16 Progressive Tax RatesAlice, who is single, has $38,000 taxable income in How much federal income taxes would she have to pay?10% X $8,500+15% X ($34,500-$8,500)+25% X ($38,000-$34,500)=$5,625
17 Types of Taxes Transactional Tax Property Tax Taxes on Privileges and RightsIncome Tax
18 Transactional Taxes Sales Taxes Employment Taxes Excise vs. Sales Tax Use TaxEmployment TaxesFICAFUTA
19 Wealth Transfer Taxes Estate Tax Estate vs. inheritance tax ComputationFMV of decedent’s property, lessFuneral expensesDebtsCharitable donationsMarital deduction to a surviving spouseUnited transfer tax credit
20 Wealth Transfer Taxes Gift Tax Original goal Donor is taxed Annual ExclusionComputation
21 Gift TaxAntonio makes the following gifts in the current year: (1) gift of a personal automobile valued at $25,000 to his adult son; (2) gift of a personal computer valued at $4,000 to a friend. Are any of these transfers taxable?
22 Property Taxes Assessed on personal or/and real property Difference between real and personal property
23 Taxes on Privileges & Rights Custom DutiesFranchise TaxOccupational Tax
24 Income Tax Main Source of Revenues for the Federal Government Progressive in NatureIncome Tax Computation
26 Top Income Tax Rates Average 67 1980 2010 Australia 63% 45% Canada 60 29France40Germany6545Ireland41Italy7243Japan7550Korea89Spain66Sweden8757Switzerland3126U.K.83United States7035Average67
27 Formula for Federal Income Tax on Individuals Income (Slide 1 of 3) Income (broadly conceived) $xx,xxx)Less: Exclusions (x,xxx)Gross income $xx,xxx)Less: Certain deductions for AGI (x,xxx)Adjusted Gross Income $xx,xxx
28 Formula for Federal Income Tax on Individuals Income (Slide 2 of 3) Adjusted Gross Income $xx,xxx)Less: The greater of:Itemized deductions, orThe standard deduction (x,xxx)Less: Personal anddependency exemptions (x,xxx)Taxable income $xx,xxx)
29 Formula for Federal Income Tax on Individuals Income (Slide 3 of 3) Tax on taxable income (see Tax Rate Schedules in Appendix A) $ x,xxxLess: Tax creditsLess: Federal income tax withheld andother prepayments of Federalincome taxes) $(xxx)Tax due (or refund) $ xxx
30 Alternatives to Income Tax Value Added TaxNetworth TaxFlat Tax
31 Business Entities Sole proprietorships Partnerships C corporations S corporationsLimited liability Company (LLC)
32 Types of Tax Rates Marginal Tax Rate Average Tax Rate Sandra, who is single, is considering the purchase of a personal residence that will provide a $10,000 tax deduction. Her current AGI is $95,000. What is the tax effect of this transaction?Average Tax RateSam, who is single, has $29,700 of taxable income in Based on applicable tax rates, Sam’s total tax is $4,030. What is the average tax rate?
33 Ethics & Professional Responsibilities AICPA Code of ConductAICPA Statements on Standards of Tax ServiceInternal Revenue CodeIRS Circular 230
34 Due DiligenceRebecca, an accountant, fails to include dividend income on a tax return she completed for a client. The omitted dividend income was from a new stock purchased by the client this year from a new investment banking firm and therefore had not been reported in prior years. The taxpayer did not mention the new stock investment to Rebecca in any communication with her. Has Rebecca exercised due diligence?
35 Advocating Positions on Behalf of Client Circular 230Substantial authority for the position takenReasonable Basis and fully disclosedPenalties
36 Advocating Positions on Behalf of Client Clara Li owns 80% of the Li Corporation. The other 20% of the stock is held by her husband, Kevin Li. While working on the return, you note that Li Corporation pays rent to Clara at least four times the normal rate for rentals of similar property in that area of town. You recall that under the code, in order for a business expense to be deductible, it must be reasonable in amount. You report this observation to the partner. She tells you that it is all right to deduct the payments because the corporation has been doing it for several years. She asks you to sign the return. Should you sign this tax return?
37 Advocating Positions on Behalf of Client Burger, Inc. has been engaged in unique lending practices for many years. Congress has recently adopted a new Code provision that prevents recognition of expenses associated with such lending practices. Burger Inc. and its tax advisor believe that the new Code provision is unfair to the taxpayer. However, the Code provision is clear and constitutional. May Burger Inc. claim the expense deduction nonetheless?
38 Advocating Positions on Behalf of Client Assume the same facts as above, except that Burger Inc. insists on taking the tax return position (even though the CPA concluded that it is frivolous) because the company did not believe that the position would be detected by the IRS on an audit. May the tax preparer sign the tax return?
39 Reliance on Client’s Information Is the information suppliedby client appear correct,complete and consistent?If no, must verifyinformationIf yes, may relywithout verification
40 Use of Estimates Estimates are allowed as long as: It is impractical to obtain exact dataThe estimated amount appears to be reasonableEstimates are not allowed for certain expenditures such as travel and entertainment
41 Use of EstimatesWhich of the following situations would provide an acceptable case for using a taxpayer’s estimated figures in the preparation of a federal income tax return?a. The taxpayer has the necessary data available, but is busy with a pressing criminal prosecution.b. The data are not available at the time of filing the return, and the estimated amounts appear reasonable to the accountant.c. The taxpayer desires to use an estimate to determine the amount of his deduction for entertainment expenses.
42 Knowledge of an Error Advise client Include recommendation for corrective actionNo disclosure to IRS, without client’s permission
43 Knowledge of an ErrorDavid Raskoff was hired as an accountant by Pipe & Supply Inc. to prepare its tax returns. In preparing the tax return David learns that his client has not complied with an IRS regulation addressing the depreciation of new machinery acquired by the business. David is required to:a. do nothing until advised by client or by previous accountant to take corrective action.b. advise the client of the noncompliance.c. immediately notify the IRSd. advise the client and notify the IRS, unless the client wants to contact the IRSdirectly.
