Fed Income Tax Chapter 4

In 2014, Eric B. purchased for $500,000 a 20% interest in a business venture that is not subject to the passive activity rules. During 2014, his share of the entity's loss was $400,000. How much is Eric at risk for in 2014 prior to considering the loss? How much of the $400,000 loss in 2014 can Eric deduct?

$500,000; $400,000

If taxpayers contribute to both a traditional and Roth IRA combined amount cannot exceed $5,500

$6,500 is over the age of 50

Direct Transfer

- No consequence - No limit to the number of times a taxpayer can do this in a single year.

Drawback of Rollover Distribution

- Trustee must withhold 20 percent of the amount distributed for federal income taxes, giving the employee only 80 percent of the amount in his or her plan. However, the employee must contribute 100 percent of the amount in the old plan to the new trustee within the required 60 day period to avoid a tax on the distribution. Amounts that are not placed in the new plan within the required period are taxable as ordinary income in the current year. If the taxpayer is 59.5 years old, the portion of the retirement plan distribution not transferred will be subject to 0 percent penalty tax.

Sherry rents her vacation home for 6 months and lives in it for 6 months during the year. Her gross rental income during the year is $4,000. Total real estate taxes for the home are $950, and interest on the home mortgage is $3,000. Annual utilities and maintenance expenses total $1,800, and depreciation expense is $4,500. Calculate Sherry's net income or loss from the vacation home for this tax year.

0

Two ways to transfer can be accomplished:

1. Direct transfer, also known as a trustee-to-trustee transfer, and 2. rollover of the distribution, in whole or in part, to an IRA or other qualified plan.

In establishing the limitations, the tax law classifies individual income into three categories

1. active income (wages, self-employment income, salaries) 2. portfolio income (dividends and interest) 3. passive income and losses (rental real estate income and loss, and income and loss passed through the limited partnerships and other ventures in which the taxpayer has minimal or no involvement)

Roth IRA or Tradition IRA contribution limited to lesser of:

100% of earned income, compensation or self-employment income OR $5,500 - Spouse with no earned income will be able to contribute up to $5,500 - Taxpayers are spouses age 50 and older can contribute an additional $1,000/year (called "catch-up provision)

Lyndon, age 24, has a nonworking spouse and earns wages of $36,000 for 2014. He also received rental income of $5,000 and dividend income of $900 for the year. What is the maximum total amount Lyndon can deduct for contributions to his and his wife's individual retirement accounts for the 2014 tax year?

1000

In 2014, Andy has passive income of $100,000 and passive losses of $250,000. How much of the passive losses can Andy deduct in 2014?

100000

At the beginning of 2015, the entity obtained $1,000,000 of recourse financing. During 2015, Eric withdraw cash of $30,000, and his share of the entity's loss was $20,000. How much is Eric at risk for that the end of 2015?

100000 at risk - 200000 (1000000 x 20%) - 30000 withdraw - 20000 withdraw = 250000 at risk at the end up 2015

Allen (age 32) takes a distribution of $20,000 from his Traditional IRA account which he plans to deposit into an IRA with a different bank. During the 60-day rollover period, he gambles and loses the entire IRA balance. What income must he show on his tax return related to the failed rollover? How much must Allen pay in penalties for withdrawing the funds from the IRA and not repaying within 60 days?

20000 2000 ( 20000 x 10%)

Mary has a Roth IRA held more than 5 years to which she has contributed $30,000. The IRA has a current value of $62,000. Mary is 55 years old and she takes a distribution of $38,000. How much of the distribution will be taxable to Mary?

38000-30000

Norm is a real estate professional with a real estate trade or business as defined in the tax law. He has $80,000 of business income and $40,000 of losses from actively managed real estate rentals. How much of the $40,000 in losses is he allowed to claim on his tax return?

40000

In 2015, Andy generates $200,000 of passive income and $40,000 of passive losses. How much passive loss in total can Andy deduct in 2015?

