Tax Planning (Section II.A) (13%, 16 Questions)

Question 1

Marginal Tax Rate

Answer 1

• The tax rate applied to the next marginal (incremental) portion of income earned.

Question 2

Effective Tax Rate

Answer 2

• The tax rate actually paid on total income calculated by dividing total taxes paid by total income.

Question 3

All Taxable Income and Taxable Gains

Answer 3

Examples: Wages, Income, Investment interest and taxable gains, qualifying alimony from contract pre-2019, retirement account distributions, etc.

Question 4

Applicable Deductions (above the line)

Answer 4

Examples: Self-employment tax, self-employed insurance premium deductions. Contributions to retirement accounts, certain education expenses, etc.

Question 5

Adjustable Gross Income

Answer 5

Equal All taxable income and taxable gains reduced by applicable (above the line) deductions.

Question 6

Taxable Income

Answer 6

Equals AGI reduced by applicable deductions, for example: Standard or itemized deductions, exemptions. (Below the line)

Question 7

Total Tax

Answer 7

Equals Taxable Income reduced by applicable credits, for example: Foreign tax credit, dependent care, education credits and other taxes (self-employment tax, household employment tax).

Question 8

Calculate Adjusted Gross Income Example #1: Employee

Answer 8

Question 9

Calculate Adjusted Gross Income Example #2: Self-Employed

Answer 9

Question 10

Calculating Self-Employment Tax

Answer 10

Social Security’s old age, survivors, and disability insurance (OASDI) program taxed at a flat rate (6.20% for employee and 6.20% for employer = 12.40% for self-employed) on net earnings from SE up to maximum income level of $160,200 for 2023.
- Medicare’s Hospital Insurance (HI) program taxed at a flat rate (1.45% for employee and 1.45% for employer = 2.90% for self-employed)
-An income deductions is allowed (above the line) for one half of SE tax paid.

Question 11

Schedule A Itemized Deductions

Answer 11

• Medical and Dental Expensess (7.5% of AGI Threshold)
• State and local tax deductions limited to $10,000 MFJ interest you paid.
• Gifts to charity

Question 12

Tax credits

Answer 12

• Directly reduce tax liability (dollar for dollar)

Question 13

Tax Deductions

Answer 13

• Reduce taxable income which means the value of a tax deductions lies in the marginal rate which rises with additional income.

Question 14

Estimated Tax Payment Rules

Answer 14

• If prior year AGI was $150k or less, to avoid underpayment penalties, pay 100% of prior year tax or 90% of current year tax, whichever is less.
• If prior year AGI was over $150k, to avoid underpayment penalties, pay 110% of prior year tax of 90% of current year tax,whichever is less.
  -Tax withheld from retirement distributions is considered paid evenly throughout the year and qualifies as estimated tax payments.

Question 15

Distributable Net Income (DNI)

Answer 15

• The amount transferred to unitholders (if an income related trust) or the amount distributed to bene’s (if an estate related trust)
• DNI may be deducted by trusts for tax purposes
  -Calculation:
  Taxable Income before exemptions, distributions and special deductions
  ADD capital losses and net muni income
  SUBTRACT capital gains.

Question 16

Taxation of Trusts: First-Tier Bene

Answer 16

• Must have income distributed to the in the year earned. They are taxed on income actually or constructively distributed to the extent of the trust’s or estate’s distributable net income (DNI).
• Currently DNI must be distributed in the same year tax year as earned.

Question 17

Taxations of Trusts - Second Tier Bene

Answer 17

• Receive all distributions that are properly paid, credited or required to be distributed other than tier one distributions and gifts or specific bequests or property or sums of money.
• This includes discretionary distributions, distributions required upon a specified occurence, an annuity paid out of corpus and a spousal support allowance required by court order.

Question 18

Key 2023 Tax Rates

Answer 18

• LTCG = 0-20%
• Ordinary Income = 10-37%
• Collectibles = 28%
• AMT 26 & 28%

Question 19

Medicare Hospital Insurance Tax & Surtax on Net Investment Income

Answer 19

0.9% Medicare Hospital Insurance Tax
- Tax assessed on earned income above: $250k MFJ & $200k Single.
3.8% Surtax on Net Investment Income
- Tax assessed on certain net investment income when modified AGI is above: $250k MFJ & $200k Single.

Question 20

Step-Transaction Doctrine

Answer 20

Used to help identify so called sham loans and transactions (that are often found in family transactions)

Question 21

Gifts to Minors

Answer 21

• UGMA:
• Limited to transfer of certain assets
• Growth can be tax-free
• Ownership typically transfers to child at 18.
• UTMA:
• Growth can be tax-free
• May be included in grantor’s taxable estate until child takes ownership which transfers from age 21-25.

Question 22

Kiddie Tax

Answer 22

• Amount of unearned income above $2,300 for those dependents under 19 years old and full-time student dependents from 19-23 years old to be taxed at the parent’s rate.

