

Field examinations

Back 86

1) Least common audit
2) IRS conducts these at the taxpayer's place of business or the location where the taxpayer's books, records, and source documents are maintained
3) Generally the broadest in scope and the most complex
4) Can last months to years
5) Generally limited to business returns and the most complex individual returns

Front 87

After the audit . . .

Back 87

the IRS will send the taxpayer a 30-day letter, which provides the taxpayer the opportunity to pay the proposed assessment or request an appeals conference.

Front 88

If an agreement is not reached at appeals or the taxpayer does not pay the proposed assessment . . .

Back 88

the IRS will send the taxpayer a 90-day letter (also known as a statutory notice of deficiency) explaining that the taxpayer has 90 days to either (1) pay the proposed deficiency or (2) file a petition in the US Tax Court to hear the case.

Front 89

US Tax Court

Back 89

National court whose judges are tax experts and who hear only tax cases.

Front 90

T/F: If the taxpayer would like to litigate the case but prefers it to be heard in the local US District Court or the US Court of Federal Claims, the taxpayer must pay the tax deficiency first and then sue the IRS for refund in court.

Back 90

TRUE

Front 91

Which court is the only court that provides for a jury trial?

Back 91

US District Court

Front 92

Which court is the only court that allows tax cases to be heard before the taxpayer pays the disputed liability and the only court with a small claims division (hearing claims involving disputed liabilities of $50,000 or less)?

Back 92

US Tax Court

Front 93

After the trial court's verdict . . .

Back 93

the losing party has the right to request one of the 13 US Circuit Courts of Appeal to hear the case.

Front 94

After an appeals court hears a case, the losing party has one last option to receive a favorable ruling . . .

Back 94

a petition to the US Supreme Court.

Front 95

T/F: The Supreme Court agrees to hear most tax cases.

Back 95

FALSE; For most tax cases, the Supreme Court refuses to hear the case (denies the writ of certiorari) and litigation ends with the circuit court decision.

Front 96

Two broad categories of tax authorities:

Back 96

1) Primary
2) Secondary

Front 97

Primary authorities

Back 97

Official sources of the tax law generated by the legislative branch (statutory authority issued by Congress), judicial branch (rulings by the US District Court, US Tax Court, US Court of Federal Claims, US Circuit Court of Appeals, or US Supreme Court), and executive/administrative branch (Treasury and IRS pronouncements).

Front 98

US Treasury/IRS: Administrative Authorities:

Back 98

1) Treasury regulation
2) Revenue procedures & revenue rulings
3) Private letter rulings, technical advice memorandums, & other

Front 99

Congress: Legislative/Statutory Authorities:

Back 99

1) US Constitution
2) Internal Revenue Code & Tax Treaties

Front 100

The Courts: Judicial Authorities:

Back 100

1) US Supreme Court Opinion
2) Opinion of US Circuit Court of Appeal
3) US District Court Opinion, US Court of Federal Claims Opinion, & US Tax Court Opinion

Front 101

Secondary authorities

Back 101

Unofficial tax authorities that interpret and explain the primary authorities, such as tax research services, tax articles from professional journals and law reviews, and newsletters.

Front 102

US Constitution

Back 102

Highest authority in the United States.

Front 103

16th Amendment

Back 103

Provides Congress the ability to tax income directly, from whatever source derived, without apportionment across the states.

Front 104

Internal Revenue Code of 1986

Back 104

1) Main statutory authority
2) Has the same authoritative weight as tax treaties and Supreme Court rulings
3) Changes to the Code are passed by the House of Representatives and Senate and signed into law by the president
4) The house Ways and Means Committee and Senate Finance Committee oversee tax legislation in the House of Representatives and Senate, respectively
5) When referencing a tax law, the researcher generally refers to the law by its code section

Front 105

Tax treaties

Back 105

Agreements negotiated between countries that describe the tax treatment of entities subject to tax in both countries.

Front 106

Judicial Authorities:

Back 106

1) Our judicial system is tasked with the ultimate authority to interpret the Internal Revenue Code and settle disputes between taxpayers and the IRS.
2) The Supreme Court is the highest judicial authority.
3) Beneath the Supreme Court, the decisions of the 13 Circuit Courts of Appeal represent the next highest judicial authority.
4) The lowest level of judicial authority consists of three different types of trial-level courts (US District Courts, US Court of Federal Claims, and the US Tax Court).
5) US Tax Court decisions typically are considered to have more authoritative weight than decisions rendered by a district court or the US Court of Federal Claims.
6) All courts apply the judicial doctrine of stare decisis, which means that a court will rule consistently with its previous rulings and the rulings of higher courts with appellate jurisdiction.

Front 107

Golsen rule

Back 107

The tax court will abide by rulings of the circuit court that has appellate jurisdiction for a case.

Front 108

Regulations

Back 108

1) Are the Treasury Department's official interpretation of the International Revenue Code and have the highest authoritative weight.
2) Are issued in three different forms (proposed, temporary, and final) and serve three basic purposes (interpretative, procedural, and legislative).

Front 109

Final regulations

Back 109

Regulations that have been issued in final form and represent the Treasury's interpretation of the Code.

Front 110

Temporary regulations

Back 110

Have a limited life (three years for regulations issued after Nov 20, 1988).

Front 111

Proposed regulations

Back 111

Allow public comment on them.

Front 112

Interpretative regulations

Back 112

Represent the Treasury's interpretation of the Code.

Front 113

Procedural regulations

Back 113

Explain Treasury Department procedures as they relate to administering the Code.

Front 114

Legislative regulations

Back 114

Issued when Congress specifically directs the Treasury Department to create regulations to address an issue in an area of law.

Front 115

Revenue rulings and revenue procedures:

Back 115

1) Revenue rulings and revenue procedures are second in administrative authoritative weight after regulations.
2) Revenue rulings address the application of the Code and regulations to a specific factual situation.
3) Revenue procedures explain in greater detail IRS practice and procedures in administering the tax law.

Front 116

Letter rulings are . . .

Back 116

less authoritative but more specific than revenue rulings and regulations.

Front 117

Private letter rulings

Back 117

Represent the IRS' application of the Code and other tax authorities to a specific transaction and taxpayer.

Front 118

Acquiescence

Back 118

Indicates that the IRS has decided to follow the court's adverse ruling in the future.

Front 119

Nonacquiescence

Back 119

Alerts taxpayers that the IRS does plan to continue to litigate this issue.

Front 120

Actions on decisions

Back 120

Explain the background reasoning behind an IRS acquiescence or nonacquiescence.

Front 121

Tax practitioners are subject to a variety of statutes, rules, and codes of professional conduct, and they should absolutely have a working knowledge of these statutes, rules, and guidelines because:

Back 121

1) They establish the professional standards for the practitioner
2) Failure to comply with the standards could result in adverse consequences for the tax professional, such as being admonished, suspended, or barred from practicing before the IRS; being admonished, suspended, or expelled from the AICPA; or suffering suspension or revocation of the CPA license.

Front 122

AICPA Code of Professional Conduct:

Back 122

Not specific to tax practice and provides broader professional standards that are especially relevant for auditors.

Front 123

Provisions:

Back 123

Address the importance of a CPA maintaining independence from the client and using due professional care in carrying out responsibilities.

Front 124

AICPA's seven Statements on Standards for Tax Services (SSTS):

Back 124

Recommend appropriate standards of practice for tax professionals.

Front 125

Substantial authority

Back 125

Suggests the probability that the taxpayer's position is sustained upon audit or litigation is in the 40 plus percent range or above.

Front 126

Circular 230

Back 126

Provides regulations governing tax practice and applies to all persons practicing before the IRS.

1) Subpart A--desciribes who may practice before the IRS (CPAs, attorneys, enrolled agents) and what practicing before the IRS means (tax return, preparation, representing clients before the IRS, etc.)
2) Subpart B--describes the duties and restrictions that apply to individuals governed by Circular 230
3) Subpart C--explains disciplinary proceedings for practitioners violating the Circular 230 provisions

Front 127

The IRS can impose both ________ and _____ penalties to encourage tax compliance by both tax professionals and taxpayers:

Back 127

criminal, civil

Front 128

The standard of conviction is ______ in a criminal trial, but the penalties are also much ______.

Back 128

higher, higher

Front 129

T/F: A taxpayer will not be subject to an underpayment penalty if there is substantial authority that supports the tax return position.

Back 129

TRUE

Front 130

T/F: A tax practitioner will also not be subject to penalty for recommending a tax return position if there is substantial authority that supports the position.

Back 130

TRUE

Front 131

Civil penalties:

Back 131

1) Much more common
2) Generally come in the form of monetary penalties
3) May be imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause--say, as the result of negligence, intentional disregard of pertinent rules, willful disobedience, or outright fraud.

Front 132

Criminal penalties:

Back 132

1) Much less common than civil penalties
2) Commonly charged in tax evasion cases, which include willful intent to defraud the government, but are imposed only after normal due process, including a trial

Front 133

Five basic steps in tax research:

Back 133

1) Understand the facts
2) Identify issues
3) Locate relevant authorities
4) Analyze the tax authorities
5) Communicate research results

Front 134

T/F: Effective tax planning minimizes taxes.

Back 134

FALSE; Effective tax planning maximizes the taxpayer’s after-tax wealth while achieving the taxpayer’s nontax goals.

Front 135

Maximizing after-tax wealth requires us to consider . . .

Back 135

the tax and nontax costs and benefits of alternative transactions.

