REG 1 Individual Taxation: Gross Income

Question 1

In order to be taxable, what must a gain be?

Answer 1

It must be both realized and recognized. Realization = real world: requires the accrual or receipt of cash, property, or services, or a change in the form or the nature of the investment (a sale or exchange). Recognition = record: the realized gain must be included on the tax return.

Question 2

What are the 4 baskets of income?

Answer 2

1. Ordinary: anything not in other three
2. Portfolio: income earned on portfolio of assets, such as interest and dividends.
3. Passive: = rental activity: taxpayer did not actively participate - only passive losses may offset passive income; a net passive loss is not deductible, it’s carried forward - i.e. rental income and royalties.
4. Capital: sales of capital assets create capital gains and losses

Question 3

How is the cancellation of debt handled?

Answer 3

The part that is forgiven is included in gross income.

Question 4

How are taxable (non-statutory) and partially taxable fringe benefits handled?

Answer 4

The FMV not specifically excluded by law is includable in income: i.e. use of company car included as wage in employee income.
For a group-term life insurance policy, premiums above the first $50,000 of coverage are taxable income and included in W-2 wages (not whole amount, table used).

Question 5

How is the nontaxable fringe benefit of life insurance proceeds handled?

Answer 5

Proceeds paid because of the death of the insured are excluded from the beneficiary’s gross income. The interest income element on deferred payout arrangements is fully taxable. Accelerated benefits received by a terminally ill insured are not taxable or if used to pay for long-term care.

Question 6

How are employer paid accident, medical, and health insurance handled?

Answer 6

Premium payments are excludable from the employee’s income when the employer paid it, but amounts paid to the employee under the policy are included in income unless such amounts are: reimbursements for medical expenses actually incurred by the employee OR compensation for the permanent loss or loss of use of a member or function of the body.

Question 7

What are de minimis fringe benefits?

Answer 7

So minimal they are impractical to account for such as personal use of a company computer.

Question 8

What is the general rule for taxable interest income and what does it include?

Answer 8

All interest income is taxable unless it is specifically excluded.

a. Federal bonds
b. Industrial development bonds
c. Corporate bonds
d. Premiums for opening savings accounts at FMV
e. Part of the proceeds from an installment sale
f. Interest paid by the federal of state government for late payment of tax refund
g. Amort. of bond prem. can offset int. rec. and reduce bond basis & amort. of bond disc. adds to int. rec. and bond basis.

Question 9

What does tax-exempt interest income (reportable but not taxable) include?

Answer 9

Interest on state and local government bonds/obligations;
interest on the obligation (bond) of a possession in the United States (possessions of US include Guam and Puerto Rico);
Series EE (U.S. savings bond) = Educational Expenses - tax exempt when: used to pay for higher education of the taxpayer, spouse, or dependents, there is a taxpayer or joint ownership (spouse), the taxpayer is over age 24 when issued, AND the bonds are acquired after 1989 - phase out starts when modified AGI exceeds an indexed amount;
Interest on Veterans Administration Insurance.

Question 10

What are taxable dividends?

Answer 10

All dividends that represent distributions of a corporation’s earnings and profits (similar to R/E) are includable in gross income. The taxable amount is the amount received for cash and FMV for property.

Question 11

What do tax-free distributions include?

Answer 11

1. Return of capital
2. Stock split
3. Stock dividend (unless cash or other property option/taxable FMV)
4. Life insurance dividend

Question 12

What is a capital gain distribution and how is it treated?

Answer 12

Distributions by a corporation that has no earnings and profits, and for which the shareholder has recovered his or her entire basis, are treated as taxable gross income.

Question 13

How are state and local tax refunds treated?

Answer 13

The receipt of a state or local income tax refund in a subsequent year is not taxable if the taxes paid did not result in a tax benefit in the prior year. (1) Itemized in prior year = state or local refund is taxable; (2) Standard deduction used in prior year = nontaxable state or local refund (1040EZ). Interest Income is taxable.

Question 14

What is net income from self-employment computed on, and where is the net income from the sole proprietorship then transferred to?

Answer 14

Schedule C or C-EZ

To Form 1040 as one amount

Question 15

What are the two taxes on net business income and how do you treat net taxable loss?