44 Working with the Tax Law CHAPTER TWOWorking with the Tax Law
45 Sources of Tax Law Legislative branch Executive branch Judicial branch Statutory lawExecutive branchAdministrative lawJudicial branchCase law
47 Statutory Sources of Tax Law Internal Revenue CodeHave had three codes:1939, 1954, 1986Example of Code Citation: IRC§ 2(a)(1)(A)2 = section number(a) = subsection(1) = paragraph designation(A) = subparagraph designation
48 Administrative Sources of Tax Law- Regulations Issued by IRSProvide general interpretations and guidance in applying the CodeExample of Regulation citation:Reg. § (c)(1)1 = income tax regulation117 = code section to which regulation pertains-4 = fourth regulation on section 117 issued
49 Administrative Sources of Tax Law- Revenue Rulings Officially issued by National Office of IRSProvide specific interpretations and guidance in applying the CodeLess legal force than RegulationsPublished in the Cumulative BulletinsExample of Revenue Ruling citation:Rev. Rul. 2004–18, 2004–1 C.B. 509Revenue Ruling Number 18, appearing on page 509 of Volume 1 of the Cumulative Bulletin for 2004
50 Administrative Sources of Tax Law- Private Letter Rulings Provide guidance on how a transaction will be taxed before proceeding with itIssued for a fee & describes how the IRS will treat a proposed transactionApply only to the taxpayer who asks for and obtains the rulingExample of Letter Ruling citationLtr.Rul (39th ruling issued in the 14th week of 2004)
51 Administrative Sources of Tax Law-Determination Letters Issued by Area Director at taxpayer’s requestUsually involve completed transactionsNot published, but made known only to party making the request
54 Forum ComparisonIssue U.S. Tax Court U.S. District Court U.S. Court of Federal ClaimsPaymentof Deficiency No Yes YesJury trial No Yes NoTypes ofdisputes Tax cases only Most criminal Claims against the& civil issues U.S. GovAppeal U.S. Court of U.S. Court of U.S. Court ofAppeals Appeals Appeals for the Federal Circuit
56 Case BriefFactsIssue/sRule/sHolding/sReasoning/s
57 Formulating an Issue Whether/Does Key Facts Tax Provision Whether payments under a life insurance must be reported as income under section 61 of the Internal Revenue Code.
58 Drafting a MemoBrief AnswerFactsIssueRuleDiscussion
59 Income vs. GiftDonlad Bauta, who is homeless, listed in his tax return in 2011 his occupation as a beggar. During the year at issue, Mr. Bauta did not otherwise earn any income working for anyone. Nonetheless, Mr. Bauta reported income from begging in the amount of $3,000 in his 2011 Federal income tax return and claimed an earned income credit, in the amount of $550. Based on that credit, Mr. Bauta claimed a refund in the amount of $550. The IRS denied his claim arguing that the funds he collected while begging are not earned income, and since the credit is available only to individuals with earned income Mr. Bauta is ineligible for the earned income credit. Is he entitled to receive a refund?
61 Income Defined - Except otherwise provided, gross income means all income from whatever source- Economic Benefit Test:-Compensation for services-Business income-Gains from the disposition of property-Interest and dividends-Rents and royalties-Income arising out of debt forgiveness-Income from partnerships
62 Form of IncomeKing Corporation transfers 1,000 shares of its stock to its president. The stock has no restrictions and is part of the president’s compensation. Must the president include the value of the stock in gross income?Ali, an attorney, performs legal services for Paul, a painter, in exchange for Paul’s promise to paint Ali’s residence. Must Ali & Paul report income for this transaction?
63 When is Income Taxable? Depends on Accounting Method Selected Who Selects Accounting MethodCash Methodactual or constructive receipt of incomeCash equivalency is required
64 Constructive ReceiptCathy, a cash basis taxpayer, has received a paycheck from her employer but has been told to hold the check until the employer has sufficient funds to cover the payroll. When does Cathy need to report the amount of the check as income?
65 When is Income Taxable? Accrual Method All Events TestAll events have occurred that fix the right to receive incomeAmount can be determined with reasonable degree of certaintyPrepaid Income ExceptionPrepaid payment for goodsPrepaid payment for services
66 Prepaid Payment for Services Bear Corporation, an accrual basis taxpayer that uses the calendar year as its tax year, sells computer courses under contracts ranging from three months to two years. Assume Bear Corporation sold and received full payments for three contracts in July 2011: one for three months costing $90, one for one year costing $300, and one for two years costing $500. How much income must it recognize in 2011 and in 2012?
67 Income Sources Personal Services Dividends Income from Property Imputed Interest on Below Market LoansTax Benefit RuleInterest on Municipal BondsLeasehold ImprovementsLife Insurance ProceedsIncome from Discharge of DebtsGains and Losses from Property Transactions
69 Tax Benefit RuleIn 2010, Jack’s employer withheld $1,200 from his wages for state income tax. Jack claimed the $1,200 as an itemized deduction on his 2010 federal income tax return. Because of a variety of losses incurred by Jack, he reported a negative taxable income of $32,000 during The state refunded the $1,200 during 2011.
70 Leasehold Improvements Denver Investments, Inc. rents a retail space to KFC, Inc. The space normally would rent for $5,500 per month, but Denver Investment Inc. agrees to accept $5,000 per month for the first year if KFC builds a patio outside the premises. This would cause the building to appreciate in the amount of $10,000. Are there any tax consequences?
71 Discharge of DebtIndy Coal Company has seen its business decline during the past two years. The Company has a significant amount of bank debt that was incurred over the years to fund its coal operations. In order to maintain its operations, Indy entered into an agreement with the bank whereby the bank agreed to cancel 20% of Indy’s $500,000 debt. Assume Indy was solvent at the time of the cancellation. Does Indy have to recognize any income arising out of this transaction?
72 Discharge of Debt- Creditors’ gift exception Farouk loaned his daughter $4,000 to help her purchase a car. Several months after she purchased the car, but before she repaid the $4,000, Farouk’s daughter got married. Farouk told his daughter that he was “tearing up” the $4,000 note as a wedding present.
73 Discharge of Debt: Insolvency and bankruptcy exception In year one, Donald borrows $100,000 from a bank. The 10% interest on the loan is payable annually and the principal is to be repaid 10 years later. In year ten, Donald notifies the bank that he cannot repay the full $100,000 of principal. After some negotiations, the bank agrees to discharge the debt for $85,000. Immediately before the discharge, Donald has $300,000 of debt and $290,000 of assets; after discharge, he has $200,000 of debt and $205,000 of assets. What are the tax consequences to Donald in year 10?
74 Discharge of Debt: Student loan exception Lee borrowed $160,000 from the federal government to attend medical school. Under the terms of the loan, $20,000 of debt is forgiven for each year she practices medicine in designated low-income neighborhoods.
75 Discharge of Debts: Seller’s cancellation exception Clay purchased a used automobile from a dealer for $6,000. He paid $2,000 down and agreed to pay the balance of $4,000 over three years. After Clay purchased the automobile, he determined that it was defective. Clay tried to return the car, but the auto dealer refused. Clay threatened to sue the dealer. To resolve the problem, the dealer offered to reduce the balance due on the debt from $4,000 to $2,500. Clay agreed.
76 Discharge of Debt: Insolvency General RuleExceptionsCreditors’ giftInsolvency and bankruptcyStudent loanSeller cancellationShareholder’s cancellationTaxpayer’s principal residence
77 Gains and Losses from Property Transactions How Gain/Loss is CalculatedCapital vs. Ordinary Gain/LossCapital Asset DefinedTreatment by individualsTreatment by Corporations
79 Business Deductions Ordinary- normal, customary, or usual Necessary- Reasonable
80 Business deduction: Ordinary expense For several years, Donna has been engaged in the business of making and selling false teeth. Most of the advertisements, orders and deliveries of the teeth are done through the mail. During the current year, the post office judged that some of the advertisements were misleading. As a result, a fraud order is issued under which the post office stamps “Fraudulent” on all letters addressed to Donna, and then returns them to the senders. In an unsuccessful suit to prevent the post office from continuing this practice, Donna expends $25,000 in lawyer’s fees. Are these fees deductible?
