Bryant - Course 4. Tax Planning. 16. Tax Management Techniques Flashcards

Question

The Work Opportunity Credit (WOC) is available for employers hiring from each of the following groups EXCEPT: * Qualified SSI recipients * Qualified veterans * Qualified ex-felons * New Immigrants

Answer 1

New Immigrants The WOC includes the following targeted groups: * Long-term family assistance recipient, * Qualified recipient of Temporary Assistance for Needy Families (TANF), * Qualified veteran, * Qualified ex-felon, * Designated community resident, * Vocational rehabilitation referral, * Summer youth employee, * Supplemental Nutrition Assistance Program (SNAP) benefits (food stamps) recipient, * SSI recipient, or * Qualified long-term unemployment recipient.

Answer 2

The **Earned Income Credit is fully refundable**. It is a special **"negative income tax" or welfare benefit for certain low-income families based on earned income** that includes wages, salaries, tips, and other employee compensation plus net earnings from self-employment. * The Earned Income Credit **encourages low-income individuals to become gainfully employed**. * Eligibility Rules: The credit is available to **individuals with qualifying children and certain individuals without children if the earned income and AGI thresholds are met**. * Qualifying children are the taxpayer's children, stepchildren, foster children, or descendants of the taxpayer's children. The **children must share the same principal place of residence with the taxpayer for more than one-half of the tax year**. They **must be less than age 19 or be full-time students under age 24 or be permanently and totally disabled.** * The earned income credit **applies to married individuals only if a joint return is filed**.

Answer 3

Individuals without children are eligible only if the following requirements are met: * The individual's principal **place of residence is in the United States for more than one-half of the tax year**. * The individual (or spouse if married) is **at least age 25 and not more than age 64** at the end of the tax year. * The individual is **not a dependent of another taxpayer for the tax year**. * **A taxpayer will become ineligible for the earned income credit if the taxpayer has excessive investment income**. * **Excessive investment income is defined as disqualified income that exceeds $10,000 for the taxable year 2023**. **Disqualified income includes**: * Dividends * Interest (both taxable and tax-free) * Net rental income * Capital gain net income

Answer 4

The miscellaneous credits, except the foreign tax credit, are specialized types of tax credits. U.S. citizens, resident aliens, and U.S. corporations are subject to U.S. taxation on their worldwide income. To reduce double taxation, the tax law provides a foreign tax credit for income taxes paid or accrued to a foreign country or a U.S. possession. * Taxpayers **may elect to take a deduction for the taxes paid or accrued instead of a foreign tax credit**. **Generally, the foreign tax credit results in a greater tax benefit because the credit is fully offset against the tax liability, while a deduction merely reduces taxable income**. * **Treatment of Unused Credits**: If a taxpayer cannot claim a credit for the full amount of qualified foreign income taxes paid or accrued in the year, they are allowed a carryback and/or carryover of the unused foreign income tax, except that no carryback or carryover is allowed for foreign tax on income included under IRC Section 951A. **Taxpayers can carry back for one year and then forward for ten years the unused foreign tax**. For more information on this topic, see **Publication 514, Foreign Tax Credit for Individuals.**

Answer 5

* **Refundable Credits** are typically earned income credits. The **Earned Income Credit is a special "negative income tax" or welfare benefit for certain low-income families**. The credit is **based on earned income that includes wages, salaries, tips, and other employee compensation plus net earnings from self-employment**. It is designed to encourage low-income individuals to become gainfully employed. * The **Child Tax Credit is partially refundable in 2023**. * **The American Opportunity Credit allows a 40% refundable credit, up to $1,000**. * **Miscellaneous Credits** **are specialized tax credits, except the foreign tax credit**. U.S. citizens, resident aliens, and U.S. corporations are subject to U.S. taxation on their worldwide income. To reduce double taxation, the **tax law provides a foreign tax credit for income taxes paid or accrued to a foreign country or a U.S. possession**.

Answer 6

Earned Income Credit Refundable credits not only offset a taxpayer's income tax liability but, if the refundable credits exceed the taxpayer's tax liability, such excess will be refunded by the government to the taxpayer. The only fully refundable credit listed is the Earned Income Credit. 40% of the AOTC is refundable (i.e., up to $1,000). However, the AOTC is categorized as a 'partially refundable credit.'

Answer 7

$15,950 in 2023 The credit is available the year the adoption becomes final. The 2023 maximum credit is $15,950. Since the couple is below the phaseout range for 2023 (i.e., $239,230 and $279,230), they are eligible for the full credit.

Answer 8

Foreign tax credit A foreign tax credit is a type of miscellaneous credit and not a general business credit.

Answer 9

* **The current long-term capital gain tax rates are 0%, 15%, and 20%, based on the taxpayer's income**. The **impact of lower tax rates on long-term capital gains has been substantial for tax planning**. Some traditional tax planning, such as avoiding dividend treatment for distributions from C corporations, has been altered significantly. The changes are too recent to determine their implications, but major alterations in planning should result from this fundamental change in the tax system. To ensure that you have an understanding of some tax planning issues, the following topics will be covered in this lesson: * Intra-family Transfers * Incentive Stock Options * Charitable Gifts * Stock Redemption Upon completion of this lesson, you should be able to: * Describe the major intra-family transfer techniques, * Determine which of the two stock-option arrangements will be preferred by employees, * List employer and employee requirements for an incentive stock option to be valid, * List different organizations qualified under IRC Section 170 for charitable contributions, * Calculate the amount of contribution for various non-cash property donated, * Determine the limitation applied to contributions in different situations, and * Describe the application of carryovers in charitable contributions.

Answer 10

The **most significant benefit of transferring property to other family members is often for wealth transfer reasons or to utilize estate planning techniques**. * Due to the large reduction in marginal tax rates after 1986, the income tax benefits of these transfers have been greatly reduced. Furthermore, the compression (e.g., 10% - 37% versus 11% - 50%) of the marginal tax brackets has also reduced the income tax benefits of intra-family transfers. In the pages that follow, the following techniques will be reviewed: * Employment of family members * Sale-lease backs and gift-lease backs * Family limited partnerships (FLP) * Installment sales and self-canceling installment note (SCIN) * Private annuity

Answer 11

* This technique is **usually done in the context of family-owned businesses since children pay taxes at much lower tax rates than parents**. * The key to this strategy is to **compensate a child with a wage that matches a market-based rate for the job they are performing**. * Additionally, the **child must be qualified and have a skill set equal to the job requirements**. * As long as these two issues are addressed, the employment of a child in a family-owned business should withstand any potential IRS challenge.

Answer 12

The **biggest advantage** of **sale-leasebacks** and **gift-leasebacks** is that they **can transfer wealth relatively quickly while gaining some income tax advantages**. * **Property that is used in a trade or business is the most appropriate type of property to use for this technique**. * For instance, **a parent who is a dentist in the highest marginal tax bracket could sell or gift all of the office equipment to a child who is in a lower tax bracket. The parent would then make lease payments to the child for the equipment, which would be a tax-deductible expense**. * **The child would have to report income on the lease payments but pay tax at lower marginal tax rates**. The **child would be able to offset some of this income by the depreciation expense of the newly acquired equipment**. * The **child's basis in the equipment would represent the depreciable value**. * However, **if the equipment was purchased through a sale-leaseback, the purchase price becomes the child's basis**. * In the case of a **gift-leaseback, the child would simply assume the parent's basis**. * To validate the transaction, it is **extremely important to structure the sale and the lease at the prevailing market rates**. Not doing so would invite a challenge from the IRS. **To the extent that the parent sold the equipment for more than their adjusted basis, there would be recapture issues for the parent under IRC Section 1245**. However, the primary motive underlying this technique is the actual transfer of wealth to other family members.

