Tax Accounting Chapter 4

Discharge of Student Indebtedness

For tax years beginning after December 31, 2017, and before January 1, 2026, discharge of a student loan does not give rise to gross income if the debt is discharged on account of death or total and permanent disability. This provision does not apply if the student is insolvent or is involved in a bankruptcy case.

Discharge of Debt

Forgiveness of debt is generally includable in gross income.

Gift, Employee, and Commercial Loans

Gift Loans between individuals if: a.The aggregate outstanding amount of loans between such individuals does not exceed $10,000, and b.the loan is not attributable to the purchase or carrying of income producing assets 2.Compensation-related or corporation-shareholder loans if: a.the aggregate outstanding amount of loans between the borrower and the lender does not exceed $10,000 and b.the avoidance of federal tax is not a principal purpose of the loan

Below-Market Interest Loans—Types of Loans

Gift loans Compensation-related loans Corporation-shareholder loans Tax Avoidance loans Other below-market loans in which the interest arrangements have a significant effect on federal tax liability

Exceptions to the Recapture Rule

1.Payments cease by reason of death or remarriage prior to the end of the third post-seperation year 2.Payments received under a temporary support order before the divorce or separation 3.Payments pursuant to a continuing liability to pay a fixed part of your income from a business or property or from compensation for employment or self employment

Under the recapture rules adopted by the tax reform act of 1986 payments will be recaptured if

1.Payments made int he second post separation year exceed the payments in the third post-seperation year by more than 15 grand and or 2.Payments made in the first post-separation year exceed the average of (the alimony payments of the second separation year and the third separation year less than the year 2 recapture) by more than $15,000

Post 1984 Agreements Through December 31, 2018

1.Payments must be made in cash 2.Payments must be made under a divorce or separation instrument 3.Parties must live in separate households after a divorce or separation decree is entered 4.Alimony must end at the payee's death 5.Parties must not be for child support 6.Payments must not be for child support

The general rule is that compensation results if property is transferred "in connection with" services rendered. Thus, it does not matter whether:

1.Services are rendered as an employee or independent contractor 2.The property was transferred by the employer or another person such as a shareholder 3.The property was transferred to the compensated person or to anyone else example a beneficiary, a trust, a corporation, or other agent. Any income received w.g dividends before the property is substantially vested is also treated as compensation

For discharges after 1986 two types of exclusions are provided in the following priority order

1.The discharge occurs in a bankruptcy case under Title 11 of the U.S Code 2.The discharge occurs when the taxpayer is insolvent outside of bankruptcy. An insolvent taxpayer is one who has an excess of liabilities over the fair market value of assets immediately prior to the discharge. The exclusion is limited to the insolvent movement

Other conditions that must be met either by the plan or in the stock offering are

1.The option price may not be less than the smaller of (a) 85% of fair market value of the stock when the option is granted or (b) 85% of the fair market value at exercise 2.The option must be exercisable within five years from the date of grant where the option price is not less than 85% of the fair market value of the stock at exercise. If the option price is stated in any other terms, the option must not exercisable after 27 months from the date of the grant. 3.No options may be granted to owners of five percent or more of the value or voting power of all classes of stock of the employer or its parent or subsidiary 4.No employee may be able to purchase more than $25,000 of stock in any one calendar year 5.The option may not be transferable (other than by will or laws of inheritance) and may be excerisable only by the employee to whom it is granted 6.If the exercise price was less than the value of the stock upon grant and the option was exercised, the employee may have compensation income(with an offsetting deduction by the employer,) upon disposition, including a transfer at death. The compensation equals the lesser of fair market value at grant or at exercise, less the exercise price, and is added to the stock basis. There is no offsetting deduction by the employer.

Conditions not constituting substantial risks include

1.The person is being discharged for cause or for committing a crime 2.The person accepts a job with a competitor 3.The employer must pay the full market value upon forfeiture

The following are examples if substantial risks or forfeiture

1.The property must be returned unless earning go up 2.Substantial services must be rendered 3.A successful completion of "going public" is a condition

For options to qualify as ISO's the following

1.The term of the option may not exceed 10 years 2.The option price must be no less than the fair market value of the stock on the date of issuance 3.The option must be transferable by inheritance only 4.The option plan must specify the aggregate number of shares that may be issued and the employees eligible to receive the option 5.The option must be granted within 10 years of the earlier of the date of adoption of the plan or the date it was approved by the shareholders 6.If the employee owns more than 10% of the company, the option price must be at least 110% of the market value and its term may not exceed five years

Partnership

A business in which two or more persons combine their assets and skills

Transfer of Property Between Souses

A deed is a written document that legally transfers property from one person or entity to another. Through a deed, one spouse can give his or her own property to the other, and the property becomes the receiving spouse's separate property.