81 Business deduction: Necessary expense Ronald owns a chain of 10 donut shops.During the past three years the profits of theshops have declined sharply. Ronald consults apsychic to determine what to do about his reducedprofits. On the advice of his psychic he pays $10,000for 10 custom made doormats, which he places infront of the entrance to each of his stores. Thepsychic tells him that the doormats will bring luck tohis business for the rest of the year. Is the costdeductible?
82 Business deduction: Reasonable amount Brian, the controlling shareholder and an employee of Central Corporation, receives an annual salary of $250,000 from the corporation. Based on several factors, such as the size of Central Corporation’s total operations and a comparison of salary received by officers of comparably sized corporations, the IRS contends that Brian’s salary should be no higher than $150,000. What is deductible?
83 Business Deductions: Cash Method Timing of Deduction:Deductible when paid with cash or other property
84 Business Deduction: Cash Method Peter, a calendar year taxpayer, is the sole owner of a plumbing repair business. The business uses the cash method of accounting. Under an arrangement with one of his suppliers, Peter and his employees can pick up supplies at any time during the month by merely signing for them. At the end of the month, the supplier sends Peter a bill for the charges. Peter always pays the bill in full during the following month. In December of the current year, Peter charges on the open account $1,500 for supplies. During the same month Peter purchases a plumbing fixture for $250 from another supplier. Peter uses his charge card at the time of the purchase. How much may Peter deduct?
85 Business Deduction: Capital Expenditures On November 1 of the current year, Jack, a cash basis taxpayer, enters into a lease arrangement with Raul to rent Raul’s office space for the following 36 months. By prepaying the rent for the entire 36 month period, Jack is able to obtain a favorable monthly lease payment of $800 /month. How much may Jack deduct in the current year?
86 Business Deduction: Accrual Method All Events TestLiability is establishedAccuracyEconomic Performance TestRecurring liability exception
87 Business Deduction: Accrual Method During the current year, Phil provides services to Gary. Gary uses the accrual method of accounting. Phil claims that Gary owes $10,000 for the services. Gary admits owing Phil $6,000, but contests the remaining $4,000. How much can Gary deduct?
88 Business Deduction: Accrual Method Best Corporation uses the accrual method of accounting and is engaged in the business of painting automobiles. Best Corporation provides a five year warranty for new vehicles and a two year warranty for used vehicles. Best Corporation’s financial accounting reports include a reserve (i.e., liability) for estimated warranty expense and deduct an amount as an expense on an annual basis. Is the warranty expense deductible for tax purposes before the warranty claim is actually made?
89 Business Deduction: Accrual Method On December 20 of the current year, Chris, an accrual method taxpayer, enters into a binding contract with Pat to have Pat clean and paint the exterior of Chris’ business building. Under the terms of the contract, the work is to be done in March of the following year. The total cost of the job is $4,000. Chris pays 10% down at the time the contract is signed. How much may Chris deduct in the current year?
90 Business Deduction: Accrual Method Dawn is a calendar year, accrual method taxpayer. Every year at the end of October, Dawn enters into a contract with Sam to provide snow removal services for the parking lots at Dawn’s business. This contract extends for five months through the end of March of the following year. How much may Dawn deduct in the current year?
91 Non Deductible Business Expenses: Fines & Penalties The delivery truck of Pizza Shack often has to park illegally to deliver their pizza on time. As a consequence, Pizza Shack pays approximately $7,000 per year in parking fines. Is the expense deductible?
92 Expenses Relating to an Illegal Activity Tom runs an illegal bookie operation for an organized crime ring. Last year he spent $14,500 on rent and utilities for his gambling operation and an additional $20,000 to hire a thug to break the legs of customers who did not pay their gambling debts. Are these expenses deductible?
93 Political Contributions & Lobbying Activities Kate is a senior partner of a large New York law firm. During the year, she flies to Washington, D.C., to testify before a Congressional subcommittee with regard to proposed changes in the Social Security taxes imposed on employers. Such changes directly affect her business because they affect the amount of taxes she must pay on behalf of her employees. Are Kate’s expenses deductible?
95 Capital ExpendituresAcquiring or constructing a property that has a useful life that extends substantially beyond the end of the tax year.Permanent improvements made to:increase the value of the property;substantially prolong the useful life of the property; oradapt the property to a new use.
96 Capital Expenditures Determine whether any of the following expenditures may be deducted currently or must be capitalized:Purchase of the copyright to the song “Stormy Weather”Purchase of a copying machine that will be used in an accounting firm.c. Purchase of paper used in the copying machine.d. Repair and maintenance of the copying machine.e. Legal fees incurred in purchasing the property on which the taxpayer’ business is located.
97 Capital Expenditures Pete’s Big Business, Inc. outgrows the office building it has occupied for the last several years. Rather than buy or lease an existing structure, Pete commissions an architect to design a new office building. The architect’s fees are $120,000. The building costs $15 million to construct. The office furniture and fixtures cost an additional $1.2 million. How much of these expenditures are currently deductible?
98 Investigation of a New Business Taxpayer is in a business the same as or similar to that being investigatedBusiness acquiredBusiness not acquiredTaxpayer is not in a business the same as or similar to that being investigated
99 Related Party Transactions Losses from property transactions between related partiesWhat is related party?Unpaid expense arising out of a transaction between related parties
100 Transactions between Related Parties Alice, Craig (Alice’s husband) and Beth each own a third of the outstanding shares of First Corporation. Alice sells a building she owns with a basis of $250,000 to First Corporation for $200,000. Is she able to deduct the $50,000 loss?
101 Transactions between Related Parties Assume two separate scenarios in which Sam sells a tract of land during the current year (scenario one for $17,000; scenario two for $8,000). In each case assume that Sam purchased the land from his father, Frank, for $10,000. Frank’s basis at the time of the original sale was $15,000 in each case. Was Frank able to deduct his loss at the time of the original sale to Sam? What is Sam’s recognized loss/gain at each of the two scenarios of the subsequent sale?
102 Expenses Related to Exempt Income Chuck borrows $100,000 at 5% rate of interest and invests the $100,000 in a municipal bond yielding 8%. Is the interest expense on his loan deductible?