Answer 13

The family limited partnership (FLP) **form of business does not constitute a taxable entity**. * Instead, **income is distributed from the business directly to the partners in proportion to their ownership percentage**. * Therefore, **a parent can transfer limited partnership shares to children without relinquishing control of the business**. * These shares are significantly discounted in value when transferred to family members because limited partnership shares cannot control the business. * **The combination of these discounts, along with utilizing annual exclusions, allows parents to transfer substantial ownership percentages over time**. * The **parents can maintain control by keeping the general partnership share, which can be as little as 1%**. * However, as with a general partnership, **the general partners of a family limited partnership have unlimited personal liability**. * **This situation can be remedied with the use of a family LLC**.

Answer 14

The FLP technique is most appropriate to use **when the business generates income from capital resources and not from personal services**. * **A family business in real estate development, management, etc., would be an ideal situation for a FLP**. * **The ability to transfer fractional interests in an apartment building to limited partners is also highly advantageous**. * However, if the family business generates income from personal services, the use of a FLP might be challenged by the IRS under the assignment of income doctrine.

Answer 15

**The advantage of using an installment sale is that the seller can defer recognition of capital gain over several years**. * For an installment sale to be **structured properly, the note must be secured with the underlying asset being sold**. * An installment sale **works well with a sale-leaseback, when the buyer may be a young family member without the ability to pay** for assets or down payment in a lump sum amount. * From an estate planning perspective, an **installment sale** presents a **problem when the seller meets their demise**. The reason is that the **present value of the remaining installment payments is included in the seller's gross estate at death**. This can be corrected using a **self-canceling installment note (SCIN)**. * **If a seller should die before receiving all scheduled payments using a SCIN, the present value of the future payments will not be in the seller's gross estate**. However, **the unrealized capital gain from the forgone remaining SCIN payments will be recognized on the estate's income tax return**. **As with a regular installment sale, a self-canceling installment note must be secured with the underlying asset**.

Answer 16

A **private annuity has income tax consequences akin to self-canceling installment notes (SCINs)**. * For a private annuity to be **structured correctly, the annuity payments must be unsecured**. This is in direct contrast to the structure of an installment sale or a SCIN. * Furthermore, the **payments must be based on the seller's actuarial life expectancy**. * The **buyer's basis of the purchased asset is determined by the actual payments made**. * If a **buyer should die before the seller, the buyer's estate must continue to make payments to the seller**. * If the **seller should die sooner than actuarially expected, the present value of the remaining payments will not be included in the seller's estate**. This is **in direct contrast to outstanding installment sale payments included in the decedent's estate**. * **The unrealized gain from the private annuity will be included on the estate's income tax return, exactly like the SCIN**.

Answer 17

The income tax treatment of unsecured private annuities is based on the following principles: * **Gain is equal to the difference between the present value of the annuity promised and the transferor’s basis**. * **Gain should be reported ratably over a period of years measured by the life expectancy of the annuitant**. * The **transferor’s investment in the contract is the transferor’s basis in the property**. A **portion of each annuity payment payable to the transferor is treated as**: * **return of basis**; * **capital gain**; and * **ordinary income**.

Answer 18

**Stock option plans are used by corporate employers to attract and retain key employees**. * **Both stock option and restricted property arrangements using the employer's stock permit the executive to receive a proprietary interest in the corporation**. Therefore, an executive may identify more closely with shareholder interests and the firm's long-run profit-maximization goals. In addition, it **allows an undercapitalized corporation to acquire employees without expending cash**. The tax law currently includes two types of stock-option arrangements: * **The incentive stock options (ISOs)**, and * The **non-qualified stock options (NQSOs)**. Each type is treated differently for tax purposes.

Answer 19

A stock option can qualify as an incentive stock option (ISO) only if all of the requirements of IRC Section 422 are satisfied. * As a general rule, **the employee will not recognize any taxable income upon the grant or the exercise of an ISO**. Instead, **taxation will occur upon the ultimate sale of the stock acquired through the exercise of the ISO**. * **So the timing of the taxable event is within the employee's control**. At that point, the resulting gain is normally **taxed as a long-term capital gain**. Although no taxable income is recognized at the exercise of an ISO, **the spread does create an adjustment item for alternative minimum tax (AMT) purposes**. Since the AMT is often an unexpected (and costly) result of exercising ISOs, **proper planning must be done to determine the amount and timing of ISO exercises**. Incentive stock option arrangements are **preferred by employees when long-term capital gain rates are low as compared to ordinary income rates**. As the long-term capital gain rate has been decreased to a maximum of 20% (2022) and marginal tax rates for ordinary income are significantly higher (37%), individual taxpayers (employees) favor incentive stock option arrangements.

Answer 20

An incentive stock option (ISO) must meet the following plan or employer requirements: * The **option price must be equal to or greater than the stock's FMV on the option's grant date**. * The **option must be granted within ten years of the date the plan is adopted**, and the **employee must exercise the option within ten years of the grant date**. * The option **must be exercisable only by the employee and non-transferable except in the event of death**. * The **employee cannot own more than 10% of the voting power of the employer corporation's stock immediately before the option's grant date**. * The **total FMV of the stock options that become exercisable to an employee in any given year must not exceed $100,000** (for example, an employee can be granted ISOs to acquire $200,000 of stock in one year, provided that no more than $100,000 is exercisable in any given year). * Other procedural requirements must be met (e.g., **shareholder approval of the plan**). **ISOs can be a valuable tax planning tool because the earliest they are generally taxed is when they are exercised**. Also, **when an employee realizes profits from stock options, those profits in certain cases may qualify as capital gains**.

Answer 21

In addition to the employer plan requirements, the employee must meet the following requirements: * The **employee must neither dispose of the stock within two years of the option's grant date nor within one year after the option's exercise date**. * The employee **must be employed by the issuing company on the grant date and continue such employment until within three months before the exercise date**. **If an employee meets the requirements listed above, no tax consequences occur on the grant date or the exercise date**. * However, **the excess of the FMV over the strike price on the exercise date is a tax preference item for purposes of the alternative minimum tax**. * When the **employee sells the optioned stock, a long-term capital gain or loss is recognized**. * If the employee meets the two requirements, the employer does not receive a corresponding compensation deduction. * **If the requirements are not met, the option is treated as a non-qualified stock option**.

Answer 22

* Because Kay **holds the stock for the required period (at least two years from the grant date and one year from the exercise date)** and because American Corporation **employs Kay on the grant date and within three months before the exercise date**, all of the requirements for an ISO have been met. * **No income is recognized on the grant date or the exercise date** * Although **$30,000 [($400 - $100) x 100 shares] is a tax preference item for the alternative minimum tax in 2021**. * Kay **recognizes a $40,000 [($500 - $100) x 100 shares] long-term capital gain on the sale** date in 2023. * American Corporation is **not entitled to a compensation deduction in any year.**

Answer 23

* This is known as a **disqualifying disposition**. * Kay must **recognize ordinary income on the sale date equal to the spread between the option price and the exercise price, or $30,000 [($400 - $100) x 100 shares]**. * The $30,000 spread between the FMV and the option price is **no longer a tax preference item because the option ceases to qualify as an ISO**. * American Corporation **can claim a $30,000 compensation deduction in 2021**. * Kay also **recognizes a $10,000 [($500 - $400 adjusted basis) x 100 shares] short-term capital gain on the sale date that represents the stock's appreciation from the exercise date to the sale date**. * The gain is short-term because the holding period from the exercise date to the sale date does not exceed one year.

