Wealth Transfer Taxes Estate Tax –Estate vs. inheritance tax –Computation FMV of decedent’s property, less Funeral expenses Debts Charitable donations Marital deduction to a surviving spouse United transfer tax credit
Wealth Transfer Taxes Gift Tax –Original goal –Donor is taxed –Annual Exclusion –Computation
Gift Tax Antonio 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?
Property Taxes Assessed on personal or/and real property Difference between real and personal property
Taxes on Privileges & Rights Custom Duties Franchise Tax Occupational Tax
Income Tax Main Source of Revenues for the Federal Government Progressive in Nature Income Tax Computation
U.S. Federal Tax Revenues
Top Income Tax Rates Australia63%45% Canada6029 France6040 Germany6545 Ireland6041 Italy7243 Japan7550 Korea8940 Spain6643 Sweden8757 Switzerland3126 U.K.8340 United States7035 Average6743
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
Formula for Federal Income Tax on Individuals Income (Slide 2 of 3) Adjusted Gross Income $xx,xxx) Less: The greater of: Itemized deductions, or The standard deduction (x,xxx) Less: Personal and dependency exemptions (x,xxx) Taxable income $xx,xxx)
Formula for Federal Income Tax on Individuals Income (Slide 3 of 3) Tax on taxable income (see Tax Rate Schedules in Appendix A) $ x,xxx Less: Tax credits Less: Federal income tax withheld and other prepayments of Federal income taxes) $(xxx) Tax due (or refund) $ xxx
Alternatives to Income Tax Value Added Tax Networth Tax Flat Tax
Business Entities Sole proprietorships Partnerships C corporations S corporations Limited liability Company (LLC)
Types of Tax Rates Marginal 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 Rate Sam, 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?
Ethics & Professional Responsibilities AICPA Code of Conduct AICPA Statements on Standards of Tax Service Internal Revenue Code IRS Circular 230
Due Diligence Rebecca, 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?
Advocating Positions on Behalf of Client Circular 230 –Substantial authority for the position taken –Reasonable Basis and fully disclosed Penalties
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?
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?
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?
Reliance on Client’s Information Is the information supplied by client appear correct, complete and consistent? If yes, may rely without verification If no, must verify information
Use of Estimates Estimates are allowed as long as: – It is impractical to obtain exact data – The estimated amount appears to be reasonable Estimates are not allowed for certain expenditures such as travel and entertainment
Use of Estimates Which 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.
Knowledge of an Error Advise client Include recommendation for corrective action No disclosure to IRS, without client’s permission
Knowledge of an Error David 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 IRS d.advise the client and notify the IRS, unless the client wants to contact the IRS directly.
CHAPTER TWO Working with the Tax Law
Sources of Tax Law Legislative branch –Statutory law Executive branch –Administrative law Judicial branch – Case law
Legislative Process for Tax Bills
Statutory Sources of Tax Law Internal Revenue Code –Have had three codes: 1939, 1954, 1986 Example of Code Citation: IRC§ 2(a)(1)(A) 2 = section number (a) = subsection (1) = paragraph designation (A) = subparagraph designation
Administrative Sources of Tax Law- Regulations Issued by IRS Provide general interpretations and guidance in applying the Code Example of Regulation citation: Reg. § (c)(1) 1 = income tax regulation 117 = code section to which regulation pertains -4 = fourth regulation on section 117 issued
Administrative Sources of Tax Law- Revenue Rulings Officially issued by National Office of IRS Provide specific interpretations and guidance in applying the Code Less legal force than Regulations Published in the Cumulative Bulletins Example of Revenue Ruling citation: –Rev. Rul. 2004–18, 2004–1 C.B. 509 Revenue Ruling Number 18, appearing on page 509 of Volume 1 of the Cumulative Bulletin for 2004
Administrative Sources of Tax Law- Private Letter Rulings Provide guidance on how a transaction will be taxed before proceeding with it Issued for a fee & describes how the IRS will treat a proposed transaction Apply only to the taxpayer who asks for and obtains the ruling Example of Letter Ruling citation –Ltr.Rul (39th ruling issued in the 14th week of 2004)
Administrative Sources of Tax Law-Determination Letters Issued by Area Director at taxpayer’s request Usually involve completed transactions Not published, but m ade known only to party making the request
Federal Judicial System
Circuits of the United States Courts of Appeal
Forum Comparison Issue U.S. Tax Court U.S. District Court U.S. Court of Federal Claims Payment of Deficiency No Yes Yes Jury trial No Yes No Types of disputes Tax cases only Most criminal Claims against the & civil issues U.S. Gov Appeal U.S. Court of U.S. Court of U.S. Court of Appeals Appeals Appeals for the Federal Circuit
Tax Research Process
Case Brief Facts Issue/s Rule/s Holding/s Reasoning/s
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.