103 Charitable Contribution Qualified donees:Donative intent:Time of recognition:Valuation of contribution:Limits on deductionCharitable contribution carryover
104 Research & Experimental Activities What is it?Costs for the development of an product, invention, and improvement of such existing propertyDeduction method:Expense in year paid or incurred,Defer and amortize over period of 60 months
105 Cost Recovery Capitalization vs. Expensing Goal of Cost Recovery AllowanceTypes of Cost Recovery AllowanceDepreciationAmortizationDepletion
106 Modified Accelerated Cost Recovery System CoverageReal vs. Personal PropertyEligible Property:Property is used in business or is income producing activity; andProperty has determinable useful life; orProperty declines in value due to exhaustion, wear & tear, or obsolescence
107 Cost RecoveryA cost recovery allowance may be taken for which, if any, of the following assets:-Copyright-An office building-Land on which an office building sits-A valuable original painting placed in the office building lobby-An owner occupied residence
108 Cost Recovery Allowance Cost recovery formula:Adjusted Basis X PercentageAdjusted BasisComputation:Purchase Price Less Depreciation Plus Capital ImprovementsFailure to take deductionConversion of personal use property to business use
109 Cost Recovery Allowance Depreciation formula:Adjusted Basis times a PercentagePercentage DeterminationApplicable recovery periodApplicable conventionApplicable depreciation method
110 Cost Recovery for Real Property Applicable Depreciation Method:Straight lineApplicable Convention:Mid month conventionApplicable Recovery Period:Residential real property yearsNon Residential real property- 39 years
111 Cost Recovery for Personal Property Applicable Recovery period:Applicable Convention:Mid year conventionMid quarter conventionApplicable Depreciation MethodDouble Declining orStraight line
112 179 Election Expense of acquisition in lieu of capitalization Tangible personal business propertyPlaced in service during the year of electionMACRS applies for unused portion of costLarge scale property acquisition limitationTaxable income limitation
113 179 ElectionPam owns an unincorporated manufacturing business. In 2011, she purchases and places in service $2,050,000 of qualifying equipment for use in her business. Pam’s taxable income from the business (before deducting any Sec. 179 amount) is $40,000. How much can Pam expense under Section 179?
114 Mixed Used Personal Property What is mixed use personal property?Listed propertyPredominant use testPredominant business usePredominant personal useLuxury automobiles restrictions
115 LOSSES AND LOSS LIMITATIONS CHAPTER SIXLOSSES AND LOSS LIMITATIONS
116 Bona Fide Debtor- Creditor Relationship Intent testDoes a note or other written instrument exist which evidences an obligation to repay?Is a reasonable rate of interest stated?Would a person who is unrelated to the debtor make the loan?Have the parties established a definite schedule of repayment?
117 Bona fide DebtSherrill loaned her sister Penny $5,000 three years ago. No written agreement was ever entered into. Penny had never made any payments to Sherrill, and Sherrill never tried to collect from Penny. This year, Penny filed for bankruptcy and told Sherrill that she would not be able to repay any of the $5,000 loan. Determine Sherrill’s tax treatment for the loan for the current year.
118 Bad Debts Charge off method is utilized Type of debt Loan or debt instrumentAccount receivableCash MethodAccrual Methodtax benefit rule
119 Bad Debt LossTed, who uses the accrual method of accounting, sells inventory on account for $2,000. Buyer pays $200 down and makes no further payments. How much bad debt deduction, if any, does Ted get? Will your answer change if he follows a cash method of accounting?
120 Business Bad Debt When does a business bad debt arise? Creditor is in the business of lending money; orProximate relationship between creation of the debt and taxpayer’s businessWhat type of loss is recognized?Complete & partial loss are recognized
121 Non Business Bad Debt When does a non-business bad debt arise? What type of loss is recognized?Partial loss cannot be recognized
122 Bad DebtLisa is engaged in the advertising business. If clients occasionally need additional funds to meet their cash-flow obligations, Lisa lends them money so that she can retain those clients. If any of these loans become worthless, can Lisa deduct them as bad debt losses?
123 Worthless Securities Complete loss is required Capital loss is recognized
124 Worthless SecuritiesOn November 1, 2011, Y Corporation purchased stock for $100,000. The stock became worthless on March 1, Is there a deduction? If so, when, how much and what type?
125 Worthless Securities Small business stock exception Direct purchase by taxpayerSmall investmentLimited corporate equity
126 Worthless SecuritiesTony, a single taxpayer, incorporated Waffle, Inc. three years ago by contributing $70,000 in exchange for the stock. Waffle, Inc. owns and operates a small restaurant. Unfortunately, Waffle, Inc.’s business never really became profitable. In February of the current year, Waffle, Inc. has filed for bankruptcy. Tony did not receive anything for his stock. What deductions can Tony claim in his personal tax return?
127 Casualty and Theft Loss Identifiable eventDamaging to the propertySudden- swiftUnexpected- Ordinarily unanticipatedUnusual- Not a day to day occurrence
128 Casualty Loss Fire, storm floods, vandalism Damage to building due to unusual jet sonic boomDamage to automobile due to an accident that is not the fault of the taxpayerSteady weakening of a building caused by normal windDamage to carpet caused by moths
129 When to Deduct the Loss Casualty Theft Reasonable prospect of recovery limitationTreatment of reimbursement
130 Measuring the Loss Complete loss of business or investment property Partial loss of business or investment propertyComplete or partial loss of personal use propertyPer incident limitationTotal amount limitation
131 Casualty LossTroy purchased a home for $25,000 several years ago. Through the years, the value of the home appreciated until it was appraised at $125,000 in the current year. Shortly after the appraisal, a flood sweeps through the area, severely damaging Troy’s home and reducing its value to $90,000. Troy does not have any flood insurance. Before addressing AGI limitation and per incident limitation, what is Troy’s casualty loss deduction?
132 Casualty Loss A machine that Beth uses in her A machine that Beth uses in herbusiness is completely destroyed byfire. At the time of the fire, the adjustedbasis of the machine is $5,000 and itsFMV is $3,000. How much could Bethdeduct?
133 Net Operating Losses Definition of net operating loss Business losses from any one year can offset past or future incomeCarryover periodMust carryback to 2 prior years, then carryforward to 20 future yearsMay make an irrevocable election to just carryforwardWhen there are NOLs from two or more years, use on a FIFO basis
134 Net Operating LossesWarren Corp. has a NOL for 2011 in the amount of $60,000. How must Warren use the NOL?
135 Limitations on Loss Deductions At risk limitationPassive loss limitation
136 At-Risk LimitsThe amount of a taxpayer’s economic investment in an activityCan deduct losses from activity only to extent taxpayer is at-riskAny losses disallowed due to at-risk limitation are carried forward until at-risk amount is increasedAt-risk limitations must be computed for each activity of the taxpayer
137 At Risk Limitations- At Risk Amount Cash contributedBasis of property contributedDebt for which the taxpayer is personally liableAdjusted basis of property pledged as security for a debt, where the property is not used in the activityTaxpayer’s share of annual income relating to the activity less, share of annual losses or withdrawals
138 At Risk LimitationSiskel Ebert, a prominent movie critic, buys a motion picture for $500,000. He puts up $50,000 of his own money and $450,000 from a nonrecourse loan. In the first year of distribution, the movie loses $80,000. What are the tax consequences?