Awards

A form of recognition to people in the entertainment industry. It is a mean to psychologically coping with stress and the paranoia of permanent disequilibrium and also a way to schoomze with actors who are out of work.

Bankruptcy

A legal process to get out of debt when you can no longer make all your required payments

Mutual Funds

A pool of money used by a company to purchase a variety of stocks, bonds or money market instruments. Provides diversification and professional management for investors.

Eisner v. Macomber

A stock dividend is capital not income but payment in more stock

Incentive Stock Options

A stock option that gives an employee the opportunity to buy the employer corporation's stock at a fixed price for a certain period of time, and that offers favorable tax treatment if certain conditions are met.

S corporation

A unique government creation that looks like a corporation but is taxed like sole proprietorships and partnerships

Employee Achievement Awards

Employee achievement awards are generally taxable, except that the value of awards for length of service or safety achievement delivered at a "meaningful presentation" are excluded up to 1.Average award cannot exceed $400 (FMV) if the plan is non-qualified (i.e., discriminates in favor of highly paid employees), or 2.$1,600 if the plan is qualified (i.e., does not discriminate in favor of highly paid employees). If an employee receives both qualified and non qualified awards, then the overall exclusion may not exceed $1,600.) (TCJA requires that the award be tangible personal property. It cannot be cash or cash equivalents.)

Stock Rights

Existing stockholders have the right (preemptive privilege) to purchase newly issued shares in proportion to their holdings.

Student Loans

Financial aid that is borrowed from financial institutions. These funds must be paid back; usually with interest.

Corporate Debts

Non-government debt securities. Short term corporate debt is issued as commercial paper whereas long-term debt is issued as bonds. Read more:

Recapture Rules

recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus "recaptured" by reporting it as ordinary income. Depreciation recapture is reported on Internal Revenue Service (IRS) Form 4797.

realization of income

revenue can only be recognized once the underlying goods or services associated with the revenue have been delivered or rendered, respectively. Thus, revenue can only be recognized after it has been earned. ... Advance payment for goods.

Tenants in Common

shared ownership of a single property among two or more persons; interests need not be equal and no right of survivorship exists

Rent and Royalty Income

taxable (related deductions are FOR AGI deductions)

Constructive Receipt Doctrine

taxpayer must recognize income when it is actually or constructively received

Discharge of Debt—Bankruptcy

Offsetting reduction of tax attributes. As a price for the deferral (exclusion from gross income), the Code requires that the amount deferred be applied to reduce seven tax attributes. However, the Code offers a special election to first reduce the tax basis of depreciable property or real property held as inventory. 1. Net operating losses and loss carryovers 2. General business credits under Code Sec. 38 3. Minimum tax credits under Code Sec. 53 4. Net capital loss and loss carryovers 5. Basis of depreciable assets or non-depreciable real assets held as inventory 6. Passive activity losses 7. Foreign tax credit carryovers under Code Sec. 27

Front-Loading Limitation

to assign costs or benefits to the early stages of (such as a contract, project, or time period)

virtual currency

typically circulates within an internal virtual world community or is issued by a specific corporate entity, and used to purchase virtual goods

absolute right

when there is no restriction whatsoever on the individual's entitlement

Employee Stock Purchase Plans

Opportunity to buy stock during a period (payroll deduction or discounted)

Partnerships and S corps

Partnerships and S corps are not taxed, but their taxable income is taxed to individual partners and shareholders. Partners and shareholders must include their proportionate share of business income in their gross income, regardless of whether or not the income was distributed. The new tax law allows sole proprietorships, partnerships, and S corporations to deduct up to 20 percent of domestic qualified business income. Certain businesses are excluded. See Chapter 8 for a more detailed discussion.

payments in arrears

Payments made at the end of a payment period

Alimony—Post-1984 Agreements Through December 31, 2018

Payments under instruments executed after December 31, 1984, that meet the following requirements are deductible as alimony: Payments must be made in cash Payments must be made under a divorce or separation instrument Parties must live in separate households after a divorce or separation decree is entered Alimony must end at the payee's death Parties involved may not file a joint return

Prizes and Awards

Prizes and awards are generally taxable based on fair market value at time of receipt.However, if ALL of the following 4 conditions occur, then they are excludable : Excluded only if (1) made for scientific, literary, or charitable achievement and (2) transferred to a qualified charity.