Answer 24

Non-Qualified Stock Options (NQSOs) are **options that do not meet the requirements of IRC Section 422, either intentionally or otherwise**. * There are **generally no tax implications to the recipient of an NQSO on the grant date**. * The **only exception is for publicly traded stock options**. But it is **extremely rare to find nonqualified employee stock options that trade in the public market**. * Note that **employee stock options differ from puts and calls that commonly trade on publicly held companies**. **NQSOs are a convenient and flexible way to award or encourage employees**. * There are **no limits as to how many NQSOs may be granted, how the exercise price is determined, or the time limitation for the expiration of the option**. * NQSOs are **sometimes granted at an exercise price that is less than the fair market value of the stock on the grant date**. These are referred to as **“discounted stock options.”** * **But the deferred compensation rules of Code section 409A may cause such discounted stock options to be subject to tax upon grant**.

Answer 25

* The **taxation of NQSOs typically occurs on the exercise date**. At that point, **the difference between the fair market value of the stock and the exercise price is recognized as additional compensation unless the stock is restricted** (i.e., the stock is subject to a substantial risk of forfeiture and is not transferable). * **Payroll taxes must be withheld upon the exercise of NQSOs (federal, state, and local withholding, FICA, and FUTA)**. * The **spread is also included on the employee’s Form W-2 wages in the year of exercise**.

Answer 26

Employers benefit in two ways from the exercise of NQSOs: * The **company receives the gross exercise cost of the options**. * The **company is entitled to a tax deduction for the compensation element that is taxed to the employee**.

Answer 27

Employer Employers are more favorably treated under the non-qualified stock-option rules. That is, **employers receive a tax deduction for the compensation related to a NQSO plan, but do not receive a corresponding deduction if an ISO plan is adopted**.

Answer 28

**Under IRC Section 170, corporations and individuals who itemize their deductions can deduct charitable contributions to qualified organizations**. Except for certain contributions made by corporations, **taxpayers take the deduction in the year the contribution is made**, regardless of the taxpayer's method of accounting. The amount of the deduction depends on: * The type of charity receiving the contribution, * The type of property contributed, and * Any applicable limitations.

Answer 29

* If a taxpayer contributes **cash**, the deduction amount is easily determinable. However, if non-cash property is donated, the contribution amount is not as easy to identify. In the case of **non-cash property**, the amount of the donation depends on two factors: * The type of property donated, and * The type of qualifying organization (public charity or private non-operating foundation) to which the property is given. A gift of property that consists of less than the donor's entire interest in the property is not usually considered a contribution of property. For example, no charitable contribution is made when an individual donates the use of a vacation home for a charitable fund-raising auction.

Answer 30

Contribution Of Capital Gain Property * In general, **the amount of a donation of capital gain property is its fair market value (FMV)**. * **IRC Section 1.170A-1(c)(2)** defines a property's FMV as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. * For charitable contributions, **capital gain property is defined as property held over one year on which a capital gain would be recognized if it were sold at its FMV on the date of the contribution**. * **If a capital loss or a short-term capital gain would be recognized on the sale of the property, the property is considered to be ordinary income property for purposes of the charitable contribution deduction**.

Answer 31

**Property’s FMV – Capital Gain that would be recognized** = Contribution to Private Non−Operating Foundation The tax law provides an exception to the above general rule for contributions of capital gain property, other than **publically traded stock which qualifies for long-term gain treatment**, to private non-operating foundations. * The **amount of the contribution to a private non-operating foundation is the property's FMV, reduced by the capital gain that would be recognized if the property were sold at its FMV on the date of the contribution**. * This means that generally, **the deductible amount of the contribution is the property's adjusted basis**.

Answer 32

A second exception applies to capital gain property (i.e., tangible personal property) contributed to a public charity and used by the organization for purposes unrelated to the charity's function. In such cases, **the amount of the contribution deduction is equal to the property's FMV minus the capital gain that would be recognized if the property were sold at its FMV**. * This **amount generally is the property's adjusted basis**. * **Tangible property is all property that is not intangible (e.g., property other than stock, securities, copyrights, patents, etc.**). * Personal property is all property other than real estate. The **taxpayer is responsible for proving that the property was not put to unrelated use**. * However, **a taxpayer meets this burden of proof if, at the time of the contribution, the taxpayer reasonably anticipates that the property will not be put to unrelated use**. The immediate sale of the property by the charitable organization is considered to be a use unrelated to its tax-exempt purpose.

Answer 33

* As the college does not use the painting for purposes unrelated to its function as an educational institution,** the amount of Laura's contribution is equal to its FMV ($5,000)**. * On the other hand, if the college had sold the painting immediately after receiving it, the presumption is that the **property's use was unrelated to the college's tax-exempt purpose**. In this case, Laura's contribution is only **$3,000**.

Answer 34

* In general, if ordinary income property is contributed to a charitable organization, **the deduction is equal to the property's FMV minus the amount of gain recognized if the property were sold at its FMV on the contribution date**. * In most cases, **this deduction is equal to the property's adjusted basis**. * This rule applies regardless of the charitable organization to which the property is donated. * For this purpose, **ordinary income property includes any property that would result in the recognition of income taxed at ordinary income rates if the property were sold**. Therefore, ordinary income property includes: * **inventory** * **works of art or manuscripts created by the taxpayer** * **capital assets that have been held for one year or less** * **Section 1231 property (property used in a trade or business that is subject to depreciation) to the extent a sale would result in the recognition of ordinary income due to depreciation recapture**

Answer 35

* The amount of Bart's contribution is $10,000 ($15,000 - [$15,000 - $10,000]) because he held the land for less than one year.

Answer 36

Under certain circumstances, a corporation's donation of inventory to certain public charities gives rise to a contribution valued at more than the adjusted basis of the inventory. Exceptions to the above statement: * Inventory to be used by the charity solely for the **care of the ill, needy, or infants**. * Donations of **scientific equipment constructed by the taxpayer and donated to a college, university, or qualified research organization to be used for research, experimentation**, or research training in the physical or biological sciences. * **Contributions of computer technology and equipment that is donated to public libraries and elementary and secondary schools**. In all three cases, **the amount of the charitable contribution is the property's FMV, reduced by 50% of the ordinary income that would be recognized if the property were sold at its FMV**. However, **the contribution amount is limited to twice the basis of the property**.

Answer 37

* Because this transaction qualifies under the exception, the amount of Able's contribution (before any limitations are applied) is $6,500 [$10,000 - (0.50 x $7,000)]. * The actual amount of the contribution is limited to $6,000 (2 x the $3,000 basis in the property).

Answer 38

When a **taxpayer renders services to a qualified charitable organization, the taxpayer may only deduct the un-reimbursed expenses incurred to render the services**. These items include: * out-of-pocket transportation expenses * the cost of lodging * meal expenses [50% deductible if purchased from a restaurant while away from home (2023)] * and the cost of a uniform without general utility that is required to be worn in performing the donated services. The out-of-pocket expenses are deductible only if they are incurred by the taxpayer who renders the services to the charity. No deduction is allowed for traveling expenses while away from home unless there is no significant element of personal pleasure, recreation, or vacation in such travel.

