Tax Exam 2

child tax credit

a $2,000 tax credit, subject to an AGI phase-out, for each qualifying child who is under age 17 at the end of the year and claimed as a dependent of the taxpayer, and a $500 credit, also subject to the AGI phase-out, for other qualified dependents claimed as dependents of the taxpayer. -$2,000 for each qualifying child under age 17 at end of year who is claimed as taxpayer's dependent ▪Generally refundable in 2021; Partially refundable other years; -$500 for each other qualifying dependent -Phase-out amount, not percentage ▪Phaseout $50 for each $1000 or portion thereof above applicable threshold ▪Exhibit 8-8 has thresholds where phaseout starts -Additional $1,000 child tax credit for 2021 only (and an additional $1,600 for children under age 6); and eligibility is under age 18 ▪Subject to separate phase-out (Exhibit 8-9) ▪Advance payments started July 2021 = $300/ month per qualifying child

net investment income tax

a 3.8 percent tax on the lesser of (a) net investment income or (b) the excess of modified adjusted gross income over $250,000 for married-joint filers and surviving spouses, $125,000 for married-separate filers, and $200,000 for other taxpayers.

§481 adjustment

a change to taxable income associated with a change in accounting methods.

bunching itemized deductions

a common planning strategy in which a taxpayer pays two years' worth of itemized expenses in one year to exceed the standard deduction in that year. -Tax benefit can be gained by implementing simple timing tax planning strategy. §Taxpayers with itemized deductions that fall just short of the standard deduction amount §These itemized deductions do not produce any tax benefit -Rather than deduct the standard deduction every year, time deductions (when possible) to bunch together in one year.

alternative minimum tax (AMT) exemption

a deduction to determine the alternative minimum tax base that is phased out based on alternative minimum taxable income. •Exemption phased out 25 cents for each dollar over the threshold.

standard deduction

a fixed deduction offered in lieu of itemized deductions. The amount of the standard deduction depends on the taxpayer's filing status.

tax year

a fixed period in which a business reports income and deductions, generally 12 months.

floor limitation

a minimum amount that an expenditure (or credit or other adjustment to taxable income) must meet before any amount is allowed.

late filing penalty

a penalty assessed if a taxpayer does not file a tax return by the required date (the original due date plus extension). -5 percent of tax owed per month (or a fraction of month) up to 25 percent if not fraudulent, i.e. max 5 months of 5% penalties; 15 percent of tax owed per month up to 75 percent if fraudulent No penalty if no tax is owed as of the due date

employee

a person who is hired to provide services to a company on a regular basis in exchange for compensation and who does not provide these services as part of an independent business.

independent contractor

a person who provides services to another entity, usually under terms specified in a contract. The independent contractor has more control over how and when to do the work than does an employee.

trade or business

a profit-motivated activity characterized by a sustained, continuous, high level of individual involvement or effort.

business activities

a profit-motivated activity that requires a relatively high level of involvement or effort from the taxpayer to generate income.

investment activities

a profit-seeking activity that is intermittent or occasional in frequency, including the production or collection of income or the management, conservation, or maintenance of property held for the production of income.

Tax credits reduce a taxpayer's taxable income dollar for dollar. A.TRUE B.FALSE

B.FALSE

The kiddie tax does not apply to children over 21 years old at the end of the tax year. A.True B.False

B.False

According to the Internal Revenue Code §162, deductible trade or business expenses must be which one of the following? A.Incurred for the production of investment income B.Ordinary and necessary C.Minimized D.Appropriate and measurable E.Personal and justifiable

B.Ordinary and necessary

permissible accounting method

accounting method allowed under the tax law. Permissible accounting methods are adopted the first time a taxpayer uses the method on a tax return.

alternative minimum tax adjustments

adjustments (positive or negative) to regular taxable income to arrive at the alternative minimum tax base.

private operating foundations

privately sponsored foundations that actually fund and conduct charitable activities.

private nonoperating foundations

privately sponsored foundations that disburse funds to other charities.

ordinary income property

property that if sold would generate income taxed at ordinary rates.

safe-harbor provisions

provision of the tax law that reduces or eliminates a taxpayer's liability under the law if the taxpayer meets certain requirements.

estimated tax payments

quarterly tax payments that a taxpayer makes to the government if the tax withholding is insufficient to meet the taxpayer's tax liability.

12-month rule

regulation that allows prepaid business expenses to be currently deducted when the contract does not extend beyond 12 months and the contract period does not extend beyond the end of the tax year following the year of the payment.

direct write-off method

required method for deducting bad debts for tax purposes. Under this method, businesses deduct bad debt only when the debt becomes wholly or partially worthless.

all-events test

requires that income or expenses are recognized when (1) all events have occurred that determine or fix the right to receive the income or liability to make the payments and (2) the amount of the income or expense can be determined with reasonable accuracy.

deduction for qualified business income

subject to limitations, equal to 20 percent of the taxpayer's qualified business income.

Nonrefundable Personal Credits

tax credits that reduce a tax payer's gross tax liability but are limited to the amount of gross tax liability. Any credit not used in the current year is lost. -Child tax credit -Child and dependent care credit -American opportunity credit -lifetime learning credit -education credit

Medicare tax

the Medical Health Insurance (MHI) tax. This tax helps pay medical costs for qualifying individuals. The Medicare tax rate for employees and employers is 1.45 percent on salary or wages. An additional Medicare tax of .9 percent is assessed on employees (not employers) on salary or wages in excess of $200,000 ($125,000 for married filing separate; $250,000 of combined salary or wages for married filing joint). Self-employed taxpayers pay both the employee and employer Medicare tax and additional Medicare tax.

Which of the following is not an additional tax a taxpayer may have to pay? A.Alternative minimum tax B.Self-employment tax C.Net investment income tax D.Excess wage tax

D.Excess wage tax

Mixed Motive Expenses: Transportation expenses: auto use

"Commuting" costs not allowed •Example: costs of going from taxpayer's home to and from regular place of business •Taxpayer can use a standard mileage rate of 56 cents per mile for 2021 business mileage, or actual costs including depreciation. •If taxpayer chooses the standard mileage rate method for a vehicle, they cannot switch to actual costs on that vehicle later"Commuting" costs not allowed •Example: costs of going from taxpayer's home to and from regular place of business •Taxpayer can use a standard mileage rate of 56 cents per mile for 2021 business mileage, or actual costs including depreciation. •If taxpayer chooses the standard mileage rate method for a vehicle, they cannot switch to actual costs on that vehicle later

•Charitable Contributions

-Contribution of money or property must be made to a qualified charity -Special rules apply to charitable contributions of property depending on the type of property: §Capital gain property §Ordinary income property •Separate from AGI deduction for charitable contributions in 2021 §For taxpayers who do not itemize their deductions §Up to $300 of cash charitable contributions ($600 for married taxpayers filing jointly) to qualified charitable organizations

•Individual Recovery Credit

-Credit only applies in 2021 -$1,400 credit for eligible taxpayers ($2,800 for married taxpayers filing joint) plus $1,400 for each dependent. -Subject to phase-out -Advanced payment of the credit based upon taxpayer 2019 (or 2020) tax return information -Taxpayers not required to repay excess advance payment -If taxpayer receives a lower advance payment than allowed, taxpayer can claim the additional amount allowed as a credit on their 2021 tax return.

