ACCY TAX

Gross Income

"all inclusive" and includes all realized income from "whatever source derived."

More inclusive than the relationship test for qualifying child. Includes: descendants, ancestors, siblings, niece/nephew, aunt/uncle, in-laws, and ANY PERSON who has the same residence for ENTIRE YEAR.

Relationship- qualifying relative

Must have same principal residence as the T/P for more than half the year.

Residence- Qualifying Child

IRS

Responsible for administration and enforcement of the tax laws

12.4% (6.2% employee/6.2% employer), base capped at $142,800 for 2021

Social security tax

daily

•For tax purposes, interest accrues ___________

-$800 * 2% = 16 •$16 of interest recognized in years 1 thru 9 -Year 10 interest income = ($200 - $144) = $56

•Viktor purchased a note for $800. The note has a maturity value in 10 years of $1,000 and yields 2% interest. What is the annual taxable OID?

Unemployment Tax

6%, base capped at $7,000

Long Term Capital Gain

Eligible for capital gains tax rates (i.e., 2021: 0%, 15%, 20%).

$2,000*100% + $2,000*25% = $2,500, But AGI is within Phase-out Range: ($180,000-175,000)/$20,000=25% not phased-out $2,500 * 25% = $625

Forky, is claimed as a dependent by his parents. He attends the University of Illinois full-time. His parents have AGI of $175,000 and paid $8,000 for his tuition expense. What is Forky's parents' American opportunity tax credit?

3

General Rule - to assess additional tax the IRS has ___ years from the later of: the filing of the income tax return or the original due date.

•Compensation, §61(a)(1) •Income from providing personal services -If providing personal services on behalf of an employer, tax on wages, not the value of personal services. •Interest & Dividends, §61(a)(4), §61(a)(7) •Income from flow-through entities (partnerships, S-corporations), §61(a)(13) •Alimony, §61(a)(8), §71 (divorces executed before 2019) •Annuity Payments, §61(a)(9), §72 •Prizes & Awards, §74 •Unemployment Compensation, §85 (Some can be excluded in 2021) •Social Security Benefits, §86 •Discharge of Indebtedness, §108

Gross income

A qualifying relative's gross income for the year (2021) must be less $4,300.

Gross income- qualifying relative

6

Gross misstatement of income (excess of 25%) increases the statute of limitations to ___ years

Less favorable than MFJ and QWW filing status, but more favorable than MFS and S filing status. To qualify for HH status, a T/P must: Be unmarried at the end of the year (unless "abandoned spouse"). 2) NOT be a qualifying widow or widower. 3) Pay more than half the costs of keeping up a home for the year. 4) Have lived with a qualifying person for more than half the year. - A parent may live in a separate household in some cases.

Head of Household

Social Security Tax

12.4% (6.2% employee), base capped at $142,800 for 2021

Medicare Tax

2.9% (1.45% employee)

Understand facts, Identify issues (based on the facts), Locate relevant authorities, Analyze tax authorities (weigh conflicting guidance), Document and communicate findings

5 Step Process for conducting tax research

•Dividends are taxable income to the shareholder of record on the date that the corporation records a dividend •Dividends on stock transferred by gift after the declaration date but before the record date are taxed to the donor

Dividends

$250,000 * 92.35% = $230,875 (SE tax base) $142,800 * 12.4% = $17,707.20 (SS tax) (uses capped tax base) $230,875 * 2.9% = $6,695.38 (Medicare tax) $230,875 - $200,000 = $30,875 $30,875 * 0.9% = $277.88 (Additional Medicare tax) Total SE taxes = $24,680.46

Ducky (single) is a self-employed computer programmer. In the current year, Ducky had net income from his business of $250,000. What amount of self-employment taxes and additional Medicare tax is Ducky required to pay on his business income?

Alimony paid (on divorces executed prior to 2019) Contributions to Health Savings Accounts Qualified moving expenses (suspended for tax years 2018 - 2025) Rental and royalty expenses One-half of self-employment taxes paid Business expenses and losses on dispositions of business assets Net capital losses (limited to $3,000 per year) Contributions to qualified retirement accounts Interest Expense on qualified educational loans

Examples of For AGI Deductions

•Duke $2,000 (Basic) + 1,600 (Additional) = $3,600 •Trixie $2,000 (Basic) + 1,000 (Additional) = $3,000 •Andy $2,000 (Basic) + 1,000 (Additional) = $3,000 •Total = $3,600 + 3,000 + 3,000 = $9,600

Jessie and Buzz are married and file a joint tax return. They have three children, Duke (age 2), Trixie (age 6) and Andy (age 9). Their AGI is $120,000. What is their child tax credit for 2021?