Front 136

Virtually every transaction includes three parties:

Back 136

1) The taxpayer
2) The other transacting party
3) The Government

Front 137

Three basic tax planning strategies:

Back 137

1) Timing (deferring or accelerating taxable income and tax deductions)
2) Income shifting (shifting income from high to low tax rate taxpayers)
3) Conversion (converting income from high to low tax rate activities)

Front 138

When income is taxed or an expense is deducted affects the associate “real” tax costs or savings. This is true for two reasons:

Back 138

1) The timing of when income is taxed or an expense is deducted affects the present value of the taxes paid on income or the tax savings on deductions.
2) The tax costs of income and tax savings of deductions vary as the tax rates change.

Front 139

The tax costs on income are ______ when tax rates are ______ and _____ when tax rates are _____.

Back 139

higher, higher, lower, lower

Front 140

Present value (time value of money)

Back 140

$1 today is worth more than $1 in the future.

Front 141

T/F: Timing of a cash inflow or a cash outflow affects the present value of the income or expense.

Back 141

TRUE

Front 142

Discount factor

Back 142

Derived from the taxpayer’s expected after-tax rate of return.

Front 143

When considering cash inflows, prefer ______ present values; when considering cash outflows, prefer _____ present values.

Back 143

higher, lower

Front 144

Taxes paid represent cash ________; savings generated from tax deductions are cash _______.

Back 144

outflows, inflows

Front 145

Two basic tax-related timing strategies when tax rates are constant (not changing):

Back 145

1) Accelerate tax deductions (deduct in an earlier period)
2) Defer recognizing taxable income (recognize in a later period)

Front 146

Why accelerate tax deductions into earlier years when tax rates are constant?

Back 146

Maximizes the present value of tax savings from deductions.

Front 147

Why defer taxable income into later years when tax rates are constant?

Back 147

Minimizes the present value of taxes paid.

Front 148

The intent of the timing strategy is to . . .

Back 148

accelerate the tax deductions significantly without accelerating the actually cash outflow that generates the expense.

Front 149

Common examples of the timing strategy:

Back 149

Accelerating depreciation deductions for depreciable assets, using LIFO instead of FIFO for corporations, and accelerating the deduction of certain prepaid expenses.

Front 150

High tax rates, higher rates of return, larger transaction amounts, and the ability to accelerate deductions by two or more years all increase the benefits of ____________ deductions.

Back 150

accelerating

Front 151

Higher tax rates, higher rates of return, larger transaction amounts, and the ability to defer revenue recognition for longer periods of time increase the benefits of ________.

Back 151

deferral

Front 152

When tax rates are increasing . . .

Back 152

the taxpayer must calculate the optimal tax strategies for deductions and income.

Front 153

When tax rates are decreasing . . .

Back 153

taxpayers should accelerate tax deductions into earlier years and defer taxable income into later years.

Front 154

All other things being equal, taxpayers should prefer to recognize deductions during ____-tax-rate years and income during ___-tax-rate years.

Back 154

high, low

Front 155

When considering cash _______, we prefer the higher present value.

Back 155

inflows

Front 156

Limitation on the Timing Strategy:

Back 156

1) Whenever a taxpayer is unable to accelerate a deduction without also accelerating the cash outflow, the timing strategy will be less beneficial.
2) Tax law generally requires taxpayers to continue their investment in an asset in order to defer income recognition for tax purposes.
3) A deferral strategy may not be optimal if the taxpayer has severe cash flow needs, if continuing the investment would generate a low rate of return compared to other investments, if the current investment would subject the taxpayer to unnecessary risk, and so on.
4) The constructive receipt doctrine, which provides that a taxpayer must recognize income when it is actually or constructively received, also restricts income deferral for cash-method taxpayers.

Front 157

Constructive receipt is deemed to have occurred if . . .

Back 157

1) The income has been credited to the taxpayer’s account or if the income is unconditionally available to the taxpayer
2) The taxpayer is aware of the income’s availability
3) There are no restrictions on the taxpayer’s control over the income

Front 158

Type of taxpayers that benefit most from the income-shifting strategy are:

Back 158

1) Related parties, such as family members or businesses and their owners, who have varying marginal tax rates and are willing to shift income for the benefit of the group
2) Taxpayers operating in multiple jurisdictions with different marginal tax rates.

Front 159

Most common example of income shifting:

Back 159

High-rate parents shifting income to low-tax-rate children.

Front 160

Assignment of income doctrine

Back 160

Requires income to be taxed to the taxpayer who actually earns it.

Front 161

Related-party transactions:

Back 161

1) Closely scrutinized by the IRS
2) Financial activities among family members (also among owners and their businesses or among businesses owned by the same owners)
3) Involve taxpayers who are much more willing to negotiate for their own common good

Front 162

Arm’s-length transactions

Back 162

Each transacting party negotiates for his or her own benefit.

Front 163

In order to shift income from the corporation to the owner . . .

Back 163

the corporation must create a tax deduction for itself in the process.

Front 164

Most common method of shifting income from corporations to their owners:

Back 164

Compensation paid to employee-owners

Front 165

Is having the business owner rent property to the corporation or loan money to the corporation an effective income-shifting method?

Back 165

Yes; both transactions generate tax deductions for the corporation and income for the shareholder.

Front 166

T/F: Paying dividends is NOT an effective way to shift income.

Back 166

TRUE; Dividends are taxed first at the corporate level, and then at the shareholder level.

Front 167

Limitations of income shifting across jurisdictions:

Back 167

1) Taxing authorities are fully aware of the tax benefits of strategically structuring transactions across tax borders (across countries or states).
2) When tax payers locate in low-tax-rate jurisdictions to, in effect, shift income to a tax-advantaged jurisdiction, they may bear implicit taxes (that is, additional costs attributable to the jurisdiction’s tax advantage).

Front 168

Conversion strategy

Back 168

Recasting income and expenses to receive the most favorable tax treatment.

Front 169

The conversion strategy is based on . . .

Back 169

the understanding that the tax law does not treat all types of income or deductions the same.

Front 170

T/F: The Internal Revenue Code contains specific provisions that prevent the taxpayer from changing the nature of expenses, income, or activities to a more tax-advantaged status.

Back 170

TRUE

Front 171

________ _____ may reduce or eliminate the advantages of conversion strategies.

Back 171

Implicit taxes

Front 172

Additional limitations to tax planning strategies:

Back 172

1) Business purpose doctrine—allows the IRS To challenge and disallow business expenses for transactions with no underlying business motivation
2) Step-transaction doctrine—allows the IRS to collapse a series of related transactions into one transaction to determine the tax consequences of the transaction
3) Substance-over-form doctrine—allows the IRS to consider the transaction’s substance regardless of its form, and where appropriate, to reclassify the transaction according to its substance

Front 173

“Smell test”:

Back 173

If the transaction “smells bad,” one of the judicial doctrines likely applies. (Transactions usually smell bad when the primary purpose is to avoid taxes and not to accomplish an independent business objective.)

Front 174

Tax avoidance

Back 174

Legal act of arranging one’s transactions to minimize taxes paid.

Front 175

Tax evasion

Back 175

Willful attempt to defraud the government by not paying taxes legally owed.

Front 176

T/F: Because the federal government must replace lost tax revenues by imposing higher taxes on others, honest taxpayers are the true victims of tax evasion?

Back 176

TRUE

Front 177

Taxable income

Back 177

Tax base for the individual income tax.

Front 178

Form 1040

Back 178

Form individuals generally use to report their taxable income.

Front 179

T/F: Income excluded from taxation is reported on the tax return.

Back 179

FALSE

Front 180

Is deferred income reported on the tax return?

Back 180

Yes, but it is usually provided on supporting schedules.

Front 181

What is the last line on page 1 of Form 1040?

Back 181

adjusted gross income (AGI)

Front 182

The US tax laws are based on the all-inclusive income concept:

Back 182

Taxpayers must include in taxable income all realized income from whatever source derived.

Front 183

Realized income

Back 183

Income generated in a transaction with second party in which there is a measurable change in property rights between parties.

Front 184

Taxpayers are allowed to permanently exclude certain types of realized income from taxation or defer paying taxes to a later year on certain types of realized income if, and only if . . .

Back 184

a specific tax provision allows them to do so.

Front 185

Excluded income/exclusions

Back 185

Income items that taxpayers permanently exclude from taxation.

Front 186

Deferral items/deferred income/deferrals

Back 186

Income items that taxpayers realize in one year, but are allowed to defer paying taxes on until a later year.

Front 187

Gross income

Back 187

Realize income minus exclusions and deferrals; the income that taxpayers actually report on their tax returns.

Front 188

Taxpayers deduct their __________ from gross income to determine their taxable income.

Back 188

deductions

Front 189

T/F: Taxpayers are not allowed to deduct anything unless a specific tax provision allows them to do so.

Back 189

TRUE; Deductions are a matter of legislative grace.

Front 190

Two distinct types of deductions:

Back 190

1) Deductions for AGI
2) Deductions from AGI

Front 191

For AGI deductions:

Back 191

1) Deducted in determining AGI
2) “Above the line” deduction
3) Generally more valuable than from AGI deductions
4) Tend to be related to business activities and certain investing activities

Front 192

From AGI deductions:

Back 192

1) Deducted from AGI to determine taxable income
2) “Below the line” deduction
3) Generally less valuable than for AGI deductions
4) Tend to be more personal in nature

Front 193

Adjusted gross income (AGI)

Back 193

Gross income minus for AGI deductions

Front 194

In contrast to ____ AGI deductions, which may be limited or may generate no tax benefit, ___ AGI deductions always reduce gross income and therefore reduce taxable income dollar for dollar.

