tax
I- Bonds
"Inflation-Adjusted US savings bonds" Good alternative to bank accounts Extremely safe Income is subject to federal, but not state and local taxes Recognition of income made be deferred for up to thirty years Maximum purchase per year is $10,000.
Describe two ways in which the transfer tax (estate and gift tax) system is a unified system.
(1) The same tax rates apply for both gift and estate tax purposes, and (2) they are combined into one maximum credit amount in 2011 or later.
4 factors to evaluate Municipal Bonds
1. Bond rating 2. Duration 3. Call risk 4. Individual bonds vs Funds
What is a complete liquidation? A partial liquidation? Explain the difference in the tax treatment accorded these two different events.
A complete liquidation is defined as one or a series of distributions made by a liquidating corporation that completely cancels or redeems all of its stock in accordance with a plan of liquidation. A partial liquidation is defined as a distribution that (1) is not essentially equivalent to a dividend and (2) is pursuant to a plan of liquidation and occurs within the tax year in which the plan is adopted or within the succeeding tax year. The complete liquidation is taxed to the extent the shareholder recognizes a gain or loss. A partial liquidation results in exchange treatment for a noncorporate shareholder.
Compare the tax treatment of administration expenses with that of the decedent's debts.
Administration expenses may be deducted on either the estate tax return or the estate's income tax return or some in each place. The executor should deduct them on the return where they will produce the greatest tax savings.
Yvonne and Larry plan to begin a business that will grow plants for sale to retail nurseries. They expect to have substantial losses for the first three years of operations while they develop their plants and their sales operations. Both Yvonne and Larry have substantial interest income, and both expect to work full-time in this new business. List three advantages for operating this business as a partnership instead of a C corporation.
Advantages include (1) partnerships are not subject to tax, thereby eliminating the problem of double taxation that exists for C corporations, (2) partners may divide the partnership's profit or loss among themselves without regard to their proportionate capital interests, (3) under the conduit principle of taxation, partnership losses and other items receiving special tax treatment flow through to the partners.
Lance and Rodney are contemplating starting a new business to manufacture computer software games. They expect to encounter losses in the initial years. Lance's CPA has talked to them about using an S corporation. Rodney, while reading a business publication, encounters a discussion on limited liability companies (LLCs). The article talks about the advantages of using an LLC instead of an S corporation. How would you respond to their inquiry?
An LLC has no restrictions on the type or number of owners. An S corporation is limited to 100 shareholders, none of which may be a corporation or a partnership.
List five disadvantages of making an S election.
An S corporation shareholder's marginal tax rate on pass-through income may be higher than the 21% tax rate that would apply if the entity were a C corporation The S corporation's earnings are taxed to the shareholders even though they are not distributed. This treatment may require the corporation to make distributions or salary payments so the shareholder can pay taxes owed on the S corporation's earnings. Dividends received by the S corporation are not eligible for the dividends-received deduction, as is the case for a C corporation. Allocation of ordinary income or loss and the separately stated items is based on the stock owned on each day of the tax year. Special allocations of particular items are not permitted, as they are in a partnership.
Explain to an executor an advantage and a disadvantage of electing the alternate valuation date.
An advantage is that the estate tax liability is lower; a disadvantage is that the heirs receive the property at a lower total basis.
What is an inadvertent termination?
An inadvertent termination is one where the IRS, corporation, and shareholders all agree was unintentional (e.g., failing the passive investment income test for three consecutive years as a result of improperly computing the corporation's Subchapter C E&P).
How will a partner's distributive share be determined if the partner sells one-half of his or her beginning-of-the-year partnership interest at the beginning of the tenth month of the partnership's tax year?
A partner's distributive share will equal the sum of the partner's earnings for one-half of his or her beginning-of-the-year interest for the full year and thepartner's earnings for the other one-half of his or her beginning-of-the year interest for nine months.
What is the purpose of the gift tax annual exclusion?
Congress enacted the annual exclusion for administrative simplicity to keep "routine" gifts from needing to be reported for gift tax purposes.
What limitations apply to the amount of loss pass-through an S corporation shareholder can deduct?
Each shareholder's deduction for his or her share of the ordinary loss and the separately stated loss and deduction items is limited to the sum of the adjusted basis for his or her S corporation stock plus the adjusted basis of any indebtedness owed directly by the S corporation to the shareholder.
What happens to any losses exceeding this limitation? What happens to losses if the shareholder transfers his or her stock?
Excess loss and deduction items carry over to subsequent years in which the shareholder again has a positive basis amount. Unused losses lapse if the shareholder transfers his or her stock to anyone other than a spouse or former spouse incident to a divorce.
Determine whether the following statement is true or false: Every donor who makes a taxable gift incurs a gift tax liability. Explain your answer.
False. Due to the unified credit, relatively large taxable gifts can be made before a gift tax liability is triggered.
A client requests that you explain the valuation rules used for gift tax and estate tax purposes. Explain the similarities and differences of the two sets of rules.