Question 23

Calculate AMT - 2023

Answer 23

1) Taxable income +/- AMT Adjustments + AMT Preference items = AMTI
2) AMTI - Exemption Amount (subject to phase out) = AMT Base
3) AMT Base x AMT Rate = Preliminary AMT (26% on first $220,700 & 28% on amounts above $220,700)
4) Preliminary AMT - Tax Credits = Tentative AMT
5) Tentative AMT - Regular Tax = AMT Due

Question 24

AMT Exemptions and Tax Rates - 2023

Answer 24

• Exemptions Amount - $126,500 MFJ
• Exemptions phaseout begins - $1,156,300 for MFJ
• AMT Rates - 26% for amounts up to $220,700 MFJ & 28% for amounts above $220,700 for MFJ.

Question 25

AMTI Calculation

Answer 25

• Start with taxable income.
• Add or Subtract: Adjustments including:
  
  • Standard Deduction
  • Certain itemized
    deductions
  • ISO
• Add: Tax Peerference Items:
  
  • Tax exempt bond interest
    from certain private
    activity bonds.
  • Excluded gain on sale of
    qualified small business
    stock
• Results = AMTI

Question 26

AMT Example

Answer 26

FACT PATTERN: Susan and Mike Jones are married, have 3 young children
and file a joint return. Their taxable income under the regular income tax
calculation for this year is $2.5 million and their regular income tax liability is
$660,000. They gave $150,000 to qualified public charities over the year and
have an AMT adjustment of $125,000 from various non-tax related itemized
deductions. The Jones’ had preference items from incentive stock options
($75,000) and tax-exempt interest ($15,000) from qualified private activity
bonds. They paid $80,000 in property taxes. Calculate the Jones’ total tax
liability.

Step 1: Calculate AMTI
Taxable Income $2.5m +/- AMT preference items and adjustments ($125,000 +
$75,000 + $15,000 + $10,000) = $2.725m
Note – charitable deductions are not added back; they paid $80k in property taxes but
were only allowed to take a $10k deduction so only the $10k is added back.

Step 2: Calculate AMT base
AMTI $2.725m – exemption amount ($0) = $2.725m
Note – The Jones’ are not allowed to take the AMT exemption because their
income (AMTI) is above the phase-out amount of $1,156,300 (for 2023)

Step 3: Calculate tentative minimum tax
AMT base ($2.725m - $220,700 = $2,504,300) x 28% = 701,204
+ (220,700 x 26% = 57,382) = $758,586

Step 4: Calculate AMT
Tentative minimum tax $758,586 – regular tax liability $660,000 = AMT
$98,586
Note – The Johnson’s have $758,586 in total tax liability (the higher of
AMT tentative tax and regular tax liability).

Question 27

AMT Planning Opportunities

Answer 27

• Income and Expense Planning:
  
  • Defer deductions for state
    income or property taxes.
  • Defer or accelerate receipt
    of income.
  • Reduce exposure to
    private activity bonds
  • Consider taxable bonds if
    subject to AMT.
  • Time Chartiable
    contributions.
• Stock and Option Planning:
  
  • Defer or accelerate receipt
    of capital gains
  • Consider disqualifying
    disposition of ISOs
  • Consider tandem exercise
    of ISOs and NSOs.

Question 28

2023 Percentage Deduction LImitation Rules

Answer 28

Question 29

Gift Property with imbedded loss (depreciated property)

Answer 29

• General rule: the taxpayer deducts the lesser of FMV or cost basis for gifts of depreciated assets.

Question 30

Gift property encumbered by debt

Answer 30

• FMV of gift property is calculated net of debt.
• The transfer of encumbered property to charity is considered a bargain sale (i.e., the amount of debt is considered an amount realized by the donor.)

Question 31

Deducting Mortgage Interest

Answer 31

• Primary residence or second home
• Points and other forms of interest
• Limits on deductability:
  
  • $750k aggregate acquisition indebtedness deduction eliminated.
  • Home equity
    indebtedness deduction
    eliminated,
  • Qualified HELOC interest
    is further limited in scope.

Question 32

Investment Interest

Answer 32

• Interest paid to borrow money to make investments is deductible but limited to the amount of net investment income.

Question 33

Business Activity Interest

Answer 33

• Interest paid on business loans including rental property and other real estate holdings is deducted from gross income personally or through a business entity “above the line”.
• In most cases, interest expense from passive activites is only deductible to the extent of income from these activities.

Question 34

Qualified and Non-qualified Dividends

Answer 34

• Dividends are generally taxed as ordinary income.
• Qualified dividends are taxed at capital gains rates.
• Holding period: In order to qualify for lower rates, investors are required to hold commond stock for more than 60 days in the 121-day period beginning 60 days before the ex-divident date.
• Holding period: In order to qualify for the lower rates, investors are required to hold preferred stock for more than 90 days in the 181-day period beginning 90 days before the ex-dividend date.

