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CFP Personal > Income Tax Planning > Flashcards

Income Tax Planning Flashcards

1
Q

Taxation on Scholarships

A
  • NOT INLUDED IN GROSS INCOME - when used for tuition and books as long as recipient is a candidate for a degree
  • INCLUDED IN GROSS INCOME - money received for living expenses, meals, housing & stipends
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2
Q

Below Mkt loan - Imputed Interest

A

Loan Amount <$10K $0 Imputed Interest

$10K < $100K = Lesser of:
- Net Inv Inc (Inv Inc - Inv Exp)
OR
- Int Calc Using AFR - Int using
stated loan rate

**if borrowers NII < $1K, $0 Imputed int

> $100K = Int Calc using AFR - Int Using stated
loan rate

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3
Q

Adoption Credit Limits

A

Limited to the lesser of:
- Qualifying Adoption Expenses
- Credit of $15,950
- Amount of tax due

*Not Refundable

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4
Q

Section 1231 vs 1245 vs 1250

A

1231 assets are held for longer than 1 year and include personalty assets (S 1245) and real assets (S 1250) used in trade or business

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5
Q

S 1231 Benefits

A
  • Depreciation recatpure is treated as ordinary income
  • Gains over the original price are treated as capital gains. Only way to have a S 1231 gain on a S 1245 property is to sell it for more than it was originally purchased for
  • Losses are treated as ordinary losses and not subject to the capital loss limits

*C Corps pay the same rate of tax on ordinary income and capital gains. The corp can recognize losses without having to generate capital gains to offset them

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6
Q

S 1245 Details

A
  • Tangible property used in trade or business & includes depreciation property (equip), patents, copyrights and other intangibles.
  • if gain, recaptured depreciation is ordinary income & anything above that is a 1231 gain
  • if loss, ordinary loss
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7
Q

S 1250 Details

A

Governs recapture of depreciation on Real S 1231 assets that includes buildings and RE

Steps:
- Recapture excess depreciation and tax at ordinary rates (Dep taken- Straight Line)
- If gain exceeds, the lesser gain or straight-line is taxed at 25%
- Any gain in excess of the above is taxed according to S 1231

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8
Q

5 Year lookback on S 1231 description

A

Forces the TP to net S 1231 gains and losses over a 5 year period.

  • if there are losses, TP will have to take the total of the previous losses as ordinary gains and any remaining gain would be classified as a 1231 gain
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9
Q

Sole Proprietor Summary

A

Advantages
- Easy to form
- simple to operate
- easy to sell business assets
- few admin burdens
- income generally passed through to owner on Schedule C of Form 1040

Disadvantages
- Limited sources of capital
- Unlimited Liability
- no guarantee of continuity beyond the proprietor
- business income subject to SE tax

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10
Q

Calculation of SE Tax

A

Net Self-Employment Income x 92.35% (100 - 6.20% -1.45% = 92.35%) =

Net Earnings subject to SE Tax

x 12.40% up to $160,200 (SS Wage Base) + 2.90% on all income (1.45% x 2 = 2.90%) = Self-Employment Tax

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11
Q

Partnership Summary

A

Advantages
- More sources of initial capital than proprietorships
- Usually have more management resources available than proprietorships
- Have fewer admin burdens than corps
- Income and losses are generally passed through to the partners for tax purposes

Disadvantages
- Transfers of interest is more difficult than for proprietorships
- Unlimited Liability - each partner is liable for partnership debts and obligations
- Partnership income tax and basis adjustment rules can be complex
- Business net income is subject to self-employment tax
- Partners are entitled to few tax-free fringe benefits that are generally available to employees

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12
Q

LP Summary

A

Advantages
- Favorable pass-through partnership taxation status
- Flexibility in structuring ownership interest
- Limited partners are not personally liable for the debts and obligations of the LP as long as they do not engage in management

Disadvantages
- must file with the state to register
- in most states, general partners are liable for debts and other obligations of the LP
- losses for limited partners are generally passive losses

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13
Q

LLP Summary

A

Advantages
- Favorable pass-through partnership taxation status available
- Flexibility in structuring ownership interest
- Partners can insulate themselves from the acts of other partners