Back 194

from, for

Front 195

Common for AGI deductions:

Back 195

1) Alimony paid
2) Health insurance deduction for self-employed taxpayers
3) Moving expenses
4) Rental and royalty expenses
5) One-half of self-employment taxes paid
6) Business expenses
7) Loss on dispositions of assets used in trade or business
8) Losses from flow-through entities
9) Losses on dispositions of investment assets (net losses limited to $3,000 for the year)
10) Contributions to qualified retirement accounts

Front 196

Because ___ AGI deductions decrease AGI, they increase the deductibility of the ____ AGI deductions subject to AGI limitations.

Back 196

for, from

Front 197

Deductions from AGI:

Back 197

1) Itemized deductions
2) Standard deduction
3) Exemptions

Front 198

Individuals have the choice of deducting the greater of their:

Back 198

1) Itemized deductions
2) Standard deduction

Front 199

Primary Categories of Itemized Deductions:

Back 199

1) Medical and dental expenses: deductible to the extent these expenses exceed 7.5% of AGI
2) Taxes: state and local income taxes, real estate taxes, personal property taxes, and other taxes
3) Interest expense: mortgage, home equity, and investment interest expense
4) Gifts to charity (charitable contributions)
5) Casualty and theft losses: deductible to the extent they exceed 10% of AGI
6) Job expenses and certain miscellaneous deductions: deductible to the extent the sum of these expenses exceeds 2% of AGI
7) Other miscellaneous deductions: gambling losses (to the extent of gambling winnings) and certain other deductions not subject to AGI limitations

Front 200

The amount of the standard deduction varies by . . .

Back 200

taxpayer filing status.

Front 201

Taxpayers __ years of age and/or _____ taxpayers are entitled to additional standard deduction amounts ($1,100 for married taxpayers and qualifying widows and widowers and $1,400 for other taxpayers).

Back 201

65, blind

Front 202

T/F: A blind taxpayer who is 65 years old or older is entitled to two additional standard deduction amounts.

Back 202

TRUE

Front 203

The standard deduction for individuals who are claimed as a dependent on another tax return is limited to the greater of

Back 203

1) $950
2) $300 plus the dependent’s earned income

Front 204

Exemption

Back 204

A flat deduction allowed for the taxpayer, the taxpayer’s spouse, and each person who qualifies as a dependent of the taxpayer.

Front 205

Personal exemptions

Back 205

Exemptions for the taxpayer(s) filing the tax return

Front 206

Dependency exemptions

Back 206

Exemptions for those who are not filing the tax return.

Front 207

Taxpayers can generally calculate their regular income tax liability using either a ___ _____ or a ___ ____ ________, depending on their filing status and income level.

Back 207

tax table, tax rate schedule

Front 208

Taxes imposed on tax bases other than the individual’s regular taxable income:

Back 208

1) Alternative minimum tax (AMT)
2) Self-employment taxes

Front 209

Individual taxpayers may reduce their tax liabilities by ___ _______ to determine their total taxes payable.

Back 209

tax credits

Front 210

Tax credits:

Back 210

1) Are specifically granted by Congress
2) Directly reduce taxes payable

Front 211

Common credits:

Back 211

1) Child tax credit ($1,000 per child that qualifies for the credit)
2) Child and dependent care credit
3) Earned income credit
4) American opportunity credit
5) Lifetime learning credit

Front 212

After calculating the total tax and subtracting their available credits, taxpayers determine their taxes due (or tax refund) by . . .

Back 212

subtracting tax prepayments from the total tax remaining after credits.

Front 213

Tax prepayments include:

Back 213

1) Withholdings--income taxes withheld from the taxpayer's salary or wages by her employer
2) Estimated tax payments the taxpayer makes for the year
3) Taxes the taxpayer overpaid in the previous year that the taxpayer elects to apply as an estimated payment for the current year

Front 214

If tax prepayments exceed the total tax after subtracting credits . . .

Back 214

the taxpayer receives a tax refund for the difference.

Front 215

If tax prepayments are less than the total tax after credits . . .

Back 215

the taxpayer owes additional tax and potentially a penalty for the underpayment.

Front 216

In 2010, taxpayers are allowed to deduct ____ for each personal and dependency exemption they are entitled to claim.

Back 216

$3,650

Front 217

Individual taxpayers may deduct a personal exemption for . . .

Back 217

1) themselves
2) their spouse (if married filing jointly)
3) each person who qualifies as the taxpayer's dependent

Front 218

T/F: Individuals who qualify as a dependent of another taxpayer may claim a personal exemption for themselves on their own individual tax returns.

Back 218

FALSE

Front 219

To qualify as a dependent of another, an individual . . .

Back 219

1) Must be a resident of the United States, Canada, or Mexico.
2) Must not file a joint return with the individual's spouse unless there is no tax liability on the couple's joint return and there would not have been any tax liability on either spouse's tax return if they had filed separately.
3) Must be considered either a qualifying child or the taxpayer or a qualifying relative of the taxpayer.

Front 220

To be considered a qualifying child of a taxpayer, an individual must satisfy the following four tests:

Back 220

1) Relationship
2) Age
3) Residence
4) Support

Front 221

Relationship test for qualifying child:

Back 221

A qualifying child must be a relative of the taxpayer. Eligible relatives include the taxpayer's son, daughter, stepchild, an eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of these relatives. This definition does NOT include cousins.

Front 222

Age test for qualifying child:

Back 222

A qualifying child must be younger than the taxpayer claiming such individual as a qualifying child and either (1) under age 19 at the end of the year or (2) under age 24 at the end of the year and a full-time student.

Front 223

A person is a full-time student if . . .

Back 223

she was in school full-time during any part of each of five calendar months during the calendar year.

Front 224

T/F: An individual who is permanently and totally disabled is deemed to have met the age test.

Back 224

TRUE

Front 225

Residence test for qualifying child:

Back 225

A qualifying child must have the same principal residence as the taxpayer for more than half the year. Time that a child (or the taxpayer) is temporarily away from the taxpayer's home because the child (or taxpayer) is ill, is pursuing an education, or has other special circumstances is counted as though the child (or taxpayer) were living in the taxpayer's home.

Front 226

Support test for qualifying child:

Back 226

A qualifying child must not have provided more than half his or her own support (living expenses) for the year. When determining who provided the support for a child of the taxpayer who is a full-time student, scholarship are EXCLUDED from the computation.

Front 227

Support generally includes:

Back 227

1) Food, school lunches, toilet articles, and haircuts.
2) Clothing.
3) Recreation--including toys, summer camp, horseback riding, entertainment, and vacation expenses.
4) Medical and dental care.
5) Child care expenses.
6) Allowances and gifts.
7) Wedding costs.
8) Lodging.
9) Education--including board, uniforms at military schools, and tuition.

Front 228

When one person is a qualifying child to more than one taxpayer, the taxpayer who has priority for claiming the dependency exemption is based on the following tiebreaking rules:

Back 228

1) If the person is a qualifying child of a parent, the parent is entitled to the dependency exemption for the child.
2) If the individual is a qualifying child to both parents, the parent with whom the child has resided for the longest period of time during the year has priority for claiming the dependency exemption.
3) If the child resides with both parents for the same amount of time or the qualifying child resides with taxpayers who are not the parents, the taxpayer with the highest AGI has priority for claiming the dependency exemption for the child.

Front 229

A qualifying relative is a person who is NOT a qualifying child AND satisfies:

Back 229

1) A relationship test
2) A support test
3) A gross income test

Front 230

Relationship test for qualifying relative:

Back 230

1) Includes people who are unrelated to the taxpayer if the unrelated person lived as a member of the taxpayer's home for the entire year.
2) A person is "related" to the taxpayer if the person is a descendant or ancestor of the taxpayer, a sibling of the taxpayer, or a stepmother, stepfather, stepbrother, stepsister, nephew, niece, aunt, uncle, or in-law of the taxpayer. Cousins are NOT considered related to the taxpayer for purposes of this test.

Front 231

Support test for qualifying relative:

Back 231

The taxpayer must pay more than half the qualifying relative's living expenses.

Front 232

Under a multiple support agreement, taxpayers who don't pay over half of an individual's support may still be allowed to claim him or her as a dependent under the qualifying relative rules if the following apply:

Back 232

1) No one taxpayer paid over 1/2 of the individual's support.
2) The taxpayer and at least one other person provided more than half the support of the individual, and the taxpayer and the other person(s) would have been allowed to claim the individual as a dependent except for the fact that they did not provide over 1/2 of the support of the individual.
3) The taxpayer contributed over 10% of the individual's support for the year.
4) Each other person who provided over 10% of the individual's support provides a signed statement to the taxpayer agreeing not to claim the individual as a dependent. The taxpayer includes the names, addresses, and Social Security numbers of each other person on a Form 2120, which the taxpayer attaches to her Form 1040.

Front 233

Gross income test for qualifying relative:

Back 233

Requires that a qualifying relative's gross income for the year be less than the person exemption amount ($3,650 for 2010).