•Eligible expenses (tuition) for postsecondary education -Includes professional or graduate school -Includes continuing education •Applied per taxpayer -MFJ return is one taxpayer. •20% of up to $10,000 of eligible expenses •Phase-out based on AGI, Phase-out range: $80,000-$90,000 Single ($160,000-$180,000 MFJ)

Lifetime Learning Credit

Tax minimization

entirely focused on minimizing taxes. Regardless of non-tax costs!

•Taxed at ordinary income rates •Include: -Dividends from certain foreign corporations •Foreign corporations NOT traded on a U.S. market •Foreign corporations that are NOT eligible for benefits of a comprehensive income tax treaty between US and home country -Dividends from tax-exempt entities, -Dividends that do not satisfy the holding period requirement •Held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date

Non-Qualified Dividends

implicit taxes

this lowers BTROR

•Lavender's interest income = $1,000*5%*(60/365) = $8.22 •Alternative (practical) Answer = $1,000*5%*(2/12) = $8.33 From 2 months that have already occurred (Jan-Feb)

On March 1, Lavender sells a $1,000 bond with a stated annual interest rate of 5%.

•interest is taxable when earned (based on the effective interest method) rather than when received.

Original Issue Discount (OID)

•Taxes must be paid-as-you-go. -Employer Withholdings •Treated as made equally throughout the year -Estimated tax payments •Due on April 15, June 15, September 15, and January 15 of the following year •Underpayment Penalties •Late Filing Penalties •Late Payment Penalties

Prepayments

Cash: $32,000 cash received (which includes cash received for work done in 2020, 2021 and work yet to be done) Accrual: $32,000 - $1,500 - $4,000 + $8,000 = $34,500

•Cho is a professional photographer and operates as a sole proprietorship. During 2021, she received cash of $32,000 for photography services. Of the amount received in 2021, $1,500 relates to photo shoots during 2020 and $4,000 relates to payments to hold the dates for wedding photography to be performed in 2022. Cho also had accounts receivable of $8,000 for services provided in 2021. Compute Cho's Gross Income Under the Cash Method and Accrual Method

-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 0.9235). Same $142,800 limit applies to Social Security portion

Self-employed taxpayers

Morgan = $2,000 + $1,600 = $3,600 Chuck = $2,000 + $1,000 = $3,000 Total CTC = $6,600

The Woodcombs are married and file a joint tax return. They have two children, Morgan age 2 and Chuck age 6. Their AGI is $115,500.

10000 * .05 *(1-.24) = 380 10000 * .03 = 300 Corporate bond is better because you receive more after tax.

Velma has $10,000 invested in corporate bonds earning 5% interest which is taxed at her regular tax rate of 24%. She is considering switching this $10,000 to a municipal bond which is tax free but which earns only 3% interest.

$2,000*100% + $2,000*25% = $2,500 AGI is below phase-out

Wheezy is single and not claimed as a dependent by his parents. He works part-time (AGI of $28,000) and attends the University of Illinois full-time. He paid $8,000 of tuition expense. What is his American opportunity tax credit?

NO statute of limitations

__________________________ when a taxpayer fails to file a return or when a fraudulent return is filed.

Tax prepayments

also deducted directly from the total tax liability to determine the amount of tax due (or tax refund). Includes: Tax withheld from paychecks. Estimated tax payments. Taxes overpaid on a prior year tax return and not refunded.

3

Refund requests must generally be filed within ___ years of the date the return was filed.

Relationship, age, residence, support

Qualifying Child Tests

Interest income from municipal bonds, gain on sale of personal residence, life insurance proceeds, gifts and inheritances.

What are excluded from realized income

•For first four years of postsecondary education •For eligible expenses and institutions only •Applied per student -Taxpayer, spouse, taxpayer's dependents -Amounts paid by dependents treated as paid by taxpayer. •100% of first $2,000 of eligible expenses and 25% of next $2,000 (maximum credit is $2,500) •Phase-out based on AGI, Phase-out range: $80,000-$90,000 Single ($160,000-$180,000 MFJ) •40% of credit is refundable (subject to restrictions).

American Opportunity Tax Credit

-Items are included in gross income in the year they are earned •All events have occurred that determine or fix the right to receive the income •Amount determined with reasonable accuracy -Common for business taxpayers, including Schedule C businesses (sole proprietorships) -Required if income is earned from the sale of inventory -All Events requirement met on the earliest of the following: •When an individual (or business) completes the task required to earn the income (i.e. provide the services or title of the property passes). •When the payment for the task is due from the customer. •When the business receives the payment for the task.

