TAX 4001 EXAM I REVIEW

#4 - Estimates can be used under some circumstances on a filed tax return.

#6 - If a tax professional knows about an error in a tax return they must advise the taxpayer to file a correct return. The tax professional may not inform the IRS without permission from the taxpayer.

Example: A single taxpayer in 2018 earns salary of $50,000 and no other taxable income. Calculate the taxpayer's federal income tax (rounded to the nearest penny):

$50,000 - tax on first 38,700 = 4,453.50 (38,700) 11,300 X 22% = 2,486.00 Total Tax 6,939.50

Judicial Authority

(The court decisions - Supreme Court is the highest authority)

Statutory Authority

(The internal revenue code and US Constitution, Treaties, etc.). Treaties and the internal revenue code are considered to be equal authority.

Administrative Authority

(Treasury & IRS pronouncements) - highest authority is Treasury Regulations, then Revenue Rulings, then Revenue Procedures, and finally Private Letter Rulings made for the requesting taxpayer.

Financial reporting (GAAP) versus Tax reporting

- GAAP wants to report all possible expenses and defer income. TAX wants to report all income and defer expenses.

#1 - Tax Return Positions

- file tax returns taking a position that has a realistic possibility of being sustained if challenged - a one in three possibility.

C Corporation

- not a flow through entity. It files a Form 1120. It is a GAAP type corporation. All income and loss and deductions stay inside the corporation and are not available to shareholders. This entity pays its' own taxes directly. The C corporation has the sole responsibility to pay all liabilities of the corporation. Corporations must file papers with the state of incorporation.

Tax free local bonds pay 7% and taxable bonds pay 10%. The taxpayer's marginal rate (on next taxable dollar earned) is 20%. Are tax free or taxable bonds the best investment (assume the risk is the same)?

10% before taxes times 20% tax nets (10-2) = 8% net 7% with zero taxes (7-0) = 7% net. So taxable bonds are the best investment.

Example: Assume that the taxpayer's tax liability is $7,000. What is the taxpayer's average tax rate (rounded to two decimal places). The average tax rate is the tax divided by the total taxable income:

7,000/50,000 = 14.00 %

16. Example: A taxpayer and spouse are married as of December 31, 2019. For 2019 what is their filing status for their 2019 Income Tax Return?

Answer: Married

What are secondary sources?

Everything that is not primary. Interpretations of the tax law.

Deductions for AGI (above the line) are available to all individual income taxpayers.

Examples: $300 cash contribution (new 2020) All deductions on Schedule C (Sole Proprietorship) and Schedule E (Rental Income) Self-employed health insurance premiums. Health savings account contributions (HSA). Self-employed retirement plan contributions. IRA contributions. Self-employment taxes (50%) Student loan interest up to $2,500 Early saving withdrawal penalty Tuition and fees up to $4,000 Moving Expenses for armed forces members on active duty Alimony paid under divorce or separation agreement executed before 2019.

Itemized deductions for 2020:

Examples: Medical expense deduction that exceeds 7.5 % of adjusted taxable income. Home mortgage interest deduction on $750,000 of qualifying debt taken out after December 15, 2017 Home mortgage interest deduction on $1,000,000 of qualifying debt taken out before December 15, 2017. State and local income and sales taxes paid up to $10,000. Certain investment interest Charitable contributions maximum 100 % of contribution base (usually AGI) - New 2020 Casualty and theft losses incurred in a federally declared disaster subject to limitations

Example: A husband and wife and minor child filed jointly in 2015. In 2016 the husband died and the surviving wife supports the minor child for the next four years. She does not remarry.

Filing status: 2016 Joint Return (assuming the wife does not remarry) 2017 Qualifying widow (because she has the minor child) 2018 Qualifying widow (because she has the minor child) 2019 Head of Household (because she has the minor child) 2020 Head of Household (because she has the minor child)

Review and Memorize the Individual Income Tax Formula:

Gross Income (Internal Revenue Code Section 61) MINUS: Deductions for AGI (above the line deductions) EQUALS: Adjusted Gross Income (AGI) MINUS: From AGI (below the line deductions): (1) Greater of (a) The Standard Deduction, or (b) Total Itemized Deductions, AND (2) The Deduction for Qualified Business Income (QBI deduction) - (Not an itemized deduction so deductible with the standard or itemized deductions) EQUALS: Taxable Income TIMES: Income Tax rates EQUALS: Income Tax Liability PLUS: Other Taxes EQUALS: Total Tax MINUS: Credits MINUS: Prepayments EQUALS: Taxes Due or Refund Due

US business travel rules:

If the taxpayer's trip is over 50% business, then 100% of the airfare is deductible. Only the business lodging and other business expenses such as a rental car are deductible. Only 50% of the business meals are deductible.

Who pays the greatest percentage of taxes?

Individual taxpayers pay the highest amount with income taxes and payroll taxes. Corporations pay a very small percentage compared to individuals.

Filing Status (Only 5):

Married filing jointly (Marital status is determined at the end of the tax year) Married filing separately Qualifying widow/widower (surviving spouse) Single Head of household. See Page 4-19 through 4-24 of textbook.

Accounting methods for tax:

Must use cash or accrual or hybrid.

What are the primary sources of the tax law?

Statutory Authority Judicial Authority Administrative Authority

What is the marginal tax rate?

That is the rate of tax on the next dollar earned.

Example: What is the taxpayer's marginal tax rate (the rate on the next dollar earned: 22%)

That marginal rate stays at 22% until the taxpayer earns 82,500.

What is the average tax rate?

The total taxes calculated divided by the taxable income.

C corporations are double taxed as dividends are paid with after tax dollars and dividend payments are not deductible to the corporation, but are dividend income to the shareholders if individuals.

Ways to avoid the double taxation of dividends to individual shareholders include paying reasonable salary to shareholder-employees, leasing property from shareholders and paying reasonable rent, borrowing money from shareholders and paying reasonable interest. All of these items are deductible to the corporation and are taxed only once when received by the shareholders.

Basic tax planning strategies include

income shifting, timing, and conversion.

Accrual Income:

income when the all events test is met. See Example 9-15 on page 9-19 of the textbook.

Implicit taxes are?

indirect taxes generally resulting from making certain expenses being deductible to some taxpayers and not deductible to others. For example, tax free municipal bond interest is not taxable, and thus are tax favored for those taxpayers who own them. So there is an implicit tax upon those taxpayers buying taxable bonds that pay the same interest rate as the non-taxable bonds. See page 1-16 and 1-17 for more detailed examples.

TAX FRAUD

is not ok as it is illegal and may result in fines and jail.

TAX AVOIDANCE

is ok as it is legitimate tax planning.

The claim of right doctrine

is when the taxpayer has the right to the income without any limitations.

Assignment of income doctrine

is when the taxpayer tries to transfer the income to a taxpayer who did not earn that income. The rule is that the taxpayer who earns the income must pay the tax on the income. The rule does not apply to cash basis taxpayers who form a corporation and assign their unrealized accounts receivables to the corporation. The corporation recognizes the income as it is paid to the corporation.

Explicit taxes include?

most direct taxes, such as income, property, sales, etc.

The objectives of the US tax system include?

raising revenues, achieving social objectives (limit or encourage having children), and achieving certain economic goals.

Code Section 162

requires that business expenses must be ordinary and necessary and reasonable.

Constructive receipt doctrine is

when the taxpayer has unlimited access to any funds. Be able to apply this doctrine to fact situations similar to our class discussions.