Front 234

Primary differences between who qualifies as a dependent and who qualifies as a dependent as a qualifying relative:

Back 234

1) The relationship requirement is more broadly defined for qualifying relatives
2) Qualifying children are subject to age restrictions
3) Qualifying relatives are subject to a gross income restriction
4) Taxpayers need not provide more than half a qualifying child's support (though the child cannot provide more than half of her own support)

Front 235

Taxpayers determine their filing status according to

Back 235

1) Their marital status at year-end
2) Whether they have any dependents

Front 236

Filing status determines:

Back 236

1) The applicable tax rate schedule for determining the taxpayer's tax liability.
2) The taxpayer's standard deduction amount.
3) The AGI threshold for reductions in certain tax benefits such as certain itemized deductions and certain tax credits, among others.

Front 237

Five filing statuses:

Back 237

1) Married filing jointly
2) Married filing separately
3) Qualifying widow or widower (surviving spouse)
4) Head of household
5) Single

Front 238

Married filing jointly:

Back 238

1) Taxpayers are legally married as of the last day of the year
2) When one spouse dies during the year the surviving spouse is still considered to be married for tax purposes during the year of the spouse's death UNLESS the surviving spouse remarries during the year.
3) Both spouses are ultimately responsible for paying the joint tax

Front 239

Married filing separately:

Back 239

1) Taxpayers are legally married as of the last day of the year
2) Generally no tax advantage to filing separately (usually a disadvantage)
3) Each spouse is ultimately responsible for paying their own tax
4) Couples may choose to file separately (generally for nontax reasons)

Front 240

Disadvantages of MFS:

Back 240

1) Tax-related items are generaly 1/2 what they are for MFJ taxpayers
2) If one spouse deducts itemized deductions, the other spouse is required to deduct itemized deductions even if his or her itemized deductions are less than the standard deduction

Front 241

It may be wise for married couples to file separately for ______ reasons.

Back 241

nontax

Front 242

Qualifying widow or widower:

Back 242

When a taxpayer's spouse dies, the surviving spouse can file as qualifying widow or widower for two years after the year of the spouse's death if the surviving spouse 1) remains unmarried and 2) pays over half the cost of maintaining a household where a dependent child lived for the entire year.

NOTE: The dependent child must be a child or stepchild (including an adopted child) for whom the taxpayer may claim an exemption (not a foster child).

Front 243

To qualify for head of household filing status, the taxpayer must

Back 243

1) Pay more than half the costs of maintaining a household
2) A "qualifying person" must live with the taxpayer in that household for MORE than half the taxable year.

NOTE: If the qualifying person is the taxpayer's parent, the parent does not need to live with the taxpayer.

Front 244

Head of household:

Back 244

Unmarried taxpayers or abandoned spouses

Front 245

A qualifying person includes (the person need meet only ONE of the following tests):

Back 245

1) A qualifying child who qualifies as the taxpayer's dependent.
2) An individual whom the taxpayer would be able to claim as a dependent qualifying child except that the taxpayer released the exemption to the noncustodial parent.
3) A mother or father who qualifies as the taxpayer's dependent.
4) An individual who is not required to live with the taxpayer in order to meet the qualifying relative test (the individual is actually related to the taxpayer). However, this does not include individuals who qualify as the taxpayer's dependent under a multiple support agreement. Note also that these individuals may qualify as the taxpayer's dependent as a qualifying relative even if they do not live with the taxpayer during more than half the year. Even though the individual qualifies as the taxpayer's dependent, unless she lives with the taxpayer for more than half the year, she is not a qualifying person for purposes of the head of household test.

Front 246

The tax laws treat married taxpayers who qualify as abandoned spouses as though . . .

Back 246

they were unmarried at the end of the year. This allows them to qualify for the more favorable head of household filing status.

Front 247

An abandoned spouse must meet all of the following requirements:

Back 247

1) Is married at the end of the year (or is not legally separated from the other spouse).
2) Files a tax return for the year separate from the other spouse's.
3) Pays MORE THAN 1/2 the costs of maintaining his or her home for the entire year, and this home is the principal residence for a child (who qualifies as the taxpayer's dependent) for MORE THAN half the year (the child must be a child (including adopted child, stepchild, or eligible foster child).
4) Whose spouse does not live in the taxpayer's home for the last six months of the year.

Front 248

Single:

Back 248

Unmarried taxpayers at year-end who do not qualify for head of household.

Front 249

Gross income

Back 249

Income that taxpayers realize and recognize and report on their tax returns for the year.

Front 250

Gross income is computed as . . .

Back 250

income realized during the year, minus realized income that is either excluded from taxation or deferred until a subsequent year.

Front 251

All-inclusive definition of income

Back 251

All income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services.

Front 252

Examples of gross income:

Back 252

1) Compensation for services
2) Business income
3) Rents
4) Royalties
5) Interest
6) Dividends

Front 253

Taxpayers recognize gross income when

Back 253

1) They receive an economic benefit.
2) They realize the income.
3) No tax provision allows them to exclude or defer the income from gross income for that year.

Front 254

T/F: When a taxpayer borrows money, the borrowed funds do NOT represent gross income because the increase in the taxpayer's assets from receiving the borrowed funds is completely offset by the liability the taxpayer is required to pay from borrowing the funds.

Back 254

TRUE

Front 255

Realization principle

Back 255

Income is realized when (1) a taxpayer engages in a transaction with another party, and (2) the transaction results in a measurable change in property rights.

Front 256

A transaction has the benefit of reducing the uncertainty associated with determining the amount of income because . . .

Back 256

a change in rights can typically be traced to a specific moment in time and is generally accompanied by legal documentation.

Front 257

T/F: For tax purposes, it doesn't matter whether income is obtained through legal or illegal activities.

Back 257

TRUE

Front 258

Adopting the realization principle provides two major advantages:

Back 258

1) Because parties to the transaction must agree to the value of the exchanged property rights, the transaction allows the income to be measured objectively.
2) The transaction generally provides the taxpayer with the wherewithal to pay taxes (The transaction itself provides the taxpayer with the funds to pay taxes on income generated by the transaction).

Front 259

Taxpayers are generally required to _________ all realized income by reporting it as gross income on their tax returns.

Back 259

recognize

Front 260

T/F: Taxpayers must receive cash to realize and recognize gross income.

Back 260

FALSE; Taxpayers realize income whether they receive money, property, or services in a transaction.

Front 261

When receiving a payment for property, taxpayers are allowed to recover the cost of the property tax free. Consequently, when taxpayers sell property . . .

Back 261

they are allowed to reduce the sale proceeds by their unrecovered investment in the property to determine the realized gain from the sale.

Front 262

When the tax basis exceeds the sale proceeds, the return of capital principle generally applies to . . .

Back 262

the extent of the sale proceeds.

Front 263

The excess basis over sale proceeds is generally considered to be a ____ that is deductible only if specifically authorized by a specific provision of the tax code.

Back 263

loss

Front 264

Why is a refund not typically included in gross income?

Back 264

It usually represents a return of capital.

Front 265

If the refund is made for an expenditure deducted in a PREVIOUS year, then under the ___ _______ ____ the refund is included in gross income to the extent that the prior deduction produced a tax benefit.

Back 265

tax benefit rule

Front 266

An itemized deduction only produces a tax benefit to the extent that . . .

Back 266

total itemized deductions exceed the standard deduction.

Front 267

Accrual method

Back 267

Income is generally recognized when earned and expenses are generally deducted in the period when liabilities are incurred.

Front 268

Most individuals use the ____ ______, and most large corporations use the _______ ______ of accounting.

Back 268

cash method, accrual method

Front 269

Cash method

Back 269

Taxpayers recognize income in the period they receive it (in the form of cash, property, or services), rather than when they actually earn it.

Front 270

Cash-method taxpayers claim deductions when . . .

Back 270

they make expenditures, rather than when they incur liabilities.

Front 271

Advantage of the cash method:

Back 271

1) Taxpayers may have some control over when income is received and expenses are paid.
2) Because of this control, taxpayers can more easily use the timing tax planning strategy to lower the present value of their tax bill.

Front 272

Constructive receipt doctrine

Back 272

A taxpayer must realize and recognize income when it is actually or constructively received.

Front 273

Constructive receipt is deemed to occur when . . .

Back 273

the income has been credited to the taxpayer's account or when the income is unconditionally available to the taxpayer, the taxpayer is aware of the income's availability, and there are no restrictions on the taxpayer's control over the income.

Front 274

Assignment of income doctrine:

Back 274

Prevents taxpayers from arbitrarily transferring the taxation on their income to others.

Front 275

Under the assignment of income doctrine,

Back 275

1) The taxpayer who earns income services must recognize the income.
2) Income from property, such as dividends and interest, is taxable to the person who actually owns the income-producing property.

Front 276

To shift income from property to another person, a taxpayer must also transfer the _________ in the property to the other person.

Back 276

ownership

Front 277

Which states implement community property systems?

Back 277

1) Arizona
2) California
3) Idaho
4) Louisiana
5) Nevada
6) New Mexico
7) Texas
8) Washington
9) Wisconsin

Front 278

Under community property systems:

Back 278

1) Income earned from services by one spouse is treated as though it was earned equally by both spouses.
2) Property acquired b either spouse during the marriage is usually community property and is treated as though it is owned equally by each spouse, but property that a spouse brings into a marriage is treated as that spouse's separate property.

Front 279

For federal income tax purposes, the community property system has the following consequences:

Back 279

1) Half of the income earned from the services of one spouse is included in the gross income of the other spouse. In contrast, in common law states, all of the income earned by one spouse is included in the gross income of the spouse who earned it.
2) Half of the income from property held as community property by the married couple is included in the gross income of each spouse.
3) In all common law states and in five community property states (Arizona, California, Nevada, New Mexico, and Washington), all of the income from property owned separately by one spouse is included in that spouse's gross income.
4) In Texas, Louisiana, Wisconsin, and Idaho, half of the income from property owned separately by one spouse is included in the gross income of each spouse.