Accrual Method of Computing Taxable Income

Additional $1,600 for each child under age 6 So max CTC = $2,000 + $1,600 = $3,600 Additional $1,000 for each child under age 18 So max CTC = $2,000 + $1,000 = $3,000 Haw lower AGI phase-out thresholds than Basic CTC Advance monthly payments for some taxpayers began in July 2021

Additional Child Tax Credit

•Additional $1,600 for each child under age 6 (cant be 6) -So max CTC = $2,000 + $1,600 = $3,600 •Additional $1,000 for each child under age 18 -So mac CTC = $2,000 + $1,000 = $3,000 •Has lower AGI phase-out thresholds than Basic CTC -$150,000 MFJ -$75,000 MFS -$112,500 Single, HOH •Phase-out reduced credit by $50 for every $1,000 of earnings (rounded up) •Advance monthly payments for some taxpayers began in July 2021

Additional Child Tax Credit

0.9% additional Medicare tax rate on salary or wages in excess of $200,000 ($125,000 for married filing separately; $250,000 married filing jointly)

Additional Medicare Tax

Must be younger than the T/P and either: < 19 at end of the year, or < 24 at end of the year and a full-time student (5+ months of year). Note: the age test does not apply to an individual that is disabled.

Age- Qualifying Child

Yes, because he received the full $100k, he has $100k of income.

Alternatively, what if Ginny pays Ron the entire $100k, but she files a lawsuit against Ron alleging breach of contract and seeks $20k in damages. Does Ron have income?

Income Taxed at Ordinary Rates $267,800 - 15,000 = $252,800 $47,843+35%*(252,800 - 209,425) = $63,024.25 Income Tax at Preferential Dividend Rates $15,000 $15,000*15% = $2,250 Total Tax Liability = $65,274.25

Assume that Gabby Gabby's taxable income is $267,800 including $15,000 of qualifying dividends. Gabby Gabby's filing status is Single. What is Gabby Gabby's tax liability?

Income Taxed at Ordinary Rates $450,000 - 15,000 = $435,000 $47,843+35%*(435,000-209,425) = $126,794.25 Income Taxed at Preferential Dividend Rates = $15,000 $445,850 - 435,000 = $10,850 $10,850*15% = $1,627.50 $15,000 - 10,850 = $4,150 $4,150*20% = $830 Total Tax Liability = $129,251.75

Assume that Slinky Dog's taxable income is $450,000 including $15,000 of qualifying dividends. Slinky's filing status is Single. What is Slinky's tax liability?

From AGI Deductions

Deductions from AGI to arrive at taxable income. Aka - "Below the line deductions" Itemized OR standard deduction Qualified Business Income Deduction (new starting in 2018) Charitable contribution deduction for taxpayers who do not itemize deductions [was for AGI in 2020] Personal and dependency exemptions (suspended for 2018-2025)

For AGI deductions

Deductions to arrive at AGI. Aka - "Above the line deductions". Typically deductions related to business or investment activities.

Tax Credit based on the # of qualifying children, under the age of 17 (under 18 in 2021 only) and a U.S. citizen. $2,000 per child $500 for other qualifying dependents Credit is phased-out for some levels of AGI.

Basic Child Tax Credit

•$2,000 per child tax credit based on the # of qualifying children, under the age of 17 (under 18 in 2021 only) and a U.S. citizen. •$500 for each other qualifying dependent •Phased-out when AGI reaches: -$400,000 MFJ -$200,000 MFS, Single, HOH •Phase-out reduced credit by $50 for every $1,000 of earnings (rounded up) •Generally partially refundable Can be fully refundable in 2021

Basic Child Tax Credit

Timing strategies, Income shifting strategies, Conversion strategies

Basic Tax Planning Strategies

Pre-tax income / Asset cost

Before Tax Rate of Return

Lesser of: Net investment income = $100,000 + 25,000 + 50,000 = $175,000; or MAGI in excess of $250,000 = $400,000 - 250,000 = $150,000 So, NIIT = $150,000*3.8% = $5,700

Bo Peep and Woody are married filing jointly and have MAGI of $400,000. Included in this is $100,000 of interest income, $25,000 of dividends, $50,000 of annuity payments and $80,000 of wages.