Child and Dependent Care Credit

-Dependent under age of 13 (or disabled dependent) -Amount of credit is based on amount of taxpayer's expenditures to provide care for one or more qualifying persons -Percentage qualifying expenditures ▪Maximum qualifying expenditures: $8,000 for one qualifying person ($3,000 all other years) , $16,000 for two or more ($6,000 all other years) ▪Credit Care percentage depends on AGI (see Exhibit 8-10) ▪Percentage credit applied to lower of: o a) actual qualifying expenditures; o b) maximum qualifying expenditures; or o c) earned income

•Three categories of deductions for AGI

-Directly related to business activities -Indirectly related to business activities -Subsidizing specific activities

Lifetime learning credit

-Eligible expenses (tuition) for any course of instruction to acquire or improve taxpayer's job skills ▪Includes professional or graduate school ▪Includes continuing education -Applied per taxpayer ▪MFJ return is one taxpayer. -20 percent of up to $10,000 of eligible expenses (maximum of $2,000) -Phase-out prorata based on AGI: (MFJ =160K to 180K; half that for all others), i.e. phaseout % = excess AGI/ phaseout range -Cannot claim both the AOTC and the LLC for the same individual's education expenses

American Opportunity Tax Credit

-For first four years of postsecondary education -For eligible expenses and institutions only -Applied per student ▪Taxpayer, taxpayer's dependents, third parties on behalf of taxpayer's dependents ▪Amounts paid by dependents treated as paid by taxpayer. -100 percent of first $2,000 of eligible expenses and 25% of next $2,000 (maximum credit is $2,500) -Phase-out prorata based on AGI: (MFJ =160K to 180K; half that for all others), i.e. phaseout % = excess AGI/ phaseout range 40 percent of credit is refundable (subject to restrictions).

•Other Itemized Deductions

-Gambling losses and expenses to the extent of gambling income -Casualty and theft losses on investment property -Unrecovered cost of a life annuity at death

Education credits

-If deduct for AGI education expenses for someone, no education credit allowed for that person slides chap 6 pages 65-67 ▪Could take American opportunity tax credit for one dependent and for AGI deduction for another

•Financial and Tax Accounting Methods

-In reporting financial statement income, businesses have incentives to select accounting methods permissible under GAAP that accelerate income and defer deductions. -In contrast, for tax planning purposes, businesses have incentives to choose accounting methods that defer income and accelerate deductions.

Tax Deductions

-Individuals may deduct itemized deductions payments for the following taxes: §State, local, and foreign income taxes §State and local real estate taxes on property held for personal or investment purposes §State and local personal property taxes that are assessed on the value of the specific property -Sales tax deduction §State and local sales taxes can be deducted in lieu of state and local income taxes -The total itemized deduction for state and local taxes is limited to $10,000 ($5,000 married filing separate). The deduction for foreign income taxes is not subject to this cap.

•Expenses Relating to Tax-Exempt Income

-Interest on loan where proceeds invested in municipal bonds -Key employee insurance premiums

FICA - Employee

-Must pay FICA taxes on compensation from employer (6.2 percent Social Security tax rate; 1.45 percent Medicare tax rate; .9 percent additional Medicare tax rate on salary or wages or self employment earnings , in excess of $200,000 if Single [$125,000 for married filing separately; $250,000 married filing jointly]) -$142,800 limit for 2021 applies to Social Security portion. -See Problem 8-64 for Multiple employers during year

Business vs. Investment Activities

-Profit-motivated activities are classified as 1.Business activities (called "trade or business") 2.Investment activities -Although both are motivated primarily by profit, business activities are distinguished from investment activities. §Trade or business activities require a relatively high involvement or effort from the taxpayer, whereas investment activities do not. §Investment activities involve investing in property for appreciation or for income payments..

Business Tax Credits

-Promote certain behaviors -If credit exceeds gross tax, carry back one year and carry forward 20 years. -Foreign Tax Credit ▪Nonrefundable; carry back one year and carry forward up to 10 years.

•Losses on Dispositions of Business Property

-Recognized losses are deductible either as ordinary or capital loss (see chapter 11). -Sec 267: Losses on sales to related parties are not deductible by the seller. -Casualty losses are limited to lesser of decline in value (repair cost) or basis; ▪Unless completely destroyed, in which case, the loss = insurance proceeds less basis -Basis is amount of loss if business asset is completely destroyed.

FICA - Self Employed

-Responsible for entire FICA tax (employee and employer share and additional Medicare tax) -Tax base is net earnings from self-employment (generally, net Schedule C income and multiply by .9235). -Same $142,800 limit applies to Social Security portion. -How does QBI deduction work: Lesser of: (a) 20% of QBI determined after 50% SE tax deduction.... unless subject to wage/asset limitation...in which case use that lower amount; or (b) 20% of taxable income before QBI deduction •If net earnings from self-employment < $400, no self-employment tax. •How does the $142,800 Social Security earnings limit apply when receiving both wages and self-employment earnings in the same year? -Wages use up limit first—favorable or unfavorable for taxpayer? Why? -See Problem 8-67 for what happens when taxpayer has both salary as an employee and is also self employed

Underpayment Penalties

-Safe-harbor provisions ▪90 percent of current tax liability or ▪100 percent of previous-year tax liability (110 percent for individuals with AGI greater than $150,000) -Applied on quarterly basis ▪90%/4 = 22.5% of current-year liability must be paid in by deadline, or ▪100%/4 = 25% of previous year's liability must be paid in by deadline (110% for taxpayers with AGI > $150,000). -Penalty based on amount of underpayment at each quarter × federal short-term rate + 3%.

•Items commonly added back to regular taxable income in computing AMT income

-Tax-exempt interest from private activity bonds -State and local income taxes or sales taxes, plus real estate taxes (the total of whatever was deducted within the $10,000 limit) -Depreciation under AMT method vs regular method (chap 10), and related difference in gain or loss

•Medical Expenses

-Taxpayers may deduct medical expenses incurred to treat themselves, their spouse, and their dependents. -Qualifying medical expenses include unreimbursed payments for care, prevention, diagnosis, or cure of injury, disease, or bodily function. Taxpayers using personal automobiles for medical transportation purposes may deduct a standard mileage allowance (16cents per mile in 2021) in lieu of actual costs

•Who is most likely to pay AMT and why?

-Taxpayers with large amounts of capital gains.

•Expenses Not Deductible

-Unreimbursed employee business expenses, tax preparation fees, investment expenses, hobby expenses

Passive Tests

1.The individual participates in the activity more than 500 hours during the year. 2.The individual's activity constitutes substantially all of the participation in such activity by all individuals, including nonowners. 3.The individual participates more than 100 hours during the year, and the individual's participation is not less than any others individual's participation in the activity. 4.The activity qualifies as a "significant participation activity" (more than 100 hours spent during the year), and the aggregate of all "significant participation activities" is greater than 500 hours for the year. 5.The individuals materially participated in the activity for any 5 of the preceding 10 taxable years. 6.The individual materially participated for any three preceding years in any personal service activity (personal services in health, law, accounting, architecture, etc.). 7.Taking into account all the facts and circumstances, the individual participates on a regular, continuous, and substantial basis during the year.

Which of the following cannot be selected as a valid tax year-end? A.December 31st B.January 31st C.The last Friday of the last week of June D.December 15th E.A tax year can end on any of these days

D.December 15th

accounting period

A period of time covered by an accounting report

The computation of the alternative minimum tax base begins with regular taxable income. Which of the following is not part of the formula for computing the alternative minimum tax base? A.Subtract state income taxes paid B.Add the standard deduction amount if used for regular tax C.Subtract the AMT exemption amount (if any) D.Add back tax-exempt interest from a private activity bond not issued in 2009 or 2010

A.Subtract state income taxes paid

The child tax credit is subject to phase-out based on the taxpayer's AGI A.TRUE B.FALSE

A.TRUE

•Ben paid the following to attend a business meeting in Chicago: - Airfare (first class)—$1,200 - Hotel (three nights)—$750 - Meals (three days)—$270 What amounts are deductible if Ben spent two days in meetings (primarily business)? What amounts are deductible if the meals were provided by a restaurant? What amounts are deductible if Ben spent one day in a meeting (primarily personal)?