Alimony

The Tax Cuts and Jobs Act provides that for divorce and separate maintenance agreements executed or modified after December 31, 2018, alimony and separate maintenance payments are not included in the gross income of the payee and are not deductible by the payor. The modification must expressly state that the alimony is not deductible by the payor nor the includible in the income of recipient. The agreement cannot just be modified. Modifications to a divorce agreement after December 31, 2018, even though the divorce agreement was executed prior to 2019, will cause the alimony payments to be excluded from the gross income of the payee and not to be deductible by the payor. Divorce or separate maintenance agreements executed or modified prior to 2019 follow the rules outlined on the following slides.

legal fees

The anticipated expenses of investigating and prosecuting or defending the case, if necessary through an appeal, and the manner in which those fees will be paid.

Economic Income

The change in the taxpayer's net worth, as measured in terms of market values, plus the value of the assets the taxpayer consumed during the year. Because of the impracticality of this income model, it is not used for tax purposes.

Compensation vs. Gift

The facts and circumstances dictate whether something received is taxable compensation or a tax-free gift Compensation is generally included in gross income. Gifts are generally excluded from gross income.

Tenancy by the Entirety

The joint ownership, recognized in some states, of property acquired by husband and wife during marriage. Upon the death of one spouse, the survivor becomes the owner of the property.

Alimony Termination on Payee's Death

The payor must not be liable to make additional or substitute payments after the payee spouse dies.

Joint Tenants

The people who are given joint-ownership of your property

Property Substantially Vested

The property is taxable whenever the right ti it is "substantially vested" which means it is either transferable or not subject to a substantial risk of forfeiture. It is to be valued without regard to any restriction unless it is one that will never lapse.

Tenant Improvements

When are tenant improvements taxable to cash-basis landlords? If in lieu of rent (or if repairs paid for by lessee are the responsibility of the lessor): lessor has rental income to the extent of the market value of the improvements. If NOT in lieu of rent: Not taxable. When the property is sold, the improvements will be taxed assuming they add value that results in a higher sales price.

Medical and Dental Expenses

You can only deduct 7.5 percent of your adjusted gross income

Dependent Child

a child who has no parent or guardian or whose parents cannot give proper care

Flat Basis Bonds

a term given to the price of a bond when it does not include any accrued interest. Accrued interest is the portion of a bond's coupon payment that the holder earns in between scheduled coupon payments.

single proprietorship

an unincorporated business owned by a single person who is responsible for its liabilities and entitled to its profits

insolvent

bankrupt

Annuity Contracts

beneficial to the individual investor in the sense that it legally binds the insurance company to provide a guaranteed periodic payment to the annuitant once the annuitant reaches retirement and requests commencement of payments.

Incentive stock option (ISO) plans

corporate programs in which a company grants an employee the opportunity to purchase its stock at some future time at a specified price

Corporation-shareholder loans

(a corporation's loans to ANY of its shareholders)

Compensation-related loans

(employer loans to employees)

Gift loans

(made out of love or generosity). Note that the "gift" is NOT the principal portion of the loan, rather, the amount of interest that is below market.

There are 2 exceptions in which taxes on a forgiveness of debt are deferred (i.e. excluded from gross income):

1. The debt is discharged in a Chapter 11 bankruptcy filing. The amount of debt discharged reduces certain tax attributes that otherwise could have provided a tax benefit in the future. 2. The borrower is insolvent outside of bankruptcy (i.e., Liabilities > FMV of assets immediately prior to discharge)However, the amount excluded from gross income cannot exceed the amount by which the taxpayer is insolvent. Once the debt is discharged the taxpayer is solvent.