Front 280

T/F: If a couple files a joint tax return, the community property rules do not affect the aggregate taxes payable by the couple, because the income of both spouse is aggregated on the return.

Back 280

TRUE; However, when couples file separate tax returns, their combined tax liability may depend on whether they live in a common law state, a community property state that shares income from separate property equally between spouses, or a community property state that does not split income from separate property between spouses.

Front 281

Income from services

Back 281

Payments for services including salary, wages, and fees that a taxpayer earns through services in a nonemployee capacity.

Front 282

Unearned income

Back 282

Income from property.

Front 283

Examples of unearned income:

Back 283

1) Gain or losses from the sale of property
2) Dividends
3) Interest
4) Rents
5) Royalties
6) Annuities

Front 284

The tax treatment of unearned income depends upon . . .

Back 284

1) The type of income
2) The type of the transaction generating the income.

Front 285

Annuity

Back 285

Investment that pays a stream of equal payments over time.

Front 286

Two basic types of annuities:

Back 286

1) Annuities paid over a fixed period
2) Annuities paid over a person's life (for as long as the person lives)

Front 287

Challenge of annuities:

Back 287

To determine how much of each annuity payment represents gross income (income taxed at ordinary tax rates) and how much represents a nontaxable return of capital (return of the original investment).

Front 288

Taxpayers use the _______ _________ _____ to determine the portion of each payment that is a nontaxable return of capital.

Back 288

annuity exclusion ratio

Front 289

Annuity exclusion ratio =

Back 289

(Original investment/Expected value of annuity) = Return of capital percentage

Front 290

For fixed annuities, the expected value is . . .

Back 290

the number of payments times the amount of the payment.

Front 291

For annuities paid over a person’s life . . .

Back 291

taxpayers must use IRS tables to determine the expected value based up on the taxpayer’s life expectancy at the start of the annuity, and to calculate the expected value of the annuity, the number of annual payments from the table (referred to as the expected return multiple) is multiplied by the annual payment amount.

Front 292

Joint-life annuity

Back 292

Annuity that provides payments over the lives of two people.

Front 293

A taxpayer who lives longer than his or her estimated life expectancy will ultimately receive more than the expected number of payments, and . . .

Back 293

the entire amount of these “extra” payments is included in the taxpayer’s gross income because the taxpayer has completely recovered her investment in the annuity by the time she receives them.

Front 294

If the taxpayer died BEFORE receiving the expected number of payments . . .

Back 294

the amount of the unrecovered investment (the initial investment less the amounts received that is treated as a nontaxable return of capital) is deducted on the taxpayer’s final income tax return.

Front 295

T/F: Taxpayers can realize a gain or loss when disposing of an asset.

Back 295

TRUE

Front 296

Taxpayers are allowed to recover their investment in property (tax basis) before they realize any ____.

Back 296

gain

Front 297

A ____ is realized when the proceeds are less than the tax basis in the property.

Back 297

loss

Front 298

When property is sold or disposed . . .

Back 298

the realized gain or loss equals the sale proceeds reduced by the tax basis of the property.

Front 299

The rate at which taxpayers are taxed on _____ from property dispositions and the extent to which they can deduct ______ from property dispositions depends on whether the taxpayer used the asset for business purposes, investment purposes, or personal purposes.

Back 299

gains, losses

Front 300

T/F: The legal form of a business affects how income generated by the business is taxed.

Back 300

TRUE; If the entity is a flow-through entity such as a partnership or a S corporation, the income and deductions of the entity "flow through" to the owners of the entity (partners or shareholders).

Front 301

To report income/deductions from flow-through entities:

Back 301

Each partner or S corporation shareholder reports his or her share of the entity's income and deductions, generally in proportion to his or her ownership percentage, on his or her individual tax return.

Front 302

T/F: Owners of flow-through entities are only taxed on their share of the entity's income if cash is distributed to them.

Back 302

FALSE; Owners of flow-through entities are taxed on their share of the entity's income whether or not cash is distributed to them.

Front 303

When owners receive cash from a flow-through entity . . .

Back 303

the distributions are generally treated as a return of capital and, therefore, NOT included in the owner's gross income.

Front 304

When couples legally separate or divorce, one spouse may be required to provide financial support to the other in the form of _______.

Back 304

alimony

Front 305

Alimony

Back 305

1) A transfer of cash made under a written separation agreement or divorce decree
2) The separation or divorce decree does not designate the payment as something other than alimony
3) The payments cannot continue after the death of the recipient

Front 306

T/F: Alimony shifts income from one spouse to another.

Back 306

TRUE; If the payment is alimony, then the amount of the payment is included in the gross income of the person receiving it and is deductible for AGI by the person paying it.

Front 307

Types of payments that DO NOT qualify as alimony:

Back 307

1) Property divisions
2) Child support payments fixed by the divorce or separation agreement

Front 308

If a transfer of property between spouses does NOT meet the definition of alimony . . .

Back 308

the recipient of the transfer excludes the value of the transfer from income, and the person transferring the property is not allowed to deduct the value of the property transferred.

Front 309

Problem with alimony:

Back 309

It is possible to use alimony transfers to assign income from the (higher tax rate) payer of the alimony to the (lower tax rate) recipient.

Front 310

Front loading restrictions:

Back 310

Make it difficult for taxpayers to disguise property payments as alimony payments.

Front 311

When taxpayers attempt to disguise property payments as alimony payments (large alimony payments shortly after the divorce, followed by smaller alimony payments in subsequent years) . . .

Back 311

the tax laws may require the taxpayers to recharacterize (or “recapture”) part of the alimony payments as nondeductible property transfers.

Front 312

Prizes, awards, and gambling winnings, such as raffle or sweepstake prizes or lottery winnings, ___ included in gross income.

Back 312

ARE

Front 313

Two exceptions to including prizes, awards, and gambling winnings in gross income:

Back 313

1) Awards for scientific, literary, or charitable achievement such as the Nobel prize are excluded from gross income, BUT ONLY IF the taxpayer IMMEDIATELY transfers the award to a federal, state, or local government unit or qualified charity such as a church, school, or charitable organization.
2) Employee awards for length of service or safety achievement limited to $400 of tangible property other than cash per employee per year.

Front 314

Transferring an award for scientific, literary, or charitable achievement has the same effect as claiming the transfer as a deduction ___ AGI; however, by receiving the award, recognizing the income, and then contributing funds to a charity, the taxpayer is deducting the donation as a deduction ____ AGI.

Back 314

for, from

Front 315

T/F: Taxpayers must include the gross amount of their gambling winnings for the year in gross income.

Back 315

TRUE; And taxpayers are allowed to deduct their gambling losses to the extent of their gambling winnings, but the losses are usually deductible as miscellaneous itemized deductions.

Front 316

For professional gamblers, the losses are deductible (to the extent of gambling winnings) ___ AGI.

Back 316

for

Front 317

Modified AGI:

Back 317

Regular AGI (without including Social Security benefits) plus tax-exempt interest income and certain other deductions for AGI.

Front 318

Taxability of Social Security benefits:

Back 318

1) Low income individuals exclude all Social Security benefits from gross income. Low income is defined to include single taxpayers whose modified AGI plus ½ of their Social Security benefits are $25,000 or less and married taxpayers whose modified AGI plus ½ of their SS benefits is $32,000 or less.
2) High-income individuals include a portion of their benefits up to a max of 85% of the total SS benefits. High income is defined to include single taxpayers whose modified AGI plus ½ of their SS benefits is above $34,000 and married taxpayers whose modified AGI plus ½ of their Social Security benefit is above $44,000.
3) Taxpayers not in groups (1) and (2) above include a portion of their benefits up to 50% of the total SS benefits.

Front 319

Taxpayers sometimes realize indirect economic benefits that they must include in gross income:

Back 319

1) They are allowed to purchase products or services from an employer at less than the market price.
2) They are allowed to borrow money at less than the market rate of interest.

Front 320

Taxpayers receiving economic benefits may be required to include a certain amount of _______ ______ from transactions in their gross income.

Back 320

imputed income

Front 321

Employees must recognize income to the extent they receive a greater than __ percent discount from their employer for the employer’s services or purchase goods from their employer at a price below the employer’s cost.

Back 321

20

Front 322

Imputed income

Back 322

The difference between the amount of the loan multiplied by an applicable federal interest rate (compounded semiannually) and the amount of interest the taxpayer actually pays.

Front 323

T/F: The imputed interest rules do not apply to loans of $10,000 or less.

Back 323

TRUE

Front 324

When a taxpayer’s debt is forgiven by a lender (the debt is discharged) . . .

Back 324

the taxpayer must include the amount of debt relief in gross income.

Front 325

Insolvent taxpayers

Back 325

Taxpayers with liabilities, including tax liabilities, exceeding their assets.

Front 326

A discharge of indebtedness is NOT taxable if the taxpayer is _________ before and after the debt forgiveness.

Back 326

insolvent

Front 327

If the discharge of indebtedness makes the taxpayer solvent . . .

Back 327

the taxpayer recognizes gross income to the extent of his solvency.

Front 328

Nonrecognition provisions

Back 328

Tax laws allowing exclusions or deferrals.