Airfare (all or none) Primarily business: $ 1,200 Primarily personal: $ 0 Hotel ($250 per day) Primarily business: 500 Primarily personal: 250 Meals ($90 per day × 50%) Primarily Business: 90 Primarily Personal: 45 Total Travel Deduction Primarily Business: $ 1,790 Primarily Personal: $ 295

Economic Performance Example Ben has signed a binding contract for Peter to provide Ben with repair services. Ben paid $1,500 to Peter and owes an additional $6,000 on the contract. The repairs will commence late next year. When can Ben claim the deduction if he uses the accrual method?

Although the all-events test is satisfied, Ben can only deduct $7,500 next year because that is when economic performance occurs (taxpayer liable for performing service).

Self Employed FICA Example Assume that Courtney received $100,000 of taxable compensation from EWD in 2021, and she received $180,000 in self-employment income from her consulting activities. What amount of self-employment taxes and additional Medicare tax is Courtney required to pay on her $180,000 of business income? Assume that Courtney's employer correctly withheld $6,200 of Social Security tax, $1,450 of Medicare tax, and $0 of additional Medicare tax.

Answer: $10,724, consisting of $10,128 of self-employment taxes and $596 of additional Medicare tax, computed as follows: 1)Social Security tax base limit less employee compensation subject to Social Security tax = $ 42,800 $142,800 − $100,000, limited to $0 2)Net earnings from self-employment = 166,230 $180,000 × 92.35% 3)Social Security portion of self-employment tax = 5,307 [Lesser of Step (1) or (2)] × 12.4%, rounded 4)Medicare tax = 4,821 Step (2) × 2.9%, rounded 5)Sum of taxpayer's compensation and net earnings from self-employment = 266,230 $100,000 + Step (2) 6)[Greater of (a) zero or (b) the amount from Step (5) minus $200,000] × 0.9% = 596 $66,230 × 0.9%, rounded 7)Step (6) less any additional Medicare tax withheld by Courtney's employer = 596 $596 − $0 8) Total = $10,724 (3) + (4) + (7) [$10,128 of self-employment taxes (3) + (4) and $596 of additional Medicare tax]

Suppose that during 2021, Deron received $5,200 in interest from an IBM bond, and he received another $2,100 in interest income from a money market account that his parents have been contributing to over the years. What is Deron's taxable income and corresponding tax liability? (Deron's mother Courtney is subject to a 24% marginal tax rate.)

Answer: $6,200 taxable income and $1,334 tax liability, calculated as follows: 1)Gross income/AGI = $7,300 ($5,200 interest from IBM bond + $2,100 interest. All unearned income.) 2)Standard deduction = 1,100 (Minimum for taxpayer claimed as a dependent on another return (no earned income, so must use minimum).) 3)Taxable income = $6,200 (1) − (2) 4)Gross unearned income minus $2,200 = 5,100 (1) − $2,200 5)Net unearned income = $5,100 Lesser of (3) or (4) 6)Kiddie tax = $ 1,224 [(5) × 24%]; see Example 8-3 (Use Courtney's marginal tax rate of 24% because she is the custodial parent.) 7)Taxable income taxed at Deron's rate = 1,100 (3) − (5) 8)Tax on taxable income using Deron's tax rates = $ 110 (7) × 10%; see single filing status, $1,100 taxable income. Deron's total tax liability= $ 1,334 (6) + (8)

Courtney filed her tax return on April 10 and included a check with the return for $4,073 made payable to the United States Treasury. The $4,073 consisted of her underpaid tax liability of $4,000 (Example 8-24) and her $73 underpayment penalty (Example 8-26). If Courtney had waited until May 1 to file her return and pay her taxes, what late filing and late payment penalties would she owe?

Answer: Her combined late filing penalty and late payment penalty would be $200 ($4,000 late payment × 5 percent × 1 month or portion thereof—the combined penalty is limited to 5 percent per month).

Which of the following is a true statement? A taxpayer's standard deduction can be higher if the taxpayer has substantial medical expenses or charitable contributions B. The standard deduction requires all taxpayers to substantiate and collect information regarding itemized deductions C. A taxpayer's standard deduction amount may vary with age. D. Bunching itemized deductions is an example of income shifting type tax planning E. None of the choices are true

C. A taxpayer's standard deduction amount may vary with age.

Which of the following best describes the manner in which self-employed taxpayers may deduct self-employment taxes? A. Deduct employer portion from AGI B. Deduct entire amount from AGI C. Deduct employer portion for AGI D. Deduct entire amount for AGI E. No deduction

C. Deduct employer portion for AGI

Which of the following statements regarding the AMT exemption amounts is not true? A. The amount of the exemption depends on the taxpayer's filing status B. The exemption amount is completely phased-out for high income taxpayers C. Taxpayers must choose whether they will claim the exemption or itemize deductions

C. Taxpayers must choose whether they will claim the exemption or itemize deductions

Which of the following statements regarding late filing penalties is true? A. If a taxpayer fails to file a tax return, the late filing penalty will continue to grow until the taxpayer files the tax return B. The amount of the late filing penalty is the same for both fraudulent failure to file and non-fraudulent failure to file C. Taxpayers who owe no tax as of the due date of their tax returns are not subject to late filing penalties D. None of the above

C. Taxpayers who owe no tax as of the due date of their tax returns are not subject to late filing penalties

Which of the following statements regarding late filing penalties and/or late payment penalties is true? A.An extension of time to file the tax return protects a taxpayer from late payment penalties as long as the tax is paid by the extended due date of the return B.The penalty rate for late filing penalties is less than the penalty rate for late payment penalties C.If a taxpayer has not paid the full tax liability by the original due date of the return and the taxpayer has not filed a tax return by the due date of the return, the maximum late filing and late payment penalty will be no greater than the late filing penalty by itself D.None of the choices are correct

C.If a taxpayer has not paid the full tax liability by the original due date of the return and the taxpayer has not filed a tax return by the due date of the return, the maximum late filing and late payment penalty will be no greater than the late filing penalty by itself

Individual proprietors report their business income and deductions on: A.Form 1065 B.Form 1120S C.Schedule C D.Schedule A E.Form 1041

C.Schedule C

Which of the following statements concerning tax credits is true? A.The tax benefit a taxpayer receives from a credit directly depends on the taxpayer's marginal tax rate B.Refundable tax credits are limited to a taxpayer's gross tax liability C.Tax credits are generally more beneficial than tax deductions D.None of these is a true statement

C.Tax credits are generally more beneficial than tax deductions

Which of the following is a true statement? A.Interest expense is not deductible if the loan is used to purchase municipal bonds B.Insurance premiums are not deductible if paid for "key-employee" life insurance C.One-half of the cost of business meals is not deductible D.All of these choices are true E.None of the choices are true

D.All of these choices are true

Harrison received a qualified dividend. Without knowing any additional facts, which of the following statements is true regarding the rate at which the dividend will be taxed to Harrison? A.The dividend will be taxed at a 15 percent tax rate B.The dividend will be taxed at a 20 percent tax rate C.The entire dividend will be taxed at 15 percent or the entire dividend will be taxed at 20 percent, depending on Harrison's marginal ordinary income tax rate D.None of the choices are correct

D.None of the choices are correct

Which of the following is not one of the general tax credit categories? A.Nonrefundable personal B.Refundable personal C.Business D.Refundable business

D.Refundable business

When does the all-events test under the accrual method require the recognition of income from the sale of goods? A.when the title of the goods passes to the buyer B.when the business receives payment C.when payment is due from the buyer D.the earliest of the three dates above E.None of the choices are correct

D.the earliest of the three dates above

199A (QBI: 2nd Limitation-- Operating Non Service Businesses)

Deduction for qualified domestic business income: The deductible amount for each trade or business is the lesser of— (A) 20 percent of the taxpayer's "qualified business income" with respect to the qualified trade or business, or (B) the greater of— (i) 50 percent of the W-2 wages with respect to the qualified trade or business, or (ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all "qualified property" *** (i.e. property still being depreciated within its first 10 yrs)Taxable Income Level Exception: For 2021, the above limitation will not apply to taxpayers with less than $326.6K (MFJ) or $163.3K (all other) of taxable income before deduction, but the limitation is phased in over the next $100K (MFJ) or $50,000 (all others) of taxable income before limitation See Textbook Example 7-20

Which of the following is a true statement as it pertains to the 20 percent deduction for qualified business income? A. Generally, service businesses are not eligible for the deduction (unless the taxpayer's income is below a threshold amount) B. The deduction could be subject to a wage limitation C. The deduction could be subject to a taxable income limitation D. The deduction applies to income from a partnership, S corporation or sole proprietorship E. All of the choices are true.

