R1 module 3

Question 1

treatment of interest expense on loans

Answer 1

-interest expense paid by cash in advance cannot be deducted until period to which it relates
-deduction is limited to:
1) business interest income
2) 30% adjusted taxable income
3) floor plan financing interest expense
-disallowed interest can be carried forward indefinitely; limitation does not apply if gross receipts $29M or less for prior three taxable years

Question 2

adjusted taxable income

Answer 2

-taxable business income for year excluding all interest income and interest expense

Question 3

floor plan financing interest expense

Answer 3

-debt typically used to acquire motor vehicles held for sale or lease where debt is secured by acquired inventory

Question 4

nondeductible expenses for schedule c

Answer 4

-salaries paid to sole proprietor
-federal income tax
-personal portion of car, travel, and meal expenses
-personal interest expense (used for itemized deduction if mortgage or investment interest paid)
-personal state and local income taxes (itemized deduction for schedule A)
-health insurance of sole proprietor (reported as adjustment to AGI)
-bad debt expense of cash basis taxpayer
-charitable contributions (itemized deduction for schedule A)
-entertainment expenses

Question 5

net business income/loss

Answer 5

-net business income taxable
-income tax and self-employment tax
-net losses can deduct against other sources of income subject to overall excess business loss and net operating loss limitations

Question 6

self-employment tax

Answer 6

-adjustment to income allowed for 1/2 of self-employment tax (medicare + SS); allowing sole proprietor to deduct employer portion of SE tax as adjustment to gross taxable income
-self-employment income subject to 2.9% Medicare tax
-Up to $160,200 subject to 12.4% SS tax
-SE tax calculated on 92.35% of self-employment income

Question 7

self-employment tax calculation

Answer 7

1) multiply self-employment income to 92.35% to get income subject to self-employment tax
2) 92.35% of income calculated * 15.3% (ss and medicare percentages)

Question 8

Hobby Gains/Losses

Answer 8

-if activity not engaged in for profit, activity is concerned a hobby for tax purposes
-deduction for hobby losses limited
-hobby income taxable income
-expenses from hobby not deductable

Question 9

Determining activity considered for profit

Answer 9

-taxpayer carry activity in businesslike manner
-maintain complete/accurate records
-expert in accepted practices of activity or seek expert advice
-devote much personal time to activity
-expectation that assets used in activity appreciate in value
-in past had activities convert from unprofitable to profitable
-history of sustained losses greater than normal start-ups or not due to fault of taxpayer
-substantial income or capital from other sources
-have personal pleasure or recreation
-3-5 years of profit; IRS has burden of proof not engaged in for profit business

Question 10

Rental Income or Loss

Answer 10

Gross rental income + prepaid rental income + rent cancellation income + improvement in lieu of rent - rental expenses

Question 11

rented for fewer than 15 days

Answer 11

-treated as personal residence
-rental income excluded from income
-mortgage interest (first or second home) and real estate taxes allowed for itemized deductions
-depreciation, repairs, utilities not deductible

Question 12

rented 15 or more days

Answer 12

-is a personal uses for greater of:
1) more than 14 days
2) more than 10% of rental days
-expenses prorated between personal and rental use
-property related expenses, mortgage and property taxes different prorated method
-rental use expenses deductible to point of rent income

Question 13

non-residence rental property

Answer 13

-includes rent income in gross income
-expenses are deductible
-reported on Schedule E
-rental losses considered passive and deductible to extent of passive income
-Exception: if active participant in rental activity can deduct up to $25k of rental losses against nonpassive income

Question 14

Income/loss from flow through entities

Answer 14

-flow-through entity’s income, deductions, gains and losses are taxed at individual’s owner level
Types of flow-through entities:
1) partnerships
2) S corporations
3) LLCs taxed as partnerships or S corps
-flow through entities provide partners Schedule K-1s with their share, including business income or loss

Question 15

partnerships

Answer 15

-two or more partners is a partnership
-partnership can elect to be taxed as a C corp and if qualified, can then elect S status

Question 16

individual items of flow-through owners separately stated

Answer 16

-rental real estate income (loss)
-interest income
-dividend income
-royalties
-net ST capital gains (losses)
-net LT capital gains (losses)
-net section 1231 gains (losses)
-charitable contributions
-section 179 expense deduction
-guaranteed payments to partners (partnerships only)

Question 17

guaranteed payments to partners

Answer 17

-compensation paid by partnership to a partner for services rendered or use of capital regardless of partnerships income
-payments are business expense that reduces partnership ordinary income (loss)
-flow through as separately stated items of income on recipient partner’s schedule K-1 and included in partner’s taxable gross income
-subject to self-employment tax and income tax

Question 18

distributions to partners and shareholders

Answer 18

not taxable income because not earned

Question 19

S corporation

Answer 19

-receives a salary not a guaranteed payment
-shareholder receives no self-employment tax because not self-employed
-half of SS and medicare taxes paid by corporation and other half withheld from shareholder’s salary

Question 20

owner’s share of ordinary income

Answer 20

-if active participant in operations, then self-employment income subject to SE tax
-if not active participant, not self-employment income
-S shareholder has no self-employment income regardless of participation or lack of participation in operations

Question 21

tax basis loss limitation

Answer 21

-taxpayer’s investment in ownership adjusted for income, distributions, deductions and sometimes debt
-loss can be deducted to extent of owner’s tax basis; loss in excess of tax basis is suspended until tax basis reinstated in future yrs and carried forward indefinitely
-any suspended losses due to insufficient tax basis remaining when owner disposes of interest are lost

Question 22

tax basis loss imitation calculation

Answer 22

ordinary business loss * partnership interest = partner’s share in loss
beginning tax basis in partnership interest - distributions = basis in ordinary business loss
-can only deduct loss to amount of basis
-suspended loss is carried forward

Question 23

excess business loss limitation

Answer 23

-not allowed to deduct an overall “excess business loss” for year
-includes persons with schedule c items and other sources of business income
-loss applied only after other applicable losses
-the excess total amount of deductions > sum of business income + threshold amount ($578k MFJ) ($289k for all others)
-excess loss over threshold after is carried forward as NOL

Question 24

net operating loss rules

Answer 24

-generated before 2018 offset 100% of future year’s taxable income, but carried forward for 20 yrs
-generated after 2017 carried forward indefinitely
-NOL carryforwards from post 2017 offset 80% taxable income in 2019 and 2020 after deducting any pre-NOL carryforwards

Question 25

Excess business loss calculation

Answer 25

1) sum business income and loss to get total loss
2) threshold amount based on filing status is amount can deduct
3) residual amount between total loss and deduction is amount to be carried forward