Front 329

Congress allows most exclusions and deferrals for two primary reasons:

Back 329

1) To subsidize or encourage particular activities
2) To be fair to taxpayers (such as mitigating the inequity of double taxation)

Front 330

Two common exclusion provisions:

Back 330

1) Municipal interest
2) Qualifying fringe benefits

Front 331

Municipal bonds

Back 331

Bonds issued by state and local governments located in the United States.

Front 332

In general, the value of fringe benefits is ________ in the employee's gross income as compensation for services.

Back 332

included

Front 333

Common qualifying fringe benefits:

Back 333

1) Medial and dental health insurance coverage: an employee may exclude from income the cost of medical and dental health insurance premiums the employer pays on an employee's behalf.
2) Life insurance coverage: employees may exclude from income the value of life insurance premiums the employer pays on an employee's behalf for up to $50,000 of group-term life insurance.
3) De minimis (small) benefits: as a matter of administrative convenience, Congress allows employees to exclude from income relatively small and infrequent benefits employees receive at work (such as limited use of a business copy machine).

Front 334

College students seeking a degree can exclude from gross income scholarships that pay for . . .

Back 334

tuition, fees, books, supplies, and other equipment REQUIRED for the student's courses.

Front 335

Excess scholarship amounts (such as for room or meals) are _____ taxable.

Back 335

fully

Front 336

T/F: The scholarship exclusion applies only if the recipient is not required to perform services in exchange for receiving the scholarship.

Back 336

TRUE

Front 337

Taxpayers are allowed to exclude from gross income earnings on investments in qualified education plans as long as . . .

Back 337

they use the earnings to pay for qualifying educational expenditures.

Front 338

Taxpayers can elect to exclude interest earned on Series EE savings bonds when . . .

Back 338

the redemption proceeds are used to pay qualified higher education expenses for the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer.

Front 339

The exclusion of interest income from Series EE bonds is partially reduced or eliminated for taxpayers exceeding a fixed level of modified adjust gross income (adjusted gross income before the educational savings bond exclusion, the foreign earned income exclusion, and certain other deductions), and if the taxpayer’s modified AGI exceeds the thresholds in the redemption year . . .

Back 339

the exclusion is phased out (gradually reduced) until all the interest from the bonds is taxed.

Front 340

Gift

Back 340

Property transfer when the transferor is alive at the time of transfer.

Front 341

Inheritance

Back 341

Property transfer when the transferor is deceased at the time of transfer.

Front 342

Gift and estate taxes are imposed on transfer of the property and not included in income by the _________.

Back 342

recipient

Front 343

Why does Congress exclude property transferred as gifts and inheritances from income taxation?

Back 343

To avoid the potential double taxation (transfer and income taxation) on these transfers.

Front 344

The tax laws allow taxpayers receiving life insurance proceeds to exclude the proceeds from taxable income. However . . .

Back 344

when the insurance proceeds rae paid over a period of time rather than in a lump sum, a portion of the payments represents interest and must be included in gross income.

Front 345

A maximum of _____ (2010) of foreign earned income can be excluded from gross income for qualifying individuals.

Back 345

$91,500

Front 346

Rather than claim a foreign earned income exclusion . . .

Back 346

taxpayers may deduct foreign taxes paid as itemized deductions or they may claim the foreign tax credit for foreign taxes paid on their foreign earned income.

Front 347

Requirements to qualify for the foreign earned income exclusion:

Back 347

1) Be considered a resident of the foreign country OR
2) Live in a foreign country for 330 days in a consecutive 12-month period

Front 348

Because the foreign earned income exclusion is computed on a _____ basis, the maximum exclusion is reduced pro rata for each day during the calendar year that the taxpayer is not considered to be a resident of the foreign country or does not actually live in the foreign country.

Back 348

daily

Front 349

Taxpayers receive worker’s compensation benefits when . . .

Back 349

they are unable to work because of a work-related injury.

Front 350

T/F: Payments a taxpayer receives from a state-sponsored worker’s compensation plan are excluded from the taxpayer’s income.

Back 350

TRUE

Front 351

Is unemployment compensation fully taxable?

Back 351

YES

Front 352

Payments received as compensation for a physical injury are excluded from gross income, but punitive damages are included in gross income because . . .

Back 352

they are intended to punish the harm-doer rather than to compensate the taxpayer for injuries.

Front 353

Reimbursements by health & accident insurance policies for medical expenses paid by the ________ are excluded from gross income.

Back 353

taxpayer

Front 354

Disability insurance/wage replacement insurance

Back 354

Pays the insured individual for wages lost when the individual misses work due to injury or disability.

Front 355

T/F: If an individual purchases disability insurance directly, the cost of the policy is deductible.

Back 355

FALSE; The cost of the policy is not deductible, but any disability benefits are excluded from gross income.

Front 356

Disability payments received from an ________-purchased policy are excluded from gross income.

Back 356

employee

Front 357

If premiums paid on the employee’s behalf are taxable compensation to the employee, the policy is considered to have been purchased by the ________. If the premium paid for by the employer is a nontaxable fringe benefit to the employee, the policy is considered to have been purchased by the ________.

Back 357

employee, employer

Front 358

Deferral provisions

Back 358

Allow taxpayers to defer (but not permanently exclude) the recognition of certain types of realized income.

Front 359

Transactions generating deferred income include:

Back 359

1) Installment sales
2) Like-kind exchanges
3) Involuntary conversions
4) Contributions to non-Roth qualified retirement accounts

Front 360

“Total income”

Back 360

Gross income minus certain deductions for AGI such as business expenses and deductible capital losses.

Front 361

Deductions appear in one of two places in the individual income tax formula:

Back 361

1) Deductions “for AGI” (“above the line” deductions) are subtracted directly from gross income
2) Deductions “from AGI” (“below the line” or “itemized” deductions) are subtracted directly from AGI, resulting in taxable income

Front 362

Three categories of for AGI deductions:

Back 362

1) Deductions directly related to business activities
2) Deductions indirectly related to business activities
3) Deductions subsidizing specific activities

Front 363

Why does Congress allow taxpayers involved in business activities to deduct expenses incurred to generate business income?

Back 363

Because taxpayers include the revenue they receive from doing business in gross income.

Front 364

For tax purposes, activities are either ______-motivated or motivated by ________ __________.

Back 364

profit, personal objectives

Front 365

Profit-motivated activities are classified as either:

Back 365

1) Business activities
2) Investment activities

Front 366

Business activities (trade or business)

Back 366

Activities that require a relatively high level of involvement or effort from the taxpayer.

Front 367

Investment activities

Back 367

1) Profit-motivated activities that don’t require a high degree of taxpayer involvement or effort.
2) Involve investing in property for appreciation or for income payments.

Front 368

Business expenses are deducted ___ AGI.

Back 368

for

Front 369

What is the lone exception to business expenses?

Back 369

Unreimbursed employee business expenses, which are deductible as itemized (from AGI) deductions.

Front 370

Expenses associated with rental and royalty activities are deductible ___ AGI regardless of whether the activity qualifies as an investment or a business.

Back 370

for

Front 371

Congress limits business deductions to expenses directly related to the business activity and those that are ________ ___ _________ for the activity.

Back 371

ordinary and necessary

Front 372

Business deductions are reported with business revenues on Schedule _ of the Form 1040.

Back 372

C

Front 373

Rental and royalty deductions are reported with rental and royalty revenues on Schedule _ of the Form 1040.

Back 373

E

Front 374

Why are rental and royalty expenses deductible for AGI?

Back 374

Because Congress believed that these activities usually require more taxpayer involvement than other types of investment activities.

Front 375

Taxpayers disposing of business assets at a loss are allowed to deduct the losses ___ AGI.

Back 375

for

Front 376

T/F: Individual taxpayers selling investment (capital) assets at a loss are allowed to deduct the “capital” losses against other capital gains.

Back 376

TRUE; If the capital losses exceed the capital gains, they can deduct up to $3,000 as a net capital loss in a particular year, and losses in excess of the $3,000 limit are carried forward indefinitely to subsequent years when they are deductible subject to the same limitations.

Front 377

Income from flow-through entities such as partnerships, LLCs, and S corporations passes through to the owners of those entities and is reported on Schedule _ of the tax returns of the owners.

Back 377

E

Front 378

T/F: Taxpayers are allowed to deduct expenses in activities that are not directly related to making money but that they would not have incurred if they were not involved in a business activity as deductions ___ AGI.

Back 378

for

Front 379

Individuals can deduct moving expenses as deductions for AGI if they meet two tests:

Back 379

1) A distance test: the distance from the taxpayer’s old residence to the new place of work must be at least 50 miles more than the distance from the old residence to the old place of work.
2) A business test associated with the move: the taxpayer must either be employed full-time for 39 of the first 52 weeks after the move or be self-employed for 78 of the first 104 weeks after the move.

Front 380

Deductible moving expenses are limited to . . .

Back 380

Reasonable expenses associated with moving personal possessions and traveling to the new residence, including transportation and lodging—NOT meals during the move or costs associated with house-hunting trips.

Front 381

T/F: Taxpayers are allowed to deduct a mileage rate in lieu of the actual costs of driving their personal automobiles during the move.

Back 381

TRUE; In 2010, taxpayers are allowed to deduct 16.5 cents a mile for driving their personal automobiles during a move.

Front 382

Taxpayers who are reimbursed by their employers for actually moving expenses _______ the reimbursement from income but do not ______ the reimbursed expenses.

Back 382

exclude, deduct

Front 383

Taxpayers who receive a flat amount as a moving allowance from their employers are required to . . .