Lesser of: Net investment income = $2,000 + 500 = $2,500; or MAGI in excess of $250,000 = $400,000 - 250,000 = $150,000 So, NIIT = $2,500*3.8% = $95

Bo Peep and Woody are married filing jointly and have MAGI of $400,000. Included in this is $500 of interest income and $2,000 of annuity payments.

municipal bonds

Bonds issued by state and local governments

•Additional CTC Phase-out •AGI of $189,025 - 150,000 = 39,025 $39,025 / 1,000 = 39.025 = 40 (rounded up) •40 * $50 = $2,000 phased-out ACTC, so -The $1,600 Additional CTC is all phased-out -None of the Basic CTC is phased out Total CTC = $3,600 - 1,600 = $2,000

Jessie and Buzz are married and file a joint tax return. They have one child, Duke (age 2). Their AGI is $189,025.

A/R, inventory, and business assets

Capital Asset Excludes

Personal-use and investment assets.

Capital Asset Includes

-Items are included in gross income in the year that the cash is actually or constructively received -Constructive receipt occurs when the amount is readily available to the taxpayer and receipt is not subject to limitations or restrictions -Common for individual taxpayers and small businesses -Prohibited for many large businesses

Cash Method of Computing Taxable Income

Tax credit

Child & dependent care credit, earned income credit, lifetime learning credit.

•Dependent under age of 13 (or disabled) •Percentage qualifying expenditures based on AGI -Maximum qualifying expenditures: $3,000 one qualifying person, $6,000 for two or more qualifying persons -In 2021 only •Max for one QP = $8,000 •Max for two or more QPs = $16,000

Child or Dependent Care Credit

80000 + 85000 + 400 + 7500 = 172900

Chuck and Sarah are married and file a joint tax return. Chuck earns $80,000 as a financial planner, while Sarah earns $85,000 as an accountant. They received $400 of interest income from a money market fund and $250 of interest income from municipal bonds. They sold stock they had owned for six years at a $7,500 gain and they received a gift from Chuck's parents of $10,000. What is their gross income for the year?

•Amounts received are included in income, even if the amount is in dispute •If payment is not received, no income is recognized until the dispute is settled •Examples: Product liability lawsuit, contractor dispute

Claim of right doctrine

Excise Tax

Consumer tax on a specific kind of merchandise, such as tobacco. levied on the quantity purchased

-Combination of cash and accrual methods -Uses accrual method to account for inventory (when earned) -Uses cash method for other income and expenses (when received)

Hybrid Method of Computing Taxable Income

higher

If you are paying, you would rather pick the _____ PV because you save the _____ PV amount

lower

If you are receiving income, you would rather pick the _____ PV because you pay the _____ PV amount

•Imputed interest must be calculated on the following below market loans: -Gift loans (individual to individual) -Employer loans to employees -Corporate loans to shareholders Compounded semi-annually, using applicable federal interest rate

Imputed Interest

-No imputed interest on aggregate loans of $10,000 or less, that do not have a tax avoidance purpose (loans for personal needs) •Unless the loan is used to purchase income-producing assets -Imputed interested on gift loans of $100,000 or less cannot exceed the borrowers net investment income. Also, no imputed interest if net investment income is $1,000 or less

Imputed Interest Exceptions

Gross Income: 150,000 HSA (5000) IRA (5000) = AGI =140,000 Standard Deduction (24,800) = Taxable Income = 115,200 Tax deduction = 9,235 + 22%(115,200 - 80,250) = 16,924

In 2020 Mr. and Mrs. Brown report earned income of $150,000 (wages). The Brown's have three children under the age of 10 and file married filing jointly. The Browns's contributed $5,000 to an HSA and $5,000 to an IRA. Additionally, the Brown's have $19,500 of itemized deductions. What is their total tax liability for 2020?

Short Term Capital Gain

Included with ordinary income and taxed at ordinary tax rates.

The income of a partnership or S-corporation flows to the individual owners • Owners are taxed in the year the partnership earns income, regardless of distributions • Distributions can be taxable or tax-free depending on their nature

Income from a Flow-through Entity

-The amount is readily available -And is not subject to substantial limitations or restrictions

Income is constructively received when

exempt

Interest income earned on municipal bonds are __________ from federal income taxation

abandoned spouse

Is married at the end of the year (or is not legally separated from the other spouse). Does not file a joint tax return with the other spouse. Pays more than half the costs of maintaining his or her home for the entire year, and this home is the principal residence for the T/P's child (who qualifies as the T/P's dependent) for > ½ the year. Lived apart from the other spouse for the last 6 months of the year.

Must be married on the last day of the tax year. When one spouse dies during the year, the surviving spouse is considered married to the spouse who died unless the surviving spouse remarries during the year. Married couples filing jointly agree to share joint and several liability for the resulting tax.

Married filing jointly

If one spouse itemizes, the other spouse must also itemize. This filing option is usually chosen for non-tax reasons.