For gift tax purposes, properties are valued at their fair market values (FMVs) as of the date of the gift. For estate tax purposes, properties are valued at their FMVs at either the date of death or, if certain requirements are met, the alternate valuation date, which generally is six months after date of death.
Index Funds
Fund performance essentially matches that of an underlying market index low turnover- can provide benefits like gain deferral when you don't trade
Individual bonds Vs Funds
Funds provide better diversification funds charge annual operating expenses Individual bonds- commissions on purchase and sale Individual bonds- cost more to purchase (commissions) Individual bonds- owner can better control recognition of gain & losses
Sam wants to help his brother, Lou, start a new business. Lou is a capable auto mechanic but has little business sense, so he needs Sam to help him make business decisions. Should this partnership be arranged as a general partnership or a limited partnership? Why? Should they consider any other form for structuring theirbusiness?
General partnership because Sam will be providing business advice. The brothers may want to consider an LLC to provide limited liability.
In what circumstances do gifts fail to qualify for the annual exclusion?
Gifts of future interests are not eligible for the annual exclusion.
If insurance policies on the decedent's life escape being included under Sec. 2042, are they definitely excluded from the gross estate? Explain.
If the insurance policy escapes being taxed under Sec. 2042, it can be included under Sec. 2035 if the decedent/insured transferred it by gift within three years of death.
What actions can an S corporation shareholder take before year-end to increase the amount of the S corporation's losses he or she can deduct in the year they are incurred?
Increase stock or debt basis. The shareholder can make additional capital contributions or make additional loans to the corporation byyear-end.
In general, at what amount are items includible in the gross estate valued? Indicate one exception to the general valuation rules and the reason for this exception.
Items included in the gross estate are valued at their fair market values (FMV) on the date of death or alternate valuation date. An exception includes the FMV rule for farmland meeting certain requirements to reduce the probability that the heirs would have to sell the land to pay estate taxes.
Jane contributes valuable property to a partnership in exchange for a general partnership interest. The partnership also assumes the recourse mortgage Jane incurred when she purchased the property two years ago. a. How will the liability affect the amount of gain that Jane must recognize? b. How will it affect her basis in the partnership interest?
Jane recognizes gain on the contribution of property and assumption of a liability if the amount of the liability assumed by the other partners exceed Jane's basis in the contributed property plus her share of existing partnership liabilities. Her basis in the partnership interest will be decreased by the amount of the liability assumed by the other partners.
Bob and Carol want to open a bed and breakfast inn as soon as they buy and renovate a turn-of-the-century home. What would be the major disadvantage of using a general partnership rather than a corporation for this business? Should they consider any other form for structuring their business? What would be the major disadvantage of using a general partnership rather than a corporation for this business?
Lack of limited liability. Should they consider any other form for structuring their business? Yes. They may want to consider a limited liability limited partnership (LLLP), if available in the taxpayer's state. And They may want to consider a limited liability company (LLC).
Managed Funds
Manager attempts to choose stocks that will do better than the underlying market index Challenge is to provide performance that will also cover additional costs of management high risk of manager turnover Greatest relative performance for small companies and foreign investments larger managed funds have risk of market impact costs
Jeff, a 10% limited partner in the recently formed JRS Partnership, expects to have losses from the partnership for several more years. He is considering purchasing an interest in a profitable general partnership in which he will materially participate. Will the purchase allow him to use his losses from the JRS Partnership?
No. As a limited partner in the JRS Partnership, Jeff is almost certainly subject to the passive loss limitation rules on losses from this partnership. Accordingly, income from a general partnership in which Jeff materially participates cannot be used to offset the passive losses. Jeff can use losses from the JRS Partnership only to offset passive income, or he can claim the losses when he sells his entire interest in the JRS Partnership or when the partnership terminates
Assume that the properties included in Alex's gross estate have appreciated during the six-month period immediately after his death. May Alex's executor elect the alternate valuation date and thereby achieve a larger step-up in basis? Explain.
No. The executor may not use the alternate valuation date if the total value has risen. The executor cannot elect it unless it will result in (1) a lower gross estate amount and (2) a smaller amount of estate tax payable.
Municipal bonds
Not subject to Federal Income taxes May be subject to state income taxes
What actions must the S corporation and its shareholders take to correct an inadvertent termination?
Once such a determination is made, the S corporation or its shareholders must take the necessary steps, within a reasonable time period after discovering the event causing the termination, to restore its small business corporation status by distributing the money or property needed to eliminate the E&P balance.
What tax years can a newly created corporation that makes an S election adopt for its first tax year? If a fiscal year is permitted, does it require IRS approval?
S corporations must generally adopt a calendar year or a 52-53 week year as its tax year. With IRS approval, an S corporation may adopt a fiscal year which is its natural business year.
Explain the procedures for allocating an S corporation's ordinary income or loss to each of the shareholders. What special allocation elections are available?