139 Limitations on passive losses Generally, passive losses can only offset passive income, i.e., they cannot reduce active or portfolio incomeDisallowed losses are suspended and carried forwardSuspended losses must be allocated to specific activitiesSuspended losses are deductible in year related activity is disposed of in a fully taxable transaction
140 Passive Loss Limits: Active Income Wages, salary, and other payments for services renderedIncome/losses from self-employed trade or business activity in which taxpayer materially participatesGain from sale or disposition of assets used in an active trade or businessIncome from intangible property created by taxpayer
141 Passive Loss Limits: Portfolio income Interest, dividends, annuities, and certain royalties not derived in the ordinary course of businessGains/losses from disposition of assets that produce portfolio income or held for investment
142 Passive Loss Limits: Passive Income Passive losses definedLosses from trade or business activities in which taxpayer does not materially participate, andRental activities
143 Passive Loss Limitation During the year, Kasi, a CPA, reports $100,000 of active business income from his CPA practice. He also owns two passive activities, from which he earned $10,000 of income from Activity A, and incurred a $15,000 loss from activity B. Can Kasi offset his losses from activity B against any of the other income he earned?
144 Material Participation Definition: Participation that is regular, continuous, and substantialWhat is regular, continuous and substantial:Taxpayer participated for more than 500 hoursTaxpayer participated for more than 100 hours and no one else had greater participationTaxpayer’s participation constituted substantially all of the participation in activity
145 Material Participation Roger’s auto repair shop shows a taxable loss of $25,000 in year one. Year one is the first taxable year for the repair shop. The shop has five full time employees. Roger, however, works at the shop for only 600 hours per year. State the amount of loss, if any, that would be deductible?
146 Rental Activities General Rule: Exceptions Real Estate Professionals Half of services testMinimum hours testRental Real Estate DeductionActive participation testMinimum ownership test
147 Rental ActivitiesOn January 1, year one, Juan purchases an apartment building. The apartment building shows a net loss for the year of $30,000. Juan has full time employee manage the building; however, Juan interviews all prospective tenants and makes the final decision on major repairs. Juan spends about 110 hours a year on the building and has no other investments. His adjusted gross income is $110,000. How much of the loss may Juan use to offset his salary income?
148 PROPERTY TRANSACTIONS- BASIS, GAIN, LOSSES AND NONTAXABLE EXCHANGES CHAPTER SEVENPROPERTY TRANSACTIONS- BASIS, GAIN, LOSSES AND NONTAXABLE EXCHANGES
149 Questions Is there a realized gain or loss? Is the gain or loss recognized?Is the gain or loss ordinary or capital?What is the basis of the acquired replacement property?
150 Determination of Gain or Loss Realized gain or lossDifference between amount realized from sale or other disposition of the asset and its adjusted basisSale or other dispositionIncludes trade-ins, casualties, condemnations, thefts
151 Determination of Gain or Loss Alice owns land that is held for investment and has a basis of $20,000. The land is taken by the city by right of eminent domain, and she receives a payment of $30,000 for the land. Is this condemnation treated as a sale or disposition? Has Alice realized a gain? If so, how much?
152 Determination of Gain or Loss Amount realized from disposition:Total consideration received-cash, FMV of property received, loans assumed by buyerReduced by any selling expenses
153 Determination of Gain or Loss Anna exchanges land subject to a liability of $20,000 and an adjusted basis of $42,000 for $35,000 of stock owned by Mario. Mario takes the land subject to the liability. What is the realized amount on this sale transaction? What is the realized gain?
154 Determination of Gain or Loss Doug sells stock of Laser Corporation, which has a cost basis of $10,000, for $17,000. Doug pays a sales commission of $300 to sell the stock. What is the amount realized and the gain realized?
155 Adjusted Basis= Original cost + capital additions - capital recoveriesCapital additions:Cost of improvements to the property that are capital in natureCapital recoveries:Depreciation or cost recovery allowancesCasualty and theft losses
156 Basis Consideration Original basis of an asset is generally its cost Bargain purchase assets have a basis equal to their FMVBargain amount may be income to purchaser (e.g., employee = compensation; shareholder = dividend)
157 Bargain PurchaseRamona is an employee of S&S Development Company. The company recently subdivided and offered lots for sale in the Porter Ranch area at a price of $200,000. S&S sells Ramona a lot for $150,000. How much gross income does Ramona have from the purchase of the property? What is her basis in the property?
158 Bargain PurchaseAllegra wishes to purchase a Lamborghini. She knows that such cars generally sell for about $75,000. However, she searches on E-Bay and locates an owner of such a car, who purchased it three months ago and is now having difficulties making monthly payments. Allegra buys the property from him for only $45,000. Does Allegra have gross income from the purchase and what is her basis in the property?
159 Basket Purchase Relative Value Allocation: Going Concern Purchase: Must allocate basis to each asset obtained based on relative FMV of assetsGoing Concern Purchase:Assign purchase price to assets (excluding goodwill) to extent of their total FMVResidual amount is goodwill
160 Gift Basis FMV> Donor’s Basis: The donee’s basis is the donor’s basisFMV< Donor’s Basis:The donee has a dual basis:Loss Basis: FMV at the time of giftGain Basis: same as donor’s adjusted basis
161 Gift BasisKevin makes a gift of property with a basis of $350 to Janet when it has a $425 FMV. What would be Janet’s realized loss/gain if she sells the property for $450? for $330?
162 Property Acquired from a Decedent Inherited property is always treated as long-term propertyGenerally, beneficiary’s basis in inherited assets will be the FMV of the asset at decedent’s date of deathException: If the executor/administrator of estate elects alternate valuation date, basis is FMV on such date
163 Property Acquired from a Decedent Dianna inherits property having a $60,000 FMV at the date of the decedent’s death. The decedent’s basis in the property is $72,000. The alternate valuation date is not elected. What is Dianna’s basis in the property?
164 Personal Use Property Converted to Business Use Gain basisLoss basisDepreciation basis
165 Personal Use Property Converted to Business Use Craig owns a personal use asset with a basis of $80,000 and a $50,000 FMV. How much losses may Craig deduct if he sells it for its FMV? If Craig converts the asset to business use and then immediately sells it, how much loss may be recognized?
166 Property Converted to Business Use Olga owns a boat that cost $2,000 and is used for personal enjoyment. At a time when the boat has a $1,400 FMV, Olga transfers the boat to her business of operating a marina. What is the basis of the boat in Olga’s business for purpose of determining depreciation?
167 Disallowed Losses from Disposition of Property Personal Use PropertyRelated Party TransactionWash Sales
168 Disposition of Personal Use Property Bruce Evans owns a personal use car that has an adjusted basis of $40,000. The fair market value of the car is $35,000.Calculate the realized and recognized loss if Bruce sells the car for $35,000.
169 Disallowed Losses- Related Parties Losses on sale of assets between related parties are disallowedRight to offsetOnly available to original transfereeNot available for sales of personal use assets
170 Wash Sales Loss on sale of security Purchase of substantially identical securityPurchase done within close time proximity sale of securityBasis of new acquired security
171 Wash SalesLeslie realizes $10,000 in short term capital gains through dealings in the stock market during the current year. To generate capital losses as a way of offsetting the capital gains, she sells her Edison Corporation stock for only $8,000, even though she originally purchased it for $16,000. Nonetheless, Leslie feels that Edison Corporation is still a good investment and wants to retain the stock. Can Leslie deduct the $8,000 loss if she sells the stock she owns and repurchases a similar number of shares of Edison stock two weeks later?