E. All of the choices are true.

Which of the following expenditures is completely deductible? A.$1,000 spent on compensating your brother for a personal expense B.$50 spent on meals while traveling on business C.$2,000 spent by the employer on reimbursing an employee for entertainment D.All of these expenses are fully deductible E.None of these expenses can be deducted in full

E.None of these expenses can be deducted in full

FICA taxes

FICA (Federal Insurance Contributions Act) taxes is a term used to denote both the Social Security and Medicare taxes upon earned income. For self-employed taxpayers, the terms "FICA tax" and "self-employment tax" are synonymous.

Bad Debt Expense - §166

General rule (1)Wholly worthless debts. There shall be allowed as a deduction any debt which becomes worthless within the taxable year, not when GAAP requires a reserve for the probability of a certain amount going uncollectible (1)Therefore the accrued method company cannot deduct their bad debt reserve additions.......deduction occurs when GAAP records the actual writeoff----this creates a "timing difference" between GAAP income and taxable income (2) Partially worthless debts. When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. •See Example 9-27

Accrual Example Ben provides consulting services and bills Ace for $12,000. Ace disputes the amount, claiming that $8,000 is the proper amount. How much income should Ben recognize under the accrual method this year? $ ________

IDK

Mixed Motive Expenses: Travel expenses

If sole purpose of trip within the US or abroad is business reasons: •All travel costs are deductible except that business meals are 50% deductible (unless provided by a restaurant in which case it is 100%); entertainment is totally nondeductible •If primary purpose of trip within U.S. is business: •Transportation costs are 100% deductible • Business meals are 50% deductible (unless provided by a restaurant in which case it is 100%); entertainment is totally nondeductible •Lodging and incidentals are limited to the business portion (generally based on days allocation and primary activity of that day) •If primary purpose of trip abroad is business: •Costs are deductible to the extent of the business portion as follows: •Transportation round trip airfare, meals, lodging and incidentals--deductible based on days primarily business vs personal •Travel days count as business days •Business meals are 50% deductible (unless provided by a restaurant in which case it is 100%); entertainment is totally nondeductible •If primary purpose of trip within U.S. or abroad is personal: •No round trip transportation costs are deductible •Business meals are 50% deductible (unless provided by a restaurant in which case it is 100%); entertainment is totally nondeductible •Lodging, transportation while there, and incidentals for the business portion (if any) are deductible, generally based on days allocation and primary activity that day

Passive Limnitations

Losses from "passive activities" may only be deducted to the extent the taxpayer has income from passive activities or when the passive activity is sold

Standard Deduction Amounts

Married filing jointly $25,100 Head of household 18,800 Single 12,550 Married filing separately 12,550

•Expenditures against Public Policy

No deduction for fines, bribes, lobby expenditures, or political contributions

Second Home Type 1:

Residence with minimal rental use (rents home for 14 or fewer days) •The taxpayer must live in the home for at least 15 days and rent it out for 14 days or fewer. •Rental income can be excluded. •No rental expenses deducted except those that are personal itemized deductions (home mortgage interest and real estate taxes).

Credit Application

Nonrefundable personal applied first and excess credit is lost Business credit is applied second and excess credit has carryback and carryover Refundable personal credit is applied last and excess credit is Refunded

Second Home Type 3:

Nonresidence, rental is a business •The taxpayer includes all income and deducts all rental expenses. -However, if the property is used for even a day of personal use, the expenses must be allocated between rental and personal usage. -Taxpayer is not allowed to deduct the personal-use portion of tier 1 interest expenses because the property doesn't qualify as a residence. -Personal-use portion of tier 1 real property taxes are deductible as a from AGI itemized deduction.

Calculate AMT

Regular Taxable Income Plus: Standard deduction if taxpayer deducted the standard deduction in computing regular taxable income Plus or Minus: Other adjustments* Equals: Alternative minimum taxable income Minus: AMT exemption amount (if any) Equals: Tax base for AMT Times: AMT rate Equals: Tentative minimum tax Minus: Regular tax Equals: Alternative minimum tax

Individual for AGI Investment Activities

Rental and royalty expense Nondeductible: Other investment expenses

Second Home Type 2:

Residence with significant rental use (rents home for 15 or more days) •Rent home for 15 days or more •Personal use, greater of -14 days -More than 10 percent of the total FMV rented days •Include rental revenues in gross income and allocate expenses between personal use and rental use •Expenses allocated to personal use are not deductible unless deductible under other provisions (generally mortgage interest and real estate taxes). •Expenses to acquire tenants deductible in full (advertising and commissions) •Expenses allocated to rental use deductible only to the extent of gross rental income after deducting expenses to acquire tenants (generally no losses for a vacation home) •Expenses must be deducted in a specific order. •Three categories or "tiers" of expenses -Tier 1: expenses that are deductible without regard to rental activity (interest/real estate taxes/expenses to acquire tenants) §Exceptions: oA) If taxpayer uses standard deduction, then mortgage interest and real estate taxes on the rental property are Tier 2 expenses. oB) If taxpayer itemizes: Øi) The mortgage interest on acquisition indebtedness is Tier 1; any remaining mortgage interest is Tier 2; Øii) If the sum of taxpayer's non rental related SALT deductions are over $10,000, then the rental real estate taxes are Tier 2; iii) If the sum is under $10,000, then the amount treated as Tier 1 is the amount needed to get to $10,000, and the rest is Tier 2. -Tier 2: all other expenses except for depreciation -Tier 3: depreciation •Generally expenses allocated based on number of days used for each activity/total days used -Exception for tier 1 expenses, which can be allocated based on: Total days in the year instead of days used (called the "Tax Court" or "Bolton" method)

Section 267: Deferred Deductions for Related-Party Transactions—applies to accrued basis taxpayers

Sec 267: Accrued expenses and interest owed to a related party are deductible by the accrual-basis taxpayer only when actually paid to the cash-basis taxpayer. This rule effectively converts the accrual-basis payer to the cash-basis for purposes of these transactions. Related parties include family members including parents, siblings, and spouses; shareholders and their C Corps when the shareholder owns more than 50% of the corp; and owners of partnerships and S Corps no matter what % ownership. See Example 9-28

Individual for AGI Business Activities

Self-employed business expenses Nondeductible: Unreimbursed employee business expenses

self-employment taxes

Social Security and Medicare taxes paid by the self-employed on a taxpayer's net earnings from self-employment. For self-employed taxpayers, the terms "self-employment tax" and "FICA tax" are synonymous.

mom and pop exception

Taxpayers may deduct up to $25K per year of net passive losses attributable to passive losses ONLY IF the individuals are ACTIVELY PARTICIPATING and own AT LEAST 10% off the rental activity Carried forward indefinitely •However, their ability to deduct these losses phases out by 50 cents for every dollar of AGI they earn above $100,000. Once their AGI hits $150,000 they will no longer be able to deduct the loss from their rental property unless they have passive income from another source.