Answer 39

Instead of the actual costs of operating an automobile while performing the donated services, the law permits a deduction of 14 cents per mile.

Answer 40

$140 Mindy can deduct $0.14 mile for the 1,000 miles of travel for charitable purposes. $0.14 x 1,000 miles = $140 of deductible volunteer expenses. **A taxpayer’s time is not deductible.**

Answer 41

* For individuals, the **general overall limitation applicable to public charities is 50% of the taxpayer's AGI for the year**. * **Gifts of cash only** to a 50% limit organization (i.e., public charity) have a **deduction limit of 60% AGI**. * Any contributions over the overall limitation **may be carried forward and deducted in the subsequent five tax years**. * In addition, the tax law **imposes further limitations on contributions of capital gain property to either a public charity or a private non-operating foundation and all types of property contributions to private non-operating foundations**.

Answer 42

Under certain circumstances, a **special 30% of AGI limitation applies**. * **Contributions of capital gain property to public charities are generally valued at the property's FMV but are subject to an overall limit of 30% of AGI instead of a 50% limit**. * **However, the taxpayer may elect to use the property's basis instead, and the deductible amount would be 50% of AGI**. This limit does not apply, however, in the following situations: * **Capital gain property (tangible personal property) donated to a public charity that does not put the property to its related use**. In such cases, the **contribution amount is scaled down by the capital gain that would be recognized if the property were sold**. * The taxpayer elects to reduce the amount of the charitable contribution deduction by the capital gain that would be recognized if the property were sold.

Answer 43

* Because the painting is put to a use related to the university's purpose, the amount of Joy's contribution is $30,000. * The amount of Joy's charitable deduction for the year, however, is limited to $15,000 (0.30 x $50,000 AGI) * Unless she elects to reduce the amount of the contribution by the long-term capital gain.

Answer 44

* The overall deduction limitation of 30% of AGI also applies to the **contribution of all types of property other than capital gain property (e.g., cash and ordinary income property) to a private non-operating foundation**. * However, the deductibility of certain contributions to this type of charity may be subject to even further restrictions.

Answer 45

Contributions of capital gain property to private non-operating foundations are **limited to the lesser of**: * **20% of the taxpayer's AGI** or * **30% of the taxpayer's AGI, reduced by any contributions of capital gain property donated to a public charity**.

Answer 46

* The church contribution is initially subject to the **60%** limitation and is fully deductible because the $22,000 contribution is less than the limitation amount of $42,000 (0.60 x $70,000). * Ted's deduction for the contribution to the private non-operating charity (a 30% charity) is limited to **$13,000**. * This is the **lesser of (i) 30% AGI (ii) 50% AGI ($35,000) - the $22,000 gift to the church**.

Answer 47

* Carryovers may be deducted only to the extent that the limitation of the subsequent year exceeds the contributions made during that year. * These general rules also apply with regard to special limitations. For example, if the property subject to the 30% limitation is donated during the current year, and the contribution amount exceeds the limitation, the excess may be carried over to the five subsequent years subject to the 30% limitation in the carryover years. * If a taxpayer has contribution carryovers about to expire, the taxpayer should consider reducing the current year's contribution so that the carryovers can be deducted. * A deduction for carryover contributions may be taken to the extent that the 30% limitation (or 50%, 60%, or another applicable limitation is applied to the original contribution) of the subsequent year exceeds the amount of the property donated during the subsequent year, which was subject to the same percentage limitation. * The carryovers are used in chronological order.

Answer 48

* The **redemption is treated as a taxable dividend (to the extent of E & P)** * The **redemption is treated as an exchange of the stock, generally resulting in capital gain or loss treatment by the shareholder**.

Answer 49

The first consequence, taxable dividend treatment, **prevents corporations from paying disguised dividends in the form of a stock redemption taxable as a capital gain**. For example, the corporation might redeem 10% of its sole shareholder's stock rather than pay a cash dividend to the shareholder. After the redemption, the shareholder continues to own all of the outstanding stock, retains the same amount of control over the corporation, and has received a substantial distribution of money or other property. The **rules to determine when a stock redemption is treated as a taxable dividend and when it is an exchange of the stock are very complex**. As a guide, **if the stockholder whose stock is being redeemed has a significantly reduced ownership interest, exchange treatment may be possible**.

Answer 50

The second consequence, exchange treatment, is far less significant than prior to the tax rate changes for long-term capital gains and qualified dividends. **Since long-term capital gain and qualified dividend income have the same applicable tax rates, the rate differential between the two is eliminated**. However, **the exchange treatment is preferable if the shareholders have unused capital losses or capital loss carryovers that otherwise would be of limited tax benefit**. **A tax-free recovery of the shareholder's stock basis is not permitted if the distribution is a dividend. In contrast, exchange treatment permits shareholders a tax-free recovery of their investment in the stock**.

Answer 51

**Dividends paid from earnings and profits (E&P) are fully taxable to shareholders and are not deductible by the corporation**. * Therefore, in a closely held corporation where ownership and management are not separated, the parties have in the past wished to increase salary payments to shareholder-employees rather than increase dividends. **Such payments are deductible to the corporation (if they are reasonable)**. This would allow the corporation to get a deduction for the amounts paid to shareholder-employees when the distribution will be taxed as ordinary income to the shareholder-employee if paid as a dividend. * **With the reduction of the tax rates for qualified dividends, this strategy may not be beneficial in many cases**. * **While the corporation can deduct reasonable compensation, the shareholder-employee will pay at ordinary income rates, and employment taxes will also have to be paid by the corporation and the shareholder-employee**. * It may often be the case that the net after-tax dollars to the shareholder-employee will be greater if the corporation foregoes the deduction and the shareholder-employee pays the dividend tax rate without the need to pay employment taxes.

Answer 52

A **contrary incentive may be present for a shareholder to lease property to a corporation instead of transferring it to the corporation as a capital contribution**. Even though the increased rental payments are **taxable to the shareholders as ordinary income, these payments are deductible as business expenses by the entity as long as the amounts paid are reasonable**. Each case will have to be examined individually to determine the best course of action.

Answer 53

* The salary payments result in only a single level of taxation, while the dividend payments result in double taxation. * Still, since the single level of payment will be at the higher ordinary income rates and employment taxes will have to be paid, the double taxation of the corporate income tax and a dividend tax may be lower.

Answer 54

**A corporation should plan to use its net operating loss and capital loss carryovers**. * For example, **the sale of appreciated business assets may result in recognition of Section 1231 gain that can offset capital loss carryovers** because Section 1231 net gains receive capital gain treatment. * Alternatively, **the sale or disposition of assets may result in recognizing ordinary income because of the depreciation recapture rules**. This **ordinary income can offset expiring net operating losses (NOLs)**.

Answer 55

If a business anticipates net operating losses or capital losses during its start-up phase, **an S election may be desirable because the shareholders can use the losses immediately**. The S election may be terminated when the corporation becomes profitable, and C corporation treatment is preferred.

