Federal Income Tax Flashcards
(33 cards)
Tax Liability Steps
Step 1: Determine Gross Income
Step 2: Subtract “above the line deductions” to determine Adjusted Gross Income
Step 3: Subtract standard deduction or itemized deductions to determine taxable income
Step 4: Multiply by tax rate
Step 5: Subtract any available credits
Gross Income
Definition: Any economic benefit or any clearly realized accession to your wealth
- Change in value of asset does not affect taxes until realization (e.g., sale)
Includes:
- FMV of non-cash receipts
- Assets claimed under claim of right
- Stolen, embezzled funds or property
- Tax Benefit Rule
Special rules for:
1) Alimony
2) Child Support
3) Prizes and Awards
4) Cancellation of Indebtedness
Exclusions:
1) Life Insurance Proceeds
2) Inheritances
3) Gifts
4) Tort Awards
5) Employee-Related exclusions
Claim of Right
Definition: If received without restriction as to use or disposition, even if taxpayer may later be required to return
If assets are later re-taken, taxpayer takes a deduction in Year 2.
Tax Benefit Rule
Definition: If taxpayer takes a deduction one year, and then recovers the property that ave rise to the deduction, recovered property is taxable income.
Amount is judged as the amount of the prior deduction
Underlying assumption: that you benefitted from the giving in year 1
Alimony
Rule: Unless otherwise agreed to, alimony is taxable income and a deductible payment
Requirements
1) writing
2) living together disallowed
3) cease at or before death
4) cash (or equivalent)
Child Support
Rule: Not taxable income, and not deductible payment
Child Support in Disguise! If payment (e.g., alimony) is reduced based on contingency related to the child, the amount of reduction is considered child support
If total payments don’t satisfy both alimony and child support, payments are treated as first satisfying child support
Prizes and Awards
Rule: Gross income includes the value of cash, property, or services received as a price, award, or windfall
But watch out! Bargain purchase (e.g., at a flea market) does not get treated as FMV
Cancellation of Indebtedness
Rule: Borrower has no gross income upon the initial receipt of borrowed funds. But if debt is canceled or discharged at less than full amount, difference is income.
Exceptions – RIG
1) Reduction in purchase price: If apparent discharge of debt is really just a reduction in purchase price
2) Insolvency: If the discharge occurs when taxpayer is insolvent or bankrupt
3) Gift: If the lender intends the discharge as a gift
Exclusions - Life Insurance Proceeds
Rule: GI does not include proceeds paid by reason of death of the insured.
But if paid in installments, any interest paid is taxable
Exclusions - Inheritances
Rule: GI does not include amounts received by bequest, devise, or inheritance
Exclusions - Tort Awards
Rule: GI does not include damages received on account of physical personal injury or sickness
Rule: By themselves, damages for emotional distress may be included
Rule: Punitive damages are taxable
Exclusions - Gifts
Rule: GI does not include. Gifts are made out of detached and disinterested generosity
Irrebutable presumption that employers don’t make gifts
Exclusions - Employee-Related Exclusions
Health Insurance: Premiums paid by employer and reimbursed medical expenses are excluded
Life Insurance: Can exclude the value of the first $50K
Meals and Lodging: Employer-provided meals and lodging are excluded if
1) provided for the convenience of the employer
2) in-kind
3) on the employer’s premises
Other Tax-Free Fringe Benefits:
1) De minimus
2) No additional cost to the employer
3) Qualified employee discounts
4) Contributions to qualified pension plans
5) Employee safety or length of service awards
Qualified Scholarship: For tuition and related expenses are excluded if primarily for the benefit of the individual
Above-the-Line Deductions
Subtotal reached is referred to as Adjusted Gross Income (AGI)
Examples:
1) Ordinary and Necessary Business Expenses
2) Depreciation
3) Net Capital Losses (up to $3K)
4) Alimony
5) Net Gambling Losses
6) Moving Expenses
7) Limited Deduction for School Loan Interest
Itemized Deductions
1) Home Mortgage Interest
2) State and Local Taxes
3) Unreimbursed Casualty Losses
4) Unreimbursed Medical Expenses
5) Charitable Contributions
6) Miscellaneous Deductions
7) Business Legal Expenses
8) Investment Fees or Expenses
9) Exemptions
Itemized Deductions - Home Mortgage Interest
Can deduct home mortgage interest up to $1m (in the aggregate) on a principal and second personal residence
Can also deduct home equity loan up to $100K
Itemized Deductions - State and Local Taxes
Deductible, with the exception of sales tax
Itemized Deductions - Unreimbursed Casualty Losses
Deductible if:
1) loss is greater than $100
2) loss is sudden and unexpected
3) only to the extent that aggregated losses exceed 10% of AGI
Itemized Deductions - Unreimbursed Medical Expenses
Deductible to the extent that aggregated losses exceed 10% of AGI
Itemized Deductions - Charitable Contributions
Taxpayers can deduct FMV of contributions to qualified charities
Itemized Deductions - Miscellaneous Deductions
Taxpayers may deduct eligible miscellaneous deductions to the extent that, aggregated, they exceed 2% of AGI
Look for expenses necessary to maintain and improve skills for taxpayer’s job
Itemized Deductions - Investment Fees or Expenses
Can deduct fees or expenses necessary to generate taxable income (e.g., broker fees, advertising)
Itemized Deductions - Exemptions
Entitled to one exemption for themselves, and one for each dependent
Allocation of Income - To whom is it income?
Rule 1: Income is taxed to he or she who earns it. Assignment of income
Rule 2: Income from property (investment income) is taxed to he or she who owns the property