▪4. For "payment liabilities"

The liabilities listed in Exhibit 9-2 (see next slide) are deducted generally only when the liability is paid---UNLIKE GAAP Example 9-26 Economic performance occurs when taxpayer pays liabilities related to •1) Worker's compensation, tort, breach of contract, violation of law. •2) Rebates and refunds. •3) Awards, prizes, and jackpots. •4) insurance contracts, warranties, and product service contracts provided to the taxpayer. (But 12 month rule applies) * •5) Taxes (except can elect to accrue real estate taxes over relevant period instead of deducting them when paid). •6) Other liabilities and reserves not provided for elsewhere, e.g. claims against the company (e.g. product liability, environmental, health care, lawsuits), & reserves for restructuring, shutdowns, etc. *If an accrual method taxpayer prepays items in 4 above, and those items meet the "recurring item" exception definition on slide 53, the 12 month rule will apply to the prepayment, just like a cash basis taxpayer, but only to the extent the 12 month rule allows it.

199A (QBI: Overall First Limitation)

The taxpayer's deduction for qualified business income *** for the taxable year is generally equal to the sum of : (1) the LESSER of-- (A) 20% of the taxpayer's "combined qualified business income" amount (QBI) for the taxable year or (B) an amount equal to 20 percent of the excess (if any) of the taxpayer's taxable income for the year, over the sum of any net capital gain, plus the aggregate amount of the qualified cooperative dividends, of the taxpayer for the taxable year, ***"Combined qualified business income: amount for the taxable year is the sum ofthe deductible amounts determined for each qualified trade or business carried on by the taxpayer This sum may not exceed the taxpayer's taxable income for the taxable year (reduced by net capital gain).

earned income credit

a refundable credit designed to help offset the effect of employment taxes on compensation paid to low-income taxpayers and to encourage lower income taxpayers to seek employment. •Earned Income Credit (text page 8-30 thru 32; Problem 8-74) -Effectively a negative income tax because it is refundable even if no tax is assessed -It reflects an attempt to refund payroll taxes on low earners, encourage employment -To qualify, taxpayer must: -1) Have earned income -2) Be a "qualified individual" -3) Not have more than $10,000 of investment income (interest, dividends, gains) $3650 all other years -A "qualified individual" eligible for the credit generally includes: -1) Those who have at least one "qualifying child"; and -2) Those who do not have a "qualifying child", but who live in the U.S for more than half the year, satisfy "age requirements" at the end of the year, and are not a dependent of another taxpayer -"Age Requirements" for 2021: taxpayer must be at least 19 at year end (or, if a student for at least 5 months in the year, the student must be at least 24 at year end.) -For all other years, the "age requirement" is that the taxpayer must be at least 25 years old and less than 65 and not a dependent of another taxpayer See Exhibit 8-11 for calculating the credit. It

alternative minimum tax system

a secondary or parallel tax system calculated on an alternative tax base that more closely reflects economic income than the regular income tax base. The system was designed to ensure that taxpayers generating economic income pay some minimum amount of income tax each year. 26% on first $199,900 of AMT base (for all taxpayers other than MFS which is on first $99,950); -28% on AMT base in excess of $199,900 (for all taxpayers other than MFS which is in excess of $99,950) -Preferential income is still taxed at preferential rates

additional Medicare tax

a tax imposed at a rate of .9 percent for salary or wages or net self-employment earnings in excess of $200,000 ($125,000 for married filing separate; $250,000 of combined salary or wages or net self-employment earnings for married filing joint).

kiddie tax

a tax imposed at parents' marginal tax rate on a child's unearned income. - applies if ▪Child is under age 18 at year-end ▪Child is 18 at year-end but earned income not greater than half of child's support, or ▪Child is over age 18 but under age 24 at year-end, is a full-time student during the year, and child's earned income not greater than half of child's support (excluding scholarships).

alternative minimum tax (AMT)

a tax on a broader tax base than the base for the "regular" tax; the additional tax paid when the tentative minimum tax (based on the alternative minimum tax base) exceeds the regular tax (based on the regular tax base). The alternative minimum tax is designed to require taxpayers to pay some minimum level of tax even when they have low or no regular taxable income as a result of certain tax breaks in the tax code.

late payment penalty

a tax penalty equal to .5 percent of the amount of tax owed for each month (or fraction thereof) that the tax is not paid. -If don't pay entire tax owed by due date of return ▪.5 percent of the tax owed for each month (or fraction of a month) that the tax is not paid •Combined late filing and late payment penalties may not exceed maximum amounts for either one, i.e. 25% of the tax due per the late filing penalty.

preferential tax rate

a tax rate that is lower than the tax rate applied to ordinary income.

The Section 199A Deduction

a) A permanent tax benefit that reduces a taxpayer's federal effective tax rate (ETR) of a pass through by a maximum 7.4 pts b) A max 20% deduction from "qualifying business income" c) But there are limitations: i) Specified service trades or businesses (SSTBs) ii) W-2 amount iii) Level of qualifying assets iv) Amount of taxable income (i.e. AGI) v) Other considerations raised by proposed regs and many still unanswered questions See Examples 7-19 and 7-20 in text

alternative minimum tax (AMT) base

alternative minimum taxable income minus the alternative minimum tax exemption.

impermissible accounting method

an accounting method prohibited by tax laws.

recurring item

an election under economic performance to currently deduct an accrued liability if the liability is expected to persist in the future and is either not material or a current deduction better matches revenue.

specific identification method

an elective method for determining the cost of an asset sold. Under this method, the taxpayer specifically chooses the assets that are to be sold.

reasonable in amount

an expenditure is reasonable when the amount paid is neither extravagant nor exorbitant.

active participant in a rental activity

an individual who owns at least 10 percent of a rental property and participates in the process of making management decisions, such as approving new tenants, deciding on rental terms, and approving repairs and capital expenditures.

traditional IRAs

an individually managed retirement account with deductible contributions and taxable distributions.

capital gain property

any asset that would have generated a long-term capital gain if the taxpayer had sold the property for its fair market value.

specified service trade or business

any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. Architecture and engineering services (their services build things) are specifically excluded from the definition of specified service trade or business.

minimum tax credit

credit available in certain situations for the alternative minimum tax paid. The credit can be used only when the regular tax exceeds the tentative minimum tax.

gross receipts test

determines if a business qualifies as a "small" business under an annual gross receipts test if its average annual gross receipts for the three prior taxable years does not exceed an indexed threshold set at $26 million for 2020. For purposes of the test, includes total sales (net of returns and allowances but not cost of goods sold), amounts received for services, and income from investments (including tax-exempt interest). -Businesses without 3 years of data use the period for which gross receipts are available. -Gross receipts for short years must be annualized by multiplying by 12 and dividing the product by the number of months in the short period. -Tax shelters never qualify under the gross receipts test.

•C corporations

either a calendar, or fiscal, or 52/53 week year; choice made on first tax return and is consistent with book accounting period, except that the 52/53 week year end is by election

excess business loss

excess of aggregate business deductions for the year over aggregate business gross income or gain of an individual taxpayer plus a threshold amount depending on filing status.

travel expenses

expenditures incurred while "away from home overnight," including the cost of transportation, meals, lodging, and incidental expenses.

personal expenses

expenses incurred for personal motives. Personal expenses are not deductible for tax purposes.

poll 3

fill in

qualified trade or business

for purposes of the deduction for qualified business income, any trade or business other than a specified trade or business.

type 2 rental income

hardest

Form 1120S

if incorporated, and an "S Corp election" was filed, in which case there is no corporate income tax and the activity flows through to the individual owners(s

Form 1120

if incorporated, but no S Corp election was filed, in which case the activity is subject to corporate income tax as a "C Corp."