40000 + 150000 = 190000

Interest

Portfolio

Wages From a Job

Active income

Bob established a Roth IRA at age 50 and contributes the maximum each year for 10 years. The account is now worth $61,000 consisting of $35,000 of nondeductible contributions and $26,000 in earnings that have not been taxed.

Bob may withdraw the $61,000 tax-free from the Roth IRA because he is over 59.5 and has met the 5 year holding period requirement.

Dan is a self-employed doctor, and the net earned income (Schedule C net income less one-half of self-employment tax) from his practice is $125,000. Under the terms of his Keogh plan, Dan contributes 20% of net earned income (up to the maximum allowable) to the plan.

Dan's contribution to the plan is calculated as: The lesser of 20% of $125,000 ($25,000) OR $52,000... Contribution: $25,000

Traditional IRA

Deduction for AGI if certain conditions are met. Distribution in retirement are taxible

Bob earns $40,000 during the current year. His employer contributes $2,000 (5 percent of Bob's salary) to a qualified retirement plan for Bob. This pension plan is what kind of plan?

Defined contribution plan

Which of the following is true about the rental of real estate?

Depreciation and maintenance expenses for an apartment complex are deductible. A vacation home is a home that is rented for 15 days or more and is used by the taxpayer for personal use for more than the greater of 14 days or 10 percent of the days it is rented for fair value during the year. If a home is rented for less than 15 days a year, the rental income is not taxable. Incorrect Response Repairs on rental property are deductible by the taxpayer

Portfolio

Dividends, Interest, Royalties

Glenn rents the lake home for $2,500 for 20 days and uses it for personal purposes for 60 days. Assume Glenn has the same operating expenses as in the previous examples. Since the lake home is rented for 15 days or mot and Glenn uses the home for personal purposes for more than 14 days (or 10 percent of the days rented, if greater), the property is subject to the vacation home limitations.

Glenn's personal use percentage is 75% (60 days days/ 80 days) and the rental portion is 25% (20 days / 80 days). The IRS requires that the rental income or loss be calculated as follows: Gross Rental Income - $2,500 Less: interest and taxes (25%) - (1425) Balance - 1075 Less utilities and maintenance (25%) - (550) Balance - 550 Less depreciation (25% limited to 550) - (550) Net income - $0 The interest and taxes allocable to Glenn's personal use of the property in both examples are deductible as itemized deductions on Schedule A. The person portion of the utilities, maintenance, and depreciation is a nondeductible personal expense.

Quincy, age 31, works for Big Corporation and has a salary of $40,000 for 2014. Quincy is eligible to contribute the maximum $5,500 to his Traditional IRA or Roth IRA for 2014. If Quincy has a spouse who does not work, he could also contribute $5,500 into her IRA or Roth IRA.

If Quincy is 55 years old instead of 31 years old, he could contribute $6,500 to his traditional or Roth IRA, and $5,500 or $6,500 for his spouse depending on whether she is old enough to quality for the $1,000 catch-up contribution.

1. Primary Personal Use

If a resident is rented for fewer than 15 days during the year, the rental period is disregarded and it is treated as a personal residence for tax purposes. The rental income is not taxable and the mortgage interest and real estate taxes may be allowed as itemized deductions. Other expenses, such as utilities and maintenance, are considered nondeductible personal expenses.

3. Rental/Personal Use

If the residence is rented for 15 days of more and is used for personal purposes for more than 14 days or 10 percent of the days rented, whichever is greater, allocable rental expenses are allowed only to the extent of rental income. Allocable rental expenses are deductible in three separate steps: 1. The interest and taxes are deductible 2. Utilities and maintenance are deductible 3. Depreciation expenses is deducted. For utilities, maintenance, and depreciation expenses to be deductible, there much be positive income following the deduction of items in the preceding step(s). In addition, the expenses, other than interest and taxes, are only deductible to the extent of that positive income. Expenses are allocated between the rental and personal days before the limits are applied. The IRS requires that the allocation be on the basis of the total days of rental use or personal use divided by the total days of use.