Back 383

Include the allowance in gross income, and can deduct their actually moving expenses for AGI.

Front 384

Employers are allowed to deduct health insurance premiums as compensation expense while employees are allowed to _______ these premiums from gross income.

Back 384

exclude

Front 385

To provide equitable treatment, Congress allows self-employed taxpayers to . . .

Back 385

Claim personal health insurance premiums as deductions for AGI—unless the taxpayer is eligible to participate in an employer-provided health plan, regardless of whether the taxpayer actually participates in the plan.

Front 386

T/F: Self-employed individuals are required to pay self-employment tax, which is double that paid by employees, because it represents both the employee’s and the employer’s share of the Social Security tax.

Back 386

TRUE; However, self-employed taxpayers are allowed to deduct ½ of the self-employment tax they pay.

Front 387

The penalty for early withdrawal of savings provision allows a deduction ___ AGI for any interest income an individual forfeit to a bank as a penalty for prematurely withdrawing a certificate of deposit or similar deposit.

Back 387

for

Front 388

Congress has created two important deductions for AGI to encourage and subsidize higher education:

Back 388

1) Interest expense on qualified educational loans (loans whose proceeds are used to pay qualified education expenses)
2) Qualified educational expenses

Front 389

Up to ____ of interest on education loans is deductible for AGI; however, the maximum deduction is reduced (phased-out) for taxpayers with AGI exceeding $60,000 ($120,000 married filing jointly).

Back 389

$2,500

Front 390

T/F: Married individuals who file separately are allowed to deduct the qualified education loans expense.

Back 390

FALSE; They are not allowed to deduct this expense under any circumstance.

Front 391

Education expenses:

Back 391

1) Up to $4,000 of qualified education expenses can be deducted for AGI.
2) Qualified education expenses include tuition and related costs for postsecondary or higher education.
3) The deduction is reduced for taxpayers with modified AGI over $65,000 ($130,000 married filing jointly) and eliminated for taxpayers with modified AGI of $80,000 ($160,000 married filing jointly) or more.

Front 392

T/F: Married individuals filing separately are ineligible for the qualified education expense deduction.

Back 392

TRUE

Front 393

Two important differences between the AGI limits on the interest on education loans deduction and the AGI limits on the educational expense deduction:

Back 393

1) The definition of modified AGI for qualified education expenses includes the deduction for interest on education loans.
2) The interest expense on education loans is phased out gradually over a range of AGI but the deduction for qualified education expense is phased out in specific AGI increments (the phase-out applies in steps).

Front 394

A single expenditure ______ generate multiple tax benefits.

Back 394

cannot

Front 395

Deductions from AGI:

Back 395

1) The greater of itemized deductions or the standard deduction
2) Personal and dependency exemption deductions

Front 396

Many itemized deductions are ________ in nature but are allowed to subsidize desirable activities such as home ownership and charitable giving.

Back 396

personal

Front 397

The medical expense deduction is designed to . . .

Back 397

provide relief for taxpayers whose ability to pay taxes is seriously hindered by health-related circumstances.

Front 398

Qualifying medical expenses include:

Back 398

Any payments fro the care, prevention, diagnosis, or cure of injury, disease, or bodily function that are not reimbursed by health insurance or are not paid for through a "flexible" spending account.

Front 399

T/F: Taxpayers must also deduct medical expenses incurred to treat their spouses and their dependents.

Back 399

TRUE

Front 400

Medical expenses for cosmetic surgery or other similar procedures are not deductible UNLESS . . .

Back 400

the surgery or procedure is necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease.

Front 401

T/F: Taxpayers traveling for the primary purpose of receiving essential and deductible medical care may deduct the cost of lodging while away from home overnight (with certain restrictions) and transportation.

Back 401

TRUE; Taxpayers using personal automobiles for medical transportation purposes may deduct a standard mileage allowance in lieu of actual costs (16.5 cents a mile for 2010).

Front 402

When may taxpayers deduct the cost of meals and lodging at hospitals?

Back 402

When the principal purpose for the stay is medical care rather than convenience.

Front 403

The deduction for medical expenses is limited to the amount of unreimbursed qualifying medical expenses paid during the year reduced by ___ percent of the taxpayer's AGI.

Back 403

7.5

Front 404

Floor limitation

Back 404

Eliminates any deduction for amounts below the floor.

Front 405

Purpose of the floor limitation:

Back 405

To restrict a deduction to taxpayers with substantial qualifying expenses.

Front 406

T/F: Unreimbursed medical expenses typically produce tax benefits for high income taxpayers.

Back 406

FALSE; Unreimbursed medical expenses rarely produce tax benefits, especially for high income taxpayers.

Front 407

Individuals may deduct as itemized deductions payments made during the year for the following taxes:

Back 407

1) State, local, and foreign income taxes, including state and local taxes paid during the year through employer withholding, estimated tax payments, and overpayments on the prior year return that the taxpayer applies to the current year (the taxpayer asks the state to keep the overpayment rather than refund it).
2) Real estate taxes on property held for personal or investment purposes.
3) Personal property taxes that are assessed on the value of the specific property.

Front 408

In 2009, taxpayers who did not itemize deductions were allowed to increase their standard deduction amount for

Back 408

1) real property taxes they paid during the year and
2) sales taxes paid during the year on purchases of qualified motor vehicles

Front 409

For real property taxes, the additional standard deduction amount is limited to the lesser of:

Back 409

1) The amount of real property taxes paid during the year.
2) $500 ($1,000 for married filing jointly).

Front 410

For sales taxes, the additional standard amount is limited to . . .

Back 410

the tax on up to $49,500 of the purchase price of qualified motor vehicles ($24,750 if married filing jointly)

Front 411

T/F: The additional standard deduction for sales taxes was phased out ratably for taxpayers with modified AGI between $125,000 and $135,000 ($250,000 and $260,000 on a joint return).

Back 411

TRUE

Front 412

The itemized deduction for qualified motor vehicle taxes _____ available to a taxpayer who elected to deduct state and local sales taxes in lieu of state income taxes.

Back 412

wasn't

Front 413

Two itemized deductions for interest expense:

Back 413

1) Interest paid on loans secured by a personal residence
2) Interest paid on loans used to purchase investment assets such as stocks, bonds, or land (investment interest expense)

Front 414

The deduction of investment interest is limited to . . .

Back 414

a taxpayer's net investment income (investment income minus investment expense), and any investment interest in excess of the the net investment income limitation carries forward to the subsequent year.

Front 415

T/F: Taxpayers are allowed to deduct interest on personal credit card debt or on loans to acquire (and secured by) personal-use automobiles.

Back 415

FALSE

Front 416

Congress encourages donations to charities by allowing taxpayers to deduct contributions of money and other property to _________ charitable organizations.

Back 416

qualified

Front 417

Qualifying charitable organizations include:

Back 417

organizations that engage in educational, religious, scientific, governmental, or other public activities.

Front 418

The ______ of the charitable contribution depends on whether the taxpayer contributes money or other property to the charity.

Back 418

amount

Front 419

T/F: Cash contributions are deductible in the year paid, including donations of cash or by check, electronic funds transfers, credit card charges, and payroll deductions.

Back 419

TRUE

Front 420

Taxpayers are also considered as making monetary contributions for the cost of transportation and travel for charitable purposes if . . .

Back 420

there is no significant element of pleasure or entertainment in the travel.

Front 421

When taxpayers use their personal vehicles for charitable transportation purposes, they may deduct, as a cash contribution, a standard mileage allowance for each mile driven (__ cents a mile in 2010).

Back 421

14

Front 422

T/F: Taxpayers are allowed to deduct the value of the services they provide for charities.

Back 422

FALSE

Front 423

Taxpayers receiving goods or services from a charity in exchange for a contribution may only deduct the amount of . . .

Back 423

the contribution in excess of the fair market value of the goods or services they receive in exchange for their contribution.

Front 424

When a taxpayer donates property to charity, the amount the taxpayer is allowed to deduct depends on whether the property is ______ ___ ________ or ________ ______ ________.

Back 424

capital gain property, ordinary income property

Front 425

Capital gain property:

Back 425

Taxpayers are allowed to deduct the fair market value of capital gain property on the date of the donation.

Front 426

Capital gain property

Back 426

Any appreciated asset that would have generated a long-term capital gain if the taxpayer had sold the property for its fair market value instead of contributing the asset to charity.

Front 427

To qualify as long term, the taxpayer must have held the asset for more than _ ____.

Back 427

a year

Front 428

Capital assets include:

Back 428

1) Investment assets (stocks, bonds, land held for investment, paintings, etc.)
2) Business assets (to the extent that gain on the sale of the business asset would not have been considered ordinary income)
3) Personal-use assets

Front 429

T/F: When taxpayers contribute capital gain property, they are NOT required to include the appreciation on the asset in gross income.

Back 429

TRUE

Front 430

The deduction for capital gain property that is tangible personal property is limited to . . .

Back 430

the adjusted basis of the property if the charity uses the property for a purpose that is unrelated to its charitable purpose.

Front 431

Taxpayers contributing ordinary income property can only deduct the lesser of

Back 431

1) The property's fair market value
2) The property's adjusted basis.

Front 432

Ordinary income property

Back 432

1) All assets other than capital gain property.
2) Property that if sold would generate income taxed at ordinary rates.