Married filing separately

Effective tax planning

Maximizing after-tax profit/after-tax wealth while achieving non-tax goals and considering both tax and non-tax costs and benefits

2.9% (1.45% employee/1.45% employer)

Medicare Tax

Net Capital Losses

Net capital losses generate a "For AGI Deduction" that is limited to $3,000 per year for individual T/Ps. Any net capital loss > $3,000 is carried forward (into future tax years). Capital losses on the sale of personal-use assets are NOT deductible on the individual's tax return.

3.8% tax imposed on lesser of: Net investment income (e.g., interest, dividends, annuities, royalties, rents, passive activity income, net gains from disposing of property, less related allowed deductions) or Excess of modified AGI over $250,000 (MFJ/SS), $125,000 (MFS), and $200,000 (all others).

Net investment income tax

•To minimize the double taxation of corporate dividends (income taxed at corporate level, dividends taxed when provided to shareholder), qualified dividends are taxed at preferential tax rates. •Generally dividends from U.S. Corporations are Qualified Dividends. However, "Non-qualified Dividends" are directly defined, dividends that are not "non-qualified" are Qualified Dividends.

Qualified Dividends

Relationship, support, gross income

Qualifying relative tests

T/Ps who have lost their spouses and have dependents can file as "surviving spouses" for up to two years after the end of the year in which the other spouse died. To qualify, the T/P must: Remain unmarried Pay over half of the cost of maintaining a household where a dependent blood-related or adopted child (or stepchild) lived for the entire year.

Qualifying widow

Deferrals

Realized income items that are included in taxable income in a subsequent year. Examples: Installment sales and like-kind exchanges.

Must be an eligible relative of the T/P. Eligible Relative = child, descendant of a child, sibling, or descendent of a sibling

Relationship- Qualifying Child

-Ron has $80K of income because the all events test is met (in two ways). -Ron does not have income on the remaining $20k because he has not received payment and the amount is in dispute.

Ron, who uses the accrual method for his building business, builds a home for Ginny for $100k. Ron completes the home and payment is due. However, Ginny only provides Ron with a partial payment of $80k because she believes that his work is of inferior quality. Does Ron have income?

10

Statute of limitations on collection of tax: the IRS has ___ years to collect a tax after it has been assessed.

A qualifying child must NOT have provided > ½ of their own support that year. Excludes scholarships if the student is a child, step-child, or eligible foster child of the T/P. Support includes: Food, toiletries, clothing, recreation, medical and dental, lodging, education, and wedding costs.

Support- Qualifying Child

Generally requires the T/P to pay more than half the qualifying relative's living expenses. Allows for "multiple support agreements" in certain circumstances.

Support- qualifying relative

Transfer Tax

Tax paid when title passes from one owner to another. Transfers of wealth by individual taxpayers.

Conversion Strategies

Tax rates can vary across activities. Income · Ordinary income (salaries, interest, and business income). · Capital gains and dividends. · Tax-exempt income (interest income from municipal bonds and non-taxable compensation benefits). Expense · Business expense. · Investment expense. · Personal expense. So taxpayer converts one type of income into another type OR one type of expense into another type. Tax law limits certain conversions (beyond scope of this lecture).

Income Shifting Strategies

Tax rates can vary across taxpayers and across tax jurisdictions (ex: countries, states) Shift income from a high-tax rate to a low tax rate taxpayer (to reduce tax liabilities) Shift deduction from a low tax rate to a high tax rate taxpayer (to increase value of tax deductions) These strategies are typically used by: Related parties (ex: family members and affiliated companies) Taxpayers operating in multiple tax jurisdictions

Timing Strategies

Time value of money $1 today is worth more than $1 in the future and $1 in the future is worth less than $1 today The timing of the case inflow to outflow affects the present value of the income or expense

Realized income

generated in a transaction with a second party in which there is a measurable change in property rights between the parties. Examples: Compensation, business income, rents and royalties, interest & dividends.

-This is a gift loan because it is individual to individual -$80,000*.04*1/2 = $1,600 -$81,600*.04*1/2 = $1,632 -$3,232 is less than Hermione's $5,200 of investment income •For gift loans < $100k, the imputed interest can't exceed the borrower's net investment income

•On January 1, Hermione's father loaned her $80,000 to purchase a new car and to pay off college loans. The relevant Federal rate on interest was 4 percent. The loan was outstanding for the entire year. And Hermione had $5,200 of investment income. What is the imputed interest that Hermione's father must recognize?

-Constructively received in December

•You receive a check from your client in December but don't deposit it into your bank account until January?

-Not constructively received until January

•Your client gives you a check but asks that you not cash it until January 2nd, if cashed early it will bounce.