172 Non Tax Recognition of Property Disposition Like Kind ExchangeInvoluntary ConversionsSale of Principal Residence
173 Like-Kind Exchanges§1031 requires nontaxable treatment for gains and losses when:Asset exchanged must be like-kind in natureExchange of qualified assetsExchange is simultaneous
174 Like Kind Exchange Real Estate Personal Property Improved for unimproved realty qualifiesCommercial for residential realty qualifiesPersonal PropertyOffice furniture & equipmentComputers and peripheral equipmentAirplanesAutomobiles and taxisBusesLight general purpose truckHeavy general purpose truck
175 Like ExchangeGail exchanges an office building with a $400,000 adjusted basis for an airplane with a $580,000 FMV to be used in business. Is this a like-kind exchange?
176 Like ExchangeBob transfers a personal computer used in his trade for a printer to be used in his trade. Is this a like kind exchange?
177 Like ExchangeRenee transfers an airplane that she uses in her business for a heavy general purpose truck in use in her business. Is this a like kind exchange?
178 Exchange of Qualified Assets Assets involved are used in trade or business or held for production of incomeinventory, securities, and partnership interests do not qualify
179 The Exchange Requirement Dawn’s automobile is held only for personal use. She exchanges the automobile, which has a $10,000 basis, for stock of AT&T with a $12,000 FMV. The stock will be held for investment. Is the gain recognized?
180 Simultaneous Exchange The exchange of the two like-kind properties must be simultaneousDeferred exchange exception
181 Boot What is it: What is its Impact: Gain Recognition Only: Any property involved in the exchange that is not like-kind property is “boot”What is its Impact:The receipt of boot causes gain recognition equal to the lesser of boot received (FMV) or gain realizedGain Recognition Only:No loss is recognized even when boot is received
182 Receipt of BootMario exchanges business equipment with a $50,000 adjusted basis for $10,000 cash and business equipment with a $65,000 FMV. What is the realized and recognized gain?
183 Receipt of BootMary exchanges business equipment with a $70,000 adjusted basis for $20,000 cash and business equipment with a $65,000 FMV. What is her realized and recognized gain, if any?
184 Basis of Property Received as Part of an Exchange Basis in like-kind asset received:FMV of new asset– Gain not recognized+ Loss not recognizedBasis in boot received is FMV of property
185 Involuntary Conversion May defer gain recognition if:Involuntary conversionThe destruction, theft, seizure, condemnationReinvestment of the conversion amountAmount of reinvestment >= amount realizedReinvestment in similar propertyReinvestment within specified time
186 Involuntary Conversion Business or Personal Use PropertyBasis of New Property:Cost less deferred gainPartial ReinvestmentAmount recognized is lesser of realized gain or non-reinvested amountInapplicable to LossesPermissive in Nature
187 CHAPTER EIGHTPROPERTY TRANSACTIONS: CAPITAL GAINS AND LOSSES, SECTION 1231, AND RECAPTURE PROVISIONS
188 Questions Is there a realized gain or loss? Is the gain or loss recognized?Is the gain or loss ordinary or capital?What is the basis of the acquired replacement property?
189 Capital Gain Tax Cut Windfall YearRealizationsRevenues2002$269$49200332351200449974200569010120067981172007863127Source: Congressional Budget Office, January 2008
191 Why Separate Capital Gains/Losses from Ordinary Gains/Losses? Lower Tax Rate:Long-term capital gains may be taxed at a lower rate than ordinary gainsLimitation on Deduction:The deduction of a net capital loss may be limited
192 Proper Classification of Gains and Losses Depends on three factorsThe tax character of the propertyMust be capital asset, not ordinary assetThe manner of the property’s dispositionBy sale or exchange onlyThe holding period of the propertyMust be long term
193 Capital AssetsAssets held for InvestmentPersonal Use Assets
194 Non Capital Assets Inventory Notes and accounts receivables Accrual MethodCash MethodReal property & depreciable personal property used in trade or business (§1231 assets)Creative works created by taxpayer
195 InventoryDefine:Property must be held primarily for sale to customers in the ordinary course of taxpayer’s businessAutomobiles as InventorySecurities as InventoryReal property as Inventory
196 Manner of Disposition- Sale or Exchange is Required to recognize capital gain/loss- Are the following transactions considered a “sale or an exchange”?Worthless securitiesOption transferPatent transfer
197 Sale or Exchange- Worthless Securities Charles purchased $40,000 of bonds issued by the Jet Corporation in March In February 2012, Jet is declared bankrupt, and its bonds are worthless. Can Charles recognize a capital loss?
198 Sale or Exchange: Options On March 2, 2011, Dina pays $270 for an option to acquire 100 shares of Arkansas Corporation stock for $30 per share at any time before December 11, As a result of an increase in the market value of the Arkansas stock, the market price of the option increases and Dina sells the option for $600 on August 2, What type of gain must Dina recognize?
199 Sale or Exchange: Patent Transfer all substantial rights to a patent is the equivalent of a saleTreated as a long term capital gainIndividual ownership: the transferor must be the individual creator
200 Sale or Exchange: Patent Clay invents a small utensil used to peel shrimp. He has a patent on the utensil and transfers all rights to the patent to a manufacturing company. Clay receives $100,000 plus 40 cents per utensil sold. Clay’s cost basis in the patent is $45,000. What type of gain must Clay recognize?
201 Holding Period Short-term Asset held for 1 year or less Long-term Asset held for more than 1 yearHolding period starts on the day after the property is acquired and includes the day of disposition
202 Holding PeriodOn June 1, 2011, Alfred sells stock held as an investment and recognizes a gain. If the stock was purchased on May 31, 2010, what type of a gain should Alfred recognize in his tax return?
203 Holding Period Non Taxable Exchanges Disallowed Loss Transactions Property Received as GiftCarryover basisFMV basisProperty Received from a Decedent
204 Holding PeriodCindy receives a capital asset as a gift from Marc on July 4, 2011, when the asset has a $4,000 FMV. Marc acquired the property on April 1, 2011, for $3,400. If Cindy sells the asset on April 14, 2012 for $3,800, how would any gain/loss is classified?
205 Holding PeriodThe executor of Paul’s estate sells certain securities for $41,000 on September 2, 2011, which are valued in the estate at their FMV of $40,000 on June 5, 2011, the date of Paul’s death. Paul purchased these securities six months before his death for $30,000. What type of gain does the estate have?
206 Tax Treatment of Capital Gains and Losses of Non-Corporate Taxpayers Short Term Capital Gains (STCG)No preferential tax rate availableLong Term Capital Gains (LTCG)Regular LTCG- preferential tax rate availableExceptions:28% PropertyCollectiblesSmall Business Stock25% PropertyUnrecaptured Section 1250 gain
207 Offsetting Against Capital Gains Group All Gains & All Losses for Each CategoryNet Each CategoryIn the Long Term Capital Categories, Net LTCL Against Highest Taxed Capital Gain FirstNetting any STCL Against Highest Taxed Capital Gain FirstNetting Against Ordinary Income
208 NettingSandy has a salary of $100,000. If she sells a non-personal use asset during the year and has a $40,000 loss, why is it important that the asset not be a capital asset?