2. Primarily Rental Use

If the residence is rented for 15 days or more and is used for personal purposes for not more than 14 days or 10 percent of the days rented, whichever is greater, the residence is treated as rental property. The expenses much then be allocated between the personal and rental days. If this is the case, the rental expenses may exceed the rental income, and the resulting loss would be deducted against other income subject to the passive loss rules.

Which of the following is false about the self-employed health insurance deduction?

The self-employed health insurance deduction is an itemized deduction.

Traditional IRA Deductions

Money removed from a traditional IRA is: - taxable as ordinary income and may be subject to a 10% penalty for early withdrawal. To avoid the 10% penalty, distributions from the IRA generally cannot begin before age 59. However, free withdrawals from IRAs may be made by taxpayers under the age of 59.5 who are: - Disabled - Using a special level payment option - Using the withdrawals for medical expenses in excess of 10% (7.5% if age 65 or older) of their AGI. - The recipient of at least 12 weeks of unemployment compensation and to the extent they are paying medical insurance premiums for their dependents - Paying the cost of higher education, including tuition, fees, books, and room and board for he taxpayers or their spouses, children, or grandchildren - Withdrawing up to $10,000 for the first-time home-buying expenses.

Roth IRA

No current deduction Distribution in retirement are nontaxable

Juan has $90,000 in a Section 401(k) plan with his employer. He also has two IRAs, one with ABC Bank ($20,000) and one with XYZ Mutual Fund ($30,000). In March or 20XX, Juan instructs ABC Bank to make a direct transfer to XYZ Mutual Fund of all of his funds ($20,000). In August 20XX , Juan quits his job and instructs the trustee of the Section 401(k) plan to transfer $90,000 directly to XYZ Mutual Fund.

On December 31, 20XX, Juan has $140,000 in his XYZ Mutual Fund IRA. Since these were direct transfers, there are no tax consequences to Juan in the current year.

Investment in a limited liability company where the only involvement is attending one annual meeting

Passive Income

Investment as a limited partner in a partnership

Passive income

Active

Rental income, limited partnership

If services such as cleaning and maid services are provided, the income is reported on

Schedule C and is subject to self-employment tax

Mary has modified AGI before losses of $120,000. In addition, she has a rental house which shoes a loss of $18,000 for the year.

She may only deduct $15,000 (25000 - 50% of $20000) of the loss because of the phase-out of the $25,000 allowance for passive rental losses where modified AGI is over $100,000.

Glenn owns a lake home. During the year he rented the home for $1,800 for 20 days, and Glenn lived in the lake home for 10 days during the year. This expenses for the lake home included $5,000 mortgage interest, $700 in property taxes, $2,100 in utilities and maintenance, and $3,000 in depreciation.

Since the lake home is now rented for 15 days or more and Glenn's use of the home is not more than 14 days (or 10 percent of the days rented, if greater), the property is treated partially as rental property and partially as a personal residence. Allocation of expense associated with the home is based on the number of days of rental or personal use compared to the total number of days used. Glenn's personal use percentage is 33.33 percent (10 days/30 days) and the rental portion is 66.67 percent (20 days / 30 days). For tax purposes, the rental income or loss is calculated as follows: Income - $1800 Interest & Tax - (3800) Utilities & Maintenance - (1400) Depreciation - (2000) Rental Loss = (5400)

Glenn owns a lake home. During the year he rented the home for $1,800 for 2 weeks, lived in the home for 3 months, and left the home vacant during the remainder of the year. This expenses for the lake home included $5,000 mortgage interest, $700 in property taxes, $2,100 in utilities and maintenance, and $3,000 in depreciation.

Since the lake home was RENTED fewer than 15 days, Glenn would not report the $1,800 income and would deduct only the interest and taxes as itemized deductions on Schedule A. The other expenses are nondeductible personal expenses.