Drafting a Memo Brief Answer Facts Issue Rule Discussion
Income vs. Gift Donlad 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?
CHAPTER FOUR Gross Income
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
Form of Income King 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?
When is Income Taxable? Depends on Accounting Method Selected Who Selects Accounting Method Cash Method –actual or constructive receipt of income –Cash equivalency is required
Constructive Receipt Cathy, 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?
When is Income Taxable? Accrual Method All Events Test –All events have occurred that fix the right to receive income –Amount can be determined with reasonable degree of certainty Prepaid Income Exception Prepaid payment for goods Prepaid payment for services
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?
Income Sources Personal Services Dividends Income from Property Imputed Interest on Below Market Loans Tax Benefit Rule Interest on Municipal Bonds Leasehold Improvements Life Insurance Proceeds Income from Discharge of Debts Gains and Losses from Property Transactions
Tax Benefit Rule In 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.
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?
Discharge of Debt Indy 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?
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.
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?
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.
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.
Discharge of Debt: Insolvency General Rule Exceptions –Creditors’ gift –Insolvency and bankruptcy –Student loan –Seller cancellation –Shareholder’s cancellation –Taxpayer’s principal residence
Gains and Losses from Property Transactions How Gain/Loss is Calculated Capital vs. Ordinary Gain/Loss –Capital Asset Defined –Treatment by individuals –Treatment by Corporations
Chapter Five Business Deductions
Ordinary- normal, customary, or usual Necessary- Reasonable
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?
Business deduction: Necessary expense Ronald owns a chain of 10 donut shops. During the past three years the profits of the shops have declined sharply. Ronald consults a psychic to determine what to do about his reduced profits. On the advice of his psychic he pays $10,000 for 10 custom made doormats, which he places in front of the entrance to each of his stores. The psychic tells him that the doormats will bring luck to his business for the rest of the year. Is the cost deductible?
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?
Business Deductions: Cash Method –Timing of Deduction: Deductible when paid with cash or other property
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?
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?
Business Deduction: Accrual Method –All Events Test Liability is established Accuracy –Economic Performance Test Recurring liability exception
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?
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?
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?
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?
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?
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?
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?
Capital Expenditures Acquiring 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; or – adapt the property to a new use.
Capital Expenditures Determine whether any of the following expenditures may be deducted currently or must be capitalized: a.Purchase of the copyright to the song “Stormy Weather” b.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.
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?
Investigation of a New Business Taxpayer is in a business the same as or similar to that being investigated –Business acquired –Business not acquired Taxpayer is not in a business the same as or similar to that being investigated –Business acquired –Business not acquired
Related Party Transactions Losses from property transactions between related parties –What is related party? Unpaid expense arising out of a transaction between related parties
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?
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?
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?