209 NettingBob has gross income of $60,000 before considering capital gains and losses. If Bob has Net Long Term Capital Gain (NLTCG) of $10,000 and Net Short Term Capital Loss (NSTCL) of $15,000, how much, if any, could Bob deduct against his ordinary income?
210 NettingLast year, Milt had a NSTCL of $8,000 and a NLTCG of $2,600. During the current year he sells a capital asset and generates a STCG of $800. How much capital losses could Milt deduct from his ordinary income during last year and this year?
211 NettingIn the current year, Beth has NSTCL of $2,800 and NLTCL of $2,000. Does Beth have any loss carryover for next year? How much? Is it short term or long term carryover loss?
212 NettingLeroy, whose tax rate is 35%, has NSTCL of $20,000, a $25,000 LTCG from the sale of a rare stamp held for 16 months and an $18,000 LTCG from the sale of stock held for three years. What is the effect of these gains and losses on his total tax liability?
213 NettingElizabeth, whose tax rate is 35%, has NSTCG of $40,000, a $30,000 LTCG from the sale of an antique, a $10,000 LTCG in the 25% property group, and a $22,000 LTCL from the sale of stock held for four years. What is the effect of these gains and losses on her total tax liability?
214 Capital Gains & Losses of Corporate Taxpayer No preferential tax rateNo offsetting against ordinary incomeCarryback and carryforward period
215 Capital Gains & Losses of Corporate Taxpayer The Peach Corporation has income from operations of $200,000, a NSTCG of $40,000, and NLTCL of $56,000 during the current year. How much of the loss can Peach Corporation offset against its income from operations?
216 Section 1231 Asset Depreciable personal property used in business Real property used in a businesspurchased intangiblesProperty held greater than 1 yearNet §1231 loss = ordinary lossNet §1231 gain = long-term capital gain
217 Capital Gains & Losses of Corporate Taxpayer Dawn sold a machinery for $20,000 gain. In the same year, she also sold land for $12,000 loss. Both properties were used in her business and were owned by Dawn for three years. What kind of gain/loss must Dawn recognize?
218 Depreciation Recapture Why §1231 gain is recaptured sometimes?The impact of recaptureGain recapture characterizes gains that would otherwise be capital as ordinary incomeProperties subject to recapture:§1231 assets subject to depreciation are subject to depreciation recapture when disposed of at a gainThe recapture provisions:§1245§1250
219 §1245 Recapture §1245 property: Depreciable personal property Purchased intangiblesApplies to gain onlyRecapture amount:Total accumulated depreciation will be recaptured as ordinary incomeThe gain in excess of depreciation recapture will be §1231 gain
220 Section 1245 RecaptureBuckeye Corporation owns the following assets acquired in 2010: a truck, a purchased patent, an office building and a land, all of which are used in business. Which one of these properties are Section 1245 property?
221 Section 1245 RecaptureAdobe Corporation sells equipment used in its trade for $95,000. The equipment was acquired several years ago for $110,000. The equipment’s adjusted basis is $60,000 because of $50,000 of depreciation was deducted. Will Adobe have to recognize 1231 gain? What if the equipment is sold for $117,000?
222 §1250 Recapture§1250 property: Depreciable real property sold at a gainRecapture amount:Recapture potential is limited to excess of accelerated depreciation taken on asset over depreciation that would have been deductible if straight-line depreciation had been usedTax rate:Recaptured gain: ordinary incomeNonrecaptured gain: LTCG 25% PropertySection 1231 gain: excess of sale prices over original purchase price
224 TAXATION OF INDIVIDUALS CHAPTER SIXTEENTAXATION OF INDIVIDUALS
225 Tax Formula Income (broadly conceived) $x,xxx Less: Exclusions (x,xxx) Gross Income $x,xxxLess: Deductions for AGI (x,xxx)AGI $x,xxxLess: The greater of-Total itemized deductionsor the standard deduction (x,xxx)Personal & dependency exemptions (x,xxx)Taxable Income $x,xxx
226 Exclusions from Gross Income Child SupportGifts & InheritancesScholarshipsDamagesLoss of IncomeExpenses IncurredProperty DamagePersonal InjuryCompensatory DamagesPunitive Damages
227 ScholarshipsBecky is awarded a $7,000 per year scholarship by State University. Becky spends $5,000 of the scholarship for tuition, books and supplies, and $2,000 is for room and board. In addition, Becky is a graduate student assistant and the University grants her a waiver of half of her $6,000 annual tuition. How much is Becky taxed on?
228 Items Included in Gross Income CompensationBusiness IncomeInterestRents & RoyaltiesAlimonyUnemployment CompensationPrizes and Awards
229 AlimonyHelen earned $500,000 and, as a result of her divorce, she was required to pay William $250,000. Is this payment included in William’s gross income?
230 AlimonyAs a result of a divorce, Dawn receives stock that she has purchased with her former husband during their marriage. They had purchased the stock for $12,000. At the time of the divorce, the stock was worth $14,000. Assume the transfer is not considered as alimony. How will this transfer affect the parties’ taxable income? What if Dawn subsequently sells the stock for $15,000?
231 Prizes and Awards General rule: FMV of item is included in income Exception One:Non commercial achievementNo substantial services are dueRedirected to non for profitNot self nominated incomeException Two:Employee achievement awards (up to $400) of tangible personal property made in recognition of length of service or safety achievement
232 Deductions for AGI Ordinary and necessary business expense One half of self employment tax paidMoving expensesCapital loss deductionAlimony paidIRA contribution
233 Standard DeductionThe basic standard deduction (BSD) amount depends on filing status of taxpayerFiling statusSingle $5,800MFJ, SS $11,600HH $8,500MFS $5,800
234 Standard Deduction Additional standard deduction (ASD) For taxpayers age 65 or older and/or legally blindFiling StatusSingle $1,450MFJ, SS ,150HH ,450MFS ,150
235 SD Limit for Person Claimed as Dependent In 2011, individual claimed as dependent has a BSD limited to the greater of:$950 or$300 plus earned income (but not exceeding normal BSD)ASD amount(s) still available
236 Itemized Deductions Medical Expenses Taxes Personal & Real Property TaxesState, Local & Foreign TaxesInterestBusiness Interest- For AGIPersonal Interest- Not deductibleInterest on Student Loan-For AGIInvestment Interest- For AGIQualified Residence Interest- ItemizedCharitable Contributions
237 Medical ExpensesDuring the current year, Kelly incurs qualified medical expenditures of $3,000. Her adjusted gross income for the year is $30,000. What is the itemized deduction for medical expense?
238 Investment Interest Expense Skip borrows $100,000 from a bank at 10% interest, interest only for three years, to buy Pork Belly common stock. In year one the stock pays dividends of $8,000. In year two the Pork Belly stock pays no dividends but Skip receives $3,000 in dividends from some Growth Company stock that he inherited. In year three the Pork Belly stock pays $25,000 in dividends. How much of the $10,000 of annual interest can Skip deduct each year?