Answer 56

* **Accelerating or deferring deductions can be a useful planning tool for AMT or regular tax planning**. Such acceleration or deferral of deductions is **accomplished by paying a deductible item in a year other than the year in which the expense arose**. * There are limitations to this planning tool. * Only **cash-basis taxpayers may make effective use of this strategy**. * Because of the limitations on the use of certain deductions for regular tax (for example, charitable deductions, medical deductions, and others.) or AMT (e.g., state tax deductions), the timing of the payment of a deduction can provide an opportunity for a taxpayer to choose the tax year in which the deduction will arise.

Answer 57

If she waits and pays the state tax in January, when she will not likely be subject to AMT since she will have no ISO option exercises, she can take full advantage of the state tax deduction against regular tax liability in that year.

Answer 58

* **Charitable Gifts**: Under **IRC Section 170**, corporations and individuals who itemize their deductions can deduct charitable contributions to qualified organizations. Except for certain contributions made by corporations, taxpayers take the deduction in the year the contribution is made, regardless of the taxpayer's method of accounting. * **Stock Redemption**: **Two possible tax consequences can result when a corporation repurchases (redeems) some of its outstanding stock from a shareholder: The redemption is treated as a taxable dividend. (to the extent of E & P) The redemption is treated as an exchange of stock, generally resulting in capital gain or loss treatment by the shareholder**. * **Accelerated or Deferred Deductions**: Acceleration or deferral of deductions is accomplished by paying a deductible item in a year other than the year in which the expense arose. There are **limitations to this planning tool**.

Answer 59

$100,000 * The employer requirements for an ISO to remain valid state that the **total FMV of the stock options that become exercisable to an employee in any given year must not exceed $100,000**. * An employee can be granted ISOs to acquire $500,000 of stock in one year, provided that no more than $100,000 is exercisable in any given year.

Answer 60

The employee cannot own more than twenty percent of the voting power of the employer corporation's stock immediately prior to the option's grant date. * The employee cannot own more than ten percent of the voting power of the employer corporation's stock immediately prior to the option's grant date.

Answer 61

$20,000 * Since Veronica donates the land to Cherry Foundation, which is a private non-operating foundation, the amount of her contribution is $20,000 ($50,000 - $30,000 capital gain that would be recognized if the land were sold).

Answer 62

All of these statements about sale-leasebacks are true. * The selling price and the lease payments must be realistic. * The buyer can depreciate the newly acquired property. * The lease payments made by the seller are deductible as a business expense.

Answer 63

To ensure that you have an understanding of deferral of compensation, the following topics will be covered in this lesson: * Qualified Plans * Qualification Requirements * Tax Treatment to Employees and Employers * Non-Qualified Plans Upon completion of this lesson, you should be able to: * Identify a qualified plan, * Differentiate between defined benefit plans and defined contribution plans, * List distinguishing features of profit-sharing plans, * List qualification requirements for qualified plans, and * Describe two common forms of non-qualified plans.

Answer 64

* The federal tax law provides favorable tax benefits for **qualified pension and profit-sharing plans**. * A qualified plan must meet strict requirements, such as **not discriminating in favor of highly compensated individuals, being formed and operated for the exclusive benefit of employees, and meeting specified vesting & funding requirements**.

Answer 65

* In a qualified plan: **The employer receives an immediate tax deduction for pension and profit-sharing contributions made on behalf of employees.** * **The employee is not taxed on either employer or employee contributions or earnings of the plan assets until funds are withdrawn from the plan at retirement**.

Answer 66

* **Pension plans** * **Profit-sharing plans (including Sec. 401(k) plans)** * **Stock bonus plans, including employee stock ownership plans (ESOPs)**

Answer 67

The features that distinguish a qualified pension plan include the following: * Systematic and definite payments are made to a pension trust (without regard to profits) based on formulas or actuarial methods. * A pension plan may provide for incidental benefits such as disability, death, or medical insurance benefits.

Answer 68

* Under a **non-contributory pension plan**, the **contributions are made solely by the employer**. * Under a **contributory pension plan**, the **employee also makes voluntary contributions** that supplement those made by the employer.

Answer 69

* In a **defined contribution pension plan**, **a separate account is established for each participant, and fixed amounts are contributed based on a specific formula (e.g., a specified percentage of compensation).** * The **retirement benefits are based on the value of a participant's account** (including the amount of earnings that accrue to the account) at the time of retirement.

Answer 70

The pension plan is a **defined contribution plan because the contribution rate is based on a specific and fixed percentage of compensation**.

Answer 71

**Defined benefit plans establish a contribution formula based on actuarial techniques that are sufficient to fund a fixed benefit amount to be paid upon retirement**. For example, a defined benefit plan might provide fixed retirement benefits equal to 40% of an employee's average salary for the five years before retirement. * A **distinguishing feature of a defined benefit plan is that forfeitures of unvested amounts (e.g., due to employee resignations) must be used to reduce the employer contributions that would otherwise be made under the plan**. * In a defined contribution plan, however, the **forfeitures related to unvested amounts may either be reallocated to the other participants in a non-discriminatory manner or used to reduce future employer contributions**.

Answer 72

An employer may also establish a **qualified profit-sharing plan (PSP)** in addition to, or instead of, a qualified pension plan arrangement. Distinguishing features of profit-sharing plans: * A **definite, predetermined formula must be used to allocate employer contributions to individual employees and to establish benefit payments**. * **Annual employer contributions are not required, but substantial and recurring contributions must be made to satisfy the requirement that the plan is permanent**. * **Employees may be given the option to receive cash that is fully taxable as current compensation or to defer taxation on employer contributions by having such amounts contributed to the profit-sharing trust**. Plans of this type are **called Section 401 (k) plans**. * Forfeitures arising under the plan may be reallocated to the remaining participants to increase their profit-sharing benefits, provided that certain nondiscrimination requirements are met. * Lump-sum payments made to an employee before retirement may be provided following a prescribed period for the vesting of such amounts. * **Incidental benefits such as disability, death, or medical insurance may also be provided in a profit-sharing arrangement**.

Answer 73

A **stock bonus plan** is a special type of **defined contribution plan whereby the investments of the plan are made in the stock of the company**. * The **employer makes its contribution to the trust either in cash or in stock**. If in cash, the amounts are invested in the company's stock. * **The stock is allocated and subsequently distributed to the participants**. * Stock bonus plan requirements are similar to profit-sharing plans.

Answer 74

An Employee Stock Ownership Plan (ESOP) is a type of **qualified stock bonus plan**. * An ESOP, **funded by employer and employee contributions and plan loans, invests primarily in employer stock**. * The stock is held for the benefit of the employees. * ESOPs are attractive because the **employer is allowed to reduce taxable income by deducting any contributions to the ESOP but get back the contribution as payment for its stock**.

Answer 75

* Pension Plan - May be either a defined benefit plan or defined contribution plan. * Stock bonus plan - A special type of defined contribution plan whereby the investments of the plan are in the stock of the company. * Defined contribution pension plan - A separate account is established for each participant and fixed amounts are contributed based on a specific formula. * Profit Sharing Plan - A definite, predetermined formula must be used to allocate employer contributions to individual employees and to establish benefit payments.