Disadvantages
- required to file with the state to register
- unlimited liability for own acts of malpractice

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14
Q

Family Limited Partnerships Summary

A

Advantages
- Control retained by senior family member
- Valuation discounts are available for minority interests
- annual exclusion gifts are generally used to transfer interests to family members
- Some creditor protection
- Restrictions can be placed on transferability of LP interest of junior family members
- FLP is commonly used as an estate planning strategy

Disadvantages
- Attorney setup fees and costs
- periodic valuation costs
- operational requirements
- potential IRS challenges regarding valuation and discounts

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15
Q

LLC Summary

A

Advantages
- members have limited liability
- number of members is unlimited but a single member LLC is a disregarded entity for tax purposes
- members may be individuals, corps, trusts, other LLC and other entities
- income is passed through to the members, usually a k-1
- double taxation affecting most C corps is avoided if partnership tax status is elected
- members can participate in managing the LLC
- distributions to members do not have to be directly proportional to the members’ ownership interest as they do for S corps
- can have multiple classes of ownership
- entity may elect to be taxed as a partnership, an S corp or a C Corp

Disadvantages
- may have limited life
- transfer of interest is difficult and sometimes limited by operating agreement
- some industries or professions may not be permitted to use LLC
- laws vary from state to state regarding LLCs
- laws are relatively new for LLCs
- for tax purposes, the complex partnership rules generally apply
- members not meeting exceptions are subject to SE tax on all income earned if partnership status is elected

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16
Q

C Corp Summary

A

Advantages
- relative ease of raising capital
- limited liability of shareholders
- unlimited life of entity
- ease of transfer of ownership interest
- generally more management resources
- shareholder may receive full array of employer-provided tax-free fringe benefits

Disadvantages
- potential for double taxation due to entity level taxation
- administrative burdens
- more difficult to form and dissolution can cause taxable gains
- borrowing may be difficult without stockholder personal guarantees
- requires a registered agent
- requires a federal tax ID

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17
Q

S Corp Summary

A

Advantages
- income is passed through to the shareholders for federal income tax purposes
- income is taxed at the individual level which may be a lower tax rate than the applicable corporate rate
- shareholders have limited liability
- distributions from S corps are exempt from the payroll tax system, assuming the corp provides adequate comp to those shareholders who are employees of the corp

Disadvantages
- limited to 100 shareholders
- only one class of stock
- can’t have corporate, partnership, certain trust or nonresident alien shareholders
- shareholder employees owning more than 2% must pay taxes on a range of employee fringe benefits that would be tax free to a shareholder/employee of a c corp
- the tax rate of the individual shareholder may be higher than the corporate tax rate
- borrowing may be difficult without stockholder personal guarantees, which negates part of the advantage of limited liability

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18
Q

Personal Holding Company Definition

A

A corp is a PHC if both are met:

  • at least 60% of the corp adj ordinary gross income for the tax year is from divs, interest, rent and royalties
  • more than 50% of the corps outstanding stock is owned by 5 or fewer individuals

**if PHC has too much undistributed income, a penalty tax of 20% can be imposed

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19
Q

Tax filing for different business orgs

A

Sole Prop - Schedule C 1040

GP, LP, FLP - Form 1065, k-1 flows to Schedule E of 1040

LLP - may file as corp or partnership

LLC - 1 member > Schedule c of 1040. 2 or more, form 1065 (Partnership), Form

1120-S (S Corp) or form 1120 (C Corp)

S Corp - 1120S, k-1 to shareholders

C Corp - Form 1120

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20
Q

Taxation Concepts of different business orgs

A

Sole Proprietor - individual

C Corp - Entity

GP, LP, LLP, FLP, LLC, S Corp - Flow through

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21
Q

Deduction for Business Income From Pass-through Entities and Sole Props

A
  • individuals generally may deduct 20% of QBI from a partnership, S corp, or Sole prop as well as 20% of aggregate qualified REIT dividends, qualified cooperative divs, and qualified publicly traded partnership income
  • not allowed in computing AGI but rather a deduction reducing taxable income
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22
Q