The amount excluded from gross income (the portion of the debt that was cancelled) reduces tax attributes in the order given in Code Sec 108

1.Net operating losses and carryovers 2.General business credit 3.Capital Loss carryovers 4.Reduction of basis of the property of the taxpayer 5.Foreign tax credit carryovers

Pre 1985 Agreements what qualifies

1.Payments are required under the terms of the decree of divorce or separate maintenance or a written separation agreement or a decree of support 2.Payments must be to discharge the legal obligation of support 3.Payments must be Periodic 4.Payments must not be for child support

Whether an interest arrangement has a significant effect on the federal tax liability (item 5, above) will be determined by all the facts and circumstances. Some factors to be considered are:

1. Whether items of income and deduction generated by the loan offset each other 2.The amount of such items; 3.The cost of complying with the below-market loan provisions if they applied; and 4.any reasons other than taxes for structuring the transaction as a below-market loan

There are twi advantages of making the election

1.Any future appreciation will qualify as a capital gain, historically taxed at rates lower than ordinary income 2. The appreciation between the date of transfer and the date of substantial vesting is not taxed until the eventual disposition of the property in a taxable sale or exchange 3.There will be no self-employment tax on the increase in value

Cash Dividend

1.Declaration 2.Record 3.Payment 4.Receipt

stock dividend

1.Distributions in lieu of money. If the stockholder has the option of receiving stock in lieu of money, then the corporate distribution is taxable to the recipient 2.Disporportionate distributions if some shareholders receive property and other shareholders receive stock so as to alter the individual stockholders' proportionate interest in the corporation, then the distribution is included as gross income 3.Distributions on preferred stock If some stockholders receive common stock and other stockholders receive preferred stock, them the distribution is considered part of gross income 4.Distributions on preferred stock A stock dividend o preferred stock is taxable to the recipient unless it increases the conversion ratio of convertible preferred ststock made specifically to take into account a stock dividend or stock split on the converitivle preferred stock in which case it is tax free 5.Distibutions of convertible [referred stock A distribution of convertible preferred stock is taxable to the recipient unless it can be proven to the commissioner that the individual stockholder's equity in the corporation remains constant

If two individuals are married to each other at some point during a calendar year but live apart for the entire tax year, do not file a joint return, and one or both have earned income, none of which is transferred between them, the following rules cover the reporting of income on their separate tax returns

1.Earned income (other than trade or business income and partnership income) is treated as income of the spouse who rendered the personal services 2.Trade or business income is treated as the husband's income unless the wife excerises substantially all of the management and control of the business 3.Community income derived from the separate property of one spouse is treated as the income of such spouse 4.All other community income is taxed in accordance with the applicable community property law

Some loans are specifically excluded fro the rules for below-market loans, such as:

1.Loans made available by lenders to the general public on the same terms and conditions; 2.Loans subsidized by a federal, state, or municipal government that are made available to the general public; 3.Cetain employee-relocation loans 4.Loans to or from a foreign person, unless the interest would be effectively connected with the conduct of a U.S trade or business and not exempt from U.S tax under an income tax treaty; and 5.Loans on which the interest arrangement can be shown to have no significant effect on the federal tax liability of the lender or the borrower

Pre 1985 Agreements Would not qualify

1.Lump-sum settlements 2.Payments not required under the decree or agreement 3.Payments not arising out of a marital relationship (repayment of a loan), and 4.Payments made before the decree

Tax Effect on Landlord

ALL rent received is taxable income, including future years' rent received in advance

Alimony Recapture

Alimony is required to be recaptured if: Payments made in the 2nd post-separation year exceed payments in the 3rd post-separation year by more than $15,000 and/or Payments made in the 1st post-separation year exceed the average payments made in the 2nd and 3rd post-separation years by more than $15,000.

prizes

An item of value provided to an employee. The fair-market value is included in the employee's income.

Items Included in Gross Income

Code Sec. 61(a) lists 15 items that generally must be included in gross income: Compensation for services, including fees, commissions, fringe benefits, and similar items Gross income derived from business Gain derived from dealings in property Interest Rents Royalties Dividends Alimony and separate maintenance payments (Divorces prior to 2019) Annuities Income from life insurance and endowment contracts Pensions Income from discharge of indebtedness Distributive share of partnership gross income Income in respect of a decedent Income from an interest in an estate or trust Special circumstances may result in the exclusion or deferral of any of these items.