Charitable Contribution Qualified donees: Donative intent: Time of recognition: Valuation of contribution: Limits on deduction Charitable contribution carryover
Research & Experimental Activities What is it? –Costs for the development of an product, invention, and improvement of such existing property Deduction method: – Expense in year paid or incurred, –Defer and amortize over period of 60 months
Cost Recovery -Capitalization vs. Expensing -Goal of Cost Recovery Allowance -Types of Cost Recovery Allowance -Depreciation -Amortization -Depletion
Modified Accelerated Cost Recovery System Coverage Real vs. Personal Property Eligible Property: –Property is used in business or is income producing activity; and –Property has determinable useful life; or –Property declines in value due to exhaustion, wear & tear, or obsolescence
Cost Recovery A 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
Cost Recovery Allowance Cost recovery formula: –Adjusted Basis X Percentage Adjusted Basis –Computation: Purchase Price Less Depreciation Plus Capital Improvements –Failure to take deduction –Conversion of personal use property to business use
Cost Recovery Allowance Depreciation formula: –Adjusted Basis times a Percentage –Percentage Determination Applicable recovery period Applicable convention Applicable depreciation method
Cost Recovery for Real Property Applicable Depreciation Method: –Straight line Applicable Convention: –Mid month convention Applicable Recovery Period: –Residential real property years –Non Residential real property- 39 years
Cost Recovery for Personal Property Applicable Recovery period: Applicable Convention: –Mid year convention –Mid quarter convention Applicable Depreciation Method –Double Declining or –Straight line
179 Election Expense of acquisition in lieu of capitalization –Tangible personal business property –Placed in service during the year of election –MACRS applies for unused portion of cost Large scale property acquisition limitation Taxable income limitation
179 Election Pam 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?
Mixed Used Personal Property What is mixed use personal property? –Listed property Predominant use test –Predominant business use –Predominant personal use Luxury automobiles restrictions
CHAPTER SIX LOSSES AND LOSS LIMITATIONS
Bona Fide Debtor- Creditor Relationship Intent test –Does 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?
Bona fide Debt Sherrill 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.
Bad Debts Charge off method is utilized Type of debt –Loan or debt instrument –Account receivable Cash Method Accrual Method –tax benefit rule
Bad Debt Loss Ted, 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?
Business Bad Debt When does a business bad debt arise? –Creditor is in the business of lending money; or –Proximate relationship between creation of the debt and taxpayer’s business What type of loss is recognized? Complete & partial loss are recognized
Non Business Bad Debt When does a non-business bad debt arise? What type of loss is recognized? Partial loss cannot be recognized
Bad Debt Lisa 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?
Worthless Securities Complete loss is required Capital loss is recognized
Worthless Securities On 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?
Worthless Securities –Small business stock exception Direct purchase by taxpayer Small investment Limited corporate equity
Worthless Securities Tony, 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?
Casualty and Theft Loss –Identifiable event –Damaging to the property –Sudden- swift –Unexpected- Ordinarily unanticipated –Unusual- Not a day to day occurrence
Casualty Loss –Fire, storm floods, vandalism –Damage to building due to unusual jet sonic boom –Damage to automobile due to an accident that is not the fault of the taxpayer –Steady weakening of a building caused by normal wind –Damage to carpet caused by moths
When to Deduct the Loss Casualty Theft Reasonable prospect of recovery limitation Treatment of reimbursement
Measuring the Loss Complete loss of business or investment property Partial loss of business or investment property Complete or partial loss of personal use property –Per incident limitation –Total amount limitation
Casualty Loss Troy 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?
Casualty Loss A machine that Beth uses in her business is completely destroyed by fire. At the time of the fire, the adjusted basis of the machine is $5,000 and its FMV is $3,000. How much could Beth deduct?
Net Operating Losses Definition of net operating loss Business losses from any one year can offset past or future income Carryover period –Must carryback to 2 prior years, then carryforward to 20 future years May make an irrevocable election to just carryforward When there are NOLs from two or more years, use on a FIFO basis
Net Operating Losses Warren Corp. has a NOL for 2011 in the amount of $60,000. How must Warren use the NOL?
Limitations on Loss Deductions At risk limitation Passive loss limitation
At-Risk Limits –The amount of a taxpayer’s economic investment in an activity –Can deduct losses from activity only to extent taxpayer is at-risk –Any losses disallowed due to at-risk limitation are carried forward until at- risk amount is increased –At-risk limitations must be computed for each activity of the taxpayer
At Risk Limitations- At Risk Amount Cash contributed Basis of property contributed Debt for which the taxpayer is personally liable Adjusted basis of property pledged as security for a debt, where the property is not used in the activity Taxpayer’s share of annual income relating to the activity less, share of annual losses or withdrawals
At Risk Limitation Siskel 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?