Corp dividend-received deductions based on ownership

A
  • < 20% = 50% Dividend Deduction
  • 20% < 80% = 65% Dividend Deduction

> 80% = 100% Dividend Deduction

23
Q

Owners income on different business orgs

A
  • Sole prop - SE
  • C Corps - w-2 and div income
  • S Corp - w-2 and ordinary income. Excess profits distributed are not subject to SS Tax
  • GP, LP, LLP, FLP’s - SE but limited partners/members are not subject to SS tax unless they perform personal services for their entity
  • LLC - depends on filing choice. Limited partners are not subject to SS tax unless they perform personal services for their entity
24
Q

Child Tax Credit

A
  • $2K credit per qualifying child < 17 years old
  • $1,600 can be refundable
  • includes descendants of children, ie. grandchildren
  • > 50% of support and > 1/2 of the year in home
  • Phase out - $200K (S) $400K (MFJ)
25
Q

Dependent Care Credit

A
  • Employment related care cost for dependent < 13 or handicapped dep. or spouse
  • credit of 20% on up to $3K of expenses per qualified child with a max of $6K for 2 or more children
  • lesser of actual costs or $3K x 20% = $600 or $6K x 20% = $1,200
26
Q

Qualifying Relative Test

A
  • Relationship - includes in-laws, uncle, aunt
  • Support - provides 50%+ of support (something given, not just used)
  • Gross Income - Dependent Income < $4,700**
  • Joint tax return - if joint with spouse, return only to claim a refund
  • Citizenship - US, Canada or Mexico
27
Q

Qualifying Child Tests

A
  • Relationship
  • Adobe - more than 1/2 the year at the home
  • Age - < 19 or < 24 if FT student (5 months out of the year)
  • Support - provides 50%+ of support
  • Joint tax return - if joint with spouse, return only to claim a refund
  • Citizenship - US, Canada or Mexico
28
Q

DIF System

A

Discriminant Inventory Function - computer program that assigns a numerical value to individual and some corp returns

  • the higher the number, the greater chance that an examination will change the tax liability
29
Q

Accuracy Related Penalty on Returns

A
  • Penalty is 20% due to negligence or disregard of rules or regulations, or substantial understatement of income tax
  • Substantially understate if understatement of tax exceeds the greater of 10% of the correct tax or $5K
  • Fraud penalty is 75% of underpayment due to fraud
30
Q

Statute of limitations on Returns

A

If NO return filed:
- TP has a 3 year window for claiming a refund and applying any credits
- For IRS, time starts when return is filed to assess and collect any outstanding balances

If Return is filed:
- 3 year limit for auditing a tax return & a 10 year limit for the IRS to collect this tax
- If gross income is understated by 25% or more, the limit is 6 years

31
Q

Interest and Penalties for Late Returns

A

Failure to File = FIVE % up to 25%
Failure to Pay - POINT 5% up to 25%

If both apply, failure to file is reduced by the F t P penalty

32
Q

Items specifically excluded from Gross Income

A

Gifts & Inheritance
Life insurance proceeds
Scholarships
Gains on sale of personal residence
Roth qualified distributions
Compensation for sickness or injuries
Hospital premiums paid by employer
Any benefit required by the employer for the employer benefit
occasional benefits from employer: like tix to the baseball game

33
Q

Safe Harbor Rules for Tax Withholding

A
  • 100% of last year’s tax liability
  • 90% of this year’s tax liability

if AGI > $150K
- 110% of last year’s tax liability
- 90% of this year’s tax liability

  • by January 15th of the following year
34
Q

Above the line deductions - FOR AGI

A

Known as adjustment to income:
$2500 of student loan interest (phaseout)
HSA, IRA, PSP contributions
Alimony for divorces prior to 2019 if pmts don’t extend beyond death
Trade or business expense (ordinary, necessary, reasonable)
1/2 SE tax paid & SE health insurance premiums
Losses on sale or exchange of property
Premature with penalties
50% limit on meals
100% limit on transportation
moving & entertainment expenses are no longer deductible

