Unit 21- Tax Considerations

What are all the different filing statuses?

1. Single 2. Married filing jointly. 3. Married filing separately. 4. Head of household. 5. Qualifying widower with dependent child.

Taxtion of Social Security

50% starts becoming taxable once a single person's base income exceeds 25k and a married couple's exceeds 32K.

Child Support

A legal obligation of a parent to provide financial support for a child. Not deductible by the parent who pays it, nor is it includable in income by the recipient

Bypass Trust

An estate planning tool used to take advantage of the lifetime estate tax exclusion.

Gift tax

An individual may give up to 15k per year per person to any number of individuals without generating the federal gift tax.

Wash Sale

An investor may not use capital losses to offset gains or income if the taxpayer sells a security at a loss and purchases the same or a substantially identical security within 30 days before or after the trade date establishing the loss. The loss that was disallowed is added to the repurchased shares cost basis.

Policy Surrender

Any cash value in excess of the basis in the policy is taxable as ordinary income.

Sale of a Primary Residence

As long as it has been lived in as a primary residence for at least two of the past five years the first $500,000 in profit is excluded from capital gains taxation; for a single person it is the first $250,000.

Effect of Reinvestments on Cost Basis

Because the taxes have already been paid on any income reinvested, when the investor sells the asset, the cost basis is increased so that the income is not taxed again.

Adjusted Gross Estate (AGE)

Certain expenses are then deducted from the gross estate to arrive at this.

Passive Income/Losses

Come from rental property, limited partnerships, and enterprises in which an individual does not actively participate. Netted against the same kind of losses to determine net taxable income which is then taxed at ordinary income rates.

Dividend Exclusion Rule

Dividends paid from one corporation to another are 50% exempt from taxation.

TIPS Taxation

Exempt from state and local income tax, however the annual interest payment received is taxable on a federal basis as ordinary income.

Dividend Income

If qualified the tax rate is generally a maximum of 15%.

Gross Estate

Includes all interests in property held by an individual at the time of death.

Portfolio Income

Includes dividends, interest, and net capital gains derived from the sale of securities. Taxed in the year in which it is earned.

Earned income

Includes salary, bonuses, tips, and income derived from active participation in a trade or business.

Progressive Taxes

Increase the tax rate as income increases. Costlier to people with high incomes than to people with low incomes.

Share Identification accounting method

Investor keeps track of the cost of each share purchased and uses this information to liquidate the shares that would provide the lowest capital gain.

Tax Preference Items

Items that must be added back in for the purpose of the AMT computation.

Regressive Taxes

Levied at the same rate regardless of income and thus represent a smaller percentage of income for wealthy taxpayers than for taxpayers with lower incomes.

When are estate taxes due?

No later than nine months after death.

Interest Income

On any debt security is always taxed at ordinary income rates.

Taxable Estate

Once the amount of the AGE is determined, the unlimited marital and charitable deductions are subtracted to arrive at this.

Sole Proprietorship

Only form of business where the potential loss is unlimited because the personal assets of the owner are at risk in addition to any assets owned by the business. Owner computes the earnings of the business on the Schedule C of her form 1040 so anything made by the business is reflected directly on her tax return.

Alimony

Payment made under a court order to an ex spouse. Generally deductible to the spouse making the payments and includable in income for tax purposes by the spouse receiving them.

Income Tax Implications of Life Insurance

Premiums for individually purchased life insurance are generally nondeductible for income tax purposes. Proceeds from life insurance policies made to a beneficiary are exempt from federal income tax.

Partnership

Provide no liability protection to the partner. An LPs max loss is what has already been invested plus any funds committed for but not yet contributed. These type of business structures do not pay taxes. They file an information return, a form 1065 and attach to that a Schedule K-1 indicating the amount of income to the inserted on the investors personal form 1040.

Distributable Net Income (DNI)

Refers to a trust or an estate and determines the amount of income that maybe taxable to beneficiaries whereas the balance may be taxed to the trust.

Dividend Reinvestment Plans (DRIPS)

Shareholder automatically purchases the additional shares directly from the issuer paying little or no commission and often at a discount to market price. They are taxed in the year of receipt, the amount of reinvested dividends increases the investors cost basis, thereby reducing the amount of capital gains.

Taxation of Reinvested Distributions

Taxable to shareholders whether the distributions are taken in cash or reinvested.

Qualified Retirement Plan Distributions Taxation

Taxed at the investors ordinary income tax rate when funds are withdrawn from the plan. Before the investor reaches age 59.5 are also subject to a 10% early withdrawal penalty. Distributions from a qualified plan must begin by April 1 following the year the participant reaches 70.5.

Withdrawal of Cash Value from a Variable life insurance policy.

The FIFO rules apply therefore, there are no tax consequences until the amount withdrawn exceeds the cost basis in the policy.

Portability of Unused Estate Tax Exemptions Under ATRA

The Tax Act of 2010 contained the concept of portability, which permits the surviving spouse to take the unused portion of the first deceased spouse's federal exemption and aggregate it with the surviving spouse's unused portion.

Gifts

The cost basis to the recipient is the donor's cost basis.

Inherited Securities

The cost basis to the recipients is usually the fair market value on the date of the owner's death.

Alternative Valuation Date

The executor of an estate may choose to value the assets in the estate as of date of death or, alternatively, six months later.

Average Cost Basis

The investor would calculate average basis by dividing the total cost of all shares owned by the total number of shares.

Corporations

The only one that actually files a tax return on which it must pay income tax is the C corporation. It files on Form 1120 and pays taxes at a rate that generally does not exceed 21%. The S corporation is treated for tax purposes the same as a partnership except that the return filed is the Form 1120S.

Effective Tax Rate

The overall rate of tax you pay on your total taxable income.

Marginal Tax Rate

The rate you pay on each additional dollar you receive as income.

LLC

This type of business entity must file as a corporation a partnership, or sole proprietorship. One member will use the schedule C, those with two or more members invariably file Form 1065 and attach a Schedule K-1. If filing as a corporation they generally file as an S Corp.

Alternative Minimum Tax (AML)

To ensure that high income taxpayers do not escape federal income taxes. You compute your regular tax and then you compute the AMT and pay whichever is the higher amount.

Generation Skipping Trust (GST)

Trust that is used to pass money from family members to other members more than one generation removed.

Taxation on income from foreign issuers

US Tax law allows investors to reclaim the withheld tax as a credit against taxes owed on their tax returns and it is not a preference item for AMT.

Policy Loans

When you borrow cash value from your life insurance policy, the funds received are nontaxable.