Form 1065

if owned by a partnership, and the activity flows through to individual partners

flow-through entity

legal entities, like partnerships, limited liability companies, and S corporations, that do not pay income tax. Income and losses from flow-through entities are allocated to their owners.

payment liabilities

liabilities of accrual method businesses for which economic performance occurs when the business actually pays the liability for, among others, worker's compensation; tort; breach of contract or violation of law; rebates and refunds; awards, prizes, and jackpots; insurance, warranties, and service contracts provided to the business; and taxes.

ceiling

limitation that is the maximum amount for adjustments to taxable income (or credits). The amounts in excess of the ceiling are either lost or carried to another tax year.

qualified education loans

loans whose proceeds are used to pay qualified education expenses.

mixed-motive expenditures

lot to include here

allowance method

method used for financial reporting purposes; under this method, bad debt expense is based on an estimate of the amount of the bad debts in accounts receivable at year-end.

qualified business income

net business income from a qualified trade or business conducted in the United States. This is the tax base for the deduction for qualified business income.

business tax credits

nonrefundable credits designed to provide incentives for taxpayers to hire certain types of individuals or to participate in certain business activities.

first-in, first-out (FIFO) method

not on exam

last-in, first-out (LIFO) method

not on exam

Charitable Contribution Deduction Steps

oStep 1: Determine limitation for the 60 percent contributions, if applicable. Not applicable for 2020 or 2021 cash contributions to public charities or private operating foundations. oStep 2: Apply limitation to 50 percent contributions, which is AGI × 50 percent minus the contributions subject to 60 percent limit (in 2020 and 2021, minus the cash contributions to public charities and private operating foundations not subject to limit). oStep 3: Apply limitation to 30 percent contributions, which is the lesser of (a) AGI × 30% or (b) AGI × 50% minus the contributions subject to the 50 percent limit and the contributions subject to the 60 percent limit (in 2020 and 2021, minus the cash contributions to public charities and private operating foundations not subject to limit). oStep 4: Apply limitation to the 20 percent contributions, which is the lesser of (a) AGI × 20%, (b) AGI × 30% minus the contributions subject to 30 percent limit, or (c) AGI × 50% minus the contributions subject to the 50 percent limit, the contributions subject to the 60 percent limit (in 2020 and 2021, minus the cash contributions to public charities and private operating foundations not subject to limit), and the contributions subject to the 30 percent limit.

arm's-length amount

price in transactions among unrelated taxpayers, where each transacting party negotiates for his or her own benefit.

Social Security tax

the Old Age, Survivors, and Disability Insurance (OASDI) tax. The tax is intended to provide basic pension coverage for the retired and disabled. Employees pay Social Security tax at a rate of 6.2 percent on the wage base (employers also pay 6.2 percent). Self-employed taxpayers are subject to a Social Security tax at a rate of 12.4 percent on their net earnings from self-employment. The base on which Social Security taxes are paid is limited to an annually determined amount of wages and/or net earnings from self-employment.

net earnings from self-employment

the amount of earnings subject to self-employment income taxes. The amount is 92.35 percent of a taxpayer's self-employment income.

marriage penalty

the extra tax cost a married couple pays by filing a joint return relative to what they would have paid had they each filed as single taxpayers. This typically occurs when both spouses earn approximately the same amount of income.

underpayment penalty

the penalty that applies when taxpayers fail to adequately prepay their tax liability. The underpayment penalty is determined by multiplying the federal short-term interest rate plus 3 percentage points by the amount of tax underpayment per quarter.

accounting methods

the procedure for determining the taxable year in which a business recognizes a particular item of income or deduction, thereby dictating the timing of when a taxpayer reports income and deductions.

federal short-term interest rate

the quarterly interest rate used to determine the interest charged for tax underpayments (federal short-term rate plus 3 percent).

marriage benefit

the tax savings married couples receive by filing a joint return relative to the tax they would have paid had they each filed as single taxpayers. This typically occurs when one spouse is either not working or earns significantly less than the other spouse.

economic performance test

the third requirement that must be met for an accrual method taxpayer to deduct an expense currently. The specific event that satisfies the economic performance test varies based on the type of expense.

net unearned income

unearned income in excess of a specified threshold amount of a child under the age of 19 or under the age of 24 if a full-time student. ▪Net unearned income = unearned income in excess of $2,200 (i.e. the first $2,200 is exempt from the kiddie tax, but not from possible regular income tax) ▪Don't forget the special standard deduction for taxpayer's who are dependents of another taxpayer: the 2021 standard deduction is the greater of (1) $1,100 or (2) $350 plus earned income not to exceed the standard deduction amount of those who are not dependents, i.e. $12,550 for singles.

Net Capital Loss

§A net capital loss is deducted for AGI but limited to $3,000. Losses in excess of the $3,000 limit are carried forward indefinitely to subsequent years.

-Rental and Royalty Expenses

§Claimed above the line (for AGI) §Could either be an investment activity or a trade activity depending on facts Taxpayers report expenses and revenue on Schedule E and transfer the net income or loss from Schedule E to Schedule 1, line 5, and then combine with other items and include on Form 1040 (page 1), line 8

-Two itemized deductions for interest expense

§Deduction of investment interest is limited to a taxpayer's net investment income §Any investment interest in excess of the net investment income limitation carries forward to the subsequent year.

-Home mortgage interest

§Interest on acquisition indebtedness of $1 million if incurred before December 15, 2017 §Interest on acquisition indebtedness of $750,000 if incurred on or after December 15, 2017

-Medical Expense Deduction Limitation

§Limited to the amount of unreimbursed qualifying medical expenses paid during the year reduced by 7.5 percent of the taxpayer's AGI.

Losses

§Taxpayers disposing of trade or business assets at a loss are allowed to deduct the loss for AGI. §Losses from investment assets (called capital assets) are offset against capital gains.

-Hospitals and Long-Term Care Facilities

§Taxpayers may deduct the costs of actual medical care whether the care is provided at hospitals or other long-term care facilities.

▪2. Use of property or money--Renting property from another party and borrowing money

—economic performance for rent expense occurs as the taxpayer uses the property , and same for interest (i.e. like GAAP), regardless if prepaid or accrued. Example 9-23, 24

▪1. Receiving goods or using services from another party

—economic performance occurs as the goods or services are provided to the taxpayer (like GAAP); or within 3 ½ months of payment. Example 9-22

▪3. Providing goods or services to another party (e.g., warranty services of products sold by the taxpayer)

—economic performance occurs as the taxpayer provides the goods or services (similar to GAAP) Example 9-25

•Flow-through entities

—generally, a "required" tax year matched to the period of the majority of owners (multiple owners for partnerships can be complicated); but other years are also allowed with IRS approval.

•Sole Proprietorships

—same as proprietor's year-end, which is a calendar year end

Passive Activity

•A passive activity is a trade, business, or rental activity in which the taxpayer does not materially participate -Participants in rental real estate and limited partners without management rights are generally considered to be passive participants. -All other participants are considered to be passive unless their involvement is "regular, continuous, and substantial." -Seven factors for testing material participation.

Choosing or Changing an Accounting Method

•Accounting methods are generally adopted by use. -A permissible method is adopted by using and reporting the method for one year. -An impermissible method is adopted by using and reporting the method for two years. •Generally, method changes require IRS permission. -Some changes are automatic. -Permission is necessary to correct the use of an impermissible method. See Examples 9-29, 30

Accrual Method Deductions: Recurring Item Exception

•Accrual method taxpayers can deduct certain accrued expenses even if economic performance has not occurred by year-end, if all the following are met: •1. Item is not material or better matches the revenue •2. Item consistently occurs every year •3. All events test is satisfied by year end •4. Actual economic performance must occur within a reasonable time or within 8 ½ months after year end Does not apply to items 1 or 6 on prior slide since those do not satisfy do not satisfy the above criteria, but does apply to the other items. (Example 9-26)

Accrual - Prepaid Income

•Advance payments for goods and services -Allowed to defer recognition for one year unless income is earned or recognized for financial records -Not applicable to payments relating to rent or interest income

Alimony

•Alimony payments are deductible for AGI if paid pursuant to a divorce or separation agreement executed before 2019.