35
Q

Below the Line Deductions - FROM AGI

A
  • Standard Deduction
  • Itemized Deductions
  • Charitable contributions
  • Limited casualty losses - from federally declared disasters
  • Medical expenses > 7.50% of AGi
  • Mortgage interest up to $750K of indebtedness
  • State and local use taxes, property taxes (Capped at $10K)
  • Investment Interest to the extent of net investment income (Not including Qualified Divs and LTCG’s)
  • Gambling losses to the extent of gains
  • Qualified Business income deduction
36
Q

3 Primary Sources of Tax Law

A
  1. IRC
  2. Administrative
    - Regulations - issued by the TSY
    - Rev Rulings - interpretations by the IRS, courts not bound
    - Rev Procedures - internal practices & processes within IRS
    - PLR - issued by the IRS at TP’s request, can’t be relied on by other TP’s
    - Determination Letters - for completed transactions issued by the District Directors
    - TAM’s - issued by national IRS office and only apply to TP’s in an audit
  3. Judicial - 5 different court jurisdictions. Only the US District court which allows a jury trial
37
Q

Depreciation of Property Classes

A

3 Years - Tractors, rent-to-own property, horses

5 Years - Autos, computers, office equipment

7 Years - Office Furniture & Fixtures

27.5 Years - Rental Home - (Use mid-month convention)

39 Years - Office Building

38
Q

Depreciation Convention Methods

A
  • 1/2 year for property placed into service
  • mid-month - for real property
  • mid-quarter - if > 40% of personal property is placed into service in the last quarter
39
Q

Section 179 Deduction

A

Deduction is lesser of:

  • Property placed into service
  • Taxable income
  • $1,160,000 Phased out for PPS > $2,890,000 (anything over this limit reduces the deduction $ for $)

Basis is reduced by amount claimed

Carryover is allowed

40
Q

Holding Period on gifted property

A
  • If GAIN - holding period is donor + donee’s holding period
  • if LOSS - holding period starts at the date of the gift
41
Q

Passive income rules

A

*max deduction is lesser of: at risk or passive income

42
Q

Preferred stock tax treatment for Corporations

A

70% of the preferred dividends received by a corp are exempt from federal income taxes

If 20% or more of the corp paying the dividend is owned by the company receiveing the dividends, then 100% of the div is tax free

43
Q

Accrual vs cash basis

A
  • Accrual - recognizes income in the year the services or goods are provided
  • Cash - recognize income in the year the payment is actually or contructively received
44
Q

How are nondividend distributions taxed

A
  • they are taxed to the extent that they exceed the basis
45
Q

Commerce Clearing House

A
  • plain language interpretation of tax law
46
Q

Material participation rules

A
  • the TP dedicated more than 500 hours to the activity OR
  • the TP dedicated more than 100 hours and the most of anyone

*Part of the rules for PAL allows a TP to make an annual election to join similar activities to acheive the > 500 hours for materiality

47
Q

Passive activity suspended losses

A
  • they are expensed when an activity either has a passive income for that year or the activity is disposed/sold
48
Q

what is 52-53 week

A
  • it is a special calendar year, otehr than fiscal or calendar, that the IRS recognizes that ends on a specified day of the week (such as Friday) that occurs in the last week of the last month of the tax year
  • example September 29
49
Q

Under what circumstances is a trip outside the US considered to be purely for business?

A
  • the TP does not have control over the timing or arrangements for the trip
  • the trip lasts < 7 days
  • < 25% of the time spent on the trip was personal
  • vacation was not a primary consideration for the trip
50
Q

Sources of substantial authority available for tax research include

A
  • IRC
  • Congressional Committee Reports
  • Treasury Regulations
  • PLR’s
51
Q

Who can not own S corp shares

A
  • limited to 100 shareholders
  • LLCs, partnerships and other corps
  • NRA and most trusts

*a GRAT could own shares though

52
Q

Types of property subject to cost recovery

A

If used in business:
- Personalty - deprecitaion
- Real estate - depreciation
- natural resources - depletion
- intangibles - amortization

*land is not subject to depreciation

53
Q
A

CFP Personal (3 decks)

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