Limitations on passive losses –Generally, passive losses can only offset passive income, i.e., they cannot reduce active or portfolio income –Disallowed losses are suspended and carried forward Suspended losses must be allocated to specific activities Suspended losses are deductible in year related activity is disposed of in a fully taxable transaction
Passive Loss Limits: Active Income –Wages, salary, and other payments for services rendered –Income/losses from self-employed trade or business activity in which taxpayer materially participates –Gain from sale or disposition of assets used in an active trade or business –Income from intangible property created by taxpayer
Passive Loss Limits: Portfolio income –Interest, dividends, annuities, and certain royalties not derived in the ordinary course of business –Gains/losses from disposition of assets that produce portfolio income or held for investment
Passive Loss Limits: Passive Income Passive losses defined –Losses from trade or business activities in which taxpayer does not materially participate, and –Rental activities
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?
Material Participation Definition: Participation that is regular, continuous, and substantial What is regular, continuous and substantial: –Taxpayer participated for more than 500 hours –Taxpayer participated for more than 100 hours and no one else had greater participation –Taxpayer’s participation constituted substantially all of the participation in activity
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?
Rental Activities General Rule: Exceptions –Real Estate Professionals Half of services test Minimum hours test –Rental Real Estate Deduction Active participation test Minimum ownership test
Rental Activities On 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?
CHAPTER SEVEN PROPERTY TRANSACTIONS- BASIS, GAIN, LOSSES AND NONTAXABLE EXCHANGES
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?
Determination of Gain or Loss Realized gain or loss –Difference between amount realized from sale or other disposition of the asset and its adjusted basis –Sale or other disposition Includes trade-ins, casualties, condemnations, thefts
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?
Determination of Gain or Loss Amount realized from disposition: –Total consideration received- cash, FMV of property received, loans assumed by buyer –Reduced by any selling expenses
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?
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?
Adjusted Basis = Original cost + capital additions - capital recoveries Capital additions: –Cost of improvements to the property that are capital in nature Capital recoveries: –Depreciation or cost recovery allowances –Casualty and theft losses
Basis Consideration Original basis of an asset is generally its cost Bargain purchase assets have a basis equal to their FMV –Bargain amount may be income to purchaser (e.g., employee = compensation; shareholder = dividend)
Bargain Purchase Ramona 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?
Bargain Purchase Allegra 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?
Basket Purchase Relative Value Allocation: Must allocate basis to each asset obtained based on relative FMV of assets Going Concern Purchase: –Assign purchase price to assets (excluding goodwill) to extent of their total FMV –Residual amount is goodwill
Gift Basis FMV> Donor’s Basis: –The donee’s basis is the donor’s basis FMV< Donor’s Basis: –The donee has a dual basis: Loss Basis: FMV at the time of gift Gain Basis: same as donor’s adjusted basis
Gift Basis Kevin 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?
Property Acquired from a Decedent Inherited property is always treated as long- term property Generally, beneficiary’s basis in inherited assets will be the FMV of the asset at decedent’s date of death –Exception: If the executor/administrator of estate elects alternate valuation date, basis is FMV on such date
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?
Personal Use Property Converted to Business Use Gain basis Loss basis Depreciation basis
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?
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?
Disallowed Losses from Disposition of Property Personal Use Property Related Party Transaction Wash Sales
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.
Disallowed Losses- Related Parties Losses on sale of assets between related parties are disallowed Right to offset Only available to original transferee Not available for sales of personal use assets
Wash Sales Loss on sale of security Purchase of substantially identical security Purchase done within close time proximity sale of security Basis of new acquired security
Wash Sales Leslie 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?
Non Tax Recognition of Property Disposition Like Kind Exchange Involuntary Conversions Sale of Principal Residence
Like-Kind Exchanges §1031 requires nontaxable treatment for gains and losses when: –Asset exchanged must be like- kind in nature –Exchange of qualified assets –Exchange is simultaneous
Like Kind Exchange Real Estate Improved for unimproved realty qualifies Commercial for residential realty qualifies Personal Property Office furniture & equipment Computers and peripheral equipment Airplanes Automobiles and taxis Buses Light general purpose truck Heavy general purpose truck
Like Exchange Gail 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?