Rental Property

Taxable to the taxpayer

Roth IRA Distrbutions

Taxpayers can make a tax-free withdrawal from Roth IRAs after a 5-year holding period if any of the following requirements are satisfied: 1. The distribution is made on or after the date on which the participant attains age 59.5 2. The distribution is made to a beneficiary (or the participant's estate) on or after the participant's death. 3. The participant becomes disabled 4. The distribution is used to pay for qualified first-time home-buyer's expenses

James' employer makes a $2,000 contribution to a qualified retirement plan for James in the current year. James is only 45 years old and does not expect to retire until age 65, 20 years from now. What is the proper tax treatment of the $2,000 contribution for James' employer?

The $2,000 is deductible in the current year by the employer.

Individual Taxpayers may deduct up to $25,000 of rental property losses against other income, if they are actively involved in the management of the property and their income does not exceed certain limits.

The $25,0000 loss deduction is phased out when the taxpayer's modified adjusted gross income exceeds $100,000. The $25,000 is reduced by 50 cents for each $1.00 the taxpayer's modified adjusted gross income exceeds that amount. Therefore, no deduction is allowed when the taxpayer's modified gross income reaches $150,000. Special limitations apply to taxpayers filing as Married, Filing Separately and claiming a deduction for real estate rental losses under this special rule.

Tomas is 48 years old and has a midlife crisis and decides he has to have a red sports car. He withdraws $35,000 from his traditional IRA to pay for it. Tomas does not quality for any of the penalty-free withdrawals listed.

The $35,000 is taxable to Tomas as ordinary income and he is subject to a $3,500 ($35,000 x 10%) penalty for removing the funds before age 59.

Bob established a Roth IRA at age 56 and receives distributions of $10,000. Assume his adjusted basis for the Roth IRA is $12,000 ($2,000 x 6 years).

The distribution is tax-free and his adjusted basis is reduced to $2,000. ($12,000 - $10,000)

U.S. Tax Court has allowed taxpayers to use 365 days for the allocation of interest and taxes allocable to the rental use of the property instead of 20/80= 25%, it would be 20/365 = 5.5 percent. Allocation for utilities and maintenance remain the same while a full $750 of depreciation 25% of $3,000 would be allowed and the remaining interest and taxes 345/365 would be included in itemized deductions.

This controversy between the Tax Court and the IRS has not been resolved

Passive

Wages, self-employment income

Passive Activity

a trade of business in which the taxpayer does not materially participate and most rental real estate activity.

Self employment income

active income

Simplified Employee Pensions (SEPs)

are one of the most popular retirement plans for self-employed taxpayers. Contribution limits for 2014 are the same limits for Keogh plans - the lesser of 20% of net earned income before the SEP deduction OR $52,000.

Direct Transfers

in some situations taxpayers need to transfer assets from one retirement plan to another plan of the same or different type. Example: taxpayer may change jobs, take early retirement, or simply seek a better retirement fund manager.

Keogh Plans

plans by self-employed taxpayers generally limited to lesser of 20% of their net earned income (before the Keogh deduction) or $52,000. Net earned income includes profits from a business if a material part must be reduced by one-half of the self-employment tax on the income to arrive to net earned income used in the pension calculations

Dividends

portfolio

Health Savings Account (HSAs)

relatively new type of savings account which may be established for the purpose of paying unreimbursed medical expenses by taxpayers who carry qualifying high-deductible medical insurance. - deductions for AGI, and are limited to certain dollars amounts depend on age and whether the high-deductible insurance covers an individual or a family. Earnings unused are not taxed, and distributions cover medical expenses are not penalized.

Exceptions to mandatory withholding is a distribution from an IRA;

such distributions are not subject to 20 percent withholding tax. Taxpayers are only allowed ONE distribution rollover each year for transfer from one IRA to another IRA.

Distribution Rollovers

taxpayer receives a distribution of funds from a retirement plan and then transfers part or all of the funds to the new retirement plan trustee. The taxpayer has a minimum of 60 days in which to transfer funds to the new plan and avoid taxes and penalties. The 60 day rollover period may be waived in causes of casualty, disaster, and other events beyond the reasonable control of the taxpayer such as death, disability, incarceration, and postal error. The 60 day limit is extended to 120 days for first-time home buyers.