Answer 76

A summary of the important requirements are listed below: * **Section 401(a) requires that the plan must be for the employee's exclusive benefit**. For example, the trust must follow prudent investment rules to ensure that the pension benefits will accrue for the employees' benefit. * The plan **may not discriminate in favor of highly compensated employees**. Highly compensated employees are **employees who meet either of two tests: (1) own more than 5% of the corporation's stock in either the current or prior year, or (2) receive compensation of greater than $150,000 (2023) in the prior year**. * **Contributions and plan benefits must bear a uniform relationship to the compensation payments to covered employees**. For example, if contributions for the benefit of the participants are based on a fixed percentage of the employee's compensation (e.g., 4%), the plan should not be disqualified even though the contributions for highly-compensated employees are greater on an actual dollar basis than those for lower paid individuals. * Certain coverage requirements expressed in terms of a portion of the employees covered by the plan must be met. * **An employee's right to receive benefits from the employer's contributions must vest (that is, become non-forfeitable) after a certain period or a number of years of employment**. The vesting requirement ensures that a significant percentage of employees will eventually receive retirement benefits. * **Employer-provided benefits must be 100% vested after five years of service**. * In all cases, **any employee contributions to the plan must vest immediately**.

Answer 77

* **As Ken has not met the minimum vesting requirements, he is not entitled to receive any of the employer contributions that are made on his behalf**. * If the plan adopted the alternative 3- to 7-year graded vesting schedule, **40% of the employer-provided benefits would be vested** at the time of his termination and would provide Ken with future retirement benefits.

Answer 78

* **Employer contributions to a qualified plan are immediately deductible** (subject to specific limitations on contribution amounts), and **earnings on pension fund investments are tax-exempt to the plan**. * **Amounts paid into a plan by or for an employee are not taxable until the pension payments are received**, normally at retirement. At the election of the employee, amounts may be treated as having been made from either pre-tax or after-tax earnings. * **If amounts contributed to a qualified plan by an employee are made pre-tax, the contribution amount reduces the taxable portion of the employee's earnings**. This has the **effect of permitting a deduction for the contribution amount**. * **When amounts are withdrawn at retirement, the entire distribution is subject to taxation**. Conversely, an employee may elect to contribute to a qualified plan after-tax. If in the example above, Larry contributed to the Section 401(k) plan on an after-tax basis, his taxable salary would have been $80,000. The $4,000 contributed to the plan is treated as an investment and is considered a tax-free return of capital when this amount is withdrawn at retirement.

Answer 79

Conversely, an employee may elect to contribute to a qualified plan after-tax. If in the example, Larry contributed to the Section 401(k) plan on an after-tax basis, his taxable salary would have been $80,000. The $4,000 contributed to the plan is treated as an investment and is considered a tax-free return of capital when this amount is withdrawn at retirement.

Answer 80

**Employee retirement benefits are generally taxed under the IRC Section 72 annuity rules**. * **If the plan is non-contributory (no employee contributions are made to the plan), all of the pension benefits when received by the employee are fully taxable**. * **If the plan is contributory, each payment is treated, in part, as a tax-free return of the employee's contributions, and the remainder is taxable**. * **The excluded portion is based on the ratio of the employee's investment in the contract to the expected return under the contract**. However, the total amount that may be excluded is limited to the amount of the employee's contributions to the plan. * **If the employee dies before the entire investment in the contract is recovered, the unrecovered amount is allowed as an itemized deduction in the year of death**.

Answer 81

* So, for the next 260 months, she can exclude $384.62 ($100,000/260 months). * In 2024, Kira would exclude $4,615.44 ($384.62 x 12 months) * $19,384.56 would be taxable ($24,000 - $4,615.44). * After Kira receives payments for 260 months and her entire $100,000 investment in the contract is recovered, all subsequent payments are fully taxable.

Answer 82

There are limitations on * (1) **amounts an employer may contribute to qualified pension, profit sharing, and stock bonus plans** and * (2) **amounts that the employer may deduct**: * **Defined contribution plan contributions in 2023 are limited to the lesser of $66,000 or 100% of the employee's compensation**. * **Defined benefit plans are restricted to an annual benefit to an employee of the lesser of $265,000 for 2023 or 100% of the participant's average compensation for the highest three years**. * **An overall maximum annual employer deduction of 25% of covered compensation paid or accrued to plan participants is placed on defined contribution, profit sharing, and stock bonus plans**.

Answer 83

Employers often use non-qualified deferred compensation (NQDC) plans **to provide incentives or supplementary retirement benefits for executives**. Two common forms of non-qualified plans include the following: * An **unfunded, non-forfeitable promise to pay fixed compensation amounts in future periods**. * **Restricted property plans involving property transfers (usually in the form of the employer-company stock), where the property transferred is subject to a substantial risk of forfeiture and is non-transferable**. Non-qualified plans are **not subject to the same restrictions imposed on qualified plans (such as the non-discrimination and vesting rules)**, although non-qualified plans may have some vesting rules. Therefore, such plans are **particularly suitable for use in executive compensation planning**. In general, non-qualified plans **impose certain restrictions on the outright transfer of the plan's benefits to the employee**. This **avoids immediate taxation under the constructive receipt doctrine**, which does not apply if the benefits are not yet credited, set apart, or made available so that the employee may draw on them. **The amount is taxed to the employee upon the lapse of such restrictions, and the employer receives a corresponding deduction in the same year.**

Answer 84

**Unfunded deferred compensation plans are often used to compensate highly compensated employees (HCEs) who desire to defer the recognition of income until future periods** (e.g., a professional athlete or a business executive who receives a signing bonus may want to defer the recognition of income from the bonus). * In general, **if the promise to make the compensation payment in a future period is non-forfeitable, the agreement must not be funded** (e.g., the transfer of assets to a trust for the employee's benefit) **or evidenced by a negotiable note**. * The **employer, however, may establish an escrow account on behalf of the employee but the assets in such account must be available in the event of bankruptcy to the employer's general creditors** (non-secured and non-preferential creditors). * **An escrow account is used to accumulate and invest the deferred compensation amounts**. * If the requirements for deferral are met, the employee is taxed when the amounts are paid or made available, and the employer receives a corresponding deduction in the same year.

Answer 85

Taxable income to Anita of $150,000 & a tax deduction to XYZ of $150,000 * If the requirements of the deferral are met, the employee is taxed when the amounts are actually paid or made available and the employer receives a corresponding deduction in the same year.

Answer 86

**Restricted property plans are used to attract and retain key executives. Under such arrangements, the executive generally obtains an ownership interest (i.e., stock) in the corporation**. * Restricted property plans are **governed by the income recognition rules contained in IRC Section 83**. Under these rules, **the receipt of restricted property in exchange for services rendered is not taxable if the property is non-transferable and subject to a substantial risk of forfeiture**. * The **employee is treated as receiving taxable compensation based on the amount of the property's fair market value (less any amount paid for the property) at the earlier of the time the property is no longer subject to a substantial risk of forfeiture or is transferable.** * The **employer receives a corresponding compensation deduction at the same time the income is taxed to the employee**. An **exception that permits an employee to elect (within 30 days after the receipt of restricted property) to recognize income immediately upon receipt of the restricted property is provided in Section 83(b)**. * If the election is made, **the employer is entitled to a corresponding deduction at the time the income is taxed to the employee**. * **This election is frequently made when the fair market value of the restricted property is expected to increase significantly in the future, and the taxpayer wishes the future gain to be taxed as a long-term capital gain**. * Because the long-term capital gains tax is currently 0%, 15%, or 20%, one would expect that more taxpayers make the Section 83(b) election.