Like Exchange Bob transfers a personal computer used in his trade for a printer to be used in his trade. Is this a like kind exchange?
Like Exchange Renee 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?
Exchange of Qualified Assets Assets involved are used in trade or business or held for production of income inventory, securities, and partnership interests do not qualify
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?
Simultaneous Exchange The exchange of the two like-kind properties must be simultaneous –Deferred exchange exception
Boot What is it: –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 realized Gain Recognition Only: –No loss is recognized even when boot is received
Receipt of Boot Mario 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?
Receipt of Boot Mary 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?
Basis of Property Received as Part of an Exchange Basis in like-kind asset received: FMV of new asset – Gain not recognized + Loss not recognized Basis in boot received is FMV of property
Involuntary Conversion May defer gain recognition if: –Involuntary conversion The destruction, theft, seizure, condemnation –Reinvestment of the conversion amount Amount of reinvestment >= amount realized –Reinvestment in similar property –Reinvestment within specified time
Involuntary Conversion Business or Personal Use Property Basis of New Property: –Cost less deferred gain Partial Reinvestment –Amount recognized is lesser of realized gain or non-reinvested amount Inapplicable to Losses Permissive in Nature
CHAPTER EIGHT PROPERTY TRANSACTIONS: CAPITAL GAINS AND LOSSES, SECTION 1231, AND RECAPTURE PROVISIONS
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?
Capital Gain Tax Cut Windfall YearRealizationsRevenues 2002$269$ Source: Congressional Budget Office, January 2008
Total Federal Revenues
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 gains Limitation on Deduction: The deduction of a net capital loss may be limited
Proper Classification of Gains and Losses Depends on three factors –The tax character of the property Must be capital asset, not ordinary asset –The manner of the property’s disposition By sale or exchange only –The holding period of the property Must be long term
Capital Assets Assets held for Investment Personal Use Assets
Non Capital Assets –Inventory –Notes and accounts receivables Accrual Method Cash Method –Real property & depreciable personal property used in trade or business (§1231 assets) –Creative works created by taxpayer
Inventory Define: Property must be held primarily for sale to customers in the ordinary course of taxpayer’s business Automobiles as Inventory Securities as Inventory Real property as Inventory
Manner of Disposition - Sale or Exchange is Required to recognize capital gain/loss - Are the following transactions considered a “sale or an exchange”? –Worthless securities –Option transfer – Patent transfer
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?
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?
Sale or Exchange: Patent Transfer all substantial rights to a patent is the equivalent of a sale Treated as a long term capital gain Individual ownership: the transferor must be the individual creator
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?
Holding Period Short-term –Asset held for 1 year or less Long-term –Asset held for more than 1 year Holding period starts on the day after the property is acquired and includes the day of disposition
Holding Period On 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?
Holding Period Non Taxable Exchanges Disallowed Loss Transactions Property Received as Gift –Carryover basis –FMV basis Property Received from a Decedent
Holding Period Cindy 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?
Holding Period The 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?
Tax Treatment of Capital Gains and Losses of Non-Corporate Taxpayers Short Term Capital Gains (STCG) –No preferential tax rate available Long Term Capital Gains (LTCG) –Regular LTCG- preferential tax rate available –Exceptions: 28% Property –Collectibles –Small Business Stock 25% Property –Unrecaptured Section 1250 gain
Offsetting Against Capital Gains Group All Gains & All Losses for Each Category Net Each Category In the Long Term Capital Categories, Net LTCL Against Highest Taxed Capital Gain First Netting any STCL Against Highest Taxed Capital Gain First Netting Against Ordinary Income
Netting Sandy 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?
Netting Bob 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?
Netting Last 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?
Netting In 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?
Netting Leroy, 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?
Netting Elizabeth, 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?
Capital Gains & Losses of Corporate Taxpayer No preferential tax rate No offsetting against ordinary income Carryback and carryforward period
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?