Which of the following is a payment liability? •Tort claims •Refunds •Insurance premiums •Real estate taxes •All of the choices are correct

•All of the choices are correct

Accruing Business Expenses

•All-events test must be met -All events have occurred to establish the liability to pay. -The amount is determinable with reasonable accuracy. -Reserves for future liabilities not allowed; AND •Economic performance must be met Example 9-21 Note that interest expense is deducted ratably under the accrual method regardless when paid.

Qualifying medical expenses are deductible if the taxpayer itemizes, but limited to the excess of such expenses over what % of AGI? •A. 5% •B. 7.5%. •C. 10% •D. 50%

•B. 7.5%.

Regarding interest expenses, which of the following is a true statement? •A. Taxpayers may only deduct interest on up to $750,000 of acquisition indebtedness incurred before December 15, 2017 •B. Taxpayers may deduct interest on up to $1,000,000 of acquisition indebtedness incurred before December 15, 2017. •C. The deduction for investment interest expense is not subject to limitation •D. Interest on home-equity debt up to $1,000,000 is deductible, even if the loan proceeds are used to buy a new car •E. None of the choices is true • The qualified residence interest deduction rules limit the deduction to interest on up to $1,000,000 of acquisition indebtedness incurred before December 15, 2017.

•B. Taxpayers may deduct interest on up to $1,000,000 of acquisition indebtedness incurred before December 15, 2017.

Regarding state and local taxes, which of the following is true? •A. There is an overall cap if itemizing, of up to $10,000 for all combined state and local taxes. •B. There is an overall cap if itemizing, of up to $10,000 for each of the various types of state and local taxes •C. There is an overall cap if itemizing, of up to $10,000 for all combined state taxes, and a separate $10,000 cap on combined local taxes •D. There is an overall cap of up to $10,000 which can be added to the standard deduction

•B. There is an overall cap if itemizing, of up to $10,000 for each of the various types of state and local taxes

Type 2 Tax Court vs IRS

•Before tax reform: -The use of the Tax Court Method usually provided the taxpayer with a more favorable result in the current year. -This was because it shifted more of the total mortgage interest and property taxes to the itemized deduction schedule where it would serve to reduce current overall taxable income -Otherwise, if it stayed on the rental income schedule, it usually served to increase an otherwise currently nondeductible loss. •After tax reform: -The use of the Tax Court method generally will be disadvantageous to the taxpayer because it will shift more of the total mortgage interest and property taxes to the itemized deduction schedule where it may not provide a benefit, and should instead stay on the rental income schedule where although it would increase the overall net rental loss----- at least that loss could carryover to be useful in a future year against rental income or a gain on a disposition of the property. -Specifically, if any mortgage interest and property taxes are shifted to the itemized deduction schedule: •1) what if the taxpayer does not itemize any longer because of the doubling of the standard deduction? •2) what if the taxpayer already has mortgage interest exceeding the various new mortgage interest limits? •3) what if the taxpayer already has reached the new $10,000 limit on state and local tax deductions?

12-Month Rule Example: •Ben, a cash-basis taxpayer, makes the following payments on June 30 of this year: -$10,000 for the next 10 months of utilities. -$12,000 for insurance over the next 24 months. -$9,600 for the next eight months of interest on a business loan. What amounts are deductible this year?

•Ben can deduct all $10,000 for the utilities because: -The benefit does not exceed 12 months and -The benefit ends prior to the end of next year. •Ben can deduct $3,000 for insurance because: -The benefit exceeds 12 months. Hence, Ben can only deduct six months in this year ($500 per month). •Ben can deduct $7,200 for interest because: -The 12-month rule does not apply to interest.

Business Interest Example: This year MH Inc. reported $300,000 of taxable income on $30 million of revenue. The revenue included $250,000 of interest income. In calculating the taxable income, MH deducted: $340,000 of depreciation $210,000 of interest expense What is MH's maximum business interest deduction this year?

•Calculate limit on adjusted taxable income Taxable income $ 300,000 less interest income − 250,000 plus depreciation + 340,000 plus interest expense + 210,000 Adjusted taxable income $ 600,000 Times 30% × 30% $ 180,000 Plus interest income + 250,000 Maximum interest deduction $ 430,000

Regarding charitable contributions to public charities, which is FALSE? •A. Cash type are limited to 60% of AGI •B. Capital gain type is limited to 30% of AGI •C. Ordinary income property is limited to 50% of AGI •D. The amount of deduction for ordinary income property is its FV.

•D. The amount of deduction for ordinary income property is its FV.

deduction for education interest

•Deduction for interest expense on loans used to fund qualified educational expenses -Up to $2,500 of interest on education loans is deductible for AGI. -The interest deduction is phased out for taxpayers with AGI exceeding $70,000 ($140,000 filing jointly). -The deduction is eliminated for taxpayers with AGI exceeding $85,000 ($170,000 filing jointly). Phase-out Percentage Single or head of household (Modified AGI − $70,000)/$15,000 Married filing jointly (Modified AGI − $140,000)/$30,000

199A (QBI: 3rd Limitation-- Service Businesses)

•Deduction will generally not apply to "specified service businesses" or the "trade or business of performing services as an employee". • A "specified service trade or business" subject to deduction limitation means "any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities." • Taxable Income Level Exception: For 2021, the above restriction is not applicable to taxpayers with taxable income less $329,800 (MFJ) and $164,900 (all others), but that benefit is phased out over the next $100,000/ $50,000 respectively. See Textbook Example 7-19 Interestingly, the statute exempts engineering and architecture services from being disqualified.

Business Income and deductions

•Deductions must be directly connected to business activity. •Business expenditures must be both ordinary and necessary to be deductible. -Ordinary and necessary means conducive to profit generation. Reasonable in amount means not extravagant

Employee vs Independent Contractor

•Determining whether taxpayer is employee or independent contractor -Primary question: who has control over how, when, where work is performed? •Tax differences -Amount of FICA or self-employment taxes payable -Deductibility of expenses ▪For AGI ▪From AGI ▪Employer portion of self-employment taxes

Cash Method

•Income recognized when actually or constructively received. •Expenses recognized when paid. •Pros and cons -Flexible -Simple and relatively inexpensive -Poor matching of income and expense -Can be used by taxpayers who satisfy the gross receipts test

Sec 163(j): Business Interest Limitation

•Does not apply to any taxpayer with average annual gross receipts of $26 million or less for the prior three taxable years. Example 9-11 •Business interest expense deduction is limited to: -Business interest income plus -30 percent of the adjusted taxable income -Currently disallowed amount is carried over indefinitely •Adjusted taxable income is: -Taxable income allocable to the business computed without regard to: ▪Any item of income, gain, deduction, or loss not properly allocable to trade or business ▪Interest expense or income ▪Depreciation, amortization, and depletion ▪Net operating loss deduction

•Capital Expenditures

•Does the expenditure provide future benefit (beyond this year)? -If so, capitalize rather than deduct. -Examples: Equipment; real estate; prepaids; inventory; deposits on rental property; (expense the above as allowed under tax law, e.g. depreciation) •12-month rule for prepaid expenses -Deduct if benefit < 12 months and benefits do not extend beyond end of next tax year. -Does not apply to interest expense More about this later in these slides

FICA - Employer

•Employer -Pays FICA tax on employee's compensation (6.2 percent Social Security tax rate; 1.45 percent Medicare tax rate) -Withholds FICA tax from employee's paycheck

Self-Employment Tax Deduction

•Employers and employees each pay employees' Social Security tax. •Employers deduct the portion of Social Security taxes they pay for employees. •Self-employed individuals are required to pay SE tax in lieu of Social Security tax. •Self-employed taxpayers are allowed to deduct the 50% employer portion of the SE tax they pay to compensate for employers deducting their portion of Social Security.