Answer 87

**Qualification Requirements**: The qualification requirements for **qualified pension, profit-sharing, and stock bonus plans** are: * Section 401(a) requires that the **plan must be for the employee's exclusive benefit**. * The plan **may not discriminate in favor of highly compensated employees**. Highly compensated employees are employees who meet either of two tests: (1) own more than 5% of the corporation's stock in either the current or prior year, or (2) receive compensation of greater than $150,000 (2023) in the prior year. * Contributions and plan benefits must bear a uniform relationship to the compensation payments made to covered employees. * Certain coverage requirements expressed in terms of a portion of the employees covered by the plan must be met. * An employee's right to receive benefits from the employer's contributions must vest (that is, become nonforfeitable) after a certain period or number of years of employment. The vesting requirement ensures that a significant percentage of employees will eventually receive retirement benefits. Employer-provided benefits must be 100% vested after three years of service unless the plan provides for a phase in of the vesting interest, in which case the full vesting can be as long as six years. In all cases, any employee contributions to the plan must vest immediately.

Answer 88

Retirement benefits are a fixed amount based on the level of compensation earned by the employee during the working years. * **Benefits are based on the value of the participant's account at the time of retirement**.

Answer 89

$76,000 * Robert's gross salary is $80,000. Therefore, his Sec. 401(k) contribution is $4,000 (that is, 5% of $80,000). Since Robert's contribution is made on a pre-tax basis, his taxable salary for the current year will be $76,000 ($80,000 - $4,000). In effect, Robert is able to deduct the $4,000 from his salary in the current year.

Answer 90

The company must make contributions to the plan if it has profits during the year. * Annual employer contributions are not required, but substantial and recurring contributions must be made, to satisfy the requirement that the plan be permanent.

Answer 91

To ensure that you have an understanding of estimated taxes and withholding, the following topics will be covered in this lesson: * Estimated Tax Payments * Required Estimated Tax Payments * Withholding Taxes and Estimated Payments Upon completion of this lesson, you should be able to: * Identify certain types of income that are not subject to withholding, * Recall conditions to avoid the imposition of a penalty on an underpaid amount, and * Describe how withholding of taxes depends on whether you are paying FICA taxes or income taxes.

Answer 92

* **Certain types of income are not subject to withholding, such as investment income, rents, income from self-employment, and capital gains**. * **Taxpayers who earn this income may need to make quarterly estimated tax payments**. * The **estimated tax amount is the taxpayer's tax liability that includes self-employment tax and alternative minimum tax reduced by withholdings, tax credits, and any excess FICA amounts**.

Answer 93

Rent Capital Gains Investment Income **The following types of income are not subject to withholding**: * investment income, * rents, * income from self-employment, and * capital gains.

Answer 94

For calendar-year individuals, required quarterly payments are **due by April 15, June 15, and September 15 of the current year, and January 15 of the following year**.

Answer 95

To avoid the imposition of a penalty on the underpaid amount, the estimated tax payments must be lesser of the following amounts: * **90% of the tax liability shown on the return for the current year**. * **100% of the tax liability shown on the return for the prior year if the taxpayer's AGI for such prior year was $150,000 or less**. **If the taxpayer's AGI exceeds $150,000, no penalty will be imposed if the taxpayer pays estimated tax payments in the current year equal to 110% of the prior year tax**. * **90% of the tax liability shown on the return for the current year computed on an annualized basis**.

Answer 96

Furthermore, no penalty is imposed if: * **The estimated tax for the current year is less than $1,000**, or * The **individual had no tax liability for the prior year**. No penalty is imposed for failure to file quarterly estimated tax payments, even though the IRC includes specific filing requirements. A penalty is imposed only if the taxpayer fails to meet the minimum payment requirements or one of the previously mentioned exceptions does not apply.

Answer 97

**Form 2210** should be completed and submitted with the tax return if a possible underpayment of tax is indicated.

Answer 98

* Sarah's tax liability for 2020 was $28,000. There is **no penalty for failure to make the quarterly estimated tax payments because she meets one or more of the exceptions** relating to the minimum payment requirement. Although the first exception is not met because her $30,000 of withholdings (plus zero estimated tax payments) is less than 90% of her $40,000 tax liability for 2023 ($30,000 / $40,000 = 75%), **she meets the second exception because the $30,000 of withholdings is more than 100% of her $28,000 tax liability for 2020**. * If Sarah's AGI for 2023 was more than $150,000, **the second exception safe harbor amount would be 110% (instead of 100%) of the prior year's tax or $30,800 ($28,000 x 1.10)**. Because the $30,000 of withholding is not more than 110% of her $28,000 prior year tax liability, **Sarah would not meet the second exception and would be subject to the underpayment penalty**.

Answer 99

110% When the taxpayer’s AGI is greater than $150,000, the estimated tax payments for the current year need to be at least 110% of the prior year’s tax liability in order to avoid a penalty.

Answer 100

Withholding Taxes * **FICA taxes are to be withheld on all employee earnings up to $160,200 (2023) per employer**. * **No ceiling applies to the 1.45% Medicare portion of the tax**. * **Taxpayers pay an additional 0.9% Medicare tax if self-employment income or wages exceed $250,000 married filing jointly, $125,000 married filing separately, or $200,000 for single**. For income tax, all employee wages, salaries, fees, bonuses, commissions, taxable fringe benefits, and so on are subject to withholding. * The amount of withholding for FICA taxes is 7.65% of FICA wages, including 1.45% for the Medicare portion of the tax. 1.45% for amounts over $160,200 (2023) is withheld from the employee's earnings. For income tax, the amount to withhold is determined using withholding tables or the percentage method based on an individual's filing status and the number of exemptions.

Answer 101

**Withholding Taxes and Estimated Payments**: Payments for the year must be equal to or exceed any one of the following: * 90% of the tax liability shown on the return for the current year, or * 100% of the tax liability shown on the return for the prior year (110% if AGI for the prior year exceeds $150,000), or * 90% of the tax liability shown on the return for the current year computed on an annualized basis. * The underpayment penalty is not deductible for income tax purposes. **Form 2210** should be completed and submitted with the tax return if an underpayment is indicated.

Answer 102

The NOL deduction is **intended to mitigate the inequity caused by the interaction of the progressive rate structure and the requirement to report income on an annual basis**. This i**nequity arises between taxpayers whose business income fluctuates widely from year to year and those whose business income remains relatively constant**. To ensure that you have an understanding of net operating losses, the following topics will be covered in this lesson: * Computing the Net Operating Losses * Carryback and Carryover Periods Upon completion of this lesson, you should be able to: * Recall the three basic types of expenses that taxpayers may deduct to arrive at the amount of taxable income, * List steps to add back to taxable income any capital loss deductions, * Identify business and non-business incomes, and * Describe carryback and carryover periods.

Answer 103

The **starting point** in calculating an individual's NOL is **generally taxable income**. **Individuals may deduct three basic types of expenses to arrive at the amount of taxable income**: * Business-related expenses * Investment-related expenses * Certain personal expenses The **NOL, however, only measures the economic loss that occurs when business expenses exceed business income**. Therefore, taxpayers must make several adjustments to taxable income to arrive at the amount of the NOL for any particular year. These include **adjustments for an NOL deduction, a capital loss deduction, and the excess of non-business deductions over non-business income**.

Answer 104

Under certain circumstances, a taxpayer might have taken a deduction for a NOL arising from another tax year in computing the taxable loss for the current loss year. Allowing this deduction to create or increase the NOL of the current loss year would provide an unwarranted benefit. Therefore, **taxable income for the current loss year must be increased for this deduction to isolate the NOL, which applies to the tax year at issue**.