Answer 15

(1) Income tax (2) Federal self-employment (S/E) tax
May deduct the loss against other sources of income; if loss exceeds this, can use the (1) 2-year carryback (2) 20-year carryfoward.

Question 16

What are the general Uniform Capitalization Rules?

Answer 16

For inventory, even a sole proprietor will be required to apply the following rules:

(1) Capitalized as Inventory: DM, DL, & FOH
(2) Period Expense: SG&A & R&D

Question 17

What schedule is used for Self-Employment Tax (Social Security Tax)?

Answer 17

Schedule SE (Form 1040) (Short Or Long Schedule SE)

Question 18

What schedule is used for profit or loss from farming and what is it transferred to?

Answer 18

Schedule F
Form 1040 (Line 18)

Question 19

What is the difference between the cash basis and accrual method for farmers and when is each used?

Answer 19

Most use the cash basis - inventories not considered, expense inventory; profit computed by sales price less cost.
Accrual method required for certain corporate and partnership famers as well as for all farming tax shelters - inventories must be used and maintained; gross profit equals the value of inventories at year end plus the proceeds from sales less value of inv. at beg. of yr. less cost of inv. purchased during the year.

Question 20

What is the basic formula in determining the gain or loss on the disposition of property?

Answer 20

Amount Realized
Less: Adjusted Basis of Asset Sold
Equals the Gain or Loss Realized

Question 21

What is the general rule for IRA income withdrawals and the taxation of distributions/benefits?

Answer 21

Individual Retirement Accounts: generally cannot be withdrawn until age 59 1/2; required to start withdrawals by age 70 1/2 (“required minimum distribution” “RMD”); benefits not taxable until distribution received; when a person retires, the funds will be taxed as ordinary income when received regardless of what type of income, such as capital gain, was earned while the funds were invested.

Question 22

How are distributions/benefits from Roth IRA and traditional non-deductible IRAs taxed?

Answer 22

All benefits from a Roth IRA are nontaxable; traditional non-deductible IRA benefits are partially taxable - return of capital is not taxable (i) principal - nontaxable (ii) accumulated earnings - taxable when withdrawn.

Question 23

What is the penalty tax for premature retirement distribution, and what are the exceptions to this penalty tax?

Answer 23

10% penalty tax.
There is no penalty if the premature distribution was used to pay: HIM DEAD:
Home buyer (1st time; $10,000 max w/i 120 days dist.)
Insurance (medical - 12 consecutive weeks of unemployment comp. or self-employed)
Medical expenses in excess of 10% of AGI
Disability (not temporary)
Education (college tuition, books, fees, etc.)
And
Death

Question 24

For rental income (passive activity), what schedule is used to compute supplemental income and/or loss and from what?

Answer 24

Schedule E

1. Rental real estate
2. Royalties
3. Partnerships and LLCs (from schedule K-1)
4. S Corporation (“)
5. Estates (“)
6. Trusts (“)

Question 25

What is the basic formula for the determination of net rental income or loss?

Answer 25

Gross rental income
\+ prepaid rental income (nonrefundable deposits)
\+ rent cancellation payment
\+ Improvement In-Lieu-of Rent (at FMV)
less: Rental expenses
= Net rental income Or loss

Question 26

An individual may deduct PALs if either of what two conditions are met?

Answer 26

1. ) May deduct up to 25,000 per year if actively participating/managing and own more than 10% of the rental activity; The allowance is reduced by 50% of the excess of the taxpayer’s AGI over 100,000; AGI > 150,000, allowance eliminated.
2. ) Can fully deduct if taxpayer is deemed to have material participation in the activity, more than 50% of personal services during the year are performed in real property business, and performs more than 750 hours of services in real property businesses during the year (“real estate person”).

Question 27

What are the five categories taxpayers are classified into depending on their level of provisional income along with the social security benefits treatment in each category?

Answer 27

1. Low Income: income below single 25k/MFJ 32k - no ss benefits taxable.
2. Lower middle income: less than 50% taxable.
3. Middle Income: income above single 25k/MFJ 32k - 50% taxable.
4. Upper middle income: between 50% and 85% taxable.
5. Upper income: income above single 34k/MFJ 44k - 85% taxable.