Question 35

Netting of Capital Gains

Answer 35

• Net all short-term gains and losses
• Net all long-term gains and losses.
• Loss offsets:
  
  • If total short-term net is a
    loss, it may be used to offset
    any LTCG
  • If total long-term net is a
    loss, it may be used to offset
    any STCG
• The the net of all capital gains
  and losses is a loss:
  
  • $3,000 of the capital loss
    may offset ordinary income
  • Balance of capital loss is
    carried forward to next year,

Question 36

Realized Gain vs. Recognized Gains

Answer 36

Realized = gains occur upon transaction. LIke in an IRA.
Recognized = Gains occur when triggering a taxable event. Like in a JT.

Question 37

Taxation of Incentive Stock Options

Answer 37

• Holding period requirements: hold 2 years after grant.
• If holding period is met.
  *Grant - Not a taxable event
  *Exercise - Not a taxable event
  *Sale - Taxation upon sale as appropriate.
• If holding period is not met.
  *Difference between FMV at time of exercise and the option price is considered ordinary income for tax purposes.

Question 38

ISO Spread Impact on AMT

Answer 38

• The holder of an ISO realizes gain or loss for AMT purposes equal to the difference between the FMV of the stock on the date of exercise and the exercise price (Called the “Spread”).
• The spread is an AMT preference item that must be added bacck when computing AMTI.

Question 39

Taxation of Non-Qualified Stock Options

Answer 39

• Not taxed at time of grant.
• NQSO are taxed as ordinary income at time of exercise.
• First taxable event: Tax is based on the spread between market price at exercise and the exercise price actually paid by the executive.
• Second taxable event: LTCG/L if stock sold more than one year after the exerrcise. STCG/L if sold less that one year after the exercise.

Question 40

Flow-through Character

Answer 40

• Partnerships, LLPs and S corps are pass through entities. This means income is passed through from an entity to the individual and is taxed to the individual.
• LLC can elect to be taxed as a corporation, but LLC members usually elect to be taxed as a partnership. With this election an LLC is also a pass-through entity.

Question 41

Basis in an S Corp

Answer 41

• Calculating basis (re-calc’d each year)
  Beginning basis
  +Capital contributions
  +debt shareholder personally loaned to company
  +Income/gains
• Distributions
  =Adjusted basis before loss allocation
• Deductions
  =Ending basis

Question 42

Basis in a Partnership/LLC

Answer 42

• Calculating basis (re-calc’d each year)
  Beginning basis
  +Capital contributions
  +Allocable share of recourse debt
  +Allocable share of qualified nonrecourse debt
  +Income/gains
  -Distributions
  =Adjusted basis before loss allocation
  -Deduction/losses
  =Ending basis

Question 43

Pass-Through Basis Limitations

Answer 43

• Income tax losses may not be deducted if they exceed the owner’s basis:
  *The unused loss is suspended until sufficient basis become available.
• An individual partner/shareholder may not have a negative basis in the interest.
• Distributions in excess of basis result in a taxable gain.

Question 44

Recourse vs Non-recourse Debt

Answer 44

• A recourse debt holds the borrower personally liable. All other debt is considered non-recourse.
• In general, recourse debt allows lenders to collect what is owed even after they’ve taken collateral (home, credit cards). Lender have the right to garnish wages or levy accounts in order to collect what is owed.

Question 45

Capital Account (Partnership)

Answer 45

• Represents each partners ownership stake in the business. It tracks the initial contributions, additional investments, and their share of profits and losses. Its crucial for understanding each partner’s financial position within the partnership.

Question 46

Pass Through At Risk Limitations

Answer 46

• Loss deductions are also limited by the amount the taxpayer has at risk.
• S corps - Shareholders include only debt that they personally loan to the corporation.
• Partnerships/LLCs - General partners include all partnership debt on which they have personal liability.
  _ Limited parterns and LLC members include only recourse debt for which they are personally exposed and qualified nonrecourse debt for business real estate.

Question 47

Passive Activities

Answer 47

• A passive activity is a trade of business in which the taxpayer does not materially participate.
• Often involve things like real estate rentals.
• Net income from passive activities is usually ordinary income taxed at rates of up to 37% and the 3.8% surtax on net investment income may apply.

Question 48

Passive Loss Limitations

Answer 48

• Losses from passive activites are deductible to the extent there is passive income.

Question 49

1031 Exchanges

Answer 49

• Gain recognition is deferred on like-kind exchanges of real property
  *Investment property for investment property
  *Trade/business for trade/business
  *Does not apply to persona use property or residences
• Gain recognized to the extent of “boot” received
  *Boot includes cash and debt relief
• Losses are not recognized.

Question 50

Section 1250

Answer 50

• Re-characterization of cap gains as ordinary income to recapture accelerated depreciation on certain real property.

Question 51

Section 1231

Answer 51

• Depreciable and real property used in trade or business and held for more than one year are allowed cap gains treatment of gains and ordinary income treatment of losses.

Question 52

Section 1244

Answer 52

• Certaian small company stock owners are allowed ordinary income (vs. cap gains) treatment for losses up to $50k/individual and $100k/joint.

Question 53

Example: Strategy to maximize the value of interest expense deductions (by deferring)

Answer 53