Answer 105

**To compute taxable income, individuals may deduct up to $3,000 in capital losses over capital gains in any year**. * **Any capital loss above this limit can be carried over and deducted in a subsequent tax year**, subject to the same limitation. * **As capital losses have their separate carryover provisions, taxpayers must add back any deduction associated with these losses to taxable income to arrive at the NOL for the current loss year**.

Answer 106

* Step 1: A taxpayer must **separate non-business capital gains and losses from business capital gains and losses**. The **non-business gains and losses are then netted, while the business gains and losses are netted separately**. * Step 2: If the non-business capital gains exceed the non-business capital losses, **the excess, along with other types of non-business income, is first used to offset any non-business ordinary deductions**. **Any non-business capital gain remaining is then used to offset any business capital loss above the business capital gain for the year**. * Step 3: **If both groups of transactions result in net losses, the capital loss deduction provided by these transactions must be added back**. **For purposes of the NOL, no deduction is allowed for either business or non-business net capital losses**. * Step 4: **If the taxpayer's non-business capital losses exceed the non-business capital gains, the losses may not be offset against the taxpayer's excess business capital gains**. Allowing this offset would provide an indirect deduction for a non-business economic loss.

Answer 107

To compute the NOL, however, none of the $10,000 non-business capital loss is deductible. Thus, the $3,000 deduction and the $5,000 loss that offset the business capital gain must be added back.

Answer 108

As non-business deductions do not reflect an economic loss from business, they are not deductible in arriving at the NOL. However, these deductions do offset any non-business income reported during the year. * **Non-business income includes sources of income such as dividends and interest as well as non-business capital gains over non-business capital losses**. * **Wages and salary, even if they are earned from part-time employment, are considered business income**. * **Non-business deductions** include itemized deductions such as charitable contributions, medical expenses, and non-business interest and taxes. * **Casualty losses on personal-use assets, however, are treated as business losses and are excluded from this adjustment**. If a taxpayer does not have itemized deductions over the standard deduction, **the standard deduction is used as the amount of the non-business deductions**.

Answer 109

The computation of a net operating loss (NOL) does not involve making adjustments for non-business deductions and capital gains and losses as are required for individuals. * Most taxpayers no longer have the option to carry back a net operating loss (NOL). For most taxpayers, **NOLs arising in tax years ending after 2020 can only be carried forward**. * There was a 2-year carryback rule in effect before 2018 that, generally, does not apply to NOLs arising in tax years ending after December 31, 2017. * **The CARES Act provided for a special 5-year carryback for taxable years beginning in 2018, 2019, and 2020**. * **Exceptions apply to certain farming losses and NOLs of insurance companies other than a life insurance company**. * Also, **for losses arising in taxable years beginning after Dec. 31, 2020, the net operating loss deduction is limited to 80% of the excess (if any) of taxable income**.

Answer 110

Carry forward indefinitely * **If an NOL may not be fully claimed in the current year the loss may be carried forward indefinitely**.

Answer 111

In this lesson, we have covered the following: * **Net Operating Loss**: Under **IRC Section 172, NOL involves only business income and expenses and occurs when taxable income for any year is negative because business expenses exceed business income**. **Computing Net Operating Loss**: The starting point in calculating an individual's NOL is generally taxable income. **Individuals may deduct three basic types of expenses to arrive at the amount of taxable income:** * Business-related expenses * Investment-related expenses * Certain personal expenses

Answer 112

$9,000 * For taxable income purposes, the loss of $20,000 is netted against the gain of $6,000, leaving a $14,000 net short-term capital loss. This loss provides a $3,000 deduction from taxable income, with the remaining $11,000 being carried forward to the following year. * **To compute the NOL, however, none of the $20,000 non-business capital loss is deductible. Therefore, the $3,000 deduction as well as the $6,000 loss (from the $20,000 loss) that offset the $6,000 capital gain must be added back**. Therefore, the total capital loss deduction that must be added back is $9,000.

Answer 113

Charitable contributions * The recomputation of taxable income for the carryback year may affect the deductible amount of certain itemized deductions because some of the deductions, such as **deductions for medical expenses, charitable contributions, and casualty losses, are limited or measured by reference to the taxpayer's AGI**. * **All of these deductions except the deduction for charitable contributions must be recomputed using the reduced AGI amount**.

Answer 114

* **Deferral of Compensation**: Deferred compensation refers to methods of compensating employees that are based on their current service, but the actual payments are deferred until future periods. The two principal types of deferred compensation methods are **qualified plans and non-qualified plans**. * **Estimated Taxes and Withholding**: The estimated tax amount is the taxpayer's tax liability that includes self-employment tax and alternative minimum tax reduced by withholdings, tax credits, and any excess FICA amounts. * **Net Operating Losses (NOLs)**: NOLs arising after 2020 can only be carried forward indefinitely.

Answer 115

Private Annuity * **For a private annuity to be structured correctly, the annuity payments must be unsecured**. * This is in direct contrast to the structure of an installment sale or a SCIN.

Answer 116

$5,000 * Although JoJo Co. **failed the gross receipt test (i.e., gross receipts of $1 million or less in the preceding year), they had 25 full-time employees in the preceding year and, as a result, qualify for the disabled access credit**. * The qualifying expenditures were $17,500. The **disabled access credit is equal to 50% of eligible expenditures that exceed $250 but do not exceed $10,000**. * Therefore, **only $10,000 of eligible expenditures qualify for the credit, limiting the credit to $5,000 ($10,000 x 0.50)**.

Answer 117

immediately deductible * Employer contributions to a qualified plan are immediately deductible (subject to specific limitations on contribution amounts), and earnings on pension fund investments are tax-exempt to the plan. * Amounts paid into a plan by or for an employee are not taxable until the pension payments are received, normally at retirement.

Answer 118

will not be included the seller's gross estate * If a seller should die prior to receiving all of the scheduled payments using a SCIN, the present value of the future payments will not be included the seller's gross estate.

Answer 119

five years * Any charitable contributions that exceed the deductible gift limitations may be carried over and deducted in the subsequent five years.

Answer 120

$197 * Deductible items include out-of pocket transportation expenses, the cost of lodging, meal expenses [100% deductible if purchased from a restaurant while away from home (in 2021 and 2022)], and the cost of a uniform without general utility that is required to be worn in performing the donated services. * The law permits a deduction of 14 cents per mile. * Volunteers contributing their services are not able to use their hourly rate as a deduction. Therefore, Chyou can deduct the special scrubs ($75), 100% of her meals ($80), and her mileage at a special rate of $0.14/mile (300 x $0.14 = $42) $75 + $80 + $42 = $197

Answer 121

two; one * The **employee must neither dispose of the stock within two years of the option's grant date nor within one year after the option's exercise date**.

Answer 122

I only * If adoption expenses are paid prior to the year the adoption is finalized, such expenses are deductible in the year the adoption is finalized.

Answer 123

zero years; indefinitely Generally, if you have an NOL for a tax year ending in 2023: * You cannot carry back your NOL, but you can **carry it forward an indefinite number of years**, and * **Your NOL can offset only up to 80 percent of your taxable income before your 20 percent Section 199A deduction**.

Answer 124

II only * The Lifetime Learning Credit is allowed for students who take part-time courses to improve their job skills.

Bryant - Course 4. Tax Planning. 16. Tax Management Techniques Flashcards

(150 cards)