Cash Method:12-Month Rule

•Expenditures that have a benefit for more than a year generally get capitalized, even for cash basis taxpayers •Exception: 12-month rule for prepaid expenses -Deduct if benefit < 12 months and benefits do not extend beyond end of next tax year. -Does not apply to interest expense which must be expensed under the normal accrual method whether cash basis or accrual basis

Individual Retirement Accounts (IRAs)

•For AGI deduction for contributions -Generally not allowed if participant in employer-sponsored plan -If taxpayer is single, deduction allowed if they participate in employer plan but income is below certain thresholds §In 2021, lesser of $6,000 or earned income §If 50 years or older at end of year, limit is $7,000 oAdditional "catch-up" contribution -For married taxpayers deduction is allowed if they participate in employer plan but income is below certain thresholds §In 2021, lesser of $6,000 or earned income of both spouses reduced by other spouse's contributions to IRA or Roth IRA §If 50 years or older at end of year limit is $7,000 oAdditional "catch-up" contribution •May make nondeductible contributions -Deductible + nondeductible cannot exceed $6,000 for one taxpayer (plus catch-up) •Must contribute by April 15 of subsequent year •Distributions taxed as ordinary income -10 percent penalty if before 59½ -Certain exceptions §Medical expenses, insurance premiums, first home -Same minimum distributions apply as to qualified contribution plans -Nontaxable percentage = nondeductible contributions divided by balance of account

Moving Expenses

•Generally not deductible by employee (and employer reimbursements of moving expenses are taxable)

Mixed Motive Expenses: Meals and Entertainment Example 9-7

•Generally, can only deduct 50% of meals (i.e. food and beverages) and 0% of entertainment (text page 9 says entertainment is 50% deductible but that is an error) ▪Exception for 2021 and 2022, can deduct 100% of both food and beverage if provided by a restaurant as eat in or take out. This does not apply to entertainment expenses except if reported as compensation to the employee, or if provided as a benefit for the employees. ▪Cost of the meal must be shown separate from entertainment •The setting must be business related, and must have adequate, contemporaneous records re: 1) The taxpayer (or employee) must be present with business associates who the taxpayer reasonably expects to do business with (customers, suppliers, employees, advisors); 2) The amount must be reasonable under the circumstances; and 3) The entertainment must be "directly related" , or "associated with" the active conduct of business a business reason or purpose (i.e. active business related discussions at, or preceding ,or following the event)

Advance Payment Example Ben provides dancing lessons. On September 30 of this year he received $2,400 full payment for a two-year service contract. •What amount of income must Ben recognize -if he is on the cash method? -if he is on the accrual method?

•If Ben uses the cash method, he must recognize income as received—$2,400 this year. •If Ben uses the accrual method, then he can elect to defer advances for services for a year. •This year Ben would recognize $300—the income earned from September 30 (3/24 × $2,400). •Next year Ben would recognize the remaining $2,100—income can only be deferred one year.

Accrual Basis

•Income is recognized when earned or received. -All-events test—recognize income when all the events have occurred that fix the right to receive such income and -The amount can be determined with reasonable accuracy •Earliest of these dates: -Complete service or sale -Payment is due -Payment is received

Deductions Indirectly Related to Business Activities

•Individual Retirement Accounts •Health Insurance Deduction by Self-Employed Taxpayers •Self-Employment Tax Deduction •Penalty for Early Withdrawal of Savings -Health Insurance Deduction by Self-Employed Taxpayers §Deduction provides equity with employees who receive health insurance as a qualified fringe benefit §Insurance must be provided for taxpayer or dependents who are not eligible for employer-provided health insurance. -Penalty for Early Withdrawal of Savings §Reduces the taxpayer's net interest income to the amount actually received

Inventories

•Inventories must generally be accounted for under the accrual method if sales of goods constitute an income-producing factor. -Sales and purchases must be recorded using the accrual method. -The "hybrid" method applies to cash method taxpayers with inventory who use accrual for sales and purchases. -Taxpayers that qualify under the gross receipts test can opt to treat purchases of goods for sale as non-incidental materials or use the financial reporting inventory method.

Sec 263A: UNICAP uniform cost capitalization (UNICAP) rules

•Inventory (purchased or produced) must be accounted for using tax version of "full absorption" rules. •Indirect costs are allocated to inventories (not expensed). •Costs of selling, advertising, and research need not be capitalized. •Exception for businesses that qualify under the gross receipts test. specify that inventories must be accounted for using full absorption rules to allocate the indirect costs of productive activities to inventory.

Who can use cash and who uses accrual

•Large corporations and partnerships with corporate partners must use accrual. -Taxpayers that satisfy the gross receipts test can elect the cash method.

At-risk limitation

•Losses may not exceed an investor's amount at risk in the activity. -Excess loss carried forward until event occurs to create additional amount at risk •At-risk amount calculated like tax basis except: -The types of debt that increase a taxpayer's at-risk amount are more restrictive than the types of debt that increase tax basis.

Tax-basis limitation

•Losses may not exceed an investor's tax basis in the activity. -Excess loss carried over until event occurs to create more tax basis •Increases to tax basis -Cash invested -Share of undistributed income -Share of debt •Decreases to tax basis -Cash distributions -Prior-year losses

Personal Expenditures

•No business deduction for purely personal expenditures •Mixed motive? Example 9-10 •Primary motive for some expenditures (all or nothing) ▪Business travel (away from home overnight) -Otherwise, allocate deduction to business portion ▪Arbitrary percentage (50 percent meals) ▪Basis for allocation (mileage or time) •Record keeping -Document business purpose

Roth IRA

•Nondeductible contributions •Contributions to a Roth IRA -Same $6,000 limit ($7,000 if 50 or older at year-end) -Phase-out based on AGI •Distributions from a Roth -Distributions of contributions never taxed -Qualified distributions of earnings from Roth not taxed §Account must be open for five years before holder can receive qualified distributions and oTaxpayer must be at least 59½ to receive qualified distribution or oDistributions on death of taxpayer or oTaxpayer is disabled or oFirst home (limited to $10,000) -No minimum distribution requirements

Prepayments

•Taxes must be paid as you go. -Withholdings ▪Treated as made equally throughout the year -Estimated tax payments ▪Due on April 15, June 15, and September 15 of the current year and January 15 of the following year

Economic Performance (3 of 4 ): Accrual Method: Business Expenses- the 12 month rule for Prepaids

•The 12-month rule for prepayments of expenditures (i.e. prepaid expenses) on certain contracts such as rent, security, service warranties, insurance, and utilities: •Deduct upon payment if: •1) The benefit of the underlying contract is < 12 months; and •2) The contract period does not extend beyond the end of the taxable year following the tax year in which the taxpayer makes the payment; and •3) Meet the all events test; and •4) Meet the economic performance rules

home office deductions

•To qualify for a "home office" deduction, a taxpayer must use her home or part of her home exclusively and regularly as either: -The principal place of business for any of the taxpayer's trade/business -A place to meet with patients/clients in the normal course of business •If employee, home office expense is not deductible •If self-employed, deducted for AGI but deduction limited to business income before the deduction •Must allocate expenses between personal and business use of home -Direct versus indirect expenses -Indirect expenses allocated based on square footage -Deduct using same tier 1-3 sequence used for vacation homes -Depreciation expense §Reduces basis in home §Gain on sale due to depreciation is ineligible for exclusion. §Gain is taxed at a maximum 25 percent rate as unrecaptured §1250 gain. •Optional Simplified Method: Allowable business use square footage X $5 /sq ft, up to a max of $1500.

Schedule C

•if owned by an individual as a sole proprietorship and included with personal tax return Form 1040 a schedule on which a taxpayer reports the income and deductions for a sole proprietorship.

Economic Performance: Accrued Method (1 of 4) 461(h)

▪1. Receiving goods or using services from another party ▪2. Use of property or money--Renting property from another party and borrowing money ▪3. Providing goods or services to another party (e.g., warranty services of products sold by the taxpayer) ▪4. For "payment liabilities"