Section 1231 Asset –Depreciable personal property used in business –Real property used in a business –purchased intangibles –Property held greater than 1 year –Net §1231 loss = ordinary loss –Net §1231 gain = long-term capital gain
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?
Depreciation Recapture Why §1231 gain is recaptured sometimes? The impact of recapture –Gain recapture characterizes gains that would otherwise be capital as ordinary income Properties subject to recapture: –§1231 assets subject to depreciation are subject to depreciation recapture when disposed of at a gain The recapture provisions: – §1245 – §1250
§1245 Recapture §1245 property: –Depreciable personal property –Purchased intangibles Applies to gain only Recapture amount: –Total accumulated depreciation will be recaptured as ordinary income –The gain in excess of depreciation recapture will be §1231 gain
Section 1245 Recapture Buckeye 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?
Section 1245 Recapture Adobe 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 $117,000?
§1250 Recapture §1250 property: Depreciable real property sold at a gain Recapture amount: –Recapture potential is limited to excess of accelerated depreciation taken on asset over depreciation that would have been deductible if straight-line depreciation had been used Tax rate: –Recaptured gain: ordinary income –Nonrecaptured gain: LTCG 25% Property –Section 1231 gain: excess of sale prices over original purchase price
CHAPTER SIXTEEN TAXATION OF INDIVIDUALS
Tax Formula Income (broadly conceived)$x,xxx Less: Exclusions (x,xxx) Gross Income$x,xxx Less: Deductions for AGI (x,xxx) AGI$x,xxx Less: The greater of- Total itemized deductions or the standard deduction (x,xxx) Personal & dependency exemptions(x,xxx) Taxable Income$x,xxx
Exclusions from Gross Income Child Support Gifts & Inheritances Scholarships Damages –Loss of Income –Expenses Incurred –Property Damage –Personal Injury Compensatory Damages Punitive Damages
Scholarships Becky 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?
Items Included in Gross Income Compensation Business Income Interest Rents & Royalties Alimony Unemployment Compensation Prizes and Awards
Alimony Helen 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?
Alimony As 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?
Prizes and Awards General rule: FMV of item is included in income Exception One: –Non commercial achievement –No substantial services are due –Redirected to non for profit –Not self nominated income Exception Two: –Employee achievement awards (up to $400) of tangible personal property made in recognition of length of service or safety achievement
Deductions for AGI Ordinary and necessary business expense One half of self employment tax paid Moving expenses Capital loss deduction Alimony paid IRA contribution
Standard Deduction The basic standard deduction (BSD) amount depends on filing status of taxpayer Filing status 2011 Single $5,800 MFJ, SS $11,600 HH $8,500 MFS $5,800
Standard Deduction Additional standard deduction (ASD) –For taxpayers age 65 or older and/or legally blind Filing Status Single $1,450 MFJ, SS 1,150 HH 1,450 MFS 1,150
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
Itemized Deductions Medical Expenses Taxes –Personal & Real Property Taxes –State, Local & Foreign Taxes Interest –Business Interest- For AGI –Personal Interest- Not deductible –Interest on Student Loan-For AGI –Investment Interest- For AGI –Qualified Residence Interest- Itemized Charitable Contributions
Medical Expenses During 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?
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?
Qualified Residence Interest Loans covered: acquisition or equity loans on qualified residence Qualified Residence Acquisition Indebtedness Home Equity Loan Points Prepayment Penalty
Charitable Contributions Contributions must be made to domestic organizations Contributor must have donative intent and expect nothing in return No deduction is allowed for the contribution of services (except for unreimbursed expenses) Valuation Substantiation requirement Limit on deduction
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?
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.