Separately stated items are allocated an equal portion of (1) the item to each day of the tax year, (2) the daily amount for the item to each share of stock outstanding on each day, (3) the total daily allocations for each outstanding share of stock, and (4) the total amounts allocated to each share of stock held by the shareholder. Special allocation elections are available only if the S election terminates in the tax year or if a shareholder no longer holds his or her entire S corporation stock interest.
Explain how shares of stock traded on a stock exchange are valued. What is the blockage rule?
Shares traded on a stock exchange are valued at the average of their high and low selling prices as of the applicable valuation date. The blockage rule allows a reduction from the average value where the decedent owned a large block of shares that would be difficult to dispose of at one time without using an underwriter and/or accepting a lower price.
Why do some donors consider the qualified terminable interest property (QTIP) transfer an especially attractive arrangement for making gifts to their spouses?
Some donors find a QTIP arrangement especially attractive because it enables them to receive a marital deduction (which results in their transfer being nontaxable) and also permits them to designate who will receive the property upon the donee spouse's death.
US Treasury note
Subject to Federal Income tax Not subject to state income tax
When is the S corporation's tax return due? What extensions are available for filing the return?
The S corporation's tax return is due on the fifteenth day of the third month following the close of the tax year. The corporation can request an automatic six-month extension of time to file the return.
What is an accumulated adjustments account (AAA)? What income, gain, loss, and deduction items do not affect this account assuming the S corporation has an accumulated E&P balance?
The accumulated adjustments account (AAA) is the cumulative total of ordinary income or loss and separately stated items for the S period. The AAA is required only of S corporations that have an accumulated E&P balance. Tax-exempt income and nondeductible expenses related to tax-exempt income do not increase or decrease the AAA. They are included in the other adjustments accounts (OAA), which is not a separate earnings balance but is included in the basis of the S corporation stock.
After an S corporation revokes or terminates its S election, how long must the corporation wait to make a new election? What circumstances permit an early reelection?
The corporation must wait five tax years before making a new election. An early reelection can occur when (1) more than 50% of the corporation's stock is owned by persons who did not own stock on the date of the termination, or (2) the termination was caused by events not reasonably within the control of the corporation or the shareholders owning a substantial interest in the corporation and was not part of a plan to terminate the election involving the corporation or its shareholders.
In general, when is the estate tax due? What are some exceptions?
The estate tax is due by the due date for the estate tax return, which is nine months after the date of death. Exceptions include, a one year extension to pay the estate taxes, and installment payments can be automatic if the estate has an interest in a closely held business.
Describe two circumstances in which life insurance on a decedent's life is includible in the gross estate under Sec. 2042. If insurance policies on the decedent's life escape being included under Sec. 2042, are they definitely excluded from the gross estate? Explain.
The policy proceeds are payable to the executor or for the benefit of the estate. The decedent possessed incidents of ownership in the policy at the time of his or her death.
What taxes must an S corporation prepay by making quarterly estimated tax payments? Can a shareholder owning S corporation stock use the corporation's estimated tax payments to reduce the amount of his or her individual estimated tax payments? Explain.
The two taxes S corporations must prepay are (1) excess net passive income tax and (2) built-in gains tax. These payments do not reduce shareholder's individual estimated tax payments but they do reduce ordinary income and separately stated items passed through to the shareholders.
Antonio would like to make a gift of a life insurance policy on his life. Explain to him what action he must take to make a completed gift.
To make a gift of a life insurance policy, Antonio must irrevocably transfer all incidents of ownership in the policy to another party.
List five advantages of making an S election
Undistributed income taxed to the shareholder is not taxed again when subsequently distributed unless the distribution exceeds theshareholder's basis for his or her stock. Deductions, losses, and tax credits are separately stated and retain their character when passed through to the shareholders. Splitting the S corporation's income among family members is possible. The corporation's losses pass through to its shareholders and can be used to reduce the taxes owed on other types of income. The corporation's income is exempt from the corporate income tax. An S corporation's income is taxed only to its shareholders, whose tax bracket may be lower than a C corporation's tax bracket.
Why did Congress enact the 20% qualified business income deduction? Congress enacted the qualified business income deduction to give pass-through entity owners
a tax rate somewhat comparable to the 21% corporate tax rate. Thus, Congress did not want to give a tax break to C corporations while not giving a tax break to businesses operating in a pass-through form.
Which of the following classifications make a shareholder ineligible to own stock in an S corporation? a. U.S. citizen b. Domestic corporation c. Partnership where all the partners are U.S. citizens d. Estate of a deceased U.S. citizen e. Grantor trust created by a U.S. citizen f. Nonresident alien individual
b. Domestic corporation c. Partnership where all the partners are U.S. citizens f. Nonresident alien individual
Explain the requirements for classifying a transaction as a transfer of a qualified terminable interest property (QTIP).
the donee-spouse be entitled to receive all the income for life and that the income be paid out at least annually. Inaddition, no one can have a power to appoint any part of the property to anyone other than the donee-spouse unless such power is not exercisable while the donee-spouse is alive. Finally a donor must elect to claim a marital deduction.