239 Qualified Residence Interest Loans covered: acquisition or equity loans on qualified residenceQualified ResidenceAcquisition IndebtednessHome Equity LoanPointsPrepayment Penalty
240 Charitable Contributions Contributions must be made to domestic organizationsContributor must have donative intent and expect nothing in returnNo deduction is allowed for the contribution of services (except for unreimbursed expenses)ValuationSubstantiation requirementLimit on deduction
241 Charitable Contribution Cindy, a gym teacher, volunteered to work for a week with handicapped children as part of an athletic event sponsored by a charitable organization. Cindy spent $40 on transportation and $200 on lodging in connection with the event. If Cindy had been paid her normal fee for her services, she would have received $500. What amount can Cindy deduct as a charitable contribution?
242 Charitable Contribution Mona says: “It costs a low income taxpayer more to make a donation to charity than it costs a high income taxpayer.” Is Mona correct? Explain.
243 Miscellaneous Itemized Deductions Professional dues to membership organizationsUniformsFees incurred for the preparation of one’s tax return for tax litigation before the IRSJob hunting costsHobby lossesUnreimbursed employee expenses
244 Exemptions Amount One Exemption Per Person Personal Exemptions Dependency ExemptionsQualifying ChildQualifying Relative
245 Qualifying Child Relationship Domicile Age Joint return Citizen or residency
246 Qualifying RelativeA dependency exemption may be claimed for each individual that meets all of the following tests:SupportGross incomeRelationship (or household member)Joint returnCitizen or residency
247 Qualifying Relative- Support Taxpayer must provide more than 50% of the dependent’s supportOnly amounts expended are considered in the support testScholarships of children are not considered in the support test
248 Qualifying Relative- Gross Income Dependent’s gross income cannot be greater than amount allowed for an exemptionException: No gross income limitation if dependent is child of taxpayer AND either:i) Less than age 19, ORii) Less than age 24 and a full-time student
249 Taxable Income General Rule: Tax return must be filed if gross income is ≥ the sum of the standard deduction and exemption amount
250 Filing Status There are 5 filing statuses Single Married, filing jointlySurviving spouse (qualifying widow/er)Head of householdMarried, filing separatelyFiling status affects tax rate brackets, standard deduction, and other amounts
251 Kiddie Tax Limitations on Shifting Income to Dependents: No Personal ExemptionLower Standard DeductionParent’s Tax Rate on Net Unearned Income (NUI)-Child must be under age 19 (or under age 24 if full time student) at end of year-NUI generally equals unearned income less $1,900
252 Credits Adoption Expense Credit Child Tax Credit Child Care Credit Education Tax CreditAmerican Opportunity CreditLife Time Learning CreditEarned Income Credit
253 Adoption Expenses Credit Credit for qualified adoption expenses incurred in adoption of eligible child (fees, court costs, attorney fees)Maximum credit in 2010 is $12,170Eligible child is one that isLess than 18 years of age, orPhysically or mentally handicappedNonrefundable creditExcess may be carried forward for five years
254 Child Tax Credit Credit amount is $1,000 per child Eligible children are:Under age 17,US citizen, andClaimed as dependent on taxpayer’s tax return
255 Child & Dependent Care Credit General qualifications for creditMust have employment related care costs for aDependent under age 13, or Handicapped dependent or spouseCredit amountEligible care costs x 20% to 35% depending on AGIAmount of costs that qualify is the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individualsAmount of eligible care costs cannot exceed lower of taxpayer’s or spouse’s earned income
256 Education Tax Credit 2 education tax credits are available American Opportunity Credit creditLifetime learning creditBoth nonrefundable credits are available for qualifying tuition and related expensesRoom, board, and book costs are ineligible for the creditsUndergraduate degrees, graduate degrees, or vocational training.
257 Educational Tax Credit-Maximum Credit American Opportunity Tax Credit maximum per eligible student is $2,500 per year for first 4 years of postsecondary education100% of first $2,000 of qualifying expenses plus 25% of next $2,000 of qualifying expensesLifetime learning credit maximum per taxpayer is 20% of qualifying expenses up to $10,000 per yearCannot be claimed in same year the American Opportunity Tax Credit is claimed
258 INDIVIDUALS AS EMPLOYEES AND PROPRIETORS CHAPTER SEVENTEENINDIVIDUALS AS EMPLOYEES AND PROPRIETORS
259 Employee vs. Independent Contractor Why Proper Classification is Important?Expense DeductionsPayment of Taxes and BenefitsLiabilityHow to Distinguish?Degree of ControlTools of WorkMethod of PaymentSkills RequiredPermanency
260 Employee vs. Independent Contractor Truck drivers, who are owner operated, are engaged under a contract with an interstate trucking company. The truck drivers selected their own routes and were paid a percentage of the company’s receipts for shipments. Are the truck drivers considered employees or independent contractors?
261 Exclusions from Gross Income Available to Employees Accident & Health Insurance PlansPremiumsPayment of Medical Care BenefitsLong Term Care BenefitsMeals & LodgingLife InsuranceTuition Reduction Plans
262 Meals & Lodging Meals: Furnished by Employer Employer’s Convenience Business PremisesLodgingAll of the AboveCondition of Employment
263 Life InsuranceDavid receives $50,000 of group term life insurance from his employer. He names his long-time companion Fred as beneficiary. Is David subject to tax on the premiums paid by his employer for the life insurance policy? If David dies, is Fred taxed on the $50,000 death benefits?
264 Other Fringe Benefits Dependent care Up to $5,000 of care costs paid for by employer can be excludedAthletic facilitiesValue of use of athletic facilities located on employer premises can be excludedEducational assistance programsUp to $5,250 for undergraduate and graduate education is excludible
265 Other Fringe Benefits Adoption assistance programs Exclusion limited to $10,630Qualified transportation expensesParkingCommuter passNo additional costs services:No additional cost to employerOrdinary course of employer’s business
266 No Additional Cost Service Dean, an airline reservation clerk for Friendly Airlines, is allowed to fly free of charge on Friendly Airlines flights. Dean is required to fly on a stand by basis and is permitted to board only when there otherwise would be unoccupied seats. Is the flight taxable to Dean?
267 Other Fringe Benefits Qualified employee discounts Goods Services Working condition fringe benefitDe minimis fringe benefit
268 Employee DiscountMary is an accountant for the Eastside cleaning Service. The business pays house cleaners $5 an hour to clean customers’ homes. The gross receipts of the business for the year were $500,000 and its total expenses were $450,000. Employees of Eastside are permitted to purchase cleaning services at a 20% discount. Mary hires the service to clean her apartment once a week for $40. The ordinary price for such cleaning would have been $50. Is Mary subject to tax on the $10 discount?
269 Working Condition Fringe Mark is a professional hockey player for the Boston Brawlers. During the off-season Mark lives in Mystic, Connecticut. The Brawlers purchase a membership for Mark in a Mystic health club at a cost of $500 and hire a private trainer at a cost of $1,000 to supervise Mark’s workouts. Is Mark taxed on the cost of the club membership and trainer?