Miscellaneous Itemized Deductions Professional dues to membership organizations Uniforms Fees incurred for the preparation of one’s tax return for tax litigation before the IRS Job hunting costs Hobby losses Unreimbursed employee expenses
Exemptions Amount One Exemption Per Person Personal Exemptions Dependency Exemptions –Qualifying Child –Qualifying Relative
Qualifying Child Relationship Domicile Age Joint return Citizen or residency
Qualifying Relative A dependency exemption may be claimed for each individual that meets all of the following tests: –Support –Gross income –Relationship (or household member) –Joint return –Citizen or residency
Qualifying Relative- Support Taxpayer must provide more than 50% of the dependent’s support –Only amounts expended are considered in the support test –Scholarships of children are not considered in the support test
Qualifying Relative- Gross Income Dependent’s gross income cannot be greater than amount allowed for an exemption –Exception: No gross income limitation if dependent is child of taxpayer AND either: i) Less than age 19, OR ii) Less than age 24 and a full-time student
Taxable Income General Rule: Tax return must be filed if gross income is ≥ the sum of the standard deduction and exemption amount
Filing Status There are 5 filing statuses –Single –Married, filing jointly –Surviving spouse (qualifying widow/er) –Head of household –Married, filing separately Filing status affects tax rate brackets, standard deduction, and other amounts
Kiddie Tax Limitations on Shifting Income to Dependents: –No Personal Exemption –Lower Standard Deduction –Parent’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
Credits Adoption Expense Credit Child Tax Credit Child Care Credit Education Tax Credit –American Opportunity Credit –Life Time Learning Credit Earned Income Credit
Adoption Expenses Credit Credit for qualified adoption expenses incurred in adoption of eligible child (fees, court costs, attorney fees) Maximum credit in 2010 is $12,170 Eligible child is one that is –Less than 18 years of age, or –Physically or mentally handicapped Nonrefundable credit –Excess may be carried forward for five years
Child Tax Credit Credit amount is $1,000 per child Eligible children are: –Under age 17, –US citizen, and –Claimed as dependent on taxpayer’s tax return
Child & Dependent Care Credit General qualifications for credit –Must have employment related care costs for a Dependent under age 13, or Handicapped dependent or spouse Credit amount –Eligible care costs x 20% to 35% depending on AGI –Amount 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 individuals –Amount of eligible care costs cannot exceed lower of taxpayer’s or spouse’s earned income
Education Tax Credit 2 education tax credits are available –American Opportunity Credit credit –Lifetime learning credit Both nonrefundable credits are available for qualifying tuition and related expenses –Room, board, and book costs are ineligible for the credits –Undergraduate degrees, graduate degrees, or vocational training.
Educational Tax Credit- Maximum Credit –American Opportunity Tax Credit maximum per eligible student is $2,500 per year for first 4 years of postsecondary education 100% of first $2,000 of qualifying expenses plus 25% of next $2,000 of qualifying expenses –Lifetime learning credit maximum per taxpayer is 20% of qualifying expenses up to $10,000 per year Cannot be claimed in same year the American Opportunity Tax Credit is claimed
CHAPTER SEVENTEEN INDIVIDUALS AS EMPLOYEES AND PROPRIETORS
Employee vs. Independent Contractor Why Proper Classification is Important? –Expense Deductions –Payment of Taxes and Benefits –Liability How to Distinguish? –Degree of Control –Tools of Work –Method of Payment –Skills Required –Permanency
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?
Exclusions from Gross Income Available to Employees Accident & Health Insurance Plans –Premiums –Payment of Medical Care Benefits Long Term Care Benefits Meals & Lodging Life Insurance Tuition Reduction Plans
Meals & Lodging Meals: –Furnished by Employer –Employer’s Convenience –Business Premises Lodging –All of the Above –Condition of Employment
Life Insurance David 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?
Other Fringe Benefits Dependent care –Up to $5,000 of care costs paid for by employer can be excluded Athletic facilities –Value of use of athletic facilities located on employer premises can be excluded Educational assistance programs –Up to $5,250 for undergraduate and graduate education is excludible
Other Fringe Benefits Adoption assistance programs Exclusion limited to $10,630 Qualified transportation expenses –Parking –Commuter pass No additional costs services: –No additional cost to employer –Ordinary course of employer’s business
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?
Other Fringe Benefits Qualified employee discounts –Goods –Services Working condition fringe benefit De minimis fringe benefit
Employee Discount Mary 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?
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?