Two common types of dividends

Cash Stock(dividends and rights)

Reporting Requirements

Conclusions fulfill the deliverables promised in the research proposal Consider the varying abilities of people to understand the research results A clearly-written, understandable summary of the research findings

compensation

payment

gift

present

Chapter 11 Bankruptcy

protects an insolvent firm from creditors during a period of reorganization to restore profitability

Property Not Substantially Vested

If property transferred in connection with services rendered is not "substantially vested" it is subject to a substantial risk of forfeiture, an election may nevertheless be made to include the current fair market value of the property in gross income

Tax Effect on Tenant with Business Lease

If rent is paid in advance, no deduction for rent expense is allowed until the year the payment is due.

Community Property Income

In a community property state: Property acquired after marriage is community property. Income from community property is community income Property acquired before marriage remains separate property. What happens to income from separate property

Sole proprietor

Include all business income (less cost of goods sold) in gross income.

TX Rule

Income from separate property is community income. Therefore, if spouses filed separate returns, the income would be shared between them. Applies to Texas, Idaho and Louisiana.

CA Rule

Income from separate property remains separate. Applies to California, Arizona, Nevada, New Mexico, Washington and Wisconsin.

If all of the following apply regarding loans

Interest charged is less than the applicable federal rate (AFR) Sum of all loans between lender and borrower exceeds $10,000 The loan was made after June 7, 1984

Mortgage Debt Forgiveness

Mortgage Forgiveness Debt Relief Act was introduced in the United States Congress on September 25, 2007, and signed into law by President George W. Bush on December 20, 2007. This act offers relief to homeowners who would have owed taxes on forgiven mortgage debt after facing foreclosure.

Qualified Equity Grant

Qualified stock is stock received in connection with the exercise of a stock option or settlement of an RSU that was granted by an employer, during the calendar year in which it was an eligible corporation, in connection with the performance of services.

Economic Benefit Doctrine

States that if a taxpayer receives an economic benefit as income, the value of that benefit will be subject to tax.

Alimony Recapture Formula Step 1

Step 1: Year 2 RecaptureYear 2 Payment Less Year 3 Payment= Excess Payment Less $15,000= Amount subject to recapture for Year 2

Alimony Recapture Formula Step 2

Step 2: Year 1 RecaptureYear 1 Payment Less (Year 2 Payment - Year 2 Recapture + Year 3 Payment) / 2= Excess PaymentLess $15,000= Amount subject to recapture for Year 1

Alimony Recapture Step 3

Step 3: Total recapture The total amount subject to recapture equals Year 2 recapture plus Year 1 recapture. The amount recaptured is included in the payor's income and allowed as a deduction from the payee's income in Year 3.

Divorce and Separation

Stressed because failure at one of life's most important endeavors, but still strong emotional ties; children impacted by divorce

Rental Income

Tax Effect on Landlord Tax Effect on Tenant

Dividend Income

The term "dividend" means any distribution of property made by a corporation to its shareholders out of its earnings and profits. There are two common types of dividends: Cash Dividends - taxable. Stock Dividends - generally not taxable. There are 5 exceptions to this rule. If a stock dividend meets one or more of these exceptions, it is taxable.

Below-Market Interest Loans—Tax Effect

The two steps for each of the three below-market interest loans are not easy to conceptualize. See if this makes sense: Step 1: "Pretend" that the borrower has "paid" the imputed interest to the lender as an interest payment. Step 2: "Pretend" that the lender has returned the imputed interest back to the borrower as either a gift, compensation, or a dividend.

Scholarships and Fellowships

The value of scholarships or fellowships are generally taxable, but may be excluded if they are: 1. To a degree candidate attending an educational institution 2. For tuition and course related material (not room and board) 3. As a result of academic achievement, and not connected with services provided.

assignment of income doctrine

income must be taxed to the entity that renders the service or owns the capital with respect to which the income is paid

life insurance

insurance paid to named beneficiaries when the insured person dies

Lessee Improvements

made by the lessee are commonly referred to as "tenant improvements" or "TI's" or "leasehold improvements." California Revenue and Taxation Code Section 441(d) requires the lessor and lessee to provide the assessor with a copy of the lease and the construction contract(s) of the lessor and lessee.

Purchase Money Debts

means Indebtedness incurred by a Person in connection with the purchase of fixed or capital assets by such Person, in which assets the seller or financier thereof has taken or retained a Lien; provided that (x) any such Lien attaches to such assets concurrently with or within 120 days after the

child support

money paid to a former spouse for support of dependent children