Front 433

Ordinary income property includes the following types of assets:

Back 433

1) Assets the taxpayer has held for a year or less.
2) Inventory the taxpayer sells in a trade or business.
3) Business assets held for more than a year to the extent the taxpayer would recognize ordinary income under the depreciation recapture rules if the taxpayer has sold the property.
4) Assets, including investment assets and person-use assets, with a value less than the taxpayer's basis in the assets (assets that have declined in value).

Front 434

The amount of a taxpayer's charitable contribution deduction for the year is limited to a _______ or maximum deduction.

Back 434

ceiling

Front 435

Private operating foundations

Back 435

Privately sponsored foundations that actually fund and conduct charitable activities.

Front 436

Cash and property donations to public charities and private operating foundations are limited to __ percent of the taxpayer's AGI.

Back 436

50

Front 437

Deductions for contributions of capital gain property to public charities and private operating foundations are generally limited to __ percent of the taxpayer's AGI.

Back 437

30

Front 438

Private nonoperating foundations

Back 438

Privately sponsored foundations that disburse funds to other charities.

Front 439

Deductions for cash and property contributions to private nonoperating foundations are limited to __ percent of the taxpayer's AGI.

Back 439

30

Front 440

Deductions for contributions of capital gain property to private nonoperating foundations are limited to __ percent of the taxpayer's AGI.

Back 440

20

Front 441

When taxpayers make contributions that are subject to different percentage limitations, they apply the AGI limitations in the following sequence:

Back 441

1) Determine the limitation for the 50% contributions.
2) Apply the limitations for the 30% contributions. The 30% contribution limit is the lesser of (a) AGI x 30% or (b) AGI x 50% minus the amount of contributions deducted in Step 1.
3) Apply the limitations to the 20% contributions. The 20% contribution limit is the lesser of (a) AGI x 20% or (b) AGI x 30% minus the amount of contributions from Step 2.

Front 442

When a taxpayer's contributions exceed the AGI ceiling limitation for the year . . .

Back 442

the excess contribution is treated as though it were made in the subsequent tax year and is subject to the same AGI limitations in the next year. It can be carried forward for five years before it expires.

Front 443

T/F: Individuals cannot deduct losses they realize when they sell or dispose of assets used for personal purposes.

Back 443

TRUE; However, individuals are allowed to deduct casualty and theft losses realized on personal-use assets.

Front 444

Casualty loss

Back 444

Loss arising from a sudden, unexpected, or unusual event such as a "fire, storm, or shipwreck" or loss from theft.

Front 445

Why does Congress allow deductions for unreimbursed casualty and theft losses?

Back 445

Because these losses may substantially reduce a taxpayer's ability to pay taxes.

Front 446

The amount of the tax loss from any specific casualty event (including theft) is the lesser of:

Back 446

1) The decline in value of the property caused by the casualty
2) The taxpayer's tax basis in the damaged or stolen asset.

Front 447

Losses from casualty losses are reduced by . . .

Back 447

any reimbursements the individual is eligible to receive, such as insurance reimbursements.

Front 448

Casualty losses must exceed two separate floor limitations to qualify as itemized deductions:

Back 448

1) $100 for each casualty event during the year
2) 10% of AGI (applies to the sum of all casualty losses for the year after applying the $100 floor)

Front 449

Miscellaneous itemized deductions subject to the floor limitation:

Back 449

1) Employee business expenses
2) Investment expenses
3) Certain other expenses

Front 450

Miscellaneous itemized deductions are summed together and are deductible only to the extent that their sum exceeds _% of the taxpayer's AGI.

Back 450

2

Front 451

Employee business expenses

Back 451

Those that are appropriate and helpful for the employee's work.

Front 452

Several types of employee expenses are restricted. For example:

Back 452

1) The costs of job hunting qualify if the job is in the employee's current trade or business, but not for the individual's first job.
2) The cost of education qualifies if it serves to maintain or improve the employee's skill in the business, but not if the education is required to qualify for a new business or profession.

Front 453

T/F: The cost of travel is deductible if the primary purpose of the trip is business.

Back 453

TRUE; However, the cost of commuting is personal and never deductible.

Front 454

When employees drive their personal automobiles for business purposes, they may deduct a standard mileage rate in lieu of deducting actual costs (__ cents per mile in 2010).

Back 454

50

Front 455

When employees travel on business trips long enough to be away from home overnight, meals and lodging qualify as employee business expenses, but employees are allowed to deduct only __ the cost of the meals.

Back 455

1/2

Front 456

As a generally rule, employees _______ reimbursements in gross income and ______ employee business expenses as miscellaneous itemized deductions.

Back 456

include, deduct

Front 457

Accountable plan

Back 457

If an employee is required to submit documentation supporting expenses to receive reimbursement and the employer reimburses only legitimate business expenses.

Front 458

Under an accountable plan . . .

Back 458

employees exclude expense reimbursements from gross income and do NOT deduct the reimbursed expenses.

Front 459

Under an accountable plan, if expenses exceed the reimbursements . . .

Back 459

the excess (unreimbursed) portion is deductible as an employee business expense.

Front 460

Investment expenses

Back 460

Include expenditures necessary for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.

Front 461

Common investment expenses:

Back 461

1) Expenses associated with investment income or property.
2) Investment advisory fees.
3) Safe-deposit box fees.
4) Subscriptions to investment-related publications.

Front 462

Ordinary and necessary expenses incurred in connection with determining tax obligations imposed by federal, state, municipal, or foreign authorities are deductible as . . .

Back 462

miscellaneous itemized deductions subjet to the 2% floor.

Front 463

Hobby

Back 463

Certain activities for primarily personal enjoyment that may also generate revenue.

Front 464

Hobby loss limitation

Back 464

Hobby expenses are deductible only to the extent of the revenue generated by the hobby.

Front 465

The tax law explicitly presumes that an activity is a business if it generates a profit in _ of _ consecutive years.

Back 465

3, 5

Front 466

If an activity is determined to be a hobby, the taxpayer must . . .

Back 466

include the revenue from the activity in gross income and may deduct the expenses, to the extent of the gross income from the activity, as miscellaneous itemized deductions.

Front 467

Miscellaneous itemized deductions:

Back 467

1) Employee business expenses not reimbursed by an accountable plan.
2) Investment expenses if not in a rental or royalty activity.
3) Tax preparation fees and allowable hobby expenses.
4) Total miscellaneous itemized deductions subject to a 2% of AGI floor limit.

Front 468

Standard deduction

Back 468

Flat amount that most individuals can elect to deduct instead of deducting their itemized deductions (if any).

Front 469

Taxpayers generally deduct the _______ of their standard deduction or their itemized deductions.

Back 469

greater

Front 470

The amount of the standard deduction varies according to the taxpayer's . . .

Back 470

1) Filing status
2) Age
3) Eyesight

Front 471

For an individual who is claimed as a dependent on another's return, the standard deduction is the greater of

Back 471

1) $950
2) $300 plus the individual's earned income limited to the regular standard deduction (including the additional standard deduction amounts, if any).

Front 472

From the government's standpoint, the standard deduction serves two purposes:

Back 472

1) To help taxpayers with lower income
2) Eliminates the need for the IRS to verify and audit itemized deductions for those taxpayers who choose to deduct the standard deduction.

Front 473

From the taxpayer's perspective, the standard deduction allows them to . . .

Back 473

avoid taxation on a portion of their income, and for those not planning to itemize, it eliminates the need to substantiate and collect information about them.

Front 474

While the standard deduction reduces taxes by offsetting income with an automatic deduction, it eliminates the tax benefits of itemized deductions up to the amount of the _________ _________.

Back 474

standard deduction

Front 475

Bunching itemized deductions

Back 475

Consists of shifting itemized deductions into one year such that the amount of itemized deductions exceeds the standard deduction for the year, and then deducting the standard deduction in the near year (or vise versa).

Front 476

Why is taxpayer's ability to shift itemized deductions limited?

Back 476

Because the timing of these payments is not completely discretionary.

Front 477

Taxpayers are generally allowed to deduct ____ in 2010 for each personal and dependency exemption.

Back 477

$3,650

Front 478

A taxpayer's from AGI deduction for personal and dependency exemption is $3,650 multiplied for . . .

Back 478

the number of the taxpayer's exemptions.

Front 479

Taxpayers with AGI in excess of the threshold amount determine the phase-out by comparing the lesser of the following two numbers:

Back 479

1) 3% x (AGI in excess of the threshold amount)
2) 80% of the those itemized deductions subject to phase-out

Front 480

Because itemized deductions can be reduced by not completely eliminated, the phase-out provision is sometimes referred to as a _______ or _______.

Back 480

cutback, haircut

Front 481

The process for determining the taxpayer's allowable personal and dependency exemptions after the phase-out involves the following five steps:

Back 481

1) Subtract the taxpayer's AGI from the AGI threshold based on the taxpayer's filing status. If the threshold equals or exceeds the taxpayer's AGI, the taxpayer deducts her full personal and dependency exemptions.
2) Divide the excess AGI (the amount from Step 1) by 2,500. If the result is not a whole number (i.e., the excess AGI is not evenly divisible by 2,500), round up to the next whole number.
3) Multiply the outcome of Step 3 by 2%, but limit the product to 100%. This is the full-phase out percentage.
4) Multiply the percentage determined in Step 3 by the taxpayer's total personal and dependency exemptions (number of personal and dependent exemptions times the exemption amount for that year). The product is the amount of personal and dependency exemption deductions that is phased-out (the taxpayer is not allowed to deduct this amount).
5) Subtract the Step 4 result from the taxpayer's total personal and dependency exemptions that would be deductible without any phase-out (i.e., number of personal and d