Presentation on theme: "Federal Income Taxation Lecture 6Slide 1 Taxpayers using the Cash Method of Accounting Only assets actually received during the calendar year are taxable."— Presentation transcript:
Federal Income Taxation Lecture 6Slide 1 Taxpayers using the Cash Method of Accounting Only assets actually received during the calendar year are taxable If you have a business expense that will provide services for years to come, the deduction must be spread over the life of the service. If there is a sale or if one earns money in a year, that is considered income for that year, even if it isn’t actually received until the next year! But, if the arrangement called for the payments to be made in the following year, it’s income in the following year. When is a payment considered “made? The “economic benefit” rule states that it’s considered made as soon as the payer irrevocably sets it aside for the payee so that the payer’s creditors no longer have access to it. All the same ideas are true in reverse for expense deductions claimed by the payer.
Federal Income Taxation Lecture 6Slide 2 Taxpayers using the Accrual Method of Accounting Under the accrual method, a taxpayer is considered to have received an asset (or paid an expense) when “all the events have occurred that fix the right to receive the income and the amount thereof can be determined with reasonable accuracy. For example, if you do work in 2010 but are scheduled to get paid in 2011, under the cash method, you would receive the income in 2011, but under the accrual method, it would be 2010. The receipt of prepaid dues and similar prepayment for services can be “spread out” (in terms of income recognized) over the course of the period of time when the services are to be rendered.
Federal Income Taxation Lecture 6Slide 3 Section 83 Transfers Section 83 of the IRC provides that if an employer irrevocably gifts assets to a trust (or similar) for an employee’s benefit, the employee must count it as income in that year unless there is a chance that the assets could be lost or forfeited before the employee actually gets them. The amount included in that year’s income is the value of the property at the time that it will vest, minus whatever the employee paid for the property. [The employee can also elect to have the valuation be at the time of the transfer if he or she so chooses.]
Federal Income Taxation Lecture 6Slide 4 Tax Deferred Account - Traditional IRA A Traditional IRA is primarily an individual savings plan. Contributions are made up to a specified limit with the contribution tax deductible for the year of the contribution. Money invested and earned in a traditional IRA are subject to income taxes at time of withdrawal. Contributions: Maximum deductible contribution is currently $5000 for those under 50 and $6000 for those 50 and over Married couples can (together) contribute double even if only one works Contributions can be made until April 15 of the following year
Federal Income Taxation Lecture 6Slide 5 Traditional IRA- Withdrawals After age 59 ½, one may withdraw as little or as much as s/he wants at any time. At age 70 ½, one must start taking minimum required distributions (MRD). Each year’s MRD is a percentage of the IRA that is equal to 1 divided by the number of years left on his or her life expectancy. Withdrawals prior to 59 ½ are subject to a 10 penalty except: Extreme medical expenses Health Insurance Premiums (in certain cases) First-time home buyers Certain expenses for higher education If the beneficiary dies (then the rules get more complex) Any withdrawal is taxed as ordinary income.
Federal Income Taxation Lecture 6Slide 6 Tax Deferred Account- Roth IRA This is primarily an individual savings plan. The IRA is funded after tax (contributions are NOT tax deductible). However, money withdrawn is not taxed at all; i.e., none of the income earned on the contributions is ever taxed as income! Contributions: Same basic contribution rules as the traditional IRA, except that: There is an income limit (now a little over $100,000 for an individual or $160,000 for a couple), over which one cannot contribute to a Roth IRA.
Federal Income Taxation Lecture 6Slide 7 Roth IRA- Withdrawals Principal put into the account can be withdrawn at any time for any reason. Withdrawals of income that do not “qualify” are subject to income tax PLUS a 10% penalty. To qualify, a withdrawal must: Be made at least five years after the owner establishes the Roth IRA; AND Satisfy one of these criteria: Made by a person over age 59 ½ Made for purpose of buying a first home Made to cover certain emergencies, etc. Any qualifying Roth IRA withdrawal is not taxed at all.
Federal Income Taxation Lecture 6Slide 8 Simplified Employee Pension (SEP) IRA Must be established by an employer for an employee or by someone working for herself on behalf of herself. Contribution and distribution rules are similar to a traditional IRA. The contribution limits are higher with a SEP IRA than with a traditional IRA - hence its usefulness. This is generally used by companies who want to establish a deferred plan for their employees, but who don’t want to establish more complex qualified plans.
Federal Income Taxation Lecture 6Slide 9 Tax Deferred Accounts - 401(k) and 403(b) Plans These are employer created “profit sharing” plans that allow employees to contribute some of their salaries to the plan. Even though it’s technically a profit sharing plan, in effect, each employee has his or her own account. The limits of the contributions are much higher than a traditional or Roth or even a SEP IRA (currently $15,500 per year). Also, an employer can “match” an employees contribution up to a certain point (as an alternative form of compensation) in addition to the employee’s contribution Withdrawal rules are similar to that of the traditional IRA.
Federal Income Taxation Lecture 6Slide 10 Some Transfer Rules Relevant to Qualified Accounts Rollover: A “share” of a 401(k) account can usually be transferred to a traditional IRA account since they basically have the same withdrawal rules. Spousal rollover: If a person with a qualified account dies, the spouse can rollover the account into his or her name and treat it entirely as if it were his or her own, for withdrawal purposes (e.g., age limits, etc.) A non-spouse beneficiary of a deceased person’s qualified account can: 1) withdraw the money immediately (often not a good idea because it’s all subject to income tax at that time); or 2) Keep the money in the account, but must withdraw an amount based on the beneficiary’s life expectancy (like the MRD)